2nd PUC Economics Question Bank Chapter 5 The Theory Of The Firm And Perfect Competition

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Karnataka 2nd PUC Economics Question Bank Chapter 5 Theory of The Firm And Perfect Competition

2nd PUC Economics The Theory Of The Firm And Perfect Competition One Mark Questions and Answers

Question 1.
Write the meaning of market.
Answer:
Generally, the term market is a market place where goods are sold and bought. But in Economics, by market we mean a commodity whose buyers and sellers are in direct contact with one another. According to Prof.J.C.Edwards “A market is that mechanism by which buyers and sellers are brought together”.

Question 2.
Who is a price taker?
Answer:
Each firm is a price taker in a perfect competitive market.

Question 3.
What is revenue?
Answer:
Revenue refers to the money income received by a firm or producer or seller after the sale of commodities.

Question 4.
How do you calculate the Average Revenue?
Answer:
The Average Revenue can be obtained by dividing the Total Revenue by the number of units sold i.e., AR = TR/Q

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Question 5.
What is supply?
Answer:
The supply in economics refers to the quantity of a product which the sellers or producers offer for sale at a particular level of price and particular period of time.

Question 6.
How do you calculate Price Elasticity of Supply?
Answer:
To calculate Price Elasticity of Supply, the following formula is used

2nd PUC Economics Question Bank Chapter 5 The Theory Of The Firm And Perfect Competition 1

where ∆q is change in quantities supplied, ∆p is change in price, ‘p’ is original price and ‘q’ is original quantity.

Question 7.
MR = TR – ?
Answer:
MR = TRn – TRn-1

Question 8.
What is Price mechanism?
Answer:
The process of determination of price of goods and services through market forces viz., demand and supply is called ‘Price Mechanism’.

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Question 9.
Give the meaning of equilibrium.
Answer:
Equilibrium refers to a position of rest. It is a position from which the producer or a firm has no tendency to move or change.

Question 10.
What is equilibrium Price?
Answer:
The equilibrium price is that level of price which is determined at the point where the demand and supply intersect (i.e., when supply and demand become equal).

Question 11.
What do you mean by Marginal Revenue?
Answer:
Marginal Revenue is the additional revenue received by the producer from the sale of additional unit of output.

Question 12.
What is Elasticity of supply?
Answer:
A proportionate change in quantities supplied in response to a proportionate change in price is called Elasticity of Supply.

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2nd PUC Economics The Theory Of The Firm And Perfect Competition Two Marks Questions and Answers

Question 1.
Write the differences between firm and industry.
Answer:

Firm

Industry

  1. Firm refers to a single individual unit of business inside an industry.
  2. It operates within an industry.
  3. There will be existence of one firm.
  4. No separate rules and regulations for a firm.
  1. Industry refers to a group of firms doing the same business.
  2. Operates within an economy
  3. There can be many firms in an industry
  4. Rules and regulations are made specifically for a particular industry.

Question 2.
State the essentials of a market.
Answer:
There are four essential requirements for existence of a market, they are as follows;

  • Existence of goods and services.
  • Existence of buyers and sellers.
  • Existence of Price
  • A place – region, a country or means of exchange – internet/telephone.

Question 3.
List the determinant elements of a market structure.
Answer:

  • Existence of a number of firms to produce a product offering a degree of competition.
  • Nature of commodities as to homegeneous or heterogeneous.
  • Freedom of entry and exit from the industry.

Question 4.
A firm in a Perfect competitive market is a price-taker. Why?
Answer:
In a perfect competitive market, each firm is a price taker as no single firm can influence the price level. The firms do not have any power over the market. The firm has to accept the existing price and sell its goods or services.

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Question 5.
What do you mean by shut down point?
Answer:
The shut down point is that point where short run Marginal Cost curve cuts Average Variable Cost curve at the minimum. A firm will continue to produce goods as long as the price, is more than or equal to the minimum of Average Variable Cost.

Question 6.
What is normal profit?
Answer:
The normal profit is that level of profit which is just enough to cover the explicit costs and Opportunity costs of die firm. Here, the revenue of the firm is just sufficient to cover all its cost of production.

Question 7.
When does a firm reach the break even point?
Answer:
A firm reaches its Break Even Point when its Total Revenue is equal to its Total Cost. At this point, the firm is just willing to stay in the industry. Here, we do not see any attractions for new firms to enter the industry and the existing firms also do not undertake any expansion.

