Managerial economics


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Managerial economics

  1. 1. Master of Business Administration Semester I MB0042 – Managerial Economics Assignment Set- 1Q1. What is a business cycle? Describe the different phases of a business cycle.Ans.The business cycle describes the phases of growth and decline in an economy. The goalof economic policy is to keep the economy in a healthy growth rate -- fast enough to create jobsfor everyone who wants one, but slow enough to avoid inflation. Unfortunately, life is not sosimple. Many factors can cause an economy to spin out of control, or settle into depression. Themost important, over-riding factor is confidence -- of investors, consumers, businesses andpoliticians. The economy grows when there is confidence in the future and in policymakers, anddoes the opposite when confidence drops. The phase of the Business CycleThere are four stages that describe the business cycle. At any point in time you are in oneof these stages: 1. Contraction - When the economy starts slowing down. 2. Trough - When the economy hits bottom, usually in a recession. 3. Expansion - When the economy starts growing again. 4. Peak - When the economy is in a state of "irrational exuberance."
  2. 2. Who Determines the Business Cycle Stages?The National Bureau of Economic Research (NBER) analyzes economic indicators to determinethe phases of the business cycle. The Business Cycle Dating Committee uses quarterly GDP growth rates asthe primary indicator of economic activity. The Bureau also uses monthly figures, such as employment,real personal income, industrial production and retail sales. What GDP Can You Expect in Each Business Cycle Phase?In the Contraction phase, GDP growth rates usually slow to the 1%-2% level before actuallyturning negative. The 2008 recession was so nasty because the economy immediatelyshrank 1.8% in the first quarter 2008, grew just 1.3% in the second quarter, before fallinganother 3.9% in the third quarter, and then plummeting a whopping 8.9% in the fourth quarter.The economy received another wallop in the first quarter of 2009, when the economy contracteda brutal 6.9%.
  3. 3. Q2. What is monetary policy? Explain the general objectives and instruments of monetary policy?Ans. Monetary PolicyMonetary policy, in its narrow concept, is defined as the measures focused on regulating moneysupply. In harmony with monetary policy goals, as will be shown later, and adopting the mostcommon concept of monetary policy as one of the central bank‘s functions, monetary policy isdefined as ― the set of procedures and measures taken by monetary authorities to manage moneysupply, interest and exchange rates and to influence credit conditions to achieve certaineconomic objectives‖. We find this definition more consistent with the practical applications ofmonetary policy, particularly with respect to the difference from one country to another inobjectives selected as a link between the instruments of monetary policy and its ultimate goals. First: Monetary Policy and General Economic PoliciesMonetary policy is basically a type of stabilization policy adopted by countries to deal withdifferent economic imbalances. Since monetary policy covers the monetary aspect of the generaleconomic policy, a high level of co-ordination is required between monetary policy and otherinstruments of economic policy. Further, the effectiveness of monetary policy and its relativeimportance as a tool of economic stabilization various from one economy to another, due todifferences among economic structures, divergence in degrees of development in money andcapital markets resulting in differing degree of economic progress, and differences in prevailingeconomic conditions. However, we may briefly mention that the weak effectiveness which isusually attributed to monetary policy in developing countries is caused by the fact that theeconomic problems in these countries are mainly structural and not monetary in nature, while thelimited effectiveness of monetary policy in countries which lack developed money marketsoccurs because monetary policy is deprived of one of its major tools, the instrument of openmarket operations.Also, there are those who belittle the effectiveness of monetary policy in time of recession,comparing the use of this policy in controlling recession as ―pressing on a spring‖. Many otherssee monetary policy as ineffective in controlling the inflation that results from an imbalancebetween the demand and supply of goods and services originating from the supply side, whilethey confirm the effectiveness of monetary policy in controlling inflation that results fromincreased demand. However, this does not preclude the effectiveness of monetary policy as aflexible instrument allowing the authorities to move quickly to achieve stabilization, apart fromits importance in realizing external equilibrium in open economies.
  4. 4. Monetary Policy InstrumentsThe set of instruments available to monetary authorities may differ from one country to another,according to differences in political systems, economic structures, statutory and institutionalprocedures, development of money and capital markets and other considerations. In mostadvanced capitalist countries, monetary authorities use one or more of the following keyinstruments: changes in the legal reserve ratio, changes in the discount rate or the official keybank rate, exchange rates and open market operations. In many instances, supplementaryinstruments are used, known as instruments of direct supervision or qualitative instruments.Although the developing countries use one or more of these instruments, taking intoconsideration the difference in their economic growth levels, the dissimilarity in the patterns oftheir production structures and the degree of their of their link with the outside world, manyresort to the method of qualitative supervision, particularly those countries which face problemsarising from the nature of their economic structures. Although the effectiveness of monetarypolicy does not necessarily depend on using a wide range of instruments, coordinated use ofvarious instruments is essential to the application of a rational monetary policy.
