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

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Summer / May 2012 Master of Business Administration Semester I MB0042 – Managerial Economics - 4 Credits (Book ID: B1131) Assignment Set- 1 (60 Marks) Note: Each Question carries 10 marks. Answer all the questions. Q1. Distinguish between a firm and an industry. Explain the equilibrium of a firm and industry under perfect competition. An : An 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 to computers, anything in the shops that get sold to the public. The retail industry is very vast and has many sub divisions, such as electrical and cosmetics. More specialised industries deal with a specific thing. The steel industry is a more specialised industry, dealing with the making of steel and selling it on to buyers. The difference between this and a firm is that a firm is the company that operates within the industry to create the product. The firm might be a factory, or the chain of stores that sells the clothes, within its industry. For example, one firm that makes steel might be Avida steel. They create the steel in that firm for the steel industry.

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Page 1: 104774114 mb0042-mb0042-–-managerial-economics-november-2012

Summer / May 2012

Master of Business Administration

Semester I

MB0042 – Managerial Economics - 4 Credits

(Book ID: B1131)

Assignment

Set- 1 (60 Marks)

Note: Each Question carries 10 marks. Answer all the questions.

Q1. Distinguish between a firm and an industry. Explain the equilibrium of a firm and

industry under perfect competition.

An : An 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 to computers, anything in the shops that get sold to the public. The retail industry is

very vast and has many sub divisions, such as electrical and cosmetics. More specialised

industries deal with a specific thing. The steel industry is a more specialised industry, dealing

with the making of steel and selling it on to buyers.

The difference between this and a firm is that a firm is the company that operates within the

industry to create the product. The firm might be a factory, or the chain of stores that sells the

clothes, within its industry. For example, one firm that makes steel might be Avida steel.

They create the steel in that firm for the steel industry.

A firm is usually a corporate company that controls a number of chains in the industry it is

operating within. For example in retail, the firm Arcadia stores owns the clothing chains Top

shop, Dorothy Perkins, Miss Selfridge, and Evans. These all operate for the firm Arcadia

within the industry of retail.

Several firms can operate in one industry to ensure that there is always competition to keep

prices reasonable and stop the market becoming a monopoly, which is where one firm is in

charge of the whole industry. Sometimes, a firm is not necessary within the industry and

independent 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

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you is that it is a safeguard against possible bankruptcy because the firm can support the

chain that it owns.

Profit maximization is one of the important assumptions of economics. It is assumed that the

entrepreneur always tries to maximize profit. Hence the firm or entrepreneur is said to be in

equilibrium if the profit is maximized. According to Tibor Sitovosky "A market or an

economy or any other group of persons and firms is in equilibrium when none of its

member's fells impelled to change his behaviour". Naturally, the firm will not try to change

its position when it is in equilibrium by maximizing profit.

There are two approaches to explain the equilibrium of the firm regards to profit

maximization. They are - total revenue-total cost approach and marginal revenue-marginal

cost approach. Here we concentrate only on MR - MC approach.

The equilibrium of firm on the basis of MR - MC approach has been presented in the table

below

According to MT -MC approach, when marginal revenue equals marginal cost the firm is in

equilibrium and gets maximum profit. Hence, a rational producer determines the quality of

output where marginal revenue equals marginal cost.

The difference between total revenue and total cost is highest 210, at four units of output. At

this output, both marginal revenue and marginal cost are equal, 80. Hence profit is

maximized. The firm is in equilibrium. It should be noted that the table relates to imperfect

competition, when price is reduced to sell more.

The following two conditions are necessary for a firm to be in equilibrium.

(a) The marginal revenue should be equal to marginal cost.

(b) The marginal cost curve should cut marginal revenue curve from below.

The equilibrium of a under to MR - MC approach has been presented in figure:-

The figure depicts the equilibrium of a firm under perfect competition. The same is

applicable to the firms under imperfect competition. The only difference is that the AR & MR

curves under imperfect competition are different and they are downward sloping.

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In the figure 'OP' is the given price. Since, under perfect competition, average revenue equals

marginal revenue, the AR and MR curves are horizontal from P. The profit-maximizing

output is OM. Here, marginal revenue and marginal cost are equal. It is because MC and MR

curves intersect each other at point E. The firm earns profit equal to PEBC.

The first condition necessary for firm's equilibrium is that marginal cost should be equal to

marginal revenue. But this is not a sufficient condition. It is because the firm may not be in

equilibrium even if this condition is fulfilled. In the figure, this condition is fulfilled at point

F. but the firm is not in equilibrium. The profit is maximized only at output OM which is

higher than output ON.

