Managerial_economics (14).docx

Managerial Economics 2014
1. Discuss in details the role and Contribution of managerial economics in
business decision making?
Ans: Decision making is an integral part of management. Managerial
economics helps in effective decision making and a business manager is
essentially involved in the processes of decision making as well as forward
planning. In doing so, managerial economics is of great importance for a
business manager.
The fact that a business entity is influenced by the conditions is uncertainty about the
future and due to the changes in the business environment resulting complexities in
business decisions. Since no information or the knowledge about the future sales,
profits or the costs is available for a business executive, the decisions are to be made
on the basis of past data as well as the approximations being forecasted. In order that
the decision making process is carried out in such conditions in an efficient way,
economic theory is of great value and relevance as it deals with production, demand,
cost, pricing etc. This gives rise to understand the concepts of managerial economics
for business manager, so that he may apply the economic principles to the business
and appraise the relevance and impact of external factors in relation to the business.
Having been regarded as micro economic as well as the economics of the firm,
managerial economics is related to the economic theory which is to be applied to the
business with the objective of solving business problems and to analyze business
situations and the factors constituting the environment in which a business is operated.
Managerial economics has been defined by Spencer and Siegelman as,“The
integration of economic theory with business practice for the purpose of facilitating
decision making and forward planning by management.”
Managerial economics is very much capable of serving various purposes and useful
for managers in making decisions in relation to the internal environment. It aims at the
development of economic theory of the firm while facilitating the decision making
process with regard to sales and profits etc.
Moreover, it enables to make decisions about appropriate production and inventory
policies for the future.

2. What are the types of Demand ? Enumerate the types of determinants of
demand for FMCG?
Ans:
The different types of demand (as shown in Figure-1) are discussed as follows:
 i. Individual and Market Demand: ...
 ii. Organization and Industry Demand: ...
 iii. Autonomous and Derived Demand: ...
 iv. Demand for Perishable and Durable Goods: ...
 v. Short-term and Long-term Demand:
 Determinants of Demand
 When price changes, quantity demanded will change. That is a
movement along the same demand curve. When factors other than price
changes, demand curve will shift. These are the determinants of the
demand curve.
 1. Income: A rise in a person’s income will lead to an increase in
demand (shift demand curve to the right), a fall will lead to a decrease in
demand for normal goods. Goods whose demand varies inversely with
income are called inferior goods (e.g. Hamburger Helper).
 2. Consumer Preferences: Favorable change leads to an increase in
demand, unfavorable change lead to a decrease.
 3. Number of Buyers: the more buyers lead to an increase in demand;
fewer buyers lead to decrease.
 4. Price of related goods:
 a. Substitute goods (those that can be used to replace each other): price
of substitute and demand for the other good are directly related.
 Example: If the price of coffee rises, the demand for tea should
increase.
 b. Complement goods (those that can be used together): price of
complement and demand for the other good are inversely related.
 Example: if the price of ice cream rises, the demand for ice-cream
toppings will decrease.
 5. Expectation of future:
 a. Future price: consumers’ current demand will increase if they expect
higher future prices; their demand will decrease if they expect lower
future prices.
 b. Future income: consumers’ current demand will increase if they
expect higher future income; their demand will decrease if they expect
lower future income.
 1) Demand showing improvement post note
ban:Most companies from Unilever to Dabur to Marico, Nestle and Mondelez have

highlighted recently that demand has recovered post the high-value note ban in the December
quarter. They say that consumers, especially, in urban areas have got past the hurdles faced
during the note ban, prompting sales to show improvement in the March quarter.
 2) Consumer staples is resilient as a category: Most analysts believe that consumer staples
as a category remains resilient to external factors such as note ban since these are essential
goods required for consumption and survival. So while factors such as demonetisation can
dampen demand for one quarter, it cannot do so for long.
 3) Companies were quick to adapt to the changing scenario: To lessen the pain,
companies were quick to manage inventory and distribution during the note ban, increasing
credit period for trade strapped for cash. In recent months, companies have been talking to
traders to switch to digital payments to ensure seamless transfer of goods.
 4) Companies focusing on urban for now: Most FMCG companies admit that business will
take time to return to normal in rural areas owing to the note ban. So the focus for them will
be on pushing sales in urban areas. While rural constitutes a third of FMCG, two-thirds
continues to come from urban areas so for the medium to short term emphasis on urban till
rural returns to normal, say analysts, is not a bad idea.
 5) GST preparedness: That is expected to be critical for companies going forward. How
they accustom themselves to this tax regime will determine whether it will be business as
usual for them in the coming quarters.
3. Explain the COBB DOGLAS Production function with suitable illustration.?
The Cobb-Douglas production function represents the relationship between two
or more inputs - typically physical capital and labor - and the number of outputs
that can be produced. It's a commonly used function in macroeconomics and
forecast production.
Factors of Production
You can't make something from nothing. You need supplies, equipment,
resources, and some know-how, too. How much you have of these things can
affect your production. In economics, a production function is a way of
calculating what comes out of production to what has gone into it. The formula
attempts to calculate the maximum amount of output you can get from a certain
number of inputs.
In macroeconomics, the factors of production are:
 Physical capital (K), or tangible assets that are created for use in the
production process. This includes such things as buildings, machines,
computers, and other equipment.
 Labor (L), or input of skilled and unskilled activities of human workers.
 Land (P), which includes natural resources, raw materials, and energy
sources, such as oil, gas, and coal.

 Entrepreneurship (H), which is the quality of the business intelligence
that is applied to the production function.
The production function is expressed in the formula: Q = f(K, L, P, H), where
the quantity produced is a function of the combined input amounts of each
factor. Of course, not all businesses require the same factors of production or
number of inputs. Another form of the production function reduces the inputs to
just labor and physical capital. The formula for this form is: Q = f(L, K), in
which labor and capital are the two factors of production with the greatest
impact on the quantity of output.
Cobb-Douglas Production Function
In 1928, Charles Cobb and Paul Douglas presented the view that production
output is the result of the amount of labor and physical capital invested. This
analysis produced a calculation that is still in use today, largely because of its
accuracy.
The Cobb-Douglas production function reflects the relationships between its
inputs - namely physical capital and labor - and the amount of output produced.
It's a means for calculating the impact of changes in the inputs, the relevant
efficiencies, and the yields of a production activity. Here's the basic form of the
Cobb-Douglas production function:
The Cobb-Douglas production function
In this formula, Q is the quantity produced from the inputs L and K. L is the
amount of labor expended, which is typically expressed in hours. K represents
the amount of physical capital input, such as the number of hours for a
particular machine, operation, or perhaps factory. A, which appears as a lower
case b in some versions of this formula, represents the total factor productivity
(TFP)that measures the change in output that isn't the result of the inputs.
Typically, this change in TFP is the result of an improvement in efficiency or
technology. The Greek characters alpha and beta reflect the output elasticity of
the inputs. Output elasticity is the change in the output that results from a
change in either labor or physical capital.

