Q.No. 1: What is Managerial Economics.? Explain the nature and scope of Managerial Economics.?

Answer:

Managerial Economics generally refers to the integration of economic theory with business practice. While
economics provides the tool which explain various concepts such as demand, supply, price, competition etc.
Managerial economics applies these tools to the management of business, in this sense managerial
economics is also understood to refer to business economics or applied economics.

Managerial economics lies on the border line of management and economics. It is a hybrid of two disciplines
and it is primarily an applied branch of knowledge. Management deals with principles which help in decision
making under uncertainty and improve effectiveness of organisation. Economics on the other hand provides
a set of propositions for optimum allocation of scare resources to achieve the desired objectives.

Nature of Managerial Economics:

It is true that managerial economics aims at providing help in decision making by firms. For this purpose it
draws heavily on the prepositions of micro economic theory. Note that micro economics studies the
phenomenon at the individuals level and behavior of consumers, firms. The concepts of micro economics
used frequently in managerial economics are elasticity, marginal cost, managerial revenue, market structure
and their significance in primary policies. Some of these concepts however provide only the logical base and
have to be modified in practice.

Micro economics assists firms in forecasting. Note that micro economics theory studies the economy at the
aggregative level and ignores the distinguishing features of individual observations. For example micro
economics indicates the relationship between the

 Magnitude of Investment and Level of National Income

 Level of National Income and Level of Employment
 Level of Consumption and National Income etc.

Therefore the postulates of microeconomics can be used to identify the level of demand at some future point
in time, based on the relationship between the level of national income and demand for electric motors. Also
the demand for durable goods such as refrigerators, air-conditioners, motor cars depends upon the level of
national income.

Managerial economics is decidedly applied branch of knowledge. Therefore the emphasis is laid on those
prepositions which are likely to be useful to the management. The precision of a scientist is not motivating
factor in research activity. Improvement in the quality of results is attempted, provided the additional cost is
not very high and the decision maker can wait. For example it may be possible to have more accurate data
on demand for the firm’s product by taking into consideration, additional factors. But this may not be the
attempted because the decision has to be made without delay. Besides more accurate forecasts may not be
justified on cost considerations.

Management economics is perspective in nature and character. It recommends that it should be done
alternate conditions. For example if the price of the synthetic yarn falls by 50% it may be desirable to
increase its use in producing different types of textiles. Thus managerial economics is one of the normative
sciences and reflects upon the desirability or otherwise of the prepositions. For example if the analysis
suggests that the benefit-cost ratio is used as the criterion for project appraisal it is recommended that the
firm should not install a large plant. Contract this with the positive sciences which state the prepositions
without connecting upon what should be done. For example 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 the extent that it is uses economic thought is a science, but it is an applied
science. Economic thought uses deductive logic (if X is true, then Y is true). For example if the triangles ate
congruent then angles are equal. To have confidence in the findings, the prepositions deducted are subject
empirical verification. For example empirical studies try to verify whether cost curves faced by a firm are
really U shaped as suggested by the theory. Furthermore there is an attempt to generalize the prepositions
which provide a predictive character. For example empirical studies may suggest that every 1% rise in
expenditure on advertising, the demand for the product shall increase by 5%.

Managerial economics uses scientific approach. In practice, some firms may use simple rules based on past
experience. However the quality of decisions made can be improved using a systematic approach.

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Scope of Managerial Economics:

Scope means province or an area of study. There is hardly any uniform pattern as regards the scope of
managerial economics as it is comparatively a new subject. However, the scope of managerial economics
may be discussed under following points.

Whether managerial economics is normative or positive economics: Economics is divided in to positive

economics and normative economics. Positive economics is that branch of economics which studies the
things as they are. Normative economics deals with the things they ought to be or should be. Positive
economics is descriptive in nature where as normative economics is prescriptive in nature. Managerial
economics is considered to be the part of normative economics. It lays more emphasis on prescribing choice
and action and less on explaining what happened. Managerial economics draws descriptive economics and
tries to pass judgments to value in the context of time.

Area of Study: Broadly speaking managerial economics deals with the following topics.

