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Managerial economics
 

Managerial economics

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    Managerial economics Managerial economics Document Transcript

    • Master of Business Administration Semester I MB0042 – Managerial Economics - 4 Credits (Book ID: B1131) Assignment Set- 1 (60 Marks)Q1. Distinguish between a firm and an industry. Explain the equilibrium of a firmand industry 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 to computers,anything in the shops that get sold to the public. The retail industry is very vast and has many subdivisions, such as electrical and cosmetics. More specialized industries deal with a specific thing. Thesteel industry is a more specialized industry, dealing with the making of steel and selling it on to buyers.The difference between this and a firm is that a firm is the company that operates within the industry tocreate the product. The firm might be a factory, or the chain of stores that sells the clothes, within itsindustry. For example, one firm that makes steel might be Aveda steel. They create the steel in that firmfor the steel industry.A firm is usually a corporate company that controls a number of chains in the industry it is operatingwithin.For example in retail, the firm Arcadia stores own the clothing chains Top shop, Dorothy Perkins, MissSelfridge, and Evans. These all operate for the firm Arcadia within the industry of retail.Several firms can operate in one industry to ensure that there is always competition to keep pricesreasonable and stop the market becoming a monopoly, which is where one firm is in charge of thewhole industry. Sometimes, a firm is not necessary within the industry and independent chains andretailers can enter straight into the market without a firm behind them, although this is risky. This isbecause one of the advantages of having a firm behind you is that it is a safeguard against possiblebankruptcy because the firm can support the chain that it owns.The equilibrium of a firm and industry under perfect competition According 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 to Lipsey,“Industry is a group of firms that sells a well defined product or closely related set of products.”Conditions of Equilibrium of the Firm and Industry A firm is in equilibrium when it has no propensity to modify its level of productivity. It requiresneither extension nor retrenchment. It wants to earn maximum profits in by equating its marginal costwith its marginal revenue, i.e. MC = MR. Diagrammatically, the conditions of equilibrium 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 be fulfilledyet 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 must be abovethe MR.This is the second order condition. Under conditions of perfect competition, the MR curve of a firmoverlaps with the AR curve. The MR curve is parallel to the X axis. Hence the firm is in equilibrium whenMC = MR = AR.The first order figure (1), the MC curve cuts the MR curve first at point X. It contends the condition ofMC = MR, but it is not a point of maximum profits for the reason that after point X, the MC curve isbeneath the MR curve. It does not pay the firm to produce the minimum output OM when it can earnhuge profits by producing beyond OM. Point Y is of maximum profits where both the situations arefulfilled.Amidst points X and Y it pays the firm to enlarges its productivity for the reason that it’s MR > MC. It willnevertheless stop additional production when it reaches the OM1 level of productivity where the firmfulfils both the circumstances of equilibrium. If it has any plants to produce more than OM1 it will beincurring losses, for its marginal cost exceeds its marginal revenue beyond the equilibrium point Y. Thesame finale hold good in the case of straight line MC 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 or either theindustry and next, when each firm is also in equilibrium. The first clause entails that the average costcurves 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 cost curvesof the firms. The second condition entails the equality of MC and MR. Under a perfectly competitiveindustry 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 theindustry.
    • 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 its productivityand 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 the erraticfactors of production. The number of firms in the industry is fixed since neither the existing firms canleave 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 industryso 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 totalcost revenue study.Marginal Cost, Marginal Revenue analysis – During the short run, a firm will produce only its price equalsaverage variable cost or is higher than the average variable cost (AVC). Furthermore, if the price is morethan the averages total costs, ATC, i.e. P = AR > ATC the firm will be earning super normal profits. If priceequals the average total costs, i.e. P = AR = ATC the 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, the firm willshut down since in order to produce it must cover atleast it’s AVC through short run. So during the shortrun, under perfect competition, affirm is in equilibrium in all the above mentioned stipulations.Super normal profits – The firm will be earning super normal profits in the short run when price is higherthan the short run average cost.Normal Profits = The firm may earn normal profits when price equals the short run average costs.Total Cost – Total Revenue Analysis – The short run equilibrium of the firm can also be represented withthe help of total cost and total revenue curves. The firm is able to maximise its profits when the positivediscrimination 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 is also inequilibrium. For full equilibrium of the industry in the short run all firms must be earning normal profits.But full equilibrium of the industry is by sheer accident for the reason that in the short rum some firmsmay be earning super normal profits and some losses. Even then the industry is in short run equilibriumwhen its quantity demanded and quantity supplied is equal at the price which clears the market.Online Live Tutor Conditions of Equilibrium of the Firm and Industry: We have the best tutors in Economics in the industry. Our tutors can break down a complexConditions of Equilibrium of the Firm and Industry problem into its sub parts and explain to you in detailhow each step is performed. This approach of breaking down a problem has been appreciated bymajority of our students for learning Conditions of Equilibrium of the Firm and Industry concepts. Youwill get one-to-one personalized attention through our online tutoring which will make learning fun andeasy. Our tutors are highly qualified and hold advanced degrees. Please do send us a request forConditions of Equilibrium of the Firm and Industry tutoring and experience the quality yourself.Online Equilibrium of the Firm and Industry Help: If you are stuck with Equilibrium of the Firm and Industry Homework problem and need help, wehave excellent tutors who can provide you with Homework Help. Our tutors who provide Equilibrium ofthe Firm and Industry help are highly qualified. Our tutors have many years of industry experience andhave had years of experience providing Equilibrium of the Firm and Industry Homework Help. Please dosend us the Equilibrium of the Firm and Industry problems on which you need help and we will forwardthen 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 MaximizationQ2. 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. 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 environment
    • of 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 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. 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.Q3. A firm supplied 3000 pens at the rate of Rs 10. Next month, due to a riseof in the price to 22 Rs. per pen the supply of the firm increases to 5000 pens.Find the elasticity of supply of the pens.Ans.Of course, consumption is not the only thing that changes when prices go up or down. Businessesalso respond to price in their decisions about how much to produce. Economists define the priceelasticity of supply as the responsiveness of the quantity supplied of a good to its market 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 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.Q4. 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 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. 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.
    • Q5. Explain in brief the relationship between TR, AR, and MR underdifferent market condition.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 ofits products, i.e. .gross revenue. In other words, it is the total sales receipts earned from the saleof its total output produced over a given period of time. In brief, it refers to the total salesproceeds. It will vary with the firm’s output and sales. We may show total revenue as a functionof the total quantity 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 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.
    • 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 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.
    • 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 rateTR 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.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.5 per 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
    • Q6. What is a business cycle? Describe the different phases of a businesscycle.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." 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%.