For example, if the output elasticity for physical capital (K) is 0.60 and K is
increased by 20 percent, then output increases by 3 percent (0.6/0.2). The same
is true for the output elasticity of labor: an increase of 10 percent in L with an
output elasticity of 0.40 increases the output by 4 percent (0.4/0.1).
Marginal Product
Another concept associated with the Cobb-Douglas production function
is marginal product, which is the change in the output that results from one
additional unit of a single production factor with all other factors held constant.
Or, as the economists say, ceteris parabis, which means 'all other things equal.'
Marginal product is measured in physical units, which is why it is also
called marginal physical product.
For example, consider a company called WeeBee Toys. When there are no
workers in the factory, there is no output even though physical capital is
present. When a single worker shows up, three units are produced per labor
hour. When two workers come in, output increases to five units per hour.
The addition of the labor of the second worker results in two more units per
hour, or a marginal product of two. Because the marginal product is directly
related to the increase in labor, this is also called the marginal product of
labor. Had the increase in output been a result of new technology or physical
capital, the change would be marginal product of capital.
4. Bring out the meaning of economics and diseconomics of scale. Explain
their merits and demerits?
Ans: Economies of scale are defined as the cost advantages that an organization
can ... Take place when large organizations borrow money at lower rate of interest.
... There are two types of diseconomies ofscale, namely,
internal diseconomies and ... It is harder to make out that all the employees of an
organization are working ...
7. Discus the various methods of Pricing’?
Ans: Competitor-based pricing. This pricing method is a method, when the company sets
the price, focusing on the cost of competitive products. In other words, the company
establishes the principles of pricepositioning according to their competitors' prices and
follows them when calculating the price of the product
The different pricing methods (Figure-4) are discussed
below;
Cost-based Pricing:
Cost-based pricing refers to a pricing method in which some
percentage of desired profit margins is added to the cost of the

product to obtain the final price. In other words, cost-based pricing
can be defined as a pricing method in which a certain percentage of
the total cost of production is added to the cost of the product to
determine its selling price. Cost-based pricing can be of two types,
namely, cost-plus pricing and markup pricing.
These two types of cost-based pricing are as follows:
i. Cost-plus Pricing:
Refers to the simplest method of determining the price of a product.
In cost-plus pricing method, a fixed percentage, also called mark-up
percentage, of the total cost (as a profit) is added to the total cost to
set the price. For example, XYZ organization bears the total cost of
Rs. 100 per unit for producing a product. It adds Rs. 50 per unit to
the price of product as’ profit. In such a case, the final price of a
product of the organization would be Rs. 150.
Cost-plus pricing is also known as average cost pricing. This is the
most commonly used method in manufacturing organizations.
In economics, the general formula given for setting price
in case of cost-plus pricing is as follows:
P = AVC + AVC (M)
AVC= Average Variable Cost
M = Mark-up percentage
AVC (m) = Gross profit margin
Mark-up percentage (M) is fixed in which AFC and net profit
margin (NPM) are covered.
AVC (m) = AFC+ NPM
ii. For determining average variable cost, the first step is to fix
prices. This is done by estimating the volume of the output for a
given period of time. The planned output or normal level of
production is taken into account to estimate the output.

The second step is to calculate Total Variable Cost (TVC) of the
output. TVC includes direct costs, such as cost incurred in labor,
electricity, and transportation. Once TVC is calculated, AVC is
obtained by dividing TVC by output, Q. [AVC= TVC/Q]. The price is
then fixed by adding the mark-up of some percentage of AVC to the
profit [P = AVC + AVC (m)].
iii. The advantages of cost-plus pricing method are as
follows:
a. Requires minimum information
b. Involves simplicity of calculation
c. Insures sellers against the unexpected changes in costs
The disadvantages of cost-plus pricing method are as
follows:
a. Ignores price strategies of competitors
b. Ignores the role of customers
iv. Markup Pricing:
Refers to a pricing method in which the fixed amount or the
percentage of cost of the product is added to product’s price to get
the selling price of the product. Markup pricing is more common in
retailing in which a retailer sells the product to earn profit. For
example, if a retailer has taken a product from the wholesaler for
Rs. 100, then he/she might add up a markup of Rs. 20 to gain
profit.
It is mostly expressed by the following formulae:
a. Markup as the percentage of cost= (Markup/Cost) *100
b. Markup as the percentage of selling price= (Markup/ Selling
Price)*100
c. For example, the product is sold for Rs. 500 whose cost was Rs.
400. The mark up as a percentage to cost is equal to (100/400)*100
=25. The mark up as a percentage of the selling price equals
(100/500)*100= 20.

Demand-based Pricing:
Demand-based pricing refers to a pricing method in which the price
of a product is finalized according to its demand. If the demand of a
product is more, an organization prefers to set high prices for
products to gain profit; whereas, if the demand of a product is less,
the low prices are charged to attract the customers.
The success of demand-based pricing depends on the ability of
marketers to analyze the demand. This type of pricing can be seen
in the hospitality and travel industries. For instance, airlines during
the period of low demand charge less rates as compared to the
period of high demand. Demand-based pricing helps the
organization to earn more profit if the customers accept the product
at the price more than its cost.
Competition-based Pricing:
Competition-based pricing refers to a method in which an
organization considers the prices of competitors’ products to set the
prices of its own products. The organization may charge higher,
lower, or equal prices as compared to the prices of its competitors.
The aviation industry is the best example of competition-
based pricing where airlines charge the same or fewer
prices for same routes as charged by their competitors. In
addition, the introductory prices charged by publishing
organizations for textbooks are determined according to
the competitors’ prices.
Other Pricing Methods:
In addition to the pricing methods, there are other
methods that are discussed as follows:
i. Value Pricing:
Implies a method in which an organization tries to win loyal
customers by charging low prices for their high- quality products.
The organization aims to become a low cost producer without
sacrificing the quality. It can deliver high- quality products at low
prices by improving its research and development process. Value
pricing is also called value-optimized pricing.
ii. Target Return Pricing:

Helps in achieving the required rate of return on investment done
for a product. In other words, the price of a product is fixed on the
basis of expected profit.
iii. Going Rate Pricing:
Implies a method in which an organization sets the price of a
product according to the prevailing price trends in the market.
Thus, the pricing strategy adopted by the organization can be same
or similar to other organizations. However, in this type of pricing,
the prices set by the market leaders are followed by all the
organizations in the industry.
iv. Transfer Pricing:
Involves selling of goods and services within the departments of the
organization. It is done to manage the profit and loss ratios of
different departments within the organization. One department of
an organization can sell its products to other departments at low
prices. Sometimes, transfer pricing is used to show higher profits in
the organization by showing fake sales of products within
departments.
7. Elucidate the characteristics of different types of market structure?
On the basis of above elements of a market, its general
definition may be as follows:
The market for a product refers to the whole region where buyers
and sellers of that product are spread and there is such free
competition that one price for the product prevails in the entire
region.
Market Structure:
Meaning:
Market structure refers to the nature and degree of competition in
the market for goods and services. The structures of market both for

goods market and service (factor) market are determined by the
nature of competition prevailing in a particular market.
Determinants:
There are a number of determinants of market structure for a
particular good.
They are:
(1) The number and nature of sellers.
(2) The number and nature of buyers.
(3) The nature of the product.
(4) The conditions of entry into and exit from the market.
(5) Economies of scale.
They are discussed as under:
1. Number and Nature of Sellers:
The market structures are influenced by the number and nature of
sellers in the market. They range from large number of sellers in
perfect competition to a single seller in pure monopoly, to two
sellers in duopoly, to a few sellers in oligopoly, and to many sellers
of differentiated products.
2. Number and Nature of Buyers:
The market structures are also influenced by the number and nature
of buyers in the market. If there is a single buyer in the market, this
is buyer’s monopoly and is called monopsony market. Such markets
exist for local labour employed by one large employer. There may be
two buyers who act jointly in the market. This is called duopsony
market. They may also be a few organised buyers of a product.

This is known as oligopsony. Duopsony and oligopsony markets are
usually found for cash crops such as rice, sugarcane, etc. when local
factories purchase the entire crops for processing.
3. Nature of Product:
It is the nature of product that determines the market structure. If
there is product differentiation, products are close substitutes and
the market is characterised by monopolistic competition. On the
other hand, in case of no product differentiation, the market is
characterised by perfect competition. And if a product is completely
different from other products, it has no close substitutes and there
is pure monopoly in the market.
4. Entry and Exit Conditions:
The conditions for entry and exit of firms in a market depend upon
profitability or loss in a particular market. Profits in a market will
attract the entry of new firms and losses lead to the exit of weak
firms from the market. In a perfect competition market, there is
freedom of entry or exit of firms.
But in monopoly and oligopoly markets, there are barriers to entry
of new firms. Usually, governments have a monopoly in public
utility services like postal, air and road transport, water and power
supply services, etc. By granting exclusive franchises, entries of new
supplies are barred. In oligopoly markets, there are barriers to entry
of firms because of collusion, tacit agreements, cartels, etc. On the
other hand, there are no restrictions in entry and exit of firms in
monopolistic competition due to product differentiation.

