A Passage to Banking Diploma

Principles of Economics & Bangladesh Economy (PBE)

Question Bank Solution

Written By

Nur H Palash
MBA (DU) JAIBB (IBB)

Bangladesh Krishi Bank

Mobile:01711942410

This version is only for non-economics background student .

Advanced students are not recommended to follow it.

NOT CHEKED.NOT REVISED

 JUNE 2011

Q.1 a) What do mean by normative and positive economics. Points their difference.

Suggested Answer:

Economics is the study of production, distribution and consumption of good and services. Economics can be
normative or positive.

Normative economics focus on what the economy should be. It is a value judgment to show what measure to be
taken to solve economic problems. It is a prescription what should be done in an economy.

Example: Got should provide subsidy to reduce oil price.

Positive Economics is the scientific attempt to describe and explain the behavior of the economy and its important
variables. It reflects facts and studies actual economic performances.

Example: Lowe interest rate rise aggregated demand and inflation.

Points of Diff Positive Normative

Meanings it show how economic problems
should are actually solved
Verification can be verified with actual data
Suggestive based on data, so it is not suggestive
Example There is high inflation in Greece
it shows how economic problem
Should be solved
can be verified with actual data
it is not suggestive
Greece should control inflation

b) Explain relationship between –Statistics and sociology.

Economics is the study, analysis and interpretation of production, distribution and consumption. Though it is a
distinct branch of knowledge, it has a strong linkage with other branches of knowledge like Statistic, Sociology.

Economics & Statistics: Economics is the study of how Money relates to, and supports society. Statistics simply is
a way to analyze data. In economics research, statistical methods are used to collect and analyze the data .The
relationship between supply and demand is studied by statistical methods; Again imports and exports, inflation
rates, and per capita income are problems which require a good knowledge of statistics. That’s why Economics is
highly related with Statistics.

Economics & Sociology: Sociology and Economics have close relations. Society is greatly influenced by economic
factors, and economic processes are largely determined by the environment of the society. Economics deals with the
economic activities of man. It deals with production, consumption and distribution of wealth. Without economic
conditions, the study of society is quite impossible. All the social problems are directly connected with the economic
conditions of the people.
Q 2 a) what is meant by Opportunity cost? 10

Suggested Answer:

a) Opportunity cost simply is the cost of losing an alternative. It is chance of profit we voluntary ignore due to chose
one project while choosing a project.

When we think about investing project or buying an asset or make any decision, there may be many alternatives .But
we may not have sufficient resources like money or material or manpower to choose more. Then we have to chose
the best one and ignore the other alternatives. Those rejected projects or investment might bring profit for us but we
are losing this chance of profit as we haven’t invests those projects. As per economics terms, these ignored projects
are opportunity cost of those sleeted projects.

As example Nur Ltd has resources to invest in project A only that it can’t invest B.Project B would offer 30 lacs
taka where projects A offers 40 lacs.As Nur ltd has chosen project A, so project B is the opportunity cost of Project
A.

Why Opportunity cost?

The term Opportunity cost is the result of basic economic problem-limited resources, unlimited demands and
opportunities.

Importance of Opportunity cost

-- It helps to determine prices

--it helps to fix remuneration of a factor of production

--it ensures efficient allocation of resources.

Limitation:

--it is based on perfect competitive market only

--sometimes factors are reluctant to move alternatives.

b) What is implication of opportunity cost curve being 1) convex 2) concave 3) straight line?

Suggested Answer:

We can find opportunity cost concept in a production possibilities curve (PPF) .PPF is a graphical representation of
a combination of two goods that a country can produce with a given amount of resources.

Implication the curve being convex:

PPC curve can be convex to the origin when the opportunity cost decreases. This can happen only when less and less
units are forgone of first commodity for the introduction of additional unit of another commodity.

Implication of curve being Concave:

PPC curve is concave to the origin because the opportunity cost of producing a good increases when we produce
more of that good. PPC is concave because of increasing Marginal opportunity cost.

Implication of curve benign straight line:

If the shape of the PPF curve is a straight-line, the opportunity cost is constant as production of different goods is
changing. Same amount of a commodity is sacrificed to gain an additional unit of another commodity. It is possible
only when we assume that all the resources are equally efficient in production of all goods. In such case puff will be
a straight line.

