Subject : Managerial Economics Assignments Set 1

Subject : MANAGERIAL ECONOMICS ASSIGNMENTS SET 1

Q.1 - The demand function of a good is as follows: Q1 = 100-6P1 - 4P2+2P3+0.003y Where P1 and Q1 are the price and quantity values of good 1 P2 and P3 are the prices of good 2 and good 3 and y is the income of the consumer. The initial values are given : P1 = 7 P2 = 15 P3 = 4 Y = 8000 Q1 = 30 You are required to: a) Using the concept of cross elasticity determine the relationship between good 1 and others b) Determine the effect on Q1 due to a 10% increase in the price of good 2 and good 3. Answer. a) Cross elasticity between good 1 and product 2 = (dQ1/dP2)*(P2/Q1) Cross elasticity between good 1 and product 3 = (dQ1/dP3)*(P3/Q1) Taking the differentiation of the equation: dQ1/dP2 = -4 dQ1/dP3 = 2 Putting the values in the elasticity equation: Cross elasticity between good 1 and product 2 = (dQ1/dP2)*(P2/Q1) = (-4) * (P2/Q1) = (-4) * (15/30) = -2 Cross elasticity between good 1 and product 3 = (dQ1/dP3)*(P3/Q) = (2) * (P3/Q1) = (2) * (4/30) = 0.267 b)

P2 = 15* 10/100 P2 = 1.5

P3 = 4810/100 P3 = 4.4

^P2 = 15+1.5 = 16.5 Page 1 of 15

Subject : MANAGERIAL ECONOMICS Q1 = 100 – 6P1 – 4P2 + 2P3 + .003y Q1 = 100 – 6 * 7 – 4 * 16.5 + 2 * 4.4 + .003 * 8000 = 100 - 42 – 66 + 8.8 + 24 = 132.8 – 108.0 = 24.8

Q.2 - What are the factors that determine the Demand curve? Explain. Answer. Demand for a commodity or service is determined by a number of factors. All such factors are called demand determines’ 1. Price of the given commodity, prices if other substitutes and/complements, future expected trend in prices etc. 2. General Price level existing in the country-inflation or deflation. 3. Level of income and living standards of the people. 4. Size, rate of growth and composition of population. 5. Tastes, preferences, customs, habits, fashion and styles 6. Publicity, propaganda and advertisements. 7. Quality of the product. 8. Profit margin kept by the sellers. 9. Weather and climatic conditions. 10. Conditions of trade –boom or prosperity in the economy. 11. Terms & conditions of trade. 12. Governments’ policy-taxation, liberal or restrictive measures. 13. Level of savings &pattern of consumer expenditure. 14. Level of saving & pattern of consumer expenditure. 15. Total supply of money circulation and liquidity preference of the people. 16. Improvements in educational standards etc. Thus, several factors are responsible for bringing changes in the demand for a product in the market. A business executive should have the knowledge and information about all these factors and forces in order to finalize his own production, marketing and other business strategies. Q.3 - 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 increase to 5000 pens. Find the elasticity of supply of the pens. Answer. P 10 22

Qs 3000 5000

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Subject : MANAGERIAL ECONOMICS

Es

=

^Qs/^p *p/Qs

=

2000/12 * 10/3000

=

1.6

Q.4 - Briefly the profit-maximization model. Answer. Profit-making is one of the most traditional, basic and major objectives of a firm. Profit-motive is the driving-force behind all business activities of a company. It is the primary measure of success or failure of a firm in the market. Profit earning capacity indicates the position, performance and status of a firm in the market. It is an acid test of economics ability and status of a firm in the market. It is an acid test of economic ability and performance of an individual Firm. There is no place for a firm unless it earns a reasonable amount of profit in the business. Main propositions of the profit-maximization model The model is based on the assumption that each firm seeks to maximize its profit given certain technical and market constraints. The following are the main propositions of the model. 1. A firm is a producing unit and as such it converts various inputs into outputs of higher value under a given technique of production. 2. The basic objective of each firm is to earn maximum profit. 3. A firm operates under a given market condition. 4. A firm will select that alternative course of action which helps to maximize consistent profits 5. A firm makes an attempt to change its prices, input and output quantity to maximize its profit. The model Profit-maximization implies earning highest possible amount of profits during a given period of time. Assumptions of the model The profit maximization model is based on tree important assumptions. They are as follows – 1. Profit maximization is the main goal of the firm. 2. Rational behavior on the part of the firm to achieve its goal of profit maximization. 3. The firm is managed by owner –entrepreneur. Determination of profit –maximizing price and output Page 3 of 15

