MB00426Q. What is a business cycle? Describe the different phases of a business cycle. Business Cycle:The term business cy...
MB0042all most all economies. Now, there is all round stability in output, wages, prices, income, etc. According to Prof.H...
MB0042polar case of infinitely elastic supply. Between these extremes, we call elastic or inelastic depending upon whether...
MB0042output and sales. We may show total revenue as a function of the total quantity sold at a given price as below. TR =...
MB0042the output offered for sale. When the total revenue increases in direct proportion to the sale of output, the AR wou...
MB0042The relationship between AR and MR curves is determined by the elasticity of demand on theaverage revenue curve.Unde...
MB0042Several firms can operate in one industry to ensure that there is always competition to keep prices reasonable andst...
MB0042 An industry is in equilibrium, first when there is no propensity for the firms either to leave or either the indust...
MB0042          Short Run Equilibrium of the IndustryAn industry is in equilibrium in the short run when its total output ...
MB0042instrument allowing the authorities to move quickly to achieve stabilization, apart from its importance in realizing...
MB0042Similar will be the effects when the decrease in demand is greater than the decrease in supply on the marketequilibr...
MB0042b. Substitute approachIf the new product developed serves as substitute for the existing product, the demand for the...
MB0042In the table at Rs.20 the quantity demanded is equal to the quantity supplied. Since the price is agreeable to both ...
MB0042For any given value of L, (2a) gives us a corresponding value for K. Graphing these values, with K on the verticalax...
MB0042parties are associated with pricing of a product. They are rival competitors, potential rivals, middlemen, wholesale...
MB0042One of the objectives of the pricing policy is to face the competitive situations in the market. In many cases, this...
MB0042There are many reasons why the pace of technological innovations varies. Major innovations do not occur everyday. No...
MB0042the bottom of a cycle need to be adopted as much as ones that work at the top of a cycle. While there will be nodefi...
Upcoming SlideShare
Loading in …5



Published on

Published in: Business, Economy & Finance
1 Comment
1 Like
No Downloads
Total views
On SlideShare
From Embeds
Number of Embeds
Embeds 0
No embeds

No notes for slide


  1. 1. MB00426Q. What is a business cycle? Describe the different phases of a business cycle. Business Cycle:The term business cycle refers to a wave like fluctuation in the overall level of economic activity particularly innational output, income, employment and prices that occur in a more or less regular time sequence. It is nothing butrhythmic fluctuations in the aggregate level of economic activity of a nation.Different writers have defined business cycles in different ways.According to Prof. Haberler: The business cycle in the general sense may be defined as an alternation of periodsof prosperity and depression of good and bad trade.In the words of Prof. Gordon: Business cycles consists of recurring alternations of expansion and contraction inaggregate economic activity, the alternating movements in each direction being self- reinforcing and pervadingvirtually all parts of the economy.According to Keynes: A trade cycle is composed of periods of good trade characterized by rising prices and lowunemployment percentages, alternating with periods of bad trade characterized by falling prices and highunemployment percentages.Thus, one can notice a common feature in all these definitions, i.e., variations in the aggregate level of economicactivities in different magnitudes. Phases of a Business Cycle:A Business Cycle has Five Phases. They are as follows:1. Depression, contraction or downswingIt is the first phase of a trade cycle. It is a protracted period in which business activity is far below the normal leveland is extremely low. According to Prof. Haberler depression is a ―state of affairs in which the real incomeconsumed or volume of production per head and the rate of employment are falling and are sub-normal in the sensethat there are idle resources and unused capacity, especially unused labor‖.During depression, all construction activities come to a more or less halting stage. Capital goods industries suffermore than consumer goods industries. Since costs are ―sticky‖ and do not fall as rapidly as prices, the producerssuffer heavy losses. Prices of agricultural goods fall rapidly than industrial goods. During this period purchasingpower of money is very high but the general purchasing power of the community is very low. Thus, the aggregatelevel of economic activity reaches its rock bottom position. It is the stage of trough. The economy enters the phaseof depression, as the process of depression is complete. It is also called, the period of slump.During this period, there is disorder, demoralization, dislocation and disturbances in the normal working of theeconomic system. Consequently, one can notice all-round pessimism, frustration and despair. The entire atmosphereis gloomy and hopes are less. It is a period of great suffering and hardship to the people. Thus, it is the worst andmost fearful phase of the business cycle.2. Recovery or revivalDepression cannot last long, forever. After a period of depression, recovery starts. It is a period where in, economicactivities receive stimulus and recover from the shocks. This is the lower turning point from depression to revivaltowards upswing. Depression carries with itself the seeds of its own recovery. After sometime, the rays of hopeappear on the business horizon. Pessimism is slowly replaced by optimism. Recovery helps to restore the confidenceof the business people and create a favorable climate for business ventures.As a result of these factors, business people take more risks and invest more. Low wages and low interest rates, lowproduction costs, recovery in marginal efficiency of capital etc induce the business people to take up new ventures.In the early phase of the revival, there is considerable excess capacity in the economy so, the output increaseswithout a proportionate increase in total costs. Repairs, renewals and replacement of plants take place. Increase ingovernment expenditure stimulates the demand for consumption goods, which in its turn pushes up the demand forcapital goods. Construction activity receives an impetus. As a result, the level of output, income, employment,wages, prices, profits, start rising. Rise in dividends induce the producers to float fresh investment proposals in thestock market. Recovery in stock market begins. Share prices go up. Optimistic expectations generate a favorableclimate for new investment. Attracted by the profits, banks lend more money leading to a high level of investment.The upward trends in business give a sort of fillip to economic activity. Through multiplier and acceleration effects,the economy moves upward rapidly. It is to be noted that revival may be slow or fast, weak or strong; the wave ofrecovery once initiated begins to feed upon itself. Generally, the process of recovery once started takes the economyto the peak of prosperity.3. Prosperity or Full-employmentThe recovery once started gathers momentum. The cumulative process of recovery continues till the economyreaches full employment. Full employment may be defined as a situation where in all available resources are fullyemployed at the current wage rate. Hence, achieving full employment has become the most important objective of