5. Economies of Scale:
Firms that achieve large economies of scale in production grow
large in comparison to others in an industry. They tend to weed out
the other firms with the result that a few firms are left to compete
with each other. This leads to the emergency of oligopoly. If only
one firm attains economies of scale to such a large extent that it is
able to meet the entire market demand, there is monopoly.
Forms of Market Structure:
On the basis of competition, a market can be classified in
the following ways:
1. Perfect Competition
2. Monopoly
3. Duopoly
4. Oligopoly
5. Monopolistic Competition
1. Perfect Competition Market:
A perfectly competitive market is one in which the number of
buyers and sellers is very large, all engaged in buying and selling a
homogeneous product without any artificial restrictions and
possessing perfect knowledge of market at a time. In the words of A.
Koutsoyiannis, “Perfect competition is a market structure
characterised by a complete absence of rivalry among the individual
firms.” According to R.G. Lipsey, “Perfect competition is a market

structure in which all firms in an industry are price- takers and in
which there is freedom of entry into, and exit from, industry.”
Characteristics of Perfect Competition:
The following are the conditions for the existence of
perfect competition:
(1) Large Number of Buyers and Sellers:
The first condition is that the number of buyers and sellers must be
so large that none of them individually is in a position to influence
the price and output of the industry as a whole. The demand of
individual buyer relative to the total demand is so small that he
cannot influence the price of the product by his individual action.
Similarly, the supply of an individual seller is so small a fraction of
the total output that he cannot influence the price of the product by
his action alone. In other words, the individual seller is unable to
influence the price of the product by increasing or decreasing its
supply.
Rather, he adjusts his supply to the price of the product. He is
“output adjuster”. Thus no buyer or seller can alter the price by his
individual action. He has to accept the price for the product as fixed
for the whole industry. He is a “price taker”.
(2) Freedom of Entry or Exit of Firms:
The next condition is that the firms should be free to enter or leave
the industry. It implies that whenever the industry is earning excess
profits, attracted by these profits some new firms enter the industry.
In case of loss being sustained by the industry, some firms leave it.
(3) Homogeneous Product:

Each firm produces and sells a homogeneous product so that no
buyer has any preference for the product of any individual seller
over others. This is only possible if units of the same product
produced by different sellers are perfect substitutes. In other words,
the cross elasticity of the products of sellers is infinite.
No seller has an independent price policy. Commodities like salt,
wheat, cotton and coal are homogeneous in nature. He cannot raise
the price of his product. If he does so, his customers would leave
him and buy the product from other sellers at the ruling lower price.
The above two conditions between themselves make the average
revenue curve of the individual seller or firm perfectly elastic,
horizontal to the X-axis. It means that a firm can sell more or less at
the ruling market price but cannot influence the price as the
product is homogeneous and the number of sellers very large.
(4) Absence of Artificial Restrictions:
The next condition is that there is complete openness in buying and
selling of goods. Sellers are free to sell their goods to any buyers and
the buyers are free to buy from any sellers. In other words, there is
no discrimination on the part of buyers or sellers.
Moreover, prices are liable to change freely in response to demand-
supply conditions. There are no efforts on the part of the producers,
the government and other agencies to control the supply, demand
or price of the products. The movement of prices is unfettered.
(5) Profit Maximisation Goal:
Every firm has only one goal of maximising its profits.

(6) Perfect Mobility of Goods and Factors:
Another requirement of perfect competition is the perfect mobility
of goods and factors between industries. Goods are free to move to
those places where they can fetch the highest price. Factors can also
move from a low-paid to a high-paid industry.
(7) Perfect Knowledge of Market Conditions:
This condition implies a close contact between buyers and sellers.
Buyers and sellers possess complete knowledge about the prices at
which goods are being bought and sold, and of the prices at which
others are prepared to buy and sell. They have also perfect
knowledge of the place where the transactions are being carried on.
Such perfect knowledge of market conditions forces the sellers to
sell their product at the prevailing market price and the buyers to
buy at that price.
(8) Absence of Transport Costs:
Another condition is that there are no transport costs in carrying of
product from one place to another. This condition is essential for
the existence of perfect competition which requires that a
commodity must have the same price everywhere at any time. If
transport costs are added to the price of the product, even a
homogeneous commodity will have different prices depending upon
transport costs from the place of supply.
(9) Absence of Selling Costs:
Under perfect competition, the costs of advertising, sales-
promotion, etc. do not arise because all firms produce a
homogeneous product.

Perfect Competition vs Pure Competition:
Perfect competition is often distinguished from pure competition,
but they differ only in degree. The first five conditions relate to pure
competition while the remaining four conditions are also required
for the existence of perfect competition. According to Chamberlin,
pure competition means, competition unalloyed with monopoly
elements,” whereas perfect competition involves perfection in many
other respects than in the absence of monopoly.” The practical
importance of perfect competition is not much in the present times
for few markets are perfectly competitive except those for staple
food products and raw materials. That is why, Chamberlin says that
perfect competition is a rare phenomenon.”
Though the real world does not fulfil the conditions of perfect
competition, yet perfect competition is studied for the simple
reason that it helps us in understanding the working of an economy,
where competitive behaviour leads to the best allocation of
resources and the most efficient organisation of production. A
hypothetical model of a perfectly competitive industry provides the
basis for appraising the actual working of economic institutions and
organisations in any economy.
2. Monopoly Market:
Monopoly is a market situation in which there is only one seller of a
product with barriers to entry of others. The product has no close
substitutes. The cross elasticity of demand with every other product
is very low. This means that no other firms produce a similar
product. According to D. Salvatore, “Monopoly is the form of
market organisation in which there is a single firm selling a
commodity for which there are no close substitutes.” Thus the

monopoly firm is itself an industry and the monopolist faces the
industry demand curve.
The demand curve for his product is, therefore, relatively stable and
slopes downward to the right, given the tastes, and incomes of his
customers. It means that more of the product can be sold at a lower
price than at a higher price. He is a price-maker who can set the
price to his maximum advantage.
However, it does not mean that he can set both price and output. He
can do either of the two things. His price is determined by his
demand curve, once he selects his output level. Or, once he sets the
price for his product, his output is determined by what consumers
will take at that price. In any situation, the ultimate aim of the
monopolist is to have maximum profits.
Characteristics of Monopoly:
The main features of monopoly are as follows:
1. Under monopoly, there is one producer or seller of a particular
product and there is no difference between a firm and an industry.
Under monopoly a firm itself is an industry.
2. A monopoly may be individual proprietorship or partnership or
joint stock company or a cooperative society or a government
company.
3. A monopolist has full control on the supply of a product. Hence,
the elasticity of demand for a monopolist’s product is zero.

4. There is no close substitute of a monopolist’s product in the
market. Hence, under monopoly, the cross elasticity of demand for
a monopoly product with some other good is very low.
5. There are restrictions on the entry of other firms in the area of
monopoly product.
6. A monopolist can influence the price of a product. He is a price-
maker, not a price-taker.
7. Pure monopoly is not found in the real world.
8. Monopolist cannot determine both the price and quantity of a
product simultaneously.
9. Monopolist’s demand curve slopes downwards to the right. That
is why, a monopolist can increase his sales only by decreasing the
price of his product and thereby maximise his profit. The marginal
revenue curve of a monopolist is below the average revenue curve
and it falls faster than the average revenue curve. This is because a
monopolist has to cut down the price of his product to sell an
additional unit.
3. Duopoly:
Duopoly is a special case of the theory of oligopoly in which there
are only two sellers. Both the sellers are completely independent
and no agreement exists between them. Even though they are inde-
pendent, a change in the price and output of one will affect the
other, and may set a chain of reactions. A seller may, however,
assume that his rival is unaffected by what he does, in that case he
takes only his own direct influence on the price.

