mb0042 managerial economics assignment set 2

7/29/2019 MB0042 Managerial Economics Assignment Set 2

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uploaded on or before the dates mentioned above. (September 15,2012)

2. Ensure that you answer all questions according to the marks allocated.

MBA Semester I

Assignment 2 - Marks 60 (6X10=60)

MB0042 - Managerial Economics - 4 credits

Subject Code - MB0042

*** Please fill in all the details in complete and only in CAPITAL letters

BIPIN PRASADName

1205011977Registration Number


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Note: Each question carries 10 Marks. Answer all the questions.

Q1. Discuss the various measures that may be taken by a firm to counteract the

evil effects of a trade cycle.

Answer: By the end of the 19th century, however, many economists had begun torecognize that economies were cyclical by their very nature, and studies increasingly

turned to determining which factors were primarily responsible for shaping the direction

and disposition of national, regional, and industry-specific economies. Today,

economists, corporate executives, and business owners cite several factors as

particularly important in shaping the complexion of business environments.

VOLATILITY OF INVESTMENT SPENDING

Variations in investment spending are one of the important factors in business cycles.

There are several reasons for the volatility that can often be seen in investment

spending. One generic reason is the pace at which investment accelerates in response


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to upward trends in sales. This linkage, which is called the acceleration principle by

economists, can be briefly explained as follows. Suppose a firm is operating at full

capacity.

MOMENTUM

Many economists cite a certain "follow-the-leader" mentality in consumer spending. In

situations where consumer confidence is high and people adopt more free-spending

habits, other customers are deemed to be more likely to increase their spending as well.Conversely, downturns in spending tend to be imitated as well.

TECHNOLOGICAL INNOVATIONS

Technological innovations can have an acute impact on business cycles. Indeed,

technological breakthroughs in communication, transportation, manufacturing, and other

operational areas can have a ripple effect throughout an industry or an economy.There

are many reasons why the pace of technological innovations varies. Major innovations

do not occur every day. Nor do they take place at a constant rate. Chance factors

greatly influence the timing of major innovations, as well as the number of innovations in

a particular year. Economists consider the variations in technological innovations as

random (with no systematic pattern). Thus, irregularity in the pace of innovations in new

products or processes becomes a source of business fluctuations.

VARIATIONS IN INVENTORIES

Variations in inventoriesexpansion and contraction in the level of inventories of goods

kept by businessesalso contribute to business cycles. Inventories are the stocks of

goods firms keep on hand meeting demand for their products. How do variations in the

level of inventories trigger changes in a business cycle? Usually, during a business

downturn, firms let their inventories decline. As inventories dwindle, businesses

ultimately find themselves short of inventories. As a result, they start increasing

inventory levels by producing output greater than sales, leading to an economicexpansion.

FLUCTUATIONS IN GOVERNMENT SPENDING

Variations in government spending are yet another source of business fluctuations. This

may appear to be an unlikely source, as the government is widely considered to be a

stabilizing force in the economy rather than a source of economic fluctuations or

instability. Nevertheless, government spending has been a major destabilizing force on

several occasions, especially during and after wars.

POLITICALLY GENERATED BUSINESS CYCLES

Many economists have hypothesized that business cycles are the result of the politically

motivated use of macroeconomic policies (monetary and fiscal policies) that are

designed to serve the interest of politicians running for re-election. The theory of political

business cycles is predicated on the belief that elected officials (the president, members

of congress, governors, etc.) have a tendency to engineer expansionary

macroeconomic policies in order to aid their re-election efforts.

MONETARY POLICIES

Variations in the nation's monetary policies, independent of changes induced by political

pressures, are an important influence in business cycles as well. Use of fiscal policy

increased government spending and/or tax cutsis the most common way of boosting

aggregate demand, causing an economic expansion. Moreover, the decisions of the


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Federal Reserve, which controls interest rates, can have a dramatic impact on

consumer and investor confidence as well.

FLUCTUATIONS IN EXPORTS AND IMPORTS

The difference between exports and imports is the net foreign demand for goods and

services, also called net exports. Because net exports are a component of the

aggregate demand in the economy, variations in exports and imports can lead tobusiness fluctuations as well. There are many reasons for variations in exports and

imports over time

Q2. Define the term equilibrium. Explain the changes in market equilibrium and

effects to shifts in supply and demand.

Answer: The term equilibrium means, a state of even balance in which opposing

forces or tendencies neutralize each other. It is a position of rest characterized by

absence of change. It is a state where there is complete agreement of the economic

plans of the various market participants so that no one has a tendency to revise or alter

his decision. It means a state of even balance in which opposing forces or tendencies

neutralize each other. It is a position of rest characterized by absence of change. It is a

state where there is complete agreement of the economic plans of the various market

participants so that no one has a tendency to revise or alter his decision. In the words of

professor Mehta: Equilibrium denotes in economics absence of change in movement.