  2. 2. MB0042all most all economies. Now, there is all round stability in output, wages, prices, income, etc. According to Prof.Haberler ―Prosperity is a state of affair in which the real income consumed, produced and the level of employmentare high or rising and there are no idle resources or unemployed workers or very few of either.‖4. Boom or Over full Employment or InflationThe prosperity phase does not stop at full employment. It gives way to the emergence of a boom. It is a phase wherein there will be an artificial and temporary prosperity in an economy. Business optimism stimulates furtherinvestment leading to rapid expansion in all spheres of business activities during the stage of full employment,unutilized capacity gradually disappears. Idle resources are fully employed. Hence, rise in investment can only meanincreased pressure for the available men and materials. Factor inputs become scarce commanding higherremuneration. This leads to a rise in wages and prices. Production costs go up. Consequently, higher output isobtained only at a higher cost of production.Once full employment is reached, a further increase in the demand for factor inputs will lead to an increase in pricesrather than an increase in output and income. Demand for Loanable funds increases leading to a rise in interest rates.Now there will be hectic economic activity. Soon a situation develops in which the number of jobs exceed thenumber of workers available in the market. Such a situation is known as overfull employment or hyper-employment.The boom carries with it the gems of its own destruction. The prosperity phase comes to an end when the forcesfavoring expansion becomes progressively weak. Bottlenecks begin to appear. Scarcity of factor inputs and rise intheir prices disturb the cost calculations of the entrepreneurs. Now the entrepreneurs realize that they have overstepped the mark and become over cautious and their over-optimism paves the way for their pessimism. Thus,prosperity digs its own grave. Generally the failure of a company or a bank bursts the boom and ushers in arecession.5. Recession – A turn from prosperity to DepressionThe period of recession begins when the phase of prosperity ends. It is a period of time where in the aggregate levelof economic activity starts declining. There is contraction or slowing down of business activities. After reaching thepeak point, demand for goods decline. Over investment and production creates imbalance between supply anddemand. Inventories of finished goods pile up. Future investment plans are given up. Orders placed for newequipments and raw materials and other inputs are cancelled. Replacement of worn out capital is postponed. Thecancellation of orders for the inputs by the producers of consumer goods creates a chain reaction in the input market.Incomes of the factor inputs decline this creates demand recession. In order to get rid of their high inventories, andto clear off their bank obligations, producers reduce market prices. In anticipation of further fall in prices, consumerspostpone their purchases. Production schedules by firms are curtailed and workers are laid-off. Banks curtail credit.Share prices decline and there will be slackness in stock and financial market. Consequently, there will be a declinein investment, employment, income and consumption. Liquidity preference suddenly develops. Multiplier andaccelerator work in the reverse direction. Unemployment sets in the capital goods industries and with the passage oftime, it spreads to other industries also. The process of recession is complete. The wave of pessimism getstransmitted to other sectors of the economy. The whole economic system thereby runs in to a crisis.Failure of some business creates panic among businessmen and their confidence is shaken. Business pessimismduring this period is characterized by a feeling of hesitation, nervousness, doubt and fear. Prof. M. W. Lee remarks,―A recession, once started, tends to build upon itself much as forest fire. Once under way, it tends to create its owndrafts and find internal impetus to its destructive ability‖. Once the recession starts, it becomes almost difficult tostop the rot. It goes on gathering momentum and finally converts itself in to a full- fledged depression, which is theperiod of utmost suffering for businessmen. Thus, now we have a full description about a business cycle.A detailed study of the various phases of a business cycle is of paramount importance to the management. It helpsthe management to formulate various anti-cyclical measures to be taken up to check the adverse effects of a tradecycle and create the necessary conditions for ensuring stability in business.Q3. A firm supplied 3000 pens at the rate of Rs 10. Next month, due to a rise of in the price to 22 Rs. per penthe supply of the firm increases to 5000 pens. Find the elasticity of supply of the pens.Of course, consumption is not the only thing that changes when prices go up or down. Businesses also respond toprice in their decisions about how much to produce. Economists define the price elasticity of supply as theresponsiveness of the quantity supplied of a good to its market price. More precisely, the price elasticity of supply isthe percentage change in quantity supplied divided by the percentage change in price.Suppose the amount suppliedis completely fixed, as in the case of perishable pen brought to market 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. At theother extreme, say that a tiny cut in price will cause the amount supplied to fall to zero, while the slightest rise inprice will coax out an indefinitely large supply. Here, the ratio of the percentage change in quantity suppliedpercentage change in price is extremely large and gives rise to a horizontal supply curve. This is because the
  3. 3. MB0042polar case of infinitely elastic supply. Between these extremes, we call elastic or inelastic depending upon whetherthe percentage change in quantity is larger or smaller than the percentage change in price. Price elasticity of demandis a ratio of two pure numbers, the numerator is the percentage change in the quantity demanded and thedenominator is the percentage change in price of the commodity. It is measured by the following formula:Ep = Percentage change in quantity demanded/ Percentage changed in price Applying the provided data in theequation: Percentage change in quantity demanded = (5000 – 3000)/3000Percentage changed in price=(22 – 10) /10 Ep = ((5000 – 3000)/3000) / ((22 – 10)/10)= 1.2. Q2. Give a brief description of:a. Implicit and explicit cost b. Actual and opportunity costa. Implicit and explicit costImplicit cost:In economics, an implicit cost, also called an imputed cost, implied cost, or notional cost, isthe opportunity cost equal to what a firm must give up in order using factors which it neither purchases nor hires. Itis the opposite of an explicit cost, which is borne directly. In other words, an implicit cost is any cost that resultsfrom using an asset instead of renting, selling, or lending it. The term also applies to forgone income from choosingnot to work.