Demand Analysis and Forecasting: Effective decision making at the firm level depends on accurate
estimates of demand. Demand analysis aims at discovering the forces that determine sales. The
demand analysis mainly relates to the study of demand, determinants, demand distinctions and
demand forecasting.

Cost and Production Analysis: Cost estimates are also essential for effective decision making and
production planning at the firm level. Profit planning, cost control and sound pricing practices call for
accurate cost and production analysis. Cost relations are production function and cost control.

Pricing Decisions, Policies and Practices: Pricing is an important area of managerial economics.
Success of a business firm largely depends on the accuracy of price decisions. Price determinations
under different markets, pricing methods policies, product line pricing and price forecasting are
some of the topics of this area.

Profit Management: Business firms are mainly profit hunting institutions. The success of the firm is
always measured in terms of profits. Nature and management of profit, profit policies and
techniques and profit planning are the important aspects covered in this area.

Capital Management: The most complex, troublesome problem faced by the business manager is
the capital management. Capital management implies planning and control of capital expenditure.
Cost of capital rate of return and selection of projects are the important points under this.

Linear Programming and Theory of Games: Since managerial economics and operations research are
closely connected with each other, managerial economics has started using such techniques of
operations research as linear programming and the theory of games. Recently the linear
programming and the theory of games have been brought as part of managerial economics.

Profits – a central point in managerial economics: Profit in other words is the central concept of managerial
economics. Without profits business firms can not run. The maximization of profits is the main objective of
any firm or a business unit. The survival of the firm is determined by the ability of a firm to earn profits.
Profit is the main indicator of firm’s success.

Optimisation: Optimisation is another important concept used in economic theory and managerial
economics. Managerial economics often aims at optimising a given objective. In recent years, a new concept
was found out called “Sub-Optimisation”. The greatest merit of this concept is its flexibility.

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Q.No. 2: Answer briefly any four of the following.?

2(a): How would you distinguish between a firm and industry.?

Answer:

For understanding the difference between a firm and industry, it would be advisable to understand the
nature of a competitive industry. A competitive industry has three basic characteristics.
Large Number of Firms, Homogeneous Product and Freedom of Entry and Exit.

In a competitive industry, there is a large number of firms so that he action of a single firm has no effect on
the price and output of the whole industry. Every firm therefore enjoys the freedom to increase or decrease
its output substantially by taking the price of the product as given. Secondly every firm in a purely
competitive industry must be making a product which is accepted by customers as being identical with that
made by all the other producers. In the industry. This is known as the condition of homogeneity. This
ensures that all firms have to charge the same price. The buyers, of course are to decide that the product is
the same. The buyers should not find any real or imaginary differences between the products sold by any
two pair of firms. There should be no barriers to the entry of new firms or exit of old firms to the industry.

We considered competitive industry because we wanted to contrast such an industry with a monopoly.
Under monopoly there is only one firm producing a product. Entry into the industry is not free, because if
entry of an additional firm is allowed, monopoly no longer remains. Thus under monopoly, the firm is the
industry or the distinction between the firm and the industry disappears under the conditions of monopoly.

Between these two extremes, we get a wide range of marked structures where there are more than one
firms product. Strictly speaking, all firms producing the same i.e. homogeneous product make an industry
and whatever all such firms supply becomes the supply of the industry. In practice however, we speak of
the cotton textile industry, through all cotton textile units do not produce identical textile products. Though
the sugar produced by sugar factories might have different grades of quality, we speak of one sugar
industry. Similarly we speak of the automobile industry, steel industry, cement industry and so on.

It should, therefore be clear that all firms producing a given product, together make an industry.

2(b): What are the determinant of Demand.?

Answer:

Demand for a commodity depends upon number of factors. Factors influencing individual demand. An
individual’s demand for a commodity is generally determined by factors such as:

Price of the Product: Price is always a basic consideration in determining the demand for a commodity.
Normally a larger quantity is demanded at a lower price than at a higher price.

Income: Income is an equally important determinant of demand. Obviously with the increase in income one
can buy more goods. Thus a rich consumer usually demands more goods than poor consumer.

