Economics

Q1. Managerial economics refers to the integration of economic theory with business
practice. It deals with application of economic principle to the problems of business firms
it modifies or reformulates already existing economic models to suit the specific
conditions and serve the specific problem of the business firms .it helps to solve real
complex business problems using other related branches.
Definition: According to Prof. Joel Dean The purpose of Managerial Economics is to
show how economic analysis can be used in formulating business policies

Nature of Managerial Economics :

It aims in providing help in making decisions by the firms as it draws heavily on the
propositions of macro economics
It assists the firm in forecasting as macro economics studies the economy at the
aggregate level .It also helps to identify the level of demand at some future point
based on the relationship between level of national income & demand for a
particular product
It helps on those propositions which are likely to be useful to the management, as
decision has to be made without delay. Besides more accurate forecast may not
justified on cost considerations
Managerial economics prescriptive in nature and character. It recommends that
which should be done on alternative conditions. E.g. if the distribution of income
has become more uneven it is stated without indicating what should be done to
correct this phenomenon.
Managerial economics to an extent is an applied science e.g. empirical study may
suggest that for every one percent raise in expenditure on advertising the demand for
the product shall increase by 0.5% .

Scope of Managerial Economics

Demand analysis and forecasting : Demand forecasting is the process of finding the
values for demand in future time period. The current values are needed to make
optimal current pricing and promotional policies, while future values are necessary
for planning future production inventories, new product development etc. Correct
estimates of demand is essential for decision making , strengthening market position
and enlarging profits. Regression analysis is one of the most common methods of
estimating an economic variables which are explanatory variables with the view to
estimate and credit the average value of dependent variable.
Cost and Production Analysis: Production deals with the physical aspects of the
business investment. It is the process whereby inputs are transformed into outputs.
Efficiency of production depends on ratio in which various inputs are employed
absolute level of each input and productivity of each input. A production function is
the relation which gives us the technically efficient way of producing the output given
the inputs. Actually cost is the monetary side of production . Given the production
function, one can go for cost estimation and forecasting. While the former refers to
the present period cost levels, cost forecasting refers to the levels of cost in a future
period. The firm must undertake cost estimation and forecasting to judge the
optimality of present output levels and assess the optimal level of production in
future.
Inventory Management: It refers to stock of raw materials which a firm keeps. If it
is high, capital is unproductively tide up which might, if stock of inventory is
reduced, be used for other productive purpose . On the other hand, if the level of
inventory is low, production will be hampered. Hence, managerial economics with
methods such as ABC analysis a simple simulation exercise and some mathematical
models with a view to minimize inventory cost. It also helps in aspects of inventory
control and cost of carrying them.
Advertising: Managerial economics helps in determining the total advertising cost
and budget, the measuring of economic effects of advertising and form an integral
part of decision making and forward planning.
Market Structure and Pricing Policies: Managerial economics helps to clear surplus
and excess demand to bring market equilibrium as there is continuos changes in
market. Success of business firm depends on correctness of price decisions. Price
theory works according to the nature of the market depending on the number of
sellers, demand conditions etc.
Resource Allocation: Managerial economics with the help of advanced tools such as
linear programming are used to arrive at the best course of action for the maximum
use of the available resources and its substitutes.
Capital Budgeting: Capital is scarce and it costs something . Hence, managerial
economics helps in decision making and forward planning on allocation of capital to
various factors of productions , marketing and management.
Investment Analysis: It involves planning and control capital expenditure. Whether
or not to invest funds in purchase of assets or other resources in an attempt to make
profit and how to choose among completing uses of funds. Managerial economics
help in analysis and decision making on the investment of funds.
Risk and Uncertainty Analysis: As business firm have to operate under conditions
of risk and uncertainty both decision making and forward planning becomes difficult.
Hence managerial economics helps the business firm in decision making and
formulating plans on the basis of past data, current information and future prediction.