  5. 5. Q3. A firm supplied 3000 pens at the rate of Rs 10. Next month, due to a rise of in theprice to 22 Rs. per pen the supply of the firm increases to 5000 pens. Find the elasticity ofsupply of the pens.Ans.Of course, consumption is not the only thing that changes when prices go up or down.Businesses also respond to price in their decisions about how much to produce. Economistsdefine the price elasticity of supply as the responsiveness of the quantity supplied of a good to itsmarket price.More precisely, the price elasticity of supply is the percentage change in quantity supplieddivided by the percentage change in price.Suppose the amount supplied is completely fixed, as in the case of perishable pen brought tomarket to be sold at whatever price they will fetch. This is the limiting case of zero elasticity, orcompletely inelastic supply, which is a vertical supply curve.At the other extreme, say that a tiny cut in price will cause the amount supplied to fall to zero,while the slightest rise in price will coax out an indefinitely large supply. Here, the ratio ofthe percentage change in quantity supplied to percentage change in price is extremely large andgives rise to a horizontal supply curve. This is because the polar case of infinitely elastic supply.Between these extremes, we call elastic or inelastic depending upon whether the percentagechange in quantity is larger or smaller than the percentage change in price. Price elasticity ofdemand is a ratio of two pure numbers, the numerator is the percentage change in the quantitydemanded and the denominator is the percentage change in price of the commodity. It ismeasured by the following formula:Ep = Percentage change in quantity demanded/ Percentage changed in price Applying theprovided data in the equation: Percentage change in quantity demanded = (5000 – 3000)/3000Percentage changed in price = (22 – 10) / 10Ep = ((5000 – 3000)/3000) / ((22 – 10)/10) = 1.2.
  6. 6. Q4. Give a brief description of: a. Implicit and explicit cost b. Actual and opportunity costAns. a. Implicit and explicit cost Implicit costIn economics, an implicit cost, also called an imputed cost, implied cost, or notional cost, isthe opportunity cost equal to what a firm must give up in order using factors which it neitherpurchases nor hires. It is the opposite of an explicit cost, which is borne directly. In other words,an implicit cost is any cost that results from using an asset instead of renting, selling, or lendingit. The term also applies to forgone income from choosing not to work.Implicit costs also represent the divergence between economic profit (total revenues minus totalcosts, where total costs are the sum of implicit and explicit costs) and accounting profit (totalrevenues minus only explicit costs). Since economic profit includes these extra opportunity costs,it will always be less than or equal to accounting profit Explicit costAn explicit cost is a direct payment made to others in the course of running a business, such aswage, rent and materials, as opposed to implicit costs, which are those where no actual paymentis made. It is possible still to underestimate these costs, however: for example, pensioncontributions and other "perks" must be taken into account when considering the cost of labour.Explicit costs are taken into account along with implicit ones when considering economicprofit. Accounting profit only takes explicit costs into account.
  7. 7. b. Actual and opportunity cost Actual costAn actual amount paid or incurred, as opposed to estimated cost or standard cost. In contracting,actual costs amount includes direct labor, direct material, and other direct charges.Cost accounting information is designed for managers. Since managers are taking decisionsonly for their own organization, there is no need for the information to be comparable tosimilar information from other organizations. Instead, the important criterion is that theinformation must be relevant for decisions that managers operating in a particular 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 who handle the cost accounting information generate add value by providinggood information to managers who are taking decisions. Among the better decisions, the betterperformance of ones organization, regardless if it is a manufacturing company, a bank, a non-profit organization, a government agency, a school club or even a business school. The cost-accounting system is the result of decisions made by managers of an organization and theenvironment in which they make them. Opportunity costOpportunity cost is the cost of any activity measured in terms of the value of the next bestalternative forgone (that is not chosen). It is the sacrifice related to the second best choiceavailable to someone, or group, who has picked among several mutually exclusive choices. Theopportunity cost is also the cost of the forgone products after making a choice. Opportunity costis a key concept in economics, and has been described as expressing "the basic relationshipbetween scarcity and choice". The notion of opportunity cost plays a crucial part in ensuring thatscarce resources are used efficiently. Thus, opportunity costs are not restricted to monetary orfinancial costs: the real cost of output forgone, lost time, pleasure or any other benefit thatprovides utility should also be considered opportunity costs.
  8. 8. Opportunity costs in productionOpportunity costs may be assessed in the decision-making process of production. If the workerson a farm can produce either one million pounds of wheat or two million pounds of barley, thenthe opportunity cost of producing one pound of wheat is the two pounds of barley forgone(assuming the production possibilities frontier is linear). Firms would make rational decisions byweighing the sacrifices involved.
  9. 9. Q5. Explain in brief the relationship between TR, AR, and MR under different marketcondition.Ans. Meaning and Different Types of RevenuesRevenue is the income received by the firm. There are three concepts of revenue – 1. Total revenue (T.R) 2. Average revenue (A.R) 3. Marginal revenue (M.R) 1. Total revenue (TR): Total revenue refers to the total amount of money that the firm receives from the sale of itsproducts, i.e. .gross revenue. In other words, it is the total sales receipts earned from the sale ofits total output produced over a given period of time. In brief, it refers to the total sales proceeds.It will vary with the firm‘s output and sales. We may show total revenue as a function of the totalquantity sold at a given price as below.TR = f (q). It implies that higher the sales, larger would be the TR and vice-versa. TR iscalculated by multiplying the quantity sold by its price. Thus, TR = PXQ. For e.g. a firm sells5000 units of a commodity at the rate of Rs. 5 per unit, then TR would be
  10. 10. 2. Average revenue (AR)Average revenue is the revenue per unit of the commodity sold. It can be obtained bydividing the TR by the number of units sold. Then, AR = TR/Q AR = 150/15= 10.When different units of a commodity are sold at the same price, in the market, average revenueequals price at which the commodity is sold for e.g. 2 units are sold at the rate of Rs.10 per unit,then total revenue would be Rs. 20 (2×10). Thus AR = TR/Q 20/2 = 10. Thus average revenuemeans price. Since the demand curve shows the relationship between price and the quantitydemanded, it also represents the average revenue or price at which the various amounts of acommodity are sold, because the price offered by the buyer is the revenue from seller‘s point ofview. Therefore, average revenue curve of the firm is the same as demand curve of theconsumer.Therefore, in economics we use AR and price as synonymous except in the context of pricediscrimination by the seller. Mathematically P = AR. 3. Marginal Revenue (MR)Marginal revenue is the net increase in total revenue realized from selling one more unit of aproduct. It is the additional revenue earned by selling an additional unit of output by theseller.MR differs from the price of the product because it takes into account the effect of changes inprice. For example if a firm can sell 10 units at Rs.20 each or 11 units at Rs.19 each, then themarginal revenue from the eleventh unit is (10 × 20) - (11 × 19) = Rs.9. Relationship between Total revenue, Average revenue and Marginal Revenue conceptsIn order to understand the relationship between TR, AR and MR, we can prepare a hypotheticalrevenue schedule.
