104774114 mb0042-mb0042-–-managerial-economics-november-2012


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104774114 mb0042-mb0042-–-managerial-economics-november-2012

  1. 1. Summer / May 2012Master of Business AdministrationSemester IMB0042 – Managerial Economics - 4 Credits(Book ID: B1131)AssignmentSet- 1 (60 Marks)Note: Each Question carries 10 marks. Answer all the questions.Q1. Distinguish between a firm and an industry. Explain the equilibrium of a firm andindustry under perfect competition.An : An industry is the name given to a certain type of manufacturing or retailingenvironment. For example, the retail industry is the industry that involves everything fromclothes to computers, anything in the shops that get sold to the public. The retail industry isvery vast and has many sub divisions, such as electrical and cosmetics. More specialisedindustries deal with a specific thing. The steel industry is a more specialised industry, dealingwith 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 theindustry to create the product. The firm might be a factory, or the chain of stores that sells theclothes, within its industry. For example, one firm that makes steel might be Avida steel.They create the steel in that firm for the steel industry.A firm is usually a corporate company that controls a number of chains in the industry it isoperating within. For example in retail, the firm Arcadia stores owns the clothing chains Topshop, Dorothy Perkins, Miss Selfridge, and Evans. These all operate for the firm Arcadiawithin the industry of retail.Several firms can operate in one industry to ensure that there is always competition to keepprices reasonable and stop the market becoming a monopoly, which is where one firm is incharge of the whole industry. Sometimes, a firm is not necessary within the industry andindependent chains and retailers can enter straight into the market without a firm behindthem, although this is risky. This is because one of the advantages of having a firm behind
  2. 2. you is that it is a safeguard against possible bankruptcy because the firm can support thechain that it owns.Profit maximization is one of the important assumptions of economics. It is assumed that theentrepreneur always tries to maximize profit. Hence the firm or entrepreneur is said to be inequilibrium if the profit is maximized. According to Tibor Sitovosky "A market or aneconomy or any other group of persons and firms is in equilibrium when none of itsmembers fells impelled to change his behaviour". Naturally, the firm will not try to changeits position when it is in equilibrium by maximizing profit.There are two approaches to explain the equilibrium of the firm regards to profitmaximization. They are - total revenue-total cost approach and marginal revenue-marginalcost approach. Here we concentrate only on MR - MC approach.The equilibrium of firm on the basis of MR - MC approach has been presented in the tablebelowAccording to MT -MC approach, when marginal revenue equals marginal cost the firm is inequilibrium and gets maximum profit. Hence, a rational producer determines the quality ofoutput where marginal revenue equals marginal cost.The difference between total revenue and total cost is highest 210, at four units of output. Atthis output, both marginal revenue and marginal cost are equal, 80. Hence profit ismaximized. The firm is in equilibrium. It should be noted that the table relates to imperfectcompetition, when price is reduced to sell more.The following two conditions are necessary for a firm to be in equilibrium.(a) The marginal revenue should be equal to marginal cost.(b) The marginal cost curve should cut marginal revenue curve from below.The equilibrium of a under to MR - MC approach has been presented in figure:-The figure depicts the equilibrium of a firm under perfect competition. The same isapplicable to the firms under imperfect competition. The only difference is that the AR & MRcurves under imperfect competition are different and they are downward sloping.
  3. 3. In the figure OP is the given price. Since, under perfect competition, average revenue equalsmarginal revenue, the AR and MR curves are horizontal from P. The profit-maximizingoutput is OM. Here, marginal revenue and marginal cost are equal. It is because MC and MRcurves intersect each other at point E. The firm earns profit equal to PEBC.The first condition necessary for firms equilibrium is that marginal cost should be equal tomarginal revenue. But this is not a sufficient condition. It is because the firm may not be inequilibrium even if this condition is fulfilled. In the figure, this condition is fulfilled at pointF. but the firm is not in equilibrium. The profit is maximized only at output OM which ishigher than output ON.The second condition necessary for equilibrium is that the marginal cost curve must cutmarginal revenue curve from below. This implies that marginal cost should be rising at thepoint of intersection with MR curve. Hence, both the conditions have been fulfilled at pointE. In the figure, MC curve cuts MR curve from at point F from above. Hence, this pointcannot be the point of stable equilibrium. It is because before that point marginal cost exceedsmarginal revenue. It shows that it is not reasonable to increase output. After point F, the MRcurve lies above MC curve. This shows that it is reasonable to increase output.Q2. Give a brief description ofa. Implicit and explicit costb. Actual and opportunity cost a. Implicit and explicit cost b. c. d. a. Implicit and explicit cost e. f. Implicit cost g. h. i. In economics, an implicit cost, also called an imputed cost, implied cost, or notional cost, is the opportunity cost equal to what a firm must give up in order using factors which it neither purchases 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 lending it. The term also applies to forgone income from choosing not to work.
