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FALL 2014
MBA/ MBADS/ MBAFLEX/ MBAHCSN3/ PGDBAN2
1
MB0042- MANAGERIAL ECONOMICS
B1625
past debt by the government to the people, increase in legal tender money
and public borrowing.
High rates Higher rates of indirect taxes would lead to a rise in prices.
Reduction in the rates of direct taxes This would leave more cash in the
hands of people inducing them to buy more goods and services leading to an
increase in prices.
Reduction in the level of savings This creates more demand for goods and
services.
Generally, the supply of goods and services do not keep pace with the everincreasing demand for goods and services. Thus, supply does not match the
demand. Supply falls short of demand. Increase in supply of goods and services
may be limited because of the following reasons.
Hoardings by traders and speculators During the period of shortage and rise
in prices, hoardings of essential commodities by traders and speculators with
the objective of earning extra profits in the future creates an artificial scarcity
of commodities. This creates a situation of excess demand paving the way for
further inflation.
Role of trade unions Trade union activities leading to industrial unrest in the
form of strikes and lockouts also reduce production. This will lead to creation
of excess demand that eventually brings a rise in the price level.
War During the period of war, shortage of essential goods creates a rise in
prices.
Expectations about higher wages and salaries affect the prices of related
goods.
Q2. Monopoly is the situation there exists a single control over the market
producing a commodity having no substitutes with no possibilities for
anyone to enter the industry to compete. In that situation, they will not
charge a uniform price for all the customers in the market and also the
pricing policy followed in that situation.
Define Monopoly: Monopoly means existence of a single seller in the market.
Monopoly is that market form in which a single producer controls the whole supply
of a single commodity which has no close substitutes. Monopoly may be defined, as
a condition of production in which a single firm has the power to fix the price of the
commodity or the output of the commodity. It is a situation there exists a single
control over the market producing a commodity having no substitutes with no
possibilities for anyone to enter the industry to compete.
Features of Monopoly:
Existence of a single seller There will be only one seller in the market who
exercises single control over the market.
Control over supply Seller will have complete control over output and supply
of the commodity.
Price maker The monopolist is the price maker and in taking decisions on
price fixation, he or she is independent. He or she can set the price to the
best of his or her advantage. Hence, the monopolist can either charge a high
price for all customers or adopt price discrimination policy if there are
different types of buyers.
Entry barriers Entry of new firms is difficult. Hence, monopolist will not have
direct competitors in the market.
Firm and industry is same There will be no difference between the firm and
an industry.
5. Similar products but not identical under monopolistic competition, the firm
produces commodities which are similar to one another but not identical or
homogenous. For example, toothpastes, blades, cigarettes, shoes, etc.,
6. Non-price competition In this market, there will be competition among Minimonopolists for their products and not for the price of the product. Thus, there is
product competition rather than price competition.
7. Definite preference of the consumers will have definite preference for particular
variety or brands loyalty owing to the special features of a product produced by a
particular firm.
8. Product differentiation The most outstanding feature of monopolistic competition
is product differentiation. Firms adopt different techniques to differentiate their
products from one another.
9. Selling costs All those expenses which are incurred on sales promotion of a
product are called as selling costs. In short, selling costs represents all those selling
activities which are directed to persuade buyers to change their preferences so as
to maximize the demand for a given commodity. Selling costs include expenses on
sales depots, decoration of the shop, commission given to intermediaries, window
displays, demonstrations, etc.
10. Under monopolistic competition, no doubt, different firms produce similar
products but they are not identical. The monopolistically competitive industry is a
group of firms producing a closely related commodity referred to as product
group. Thus, group refers to a collection of firms that produce closely related but
not identical products.
11. More elastic demand curve Product differentiation makes the demand curve of
the firm much more elastic. It implies that a slight reduction in the price of one
product, assuming the price of all other products remaining constant leads, to a
large increase in the demand for the given product.
perfect competition entails Rational conduct on the part of buyers and sellers, full
knowledge, absence of friction, perfect mobility and perfect divisibility of factors of
production and completely static conditions.