  11. 11. From the table, it is clear that:MR falls as more units are sold.TR increases as more units are sold but at a diminishing rate.TR is the highest when MR is zeroTR falls when MR become negativeAR and MR both falls, but fall in MR is greater than AR i.e., MR falls more steeply than AR. Relationship between AR and MR and the nature of AR and MR curves under difference market conditions1. under Perfect MarketUnder perfect competition, an individual firm by its own action cannot influence the marketprice. The market price is determined by the interaction between demand and supply forces. Afirm can sell any amount of goods at the existing market prices. Hence, the TR of the firmwould increase proportionately with the output offered for sale. When the total revenue increasesin direct proportion to the sale of output, the AR would remain constant. Since the market priceof it is constant without any variation due to changes in the units sold by the individual firm, theextra output would fetch proportionate increase in the revenue. Hence, MR & AR will be equalto each other and remain constant. This will be equal to price.
  12. 12. Under perfect market condition, the AR curve will be a horizontal straight line and parallel toOX axis. This is because a firm has to sell its product at the constant existing market price. TheMR cure also coincides with the AR curve. This is because additional units are sold at the sameconstant price in the market.2. under Imperfect MarketUnder all forms of imperfect markets, the relation between TR, AR, and MR is different. Thiscan be understood with the help of the following imaginary revenue schedule.From the above table it is clear that:In order to increase the sales, a firm is reducing its price, hence AR fallsAs a result of fall in price, TR increase but at a diminishing rate
  13. 13. TR will be higher when MR is zeroTR falls when MR becomes negativeFrom the above table it is clear that:In order to increase the sales, a firm is reducing its price, hence AR falls.As a result of fall in price, TR increase but at a diminishing rate.TR will be higher when MR is zeroTR falls when MR becomes negativeAR and MR both declines. But fall in MR will be greater than the fall in AR.The relationship between AR and MR curves is determined by the elasticity ofdemand on the average revenue curve.Under imperfect market, the AR curve of an individual firm slope downwards fromleft to right. This is because; a firm can sell larger quantities only when it reduces theprice. Hence, AR curve has a negative slope.The MR curve is similar to that of the AR curve. But MR is less than AR. AR and MRcurves are different. Generally MR curve lies below the AR curve.The AR curve of the firm or the seller and the demand curve of the buyer is the sameSince, the demand curve represents graphically the quantities demanded by the buyers at variousprices it shows the AR at which the various amounts of the goods that are sold by the seller. Thisis because the price paid by the buyer is the revenue for the seller (One man‘s expenditure isanother man‘s income). Hence, the AR curve of the firm is the same thing as that of the demandcurve of the consumers.
  14. 14. 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.5per unit. Hence, his total income is 10 x 5 = Rs.50/-.Thus, it is clear that AR curve and demand curve is really one and the same.
  15. 15. Q6. Distinguish between a firm and an industry. Explain the equilibrium of a firm andindustry under perfect competition.Ans. Distinguish between a firm and an industryAn industry is the name given to a certain type of manufacturing or retailing environment.For example, the retail industry is the industry that involves everything from clothes tocomputers, anything in the shops that get sold to the public. The retail industry is very vast andhas many sub divisions, such as electrical and cosmetics. More specialized industries deal with aspecific thing. The steel industry is a more specialized industry, dealing with the making of steeland selling it on to buyers.The difference between this and a firm is that a firm is the company that operates within theindustry to create the product. The firm might be a factory, or the chain of stores that sells theclothes, within its industry. For example, one firm that makes steel might be Aveda steel. Theycreate the steel in that firm for the steel industry.A firm is usually a corporate company that controls a number of chains in the industry it isoperating within.For example in retail, the firm Arcadia stores own the clothing chains Top shop, DorothyPerkins, Miss Selfridge, and Evans. These all operate for the firm Arcadia within the industry ofretail.Several firms can operate in one industry to ensure that there is always competition to keepprices reasonable and stop the market becoming a monopoly, which is where one firm is incharge of the whole industry. Sometimes, a firm is not necessary within the industry andindependent chains and retailers can enter straight into the market without a firm behind them,although this is risky. This is because one of the advantages of having a firm behind you is that itis a safeguard against possible bankruptcy because the firm can support the chain that it owns.
  16. 16. The equilibrium of a firm and industry under perfect competitionAccording to Miller, ―Firm is an organization that buys and hires resources and sells goods andservices‖. Lipsey has defined as ―firm is the unit that employs factors of production to producecommodities that it sells to other firms, to households, or to the government.‖ Industry is a group of firms producing standardized products in a market. According toLipsey, ―Industry is a group of firms that sells a well defined product or closely related set ofproducts.‖Conditions of Equilibrium of the Firm and Industry A firm is in equilibrium when it has no propensity to modify its level of productivity. Itrequires neither extension nor retrenchment. It wants to earn maximum profits in by equating itsmarginal cost with its marginal revenue, i.e. MC = MR. Diagrammatically, the conditions ofequilibrium 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 befulfilled yet the firm may not be in equilibrium.(2) The MC curve must cut the MR curve from below and after the point of equilibrium it mustbe above the MR.This is the second order condition. Under conditions of perfect competition, the MR curve of afirm overlaps with the AR curve. The MR curve is parallel to the X axis. Hence the firm is inequilibrium when MC = MR = AR.
