IMT-20: MANAGERIAL ECONOMICSPART – AQ1. Distinguish between the principles of marginalism andincrementalism with the help ...
Q2. How is the price elasticity of demand measured? Explain therelationship between price elasticity, average revenue andm...
4. The Total Outlay Method:The total outlay method of ascertaining the elasticity of demand isdenoted as price proliferate...
Q4. Why is an indifference curve for two normal goods convex toorigin? Why cannot it be a concave curve or a straight line...
Q5. Why is demand forecasting important? Explain the varioustypes of survey methods of forecasting demand and theirusefuln...
PART – BQ1. Diagramatically explain the three stages of the law ofdiminishing marginal returns.Ans. The law of diminishing...
Q2. What are isoquants and isocost lines? Explain graphicallyAns. In economics an isocost line shows all combinations of i...
Conversely, if the distance is decreasing as output increases, the firm isexperiencing increasing returns to scale; doubli...
In addition, implicit cost and explicit cost are also distinguished through:Implicit cost is considered as the cost that h...
Q5. Describe the long run average cost (LAC) curve according tothe modern cost theory.Ans. The Long-run Average Cost (LAC)...
PART – CQ1. Explain the Cyert-March Hypothesis of satisficng behaviour.Ans. Cyert and March Hypothesis of satisfying behav...
Q2. Explain the profit maximizing conditions of a firm with thehelp of marginal revenue and marginal cost.Ans. The profit ...
Competitors do not base decisions on the anticipated individual reactionsof their many competitors, so they are not mutual...
Price discrimination or yield management occurs when a firm charges adifferent price to different groups of consumers for ...
As such, firms within an oligopoly produce branded products (advertisingand marketing is an important feature of competiti...
CASE STUDY – IEstimation of the Demand for Oranges by Market ExperimentResearchers at the University of Florida conducted ...
Price Elasticity and Cross-Price Elasticity of Demand for Florida IndianRiver, FloridaInterior, and California OrangesPric...
2) Suggest a suitable price policy for the three types oforanges.Ans. The concepts of comparative advantage and competitiv...
CASE STUDY – IIA deodorant company manufactures and sells several types of deodorantswhich are branded as ‘Smell Fresh’. T...
However, while competitive prices are beneficial to consumers, certainanti-competitive pricing behaviour, such as predator...
2) MARKET DEVELOPMENTThe deodorant company must also focus high on the low andmedium and low on the high price segments, a...
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  1. 1. IMT-20: MANAGERIAL ECONOMICSPART – AQ1. Distinguish between the principles of marginalism andincrementalism with the help of examples.Ans. Marginalism is the study of marginal theories and relationshipswithin economics, and its key focus is how much extra use is gained fromincremental increases in the quantity of goods created, sold, etc. and howthose measures relate to consumer choice and demand.The principles of marginalism relies on the assumption of (near) perfectmarkets, which do not exist in the practical world, but still the core ideasof marginalism are generally accepted by most economic schools ofthought, and are still used by businesses and consumers to make choicesand substitute goods.The distinction between marginalism and incrementalism are statedthrough the following:• Marginal concepts are always defined in terms of unit changes, butincremental concepts are defined in terms of chunk changes.• Incremental concepts are more flexible than marginal concepts. Inmarginalism, the reference is to one independent variable, but inincrementalism, more than one independent variable can beconsidered at a time. Marginal revenue is the increase in revenuedue to one-unit increase in level of output. But revenue mayincrease due to a change in not only output, but also price andproduction process.• Under special circumstances, incremental and marginal revenue(cost) may be the same.Incremental revenue and incremental cost are two basic concepts formaking optimum economic decisions, and a decision is optimum if itincreases revenue more than cost or if it reduces costs more thanrevenue, like if the net incremental revenue is positive which may betermed as the incremental principle to be followed by management inmaking decisions.In economic theory, the concept of margin is very useful because itrenders the determination/derivation of an equilibrium solution quitesimple and easy. However, in the real world of business management,marginalism should better be replaced by incrementalism because inmaking economic decision, management is interested in knowing theimpact of a chuck-change rather than a unit-change.Incremental reasoning involves a measurement of the impact of decisionalternatives on economic variables like revenue and costs which refer tothe total magnitude of changes in total revenues (or costs) that resultfrom a set of factors like change in prices, products, processes andpatterns.IMT 20 Managerial Economics - Assignment Page 1 of 21 22/06/2012
  2. 2. Q2. How is the price elasticity of demand measured? Explain therelationship between price elasticity, average revenue andmarginal revenue.Ans. Price elasticity of demand (PED or Ed) is a measure used ineconomics to show the responsiveness, or elasticity, of the quantitydemanded of a good or service to a change in its price.In general, the demand for a good is said to be inelastic (or relativelyinelastic) when the price elasticity demand is less than one, in absolutevalue, which is, changes in price have a relatively small effect on thequantity of the good demanded. While the demand for a good is said to beelastic or relatively elastic when its PED is greater than one, in absolutevalue, that is, changes in price have a relatively large effect on thequantity of a good demanded.There are four methods of approaching price elasticity of demand, whichare as follows.1. The Percentage Method:It is determined by thee co-efficient of price elasticity (Ep), and thisco-efficient determines the percentage change in the quantitydemanded of an article from a specified percentage price change.2. The Point Method:This method has been formulated by Prof. Marshall for measuringelasticity at a point on the demand curve.In the diagram, shows AB being straight line demand curve, if theprice falls from PG(=OC) to FH(=OE), the quantity demanded isaugmented from OG to OH. Elasticity at Point P on the AB demandcurve as per the formulae is Ep = (∆q / ∆p) x p / q, where ∆qrepresents change in quantity demanded, ∆p change in price levelwhereas p and q are prime price and quantity levels.3. The Arc Method:Any two points in the demand curve is an arc which measureselasticity over a definite array of the price and quantity demanded.IMT 20 Managerial Economics - Assignment Page 2 of 21 22/06/2012
