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Managerial economics
1. Managerial economics — Document Transcript
1. Master of Business Administration Semester I MB0042 – Managerial Economics
Assignment Set- 1Q1. What is a business cycle? Describe the different phases of a
business cycle.Ans.The business cycle describes the phases of growth and decline in an
economy. The goalof economic policy is to keep the economy in a healthy growth rate --
fast enough to create jobsfor everyone who wants one, but slow enough to avoid
inflation. Unfortunately, life is not sosimple. Many factors can cause an economy to spin
out of control, or settle into depression. Themost important, over-riding factor is
confidence -- of investors, consumers, businesses andpoliticians. The economy grows
when there is confidence in the future and in policymakers, anddoes the opposite when
confidence drops. The phase of the Business CycleThere are four stages that describe the
business cycle. At any point in time you are in oneof these stages: 1. Contraction - When
the economy starts slowing down. 2. Trough - When the economy hits bottom, usually in
a recession. 3. Expansion - When the economy starts growing again. 4. Peak - When the
economy is in a state of "irrational exuberance."
2. Who Determines the Business Cycle Stages?The National Bureau of Economic
Research (NBER) analyzes economic indicators to determinethe phases of the business
cycle. The Business Cycle Dating Committee uses quarterly GDP growth rates asthe
primary indicator of economic activity. The Bureau also uses monthly figures, such as
employment,real personal income, industrial production and retail sales. What GDP Can
You Expect in Each Business Cycle Phase?In the Contraction phase, GDP growth rates
usually slow to the 1%-2% level before actuallyturning negative. The 2008 recession was
so nasty because the economy immediatelyshrank 1.8% in the first quarter 2008, grew
just 1.3% in the second quarter, before fallinganother 3.9% in the third quarter, and then
plummeting a whopping 8.9% in the fourth quarter.The economy received another wallop
in the first quarter of 2009, when the economy contracteda brutal 6.9%.
3. Q2. What is monetary policy? Explain the general objectives and instruments of
monetary policy?Ans. Monetary PolicyMonetary policy, in its narrow concept, is defined
as the measures focused on regulating moneysupply. In harmony with monetary policy
goals, as will be shown later, and adopting the mostcommon concept of monetary policy
as one of the central bank‘s functions, monetary policy isdefined as ― the set of
procedures and measures taken by monetary authorities to manage moneysupply, interest
and exchange rates and to influence credit conditions to achieve certaineconomic
objectives‖. We find this definition more consistent with the practical applications
ofmonetary policy, particularly with respect to the difference from one country to another
inobjectives selected as a link between the instruments of monetary policy and its
ultimate goals. First: Monetary Policy and General Economic PoliciesMonetary policy is
basically a type of stabilization policy adopted by countries to deal withdifferent
economic imbalances. Since monetary policy covers the monetary aspect of the
generaleconomic policy, a high level of co-ordination is required between monetary
policy and otherinstruments of economic policy. Further, the effectiveness of monetary
policy and its relativeimportance as a tool of economic stabilization various from one
economy to another, due todifferences among economic structures, divergence in degrees
of development in money andcapital markets resulting in differing degree of economic
progress, and differences in prevailingeconomic conditions. However, we may briefly
2. mention that the weak effectiveness which isusually attributed to monetary policy in
developing countries is caused by the fact that theeconomic problems in these countries
are mainly structural and not monetary in nature, while thelimited effectiveness of
monetary policy in countries which lack developed money marketsoccurs because
monetary policy is deprived of one of its major tools, the instrument of openmarket
operations.Also, there are those who belittle the effectiveness of monetary policy in time
of recession,comparing the use of this policy in controlling recession as ―pressing on a
spring‖. Many otherssee monetary policy as ineffective in controlling the inflation that
results from an imbalancebetween the demand and supply of goods and services
originating from the supply side, whilethey confirm the effectiveness of monetary policy
in controlling inflation that results fromincreased demand. However, this does not
preclude the effectiveness of monetary policy as aflexible instrument allowing the
authorities to move quickly to achieve stabilization, apart fromits importance in realizing
external equilibrium in open economies.
4. Monetary Policy InstrumentsThe set of instruments available to monetary authorities
may differ from one country to another,according to differences in political systems,
economic structures, statutory and institutionalprocedures, development of money and
capital markets and other considerations. In mostadvanced capitalist countries, monetary
authorities use one or more of the following keyinstruments: changes in the legal reserve
ratio, changes in the discount rate or the official keybank rate, exchange rates and open
market operations. In many instances, supplementaryinstruments are used, known as
instruments of direct supervision or qualitative instruments.Although the developing
countries use one or more of these instruments, taking intoconsideration the difference in
their economic growth levels, the dissimilarity in the patterns oftheir production
structures and the degree of their of their link with the outside world, manyresort to the
method of qualitative supervision, particularly those countries which face
problemsarising from the nature of their economic structures. Although the effectiveness
of monetarypolicy does not necessarily depend on using a wide range of instruments,
coordinated use ofvarious instruments is essential to the application of a rational
monetary policy.
5. Q3. A firm supplied 3000 pens at the rate of Rs 10. Next month, due to a rise of in
theprice to 22 Rs. per pen the supply of the firm increases to 5000 pens. Find the
elasticity ofsupply of the pens.Ans.Of course, consumption is not the only thing that
changes when prices go up or down.Businesses also respond to price in their decisions
about how much to produce. Economistsdefine the price elasticity of supply as the
responsiveness of the quantity supplied of a good to itsmarket price.More precisely, the
price elasticity of supply is the percentage change in quantity supplieddivided by the
percentage change in price.Suppose the amount supplied is completely fixed, as in the
case of perishable pen brought tomarket to be sold at whatever price they will fetch. This
is the limiting case of zero elasticity, orcompletely inelastic supply, which is a vertical
supply curve.At the other extreme, say that a tiny cut in price will cause the amount
supplied to fall to zero,while the slightest rise in price will coax out an indefinitely large
supply. Here, the ratio ofthe percentage change in quantity supplied to percentage change
in price is extremely large andgives rise to a horizontal supply curve. This is because the
polar case of infinitely elastic supply.Between these extremes, we call elastic or inelastic
depending upon whether the percentagechange in quantity is larger or smaller than the
3. percentage change in price. Price elasticity ofdemand is a ratio of two pure numbers, the
numerator is the percentage change in the quantitydemanded and the denominator is the
percentage change in price of the commodity. It ismeasured by the following formula:Ep
= Percentage change in quantity demanded/ Percentage changed in price Applying
theprovided data in the equation: Percentage change in quantity demanded = (5000 –
3000)/3000Percentage changed in price = (22 – 10) / 10Ep = ((5000 – 3000)/3000) / ((22
– 10)/10) = 1.2.
