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Department of Business Administration

Block No. 13, Sector H-8, Allama Iqbal Open University, Islamabad.

Economic Analysis (522)


Assignment No. 01
Submitted to:
Mr. Tahir Mahmood
House No. 67, CAT - II, Street No. 04, Sector I 8/1, ISLAMABAD (0300-989 2976)

Submitted by:
Muhammad Hammad Manzoor (Courtesy: Ms. Madiha Ahmed Khan) MBA (HRM) 1st Semester
Roll No. 508195394 508, 5 Floor, Continental Trade Centre (CTC) Block 08, Clifton, KARACHI
th

Economic Analysis (522)


(0321-584 2326, 0322-555 5901)

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By: M. Hammad Manzoor (Courtesy: Madiha Ahmed Khan), MBA HRM-I, 508, 5th Floor, Continental Trade Centre (CTC), Clifton 08, KARACHI. (Roll No. 508195394)

Economic Analysis (522)

Q.1 People have unlimited wants but resources are limited Comment on this statement. Also discuss Production Possibility Frontier (PPF) in detail.
Answer:

The conspicuous consumption of limited resources has yet to be accepted widely as a spiritual error or even bad manners Barbara Kingsolver
Limited Resources and Unlimited Wants:
Faces with the undeniable fact that goods are scarce relative to wants, an economy must decide how to cope with limited resources. It must:

Choose among different potential bundles of goods (the what) Select from different techniques of production (the how) Decide in the end who will consume the goods (the for whom) To answer these three questions, every society must make choices about the economys inputs and outputs.

INPUTS
Inputs are commodities or services that are used to produce goods and services. An economy uses its existing technology to combine inputs to produce outputs.

OUTPUTS
Outputs are the various useful goods or services that result from the production process and are either consumed or employed in further production.

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By: M. Hammad Manzoor (Courtesy: Madiha Ahmed Khan), MBA HRM-I, 508, 5th Floor, Continental Trade Centre (CTC), Clifton 08, KARACHI. (Roll No. 508195394)

Economic Analysis (522) Production Possibility Frontier (PPF)


Production possibility frontier (PPF) represents the point at which an economy is most efficiently producing its goods and services and, therefore, allocating its resources in the best way possible. If the economy is not producing the quantities indicated by the PPF, resources are being managed inefficiently and the production of society will dwindle. The production possibility frontier shows there are limits to production, so an economy, to achieve efficiency, must decide what combination of goods and services can be produced. According to the PPF, points A, B and C - all appearing on the curve - represent the most efficient use of resources by the economy. Point X represents an inefficient use of resources, while point Y represents the goals that the economy cannot attain with its present levels of resources.

As we can see, in order for this economy to produce more wine, it must give up some of the resources it uses to produce cotton (point A). If the economy starts producing more cotton (represented by points B and C), it would have to divert resources from making wine and, consequently, it will produce less wine than it is producing at
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By: M. Hammad Manzoor (Courtesy: Madiha Ahmed Khan), MBA HRM-I, 508, 5th Floor, Continental Trade Centre (CTC), Clifton 08, KARACHI. (Roll No. 508195394)

Economic Analysis (522)


point A. As the chart shows, by moving production from point A to B, the economy must decrease wine production by a small amount in comparison to the increase in cotton output. However, if the economy moves from point B to C, wine output will be significantly reduced while the increase in cotton will be quite small. Keep in mind that A, B, and C all represents the most efficient allocation of resources for the economy; the nation must decide how to achieve the PPF and which combination to use. If more wine is in demand, the cost of increasing its output is proportional to the cost of decreasing cotton production. Point X means that the country's resources are not being used efficiently or, more specifically, that the country is not producing enough cotton or wine given the potential of its resources. Point Y, as we mentioned above, represents an output level that is currently unreachable by this economy. However, if there was a change in technology whiles the level of land, labor and capital remained the same, the time required to pick cotton and grapes would be reduced. Output would increase, and the PPF would be pushed outwards. A new curve, on which Y would appear, would represent the new efficient allocation of resources.

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By: M. Hammad Manzoor (Courtesy: Madiha Ahmed Khan), MBA HRM-I, 508, 5th Floor, Continental Trade Centre (CTC), Clifton 08, KARACHI. (Roll No. 508195394)

Economic Analysis (522)


When the PPF shifts outwards, we know there is growth in an economy. Alternatively, when the PPF shifts inwards it indicates that the economy is shrinking as a result of a decline in its most efficient allocation of resources and optimal production capability. A shrinking economy could be a result of a decrease in supplies or a deficiency in technology. An economy can be producing on the PPF curve only in theory. In reality, economies constantly struggle to reach an optimal production capacity. And because scarcity forces an economy to forgo one choice for another, the slope of the PPF will always be negative; if production of product. A increases then production of product B will have to decrease accordingly.

