This action might not be possible to undo. Are you sure you want to continue?
Name Roll No. Program Subject Code Learning Centre
RATI BHAN 511022630 MBA Managerial Economics [Set 1] MB0042 IICM KINGSWAY CAMP
RATI BHAN, MBA (1ST SEM), SUBJECT CODE-MB042, SET-1Page 1 8/10/2010
Q1. Mention the demand function. What is elasticity of demand? Describe the determinants of elasticity of demand. Demand Function: The demand for a product or service is affected by its price, the income of the individual, the price of other substitutes, population, and habit. Hence we can say that demand is a function of the price of the product, and others as mentioned above. Demand function is a comprehensive formulation which specifies the factors that influence the demand for a product. Mathematically, a demand function can be represented in the following manner. Dx = f (Px, Ps, Pc, Ep, Y, Ey, T, W, A, U….etc) Where Dx = Demand for commodity X Pc = Price of the complements T = Tastes and preferences Ps = Price of substitutes Px = Price of a commodity X Y = Income of the consumer A = Advertisement and its impact Ep = Expected future price
Ey= Expected income in the future W= Wealth of the consumer U = All other determinants Elasticity of demand In economics the term elasticity refers to a ratio of the relative changes in two quantities. It measures the responsiveness of one variable to the changes in another variable. Elasticity of demand is generally defined as the responsiveness or sensitiveness of demand to a given change in the price of a commodity. It refers to the capacity of demand either to stretch or shrink to a given change in price. Elasticity is an index of reaction. Elasticity of demand indicates a ratio of relative changes in two quantities.ie, price and demand.
RATI BHAN, MBA (1ST SEM), SUBJECT CODE-MB042, SET-1Page 2 8/10/2010
According to professor Boulding: “Elasticity of demand measures the responsiveness of demand to changes in price”. In the words of Marshall,” The elasticity (or responsiveness) of demand in a market is great or small according to as the amount demanded much or little for a given fall in price, and diminishes much or little for a given rise in price” Different Degree of Price Elasticity of Demand Perfectly Elastic Demand: In this case, a very small change in price leads to an infinite change in demand. The demand curve is a horizontal line and parallel to OX axis. The numerical coefficient of perfectly elastic demand is infinity (ED=infinity)
Perfectly Inelastic Demand : In this case, whatever may be the change in price, quantity demanded will remain perfectly constant. The demand curve is a vertical straight line and parallel to OY axis. Quantity demanded would be 10 units, irrespective of price changes from Rs. 10.00 to Rs. 2.00. Hence, the numerical coefficient of perfectly inelastic demand is zero. ED = 0
RATI BHAN, MBA (1ST SEM), SUBJECT CODE-MB042, SET-1Page 3 8/10/2010
a slight change in price leads to more than proportionate change in demand. SUBJECT CODE-MB042. a large change in price. RATI BHAN. Hence.. the elasticity is greater than one. Hence. say 4 % rise in demand.MANAGERIAL ECONOMICS Relative Elastic Demand: In this case. leads to less than proportionate change in demand. elasticity is less than one. price falls by 3 % and demand rises by 9 %. say 8 % fall price. MBA (1ST SEM). One can notice here that change in demand is less than that of change in price. SET-1Page 4 8/10/2010 . This can be represented by a steeper demand curve. Hence. For e. Relatively Inelastic Demand: In this case.g. One can notice here that a change in demand is more than that of change in price. the numerical coefficient of demand is greater than one.