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 explicitcosts). Since economic profit includes these extra opportunity costs, it will always be less than or equal toaccounting profitExplicit cost: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 stillto underestimate these costs, however: for example, pension contributions and other "perks" must be taken intoaccount when considering the cost of labour.Explicit costs are taken into account along with implicit ones whenconsidering economic profit. Accounting profit only takes explicit costs into account.b. Actual and opportunity costActual cost:An actual amount paid or incurred, as opposed to estimated cost or standard cost. In contracting, actualcosts amount includes direct labor, direct material, and other direct charges.Cost accounting information isdesigned for managers. Since managers are taking decisions only for their own organization, there is no need forthe information to be comparable to similar information from other organizations. Instead, the important criterion isthat the information must be relevant for decisions that managers operating in a particular environmentof business including strategy make. Cost accounting information is commonly used in financialaccounting information, but first we are concentrating in its use by managers to take decisions. The accountants whohandle the cost accounting information generate add value by providing good information to managers who aretaking decisions. Among the better decisions, the better performance of ones organization, regardless if it is amanufacturing company, a bank, a non-profit organization, a government agency, a school club or even a businessschool. The cost-accounting system is the result of decisions made by managers of an organization and theenvironment in which they make them.Opportunity cost:Opportunity cost is the cost of any activity measured in terms of the value of the next bestalternative forgone (that is not chosen). It is the sacrifice related to the second best choice available to someone, orgroup, who has picked among several mutually exclusive choices. The opportunity cost is also the cost of theforgone products after making a choice. Opportunity cost is a key concept in economics, and has been described asexpressing "the basic relationship between scarcity and choice". The notion of opportunity cost plays a crucial partin ensuring that scarce resources are used efficiently. Thus, opportunity costs are not restricted to monetary orfinancial costs: the real cost of output forgone, lost time, pleasure or any other benefit that provides utility shouldalso be considered opportunity costs.Opportunity costs in production: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 theopportunity cost of producing one pound of wheat is the two pounds of barley forgone (assuming the productionpossibilities frontier is linear). Firms would make rational decisions by weighing the sacrifices involved.Q5. Explain in brief the relationship between TR, AR, and MR under different market condition.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 from the sale of its totaloutput produced over a given period of time. In brief, it refers to the total sales proceeds. It will vary with the firm‘s
  4. 4. MB0042output and sales. We may show total revenue as a function 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 is calculated by multiplyingthe quantity sold by its price. Thus, TR = PXQ. For e.g. a firm sells 5000 units of a commodity at the rate of Rs. 5per unit, then TR would be2. Average revenue (AR)Average revenue is the revenue per unit of the commodity sold. It can be obtained by dividing the TR by thenumber of units sold. Then, AR = TR/Q AR = 150/15= 10.When different units of a commodity are sold at the same price, in the market, average revenue equals price at whichthe commodity is sold for e.g. 2 units are sold at the rate of Rs.10 per unit, then total revenue would be Rs. 20(2×10). Thus AR = TR/Q 20/2 = 10. Thus average revenue means price. Since the demand curve shows therelationship between price and 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 the revenue from seller‘s pointof view. Therefore, average revenue curve of the firm is the same as demand curve of the consumer.Therefore, in economics we use AR and price as synonymous except in the context of price discrimination by theseller. Mathematically P = AR.3. Marginal Revenue (MR)Marginal revenue is the net increase in total revenue realized from selling one more unit of a product. It is theadditional revenue earned by selling an additional unit of output by the seller.MR differs from the price of the product because it takes into account the effect of changes in price. For example if afirm can sell 10 units at Rs.20 each or 11 units at Rs.19 each, then the marginal revenue from the eleventh unit is (10× 20) - (11 × 19) = Rs.9.Relationship between Total revenue, Average revenue and Marginal Revenue conceptsIn order to understandthe relationship between TR, AR and MR, we can prepare a hypothetical revenue schedule.From the table, it is clear that:MR falls as more units are sold.TR increases as more units are sold but at a diminishing rate.TR is the highest when MR is zeroTR falls when MR become negativeAR and MR both falls, but fall in MR is greater than AR i.e., MR falls more steeply than AR.Relationship between AR and MR and the nature of AR and MR curves under difference market conditions1. under Perfect Market:Under perfect competition, an individual firm by its own action cannot influence themarket price. The market price is determined by the interaction between demand and supply forces. A firm can sellany amount of goods at the existing market prices. Hence, the TR of the firm would increase proportionately with
  5. 5. MB0042the output offered for sale. When the total revenue increases in direct proportion to the sale of output, the AR wouldremain constant. Since the market price of it is constant without any variation due to changes in the units sold by theindividual firm, the extra output would fetch proportionate increase in the revenue. Hence, MR & AR will be equalto each other and remain constant. This will be equal to priceUnder perfect market condition, the AR curve will be a horizontal straight line and parallel to OX axis. This isbecause a firm has to sell its product at the constant existing market price. The MR cure also coincides with the ARcurve. This is because additional units are sold at the same constant price in the market.2. under Imperfect Market:Under all forms of imperfect markets, the relation between TR, AR, and MR isdifferent. This can 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.
  6. 6. MB0042The relationship between AR and MR curves is determined by the elasticity of demand on theaverage revenue curve.Under imperfect market, the AR curve of an individual firm slope downwards from left to right. Thisis because; a firm can sell larger quantities only when it reduces the price. Hence, AR curve has a negativeslope.The MR curve is similar to that of the AR curve. But MR is less than AR. AR and MR curves are different.Generally MR curve lies below the AR curve.The AR curve of the firm or the seller and the demand curve of the buyer is the sameSince, the demand curve represents graphically the quantities demanded by the buyers at various prices it shows theAR at which the various amounts of the goods that are sold by the seller. This is because the price paid by the buyeris the revenue for the seller (One man‘s expenditure is another man‘s income). Hence, the AR curve of the firm isthe same thing as that 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 of Rs.5 per unit. Hence, histotal income is 10 x 5 = Rs.50/-. Thus, it is clear that AR curve and demand curve is really one and the same.Q1. Distinguish between a firm and an industry. Explain the equilibrium of a firm and industry under perfectcompetition. Distinguish between a firm and an industryAn industry is the name given to a certain type of manufacturing or retailing environment. For example, the retailindustry is the industry that involves everything from clothes to computers, anything in the shops that get sold to thepublic. The retail industry is very vast and has many sub divisions, such as electrical and cosmetics. Morespecialized industries deal with a specific thing. The steel industry is a more specialized industry, dealing with themaking of steel and selling it on to buyers.The difference between this and a firm is that a firm is the company that operates within the industry to create theproduct. The firm might be a factory, or the chain of stores that sells the clothes, within its industry. For example,one firm that makes steel might be Aveda steel. They create the steel in that firm for the steel industry. A firm isusually a corporate company that controls a number of chains in the industry it is operating within.For example in retail, the firm Arcadia stores own the clothing chains Top shop, Dorothy Perkins, Miss Selfridge,and Evans. These all operate for the firm Arcadia within the industry of retail.
