managerial economics (1)

Managerial Economics – Page

ASSIGNMENT

Q1. What is Managerial Economics? Explain the nature and cope of Managerial Economics?

Ans. Managerial Economics refer to the integration of economic theory with business practice. While economics provides the tools which explain various concepts of Demand, Supply, Price, etc. managerial economics applied these tools to the management of business.

Managerial Economics is concerned with using logic of economics, mathematics and statistics to provide effective ways of thinking about business decision problems – Prof. Hague.

In simple words, management deals with principles which help in decision making under uncertainty & improve effectives of organization and economics, on the other hand, provides a set of propositions for optimum allocation of scarce resources to achieve the desired objectives.

NATURE OF MANAGEMENT ECONOMICSi) Helps in Decision Making: Managerial economics aims at providing help

in decision making based on the propositions of micro economic theory i.e. study of the phenomenon at the individual’s level behaviour of individual consumers, firms. The concepts frequently covered by managerial economics are: (i) elasticity of demand, (ii) marginal cost, (iii) marginal revenue, (iv) market structures and their significance in pricing policies, etc.

ii) Assists Firms in Forecasting: Forecasting is an important aspect of the managerial economics. Macro economics studies the economy at an aggregative level. For eg: (i) the magnitude of investment and the level of employment (iii) the level of consumption and the national income, etc., This helps in identifying the level of demand at some future time based on the relationship of national income and demand for a particulate product.

For Eg.: The demand for cars depends upon the level of national income, etc.

iii) Applied Branch of Knowledge: Managerial economics lays emphasis on those propositions which are likely to be useful to the management. Improvement in the accuracy of the results is attempted, provided the additional cost is not very high and the decision maker can wait. Accurate forecasting is not justified on the grounds of time and cost.

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iv) Prescriptive in Nature & Character: Managerial Economics is prescriptive in nature and character in the sense that it recommends steps be taken under alternative conditions. The example, if the analysis suggests that the cost-benefit ratio of a large plant is less than that of a smaller plant and the ratio, is used as the criterion for project appraisal, the installation of a small plant is recommended. Managerial economics is one of the normative sciences and reflects upon the desirability.

v) Managerial Economics is an Applied Science: It is an applied science to the extent that it uses economic thought. Economic thought uses deductive logic, but to be sure of the findings, the propositions need to be verified empirically.For example, empirical studies verify whether cost curves of the firm are actually U-shaped as suggested by the theory. In addition, there is an attempt to generalize the proposition which provide a predictive character.

For eg.: Empirical studies may suggest that for every 1% rise in advertisement cost or expenditure, the demand for a product shall increase by 0.5%.

The nature of managerial economics suggests that it uses a scientific approach. Some firms use past experience to set rules for future but by using a systematic approach the quality of discussions can be improved.

SCOPE OF MANAGERIAL ECONOMICSThe scope of managerial economics is very wide and covers almost all the problems and areas of the manager and firm. Its scope can be explained as:-

i) Demand Analysis & Forecasting: Managerial economics helps in analyzing the various types of demand which in turn helps the manager to estimate the demand for the products of his company. The estimation of demand is not restricted to just current demand, but it also takes into consideration the future demand. This is demand forecasting. He even considers the income and cross elasticity.

ii) Production Function : Resources are scarce and have alternative uses. Production is primarily based on inputs. The factors of production are combined in such a way so as to yield maximum output. When the cost of the factors of production increases, the combination is made such so as to reduce the cost combination. This production function is applied by managerial economics

iii) Cost Analysis: Managerial economics studies cost analysis also. Determinants of cost, the relationship between cost and output, the forecast of cost and profit, methods of estimating cost are all covered by managerial economics. The success of a firm is dependent on the cost analysis.

iv) Inventory Management: Inventory means stock of raw materials and it plays an important role. The problem faced by the firm is that what quantity

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is an ideal quantity because if the stock is high, the capital is blocked which could otherwise have been used productively. On the hand, if the stock is low it can hamper production. Thus, managerial economics uses such methods as would minimize the inventory cost. It also considers the need for inventory control, classifies them and discusses its cost.