Tastes and Habits: Demand for many goods depend on the person’s tastes, habits and preferences. Demand
for several products like ice-creams, chocolates, cool drinks etc., depend on an individual’s taste. Demand
for tea, betel, tobacco etc., is a matter of habit. People with different tastes and habits have different
preferences for different goods. A strict vegetarian will have no demand for meat at any price., whereas a
non-vegetarian who has liking for chicken may demand it even at a high price. Similar is the case with
demand for cigarettes by smokers and non-smokers.

Relative prices of Other Goods: How much the consumer would like to buy of a given commodity, however
also depends on the relative prices of other related goods such as substitutes or complementary goods to a
commodity. When a want can be satisfied by alternate similar goods, they are called substitutes. For
example, peas and beans, ground nuts oil and sun-flower oil, tea and coffee etc., are substitutes of each
other. The demand for commodity depends on the relative process f its substitutes. If the substitutes are
relatively costly, then there will be more demand for the commodity is question at a given price than in case
its substitutes are relatively cheaper.

Substitutes and Complementary Products: The demand for a commodity is also affected by its
complementary products. In order to satisfy a given want, two or more goods are needed in combination,
these goods are referred as complementary goods. For example car and petrol, pen and ink, tea and sugar,
shoes and sacks, gun and bullets etc., are complementary products to each other. Complementary goods
are always in joint demand. Thus if a given commodity is a complementary product, its demand will be
relatively high when its related commodity’s price is lower, than otherwise. When the price of one

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commodity decreases the demand for its complementary product will tend to increase and vice versa. For
example, a fall in price of cars will lead to increase in the demand for petrol. Similarly a steep rise in the
price of petrol will cause a decrease in demand of petrol driven cars and its accessories.

Consumers Expectations: Consumers expectations about the future changes in the price of a given
commodity also may affect its demand. When consumer expects its prices to fall in future, they will tend to
buy less at the present prevailing price. Similarly if they expects its prices to rise in future they will tend to
buy more at present.

Advertisement Effect: In modern times the preferences of a consumer can be altered by advertisement and
sales propaganda, albeit to certain extent only. Thus demand for many products like tooth pastes, toilet
soaps, washing powder, processed foods etc. is particularly caused by the advertisement effect.

Q.No. 2(c): Explain the features of Monopoly.?

Answer:

The following features are seen under simple or limited monopoly.

Single Producer: For monopoly to exist only one producer should be in the market. The producer may be an
individual, a partnership firm, an enterprise, the government or a joint stock company.

No close Substitute: To avoid any possibility of competition in the market, there should be no close
substitutes for the product of the monopolist. This means that the cross-elasticity of demand for the
monopolists product is low.

Barriers to entry of firm: The basis of monopoly is the barriers or restrictions of new firms into the market,
those can be either natural barriers or artificial barriers.

Demand curve under monopoly: The above mentioned features explain the demand curve or the average
revenue(AR) curve under the monopoly.

The demand curve for a firm(which means the industry under monopoly) is downward sloping. It is the
monopolist who is the price- market in the market.

Demand Curve under Monopoly

Average Revenue Price

O Quantity Demanded X
Under the monopoly, there is only one seller who controls the entire supply in the market. Since this is the
only producer and seller, he can fix the price of his product. In order to maximize his profit, he may rise the
price frequently. He may exploit the consumers by charging an excessive price. Since there are no sellers,
the buyers have no alternative than to buy from the monopolist. Indeed all buyers are put at that mercy of
the monopolist.

Many times, monopolies are created under law. Urban transport, supply of gas and electricity, nowadays
cable television system and such other public utilities are usually managed as monopolies. Such monopolies
are called natural monopolies. On the other hand if a producer acquires monopoly on the basis of patent
laws, it is called an artificial monopoly.

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Q.No. 2(g): State the causes of Inflation.?
Answer:

The causes for inflation can be studied from demand side and supply side.

Factors from Demand side:

Increase in public expenditure: There may be an increase in the expenditure of the government
because of wars or for developing the economy. This increase in governmental expenditure means
an increase in the total demand, which leads to rise in price. This demand is in addition to the
normal demand, which leads to a rise in price.