The second condition necessary for equilibrium is that the marginal cost curve must cut

marginal revenue curve from below. This implies that marginal cost should be rising at the

point of intersection with MR curve. Hence, both the conditions have been fulfilled at point

E. In the figure, MC curve cuts MR curve from at point F from above. Hence, this point

cannot be the point of stable equilibrium. It is because before that point marginal cost exceeds

marginal revenue. It shows that it is not reasonable to increase output. After point F, the MR

curve lies above MC curve. This shows that it is reasonable to increase output.

Q2. Give a brief description of

a. Implicit and explicit cost

b. Actual and opportunity cost

a. Implicit and explicit cost

b.c.

d. a. Implicit and explicit cost

e.f. Implicit cost

g.h.i. In economics, an implicit cost, also called an imputed cost, implied cost, or notional

cost, is the opportunity cost equal to what a firm must give up in order using factors which it neither purchases nor hires. It is the opposite of an explicit cost, which is borne directly. In other words, an implicit cost is any cost that results from using an asset instead of renting, selling, or lending it. The term also applies to forgone income from choosing not to work.

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j. Implicit costs also represent the divergence between economic profit (total revenues minus total costs, where total costs are the sum of implicit and explicit costs) and accounting profit (total revenues minus only explicit costs). Since economic profit includes these extra opportunity costs, it will always be less than or equal to accounting profit

k.l.m.

n. Explicit cost o.

p.q. An explicit cost is a direct payment made to others in the course of running a

business, such as wage, rent and materials, as opposed to implicit costs, which are those where no actual payment is made. It is possible still to underestimate these costs, however: for example, pension contributions and other "perks" must be taken into account when considering the cost of labour.

r. Explicit costs are taken into account along with implicit ones when considering economic profit. Accounting profit only takes explicit costs into account.

s.t.u.v.w.

x. b. Actual and opportunity cost y.

z. Actual cost aa. An actual amount paid or incurred, as opposed to estimated cost or standard cost. In

contracting, actual costs amount includes direct labor, direct material, and other direct charges.

bb.cc. Cost accounting information is designed for managers. Since managers are taking

decisions only for their own organization, there is no need for the information to be comparable to similar information from other organizations. Instead, the important criterion is that the information must be relevant for decisions that managers operating in a particular environment of business including strategy make. Cost accounting information is commonly used in financial accounting information, but first we are concentrating in its use by managers to take decisions. The accountants who handle the cost accounting information generate add value by providing good information to managers who are taking decisions. Among the better decisions, the better performance of one's organization, regardless if it is a manufacturing company, a bank, a non-profit organization, a government agency, a school club or even a business school. The cost-accounting system is the result of decisions made by managers of an organization and the environment in which they make them.

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dd.ee.

ff. Opportunity cost gg.hh. Opportunity cost is the cost of any activity measured in terms of the value of the

next best alternative forgone (that is not chosen). It is the sacrifice related to the second best choice available to someone, or group, who has picked among several mutually exclusive choices. The opportunity cost is also the cost of the forgone products after making a choice. Opportunity cost is a key concept in economics, and has been described as expressing "the basic relationship between scarcity and choice". The notion of opportunity cost plays a crucial part in ensuring that scarce resources are used efficiently. Thus, opportunity costs are not restricted to monetary or financial costs: the real cost of output forgone, lost time, pleasure or any other benefit that provides utility should also be considered opportunity costs.

ii.jj.kk.

ll. Opportunity costs in production mm. Opportunity costs may be assessed in the decision-making process

of production. If the workers on a farm can produce either one million pounds of wheat or two million pounds of barley, then the opportunity cost of producing one pound of wheat is the two pounds of barley forgone (assuming the production possibilities frontier is linear). Firms would make rational decisions by weighing the sacrifices involved.

Q3. A firm supplied 3000 pens at the rate of Rs 10. Next month, due to a rise of in the price to 22 rs per pen the supply of the firm increases to 5000 pens. Find the elasticity of supply of the pens. Of course, consumption is not the only thing that changes when prices go up or down. Businesses also respond to price in their decisions about how much to produce. Economists define the price elasticity of supply as the responsiveness of the quantity supplied of a good to its market price.

More precisely, the price elasticity of supply is the percentage change in quantity supplied divided by the percentage change in price.

Suppose the amount supplied is completely fixed, as in the case of perishable pen brought to market to be sold at whatever price they will fetch. This is the limiting case of zero elasticity, or completely inelastic supply, which is a vertical supply curve.