Q2.Law of demand is one of the important laws of economic theory .It explains the
general tendency of the consumers to buy more of a good at a lower price and less of it at
a higher price lower price attracts consumers to buy more goods .thus law of demand
expresses an inverse relationship b/w the price and the quantity demanded of a
commodity other things being equal.According to Lipsey A fall in the price of a
commodity cause a household to buy more of that commodity and less of the other
commodity which compete with it, while rise in price causes the household to buy less of
this commodity & more of the competing commodities
The law of demand indicates only the direction of change of demand corresponding
the change in the price. This can be illustrated through a demand curve. Price is measured
in theY axis&quantity in the X axis.DD is the demand curve of the good under
consideration.At price OP1the quantiy demanded is OQ1 if price of the good falls into
OP2 the quantity demanded rises to OQ2 the demand curve is sloping downwards which
is in accordance to the law of demand all the determinants of demand are assumed to be
constant




Y




P M
P
R
I P
1
M
1
C
E




O Q Q
1
X
Quantity


Law of demand states the inverse relationship between price of a commodity and
quantity demanded, other things remaining the same. The demand of a commodity is
more at a lower price and less at a higher price. That is why the demand curve slopes
downward. The factors responsible for the downward slope of demand curve are :
(a) Law of diminishing marginal utility: The law of diminishing marginal utility states
that as the consumption of a commodity by a consumer increases the satisfaction
obtained by the consumer from each additional unit of the commodity goes on
diminishing.
(b) Income effect: A fall in the price of the commodity increase the purchasing power of
the consumer, in otherwords the consumer has to spend less to buy the same quantity
of the commodity as before. The money so saved because of a fall in the price of the
commodity can be spent by the consumer in ways he likes. He will spend a part of
this money on buying some more units of the same commodity whose price has
fallen. Thus a fall in the price of this commodity increases its demand. This is
called income effect.

(c) Substitution effect: This also increases demand as a result of a fall in the price of the
commodity and viceversa. When the price of a commodity falls it becomes relatively
cheaper than other commodity whose prices have not fallen. So the consumer
substitute this commodity for other commodities which are now relatively dearer.
This is know as substitution or complementarily effect.

(d) Changes in the number of consumers: Many people cannot afford to buy a
commodity at a high price. When price of a commodity falls, the number of persons
who could not afforded at a higher price can purchase it at a reduced price. This
increases the consumer of the commodity. Thus at a lower price the quantity demand
of the commodity increases because of increase in the number of consumers of the
commodity and vice versa.

(e) Diverse Uses of the commodity: Many commodities can be put to several uses. The
commodity having several uses is set to have composite demand.

All the above factors are responsible for the downward slope of demand curve.
These factors explain the operations of the Law of Demand. The important of these
factors depends upon the circumstances of the case.

Exceptions to the Law of Demand:

Under certain circumstances the inverse relationship between price and
demand does not hold good. These are know as the exceptions to the law of demand.
Some of the important exceptions are :

(a)Giffen Goods: These are special type of inferior goods. A rise in the price of giffen
goods leads to a rise in their demand and viceversa. E.g. A poor household who spends
a major portion of his money on an inferior goods like coarse grain, say bajra. If the
price of bajra goes up the household will be forced to maintain the earlier consumption
level of consumption of this good, he will be left with lesser income to spend on other
commodities that he used to consume earlier. The household will be forced to cut down
the consumption of other commodities still further to compensate itself for the loss of
consumption of bajra. Conversely, a fall in price of bajra will enable the household to
release more money for other commodities and may substitute consumption of bajra by
consumption of other superior commodities. The bajra will be considered as gifen goods
to which law demand does not apply.

(b)Conspicuous necessities: Another exception occur in case of such commodities as
though their constant use is because of fashion or prestige value attached to them have
become necessity of life. Eventhough their price rises continuously their demand does
show any tendency to fall.

Conspicuous consumption: A few goods like diamond etc. purchased by rich persons of
the society because the prices of those goods are so high that they are beyond the reach of
the common man. More of these commodities is demanded when their prices go up very
high. The law of demand does not apply.