v) Advertising: Advertisement is also an area covered by managerial economics. The problems of cost and the budget of advertising are fields actually covered by the manager. Advertising forms an integral part of decision making and forward planning because it is an important aspect that what is produced is to be marketed.

vi) Price System: Pricing is one of the central functions of an enterprise. For the determination of the price the cost of production is also considered, along with a complete knowledge of the price system. Pricing is actually guided by considerations of cost plus pricing ad the policies of public enterprises. The system of pricing is different under different competitions and for different markets. The other things to be considered are price leadership and non-price competition. Thus, the price system touches the various aspects of managerial economics and guides the manager towards valid and profitable decisions.

vii) Resource Allocation: Resources are scarce and have to be allocated in such a way so as to achieve optimization. The two kinds of problems are of utmost importance and concern, firstly, how to arrive at an optimum combination of inputs in order to get maximum output? Secondly, when the prices of inputs increase, what type of sub-situation should be resort to?

viii) Capital Budgeting: Capital budgeting plays an important role for arriving at meaningful decisions. The problems faced by the manager are: how to ensure that capital becomes rational, how to face budgeting problems, how to arrive at investment decisions under conditions of uncertainty, how to effect a cost-benefit analysis, etc.Some other areas covered by Managerial Economics are:-i) Linear programming, its assumptions and solutionsii) Decision making under risk and uncertaintyiii) Profit planning and investment analysis, etc.

ConclusionManagerial Economics covers two important areas, decision making and forward planning and these areas are essential for every stage of production, marketing, etc. The nature and scope of managerial economics makes it obvious that it is an applied economics.

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Q2. State and Explain the law of demand. What are its exceptions?

Ans. Introduction – Demand can be defined as an effective desire, i.e. a desire backed by means as well as willingness to pay for it. For a consumer’s desire to become a ‘demand’ the following conditions must be fulfilled:-a) Desire to possess a commodity,b) Means (i.e. money) to purchase it, and c) Willingness to part with the means for purchasing it

The demand is always at a prices and the consumer varies his consumption according to changes in price. Such a variation has been described by the law of demand.

THE LAW OF DEMANDThe law has been stated as, “Other things being equal, the higher the price of a commodity, the smaller is the quantity demanded and lower the price, larger is the quantity demanded”.

The law of demand states the relationship between the price levels and the quantity demanded. The phrase “other things remaining the same “is a very important qualifying phrase in the law because, demand does not depend on price alone. It depends on many other factors like population, size of income, prices of related commodities, etc.

The conventional law of demand, however, relates to the much simplified demand function = D = f(P), where ‘D’ represents demand, ‘P’ price and ‘F’ the functional relationship. The relation between price and quantity demanded is usually an inverse relation, indicating less being demanded at higher price and more at lower price.

Explanation: The law of demand usually refers to market demand. The aw of demand can be explained with the help of a demand schedule:-

Price of Commodity/Unity Quantity Demanded/Week5 104 203 302 401 50

The above table represents a hypothetical demand schedule for a commodity ‘X’.T he table clearly explains that with every fall in price there is an increase in the quantity demanded and vice-versa. There is an inverse relation between price and quantity demanded.

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The above schedule can be better explained with the help of a demand curve:-

In the figure, DD is the downward sloping curve indicating that the price and quantity demanded have an inverse relation i.e. when price increases demand falls and when price falls demand increases.

OX represents the quantity demanded per week.OY represents the price per unit.

ASSUMPTIONS UNDERLYING THE LAW OF DEMANDThe law of demand is based on certain assumptions. The statement ‘other things being equal’ is indicative of these assumptions. These assumptions are:-

i) No Change In Consumer’s Income: The law of demand assumes that the income of the consumer remains constant. If the income of the consumer rises, he may by more even at a higher price and if his income decreases he may buy less even at a decreased price, thus, invalidating the law of demand.

ii) No Change in Consumer’s Preferences: The law assumes that the habits, tastes and preferences of the consumer remains constant. This is so because if the preference or taste of consumers changes then his demand will shift from one commodity to another and hill demand less even at decreased price.

iii) No Change in Fashion: Fashion is an influencing the commodity in question goes out of fashion the consumers will not buy more of it, even if the price is less. Thus, the law of demand will not hold good if there is a change in fashion and so it is assumed to be constant.

iv) No Change in the Prices of Related Goods: The prices of substitutes and complementary goods are assumed to remain unchanged. If the prices of

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X

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0

1

2

3

4

5

10 20 30 40 50

D

D


substitutes change the demand will shift to substitutes and the consumer will buy less even at a decreased price.