  17. 17. The first order figure (1), the MC curve cuts the MR curve first at point X. It contends thecondition 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. It does not pay the firm to produce the minimum outputOM when it can earn huge profits by producing beyond OM. Point Y is of maximum profitswhere 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 will nevertheless stop additional production when it reaches the OM1 level ofproductivity where the firm fulfils both the circumstances of equilibrium. If it has any plants toproduce more than OM1 it will be incurring losses, for its marginal cost exceeds its marginalrevenue beyond the equilibrium point Y. The same finale hold good in the case of straight lineMC curve and it is presented in the figure.An industry is in equilibrium, first when there is no propensity for the firms either to leave oreither the industry and next, when each firm is also in equilibrium. The first clause entails thatthe average cost curves overlap with the average revenue curves of all the firms in the industry.They are earning only normal profits, which are believed to be incorporated in the average costcurves of the firms. The second condition entails the equality of MC and MR. Under a perfectlycompetitive industry these two circumstances must be fulfilled at the point of equilibrium i.e.MC = MR….(1), AC = AR…. (2), AR = MR.Hence MC = AC = AR. Such a position represents full equilibrium of the industry.
  18. 18. Short Run Equilibrium of the Firm and Industry1. Short Run Equilibrium of the FirmA firm is in equilibrium in the short run when it has no propensity to enlarge or contract itsproductivity and needs to earn maximum profit or to incur minimum losses.The short run is an epoch of time in which the firm can vary its productivity by changing theerratic factors of production. The number of firms in the industry is fixed since neither theexisting firms can leave nor new firms can enter it.Postulations All firms use standardised factors of production Firms are of diverse competence Cost curves of firms are dissimilar from each other All firms sell their produces at the equal price ascertained by demand and supply of the 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 itsprice equals average variable cost or is higher than the average variable cost (AVC).Furthermore, if the price is more than the averages total costs, ATC, i.e. P = AR > ATC the firmwill be earning super normal profits. If price equals the average total costs, i.e. P = AR = ATCthe 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, thefirm will shut down since in order to produce it must cover atleast it‘s AVC through short run.So during the short run, under perfect competition, affirm is in equilibrium in all the abovementioned stipulations.Super normal profits – The firm will be earning super normal profits in the short run when priceis higher than the short run average cost.
  19. 19. Normal Profits = The firm may earn normal profits when price equals the short run averagecosts.Total Cost – Total Revenue Analysis – The short run equilibrium of the firm can also berepresented with the help of total cost and total revenue curves. The firm is able to maximise itsprofits when the positive discrimination between TR and TC is the greatest. Short Run Equilibrium of the IndustryAn industry is in equilibrium in the short run when its total output remains steady there being nopropensity to enlarge or contract its productivity. If all firms are in equilibrium the industry isalso in equilibrium. For full equilibrium of the industry in the short run all firms must be earningnormal profits.But full equilibrium of the industry is by sheer accident for the reason that in the short rum somefirms may be earning super normal profits and some losses. Even then the industry is in short runequilibrium when its quantity demanded and quantity supplied is equal at the price which clearsthe market.Online Live Tutor Conditions of Equilibrium of the Firm and Industry: We have the best tutors in Economics in the industry. Our tutors can break down a complexConditions of Equilibrium of the Firm and Industry problem into its sub parts and explain to youin detail how each step is performed. This approach of breaking down a problem has beenappreciated by majority of our students for learning Conditions of Equilibrium of the Firm andIndustry concepts. You will get one-to-one personalized attention through our online tutoringwhich will make learning fun and easy. Our tutors are highly qualified and hold advanceddegrees. Please do send us a request for Conditions of Equilibrium of the Firm and Industrytutoring and experience the quality yourself.