  3. 3. 4. The Total Outlay Method:The total outlay method of ascertaining the elasticity of demand isdenoted as price proliferated with the quantity of an articlepurchased that is denoted as below.Total outlay = Price x Quantity DemandedQ3. Critically examine the law of diminishing marginal utility.Ans. The law of diminishing marginal utility describes a familiar andfundamental tendency of human behaviour, which states that as aconsumer consumes more and more units of a specific commodity, theutility from the successive units goes on diminishing. Thus, the additionalbenefit which a person derives from an increase of his stock of a thingdiminishes with every increase in the stock that already has.The law of diminishing marginal utility is based upon three facts:1) Total wants of a man are unlimited, but each single want can besatisfied, and as a man gets more and more units of a commodity,the desire of his for that good goes on falling, by which a point isreached when the consumer no longer wants any more units of thatgood.2) Different goods are not perfect substitutes for each other in thesatisfaction of various particular wants, and the marginal utility willdecline as the consumer gets additional units of a specific good.3) The marginal utility of money is constant, given the consumer’swealth.The basis of the Law of Diminishing Marginal Utility is a fundamentalfeature of wants which states that when people go to the market for thepurchase of commodities, they do not attach equal importance to all thecommodities which they buy.In case of some of commodities, they are willing to pay more and in someless. There are two main reasons for this difference in demand:1) The linking of the consumer for the commodity2) The quantity of the commodity which the consumer has withhimself, by which the marginal utility of a commodity diminishing asthe consumer gets larger quantities of it.In given span of time, the more of a specific product a consumer obtains,the less anxious he is to get more units of that product or that as moreunits of a good are consumed, additional units will provide less additionalsatisfaction than previous units.IMT 20 Managerial Economics - Assignment Page 3 of 21 22/06/2012
  4. 4. Q4. Why is an indifference curve for two normal goods convex toorigin? Why cannot it be a concave curve or a straight line?Ans. An indifference curve is a graph showing different bundles of goodsbetween which a consumer is indifferent, that is, at each point on thecurve, the consumer has no preference for one bundle over another.One can equivalently refer to each point on the indifference curve asrendering the same level of utility (satisfaction) for the consumer, andutility is then a device to represent preferences rather than somethingfrom which preferences come.The main use of indifference curves is in the representation of potentiallyobservable demand patterns for individual consumers over commoditybundles, which shows combination of goods between which a person isindifferent.An indifference curve for two normal goods is convex in origin, and notconcave curve or a straight line because its main attributes or propertiesor characteristics are as follows:1) Indifference Curves are Negatively Sloped:The indifference curves must slope down from left to right, whichmeans that an indifference curve is negatively sloped downwardbecause as the consumer increases the consumption of Xcommodity, one has to give up certain units of Y commodity inorder to maintain the same level of satisfaction. Thus, the higherindifference curve that lies above and to the right of anotherindifference curve represents a higher level of satisfaction andcombination on a lower indifference curve yields a lowersatisfaction.2) Indifference Curve are Convex to the Origin:They are convex to the origin (bowed inward), that as theconsumer substitutes commodity X for commodity Y, the marginalrate of substitution diminishes of X for Y along an indifferencecurve. Thus, the indifference curves cannot intersect each otherbecause at the point of tangency, the higher curve will give asmuch as of the two commodities as is given by the lowerindifference curve.3) Indifference Curves do not Touch the Horizontal or Vertical Axis:One of the basic assumptions of indifference curves is that theconsumer purchases combinations of different commodities, andnot supposed to purchase only one commodity. Thus, in that caseindifference curve will touch one axis.IMT 20 Managerial Economics - Assignment Page 4 of 21 22/06/2012
