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Managerial economics


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Managerial economics

  1. 1. Managerial economics — Document Transcript 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. 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. 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
  2. 2. mention that the weak effectiveness which isusually attributed to monetary policy indeveloping countries is caused by the fact that theeconomic problems in these countriesare mainly structural and not monetary in nature, while thelimited effectiveness ofmonetary policy in countries which lack developed money marketsoccurs becausemonetary policy is deprived of one of its major tools, the instrument of openmarketoperations.Also, there are those who belittle the effectiveness of monetary policy in timeof recession,comparing the use of this policy in controlling recession as ―pressing on aspring‖. Many otherssee monetary policy as ineffective in controlling the inflation thatresults from an imbalancebetween the demand and supply of goods and servicesoriginating from the supply side, whilethey confirm the effectiveness of monetary policyin controlling inflation that results fromincreased demand. However, this does notpreclude the effectiveness of monetary policy as aflexible instrument allowing theauthorities to move quickly to achieve stabilization, apart fromits importance in realizingexternal equilibrium in open economies.4. Monetary Policy InstrumentsThe set of instruments available to monetary authoritiesmay differ from one country to another,according to differences in political systems,economic structures, statutory and institutionalprocedures, development of money andcapital markets and other considerations. In mostadvanced capitalist countries, monetaryauthorities use one or more of the following keyinstruments: changes in the legal reserveratio, changes in the discount rate or the official keybank rate, exchange rates and openmarket operations. In many instances, supplementaryinstruments are used, known asinstruments of direct supervision or qualitative instruments.Although the developingcountries use one or more of these instruments, taking intoconsideration the difference intheir economic growth levels, the dissimilarity in the patterns oftheir productionstructures and the degree of their of their link with the outside world, manyresort to themethod of qualitative supervision, particularly those countries which faceproblemsarising from the nature of their economic structures. Although the effectivenessof monetarypolicy does not necessarily depend on using a wide range of instruments,coordinated use ofvarious instruments is essential to the application of a rationalmonetary policy.5. Q3. A firm supplied 3000 pens at the rate of Rs 10. Next month, due to a rise of intheprice to 22 Rs. per pen the supply of the firm increases to 5000 pens. Find theelasticity ofsupply of the pens.Ans.Of course, consumption is not the only thing thatchanges when prices go up or down.Businesses also respond to price in their decisionsabout how much to produce. Economistsdefine the price elasticity of supply as theresponsiveness of the quantity supplied of a good to itsmarket price.More precisely, theprice elasticity of supply is the percentage change in quantity supplieddivided by thepercentage change in price.Suppose the amount supplied is completely fixed, as in thecase of perishable pen brought tomarket to be sold at whatever price they will fetch. Thisis the limiting case of zero elasticity, orcompletely inelastic supply, which is a verticalsupply curve.At the other extreme, say that a tiny cut in price will cause the amountsupplied to fall to zero,while the slightest rise in price will coax out an indefinitely largesupply. Here, the ratio ofthe percentage change in quantity supplied to percentage changein price is extremely large andgives rise to a horizontal supply curve. This is because thepolar case of infinitely elastic supply.Between these extremes, we call elastic or inelasticdepending upon whether the percentagechange in quantity is larger or smaller than the
  3. 3. percentage change in price. Price elasticity ofdemand is a ratio of two pure numbers, thenumerator is the percentage change in the quantitydemanded and the denominator is thepercentage change in price of the commodity. It ismeasured by the following formula:Ep= Percentage change in quantity demanded/ Percentage changed in price Applyingtheprovided 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. Q4. Give a brief description of: a. Implicit and explicit cost b. Actual and opportunitycostAns. a. Implicit and explicit cost Implicit costIn economics, an implicit cost, alsocalled an imputed cost, implied cost, or notional cost, isthe opportunity cost equal to whata firm must give up in order using factors which it neitherpurchases nor hires. It is theopposite of an explicit cost, which is borne directly. In other words,an implicit cost is anycost that results from using an asset instead of renting, selling, or lendingit. The term alsoapplies to forgone income from choosing not to work.Implicit costs also represent thedivergence between economic profit (total revenues minus totalcosts, where total costsare the sum of implicit and explicit costs) and accounting profit (totalrevenues minusonly explicit costs). Since economic profit includes these extra opportunity costs,it willalways be less than or equal to accounting profit Explicit costAn explicit cost is a directpayment made to others in the course of running a business, such aswage, rent andmaterials, 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 thecost of labour.Explicit costs are taken into account along with implicit ones whenconsidering economicprofit. Accounting profit only takes explicit costs into account.7. b. Actual and opportunity cost Actual costAn actual amount paid or incurred, asopposed to estimated cost or standard cost. In contracting,actual costs amount includesdirect labor, direct material, and other direct charges.Cost accounting information isdesigned for managers. Since managers are taking decisionsonly for their ownorganization, there is no need for the information to be comparable tosimilar informationfrom other organizations. Instead, the important criterion is that theinformation must berelevant for decisions that managers operating in a particular environmentof businessincluding strategy make. Cost accounting information is commonly used infinancialaccounting information, but first we are concentrating in its use by managers totake decisions.The accountants who handle the cost accounting information generate addvalue by providinggood information to managers who are taking decisions. Among thebetter decisions, the betterperformance of ones organization, regardless if it is amanufacturing company, a bank, a non-profit organization, a government agency, aschool club or even a business school. The cost-accounting system is the result ofdecisions made by managers of an organization and theenvironment in which they makethem. Opportunity costOpportunity cost is the cost of any activity measured in terms ofthe value of the next bestalternative forgone (that is not chosen). It is the sacrifice relatedto the second best choiceavailable to someone, or group, who has picked among severalmutually exclusive choices. Theopportunity cost is also the cost of the forgone productsafter making a choice. Opportunity costis a key concept in economics, and has beendescribed as expressing "the basic relationshipbetween scarcity and choice". The notionof opportunity cost plays a crucial part in ensuring thatscarce resources are used
