Managerial economics july 2003
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Managerial economics july 2003  Managerial economics july 2003 Document Transcript

  • Managerial Economics M. D University Paper no. 3.12 July - 2003 MBA – 1st SemesterQ No.1 What is the basic objectives of a firm? Explain the role andresponsibility on Managerial Economics?Ans. Conventional theory of firm assumes profit maximization is the soleobjective of business firms. But recent researches on this issue reveal that theobjectives the firms pursue are more than one. Some important objectives, otherthan profit maximization are:(a) Maximization of the sales revenue(b) Maximization of firm’s growth rate(c) Maximization of Managers utility function(d) Making satisfactory rate of Profit(e) Long run Survival of the firm(f) Entry-prevention and risk-avoidanceProfit Business Objectives: Profit means different things to different people. Toan accountant “Profit” means the excess of revenue over all paid out costsincluding both manufacturing and overhead expenses. For all practical purpose,profit or business income means profit in accounting sense plus non-allowableexpenses.Economist’s concept of profit is of “Pure Profit” called ‘economic profit’ or “Justprofit”. Pure profit is a return over and above opportunity cost, i. e. the incomethat a businessman might expect from the second best alternatives use of hisresources.Sales Revenue Maximisation: The reason behind sales revenue maximisationobjectives is the Dichotomy between ownership & management in large businesscorporations. This Dichotomy gives managers an opportunity to set their goalother than profits maximisation goal, which most-owner businessman pursue.Given the opportunity, managers choose to maximize their own utility function.The most plausible factor in manager’s utility functions is maximisation of thesales revenue.The factors, which explain the pursuance of this goal by the managers arefollowing:.First: Salary and others earnings of managers are more closely related to salesrevenue than to profitsSecond: Banks and financial corporations look at sales revenue while financingthe corporation.
  • Third: Trend in sales revenue is a readily available indicator of the performanceof the firm.Maximisation of Firms Growth rate: Managers maximize firm’s balance growthrate subject to managerial & financial constrains balance growth rate defined as:G = GD – GCWhere GD = Growth rate of demand of firm’s product & G C = growth rate ofcapital supply of capital to the firm.In simple words, A firm growth rate is balanced when demand for its product &supply of capital to the firm increase at the same time.Maximisation of Managerial Utility function: The manager seek to maximizetheir own utility function subject to the minimum level of profit. Managers utilityfunction is express as:U= f(S, M, ID)Where S = additional expenditure of the staff M= Managerial emoluments ID = Discretionary InvestmentsThe utility functions which manager seek to maximize include both quantifiablevariables like salary and slack earnings; non- quantifiable variables such asprestige, power, status, Job security professional excellence etc.Long run survival & market share: according to some economist, the primarygoal of the firm is long run survival. Some other economists have suggested thatattainment & retention of constant market share is an additional objective of thefirm’s. the firm may seek to maximize their profit in the long run through it is notcertain.Entry-prevention and risk-avoidance, yet another alternative objectives of thefirms suggested by some economists is to prevent entry-prevention can be: a) Profit maximisation in the long run b) Securing a constant market share c) Avoidance of risk caused by the un-predictable behavior of the new firmsMicro economist has a vital role to play in running of any business. Microeconomists are concern with all the operational problems, which arise with in thebusiness organization and fall in with in the preview and control of themanagement. Some basic internal issues with which micro-economist areconcerns: (i) Choice of business and nature of product i.e. what to produce (ii) Choice of size of the firm i. e how much to produce (iii) Choice of technology i.e. choosing the factor-combination (iv) Choose of price i.e. how to price the commodity (v) How to promote sales (vi) How to face price competition
  • (vii) How to decide on new investments (viii)How to manage profit and capital (ix) How to manage inventory i.e. stock to both finished & raw materialThese problems may also figure in forward planning. Micro economist deals withthese questions and like confronted by managers of the enterprises.Q. No 2 Explain the following with examples. a) Short run versus Long run b) Nature of marginal analysisAns a). Short Run & Long Run: The concept of short run and long run is usedin economic theories like production theory, cost theory etc.In production, theory short run refers to a period of time in which supply of certaininputs such as plant, building, machinery etc is fixed or is inelastic. In the shortrun therefore, increasing the use of only one variable input as labour and rawmaterial can increase production of a commodity.The long run refers to a period of time in which the supply of all the inputs iselastic, but not enough to permit a change in technology. That is, in the long run,all the inputs are variable. Therefore, in the end, production of or commodity canbe increased by employing more of both variable and fixed inputs.Short run costs are the costs that vary with the variation in input, the size of thefirm remaining the same. In the other words, short run costs are the same asvariable costs. Long run costs, on the other hand are the costs, which areincurred on the fixed assets like plant, building, machinery etc.Ans.(b) Nature Marginal analysis: The concept of marginal value is widely usedin economic analysis, for example marginal utility, marginal cost and marginalrevenue. Marginality concept assumes special significance where maximisationor maximization problem is involved e.g. maximization of consumer’s utility,maximisation of firm’s profit, minimization of cost etc. The terun “marginal” refersto the change (increase or decrease) in the total of any quantity due to one unitchange in its determinant e.g. the total cost of production of a commoditydepends on the number of units produced. In this case “marginal cost” or (MC)can be defined as the change in total cost as result of producing one unit less ofa commodity thus,Marginal Cost (MC) = TCn – TCn – 1Where TCn = total cost of producing n unitsTCn-1 = total cost of producing n – 1 units.