. Existence of Substitutes Substitute goods are those that are considered to be economically interchangeable by buyers. the first two are theoretical and the last one is a rare possibility.g.MANAGERIAL ECONOMICS In all economic discussion. relatively elastic demand is generally called as ‘elastic demand’ or ‘more elastic’ demand while relatively inelastic demand is popularly known as ‘inelastic demand’ or ‘less elastic demand’. for comforts and luxuries. For e. If a commodity has no substitutes in the market. Unitary elastic Demand: In this case. 1. wheat. milk.g. TV sets. Hence. SET-1Page 5 8/10/2010 . sugar. demand tends to be elastic e. on the other hand. 5 % fall in price leads to exactly 5 % increase in demand. MBA (1ST SEM). in all our general discussion. we make reference only to two terms relatively elastic demand and relatively inelastic demand. refrigerators etc. Hence. demand tends to be inelastic because people have to pay higher price RATI BHAN. Out of five different degrees. Determinants of Elasticity of Demand: The elasticity of demand depends on several factors of which the following are some of the important ones. vegetables etc. elasticity is equal to unity. It is possible to come across unitary elastic demand but it is a rare phenomenon.. Nature of the Commodity Commodities coming under the category of necessaries and essentials tend to be inelastic because people buy them whatever may be the price. rice. SUBJECT CODE-MB042. proportionate change in price leads to equal proportionate change in demand. 2. For example.
onions. For example. For example. demand for them is inelastic in nature. electricity. seeds. demand tends to be elastic. buying a TV set. demand tends to be elastic. fertilizers. for perishable and non-repairable goods. commodities having normal prices are elastic in nature. 8. If there is possibility to postpone the use of a commodity. vessels etc. ginger etc.. 5. salt. milk. soaps etc. Durability and reparability of a commodity Durable goods are those which can be used for a long period of time. For example. which are costly in nature. coal. On the contrary. vegetables. blades. refrigerators. On the contrary. In case of commodities having different substitutes. washing machine or a car etc. For example: all kinds of eatables. are low priced goods.g. However. On the other hand. demand will be relatively inelastic in case of rich people because any change in market price will not alter and affect their purchase plans. table. motor cycle. demand tends to be elastic e. Level of Income of the people Generally speaking. MBA (1ST SEM). electronic watches etc. chair. Similarly. pesticides etc. Hence. demand tends to be elastic in case of poor. If a commodity has only one use (singe use product) then demand tends to be inelastic because people have to pay more prices if they have to use that product for only one use. 6. tooth pastes. TV etc. SUBJECT CODE-MB042. steel etc. 4.MANAGERIAL ECONOMICS for such articles.g. commodities having several uses. needles etc. Possibility of postponing the use of a commodity In case there is no possibility to postpone the use of a commodity to future. For example: medicines. demand tends to be inelastic e. Demand tends to be elastic in case of durable and repairable goods because people do not buy them frequently. garlic. a few other goods like nails. the demand tends to be inelastic because people have to buy them irrespective of their prices. Proportion of the expenditure on a commodity RATI BHAN.. 7. 3. SET-1Page 6 8/10/2010 . Range of Prices There are certain goods or products like imported cars. computers. Number of uses for the commodity Single-use goods are those items which can be used for only one purpose and multiple-use goods can be used for a variety of purposes. For example.
Habits When people are habituated for the use of a commodity. in the short period. In this case the use of a product is not linked to any other products. tape recorders. 10. MBA (1ST SEM). If a product does not have complements. chocolates. milk. the amount of money spent is moderate. For example. On the other hand. demand tends to be elastic. For example. demand tends to be elastic in the long period where there is possibility of all kinds of changes. On the contrary. Period of time Price elasticity of demand varies with the length of the time period. in that case demand tends to be inelastic. vehicles and petrol. biscuits. demand is inelastic because consumption habits of the people. Existence of complementary goods Goods or services whose demands are interrelated. How is demand forecasting useful for managers? RATI BHAN. in that case demand tends to be elastic. salt. demand in that case tends to be elastic. on the other hand. an increase in the price of one of the products. tea. For e. Q2. SUBJECT CODE-MB042. 13. Purchase frequency of a product If the frequency of purchase is very high. coffee.MANAGERIAL ECONOMICS When the amount of money spent on buying a product is either too small or too big. shoes and socks etc have inelastic demand for this reason. In that case. ice creams etc. For example: in case of smoking.g. vegetables and fruits. then demand generally tends to be elastic.. results in a fall in the demand for the other. newspaper or a site or house. 12. cloths. For example. such that. demand tends to be inelastic. Level of Knowledge Demand in case of enlightened customer would be elastic and in case of ignorant customers. the demand tends to be inelastic. For example. SET-1Page 7 8/10/2010 . provision items etc. use of tobacco etc. if people buy a product occasionally. For example. If people are not habituated for the use of any products. Generally speaking. durable goods like radio. drinking. match box etc. do not change. pen and ink. it would be inelastic. refrigerators etc. 11. they do not care for price changes over a certain range. 9. customs and traditions etc.