  7. 7. MB0042Several firms can operate in one industry to ensure that there is always competition to keep prices reasonable andstop the market becoming a monopoly, which is where one firm is in charge of the whole industry. Sometimes, afirm is not necessary within the industry and independent chains and retailers can enter straight into the marketwithout a firm behind them, although this is risky. This is because one of the advantages of having a firm behind youis that it is a safeguard against possible bankruptcy because the firm can support the chain that it owns.The equilibrium of a firm and industry under perfect competitionAccording to Miller, ―Firm is an organization that buys and hires resources and sells goods and services‖. Lipseyhas defined as ―firm is the unit that employs factors of production to produce commodities that it sells to other firms,to households, or to the government. Industry is a group of firms producing standardized products in a market.According to Lipsey, ―Industry is a group of firms that sells a well defined product or closely related set ofproducts.‖Conditions of Equilibrium of the Firm and IndustryA firm is in equilibrium when it has no propensity to modify its level of productivity. It requires neither extensionnor retrenchment. It wants to earn maximum profits in by equating its marginal cost with its marginal revenue, i.e.MC = MR. Diagrammatically, the conditions of equilibrium of the firm are(1) the MC curve must equal the MR curve.This is the first order and essential condition. But this is not a sufficient condition which may be fulfilled yet thefirm may not be in equilibrium.(2) The MC curve must cut the MR curve from below and after the point of equilibrium it must be above the MR.This is the second order condition. Under conditions of perfect competition, the MR curve of a firm overlaps withthe AR curve. The MR curve is parallel to the X axis. Hence the firm is in equilibrium when MC = MR = AR.The first order figure (1), the MC curve cuts the MR curve first at point X. It contends the condition of MC = MR,but it is not a point of maximum profits for the reason that after point X, the MC curve is beneath the MR curve. Itdoes not pay the firm to produce the minimum output OM when it can earn huge profits by producing beyond OM.Point Y is of maximum profits where both the situations are fulfilled.Amidst points X and Y it pays the firm to enlarges its productivity for the reason that it‘s MR > MC. It willnevertheless stop additional production when it reaches the OM1 level of productivity where the firm fulfils both thecircumstances of equilibrium. If it has any plants to produce more than OM1 it will be incurring losses, for itsmarginal cost exceeds its marginal revenue beyond the equilibrium point Y. The same finale hold good in the caseof straight line MC curve and it is presented in the figure.
  8. 8. MB0042 An industry is in equilibrium, first when there is no propensity for the firms either to leave or either the industry andnext, when each firm is also in equilibrium. The first clause entails that the average cost curves overlap with theaverage revenue curves of all the firms in the industry.They are earning only normal profits, which are believed to be incorporated in the average cost curves of the firms.The second condition entails the equality of MC and MR. Under a perfectly competitive industry these twocircumstances must be fulfilled at the point of equilibrium i.e. MC = MR….(1), AC = AR…. (2), AR = MR.Hence MC = AC = AR. Such a position represents full equilibrium of the industry.Short Run Equilibrium of the Firm and IndustryShort Run Equilibrium of the FirmA firm is in equilibrium in the short run when it has no propensity to enlarge or contract its productivity and needs toearn maximum profit or to incur minimum losses.The short run is an epoch of time in which the firm can vary its productivity by changing the erratic factors ofproduction. The number of firms in the industry is fixed since neither the existing firms can leave nor new firms canenter it.Postulations All firms use standardised factors of production Firms are of diverse competence Cost curves of firms are dissimilar from each other All firms sell their produces at the equal price ascertained by demand and supply of the industry so that the price of each firm, P (Price) = AR = MR Firms produce and sell various volumes The short run equilibrium of the firm can be described with the helps of marginal study and total cost revenue study.Marginal Cost, Marginal Revenue analysis – During the short run, a firm will produce only its price equals averagevariable cost or is higher than the average variable cost (AVC). Furthermore, if the price is more than the averagestotal costs, ATC, i.e. P = AR > ATC the firm will be earning super normal profits. If price equals the average totalcosts, i.e. P = AR = ATC the firm will be earning normal profits or break even.If price equals AVC, the firm will be incurring losses. If price drops even a little below AVC, the firm will shutdown since in order to produce it must cover atleast it‘s AVC through short run. So during the short run, underperfect competition, affirm is in equilibrium in all the above mentioned stipulations.Super normal profits – The firm will be earning super normal profits in the short run when price is higher than theshort run average cost.Normal Profits = The firm may earn normal profits when price equals the short run average costs.Total Cost – Total Revenue Analysis – The short run equilibrium of the firm can also be represented with the help oftotal cost and total revenue curves. The firm is able to maximise its profits when the positive discrimination betweenTR and TC is the greatest.