  • UNIT – IIQ. No. 3 What is elasticity of demand? How can it be measured?Ans. The degree of responsiveness of demand to the change in itsdeterminants is called elasticity of demand. The concept of demand elasticity isused in business decisions are (1) Price elasticity; (2) Cross – elasticity (3)Income elasticity (4) Elasticity of price expectation. 1) Price elasticity of demand is generally defined as the responsiveness or sensitivity of demand for a commodity to change in its price. More precisely, elasticity of demand is the percentage change in demand because of one percent change in the price of the commodity. The price elasticity of demand (ep) is given as Ep = Percentage change in quantity demanded Percentage change in price Ep = Q ÷ P = Q × P ⇒ Q Q Q P Q P P P Q = Changes in quantity Q = Original quantity P = Change in price P = Original Price 2) Cross Elasticity is the measure of responsiveness of demand for a commodity to the changes in the price of its Substitutes and complementary goods .for example, cross elasticity of demand of tea is the percentage change in its quantity demanded with respect to the changes in the price of its substitutes coffee. The formula for tea and same for coffee is given by Ep = Percentage change in demanded for tea Qt Percentage change in price of coffee Ep = Pc . Qt Qt Pc 3) Income Elasticity of demand is responsiveness of demand to the changes in income. Income elasticity of demand for product X may be defined as
  • X ÷ Y = Y × X X Y X Y Where X = Quantity of X demanded Y = Disposable Income X = Change in quantity demanded Y = Changes in Income 4) Advertisement Elasticity of sales is defined as responsiveness of demand / sales to the changes in advertisement expenditure Percentage change in demanded for tea Qt Percentage change in Advt expenditure S/S = S .A A/A A SWhere S = Sales, S = increase in sales A = initial advertisement expenditure A = additional expenditure on advertisement 5) Elasticity of Price Expectations refers to the expected range in future price as a result of change in current prices of a product. The elasticity of price expectation is defined as measured by the formula Ex = Pf / Pf = Pf . Pc Pc/ Pc Pc Pf Where Pc and Pf are current and future prices respectively. The co – efficient ex gives the measure of expected percentage changein future price as a result of 1% change in present price, if ex >1, it indicates thatfuture change in price will be greater than the present change in price, and viceversa.Question 4 – What are the main techniques of demand estimation? What istheir reliability?
  • Answer: Demand estimation is predicting future demand form a product. Theinformation regarding future demand is essential for planning and schedulingproduction, purchase of raw materials, acquision of finance and advertising.The various techniques of demand estimation: -1) Survey Method2) Statistical Method• Survey MethodSurvey method is generally used where the purpose is to make short run forecastof demand. Under this method, customer surveys are conducted to collectinformation about their intentions and future purchase plan. This method includes(a) Consumer survey method(b) Opinion Poll methodConsumer survey methodMay be in form ofa) Consumer enumeration: - In this method, almost all the potential users of the product are contacted and are asked about the future plan of purchasing the product in question. The quantities indicated by the consumers are added together to obtain the probable demand for the product.b) Sample survey method: - Under this method only a few potential consumers selected from relevant market through a sampling method are surveyed, on the basis of the information obtained, the probable demand may be estimated through the following formula. D = HR (H.AD) Hs Where D = probable demand forecast H = Census number of households from the relevant market. Hs = number of households reporting demand for the product. HR = number of households reporting demand for the product. AD = average expected consumption by the reporting households.c) End User Method: - The end user method of demand forecasting is used for estimating demand for inputs. Making forecast by this method requires building up a schedule of probable aggregate future demand for inputs by consuming industries and various other sectors.