  4. 4. j. Implicit costs also represent the divergence between economic profit (total revenues minus total costs, where total costs are the sum of implicit and explicit costs) and accounting profit (total revenues minus only explicit costs). Since economic profit includes these extra opportunity costs, it will always be less than or equal to accounting profitk.l.m. n. Explicit cost o.p.q. An explicit cost is a direct payment made to others in the course of running a business, such as wage, rent and materials, as opposed to implicit costs, which are those where no actual payment is made. It is possible still to underestimate these costs, however: for example, pension contributions and other "perks" must be taken into account when considering the cost of labour.r. Explicit costs are taken into account along with implicit ones when considering economic profit. Accounting profit only takes explicit costs into account.s.t.u.v.w. x. b. Actual and opportunity costy. z. Actual costaa. An 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.bb.cc. Cost accounting information is designed for managers. Since managers are taking decisions only for their own organization, there is no need for the information to be comparable to similar information from other organizations. Instead, the important criterion is that the information must be relevant for decisions that managers operating in a particular environment of business including strategy make. Cost accounting information is commonly used in financial accounting 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 providing good information to managers who are taking decisions. Among the better decisions, the better performance 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 the environment in which they make them.
  5. 5. dd. ee. ff. Opportunity cost gg. hh. Opportunity cost is the cost of any activity measured in terms of the value of the next best alternative forgone (that is not chosen). It is the sacrifice related to the second best choice available to someone, or group, who has picked among several mutually exclusive choices. The opportunity cost is also the cost of the forgone products after making a choice. Opportunity cost is a key concept in economics, and has been described as expressing "the basic relationship between scarcity and choice". The notion of opportunity cost plays a crucial part in ensuring that scarce resources are used efficiently. Thus, opportunity costs are not restricted to monetary or financial costs: the real cost of output forgone, lost time, pleasure or any other benefit that provides utility should also be considered opportunity costs. ii. jj. kk. ll. Opportunity costs in production mm. Opportunity costs may be assessed in the decision-making process of production. If the workers on a farm can produce either one million pounds of wheat or two million pounds of barley, then the 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 by weighing the sacrifices involved.Q3. A firm supplied 3000 pens at the rate of Rs 10. Next month, due to a rise of in the price to 22 rsper pen the supply of the firm increases to 5000 pens. Find the elasticity of supply of the pens. Ofcourse, consumption is not the only thing that changes when prices go up or down.Businesses also respond to price in their decisions about how much to produce. Economistsdefine the price elasticity of supply as the responsiveness of the quantity supplied of a goodto 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,or completely inelastic supply, which is a vertical supply curve.
  6. 6. 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 largeand gives rise to a horizontal supply curve. This is because the polar case of infinitely elasticsupply.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 monetarypolicy Monetary PolicyMonetary policy, in its narrow concept, is defined as the measures focused on regulatingmoney supply. In harmony with monetary policy goals, as will be shown later, and adoptingthe most common concept of monetary policy as one of the central bank‘s functions,monetary policy is defined as ― the set of procedures and measures taken by monetaryauthorities to manage money supply, interest and exchange rates and to influence creditconditions to achieve certain economic objectives‖. We find this definition more consistentwith the practical applications of monetary policy, particularly with respect to the differencefrom one country to another in objectives selected as a link between the instruments ofmonetary 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
  7. 7. general economic policy, a high level of co-ordination is required between monetary policyand other instruments of economic policy. Further, the effectiveness of monetary policy andits relative importance as a tool of economic stabilization various from one economy toanother, due to differences among economic structures, divergence in degrees ofdevelopment in money and capital markets resulting in differing degree of economicprogress, and differences in prevailing economic conditions. However, we may brieflymention that the weak effectiveness which is usually attributed to monetary policy indeveloping countries is caused by the fact that the economic problems in these countries aremainly structural and not monetary in nature, while the limited effectiveness of monetarypolicy in countries which lack developed money markets occurs because monetary policy isdeprived of one of its major tools, the instrument of open market 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‖. Manyothers see monetary policy as ineffective in controlling the inflation that results from animbalance between the demand and supply of goods and services originating from the supplyside, while they confirm the effectiveness of monetary policy in controlling inflation thatresults from increased demand. However, this does not preclude the effectiveness ofmonetary policy as a flexible instrument allowing the authorities to move quickly to achievestabilization, apart from its importance in realizing external equilibrium in open economies. Monetary Policy InstrumentsThe set of instruments available to monetary authorities may differ from one country toanother, according to differences in political systems, economic structures, statutory andinstitutional procedures, development of money and capital markets and other considerations.In most advanced capitalist countries, monetary authorities use one or more of the followingkey instruments: changes in the legal reserve ratio, changes in the discount rate or the officialkey bank 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 patternsof their production structures and the degree of their of their link with the outside world,many resort to the method of qualitative supervision, particularly those countries which faceproblems arising from the nature of their economic structures. Although the effectiveness ofmonetary policy does not necessarily depend on using a wide range of instruments,coordinated use of various instruments is essential to the application of a rational monetarypolicy.