Generally it would be one year period. Reduce the dependence on chances: The firm would be able to plan its production properly and face the challenges of competition efficiently. Sales forecasting: It helps the company to set realistic sales targets for each individual salesman and for the company as a whole. Financial planning: It helps to plan long run financial requirements and investment programs by floating shares and debentures in the open market. In the long run: Long run forecasting of probable demand for a product of a company is generally for a period of 3 to 5 or 10 years. which cuts down cost of operation. Helps to evolve a suitable labor policy: A proper sales and production policy. in the short run. Helps in estimating short run financial requirements: It helps the company to plan the finances required for achieving the production and sales targets. SUBJECT CODE-MB042. MBA (1ST SEM). Production planning: It helps in determining the level of output at various periods and avoiding under or over production. Helps to frame realistic pricing policy: A rational pricing policy can be formulated to suit short run and seasonal variations in demand. Capital budgeting of a firm is based on long run demand forecasting. SET-1Page 8 8/10/2010 . RATI BHAN. Helps to formulate right purchase policy: It helps in better material management of buying inputs and control its inventory level.MANAGERIAL ECONOMICS In the short run: Demand forecasts for short periods are made on the assumption that the company has a given production capacity and the period is too short to change the existing production capacity. The company will be able to raise the required finance well in advance at reasonable rates of interest. helps to determine the exact number of laborers to be employed. Business planning: It helps to plan expansion of the existing unit or a new production unit.
dye-stuff industry etc. Thus it is possible to regulate business effectively to meet the challenges of the market.. SET-1Page 9 8/10/2010 . Establishment of stability in the working of the firm: Fluctuations in production cause ups and downs in business which retards smooth functioning of the firm. Determination of the growth rate of the firm: A steady and well conceived demand forecasting determine the speed at which the company can grow. Q3. a graph or an equation specifying maximum output rate from a given amount of inputs used. color. Since it relates inputs to outputs. demand forecast for cotton textile industry supply information to the most likely demand for textile machinery. It may be in the form of a table.. Demand forecasting reduces production uncertainties and help in stabilizing the activities of the firm. it is also called “Input-output relation. MBA (1ST SEM). How is it useful for business? Production Function “A production Function” expresses the technological or engineering relationship between physical quantity of inputs employed and physical quantity of outputs obtained by a firm. SUBJECT CODE-MB042.” The production is purely physical in nature and is RATI BHAN. Business control: Effective control over total costs and revenues of a company helps to determine the value and volume of business. Explain production function. More useful in case of developed nations: It is of great use in industrially advanced countries where demand conditions fluctuate much more than supply conditions. e. This in its turn helps to estimate the total profits of the firm.MANAGERIAL ECONOMICS Manpower planning: It helps in preparing long term planning for imparting training to the existing staff and recruit skilled and efficient labor force for its long run growth.g. Indicates interdependence of different industries: Demand forecasts of particular products become the basis for demand forecasts of other related industries. It specifies a flow of output resulting from a flow of inputs during a specified period of time.