(d)Future changes in price: Household also act as speculators when the price are rising,
the house hold tend to buy larger quantity of the commodity out of apprehension that the
prices may go up further. Likewise when prices are expected to fall further a reduced
price may not be sufficient incentive to induce the household to buy more. E.g. share
market.

(e)Emergencies: Emergencies like war, famine, flood etc. may negate the operations of
lay of demand. At such time the household may behave in a abnormal way. Household
accentuate scarcity and induce further price rises by making increase purchases even at
higher prices during such period. During depression, on the other hand, no amount of
falling price is sufficient inducement for consumer to demand more.

(f)Change in fashion: A change fashion entails effect demand for a commodity.

(g)Ignorance: Consumers ignorance is another factor that at times induces him to buy
more of commodity at a higher price. This happens when the consumer thinks that a
high price commodity is better in quality than low price commodity.



Q3. Demand forecasting is an attempt to foresee the future by examining the past
.Business firms can estimate and minimize the future risk & uncertainty through
forecasting &forward planning .It is an essential tool in developing new products
scheduling production determining necessary inventory levels&creating a distribution
system . Its essence is estimating future events acc to the past patterns and applying
judgement to those projections .Virtually all types of national & intl organisations Govt
,social &business engage in some type of demand forecasting the goal of course is better
mgt ability to plan &control operations churches try to predict future revenues from
members contributions to develop reasonable budgets. School administrators use
Enrolment forecasts to determine faculty sizes, supplies &classroom requirements
.Demand forecasting is a crucial activity for planning survival &growth of a corporate
unit. Demand forecasts may be passive or active the former predict the future demand by
extrapolating the demands of the previous years in the absence of any action by the firm
Here the things are assumed to continue the way they have been in the past these
forecasts are used only to assess the impact of new policies on the market while the latter
estimate the future scenario inclusive of own future actions &strategies of the firm itself
These forecasts are more meaningful as they take into account the likely changes in the
relevant variable in estimating future demand here the firm manipulates the demand by
changing price,product quality etc.Demand forecasts methods vary acc to whether they
apply to a large aggregate such as the whole economy(macro forecasts)or to a
component of this aggregate such as an industry or a co. (micro forecasts) a frequent
practice is to translate forecasts of overall levels into industry forecasts by trade
associations &to use this in turn to generate co. forecasts.However small firms cannot
afford these sophisticated techniques .

Methods of demand forecasting : The imp. Of selecting the right type of forecasting
method cannot be overstated however the choice is complicated bcoz each situation
might require a different method mgt. should be aware of the factors favoring one method
over another in a given demand forecasting situation in some cases mgrs are interested
in the total demand for a product service in other circumstances the projection may focus
on the firms probable mkt share forecasts can also provide inft. on the product mix
major decisions in large business houses are generally based on forecasts on some type
in some cases the forecasts may be little more than an intuitive assessment or value
judgement of the future by those involved in the decision .Thus no forecasting method is
suitable for all situations.Selection of a forecasts has to be appropriate to the situation that
is objective, urgency data availability ,nature of the product etc. The firm can afford
acurracy level required.

Forecasting Methods



Survey Methods Statistical Methods



Consumer Collective Market experiment
S.M opinion method method



Time series Analysis Regression analysis



Graphical Semi-average Moving average Least
square




Survey methods : Under this approach are conducted about the intentions of the
consumers (individuals, firms or industries) opinion of experts or of mkt .Under census
survey, all consumers\ experts mkts are surveyed.While in sample survey a selected
subset of them are surveyed and through their study, inferences abt the whole popln. are
drawn .These methods are usually suitable for short-term forecast due to volatile nature
of consumers intentions.New products demand forecasting also makes use of survey
approach,as data availability problem is overcome through surveys of consumers.