  4. 4. efficiently. Thus, opportunity costs are not restricted to monetary orfinancial costs: thereal cost of output forgone, lost time, pleasure or any other benefit thatprovides utilityshould also be considered opportunity costs.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 millionpounds of wheat or two million pounds of barley, thenthe opportunity cost of producingone pound of wheat is the two pounds of barley forgone(assuming the productionpossibilities frontier is linear). Firms would make rational decisions byweighing thesacrifices involved.9. Q5. Explain in brief the relationship between TR, AR, and MR under differentmarketcondition.Ans. Meaning and Different Types of RevenuesRevenue is the incomereceived 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 revenuerefers 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 totaloutput produced over a given period of time. In brief, it refers to the total salesproceeds.It will vary with the firm‘s output and sales. We may show total revenue as afunction of the totalquantity sold at a given price as below.TR = f (q). It implies thathigher the sales, larger would be the TR and vice-versa. TR iscalculated by multiplyingthe quantity sold by its price. Thus, TR = PXQ. For e.g. a firm sells5000 units of acommodity at the rate of Rs. 5 per unit, then TR would be10. 2. Average revenue (AR)Average revenue is the revenue per unit of the commoditysold. It can be obtained bydividing the TR by the number of units sold. Then, AR = TR/QAR = 150/15= 10.When different units of a commodity are sold at the same price, in themarket, average revenueequals price at which the commodity is sold for e.g. 2 units aresold 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 therelationship between price and the quantitydemanded, it also represents the averagerevenue or price at which the various amounts of acommodity are sold, because the priceoffered by the buyer is the revenue from seller‘s point ofview. Therefore, averagerevenue curve of the firm is the same as demand curve of theconsumer.Therefore, ineconomics we use AR and price as synonymous except in the context ofpricediscrimination by the seller. Mathematically P = AR. 3. Marginal Revenue(MR)Marginal revenue is the net increase in total revenue realized from selling one moreunit of aproduct. It is the additional revenue earned by selling an additional unit of outputby theseller.MR differs from the price of the product because it takes into account theeffect of changes inprice. For example if a firm can sell 10 units at Rs.20 each or 11 unitsat 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 RevenueconceptsIn order to understand the relationship between TR, AR and MR, we can preparea hypotheticalrevenue schedule.11. From the table, it is clear that:MR falls as more units are sold.TR increases as moreunits are sold but at a diminishing rate.TR is the highest when MR is zeroTR falls whenMR become negativeAR and MR both falls, but fall in MR is greater than AR i.e., MRfalls more steeply than AR. Relationship between AR and MR and the nature of AR andMR curves under difference market conditions1. under Perfect MarketUnder perfect
  5. 5. competition, an individual firm by its own action cannot influence the marketprice. Themarket price is determined by the interaction between demand and supply forces. Afirmcan sell any amount of goods at the existing market prices. Hence, the TR of thefirmwould increase proportionately with the output offered for sale. When the totalrevenue increasesin direct proportion to the sale of output, the AR would remainconstant. Since the market priceof it is constant without any variation due to changes inthe units sold by the individual firm, theextra output would fetch proportionate increasein the revenue. Hence, MR & AR will be equalto each other and remain constant. Thiswill be equal to price.12. Under perfect market condition, the AR curve will be a horizontal straight line andparallel toOX axis. This is because a firm has to sell its product at the constant existingmarket price. TheMR cure also coincides with the AR curve. This is because additionalunits are sold at the sameconstant price in the market.2. under Imperfect MarketUnder allforms of imperfect markets, the relation between TR, AR, and MR is different. Thiscanbe understood with the help of the following imaginary revenue schedule.From the abovetable it is clear that:In order to increase the sales, a firm is reducing its price, hence ARfallsAs a result of fall in price, TR increase but at a diminishing rate13. TR will be higher when MR is zeroTR falls when MR becomes negativeFrom theabove table it is clear that:In order to increase the sales, a firm is reducing its price, henceAR falls.As a result of fall in price, TR increase but at a diminishing rate.TR will behigher 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 MRcurves is determined by the elasticity ofdemand on the average revenue curve.Underimperfect 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 MRis less than AR. AR and MRcurves are different. Generally MR curve lies below the ARcurve.The AR curve of the firm or the seller and the demand curve of the buyer is thesameSince, the demand curve represents graphically the quantities demanded by thebuyers at variousprices it shows the AR at which the various amounts of the goods thatare sold by the seller. Thisis because the price paid by the buyer is the revenue for theseller (One man‘s expenditure isanother man‘s income). Hence, the AR curve of the firmis the same thing as that of the demandcurve of the consumers.14. Suppose, a consumer buys 10 units of a product when the price per unit is Rs.5 perunit.Hence, the total expenditure is 10 x 5 = Rs.50/-. The seller is selling 10 units at therate of Rs.5per unit. Hence, his total income is 10 x 5 = Rs.50/-.Thus, it is clear that ARcurve and demand curve is really one and the same.15. Q6. Distinguish between a firm and an industry. Explain the equilibrium of a firmandindustry under perfect competition.Ans. Distinguish between a firm and anindustryAn industry is the name given to a certain type of manufacturing or retailingenvironment.For example, the retail industry is the industry that involves everything fromclothes tocomputers, anything in the shops that get sold to the public. The retail industryis very vast andhas many sub divisions, such as electrical and cosmetics. Morespecialized industries deal with aspecific thing. The steel industry is a more specializedindustry, dealing with the making of steeland selling it on to buyers.The differencebetween this and a firm is that a firm is the company that operates within theindustry to