  20. 20. Online Equilibrium of the Firm and Industry Help: If you are stuck with Equilibrium of the Firm and Industry Homework problem and needhelp, we have excellent tutors who can provide you with Homework Help. Our tutors whoprovide Equilibrium of the Firm and Industry help are highly qualified. Our tutors have manyyears of industry experience and have had years of experience providing Equilibrium of the Firmand Industry Homework Help. Please do send us the Equilibrium of the Firm and Industryproblems on which you need help and we will forward then to our tutors for review.Other topics under Product Pricing: Applications of Demand and Supply Analysis under Perfect Competition Concepts of Revenue Derived Demand, Joint Supply Determination of Profit Maximization under monopolist situation Duopoly and Oligopoly Forms of Market Structure Importance of Time Element in Price Theory Joint Demand Supply Linear Programming Long Run Equilibrium of Firm and Industry Market Structures Monopolistic Competition Monopsony and Bilateral Monopoly, Price output Determination Objectives of Business Firm Oligopoly, Cornet‘s Oligopoly Model Pricing of Public Undertakings Profit Maximization, Full cost, Pricing and Sales Maximization Pricing Under Perfect Competition - Demand Supply - Basic Framework Profit Price Policy Resource allocation under monopoly Short, Long Run Supply Curve of the Firm and Industry Similarities and Dissimilarities between Monopoly Competition and Perfect Competition Supply Its Law - Elasticity and Curve The Nature of Costs and Cost Curves Williamsons Utility Maximization
  21. 21. Set 2Q1. Suppose your manufacturing company planning to release a new product into market,Explain the various methods forecasting for a new product.Ans.When a manufacturing companies planning to release a new product into themarket, it shouldperform the demand forecasting to check the demand of the product in the market and also theavailability of similar product in the market.Demand forecasting for new products is quite different from that for established products. Herethe firms will not have any past experience or past data for this purpose. An intensive study ofthe economic and competitive characteristics of the product should be made to make efficientforecasts.As per Professor Joel Dean, few guidelines to make forecasting of demand for newproducts are:a. Evolutionary approachThe demand for the new product may be considered as an outgrowth of an existing product. Fore.g., Demand for new Tata Indica, which is a modified version of Old Indica can most effectivelybe projected based on the sales of the old Indica, the demand for new Pulsor can be forecastedbased on the sales of the old Pulsar. Thus when a new product is evolved from the old product,the demand conditions of the old product can be taken as a basis for forecasting the demand forthe new product.b. Substitute approachIf the new product developed serves as substitute for the existing product, the demand for thenew product may be worked out on the basis of a ‗market share‘. The growths of demand for allthe products have to be worked out on the basis of intelligent forecasts for independent variablesthat influence the demand for the substitutes. After that, a portion of the market can be sliced outfor the new product. For e.g., A moped as a substitute for a scooter, a cell phone as a substitutefor a land line. In some cases price plays an important role in shaping future demand for theproduct.
  22. 22. c. Opinion Poll approachUnder this approach the potential buyers are directly contacted, or through the use of samples ofthe new product and their responses are found out. These are finally blown up to forecastthe demand for the new product.d. Sales experience approachOffer the new product for sale in a sample market; say supermarkets or big bazaars in big cities,which are also big marketing centers. The product may be offered for sale through one supermarket and the estimate of sales obtained may be ‗blown up‘ to arrive at estimated demand forthe product.e. Growth Curve approachAccording to this, the rate of growth and the ultimate level of demand for the new product areestimated on the basis of the pattern of growth of established products. For e.g., An AutomobileCo., while introducing a new version of a car 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 touchwith some specialized and informed dealers who have good knowledge about the market, aboutthe different varieties of the product already available in the market, the consumers‘ preferencesetc. This helps in making a more efficient estimation of future demand.
  23. 23. Q2. Define the term equilibrium. Explain the changes in market equilibrium and effects toshifts in supply and demand.Ans. EquilibriumThe word equilibrium is derived from the Latin word a ―equilibrium‖ which means equalbalance. It means a state of even balance in which opposing forces or tendencies neutralize eachother. It is a position of rest characterized by absence of change. It is a state where there iscomplete agreement of the economic plans of the various market participants so that no one has atendency to revise or alter his decision. In the words of professor Mehta: ―Equilibrium denotesin economics absence of change in movement‖.Market EquilibriumThere are two approaches to market equilibrium viz., partial equilibrium approach and thegeneral equilibrium approach. The partial equilibrium approach to pricing explains pricedetermination of a single commodity keeping the prices of other commodities constant. On theother hand, the general equilibrium approach explains the mutual and simultaneousdetermination 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 orthe force of supply is more important in determining price. Marshall gave equal importance toboth demand and supply in the determination of value or price. He compared supply and demandto a pair of scissors We might as reasonably dispute whether it is the upper or the under blade of a pair of scissors thatcuts a piece of paper, as whether value is governed by utility or cost of production. Thus neitherthe upper blade nor the lower blade taken separately can cut the paper; both have theirimportance in the process of cutting. Likewise neither supply alone, nor demand alonecan determine the price of a commodity, both are equally important in the determination of price.But the relative importance of the two may vary depending upon the time under consideration.Thus, the demand of all consumers and the supply of all firms together determine the price ofa commodity in the market.
  24. 24. Equilibrium between demand and supply price:Equilibrium between demand and supply price is obtained by the interaction of these two forces.Price is an independent variable. Demand and supply are dependent variables. They depend onprice. Demand varies inversely with price; arise in price causes a fall in demand and a fall inprice causes a rise in demand. Thus the demand curve will have a downward slope indicating theexpansion of demand with a fall in price and contraction of demand with a rise in price. On theother hand supply varies directly with the changes in price, a rise in price causes arise in supplyand a fall in price causes a fall in supply. Thus the supply curve will have an upward slope. At apoint where these two curves intersect with each other the equilibrium price is established. Atthis price quantity demanded is equal to the quantity demanded.This we can explain with the help of a table and a diagramIn the table at Rs.20 the quantity demanded is equal to the quantity supplied. Since the price isagreeable to both the buyer and sellers, there will be no tendency for it to change; this is calledequilibrium price. Suppose the price falls to Rs.5 the buyer will demand 30 units while the sellerwill supply only 5 units. Excess of demand over supply pushes the price upward until it reachesthe equilibrium position supply is equal to the demand. On the other hand if the price rises toRs.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 demandpushes the price downward until it reaches the equilibrium. This process will continue till theequilibrium price of Rs.20 is reached. Thus the interactions of demand and supply forces actingupon each other restore the equilibrium position in the market. In the diagram DD is the demandcurve, SS is the supply curve. Demand and supply are in equilibrium at point E where the two
  25. 25. curves intersect each other. OQ is the equilibrium output. OP is the equilibrium price. Supposethe price OP2 is higher than the equilibrium price OP. at this point price quantity demandedisP2D2. Thus D2S2 is the excess supply which the seller wants to push into the market,competition among the sellers will bring down the price to the equilibrium level where thesupply is equal to the demand. At price OP1, the buyers will demand P1D1 quantity while thesellers are ready to sell P1S1. Demand exceeds supply. Excess demand for goods pushes up theprice; this process will go until equilibrium is reached where supply becomes equal to demand.