Consumer Survey Method: Surveys of managerial plans can be one of the impt. Methods
of forecasting .The rationale for conducting such surveys is that plans generally form the
basis for future actions by using this method, a firm can ask consumers what &
How much they are planing to buy it at various prices of the product for the forthcoming
time period, usually a year. If the product happens to be a consumer good the consumers
are firms or industries using that product the survey may involve a complete enumeration
of all consumers of the given product, whose demand is to be forecasted.

Collective Opinion Method: Under this method(also called sales- force polling), salesman
or experts are required to estimate expected future demand of the product in their
respective territories &sections the rationale of this method is that salesman, being the
closest to the customers, are likely to have the most intimate feel of the market i.e
customer reaction to the product of the firm &their sales trends the estimates of
individual salesman are averaged or consolidated to find out the total estimated sales the
final sales forecast would emerge after these factors are being taken into account.This
method is known as the collective opinion method, as it takes advantage of the collective
wisdom of the salesmen,departmental heads like prod.mgr sales.mgr etc&the top
executives.

Market Experiments Method: Under this method, the main determinants of the demand of
a product like prices, advt, product design, packaging,etc are identified. These factors are
then varied separately over different markets or time periods holding other factors
constant. The effect of the experiment on consumer behaviour is studied under actual or
controlled mkt conditions which is used for overall forecasting purpose.

Statistical methods:
These methods make use of historical data as a basis for extrapolating quantitative
relationships to arrive at the future demand pattern and trends. The data a may also be
analyzed through econometric models. These are used for long term forecasting and for
products for larger levels of aggregation. They are based on scientific base of estimation
which are logical, unbiased and proven to be useful.

Time series analysis: It is an arrangement of statistical data in a chronological order, i.e.
in accordance with its time of occurrence. It reflects the dynamic pace of steady
movement of a phenomenon over a period of time. Most of the variables in business,
economic and commerce be it a series related to price, production, consumption,
projects,sales, etc. at all time series data spread over long period of time.

Graphical Methods: This method gives the basic tendency of a series to grow, decline or
remain steady over a period of time. This method is useful in forecasting population,
demand etc.where the future is not too much different from average of the past.
Theperiod time in the trend analysis is always long; but the concept of trend does not
include short time oscillations and fluctuations.

Semi Average Method: According to this method the date is divided into two parts
preferably with the same number of years. The averages of the first and second part are
calculated separately. These averages are called semi averages which are plotted as
points against middle point of the respective time period covered by each part.

Moving Averages Method: This is a very simple and flexible method of measuring trend
which consists of obtaining a series of moving averages of successes overlapping groups
of the time series. The averaging process smoothens out fluctuation as well as the ups
and down in the given data.

Least square method:The principle of least squares provides us an analytical tool to
obtain an objective fit to the trend of the given time series. Most of the data relating to
economic and business time series conform to definite laws of growth or decay. Thus,
in such situation, trend fittings will be most reliable way of forecasting.

Regression Analysis:This is also a popular method of forecasting among the economists.
It is a mathematical analysis of the average relation between two or more variables in
terms of original units of the data. Here the data analysis should be based on logic of
economic theory.

Demand Forecasting of New Products:Projecting demand of new products is different
from those of established products. This requires an intensive study of the economic and
competitive characteristics of the product.

Product Life Cycle Analysis:Many products ar distinct when it degenerates over the
years into a common product. Innovation of a new product and its degeneration into a
common product is termed as Life Cycle of a Product. The forecaster must identify the
phase of product cycle at which the industry is operating at the time of prediction.

Test Markting:Under test marketing the product is introduced in selected area often at
different prices. Th number of area selected depends on the representatives and cost of
marketing. The selected area must have an average competition, presence of chain of
departmental stores, optimum size of population, etc. The duration of testing depends
upon the average purchase period, the competitive situation and cost of testing.

Survey of Consumer Intention: This method involves interviewing the consumer by
sending questionnaires to elicit replies so as to make short term prediction of demand.
Samples may be given for this purpose. This method is most useful when bulk of the
sales is made to industrial producers. Here the burden of forecasting is shifted to
consumer.