Subject : MANAGERIAL ECONOMICS Profit maximization of a firm can be explained in two different ways. a) Total Revenue and total cost. Profit is the difference between TR and TC. In other words, excess of revenue over costs is the profit. Profit = TR-TC. If TR is equal to TC in that case, there will be break even point. If TR is less than TC, in that case, a firm will be incurring losses. In this case, we take in to account of total cost and total revenue of the firm while measuring profits. b) MR and MC approach. In this case, we take in to account of revenue earned from one unit and cost incurred to produce only one unit of output. A firm will be maximizing its profits when MR=MC and MC curves cuts MR curve cuts MR curve from below. If MC curve cuts MR curve from above either under perfect market or under imperfect market, no doubt MR equals MC but total output will not be maximized and hence total profits also will not be maximized. Hence, two conditions are necessary for profit maximization1. MR =MC. 2. MC curve cut MR curve from below.

Q.5 - What is Cyert and March’s behavior theory? What are the demerits? Answer. Cyert and March suggest the following methods to overcome the conflicts of different groups and smooth working of the organization. They are as follows. Demands of each group may be separated from that of the other and separate attempts are made to fulfill them so that their impact on the whole organization may be avoided. Demands of each group may be met over a period of time as and when they arise without jeopardizing the general interest of the organization. The management may follow the policy of sequential attention. On the basis of the priority and importance of each demand, the management may fulfill most urgent demand first and then postpone the remaining less-urgent ones. The management may also tackle the problem by decentralizing the decision making process. It can give more autonomy by department to work out its program, avoid mutual conflicts, ensure harmony and balance in different goals, and optimize its working. Cyert and March are of the opinion that out of several objectives a firm has five important goals. They are— 1. Production goal. Production is to be organized on the basis of demand in the market. Neither there should be over production nor under production but just Page 4 of 15

Subject : MANAGERIAL ECONOMICS that much to meet the required demand in the market, avoid excess capacity, over utilization of capital assets, lay-off of workers etc. 2. Inventory goal. Inventory refers to stock of various inputs. In order to ensure continuity in production and supply, certain minimum level of inventory has to be maintained by a firm. Neither there should be surplus stock or shortage of different inputs. Proper balance between demand and supply is to be maintained. 3. Sales goal. There should be adequate sales in any organization to earn reasonable amounts of profits. In order to create demand sales promotion policies may be adopted from time to time. 4. Market – share goal. Each firm has to make consistent effort to increase its market share to complete successfully with other firms and make sufficient profits. 5. Profit goal. This is one of the basic objectives of any firm. The very survival and success of the firm would depend upon the volume of profits earned by it. It is quite clear that each business organization has its own set of goals. These goals would depend on the ever changing demands of different groups who have their own conflicting objectives. There is need for harmonious and balanced blending of different objectives of an organization and multiple objectives of different objectives of an organization and multiple objectives of different groups working in the organization. On the basis of its performance, the goals are set. Hence , Cyert and March points out that satisfactory behavior is most rational in nature Demerits 1. The theory fails to analyze the behavior of the firm but it simply predicts the future expected behavior of different groups. 2. It does not explain equilibrium of the industry as a whole. 3. It fails to analyze the impact of the potential entry of new firms in to the industry and the behavior of the well established firms in the market. 4. It highlights only on short run goals rather than long run objectives of an organization. Thus, there are certain limitations to this theory.

Q.6 - What is Boumal’s Static and Dynamic Answer. Sales maximization model is an alternative model for profit maximization. This model is developed by Prof. W .J. Bournal, an American economics. This alternative goal has assumed greater significance in the content of the growth of Oligopolistic firms. Page 5 of 15