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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 of the percentage change in quantity supplied to percentage change in price is extremely large and gives 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 percentage change in quantity is larger or smaller than the percentage change in price. Price elasticity of demand is a ratio of two pure numbers, the numerator is the percentage change in the quantity demanded and the denominator is the percentage change in price of the commodity. It is measured by the following formula: 

Ep = Percentage change in quantity demanded/ Percentage changed in price Applying the provided data in the equation: Percentage change in quantity demanded = (5000 – 3000)/3000Percentage changed in price = (22 – 10) / 10 

Ep = ((5000 – 3000)/3000) / ((22 – 10)/10)

= 1.2.

Q4. What is monetary policy? Explain the general objectives and instruments of monetary

policy

Monetary Policy

Monetary policy, in its narrow concept, is defined as the measures focused on regulating money supply. In harmony with monetary policy goals, as will be shown later, and adopting the most common concept of monetary policy as one of the central bank’s functions, monetary policy is defined as “ the set of procedures and measures taken by monetary authorities to manage money supply, interest and exchange rates and to influence credit conditions to achieve certain economic objectives”. We find this definition more consistent with the practical applications of monetary policy, particularly with respect to the difference from one country to another in objectives selected as a link between the instruments of monetary policy and its ultimate goals.

First: Monetary Policy and General Economic Policies

Monetary policy is basically a type of stabilization policy adopted by countries to deal with different economic imbalances. Since monetary policy covers the monetary aspect of the

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general economic policy, a high level of co-ordination is required between monetary policy and other instruments of economic policy. Further, the effectiveness of monetary policy and its relative importance as a tool of economic stabilization various from one economy to another, due to differences among economic structures, divergence in degrees of development in money and capital markets resulting in differing degree of economic progress, and differences in prevailing economic conditions. However, we may briefly mention that the weak effectiveness which is usually attributed to monetary policy in developing countries is caused by the fact that the economic problems in these countries are mainly structural and not monetary in nature, while the limited effectiveness of monetary policy in countries which lack developed money markets occurs because monetary policy is deprived of one of its major tools, the instrument of open market operations.

Also, there are those who belittle the effectiveness of monetary policy in time of recession, comparing the use of this policy in controlling recession as “pressing on a spring”. Many others see monetary policy as ineffective in controlling the inflation that results from an imbalance between the demand and supply of goods and services originating from the supply side, while they confirm the effectiveness of monetary policy in controlling inflation that results from increased demand. However, this does not preclude the effectiveness of monetary policy as a flexible instrument allowing the authorities to move quickly to achieve stabilization, apart from its importance in realizing external equilibrium in open economies.

Monetary Policy Instruments

The set of instruments available to monetary authorities may differ from one country to another, according to differences in political systems, economic structures, statutory and institutional procedures, development of money and capital markets and other considerations. In most advanced capitalist countries, monetary authorities use one or more of the following key instruments: changes in the legal reserve ratio, changes in the discount rate or the official key bank rate, exchange rates and open market operations. In many instances, supplementary instruments are used, known as instruments of direct supervision or qualitative instruments. Although the developing countries use one or more of these instruments, taking into consideration the difference in their economic growth levels, the dissimilarity in the patterns of their production structures and the degree of their of their link with the outside world, many resort to the method of qualitative supervision, particularly those countries which face problems arising from the nature of their economic structures. Although the effectiveness of monetary policy does not necessarily depend on using a wide range of instruments, coordinated use of various instruments is essential to the application of a rational monetary policy.

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Q5. Explain in brief the relationship between TR, AR, and MR under different market

condition.

Meaning and Different Types of Revenues

Revenue 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 its products, i.e. .gross revenue. In other words, it is the total sales receipts earned from the sale of its 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 total quantity sold at a given price as below. 

TR = f (q). It implies that higher the sales, larger would be the TR and vice-versa. TR is calculated by multiplying the quantity sold by its price. Thus, TR = PXQ. For e.g. a firm sells 5000 units of a commodity at the rate of Rs. 5 per unit, then TR would be

       

2. Average revenue (AR)

Average revenue is the revenue per unit of the commodity sold. It can be obtained by dividing the TR by the number of units sold. Then, AR = TR/Q AR = 150/15= 10.

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When different units of a commodity are sold at the same price, in the market, average revenue equals 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 revenue means price. Since the demand curve shows the relationship between price and the quantity demanded, it also represents the average revenue or price at which the various amounts of a commodity are sold, because the price offered by the buyer is the revenue from seller’s point of view. Therefore, average revenue curve of the firm is the same as demand curve of the consumer.

Therefore, in economics we use AR and price as synonymous except in the context of price discrimination by 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 a product. It is the additional revenue earned by selling an additional unit of output by the seller.

MR differs from the price of the product because it takes into account the effect of changes in price. For example if a firm can sell 10 units at Rs.20 each or 11 units at Rs.19 each, then the marginal revenue from the eleventh unit is (10 × 20) - (11 × 19) = Rs.9.