Evolutionary Approach: The demand for a new product may be projected as an
outgrowth and evolution of an existing old product. This approach is useful when the
new product is nearly an improvement of an existing product.

Growth Curve Approach: Roll of growth and demand for new product may be estimated
on the basis of pattern of growth of some existing substitute established product.


Q4. Pure monopoly or simple monopoly is a market structure in which there is a single
seller of a good with no close substitutes. Being the sole supplier of the commodity, the
monopolist has complete control over the supply of and can independently supply& can
independently determine equilibrium price &output eg.railways, electricity etc.There may
be different reasons for the emergence of monopoly few of the causes for the emergence
of monopoly are:
Natural causes: A firm may enjoy monopoly bcoz of its control over a crucial raw
material or mineral eg petrol uranium etc.
Legal factor: A firm can legally procure monopoly power eg patent copy right etc
Cost factor: A firm may produce at such low cost at which no other firm can produce a
commodity
Market factors: Sometimes the size of market is so small that it cannot accommodate
more than one firm.
Heavy investment: Certain industries like iron &steel locomotives etc need heavy
investment which only a particular firm can afford to arrange
Protection of public rights: Motivated by public welfare&public interest the Govt. itself
can assume monopoly power eg.railways post&telegraph etc
Equilibrium of the monopoly Firm
Equilibrium of a monopoly firm is to maximize its profits or minimise losses.
Equilibrium of a monopoly firm is attained at that level of output at which it maximizes
its profits & minimises losses there are 2 approaches to study equilibrium of a monopoly
firm, these are (a) total revenue total cost approach,&(b) marginal revenue marginal cost
approach
(a)Total revenue total cost approach: Acc to this approach a monopoly firm attains
equilibrium when the difference between its total revenue &total cost is the maximum at
the equillibrium point, monopolist get the maximum profit & suffer the minimum loss.
(b)Marginal revenue marginal cost approach: According to the marginal revenue
marginal cost approach, equilibrium of monopoly firm is obtained at that level of output
at which its marginal cost equals marginal revenue.
Monopoly price during short-run
During short run monopolist cannot expand or contract the size of this plant nor can he
change the structure of the fixed costs. In order to be in equilibrium of monopoly from
would like to product that level of output at which it is marginal revenue is equal to
marginal cost . In the short run the monopoly firm may get abnormal profit and may
suffer loss.

Monopoly price during long run: The long rum equilibrium of the monopoly firm is
attained at that level of output where its marginal cost equals the marginal lrevenue.
Monopoly in the long run gets abnormal profit. It is Los because the new firms are not
allowed to enter the market. Monopoly does not suffer loss in the long run because all
the costs in the long run are variable and these must be recovered. In case a monopoly
firm fails to recover the variable in the long run, it would better stop production and quit
the market.

Q.5 Opportunity Cost: Opportunity cost is to cost which is not actually incurred, but
would have been incurred in the absence of employment of self owned factors.As
expenditure is not currently incurred this cost is often incurred &not recorded in the
books of accounts .Opportunity cost occupies a very important place in modern economic
analysis .Opportunity cost of any input is the next best alternative use that is sacrificed by
its present use it is measured by the value of factors of prod used in producing a good,
when put to the next best alternative use O.C reflects the benefits we give up to select the
most preferred choice eg if a farmer decides to grow wheat instead of rice, the O.C of the
wheat would be the rice, which he might have grown rather .thus ,O.C is the cost of
foregone alternative. If he produce more of one thing, resources have to be withdrawn
from other uses as these are scrace.Implicit cost incurred by a firm is actually the O.C of
the factor owned by him by employing the factor in the firm, the producer loses the
opportunity of earning the factor income had it been employed elsewhere. Thus the O.C
of a factor input is nothing but a potential return from the next best alternative use of that
factor . O.C is also the minimum price necessary to retain a factor in the current
employment .O.C of a good is not simply any other alternative good that could be
produced with the same factors it is only the most valuable good, which the same factor
or nearly the same value of factors could produce. The concept of O.C has some
limitations it is only applicable to those factors which have alternative uses thus, if no
sacrifice is involved then O.C is 0,Eventhough the actual cost or the acquisition cost or
the historical cost was substantial.


