Master of Business Administration Semester I MB0042 Managerial Economics - 4 Credits (Book ID: B1131) Assignment Set- 1 (60 Marks)

) Q1) What is a business cycle? Describe the different phases of a business cycle. Parkin and Bade's text "Economics" gives the following definition of the business cycle: The business cycle is the periodic but irregular up-and-down movements in economic activity, measured by fluctuations in real GDP and other macroeconomic variables. If you're looking for information on how various economic indicators and their relationship to the business cycle, please see A Beginner's Guide to Economic Indicators. Parkin and Bade go on to explain: A business cycle is not a regular, predictable, or repeating phenomenon like the swing of the pendulum of a clock. Its timing is random and, to a large degress, unpredictable. A business cycle is identified as a sequence of four phases: 1) Contraction: A slowdown in the pace of economic activity 2) The lower turning point of a business cycle, where a contraction turns into an expansion 3) Expansion: A speedup in the pace of economic activity 4) Peak: The upper turning of a business cycle

Q2. What is monetary policy? Explain the general objectives and instruments of monetary policy? Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability. The official goals usually include relatively stable prices and low unemployment. Monetary theory provides insight into how to craft optimal monetary policy. It is referred to as either being expansionary or contractionary, where an expansionary policy increases the total supply of money in the economy more rapidly than usual, and contractionary policy expands the money supply more slowly than usual or even shrinks it. Expansionary policy is traditionally used to try to combat unemployment in a recession by lowering interest rates in the hope that easy credit will entice businesses into expanding. Contractionary policy is intended to slow inflation in hopes of avoiding the resulting distortions and deterioration of asset values. Various objectives or goals of monetary policy are: 1. 2. 3. 4. 5. Neutrality of Money Price Stability Economic growth Exchange Stability Full Employment

Q3) 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 increases to 5000 pens. Find the elasticity of supply of the pens. . ANS:The elasticity of supply is the increment (difference) in price divided by the increment in quantity.
Elasticity is : (22 - 10)/ (5,000 - 3,000) Rs per item. Note the unites must be given and the numerical value is positive due to the shape of the supply characteristic. The value of elasicty of supply of the pens is 0.006

Q4. Give a brief description of A ) Implicit and explicit cost In economics, an implicit cost, also called an imputed cost, implied cost, or notional cost, is the opportunity cost equal to what a firm must give up in order to use factors which it neither purchases nor hires. It is the opposite of an explicit cost, which is borne directly.[1] In other words, an implicit cost is any cost that results from using an asset instead of renting, selling, or lending it. The term also applies to forgone income from choosing not to work. Implicit costs also represent the divergence between economic profit (total revenues minus total costs, where total costs are the sum of implicit and explicit costs) and accounting profit (total revenues minus only explicit costs). Since economic profit includes these extra opportunity costs, it will always be less than or equal to accounting profit. Lipsey (1975) uses the example of a firm sitting on an expensive plot worth 10,000 a month in rent which it bought for a mere 50 a hundred years before. If the firm cannot obtain a profit after deducting 10,000 a month for this implicit cost, it ought to move premises (or close down completely) and take the rent instead.[1] In calculating this figure, the firm ought to ignore the figure of 50, and remember instead to look at the land's current value. Explicit cost:An explicit cost is a direct payment made to others in the course of running a business, such as wage, rent and materials, as opposed to implicit costs, which are those where no actual payment is made. It is possible still to underestimate these costs, however: for example, pension contributions and other "perks" must be taken into account when considering the cost of labour. Explicit costs are taken into account along with implicit ones when considering economic profit. Accounting profit only takes explicit costs into account. B) Actual and opportunity cost:Opportunity cost:It is the cost of any activity measured in terms of the value of the next best alternative forgone (that is not chosen). It is the sacrifice related to the second best choice available to someone, or group, who has picked among several mutually exclusive choices. The opportunity cost is also the cost of the forgone products after making a choice. Opportunity cost is a key concept in economics, and has been described as expressing "the basic relationship between scarcity and choice". The notion of opportunity cost plays a crucial part in ensuring that scarce resources are used efficiently. Thus, opportunity costs are not restricted to monetary or financial costs: the real cost of output forgone, lost time, pleasure or any other benefit that provides utility should also be considered opportunity costs