  8. 8. Q5. Explain in brief the relationship between TR, AR, and MR under different marketcondition. 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 saleof its products, i.e. .gross revenue. In other words, it is the total sales receipts earned fromthe sale of its total output produced over a given period of time. In brief, it refers to the totalsales proceeds. It will vary with the firm‘s output and sales. We may show total revenue as afunction of 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.
  9. 9. When different units of a commodity are sold at the same price, in the market, averagerevenue equals price at which the commodity is sold for e.g. 2 units are sold at the rate ofRs.10 per unit, then total revenue would be Rs. 20 (2×10). Thus AR = TR/Q 20/2 = 10. Thusaverage revenue means price. Since the demand curve shows the relationship between priceand the quantity demanded, it also represents the average revenue or price at which thevarious amounts of a commodity are sold, because the price offered by the buyer is therevenue from seller‘s point of view. Therefore, average revenue curve of the firm is thesame as demand curve of the consumer.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 ahypothetical revenue schedule.From the table, it is clear that:MR falls as more units are sold.
  10. 10. TR increases as more units are sold but at a diminishing rate.TR is the highest when MR iszeroTR 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 supplyforces. A firm can sell any amount of goods at the existing market prices. Hence, the TRof the firm would increase proportionately with the output offered for sale. When the totalrevenue increases in direct proportion to the sale of output, the AR would remain constant.Since the market price of it is constant without any variation due to changes in the units soldby the individual firm, the extra output would fetch proportionate increase in the revenue.Hence, MR & AR will be equal to each other and remain constant. This will be equal toprice. Under perfect market condition, the AR curve will be a horizontal straight line and parallelto OX axis. This is because a firm has to sell its product at the constant existing market price.The MR cure also coincides with the AR curve. This is because additional units are sold atthe same constant price in the market.
  11. 11. 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.
  12. 12. 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 atvarious prices it shows the AR at which the various amounts of the goods that are sold by theseller. This is because the price paid by the buyer is the revenue for the seller (One man‘sexpenditure is another man‘s income). Hence, the AR curve of the firm is the same thing asthat of the demand curve 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 ofRs.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.
  13. 13. Q6. What is a business cycle? Describe the different phases of a business cycle.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 createjobs for everyone who wants one, but slow enough to avoid inflation. Unfortunately, life isnot so simple. Many factors can cause an economy to spin out of control, or settle intodepression. The most important, over-riding factor is confidence -- of investors, consumers,businesses and politicians. The economy grows when there is confidence in the future andin policymakers, and does 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 inone of 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 todetermine the phases of the business cycle. The Business Cycle Dating Committee uses quarterly GDPgrowth rates as the primary indicator of economic activity. The Bureau also uses monthly figures, suchas 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 immediately
  14. 14. shrank 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 fourthquarter. The economy received another wallop in the first quarter of 2009, when the economycontracted a brutal 6.9%.