and so on employed by a firm. raw materials. They are as follows. The distinction between the two will hold good only in the short run. top management etc. the producer will keep all fixed factors as constant and change only a few variable factor inputs. it is assumed that a change in any of the variable factors produces corresponding changes in the output. Long run is a period of time where in the producer will have adequate time to make any sort of changes in the factor combinations.etc) where Q stands for quantity of output per unit of time and L N K etc are the various factor inputs like land. Short Run Production Function In this case. Short run is a period of time in which only the variable factors can be varied while fixed factors like plants. water. all factor inputs will become variable in nature. SUBJECT CODE-MB042. N. For example. MBA (1ST SEM). we come across two kinds of production functions: RATI BHAN. A production function can be represented in the form of a mathematical model or equation as Q = f (L. superior types of labor. availability of equipments. land. Fixed inputs are those factors the quantity of which remains constant irrespective of the level of output produced by a firm. a function of the factor inputs L N K etc. SET-1Page 10 8/10/2010 . there are two types of production functions.MANAGERIAL ECONOMICS determined by the quantum of technology. Variable inputs. 1. Factor inputs are of two types 1. top management etc would remain constant. Time available at the disposal of a producer to make changes in the quantum of factor inputs is very much limited in the short run. buildings. 2. In the short run. tools. and raw materials. employed by the firm per unit of time. transport and communication etc. The rate of output Q is thus.e. machines. Fixed Inputs. In the long run. power. Generally speaking. labor etc which are used in the production of output. fuel. labor. machineries. capital. K…. Variable inputs are those factors the quantity of which varies with variations in the levels of output produced by a firm For example. It is necessary to note that production function is assumed to be a continuous function. i. equipments.
Long Run Production Function In this case. The utility of employing a unit of variable factor input in the production process can be better judged with the help of production function. 2. organizational skills etc of a firm. 2. If returns to scale are increasing. Production function also helps in making long run decisions. 2. Additional employment of a variable factor input is desirable only when the marginal revenue productivity of that variable factor input is greater than or equal to cost of employing it in an organization. both fixed as well as variable in the same proportion. Each firm has its own production function which is determined by the state of technology. The quantity of output may increase and quantity of inputs may decrease. The quantity of inputs may be reduced while the quantity of output may remain same. in reality. There are several possible combinations of inputs and decision makers have to choose the most appropriate among them. 3. The quantity of output may increase while the quantity of inputs may remain same. it is wise to employ more factor units and increase RATI BHAN. The following are some of the important uses of production function. SET-1Page 11 8/10/2010 . It is useful in working out an optimum. SUBJECT CODE-MB042. managerial ability. Uses of Production Function Though production function may appear as highly abstract and unrealistic. 2. It may be in the following manner – 1. the old production function is disturbed and a new one takes its place. If there are any improvements in them. It is of immense utility to the managers and executives in the decision making process at the firm level. 3. Law of Variable Proportions. the producer will vary the quantities of all factor inputs. MBA (1ST SEM). 1. For example. It can be used to calculate or work out the least cost input combination for a given output or the maximum output-input combination for a given cost.MANAGERIAL ECONOMICS 1. Quantities of all factor inputs are kept constant and only two variable factor inputs are varied. it is both logical and useful. and economic combination of inputs for getting a certain level of output. Quantities of all inputs both fixed and variable will be kept constant and only one variable input will be varied.
Managers will be indifferent whether to increase or decrease production. it is unwise to employ more factor inputs & increase production.MANAGERIAL ECONOMICS production. SUBJECT CODE-MB042. RATI BHAN. SET-1Page 12 8/10/2010 . Thus. If returns to scale are diminishing. if production is subject to constant returns to scale. production function helps both in the short run and long run decision – making process. MBA (1ST SEM).