Relationship between Total revenue, Average revenue and Marginal Revenue concepts

In order to understand the relationship between TR, AR and MR, we can prepare a hypothetical revenue schedule.

From the table, it is clear that:

MR falls as more units are sold.

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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 conditions

1. under Perfect Market

Under perfect competition, an individual firm by its own action cannot influence the market price. The market price is determined by the interaction between demand and supply forces. A firm can sell any amount of goods at the existing market prices. Hence, the TR of the firm would increase proportionately with the output offered for sale. When the total revenue increases in direct proportion to the sale of output, the AR would remain constant. Since the market price of it is constant without any variation due to changes in the units sold by the individual firm, the extra output would fetch proportionate increase in the revenue. Hence, MR & AR will be equal to each other and remain constant. This will be equal to price.

 

 

   Under perfect market condition, the AR curve will be a horizontal straight line and parallel to OX axis. This is because a firm has to sell its product at the constant existing market price. The MR cure also coincides with the AR curve. This is because additional units are sold at the same constant price in the market.

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2. under Imperfect Market

Under all forms of imperfect markets, the relation between TR, AR, and MR is different. This can be understood with the help of the following imaginary revenue schedule.

From the above table it is clear that:

In order to increase the sales, a firm is reducing its price, hence AR fallsAs a result of fall in price, TR increase but at a diminishing rateTR will be higher when MR is zeroTR falls when MR becomes negative

From 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 zero

TR 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 of demand on the average revenue curve.      

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Under imperfect market, the AR curve of an individual firm slope downwards from left to right. This is because; a firm can sell larger quantities only when it reduces the price. 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 MR curves are different. Generally MR curve lies below the AR curve.    

     

The AR curve of the firm or the seller and the demand curve of the buyer is the same

Since, the demand curve represents graphically the quantities demanded by the buyers at various prices it shows the AR at which the various amounts of the goods that are sold by the seller. This is because the price paid by the buyer is the revenue for the seller (One man’s expenditure is another man’s income). Hence, the AR curve of the firm is the same thing as that of the demand curve of the consumers.

Suppose, a consumer buys 10 units of a product when the price per unit is Rs.5 per unit.

Hence, the total expenditure is 10 x 5 = Rs.50/-. The seller is selling 10 units at the rate of Rs.5 per unit. Hence, 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.

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Q6. What is a business cycle? Describe the different phases of a business cycle.

The business cycle describes the phases of growth and decline in an economy. The goal of economic policy is to keep the economy in a healthy growth rate -- fast enough to create jobs for everyone who wants one, but slow enough to avoid inflation. Unfortunately, life is not so simple. Many factors can cause an economy to spin out of control, or settle into depression. The most important, over-riding factor is confidence -- of investors, consumers, businesses and politicians. The economy grows when there is confidence in the future and in policymakers, and does the opposite when confidence drops.

The phase of the Business Cycle

There are four stages that describe the business cycle. At any point in time you are in one of these stages:

1. Contraction - When the economy starts slowing down.

2. Trough - When the economy hits bottom, usually in a recession.

3. Expansion - When the economy starts growing again.

4. Peak - When the economy is in a state of "irrational exuberance."

Who Determines the Business Cycle Stages?

The National Bureau of Economic Research (NBER) analyzes economic indicators to determine the phases of the business cycle. The Business Cycle Dating Committee uses quarterly GDP growth rates as the 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 actually turning negative. The 2008 recession was so nasty because the economy immediately

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shrank 1.8% in the first quarter 2008, grew just 1.3% in the second quarter, before falling another 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 contracted a brutal 6.9%.

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Summer / May 2012

Master of Business Administration

Semester I

MB0042 – Managerial Economics - 4 Credits

(Book ID: B1131)

Assignment

Set- 2 (60 Marks)

Note: Each Question carries 10 marks. Answer all the questions.

Q1. Discuss the various measures that may be taken by a firm to counteract the evil effects of

a trade cycle.

An : FACTORS THAT SHAPE BUSINESS CYCLES

For 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

and affluence were regarded as "healthy" economies. By the end of the 19th century,

however, many economists had begun to recognize that economies were cyclical by their

very nature, and studies increasingly turned to determining which factors were primarily

responsible for shaping the direction and disposition of national, regional, and industry-

specific economies. Today, economists, corporate executives, and business owners cite

several factors as particularly important in shaping the complexion of business environments.

VOLATILITY OF INVESTMENT SPENDING

Variations in investment spending is one of the important factors in business cycles.