  15. 15. Summer / May 2012Master of Business AdministrationSemester IMB0042 – Managerial Economics - 4 Credits(Book ID: B1131)AssignmentSet- 2 (60 Marks)Note: Each Question carries 10 marks. Answer all the questions.Q1. Discuss the various measures that may be taken by a firm to counteract the evil effects ofa trade cycle.An : FACTORS THAT SHAPE BUSINESS CYCLESFor centuries, economists in both the United States and Europe regarded economic downturnsas ―diseases" that had to be treated; it followed, then, that economies characterized by growthand affluence were regarded as "healthy" economies. By the end of the 19th century,however, many economists had begun to recognize that economies were cyclical by theirvery nature, and studies increasingly turned to determining which factors were primarilyresponsible for shaping the direction and disposition of national, regional, and industry-specific economies. Today, economists, corporate executives, and business owners citeseveral factors as particularly important in shaping the complexion of business environments.VOLATILITY OF INVESTMENT SPENDINGVariations in investment spending is one of the important factors in business cycles.Investment spending is considered the most volatile component of the aggregate or totaldemand (it varies much more from year to year than the largest component of the aggregatedemand, the consumption spending), and empirical studies by economists have revealed thatthe volatility of the investment component is an important factor in explaining businesscycles in the United States. According to these studies, increases in investment spur asubsequent increase in aggregate demand, leading to economic expansion. Decreases ininvestment have the opposite effect. Indeed, economists can point to several points inAmerican history in which the importance of investment spending was made quite evident.The Great Depression, for instance, was caused by a collapse in investment spending in the
  16. 16. aftermath of the stock market crash of 1929. Similarly, prosperity of the late 1950s wasattributed to a capital goods boom.There are several reasons for the volatility that can often be seen in investment spending. Onegeneric reason is the pace at which investment accelerates in response to upward trends insales. This linkage, which is called the acceleration principle by economists, can be brieflyexplained as follows. Suppose a firm is operating at full capacity. When sales of its goodsincrease, output will have to be increased by increasing plant capacity through furtherinvestment. As a result, changes in sales result in magnified percentage changes ininvestment expenditures. This accelerates the pace of economic expansion, which generatesgreater income in the economy, leading to further increases in sales. Thus, once theexpansion starts, the pace of investment spending accelerates. In more concrete terms, theresponse of the investment spending is related to the rate at which sales are increasing. Ingeneral, if an increase in sales is expanding, investment is spending rises, and if an increasein sales has peaked and is beginning to slow, investment spending falls. Thus, the pace ofinvestment spending is influenced by changes in the rate of sales.MOMENTUMMany economists cite a certain "follow-the-leader" mentality in consumer spending. Insituations where consumer confidence is high and people adopt more free-spending habits,other customers are deemed to be more likely to increase their spending as well. Conversely,downturns in spending tend to be imitated as well.TECHNOLOGICAL INNOVATIONSTechnological innovations can have an acute impact on business cycles. Indeed,technological breakthroughs in communication, transportation, manufacturing, and otheroperational areas can have a ripple effect throughout an industry or an economy.Technological innovations may relate to production and use of a new product or productionof an existing product using a new process. The video imaging and personal computerindustries, for instance, have undergone immense technological innovations in recent years,and the latter industry in particular has had a pronounced impact on the business operations
  17. 17. of countless organizations. However, technological innovations —and consequent increasesin investment—take place at irregular intervals. Fluctuating investments, due to variations inthe pace of technological innovations, lead to business fluctuations in the economy. There aremany reasons why the pace of technological innovations varies. Major innovations donoroccur every day. Nor do they take place at a constant rate. Chance factors greatly influencethe timing of major innovations, as well as the number of innovations in a particular year.Economists consider the variations in technological innovations as random (with nosystematic pattern). Thus, irregularity in the pace of innovations in new products or processesbecomes a source of business fluctuations.VARIATIONS IN INVENTORIESVariations in inventories—expansion and contraction in the level of inventories of goods keptby businesses—also contribute to business cycles. Inventories are the stocks of goods firmskeep unhand to meet demand for their products. How do variations in the level of inventoriestrigger changes in a business cycle? Usually, during a business downturn, firms let theirinventories decline. As inventories dwindle, businesses ultimately find themselves short ofinventories. As result, they start increasing inventory levels by producing output greater thansales, leading to an economic expansion. This expansion continues as long as the rate ofincrease in sales holds up and producers continue to increase inventories at the precedingrate. However, as the rate of increase insoles slows, firms begin to cut back on their inventoryaccumulation. The subsequent reduction in inventory investment dampens the economicexpansion, and eventually causes an economic downturn. The process then repeats itself allover again. It should be noted that while variations in inventory levels impact overall rates ofeconomic growth, the resulting business cycles are not really long. The business cyclesgenerated by fluctuations in inventories are called minor or short business cycles. Theseperiods, which usually last about two to four years, are sometimes also called inventorycycles.FLUCTUATIONS IN GOVERNMENT SPENDINGVariations in government spending are yet another source of business fluctuations. This mayappear to be an unlikely source, as the government is widely considered to be a stabilizingforce in the economy rather than a source of economic fluctuations or instability.Nevertheless, government spending has been a major destabilizing force on severaloccasions, especially during and after wars. Government spending increased by an enormous
