However a low rate of inflation around the 2-3% may be desirable. The beneficial effects of inflation are :-
- Inflation may encourage firms to expand. A low and stable level of demand-pull inflation may make entrepreneurs optimistic about future sales.
- It can prevent some workers being made redundant. This is because it may be difficult to cut nominal wages (workers resent wage cut). But, if average prices are rising they may accept their money wages rising by less than inflation. In such a case, firms’ real wage costs will fall without making workers redundant.
Q2) Explain the functions of price in a market economy. (10)
ANS 2:- In a market economy resource allocation is carried out by private individuals only. All factors of production are privately owned and managed. There is no government intervention and everyone is free to operate according to his will and desire. Price/ market mechanism which manipulates the allocation of resources or tries to resolve the three fundamental questions of what, how and for whom to produce. In other words, resources are allocated through changes in relative prices. Adam Smith referred to it as the “invisible hands” of the market.
Firstly, price acts as a rationing device. In other words, price serves to ration the scarce goods among the people who are demanding them. Where the supply of a good or service is insufficient to meet the demands of prospective buyers at the existing price, the market price will rise and continue to rise until the quantity demanded is just equal to the existing supply. Those unable to pay a higher prices will be eliminated from the market. Price rations scarce goods to those who can afford to pay the price. Hence, for price to act as a rationing mechanism, the effect of a rising price must be to reduce the quantity demanded by some individuals.
Secondly, prices act as signals and guides to firms about what should be produced in the future. Producers aim at profit maximisation. If consumers wish to consume more of a particular commodity then its price will tend to rise. This indicates to firms that more should be produced; at the same time it provides and incentive for more factors of production to move into that line of production. Firms making the good will be earning high profits. They will wish to expand output.
To obtain more of the new materials, machinery and workers wanted they will be prepared to offer higher prices and thus more resources will be drawn to this line of production to meet the increase in demand. In the process we see the operation of what to Adam Smith was like and ‘invisible hand’ by which individuals, following their own self interest , led to pursue the interests of the community.
Thirdly, the price system enables the economic problem to be solved in a way which combines efficiency. Efficiency, because the profit motive promotes enterprise; because movements in the relative prices of the factors of production stimulate entrepreneurs to economize in the use of scare factors.
Q3) Explain what influences the price elasticity of supply of a product. (8)
Ans 3:- Price elasticity of supply measures the degree of responsiveness of quantity supplied to a change in the price of the commodity.
Formula of Price elasticity of supply = percentage change in quantity supplied
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Percentage change in price.
Price elasticity of supplied is always positive, indicating the direct relationship between quantity supplied and price.
FACTORS INFLUENCING PRICE ELASTICITY OF SUPPLY:
Time period: The elasticity of supply tends to be greater in the long run than in the short run because it is easier to increase the amount produced when the firm has more time in which to do it.
It may be difficult to change quantities supplied in response to a price increase in the short run. This is obvious if one considers agricultural products. Suppose that the price of an agricultural product rises unexpectedly. There is little that farmers can do to supply more agricultural products because it takes time to grow them. Thus, the supply of agricultural products tends to be inelastic in the short run. However, supply is elastic in the long run since the long run offers opportunities to expand output that are not available instantaneously.
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Availability of resources: If a firm wishes to expand production, it will need more resources. If the economy is already using most of its scarce resources, then firms will find it difficult to employ more, and therefore, output will not rise. Hence, supply of most goods will be inelastic. If, however, there is unemployment of resources, firms can easily raise output, and in this case, supply is elastic.
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Availability of stocks: When suppliers are holding large stocks, supply will be elastic. This is because any increase in demand can be easily met by running down the stocks. However, once the stocks are depleted, it may be very difficult to increase output, and therefore, supply will be inelastic.
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Risk taking: The more willing entrepreneurs are to take risks the greater will be the elasticity of supply. This will be partly influenced by the system of incentives in the economy. If the rates of taxes are very high, this may reduce the elasticity of supply.
Q4) Explain the difficulties of measuring inflation accurately. (8)
Ans 4:- Inflation is a sustained rise in the general price level and is measured by a price index. This is a statistical measure that expresses the average price of some group of commodities in some year as a percentage of the average price of the same commodities in some other year.
Problems in measuring inflation accurately can arise from the following reasons
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The choice of the base year: The selection of the base year is a very complicated task. The prices in the chosen base year should be reasonably steady. Periods of severe inflation, deflation or recession should be avoided.
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The price index is not able to take into account changes in quality: A commodity may not have changed in price but its quality may have fallen. Conversely, a good may be more expensive because it is of a better quality than before. Such changes in quality affect the consumer’s standard of living but cannot be reflected in the price index.
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Finding a representative group of commodities: In selecting commodities to include in the basket of goods, accurate information on expenditure patterns of households is needed. But there are great difficulties in collecting such data. People are unwilling to disclose their expenditure truthfully. Besides, different income groups do not share the same basket of goods. Even people with the same income do not buy the same commodities in the basket. Thus, the construction of consumer price index involves a lot of guesswork.
by
sc_shashank631 (student)