  6. 6. 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 corporatecompany that controls a number of chains in the industry it isoperating within.Forexample in retail, the firm Arcadia stores own the clothing chains Top shop,DorothyPerkins, Miss Selfridge, and Evans. These all operate for the firm Arcadia withinthe industry ofretail.Several firms can operate in one industry to ensure that there isalways 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 notnecessary within the industry andindependent chains and retailers can enter straight intothe market without a firm behind them,although this is risky. This is because one of theadvantages of having a firm behind you is that itis a safeguard against possiblebankruptcy because the firm can support the chain that it owns.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 toproducecommodities that it sells to other firms, to households, or to the government.‖Industry is a group of firms producing standardized products in a market. AccordingtoLipsey, ―Industry is a group of firms that sells a well defined product or closelyrelated set ofproducts.‖Conditions of Equilibrium of the Firm and Industry A firm is inequilibrium when it has no propensity to modify its level of productivity. Itrequiresneither extension nor retrenchment. It wants to earn maximum profits in by equatingitsmarginal cost with its marginal revenue, i.e. MC = MR. Diagrammatically, theconditions ofequilibrium of the firm are (1) the MC curve must equal the MR curve.Thisis the first order and essential condition. But this is not a sufficient condition which maybefulfilled yet the firm may not be in equilibrium.(2) The MC curve must cut the MRcurve from below and after the point of equilibrium it mustbe above the MR.This is thesecond order condition. Under conditions of perfect competition, the MR curve of afirmoverlaps with the AR curve. The MR curve is parallel to the X axis. Hence the firm isinequilibrium when MC = MR = AR.17. The first order figure (1), the MC curve cuts the MR curve first at point X. It contendsthecondition of MC = MR, but it is not a point of maximum profits for the reason thatafter point X,the MC curve is beneath the MR curve. It does not pay the firm to producethe minimum outputOM when it can earn huge profits by producing beyond OM. Point Yis of maximum profitswhere both the situations are fulfilled.Amidst points X and Y itpays 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 ofproductivitywhere the firm fulfils both the circumstances of equilibrium. If it has any plantstoproduce more than OM1 it will be incurring losses, for its marginal cost exceeds itsmarginalrevenue beyond the equilibrium point Y. The same finale hold good in the caseof 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 andnext, when each firm is also in equilibrium. The first clause entails thatthe average costcurves overlap with the average revenue curves of all the firms in the industry.They areearning only normal profits, which are believed to be incorporated in the averagecostcurves of the firms. The second condition entails the equality of MC and MR. Under
  7. 7. a perfectlycompetitive industry these two circumstances must be fulfilled at the point ofequilibrium i.e.MC = MR….(1), AC = AR…. (2), AR = MR.Hence MC = AC = AR.Such a position represents full equilibrium of the industry.18. Short Run Equilibrium of the Firm and Industry1. Short Run Equilibrium of theFirmA firm is in equilibrium in the short run when it has no propensity to enlarge orcontract itsproductivity and needs to earn maximum profit or to incur minimumlosses.The short run is an epoch of time in which the firm can vary its productivity bychanging theerratic factors of production. The number of firms in the industry is fixedsince neither theexisting firms can leave nor new firms can enter it.Postulations All firmsuse standardised factors of production Firms are of diverse competence Cost curves offirms are dissimilar from each other All firms sell their produces at the equal priceascertained 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 thefirm can be described with the helps of marginal study and total cost revenuestudy.Marginal Cost, Marginal Revenue analysis – During the short run, a firm willproduce only itsprice equals average variable cost or is higher than the average variablecost (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 totalcosts, i.e. P = AR = ATCthe firm will be earning normal profits or break even.If priceequals 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 throughshort run.So during the short run, under perfect competition, affirm is in equilibrium inall the abovementioned stipulations.Super normal profits – The firm will be earning supernormal profits in the short run when priceis higher than the short run average cost.19. Normal Profits = The firm may earn normal profits when price equals the short runaveragecosts.Total Cost – Total Revenue Analysis – The short run equilibrium of the firmcan also berepresented with the help of total cost and total revenue curves. The firm isable to maximise itsprofits when the positive discrimination between TR and TC is thegreatest. Short Run Equilibrium of the IndustryAn industry is in equilibrium in the shortrun when its total output remains steady there being nopropensity to enlarge or contractits productivity. If all firms are in equilibrium the industry isalso in equilibrium. For fullequilibrium of the industry in the short run all firms must be earningnormal profits.Butfull equilibrium of the industry is by sheer accident for the reason that in the short rumsomefirms may be earning super normal profits and some losses. Even then the industryis in short runequilibrium when its quantity demanded and quantity supplied is equal atthe price which clearsthe market.Online Live Tutor Conditions of Equilibrium of theFirm and Industry: We have the best tutors in Economics in the industry. Our tutors canbreak down a complexConditions of Equilibrium of the Firm and Industry problem intoits sub parts and explain to youin detail how each step is performed. This approach ofbreaking down a problem has beenappreciated by majority of our students for learningConditions of Equilibrium of the Firm andIndustry concepts. You will get one-to-onepersonalized 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 forConditions of Equilibrium of the Firm and Industrytutoring and experience the qualityyourself.