  18. 18. amount during World War II, leading to an economic expansion that continued for severalyears after the war. Government spending also increased, though to a smaller extentcompared to World War II, during the Korean and Vietnam wars. These also led to economicexpansions. However, government spending not only contributes to economic expansions,but economic contractions as well. In fact, the recession of 1953-54 was caused by thereduction in government spending after the Korean War ended. More recently, the end of theCold War resulted in a reduction in defence spending by the United States that had apronounced impact on certain defence-dependent industries and geographic regions.POLITICALLY GENERATED BUSINESS CYCLESMany economists have hypothesized that business cycles are the result of the politicallymotivated use of macroeconomic policies (monetary and fiscal policies) that are designed toserve the interest of politicians running for re-election. The theory of political business cyclesis predicated on the belief that elected officials (the president, members of congress,governors, etc.) have a tendency to engineer expansionary macroeconomic policies in orderto aid their re-election efforts.MONETARY POLICIESVariations in the nations monetary policies, independent of changes induced by politicalpressures, are an important influence in business cycles as well. Use of fiscal policy—increased government spending and/or tax cuts—is the most common way of boostingaggregate demand, causing an economic expansion. Moreover, the decisions of the FederalReserve, which controls interest rates, can have a dramatic impact on consumer and investorconfidence as well.FLUCTUATIONS IN EXPORTS AND IMPORTSThe difference between exports and imports is the net foreign demand for goods and services,also called net exports. Because net exports are a component of the aggregate demand in theeconomy, variations in exports and imports can lead to business fluctuations as well. Thereare many reasons for variations in exports and imports over time. Growth in the grossdomestic product of an economy is the most important determinant of its demand forimported goods—as people‘s incomes grow, their appetite for additional goods and services,including goods produced abroad, increases. The opposite holds when foreign economies aregrowing—growth in incomes in foreign countries also leads to an increased demand for
  19. 19. imported goods by the residents of these countries. This, in turn, causes U.S. exports to grow.Currency exchange rates can also have a dramatic impact on international trade—and hence,domestic business cycles—as well.KEYS TO SUCCESSFUL BUSINESS CYCLE MANAGEMENTSmall business owners can take several steps to help ensure that their establishments weatherbusiness cycles with a minimum of uncertainty and damage. "The concept of cyclemanagement may be relatively new," wrote Matthew Gallagher inChemical Marketing Reporter,"but it already has many adherents who agree that strategies that work at the bottom of acycle need to be adopted as much as ones that work at the top of a cycle. While there will beno definitive formula for every company, the approaches generally stress a long-term viewwhich focuses on a firms key strengths and encourages it to plan with greater discretion at alltimes. Essentially, businesses are operating toward operating on a more even keel."Specifictips for managing business cycle downturns include the following: Flexibility — Accordingto Gallagher, "part of growth management is a flexible business plan that allows fordevelopment times that span the entire cycle and includes alternative recession-resistantfunding structures."Long-Term Planning—Consultants encourage small businesses to adopt amoderate stance in their long-range forecasting. Attention to Customers—this can be anespecially important factor for businesses seeking to emerge from an economic downturn."Staying close to the customers is a tough discipline to maintain in good times, but it isespecially crucial coming out of bad times," stated Arthur Dalasi Industry Week."Your customer is the best test of when your own upturn will arrive. Customers, especiallyindustrial and commercial ones, can give you early indications of their interest in placinglarge orders in coming months."Objectivity—Small business owners need to maintain a highlevel of objectivity when riding business cycles. Operational decisions based on hopes anddesires rather than a sober examination of the facts can devastate a business, especially ineconomic down periods. Study—"Timing any action for an upturn is tricky, and theconsequences of being early or late are serious," said Deltas. "For example, expanding a salesforce when the markets dont materialize not only places big demands on working capital, butalso makes it hard to sustain the motivation of the sales-people. If the force is improved toolate, the cost is decreased market share or decreased quality of the customer base. How does
  20. 20. the company strike the right balance between being early or late? Listening to economists,politicians, and media to get a sense of what is happening is useful, but it is unwise to relysolely on their sources. The best route is to avoid trying to predict the upturn. Instead, listento your customers and know your own response-time requirements."Q2. Define the term equilibrium. Explain the changes in market equilibrium and effects toshifts in supply and demand.Ans. EquilibriumThe word equilibrium is derived from the Latin word a ―equilibrium‖ which means equalbalance. It means a state of even balance in which opposing forces or tendencies neutralizeeach other. It is a position of rest characterized by absence of change. It is a state where thereis complete agreement of the economic plans of the various market participants so that no onehas a tendency to revise or alter his decision. In the words of professor Mehta: ―Equilibriumdenotes in economics absence of change in movement‖.Market EquilibriumThere are two approaches to market equilibrium viz., partial equilibrium approach and thegeneral equilibrium approach. The partial equilibrium approach to pricing explains pricedetermination of a single commodity keeping the prices of other commodities constant. Onthe other hand, the general equilibrium approach explains the mutual and simultaneousdetermination of the prices of all goods and factors. Thus it explains a multi marketequilibrium position. Earlier to Marshall, there was a dispute among economists on whether the force of demandor the force of supply is more important in determining price. Marshall gave equalimportance to both demand and supply in the determination of value or price. He comparedsupply and demand to a pair of scissors We might as reasonably dispute whether it is the upper or the under blade of a pair of scissorsthat cuts a piece of paper, as whether value is governed by utility or cost of production. Thusneither the upper blade nor the lower blade taken separately can cut the paper; both have theirimportance in the process of cutting. Likewise neither supply alone, nor demand alonecan determine the price of a commodity, both are equally important in the determination ofprice. But the relative importance of the two may vary depending upon the timeunder consideration. Thus, the demand of all consumers and the supply of all firms togetherdetermine the price of a commodity in the market.