If, on the other hand, each seller takes into account the effect of his
policy on that of his rival and the reaction of the rival on himself
again, then he considers both the direct and the indirect influences
upon the price. Moreover, a rival seller’s policy may remain
unaltered either to the amount offered for sale or to the price at
which he offers his product. Thus the duopoly problem can be
considered as either ignoring mutual dependence or recognising it.
4. Oligopoly:
Oligopoly is a market situation in which there are a few firms selling
homogeneous or differentiated products. It is difficult to pinpoint
the number of firms in ‘competition among the few.’ With only a few
firms in the market, the action of one firm is likely to affect the
others. An oligopoly industry produces either a homogeneous
product or heterogeneous products.
The former is called pure or perfect oligopoly and the latter is called
imperfect or differentiated oligopoly. Pure oligopoly is found
primarily among producers of such industrial products as
aluminium, cement, copper, steel, zinc, etc. Imperfect oligopoly is
found among producers of such consumer goods as automobiles,
cigarettes, soaps and detergents, TVs, rubber tyres, refrigerators,
typewriters, etc.
Characteristics of Oligopoly:
In addition to fewness of sellers, most oligopolistic
industries have several common characteristics which are
explained below:
(1) Interdependence:

There is recognised interdependence among the sellers in the
oligopolistic market. Each oligopolist firm knows that changes in its
price, advertising, product characteristics, etc. may lead to counter-
moves by rivals. When the sellers are a few, each produces a
considerable fraction of the total output of the industry and can
have a noticeable effect on market conditions.
He can reduce or increase the price for the whole oligopolist market
by selling more quantity or less and affect the profits of the other
sellers. It implies that each seller is aware of the price-moves of the
other sellers and their impact on his profit and of the influence of
his price-move on the actions of rivals.
Thus there is complete interdependence among the sellers with
regard to their price-output policies. Each seller has direct and
ascertainable influences upon every other seller in the industry.
Thus, every move by one seller leads to counter-moves by the
others.
(2) Advertisement:
The main reason for this mutual interdependence in decision
making is that one producer’s fortunes are dependent on the
policies and fortunes of the other producers in the industry. It is for
this reason that oligopolist firms spend much on advertisement and
customer services.
As pointed out by Prof. Baumol, “Under oligopoly advertising can
become a life-and-death matter.” For example, if all oligopolists
continue to spend a lot on advertising their products and one seller
does not match up with them he will find his customers gradually

going in for his rival’s product. If, on the other hand, one oligopolist
advertises his product, others have to follow him to keep up their
sales.
(3) Competition:
This leads to another feature of the oligopolistic market, the
presence of competition. Since under oligopoly, there are a few
sellers, a move by one seller immediately affects the rivals. So each
seller is always on the alert and keeps a close watch over the moves
of its rivals in order to have a counter-move. This is true
competition.
(4) Barriers to Entry of Firms:
As there is keen competition in an oligopolistic industry, there are
no barriers to entry into or exit from it. However, in the long run,
there are some types of barriers to entry which tend to restraint new
firms from entering the industry.
They may be:
(a) Economies of scale enjoyed by a few large firms; (b) control over
essential and specialised inputs; (c) high capital requirements due
to plant costs, advertising costs, etc. (d) exclusive patents and
licenses; and (e) the existence of unused capacity which makes the
industry unattractive. When entry is restricted or blocked by such
natural and artificial barriers, the oligopolistic industry can earn
long-run super normal profits.
(5) Lack of Uniformity:
Another feature of oligopoly market is the lack of uniformity in the
size of firms. Finns differ considerably in size. Some may be small,

others very large. Such a situation is asymmetrical. This is very
common in the American economy. A symmetrical situation with
firms of a uniform size is rare.
(6) Demand Curve:
It is not easy to trace the demand curve for the product of an
oligopolist. Since under oligopoly the exact behaviour pattern of a
producer cannot be ascertained with certainty, his demand curve
cannot be drawn accurately, and with definiteness. How does an
individual seller s demand curve look like in oligopoly is most
uncertain because a seller’s price or output moves lead to
unpredictable reactions on price-output policies of his rivals, which
may have further repercussions on his price and output.
The chain of action reaction as a result of an initial change in price
or output, is all a guess-work. Thus a complex system of crossed
conjectures emerges as a result of the interdependence among the
rival oligopolists which is the main cause of the indeterminateness
of the demand curve.
If the oligopolist seller does not have a definite demand curve for
his product, then how does he affect his sales. Presumably, his sales
depend upon his current price and those of his rivals. However, a
number of conjectural demand curves can be imagined.
For example, in differentiated oligopoly where each seller fixes a
separate price for his product, a reduction in price by one seller may
lead to an equivalent, more, less or no price reduction by rival
sellers. In each case, a demand curve can be drawn by the seller
within the range of competitive and monopoly demand curves.

Leaving aside retaliatory price movements, the individual seller’s
demand curve under oligopoly for both price cuts and increases is
neither more elastic than under perfect or monopolistic competition
nor less elastic than under monopoly. It may still be indefinite and
indeterminate.
This situation is shown in Figure 1 where KD1 is the elastic demand
curve and MD is the less elastic demand curve. The oligopolies’
demand curve is the dotted kinked KPD. The reason is quite simple.
If a seller reduces the price of his product, his rivals also lower the
prices of their products so that he is not able to increase his sales.
So the demand curve for the individual seller’s product will be less
elastic just below the present price P (where KD1and MD curves are
shown to intersect). On the other hand, when he raises the price of
his product, the other sellers will not follow him in order to earn
larger profits at the old price. So this individual seller will
experience a sharp fall in the demand for his product.
Thus his demand curve above the price P in the segment KP will be
highly elastic. Thus the imagined demand curve of an oligopolist
has a comer or kink at the current price P. Such a demand curve is
much more elastic for price increases than for price decreases.
(7) No Unique Pattern of Pricing Behaviour:

The rivalry arising from interdependence among the oligopolists
leads to two conflicting motives. Each wants to remain independent
and to get the maximum possible profit. Towards this end, they act
and react on the price-output movements of one another in a
continuous element of uncertainty.
On the other hand, again motivated by profit maximisation each
seller wishes to cooperate with his rivals to reduce or eliminate the
element of uncertainty. All rivals enter into a tacit or formal
agreement with regard to price-output changes. It leads to a sort of
monopoly within oligopoly.
They may even recognise one seller as a leader at whose initiative all
the other sellers raise or lower the price. In this case, the individual
seller’s demand curve is a part of the industry demand curve, having
the elasticity of the latter. Given these conflicting attitudes, it is not
possible to predict any unique pattern of pricing behaviour in
oligopoly markets.
5. Monopolistic Competition:
Monopolistic competition refers to a market situation where there
are many firms selling a differentiated product. “There is
competition which is keen, though not perfect, among many firms
making very similar products.” No firm can have any perceptible
influence on the price-output policies of the other sellers nor can it
be influenced much by their actions. Thus monopolistic competition
refers to competition among a large number of sellers producing
close but not perfect substitutes for each other.
It’s Features:

The following are the main features of monopolistic
competition:
(1) Large Number of Sellers:
In monopolistic competition the number of sellers is large. They are
“many and small enough” but none controls a major portion of the
total output. No seller by changing its price-output policy can have
any perceptible effect on the sales of others and in turn be
influenced by them. Thus there is no recognised interdependence of
the price-output policies of the sellers and each seller pursues an
independent course of action.
(2) Product Differentiation:
One of the most important features of the monopolistic competition
is differentiation. Product differentiation implies that products are
different in some ways from each other. They are heterogeneous
rather than homogeneous so that each firm has an absolute
monopoly in the production and sale of a differentiated product.
There is, however, slight difference between one product and other
in the same category.
Products are close substitutes with a high cross-elasticity and not
perfect substitutes. Product “differentiation may be based upon
certain characteristics of the products itself, such as exclusive
patented features; trade-marks; trade names; peculiarities of
package or container, if any; or singularity in quality, design, colour,
or style. It may also exist with respect to the conditions surrounding
its sales.”
(3) Freedom of Entry and Exit of Firms:

Another feature of monopolistic competition is the freedom of entry
and exit of firms. As firms are of small size and are capable of
producing close substitutes, they can leave or enter the industry or
group in the long run.
(4) Nature of Demand Curve:
Under monopolistic competition no single firm controls more than
a small portion of the total output of a product. No doubt there is an
element of differentiation nevertheless the products are close
substitutes. As a result, a reduction in its price will increase the
sales of the firm but it will have little effect on the price-output
conditions of other firms, each will lose only a few of its customers.
Likewise, an increase in its price will reduce its demand
substantially but each of its rivals will attract only a few of its
customers. Therefore, the demand curve (average revenue curve) of
a firm under monopolistic competition slopes downward to the
right. It is elastic but not perfectly elastic within a relevant range of
prices of which he can sell any amount.
(5) Independent Behaviour:
8. Describe the various methods of measuring national income.?
Ans:
Value Added Method 2. Income Method 3. Expenditure Method. Since factor incomes
arise from the production of goods and services, and since incomes are spent on goods and
services produced, three alternative methods of measuring national income are possible.
Since factor incomes arise from the production of goods and
services, and since incomes are spent on goods and services
produced, three alternative methods of measuring national income
are possible.

1. Value Added Method:
This is also called output method or production method. In this
method the value added by each enterprise in the production goods
and services is measured. Value added by an enterprise is obtained
by deducting expenditure incurred on intermediate goods such as
raw materials, unfinished goods (purchased from other firms from
the value of output produced by an enterprise.
Value of output produced by an enterprise is equal to physical
output (Q) produced multiplied by the market price (P), that is, P.Q.
From the value added by each enterprise we subtract consumption
of fixed capital (i.e., depreciation) to obtain net value added at
market prices (NVAMP).
However, for estimating national income (that is, Net National
Product at factor cost (NNPFC) we require to estimate net value
added at factor cost (NVAFC) by each enterprise in the economy.
NVAFC can be found out by deducting net indirect taxes (i. e. indirect
taxes less subsidies provided by the Government).
Under this method, the economy is divided into different industrial
sectors such as agriculture, fishing, mining, construction,
manufacturing, trade and commerce, transport, communication
and other services. Then, the net value added at factor cost (NVAFC)
by each productive enterprise as well as by each industry or sector is
estimated.
It follows from above that in order to arrive at the net
value added at factor cost by an enterprise we have to
subtract the following from the value of output of an
enterprise:
1. Intermediate consumption which is the value of goods such as
raw materials, fuels purchased from other firms
2. Consumption of fixed capital (i.e., depreciation)
3. Net indirect taxes.
Summing up the net values added at factor cost (NVAFC) by all
productive enterprises of an industry or sector gives us the net value
added at factor cost of each industry or sector. We then add up net
values added at factor cost by all industries or sectors to get net

domestic product at factor cost (NDPFC). Lastly, to the net domestic
product we add the net factor income from abroad to get net
national product at factor cost (NNPFC) which is also called national
income. Thus,
NI or NNPFC = NDPFC + Net factor income from abroad
This method of calculating national income can be used where there
exists a census of production for the year. In many countries, the
data of production of only important industries are known. Hence
this method is employed along with other methods to arrive at the
national income. The one great advantage of this method is that it
reveals the relative importance of the different sectors of the
economy by showing their respective contributions to the national
income.
Precautions:
The following precautions should be taken while
measuring national income of a country through value
added method:
1. Imputed rent values of self-occupied houses should be included in
the value of output. Though these payments are not made to others,
their values can be easily estimated from prevailing values in the
market.
2. Sale and purchase of second-hand goods should not be included
in measuring value of output of a year because their values were
counted in the year of output of the year of their production. Of
course, commission or brokerage earned in their sale and purchase
has to be included because this is a new service rendered in the
current year.
3. Value of production for self-consumption are be counted while
measuring national income. In this method, the production for self-
consumption should be valued at the prevailing market prices.
4. Value of services of housewives are not included because it is not
easy to find out correctly the value of their services.

5. Value of intermediate goods must not be counted while
measuring value added because this will amount to double
counting.
2. Income Method:
This method approaches national income from distribution side. In
other words, this method measures national income at the phase of
distribution and appears as income paid and or received by
individuals of the country. Thus, under this method, national
income is obtained by summing up of the incomes of all individuals
of a country. Individuals earn incomes by contributing their own
services and the services of their property such as land and capital
to the national production.
Therefore, national income is calculated by adding up the rent of
land, wages and salaries of employees, interest on capital, profits of
entrepreneurs (including undistributed corporate profits) and
incomes of self-employed people. This method of estimating
national income has the great advantage of indicating the
distribution of national income among different income groups
such as landlords, owners of capital, workers, entrepreneurs.
Measurement of national income through income method
involves the following main steps:
1. Like the value added method, the first step in income method is
also to identify the productive enterprises and then classify them
into various industrial sectors such as agriculture, fishing, forestry,
manufacturing, transport, trade and commerce, banking, etc.
2. The second step is to classify the factor payments. The factor
payments are classified into the following groups:
i. Compensation of employees which includes wages and salaries,
both in cash and kind, as well as employers’ contribution to social
security schemes.
ii. Rent and also royalty, if any.
iii. Interest.

iv. Profits:
Profits are divided into three sub-groups:
(i) Dividends
(ii) Undistributed profits
(iii) Corporate income tax
v. Mixed income of the self-employed:
In India as in other developing countries there is fifth category of
factor income which is termed as mixed income of self-employed. In
India a good number of people are engaged in household industries,
in family farms and other unorganised enterprises. Because of self-
employment nature of the business it is difficult to separate wages
for the work done by the self-employed from the surplus or profits
made by them. Therefore, the incomes earned by them are mix of
wages, rent, interest and profit and are, therefore, called mixed
income of the self-employed.
3. The third step is to measure factor payments. Income paid out by
each enterprise can be estimated by gathering information about
the number of units of each factor employed and the income paid
out to each unit of every factor. Price paid out to each factor
multiplied by the number of units of each factor employed would
give us the factor’s income.
4. The adding up of factor payments by all enterprises belonging to
an industrial sector would give us the incomes paid out to various
factors by a particular industrial sector.
5. By summing up the incomes paid out by all industrial sectors we
will obtain domestic factor income which is also called net domestic
product at factor cost (NDPFC).
6. Finally, by adding net factor income earned from abroad to
domestic factor income or NDPFC we get net national product at
factor cost (NNPFC) which is also called national income.
Income approach to measurement of national income is shown
through bar diagrams in Figure 2.7.