Actual cost:An actual amount paid or incurred, as opposed to estimated cost or standard cost. In contracting, actual costs amount includes direct labor, direct material, and other direct charges. Actual cost is the total amount of materials, labor costs, and any directly associated overhead costs that can be charged to a specific project. The actual cost is different from the standard cost, although both approaches are often used to evaluate the profitability of a given project. With actual costs, the goal is to break down the specifics of the costs involved with the project and determine if the production process associated with the project is in fact working at optimum efficiency.

Q5)Explain in brief the relationship between TR, AR, and MR under different market condition. total Average and Marginal Revenue The revenue of a firm jointly with its costs ascertains profits. Now let us discuss the concepts of revenue. The term revenue denotes to the receipts obtained by a firm from the scale of definite quantities of a commodity at various prices. The revenue concept relates to total revenue, average revenue and marginal revenue. 1. Total Revenue It is the total sale proceeds of a firm by selling a commodity at a given price. If a firm sells 3 units of an article at $ 24, its total revenue is 3 x 24. Thus total revenue is price per unit proliferated by the number of nits sold, i.e. TR = P x Q, where TR is the total revenue, P the price and Q the quantity. 2. Average Revenue It is the average receipts from the sale of certain units of the commodity. It is obtained by dividing the total revenue by the number of units sold. The average revenue of a firm is in fact the price of the commodity at each level of output since TR = P x Q, therefore, AR = TR / Q = P x Q / Q = P. 3. Marginal Revenue MR In addition to total revenue as a result of a small hike in the sale of a firm. Algebraically it is the total revenue earned by selling N units of the commodity instead of N-1 i.e., MRn = TRn TRn-1. Relation Between AR and MR Curves 1. Under Ideal Rivalry The average revenue curve is a horizontal straight line parallel to X axis and the marginal revenue curve coincides with it. This is since under ideal rivalry the number of firms selling an identical product is very huge. The price is determined the market forces of supply and demand so that only one price tends to prevail for the whole industry.

Q6) Distinguish between a firm and an industry. Explain the equilibrium of a firm and industry under perfect competition An industry is a type of business in the economy while a firm is a unit or entity carrying a portion of the business in an economy. A firm generally thought of as one company. An industry is a generalization for the type of business in which a company engages. For example, General Motors is a company that builds cars. Automobile manufacturing is the industry. A firm is the smallest unit of production or sale. Microeconomic theory is anequilibrium analysis. It is concerned with the behavior of demand and supply forces. Marshall is reported to have said that demand and supply are like two blades of a pair of scissors. Demand is a result of the utility-maximizing behavior of a consumer in rational bounds. Similarly supply is an outcome of the profit-maximizing behavior of a firm, again in rational bounds. Equilibrium of firm:Firms may have different organizational forms. A firm may be an individual enterprise, a partnership, a joint stock company, a corporate body, a cooperative enterprise or a public utility agency. Again a firm may be a producer, seller, trader, exporter or a financier. In any one of these capacities, firms show similar basic tendencies. In order to maximize its profits a firm has to maintain as large a difference between what it spends on resources or cost of production and what it earns by selling goods in the form of revenue or returns. The difference between the two is the firms profit. So the firm has to keep its cost of production as low as possible. On the other hand, it has to charge a high price and sell as much quantity of products as possible. In this respect, the firms actions are related to the behavior of consumers. Besides the limitation of cost of production, the capacity of a firm to charge a suitable price is restricted by the consumers willingness to pay. Equilibrium of industry:-