Investment spending is considered the most volatile component of the aggregate or total

demand (it varies much more from year to year than the largest component of the aggregate

demand, the consumption spending), and empirical studies by economists have revealed that

the volatility of the investment component is an important factor in explaining business

cycles in the United States. According to these studies, increases in investment spur a

subsequent increase in aggregate demand, leading to economic expansion. Decreases in

investment have the opposite effect. Indeed, economists can point to several points in

American history in which the importance of investment spending was made quite evident.

The Great Depression, for instance, was caused by a collapse in investment spending in the

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aftermath of the stock market crash of 1929. 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. One

generic 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

explained as follows. Suppose a firm is operating at full capacity. When sales of its goods

increase, output will 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. This accelerates 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 investment spending accelerates. In more concrete terms, the

response of the investment spending is related to 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 the rate of sales.

MOMENTUM

Many economists cite a certain "follow-the-leader" mentality in consumer spending. In

situations where consumer confidence is high and people adopt more free-spending habits,

other customers are deemed to be more likely to increase their spending as well. Conversely,

downturns in spending tend to be imitated as well.

TECHNOLOGICAL INNOVATIONS

Technological innovations can have an acute impact on business cycles. Indeed,

technological breakthroughs in communication, transportation, manufacturing, and other

operational areas can have a ripple effect throughout an industry or an economy.

Technological innovations may relate to production and use of a new product or production

of an existing product using a new process. The video imaging and personal computer

industries, for instance, have undergone immense technological innovations in recent years,

and the latter industry in particular has had a pronounced impact on the business operations

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of countless organizations. However, technological innovations —and consequent increases

in investment—take place at irregular intervals. 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 donor

occur every day. Nor do they take place at a constant rate. Chance factors greatly influence

the 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

systematic pattern). Thus, irregularity in the pace of innovations in new products or processes

becomes a source of business fluctuations.

VARIATIONS IN INVENTORIES

Variations in inventories—expansion and contraction in the level of inventories of goods kept

by businesses—also contribute to business cycles. Inventories are the stocks of goods firms

keep unhand to meet demand for their products. How do variations in the level of inventories

trigger changes in a business cycle? Usually, during a business downturn, firms let their

inventories decline. As inventories dwindle, businesses ultimately find themselves short of

inventories. As result, they start increasing inventory levels by producing output greater than

sales, leading to an economic expansion. This expansion continues as long as the rate of

increase in sales holds up and producers continue to increase inventories at the preceding

rate. However, as the rate of increase insoles slows, firms begin to cut back on their inventory

accumulation. The subsequent reduction in inventory investment dampens the economic

expansion, and eventually causes an economic downturn. The process then repeats itself all

over again. It should be noted that while variations in inventory levels impact overall rates of

economic growth, the resulting business cycles are not really long. The business cycles

generated by fluctuations in inventories are 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 SPENDING

Variations in government spending are yet another source of business fluctuations. This may

appear to be an unlikely source, as the government is widely considered to be a stabilizing

force in the economy rather than a source of economic fluctuations or instability.

Nevertheless, government spending has been a major destabilizing force on several

occasions, especially during and after wars. Government spending increased by an enormous

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amount during World War 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 as well. In fact, the recession of 1953-54 was caused by the

reduction in government spending after the Korean War ended. More recently, the end of the

Cold War resulted in a reduction in defence spending by the United States that had a

pronounced impact on certain defence-dependent industries and geographic regions.

POLITICALLY GENERATED BUSINESS CYCLES

Many economists have hypothesized that business cycles are the result of the politically

motivated use of macroeconomic policies (monetary and fiscal policies) that are designed to

serve the interest of politicians running for re-election. The theory of political business cycles

is predicated on the belief that elected officials (the president, members of congress,

governors, etc.) have a tendency to engineer expansionary macroeconomic policies in order

to aid their re-election efforts.

MONETARY POLICIES

Variations in the nation's monetary policies, independent of changes induced by political

pressures, are an important influence in business cycles as well. Use of fiscal policy—

increased government spending and/or tax cuts—is the most common way of boosting

aggregate demand, causing an economic expansion. Moreover, the decisions of the Federal

Reserve, which controls interest 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 the

economy, variations in exports and imports can lead to business fluctuations as well. There

are many reasons for variations in exports and imports over time. Growth in the gross

domestic product of an economy is the most important determinant of its demand for

imported goods—as people’s incomes grow, their appetite for additional goods and services,

including goods produced abroad, increases. The opposite holds when foreign economies are

growing—growth in incomes in foreign countries also leads to an increased demand for

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imported goods by the residents of these countries. This, in turn, causes U.S. exports to grow.

Currency exchange rates can also have a dramatic impact on international trade—and hence,

domestic business cycles—as well.