  26. 26. Q3. Explain how a product would reach equilibrium position with the help of ISO - Quantsand ISO-Cost curve.Ans.When producing a good or service, how do suppliers determine the quantity of factors to hire?Below, we work through an example where a representative producer answers this question.Let‘s begin by making some assumptions. First, we shall assume that our producer choosesvarying amounts of two factors, capital (K) and labor (L). Each factor was a price that does notvary with output.That is, the price of each unit of labor (w) and the price of each unit of capital (r) are assumedconstant. We‘ll further assume that w = $10 and r = $50. We can use this information todetermine the producer‘s total cost. We call the total cost equation an iso-cost line (it‘s similar toa 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 1000units of output. In order to produce those 1000 units of output, our producer must get acombination of L and K that makes (2) equal to 1000. Implicitly, this means that we must find aparticular isoquant.Set (2) equal to 1000 units of output, and solve for K. Doing so, we get the following equationfor a specific iso-quant (one of many possible iso-quants):K = 1,000,000/L (2a)For any given value of L, (2a) gives us a corresponding value for K. Graphing these values, withK on the vertical axis and L on the horizontal axis, we obtain the blue line on the graph below.Each point on this curve is represented as a combination of K and L that yields an output level of1000 units. Therefore, as we move along this iso-quant output is constant (much like the fact thatutility is constant as A basic understanding of statistics is a critical component of informeddecision making.
  27. 27. Q4. Critically examine the Marris growth maximizing model??Ans.Profit maximization is traditional objective of a firm. Sales maximization objective is explainedby Prof. Boumal. On similar lines, Prof. Marris has developed another alternative growthmaximization model in recent years. It is a common factor to observe that each firm aims atmaximizing its growth rate as this goal would answer many of the objectives of a firm. Marrispoints 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 ofpeople, i.e. owner and managers. He further points out that both of them have two distinctivegoals. Managers have a utility function in which the amount of salary, status, position, power,prestige and security of job etc are the most import variable where as in case of are moreconcerned about the size of output, volume of profits, market shares and sales maximization.Utility function of the manager and that the owner are expressed in the following manner-Uo= f [size of output, market share, volume of profit, capital, public esteem etc.]Um= f [salaries, power, status, prestige, job security etc.]In view of Marris the realization of these two functions would depend on the size of the firm.Larger the firm, greater would be the realization of these functions and vice-versa. Size of thefirm according to Marris depends on the amount of corporate capital which includes total volumeof the asset, inventory level, cash reserve etc. He further points out that the managers always aimat maximizing the rate of growth of the firm rather than growth in absolute size 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 ou mal ’s S al es Maxi mi zati on mod el :Sales maximization model is an alternative for profit maximization model. This model isdeveloped by Prof. W.J. Boumal, an American economist. This alternative goal has assumedgreater significance in the context of the growth of the oligopolistic firms. The model highlightsthat the primary objective of the firm is to maximize its sales rather than profit maximization. Itstates that the goal of the firm is maximization of sales revenue subject to a minimum profitconstraint. The minimum profit constraint is determined by the expectation of the share holders.This is because no company can displease the shareholders. It is to be noted here thatmaximization of sales does not mean maximization of physical sales but maximization of totalsales revenue. Hence, the managers are more interested in increasing sales rather than profit. Thebasic philosophy is that when sales are maximized automatically profits of the company would
  28. 28. also go up. Hence, attention is diverted to increase the sales of the company in recent years in thecontext 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.
  29. 29. Q5. Define Pricing Policy. Explain the various objective of pricing policy.Ans. Pricing PoliciesA detailed study of the market structure gives us information about the way in which prices aredetermined under different market conditions. However, in reality, a firm adopts differentpolicies and methods to fix the price of its products.Pricing policy refers to the policy of setting the price of the product or products and services bythe management after taking into account of various internal and external factors, forces and itsown business objectives.Pricing Policy basically depends on price theory that is the corner stone of economic theory.Pricing is considered as one of the basic and central problems of economic theory in a moderneconomy. Fixing prices are the most important aspect of managerial decision making becausemarket price charged by the company affects the present and future production plans, pattern ofdistribution, nature of marketing etc. Generally speaking, in economic theory, we take intoaccount of only two parties, i.e., buyers and sellers while fixing the prices. However, in practicemany parties 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 shouldgive due consideration to theinfluence exerted by these parties in the process of pricedetermination. Broadly speaking, the various factors and forces that affect the price are dividedinto 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.
  30. 30. 7. Purchasing power of the buyers.8. Bargaining power of customers9. Buyers behavior in respect of particular product II. Internal Factors (Inside Factors)1. Objectives of the firm.2. Production Costs.3. Quality of the product and its characteristics.4. Scale of production.5. Efficient management of resources.6. Policy towards percentage of profits and dividend distribution.7. Advertising and sales promotion policies.8. Wage policy and sales turn over policy etc.9. The stages of the product on the product life cycle.10. Use pattern of the product. Objectives of the Price Policy:A firm has multiple objectives today. In spite of several objectives, the ultimate aim of everybusiness concern is to maximize its profits. This is possible when the returns exceed costs. In thiscontext, setting an ideal price for a product assumes greater importance. Pricing objectives has tobe established by top management to ensure not only that the company‘s profitability is adequatebut also that pricing is complementary to the total strategy of the organization. Whileformulating the pricing policy, a firm has to consider various economic, social, political andother factors.
