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Q1. Explain the loanable funds theory with the help of table and diagram.Ans: The neo classical or loanable funds theory explains the determination of interest raete in terms of demand and supply of loanable funds or credit.This theory was given by Wicksell and it was further elaborated by Ohlin, Ro...

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Q1. Explain the loanable funds theory with the help of table and diagram. Ans: The neo classical or loanable funds theory explains the determination of interest raete in terms of demand and supply of loanable funds or credit. This theory was given by Wicksell and it was further elaborated by Ohlin, Robertson, Pigiu and other new classical economists. Statement: According to this theory, the rate of interest is the price of credit which is determined by the demand and supply for loanable funds.

Demand for Loanable Funds: The demand for loanable funds has primarirly 3 sourecs: 1.Government: The Government borrows funds for constructing public works or for war preparations’. 2. Businessmen: The businessmen borrow for the purchase of capital goods and for starting investment projects. Such investments are interest elastic (means lower the interest more shall be the demand for such funds) and it depends on the rate of profit as compared to the rate of interest. 3. Household: Even the household people shall demand funds mainly for purchasing the consumer durables like scooters, houses,etc. Individual borrowings are also interest elastic means that the individuals will borrow more funds at lower rate of interest.

The determination of the interest rate of demand and supply for loanable funds or credit can be explained with the help of the following diagram:

In the above diagram on the OX axis we have loanable funds. On the OY axis we have interest rate

Demand for Loanable Funds: In the diagram, the demand for loanable funds can be shown with the following curves: Investment(I): The demand for investment of funds by both the government and the businessmen is shown with ‘I’. It is sloping downwards reflecting the fact that more funds are borrowed at lower interest rate and less funds are borrowed at higher interest rate by both the government and the businessmen for the purpose of investment. Dissavings(DS): Households tend to buy consumer durables through their past savings which is also called Dissavings. It is represented by curve DS. Curve DS is also sloping downwards reflecting that at higher interest people would not want to consume their savings but at a lower returns for their savings they would not mind spending their savings on the consumer durables. Hoarding(H): Lastly the funds are demanded for the purpose of hoarding by the households. Hoarding means that the funds are kept in form of idle cash. They

are also interest elastic. It means that at a lower interest rate people tend to hoard more...however at a higher interest rate people would tend to hoard less. The lateral summation of these curves , H, DS, and I gives us the aggregate demand curve for the loanable funds that is ΣD( that is aggregate demand) SUPPLY OF LOANABLE FUNDS The supply of loanable funds comes from three sources: 1.Savings: Private savings, individual and corporate are the main source of savings. Though personal savings are interest elastic, assuming the income level to be constant they are regarded as interest elastic. The higher the interest rate greater shall be the inducement for savings and vice versa. Corporate savings are the undistributed profits of a firm which also depend on the current rate of interest to some extent. If the interest rate is high it shall act as a deterrent to the borrowing and thus encourage savings. Savings is indicated by curve S in the diagram. 2.Dishoardings: The second source of supply of funds in Dishoardings. Dishoardings represent purchase of old assets or securities from idle cash balances. The higher the rate of interest, the larger the funds that shall be coming out of the hoards. These funds are represented by the curve DH. 3.Bank Credit(BM): lastly bank credit is an important source of loanable funds. It is also interest elastic. Higher the interest rate more shall be the loans that the banks shall be willing to give and voice versa..It is represented by the curve DH. If these curves DH, BM and S are laterally added up, we have the aggregate supply curve for the loanable funds that is ΣS( that is aggregate supply) Its determination: When the total demand curve for loanable funds ΣD is equal to the ΣS. The point at which the aggregate demand is equal to the aggregate supply curve, that is the point in which equilibrium is determined.