  8. 8. 20. Online Equilibrium of the Firm and Industry Help: If you are stuck with Equilibriumof the Firm and Industry Homework problem and needhelp, we have excellent tutors whocan provide you with Homework Help. Our tutors whoprovide Equilibrium of the Firmand Industry help are highly qualified. Our tutors have manyyears of industry experienceand have had years of experience providing Equilibrium of the Firmand IndustryHomework Help. Please do send us the Equilibrium of the Firm and Industryproblems onwhich you need help and we will forward then to our tutors for review.Other topics underProduct Pricing: Applications of Demand and Supply Analysis under Perfect CompetitionConcepts of Revenue Derived Demand, Joint Supply Determination of ProfitMaximization under monopolist situation Duopoly and Oligopoly Forms of MarketStructure Importance of Time Element in Price Theory Joint Demand Supply LinearProgramming Long Run Equilibrium of Firm and Industry Market StructuresMonopolistic Competition Monopsony and Bilateral Monopoly, Price outputDetermination Objectives of Business Firm Oligopoly, Cornet‘s Oligopoly Model Pricingof Public Undertakings Profit Maximization, Full cost, Pricing and Sales MaximizationPricing Under Perfect Competition - Demand Supply - Basic Framework Profit PricePolicy Resource allocation under monopoly Short, Long Run Supply Curve of the Firmand Industry Similarities and Dissimilarities between Monopoly Competition and PerfectCompetition Supply Its Law - Elasticity and Curve The Nature of Costs and Cost CurvesWilliamsons Utility Maximization21. Set 2Q1. Suppose your manufacturing company planning to release a new productinto market,Explain the various methods forecasting for a new product.Ans.When amanufacturing companies planning to release a new product into themarket, itshouldperform the demand forecasting to check the demand of the product in the marketand also theavailability of similar product in the market.Demand forecasting for newproducts is quite different from that for established products. Herethe firms will not haveany past experience or past data for this purpose. An intensive study ofthe economic andcompetitive characteristics of the product should be made to make efficientforecasts.Asper Professor Joel Dean, few guidelines to make forecasting of demand for newproductsare:a. Evolutionary approachThe demand for the new product may be considered as anoutgrowth of an existing product. Fore.g., Demand for new Tata Indica, which is amodified version of Old Indica can most effectivelybe projected based on the sales of theold Indica, the demand for new Pulsor can be forecastedbased on the sales of the oldPulsar. Thus when a new product is evolved from the old product,the demand conditionsof the old product can be taken as a basis for forecasting the demand forthe newproduct.b. Substitute approachIf the new product developed serves as substitute for theexisting 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 thebasis of intelligent forecasts for independent variablesthat influence the demand for thesubstitutes. After that, a portion of the market can be sliced outfor the new product. Fore.g., A moped as a substitute for a scooter, a cell phone as a substitutefor a land line. Insome cases price plays an important role in shaping future demand for theproduct.22. c. Opinion Poll approachUnder this approach the potential buyers are directlycontacted, or through the use of samples ofthe new product and their responses are foundout. These are finally blown up to forecastthe demand for the new product.d. Salesexperience approachOffer the new product for sale in a sample market; say supermarkets
  9. 9. or big bazaars in big cities,which are also big marketing centers. The product may beoffered for sale through one supermarket and the estimate of sales obtained may be‗blown up‘ to arrive at estimated demand forthe product.e. Growth CurveapproachAccording to this, the rate of growth and the ultimate level of demand for thenew 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 levelof demand for the existing car.f. Vicarious approachA firm will survey consumers‘reactions to a new product indirectly through getting in touchwith some specialized andinformed dealers who have good knowledge about the market, aboutthe different varietiesof the product already available in the market, the consumers‘ preferencesetc. This helpsin making a more efficient estimation of future demand.23. Q2. Define the term equilibrium. Explain the changes in market equilibrium andeffects toshifts in supply and demand.Ans. EquilibriumThe word equilibrium is derivedfrom the Latin word a ―equilibrium‖ which means equalbalance. It means a state ofeven balance in which opposing forces or tendencies neutralize eachother. It is a positionof rest characterized by absence of change. It is a state where there iscomplete agreementof the economic plans of the various market participants so that no one has atendency torevise or alter his decision. In the words of professor Mehta: ―Equilibrium denotesineconomics absence of change in movement‖.Market EquilibriumThere are twoapproaches to market equilibrium viz., partial equilibrium approach and thegeneralequilibrium approach. The partial equilibrium approach to pricing explainspricedetermination of a single commodity keeping the prices of other commoditiesconstant. On theother hand, the general equilibrium approach explains the mutual andsimultaneousdetermination of the prices of all goods and factors. Thus it explains a multimarket equilibriumposition. Earlier to Marshall, there was a dispute among economistson whether the force of demand orthe force of supply is more important in determiningprice. Marshall gave equal importance toboth demand and supply in the determination ofvalue or price. He compared supply and demandto a pair of scissors We might asreasonably dispute whether it is the upper or the under blade of a pair of scissors thatcutsa piece of paper, as whether value is governed by utility or cost of