When we speak of market equilibrium in economics it refers to level of prices at which the quantity demanded by the customers is same as the quantity offered for for supply by the suppliers. Thus the market equilibrium has has two dimensions. (1) price, and (2) quantity sold and purchased. Please note that the we are talking about quantity actual sold and purchased. Unlike quantities demanded and quantity offered for supply, the actual quantity sold and purchased is always equal.In a monopoly market, the entire market supply is accounted by one firm. Therefore, equilibrium point for the market and for the firm are the same. In a perfectly competitive market, individual firms have no influence on the market price as the demand curve for the firm is a horizontal line at the level of the market price. Thus same price is applicable to firm level equilibrium. However the quantity supplied by each firm at this equilibrium price depends on the cost structure of the firm. The firm can supply as much as it wishes, therefore it supplies a quantity that maximizes its profit. This occurs when the marginal cost of the firm just equals the marginal revenue. In a perfectly competitive market the marginal cost and revenue at this point are also same as the market price. Since marginal cost for every firm operating in a perfect competition is same as market price, the combined marginal cost for all the firms in a perfectly competitive market is also same as market equilibrium price. Master of Business Administration Semester I MB0042 Managerial Economics - 4 Credits (Book ID: B1131) Assignment Set- 2 (60 Marks)

Q1. Suppose your manufacturing company planning to release a new product into market, Explain the various methods forecasting for a new product. Methods of forecasting Broadly Speaking, there are two methods of demand forecasting. They are 1. Survey methods 2 Statistical methods Survey Methods Survey methods helps us in obtaining information about the future purchase plans of potential buyers through collecting the opinions of experts or by interviewing the consumers. These methods are extensively used in short run and estimating the demand for new products A) Consumer's Interview Method: Efforts are made to collect the relevant information directly from the consumers with regard to their future purchase plans. B) Opinion survey method : Under this method, sales representatives, professional experts and the market consultants and others are asked to express their considered opinions about the volume of sales expected in the future. C) Experts Opinion Method : Under this method, outside experts are appinted. They are supplied with all kinds of information and statistical data. The management requests the experts to express their considered opinions and views about the expected future sales of the company D) Output Method - Under this method, the sale of the product under consideration is projected on the basis of demand surveys of the industries using the given product as an intermediate product Statistical Method Statistical, mathematical models, equations etc are extensively sed in order to estimate future demand of a particular product

1 Trend Projection MethodOn the basis of time series, it is possible to project the future sales of a company 2 Economic Indicator An economic indicator indicates change in the magnitude of an economic variable. It gives the signal about the direction of change in an economic variable. Q2) Define the term equilibrium. Explain the changes in market equilibrium and effects to shifts in supply and demand. Market Equilibrium Price In this note we bring the forces of supply and demand together to consider the determination of equilibrium prices. The Concept of Market Equilibrium

Equilibrium means a state of equality or a state of balance between market demand and supply. Without a shift in demand and/or supply there will be no change in market price. In the

diagram above, the quantity demanded and supplied at price P1 are equal. At any price above P1, supply exceeds demand and at a price below P1, demand exceeds supply. In other words, prices where demand and supply are out of balance are termed points of disequilibrium. Changes in the conditions of demand or supply will shift the demand or supply curves. This will cause changes in the equilibrium price and quantity in the market. Demand and supply schedules can be represented in a table. The example below provides an illustration of the concept of equilibrium. The weekly demand and supply schedules for T-shirts (in thousands) in a city are shown in the next table: Price per unit () Demand (000s) Supply (000s) New Demand (000s) New Supply (000s) 1. 2. 3. 4. 8 6 18 10 26 7 8 16 12 24 6 10 14 14 22 5 12 12 16 20 4 14 10 18 18 3 16 8 20 16 2 18 6 22 14 1 20 4 24 12