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By: M. Hammad Manzoor (Courtesy: Madiha Ahmed Khan), MBA HRM-I, 508, 5th Floor, Continental Trade Centre (CTC), Clifton 08, KARACHI. (Roll No. 508195394)

Economic Analysis (522) Q.2 a) Explain in detail the Islamic economic system in relation to Pakistan. Islamic Economic System
Everything in Islam is for the benefit and welfare of mankind. The economic principle of Islam aim at establishing a just society wherein everyone will behave responsibly and honestly, and not as cunning foxes fighting for as big a share of something as possible without regard for honesty, truth, decency, trust and responsibility. The Islamic Economic System is based on the following fundamental principles:

1.Earning and expenditure by Halal means


Islam has prescribed laws to regulate earnings and expenditure. Muslims are not allowed to earn and spend in any way they like. The must follow the rules of the Quran and the Sunnah.

2. Right to property and individual liberty


Islam allows a person to own his earnings. The Islamic state does not interfere with the freedom of speech, work and earnings of an individual provided this freedom is not harmful to the greater good of society.

3. System of Zakah (welfare contribution)


Compulsory payment of Zakah is one of the main principles of an Islamic economy. Every Muslim who owns wealth more than his needs must pay the fixed rate of Zakah to the Islamic state. Zakah is a means of narrowing the gap between the rich and the poor. It helps the fair distribution of wealth. It is a form of social security.

4. Prohibition of interest (Riba).


An Islamic economy is free of interest. Islam prohibits all transactions involving interest. Interest is neither a trade nor a profit. It is a means of exploitation and concentration of wealth. The Quran says:

"O you, who believe, do not take interest, doubling and quadrupling, and keep your duty to Allah, so that you may prosper." (3:130)

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By: M. Hammad Manzoor (Courtesy: Madiha Ahmed Khan), MBA HRM-I, 508, 5th Floor, Continental Trade Centre (CTC), Clifton 08, KARACHI. (Roll No. 508195394)

Economic Analysis (522)

"O you, who believe, observe your duty to Allah and give up what remains (due) from interest, if you are believers. But if you do not do it, then be warned of war from Allah and His messenger; and if you repent, then you shall have your capital. Do not exploit and be not exploited." (2:278-279). 5. Law of Inheritance (Mirath)

The Islamic law of inheritance is a wonderful system of stopping the concentration of wealth. It provides very detailed laws regarding the rights of dependents over the property of the deceased person.

Islamic Economics and Pakistan


Allah knows best [who are] your enemies. Allah is sufficient as a Friend, and Allah is sufficient as a Helper. [4:45]
Islamic Economics differs fundamentally from man-made laws and systems in defining economic problem. It represents the only wholly independent, alternative economic paradigm in the world today. It is based on principles revealed from Islamic sources as norms for human welfare that offer a strikingly alternative set of parameters for economic activity. According to its proponents its offers a comprehensive, coherent and better alternative to those currently in use in Western economics. The Shariah defines certain rules that regulate company structure, effectively preventing abuse and corruption. For instance, Islam forbids monopolies by outlawing the hoarding of wealth (Al-Ihtikar), and eliminates copyright or potency laws that would open the avenue for potential monopolies to develop. Also, Islam protects the ownership of businesses and companies by restricting ownership of companies only to those who contribute both capital and effort to the company or business, thus effectively putting the seal on such concepts as "corporate takeover" from ever becoming a reality. Yet, generally we will exhibit the root of Shariah rules to solve those problems in this section.

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By: M. Hammad Manzoor (Courtesy: Madiha Ahmed Khan), MBA HRM-I, 508, 5th Floor, Continental Trade Centre (CTC), Clifton 08, KARACHI. (Roll No. 508195394)

Economic Analysis (522)

Monetary & Fiscal


The role and realm of reign of each will be specified to the set of assumptions that is derived from the Islamic economic system, which include Zakah, prohibition of interest, moderation in consumption, the Islamic inheritance system, Hisbah, Qirad, and the co-existence of private and social ownership of the means of production. Zakah provides a major means of fiscal policy because it affects the allocation of resources, the level of aggregate demand and the distribution of income as well since the variations in the volume and the timing of collection and disbursement of Zakah creates variations in disposable income and fixed and circulating capital. The economic policy has to do with the role of the government Such a government role is made available through its ownership of the major natural resources and al-Hisbah.