Q3.a) what is law of deamd? Illustrate it with diagram.

Suggested Answer:

Demand is the number of units a buyer wants to buy at a certain price within a specific time. Study of demand is an
important aspect if economics.

Law of demand means the relationship between demand and price. In general, law of demand tells that demand of a
product will fall if price of that product rises. Again, fall in price will lead more demands.

Law of demand from demand schedule:

Price Demand of apple

8 12

6 15

4 18

Here, we see that price falls and buyers want more apples.
Law of Dead curve

b) What is meant by the phrases other things remain same?

Suggested Answer:

.There is many factors that have deep impact on demand. Price is one of them. The phrases given mean other factors
without price. These factors are

-income of consumer because consumers can afford extra price if income is high

-if price of alternative products doesn’t rise, consumer can buy these/

-no change in consumers tastes, and buying patterns

-size of populations doesn’t change.

c) State, if any, exception of law of demand:

Suggested Answer:

Though law of demand is widely applicable, it has some cases where the law doesn’t work. It means in some cases,
fall in price may not bring more demand. These exceptions are:

1. Change in income:

When income of some consumers falls, they may try to cut expenditures and demand may fall even price doesn’t
cahnage.Agiain,a banker having increased income now may try to buy a car now price rises.

2.Inferior goods:

Inferiors goods are luxury goods people buy mainly to make their like more comfortable and with high status. These
goods have buyer of high income groups.So rise if price doesn’t lead fall in demand rather may rise demand as high
price means high quality and more status to them.

3. Change in fashion:

Fashion is an important determinant of demand. It has become a fashion to have wireless phone at households so
land phones has lost customers and fall in price may not attract customers.
4. Chance of a rise in price in Future (Speculation):

If the consumer thinks that the price of particular goods will increase in the future, they will store it. In other words,
the demand for those goods shall increase at the same price. But this law states that demand should go up only of
price falls.

6. Highly Essential Good:

Finally, in the case of certain highly essential items such as life-saving drugs, people buy a fixed quantity no matter
prices rise or fall.

Q4.a) Using formulas, distinguish between price elasticity of demand and income elasticity of demand.

Suggested Answer:

Elasticity tells us how much demand changes if price or income or supply changes. So price and income elasticity of
demand are related each other. Hence they have some differences between them .They are:

Price elasticity of demand (PED) Income elasticity .of demand (YED

1. The effect on demand if price changes 1.the effect on demand if income changes

2. Demand falls if prices raise 2.deamand rises when income rises

3. Formula: %change in quantity /% change in price 3. %change in quantity /% change in price

b) What is the importance of PED in real life?

Hints:

Inelastic PED: Demand not fall even price rise. Example price of rice

Elastic PED: Demand falls when price rises. Example: price of luxury car.

Suggested Answer:

Price elasticity of demand (PED) is a calculation that shows the impact on demand of a product or services when
price of that product or service changes.PED can be elastic or inelastic.PED is very important in real life. There are
discussed below:

1. Determination of price: Pricing is very important because the success of a product vastly depends on its prices.
If PED is elastic, it means o small change in price will bring larger change in demand. So if the firm needs to change
prices, PED must be considered.

2. Short term profit target: When a firm wants to ensure short term profit, it may raise price only those product
with inelastic PED. Because those products are less sensitive to price and rise in price many reduces demand and
sales revenues.

3. Formulation of Government Policies: The concept of price elasticity of demand is important for formulating
government policies, especially the taxation policy. Government can impose higher taxes on goods with inelastic
demand, whereas, low rates of taxes are imposed on commodities with elastic demand.
4. Wages determination: PED helps of to determine wages. Because elastic PED may lead to lower wages as firms
may try to cut wages to keep price lower to ensure more sales.

5. Return to factor of production: PED helps to determine reward of factor of production as inelastic PED may
have higher return than elastic PED.

c) Estimate PED if prices fall from 5tk to 3 tk and demand rise from 5 tk to 8 tk.