  21. 21. Equilibrium between demand and supply price:Equilibrium between demand and supply price is obtained by the interaction of these twoforces. Price is an independent variable. Demand and supply are dependent variables. Theydepend on price. Demand varies inversely with price; arise in price causes a fall in demandand a fall in price causes a rise in demand. Thus the demand curve will have a downwardslope indicating the expansion of demand with a fall in price and contraction of demand witha rise in price. On the other hand supply varies directly with the changes in price, a rise inprice causes arise in supply and a fall in price causes a fall in supply. Thus the supply curvewill have an upward slope. At a point where these two curves intersect with each other theequilibrium price is established. At this price quantity demanded is equal to the quantitydemanded.This we can explain with the help of a table and a diagramIn the table at Rs.20 the quantity demanded is equal to the quantity supplied. Since the priceis agreeable to both the buyer and sellers, there will be no tendency for it to change; this iscalled equilibrium price. Suppose the price falls to Rs.5 the buyer will demand 30 units whilethe seller will supply only 5 units. Excess of demand over supply pushes the price upwarduntil it reaches the equilibrium position supply is equal to the demand. On the other hand ifthe price rises to Rs.30 the buyer will demand only 5 units while the sellers are ready tosupply 25 units. Sellers compete with each other to sell more units of the commodity. Excessof supply over demand pushes the price downward until it reaches the equilibrium. Thisprocess will continue till the equilibrium price of Rs.20 is reached. Thus the interactions ofdemand and supply forces acting upon each other restore the equilibrium position in
  22. 22. the market. In the diagram DD is the demand curve, SS is the supply curve. Demand andsupply are in equilibrium at point E where the two curves intersect each other. OQ is theequilibrium output. OP is the equilibrium price. Suppose the price OP2 is higher than theequilibrium price OP. at this point price quantity demanded isP2D2. Thus D2S2 is the excesssupply which the seller wants to push into the market, competition among the sellers willbring down the price to the equilibrium level where the supply is equal to the demand. Atprice OP1, the buyers will demand P1D1 quantity while the sellers are ready to sell P1S1.Demand exceeds supply. Excess demand for goods pushes up the price; this process will gountil equilibrium is reached where supply becomes equal to demand.Q3. What do you mean by pricing policy? Explain the various objective of pricing policy of afirm. Pricing PoliciesA detailed study of the market structure gives us information about the way in which pricesare determined under different market conditions. However, in reality, a firm adopts differentpolicies and methods to fix the price of its products.Pricing policy refers to the policy of setting the price of the product or products and servicesby the management after taking into account of various internal and external factors, forcesand its own business objectives.Pricing Policy basically depends on price theory that is the corner stone of economic theory.Pricing is considered as one of the basic and central problems of economic theory in amodern economy. Fixing prices are the most important aspect of managerial decision makingbecause market price charged by the company affects the present and future production plans,pattern of distribution, nature of marketing etc. Generally speaking, in economic theory, wetake into account of only two parties, i.e., buyers and sellers while fixing the prices.However, in practice many parties are associated with pricing of a product. They are rivalcompetitors, potential rivals, middlemen, wholesalers, retailers, commission agents and aboveall the Govt. Hence, we should give due consideration to theinfluence exerted by these partiesin the process of price determination. Broadly speaking, the various factors and forces thataffect the price are divided into two categories.They are as follows: I External Factors (Outside factors)1. Demand, supply and their determinants.