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Question 8.
State any four determinants of supply.
Answer:

  • Techniques of production,
  • Cost of production,
  • Government policy on tax, subsidies etc,
  • Objectives of the firm and
  • Climatic conditions.

Question 9.
State the law of supply.
Answer:
The law of supply states that “Other things remaining Same, a fall in price leads to fall in quantities supplied and rise in price leads to expansion in quantities supplied”.

Question 10.
If the price of potato increases from Rs.20 per kg. to Rs.25 per kg., the quantity offered for sale in the market increases from 100 kg to 120 kg. Find the price elasticity of supply.

2nd PUC Economics Question Bank Chapter 5 The Theory Of The Firm And Perfect Competition 2

∆p = 25 – 20 = 5, ∆q = 120- 100 = 20, p = 20, q=100,

2nd PUC Economics Question Bank Chapter 5 The Theory Of The Firm And Perfect Competition 3

Question 11.
What is invisible hand according to Adam Smith?
Answer:
The process of determination of price by the market forces demand and supply is called price mechanism and same is called as invisible hand by Adam Smith. According to Adam Smith, ‘invisible hand’ is always at work, it guides and directs both the producers and consumers towards equilibrium.

Question 12.
What is supply function?
Answer:
The relationship between the quantities supplied and the determinants of supply is called supply function. It may be written as follows:
S = f(x1, x2, x3………..xn)  or S = f(P, T, Gp, Fc……..) where S is quantities supplied, P is price, T is technology, Gp is Government policy, Fc is cost of factors of production.
Generally Supply Function is S = f(p).

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2nd PUC Economics The Theory Of The Firm And Perfect Competition Five Marks Questions and Answers

Question 1.
AR and MR curves of a firm in perfect competition take the shape of a horizontal line. Explain this with a diagram.
Answer:
(i)Average Revenue: It refers to the revenue per unit of output sold. It is obtained by dividing the total revenue by the number of units of output sold.

Under perfect competition, the AR will be equal to the market price. This is because, in perfect competitive market, the seller sells his product at the same price which is prevailing in the market. If the seller sells at low price, he incurs losses or if he increases the price, he loses customers.

(ii)Marginal Revenue: The Marginal Revenue is the additional revenue which the firm earns from the sale of additional unit of output. It is obtained as MR = TRn – TRn-1

Under perfect competition, the price remains same and all the firms sell their products at the existing price. As the price remains same, if the number of units sold is increased, no doubt the Total Revenue increases but AR and MR remain the same. So, the firm’s demand curve, average revenue curve and its marginal revenue curve all coincide with the same horizontal line. This is shown in the diagram given below:

2nd PUC Economics Question Bank Chapter 5 The Theory Of The Firm And Perfect Competition 4

In the diagram, TR curve increases with the increase in quantities sold. The Price is equal to AR and MR as represented by the horizontal line parallel to ‘x’ axis. In this market, price does, not change, therefore, there will be no change in AR and MR. Thus, in a perfect market, demand curve, AR and MR curves coincide with the same horizontal line.

Question 2.
Explain the Average and Marginal Revenue of a firm.
Answer:
(i)Average Revenue: It refers to the revenue per unit of output sold. It is obtained by dividing the total revenue by the number of units of output sold.

So, AR = TR/Q where, AR is Average Revenue, TR is Total Revenue and Q is quantities sold. Under perfect competition, the AR will be equal to the market price. This is because, in perfect competitive market, the seller sells his product at the same price which is prevailing in the market. If the seller sells at a lower price, he incurs losses or if he increases the price, he may lose his customers.

The AR curve of a firm is also the demand curve of the customers, because the price paid by the consumer for each unit is the average revenue from the seller’s point of view.

(ii)Marginal Revenue: The Marginal Revenue is the additional revenue’ which the firm earns from the sale of additional units of output. It is obtained as MR = TRn – TRn-1 The Marginal Revenue is the change in a firm’s total revenue resulting from the sale of an extra unit of output.
The MR is also calculated with the help of following formula

2nd PUC Economics Question Bank Chapter 5 The Theory Of The Firm And Perfect Competition 5

Under perfect competition, the price remains same and all the firms sell their products at the existing price. As the price remains same, if the number of units sold gets increased, no doubt the Total Revenue increases but AR and MR remain the same. So, the firm’s demand curve, average revenue curve and its marginal revenue curve all coincide in the same horizontal line.