Precautions:
While estimating national income through income
method the following precautions should be taken:
1. Transfer payments are not included in estimating national
income through this method.
2. Imputed rent of self-occupied houses are included in national
income as these houses provide services to those who occupy them
and its value can be easily estimated from the market value data.
3. Illegal money such as hawala money, money earned through
smuggling etc. are not included as they cannot be easily estimated.
4. Windfall gains such as prizes won, lotteries are also not included.
5. Corporate profit tax (that is, tax on income of the companies)
should not be separately included as it has already been included as
a part of profits.
6. Death duties, gift tax, wealth tax, tax on lotteries, etc., are paid
from past savings or wealth and not from current income.
Therefore, they should not be treated as a part of national income of
a year.
7. The receipts from the sale of second-hand goods should not be
treated as a part of national income. This is because the sale of

second-hand goods does not create new flows goods and services in
the current year.
8. Income equal to the value of production used for self-
consumption should be estimated and included in the measure of
national income.
3. Expenditure Method:
Expenditure method arrives at national income by adding up all
expenditures made on goods and services during a year. Income can
be spent either on consumer goods or capital goods. Again,
expenditure can be made by private individuals and households or
by government and business enterprises.
Further, people of foreign countries spend on the goods and
services which a country exports to them. Similarly, people of a
country spend on imports of goods and services from other
countries. We add up the following types of expenditure by
households, government and by productive enterprises to obtain
national income.
1. Expenditure on consumer goods and services by individuals and
households. This is called final private consumption expenditure,
and is denoted by C.
2. Government’s expenditure on goods and services to satisfy
collective wants. This is called government’s final consumption
expenditure, and is denoted by G.
3. The expenditure by productive enterprises on capital goods and
inventories or stocks. This is called gross domestic-capital
formation, or gross domestic investment and is denoted by I or
GDCF.
Gross domestic capital formation is divided into two
parts:
(i) Gross fixed capital formation
(ii) Addition to the stocks or inventories of goods

4. The expenditure made by foreigners on goods and services of a
country exported to other countries which arc called exports and are
denoted by X We deduct from exports (X) the expenditure by
people, enterprises and government of a country on imports (M) of
goods and services from other countries. That is, we have to
estimate net exports (that is, exports -imports) or (X—M) which is
also denoted by NX.
Thus, we add up the above four types of expenditure to get final
expenditure on gross domestic product at market prices (GDPMP).
Thus,
GDPMP = Private final consumption expenditure + Government’s
final consumption expenditure + Gross domestic capital formation
+ Exports — Imports or
GDPMP = C+G + I+ (X — M)
= C + G + I + NX
On deducting consumption of fixed capital (i.e., depreciation) from
gross domestic product at market prices (GDPMP) we get net
domestic product at market prices (NDPMP).
In this method, we then subtract net indirect taxes (that is, indirect
taxes – subsidies) to arrive at net domestic product at factor cost
(NDPFC),
Lastly, we add ‘net factor income from abroad’ to obtain net
national product at factor cost (NNPFC), which is called national
income. Thus,
NNPFC = GDPMP – Consumption of Fixed capital – Net Indirect taxes
+ Net Factor Income from Abroad.

Expenditure approach to national income is shown through bar
diagram in Table 2.2.
Precautions:
While estimating Gross Domestic Product through
expenditure method or measuring final expenditure on
Gross National Product, the following precautions should
be taken:
1. Second-hand goods:
The expenditure made on second-hand goods should not be
included because this does not contribute to the current year
production of goods and services.
2. Purchase of shares and bonds:
Expenditure on purchase of old shares and bonds from other people
and from business enterprises should not be included while
estimating Gross Domestic Product through expenditure method.
This is because bonds and shares are mere financial claims and do
not represent expenditure on currently produced goods and
services.
3. Expenditure on transfer payments by government such as
unemployment benefits, old-age pension should also not be
included because no goods or productive services are produced in
exchange by the recipients of these payments.
4. Expenditure on intermediate goods such as fertilisers and seeds
by the farmers and wool, cotton and yarn by manufacturers of
garments should also be excluded. This is because we have to avoid
double counting. Therefore, for estimating Gross Domestic Product
we have to include only expenditure on final goods and services.
A greatest difficulty in the measurement of national income in the
developing countries is general lack of adequate statistical data.
Inadequacy, non-availability and unreliability of statistics is a great
handicap in measuring national income in these countries.
Statistical information regarding agriculture and allied occupations,
and household enterprises is not available. Even the statistical

information regarding the enterprises in the organised sector is
sketchy and unreliable. There is no accurate information available
regarding consumption, investment expenditure and savings of
either rural or urban population.
Managerial Economics May 2013
1. Elaborate the elasticity of demand and explain the demand curve and
determinants of demand?
Meaning of Elasticity of Demand:
Demand extends or contracts respectively with a fall or rise in price.
This quality of demand by virtue of which it changes (increases or
decreases) when price changes (decreases or increases) is called
Elasticity of Demand.
“The elasticity (or responsiveness) of demand in a market is great
or small according as the amount demanded increases much or
little for a given fall in price, and diminishes much or little for a
given rise in price”. – Dr. Marshall.
Elasticity means sensitiveness or responsiveness of demand to the
change in price.
This change, sensitiveness or responsiveness, may be small or great.
Take the case of salt. Even a big fall in its price may not induce an
appreciable ex appreciable extension in its demand. On the other
hand, a slight fall in the price of oranges may cause a considerable
extension in their demand. That is why we say that the demand in
the former case is ‘inelastic’ and in the latter case it is ‘elastic’.
The demand curve is a visual representation of how many units of a good or
service will be bought at each possible price. It plots the relationship between
quantity and price that's been calculated on the demand schedule. That's a

table that shows exactly how many units of a good or service will be
purchased at various prices.
As you can see in the chart, the price is on the vertical (y) axis and the
quantity is on the horizontal (x) axis.
This chart plots the conventional relationship between price and quantity. The
lower the price, the higher the quantity demanded. As the price
decreases from p0 to p1, the quantity increases from q0 to q1.
This relationship follows the law of demand. It states that the quantity
demanded will drop as the price rises, ceteris paribus, or "all other things
being equal."
The relationship between quantity and price will follow the demand curve as
long as the four determinants of demand don't change These determinants
are:
1. Price of related goods or services.
2. Income of the buyer.
3. Tastes or preferences of the buyer,
4. Expectation of the buyer, especially about future prices.
If any of these four determinants change, the entire demand curve
shifts. That's because a new demand schedule must be created to show the
changed relationship between price and quantity.
Demand curves are also used to show the relationship between quantity and
price in aggregate demand.
That's the total demand in a society. It has the same determinants of demand,
plus the number of potential buyers in the market.
The Two Types of Demand Curves
The demand curve plots the demand schedule on a graph. The shape of the
curve will tell you how much price affects demand for a product.

Elastic demand is when a price decrease causes a significant increase in
quantities bought.
Like a stretchy rubber band, the quantity demanded moves a lot with just a
little change in prices. An example of this would be ground beef. If prices drop
just 25 percent, you might buy three times as much as you usually would.
That's because you know you'll use it and you'll just put the extra in the
freezer. If demand is perfectly elastic, the curve looks like a horizontal flat line.
Inelastic demand is inelastic is when a price decrease won't increase the
quantities purchased. An example of this is bananas. No matter how cheap
they are, there's only so many you can eat before they spoil. Freezing them
changes them. You won't buy three bunches even if the price falls 25 percent.
If demand is perfectly inelastic, the curve looks like a vertical straight line.
The reason you react more to a sale on ground beef than a sale on bananas
is because of the marginal utility of each additional unit. Marginal utility refers
to the usefulness (utility) of each additional unit the further out on the margin
you go. Because you can freeze ground beef, the third package is just as
good to you as the first. The marginal utility of ground beef is high. Bananas
lose their consistency in the freezer, so their marginal utility is low.
If any determinants of demand other than price change, the demand curve
shifts. If demand increases, the entire curve will move to the right. That means
larger quantities will be demanded at every price. If the entire curve shifts to
the left, it means total demand has dropped for all price levels. For example, if
you just lost your job, you might not buy that third package of ground beef,
even if it is on sale. You might just buy the one package and be glad it's 25
percent off.
Aggregate or Market Demand Curve
The market demand curve describes the quantity demanded by the entire
market for a category of goods or services. An example of this is gasoline
prices. When the price of oil goes up, all gas stations must raise their prices to
cover their costs. Oil prices comprise 71 percent of gas prices.
Even if the price drops 50 percent, drivers don’t stock up on extra gas. That's
why, when the price skyrockets from $3.20 to $4.00 a gallon, people get
upset. They can't cut back their driving to work, school and the grocery store.
As a result, they are forced to pay more for gas. That’s an inelastic aggregate
demand curve. For more, see
High gas prices lower their incomes for things other than gas. Income is
another determinant of demand. That means the demand curve for other
things they would like to buy, like ice cream, will drop. This is called a demand
shift. In this case, the entire demand curve for ice cream shifts to the left.