  • Opinion poll MethodThe opinion poll methods aim at collecting opinion of those who are supposed topossess knowledge of the market e.g. sales representative, professionalmarketing experts and consultants. The opinion poll method includea) Expert opinion method: - Firms having a good network of sales representative can put them to work of assessing the demand for the product in the areas that they represent. Sales representative, beings in close touch with the consumers are supposed to know the future purchase plans of their customer, their reaction to the market changes, their response to the introduction of new products and the demand for competing products. They are, therefore, in a position to provide an estimate of likely demand for their firm’s product in the area. The estimates of demand thus obtained from different regions are added up to get the overall probable demand for a product.b) Delphi Method: - Delphi method is used to consolidate the divergent expert opinions and arrived at a compromise estimate of future demand. Under Delphi method the expert are provided information on estimates of forecast of other experts along with the underlying assumptions. The experts may revise their own estimates in the light of forecast made by other experts. The consensus of experts about the forecasts constitutes the final forecast. Although this method is simple and inexpensive, it has its own limitations. First estimates provided by sales representations and professional experts are reliable only to extend depending upon their skill to analysis the market and their experience. Second, demand estimates way involve the subjective judgement of the which may lead to over or under estimation, finally, the assessment of market demand is usually based on inadequate information’s, such as changes in GNP, available of credit, future prospects of the industry etc, fall outside their purview.c) Market studies and Experiments:- It is a method of collecting necessary information regarding demand is to carry out market studies and experiments on consumer’s behavior under actual through controlled market conditions. This method is known in common parlance market conditions. This methods is known in common parlance as market experiment method under this method, firms first select some areas of the representative markets – three or four cities having similar features viz. Population, income levels, cultural and social background, occupational distribution, choices and preferences of consumers. Then, they carry out market experiments by changing prices, advt. Expenditure and other controllable variable in the demand function under the assumption that other thing remains same. The controlled variable
  • may by changed over time either simultaneously in all the markets or in all the markets or in the selected markets. After such changes are introduced in the market, the consequent changes in the demand over a period of time (a week, a fortnight or month) are recorded. On the basis of data collected elasticity coefficient are computed. These coefficients are then used along with the variables of the demand function to assess the demand for product The market experiments methods have certain serious limitations. First, this method is very expensive and hence cannot be afforded by small forms. Second, being a costly affair, experiments are usually carried out on a scale too small to permit generalization with a high degree of reliability. Third experimental methods are based on short – term and controlled conditions that may exist in an uncontrolled market. Hence, the results may not be applicable to the uncontrolled long-term conditions of the market.• Statistical MethodStatistical method of demand projection include the following techniques1) Trends Projection Method2) Barometric Method and3) Economic MethodTrends Projection MethodTrend projection method is a classical method of business forecasting. Thismethod is essentially concerned with the study of movement of variable throughtime. The use of this method requires a long and reliable time series data. Thetrend projection method is used under the assumption that the factorsresponsible for the past trends in variables to be projected (e.g. sales anddemand) will continue to play their part in future in the same manner and to thesame extend as they did in the past in determining the magnitude and directionof the variable.There are three (3) techniques of trend projection based on time – series data.(a) Graphical Method: - under this method, annual sales data is plotted on a graph paper and a line is drawn through the plotted points. Then a free hand line is so drawn that the total distance between the line and the point is minimum.