Market Equilibrium

There are two approaches to market equilibrium viz., partial equilibrium approach and

the general equilibrium approach. The partial equilibrium approach to pricing explains

price determination of a single commodity keeping the prices of other commoditiesconstant. On the other hand, the general equilibrium approach explains the mutual and

simultaneous determination of the prices of all goods and factors. Thus it explains a

multi-market equilibrium position. Earlier to Marshall, there was a dispute among

economists on whether the force of demand or the force of supply is more important in

determining price. Marshall gave equal importance to both demand and supply in the

determination of value or price. He compared supply and demand to a pair of scissors

We might as reasonably dispute whether it is the upper or the under blade of a pair of

scissors that cuts a piece of paper, as whether value is governed by utility or cost of

production. Thus neither the upper blade nor the lower blade taken separately can cut

the paper; both have their importance in the process of cutting. Likewise neither supply

alone, nor demand alone can determine the price of a commodity, both are equally

important in the determination of price. But the relative importance of the two may vary

depending upon the time under consideration. Thus, the demand of all consumers and

the supply of all firms together determine the price of a commodity in the market.

Market equilibrium and effects


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Equilibrium between demand and supply price is obtained by the interaction of these

two forces. Price is an independent variable. Demand and supply are dependent

variables. They depend on price. Demand varies inversely with price; arise in price

causes a fall in demand and a fall in price causes a rise in demand. Thus the demand

curve will have a downward slope indicating the expansion of demand with a fall in price

and contraction of demand with a rise in price. On the other hand supply varies directlywith the changes in price, a rise in price causes arise in supply and a fall in price causes

a fall in supply. Thus the supply curve will have an upward slope. At a point where these

two curves intersect with each other the equilibrium price is established. At this price

quantity demanded is equal to the quantity demanded.

This we can explain with the help of a table and a diagram

In the table at Rs.20 the quantity demanded is equal to the quantity supplied. Since the

price is agreeable to both the buyer and sellers, there will be no tendency for it to

change; this is called equilibrium price. Suppose the price falls to Rs.5 the buyer will

demand 30 units while the seller will supply only 5 units. Excess of demand over supply

pushes the price upward until it reaches the equilibrium position supply is equal to the

demand. On the other hand if the price rises to Rs.30 the buyer will demand only 5 units

while the sellers are ready to supply 25 units. Sellers compete with each other to sell

more units of the commodity. Excess of supply over demand pushes the price

downward until it reaches the equilibrium. This process will continue till the equilibrium

price of Rs.20 is reached. Thus the interactions of demand and supply forces actingupon each other restore the equilibrium position in the market. In the diagram DD is the

demand curve, SS is the supply curve. Demand and supply are in equilibrium at point E

where the two curves intersect each other. OQ is the equilibrium output. OP is the

equilibrium price. Suppose the price OP2 is higher than the equilibrium price OP. at this

point price quantity demanded isP2D2. Thus D2S2 is the excess supply which the seller

wants to push into the market, competition among the sellers will bring down the price to

the equilibrium level where the supply is equal to the demand. At price OP1, the buyers

will demand P1D1 quantity while the sellers are ready to sell P1S1. Demand exceeds

supply. Excess demand for goods pushes up the price; this process will go untilequilibrium is reached where supply becomes equal to demand.


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Q3. What do you mean by pricing policy? Explain the various objective of pricing

policy of a firm.

Answer:

Pricing Policies: A detailed study of the market structure gives us information about theway 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.

They are as follows:

1) External Factors (Outside factors)

1. Demand, supply and their determinants. 2. Elasticity of demand and supply. 3.

Degree of competition in the market. 4. Size of the market. 5. Good will, name, fame

and reputation of a firm in the market. 6. Trends in the market. 7. Purchasing power of

the buyers. 8. Bargaining power of customers 9. Buyers behavior in respect of particular

product

2) Internal Factors (Inside Factors)

1. Objectives of the firm. 2. Production Costs. 3. Quality of the product and itscharacteristics. 4. Scale of production. 5. Efficient management of resources. 6. Policy

towards percentage of profits and dividend distribution. 7. Advertising and sales

promotion policies. 8. Wage policy and sales turn over policy etc. 9.The stages of the

product on the product life cycle. 10. Use pattern of the product.

The Following objectives are to be considered while fixing the prices of the product.

1. Profit maximization in the short term

The primary objective of the firm is to maximize its profits. Pricing policy as an

instrument to achieve this objective should be formulated in such a way as to maximize

the sales revenue and profit. Maximum profit refers to the highest possible of profit.