6. Q4. Give a brief description of: a. Implicit and explicit cost b. Actual and opportunity
costAns. a. Implicit and explicit cost Implicit costIn economics, an implicit cost, also
called an imputed cost, implied cost, or notional cost, isthe opportunity cost equal to what
a firm must give up in order using factors which it neitherpurchases nor hires. It is the
opposite of an explicit cost, which is borne directly. In other words,an implicit cost is any
cost that results from using an asset instead of renting, selling, or lendingit. The term also
applies to forgone income from choosing not to work.Implicit costs also represent the
divergence between economic profit (total revenues minus totalcosts, where total costs
are the sum of implicit and explicit costs) and accounting profit (totalrevenues minus
only explicit costs). Since economic profit includes these extra opportunity costs,it will
always be less than or equal to accounting profit Explicit costAn explicit cost is a direct
payment made to others in the course of running a business, such aswage, rent and
materials, as opposed to implicit costs, which are those where no actual paymentis made.
It is possible still to underestimate these costs, however: for example,
pensioncontributions and other "perks" must be taken into account when considering the
cost of labour.Explicit costs are taken into account along with implicit ones when
considering economicprofit. Accounting profit only takes explicit costs into account.
7. b. Actual and opportunity cost Actual costAn actual amount paid or incurred, as
opposed to estimated cost or standard cost. In contracting,actual costs amount includes
direct labor, direct material, and other direct charges.Cost accounting information is
designed for managers. Since managers are taking decisionsonly for their own
organization, there is no need for the information to be comparable tosimilar information
from other organizations. Instead, the important criterion is that theinformation must be
relevant for decisions that managers operating in a particular environmentof business
including strategy make. Cost accounting information is commonly used in
financialaccounting information, but first we are concentrating in its use by managers to
take decisions.The accountants who handle the cost accounting information generate add
value by providinggood information to managers who are taking decisions. Among the
better decisions, the betterperformance of ones organization, regardless if it is a
manufacturing company, a bank, a non-profit organization, a government agency, a
school club or even a business school. The cost-accounting system is the result of
decisions made by managers of an organization and theenvironment in which they make
them. Opportunity costOpportunity cost is the cost of any activity measured in terms of
the value of the next bestalternative forgone (that is not chosen). It is the sacrifice related
to the second best choiceavailable to someone, or group, who has picked among several
mutually exclusive choices. Theopportunity cost is also the cost of the forgone products
after making a choice. Opportunity costis a key concept in economics, and has been
described as expressing "the basic relationshipbetween scarcity and choice". The notion
of opportunity cost plays a crucial part in ensuring thatscarce resources are used
4. efficiently. Thus, opportunity costs are not restricted to monetary orfinancial costs: the
real cost of output forgone, lost time, pleasure or any other benefit thatprovides utility
should also be considered opportunity costs.
8. Opportunity costs in productionOpportunity costs may be assessed in the decision-
making process of production. If the workerson a farm can produce either one million
pounds of wheat or two million pounds of barley, thenthe opportunity cost of producing
one pound of wheat is the two pounds of barley forgone(assuming the production
possibilities frontier is linear). Firms would make rational decisions byweighing the
sacrifices involved.
9. Q5. Explain in brief the relationship between TR, AR, and MR under different
marketcondition.Ans. Meaning and Different Types of RevenuesRevenue is the income
received by the firm. There are three concepts of revenue – 1. Total revenue (T.R) 2.
Average revenue (A.R) 3. Marginal revenue (M.R) 1. Total revenue (TR): Total revenue
refers to the total amount of money that the firm receives from the sale of itsproducts, i.e.
.gross revenue. In other words, it is the total sales receipts earned from the sale ofits total
output produced over a given period of time. In brief, it refers to the total sales
proceeds.It will vary with the firm‘s output and sales. We may show total revenue as a
function of the totalquantity sold at a given price as below.TR = f (q). It implies that
higher the sales, larger would be the TR and vice-versa. TR iscalculated by multiplying
the quantity sold by its price. Thus, TR = PXQ. For e.g. a firm sells5000 units of a
commodity at the rate of Rs. 5 per unit, then TR would be
10. 2. Average revenue (AR)Average revenue is the revenue per unit of the commodity
sold. It can be obtained bydividing the TR by the number of units sold. Then, AR = TR/Q
AR = 150/15= 10.When different units of a commodity are sold at the same price, in the
market, average revenueequals price at which the commodity is sold for e.g. 2 units are
sold at the rate of Rs.10 per unit,then total revenue would be Rs. 20 (2×10). Thus AR =
TR/Q 20/2 = 10. Thus average revenuemeans price. Since the demand curve shows the
relationship between price and the quantitydemanded, it also represents the average
revenue or price at which the various amounts of acommodity are sold, because the price
offered by the buyer is the revenue from seller‘s point ofview. Therefore, average
revenue curve of the firm is the same as demand curve of theconsumer.Therefore, in
economics we use AR and price as synonymous except in the context of
pricediscrimination by the seller. Mathematically P = AR. 3. Marginal Revenue
(MR)Marginal revenue is the net increase in total revenue realized from selling one more
unit of aproduct. It is the additional revenue earned by selling an additional unit of output
by theseller.MR differs from the price of the product because it takes into account the
effect of changes inprice. For example if a firm can sell 10 units at Rs.20 each or 11 units
at Rs.19 each, then themarginal revenue from the eleventh unit is (10 × 20) - (11 × 19) =
Rs.9. Relationship between Total revenue, Average revenue and Marginal Revenue
conceptsIn order to understand the relationship between TR, AR and MR, we can prepare
a hypotheticalrevenue schedule.