Trade & Business


During the height of the great Islamic civilization, trade was among the most important activity in wealth creation. Today in a world that is being rapidly globalized, trade has become even more important, facilitated by the advancements in information and communication technology and the greater capacity and speed of transportation. Whereas in the past trade could be carried out through the barter of goods, the Muslim world would still have to trade with the rest of the world as individual countries or as a regional group or as an Islamic Financial Community.

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By: M. Hammad Manzoor (Courtesy: Madiha Ahmed Khan), MBA HRM-I, 508, 5th Floor, Continental Trade Centre (CTC), Clifton 08, KARACHI. (Roll No. 508195394)

Economic Analysis (522)

Q2 b) Briefly explain different forms of business organizations and their advantages and disadvantages. BUSINESS
A business (also known as enterprise or firm) is an organization engaged in the trade of goods, services, or both to consumers.

TYPES OF BUSINESS ORGANIZATIONS


When organizing a new business, one of the most important decisions to be made is choosing the structure of a business. Sole Proprietor Corporation Partnership Trust Non-profit organization

Sole Proprietorships
The vast majority of small business start out as sole proprietorships is very dangerous. These firms are owned by one person, usually the individual who has dayto-day responsibility for running the business. Sole proprietors own all the assets of the business and the profits generated by it. They also assume "complete personal" responsibility for all of its liabilities or debts. In the eyes of the law, you are one in the same with the business.

Advantages of a Sole Proprietorship


1. Easiest and least expensive form of ownership to organize. 2. Sole proprietors are in complete control, within the law, to make all decisions. 3. Sole proprietors receive all income generated by the business to keep or reinvest.
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By: M. Hammad Manzoor (Courtesy: Madiha Ahmed Khan), MBA HRM-I, 508, 5th Floor, Continental Trade Centre (CTC), Clifton 08, KARACHI. (Roll No. 508195394)

Economic Analysis (522)


4. Profits from the business flow-through directly to the owner's personal tax return. 5. The business is easy to dissolve, if desired.

Disadvantages of a Sole Proprietorship


1. Unlimited liability and are legally responsible for all debts against business. 2. Their business and personal assets are 100% at risk. 3. Have almost be ability to raise investment funds. 4. Are limited to using funds from personal savings or consumer loans. 5. Have a hard time attracting high-caliber employees, or those that motivated by the opportunity to own a part of the business. 6. Employee benefits such as owner's medical insurance premiums are directly deductible from business income (partially deductible as adjustment to income). the

are not an

Corporation
Corporations are incorporated businesses. Every form of business besides the sole proprietor is considered a separate entity, and this often provides a measure of legal and financial protection for the shareholders. The shareholders of corporations have limited liability protection, and corporations have full discretion over the amount of profits they can distribute or retain. Corporations are presumed to be for-profit entities, and as such they can have an unlimited number of years with losses. Corporations must have at least one shareholder.

Advantages of a corporation
1. Owners have limited Liability 2. It can exist with continuity. 3. Shares of ownership are transferable. 4. It attracts more investors. 5. You can be an employee of your own corporation. 6. The corporation pays its own tax.

Disadvantages of a corporation
1. Incorporation is costly. 2. Corporations are highly regulated. 3. Limited liability may discourage creditors.
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By: M. Hammad Manzoor (Courtesy: Madiha Ahmed Khan), MBA HRM-I, 508, 5th Floor, Continental Trade Centre (CTC), Clifton 08, KARACHI. (Roll No. 508195394)

Economic Analysis (522)


4. It may result to double taxation. 5. It is not easy to dissolve.

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By: M. Hammad Manzoor (Courtesy: Madiha Ahmed Khan), MBA HRM-I, 508, 5th Floor, Continental Trade Centre (CTC), Clifton 08, KARACHI. (Roll No. 508195394)

Economic Analysis (522) Partnerships


Partnerships are unincorporated businesses. Like corporations, partnerships are separate entities from the shareholders. Unlike corporations, partnerships must have at lease one General Partner who assumes unlimited liability for the business. Partnerships must have at least two shareholders. Partnerships distribute all profits and losses to their shareholders without regard for any profits retained by the business for cash flow purposes.