  5. 5. Q5. Why is demand forecasting important? Explain the varioustypes of survey methods of forecasting demand and theirusefulness.Ans. Demand forecasting is important and crucial to any supplier,manufacturer, or retailer because it determines the quantities that shouldbe purchased, produced, and shipped.Demand forecasts are necessary since the basic operations process,moving from the suppliers raw materials to finished goods in thecustomers hands, takes time, by which most firms must anticipate andplan for future demand so that they can react immediately to customerorders as they occur.In other words, most manufacturers make to stock rather than make toorder, and they plan ahead and then deploy inventories of finished goodsinto field locations. Thus, once a customer order materializes, it can befulfilled immediately, since most customers are not willing to wait the timeit would take to actually process their order throughout the supply chainand make the product based on their order.Consequently, companies that offer rapid delivery to their customers willtend to force all competitors in the market to keep finished goodsinventories in order to provide fast order cycle times. As a result, virtuallyevery organization involved needs to manufacture or at least order partsbased on a forecast of future demand.Furthermore, the ability to accurately forecast demand also affords thefirm opportunities to control costs through levelling its productionquantities, rationalizing its transportation, and generally planning forefficient logistics operations.In general practice, accurate demand forecasting lead to efficientoperations and high levels of customer service, while inaccurate demandforecasting will inevitably lead to inefficient, high cost operations and/orpoor levels of customer service.In many supply chains, the most important action one can take toimprove the efficiency and effectiveness of the logistics process is toimprove the quality of the demand forecasts.Accordingly, demand forecasting may be used in making pricing decisions,in assessing future capacity requirements, or in making decisions onwhether to enter a new market, as well as predict future product andservice demands so that we can supply our clients’ orders quickly andeffectively.IMT 20 Managerial Economics - Assignment Page 5 of 21 22/06/2012
  6. 6. PART – BQ1. Diagramatically explain the three stages of the law ofdiminishing marginal returns.Ans. The law of diminishing marginal returns states that an increase inthe capital and labour applied to the cultivation of land causes in general aloss than the proportionate increase in the amount of produce raisedunless, it happens to coincide with an improvement in the art ofagriculture.This law also pertains to physical returns simply stating that with anincrease in variable inputs applied, the production initially increases withincreasing rate, then at constant rate and eventually it declines. However,this law will not hold true (limitation) when there is:• An improvement in technology,• Efficient management and• Residual effectThere are three stages of the law of diminishing returns, and they are:Stage – I1) This stage starts from origin and ends where AP & MP curvesintersect each other.2) The TP is increasing at increasing rate at first then at decreasingrate.3) PP and MP both increase but MP is grater than IP.4) The EP is greater than 1 (one)Stage – II1) It starts where PP & MP intersect each other and EP = l. It endswhen MP = 02) TP increases but at decreasing rate.3) MP Starts to decline continuously and AP also start to decline but itis greater than MP4) The elasticity of production (EP) is greater than zero but less than1.Stage – III1) This stage starts when MP is zero and TP is at maximum.2) TP starts to decline and it declines continuously.3) MP becomes negative, remains positive.4) EP is always less than zero.The law of diminishing returns states that a point will be reached whenfurther additions of a variable input will yield diminishing marginal returnsper unit of that variable, which is one of the most fundamental principlesin economics.IMT 20 Managerial Economics - Assignment Page 6 of 21 22/06/2012
  7. 7. Q2. What are isoquants and isocost lines? Explain graphicallyAns. In economics an isocost line shows all combinations of inputs whichcost the same total amount, and although similar to the budget constraintin consumer theory, its use pertains to cost-minimization in production, asopposed to utility-maximization.The isocost line is combined with the isoquant map to determine theoptimal production point at any given level of output, and specifically, thepoint of tangency between any isoquant and an isocost line gives thelowest-cost combination of inputs that can produce the level of outputassociated with that isoquant.The absolute value of the slope of the isocost line, with capital plottedvertically and labour plotted horizontally, equals the ratio of unit costs oflabour and capital.An isoquant is a contour line drawn through the set of points at which thesame quantity of output is produced while changing the quantities of twoor more inputs, and are typically drawn on capital-labour graphs, showingthe technological trade-off between capital and labour in the productionfunction, and the decreasing marginal returns of both inputs. Thus, addingone input while holding the other constant eventually leads to decreasingmarginal output, and this is reflected in the shape of the isoquant.A family of isoquants can be represented by an isoquant map, a graphcombining a number of isoquants, each representing a different quantityof output, also called equal product curves.An isoquant graph can also indicate decreasing or increasing returns toscale based on increasing or decreasing distances between the isoquantpairs of fixed output increment, as output increases.IMT 20 Managerial Economics - Assignment Page 7 of 21 22/06/2012
  8. 8. Conversely, if the distance is decreasing as output increases, the firm isexperiencing increasing returns to scale; doubling both inputs results inplacement on an isoquant with more than twice the output of the originalisoquant.An isoquant map where Q3 > Q2 > Q1, which is a typical choice of inputswould be labour for input X and capital for input Y, and more of input X,input Y, or both is required to move from isoquant Q1 to Q2, or from Q2to Q3.Q3. Distinguish between implicit cost and explicit cost with thehelp of example.Ans. Implicit cost and explicit cost are terms used in accounting, whichare usually called relative cost to each transaction. However as thesecosts are measured, the most common types being mentioned are implicitand explicit cost.Implicit cost is considered as the cost that has occurred on an enterprisebut is not initially reflected and reported as a direct expenditure which isusually referred to as the deficit from a potential revenue, a result whenthe person renounces his capacity to gain higher profitability, or when acompany forgoes the satisfaction and benefits that a specific project mightgenerate.Explicit cost is the cost that is solidly reported based on numbers andstatistics, very detailed in terms of the figures that were generated whichprovides a clear and continuous cash flow from expenses that do notnecessarily proved to be obvious about it and establish the right from thethought of profitability.Difference between implicit cost and explicit cost can be attributed thisway, implicit cost is an anticipated loss of revenue even before the wholetransaction pushed through, and these are not in reflected in cash butrather this is based on benefits that a certain investment seems verypromising. While explicit cost on the other hand, is measured by itsmonetary value or any of its equivalent which can be counted and verifiedin a report, and definite in nature and very exact.IMT 20 Managerial Economics - Assignment Page 8 of 21 22/06/2012