  23. 23. 2. Elasticity of demand and supply.3. Degree of competition in the market.4. Size of the market.5. Good will, name, fame and reputation of a firm in the market.6. Trends in the market.7. Purchasing power of the buyers.8. Bargaining power of customers9. Buyers behavior in respect of particular product II. Internal Factors (Inside Factors)1. Objectives of the firm.2. Production Costs.3. Quality of the product and its characteristics.4. Scale of production.5. Efficient management of resources.6. Policy towards percentage of profits and dividend distribution.7. Advertising and sales promotion policies.8. Wage policy and sales turn over policy etc.9. The stages of the product on the product life cycle.10. Use pattern of the product. Objectives of the Price Policy:A firm has multiple objectives today. In spite of several objectives, the ultimate aim of everybusiness concern is to maximize its profits. This is possible when the returns exceed costs. Inthis context, setting an ideal price for a product assumes greater importance. Pricingobjectives has to be established by top management to ensure not only that the company‘sprofitability is adequate but also that pricing is complementary to the total strategy of the
  24. 24. organization. While formulating the pricing policy, a firm has to consider various economic,social, political and other factors.The Following objectives are to be considered while fixing the prices of the product.1. Profit maximization in the short termThe primary objective of the firm is to maximize its profits. Pricing policy as an instrument toachieve this objective should be formulated in such a way as to maximize the sales revenueand profit. Maximum profit refers to the highest possible of profit.In the short run, a firm not only should be able to recover its total costs, but also should getexcess revenue over costs. This will build the morale of the firm and instill the spirit ofconfidence in its operations.2. Profit optimization in the long runThe traditional profit maximization hypothesis may not prove beneficial in the long run. Withthe sole motive of profit making a firm may resort to several kinds of unethical practices likecharging exorbitant prices, follow Monopoly Trade Practices (MTP), Restrictive TradePractices (RTP) and Unfair Trade Practices (UTP) etc. This may lead to opposition from thepeople. In order to over- come these evils, a firm instead of profit maximization, and aims atprofit optimization.Optimum profit refers to the most ideal or desirable level of profit.Hence, earning the most reasonable or optimum profit has become a part and parcel of asound pricing policy of a firm in recent years.3. Price StabilizationPrice stabilization over a period of time is another objective. The prices as far as possibleshould not fluctuate too often. Price instability creates uncertain atmosphere in businesscircles. Sales plan becomes difficult under such circumstances. Hence, price stability is oneof the prerequisite conditions for steady and persistent growth of a firm. A stable price policyonly can win the confidence of customers and may add to the good will of the concern. Itbuilds up the reputation and image of the firm.4. Facing competitive situationOne of the objectives of the pricing policy is to face the competitive situations in the market.In many cases, this policy has been merely influenced by the market share psychology.Wherever companies are aware of specific competitive products, they try to match the pricesof their products with those of their rivals to expand the volume of their business. Most of the
  25. 25. firms are not merely interested in meeting competition but are keen to prevent it. Hence, afirm is always busy with its counter business strategy.5. Maintenance of market share Market share refers to the share of a firm‘s sales of a particular product in the total sales ofall firms in the market.The economic strength and success of a firm is measured in terms of its market share. In acompetitive world, each firm makes a successful attempt to expand its market share. If it isimpossible, it has to maintain its existing market share. Any decline in market share is asymptom of the poor performance of a firm.Hence, the pricing policy has to assist a firm to maintain its market share at any cost.Q4. Critically examine the Marris growth maximising modelAns.Profit maximization is traditional objective of a firm. Sales maximization objective isexplained by Prof. Boumal. On similar lines, Prof. Marris has developed another alternativegrowth maximization model in recent years. It is a common factor to observe that each firmaims at maximizing its growth rate as this goal would answer many of the objectives of afirm. Marris points out that a firm has to maximize its balanced growth rate over a period oftime.Marris assumes that the ownership and control of the firm is in the hands of two groups ofpeople, i.e. owner and managers. He further points out that both of them have two distinctivegoals. Managers have a utility function in which the amount of salary, status, position, power,prestige and security of job etc are the most import variable where as in case of are moreconcerned about the size of output, volume of profits, market shares and sales maximization.Utility function of the manager and that the owner are expressed in the following manner-Uo= f [size of output, market share, volume of profit, capital, public esteem etc.]Um= f [salaries, power, status, prestige, job security etc.]In view of Marris the realization of these two functions would depend on the size of the firm.Larger the firm, greater would be the realization of these functions and vice-versa. Size of thefirm according to Marris depends on the amount of corporate capital which includes total
  26. 26. volume of the asset, inventory level, cash reserve etc. He further points out that the managersalways aim at maximizing the rate of growth of the firm rather than growth in absolute sizeof the firms. Generally managers like to stay in a grouping firm. Higher growth rate of thefirm satisfy the promotional opportunity of managers and also the share holders as they getmore dividends.B ou mal ’s S al es Maxi mi zati on mod el :Sales maximization model is an alternative for profit maximization model. This model isdeveloped by Prof. W.J. Boumal, an American economist. This alternative goal has assumedgreater significance in the context of the growth of the oligopolistic firms. The modelhighlights that the primary objective of the firm is to maximize its sales rather than profitmaximization. It states that the goal of the firm is maximization of sales revenue subject to aminimum profit constraint. The minimum profit constraint is determined by the expectationof the share holders. This is because no company can displease the shareholders. It is to benoted here that maximization of sales does not mean maximization of physical sales butmaximization of total sales revenue. Hence, the managers are more interested in increasingsales rather than profit. The basic philosophy is that when sales are maximized automaticallyprofits of the company would also go up. Hence, attention is diverted to increase the sales ofthe company in recent years in the context of highly competitive market.How Profit Maximization model differs from Sales Maximization model:The sale maximization model differs on the following grounds: Emphasis is given on maximizing sales rather than profit. Increase the competitive and operational ability of the company. The amount of slack earning and salaries of the top managers are directly linked to it. It helps in enhancing the prestige and reputation of top management, distributes more dividends to share holders and increases the wage of the workers and keeps them happy. The financial and other lending institutions always keep a watch on the sales revenue of a firm as it is an indication of financial health of the firm.