Advantages of a Partnership
1. Partnerships are relatively easy to establish. 2. With more than one owner, the ability to raise funds may be increased,

because two or more partners may be able to contribute more funds and because their borrowing capacity may be greater. 3. Prospective employees may be attracted to the business if given the incentive to become a partner. 4. A partnership may benefit from the combination of complimentary skills of two or more people. 5. There is a wider pool of knowledge, skills and contacts. 6. Partnerships can be cost-effective as each partner specializes in certain aspects of their business. 7. Partnerships provide moral support and will allow for more creative brainstorming.

Disadvantages of a Partnership
1. Business partners are jointly and individually liable for the actions of the 2. 3. 4. 5. 6. 7.

other partners. Since decisions are shared, disagreements can occur. A partnership is for the long term, and expectations and situations can change, which can lead to dramatic and traumatic split ups. The partnership may have a limited life; it may end upon the withdrawal or death of a partner. A partnership usually has limitations that keep it from becoming a large business. You have to consult your partner and negotiate more as you cannot make decisions by yourself. You therefore need to be more flexible. A major disadvantage of a partnership is unlimited liability.

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By: M. Hammad Manzoor (Courtesy: Madiha Ahmed Khan), MBA HRM-I, 508, 5th Floor, Continental Trade Centre (CTC), Clifton 08, KARACHI. (Roll No. 508195394)

Economic Analysis (522) Trust


Unlike a company, a trust is not a separate legal entity. Trusts are often used in connection with running a business for the benefit of others. A trust is a structure where a trustee (an individual or company) carries out the business on behalf of the members (or beneficiaries) of the trust. Family businesses are often set up as a trust so that each family member can be made a beneficiary without having any involvement in how the business is run.

Advantages of a Trust
1. Reduced liability - especially if corporate trustee. 2. Asset protection. 3. Flexibility of asset and income distribution.

Disadvantages of a Trust
1. Can be expensive and complex to establish and administer. 2. Difficult to dissolve, dismantle, or make changes once established particularly

where children are involved.

3. Any profits retained to reinvest into the business, will incur penalty tax rates. 4. Can not distribute losses, only profits.

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By: M. Hammad Manzoor (Courtesy: Madiha Ahmed Khan), MBA HRM-I, 508, 5th Floor, Continental Trade Centre (CTC), Clifton 08, KARACHI. (Roll No. 508195394)

Economic Analysis (522) Nonprofit Corporations


Nonprofits are corporations formed for a charitable, civic, or artistic purpose. Nonprofits are generally exempt from federal and state taxation on their income, and so they are often called "exempt organizations." Nonprofits have substantial responsibilities for reporting their activities, income, and assets to ensure that they are in compliance with federal and state laws governing charities. For additional information on starting, managing, and developing a not-for-profit organization.

Advantages of Nonprofit Corporation


1. 2. 3. 4. Tax exemption/deduction Eligibility for public and private grants Formal structure Limited liability

Disadvantages of Nonprofit Corporation


1. 2. 3. 4. Cost Paperwork Shared control Scrutiny by the public

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By: M. Hammad Manzoor (Courtesy: Madiha Ahmed Khan), MBA HRM-I, 508, 5th Floor, Continental Trade Centre (CTC), Clifton 08, KARACHI. (Roll No. 508195394)

Economic Analysis (522)

Q.3 Discuss the concept of price elasticity of supply in short and long run. Aslo explain the applications of elasticity of supply. Price Elasticity of Supply
Price elasticity of supply measures the relationship between change in quantity supplied and a change in price. If supply is elastic, producers can increase output without a rise in cost or a time delay If supply is inelastic, firms find it hard to change production in a given time period. The formula for price elasticity of supply is: Percentage change in quantity supplied divided by the percentage change in price When Pes > 1, then supply is price elastic When Pes < 1, then supply is price inelastic When Pes = 0, supply is perfectly inelastic When Pes = infinity, supply is perfectly elastic following a change in demand

Factors that Affect Price Elasticity of Supply (1) Spare production capacity
If there is plenty of spare capacity then a business should be able to increase its output without a rise in costs and therefore supply will be elastic in response to a change in demand. The supply of goods and services is often most elastic in a recession, when there is plenty of spare labour and capital resources available to step up output as the economy recovers.

(2) Stocks of finished products and components


If stocks of raw materials and finished products are at a high level then a firm is able to respond to a change in demand quickly by supplying these stocks onto the market supply will be elastic. Conversely when stocks are low, dwindling supplies force prices higher and unless stocks can be replenished, supply will be inelastic in response to a change in demand.

