ECO 06 Economic Theory Solved Question Paper June 2026 for IGNOU B.Com (BDP)

Question 1 (12 marks)

1. Explain the term Economy. Discuss the fundamental problems of an economy. Explain with examples.

Meaning of an economy

An economy is the system through which a society organises the production, exchange, distribution and consumption of goods and services. Farms, factories, shops, banks, households and the government are all parts of it. Together they decide how the resources of a country are used to satisfy the wants of its people.

Every economy rests on two basic facts. Human wants are unlimited and keep growing; once one want is met, another takes its place. The resources needed to meet them, such as land, labour, capital and entrepreneurship, are limited. These resources also have alternative uses: a plot of land can grow wheat or sugarcane, but not both at the same time.

Because of this scarcity, every society has to choose. Lionel Robbins captured this idea in 1932 when he described economics as the study of human behaviour as a relationship between ends and scarce means that have alternative uses. An economy is therefore best understood as a system of choice-making under scarcity.

The basic decision-making units of an economy are households, which supply factors and buy goods, firms, which hire factors and produce goods, and the government, which taxes, spends and regulates. Their combined decisions form a circular flow of income and spending.

Fundamental problems of an economy

Whether a country is rich or poor, capitalist or socialist, it must solve the same set of central problems. These are explained below with examples.

1. What to produce and in what quantities. A society cannot produce everything it wants, so it must decide which goods to produce and how much of each. More resources for defence equipment means fewer for schools and hospitals. A farmer with limited land must decide how many acres go to wheat and how many to mustard.

This choice can be shown with a production possibility curve (PPC). Suppose an economy uses all its resources to produce only two goods, wheat and cloth. The table below shows some combinations it can produce.

Moving from A towards F, each extra lakh metres of cloth costs more wheat (1, then 2, 3, 4 and 5 lakh tonnes). This rising sacrifice is the opportunity cost of cloth. Plotted on a graph, the combinations form a curve that is concave to the origin. Choosing one point on it is the "what to produce" decision.

2. How to produce. Once the goods are chosen, the economy must decide the technique of production. A labour-intensive technique uses more workers and less machinery, such as handloom weaving. A capital-intensive technique uses more machines, such as a modern power-loom mill. A labour-surplus country like India often prefers labour-intensive methods in some sectors to create jobs, while other sectors need machines for quality and speed.

3. For whom to produce. This is the problem of distribution: how the total output is shared among people. It depends on how income is divided among the owners of land, labour, capital and enterprise as rent, wages, interest and profit. A government can change this pattern through progressive income tax, subsidised ration under the public distribution system, or old-age pensions.

4. How efficiently resources are used. An economy must make sure its scarce resources are not wasted and are fully employed. Idle factories, unemployed workers or land left fallow mean the economy is producing at a point inside its PPC. Reducing waste and unemployment moves it back to the curve.

5. Provision for growth. A society must also decide how much to consume today and how much to save and invest for tomorrow. Building roads, power plants and research capacity shifts the PPC outward over time. A country that consumes everything today has little left for future growth.

How different economies solve these problems

In a capitalist or market economy, these problems are solved mainly by the price mechanism: producers make what earns profit, choose the cheapest technique, and goods go to those who can pay. In a socialist economy, a central planning authority takes these decisions. In a mixed economy such as India, both the market and the government play a role.

Conclusion

An economy is a system for using scarce resources to meet unlimited wants. Scarcity forces every economy to answer what to produce, how to produce, for whom to produce, how to use resources efficiently and how to grow. The way a society answers these questions decides the type of economic system it has.

Question 2 (12 marks)

2. Explain the Law of Diminishing Marginal Utility. What are the limitations ?

Meaning of utility and marginal utility

Utility is the want-satisfying power of a commodity. Total utility (TU) is the total satisfaction a consumer gets from consuming a given number of units. Marginal utility (MU) is the extra satisfaction from one more unit, so MU of the nth unit equals TU of n units minus TU of (n - 1) units. The cardinal approach assumes utility can be measured in units called utils.

Statement of the law

The law was developed by H.H. Gossen and explained in detail by Alfred Marshall in his Principles of Economics (1890). Marshall stated that the additional benefit a person derives from a given increase in his stock of a thing diminishes with every increase in the stock he already has.

In simple words, as a consumer takes more and more units of a commodity in one sitting, the satisfaction from each extra unit keeps falling. After a point, MU becomes zero, and if consumption continues it can turn negative.

Assumptions of the law

The law holds only under these conditions: (i) utility is measurable in cardinal numbers; (ii) all units are homogeneous in size and quality; (iii) units are of a reasonable, standard size; (iv) consumption is continuous, with no time gap; (v) the consumer's income, tastes, habits and the prices of goods stay unchanged; (vi) the consumer is rational; and (vii) the marginal utility of money stays constant.

Explanation with a schedule

Suppose a thirsty person drinks glasses of water one after another. The schedule below shows how the satisfaction changes.

The first glass gives the highest satisfaction of 10 utils because the thirst is intense. Each following glass adds less: 8, 6, 4 and 2 utils. At the sixth glass MU is zero and TU reaches its maximum of 30 utils, which is the point of satiety. The seventh glass gives negative MU, so TU falls to 28.

Diagram

In the diagram, units of the commodity are measured on the X-axis and utility on the Y-axis. The MU curve slopes downward from left to right and cuts the X-axis at the sixth unit, then goes below it. The TU curve rises at a decreasing rate, peaks at the sixth unit where MU is zero, and then turns down. So TU rises while MU is positive, is maximum when MU is zero, and falls when MU is negative.

Why marginal utility diminishes

Two reasons explain the law. First, each particular want is satiable; the more it is satisfied, the weaker its intensity. Second, goods are imperfect substitutes for one another, so after a point extra units of the same good cannot satisfy other wants of the consumer.

Limitations of the law

1. Utility cannot be measured cardinally. Satisfaction is a mental feeling. Saying the first glass gives exactly 10 utils is not realistic, which is why later economists such as Hicks and Allen preferred the ordinal indifference curve approach.

2. Constant marginal utility of money is unrealistic. As a person spends money, the money left with him falls, so the utility of each remaining rupee rises. The law ignores this.

3. Unrealistic assumptions. In real life tastes, fashion, income and prices change, and consumption is rarely continuous. Once these change, the law may not hold.

4. Rare collections and hobbies. For a stamp or coin collector, each new rare piece can give more satisfaction because it completes the collection.

5. Small or indivisible units. If units are too small, such as a spoonful of water to a very thirsty person, the second or third unit may give more satisfaction than the first.

6. Addictive goods and misers. A drunkard may feel greater satisfaction from each extra drink, and a miser may feel greater satisfaction as his wealth grows. Such behaviour does not follow the law.

7. Complementary goods and prestige goods. One tyre gives little utility without the others, and for status goods like jewellery the satisfaction may rise as the stock grows because it signals social standing.

Conclusion

The Law of Diminishing Marginal Utility is a basic law of consumption and explains why a demand curve slopes downward: a consumer buys more units only at a lower price because each extra unit gives less satisfaction. Despite its limitations, the law holds for most ordinary goods and helps explain consumer equilibrium, consumer's surplus and progressive taxation.