Increase in private expenditure: When optimism prevails in the business world, businessmen are
eager to spend more money on capital goods. This increase the demand for capital goods and in
turn brings about an increase in the demand for consumer’s goods. This is because there is an
increase in the income of the people who work in capital goods industries. Therefore they are in a
position to spend more and thus, there is an increase in the demand for the both type of goods.

Increase in foreign demand: When there is an increase in foreign demand for the goods
manufactured in the country, exports increase and the prices of commodities in the country increase
as their supply cannot be increased instantaneously.

Reduction in taxation: If there is a reduction in the taxes levied by the government, people are left
with more money which can be spent. This increases their expenditure as well as the prices of
commodities.

Repayment of internal debts: When the government repays old loans, more purchasing power is
placed at the disposal of people. Part of the amount obtained in this manner may be re invested in
various assets, but the rest of it may be spent on consumer goods and services. It is responsible for
increase in prices to the extent. This repayment of loans leads to an increase in the total demand.

Changes in expectations: In the context of price rise the expectations of people play a very
important role. When people expect a rise in prices, businessmen increase their investment and this
leads to an increase in the demand for capital goods. If the consumers think that there will be an
increase in prices in the future, they will start purchasing commodities which they will require in the
near future. This increases the demand for consumer goods. The increase in demand for both
consumers and producers leads to the rise in price.

Factors from Supply side:

Scarcity of the factors of the production: If one or more factors of production are in short supply,
there is a reduction in production or hurdles may be created in the expansion of production. This
reduces the total supply and causes the rise in price.

Bottlenecks: Sometimes, all factors may be avoidable. But bottlenecks are created and this makes it
difficult to make these factors available at the right time and place, for actual production. For
example iron ore and coal ore available at mines, but the transport facilities required to transport
these raw materials to the production site are not available. Transportation then becomes
bottleneck. Therefore in this case production will suffer. Similarly the credit facilities, labor unrest
and strikes, unavailability of transport and several other difficulties may rise and make production
impossible or difficult. This may cause as increase in prices.

Natural calamities: There are several natural calamities which may reduce production. Excess of
rains, droughts, earthquakes, cyclones man substantially reduce the total annual production.
Agricultural production suffers and all other agro based industries such as sugar industry, textile
industry, oil industry, biscuits industry etc., also will suffer. This results in the reduction of
production and leads to the rise of prices.

Hoarding by merchants: When traders and merchants know that there is a short supply of of any
commodity, they will purchase and stock large quantities of these commodities. These commodities
then go underground and are not available in the open market. Thus there is shortage of other
commodities too and this leads to a rise in prices.

Rise in costs: Rise in costs due to increase in factors prices is another cause from the supply side.
Rent, interest and wages can rise due to number of reasons. The central bank may rise interest rate
or unions may cause a wage-rise. This may lead to inflation.

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Q.No. 3: What is Demand Forecasting.? Briefly review the methods of Demand Forecasting?
Answer:

Demand Forecasting is the method of predicting the future demand for the firm’s product. It is guess or
anticipation or prediction of what is likely to happen in the future. Forecast can be done for several things. It
is based on the experience.

Techniques or methods of Demand Forecasting: Method of Demand Forecasting is based on whether the
good is Established Good or new good.

Methods of Demand Forecasting for established goods:

Information of the established good is available so the forecast can be based on this information. Two basic
methods of demand forecasting for the established goods are:

Interview and Survey Approach (for short period forecast): Interview and Survey Approach collects
information in the different way. Depending upon how the information is collected, we have different
sub methods as follows:

Opinion-Polling Method: This method tries to collect information from the customer directly
or indirectly through market research department of the firm or through the whole sellers or
the retailers. Consumers are contacted through mails or phones or Internet and information
regarding their expected expenditure is collected. This method is useful when consumers are
small in number.

Limitations:

 It is difficult and costly to contact all the customers

 It is suitable only for short period
 Consumers are not sure of their purchase plans

Collective Opinion Method: Large firms have organized sales department. The salesman has
the technical training as how to collect the information from the buyers. This information is
further used for forecasting the demand.