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By: M. Hammad Manzoor (Courtesy: Madiha Ahmed Khan), MBA HRM-I, 508, 5th Floor, Continental Trade Centre (CTC), Clifton 08, KARACHI. (Roll No. 508195394)

Economic Analysis (522) (3) The ease and cost of factor substitution
If both capital and labour resources are occupationally mobile then the elasticity of supply for a product is higher than if capital and labour cannot easily and quickly be switched

(4) Time period involved in the production process


Supply is more price elastic the longer the time period that a firm is allowed to adjust its production levels. In some agricultural markets for example, the momentary supply is fixed and is determined mainly by planting decisions made months before, and also climatic conditions, which affect the overall production yield.

Supply curves with different price elasticity of supply


The non-linear supply curve
A non linear supply curve has a changing price elasticity of supply throughout its length. This is illustrated in the diagram below.

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By: M. Hammad Manzoor (Courtesy: Madiha Ahmed Khan), MBA HRM-I, 508, 5th Floor, Continental Trade Centre (CTC), Clifton 08, KARACHI. (Roll No. 508195394)

Economic Analysis (522) Useful applications of price elasticity of demand and supply
Elasticity of demand and supply is tested in virtually every area of the AS economics syllabus. The key is to understand the various factors that determine the responsiveness of consumers and producers to changes in price. The elasticity will affect the ways in which price and output will change in a market. And elasticity is also significant in determining some of the effects of changes in government policy when the state chooses to intervene in the price mechanism. Some relevant issues that directly use elasticity of demand and supply include:

Taxation: The effects of indirect taxes and subsidies on the level of demand and output in a market e.g. the effectiveness of the congestion charge in reducing road congestion; or the impact of higher duties on cigarettes on the demand for tobacco and associated externality effects Changes in the exchange rate: The impact of changes in the exchange rate on the demand for exports and imports Exploiting monopoly power in a market: The extent to which a firm or firms with monopoly power can raise prices in markets to extract consumer surplus and turn it into extra profit (producer surplus) Government intervention in the market: The effects of the government introducing a minimum price (price floor) or maximum price (price ceiling) into a market Elasticity of demand and supply also affects the operation of the price mechanism as a means of rationing scarce goods and services among competing uses and in determining how producers respond to the incentive of a higher market price.

Short Run and Long Run Production


The production function is a mathematical expression which relates the quantity of factor inputs to the quantity of outputs that result. We make use of three measures of production / productivity.

Total product is simply the total output that is generated from the factors of production employed by a business. In most manufacturing industries such as motor vehicles, freezers and DVD players, it is straightforward to measure the volume of production from labour and capital inputs that are used. But in many service or knowledge-based industries, where much of the output is intangible or perhaps weightless we find it harder to measure productivity
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By: M. Hammad Manzoor (Courtesy: Madiha Ahmed Khan), MBA HRM-I, 508, 5th Floor, Continental Trade Centre (CTC), Clifton 08, KARACHI. (Roll No. 508195394)

Economic Analysis (522)

Average product is the total output divided by the number of units of the variable factor of production employed (e.g. output per worker employed or output per unit of capital employed) Marginal product is the change in total product when an additional unit of the variable factor of production is employed. For example marginal product would measure the change in output that comes from increasing the employment of labour by one person, or by adding one more machine to the production process in the short run.

The Short Run Production Function


The short run is defined in economics as a period of time where at least one factor of production is assumed to be in fixed supply i.e. it cannot be changed. We normally assume that the quantity of capital inputs (e.g. plant and machinery) is fixed and that production can be altered by suppliers through changing the demand for variable inputs such as labour, components, raw materials and energy inputs. Often the amount of land available for production is also fixed. The time periods used in textbook economics are somewhat arbitrary because they differ from industry to industry. The short run for the electricity generation industry or the telecommunications sector varies from that appropriate for newspaper and magazine publishing and small-scale production of foodstuffs and beverages. Much depends on the time scale that permits a business to alter all of the inputs that it can bring to production. In the short run, the law of diminishing returns states that as we add more units of a variable input (i.e. labour or raw materials) to fixed amounts of land and capital, the change in total output will at first rise and then fall. Diminishing returns to labour occurs when marginal product of labour starts to fall. This means that total output will still be rising but increasing at a decreasing rate as more workers are employed. As we shall see in the following numerical example, eventually a decline in marginal product leads to a fall in average product. What happens to marginal product is linked directly to the productivity of each extra worker employed. At low levels of labour input, the fixed factors of production - land and capital, tend to be under-utilised which means that each additional worker will have plenty of capital to use and, as a result, marginal product may rise. Beyond a certain point however, the fixed factors of production become scarcer and new workers will not have as much capital to work with so that the capital input becomes diluted among a larger workforce. As a result, the marginal productivity of each worker tends to fall this is known as the principle of diminishing returns.
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By: M. Hammad Manzoor (Courtesy: Madiha Ahmed Khan), MBA HRM-I, 508, 5th Floor, Continental Trade Centre (CTC), Clifton 08, KARACHI. (Roll No. 508195394)

Economic Analysis (522) Long run production - returns to scale


In the long run, all factors of production are variable. How the output of a business responds to a change in factor inputs is called returns to scale.