  • Sale Years Trend ProjectionAlthough this method is very simple and least expensive, the projections madethrough this method are not very reliable. The reason is that the extension of thetrend line involves subjectivity and personal bias of the analysis.(b) Fitting Trend Equation: Least square method: - Fitting trend equation is a formal technique of projecting the trend in demand. Under this method, a trend line (or curve) is fitted to the time – series data with the aid of statistical techniques. The form of the trend equation that can be fitted to the time series data is determined either by plotting the sales data or by trying different forms of trend equations for the best fit. When plotted, a time series date may show various trends. The most common types of trend equation are 1) liner and 2) exponential trends Linear Trend: - When a time series data reveals a rising trend in sales than a straight-line trend equation of the following form is fitted S = A + BT Where S = annual sales T = Time (in year) A & B are constant. The parameter b given the measure of annual increase in salesExponential trend:- When sales ( or any dependent variable) have increased overthe past years at an increasing rate or at a constant percentage rate, than theappropriate trend equation to be used is an exponential trend equation of any ofthe following type1. Y = aebtOr its semi – logarithmic for
  • Log y = = log a + btThis form of trend equation is used when growth rate is constant.2. Double log trend equation of equation Y = aTB Or it’s double logarithmic form Log y = log a + b log tThis form of trend equation is used when growth rate is increasing.LimitationThe first limitations of this method arise out of the assumption that the past rateof change in the dependent variable will persist in the future too. Therefore, theforecast based on this method may be considered to be reliable only for theperiod during which this assumption holds.Second, this method cannot be used for short-term estimates. Also it cannot beused where trend is cyclical with sharp turning points of trough and perks.(c) Box – Jenkins Method: - This method of forecasting is used only for short – term predictions. Besides, this method is suitable for forecasting demand with only stationary time series sales data. Stationary time series data is one, which does not reveal long term trend. In other words, Box-Jenkins technique can be used only on those cases in which time-series analysis depicts monthly or seasonal variation recurring with some degree of regularity.Barometric MethodMany economists use economic indicators as barometer to forecast trends inbusiness activities.The basic approach of barometer technique is to construct an index of relevanteconomic indicators and to forecast future trends on the basis of movements inthe index of economic indicators. The indicators used in this method areclassified as(a) Leading indicators: - consists of indicators which move up and down ahead of some other series e.g. new order of durable goods, new building permits etc.(b) Coincidental indicators: - are the ones that move up and down simultaneously with the level of economic activity. E.g. number of employees in the non-agricultural sector, rate of unemployment, sales recorded by the manufacturing, trading and the retail sectors etc.(c) Lagging indicators consists of those indicators, which follow a change after some time lag. E.g. lending rate for short-term loans etc.Development and allotment of land by Delhi Development Authority to GroupHousing Societies (a lead indicator) indicates higher demand prospects for
  • cement, steel and other construction material (coincidental indicators) andincrease in housing loan distribution (lagging indicators).Econometric methodThe econometric methods combine statistical tools with economic theories toestimate economic variables and to forecast the intended economic variables. Aneconometric model may be single equation regression model or it may consist ofa system of simultaneous equations.Regression methodRegression analysis is the most popular method of demand estimation. Thismethod combines economic theory and statistical techniques of estimation.Economic theory is employed to specify the determinants of demand and todetermine the nature of the relationship between the demand for a product andits determinants. Economics theory thus helps in determining the general form ofdemand function. Statistical techniques are employed to estimate the values ofparameters in the estimation equation.Simultaneous Equation MethodIt involves estimating several behavioral equations. These equations aregenerally behavioral equations, Mathematical equations and Market – clearingequations. The first step in this technician is to develop a complete model andspecify the behavioral assumption regarding the variables included in the model.The variables that are included in the model are1) Endogenous variables2) Exogenous variablesEndogenous variables – the variables that are determined within the model arecalled endogenous variables. Endogenous variables are included in the model asdepended variables that are the variables that are to be explained by the model.These are also called controlled variables. The number of equations included inthe model must be equal to number of endogenous variables.Exogenous variables – are those that are determined outside the model.Exogenous variables are inputs of the model whether a variable is treatedendogenous variables or exogenous variables depend on the purpose of themodel. The examples of exogenous variables are “ Money Supply”, tax rates,govt. spending etc. The exogenous variables are also known as uncontrolledvariables. Unit – III