For Eg.: Tea & Coffee are substitute of each other. The change in the price of one will affect the demanded of another.

Similarly, the change in the price of a complementary good will affect the demand for a commodity, thereby invalidating the law of demand.

For Eg.: If the price of ink rises the demand for pen will fall, a factor other than the price of the commodity itself, and so the law will not hold good.

v) No Expectations of Future Price Changes or Shortages: The consumer expects the current price change to be normal and speculation is ignored. If it is not so i.e. if the consumer expects a future change in price or shortage, his demand will change accordingly.

Supposedly, he assumes a future price rise or shortage of a commodity he’ll buy or demand more even at a higher price, hence invalidating the law of demand.

For Eg.: If there is an expectation of shortage of onion in future, the consumer will demand more even at a higher price, in order to store for future use.

vi) No Change in Size, Age-Composition & Sex Ratio of Population: An essential assumption of the law of demand is that the size of population or age composition or sesc ratio is constant. This is so because with additional buyers in the market, the total market demand may not contract with a rise in price. Increased number of buyers would mean that even if an individual demand would fall with a rise in price, the total market demand will remain constant. This would violate the law.

vii) No Change in the Range of Goods Available to the consumers: This assumption implies that there is no change in the range of goods currently available in the market. If there’ll be a change the consumers preference would change and will affect the demand. A variety in products gives an option to the consumer to those and this leads to a fall in demand of a commodity even at a less price.

viii) No Change in the Distribution of Income & Wealth of the Community: There should be no change in the distribution of income and wealth of the community because this would change the income level of the consumers, which in turn would affect the demand for a commodity.

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ix) No Change In Government Policy: This implies that the level of taxation and fiscal policy of the government remains constant. Changes in income tax would change a consumer’s income and changes in sales tax or excise duty, etc. would change consumer’s preference thus changing the demand.

x) No Change in Weather Conditions: It is assumed that the climatic conditions remain constant. This is so because climatic changes would automatically change the demand for weather related commodities.

For Eg.: The demand for umbrellas would be more during rainy reason than during winters.The law of demand is actually a function of price alone. It does not consider other factors that can affect a change in demand. Therefore, these assumptions are necessary for the operation of the law of demand.

EXCEPTIONS TO THE LAW OF DEMANDThe law of demand operates on a universal phenomenon that when price falls demand increases and when price rises demand decreases. But sometimes, though very rarely, with a fall in price demand also falls and with a rise in price demand also increases. This is a situation which is contrary to the law of demand such cases are referred to as exceptions to the law of demand. The demand curve in such a case is an upward sloping curve and is represented as:-

EXCEPTIONAL DEMAND CURVEIn the figure, DD is the demand curve which slopes upward.OX represents quantity demandedOY represents price per unit

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X

Y

0

P1

P2

10 Q1 Q2

D

D

Pri

ce P

er U

nit

Quantity Demanded


The graph clearly shows that when price is OP, the quantity demanded is OQ and when price rises to OP2 demand also increases to OQ2.

The upward sloping curves is contradictory to the law of demand as it lays stress on ‘more being demanded at a higher price and vice-versa’.

The exceptions to the law of demand can be categorized as:-i) Giffen Goods: Sir Robert Giffin observed that sometimes people buy less

quantity of a commodity at lower price and more quantity at a higher price. Such goods are called giffen goods or inferior goods and they exhibit an assumption to the law of demand Giffen sited an example of low paid British workers who bought more bread at higher price during the early period of 19th century. This phenomenon is known as Giffin Pradox’.

For Eg.: If the price of inferior goods like cheap potatoes, bajra, etc. fall it’s demand will also fall because consumers would then shift their demand to superior goods also.

ii) Articles of Snob Appeal or ‘Status Symbol;: A commodity is bought sometimes not because it has any intrinsic value, but because its possession confers a social distinction on the holder.