Limitations:

 It is difficult and costly to contact all the customers

 It is suitable only for short period
 This is based on judgment & has no scientific basis.

Sample Survey Method: The total number of consumers for the firm’s product is very large
called as population. It is practically not possible to contact all the consumers. Only few of
them are contacted and this forms the sample. The sample forecasts are then generalized
for the whole population through advanced statistical methods available.

Limitations:

 Information collected may not be accurate.

 Sample is not a random sample.
 Consumers do not have the correct idea of their purchases in future.

Panel of experts: Panel of experts consists of persons either from within the firm or from
outside the firm. These experts come together and forecast the demand for their product
that is purely based on the judgment of these experts so they are less accurate. But if based
on the scientific method the forecast would be accurate.

Composite management opinion: The opinions of the experienced person within the firm are
collected and manger analyses this information. This method is quick, easy and saves time,
but is not based on the scientific analysis and thus may not give very accurate results.

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 Projection Approach(for long period forecast): In this method past experience is projected into the
future. This can be done with the help of statistical methods.

Correlation and Regression Analysis: Past data regarding the factors affecting the demand
can be collected. It is possible to express this on the graph. This is a scatter diagram.

Example: If we collect the past data about the sales and advertising expenditure of the firm,
it is possible to express in the form of scatter diagram as shown below:

Y
A
* *
** * * *
* * *
* **
Sales

X
O Advertisement Expenditure

In the above diagram we get the functional relationship as line AA. Here Advertisement
Expenditure is the independent variable and Sales is the dependent variable. The
relationship between these variables is correlation and the technique of establishing this
relationship is regression. In simple correlation we establish relationship between 2 variables
and more than 2 variables in multiple correlation.

Limitations:

 Assumption made is that correlation between two variables will continue

in future also, this might not happen.

Time Series Analysis: Demand forecasts for a period of 2-3 years are based on time series
analysis. It is similar to the correlation analysis. It is based on the assumption that the
relationship between the dependent and the independent variable continues to hold in the
future.

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Methods of Demand Forecasting for new products:

Indirect methods of forecasting are used to estimate demand for new products. Following are the methods
suggested:

Evolutionary Method: Some new goods evolve from already established goods. Demand forecast for
such new good is based on already established good from which they are evolved. For example
Demand for the color TV can be calculated from Demand for the black and white TV, from which it is
actually evolved.

Limitations:

 The product should have been evolved from the existing product.
 It ignores the problem of how the new product differs from the old product.

Substitution Method: Some new goods are substituted of already established goods. For example
VCR substituted with VCD player.

Limitations:

 New product may have many uses and each use has different substitutability
 When the substitute is added is added into market existing firm may react by
changing the prices.

Opinion Polling Method: Expected buyers and the consumers are directly contacted and opinion
about the product is directly taken from them. If the population is large then sample is selected and
results are generalized for the population.

Limitations:

 It is difficult and costly to contact all the customers

 It is suitable only for short period
 Consumers are not sure of their purchase plans

Sample Survey Method: New product are first introduced in the sample market and the results seen
in the sample market are generalized for the total market.

Limitations:

 Information collected may not be accurate

 Tastes and the preferences may differ from market to market

Indirect Opinion Polling Method: Opinion of the consumers is indirectly collected through the dealers
who are aware of the needs of the customers.

Limitations:

 It is based on the judgment

 Limited Scope

Managerial Economics Page 8 of 12

Q.No. 4: Explain how price is determined under monopoly.?
Answer:

Pure monopoly or simply monopoly is a market situation where there is only a single seller of goods with no
close substitutes. Good example are public unit utility such as water , electricity , telephone undertaking

Being the sole seller of goods without close substitute the monopolist has substantial control over the price
he charges. He may lower the price and increase the quantity soled or he may lower the quantity soled and
raise the price thus a monopolist is a price maker or price searcher who is in search of the price – quality
combination that will maximize his profit. Under the monopoly, there is only one seller who controls the
entire supply in the market. Since this is the only producer and seller, he can fix the price of his product. In
order to maximize his profit, he may rise the price frequently. He may exploit the consumers by charging an
excessive price. Since there are no sellers, the buyers have no alternative than to buy from the monopolist.