11. From the table, it is clear that:MR falls as more units are sold.TR increases as more
units are sold but at a diminishing rate.TR is the highest when MR is zeroTR falls when
MR become negativeAR and MR both falls, but fall in MR is greater than AR i.e., MR
falls more steeply than AR. Relationship between AR and MR and the nature of AR and
MR curves under difference market conditions1. under Perfect MarketUnder perfect
5. competition, an individual firm by its own action cannot influence the marketprice. The
market price is determined by the interaction between demand and supply forces. Afirm
can sell any amount of goods at the existing market prices. Hence, the TR of the
firmwould increase proportionately with the output offered for sale. When the total
revenue increasesin direct proportion to the sale of output, the AR would remain
constant. Since the market priceof it is constant without any variation due to changes in
the units sold by the individual firm, theextra output would fetch proportionate increase
in the revenue. Hence, MR & AR will be equalto each other and remain constant. This
will be equal to price.
12. Under perfect market condition, the AR curve will be a horizontal straight line and
parallel toOX axis. This is because a firm has to sell its product at the constant existing
market price. TheMR cure also coincides with the AR curve. This is because additional
units are sold at the sameconstant price in the market.2. under Imperfect MarketUnder all
forms of imperfect markets, the relation between TR, AR, and MR is different. Thiscan
be understood with the help of the following imaginary revenue schedule.From the above
table it is clear that:In order to increase the sales, a firm is reducing its price, hence AR
fallsAs a result of fall in price, TR increase but at a diminishing rate
13. TR will be higher when MR is zeroTR falls when MR becomes negativeFrom the
above table it is clear that:In order to increase the sales, a firm is reducing its price, hence
AR falls.As a result of fall in price, TR increase but at a diminishing rate.TR will be
higher when MR is zeroTR falls when MR becomes negativeAR and MR both declines.
But fall in MR will be greater than the fall in AR.The relationship between AR and MR
curves is determined by the elasticity ofdemand on the average revenue curve.Under
imperfect market, the AR curve of an individual firm slope downwards fromleft to right.
This is because; a firm can sell larger quantities only when it reduces theprice. Hence,
AR curve has a negative slope.The MR curve is similar to that of the AR curve. But MR
is less than AR. AR and MRcurves are different. Generally MR curve lies below the AR
curve.The AR curve of the firm or the seller and the demand curve of the buyer is the
sameSince, the demand curve represents graphically the quantities demanded by the
buyers at variousprices it shows the AR at which the various amounts of the goods that
are sold by the seller. Thisis because the price paid by the buyer is the revenue for the
seller (One man‘s expenditure isanother man‘s income). Hence, the AR curve of the firm
is the same thing as that of the demandcurve of the consumers.
14. Suppose, a consumer buys 10 units of a product when the price per unit is Rs.5 per
unit.Hence, the total expenditure is 10 x 5 = Rs.50/-. The seller is selling 10 units at the
rate of Rs.5per unit. Hence, his total income is 10 x 5 = Rs.50/-.Thus, it is clear that AR
curve and demand curve is really one and the same.
15. Q6. Distinguish between a firm and an industry. Explain the equilibrium of a firm
andindustry under perfect competition.Ans. Distinguish between a firm and an
industryAn industry is the name given to a certain type of manufacturing or retailing
environment.For example, the retail industry is the industry that involves everything from
clothes tocomputers, anything in the shops that get sold to the public. The retail industry
is very vast andhas many sub divisions, such as electrical and cosmetics. More
specialized industries deal with aspecific thing. The steel industry is a more specialized
industry, dealing with the making of steeland selling it on to buyers.The difference
between this and a firm is that a firm is the company that operates within theindustry to
6. create the product. The firm might be a factory, or the chain of stores that sells theclothes,
within its industry. For example, one firm that makes steel might be Aveda steel.
Theycreate the steel in that firm for the steel industry.A firm is usually a corporate
company that controls a number of chains in the industry it isoperating within.For
example in retail, the firm Arcadia stores own the clothing chains Top shop,
DorothyPerkins, Miss Selfridge, and Evans. These all operate for the firm Arcadia within
the industry ofretail.Several firms can operate in one industry to ensure that there is
always competition to keepprices reasonable and stop the market becoming a monopoly,
which is where one firm is incharge of the whole industry. Sometimes, a firm is not
necessary within the industry andindependent chains and retailers can enter straight into
the market without a firm behind them,although this is risky. This is because one of the
advantages of having a firm behind you is that itis a safeguard against possible
bankruptcy because the firm can support the chain that it owns.
16. The equilibrium of a firm and industry under perfect competitionAccording to Miller,
―Firm is an organization that buys and hires resources and sells goods andservices‖.
Lipsey has defined as ―firm is the unit that employs factors of production to
producecommodities that it sells to other firms, to households, or to the government.‖
Industry is a group of firms producing standardized products in a market. According
toLipsey, ―Industry is a group of firms that sells a well defined product or closely
related set ofproducts.‖Conditions of Equilibrium of the Firm and Industry A firm is in
equilibrium when it has no propensity to modify its level of productivity. Itrequires
neither extension nor retrenchment. It wants to earn maximum profits in by equating
itsmarginal cost with its marginal revenue, i.e. MC = MR. Diagrammatically, the
conditions ofequilibrium of the firm are (1) the MC curve must equal the MR curve.This
is the first order and essential condition. But this is not a sufficient condition which may
befulfilled yet the firm may not be in equilibrium.(2) The MC curve must cut the MR
curve from below and after the point of equilibrium it mustbe above the MR.This is the
second order condition. Under conditions of perfect competition, the MR curve of afirm
overlaps with the AR curve. The MR curve is parallel to the X axis. Hence the firm is
inequilibrium when MC = MR = AR.