  9. 9. MB0042 Short Run Equilibrium of the IndustryAn industry is in equilibrium in the short run when its total output remains steady there being no propensity toenlarge or contract its productivity. If all firms are in equilibrium the industry is also in equilibrium. For fullequilibrium of the industry in the short run all firms must be earning normal profits.But full equilibrium of the industry is by sheer accident for the reason that in the short rum some firms may beearning super normal profits and some losses. Even then the industry is in short run equilibrium when its quantitydemanded and quantity supplied is equal at the price which clears the market.Online Live Tutor Conditions of Equilibrium of the Firm and Industry: We have the best tutors in Economics in the industry. Our tutors can break down a complex Conditions ofEquilibrium of the Firm and Industry problem into its sub parts and explain to you in detail how each step isperformed. This approach of breaking down a problem has been appreciated by majority of our students for learningConditions of Equilibrium of the Firm and Industry concepts. You will get one-to-one personalized attentionthrough our online tutoring which will make learning fun and easy. Our tutors are highly qualified and holdadvanced degrees. Please do send us a request for Conditions of Equilibrium of the Firm and Industry tutoring andexperience the quality yourself.Online Equilibrium of the Firm and Industry Help:If you are stuck with Equilibrium of the Firm and Industry Homework problem and need help, we have excellenttutors who can provide you with Homework Help. Our tutors who provide Equilibrium of the Firm and Industryhelp are highly qualified. Our tutors have many years of industry experience and have had years of experienceproviding Equilibrium of the Firm and Industry Homework Help. Please do send us the Equilibrium of the Firm andIndustry problems on which you need help and we will forward then to our tutors for review.Q4. What is monetary policy?Explain the general objectives and instruments of monetary policy?Monetary PolicyMonetary policy, in its narrow concept, is defined as the measures focused on regulating money supply. In harmonywith monetary policy goals, as will be shown later, and adopting the most common concept of monetary policy asone of the central bank‘s functions, monetary policy is defined as ― the set of procedures and measures taken bymonetary authorities to manage money supply, interest and exchange rates and to influence credit conditions toachieve certain economic objectives‖. We find this definition more consistent with the practical applications ofmonetary policy, particularly with respect to the difference from one country to another in objectives selected as alink between the instruments of monetary policy and its ultimate goals.First: Monetary Policy and General Economic PoliciesMonetary policy is basically a type of stabilization policy adopted by countries to deal with different economicimbalances. Since monetary policy covers the monetary aspect of the general economic policy, a high level of co-ordination is required between monetary policy and other instruments of economic policy. Further, the effectivenessof monetary policy and its relative importance as a tool of economic stabilization various from one economy toanother, due to differences among economic structures, divergence in degrees of development in money and capitalmarkets resulting in differing degree of economic progress, and differences in prevailing economic conditions.However, we may briefly mention 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 are mainly structural andnot monetary in nature, while the limited effectiveness of monetary policy in countries which lack developed moneymarkets occurs because monetary policy is deprived of one of its major tools, the instrument of open marketoperations.Also, there are those who belittle the effectiveness of monetary policy in time of recession, comparing the use of thispolicy in controlling recession as ―pressing on a spring‖. Many others see monetary policy as ineffective incontrolling the inflation that results from an imbalance between the demand and supply of goods and servicesoriginating from the supply side, while they confirm the effectiveness of monetary policy in controlling inflation thatresults from increased demand. However, this does not preclude the effectiveness of monetary policy as a flexible
  10. 10. MB0042instrument allowing the authorities to move quickly to achieve stabilization, apart from its importance in realizingexternal equilibrium in open economies.Monetary Policy InstrumentsThe set of instruments available to monetary authorities may differ from one country to another, according todifferences in political systems, economic structures, statutory and institutional procedures, development of moneyand capital markets and other considerations. In most advanced capitalist countries, monetary authorities use one ormore of the following key 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, supplementary instruments are used,known as instruments of direct supervision or qualitative instruments. Although the developing countries use one ormore of these instruments, taking into consideration the difference in their economic growth levels, the dissimilarityin the patterns of their production structures and the degree of their of their link with the outside world, many resortto the method of qualitative supervision, particularly those countries which face problems arising from the nature oftheir economic structures. Although the effectiveness of monetary policy does not necessarily depend on using awide range of instruments, coordinated use of various instruments is essential to the application of a rationalmonetary policy.SET22Q. Define the term equilibrium. Explain the changes in market equilibrium and effects of shifts in supplyand demand.Meaning of equilibriumThe word equilibrium is derived from the Latin word ―aequilibrium‖ which means equal balance. It means a state ofeven balance in which opposing forces or tendencies neutralize each other. It is a position of rest characterized byabsence of change. It is a state where there is complete agreement of the economic plans of the various marketparticipants so that no one has a tendency to revise or alter his decision. In the words of professor Mehta:―Equilibrium denotes in economics absence of change in movement.‖ Changes in Market Equilibrium:The changes in equilibrium price will occur when there will be shift either in demand curve or in supply curve orboth:Effects of Shift in demand:Demand changes when there is a change in the determinants of demand like the income, tastes, prices of substitutesand complements, size of the population etc. If demand raises due to a change in any one of these conditions thedemand curve shifts upward to the right. If, on the other hand, demand falls, the demand curve shifts downward tothe left. Such rise and fall in demand are referred to as increase and decrease in demand.A change in the market equilibrium caused by the shifts in demand can be explained with the help of a diagram.Effects of Changes in Demand and Supply:Changes can occur in both demand and supply conditions. The effects of such changes on the market equilibriumdepend on the rate of change in the two variables. If the rate of change in demand is matched with the rate of changein supply there will be no change in the market equilibrium, the new equilibrium shows expanded market withincreased quantity of both supply and demand at the same price.This is made clear from the diagram below:
  11. 11. MB0042Similar will be the effects when the decrease in demand is greater than the decrease in supply on the marketequilibrium.Q6. Suppose your manufacturing company planning to release a new product into market, Explain thevarious methods forecasting for a new product.When a manufacturing companies planning to release a new product into themarket, it should perform the demandforecasting to check the demand of the product in the market and also the availability of similar product in themarket.Demand forecasting for new products is quite different from that for established products. Here the firms will nothave any past experience or past data for this purpose. An intensive study of the economic and competitivecharacteristics of the product should be made to make efficient forecasts.As per Professor Joel Dean, few guidelines to make forecasting of demand for new products are:a. Evolutionary approachThe demand for the new product may be considered as an outgrowth of an existing product. For e.g., Demand fornew Tata Indica, which is a modified version of Old Indica can most effectively be projected based on the sales ofthe old Indica, the demand for new Pulsor can be forecasted based on the sales of the old Pulsar. Thus when a newproduct is evolved from the old product, the demand conditions of the old product can be taken as a basis forforecasting the demand for the new product.