Subject : MANAGERIAL ECONOMICS The model highlights that the primary objectives of a 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. In defense of this model, the following arguments are given. 1. Increawe in sales and expansion in its market share is a sign of height growth of a normal company. 2. It increase the competitive ability of the firm and enhances its influenced in the market. 3. The amount of slack earnings and salaries of the top management directly linked to it. 4. It helps in enhancing the prestige and reputation of top management distribute more dividends to share holders and increase the wages workers and keep them happy. 5. It helps the managers to pursue a policy of steady performance with satisfactory levels of profits rather than spectacular profit maximization over a period of time. The Static Model This method is based on the following assumption. 1. The model is applicable to a particular time period and the model does not operate at different periods of time 2. The firm aims at maximizing its sales revenue subject to a minimum profit constraint. 3. The demand curve of the firm slope downwards from left to right. 4. The average cost curve of the firm is U-shaped one. Sales maximization (dynamic model) In the real world many changes takes place which affects business decisions of a firm. In order to include such changes, Bournal has developed another dynamic model. This model explains how changes in advertisement expenditure, a major determinant of demand, would affect the sales revenue of a firm under severe competitions. Assumption: 1. Higher advertisement expenditure would certainly increase sales revenue of a firm. 2. Market price remains constant. Page 6 of 15

Subject : MANAGERIAL ECONOMICS 3. Demand and cost curves of the firm are conventional in nature Generally under competitive condition, a firm in order to increase its volume of sales and sales revenue would go for aggressive advertisements. This leads to a shift in the demand curve to the right. Forward shift in demand curve implies increased advertisement expenditure resulting in higher sales and sales revenue. A price cut may increase sales in general. But increase in sales mainly depends on whether the demand for a product is elastic or inelastic. A price reduction policy may increase its sales only when the demand is elastic and if the demand is inelastic; such a policy would have adverse effects on sales. Hence, to promote sales, advertisements become effective instrument today. It is the expenditure of most of the firms that with and increase in advertisement expenditure, sales of the company would also go up. A sales maximizer would generally incur higher amounts of advertisement expenditure than a profit maximizer. However, it is to be remembered that amount allotted for sales promotion should bring more than proportionate increase in sales and total profits of a firm. Otherwise, it will have a negative effect.

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Subject : MANAGERIAL ECONOMICS SET 2 Q.7 - What is pricing policy? What are the internal and external factors of the policy? Answer. 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. Above all, the sales revenues and profit ratio of the producer directly depend upon the prices. Hence, a firm has to charge the most appropriate price to the customers. Charging an ideal price, which is neither too high nor too low, would depend on a number of factors and forces. There are no standard formulas or equations in economics to fix the best possible price for a product. The dynamic nature of the economy forces a firm to raise and reduce the prices continuously. Hence, prices fluctuate over a period of time. External Factors                

Demand, supply and their determinants. Elasticity of demand and supply. Degree of competition in the market. Size of the market. Good will, name, fame and reputation of a firm in the market. Trends in the market. Purchasing power of the buyers. Bargaining power of customers. Buyers behavior in respect of particular product Availability of substitutes and complements. Government’s policy relating to various kinds of incentives disincentives, controls, restrictions and regulations, licensing, taxation, export & import, foreign aid, foreign capital, foreign technology, MNCs etc. Competitors pricing policy. Social consideration. Bargaining power of customers.

Internal Factors

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Subject : MANAGERIAL ECONOMICS

Objectives of the firm. Production Costs. Quality of the product and its characteristics. Scale of production. Efficient management of resources. Policy towards percentage of profits and dividend distribution. Advertising and sales promotion policies. Wage policy an sales turn over policy etc. The stages of the product on the product life cycle. Use pattern of the product. Extent of the distinctiveness of the product and extent of product differentiation practiced by the firm.  Composition of the product and life of the firm.           

Thus, multiple factors and forces affect the pricing policy of a firm.

Q.8 - Mention three crucial objectives of price policies. Answer. 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. 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. 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.Optimum profit refers to the most ideal or desirable level of profit 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 Page 9 of 15

Subject : MANAGERIAL ECONOMICS creates uncertain atmosphere in business circles. Sales plan becomes difficult under such circumstances . 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. 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. 6. Capturing the Market Another objective in recent years is to capture the market, dominate the market, command and control the market in the long run. In order to achieve this goal, sometimes the firm fixes a lower price for its product and at the other times even it may sell at a loss in the short term. 7. Entry into new market Apart from growth, market share expansion, diversification in its activities a firm makes a special attempt to enter into new markets. Entry into new markets speaks about the successful story of the firm. 8. Deeper penetration of the market The pricing policy has to be designed in such a manner that a firm can make inroads into the market with minimum difficulties. Deeper penetration is the first step in the capturing and dominating the market in the latter stages. 9. Achieving a target return A predetermined target return on capital investment and sales turnover is another long run pricing objectives of a firm. The targets are set according to the position of individual firm. 10. Target profit on the entire product line irrespective of profit level of individual products A product line may be defined as a group of products which have similar physical features and perform generally similar functions. 11. Long run welfare of the firm A firm has multiple objectives. They are laid down on the basis of past experience and future expectations. 12. Ability to pay Pricing decisions are sometimes taken on the basis of the ability to pay of the customers, i.e., higher price can be charged to those who can afford to pay. Page 10 of 15