17. The first order figure (1), the MC curve cuts the MR curve first at point X. It contends
thecondition of MC = MR, but it is not a point of maximum profits for the reason that
after point X,the MC curve is beneath the MR curve. It does not pay the firm to produce
the minimum outputOM when it can earn huge profits by producing beyond OM. Point Y
is of maximum profitswhere both the situations are fulfilled.Amidst points X and Y it
pays the firm to enlarges its productivity for the reason that it‘s MR >MC. It will
nevertheless stop additional production when it reaches the OM1 level ofproductivity
where the firm fulfils both the circumstances of equilibrium. If it has any plants
toproduce more than OM1 it will be incurring losses, for its marginal cost exceeds its
marginalrevenue beyond the equilibrium point Y. The same finale hold good in the case
of straight lineMC curve and it is presented in the figure.An industry is in equilibrium,
first when there is no propensity for the firms either to leave oreither the industry and
next, when each firm is also in equilibrium. The first clause entails thatthe average cost
curves overlap with the average revenue curves of all the firms in the industry.They are
earning only normal profits, which are believed to be incorporated in the average
costcurves of the firms. The second condition entails the equality of MC and MR. Under
7. a perfectlycompetitive industry these two circumstances must be fulfilled at the point of
equilibrium i.e.MC = MR….(1), AC = AR…. (2), AR = MR.Hence MC = AC = AR.
Such a position represents full equilibrium of the industry.
18. Short Run Equilibrium of the Firm and Industry1. Short Run Equilibrium of the
FirmA firm is in equilibrium in the short run when it has no propensity to enlarge or
contract itsproductivity and needs to earn maximum profit or to incur minimum
losses.The short run is an epoch of time in which the firm can vary its productivity by
changing theerratic factors of production. The number of firms in the industry is fixed
since neither theexisting firms can leave nor new firms can enter it.Postulations All firms
use standardised factors of production Firms are of diverse competence Cost curves of
firms are dissimilar from each other All firms sell their produces at the equal price
ascertained by demand and supply of the industry so that the price of each firm, P (Price)
= AR = MR Firms produce and sell various volumes The short run equilibrium of the
firm can be described with the helps of marginal study and total cost revenue
study.Marginal Cost, Marginal Revenue analysis – During the short run, a firm will
produce only itsprice equals average variable cost or is higher than the average variable
cost (AVC).Furthermore, if the price is more than the averages total costs, ATC, i.e. P =
AR > ATC the firmwill be earning super normal profits. If price equals the average total
costs, i.e. P = AR = ATCthe firm will be earning normal profits or break even.If price
equals AVC, the firm will be incurring losses. If price drops even a little below AVC,
thefirm will shut down since in order to produce it must cover atleast it‘s AVC through
short run.So during the short run, under perfect competition, affirm is in equilibrium in
all the abovementioned stipulations.Super normal profits – The firm will be earning super
normal profits in the short run when priceis higher than the short run average cost.
19. Normal Profits = The firm may earn normal profits when price equals the short run
averagecosts.Total Cost – Total Revenue Analysis – The short run equilibrium of the firm
can also berepresented with the help of total cost and total revenue curves. The firm is
able to maximise itsprofits when the positive discrimination between TR and TC is the
greatest. Short Run Equilibrium of the IndustryAn industry is in equilibrium in the short
run when its total output remains steady there being nopropensity to enlarge or contract
its productivity. If all firms are in equilibrium the industry isalso in equilibrium. For full
equilibrium of the industry in the short run all firms must be earningnormal profits.But
full equilibrium of the industry is by sheer accident for the reason that in the short rum
somefirms may be earning super normal profits and some losses. Even then the industry
is in short runequilibrium when its quantity demanded and quantity supplied is equal at
the price which clearsthe market.Online Live Tutor Conditions of Equilibrium of the
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which you need help and we will forward then to our tutors for review.Other topics under
Product Pricing: Applications of Demand and Supply Analysis under Perfect Competition
Concepts of Revenue Derived Demand, Joint Supply Determination of Profit
Maximization under monopolist situation Duopoly and Oligopoly Forms of Market
Structure Importance of Time Element in Price Theory Joint Demand Supply Linear
Programming Long Run Equilibrium of Firm and Industry Market Structures
Monopolistic Competition Monopsony and Bilateral Monopoly, Price output
Determination Objectives of Business Firm Oligopoly, Cornet‘s Oligopoly Model Pricing
of Public Undertakings Profit Maximization, Full cost, Pricing and Sales Maximization
Pricing Under Perfect Competition - Demand Supply - Basic Framework Profit Price
Policy Resource allocation under monopoly Short, Long Run Supply Curve of the Firm
and Industry Similarities and Dissimilarities between Monopoly Competition and Perfect
Competition Supply Its Law - Elasticity and Curve The Nature of Costs and Cost Curves
Williamsons Utility Maximization
21. Set 2Q1. Suppose your manufacturing company planning to release a new product
into market,Explain the various methods forecasting for a new product.Ans.When a
manufacturing companies planning to release a new product into themarket, it
shouldperform the demand forecasting to check the demand of the product in the market
and also theavailability of similar product in the market.Demand forecasting for new
products is quite different from that for established products. Herethe firms will not have
any past experience or past data for this purpose. An intensive study ofthe economic and
competitive characteristics of the product should be made to make efficientforecasts.As
per Professor Joel Dean, few guidelines to make forecasting of demand for newproducts
are:a. Evolutionary approachThe demand for the new product may be considered as an
outgrowth of an existing product. Fore.g., Demand for new Tata Indica, which is a
modified version of Old Indica can most effectivelybe projected based on the sales of the
old Indica, the demand for new Pulsor can be forecastedbased on the sales of the old
Pulsar. Thus when a new product is evolved from the old product,the demand conditions
of the old product can be taken as a basis for forecasting the demand forthe new
product.b. Substitute approachIf the new product developed serves as substitute for the
existing product, the demand for thenew product may be worked out on the basis of a
‗market share‘. The growths of demand for allthe products have to be worked out on the
basis of intelligent forecasts for independent variablesthat influence the demand for the
substitutes. After that, a portion of the market can be sliced outfor the new product. For
e.g., A moped as a substitute for a scooter, a cell phone as a substitutefor a land line. In
some cases price plays an important role in shaping future demand for theproduct.