  12. 12. MB0042b. Substitute approachIf the new product developed serves as substitute for the existing product, the demand for the new product may beworked out on the basis of a ‗market share‘. The growths of demand for all the products have to be worked outon the basis of intelligent forecasts for independent variables that influence the demand for the substitutes. Afterthat, a portion of the market can be sliced out for the new product. For e.g., A moped as a substitute for a scooter, acell phone as a substitute for a land line. In some cases price plays an important role in shaping future demand forthe product.c. Opinion Poll approachUnder this approach the potential buyers are directly contacted, or through the use of samples of the new productand their responses are found out. These are finally blown up to forecast the demand for the new product.d. Sales experience approachOffer the new product for sale in a sample market; say supermarkets or big bazaars in big cities, which are also bigmarketing centers. The product may be offered for sale through one super market and the estimate of sales obtainedmay be ‗blown up‘ to arrive at estimated demand for the product.e. Growth Curve approachAccording to this, the rate of growth and the ultimate level of demand for the new product are estimated on the basisof the pattern of growth of established products. For e.g., An Automobile Co., while introducing a new version of acar will study the level of demand for the existing car.f. Vicarious approachA firm will survey consumers‘ reactions to a new product indirectly through getting in touch with some specializedand informed dealers who have good knowledge about the market, about the different varieties of the productalready available in the market, the consumers‘ preferences etc. This helps in making a more efficient estimation offuture demand.ORQ2. Define the term equilibrium. Explain the changes in market equilibrium and effects to shifts in supplyand demand.EquilibriumThe word equilibrium is derived from the Latin word a ―equilibrium‖ which means equal balance. It means a state ofeven balance in which opposing forces or tendencies neutralize each other. It is a position of rest characterized byabsence of change. It is a state where there is complete agreement of the economic plans of the various marketparticipants so that no one has a tendency to revise or alter his decision. In the words of professor Mehta:―Equilibrium denotes in economics absence of change in movement‖.Market EquilibriumThere are two approaches to market equilibrium viz., partial equilibrium approach and the general equilibriumapproach. The partial equilibrium approach to pricing explains price determination of a single commodity keepingthe prices of other commodities constant. On the other hand, the general equilibrium approach explains the mutualand simultaneous determination of the prices of all goods and factors. Thus it explains a multi market equilibriumposition. Earlier to Marshall, there was a dispute among economists on whether the force of demand or the force of supply ismore important in determining price. Marshall gave equal importance to both demand and supply in thedetermination of value or price. He compared supply 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 scissors that cuts a piece ofpaper, as whether value is governed by utility or cost of production. Thus neither the upper blade nor the lower bladetaken separately can cut the paper; both have their importance in the process of cutting. Likewise neither supplyalone, nor demand alone can 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 time under consideration. Thus, thedemand of all consumers and the supply of all firms together determine the price of a commodity in the market.Equilibrium between demand and supply price:Equilibrium between demand and supply price is obtained by the interaction of these two forces. Price is anindependent variable. Demand and supply are dependent variables. They depend on price. Demand varies inverselywith price; arise in price causes a fall in demand and a fall in price causes a rise in demand. Thus the demand curvewill have a downward slope 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 in price causes arise insupply and a fall in price causes a fall in supply. Thus the supply curve will have an upward slope. At a point wherethese two curves intersect with each other the equilibrium price is established. At this price quantity demanded isequal to the quantity demanded.This we can explain with the help of a table and a diagram
  13. 13. MB0042In the table at Rs.20 the quantity demanded is equal to the quantity supplied. Since the price is agreeable to both thebuyer and sellers, there will be no tendency for it to change; this is called equilibrium price. Suppose the price fallsto Rs.5 the buyer will demand 30 units while the seller will supply only 5 units. Excess of demand over supplypushes the price upward until 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 to supply 25 units. Sellerscompete with each other to sell more units of the commodity. Excess of supply over demand pushes the pricedownward until it reaches the equilibrium. This process will continue till the equilibrium price of Rs.20 is reached.Thus the interactions of demand and supply forces acting upon each other restore the equilibrium position inthe market. In the diagram DD is the demand curve, SS is the supply curve. Demand and supply are in equilibriumat point E where the two curves intersect each other. OQ is the equilibrium output. OP is the equilibrium price.Suppose the price OP2 is higher than the equilibrium price OP. at this point price quantity demanded isP2D2. ThusD2S2 is the excess supply which the seller wants to push into the market, competition among the sellers will bringdown the price to the equilibrium level where the supply is equal to the demand. At price OP1, the buyers willdemand P1D1 quantity while the sellers are ready to sell P1S1. Demand exceeds supply. Excess demand for goodspushes up the price; this process will go until equilibrium is reached where supply becomes equal to demand.Q5. Explain how a product would reach equilibrium position with the help of ISO - Quants and ISO-Costcurve.When producing a good or service, how do suppliers determine the quantity of factors to hire? Below, we workthrough an example where a representative producer answers this question.Let‘s begin by making some assumptions. First, we shall assume that our producer chooses varying amounts of twofactors, capital (K) and labor (L). Each factor was a price that does not vary with output.That is, the price of each unit of labor (w) and the price of each unit of capital (r) are assumed constant. We‘llfurther assume that w = $10 and r = $50. We can use this information to determine the producer‘s total cost. We callthe total cost equation an iso-cost line (it‘s similar 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 is 1000 units of output. Inorder to produce those 1000 units of output, our producer must get a combination of L and K that makes (2) equal to1000. Implicitly, this means that we must find a particular isoquant.Set (2) equal to 1000 units of output, and solve for K. Doing so, we get the following equation for a specific iso-quant (one of many possible iso-quants):K = 1,000,000/L (2a)
  14. 14. MB0042For any given value of L, (2a) gives us a corresponding value for K. Graphing these values, with K on the verticalaxis and L on the horizontal axis, we obtain the blue line on the graph below. Each point on this curve is representedas a combination of K and L that yields an output level of 1000 units. Therefore, as we move along this iso-quantoutput is constant (much like the fact that utility is constant as A basic understanding of statistics is a criticalcomponent of informed decision making.Q4. Critically examine the Marris growth maximizing model??Profit maximization is traditional objective of a firm. Sales maximization objective is explained by Prof. Boumal.On similar lines, Prof. Marris has developed another alternative growth maximization model in recent years. It is acommon factor to observe that each firm aims at maximizing its growth rate as this goal would answer many of theobjectives of a firm. Marris points out that a firm has to maximize its balanced growth rate over a period of time.Marris assumes that the ownership and control of the firm is in the hands of two groups of people, i.e. owner andmanagers. He further points out that both of them have two distinctive goals. Managers have a utility function inwhich the amount of salary, status, position, power, prestige and security of job etc are the most import variablewhere as in case of are more concerned about the size of output, volume of profits, market shares and salesmaximization.