Tutor profile: Kirti D.
What is the type 1 and type 2 error in hypothesis testing?
Hypothesis testing is the procedure of testing the claim about the value of the parameter. To test the hypothesis, we set null and alternative hypotheses. For example, if the company claims that the true average working life of the product with new features is 1000 hours. Then, we set the null hypothesis (H0) equal to 1000. And, the alternative hypothesis (H1) not equal to 1000. In following the procedure of testing, there is a possibility of making errors. When the null hypothesis is rejected when it is true, it is known as a type 1 error. While, when the null hypothesis is not rejected when it is false, this is known as type 2 errors. So, in the above example, when the null hypothesis of ‘average working life of the product with new features is 1000 hours’ is rejected when it is true, it consists of type 1 error. And, when the alternative hypothesis of “average working life of the product with new features is 1000 hours” is not rejected, when it is false, it consists of type 2 error.
Explain the Quantity theory of money using Fisher’s Equation of Exchange.
The quantity theory of Money explains the relationship between money supply in the economy and price levels. Fisher claimed that the money supply in the economy directly relates to the price level in the economy. So, an increase in the money supply by the central bank will lead to an equivalent rise in prices. He used the equation of exchange to explain this relation, which is; M*V = P*Y where M is the money supply. V is the velocity of money, which means how many times money changes hands or the number of times on average a particular unit of currency is used to make transactions. P is the price level in the economy. And, Y is the real GDP. V is considered as constant in the economy and Y is given for a particular time period. So, if the central bank in the economy increases the money supply, it will directly impact prices, and prices in the economy will rise by the same proportion.
Question1. Explain the meaning of cross elasticity of demand and based on the concept, how can we differentiate between substitutes and complements?
Cross elasticity of demand measures the change in demand of the commodity due to the change in the price of another commodity. Say, there are two goods, X and Y, cross elasticity of demand measures the percentage change in demand of X due to the percentage change in price of Y. Mathematically, Cross elasticity of Demand (Exy) = % Change in demand of X/ % Change in price of Y Or, Exy = (Change in demand of X/Change in price of Y) *(Original Price of Y/Original Quantity Demanded of X). Now, Substitutes are the goods that can be used in place of each other. For example, tea and coffee. So, if the price of tea increases, people switch to coffee. This means that increase in the price of tea leads to an increase in demand for coffee. It shows that substitutes have a direct relationship with each other. So, if the cross elasticity of demand shows a positive sign, it means that goods are substitutes. On the contrary, Complements are the goods that are used together. For example, car and petrol. So, in this case, if the price of one increases, the demand for the other falls. Say, if the price of cars increases, people buy less of car and thus, demand petrol increases. Hence, if we get a negative sign with cross elasticity of demand, it shows that goods are complements.
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