Explanation about the reason for the firms shut down in perfect
competition: A competitive firm will reach equilibrium position at the point where
short run MR equals MC. At this point equilibrium output and price is determined.
The firm in the short run will have only temporary equilibrium. The short run
equilibrium price is not a stable price. It is also called as sub - normal price. A
competitive firm will reach equilibrium position at the point where short run MR
equals MC. At this point equilibrium output and price is determined. The firm in the
short run will have only temporary equilibrium. The short run equilibrium price is not
a stable price. It is also called as sub - normal price. The competitive firm, in the
short run, will not be in a position to cover its fixed costs. But it must recover short
run variable costs for its survival and to continue in the industry. A firm will not
produce any output unless the price is at least equal to the minimum AVC. If short
run price is just equal to AVC, it will not cover fixed costs and hence, there will be
losses. But it will continue in the industry with the hope that it will recover the fixed
costs in the future
If price is above the AVC and below the AC, it is called as Loss minimization zone.
If the price is lower than AVC, the firm is compelled to stop production altogether.
While analyzing short term equilibrium output and price, apart from making
reference to SMC and AVC, we have to look into AC also. If AC = price, there will be
normal profits. If AC is greater than price, there will be losses and if AC is lower than
price, then there will be super normal profits. In the short run, a competitive firm
can be in equilibrium at various points E1, E2 and E3 depending upon cost
conditions and market price. At these various unstable equilibrium points, though
MR = MC, the firm will be earning either super normal profits or incurring losses or
earning normal profits.
In the case of the firm:
1. At OP4 price the firm will neither cover AFC nor AVC and hence it has to wind up
its operations. It is regarded as shut-down point.
2. At OP1 price, OQ1 is the equilibrium output. E1 indicates the price or AR = AVC
only. It does not cover fixed costs. The firm is ready to suffer this loss and continue
in business with the hope that price may go up in the future.
3. At OP2 price, OQ2 is the equilibrium output. E2 indicates the price = AR = AC. At
this point MR is also equal to MC. At this level of output total average revenue =
total average cost hence, the firm is earning only normal profits. It is also known as
Break - even point of the firm, a zone of no loss or no profit. The distance between
two equilibrium points E2 and E1 indicates loss-minimization zone.
4. At OP3 price, OQ3 is the output produced by the firm. At E3, MR = MC. But AR is
greater than AC. For OQ3 output, the total cost is OQ3AB. The total revenue is
OQ3E3P3. Hence, P3E3AB is the total super normal profits.
Thus in the short run, a firm can either incur losses or earn super normal profits. The
main reason for this is that the producer does not have adequate time to make all
kinds of adjustments to avoid losses in the short run. In case of the industry, E
indicates the position of equilibrium where short run demand is equal to short run
supply. OR indicates short run price and OQ indicates short run demand and supply.
Q5.Discuss the practical application of Price elasticity and Income
elasticity of demand.
Practical application of price elasticity:
Eg: 1. Production planning It helps a producer to decide about the volume of
production. If the demand for his products is inelastic, specific quantities can be
produced while he has to produce different quantities, if the demand is elastic.
2. Helps in fixing the prices of different goods It helps a producer to fix the price of
his product. If the demand for his product is inelastic, he can fix a higher price and if
the demand is elastic, he has to charge a lower price. Thus, price-increase policy is
to be followed if the demand is inelastic in the market and price-decrease policy is
to be followed if the demand is elastic. Similarly, it helps a monopolist to practice
price discrimination on the basis of elasticity of demand.
3. Helps in fixing the rewards for factor inputs Factor rewards refer to the price
paid for their services in the production process. It helps the producer to determine
the rewards for factors of production. If the demand for any factor unit is inelastic,
the producer has to pay higher reward for it and vice-versa.
4. Helps in determining the foreign exchange rates Exchange rate refers to the
rate at which currency of one country is converted in to the currency of another
country. It helps in the determination of the rate of exchange between the
currencies of two different nations. For e.g. if the demand for US dollar to an Indian
rupee is inelastic, in that case, an Indian has to pay more Indian currency to get one
unit of US dollar and vice-versa.