production. Thusneitherthe upper blade nor the lower blade taken separately can cut the paper; both havetheirimportance in the process of cutting. Likewise neither supply alone, nor demandalonecan determine the price of a commodity, both are equally important in thedetermination of price.But the relative importance of the two may vary depending uponthe time under consideration.Thus, the demand of all consumers and the supply of allfirms together determine the price ofa commodity in the market.24. Equilibrium between demand and supply price:Equilibrium between demand andsupply price is obtained by the interaction of these two forces.Price is an independentvariable. Demand and supply are dependent variables. They depend onprice. Demandvaries inversely with price; arise in price causes a fall in demand and a fall inprice causesa rise in demand. Thus the demand curve will have a downward slope indicatingtheexpansion of demand with a fall in price and contraction of demand with a rise inprice. On theother hand supply varies directly with the changes in price, a rise in pricecauses arise in supplyand a fall in price causes a fall in supply. Thus the supply curve willhave an upward slope. At apoint where these two curves intersect with each other theequilibrium price is established. Atthis price quantity demanded is equal to the quantity
  10. 10. demanded.This we can explain with the help of a table and a diagramIn the table at Rs.20the quantity demanded is equal to the quantity supplied. Since the price isagreeable toboth the buyer and sellers, there will be no tendency for it to change; this iscalledequilibrium price. Suppose the price falls to Rs.5 the buyer will demand 30 unitswhile the sellerwill supply only 5 units. Excess of demand over supply pushes the priceupward until it reachesthe equilibrium position supply is equal to the demand. On theother hand if the price rises toRs.30 the buyer will demand only 5 units while the sellersare ready to supply 25 units. Sellerscompete with each other to sell more units of thecommodity. Excess of supply over demandpushes the price downward until it reaches theequilibrium. This process will continue till theequilibrium price of Rs.20 is reached. Thusthe interactions of demand and supply forces actingupon each other restore theequilibrium position in the market. In the diagram DD is the demandcurve, SS is thesupply curve. Demand and supply are in equilibrium at point E where the two25. 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 quantitydemandedisP2D2. Thus D2S2 is the excess supply which the seller wants to push into themarket,competition among the sellers will bring down the price to the equilibrium levelwhere thesupply is equal to the demand. At price OP1, the buyers will demand P1D1quantity while thesellers are ready to sell P1S1. Demand exceeds supply. Excess demandfor goods pushes up theprice; this process will go until equilibrium is reached wheresupply becomes equal to demand.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 suppliersdetermine the quantity of factors to hire?Below, we work through an example where arepresentative 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 priceof 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 todeterminethe producer‘s total cost. We call the total cost equation an iso-cost line (it‘s similar toabudget constraint).The producer‘s iso-cost line is:10L + 50K = TC (1)The producer‘sproduction function is assumed to take the following form:q = (KL) 0.5 (2)Ourproducer‘s first step is to decide how much output to produce. Suppose that quantity is1000units of output. In order to produce those 1000 units of output, our producer mustget acombination of L and K that makes (2) equal to 1000. Implicitly, this means that wemust 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 possibleiso-quants):K = 1,000,000/L (2a)For any given value of L, (2a) gives us a correspondingvalue for K. Graphing these values, withK on the vertical axis and L on the horizontalaxis, we obtain the blue line on the graph below.Each point on this curve is represented asa combination of K and L that yields an output level of1000 units. Therefore, as we movealong this iso-quant output is constant (much like the fact thatutility is constant as A basicunderstanding of statistics is a critical component of informeddecision making.27. Q4. Critically examine the Marris growth maximizing model??Ans.Profitmaximization is traditional objective of a firm. Sales maximization objective isexplainedby Prof. Boumal. On similar lines, Prof. Marris has developed another
  11. 11. alternative growthmaximization model in recent years. It is a common factor to observethat each firm aims atmaximizing its growth rate as this goal would answer many of theobjectives of a firm. Marrispoints out that a firm has to maximize its balanced growth rateover a period of time.Marris assumes that the ownership and control of the firm is in thehands of two groups ofpeople, i.e. owner and managers. He further points out that both ofthem have two distinctivegoals. Managers have a utility function in which the amount ofsalary, status, position, power,prestige and security of job etc are the most import variablewhere as in case of are moreconcerned about the size of output, volume of profits, marketshares and sales maximization.Utility function of the manager and that the owner areexpressed 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.]Inview of Marris the realization of these two functions would depend on the size of thefirm.