  9. 9. In addition, implicit cost and explicit cost are also distinguished through:Implicit cost is considered as the cost that has occurred on anenterprise, but is not initially reflected and reported as a directexpenditure.Explicit cost is the cost that is solidly reported based on numbersand statistics. This actual cost is very detailed in terms of thefigures that were generated.Implicit cost is an anticipated loss of revenue even before the wholetransaction pushed through.Explicit cost on the other hand is the black and white accountabilityof all the profit.Q4. Graphically explain the relationship between change inoutput and AVC, AC and MC.Ans. Average Variable Cost (AVC) is found by dividing total variable cost(TVC) by the corresponding output which declines initially, reaches aminimum, and then increases again. While the Average Cost (AC) can befound by dividing total cost (TC) by total output (Q) or, by adding AFC andAVC for each level of output.On the other hand, Marginal Cost (MC) is defined as the extra, oradditional, cost of producing one more unit of output which can bedetermined for each additional unit of output simply by noting the changein total cost which that unit’s production entails: Change in TC ∆TCMC =Change in Q ∆Q.It is notable that the relationship between change in output and thatmarginal cost cuts through AVC, AC and MC at their minimum, and whenboth the marginal and average variable costs are falling, average will fallat a slower rate. Thus, when MC and AVC are both rising, MC will rise at afaster rate.As a result, MC will attain its minimum before the AVC, and when MC isless than AVC, the AVC will fall, and when MC exceeds AVC, AVC willincrease, which means that so long as MC lies below AVC, the latter willfall and where MC is above AVC, AVC will rise. Therefore, at the point ofintersection where MC=AVC, AVC has just ceased to fall and attained itsminimum, but has not yet begun to rise.Similarly, the marginal cost curve cuts the average total cost curve at thelatter’s minimum point, since MC can be defined as the addition either tototal cost or to total cost or to total variable cost resulting from one moreunit of output. However, no such relationship exists between MC and theaverage fixed cost, because the two are not related, and by definition,marginal cost includes only those costs which change with output andfixed costs by definition are independent of output.IMT 20 Managerial Economics - Assignment Page 9 of 21 22/06/2012
  10. 10. Q5. Describe the long run average cost (LAC) curve according tothe modern cost theory.Ans. The Long-run Average Cost (LAC) curves are derived from the long-run production functions in which all inputs are variable, but in the longrun none of the factors are variable and all can be varied to increase thelevel of output.The long run average cost of production is the least possible average costof production of producing any given level of output when all inputs arevariable, including of course the size of the plant, and in the long runthere is only the variable cost as total cost, by which there is nodichotomy of total cost into fixed and variable costs. Thus we study theshape and relationship of long run average cost curve and long runmarginal cost curve.Long run is a planning horizon, and it is only a perspective view for thefuture course of action which comprises all possible short run situationsfrom which a choice is made for the actual course of operation.The features of Long Run Average Cost (LAC) Curve are:• Tangent curve:By joining the loci of various plant curves relating to differentoperational short run phases, the LAC curve is drawn as a tangentcurve.• Envelope curve:It is also referred to as the envelope curve because it is theenvelope of a group of short run curves.• Planning curve:It denotes the least unit cost of producing each possible level ofoutput and the size of the plant in relation to LAC curve.• Minimum cost combination:It is derived as a tangent to various SAC’s curve underconsideration, so the cost level presented by LAC curve for differentlevel of output reflect minimum cost combination at each long runlevel of output.• Flatter U-shaped:It is less shaped or rather dish shaped. It gradually slopesdownward and then after reaching a certain level, gradually beginsto slope upwardsIMT 20 Managerial Economics - Assignment Page 10 of 21 22/06/2012