Subject : MANAGERIAL ECONOMICS

13. Ethical Pricing Basically, pricing policy should be based on certain ethical principles Business without ethics is a sin. While setting the prices, some moral standards are to be followed. Although profit is one of the most important objectives, a firm cannot earn it in a moral vacuum.

Q.9 - Mention the bases of price discrimination. Answer. Price Discrimination may take the following forms: (Basis of price Discrimination) 1. Personal differences: This is nothing but charging different prices for the same commodity because of personal differences arising out of ignorance and irrationality of consumers, preferences, prejudices and needs. 2. Place: Markets may be divided on the basis of entry barriers, for e.g. price of goods will be high in the place where taxes are imposed. Price will be low in the place where there are no taxes or low taxes. 3. Different uses of the dame commodity: When a particular commodity or service is meant for different purposes, different rates may be charged depending upon the nature of consumption. 4. Time: Special concessions or rebates may be given during festival seasons or on important occasions. 5. Distance: Railway companies and other transporters, for e.g., charge lower rates per KM if the distance is long and higher rates if the distance is short. 6. Special orders: When the goods are made to order it is easy to charge different prices to different customers. In this case, particular consumer will not know the price charged by the firm for other consumers. 7. Nature of the product: Prices charged also depends on nature of products e.g., railway department charge higher prices for carrying coal and luxuries and less prices for cotton, necessaries of life etc. 8. Quantity of purchase: Page 11 of 15

Subject : MANAGERIAL ECONOMICS When customers buy large quantities, discount will be allowed by the sellers. When small quantities are purchased, discount may not be offered. 9. Geographical area: Business enterprises may charge different prices at the national and international . 10. Discrimination on the basis of income and wealth: For e.g., A doctor may charge higher fees for rich patients and lower fees for poor Patients. 11. Special classification of consumers: For e.g., Transport authorities such as Railway and Roadways show concessions to students and daily travelers. Different charge for I class and II class traveling, ordinary rooms in hotels etc. 12. Age : Cinema houses in rural areas and transport authorities charge different rates for adults and children. 13. Preferences or brands: Certain goods will be sold at different prices even though there is not much difference in terms of costs. 14. Social and or professional status of the buyer: A seller may charge a higher price for those customers who occupy to common man on the street. 15.

If a customer is in a hurry, higher price would be charged. Otherwise normal price would be charged.

16. Discrimination on the basis of sex: In selling certain goods, producers may discriminate between male and female buyers by charging low prices to females. 17.

If price differences are minor, customers do not bother about such discrimination.

18. Peak season and off peak season services Hotel and transport authorities charge different rates during peak season and off-peak seasons.

Q.10 - What do you mean by the fiscal policy? What are the instruments of fiscal policy? Briefly comment on India’s fiscal policy. Answer. Page 12 of 15

Subject : MANAGERIAL ECONOMICS Fiscal policy: Fiscal policy is an important part of the over all economic policy of a nation. It is being increasingly used in modern times to achieve economic stability and growth throughout the world. Fiscal policy is a package of economic measures of the government regarding its public expenditure, public revenue, public debt or public borrowings. Instruments of Fiscal Policy 1. Public Revenue: It refers to the income or receipts of public authorities. It is classified into two parts – Tax-revenue. Taxes are the main source of revenue to a government. There are two types of taxes. They are direct taxes like personal and corporate income tax, property tax and expenditure tax etc and indirect taxes like customs duties, excise duties, sales tax now called VAT etc. 2. Public expenditure policy: It refers to the expenditure incurred by the kinds, development or plan expenditure and non-development or non-plan expenditure. 3. Public debt or public borrowing policy: All loans taken by the government constitutes public debt. It refers to the borrowing made by the government to meet the ever-rising expenditure. It is of two types, internal borrowings and external borrowings. 4. Deficit financing: It implies printing of fresh and new currency notes by the government by running down the cash balances with the central bank. The amount of new money printed by the government depends on the government depends on the absorption capacity of the economy. 5. built in stabilizers or automatic stabilizers: The automatic or built in stabilizers imply, automatic changes in tax collections and transfer payments or public expenditure programmes so that it may reduce destabilizing effect on aggregate effective demand.