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 whichincludes total volumeof the asset, inventory level, cash reserve etc. He further points outthat the managers always aimat maximizing the rate of growth of the firm rather thangrowth 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 alsothe 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 modelisdeveloped by Prof. W.J. Boumal, an American economist. This alternative goal hasassumedgreater significance in the context of the growth of the oligopolistic firms. Themodel highlightsthat the primary objective of the firm is to maximize its sales rather thanprofit maximization. Itstates that the goal of the firm is maximization of sales revenuesubject to a minimum profitconstraint. The minimum profit constraint is determined bythe expectation of the share holders.This is because no company can displease theshareholders. It is to be noted here thatmaximization of sales does not meanmaximization of physical sales but maximization of totalsales revenue. Hence, themanagers are more interested in increasing sales rather than profit. Thebasic philosophyis that when sales are maximized automatically profits of the company would28. also go up. Hence, attention is diverted to increase the sales of the company in recentyears in thecontext of highly competitive market.How Profit Maximization model differsfrom Sales Maximization model:The sale maximization model differs on the followinggrounds: Emphasis is given on maximizing sales rather than profit. Increase thecompetitive and operational ability of the company. The amount of slack earning andsalaries of the top managers are directly linked to it. It helps in enhancing the prestige andreputation of top management, distributes more dividends to share holders and increasesthe wage of the workers and keeps them happy. The financial and other lendinginstitutions always keep a watch on the sales revenue of a firm as it is an indication offinancial health of the firm.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 theway in which prices aredetermined under different market conditions. However, inreality, a firm adopts differentpolicies and methods to fix the price of its products.Pricingpolicy refers to the policy of setting the price of the product or products and servicesbythe management after taking into account of various internal and external factors,
  12. 12. forces and itsown business objectives.Pricing Policy basically depends on price theorythat is the corner stone of economic theory.Pricing is considered as one of the basic andcentral problems of economic theory in a moderneconomy. Fixing prices are the mostimportant aspect of managerial decision making becausemarket price charged by thecompany affects the present and future production plans, pattern ofdistribution, nature ofmarketing etc. Generally speaking, in economic theory, we take intoaccount of only twoparties, i.e., buyers and sellers while fixing the prices. However, in practicemany partiesare associated with pricing of a product. They are rival competitors, potentialrivals,middlemen, wholesalers, retailers, commission agents and above all the Govt.Hence, we shouldgive due consideration to theinfluence exerted by these parties in theprocess of pricedetermination. Broadly speaking, the various factors and forces that affectthe price are dividedinto two categories.They are as follows: I External Factors (Outsidefactors)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 andreputation of a firm in the market.6. Trends in the market.30. 7. Purchasing power of the buyers.8. Bargaining power of customers9. Buyersbehavior in respect of particular product II. Internal Factors (Inside Factors)1. Objectivesof the firm.2. Production Costs.3. Quality of the product and its characteristics.4. Scale ofproduction.5. Efficient management of resources.6. Policy towards percentage of profitsand dividend distribution.7. Advertising and sales promotion policies.8. Wage policy andsales turn over policy etc.9. The stages of the product on the product life cycle.10. Usepattern of the product. Objectives of the Price Policy:A firm has multiple objectivestoday. In spite of several objectives, the ultimate aim of everybusiness concern is tomaximize its profits. This is possible when the returns exceed costs. In thiscontext,setting an ideal price for a product assumes greater importance. Pricing objectives hastobe established by top management to ensure not only that the company‘s profitability isadequatebut 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. The Following objectives are to be considered while fixing the prices of theproduct.1. Profit maximization in the short termThe primary objective of the firm is tomaximize its profits. Pricing policy as an instrument toachieve this objective should beformulated in such a way as to maximize the sales revenue andprofit. Maximum profitrefers to the highest possible of profit.In the short run, a firm not only should be able torecover its total costs, but also should getexcess revenue over costs. This will build themorale of the firm and instill the spirit ofconfidence in its operations.2. Profitoptimization in the long runThe traditional profit maximization hypothesis may not provebeneficial in the long run. With thesole motive of profit making a firm may resort toseveral kinds of unethical practices likecharging exorbitant prices, follow MonopolyTrade Practices (MTP), Restrictive Trade Practices(RTP) and Unfair Trade Practices(UTP) etc. This may lead to opposition from the people. Inorder to over- come theseevils, a firm instead of profit maximization, and aims at profitoptimization.Optimumprofit refers to the most ideal or desirable level of profit.Hence, earning the mostreasonable or optimum profit has become a part and parcel of a soundpricing policy of afirm in recent years.3. Price StabilizationPrice stabilization over a period of time isanother objective. The prices as far as possible shouldnot fluctuate too often. Price