Thus, when the prices of diamonds rise, their demand may expand because being costlier they are considered a better mark of distinction and so rich people purchase it more. The opposite will be true if their price falls.

iii) Speculation: If the price of a commodity is increasing and is expected to increase still further, the consumers will buy more of the commodity at the higher price than they did at lower price. Thus, an increase in price may not be accompanied by a decrease in demand negativing the law of demand. In the stock exchange market, some people tend to buy more shares when the prices are rising, in the hope that the prices will continue to rise further and they would earn profit.

iv) Psychological Bias Or Illusion: The consumers, at times, judges the quality of a commodity by its price, i.e. higher the price, i.e. higher the price letter the quality. In such cases the demand increases with a rise in price and vice versa. The producers of several goods, such as cosmetics, have discovered through experience that their sales g up with an increase in price. This is the reason why some sophisticated consumers do by from the stock clearance sales.

Thus, despite, these exceptions, the law of demand is a valid generalization for most of the commodities sold in the market.

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ConclusionThe law of demand states the inverse relationship between the price and commodity. However, the law of demand is only an indicative and not a quantitative statement. It indicates only the direction of change and not the magnitude of change.

On the whole, it is not untrue to say that other things remaining the same, more of a commodity is bought at a lower price than at a higher price, though some consumers behave in an opposite manner.

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Q3. State and Explain the Law of Variable Proportion

Ans. Introduction: The law of diminishing returns is a very old economic law. The classical economists like Adam Smith, Ricardo & Mathus associated the law of diminishing returns with agriculture. But modern economists do not agree with this view. They are of the opinion that this law can be operational in any industry at any stage of production, without linking them to any specific sector.

The law which explain the relationship between the change in the proportions between fixed and variable inputs and increased output is known as the law of variable proportions. The law of variable proportion is the new name for ‘Law of Diminishing Returns’.

STATEMENT OF THE LAW

The law of variable proportion state that, “if one factor of production is fixed while another factor of production (variable) is increased, average and marginal products will rise, reach a maximum and then decline.

ASSUMPTIONS OF THE LAW OF VARIABLE PROPORTIONThe law of variable proportion holds good only under the following conditions:-i) Constant state of Technology: The law is primarily based on the

assumption that the techniques of production remain constant. If there is an improvement in technology, then marginal and average product may rise instead of diminishing. This does not imply that the use of improved methods and techniques in production will stop the operation of the law, but will just postpone it to some future date.

ii) Homogeneous Nature of Units of Variable Factors of Production: It is assumed that the various are exactly similar to each other. If the units of variable to each other. If the units are dissimilar, i.e., say if the variable factors used later are bigger in size than before then the increments in output maybe larger than before. The law of diminishing returns or variable proportions may thus be rendered inoperative.

iii) Variable Proportion of Productive Factors: The law assumes the possibility of varying the proportions in which the various factors can be combined to produce a product. The law will fail to work if the proportions between factors are fixed.

iv) Quantity of Some Inputs Kept Fixed: There must be some input whose quantity is kept fixed because it is only this way that we can alter the factor proportions and know its effect on output. If all the inputs are variable then the actual effect on output cannot be analysed.

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v) Variable Factors Are Divisible: It is assumed that units of variable factor are divisible into smaller homogeneous units. Divisibility helps in altering the proportion of factors and homogeneity is an essential assumptions of the law of variable proportion. But, this assumption may not always be true.

vi) Law Concerned with Only Physical Quantity & Not its monetary values: The law relates to physical quantities, of the factors of production are conceived in monetary terms. The law considers only physical relationship between factor inputs and output of products.

vii) Organizational Structure & Managerial Efficiency Remains Unchanged: The law assumes that the organizational structure and managerial efficiency is increased then the marginal product and average product may rise instead of diminishing.

EXPLANATION OF THE LAW OF VARIABLE PROPORTIONSThe law of variable proportion actually covers all the tree stages i.e. increasing returns, constant returns and diminishing returns. This can**

THE PRODUCTION SCHEDULEFixed Factor (say land & Cap.)

Variable factor (labour Units)

Total Product (Units) (T.P.)

Average Product (Units) (A.P

Marginal Product (Units) (M.P.)