Criticisms: 1. Equilibrium rate reflects unstable equilibrium: The demand and supply for loanable funds determine the equilibrium rate OR. However this equilibrium rate is unstable as the planned investment is not equal to planned savings. 2. Indeterminate Theory: The supply of loanable funds consists of savings. This savings shall depend on the income. However if we do not knoiw the level of income we cannot predict the savings. Hence this theory is indeterminate. 3. Cash Balance not elastic: The theory suggests that the funds in the economy can be increased by releasing the cash balances . However, in reality it is just transfer of funds and not increase of funds. 4. Savings interest elastic: The theory over emphasis the influence of rate of interest on savings. It regards savings as interest elastic. Generally, people save to fulfil their precautionary motive and not just merely because of rate of interest. 5. Wrong to combine real and monetary factors: The loanable funds theory combines real factors like saving and investment with monetary factors like bank credit and dishoarding without taking into account changes in the level of income. Conclusion: Despite its limitations, the loanable funds theory is a great improvement over the classical theory for determining interest.

Q2.Explain the theory of Marginal Productivity Theory of distribution with the help of diagram. Ans: The Marginal Productivity theory states that the demand for a factor depends on its marginal revenue productivity (MRP). MRP is the addition made to total revenue by employing one more unit of variable factor, while other factors remain constant. Assumptions of the theory The Marginal Productivity Theory is based on the following assumptions: 1. It assumes that all the units of factors of production are homogeneous. 2. They can be substituted for each other. 3. There is perfect mobility of factors as between different places and employments. 4. There is perfect competition in factor market. 5. There is perfect competition in product market. 6. There is full employment of factors and resources. 7. The various factors units of different factors are divisible. 8. One factor is variable while other factors of production remain constant. 9.Techniques of production are given and constant. 10. The entrepreneurs are motivated by the objective of profit maximistaion. 11. This theory is applicable in the long run. 12.It is based on law of variable proportions Explanation: Given these assumptions, the theory can be explained with the help of the following diagram:

First we shall explain the determination of price of a factor in an industry in terms of demand and supply. In panel A, we observe that the point at which the demand curve intersects the supply curve S , \we have the equilibrium price OP and equilibrium quantity OQ. Thus, all the factors say, labour in the industry are paid the same wages that is OP. This being the perfect competition, the firm shall pay the same price to the factor of production which is being paid by the industry. Thus the supply of labour for the firm shall be perfectly elastic that means a horizontal line. Thus for the firm AFC=MFC which is represented in panel B. AFC and MFC are the average factor cost and marginal fixed cost for the firm at which the employs are employed. The number of factors that the firm shall employ shall depend on its demand for the factors of production.. For equilibrium it is essential that the price which the firm pays to the factor of production must equal to its MRP, ARP and MFC, That is the price of the factor unit=AFC=MFC=MRP=ARP. This is shown in panel B where E is the equilibrium point for the firm where ARP=MRP=MFC=AFC and it pays OP price for OQ units of the factor of production. Case 1: Suppose the price rises toOP1: When the price rises to OP1, at this price the firm shall start incurring losses of AB per unit, as the price Q1A paid to factor units is greater than Q1B, their Average Revenue Product(ARP) . This will induce some firms to leave the industry, As a result, the supply of factors will increase by ds, as in Panel A, and the factor price will fall again to OP where equilibrium will re-established at point E in both Panel A and Panel B. Case 2 Suppose the factor price falls to OP2

When the factor price falls to OP2, firms will be earning DC unit of profit because the price Q2D being paid to the factor unit is less than Q2C , their ARP. Attracted by the profit some firms shall enter the industry. This shall raise the factor demand by s1d1 in the industry and the price will again increase to OP. These price changes are only possible in the short run. In the long run, equilibrium will stay on at point E, where OP=ARP=MRP=MFC=AFC. Criticisms: 1.Units of factors of production are not homogeneous for instance one piece of land shall differ to another in terms of fertility. 2. Factors are not perfectly mobile: In reality factors are mostly immobile especially labour. 3. No perfect Competition: Perfect competition does not exist in the real world. 4.Factors are not fully employed :According to Keynes it is not full employment but it is the underemployment which actually does exist in the real world. 5. All factors are not divisible: It is not possible in the real world. For instance how can an entrepreneur of a firm increased or decreased by small units in the real world. 6. Production not the result of one factor: According to Taussig production cannot be attributed to one factor, it is always the result of combination of factors. 7. Profit not the main motive: Profit need not be the sole motive behind entrepreneur, for instance government enterprises value social welfare above profit maximisation. 8. Not Applicable in the short run: This theory is only applicable in the long run. Moreover according to Keynes, “In the long run we are all dead”. Conclusion: Despite the limitations, this theory helps us to understand what and all factors a firm needs to consider while paying salary to their factors of production in the long run so as to maximise their profit.