The equilibrium price is 5 where demand and supply are equal at 12,000 units If the current market price was 3 there would be excess demand for 8,000 units If the current market price was 8 there would be excess supply of 12,000 units A change in fashion causes the demand for T-shirts to rise by 4,000 at each price. The next row of the table shows the higher level of demand. Assuming that the supply schedule remains unchanged, the new equilibrium price is 6 per tee shirt with an equilibrium quantity of 14,000 units 5. The entry of new producers into the market causes a rise in supply of 8,000 T-shirts at each price. The new equilibrium price becomes 4 with 18,000 units bought and sold Changes in Market Demand and Equilibrium Price

The demand curve may shift to the right (increase) for several reasons: 1. 2. 3. 4. 5. A rise in the price of a substitute or a fall in the price of a complement An increase in consumers income or their wealth Changing consumer tastes and preferences in favour of the product A fall in interest rates (i.e. borrowing rates on bank loans or mortgage interest rates) A general rise in consumer confidence and optimism

The outward shift in the demand curve causes a movement (expansion) along the supply curve and a rise in the equilibrium price and quantity. Firms in the market will sell more at a higher price and therefore receive more in total revenue. The reverse effects will occur when there is an inward shift of demand. A shift in the demand curve does not cause a shift in the supply curve! Demand and supply factors are assumed to be independent of each other although some economists claim this assumption is no longer valid! Changes in Market Supply and Equilibrium Price

The supply curve may shift outwards if there is 1. A fall in the costs of production (e.g. a fall in labour or raw material costs) 2. A government subsidy to producers that reduces their costs for each unit supplied 3. Favourable climatic conditions causing higher than expected yields for agricultural commodities 4. A fall in the price of a substitute in production 5. An improvement in production technology leading to higher productivity and efficiency in the production process and lower costs for businesses 6. The entry of new suppliers (firms) into the market which leads to an increase in total market supply available to consumers

Q3. Explain how a product would reach equilibrium position with the help of ISO - Quants and ISOCost curve When producing a good or service, how do suppliers determine the quantity of factors to hire? Below, we work through an example where a representative producer answers thisquestion. Lets begin by making some assumptions. First, we shall assume that our producer chooses varying amounts of two factors, capital (K) and labor (L). Each factor was a price that does not vary with output. That is, the price of each unit of labor (w) and the price of each unit of capital (r) are assumed constant. Well further assume that w = $10 and r = $50. We can use this information to determine the producers total cost. We call the total cost equation an iso cost line (its similar to a budget constraint).The producers iso cost line is:10L + 50K = TC

(1)The producers production function is assumed to take the following form:q = (KL)0.5 (2)Our producers first step is to decide how much output to produce. Suppose that quantity is1000 units of output. In order to produce those 1000 units of output, our producer must get a combination of L and K that makes (2) equal to 1000. Implicitly, this means that we must find a particular iso quant. Set (2) equal to 1000 units of output, and solve for K. Doing so, we get the following equation for a specific iso quant (one of many possible iso quants):

K = 1,000,000/L (2a)For any given value of L, (2a) gives us a corresponding value for K. Graphing these values, with K on the vertical axis and L on the horizontal axis, we obtain the blue line on the graph below. Each point on this curve is represented as a combination of K and L that yields an output level of 1000 units. Therefore, as we move along this iso quant output is constant(much like the fact that utility is constant as A basic understanding of statistics is a critical component of informed decision making.

Q4) Critically examine the Marris growth maximising model.