KEYS TO SUCCESSFUL BUSINESS CYCLE MANAGEMENT

Small business owners can take several steps to help ensure that their establishments weather

business cycles with a minimum of uncertainty and damage. "The concept of cycle

management may be relatively new," wrote Matthew Gallagher in

Chemical Marketing Reporter,

"but it already has many adherents who agree that strategies that work at the bottom of a

cycle need to be adopted as much as ones that work at the top of a cycle. While there will be

no definitive formula for every company, the approaches generally stress a long-term view

which focuses on a firm's 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 plan that 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 in their long-range forecasting. Attention to Customers—this can be an

especially important factor for businesses seeking to emerge from an economic downturn.

"Staying close to the customers is a tough discipline to maintain in good times, but it is

especially crucial coming out of bad times," stated Arthur Dalasi Industry Week.

"Your customer is the best test of when your own upturn will arrive. Customers, especially

industrial and commercial ones, can give you early indications of their interest in placing

large orders in coming months."Objectivity—Small business owners need to maintain a high

level of objectivity when riding business cycles. Operational decisions based on hopes and

desires rather than a sober examination of the facts can devastate a business, especially in

economic down periods. Study—"Timing any action for an upturn is tricky, and the

consequences of being early or late are serious," said Deltas. "For example, expanding a sales

force when the markets don't materialize not only places big demands on working capital, but

also makes it hard to sustain the motivation of the sales-people. If the force is improved too

late, the cost is decreased market share or decreased quality of the customer base. How does

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the company strike the right balance between being early or late? Listening to economists,

politicians, and media to get a sense of what is happening is useful, but it is unwise to rely

solely on their sources. The best route is to avoid trying to predict the upturn. Instead, listen

to your customers and know your own response-time requirements."

Q2. Define the term equilibrium. Explain the changes in market equilibrium and effects to

shifts in supply and demand.

Ans.

Equilibrium

The word equilibrium is derived from the Latin word a “equilibrium” which means equal balance. It means a state of even balance in which opposing forces or tendencies neutralize each other. It is a position of rest characterized by absence of change. It is a state where there is complete agreement of the economic plans of the various market participants so that no one has a tendency to revise or alter his decision. In the words of professor Mehta: “Equilibrium denotes in economics absence of change in movement”.

 

Market Equilibrium

There are two approaches to market equilibrium viz., partial equilibrium approach and the general equilibrium approach. The partial equilibrium approach to pricing explains price determination of a single commodity keeping the prices of other commodities constant. On the other hand, the general equilibrium approach explains the mutual and simultaneous determination of the prices of all goods and factors. Thus it explains a multi market equilibrium position.

Earlier to Marshall, there was a dispute among economists on whether the force of demand or the force of supply is more important in determining price. Marshall gave equal importance to both demand and supply in the determination of value or price. He compared supply and demand to a pair of scissors

 We might as reasonably dispute whether it is the upper or the under blade of a pair of scissors that cuts a piece of paper, as whether value is governed by utility or cost of production. Thus neither the upper blade nor the lower blade taken separately can cut the paper; both have their importance in the process of cutting. Likewise neither supply alone, nor demand alone can 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 of a commodity in the market.

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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 on price. Demand varies inversely with price; arise in price causes a fall in demand and a fall in price causes a rise in demand. Thus the demand curve will have a downward slope indicating the expansion of demand with a fall in price and contraction of demand with a rise in price. On the other hand supply varies directly with the changes in price, a rise in price causes arise in supply and a fall in price causes a fall in supply. Thus the supply curve will have an upward slope. At a point where these two curves intersect with each other the equilibrium price is established. At this price quantity demanded is equal to the quantity demanded.

This we can explain with the help of a table and a diagram

In the table at Rs.20 the quantity demanded is equal to the quantity supplied. Since the price is agreeable to both the buyer and sellers, there will be no tendency for it to change; this is called equilibrium price. Suppose the price falls to Rs.5 the buyer will demand 30 units while the seller will supply only 5 units. Excess of demand over supply pushes the price upward until it reaches the equilibrium position supply is equal to the demand. On the other hand if the price rises to Rs.30 the buyer will demand only 5 units while the sellers are ready to supply 25 units. Sellers compete with each other to sell more units of the commodity. Excess of supply over demand pushes the price downward until it reaches the equilibrium. This process will continue till the equilibrium price of Rs.20 is reached. Thus the interactions of demand and supply forces acting upon each other restore the equilibrium position in

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the market. In the diagram DD is the demand curve, SS is the supply curve. Demand and supply are in equilibrium at point E where the two curves intersect each other. OQ is the equilibrium output. OP is the equilibrium price. Suppose the price OP2 is higher than the equilibrium price OP. at this point price quantity demanded isP2D2. 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 the supply is equal to the demand. At price OP1, the buyers will demand P1D1 quantity while the sellers are ready to sell P1S1. Demand exceeds supply. Excess demand for goods pushes up the price; this process will go until equilibrium is reached where supply becomes equal to demand.