Monopoly price during the short run :

During the short run a monopolist cannot expand or contract the size of his plan. Thus in the
equilibrium situation in the short run a monopolist firm may likely to face three situation : -

 It may earn abnormal profit, when firm AR > AC .

 It may suffer losses, when firm AR < AC.
 It may earned normal profit, when firm AR = AC

Abnormal Profit: At equilibrium level of output a monopoly firm may earned abnormal profits when
the firms average revenue exceeds the average cost of production.

y
MC
AC

D C
Cost/
Revenue A B

AR

O Q X
MR
OUTPUT

The equilibrium level is determined at the point k where marginal cost = marginal revenue .
the firm get profit per unit equal to CB. The total profit enjoy by the firm is shown by the
shaded area DABC .Thus the monopolist will produce OQ output at CQ price .

Losses: At equilibrium level of output a firm may suffer losses when is average revenue is less than
average cost .

y
MC
AC

D C
Cost/
Revenue A B

AR

O Q X
MR
OUTPUT

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 The equilibrium level is determined at point and where marginal cost is equal to
marginal revenue. The total loss suffered by the firm is equal to the shaded portion
ABCD . Equilibrium output is OQ

Normal Profit: At equilibrium output is determined at the point a firm may earned normal profit
when its average revenue is equal to average cost of production.

y
MC
AC

D C
Cost/
Revenue A B

AR

O Q X
MR
OUTPUT

The equilibrium level is determined at point K where marginal cost is equal to marginal
revenue . equilibrium output is OQ . at this our put firms average revenue is equal to
average cost . there for firm earns only normal profit .

Monopoly price during long period:

A monopoly firm during the long run will necessarily receive abnormal profit .
The two reason for this are : -

 Entry of new firm is difficult .

 If the monopolist does not receive profit he will have no attraction to stay in the market .

y
LMC
LAC

D C
Cost/
Revenue A B

LAR

O Q X
LMR
OUTPUT

The long run equilibrium of the monopoly firm is obtained where the long run marginal cost is equal
to long term marginal revenue

The equilibrium level is determined at point K where LMR = LMC . the equilibrium level of output is
OQ . the total shaded area ABCD represent the profit earned by the firm.

Monopoly price during the long run is always more than long run average cost (P>LAC).

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Q.No. 5: Write Short Notes On:
Answer:

e) Fiscal Policy:

It is one of the important economic policies to achieve economic stability. Fiscal Policy refers to
variation in taxation and public expenditure programs by the government to achieve predetermined
objectives. Taxation is transferring of funds from private purses to public (Government) coffers. It is
the withdrawal of funds from private use. Public expenditure on the other hand increases the flow of
funds into the private economy.

Since the tax-revenue and public expenditure form two sides of the government budget, the
taxation and public expenditure policies are also jointly called the ‘Budgetary Policy’.

Fiscal or Budgetary Policy is regarded as powerful instrument of economic stabilization. The

importance of fiscal policy as an instrument of economic stabilization rests on the fact that
government activities in the modern economies are greatly enlarged, and government tax-revenue
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 same extent through
variation in taxation and public expenditure.

Besides fiscal policy is considered to be more effective than monetary policy because the former
directly affects the private decisions while later does so indirectly. If the fiscal policy is formulated
that it is during the period of expansion, it is known as ‘counter-cyclical fiscal policy’.

f) Monetary Policy:

Monetary Policy refers to the program of Central Bank’s variations, in the total supply of money and
cost of money to achieve certain predetermined objectives. One of the primary objectives of
monetary policy is to achieve economic stability.