  13. 13. instability creates uncertain atmosphere in business circles. Salesplan becomes difficultunder such circumstances. Hence, price stability is one of the prerequisiteconditions forsteady and persistent growth of a firm. A stable price policy only can win theconfidenceof customers and may add to the good will of the concern. It builds up the reputationandimage of the firm.4. Facing competitive situationOne of the objectives of the pricingpolicy is to face the competitive situations in the market. Inmany cases, this policy hasbeen merely influenced by the market share psychology. Wherevercompanies are awareof specific competitive products, they try to match the prices of theirproducts with thoseof their rivals to expand the volume of their business. Most of the firms arenot merelyinterested in meeting competition but are keen to prevent it. Hence, a firm is alwaysbusywith its counter business strategy.32. 5. Maintenance of market share Market share refers to the share of a firm‘s sales of aparticular product in the total sales of allfirms in the market.The economic strength andsuccess of a firm is measured in terms of its market share. In acompetitive world, eachfirm makes a successful attempt to expand its market share. If it isimpossible, it has tomaintain its existing market share. Any decline in market share is asymptom of the poorperformance of a firm.Hence, the pricing policy has to assist a firm to maintain its marketshare at any cost.33. Q6. Discuss the various measures that may be taken by a firm to counteract the evileffectsof a trade cycle.Ans. FACTORS THAT SHAPE BUSINESS CYCLESForcenturies, economists in both the United States and Europe regarded economic downturnsas"diseases" that had to be treated; it followed, then, that economies characterized bygrowth andaffluence were regarded as "healthy" economies. By the end of the 19thcentury, however, manyeconomists had begun to recognize that economies were cyclicalby their very nature, and studiesincreasingly turned to determining which factors wereprimarily responsible for shaping thedirection and disposition of national, regional, andindustry-specific economies. Today,economists, corporate executives, and businessowners cite several factors as particularlyimportant in shaping the complexion ofbusiness environments.VOLATILITY OF INVESTMENT SPENDINGVariations ininvestment spending is one of the important factors in business cycles.Investmentspending is considered the most volatile component of the aggregate or totaldemand (it variesmuch more from year to year than the largest component of theaggregate demand, theconsumption spending), and empirical studies by economists haverevealed that the volatility ofthe investment component is an important factor inexplaining business cycles in the UnitedStates. According to these studies, increases ininvestment spur a subsequent increase inaggregate demand, leading to economicexpansion. Decreases in investment have the oppositeeffect. Indeed, economists can pointto several points in American history in which theimportance of investment spending wasmade quite evident. The Great Depression, for instance,was caused by a collapse ininvestment 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 severalreasons for the volatility that can often be seen in investment spending. Onegenericreason is the pace at which investment accelerates in response to upward trends insales.This linkage, which is called the acceleration principle by economists, can bebriefly explainedas follows. Suppose a firm is operating at full capacity. When sales of itsgoods increase, outputwill have to be increased by increasing plant capacity through
  14. 14. further investment. As a result,changes in sales result in magnified percentage changes ininvestment expenditures. Thisaccelerates the pace of economic expansion, whichgenerates greater income in the economy,leading to further increases in sales. Thus, oncethe 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 anincrease in sales has peaked and is beginning to slow,investment spending falls. Thus, thepace of investment spending is influenced by changes in therate of sales.34. MOMENTUMMany economists cite a certain "follow-the-leader" mentality inconsumer spending. In situationswhere consumer confidence is high and people adoptmore free-spending habits, other customersare deemed to be more likely to increase theirspending as well. Conversely, downturns inspending tend to be imitated aswell.TECHNOLOGICAL INNOVATIONSTechnological innovations can have an acuteimpact on business cycles. Indeed, technologicalbreakthroughs in communication,transportation, manufacturing, and other operational areas canhave a ripple effectthroughout an industry or an economy. Technological innovations may relatetoproduction and use of a new product or production of an existing product using a newprocess.The video imaging and personal computer industries, for instance, haveundergone immensetechnological innovations in recent years, and the latter industry inparticular has had apronounced impact on the business operations of countlessorganizations. However,technological innovations—and consequent increases ininvestment—take place at irregularintervals. Fluctuating investments, due to variations inthe pace of technological innovations,lead to business fluctuations in the economy.Thereare many reasons why the pace of technological innovations varies. Major innovationsdonot occur every day. Nor do they take place at a constant rate. Chance factors greatlyinfluencethe timing of major innovations, as well as the number of innovations in aparticular year.Economists consider the variations in technological innovations as random(with no systematicpattern). Thus, irregularity in the pace of innovations in new productsor processes becomes asource of business fluctuations.VARIATIONS ININVENTORIESVariations in inventories—expansion and contraction in the level ofinventories of goods kept bybusinesses—also contribute to business cycles. Inventoriesare the stocks of goods firms keep onhand to meet demand for their products. How dovariations in the level of inventories triggerchanges in a business cycle? Usually, during abusiness downturn, firms let their inventoriesdecline. As inventories dwindle, businessesultimately find themselves short of inventories. As aresult, they start increasing inventorylevels by producing output greater than sales, leading to aneconomic expansion. Thisexpansion continues as long as the rate of increase in sales holds upand producerscontinue to increase inventories at the preceding rate. However, as the rate ofincrease insales slows, firms begin to cut back on their inventory accumulation. Thesubsequentreduction in inventory investment dampens the economic expansion, andeventually causes aneconomic downturn. The process then repeats itself all over again. Itshould be noted that whilevariations in inventory levels impact overall rates of economicgrowth, the resulting businesscycles are not really long. The business cycles generated byfluctuations in inventories are35. called minor or short business cycles. These periods, which usually last about two tofour years,are sometimes also called inventory cycles.FLUCTUATIONS IN