  11. 11. PART – CQ1. Explain the Cyert-March Hypothesis of satisficng behaviour.Ans. Cyert and March Hypothesis of satisfying behaviour explicitly statedthat they developed their framework for dealing with the large, multi-product firm, and in discovering how BTF can be applied to thedevelopment of a BTEF, it needs to boil down Cyert and March’s ideas tokey elements, then examined in greater detail.The Behavioural Theory of Cyert-March is a theory that is built around apolitical conception of organizational goals, a bounded rationalityconception of expectations, an adaptive conception of rules andaspirations, and a set of ideas about how the interactions among thesefactors affect decisions in a firm.Modern perspectives often rely, implicitly or explicitly, on the behaviouralideas from Cyert and March’s hypothesis, and their ideas about goalconflict, behavioural conceptions of information search and expectationformulation, and the adaptive adjustment of choice variables provided thesupporting architecture of firm decision-making essential to strategictheories of firms.Cyert-March Hypothesis’ also helped to extend the understanding ofcompetitive interaction and the performance of individual firms as well asindustries, and served to propagate modern research on individualbehaviour in firms and markets.Central to Cyert and March’s hypothesis is the idea that decision makingconsists in finding a satisfactory solution (satisficing) rather than inevaluating the best possible alternative (optimization). Thus, makingmanagement the art of dealing effectively with the reality of boundedrationality in a changing environment, by which these themes remain asfresh and relevant today as they were when Cyert and March launchedupon their endeavour in the early 1960s. However, with very fewexceptions, very little has been said by researchers in the tradition ofCyert and March about the behaviour of entrepreneurial firms, whetherthey are conceptualized as small firms, young firms, or pre-firms.There are three ideas that parallel key concepts in the Cyert and March’shypothesis:1. Accumulating stakeholder commitments under goal ambiguity2. Achieving control through non-predictive strategies3. Having a predominately exaptive orientation in the entrepreneurialfirm.Together, all these ideas can be collated into a model of entrepreneurialfirm behaviour that emphasizes transforming current realities to fabricatenew environments rather than acting within extant environments.IMT 20 Managerial Economics - Assignment Page 11 of 21 22/06/2012
  12. 12. Q2. Explain the profit maximizing conditions of a firm with thehelp of marginal revenue and marginal cost.Ans. The profit maximizing conditions of a firm with the help of marginalrevenue is shown in the amount by which a firms revenue increases whenit expands output by one unit, taking into account that to sell one moreunit it may need to reduce price on all units, and such benefits can beseen in terms of utility/satisfaction/or dollar amounts.In addition, the maximizing benefit of marginal revenue is the extrarevenue that an additional unit of product will bring a firm which can alsobe described as the change in total revenue/change in number of unitssold.Relatively, marginal revenue is equal to the change in total revenue overthe change in quantity when the change in quantity is equal to one unit(or the change in output in the bracket where the change in revenue hasoccurred).For a firm facing perfectly competitive markets, price does not changewith quantity sold, so marginal revenue is equal to price, and for amonopoly, the price received will decline with the quantity sold, somarginal revenue is less than price which means that the profit-maximizing quantity, for which marginal revenue is equal to marginalcost, will be lower for a monopoly than for a competitive firm, while theprofit-maximizing price will be higher.While marginal cost is the increase in cost that accompanies a unitincrease in output, by which the partial derivative of the cost function withrespect to output.Moreover, marginal cost is also known as incremental cost or differentialcost. A simple definition of marginal cost (MC) would be, "The change intotal costs arising from a change in the managerial control variable"(Baye, 2006). According to the Blackwell Encyclopedic Dictionary ofManagerial Economics "The marginal cost is the change in total costs dueto a unit (or incremental) change in output.Basically, marginal cost is the change in total cost that arises when thequantity produced changes by one unit, and mathematically, the functionis expressed as the derivative of the total cost (TC) function with respectto quantity (Q), which may change with volume, and so at each level ofproduction, the marginal cost is the cost of the next unit produced.Q3. Explain why does a perfectly competitive firm reaps normalprofits in the long run.Ans. A perfectly competitive firm reaps normal profits in the long runbecause ease of entry and exit in monopolistically competitive marketsforces firms into a slightly more competitive mode, in which manypotential suppliers compete vigorously with makers of close, but notperfect, substitutes for their “brand-name” products.IMT 20 Managerial Economics - Assignment Page 12 of 21 22/06/2012
  13. 13. Competitors do not base decisions on the anticipated individual reactionsof their many competitors, so they are not mutually interdependent in theway others are, by which product differentiation (e.g., packaging,advertising, or styling), however, gives them some control over prices.Pure competition allows easy entry or exit, but differs because each firmproduces a differentiated good, and have:1. Large numbers of potential buyers and suppliers.2. Differentiated products that are close substitutes.3. Easy entry or exit in the long run.Successful product differentiation creates market power by expanding thedemand curve the firm faces and decreasing its price elasticity which canallow a competitor to act a little like a monopolist that has some controlover price, but like normal competitors, monopolistic competitors earnonly normal profit in the long run because entry by potential competitorsis easy.Regardless of market structure, all firms maximize profit by producingwhere marginal revenue equals marginal cost, and in the short run, thissuccessful firms economic profit equals the shaded area.A perfectly competitive firm may also suffer short-run losses, and profitswould be impossible if a firms average cost curve were always above thedemand curve, but like all firms, a competitor would minimize losses byselling that output where marginal revenue equals marginal cost, as longas the price it could set (average revenue) exceeded average variablecosts.A competitive firm differentiate products to exploit short-run profitopportunities, and would like their profits to persist, and these hopes areusually frustrated because typical competitors earn only normal profits inthe long run; the long-run industry adjustments parallel those for purecompetition. Thus, wntry of new firms seeking profits cannot beprevented, which may increase production costs, by which profits are alsodissipated because prices fall when new competitors expand output andtake customers from existing firms.4. What is price discrimination? How does a discriminatingmonopolist allocate his output in different markets to chargedifferent price.Ans. Most businesses charge different prices to different groups ofconsumers, for what is more or less the same good or service, normallyknown as price discrimination which has become widespread in nearlyevery market.IMT 20 Managerial Economics - Assignment Page 13 of 21 22/06/2012