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Question 3.
With the help of a diagram, explain Total Revenue, Average Revenue and Marginal Revenue curves of a perfect competitive market.
Answer:
(i)Total Revenue: The total revenue is the aggregate revenue received by the seller from the sale of the entire output. It is obtained by multiplying the units sold with the price of the product. It may be stated as follows:
TR = p x q where, p is price and q is quantity sold.

(ii)Average Revenue: It refers to the revenue per unit of output sold. It is obtained by dividing the total revenue by the number of units of output sold.

Under perfect competition, AR will be equal to the market price. This is because, in perfect competitive market, the seller sells his product at the same price which is prevailing in the market. If the seller sells at low price, he incurs losses or if he increases the price, he loses customers.)

(iii)Marginal Revenue: The Marginal Revenue is the additional revenue which the firm earns from the sale of additional unit of output. It is obtained as MR = TRn – TRn-1

Under perfect competition, the price remains same and all the firms sell their products at the existing price. As the price remains same, if the number of units sold gets increased, no doubt the Total Revenue increases but the AR and MR remain the same. So, the firm’s demand curve, average revenue curve and its marginal revenue curve all coincide in the same horizontal line. This can be shown in diagram given below:

2nd PUC Economics Question Bank Chapter 5 The Theory Of The Firm And Perfect Competition 6

In the diagram, TR curve increases with the increase in quantities sold. The Price is equal to AR and MR represented as horizontal line parallel to ‘x’ axis. In this market, price does not change, therefore, there will be no change in AR and MR. Thus, in perfect market, demand curve, AR and MR curves coincide in the same horizontal line.

Question 4.
Derive the long run supply curve of a firm.
Answer:
The long run supply curve is that part of the long run Marginal Cost curve which rises from the minimum point of the long run Average Cost curve. The long run Supply curve can be shown in the following diagram.

2nd PUC Economics Question Bank Chapter 5 The Theory Of The Firm And Perfect Competition 7

In the above diagram, the quantity supplied is measured along ‘X’ axis and price is measured along ‘Y’ axis. The firm is in equilibrium at point E, as the price is equal to the long run Marginal Cost. The firm produces output of OQ1. If the price rises to P2, the long run Marginal Cost intersects at point E2 which makes the firm to increase its supply from OQ1 to OQ2. Thus, when the price rises, quantity supplied gets expanded.

Similarly, when the price falls from OP1 to OP0, the firm stops production as it is below its equilibrium or shut down point. So, the long run supply curve of a firm can be stated as that part of the curve which begins at the minimum point of LRAC and rises above the Long Run Marginal Cost curve. The long run Supply curve is from the point E1 towards E2 and so on.

Question 5.
Explain the law of supply with the help of a schedule and diagram.
Answer:
The law of supply states that the rise in price leads to a rise in supply and a fall in price leads to a fall in quantities supplied, by keeping other things constant. There is a direct proportionate relationship between price and quantities demanded. So, the supply curve slopes upwards from left to right.

(i)Supply Schedule: A supply schedule is a statement which consists of quantities supplied at different levels of price. Supply curve slopes upwards and can be represented by the linear equation QS = a + bp, where QS is quantity supplied, ‘a’ and ‘b’ are constants, ‘p’ is price. If a =10 and b = 2 then the linear supply function when p is 1, 2, 3, 4 and 5, the same may be represented as follows:

QS=10+2p then we get the supply schedule as follows:

QS=10+2p

Price Quantity supplied

10+2(1)= 12

1 12

10+2(2)= 14

2 14
10+2(3) = 16 3

16

10+2(4)= 18 4

18

10+2(5) = 20 5

20

Supply Curve:
Supply Curve is a graphical representation of supply schedule. The supply curve slopes upwards from left to right to indicate that there is direct proportionate relationship between price and quantities supplied. The supply curve can be shown as follows:

2nd PUC Economics Question Bank Chapter 5 The Theory Of The Firm And Perfect Competition 8

In the above diagram, quantity supplied is measured along ‘X’ axis and price is measured along ‘Y’ axis. The SS curve indicates the supply curve. This shows that there is a positive relationship between price level and quantity supplied.

