Question

a. i. What is the impact of the behaviour of cost of production on elasticity of supply?
ii. Draw and explain the following degrees of elasticity of supply:
1. $\epsilon p=\infty$
2. $\epsilon p=0$
3. $\epsilon p>1$
b. What are commercial banks? Explain clearly three methods adopted by commercial banks to borrow money from the public.

Answer 1

a. (i) Nature of cost of production:
Elasticity of supply depends upon change in the cost of producing additional quantity of output. If an increase in output by the firms in an industry causes only a slight increase in their cost per unit or leads to decrease in cost per unit, we would expect supply to be fairly elastic. If, on the other hand, increase in supply leads to a large increase in "cost of production, the supply would be relatively inelastic.'
ii. (1)$\epsilon p=\infty$ Perfectly Elastic Supply : In this figure, PS is perfectly elastic supply curve. It is parallel to X-axis. At price OP supply may $O{Q}_1$ or $O{Q}_2$. Symbolically, it can be said that $\epsilon p=\infty$ or elasticity of supply is infinity. It is purely an imaginary concept. When a minute change or- without any change in price, supply may change to any extent, then the supply is perfectly elastic.
2. $\epsilon p=0$ ie. Perfectly Inelastic supply: The supply of a commodity is said to be perfectly inelastic when quantity supplied does not change at all in response to change in its price. In such a case, supply curve becomes vertical or parallel to Y-axis. The fig. clearly indicates that supply remains fixed at OS, even when price rises to $O{P}_1$ or fall to $O{P}_2$. The numerical values of elasticity of supply in this case will be zero.
3. $\epsilon p>1$ i.e. More elastic supply. In this figure, supply curve SS is more elastic as in this case $\delta P<\delta Q$. Mathematically, more elastic supply can be represented as $\epsilon >1$. Supply is said to be more elastic when a small change in the price brings about a large change in quantity supplied.
(b) Commercial bank is a financial institution which deals in money i.e. borrowing and lending of money. It performs the functions of accepting
deposits from the general public and giving loans for investing to them with the aim of earning profit. The three methods adopted by commercial banks to mobilise funds from the public are as under:
1.Cash Credit: In cash credit, the bank advances a cash loan upto a specified limit to the customer against a bond or other security. A borrower is required to open a current account and bank allows the borrowers to withdraw upto the full amount of the loan. The interest is charged only on the amount actually utilized by the borrower and not on the loan sanctioned.
2. Loans: A loan is granted against some kind of security of assets or personal security of the borrower and the interest is charged on the full amount sanctioned as loan, irrespective of the fact whether full amount or part of it has been used. In case of loans, the borrower is provided with the facility to repay the loan in installment or as a lumpsum.
3. Overdraft: The overdraft facility is allowed to the depositor maintaining a current account with the bank. According to this facility, a borrower is allowed to withdraw more amount than what he has deposited. The excess amount so withdrawn has to be repaid to the bank in a short period and that too with interest. The rate of interest is usually charged more than that charged in case of loans. However, the overdraft facility is given only against security of some assets or on personal security of the customer.