How do external and internal economies affect returns to scale? Economies of Scale The study of economies of scale is associated with large scale production. They are called as “Business Secrets “of a firm. “The advantages or benefits that accrue to a firm as a result of increase in its scale of production are called ‘Economies of Scale’. They arise on account of an increase in the scale of output of a firm and cannot be achieved unless output increases. 8. They are particular to a firm and enjoyed by only one firm. MBA (1ST SEM). Thus. They arise due to improvements in internal factors. I. Marshall these economies are of two types. The following are some of the important aspects of internal economies. Technical Economies RATI BHAN. they help a lot and go a long way in the development and growth of a firm. viz Internal Economies and External Economics. Internal Economies or Real Economies Internal Economies are those economies which arise because of the actions of an individual firm to economize its cost. 3. 7. Cairncross points out that internal economies are open to a single factory or a single firm independently of the actions of other firms. 6. Large scale production is beneficial and economical in nature. They arise “with in” or “inside” a firm. SET-1Page 13 8/10/2010 . They help in reducing production cost and establishing an optimum size of a firm. 5. They arise due to specific efforts of one firm. They are dependent on the size of the firm. Prof. Kinds of Internal Economies: 1. According to Prof. 4.MANAGERIAL ECONOMICS Q4. 2. SUBJECT CODE-MB042. Today there is a general tendency to organize production on a large scale basis. They arise due to increase in the scale of production. They can be effectively controlled by the management of a firm. They arise due to increased division of labor or specialization and complete utilization of indivisible factor inputs. 1.
RATI BHAN.MANAGERIAL ECONOMICS These economies arise on account of technological improvements and its practical application in the field of business. SUBJECT CODE-MB042. MBA (1ST SEM). SET-1Page 14 8/10/2010 . Economies of techniques or technical economies are further subdivided into five heads.
molasses.MANAGERIAL ECONOMICS a) Economies of superior techniques: These economies are the result of the application of the most modern techniques of production. Just-In-Time or zero level inventory techniques. The latest and improved techniques give place for specialized production. printing press. cultivating the land with modern tractors instead of using age old wooden ploughs and bullock carts. Also it is possible that different firms through mutual agreement may decide to work together and derive the benefits of linked processes. and bagasse of sugar factory can be used for the production of paper. Managerial Economies: They arise because of better. use of computers instead of human labor etc. it becomes possible to employ bigger and better types of machinery. It is bound to be cost reducing in nature. This will enable him to bring about RATI BHAN. cane pulp. SUBJECT CODE-MB042. For example. 2. d) Economies arising out of research and by – products: A firm can invest adequate funds for research and the benefits of research and its costs can be shared by all other firms. b) Economies of increased dimension: It is found that a firm enjoys the reduction in cost when it increases its dimension. In order to keep an eye on each production process he has to delegate some of his powers or functions to trained or specialized personnel and thus relieve himself for co-ordination. varnish. Similarly. For example. MBA (1ST SEM). and scientific management of a firm. Inventory management is a part of better materials management. nursing homes etc. a) Delegation of details: The general manager of a firm cannot look after the working of all processes of production. planning and executing the plans. When the size of the firm grows. A large firm avoids wastage of time and economizes its expenditure. c) Economies of linked process: It is quite possible that a firm may not have various processes of production with in its own premises. Such economies arise in two different ways. an increase in dimension of a firm will reduce the cost of production. The rationale of the Just-In-Time technique is that instead of having huge stocks worth of lakhs and crores of rupees. e) Inventory Economies. A big firm can save a lot of money by adopting latest inventory management techniques. For example. distilleries etc. efficient. in diary farming. Thus. for example. operation of a double decker instead of two separate buses. it can ask the seller of the inputs to supply them just before the commencement of work in the production department each day. SET-1Page 15 8/10/2010 . For example. a large firm can make use of its wastes and by-products in the most economical manner by producing other products.
This will ensure better and more efficient productive management with scientific business administration. b) Functional Specialization: It is possible to secure economies of large scale production by dividing the work of management into several separate departments. SET-1Page 16 8/10/2010 . This would lead to higher efficiency and reduction in the cost of production. RATI BHAN.MANAGERIAL ECONOMICS improvements in production process and in bringing down the cost of production. Each department is placed under an expert and the rest of the work is left into the hands of specialists. MBA (1ST SEM). SUBJECT CODE-MB042.