The traditional instrument through which Central Bank carries out the Monetary Policies are:

Quantitative Credit Control measures such as open market operations, changes in bank rates (or
discount rates), and changes in the statutory reserve ratios. Briefly speaking, open market
operations by the Central Bank are the sale and purchase of government bonds, treasure bills,
securities, etc., to and from public. Bank rate is the rate at which Central Bank discounts the
commercial banks bills of exchange or first class bill. The statutory reserve ratio is the proportion of
commercial banks time and demand deposit, which they are required to deposit with Central Bank
or keep cash-in-vault. All these instruments when operated by the Central Bank reduce (or enhance)
directly and indirectly the credit creation capacity of the commercial banks and thereby reduce (or
increase) the flow of funds from the banks to the public.

In addition these instruments, Central Bank use also various selective credit control measures and
moral suasion. The selective credit controls are intended to control the credit flows to particular
sectors without affecting the total credit, and also to change the composition of credit from
undesirable to desirable pattern. Moral suasion is a persuasive method to convince the commercial
banks to behave in accordance with the demand of the time and in the interest of the nation.

The fiscal and monetary policies may be alternatively used to control the business cycles in the
economy, though monetary policy is considered to be more effective to control inflation than to
control depression. It is however, always desirable to adopt a proper mix of fiscal and monetary
policies to check the business cycles.

k) Economic Problem and its universal nature:

The same basic economic problem – unlimited wants and relatively limited resources – arises at all
levels of human organization. Thus whether we are thinking of grampanchayat, or of zilla parishad,
or club or hospital or national government, all have to face the basic economic problem. Thus
whether it is Government of India or America, the problem of economy is always there.

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 The Government of India with annual revenue of about 1,00,000/- crores has innumerable demands
on its resources such as meeting mounting defense expenditure, expanding expenditure in respect
of development that is to be brought about in various sectors like agriculture, industries, transport,
education and so on. The Government of India therefore continually faces the basic problem of
economy of how to make best use of its limited resources. In the same way, the federal government
of America, the richest government faces some basic economic problem. Though in absolute terms,
its annual revenues are enormous running into billions or trillions of dollars, its needs are also
unlimited. Expanding and modernizing the defense forces, establishing military bases all over the
world giving military assistance to the friendly countries, expenditure on space and military research
etc., and therefore even the richest government of US is always confronted by the same basic
economic problem of limited resources to fulfill unlimited wants. Every nation, poor or rich, small or
big with small or huge population, has to face the basic economic problem. No nation can escape it.

Thus we can conclude that that there is something universal about problem of economy. The basic
economic arises in the case of an native, a villager, a city resident, in the case of poor or rich, in
case of associations like clubs, schools, hospitals and government organization right from the village
level to national level. The problem of economy – unlimited wants and limited means with alternative
uses - has been forever confronting the mankind. The economic problem is the universal problem.
Economy problem does not recognize boundaries of caste, creed, color, religion and culture.

l) Profit maximization goal:

The conventional economic theory assumes profit maximization as the only objective of the business
firms. It forms the basis for the conventional price theory. Profit maximization is regarded as the
most reasonable and analytically most productive business objective.

Besides, profit maximization assumption has a great predictive power. It helps in predicting the
behavior of business firms in the real world and also the behavior of the price and output under
different market conditions.

There are two conditions that must be fulfilled for the profit maximization:

 The necessary condition requires that Marginal Revenue (MR) must be equal to marginal
cost (MC). Marginal Revenue is obtained from production and sales of one additional unit of
output. Marginal cost is the cost incurred due to one additional unit of output.

 The secondary condition requires that necessary condition must be satisfied under the
condition of decreasing MR and increasing MC. The fulfillment of two condition makes the
sufficient condition.

Objections to this approach:

 Profit maximization assumption is too simple to explain the business phenomenon in the real
world. In fact, businessman themselves are not aware of this objective attributed to them.

 It is claimed that there are alternative and equally simple objectives of business firms that
explains better the real world business phenomenon. Ex: Sales maximization, Market share.

 Firm do not have the necessary knowledge and priori data to equalize MR and MC.

In defense of Profit Maximization assumption:

 Firms continue to survive in the long run in a competitive market, which are able to make
reasonable profit.

 This assumption has been accurate in predicting the firm’s behavior.

 It is time honored objective of firm

 Profit is one of the most efficient and reliable measures of efficiency of a firm.

Managerial Economics Page 12 of 12