Increasing returns to scale occur when the % change in output > % change in inputs Decreasing returns to scale occur when the % change in output < % change in inputs Constant returns to scale occur when the % change in output = % change in inputs

In the example above, we increase the inputs of capital and labour by the same proportion each time. We then compare the % change in output that comes from a given % change in inputs.

In our example when we double the factor inputs from (150L + 20K) to (300L + 40K) then the percentage change in output is 150% - there are increasing returns to scale. In contrast, when the scale of production is changed from (600L + 80K0 to (750L + 100K) then the percentage change in output (13%) is less than the change in inputs (25%) implying a situation of decreasing returns to scale.

As we shall see a later, the nature of the returns to scale affects the shape of a businesss long run average cost curve. The effect of an increase in labour productivity at all levels of employment Productivity may have been increased through the effects of technological change; improved incentives; better management or the effects of work-related training which boosts the skills of the employed labour force.

A numerical example of long run returns to scale Units of Capital Units of Labour Total Output % Change in Inputs % Change in Output 20 40 60 80 100 150 300 450 600 750 3000 7500 12000 16000 18000 100 50 33 25 150 60 33 13

Returns to Scale

Increasing Increasing Constant Decreasing

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By: M. Hammad Manzoor (Courtesy: Madiha Ahmed Khan), MBA HRM-I, 508, 5th Floor, Continental Trade Centre (CTC), Clifton 08, KARACHI. (Roll No. 508195394)

Economic Analysis (522)

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By: M. Hammad Manzoor (Courtesy: Madiha Ahmed Khan), MBA HRM-I, 508, 5th Floor, Continental Trade Centre (CTC), Clifton 08, KARACHI. (Roll No. 508195394)

Economic Analysis (522) Q.4 Differentiate between perfect and imperfect markets with examples. Also explain the conditions for the determination of price and out put relationship of the firm in each market in the short and long run. Perfect competition
In economic theory, perfect competition describes markets such that no participants are large enough to have the market power to set the price of a homogeneous product. Because the conditions for perfect competition are strict, there are few if any perfectly competitive markets. Still, buyers and sellers in some auction-type markets, say for commodities or some financial assets, may approximate the concept. Perfect competition serves as a benchmark against which to measure reallife and imperfectly competitive markets.

Basic structural characteristics


Generally, a perfectly competitive market exists when every participant is a "price taker", and no participant influences the price of the product it buys or sells. Specific characteristics may include: Infinite buyers and sellers Infinite consumers with the willingness and ability to buy the product at a certain price, and infinite producers with the willingness and ability to supply the product at a certain price. Zero entry and exit barriers It is relatively easy for a business to enter or exit in a perfectly competitive market. Perfect factor mobility - In the long run factors of production are perfectly mobile allowing free long term adjustments to changing market conditions. Perfect information - Prices and quality of products are assumed to be known to all consumers and producers. Zero transaction costs - Buyers and sellers incur no costs in making an exchange (perfect mobility). Profit maximization - Firms aim to sell where marginal costs meet marginal revenue, where they generate the most profit. Homogeneous products The characteristics of any given market good or service do not vary across suppliers. Non-increasing returns to scale - Non-increasing returns to scale ensure that there are sufficient firms in the industry.

Imperfect competition
Imperfect competition is where there is one dominant producer who can charge whatever price he wishes to, mostly such products are innovative.
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By: M. Hammad Manzoor (Courtesy: Madiha Ahmed Khan), MBA HRM-I, 508, 5th Floor, Continental Trade Centre (CTC), Clifton 08, KARACHI. (Roll No. 508195394)

Economic Analysis (522)

Major Market Structures


Markets can be characterized by how prices for goods and services are determined 1. 2. 3. 4. Perfect competition Monopolistic competition Oligopoly Monopoly

The function of Price


1. Price brings quantity supplied in line with quantity demanded. 2. As a good becomes relatively more scarce, price will go up. 3. How does this impact firms and consumers?