  31. 31. The Following objectives are to be considered while fixing the prices of the product.1. Profit maximization in the short termThe primary objective of the firm is to maximize its profits. Pricing policy as an instrument toachieve this objective should be formulated in such a way as to maximize the sales revenue andprofit. Maximum profit refers to the highest possible of profit.In the short run, a firm not only should be able to recover its total costs, but also should getexcess revenue over costs. This will build the morale of the firm and instill the spirit ofconfidence in its operations.2. Profit optimization in the long runThe traditional profit maximization hypothesis may not prove beneficial in the long run. With thesole motive of profit making a firm may resort to several kinds of unethical practices likecharging exorbitant prices, follow Monopoly Trade Practices (MTP), Restrictive Trade Practices(RTP) and Unfair Trade Practices (UTP) etc. This may lead to opposition from the people. Inorder to over- come these evils, a firm instead of profit maximization, and aims at profitoptimization.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 soundpricing policy of a firm in recent years.3. Price StabilizationPrice stabilization over a period of time is another objective. The prices as far as possible shouldnot fluctuate too often. Price instability creates uncertain atmosphere in business circles. Salesplan becomes difficult under such circumstances. Hence, price stability is one of the prerequisiteconditions for steady and persistent growth of a firm. A stable price policy only can win theconfidence of customers and may add to the good will of the concern. It builds up the reputationand image of the firm.4. Facing competitive situationOne of the objectives of the pricing policy is to face the competitive situations in the market. Inmany cases, this policy has been merely influenced by the market share psychology. Wherevercompanies are aware of specific competitive products, they try to match the prices of theirproducts with those of their rivals to expand the volume of their business. Most of the firms arenot merely interested in meeting competition but are keen to prevent it. Hence, a firm is alwaysbusy with its counter business strategy.
  32. 32. 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 allfirms in the market.The economic strength and success of a firm is measured in terms of its market share. In acompetitive world, each firm makes a successful attempt to expand its market share. If it isimpossible, it has to maintain its existing market share. Any decline in market share is asymptom of the poor performance of a firm.Hence, the pricing policy has to assist a firm to maintain its market share at any cost.
  33. 33. Q6. Discuss the various measures that may be taken by a firm to counteract the evil effectsof a trade cycle.Ans. FACTORS THAT SHAPE BUSINESS CYCLESFor centuries, economists in both the United States and Europe regarded economic downturns as"diseases" that had to be treated; it followed, then, that economies characterized by growth andaffluence were regarded as "healthy" economies. By the end of the 19th century, however, manyeconomists had begun to recognize that economies were cyclical by their very nature, and studiesincreasingly turned to determining which factors were primarily responsible for shaping thedirection and disposition of national, regional, and industry-specific economies. Today,economists, corporate executives, and business owners cite several factors as particularlyimportant in shaping the complexion of business environments.VOLATILITY OF INVESTMENT SPENDINGVariations in investment spending is one of the important factors in business cycles. Investmentspending is considered the most volatile component of the aggregate or total demand (it variesmuch more from year to year than the largest component of the aggregate demand, theconsumption spending), and empirical studies by economists have revealed that the volatility ofthe investment component is an important factor in explaining business cycles in the UnitedStates. According to these studies, increases in investment spur a subsequent increase inaggregate demand, leading to economic expansion. Decreases in investment have the oppositeeffect. Indeed, economists can point to several points in American history in which theimportance of investment spending was made quite evident. The Great Depression, for instance,was caused by a collapse in investment spending in the aftermath of the stock market crash of1929. Similarly, prosperity of the late 1950s was attributed to a capital goods boom.There are several reasons for the volatility that can often be seen in investment spending. Onegeneric reason is the pace at which investment accelerates in response to upward trends in sales.This linkage, which is called the acceleration principle by economists, can be briefly explainedas follows. Suppose a firm is operating at full capacity. When sales of its goods increase, outputwill have to be increased by increasing plant capacity through further investment. As a result,changes in sales result in magnified percentage changes in investment expenditures. Thisaccelerates the pace of economic expansion, which generates greater income in the economy,leading to further increases in sales. Thus, once the expansion starts, the pace of investmentspending accelerates. In more concrete terms, the response of the investment spending is relatedto the rate at which sales are increasing. In general, if an increase in sales is expanding,investment is spending rises, and if an increase in sales has peaked and is beginning to slow,investment spending falls. Thus, the pace of investment spending is influenced by changes in therate of sales.