Hints: Formula %change in quantity /% change in price

%change = new price-old price/old prices

PED 1 = unitary elastic

PED more than 1 =Elastic

PED less than 1 =inelastic

1% PED means if price rise 1% tk demand will fall by 1% unit

Suggested Answer:

Given,

%change in price = 5-3/5 *100=40%

%change in demand = 8-5/5*100=60%

PED= 40%/60% = 0.67

PED 0.67 is less than 1 so PED is inelastic.

Q5.a) Distinguish perfect competition and monopolistic competition.

Suggested Answer:

Perfectly Competition: Monopolistic competitive

1. There are many buyers and sellers of similar goods or services 1.Many sellers of closely substitute goods.

2. No price control by buyers and sellers 2.Seller can control price

3. No barriers to entry or exit 3.Few barriers to entry or exit.

4. Type of products is Standardized 4.Type of product is differentiated.

5. Market situation is unrealistic 5.Realistic market situation

6. Average revenue is equal to marginal revenue 6.Average revenue is greater than marginal revenue

17. Example: Fish and vegetable market 7.Example: Restaurants markets

b) How equilibrium price and output is determined by monopoly firm.

Suggested Answer:

Monopoly is a market condition where there are many buyers but one seller. Market equilibrium is the market
condition where soupy is equal to demand at a particular price.

There are three possibilities for a firm’s Equilibrium in Monopoly. These are:

1. The firm earns normal profits when the average cost = the average revenue.

2. It earns super-normal profits when the average cost is less the average revenue.

3. It incurs losses when the average cost is greater than average revenue.

The Equilibrium level in monopoly is that level of output in which marginal revenue equals marginal cost. The
producer will continue producer as long as marginal revenue exceeds the marginal cost. At the point where MR is
equal to MC the profit will be maximum and beyond this point the producer will stop producing.

Diagram shows that at OM output, marginal revenue is greater than marginal cost, but beyond OM the marginal
revenue is less than marginal cost. Therefore, the monopolist will be in equilibrium at output OM and OP price
where marginal revenue is equal to marginal cost and the profits are the greatest.

Q6 a) what is production meant in Economics?

Suggested Answer:

Production means creation of goods. We say the carpenter has produced the chair. But in Economics it is a wrong
view. The carpenter has given shape to the wood which is a free gift of nature. As a result, it has become more
useful to us than before. So, he has created additional utility. So production in Economics means creation of new
utility. Man takes the things given by nature and simply gives it a new form so that it becomes more useful to us
than before.

Production requires co-operation of certain factors. These are known as factor of production. They are land, labour,
capital and enterprise.

Three Types of Production:

 Primary Production: Primary production is carried out by 'extractive' industries like agriculture, forestry,
fishing, mining and oil extraction. ...
  Secondary Production: manufacturing goods from raw material

 Tertiary Production-buying or selling of manufactured goods or providing services.

b) What is fixed cost, variable cost and show correct position of total cost, total fixed cost, and total variable cost
curve in a diagram?

Suggested Answer:

Fixed cost: Fixed cost is a cost that doesn’t change when production units change. It includes rent, salaries, and
interest expenses. A firm needs to continue such expenses no matter production is going or not. Fixed cost reduction
is a way to reduce total cost to earn more profit.

Variable cost: Variable is a cost the changes with the change in production level. It depends on number of outputs
to be produced. Raw materials, factory workers wages etc .No production means no variable cost. Reduction in
variable cost may be a wise decision because it may lead to poor quality raw material which may hamper product
quality.

Cost curve diagram:

Here Total cost =total variable cost +total fixed cost

Total cost starts from fixed cost point.

Q7 a) what is inflation and why does it happen?

Suggested Answer:

Inflation is gradual rise in price of daily necessaries. Inflation is the percentage rate that show whether the price of
daily necessaries rise or fall and at which rate it rises or falls. Inflation is important element and field of study of
economics.

There are many reasons behind inflation. Among them, the followings are most important:
1. Aggregated Demand: When demand rises, producers try to raise more prices to earn more profit. Again, more
demand may lead to shortage of supply and finding no way consumers may be ready to pay more which lead to
inflation.

2. Rise in cost of production: When cost of production rises, producer find no way without rising price to cover extra
cost paid during production. It may include rise in raw material cost or higher wages etc.