Factors Affecting the Form of Market Competition an Industry Expresses


1. 2. 3. 4. The number and size distribution of buyers and sellers The degree of product differentiation The extent of barriers to entry Amount of information available

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By: M. Hammad Manzoor (Courtesy: Madiha Ahmed Khan), MBA HRM-I, 508, 5th Floor, Continental Trade Centre (CTC), Clifton 08, KARACHI. (Roll No. 508195394)

Economic Analysis (522) Price and Output Determination


Price discrimination takes place when a given product is sold by a monopolist at more than one price and these price differences are not justified by cost differences. The price discrimination is possible under the following conditions.

Conditions:
(1) Monopoly power. The seller of a good must be a monopolist. (2) Segregation of market. The monopolist must be able to segregate buyers into separate classes with different price elasticities. (3) No reselling. There should be no possibility of reselling the good from a tow price market to a high price market.

Purpose of Price Discrimination:


The purpose of price discrimination by a monopolist is two fold. Firstly, to increase his total revenue and profits and secondly, to produce a larger output than a nonpracticing monopolist. Determination of price and output under monopolistic competition. Price discrimination is possible and profitable when the monopolist is able to control the amount and distribution of supply and the buyers can be separated into different classes having a demand curve with different elasticities. Let us assume that the monopolist sells his total product in two sub-markets A and B. Sub-market A has low price elastic demand for the product and the sub-market B has high price elasticity of demand. The discriminating monopolist will sell a greater quantity of his product by making a price reduction in market B. He sells lesser commodity in market A at a price higher than in market B. The monopolist will then earn maximum profit by price discriminating as is illustrated with the help of diagram given below. Diagram:

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By: M. Hammad Manzoor (Courtesy: Madiha Ahmed Khan), MBA HRM-I, 508, 5th Floor, Continental Trade Centre (CTC), Clifton 08, KARACHI. (Roll No. 508195394)

Economic Analysis (522)


In this figure above, market A and Market B have different elasticity of demand for the product of the monopolist. The slopes of the AR and MR curves in each market are different depending upon the elasticity of demand for the commodity. In market A, the elasticity of demand is relatively inelastic. The rise in price does not cause a much fall in demand. In market B, the demand for the monopolist product is relatively elastic. A reduction in price leads greater increase in the demand for the product and adds more to the revenue. In figure, the combined marginal cost curve (MC) of the total output of the monopolist intersects the combined marginal revenue curve of the two markets A and B from below at point P. The best levels of output of the monopolist is OT given by the point P where MC curve cuts the AR curve from below. The monopolist Is to distribute this equilibrium output OT between the two markets A and B in such a way that the MR in each market is OP. In market A, MR equates MC at point F. The monopolist sells output OB at price KB. In market B, where the demand is more elastic, the monopolist maximizes profit by selling output OB2 at price K2B2 in market B, where the demand is more elastic, the price K2B2 is lower than in market A, the profit of the monopolist is maximum when he sells output of OB at price KB in market. A and output of OB2 at price of K2B2 in market B. The monopolist total profit is shown in the shaded area APE. Summing up, a discriminating monopolist can maximize profits only when: (1) It is profitable for him to sell the output in different markets. (2) The price is charged in different markets in such a way that the last unit of the commodity sold in market gives the same marginal revenue. (3) The marginal revenue is equal to the marginal cost of total output.

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By: M. Hammad Manzoor (Courtesy: Madiha Ahmed Khan), MBA HRM-I, 508, 5th Floor, Continental Trade Centre (CTC), Clifton 08, KARACHI. (Roll No. 508195394)

Economic Analysis (522) Q.5 Discuss the determination of equilibrium wage rate under perfect and imperfect market conditions. Wage Determination in Perfectly Competitive Labour Markets
How wages are determined in a perfectly competitive labour market. A perfectly competitive labour market will have the following features

Many firms Perfect information about wages and job conditions Firms are offering identical jobs Many workers with same skills

Diagram of Wage Determination

The equilibrium wage rate in the industry is set by the meeting point of the industry supply and industry demand curves. In a competitive market firms are wage takers because if they set lower wages workers would not accept the wage. Therefore they have to set the equilibrium wage We. Because firms are wages takers the supply curve of labour is perfectly elastic therefore AC = MC The firm will maximise profits by employing at Q1 where MRP of Labour = MC of Labour

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By: M. Hammad Manzoor (Courtesy: Madiha Ahmed Khan), MBA HRM-I, 508, 5th Floor, Continental Trade Centre (CTC), Clifton 08, KARACHI. (Roll No. 508195394)

Economic Analysis (522)

Comparing Wage of Lawyers and McDonalds workers


Lawyers get higher pay for 2 reasons Supply is inelastic because of the qualifications required MRP of lawyers is high. If they are successful they can make firms a lot of revenue. McDonalds workers however get lower pay because: Supply is elastic, because there are many 1000s of people who are suitable for working, qualifications are not really required The MRP of a McDonalds worker is much lower because there is a limited profit to be made from selling Big Macs.