  14. 14. Price discrimination or yield management occurs when a firm charges adifferent price to different groups of consumers for an identical good orservice, for reasons not associated with costs, which makes it important tostress that charging different prices for similar goods is not pure pricediscrimination.One must be careful to distinguish between price discrimination andproduct differentiation, which is when differentiation of the product givesthe supplier greater control over price and the potential to chargeconsumers a premium price because of actual or perceived differences inthe quality / performance of a good or service.Price discrimination is an extremely common type of pricing strategyoperated by virtually every business with some discretionary pricingpower which is a classic part of price competition between firms seeking amarket advantage or to protect an established market position, as well asa discriminating monopolist firm allocates its output in different marketsto charge different price required for discriminatory pricing:a) Perfect Price Discrimination:Charging whatever the market will bear, also sometimes known asoptimal pricing, and with perfect price discrimination, the firmseparates the whole market into each individual consumer andcharges them the price they are willing and able to pay.b) Second Degree Price DiscriminationThis type of price discrimination involves businesses selling offpackages of a product deemed to be surplus capacity at lowerprices than the previously published/advertised price, and in thesetypes of industry, the fixed costs of production are high, at thesame time the marginal or variable costs are small and predictable.c) Third Degree (Multi-Market) Price DiscriminationThis is the most frequently found form of price discrimination andinvolves charging different prices for the same product in differentsegments of the market, where the key is that third degreediscrimination is linked directly to consumers’ willingness and abilityto pay for a good or service which means that the prices chargedmay bear little or no relation to the cost of production.Q5. Explain how price is determined under oligopoly underconditions of price leadership.Ans. An oligopoly is a market dominated by a few large suppliers, bywhich the degree of market concentration is very high, such as a largepercentage of the market is taken up by the leading firms.IMT 20 Managerial Economics - Assignment Page 14 of 21 22/06/2012
  15. 15. As such, firms within an oligopoly produce branded products (advertisingand marketing is an important feature of competition within suchmarkets) and there are also barriers to entry.Another important characteristic of an oligopoly is interdependencebetween companies which means that each company must take intoaccount the likely reactions of other businesses in the market whenmaking pricing and investment decisions, creating uncertainty in suchmarkets, which economists seek to model through the use of gametheory.Game theory may be applied in situations in which decision makers musttake into account the reasoning of other decision makers, and it has beenused, for example, to determine the formation of political coalitions orbusiness conglomerates, the optimum price at which to sell products orservices, the best site for a manufacturing plant, and even the behaviourof certain species in the struggle for survival.In oligopoly:• A few firms selling similar product;• Each firm produces branded products;• Likely to be significant entry barriers into the market in the long runwhich allows firms to make supernormal profits;• Interdependence between competing firms, where businesses haveto take into account likely reactions of rivals to any change in priceand outputPrice is determined under oligopoly under conditions of price leadership,through:1) Oligopoly firms collaborate to charge the monopoly price and getmonopoly profits;2) Oligopoly firms compete on price so that price and profits will bethe same as a competitive industry;3) Oligopoly price and profits will be between the monopoly andcompetitive ends of the scale;4) Oligopoly prices and profits are "indeterminate" because of thedifficulties in modelling interdependent price and output decisions.IMT 20 Managerial Economics - Assignment Page 15 of 21 22/06/2012
  16. 16. CASE STUDY – IEstimation of the Demand for Oranges by Market ExperimentResearchers at the University of Florida conducted a market experiment inGrand Rapids, Michigan, to determine the price elasticity and the cross-price elasticity of demand for three types of Valencia oranges: those fromthe Indian River district of Florida, those from the interior district ofFlorida, and those from California.Grand Rapids was chosen as the site for the market experiment becauseits size, demographic characteristics, and economic base wererepresentative of other midwestern markets for oranges.Nine supermarkets participated in the experiment, which involvedchanging the price of the three types of oranges, each day, for 31consecutive days and recording the quantity sold of each variety.The price changes ranged within ±16 cents in 4-cent increments, aroundthe price of oranges that prevailed in the market at the time of the study.More than 9,250 dozen oranges were sold in the nine supermarkets duringthe 31 days of the experiment. Each of the participating supermarketswas provided with an adequate supply of each type of orange so thatsupply effects could be ignored.The