22. c. Opinion Poll approachUnder this approach the potential buyers are directly
contacted, or through the use of samples ofthe new product and their responses are found
out. These are finally blown up to forecastthe demand for the new product.d. Sales
experience approachOffer the new product for sale in a sample market; say supermarkets
9. or big bazaars in big cities,which are also big marketing centers. The product may be
offered for sale through one supermarket and the estimate of sales obtained may be
‗blown up‘ to arrive at estimated demand forthe product.e. Growth Curve
approachAccording to this, the rate of growth and the ultimate level of demand for the
new product areestimated on the basis of the pattern of growth of established products.
For e.g., An AutomobileCo., while introducing a new version of a car will study the level
of demand for the existing car.f. Vicarious approachA firm will survey consumers‘
reactions to a new product indirectly through getting in touchwith some specialized and
informed dealers who have good knowledge about the market, aboutthe different varieties
of the product already available in the market, the consumers‘ preferencesetc. This helps
in making a more efficient estimation of future demand.
23. Q2. Define the term equilibrium. Explain the changes in market equilibrium and
effects toshifts in supply and demand.Ans. EquilibriumThe word equilibrium is derived
from the Latin word a ―equilibrium‖ which means equalbalance. It means a state of
even balance in which opposing forces or tendencies neutralize eachother. It is a position
of rest characterized by absence of change. It is a state where there iscomplete agreement
of the economic plans of the various market participants so that no one has atendency to
revise or alter his decision. In the words of professor Mehta: ―Equilibrium denotesin
economics absence of change in movement‖.Market EquilibriumThere are two
approaches to market equilibrium viz., partial equilibrium approach and thegeneral
equilibrium approach. The partial equilibrium approach to pricing explains
pricedetermination of a single commodity keeping the prices of other commodities
constant. On theother hand, the general equilibrium approach explains the mutual and
simultaneousdetermination of the prices of all goods and factors. Thus it explains a multi
market equilibriumposition. Earlier to Marshall, there was a dispute among economists
on whether the force of demand orthe force of supply is more important in determining
price. Marshall gave equal importance toboth demand and supply in the determination of
value or price. He compared supply and demandto a pair of scissors We might as
reasonably dispute whether it is the upper or the under blade of a pair of scissors thatcuts
a piece of paper, as whether value is governed by utility or cost of production. Thus
neitherthe upper blade nor the lower blade taken separately can cut the paper; both have
theirimportance in the process of cutting. Likewise neither supply alone, nor demand
alonecan determine the price of a commodity, both are equally important in the
determination of price.But the relative importance of the two may vary depending upon
the time under consideration.Thus, the demand of all consumers and the supply of all
firms together determine the price ofa commodity in the market.
24. Equilibrium between demand and supply price:Equilibrium between demand and
supply price is obtained by the interaction of these two forces.Price is an independent
variable. Demand and supply are dependent variables. They depend onprice. Demand
varies inversely with price; arise in price causes a fall in demand and a fall inprice causes
a rise in demand. Thus the demand curve will have a downward slope indicating
theexpansion of demand with a fall in price and contraction of demand with a rise in
price. On theother hand supply varies directly with the changes in price, a rise in price
causes arise in supplyand a fall in price causes a fall in supply. Thus the supply curve will
have an upward slope. At apoint where these two curves intersect with each other the
equilibrium price is established. Atthis price quantity demanded is equal to the quantity
10. demanded.This we can explain with the help of a table and a diagramIn the table at Rs.20
the quantity demanded is equal to the quantity supplied. Since the price isagreeable to
both the buyer and sellers, there will be no tendency for it to change; this is
calledequilibrium price. Suppose the price falls to Rs.5 the buyer will demand 30 units
while the sellerwill supply only 5 units. Excess of demand over supply pushes the price
upward until it reachesthe equilibrium position supply is equal to the demand. On the
other hand if the price rises toRs.30 the buyer will demand only 5 units while the sellers
are ready to supply 25 units. Sellerscompete with each other to sell more units of the
commodity. Excess of supply over demandpushes the price downward until it reaches the
equilibrium. This process will continue till theequilibrium price of Rs.20 is reached. Thus
the interactions of demand and supply forces actingupon each other restore the
equilibrium position in the market. In the diagram DD is the demandcurve, SS is the
supply curve. Demand and supply are in equilibrium at point E where the two
25. curves intersect each other. OQ is the equilibrium output. OP is the equilibrium price.
Supposethe price OP2 is higher than the equilibrium price OP. at this point price quantity
demandedisP2D2. Thus D2S2 is the excess supply which the seller wants to push into the
market,competition among the sellers will bring down the price to the equilibrium level
where thesupply is equal to the demand. At price OP1, the buyers will demand P1D1
quantity while thesellers are ready to sell P1S1. Demand exceeds supply. Excess demand
for goods pushes up theprice; this process will go until equilibrium is reached where
supply becomes equal to demand.
26. Q3. Explain how a product would reach equilibrium position with the help of ISO -
Quantsand ISO-Cost curve.Ans.When producing a good or service, how do suppliers
determine the quantity of factors to hire?Below, we work through an example where a
representative producer answers this question.Let‘s begin by making some assumptions.
First, we shall assume that our producer choosesvarying amounts of two factors, capital
(K) and labor (L). Each factor was a price that does notvary with output.That is, the price
of each unit of labor (w) and the price of each unit of capital (r) are assumedconstant.