Since buyers have less income, they will purchase a lower quantity of ice
cream even if ice cream prices don’t rise.
Determinants of Demand
When price changes, quantity demanded will change. That is a movement
along the same demand curve. When factors other than price changes,
demand curve will shift. These are the determinants of the demand curve.
1. Income: A rise in a person’s income will lead to an increase in demand
(shift demand curve to the right), a fall will lead to a decrease in demand for
normal goods. Goods whose demand varies inversely with income are
called inferior goods (e.g. Hamburger Helper).
2. Consumer Preferences: Favorable change leads to an increase in
demand, unfavorable change lead to a decrease.
3. Number of Buyers: the more buyers lead to an increase in demand;
fewer buyers lead to decrease.
4. Price of related goods:
a. Substitute goods (those that can be used to replace each other): price of
substitute and demand for the other good are directly related.
Example: If the price of coffee rises, the demand for tea should increase.
b. Complement goods (those that can be used together): price of
complement and demand for the other good are inversely related.
Example: if the price of ice cream rises, the demand for ice-cream toppings
will decrease.
5. Expectation of future:

a. Future price: consumers’ current demand will increase if they expect
higher future prices; their demand will decrease if they expect lower future
prices.
b. Future income: consumers’ current demand will increase if they expect
higher future income; their demand will decrease if they expect lower future
income.
2. Discuss in details Short run and long run production function.?
Difference Between Short Run and Long Run Production Function
July 20, 2017 By Surbhi S Leave a Comment
A short-run production
function refers to that period of time, in which the installation of new plant
and machinery to increase the production level is not possible. On the other
hand, the Long-run production function is one in which the firm has got
sufficient time to instal new machinery or capital equipment, instead of
increasing the labour units.
The production function can be described as the operational relationship
between the inputs and outputs, in the sense that the maximum amount of
finished goods that can be produced with the given factors of production,
under a particular state of technical knowledge. There are two kinds of the
production function, short run production function and long run production
function.

The article presents you all the differences between short run and long run
production function, take a read.
Content: Short Run Production Function Vs Long Run
Production Function
1. Comparison Chart
2. Definition
3. Key Differences
4. Conclusion
Comparison Chart
BASIS FOR
COMPARION
SHORT-RUN PRODUCTION FUNCTION LONG-RUN PRODUCTION FUNCTION
Meaning Short run production function alludes to
the time period, in which at least one
factor of production is fixed.
Long run production function connotes
the time period, in which all the factors
of production are variable.
Law Law of variable proportion Law of returns to scale
Scale of
production
No change in scale of production. Change in scale of production.
Factor-ratio Changes Does not change.
Entry and Exit There are barriers to entry and the firms
can shut down but cannot fully exit.
Firms are free to enter and exit.
Definition of Short Run Production Function
The short run production function is one in which at least is one factor of
production is thought to be fixed in supply, i.e. it cannot be increased or
decreased, and the rest of the factors are variable in nature.
In general, the firm’s capital inputs are assumed as fixed, and the production
level can be changed by changing the quantity of other inputs such as labour,
raw material, capital and so on. Therefore, it is quite difficult for the firm to

change the capital equipment, to increase the output produced, among all
factors of production.
In such circumstances, the law of variable proportion or laws of returns to
variable input operates, which states the consequences when extra units of a
variable input are combined with a fixed input. In short run, increasing
returns are due to the indivisibility of factors and specialisation, whereas
diminishing returns is due to the perfect elasticity of substitution of factors.
Definition of Long Run Production Function
Long run production function refers to that time period in which all the inputs
of the firm are variable. It can operate at various activity levels because the
firm can change and adjust all the factors of production and level of output
produced according to the business environment. So, the firm has the
flexibility of switching between two scales.
In such a condition, the law of returns to scale operates which discusses, in
what way, the output varies with the change in production level, i.e. the
relationship between the activity level and the quantities of output. The
increasing returns to scale is due to the economies of scale and decreasing
returns to scale is due to the diseconomies of scale.
Key Differences Between Short Run and Long Run
Production Function
The difference between short run and long run production function can be
drawn clearly as follows:
1. The short run production function can be understood as the time period
over which the firm is not able to change the quantities of all inputs.
Conversely, long run production function indicates the time period, over
which the firm can change the quantities of all the inputs.
2. While in short run production function, the law of variable proportion
operates, in the long-run production function, the law of returns to scale
operates.
3. The activity level does not change in the short run production function,
whereas the firm can expand or reduce the activity levels in the long run
production function.
4. In short run production function the factor ratio changes because one
input varies while the remaining are fixed in nature. As opposed, the
factor proportion remains same in the long run production function, as
all factor inputs vary in the same proportion.

5. In short run, there are barriers to the entry of firms, as well as the firms
can shut down but cannot exit. On the contrary, firms are free to enter
and exit in the long run.
Conclusion
To sum up, the production function is nothing but a mathematical
presentation of technological input-output relationship.
For any production function, short run simply means a shorter time period
than the long run. So, for different processes, the definition of the long run
and short run varies, and so one cannot indicate the two time periods in days,
months or years. These can only be understood by looking whether all the
inputs are variable or not.
4. Explain short run cost and long run cost function? Explain the
economies and diseconomies of scale?
Long run and short run cost functions
In the long run, the firm can vary all its inputs. In the short run, some of these
inputs are fixed. Since the firm is constrained in the short run, and not
constrained in the long run, the long run cost TC(y) of producing any given
output y is no greater than the short run cost STC(y) of producing that output:
TC(y) STC(y) for all y.
Now consider the case in which in the short run exactly one of the firm's inputs is
fixed. For concreteness, suppose that the firm uses two inputs, and the amount of
input 2 is fixed at k. For many (but not all) production functions, there
is some level of output, say y0, such that the firm would choose to use k units of
input 2 to produce y0, even if it were free to choose any amount it wanted. In such a
case, for this level of output the short run total cost when the firm is constrained to
use k units of input 2 is equal to the long run total cost: STCk(y0) = TC(y0). We
generally assume that for any level at which input 2 is fixed, there is some level of
output for which that amount of input 2 is appropriate, so that for any value of k,
TC(y) = STCk(y) for some y.

(There are production functions for which this relation is not true, however: see
the example of a production function in which the inputs are perfect substitutes.)
For a total cost function with the typical shape, the following figure shows the
relations between STC and TC.
4. Explain the different methods of pricing with Example?
Cost-plus Pricing: Refers to the simplest method of determining the price of a product.
In cost-plus pricing method, a fixed percentage, also called mark-up percentage, of the
total cost (as a profit) is added to the total cost to set the price. ... It adds Rs. 50 per unit
to the price of product as' profit.
An organization has various options for selecting a pricing method.
Prices are based on three dimensions that are cost, demand, and
competition.
The organization can use any of the dimensions or combination of
dimensions to set the price of a product.
1. COST-BASED PRICING
2. Under this category, only one approach has been taken into consideration i.e. Mark-up
pricing / Cost plus pricing.
3. Mark-up Pricing refers to the pricing method in which the selling price of the product is
fixed by adding a margin to the cost price. The mark-ups vary depending on the nature of
products & markets. Usually, the higher the value of the product (unit cost of the product)
the larger the mark-up & vice-versa. Again, the faster the turn round of the product, the
smaller the mark-up vice-versa.
2. DIFFERENTIAL PRICING
Some firms charge different prices for the same product in different zones / areas of the market.
Sometimes, the differentiation in pricing is made on the basis of customer class rather than
marketing territory. Sometimes, the differentiation is on the basis of volume of purchase.
Differentiation on the basis of volume is more common than differentiation based on customer
class in marketing territory

4. Discuss the role of Fiscal policy and monetary policy in an
developing economy?
Role of Monetary Policy in a Developing the Economy of a
Country!
In modern times, any newly-developing country may be concerned
with the problem of how to use the monetary policy successfully to
stimulate economic growth. In an under-developed country, the
monetary policy has to play a vital role in developing the economy
from a stage of primary backwardness to a stage of self-sustained
growth
It should be noted, however, that the monetary policies and
measures of developed countries are not always readily applicable
as solutions to the typical problems facing newly developing
countries. Monetary policy which is one thing in an advanced
economy may be quite another in an underdeveloped economy.
Thus, similar course of action cannot be appropriated to both types
of countries.