Diagram of Wage Determination for Lawyers and McDonald's Workers

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By: M. Hammad Manzoor (Courtesy: Madiha Ahmed Khan), MBA HRM-I, 508, 5th Floor, Continental Trade Centre (CTC), Clifton 08, KARACHI. (Roll No. 508195394)

Economic Analysis (522) Wage Determination in Competitive Markets

Explanations for wage differentials in the labour market There is a very wide gulf in pay and earnings rates between different occupations in the UK labour market. No one factor explains the gulf in pay that exists and persists between occupations and within each sector of the economy. Some of the relevant factors are listed below
1. Compensating wage differentials - higher pay can often be some reward for

risk-taking in certain jobs, working in poor conditions and having to work unsocial hours
2. Equalising difference and human capital - wage differentials compensate

workers for (opportunity and direct) costs of human capital acquisition. There is an opportunity cost in acquiring qualifications - measured by the current earnings foregone by staying in full or part-time education.
3. Different skill levels - the gap between poorly skilled and highly skilled

workers gets wider each year. One reason is that the demand for skilled labour grows more quickly than the demand for semi-skilled workers. This pushes up average pay levels.

4. Differences in labour productivity and revenue creation - workers whose

efficiency is highest and ability to generate revenue for a firm should be


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By: M. Hammad Manzoor (Courtesy: Madiha Ahmed Khan), MBA HRM-I, 508, 5th Floor, Continental Trade Centre (CTC), Clifton 08, KARACHI. (Roll No. 508195394)

Economic Analysis (522)


rewarded with higher pay. Top sports stars can command top wages because of their potential to generate extra revenue from ticket sales and merchandising
5. Trade unions - unions might exercise their collective bargaining power to

achieve a mark-up on wages compared to those of to non-union members

6. Employer discrimination is a factor that cannot be ignored

Earnings in the Labour Market

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By: M. Hammad Manzoor (Courtesy: Madiha Ahmed Khan), MBA HRM-I, 508, 5th Floor, Continental Trade Centre (CTC), Clifton 08, KARACHI. (Roll No. 508195394)

Economic Analysis (522) References:


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http://en.wikipedia.org/wiki/Production%E2%80%93possibility_frontier http://www.investopedia.com/terms/p/productionpossibilityfrontier.asp#axzz 1bgHCria http://www.friendsmania.net/forum/islamic-economics/28553.htm http://forum.pakistanidefence.com/index.php?showtopic=61367 http://en.wikipedia.org/wiki/Price_elasticity_of_demand http://www.quickmba.com/econ/micro/elas/ped.shtml http://www.investopedia.com/terms/i/imperfectmarket.asp#axzz1bgHCriaQ http://en.wikipedia.org/wiki/Perfect_market http://www.blacksacademy.net/content/3352.html http://www.economicshelp.org/labour-markets/wage-determination.html http://www.preservearticles.com/201106178068/modern-theory-of-wage determination-explained.html http://www.cliffsnotes.com/study_guide/Equilibrium-in-a-PerfectlyCompetitive Market.topicArticleId-9789,articleId-9782.html

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By: M. Hammad Manzoor (Courtesy: Madiha Ahmed Khan), MBA HRM-I, 508, 5th Floor, Continental Trade Centre (CTC), Clifton 08, KARACHI. (Roll No. 508195394)

Economic Analysis (522)

Mr. Tahir Mahmood House. No. 67, Cat II

M. Hammad Manzoor 508195394

Street No. 04, Sector I # 508, 5th Floor, 8/1 CTC ISLAMABAD. (0300 989 Continental Trade Centre, 2976) Block-08 08, KARACHI. (0321Clifton 584 2326) Economic Analysis 01 522

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By: M. Hammad Manzoor (Courtesy: Madiha Ahmed Khan), MBA HRM-I, 508, 5th Floor, Continental Trade Centre (CTC), Clifton 08, KARACHI. (Roll No. 508195394)