Profit-maximization is a traditional objective of a firm. Sales maximization objective is explained by Prof. Boumal. On similar lines, Prof. Marris has developed another alternative growth maximization model in recent years. It is a common factor to observe that each firm aims at maximizing its growth rate as this goal would answer many of the objectives of a firm. Marris points out that a firm has to maximize its balanced growth rate over a period of time. Marris assumes that the ownership and control of the firm is in the hands of two groups of people, ie, owners and managers. He further points out that both of them have two distinctive goals. Managers have a utility function in which the amount of salary, status, position, power, prestige and security of job etc are the most important variables where as in case of owners are more concerned about the size of output, volume of profits, market share and sales maximization etc. Utility function of the managers and that the owners are expressed in the following manner Uo = f [size of output, market share, volume of profit, capital, public esteem etc.] Um = f [salaries, power, status, prestige, job security etc.]. In view of Marris the realization of these two functions would depend on the size of the firm. Larger the firm, greater would be the realization of these functions and vice-versa. Size of the firm according to Marris depends on the amount of corporate capital which includes total volume of assets, inventory levels, cash reserves etc. He further points out that the managers always aim at maximizing the rate of growth of the firm rather than growth in absolute size of the firm. Generally managers like to stay in a growing firm. Higher growth rate of the firm satisfy the promotional opportunities of managers and also the share holders as they get more dividends. Marris identifies two constraints in the rate of growth of a firm: 1. There is a limit up to which output of a firm can be increased more economically, limit to manage the firm efficiently, limit to employ highly qualified and experienced managers, limit to research and development and innovation etc. 2. The ambition of job security puts a limit to the growth rate of the firm itself deliberately. If growth reaches the maximum, then there would be no opportunity to expand further and as

such the managers may loose their jobs. Rapid growth and financial soundness should go together. Managers hesitate to take unwanted risks and uncertainties in the organization at the cost of their jobs They would like to avoid risky investment projects, concentrate on generating more internal funds and invest more finance on only those products and services which brings more profits Hence, managers would like to seek their job security through adoption of a cautious and prudent financial policy. He further points out that a high risk-loving management would like to maintain a relatively low amount of cash on hand and invest more on business, borrow more external funds and invest more in business expansion and keep low profit levels. On the other hand, a highly risk-averting management may have exactly opposite policy. Ultimately, it is the job security which puts a constraint on business decisions by the managers. The Marris growth maximization model. highlights on achieving a balanced growth rate of a firm. Maximum growth rate [g] is equal to two important variables1. The rate of demand for the products [gd] 2. Growth rate of capital[gc] Hence, Max g = gd = gc. The growth rate of the firm depends on two factors- a] the rate of diversification [d]and b] the average profit margin. The diversification rate depends on the number of new products introduced per unit of time and the rate of success of new products in the market. The success of new products is determined by its changes in fashion styles, consumption habits, the range of products offered etc. More over diminishing marginal returns would operate in any business and as such there is a limit to diversification. Similarly, market price of the given product, availability of alternative substitute products and their relative prices, publicity, propaganda and advertisements, R&D expenses and utility and comparative value of the product etc would decide the profit ratio. Higher expenditure on sales promotion and R&D would certainly reduce profits level as there are limits to them. The rate of capital growth is determined by either issue of new shares to obtain additional funds and external funds and generation of more internal surplus. Generally a firm would select the last one to avoid higher degrees of risks in the business. The Marris model states that in order to maximize balanced growth rate or reach equilibrium position, there should be equality between the growth rate in demand for the products and growth rate in supply of capital. This implies the satisfaction of three conditions. 1. The management has to maintain a low liquidity ratio, ie, liquid asset / total assets. But this ratio should not create any financial embarrassment to meet the required payments to all the concerned parties. 2. The management has to maintain a proper leverage ratio between value of debts/Total assets so that it will have enough money to invest in order to stimulate growth.

3. The management has to keep a high level of retained profits for further expansion and development but it should not displease the shareholders i.e. by giving low dividends. In this case, the mangers would maximize their utility function and the owners would maximize their utility functions. The managers are able to get their job security with a high rate of growth of the firm and share holder would become happy as they get higher amount of dividends.