KKK

123

81830

8910

81012

Increasing Returns

KKK

456

445872

1111.612

141414

Constant Returns

KKK

789

808076

11.4108.4

1810-4

DiminishingReturns Negative Return

OBSERVATION OF THE TABLE: RELATIONSHIP:

The above table shows that the total product also declines but the marginal product declines first. The relationship between them can be explained as:-

i) As long as average product is rising, the marginal product is large than average product.

ii) When average product is decreasing, margin product is less than average product, as from 7th labour unit to 9th labour unit.

iii) Total Product is maximum when marginal product is zero, as in 8ty labour unit.

iv) When total product falls, marginal product becomes negative like in 9th

labour unit.

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v) The table shows that as the number of units of labour increase marginal product rises from 8 to 10 to 12 and then 14. This shows that the total product is increasing at an increasing rate. This is the stage of increasing return.

vi) After the 4th labour unit the total output increases but at a constant rate and so the marginal product does not change.

It remains the same at 14 units upto 6th labour unit. This is the 2nd stage of the law and represents constant returns.

vii) After the 6th labour unit the marginal product continuous to fall. This is the 33rd stage of diminishing returns and finally reaches negative returns. The law of variable proportion can also be represented on a graph as:-

The above graph clearly shows that T.P. curve goes on increasing to a point and after that it starts declining. AP & MP curve also rises and then declines. MP curve declines faster than AP curve. The law can be divided into three stages:-

State I: Increasing ReturnsIn this stage T.P. to a point increases at an increasing rate. In the figure, upto point F, the slope of the TP curve in increasing at an increasing rate, which means MP rises.

During state I, the quantity of fixed factor in abundant relative to the quantity of variable factor. As more and more units of variable factor. As more and more units of variable factors are added to constant quantity of fixed factor, the fixed factor (land or capital) gets more intensively and effectively utilized and the production increases at an increasing rate.

Stage II- Constant ReturnsIn this state, TP increases but at a constant rate. In the figure, from F to G the T.P. curve is increasing at a constant rate, which means MP is constant.

During stage II, the quantity of fixed factor is constant but is enhanced by the addition of variable factor. At this stage, the addition of variable factor does increase the T.P. but not as much as in stage I i.e. the T.P. increases but at a constant rate and the M.P. is constant.

Stage III – Diminishing Returns and Negative ReturnsIn this stage T.P. increases but at a diminishing rate and then declines. From point G, T.P. first increases at a diminishing rate and starts to decline and M.P. diminishes but is positive, then zero and then becomes negative. The point G, where the TP starts to increase at a diminishing rate is called the point of inflexion corresponding to this point M.P. is maximum after which it starts to decline.

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During stage III, the quantity of variable factor added increases the T.P. but at a diminishing rate and then starts to decline. This is so because after appoint, an addition in the variable factor would make the fixed factor inadequate and so M.P. & A.P. will fall.

EXCEPTIONS/LIMITATIONS TO THE LAW OF DIMINISHING RETURN

i) New Methods of Cultivation: The law of variable proportion assumes no change in the technique of production scientific rotation of crops, better quality seeds, modern implements, etc are the regular changes which take place in agriculture. In such a case the marginal product will in fact increase. So, this stands as an exception to the law of diminishing returns.

ii) New Soil: New land (soil) brings about better cultivation such a land is supposed to be more fertile and so the marginal product will increase for a time. Thus, the law of diminishing returns does not operate in the beginning.

iii) Insufficient Capital: If the capital is not sufficient more capital will be required. The increase in capital will give more than proportionate return, but later the marginal return will decrease. The early stage is an exception to the law of variable proportion.

IMPORTANCE OF THE LAW OF VARIABLE PROPORTIONi) Universal Applicability: The law is a fundamental law which is not

applicable in agriculture and industries alone, rather it is of universal applicability, such, mining, fishing, housing, etc in all branches of production.

ii) Basis of Mathus Theory of Population: Mathu’s theory of populations states that the food supply does not increase of the operation of the law of diminishing returns in agriculture.

iii) Basis of Ricardo’s Theory of Rent: Rent arises in the Ricardian sense because the operation of the law of diminishing returns on land forces the application of additional doses of labour and capital on a piece of land but does not increase the output in the same proportion due to the operation of this law.

iv) Migration of Population: This law is responsible for migration of population from one country to another. The migration of population is because of two reason.