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2nd PUC Economics The Theory Of The Firm And Perfect Competition Ten Marks Questions and Answers

Question 1.
Explain how the short run and the long run supply curve of a firm is derived under perfect competition.
Answer:
(i)Short run supply curve: In a perfect competitive market, the short run supply curve is that part of its Marginal cost curve where the Marginal Cost curve is rising from the Average Variable Cost curve. As the firm is a price taker, the supply curve has the same shape as that of Marginal cost curve above AVC (Average Variable Cost). This can be represented in the following diagram:

2nd PUC Economics Question Bank Chapter 5 The Theory Of The Firm And Perfect Competition 9

in the above diagram, quantity supplied is measured along ‘X’ axis and price is measured along ‘Y’ axis. The firm is in equilibrium at point E, where MR = MC. At point E1, the price P1 is equal to the AVC. This is also called as shut down point. If a firm produces beyond this point, the price will be less than the Average Variable Cost and it may incur losses. The three conditions in short run equilibrium may be expressed as P = SMC (Short run Marginal Cost), SMC is decreasing and P e” SAVC (Short run Average Variable Cost)

When the price increases from P1 to P2, the quantity supplied increases from Q1 to Q2 and the price line i.e., Average Revenue curve and SMC curve intersect at point E2. At this point, the P2 is equilibrium price which is also the Average Revenue and Q2 quantity of supply. Thus, it is evident from the diagram that when price rises the quantity supplied also rises and vice versa.

The relationship between price and quantity supplied in short run can be shown in the following diagram:

2nd PUC Economics Question Bank Chapter 5 The Theory Of The Firm And Perfect Competition 10

In the above diagram, quantity supplied is measured along ‘X’ axis and price is measured along ‘Y’ axis. When the price is increased from P1 to P2, the quantity also increased from Q1 to Q2. Similarly, when the Price falls from P3 to P2, the quantity supplied also falls from Q3 to Q2. Thus, there is a direct relationship between price and quantity supplied.

(ii)Long run supply curve of a firm :
Under Perfect competition, the long run supply curve is that part of the long run Marginal Cost curve which rises from the minimum point of the long run Average Cost curve. The long run Supply curve can be shown in the following diagram.

2nd PUC Economics Question Bank Chapter 5 The Theory Of The Firm And Perfect Competition 11

In the above diagram, the quantity supplied is measured along ‘X’ axis and price is measured along ‘Y’ axis. The firm is in equilibrium at point E1 as the price is equal to long run Marginal Cost. The firm produces output of OQ1. If the price rises to P2, the long Run Marginal Cost intersects at point E2 which the firm to increase its supply from Q1 to Q2. Thus, when the price rises, quantity supplied gets expanded.

Similarly, when the price falls from OP1 to OP0, the firm stops production as it is below its equilibrium or shut down point. So, the long run supply curve of a firm can be stated as that part of the curve which begins at the minimum point of LRAC and rises above the Long Run Marginal Cost curve. The long run Supply curve is from the point E1 towards E2 and so on.

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Question 2.
What is invisible hand? Show how the invisible hand guides the producers and the consumers towards equilibrium in a perfect competition.
Answer:
The process of determination of price by supply and demand forces is called Price mechanism and the same has been called as ‘invisible hand’ by Prof.Adam Smith. Prof. Adam Smith has introduced the concept of ‘Invisible hand’ which is responsible for equilibrium of a firm in perfect competition.

Perfect competitive market is that market where we can see large number of sellers and buyers dealing with homogenous goods. Every firm is a price taker as it cannot influence the price in the market.

Equilibrium in a Perfect Competitive Market:
Equilibrium is a position from which there will not be a tendency to move or change in any direction. At equilibrium price, the quantity demanded and supplied would be equal. According to Alfred Marshall, both supply and demand are equally important in determining the price of a product. Marshall has compared the supply and demand to the two blades of a scissors. Neither the upper blade nor the lower blade alone cuts the paper but both are required to do the task of cutting a paper. So, both supply and demand play an important role in determining price.

The equilibrium in a perfect market is determined by the market demand and market supply. Market demand is the aggregate demand arid market supply is the aggregate supply. The market demand curve slopes downwards from left to right and the market supply curve slopes upwards. The point of intersection between the demand and supply curve determines the equilibrium price. This can be illustrated with the help of the following table.