Q3. Briefly explain money and real wages and also the factors determining the real wages. Ans: Money wages or nominal wages relate to the amount of money received by workers for their services in production. Real wages include various facilities, benefits and comforts which workers recieve in terms of goods and services for their work. These are in addition to money wages of the workers. Real wages depend on the following factors: 1. Price Level:The purchasing power of the money depends on the price level. When the price level rises. The purchasing power of money gets reduced, thus adversely affecting the real wages of the workers. Every increase in the price level reduces the purchasing power of money, This leads to fall in real wages of workers. 2. Money wages: The size of pay packet received by the worker is an important determinant of his real wages. The greater the money wages, the greater will be the money wages, the greater will be the real wages, other things remaining the same. 3. Regularity of work: A permanent job , even though it carries a smaller money income, is considered better than a permanent job which may yield high rewards in terms of money. 4. Nature of work: The nature of work also plays an important role in determining the level of real wages. Some jobs are pleasant while others are not. Similarly some occupations are enjoyable while others are disagreeable. All this should be weighed while estimating the real wages. 5. Future Prospects: An occupation carrying the promise of better prospects of promotion in the future is considered to be better thanthe one which does not do so, even though the money wages offered by the latter may be higher. 6. Extra benefits: In some occupations employees receive in addition to their pay, some extra benefits. Forexample themanagerof the firm gets in addition to his pay , a well furnished bunglaw, free medical help etc. Such benefits increase the real wage of the worker.

7. Trade Expenses: This refers to the expenses one has to incur in the course of one’s occupation. These expenses are high in some occupations while in others in may be moderate. Theseexpenses must be deducted from the money income in order to arrive at real wage. 8. Social Prestige: The real wages of employees engaged in prestigious occupations are high compared to thereal wages of the employees working in ordinary occupations. 9. Form Of Payment:Real wages are influenced by the form of payment. Generally the workers are paid money wages. But in certain occupations, in addition to money wages, workers receive subsidised ration or free lunch, and living quarters. All these in effect increase the real wages of the workers. 10. Conditions of Work: Condition of work also affect the real wages. In some cases it is found that conditions of work are not congenial and they do adversely affect the health condition of workers. In such cases the real wages of the workers are low. Conclusion: Thus these are the differences between real wages and nominal wages and the factors determining real wages.

Q4. Write a short note on minimum wages. Ans: Minimum wage is that wage provides not only for the bare sustenance of of but also for the preservation of the efficiency of the worker. It is the minimum that must be paid to the worker to cover his and his family’s bare necessities, including some measure of education, medical and other amenities. Benefits of minimum wages: The following are the benefits from the fixation of minimum wages for workers: 1. Increase in National Income: Fixing minimum wages shall definitely help in increase in National income. To begin with when national income increases what we observe is there shall be increase in the demand of consumer goods, which shall increase the investment which shall indirectly propel the national income. 2. For Industry: Minimum wages prove beneficial for both he industries and the workers. Workers are benefitted in the sense better wages in the form of minimum wages shall definitely improve the standard of living of workers. Industries when forced to pay better wages, shall try to implement better technologies there by removing inefficiencies. 3. Industrial Peace: Minimum wages, if related to cost of living, as in the case of advanced countries, workers shall be happy. This shall ensure industrial peace in the economy. 4. Remove Exploitation: Minimum wages shall ensure to remove exploitation by employers among workers. The workers with minimum wages assured will be able to sustain themselves. 5. Profit Squeeze: In Industries where the demand for workers in inelastic, it is not possible for the employers to turn out the workers when minimum wages are fixed. Although it leads to reduction of profits, on the other hand it shall definitely help in reducing income inequalities among rich and poor.