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i) Pressure on land due to increase in population and (ii) reduction in the amount of production on account of the operation of law of diminishing returns.

v) Basis of Marginal Productivity Theory: The return to factors of production is given to marginal productivity theory which itself is based on the law of diminishing returns.

vi) Underdeveloped Countries: Agriculture is the main occupation of underdeveloped countries and so the law of diminishing returns is of utmost importance for them.

vii) Affects the Standard of Living of the People: The standard of living is affected in the sense that where the population increases at a faster rate than agriculture and other production, capital, etc the standard is bound to lower on account of the operation of law of diminishing returns.

viii) Responsible for New Researches and Inventions: The law of diminishing returns is also responsible for new researches and inventions which take place in a country simply to check it.

ConclusionThe above explanation of the law of variable proportion explains clearly that the modern approach has a wider meaning. According to the modern economists, the law works not only in agriculture, but also in other fields of economic activity including manufacturing industries. The modern version of the law of return is that the total output increases, first at an increasing rate and later at a diminishing rate but the old approach was that output increases only at a diminishing rate. Lastly, the modern approach says that the law will operate in all those activities where one or two factors of production are fixed while others are variable, while the old approach assumed land alone to be fixed factor.

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Q4. Define “Business Cycle” Explain various phases of Business Cycle?

Ans. Introduction – Business cycle is a part of the capitalist system. It refers to the phenomenon of cyclical booms and depressions. In a business cycle there are wave – like fluctuations in aggregate employment, income, output and price level. They influence business decisions tremendously and set the trend for future business. The period of prosperity opens up new and larger opportunities for investment, employment and production and thereby promotes business. On the other hand, depression reduces the business opportunities.

DefinitionsThe term business cycle has been defined in various ways by different economists.

Prof. Harberber’s is very simple, “The business cycle in general sense may be defined as an alteration of periods of prosperity and depression of good and bad trade”.

Keyness definition is more explicit, “A trade cycle is composed of periods of good trade characterized by rising prices and low unemployment percentages, altering with periods of bad trade characterized by falling prices and high unemployment percentages”.

CHARACTERISTICS OF TRADE CYCLEi) A business cycle is a wave like movementii) Expansion and contraction in a business cycle are cumulative in effectiii) Business cycle operates periodically at fairly regular intervals of 10 to12

yearsiv) Business cycle is of an all embracing nature i.e. it prevails in all areas of a

country.v) Business cycle is characterized by expansion and contraction in a business.vi) A trade cycle is characterized by the presence of crisis. ie. The pea and the

trough are not symmetrical i.e, the downward movement is more sudden and violent than the change from downward to upward.

vii) Though cycles differ in timing and amplitude, they have a common pattern of phases which are sequential in nature.

Phases of Business Cycle

The ups and downs in the economy are reflected by the fluctuations in aggregate economic magnitudes, such as, production, investment, employment, prices, wages, bank, credits, etc. The upward and downward movement in these magnitudes show different phases of a business cycle. Basically there are two phases, prosperity and depression, but considering the intermediate stages it has be divided into five phases:-1) Expansion, 2) Peak, 3) Recession, 4) Trough and 5) Recovery & expansion

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These phases are uniform and recurrent in the case of different cycles. But no phase has definite periodicity or time interval.

The give phases of the cycle can be figurised as:-

Business FluctuationsIn the above figure, OX shows the time period and OY shows the growth rate. The steady growth line shows the growth of the economy when there are no economic fluctuations. The various phases of the business cycle are shown by the line of cycle which moves up and down the steady growth line. The line of cycle moving above the steady growth line marks, the beginning of the period of expansion which reaches a peak and when the downward slide in the growth rate becomes rapid and steady the phase of recession begins. When the growth rate goes below the steady growth rate, it makes the beginning of depression in the economy. Trough is the phase during which the down trend in the economy slows down and eventually stops and the economic activities once again start an upward movement. Through this upward movement the economy enters the phase of recovery though the growth rate remains below the steady growth line. When it exceeds this line it enters the phase of expansion and prosperity.