  27. 27. Q5. Explain how a product would reach equilibrium position with the help of ISO - Quantsand ISO-Cost curveAns.When producing a good or service, how do suppliers determine the quantity of factors tohire? Below, we work through an example where a representative producer answers thisquestion.Let‘s begin by making some assumptions. First, we shall assume that our producer choosesvarying amounts of two factors, capital (K) and labor (L). Each factor was a price that doesnot vary with output.That is, the price of each unit of labor (w) and the price of each unit of capital (r) are assumedconstant. We‘ll further assume that w = $10 and r = $50. We can use this information todetermine the producer‘s total cost. We call the total cost equation an iso-cost line (it‘ssimilar to a budget constraint).The producer‘s iso-cost line is:10L + 50K = TC (1)The producer‘s production function is assumed to take the following form:q = (KL) 0.5 (2)Our producer‘s first step is to decide how much output to produce. Suppose that quantity is1000 units of output. In order to produce those 1000 units of output, our producer must get acombination of L and K that makes (2) equal to 1000. Implicitly, this means that we mustfind a particular isoquant.Set (2) equal to 1000 units of output, and solve for K. Doing so, we get the followingequation for a specific iso-quant (one of many possible iso-quants):K = 1,000,000/L (2a)For any given value of L, (2a) gives us a corresponding value for K. Graphing these values,with K on the vertical axis and L on the horizontal axis, we obtain the blue line on the graphbelow. Each point on this curve is represented as a combination of K and L that yields an
  28. 28. output level of 1000 units. Therefore, as we move along this iso-quant output is constant(much like the fact that utility is constant as A basic understanding of statistics is a criticalcomponent of informed decision making.Q6. Suppose your manufacturing company planning to release a new product into market,Explain the various methods forecasting for a new product.When a manufacturing companies planning to release a new product into themarket, it shouldperform the demand forecasting to check the demand of the product in the market and alsothe availability of similar product in the market.Demand forecasting for new products is quite different from that for established products.Here the firms will not have any past experience or past data for this purpose. An intensivestudy of the economic and competitive characteristics of the product should be made to makeefficient forecasts.As per Professor Joel Dean, few guidelines to make forecasting of demand for newproducts are:a. Evolutionary approachThe demand for the new product may be considered as an outgrowth of an existing product.For e.g., Demand for new Tata Indica, which is a modified version of Old Indica can mosteffectively be projected based on the sales of the old Indica, the demand for new Pulsor canbe forecasted based on the sales of the old Pulsar. Thus when a new product is evolved fromthe old product, the demand conditions of the old product can be taken as a basis forforecasting the demand for the new product.b. Substitute approachIf the new product developed serves as substitute for the existing product, the demand for thenew product may be worked out on the basis of a ‗market share‘. The growths of demand forall the products have to be worked out on the basis of intelligent forecasts for independentvariables that influence the demand for the substitutes. After that, a portion of the market canbe sliced out for the new product. For e.g., A moped as a substitute for a scooter, a cell phoneas a substitute for a land line. In some cases price plays an important role in shaping futuredemand for the product.c. Opinion Poll approach
  29. 29. Under this approach the potential buyers are directly contacted, or through the use of samplesof the new product and their responses are found out. These are finally blown up to forecastthe demand for the new product.d. Sales experience approachOffer the new product for sale in a sample market; say supermarkets or big bazaars in bigcities, which are also big marketing centers. The product may be offered for sale through onesuper market and the estimate of sales obtained may be ‗blown up‘ to arrive at estimateddemand for the product.e. Growth Curve approachAccording to this, the rate of growth and the ultimate level of demand for the new product areestimated on the basis of the pattern of growth of established products. For e.g., AnAutomobile Co., while introducing a new version of a car will study the level of demand forthe existing car.f. Vicarious approachA firm will survey consumers‘ reactions to a new product indirectly through getting in touchwith some specialized and informed dealers who have good knowledge about the market,about the different varieties of the product already available in the market, the consumers‘preferences etc. This helps in making a more efficient estimation of future demand.