5. Helps in determining the terms of trade t is the basis for deciding the terms of
trade between two nations. The terms of trade implies the rate at which the
domestic goods are exchanged for foreign goods. For e.g. if the demand for Japans
products in India is inelastic, we have to pay more in terms of our commodities to
get one unit of a commodity from Japan and vice-versa.
6. Helps in fixing the rate of taxes Taxes refer to the compulsory payment made by
a citizen to the government periodically without expecting any direct return benefit
from it. It helps the Finance Minister to formulate sound taxation policy of the
country. He can impose more taxes on those goods for which the demand is
inelastic and lower taxes if the demand is elastic in the market.
7. Helps in declaration of public utilities Public utilities are those institutions which
provide certain essential goods to the general public at economical prices. The
government may declare a particular industry as public utility or nationalize it, if
the demand for its products is inelastic.
8. Poverty in the midst of plenty The concept explains the paradox of poverty in
the midst of plenty. A bumper crop of rice or wheat, instead of bringing prosperity to
farmers, may actually bring poverty to them because the demand for rice and
Practical application of income elasticity of demand
Practical application of Income elasticity: Eg: 1. Helps in determining the rate
of growth of the firm If the growth rate of the economy and income growth of the
people is reasonably forecasted, in that case, it is possible to predict expected
increase in the sales of a firm and vice-versa.
2. Helps in the demand forecasting of a firm It can be used in estimating future
demand provided that the rate of increase in income and the Ey for the products are
known. Thus, it helps in demand forecasting activities of a firm.
3. Helps in production planning and marketing The knowledge of Ey is essential for
production planning, formulating marketing strategy, deciding advertising
expenditure and nature of distribution channel, etc. in the long run.
4. Helps in ensuring stability in production Proper estimation of different degrees
of income elasticity of demand for different types of products helps in avoiding overproduction or under production of a firm. One should also know whether rise or fall
in income is permanent or temporary.
5. Helps in estimating construction of houses The rate of growth in incomes of the
people also helps in housing programs in a country. Thus, it helps a lot in
managerial decisions of a firm. heat is inelastic
The same idea has been expressed by Spencer and Siegelman, in the following
words: Managerial economics is the integration of economic theory with business
practice for the purpose of facilitating decision making and forward planning by the
management1. Mc Nair and Meriam say, Managerial economics is the use of
economic modes of thought to analyze business situation2. Brighman and Pappas
define managerial economics as, the application of economic theory and
methodology to business administration practice3. Joel Dean is of the opinion that
use of economic analysis in formulating business and management policies is
known as managerial economics.
Scope of Managerial Economics:
Scope:
Objectives of a firm: All the objectives are determined by various factors and forces
such as corporate environment, socio-economic conditions, nature of power in the
organization and external constraints under which a firm operates. However, in the
midst of several objectives, even today, the traditional profit maximization objective
has a very high place. All other policies and programs of a firm revolve round this
objective.
Demand analysis and forecasting: The basic problems like: what to produce;
where to produce; for whom to produce; how to produce; how much to
produce and how to distribute them in the market, are to be answered by a
firm. Hence, the firm has to study in detail about the various determinants of
demand, nature, composition and characteristics of demand, elasticity of
demand, demand distinctions, demand forecasting, etc. include all these
points.
Production and cost analysis : Production means conversion of inputs into the
final output. It may be either in physical or in monetary terms.Production cost
is concerned with estimation of costs to produce a given quantity of output.
Cost controls, cost reduction, cost cutting and cost minimization receive top
most priority in production and cost analysis. Maximization of output with
minimum cost is the basic goal of any firm. Cost analysis deals with the study
of various cost concepts, their classification and cost-output relationship in
the short run and long run.
Pricing decisions, policies and practices: Pricing decisions means to fix the
prices for all the goods and services of any firm.
Capital management: This is one of the essential areas of business unit. The
success of any business is based on proper management and adequate
capital investment.
Linear programming and theory of games: It straight lines and the term
programming implies systematic planning or decision-making. It implies
maximization or minimization of a linear function of variables subject to a
constraint of linear inequalities.
Strategic planning: It provides long term decisions, which will have a huge
impact on the behavior of the firm.