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 the firm according to Marris depends onthe amount of corporate capital which includes total volume of the asset, inventory level, cash reserve etc. He furtherpoints out that the managers always aim at maximizing the rate of growth of the firm rather than growth in absolutesize of the firms. Generally managers like to stay in a grouping firm. Higher growth rate of the firm satisfy thepromotional opportunity of managers and also the share holders as they get more dividends.B o u ma l ’ s S a l e s M a x i m i z a t i o n mo d e l :Sales maximization model is an alternative for profit maximization model. This model is developed by Prof. W.J.Boumal, an American economist. This alternative goal has assumed greater significance in the context of the growthof the oligopolistic firms. The model highlights that the primary objective of the firm is to maximize its sales ratherthan profit maximization. It states that the goal of the firm is maximization of sales revenue subject to a minimumprofit constraint. The minimum profit constraint is determined by the expectation of the share holders. This isbecause no company can displease the shareholders. It is to be noted here that maximization of sales does not meanmaximization of physical sales but maximization of total sales revenue. Hence, the managers are more interested inincreasing sales rather than profit. The basic philosophy is that when sales are maximized automatically profits ofthe company would also go up. Hence, attention is diverted to increase the sales of the company in recent years inthe 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.Q5. Define Pricing Policy. Explain the various objective of pricing policy. Pricing PoliciesA detailed study of the market structure gives us information about the way in which prices are determined underdifferent market conditions. However, in reality, a firm adopts different policies and methods to fix the price of itsproducts.Pricing policy refers to the policy of setting the price of the product or products and services by the managementafter taking into account of various internal and external factors, forces and its own business objectives.Pricing Policy basically depends on price theory that is the corner stone of economic theory. Pricing is considered asone of the basic and central problems of economic theory in a modern economy. Fixing prices are the mostimportant aspect of managerial decision making because market price charged by the company affects the presentand future production plans, pattern of distribution, nature of marketing etc. Generally speaking, in economic theory,we take into account of only two parties, i.e., buyers and sellers while fixing the prices. However, in practice many
  15. 15. MB0042parties are associated with pricing of a product. They are rival competitors, potential rivals, middlemen, wholesalers,retailers, commission agents and above all the Govt. Hence, we should give due consideration to theinfluenceexerted by these parties in 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.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 productII. 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 every business concern is tomaximize its profits. This is possible when the returns exceed costs. In this context, setting an ideal price for aproduct assumes greater importance. Pricing objectives has to be established by top management to ensure not onlythat the company‘s profitability is adequate but also that pricing is complementary to the total strategy of theorganization. While formulating the pricing policy, a firm has to consider various economic, social, political andother 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 to achieve this objectiveshould be formulated in such a way as to maximize the sales revenue and profit. Maximum profit refers to thehighest possible of profit.In the short run, a firm not only should be able to recover its total costs, but also should get excess revenue overcosts. This will build the morale of the firm and instill the spirit of confidence in its operations.2. Profit optimization in the long runThe traditional profit maximization hypothesis may not prove beneficial in the long run. With the sole motive ofprofit making a firm may resort to several kinds of unethical practices like charging exorbitant prices, followMonopoly Trade Practices (MTP), Restrictive Trade Practices (RTP) and Unfair Trade Practices (UTP) etc. Thismay lead to opposition from the people. In order to over- come these evils, a firm instead of profit maximization,and aims at profit 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 a sound pricing policy of afirm in recent years.3. Price StabilizationPrice stabilization over a period of time is another objective. The prices as far as possible should not fluctuate toooften. Price instability creates uncertain atmosphere in business circles. Sales plan becomes difficult under suchcircumstances. Hence, price stability is one of the prerequisite conditions for steady and persistent growth of a firm.A stable price policy only 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 situation
  16. 16. MB0042One of the objectives of the pricing policy is to face the competitive situations in the market. In many cases, thispolicy has been merely influenced by the market share psychology. Wherever companies are aware of specificcompetitive products, they try to match the prices of their products with those of their rivals to expand the volume oftheir business. Most of the firms are not merely interested in meeting competition but are keen to prevent it. Hence,a firm 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 of all firms in the market.The economic strength and success of a firm is measured in terms of its market share. In a competitive world, eachfirm makes a successful attempt to expand its market share. If it is impossible, it has to maintain its existing marketshare. Any decline in market share is a symptom of the poor performance of a firm.Hence, the pricing policy has to assist a firm to maintain its market share at any cost.Q6. Discuss the various measures that may be taken by a firm to counteract the evil effects of a trade cycle. FACTORS THAT SHAPE BUSINESS CYCLESFor centuries, economists in both the United States and Europe regarded economic downturns as "diseases" that hadto be treated; it followed, then, that economies characterized by growth and affluence were regarded as "healthy"economies. By the end of the 19th century, however, many economists had begun to recognize that economies werecyclical by their very 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 cite several factors as particularly important in shaping thecomplexion of business environments.VOLATILITY OF INVESTMENT SPENDINGVariations in investment spending is one of the important factors in business cycles. Investment spending isconsidered the most volatile component of the aggregate or total demand (it varies much more from year to yearthan the largest component of the aggregate demand, the consumption spending), and empirical studies byeconomists have revealed that the volatility of the investment component is an important factor in explainingbusiness cycles in the United States. According to these studies, increases in investment spur a subsequent increasein aggregate demand, leading to economic expansion. Decreases in investment have the opposite effect. Indeed,economists can point to several points in American history in which the importance of investment spending wasmade quite evident. The Great Depression, for instance, was caused by a collapse in investment spending in theaftermath of the stock market crash of 1929. Similarly, prosperity of the late 1950s was attributed to a capital goodsboom.There are several reasons for the volatility that can often be seen in investment spending. One generic reason is thepace at which investment accelerates in response to upward trends in sales. This linkage, which is called theacceleration principle by economists, can be briefly explained as follows. Suppose a firm is operating at fullcapacity. When sales of its goods increase, output will have to be increased by increasing plant capacity throughfurther investment. As a result, changes in sales result in magnified percentage changes in investment expenditures.This accelerates the pace of economic expansion, which generates greater income in the economy, leading to furtherincreases in sales. Thus, once the expansion starts, the pace of investment spending accelerates. In more concreteterms, the response of the investment spending is related to the rate at which sales are increasing. In general, if anincrease in sales is expanding, investment is spending rises, and if an increase in sales has peaked and is beginningto slow, investment spending falls. Thus, the pace of investment spending is influenced by changes in the rate ofsales.MOMENTUMMany economists cite a certain "follow-the-leader" mentality in consumer spending. In situations where consumerconfidence is high and people adopt more free-spending habits, other customers are deemed to be more likely toincrease 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 incommunication, transportation, manufacturing, and other operational areas can have a ripple effect throughout anindustry 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 computer industries, for instance, haveundergone immense technological innovations in recent years, and the latter industry in particular has had apronounced impact on the business operations of countless organizations. However, technological innovations—andconsequent increases in investment—take place at irregular intervals. Fluctuating investments, due to variations inthe pace of technological innovations, lead to business fluctuations in the economy.