Q11 - Comment on the consequences of environmental degradation on the economy of a community. Answer. In recent years, there has been very fast and quick economic growth in many countries of the world. There is a visible change in the pattern of economic growth. In the name of quick economic development in a very short period of time, there is Page 13 of 15

Subject : MANAGERIAL ECONOMICS fast depletion of all kinds of resources and many types of resources may be exhausted in the near future. There has been excessive and over-utilization of many resources. Shortsightedness in the developmental policies has shifted the emphasis from future to the present welfare of the people. This has been responsible for environmental disorder, dislocation and degradation. There is widespread air, water, soil and noise pollution on account of rapid industrialization and growth in all modes of transportation. There is environmental decay and degeneration all round the world. The destruction in eco-system has dangerous and demoralizing effects on the economy. Degradation and destruction of resource-base is unpardonable. They have adverse effects on health, efficiency and quality of life of the people. Sustainable economic development seeks to meet the needs and aspirations of the present without compromising the ability of future generations to meet their own needs. Environmental damages may be in the following categories. They are as follows— 1. Water pollution: It is one of the most important types of pollution that is taking a heavy toll in recent years. The main water pollutants are diseasecausing agents which include bacteria, viruses, protozoa and parasitic worm that enter water from domestic sewage and untreated human and animal wastes, oxygen-depleting wastes, inorganic plant nutrients, fertilizers, pesticides, water – soluble inorganic chemicals which includes acids, salts, and compounds of toxic metals such as mercury and lead, organic chemicals like oil, gasoline, plastic cleaning solvents, detergents and many other varieties of items. 2. Air pollution: The air may become polluted by natural causes such as volcanoes, which release ash, dust, sulphur, and other gases or by forest fires that are occasionally naturally caused by lightening. But there are five primary pollutants that together contribute to about 90% of the global air pollution. 3. Deforestation: It arises as a result of excessive use of fertilizers, soil erosion, Salinization and water logging, dumping of garbage and other kinds of unused wastes. 4. Deforestation: Forests protect environment in several ways. They provide a livelihood and cultural integrity for forest dwellers and a habitat for a wealth of plants and animals. 5. Loss of biodiversity: Biological diversity, a composite diversity, a composite of genetic information, species and eco systems, all provide material wealth in the form of food, medicine and inputs to industrial processes. 6. Solid and hazardous wastes: Excessive quantities of solid wastes generation, inadequate collection and unmanaged disposal etc present serious problems for human health and productivity.

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Subject : MANAGERIAL ECONOMICS Q.12 - Write short notes on the following: a) Philips curve b) Stagflation Answer. A. Phillips Curve: A.W Philips the British economist was the first to identify the inverse relationship between the rate of unemployment and the rate of increase in money wages. Philips in his empirical study found that when unemployment was high , the rate of increase in money wage rates was low; and when unemployment was low , the rate of increase in money wage rates was high. Philips calls it as the trade-off between unemployment and money wages. Paul Samuelson and Robert Solow extended the Philips curve analysis to the relationship between the rate of change in prices and the rate of unemployment and concluded that there is a trade-off between the level of unemployment and concluded that there is a trade – off between the level of unemployment in a country and the rate of inflation. Philips curve analysis can be a guide to the government in stiking a balance between the measures to be adopted to solve the problem of unemployment and inflation. B. Stagflation: The present day inflation is the best explanation for stagflation in the whole world. It is inflation accompanied by stagnation on the development front in an economy. Instead of leading to full employment, inflation has resulted in un-employment in most of the countries of the world. It is a global phenomenon today. Both developed countries are not free from its clutches. Stagflation is a portmanteau term in macro economics used to describe a period with a high rate of inflation combined with unemployment and economic recession. The effects of rising inflation and unemployment are especially hard to counteract for the government and the central bank. If monetary and fiscal measures are adopted to redress one problem, the other gets aggravated. Say, if a cheap money policy and public works programme are adopted to remedy unemployment inflation gets aggravated. Say, if a cheap money policy and stringent fiscal measures are followed unemployment will get aggravated. ******************* Page 15 of 15