Production function : It denotes an efficient combination of inputs & output it shows
for a given technological knowledge & managerial ability, the maximum amount of a
good that can be obtained from different combinations of productive factors per unit of
time or minimum quantities of various inputs required to yield a given quantity of output
thus, prod function is a catalogue of output possibilities prices of factors or of the
product do not enter into the pro function.The pro fuction of a firm shows the technical
methods available to produce a given output of a commodity by combining the factors of
production in various possible ways. A rational producer always uses technically most
efficient method of prod a method of prod is said to be technically more efficient than
other methods, if it uses less of atleast one factor& no more of other factor inputs to
produce one unit of the commodity.The production function expresses the way out put is
produced by inputs & the way inputs co-operate with each other in varying proportions to
produce any given output these relations between inputs&outputs &inputs themselves are
determined by technology that rules at any given time the technology is embedded in the
production function, which acts as a constraint on decision making thus production
function depicts the present limits of the firm.A firm can produce higher output only by
using more inputs or with advanced technology at the same time, production function
indicates the manner in which a firm can substitute one input or output for the other
without altering their total amounts respectively prod function differs from firm to firm,
industry to industry any change in the state of technology or managerial ability disturbs
the original prod function .Production function can be represented in various forms it can
be represented by schedules, tables, graphs total, average etc

Differences between Perfect competition and Monopoly
Number of sellers: Under perfect competition there are alarge no. of sellers each selling
in a small quantity of total supply it consists of large no. of firms. Monopoly consists of
of a single seller the total supply of the product is in the hands of a single seller.

Nature of the product: The product offered by the firm in perfect competition is
homogenous while in monopoly it not homogenous i.e it does not have any substitutes

Entry & exit conditions: Entry as well as exit in case of perfect competition is said to be
free but in case of monopoly entry is assumed to be blocked .

Decision Variables:The decision variables variable of the firm is the determination of of
its output but a monopoly has to determine eithervits output or price.

Equilibrium: A perfectly competitive firm equilibrium is possible only when the MC
curve is rising at the point of equilibrium but monopoly equilibrium can be very well
established whether MC curve is rising falling or remaining constant at the equilibrium
curve.

Capacity Utilisation:Perfectly competitive firm is a long run equilibrium at the minimum
point of the long average cost curve.There are neither unexhausted economies of scale or
diseconomies of large scale production. In case of monopoly the firm may not necessarily
produce at minimum point of of the long run avg cost.

Supply curve: As perfectly competitve firm produces where MR=Price=Rising MC the
firms short run supply curve is given by the rising portion of its MC curve over &above
its avg variable cost.A monopolist however has no unique supply curve Its maximises its
profits by producing an output at which it isMR=MC

Price output Comparision:Price charged under P.C is invariably low than the one under
monopoly assuming same demand & cost conditions

Change in demand: In P.C an increase in the in mkt demand will push the price& output
but it is not the same in case of monopoly

Change in Variable cost :Increase in variable costs shifts the marginal cost upward
reduces the output & increases the price in both the mkt structures.

Differences between perfect competition & pure competition

Pure competition is unalloyed by monopoly elements .It is much simpler & less exclusive
concept than perfect competition for latter may be interpreted to involve perfect in many
other aspects than in the case of absence of monopoly .Pure competition involves purity
only in one respect i.e absence of control over the price.It is said to exist in an industry
where there are a large no. of sellers & buyers producing homogenous product. It may be
found in real life situations.
Perfect competition is a broader term & involves absence of monopoly as well as
presence of other perfections like perfect mobility of the factors of production , absence
of transportation & selling costs etc