The various phases can be described as:-1) Expansion: In the prosperity or expansion phase, demand, output,

employment and income are at a high level. They tend to raise prices. But wages, salaries, interest rates, rentals and taxes do not rise in proportion to the rise in prices The gap between prices and costs increase the margin of profit. The economy is engulfed in waves of optimism. Larger profit expectations further increases investment which is helped by liberal bank credit. They lead to considerable expansion in economic activity by increasing the demand for consumer goods and further raising the price

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wth

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DepressionProsperity

Prosperity


level. This encourages retailers, wholesalers and manufacturers to add to inventories. In this way, the expansionary process becomes cumulative and self rein-forcing.

2) Peak: The expansionary process comes to a halt when the economy reaches a very high level of production, known as the peak or loom. The peak may lead the economy to over full employment and to inflationary rise in prices. It is an indication of the end of the prosperity phase and beginning of recession. The seeds of recession are contained in the loom in the form of strains in the economic structure. They are:-

i) Scarcities of labour, raw material, etc. leading to rise in costs relative to price, which brings a decline in profit margins.

ii) Rise in the rate of interest due to scarcity of capital, which makes investments costly and along with the first lowers business expectations.

iii) Failure of consumption to rise due to rising prices and stable propensity to consume when incomes increase, which leads to the piling up of inventories indicating that sales or consumption lags behind production.

3) Recession: Recession starts when there is a downwards descend from the ‘peak’. Once the economy reaches the peak, increase in demand is hated. It even starts decreasing in some sector producers and unaware of this fact continue to maintain their existing levels of production and investment. As a result, profit margins decline further because costs start overtaking production and by to sell out of accumulated stocks. Investment, employment, incomes and demand decline.

Produces even reduce prices to get rid of stock, but, consumers postpone their purchases expecting a further reduction in price. As a result, the gap between demand and supply grows further When this process gathers speed, the recession becomes irreversible Investment decline which leads to a decline in income and consumption. Curtailed investments reduces the demand for both consumer and capital goods. At this stage, the process of recession is complete and the economy enters the phase of depression.

4) Depression & Trough: During depression there is a general decline in the economic activity. There is a considerable reduction in the production of goods and services, employment, income, demand and prices. The general decline in economic activity leads to a fall in bank deposits credit expansion stops because the business community is not willing to borrow. Bank rates fall considerably.

Thus, a depression is characterized by mass unemployment; general fall in prices, profits, wages, interest rate, consumption, expenditure, investment, bank deposits and loans; factories close-down, and construction of all types of capital goods, buildings, etc come to a ‘standstill. These forces are cumulative and self-reinforcing and the economy is at the trough.

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The trough or depression may be short-lived or it may continue at the bottom for considerable time. But sooner or later limiting forces are set in motion which ultimately tend to bring the contraction, phase to end and pane the way for the revival.

5) Recovery: As the recovery gathers momentum, some firms plan additional investment, some undertake renovation programmes and some undertake both. Suppose the semi-durable goods wear out which necessitate their replacement in the economy, it leads to an increased demand. To meet this demand, investment and employment increase. Industry begins to revive. Revival also starts in related capital goods industries. Once begun, the process of revival becomes cumulative. As a result, the levels of employment, income and output rises steadily in the economy. In the early stages of the revival phase, there is considerable excess or idle capacity in the economy so that output increases without a proportionate increase in total costs. Profit increases. Investment is encouraged which tends to raise the demand for bank loans. It leads to credit expansion

With this process catching up, the economy enters the phase of expansion & prosperity. The cycle is thus complete

CAUSES OF TRADE CYCLE

i) Expansion & Contraction of Loans by bank: When banks adopt the policy of credit expansion, firms are in a better position to borrow and so it leads to the phase of prosperity.

On the other hand, when the banks contract the loads, it leads to depression.

ii) Savings & Investment: When there is over investment it leads to the phase of prosperity and when there is under investment it leads to the phase of adversity.

iii) Demand & Supply: If the demand of goods is more than its supply it causes a phase of prosperity because more demand means, greater production and higher profits when the supply is more than demand it leads to adversity as it causes the stock to be held and capital being blocked.

iv) Income and Expenditure of Consumers: If the income of consumers is more than their expenses, they tend to save and invest more and this leads to a phase of prosperity. On the other hand, if the expenditure is more than income it leads to a phase of adversity.