  17. 17. MB0042There are many reasons why the pace of technological innovations varies. Major innovations do not occur everyday. Nor do they take place at a constant rate. Chance factors greatly influence the timing of major innovations, aswell as the number of innovations in a particular year. Economists consider the variations in technologicalinnovations as random (with no systematic pattern). Thus, irregularity in the pace of innovations in new products orprocesses becomes a source of business fluctuations.VARIATIONS IN INVENTORIESVariations in inventories—expansion and contraction in the level of inventories of goods kept by businesses—alsocontribute to business cycles. Inventories are the stocks of goods firms keep on hand to meet demand for theirproducts. How do variations in the level of inventories trigger changes in a business cycle? Usually, during abusiness downturn, firms let their inventories decline. As inventories dwindle, businesses ultimately find themselvesshort of inventories. As a result, they start increasing inventory levels by producing output greater than sales, leadingto an economic expansion. This expansion continues as long as the rate of increase in sales holds up and producerscontinue to increase inventories at the preceding rate. However, as the rate of increase in sales slows, firms begin tocut back on their inventory accumulation. The subsequent reduction in inventory investment dampens the economicexpansion, and eventually causes an economic downturn. The process then repeats itself all over again. It should benoted that while variations in inventory levels impact overall rates of economic growth, the resulting business cyclesare not really long. The business cycles generated by fluctuations in inventories are called minor or short businesscycles. These periods, which usually last about two to four years, are sometimes also called inventory cycles.FLUCTUATIONS IN GOVERNMENT SPENDINGVariations in government spending are yet another source of business fluctuations. This may appear to be anunlikely source, as the government is widely considered to be a stabilizing force in the economy rather than a sourceof economic fluctuations or instability. Nevertheless, government spending has been a major destabilizing force onseveral occasions, especially during and after wars. Government spending increased by an enormous amount duringWorld War II, leading to an economic expansion that continued for several years after the war. Governmentspending also increased, though to a smaller extent compared to World War II, during the Korean and Vietnamwars. These also led to economic expansions. However, government spending not only contributes to economicexpansions, but economic contractions as well. In fact, the recession of 1953-54 was caused by the reduction ingovernment spending after the Korean War ended. More recently, the end of the Cold War resulted in a reduction indefense spending by the United States that had a pronounced impact on certain defense-dependent industries andgeographic regions.POLITICALLY GENERATED BUSINESS CYCLESMany economists have hypothesized that business cycles are the result of the politically motivated use ofmacroeconomic policies (monetary and fiscal policies) that are designed to serve the interest of politicians runningfor re-election. The theory of political business cycles is predicated on the belief that elected officials (the president,members of congress, governors, etc.) have a tendency to engineer expansionary macroeconomic policies in order toaid their re-election efforts.MONETARY POLICIESVariations in the nations monetary policies, independent of changes induced by political pressures, are an importantinfluence in business cycles as well. Use of fiscal policy—increased government spending and/or tax cuts—is themost common way of boosting aggregate demand, causing an economic expansion. Moreover, the decisions of theFederal Reserve, which controls interest rates, can have a dramatic impact on consumer and investor confidence aswell.FLUCTUATIONS IN EXPORTS AND IMPORTS The difference between exports and imports is the net foreign demand for goods and services, also called netexports. Because net exports are a component of the aggregate demand in the economy, variations in exports andimports can lead to business fluctuations as well. There are many reasons for variations in exports and imports overtime. Growth in the gross domestic product of an economy is the most important determinant of its demand forimported goods—as peoples incomes grow, their appetite for additional goods and services, including goodsproduced abroad, increases. The opposite holds when foreign economies are growing—growth in incomes in foreigncountries also leads to an increased demand for 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—andhence, domestic business cycles—as well.KEYS TO SUCCESSFUL BUSINESS CYCLE MANAGEMENTSmall business owners can take several steps to help ensure that their establishments weather business cycles with aminimum of uncertainty and damage. "The concept of cycle management may be relatively new," wrote MatthewGallagher in Chemical Marketing Reporter, "but it already has many adherents who agree that strategies that work at
  18. 18. MB0042the bottom of a cycle need to be adopted as much as ones that work at the top of a cycle. While there will be nodefinitive formula for every company, the approaches generally stress a long-term view which focuses on a firmskey strengths and encourages it to plan with greater discretion at all times. Essentially, businesses are operatingtoward operating on a more even keel."Specific tips for managing business cycle downturns include the following:Flexibility — According to Gallagher, "part of growth management is a flexible business plan that allows fordevelopment times that span the entire cycle and includes alternative recession-resistant funding structures."Long-Term Planning—Consultants encourage small businesses to adopt a moderate stance in their long-rangeforecasting.Attention to Customers—this can be an especially important factor for businesses seeking to emerge from aneconomic 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 Daltas in Industry Week. "Your customer is the best test ofwhen your own upturn will arrive. Customers, especially industrial and commercial ones, can give you earlyindications of their interest in placing large orders in coming months."Objectivity—Small business owners need to maintain a high level of objectivity when riding business cycles.Operational decisions based on hopes and desires rather than a sober examination of the facts can devastate abusiness, especially in economic down periods.Study—"Timing any action for an upturn is tricky, and the consequences of being early or late are serious," saidDaltas. "For example, expanding a sales force when the markets dont materialize not only places big demands onworking capital, but also makes it hard to sustain the motivation of the sales-people. If the force is improved too late,the cost is decreased market share or decreased quality of the customer base. How does the company strike the rightbalance between being early or late? Listening to economists, politicians, and media to get a sense of what ishappening is useful, but it is unwise to rely solely on their sources. The best route is to avoid trying to predict theupturn. Instead, listen to your customers and know your own response-time requirements."