3. Low interest rate: When interest of loan is lower, consumer may take loan to buy products thus demand rises and
they can afford extra prices. Thus inflation takes places.

4. High rate of Taxation: When govt introduce extra VAT on a product, it will lead to higher prices. Again, when
direct tax like indirect tax rises, producer may raise price to earn more coins so that they can pay extra tax.

b) Accounts for recent increases inflationary pressure in Bangladesh?

Suggested Answer: Bangladesh is developing country and inflation is an important macroeconomic issue of
Bangladesh. Inflation helps a country to boost up economy and it also hampers economic developments also. Hence;
Bangladesh is facing inflationary pressure recent years. The reasons behinds it is discussed below:

Firstly, demand of daily necessaries like rice, fish, and vegetable is increasing due to population growth but supply
of these is not increasing accordingly. The gap between demand and supply makes producers of Bangladesh to raise
prices.

Secondly, Govt is maintaining deficit budget and to finance deficit budget, govt is asking National Board of
Revenue to raise taxation and increase the net of taxation. Thus extra tax has created inflationary pressure.

Thirdly, Govt is discouraging many producers to be imported from abroad. This creates a monopolistic market
situation for daily necessaries. Thus price is controlled by them.

Fourthly, Black marketing and illegal warehousing also lead to inflation .Dishonest businessmen create artificial
shortage in market of products and then they start supply at a higher price.

Remedies:

Inflationary pressure is not the result of single events. There are many reasons responsible for it. So to control
inflationary pressure, the root causes of it need to be identified than remedies should be applied accordingly. Some
important remedies are given below:

1. Introduction of maximum price;

Govt may introduce maximum price of raw material and finished goods so that none can sell products above that.

2. Providing subsidy:

Subsidy is given to producers to reduces cost of production .Thus it may reduce price per unit of products.

3. Contarctionary monetary policy:

Govt may raise interest rate so that the consumers are not taking loan to buy products .This will lead aggregated
demand and producer will reduce price to avoid loss.

4. Contrationary fiscal policy:

If govt cuts public sector spending, budget deficit reduces and govt feels less need of higher rate of taxation now.

Q8.a) Distinguish Balance of trade and balance of payment?

Suggested Answer:

Balance of Trade (BOT) Balance of payments (BOP)

1. It contains only visible goods like physical products 1.It contains both visible and invisible goods.

2. BOT is a part of BOP. 2. BOP is greater as it is related to current and capital

account

3. BOT is either favourable or unfavourable 3.BOP always produce equal balance.

b) Prepare a hypothetical balance of payments of Bangladesh and explain its components?

Suggested Answer:

Blanca of payment has mainly two sides –debit and credit sides. A hypothetical balance of payment is given below:

CREDIT(inflow of foreign exchange) tk. DEBIT(outflow of foreign exchange) tk

Export of goods(visible goods) 550 Import of goods(visible) 800

Export of services(invisible goods) 150 Import of services (invisible) 50

Unilateral transfer (gifts or donation received Unilateral transfer (gifts or donation paid
From foreigners) 100 To foreigners) 80
Capita receipts(Borrowing from abroad) 200 Capital payments(repaid foreign loan
and interest payment) 70
TOTAL RECEIPT 1000 TOTAL PAYMENTS 1000

Components of Balance of payments:

Exports and imports of visible good: These are physical goods like machineries, electric goods, agricultural goods
etc

Export and import of invisible goods: These are services traded like education, consultation, medical treatment

Unilateral transfer: This is money received or paid as charity or subsidy or free gifts for developments

Capital receipt: When balance of payment doest produce equal balance, govt needs to take foreign debt to finance
the balance of payment

Q 9.a)How does FDI helps accelerate a country’s economic growth?

B)how Bangladesh may attract FDI?

Suggested Answer:

Foreign Direct Investment(FDI) is the investment by a foreign country inside another country for development.
In such case, investing country retains ownership and the invested country controls the business.FDI is a popular
form of international trade. It helps accelerate development of a country in many ways.