length of the experiment was also sufficiently short so as to ensure nochange in tastes, incomes, population, the rate of inflation, anddeterminants of demand other than price.The results, summarized in the following table indicate that the priceelasticity of demand for all three types of oranges was fairly high (theboldface numbers in the main diagonal of the table).For example, the price elasticity of demand for the Indian River oranges of-3.07 indicates that a 1 percent increase in their price leads to a 3.07percent decline in their quantity demanded.More interestingly, the off-diagonal entries in the table, show that whilethe crossprice elasticities of demand between the two types of Floridaoranges were larger than 1, they were close to zero with respect to theCalifornia oranges.In other words, while consumers regarded the two types of Floridaoranges as close substitutes, they did not view the California oranges assuch.In pricing their oranges, therefore, producers of each of the two Floridavarieties would have to carefully consider the price of the other (asconsumers switch readily among them as a result of price changes) butneed not be much concerned about the price of California oranges.IMT 20 Managerial Economics - Assignment Page 16 of 21 22/06/2012
  17. 17. Price Elasticity and Cross-Price Elasticity of Demand for Florida IndianRiver, FloridaInterior, and California OrangesPrice Elasticities and Cross-Price ElasticitiesType of OrangeFlorida IndianFlorida Interior CaliforniaRiverFlorida Indian River -3.07 +1.56 +0.01Florida Interior +1.16 -3.01 +0.14California +0.18 +0.09 -2.76Questions:1) In light of the case define a test market? When should a firmtake help of market experiments to forecast demand?Ans. A test market, in the field of business and marketing, is ageographic region or demographic group used to gauge the viability of aproduct or service in the mass market prior to a wide scale roll-out, wherethe criteria used to judge the acceptability of a test market region orgroup include:o A population that is demographically similar to the proposed targetmarket; ando Relative isolation from densely populated media markets so thatadvertising to the test audience can be efficient and economical.In addition, the test market ideally aims to duplicate everything,promotion and distribution as well as product, on a smaller scale, bywhich the technique replicates, typically in one area, what is planned tooccur in a national launch, and the results are very carefully monitored, sothat they can be extrapolated to projected national results.A firm take help of market experiments to forecast demand sales since ithelps business managers determine how many units to create anddistribute, as well as vital for determining sales quotas.Also known as the buyers intentions method, the user expectationsmethod is also a market experiment in demand forecasting which relies onanswers from customers regarding their intent to purchase the productduring the forecasting time period, and works best when attempting toestimate current market potential as well as to forecast demand, becauseit does not take into account the companys marketing and advertisingefforts which may affect consumers intent to buy.While the sales force composite method is a forecasting experiment whichstarts with the forecaster asking for opinions about future sales fromevery member of the sales staff currently working in the field, where eachsales force member states how many sales she thinks shell make duringthe given forecasting period.IMT 20 Managerial Economics - Assignment Page 17 of 21 22/06/2012
  18. 18. 2) Suggest a suitable price policy for the three types oforanges.Ans. The concepts of comparative advantage and competitiveness areimportant foundations for understanding the importance of internationaltrade which illuminate the underlying factors responsible for current tradepatterns.Accordingly, comparative advantage and competitiveness are related, butare often mistakenly exchanged for one another, which explain how tradebenefits nations through more efficient use of the worlds resource basewhen that trade is totally unrestricted. While competitive advantagedefines trading patterns as they exist in the real world including all thebarriers to free trade ignored by comparative advantage.The concepts of comparative advantage and competitiveness areimportant foundations for understanding the importance of internationaltrade, and said concepts illuminate the underlying factors responsible forcurrent trade patterns.The most suitable price policy for the three types of oranges is theCalifornia Orange, given that prices of the same commodity under self-sufficient conditions vary substantially among countries even if consumerdemand was the same in each of those countries.Such price variation is due to the variable quantity and quality ofproductive factors such as land and climate, and the presence of skilledlabour more suitable for production of certain products than others. Anddue to these resource variations some goods may be produced only atvery high cost, or perhaps not at all, in some nations.Classic example of which is that the production of oranges in Canadacould only be accomplished under greenhouse conditions resulting inextremely high unit production costs while oranges are produced inCalifornia at relatively low cost due to the immovable factors of climate,water and land favourable for orange production.Considering a world where trade among nations is possible whilemaintaining the previous assumption of immovable productive resources,consumers will compare prices of locally produced oranges with the pricesof the same commodity produced in other nations.Subsequently, consumers will choose to purchase identical type oforanges at the lowest price regardless of where produced, as tradeproceeds among nations, commodity prices rise in those nations whichhad relatively low prices in the absence of trade while prices fall in nationswith relatively high pre-trade prices.IMT 20 Managerial Economics - Assignment Page 18 of 21 22/06/2012