  15. 15. GOVERNMENT SPENDINGVariations in government spending are yet another sourceof business fluctuations. This mayappear to be an unlikely source, as the government iswidely considered to be a stabilizing forcein the economy rather than a source ofeconomic fluctuations or instability. Nevertheless,government spending has been a majordestabilizing force on several occasions, especiallyduring and after wars. Governmentspending increased by an enormous amount during WorldWar II, leading to an economicexpansion that continued for several years after the war.Government spending alsoincreased, though to a smaller extent compared to World War II,during the Korean andVietnam wars. These also led to economic expansions. However,government spendingnot only contributes to economic expansions, but economic contractions aswell. In fact,the recession of 1953-54 was caused by the reduction in government spending aftertheKorean War ended. More recently, the end of the Cold War resulted in a reduction indefensespending by the United States that had a pronounced impact on certain defense-dependentindustries and geographic regions.POLITICALLY GENERATED BUSINESSCYCLESMany economists have hypothesized that business cycles are the result of thepoliticallymotivated use of macroeconomic policies (monetary and fiscal policies) thatare designed toserve the interest of politicians running for re-election. The theory ofpolitical business cycles ispredicated on the belief that elected officials (the president,members of congress, governors,etc.) have a tendency to engineer expansionarymacroeconomic policies in order to aid their re-election efforts.MONETARYPOLICIESVariations in the nations monetary policies, independent of changes inducedby politicalpressures, are an important influence in business cycles as well. Use of fiscalpolicy—increasedgovernment spending and/or tax cuts—is the most common way ofboosting aggregate demand,causing an economic expansion. Moreover, the decisions ofthe Federal Reserve, which controlsinterest rates, can have a dramatic impact onconsumer and investor confidence as well.FLUCTUATIONS IN EXPORTS ANDIMPORTS The difference between exports and imports is the net foreign demand forgoods and services,also called net exports. Because net exports are a component of theaggregate demand in theeconomy, variations in exports and imports can lead to businessfluctuations as well. There aremany reasons for variations in exports and imports overtime. Growth in the gross domestic36. product of an economy is the most important determinant of its demand for importedgoods—aspeoples incomes grow, their appetite for additional goods and services,including goodsproduced abroad, increases. The opposite holds when foreign economiesare growing—growth inincomes in foreign countries also leads to an increased demandfor imported goods by theresidents of these countries. This, in turn, causes U.S. exportsto grow. Currency exchange ratescan also have a dramatic impact on internationaltrade—and hence, domestic business cycles—aswell. KEYS TO SUCCESSFULBUSINESS CYCLE MANAGEMENTSmall business owners can take several steps tohelp ensure that their establishments weatherbusiness cycles with a minimum ofuncertainty and damage. "The concept of cycle managementmay be relatively new,"wrote Matthew Gallagher in Chemical Marketing Reporter, "but italready has manyadherents who agree that strategies that work at the bottom of a cycle need tobe adoptedas much as ones that work at the top of a cycle. While there will be no definitiveformulafor every company, the approaches generally stress a long-term view which focuses onafirms key strengths and encourages it to plan with greater discretion at all times.
  16. 16. Essentially,businesses are operating toward operating on a more even keel."Specific tipsfor managing business cycle downturns include the following:Flexibility — According toGallagher, "part of growth management is a flexible business planthat allows fordevelopment times that span the entire cycle and includes alternative recession-resistantfunding structures."Long-Term Planning—Consultants encourage small businesses toadopt a moderate stance intheir long-range forecasting.Attention to Customers—this canbe an especially important factor for businesses seeking toemerge from an economicdownturn. "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 IndustryWeek. "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 theirinterestin placing large orders in coming months."Objectivity—Small business owners need tomaintain a high level of objectivity when ridingbusiness cycles. Operational decisionsbased on hopes and desires rather than a soberexamination of the facts can devastate abusiness, especially in economic down periods.37. Study—"Timing any action for an upturn is tricky, and the consequences of beingearly or lateare serious," said Daltas. "For example, expanding a sales force when themarkets dontmaterialize not only places big demands on working capital, but also makesit hard to sustain themotivation of the sales-people. If the force is improved too late, thecost is decreased marketshare or decreased quality of the customer base. How does thecompany 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 relysolely 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. THANK YOU