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v) Seasonal Fluctuations: Seasonal fluctuations affect agricultural production to a large extent, which in turn causes trade cycle. If the climatic conditions are favourable for a particular crop, then it leads to a phase of prosperity. On the other hand, if the conditions are unfavourable it causes a phase of depression.

vi) Development of New Technologies of Production: Technology plays a great role in any industry technology affects the growth of any kind of industry in the sense that the technology develops with passage of time it causes prosperity. At the same time, if there is no advancement of technology it causes depression because the gap between cost and price increases.

vii) Feelings of Entrepreneurs: An important cause of trade cycle is the feeling of entrepreneurs. If the entrepreneurs are optimistic it will lead to a phase of prosperity because they will invest more. But, if they are pessimistic it will cause a phase of depression.

viii) Psychology of Consumers: If the consumers are hopeful and optimistic it will demand more. An increase production investment, etc. and hence would cause a phase of prosperity. But, if they are pessimistic then it would cause a phase of adversity.

ConclusionBusiness fluctuations, booms and slumps, in the economic activities form essentially the economic environment of a country. A profit maximizing entrepreneur must therefore analyze the economic environment of the period relevant for his important business decisions, particularly those pertaining to forward planning. A good planning forms the basis for the success of any business.

The behaviour of a business cycle is difficult to determine because of the multitudinous factors and circumstances that lie behind cyclical fluctuations.

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Q5. Write short notes on: (e) Fiscal Policy

Ans.(e)Introduction – Fiscal body refers to the whole body of policies dealing with the revenue – expenditure process of the government. On the revenue side, it involves the decisions regarding the taxes to be imposed (including the rates of taxation), the public debt to be issued, etc. On the expenditure side, it refers to the decision regarding the total amount of public expenditure to be undertaken as well as its distribution among the different heads of expenditure. Thus, taxes, subsidies, public debt, and public expenditure ar the instruments of fiscal policy. Public expenditure increases the flow of funds into the private economy and at the same time, taxation reduces private disposable income.

The objectives of fiscal policy can be as an instrument of economic stabilization. It is importance rests on the fact that government activities in modern economics are greatly enlarged and government tax-reverse and expenditure account for a considerable proportion of GNP, ranging from 10-25 per cent. Therefore the government may affect the private economic activities to the same extent through variations in taxation and public expenditure.

(f) Monetary PolicyIt is the programme of the Central Bank’s variations, in the total supply of money and cost of money to achieve certain pre determined objectives. It’s primary aim is to achieve economic stability. The instruments used to carry out the monetary policies are:

Quantitative credit control measures such as open market operations, changes in bank rate (or discount rate) and changes in the statutory reserve ratios.

Elaborating on the aboresaid terms:Open Market Operations is the sale and purchase of government boards, treasure bills, securities, etc to and from the public.

Bank Rat is the rate at which bank (central) discounts the commercial bank’s bills of exchange of first class bill.

Statutory Reserve Ratio is the proportion of commercial bank’s time and demand deposits, which they are required to deposit with the central bank or keep cash in vault.

All these instruments when operated by the central bank reduce (or enhance) directly or indirectly the credit creation capacity of the commercial banks and thereby reduce (or increase) the flow of funds from the banks to the public.

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(c) Economic StabilizationStabilization broadly means preventing the extremes of ups and downs or booms and depression in the economy without preventing factors of economic growth to operate.

Economic stabilization also implies preventing over and under employment. Stabilization should permit a reasonable degree of flexibility.

It’s major objectives are:(i) Preventing excersise economic fluctuations(ii) Efficient utilization of labor and productive resources as far as

possible(iii) Encouraging free competitive enterprise with minimum interference

with the functioning of the market economy. The two most important and widely used economic policies to achieve economic stability are fiscal policy and monetary policy.

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managerial economics (1)

Documents

nature of managerial

managerial economics

managerial economics

scope of managerial

logic of economics

macro economics studies

level of demand

marginal cost