We‘ll further assume that w = $10 and r = $50. We can use this information todetermine
the producer‘s total cost. We call the total cost equation an iso-cost line (it‘s similar toa
budget constraint).The producer‘s iso-cost line is:10L + 50K = TC (1)The producer‘s
production function is assumed to take the following form:q = (KL) 0.5 (2)Our
producer‘s first step is to decide how much output to produce. Suppose that quantity is
1000units of output. In order to produce those 1000 units of output, our producer must
get acombination of L and K that makes (2) equal to 1000. Implicitly, this means that we
must find aparticular isoquant.Set (2) equal to 1000 units of output, and solve for K.
Doing so, we get the following equationfor a specific iso-quant (one of many possible
iso-quants):K = 1,000,000/L (2a)For any given value of L, (2a) gives us a corresponding
value for K. Graphing these values, withK on the vertical axis and L on the horizontal
axis, we obtain the blue line on the graph below.Each point on this curve is represented as
a combination of K and L that yields an output level of1000 units. Therefore, as we move
along this iso-quant output is constant (much like the fact thatutility is constant as A basic
understanding of statistics is a critical component of informeddecision making.
27. Q4. Critically examine the Marris growth maximizing model??Ans.Profit
maximization is traditional objective of a firm. Sales maximization objective is
explainedby Prof. Boumal. On similar lines, Prof. Marris has developed another
11. alternative growthmaximization model in recent years. It is a common factor to observe
that each firm aims atmaximizing its growth rate as this goal would answer many of the
objectives of a firm. Marrispoints out that a firm has to maximize its balanced growth rate
over a period of time.Marris assumes that the ownership and control of the firm is in the
hands of two groups ofpeople, i.e. owner and managers. He further points out that both of
them have two distinctivegoals. Managers have a utility function in which the amount of
salary, status, position, power,prestige and security of job etc are the most import variable
where as in case of are moreconcerned about the size of output, volume of profits, market
shares and sales maximization.Utility function of the manager and that the owner are
expressed in the following manner-Uo= f [size of output, market share, volume of profit,
capital, public esteem etc.]Um= f [salaries, power, status, prestige, job security etc.]In
view of Marris the realization of these two functions would depend on the size of the
firm.Larger the firm, greater would be the realization of these functions and vice-versa.
Size of thefirm according to Marris depends on the amount of corporate capital which
includes total volumeof the asset, inventory level, cash reserve etc. He further points out
that the managers always aimat maximizing the rate of growth of the firm rather than
growth in absolute size of the firms.Generally managers like to stay in a grouping firm.
Higher growth rate of the firm satisfy thepromotional opportunity of managers and also
the share holders as they get more dividends.B ou mal ’s S al es Maxi mi zati on mod el
:Sales maximization model is an alternative for profit maximization model. This model
isdeveloped by Prof. W.J. Boumal, an American economist. This alternative goal has
assumedgreater significance in the context of the growth of the oligopolistic firms. The
model highlightsthat the primary objective of the firm is to maximize its sales rather than
profit maximization. Itstates that the goal of the firm is maximization of sales revenue
subject to a minimum profitconstraint. The minimum profit constraint is determined by
the expectation of the share holders.This is because no company can displease the
shareholders. It is to be noted here thatmaximization of sales does not mean
maximization of physical sales but maximization of totalsales revenue. Hence, the
managers are more interested in increasing sales rather than profit. Thebasic philosophy
is that when sales are maximized automatically profits of the company would
28. also go up. Hence, attention is diverted to increase the sales of the company in recent
years in thecontext of highly competitive market.How Profit Maximization model differs
from Sales Maximization model:The sale maximization model differs on the following
grounds: Emphasis is given on maximizing sales rather than profit. Increase the
competitive and operational ability of the company. The amount of slack earning and
salaries of the top managers are directly linked to it. It helps in enhancing the prestige and
reputation of top management, distributes more dividends to share holders and increases
the wage of the workers and keeps them happy. The financial and other lending
institutions always keep a watch on the sales revenue of a firm as it is an indication of
financial health of the firm.
29. Q5. Define Pricing Policy. Explain the various objective of pricing policy.Ans.
Pricing PoliciesA detailed study of the market structure gives us information about the
way in which prices aredetermined under different market conditions. However, in
reality, a firm adopts differentpolicies and methods to fix the price of its products.Pricing
policy refers to the policy of setting the price of the product or products and services
bythe management after taking into account of various internal and external factors,
12. forces and itsown business objectives.Pricing Policy basically depends on price theory
that is the corner stone of economic theory.Pricing is considered as one of the basic and
central problems of economic theory in a moderneconomy. Fixing prices are the most
important aspect of managerial decision making becausemarket price charged by the
company affects the present and future production plans, pattern ofdistribution, nature of
marketing etc. Generally speaking, in economic theory, we take intoaccount of only two
parties, i.e., buyers and sellers while fixing the prices. However, in practicemany parties
are associated with pricing of a product. They are rival competitors, potential
rivals,middlemen, wholesalers, retailers, commission agents and above all the Govt.
Hence, we shouldgive due consideration to theinfluence exerted by these parties in the
process of pricedetermination. Broadly speaking, the various factors and forces that affect
the price are dividedinto two categories.They are as follows: I External Factors (Outside
factors)1. Demand, supply and their determinants.2. Elasticity of demand and supply.3.
Degree of competition in the market.4. Size of the market.5. Good will, name, fame and
reputation of a firm in the market.6. Trends in the market.
30. 7. Purchasing power of the buyers.8. Bargaining power of customers9. Buyers
behavior in respect of particular product II. Internal Factors (Inside Factors)1. Objectives
of the firm.2. Production Costs.3. Quality of the product and its characteristics.4. Scale of
production.5. Efficient management of resources.6. Policy towards percentage of profits
and dividend distribution.7. Advertising and sales promotion policies.8. Wage policy and
sales turn over policy etc.9. The stages of the product on the product life cycle.10. Use
pattern of the product. Objectives of the Price Policy:A firm has multiple objectives
today. In spite of several objectives, the ultimate aim of everybusiness concern is to
maximize its profits. This is possible when the returns exceed costs. In thiscontext,
setting an ideal price for a product assumes greater importance. Pricing objectives has
tobe established by top management to ensure not only that the company‘s profitability is
adequatebut also that pricing is complementary to the total strategy of the organization.