Q5) What do you mean by pricing policy? Explain the various objective of pricing policy of a firm.
A detailed study of the market structure gives us information about the way in which prices are determined under different market conditions. However, in reality, a firm adopts different policies and methods to fix the price of its products. 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. Factors Involved In pricing Policy The pricing of the product involves consideration of the following factors: 1. Cost: Cost data occupy an important place in the price setting process. Cost are two types fixed cost and variable cost. In the short period which a firm wants to establish itself. The firm may not cover the fixed costs but it must cover the variable costs. But in the long run, all costs must be covered. If the entire costs are not covered, the producer stops production consequently, the supply is reduced which in turn may lead to higher price. 2.Competitors If the business is a monopolist, then it can set any price. At the other extreme, if a firm operates under conditions of perfect competition, it has no choice and must accept the market price. The reality is usually somewhere in between. In such cases the chosen price needs to be very carefully considered relative to those of close competitors. (3) Customers Consideration of customer expectations about price must be addressed. Ideally, a business should attempt to quantify its demand curve to estimate what volume of sales will be achieved at given prices

Q6) Discuss the various measures that may be taken by a firm to counteract the evil effects of a trade cycle.
Business cycles affect the smooth growth of an economy. Expansionary phase has, however, a favorable impact on income, output and employment. But recession and depression imply slackness in growth, contraction of economic activity, increasing unemployment, falling incomes and so on.Business cycles have their effects on individual business firms, as well. During

expansionary phase, there is a business boom. The firm gains due to rising demand, rising prices and increasing profits. Prosperity makes the business firms prosperous. But in a capitalist economy prosperity digs its own grave.

During this period, a firm may have to face some adverse effects. Rising prices and optimism in the market may encourage many new firms to enter the market and the existing firms to expand their output. Competition becomes intense. Increased demand for factors may cause a rise in their prices. Marketing and distribution costs may go up. Demand for investment funds increase. All these may result in raising the cost of production causing a rise in the product price. During this period a business unit should be extraordinarily cautious. Business decisions are to be made carefully after estimating the market situation properly. Expansion in production and sale of goods should be so organized that they take full advantage of the situation without involving themselves into any kind of risk. A prudent businessman should adopt all possible precautionary measures to avoid and minimize business problems as much as possible. He should have knowledge of the economic characteristics of the trade cycles and usual sequence of events during such periods, the phase of the trade cycle through which business is then passing, relation between cyclical changes and general business and cyclical changes and the business of the given enterprise, in particular, cyclical movements in production and sales and in the prices of commodities purchased and sold. A business firm should have a comprehensive view of the entire market internal and external factors affecting business in order to adopt an efficient business programme and prevent the adverse effects of cyclical changes on business. He should mainly see that the costs are kept under control, avoid over investment, overproduction and over expansion, excessive inventories of raw materials and finished goods. Employ a flexible credit standard, avoid excessive borrowing. Check temporary diversification programme, avoid purchase commitments, maintain satisfactory labour conditions and create sizable reserve fund. Various such measures may help a firm in avoiding the harmful effects of business expansion. During the phase of contraction, recession and depression the basic objective is to fight against pessimism and to give a big boost to all kinds of business activities. There must be a strong psychological shift during this period. A few measures are to be adopted to mitigate the harmful effects of contraction. (1) Quick liquidation of inventories. (2) Reduction of cost of production. (3) Improvement in quality (4) adoption of new selling methods. (5) Development of new methods of organization etc. (6) Management of the labour force carefully. Apart from these measures a businessman may also take up a few important steps in the best interest of the firm. By adopting a very cautious policy of planning during the period of contraction when all costs are low a firm can take up the expansion and extension programmes. The firm will have to restructure its advertising policy to suit the circumstances. Cyclical price adjustment poses the most challenging job for the firm. It will have to choose a right pricing policy keeping in view various factors like changing costs, prices of substitutes, market share, changes in general price level etc. Thus during different phases of trade cycles a firm has to make careful decisions with regard to finance, Capital budgeting, investment, production, distribution, marketing, purchasing, pricing etc. A firm should gear up itself to face the challenges of cyclical changes in a most befitting manner.