6. Price Rise: In the above situation when the employers are not planning to cut down profits then, the burden of minimum wages may be shifted on consumers which shall result in mild inflation. This mild inflation is good to the extent that it shall incentivize the production to sustain due to no reduction in profits. 7. Equitable Distribution: In advanced countries where the unemployed are covered by unemployment relief, the workers shall indirectly benefit from the imposition of minimum wages. When they become unemployed, they shall receive unemployment relief from the government. The money for this comes from taxing the relatively rich. This leads to more equitable distribution of wealth. Conclusion: Thus these are the benefits of minimum wages.

Q5. Explain the Ricardian Theory of Rent. Ans: Ricardo defines rent as” that portion of the produce of the earth which is paid to the landlord for the use of the original and indestructible powers of soil” Ricardian Theory of Rent helps us to determine how rent for the land is determined in the long run. Assumptions: 1. 2. 3. 4. 5. 6. 7. 8.

There is perfect competition in the economy. The supply of land is limited. The law of diminishing returns apply. Rent accrues from land alone. Rent arises in the long run Land and capital are single factors. Rent is price determined. Land is cultivated in historical sequence, i.e., first the best land, then the less fertile land that is in this order. Explanation: The theory of rent can be explained through two approaches: I.

Intensive Cultivation.

In the above diagram, on the OX axis we have output And on the OY axis we have Price and Cost. To start with, let us suppose that only grade A land is cultivated. The supply and demand conditions of corn determine OP price and OQ quantity of output. There is no surplus or rent because OQ output just covers the costs prevailing at price OP. Suppose with increase in population and the application ofthe law of diminishing returns to land, the demand for corn rises, thereby rising the price to OP1. To meet the increased demand, larger units of labour and capital will be applied to this piece of land for intensive cultivation. This raises costs, and the curve MC meets thenew price line P1E1 at point E1. Rent being the difference between price and average cost, this land starts earning E1F rent per unit. By multiplying it with the total output (P1E1 X E1F) We have Total rent equal to the area E1FGP1. If price rises to OP2 with the further increase in population, the land will be cultivated more intensively and the output of the corn will rise to OQ2. The new equilibrium point between the price line P2E2 and MC will be E2 which will be rent E2HKP2. II.

Extensive Cultivation

Extensive Cultivation can be explained with the help of the following diagram:

In the diagram above on the OX axis we have Price and Cost. On OY axis we have price and cost.

also necessitates the cultivation of grade B land. The grade B land is now the marginal land which just covers the price OP1(=Bb)in the Panel B. The grade A land becomes the intramarginal land which start earning the rent equal to the area a1e1d1p1. With the rise in the price on corn to OP2 as a result of further increase in the population, the C grade land is also brought under the plough with increase in the

demand for the corn. Now this land becomes the nonrent land or marginal land, the price OP2(=Cc) equals the costs MCC and ACC at point C in panel (C). The b grade land earns rent equal to the area b1f1k1p2 while more rent accrues to the grade A land equals to the area a2e2d2p2 while C grade land is the marginal land with no rent.

Situation Rent: Situation rent is regarded as that type of rent which arises due to difference in the situation of land. The land which is situated near the market will yield more rent as compared to land situated away from market. It is so because the produce of the land situated near the market can be transported at the small expenses. Limitations: 1. The soil’s fertility is not industrictable...........with continuous cultivation of the soilits fertility gradually declines. 2. There is no no rent land. 3 .The law of diminishing returns can be postponed by continuously introducing new technologies. 4 .Perfect Competition is actually not found in the real world. 5.Rent also arises in the short run which is ignored by this theory.

Conclusion: Despite the above limitations Ricardian theory of rent helps us to understand how rent is determined fpr land in the long run.

Q6. Write a short note on Wage differentials. Ans: Wage Differentials: There are wide differences in wages received by individuals from occupation to occupation, from industry to industry, from district to district and from region to region within a country. However the internayional wage differences are the greatest. The re...