Q3. What do you mean by pricing policy? Explain the various objective of pricing policy of a

firm.

Pricing Policies

A detailed study of the market structure gives us information about the way in which prices are determined under different market conditions. However, in reality, a firm adopts different policies 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 by the management after taking into account of various internal and external factors, forces and its own business objectives.

Pricing Policy basically depends on price theory that is the corner stone of economic theory. Pricing is considered as one of the basic and central problems of economic theory in a modern economy. Fixing prices are the most important aspect of managerial decision making because market price charged by the company affects the present and future production plans, pattern of distribution, nature of marketing etc. Generally speaking, in economic theory, we take into account of only two parties, i.e., buyers and sellers while fixing the prices. However, in practice many parties are associated with pricing of a product. They are rival competitors, potential rivals, middlemen, wholesalers, retailers, commission agents and above all the Govt. Hence, we should give due consideration to theinfluence exerted by these parties in the process of price determination. Broadly speaking, the various factors and forces that affect the price are divided into two categories.

They are as follows:

I External Factors (Outside factors)

1. Demand, supply and their determinants.

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2. Elasticity of demand and supply.

3. Degree of competition in the market.

4. Size of the market.

5. Good will, name, fame and reputation of a firm in the market.

6. Trends in the market.

7. Purchasing power of the buyers.

8. Bargaining power of customers

9. 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 every business concern is to maximize its profits. This is possible when the returns exceed costs. In this context, setting an ideal price for a product assumes greater importance. Pricing objectives has to be established by top management to ensure not only that the company’s profitability is adequate but also that pricing is complementary to the total strategy of the

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organization. While formulating the pricing policy, a firm has to consider various economic, social, political and other factors.

The Following objectives are to be considered while fixing the prices of the product.

1. Profit maximization in the short term

The primary objective of the firm is to maximize its profits. Pricing policy as an instrument to achieve this objective should be formulated in such a way as to maximize the sales revenue and profit. Maximum profit refers to the highest possible of profit.

In the short run, a firm not only should be able to recover its total costs, but also should get excess revenue over costs. This will build the morale of the firm and instill the spirit of confidence in its operations.

2. Profit optimization in the long run

The traditional profit maximization hypothesis may not prove beneficial in the long run. With the sole motive of profit making a firm may resort to several kinds of unethical practices like charging 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. In order to over- come these evils, a firm instead of profit maximization, and aims at profit optimization.

 Optimum profit refers to the most ideal or desirable level of profit.

Hence, earning the most reasonable or optimum profit has become a part and parcel of a sound pricing policy of a firm in recent years.

3. Price Stabilization

Price stabilization over a period of time is another objective. The prices as far as possible should not fluctuate too often. Price instability creates uncertain atmosphere in business circles. Sales plan becomes difficult under such circumstances. Hence, price stability is one of the prerequisite conditions for steady and persistent growth of a firm. A stable price policy only can win the confidence of customers and may add to the good will of the concern. It builds up the reputation and image of the firm.

4. Facing competitive situation

One of the objectives of the pricing policy is to face the competitive situations in the market. In many cases, this policy has been merely influenced by the market share psychology. Wherever companies are aware of specific competitive products, they try to match the prices of their products with those of their rivals to expand the volume of their business. Most of the

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firms are not merely interested in meeting competition but are keen to prevent it. Hence, a firm is always busy with its counter business strategy.

5. Maintenance of market share

Market share refers to the share of a firm’s sales of a particular product in the total sales of all firms in the market.

The economic strength and success of a firm is measured in terms of its market share. In a competitive world, each firm makes a successful attempt to expand its market share. If it is impossible, it has to maintain its existing market share. Any decline in market share is a symptom of the poor performance of a firm.

Hence, the pricing policy has to assist a firm to maintain its market share at any cost.

Q4. Critically examine the Marris growth maximising model

Ans.

Profit maximization is traditional objective of a firm. Sales maximization objective is explained by Prof. Boumal. On similar lines, Prof. Marris has developed another alternative growth maximization model in recent years. It is a common factor to observe that each firm aims at maximizing its growth rate as this goal would answer many of the objectives of a firm. Marris points out that a firm has to maximize its balanced growth rate over a period of time.

Marris assumes that the ownership and control of the firm is in the hands of two groups of people, i.e. owner and managers. He further points out that both of them have two distinctive goals. 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 more concerned 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 the firm according to Marris depends on the amount of corporate capital which includes total

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volume of the asset, inventory level, cash reserve etc. He further points out that the managers always aim at 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 the promotional opportunity of managers and also the share holders as they get more dividends.