In the short run, a firm not only should be able to recover its total costs, but also should

get excess revenue over costs. This will build the morale of the firm and instill the spirit

of confidence in its operations.

2. Profit optimization in the long run

The traditional profit maximization hypothesis may not prove beneficial in the long run.

With the sole motive of profit making a firm may resort to several kinds of unethical

practices like charging exorbitant prices, follow Monopoly Trade Practices (MTP),

Restrictive Trade Practices (RTP) and Unfair Trade Practices (UTP) etc. This may lead

to opposition from the people.

3. Price Stabilization


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Price stabilization over a period of time is another objective. The prices as far as

possible should not fluctuate too often. Price instability creates uncertain atmosphere in

business circles. Sales plan becomes difficult under such circumstances4. Facing

competitive situation

One of the objectives of the pricing policy is to face the competitive situations in the

market. In many cases, this policy has been merely influenced by the market share

psychology.5. Maintenance of market share

Market share refers to the share of a firms sales of a particular product in the total

sales of all firms in the market. The economic strength and success of a firm is

measured in terms of its market share

Hence, the pricing policy has to assist a firm to maintain its market share at any cost.

Q4. Critically examine the Marris growth maximizing model.

Answer: Profit maximization is 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, i.e. owner 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 import variable where as in

case of are more concerned about the size of output, volume of profits, market shares

and sales maximization.Utility function of the manager and that the owner are expressed in the following

manner-

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 the asset, inventory level, cash reserve 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 firms. Generally managers like to stay in a grouping

firm. Higher growth rate of the firm satisfy the promotional opportunity of managers and

also the shareholders as they get more dividends.

How Profit Maximization model differs from Sales Maximization model:

The sale maximization model differs on the following grounds:

1. Emphasis is given on maximizing sales rather than profit.

2. Increase the competitive and operational ability of the company.

3. The amount of slack earning and salaries of the top managers are directly linked

to it.

4. It helps in enhancing the prestige and reputation of top management, distributes

more dividends to shareholders and increases the wage of the workers andkeeps them happy.


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The financial and other lending institutions always keep a watch

on the sales revenue of a firm as it is an indication of financial health of the firm.

Q5.Explain how a product would reach equilibrium position with the help of ISO -

Quants and ISO-Cost curve

Answer: 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 produceranswers this question. 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 is 1000 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 isoquant. 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.

Q6. Suppose your manufacturing company planning to release a new product into

market, Explain the various methods forecasting for a new product.

Answer: When a manufacturing companies planning to release a new product into the

market, it should perform the demand forecasting to check the demand of the product in

the market and also the availability of similar product in the market.

Demand forecasting for new products is quite different from that for established

products. Here the firms will not have any past experience or past data for this purpose.

An intensive study of the economic and competitive characteristics of the product should

be made to make efficient forecasts.

As per Professor Joel Dean, few guidelines to make forecasting of demand for new

products are:


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a. Evolutionary approach: The demand for the new product may be considered as an

outgrowth of an existing product. For e.g., Demand for new Tata Indica, which is a

modified version of Old Indica can most effectively be projected based on the sales of

the old Indica, the demand for new Pulsor can be forecasted based on the sales of the

old Pulsar. Thus when a new product is evolved from the old product, the demand

conditions of the old product can be taken as a basis for forecasting the demand for the

new product.

b. Substitute approach: If the new product developed serves as substitute for the

existing product, the demand for the new product may be worked out on the basis of a

market share. The growths of demand for all the products have to be worked out on the

basis of intelligent forecasts for independent variables that influence the demand for the

substitutes. After that, a portion of the market can be sliced out for the new product. For

e.g., A moped as a substitute for a scooter, a cell phone as a substitute for a land line.

In some cases price plays an important role in shaping future demand for the product.

c. Opinion Poll approach: Under this approach the potential buyers are directly

contacted, or through the use of samples of the new product and their responses are

found out. These are finally blown up to forecast the demand for the new product.

d. Sales experience approach: Offer the new product for sale in a sample market; say

supermarkets or big bazaars in big cities, which are also big marketing centers. The

product may be offered for sale through one super market and the estimate of sales

obtained may be blown up to arrive at estimated demand for the product.

e. Growth Curve approach:According to this, the rate of growth and the ultimate level

of demand for the new product are estimated on the basis of the pattern of growth of

established products. For e.g., An Automobile Co., while introducing a new version of a

car will study the level of demand for the existing car.f. Vicarious approach: A firm will survey consumers reactions to a new product

indirectly through getting in touch with some specialized and informed dealers who have

good knowledge about the market, about the different varieties of the product already

available in the market, the consumers preferences etc. This helps in making a more

efficient estimation of future demand.

mb0042 managerial economics assignment set 2

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