  34. 34. MOMENTUMMany economists cite a certain "follow-the-leader" mentality in consumer spending. In situationswhere consumer confidence is high and people adopt more free-spending habits, other customersare deemed to be more likely to increase their spending as well. Conversely, downturns inspending tend to be imitated as well.TECHNOLOGICAL INNOVATIONSTechnological innovations can have an acute impact on business cycles. Indeed, technologicalbreakthroughs in communication, transportation, manufacturing, and other operational areas canhave a ripple effect throughout an industry or an economy. Technological innovations may relateto production and use of a new product or production of an existing product using a new process.The video imaging and personal computer industries, for instance, have undergone immensetechnological innovations in recent years, and the latter industry in particular has had apronounced impact on the business operations of countless organizations. However,technological innovations—and consequent increases in investment—take place at irregularintervals. Fluctuating investments, due to variations in the pace of technological innovations,lead to business fluctuations in the economy.There are many reasons why the pace of technological innovations varies. Major innovations donot occur every day. Nor do they take place at a constant rate. Chance factors greatly influencethe timing of major innovations, as well as the number of innovations in a particular year.Economists consider the variations in technological innovations as random (with no systematicpattern). Thus, irregularity in the pace of innovations in new products or processes becomes asource of business fluctuations.VARIATIONS IN INVENTORIESVariations in inventories—expansion and contraction in the level of inventories of goods kept bybusinesses—also contribute to business cycles. Inventories are the stocks of goods firms keep onhand to meet demand for their products. How do variations in the level of inventories triggerchanges in a business cycle? Usually, during a business downturn, firms let their inventoriesdecline. As inventories dwindle, businesses ultimately find themselves short of inventories. As aresult, they start increasing inventory levels by producing output greater than sales, leading to aneconomic expansion. This expansion continues as long as the rate of increase in sales holds upand producers continue to increase inventories at the preceding rate. However, as the rate ofincrease in sales slows, firms begin to cut back on their inventory accumulation. The subsequentreduction in inventory investment dampens the economic expansion, and eventually causes aneconomic downturn. The process then repeats itself all over again. It should be noted that whilevariations in inventory levels impact overall rates of economic growth, the resulting businesscycles are not really long. The business cycles generated by fluctuations in inventories are
  35. 35. called minor or short business cycles. 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 mayappear to be an unlikely source, as the government is widely considered to be a stabilizing forcein the economy rather than a source of economic fluctuations or instability. Nevertheless,government spending has been a major destabilizing force on several occasions, especiallyduring and after wars. Government spending increased by an enormous amount during WorldWar II, leading to an economic expansion that continued for several years after the war.Government spending also increased, though to a smaller extent compared to World War II,during the Korean and Vietnam wars. These also led to economic expansions. However,government spending not only contributes to economic expansions, but economic contractions aswell. In fact, the recession of 1953-54 was caused by the reduction in government spending afterthe Korean War ended. More recently, the end of the Cold War resulted in a reduction in defensespending by the United States that had a pronounced impact on certain defense-dependentindustries and geographic regions.POLITICALLY GENERATED BUSINESS CYCLESMany economists have hypothesized that business cycles are the result of the politicallymotivated use of macroeconomic policies (monetary and fiscal policies) that are designed toserve the interest of politicians running for re-election. The theory of political business cycles ispredicated on the belief that elected officials (the president, members of congress, governors,etc.) have a tendency to engineer expansionary macroeconomic policies in order to aid their re-election efforts.MONETARY POLICIESVariations in the nations monetary policies, independent of changes induced by politicalpressures, are an important influence in business cycles as well. Use of fiscal policy—increasedgovernment spending and/or tax cuts—is the most common way of boosting aggregate demand,causing an economic expansion. Moreover, the decisions of the Federal Reserve, which controlsinterest rates, can have a dramatic impact on consumer and investor confidence as well.FLUCTUATIONS IN EXPORTS AND IMPORTS The difference between exports and imports is the net foreign demand for goods and services,also called net exports. Because net exports are a component of the aggregate demand in theeconomy, variations in exports and imports can lead to business fluctuations as well. There aremany reasons for variations in exports and imports over time. Growth in the gross domestic
  36. 36. product of an economy is the most important determinant of its demand for imported goods—aspeoples incomes grow, their appetite for additional goods and services, including goodsproduced abroad, increases. The opposite holds when foreign economies are growing—growth inincomes in foreign countries also leads to an increased demand for imported goods by theresidents of these countries. This, in turn, causes U.S. exports to grow. Currency exchange ratescan also have a dramatic impact on international trade—and hence, domestic business cycles—aswell. KEYS TO SUCCESSFUL BUSINESS CYCLE MANAGEMENTSmall business owners can take several steps to help ensure that their establishments weatherbusiness cycles with a minimum of uncertainty and damage. "The concept of cycle managementmay be relatively new," wrote Matthew Gallagher in Chemical Marketing Reporter, "but italready has many adherents who agree that strategies that work at the bottom of a cycle need tobe adopted as much as ones that work at the top of a cycle. While there will be no definitiveformula for every company, the approaches generally stress a long-term view which focuses on afirms key strengths and encourages it to plan with greater discretion at all times. Essentially,businesses are operating toward 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 planthat allows for development 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 intheir long-range forecasting.Attention to Customers—this can be an especially important factor for businesses seeking toemerge from an economic downturn. "Staying close to the customers is a tough discipline tomaintain in good times, but it is especially crucial coming out of bad times," stated Arthur Daltasin Industry Week. "Your customer is the best test of when your own upturn will arrive.Customers, especially industrial and commercial ones, can give you early indications of theirinterest in placing large orders in coming months."Objectivity—Small business owners need to maintain a high level of objectivity when ridingbusiness cycles. Operational decisions based on hopes and desires rather than a soberexamination of the facts can devastate a business, especially in economic down periods.
  37. 37. Study—"Timing any action for an upturn is tricky, and the consequences of being early or lateare serious," said Daltas. "For example, expanding a sales force when the markets dontmaterialize not only places big demands on working capital, but also makes it hard to sustain themotivation of the sales-people. If the force is improved too late, the cost is decreased marketshare or decreased quality of the customer base. How does the company strike the right balancebetween being early or late? Listening to economists, politicians, and media to get a sense ofwhat is happening is useful, but it is unwise to rely solely on their sources. The best route is toavoid trying to predict the upturn. Instead, listen to your customers and know your ownresponse-time requirements."
  38. 38. THANK YOU