Boumal’s Sales Maximization model:  

Sales maximization model is an alternative for profit maximization model. This model is developed by Prof. W.J. Boumal, an American economist. This alternative goal has assumed greater significance in the context of the growth of the oligopolistic firms. The model highlights that the primary objective of the firm is to maximize its sales rather than profit maximization. It states that the goal of the firm is maximization of sales revenue subject to a minimum profit constraint. 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 that maximization of sales does not mean maximization of physical sales but maximization of total sales revenue. Hence, the managers are more interested in increasing sales rather than profit. The basic philosophy is that when sales are maximized automatically profits of the company would also go up. Hence, attention is diverted to increase the sales of the company in recent years in the context of highly competitive market.

How Profit Maximization model differs from Sales Maximization model:

The sale maximization model differs on the following grounds:

Emphasis is given on maximizing sales rather than profit.

Increase the competitive and operational ability of the company.

The amount of slack earning and salaries of the top managers are directly linked to it.

It helps in enhancing the prestige and reputation of top management, distributes more dividends to share holders and increases the wage of the workers and keeps them happy.

The financial and other lending institutions always keep a watch on the sales revenue of a firm as it is an indication of financial health of the firm.

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Q5. Explain how a product would reach equilibrium position with the help of ISO - Quants

and 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 chooses varying amounts of two factors, capital (K) and labor (L). Each factor was a price that does not vary with output.

That is, the price of each unit of labor (w) and the price of each unit of capital (r) are assumed constant. We’ll further assume that w = $10 and r = $50. We can use this information to determine the producer’s total cost. We call the total cost equation an iso-cost line (it’s similar to a budget constraint).

The producer’s iso-cost line is:

10L + 50K = TC (1)

The producer’s production function is assumed to take the following form:

q = (KL) 0.5 (2)

Our producer’s first step is to decide how much output to produce. Suppose that quantity is 1000 units of output. In order to produce those 1000 units of output, our producer must get a combination of L and K that makes (2) equal to 1000. Implicitly, this means that we must find a particular isoquant.

Set (2) equal to 1000 units of output, and solve for K. Doing so, we get the following equation for a specific iso-quant (one of many possible iso-quants):

K = 1,000,000/L (2a)

For any given value of L, (2a) gives us a corresponding value for K. Graphing these values, with K on the vertical axis and L on the horizontal axis, we obtain the blue line on the graph below. Each point on this curve is represented as a combination of K and L that yields an

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output level of 1000 units. Therefore, as we move along this iso-quant output is constant (much like the fact that utility is constant as A basic understanding of statistics is a critical component of informed decision making. 

Q6. Suppose your manufacturing company planning to release a new product into market,

Explain the various methods forecasting for a new product.

When a manufacturing companies planning to release a new product into themarket, it should perform the demand forecasting to check the demand of the product in the market and also the availability of similar product in the market.

Demand forecasting for new products is quite different from that for established products. Here the firms will not have any past experience or past data for this purpose. An intensive study of the economic and competitive characteristics of the product should be made to make efficient forecasts.

 

As per Professor Joel Dean, few guidelines to make forecasting of demand for new products are:

a. Evolutionary approach

The demand for the new product may be considered as an outgrowth of an existing product. For e.g., Demand for new Tata Indica, which is a modified version of Old Indica can most effectively be projected based on the sales of the old Indica, the demand for new Pulsor can be forecasted based 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 for the new product.

b. Substitute approach

If the new product developed serves as substitute for the existing product, the demand for the new product may be worked out on the basis of a ‘market share’. The growths of demand for all the products have to be worked out on the basis of intelligent forecasts for independent variables that influence the demand for the substitutes. After that, a portion of the market can be sliced out for the new product. For e.g., A moped as a substitute for a scooter, a cell phone as a substitute for a land line. In some cases price plays an important role in shaping future demand for the product.

c. Opinion Poll approach

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Under this approach the potential buyers are directly contacted, or through the use of samples of the new product and their responses are found out. These are finally blown up to forecast the demand for the new product.

d. Sales experience approach

Offer 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 super market and the estimate of sales obtained may be ‘blown up’ to arrive at estimated demand for the product.

e. Growth Curve approach

According to this, the rate of growth and the ultimate level of demand for the new product are estimated on the basis of the pattern of growth of established products. For e.g., An Automobile Co., while introducing a new version of a car will study the level of demand for the existing car.

f. Vicarious approach

A firm will survey consumers’ reactions to a new product indirectly through getting in touch with some specialized and informed dealers who have good knowledge about the market, about the different varieties of the product already available in the market, the consumers’ preferences etc. This helps in making a more efficient estimation of future demand.