Naturally, the economic ends and means and conditions of
developed and developing nations are bound to be different, and
hence the role of monetary policy should also vary in both cases.
Advanced countries of today can afford the luxury of debating
whether full employment should take precedence over price
stability or whether the aim should be to achieve internal or
external balance at the expense of growth. However, poor countries
cannot at any time think of anything but the policy of promoting
rapid economic growth.
Under the growth-oriented monetary policy, monetary management
by the central bank becomes a strategic factor of development in an
underdeveloped country, on the following counts:
1. When the country aspires for rapid economic development, it
adopts economic planning. In the process, financial planning needs
the support of credit planning and appropriate monetary
management.
2. Underdeveloped countries are most susceptible to inflation.
Inflation in an under-developed economy generally occurs when
there is an abnormal increase in the effective demand exerted
mainly by huge government expenditures under the planning
process. However, the maintenance of stability in the domestic price
level and a fixed, realistic exchange rate are very essential
preconditions for achieving a maximum rate of sustained economic
growth. This needs equilibrium of savings and investment.
In an underdeveloped country, however, since the rate of savings is
very low, government is usually tempted to raise the level of

investment by means of credit expansion and deficit financing.
Development efforts of this nature are generally confronted by
inflationary price increases. To some economists, this (inflation) is
an inevitable price to be paid for economic growth.
However, a heated controversy exists as to whether any relationship
exists between price rise (inflation) and economic growth.
Nevertheless, it is widely agreed that the policy of development
through inflation in under-developed countries can be successful
and meaningful only if inflation is effectively controlled. Thus,
monetary policy requires special attention in a country which seeks
to bring about rapid economic growth with controlled inflation.
3. Above all, the growth objective of monetary policy in
underdeveloped countries implies the promotional role of monetary
authorities. Briefly, the promotional role of the monetary authority
in an under developed country may be to improve the efficiency of
the banking system as a whole or extend sound credit where needed
and to respond promptly to changing conditions.
In short, it is an important task of monetary authority to improve
the conditions of the unorganised money and capital markets in
poor countries in the interest of rapid economic development and
the successful working of monetary management.
In short, monetary policy of a developing nation has an important
role in the creation, working and expansion of financial institutions.
4. Thus, it is an important task of the monetary authority to
improve the conditions of unorganised money and capital markets

in poor countries in the interest of rapid economic development and
the successful working of monetary management.
5. Moreover, an important function of monetary policy in an
underdeveloped economy is to have and also to make use of a most
suitable interest rate structure.
6. Public debt management responsibility also lies with the
monetary authority of the country. In a growing economy, thus, it is
a very important and difficult task.
7. Underdeveloped countries are characterised with 20-30 per cent
of non-monetised sector. Hence, it is the prime duty of the
monetary authority to extend the process of monetisation in these
barter sections of the economy. This will tend to improve the
working and effectiveness of the monetary policy.
Scope of Monetary Policy in Underdeveloped Countries:
The scope of monetary policy in under developed countries is
extremely limited, compared to that in advanced countries for the
following reasons:
1. The money market is unorganised in an under developed country,
and, therefore, the monetary management of the central bank
cannot be perfect.
2. In most of the underdeveloped nations, money supply primarily
consists of currency in circulation while bank deposits form
relatively a small proportion of it. Lack of banking habits on the part
of the people in poor countries makes it difficult for the monetary

authority to influence the economy by controlling the banking
system.
3. Changes in bank rate or other monetary instruments are proved
to be ineffective in underdeveloped countries also on account of the
existence of a vast non-monetised sector in their economies.
The above stated factors impose a limit on the scope of monetary
policy in underdeveloped countries. However, this does not mean
that monetary policy has no role to play at all. Despite its various
limitations, the monetary policy in an underdeveloped country can
greatly assist economic growth “by influencing the supply and use of
credit, combating inflation and maintaining the balance of
payments equilibrium. It has also been argued that since the bulk of
money supply in an underdeveloped economy is in the form of
currency rather than bank deposits, the central bank can regulate
with greater efficiency the rate of spending by controlling the
currency as such.
Monetary policy and management have an active role to play in a
scheme of planning for economic development in an
underdeveloped country. It would have to take on a direct and
active role firstly, in increasing or helping to create the machinery
needed for financing development activities all over the country,
and secondly, in ensuring that the finance available flows in the
direction intended. Briefly, thus, the monetary policy in an
underdeveloped economy has to be used to activise the growth
process and to create favourable conditions for fostering economic
development with reasonable stability

4. Explain the pricing approaches in the following cases:
a) Manufactures and retailers
b) When products are exportable
c) Perishable and durable goods
d) The price of products have to attract consumers attention .  Price is the quantity of
payment or compensation given by one party to another in return for goods or
services. Consumers feel comfortable purchasing the products.
e) 3. what is pricing? Pricing is the process whereby a business sets the price at which
it will sell its products and services and may be part of the business’s marketing plan.
f) 4. A business can use a variety of pricing strategies when selling a product or
service. The price can be set to maximize profitability for each unit sold or from the
market overall. It can be used to defend an existing market from new entrants, to
increase market share within a market or to enter a new market.
g) 5.  Survival  Profit  ROI  Market share  Product quality
h) 6.  Skimming Pricing  Premium Pricing  Discount Pricing  Penetration Pricing 
Psychological Pricing
i) 7. Price skimming or creaming: ”Goods are sold at higher prices commonly used in
electronic markets.” Find the optimum price point for a product, usually a unique item
with unknown consumer demand. To maximize the potential price layer by layer until
the optimum price is reach. Example: Electronic devices.
j) 8. Premium Pricing: Premium pricing (also called image pricing or prestige pricing) is
the practice of keeping the price of a product or service artificially high in order to
encourage favorable perceptions among buyers, based solely on the price.
k) 9. Discounting pricing: Offers a reduction from the regular or list price of a product.
Businesses use discount pricing to sell low-priced products in high quantities. With
this strategy, it is important to cut costs and stay competitive.
l) 10. Penetration Pricing: set products prices low for a specific time period to gain
market share early for company. Setting a low price for a new product in order to
attract a large no. of buyers and a large market shares. Example:
m) 11. Psychological pricing: Companies offer new products at lowest price but
consumers may buy additional items relating to the product. Also called “ Noticeable
Price Difference.”
n) 12. Distribution channels are also known as marketing channels or marketing
distribution channels or trade channel. A channel of distribution is the route or path
along which products flow from the point of production to the point of ultimate
consumption or use. It starts with producer and ends with the consumer. In between
there may be several intermediaries or middlemen who operate to facilitate the flow
of the physical product to the consumer.
o) 13. A channel of distribution shows three types of flow: a) Products flow downwards
from the producer to the consumers. b) Cash flows upwards from customers to the
producer as payment for products. c) Marketing information flows in both directions.
p) 14. IMPORTANCE •Important element of marketing mix. •Influences sales volume
and profits. •Determines where and when the product will be available to users.
•Helps in reducing the effects of fluctuations in production.
q) 15. TYPES: 1. Manufacturer-Consumer(Direct Selling): • Shortest and simplest
channel • No middleman between the producer and consumer • Very fast and
economical • Expert services of middlemen are not available • Large investment is
required • Producers sell directly to cu
Souparnika.suresh@icicibank.com

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