Whileformulating the pricing policy, a firm has to consider various economic, social,
political andother factors.
31. The Following objectives are to be considered while fixing the prices of the
product.1. Profit maximization in the short termThe primary objective of the firm is to
maximize its profits. Pricing policy as an instrument toachieve this objective should be
formulated in such a way as to maximize the sales revenue andprofit. Maximum profit
refers to the highest possible of profit.In the short run, a firm not only should be able to
recover its total costs, but also should getexcess revenue over costs. This will build the
morale of the firm and instill the spirit ofconfidence in its operations.2. Profit
optimization in the long runThe traditional profit maximization hypothesis may not prove
beneficial in the long run. With thesole motive of profit making a firm may resort to
several kinds of unethical practices likecharging exorbitant prices, follow Monopoly
Trade Practices (MTP), Restrictive Trade Practices(RTP) and Unfair Trade Practices
(UTP) etc. This may lead to opposition from the people. Inorder to over- come these
evils, a firm instead of profit maximization, and aims at profitoptimization.Optimum
profit refers to the most ideal or desirable level of profit.Hence, earning the most
reasonable or optimum profit has become a part and parcel of a soundpricing policy of a
firm in recent years.3. Price StabilizationPrice stabilization over a period of time is
another objective. The prices as far as possible shouldnot fluctuate too often. Price
13. instability creates uncertain atmosphere in business circles. Salesplan becomes difficult
under such circumstances. Hence, price stability is one of the prerequisiteconditions for
steady and persistent growth of a firm. A stable price policy only can win theconfidence
of customers and may add to the good will of the concern. It builds up the reputationand
image of the firm.4. Facing competitive situationOne of the objectives of the pricing
policy is to face the competitive situations in the market. Inmany cases, this policy has
been merely influenced by the market share psychology. Wherevercompanies are aware
of specific competitive products, they try to match the prices of theirproducts with those
of their rivals to expand the volume of their business. Most of the firms arenot merely
interested in meeting competition but are keen to prevent it. Hence, a firm is alwaysbusy
with its counter business strategy.
32. 5. Maintenance of market share Market share refers to the share of a firm‘s sales of a
particular product in the total sales of allfirms in the market.The economic strength and
success of a firm is measured in terms of its market share. In acompetitive world, each
firm makes a successful attempt to expand its market share. If it isimpossible, it has to
maintain its existing market share. Any decline in market share is asymptom of the poor
performance of a firm.Hence, the pricing policy has to assist a firm to maintain its market
share at any cost.
33. Q6. Discuss the various measures that may be taken by a firm to counteract the evil
effectsof a trade cycle.Ans. FACTORS THAT SHAPE BUSINESS CYCLESFor
centuries, economists in both the United States and Europe regarded economic downturns
as"diseases" that had to be treated; it followed, then, that economies characterized by
growth andaffluence were regarded as "healthy" economies. By the end of the 19th
century, however, manyeconomists had begun to recognize that economies were cyclical
by their very nature, and studiesincreasingly turned to determining which factors were
primarily responsible for shaping thedirection and disposition of national, regional, and
industry-specific economies. Today,economists, corporate executives, and business
owners cite several factors as particularlyimportant in shaping the complexion of
business environments.VOLATILITY OF INVESTMENT SPENDINGVariations in
investment spending is one of the important factors in business cycles.
Investmentspending is considered the most volatile component of the aggregate or total
demand (it variesmuch more from year to year than the largest component of the
aggregate demand, theconsumption spending), and empirical studies by economists have
revealed that the volatility ofthe investment component is an important factor in
explaining business cycles in the UnitedStates. According to these studies, increases in
investment spur a subsequent increase inaggregate demand, leading to economic
expansion. Decreases in investment have the oppositeeffect. Indeed, economists can point
to several points in American history in which theimportance of investment spending was
made quite evident. The Great Depression, for instance,was caused by a collapse in
investment spending in the aftermath of the stock market crash of1929. Similarly,
prosperity of the late 1950s was attributed to a capital goods boom.There are several
reasons for the volatility that can often be seen in investment spending. Onegeneric
reason is the pace at which investment accelerates in response to upward trends in
sales.This linkage, which is called the acceleration principle by economists, can be
briefly explainedas follows. Suppose a firm is operating at full capacity. When sales of its
goods increase, outputwill have to be increased by increasing plant capacity through
14. further investment. As a result,changes in sales result in magnified percentage changes in
investment expenditures. Thisaccelerates the pace of economic expansion, which
generates greater income in the economy,leading to further increases in sales. Thus, once
the expansion starts, the pace of investmentspending accelerates. In more concrete terms,
the response of the investment spending is relatedto the rate at which sales are increasing.
In general, if an increase in sales is expanding,investment is spending rises, and if an
increase in sales has peaked and is beginning to slow,investment spending falls. Thus, the
pace of investment spending is influenced by changes in therate of sales.