Firstly govt should offer financial incentives to boost up FDI.Banglasdeshi govt should offer lower taxes or almost
no taxes. Thus FDI will become more profitable at investing country’s point of view.

Secondly, Govt should build necessary infrastructure for FDI and such provision will make FDI effective. Lack of
infrastucture may lead to loss of projects.

Thirldlly,govt should make policies easy and friendly to FDI so that the investing country will not seek country for
FDI.Govt should also formulate monetary and fiscal policy favourable to FDI.

Fourthly, Bangladesh should continue and quality supply of power, water and fuel for the projects to be invested
through FDI .Sufficient support of utility will make FDI more profitable.

Lastly, govt should try to improve bilateral relationship with potential country from where Bangladesh may expect
FDI.

Finally, FDI is an important mode of international trade where Bangladesh is facing competition with
other developing and under developed country. So Bangladesh should try to make a ground where FDI will get more
rewards

10. SHORT NOTES

Geffen Goods

Geffen goods are those products whose demand rises even prices rises.Geffen products don’t follow law of demand.
People buy more greffen products when price rises.Geffen goods are inferior goods. Large portion of people
consume it and there are almost no close substitute products of geffen goods. Again demand of Geffen goods falls
when income rise. Some examples of Geffen goods that economists have identified include agricultural staples such
as: potatoes, rice, and corn.

Cross Elasticity of Demand

Cross elasticity is a calculation that shows the impact on a demand of a products when price of its alternative
productive changes. It shows relationship among products having more substitutes.

Formula = %change of a demand product A /%change of price of product B

The cross elasticity of demand for substitute goods is always positive because the demand for one good increases
when the price for the substitute good increases. For example, if the price of coffee increases, the quantity
demanded for tea (a substitute beverage) increases as consumers switch to a less expensive.

Substitution Effect on Price changes

Substitution effect means an effect due to the change in price of a good or service, leading consumer to replace
higher priced items with lower prices ones. The substitution effect is the change in consumption patterns due to a
change in the relative prices of goods.Ex example, if tuition fees of private colleges rise by 20% but tuition fees of
public college rises by 5%, then we may see that more students will shift from private college to public college.
Substitution is very important or formulation of macroeconomic policies by a govt.
 GDP as factor cost

Gross domestic product (GDP) is the total products produced and services rendered inside a country within a
specific time period especially one year.GDP at factor cost includes all the elements of GDP at market price except
net indirect taxes (indirect taxes-subsidies). GDP is calculated at market prices of each commodity. Now, the market
price includes the cost of production per unit plus the indirect taxes per unit levied by the government minus the
subsidies. So if we deduct total indirect taxes and add total subsidies to GDP (at market price) we get GDP at factor
cost.

GDP at market price is a strong indicator of economic growth but GDP as factor cost is more effective. The reason is
simple because GDP at factor cost considers indirect taxes, subsidies etc. which may affect the data. If the
Government tries to raise the subsidies, the Difference between the GDP at factor cost and GDP at market price will
increase. The same is opposite for Indirect taxes.

Index Number

Index number is statistical tools used in economics in the context of inflation. Index number is popularly known as
consumer price index. An index number is a figure reflecting price or quantity compared with a base value. The base
value always has an index number of 100. The index number is then expressed as 100 times the ratio to the base
value.

For example, if annual production of a particular chemical rose by 35%, output in the second year was 135% of that
in the first year. In index terms, output in the two years was 100 and 135 respectively. Index numbers have no units.

There are three types of index numbers which are generally used. They are price index, quantity index and
value index. These index numbers can be developed either by aggregate method or by average of relative method.

Terms of Trades

Terms of trade are measured by the ratio of import prices to export prices. It shows how many units of exports are
required to purchase a single unit of imports.

Formula:

Terms of Trade = Price of Imports and Volume of Imports

Price of Exports and Volume of Exports
When more capital is leaving the country then is entering into the country then the country’s terms of trade is less
than 100%. When the terms of trade is greater than 100%, the country is gaining more capital from exports than it is
spending on import.

The terms of trades used as an indicator of a country’s economic health, but it can lead analysts to draw the wrong
conclusions. Changes in import prices and export prices impact the terms of trades, and it's important to understand
what caused the price increases or decreases.