  19. 19. CASE STUDY – IIA deodorant company manufactures and sells several types of deodorantswhich are branded as ‘Smell Fresh’. The company introduced five yearsago, a new type of deodorant and its sales increased rapidly. However,over the past two years, sales have been declining steadily even thoughthe market for deodorants has been expanding. Worried by the decliningsales the company conducted a survey of the market, which yielded thefollowing information:(i) Several new rivals have come up during the past five years, whichmanufacture and sell almost similar deodorants.(ii) Other companies have set prices lower than the prices of thiscompany.(iii) This company had initially set the price of its new brand at Rs 40, forwhich retailer pays Rs 30, which was never changed.(iv) The rival firms have set their prices at Rs 37.50, retailers paying Rs25.In view of these facts, the company decided to review the cost structureto find out whether the margin to the retailers could be reduced to thelevel of the rival firms. The company finds that the variable costs(including raw materials and labour) stands at Rs 15 per deodorant. Atpresent the company sells 4, 00,000 deodorants. As to the marketprospects, if the price is reduced to Rs 35, the demand would increase by1,50,000 and if the price is reduced to Rs. 32.50, demand would increaseto 6,50,000 units. With such an increase in production, the firm could useits resources more fully. The bulk of purchase of raw materials and moreefficient use of labour would both help to reduce the unit variable cost toRs. 12.50.Questions:1) What price should the company charge to recapture marketlost to rival firms?Ans. In order for the deodorant company to charge and recapturemarket lost to rival firms, predatory pricing may be the solution for thefirm deliberately setting prices to incur losses for a sufficiently long periodof time to eliminate, discipline, or deter entry by a competitor, in theexpectation that they will subsequently be able to recoup its losses bycharging prices above the level that would have prevailed in the absenceof the impugned conduct, with the effect that competition would besubstantially lessened or prevented.Competition delivers many economic benefits, including competitive pricesand product choices, where low prices are usually a good indication ofvigorous competition.IMT 20 Managerial Economics - Assignment Page 19 of 21 22/06/2012
  20. 20. However, while competitive prices are beneficial to consumers, certainanti-competitive pricing behaviour, such as predatory pricing, can harmthe economy, making predatory pricing to have short-term benefits forconsumers, but it can ultimately lead to higher prices or other anti-competitive effects in the long run.Relatively, in today’s fast-paced, global economy, markets are constantlychanging, demanding flexible and innovative responses to competitivechallenges.Asset position of the deodorant company impacts the competitivestrategies, and in order to cope up with the resource constraints and earnfor livelihoods, small and medium sized firms like this case rely upon ownlabour and target the medium and low-price segments.In order to be able to recapture market lost to rival firms, the company’sproduct mixes should comprise of single varieties and medium qualities ofthe fast moving product lines, mixed lot sizes, negotiate for prices andoffer periodic price discounts since overhead costs are nearly negligible forthem, and manage their product purchases from several sources to keepthe cost prices low.Consequently, due to the company’s financial and physical constraints, itthen attempts to minimize the risks, and content with their businessesthat provide a stable flow of income. However, in contrast, large sizedfirms target the upper and medium price segments.2) Suggest alternative strategies that the company can adoptto counteract competition.Ans. There are alternative strategies that the deodorant company canadopt to counteract competition, where they tailor their competitivestrategies to the demographics features, purchase, capacity and tastepreferences of the target markets.Accordingly, they design the merchandise mixes, depth and breadth ofproduct lines, product quality, lot sizes, fix prices, advertise productpromotion, add services, operate for suitable business hours, and managefor logistic, etc.The alternative strategies that the company in this case, can adopt tocounteract competition, is presented below, namely:1) PRODUCT DIFFERENTIATIONProduct differentiation along a single/multiple attributes takes acomparatively longer time to change than price that could bechanged at a very short notice and plays merely a tactical role.Thus, the company should focus on single varieties of the seasonalproducts mainly of medium qualities with an average size of 2.43products.IMT 20 Managerial Economics - Assignment Page 20 of 21 22/06/2012
  21. 21. 2) MARKET DEVELOPMENTThe deodorant company must also focus high on the low andmedium and low on the high price segments, and medium sizedcompanies are high on the medium and moderate on the low andhigh price segments. Thus, quite often all sized firms influencecustomer purchase decisions through salesmanship, and dependingupon the sizes and characteristics of the target markets they adaptthe marketing mixes, by which within each market segment,customers comprise of two groups, regular and floating.3) PRODUCT PRICINGDifficulty of controlling the product quality and volume, intra andinter seasonality, proper temperature throughout the distributionsystem limits the evolution of true consumer franchises for specificbrands that makes the dynamics of fresh produce markets largelycommodity like and most firms act as price-takers. However, thecompany’s purchase choices, lot sizes and the product supplypositions at any point of time impact theirs offer prices for theseasonal products in the wholesale markets, where they use theprinciple of "cost plus" and "competitive" pricing for pricingproducts. Said costs set the price floor while customers andcompetitors characteristics impact the actual price fixation.IMT 20 Managerial Economics - Assignment Page 21 of 21 22/06/2012

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