34. MOMENTUMMany economists cite a certain "follow-the-leader" mentality in
consumer spending. In situationswhere consumer confidence is high and people adopt
more free-spending habits, other customersare deemed to be more likely to increase their
spending as well. Conversely, downturns inspending tend to be imitated as
well.TECHNOLOGICAL INNOVATIONSTechnological innovations can have an acute
impact on business cycles. Indeed, technologicalbreakthroughs in communication,
transportation, manufacturing, and other operational areas canhave a ripple effect
throughout an industry or an economy. Technological innovations may relateto
production and use of a new product or production of an existing product using a new
process.The video imaging and personal computer industries, for instance, have
undergone immensetechnological innovations in recent years, and the latter industry in
particular has had apronounced impact on the business operations of countless
organizations. However,technological innovations—and consequent increases in
investment—take place at irregularintervals. Fluctuating investments, due to variations in
the pace of technological innovations,lead to business fluctuations in the economy.There
are many reasons why the pace of technological innovations varies. Major innovations
donot occur every day. Nor do they take place at a constant rate. Chance factors greatly
influencethe timing of major innovations, as well as the number of innovations in a
particular year.Economists consider the variations in technological innovations as random
(with no systematicpattern). Thus, irregularity in the pace of innovations in new products
or processes becomes asource of business fluctuations.VARIATIONS IN
INVENTORIESVariations in inventories—expansion and contraction in the level of
inventories of goods kept bybusinesses—also contribute to business cycles. Inventories
are the stocks of goods firms keep onhand to meet demand for their products. How do
variations in the level of inventories triggerchanges in a business cycle? Usually, during a
business downturn, firms let their inventoriesdecline. As inventories dwindle, businesses
ultimately find themselves short of inventories. As aresult, they start increasing inventory
levels by producing output greater than sales, leading to aneconomic expansion. This
expansion continues as long as the rate of increase in sales holds upand producers
continue to increase inventories at the preceding rate. However, as the rate ofincrease in
sales slows, firms begin to cut back on their inventory accumulation. The
subsequentreduction in inventory investment dampens the economic expansion, and
eventually causes aneconomic downturn. The process then repeats itself all over again. It
should be noted that whilevariations in inventory levels impact overall rates of economic
growth, the resulting businesscycles are not really long. The business cycles generated by
fluctuations in inventories are
35. called minor or short business cycles. These periods, which usually last about two to
four years,are sometimes also called inventory cycles.FLUCTUATIONS IN
15. GOVERNMENT SPENDINGVariations in government spending are yet another source
of business fluctuations. This mayappear to be an unlikely source, as the government is
widely considered to be a stabilizing forcein the economy rather than a source of
economic fluctuations or instability. Nevertheless,government spending has been a major
destabilizing force on several occasions, especiallyduring and after wars. Government
spending increased by an enormous amount during WorldWar II, leading to an economic
expansion that continued for several years after the war.Government spending also
increased, though to a smaller extent compared to World War II,during the Korean and
Vietnam wars. These also led to economic expansions. However,government spending
not only contributes to economic expansions, but economic contractions aswell. In fact,
the recession of 1953-54 was caused by the reduction in government spending afterthe
Korean War ended. More recently, the end of the Cold War resulted in a reduction in
defensespending by the United States that had a pronounced impact on certain defense-
dependentindustries and geographic regions.POLITICALLY GENERATED BUSINESS
CYCLESMany economists have hypothesized that business cycles are the result of the
politicallymotivated use of macroeconomic policies (monetary and fiscal policies) that
are designed toserve the interest of politicians running for re-election. The theory of
political business cycles ispredicated on the belief that elected officials (the president,
members of congress, governors,etc.) have a tendency to engineer expansionary
macroeconomic policies in order to aid their re-election efforts.MONETARY
POLICIESVariations in the nations monetary policies, independent of changes induced
by politicalpressures, are an important influence in business cycles as well. Use of fiscal
policy—increasedgovernment spending and/or tax cuts—is the most common way of
boosting aggregate demand,causing an economic expansion. Moreover, the decisions of
the Federal Reserve, which controlsinterest rates, can have a dramatic impact on
consumer and investor confidence as well.FLUCTUATIONS IN EXPORTS AND
IMPORTS The difference between exports and imports is the net foreign demand for
goods and services,also called net exports. Because net exports are a component of the
aggregate demand in theeconomy, variations in exports and imports can lead to business
fluctuations as well. There aremany reasons for variations in exports and imports over
time. Growth in the gross domestic
36. product of an economy is the most important determinant of its demand for imported
goods—aspeoples incomes grow, their appetite for additional goods and services,
including goodsproduced abroad, increases. The opposite holds when foreign economies
are growing—growth inincomes in foreign countries also leads to an increased demand
for imported goods by theresidents of these countries. This, in turn, causes U.S. exports
to grow. Currency exchange ratescan also have a dramatic impact on international
trade—and hence, domestic business cycles—aswell. KEYS TO SUCCESSFUL
BUSINESS CYCLE MANAGEMENTSmall business owners can take several steps to
help ensure that their establishments weatherbusiness cycles with a minimum of
uncertainty and damage. "The concept of cycle managementmay be relatively new,"
wrote Matthew Gallagher in Chemical Marketing Reporter, "but italready has many
adherents who agree that strategies that work at the bottom of a cycle need tobe adopted
as much as ones that work at the top of a cycle. While there will be no definitiveformula
for every company, the approaches generally stress a long-term view which focuses on
afirms key strengths and encourages it to plan with greater discretion at all times.
16. Essentially,businesses are operating toward operating on a more even keel."Specific tips
for managing business cycle downturns include the following:Flexibility — According to
Gallagher, "part of growth management is a flexible business planthat allows for
development times that span the entire cycle and includes alternative recession-resistant
funding structures."Long-Term Planning—Consultants encourage small businesses to
adopt a moderate stance intheir long-range forecasting.Attention to Customers—this can
be an especially important factor for businesses seeking toemerge from an economic
downturn. "Staying close to the customers is a tough discipline tomaintain in good times,
but it is especially crucial coming out of bad times," stated Arthur Daltasin Industry
Week. "Your customer is the best test of when your own upturn will arrive.Customers,
especially industrial and commercial ones, can give you early indications of theirinterest
in placing large orders in coming months."Objectivity—Small business owners need to
maintain a high level of objectivity when ridingbusiness cycles. Operational decisions
based on hopes and desires rather than a soberexamination of the facts can devastate a
business, especially in economic down periods.
37. Study—"Timing any action for an upturn is tricky, and the consequences of being
early or lateare serious," said Daltas. "For example, expanding a sales force when the
markets dontmaterialize not only places big demands on working capital, but also makes
it hard to sustain themotivation of the sales-people. If the force is improved too late, the
cost is decreased marketshare or decreased quality of the customer base. How does the
company strike the right balancebetween being early or late? Listening to economists,
politicians, and media to get a sense ofwhat is happening is useful, but it is unwise to rely
solely on their sources. The best route is toavoid trying to predict the upturn. Instead,
listen to your customers and know your ownresponse-time requirements."
38. THANK YOU