Price of Rice (Rs.) Quantity

Demanded (tonnes)

Quantity Supplied (Tonnes)

 1000

100 10

2000

90 30

3000

70 70
4000 60

90

5000 50

100

In the above table, it is shown that the price of rice per quintal is Rs.1000 and the quantity demanded is equal to 100 tonnes and the supply is 10 tonnes. When the price increases to Rs.2000, the demand becomes 90 tonnes and supply increases to 30 tonnes. When the price reaches Rs.3000, the quantity supplied and demanded are the same. Therefore, Rs.3000 is the equilibrium price and 70 tonnes rice is equilibrium quantity. This can be represented in the following diagram.

2nd PUC Economics Question Bank Chapter 5 The Theory Of The Firm And Perfect Competition 12

In the above diagram, quantity is measured along ‘X’ axis and price is measured along ‘Y’ axis. OP is the original price and OQ is the original quantity. When the price is increased to OP2, the quantities demanded will be P2N and supplied will be P2M. Here, the quantity supplied is, greater than the quantity demanded. This excess supply leads to reduction of price to original level. When price falls from OP to OP1, the quantity demanded will be P1L and quantity supplied wiill be P1K. Here, the quantity demanded is more than the quantity supplied. This excess demand makes the price to rise to the original price level.
Thus the equilibrium of price is attained at point E where the Aggregate Demand is equal to aggregate supply.

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Question 3.
What is Perfect Competition? Explain the features of a perfectly competitive market.
Answer:
Perfect competition is a market where there will be existence of large number of buyers and sellers dealing with homogenous products. It is a market with the highest level of competition.

i) Large number of sellers: The first condition which a perfectly competitive market must satisfy is concerned with the sellers’ side of the market. The market must have such a large number of sellers that no one seller is a dominate in the market. No single firm can influence the price of the commodity sellers will be the firms producing the product for sale in the market. These firms must be all relatively small as compared to the market as a whole. Their individual outputs should be just a fraction of the total output in the market.

ii) Large number of buyers: There must be such a large number of buyers that no one buyer is able to influence the market price in any way. Each buyer should purchase just a fraction of the market supplies. Further, the buyers should not have any kind of union or association so that they compete for the market demand on an individual basis.

iii) Homogeneous products: Another prerequisite of perfect competition is that all the firms or sellers must sell completely identical or homogeneous goods. Their products must be considered to be identical by all the buyers in the market. There should not be any differentiation of products by sellers by way of quality, colour, design, packing or other selling conditions of the product.

iv) Free Entry and Free exit for firms: Under perfect competition, there is absolutely no restriction on entry of new firms into the industry or the exit of the firms from the industry when they want to leave. This condition must be satisfied especially for the long period equilibrium of the industry.

If these four conditions are satisfied, the market is said to be purely competitive. In other words, a market characterized by the presence of these four features is called purely competitive. For a market to be perfect, some conditions of perfection of the market must also be fulfilled.

v) Perfect mobility: Another feature of perfect competition is that goods and services as well as resources are perfectly mobile between firms. Factors of production can freely move from one occupation to another and from one place to another. There should be no barrier on their movement. No one can have monopoly or control over the factors of production. Goods can be sold at a place where their prices are the highest. There should not be any kind of limitation on the mobility of resources.

vi) Absence of transport cost: For the existence of perfect competition, the transport costs should not be considered. All the firms have equal access to the market. Price of the product is not affected by the cost of transportation of goods.

vii) Single Price: The market price charged by different sellers does not differ due to location of different sellers in the market. No seller is near or distant to any group of buyers.

viii) Price Taker: The firms in the perfect competitive market are price takers. That means, the producers will continue to sell their goods and services in the price existing in the market. Firms have no control over the price of the product.

ix) Absence of selling cost: Under conditions of perfect competition, there is no need of selling costs. Selling costs are the expenditures done to stimulate the sale of product or to change the shape of the demand curve. We know that under perfect competition, goods are completely homogeneous. When they cannot change the price and when their goods and completely similar, firms need not make any expenditure on publicity and advertisement.

x) Normal Profit: The firms in perfect competition will be earning normal profit. The normal profit is that profit which is just sufficient to stay in the market.

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