  • Question 5: Explain the inter–relationship between the various short runcost curve of a firm. Why is average cost curve U – shaped?Answer:The basic analytical cost concepts used in the analysis of cost behavior are total,average and Marginal costs. The total cost (TC) is defined as the actual cost thatmust be incurred to produce a given quantity of output. The short – run total costis composed of two major elements I. Total fixed cost (TFC) II. Total variable cost (TVC)TC = TFC + TVCFor a given quantity of output (q), the average total cost (TAC), average fixedcost (AFC) and average variable cost (AVC) can be defined as TAC = TC/ Q = TFC + TVC/Q AFC = TFC/Q; AVC = TVC / Q TAC = AFC + AVCMarginal cost (MC) is defined as the change in the total cost divided by change intotal output. i.e. ▲TC / ▲QAs the first derivative of cost function i.e. DTC / DQ TC TVC Cost TFCThe total fixed cost (TFC) remains fixed for whole range of output, and hence, O Outputtakes the form of a horizontal line – TFC. The total variable cost (TVC) curve
  • shows that the total variable cost first increases at decreasing rate and then atincreasing rate with the increases in the output. The pattern of change in TVCstems directly from the law of increasing and diminishing returns to the variableinputs, as the output increases, larger quantity of variable inputs are required toproduce the same quantity of output due to diminishing returns. This causes asubsequent increase in the variable cost for producing the same output. The totalvertical addition to TFC and TVC; and as the TFC is constant; the TC and TVCcurve will be parallel.COSTO OutputThe AFC curve will fall steeply in the beginning and will tend to touch thehorizontal axis, but will never become zero. The AVC curve slopes downwardsand then rises. As AFC and AVC curves are falling in the initial stages, the ACcurve registers a deep fall in the beginning. Its minimum point comes after theAVC curve has reached its minimum. The reason for this is that the AFC curvecontinues to decline. In the rising phase, both the AC and AVC curve tends toapproach each other but never exactly merge into each other, for the AFC curveis above the zero axes. Generally, the average cost curve lies above the AVC –curve at a distance equal to the corresponding height of AFC curve.The marginal curve represents the change in both TVC and TC curves due tochange in output. It downward trend in MC shows increasing marginalproductivity of the variable input mainly due to internal economy resulting fromincrease in production. Similarly, an upward trend in the MC shows increase in
  • TVC, on the one hand, and decreasing marginal productivity of the variable inputon the other.Question 6: Discuss the equilibrium of a firm under monopoly. What arethe conditions of equilibrium?Answer: Monopoly refers to a market situation on where there is only one sellerwho has complete control over the supply of a commodity, which has no closesubstitutes. The monopoly firm can adopt any price it likes; it can charge uniformprice, or it can charge different prices from different consumers. It is able toprevent others from entering the industry. The firm and industry refer to one andthe same thing; a single firm constitutes the entire industry.Determination of price and output (Equilibrium under Monopoly)Marginal cost and marginal revenue – Under monopoly, the firm is a price –maker, a firm can therefore fix the price of its products, given the output. Thedemand curve (AR curve is therefore, downward sloping under monopoly, and sothe MR curve is below the AR curve. MC = MR and MC cure cuts MR curve from below Short RunARMR AR MR Output (Units)
  • A monopoly can make either normal profits or supernormal profits in the short –run. If monopolists making sub – normal profit in the short – run so long as it AVCis covered. Thus, in the short run under monopoly there are three possibilities. ACPrice and MC/ Revenue A1 P1 Normal Profits E1 AR MR O Q1 Output (units)E1 is the point of equilibrium, OQ1 is he equilibrium output and OP1 is theequilibrium price. AC = A1Q1 AC = AR, the firm makes normal profitsSuper normal profitsACPrice and MC/ Revenue P2 C1 A2 E2 O Q2 Output (units)
  • E2 is the point of equilibrium, OQ2 is the equilibrium output, OP2 is equilibriumprice, AC = A2Q2 AR = R2Q2AR>AC, the firm makes super – normal profits equal to the area given byP2R2A2C2Sub normal Profits covering AVCE3 is the point of equilibrium, OQ3 is the equilibrium Output, OP3 is theequilibrium price. AC – A3Q3 AR – R3Q3 AVC – R3Q3AR<AC, the firm makes sub – normal profits equal to C3AS3R3P3. Even thoughthe firm makes losses. It continues to produce in the short run because AVC isrecovered.
  • Long run equilibrium under Monopoly: A firm under monopoly may make normalprofits in the long – run; however, it tries to super – normal (abnormal) profits inthe long run. LRAC is flatter than the short run average cost curve, but theconditions of equilibrium are the same as in short run.AR – R0Q0; AC- C0Q0, AR, AC so the firm makes super normal profits equal toP0R0C0P.Q No. 7 Explain Baumol’s theory of sales revenue maximization what are itsassumptions?Ans. According to Baumol, every business firm aims at maximization it salesrevenue (price x quantity0 rather than its profit. Hence his hypothesis has cometo be known as sales maximization theory & revenue maximization theory.According to baumol, sales have become an end by themselves and accordinglysales maximization has become the ultimate objective of the firm. Hence, themanagement of a firm directs its energies in promoting and maximizing its salesrevenue instead of profit.The goal of sales maximization is explained by the management’s desire tomaintain the firm’s competitive position, which is dependent to a large extent onits size. Unlike the shareholders who are interested in profit, the management isinterested in sales revenue, either because large sales revenue is a matter ofprestige or because its remuneration is often related to the size of the firm’s
  • operations than to its profits. Baumol, however does not ignore the cost ofproduction which has to be covered and also a margin of profit. In fact, headvocates the adoption of a price, which will cover the cost and also will yield aminimum rate of profits. That is, while the firm is maximizing its revenue fromsales, it should also “enough or more than enough profits” to keep theshareholders satisfied. According to Baumol the typical digopolists objective canusually be characterized approximately as sales maximization output does notyield adequate profit, the firm will have to choose that output which will yieldadequate profit even through it may not achieve sales maximization.According to sales revenue maximization theory, graphs, cost and revenuecurves are given as in conventional theory of pricing, suppose that the total cost(TC) and the total revenue (TR) curves are given, the profit curves (TP) isobtained by plotting the difference between TR and TC curves. Profit are zerowhere TR = TC. The total sales revenue is maximization where slope of TRcurve i.e MR = is equal to zero. Such a point lies at the highest point of theTR curve. The highest point on the TR curve can be obtained easily by drawing aline parallel to the horizontal axis and tangent to the TR curve. The point H on theTR curve represents the total maximum sales revenue. A line drawn from point Hto output axis shows sales revenue is maximized at output OQ3 and its priceequals HQ3 / DQ3.Profit Constraint and Revenue maximization :At output OQ3, the firmmaximizes the total revenue and makes profit HM = TQ3. If the profit is enough ormore than enough to satisfy the shareholders, the firm will produce output OQ 3and charge a price = HQ / OQ3. But if profit at output OQ3 is not enough to satisfythe shareholders, then the firm’s output must be say OQ 2 which yields a profitLQ2> TQ3.
  • Thus, there are two types of probable equilibrium: one is which the profitconstraint does not provide as effective barriers to sales maximization, andsecond in which profit constraint does provide as effective barriers to salesmaximization. In the second type of equilibrium, the firm will produce an outputwhich yields a satisfactory ar target profit. It may be an output between OQ 1 andOQ2 .e.g if minimum required profit is OP1, than the firm will stick to its salesmaximization goal and produce output OQ3 which yields a profit much greaterthan the required minimum.Since actual profit (TQ3) is much greater than the minimum required, theminimum profit constraint is not operative, But, if required minimum profit level isOP2, OQ3 will not yield sufficient profit to met the profit target. The firm will,therefore, produce an output OQ2 where its profit is just sufficient to meetrequirement of minimum profit. This output OQ2 is less than the salesmaximization output OQ3. Evidently the profit maximization output OQ1 is lessthan the sales maximization output OQ2. (with profit constraint)Q. No. 8 Explain the technique of multi-product pricing. What is therationale of the technique?Ans. Almost all the firms have more than one product in their line of production.Even the most specialized firms produce a commodity in multiple models, stylesand size, each so much differentiated from the other that each moder or size ofthe product may be considered a different products e.g. the various models oftelevision, refrigerators etc produced by the same company may be treated asdifferent product for at least pricing purpose. The various models are sodifferentiated that consumers view them as different products. Hence each modelor product has different average revenue (AR) and Marginal Revenue curves andthat one product of the firm concepts against the other product. The pricing underthis condition is known as multi-product pricing or product line pricing. In multi-product pricing, each product has a separate demand curve. But, since all ofthem are produced under one organization by interchangeable productionfacilities, they have only one inseparable marginal cost curve. That is, whilerevenue curves, AR and MR, are separate for each product, cost curves AC andMC are inseparable. A B C D MC D1 D2 D3 D4costand P1 P2 P3 P4Revenue EMR MR1 MR2 MR3 MR4
  • Q Q1 Q2 Q3 Q4 Quantities demanded per time unitSuppose a firm has four different products A, B, C and D in its line of production.The marginal cost of all the products can be taken together as curve MC, whichis the factory marginal cost curve. When the MRs. For the individual products aresummed up, the aggregate MR passes through point C on MC curve. If a lineparallel to the X – axies, is drawn from point C to the Y- axis through the MRs,the intersecting point will show the points where MC and MRs are equal for eachproduct, represented by the line EMR and MRs determine the output level andprice for each product, the output of the four product are given as OQ1 of productA; QQ2 of B; Q2Q3 of C; and Q3Q4 of D. The respective prices for the fourproducts are P1Q1 for product A; P2 Q2 for B; P3Q3 for C; and P4q4 for D, Theseprice and output combinations maximize the profit from each product and hencethe overall profit of the firm.