6. As the bargaining capacity of a big firm is much greater than that of small firms. efficiency and productivity of workers. A large firm can float debentures and issue shares and get subscribed by the general public. Transport and Storage Economies RATI BHAN. and create facilities like subsidized canteen. machine suppliers etc. recreations. Thus. It can also impart training to existing labor force in order to raise skills. because they are likely to get bulk orders. In this way economies may be secured in the purchase of different inputs. conserve the scarce resources. marketing department manned by experts who are well versed in the art of pushing the products in the market. MBA (1ST SEM). qualified and highly experienced persons by offering higher wages and salaries. As a firm expands. promotional opportunities. Financial Economies They arise because of the advantages secured by a firm in mobilizing huge financial resources. are willing to supply material and components at comparatively low rates. Another advantage will be that the raw material suppliers. rest rooms. The firm can have a separate selling organization.. trained. It can provide better working conditions. capital market. name and fame can mobilize huge funds from money market. SET-1Page 17 8/10/2010 . All these measures will definitely raise the average productivity of a worker and reduce the cost per unit of output. It can follow an aggressive sales promotion policy to influence the decisions of the consumers. crèches for infants. a big firm has an edge over small firms in securing sufficient funds more easily and cheaply. 5. New schemes may be chalked out to speed up the work. Marketing or Commercial economies: These economies will arise on account of buying and selling goods on large scale basis at favorable terms. It is also possible to have large overdrafts from banks. A large firm can have its own sales agency and channel. 4. It can borrow from banks at relatively cheaper rates. economize the expenditure and save labor time.MANAGERIAL ECONOMICS 3. it can get quantity discounts and rebates. SUBJECT CODE-MB042. sports rooms etc. A large firm on account of its reputation. A firm can reduce its selling costs also. Labor Economies These economies will arise as a result of employing skilled. and other private financial institutions at concessional interest rates. A large firm can buy raw materials and other inputs in bulk at concessional rates. it can employ a large number of highly talented persons and get the benefits of specialization and division of labor.
administration. book-keeping. If one person fails to supply. · Diversification of market: Instead of selling the goods in only one market. it can be made good in other items. highly organized and cheap transport and storage facilities and their complete utilization.MANAGERIAL ECONOMICS They arise on account of the provision of better. Over Head Economies These economies will arise on account of large scale operations. Hence many steps are taken by a firm to eliminate or to avoid or to minimize various kinds of risks. If there is loss in one item. Generally speaking. MBA (1ST SEM). · Diversification of output Instead of producing only one particular variety. Risk-bearing or survival economies These economies will arise as a result of avoiding or minimizing several kinds of risks and uncertainties in a business. Risk is avoided when few firms amalgamate or join together or when competition between different firms is either eliminated or reduced to the minimum or expanding the size of the firm. Economies of Vertical integration A firm can also reap this benefit when it succeeds in integrating a number of stages of production. Hence. RATI BHAN. Similarly. a firm has to sell its products in different markets. 8. The expenses on establishment. · Diversification of source of supply: Instead of buying raw materials and other inputs from only one source. etc. Because of vertical integration. a firm can also have its own storage facilities which reduce cost of operations. most of the costs become controllable costs which help an enterprise to reduce cost of production. 9. It secures the advantages that the flow of goods through various stages in production processes is more readily controlled. a firm can buy from several sources. it can cover the losses in other markets. SUBJECT CODE-MB042. SET-1Page 18 8/10/2010 . A large company can have its own fleet of vehicles or means of transport which are more economical than hired ones. are more or less the same whether production is carried on small or large scale. the survival of the firm may become difficult. it is better to purchase them from different sources. Unless these risks are effectively tackled. 7. A large firm secures risk-spreading advantages in either of the four ways or through all of them. a firm has to produce multiple products. If consumers in one market desert a product. A manufacturing unit has to face a number of risks in the business. the risk-bearing capacity of a big firm will be much greater than that of a small firm. cost per unit will be low if production is organized on large scale.
They are called as “open secrets” of a firm. 5. They are general. transport and communication. 8. They arise ‘outside’ the firm. water. They arise due to overall development. this is an advantage which arises from what is called ‘Localization of Industry’. SET-1Page 19 8/10/2010 . common & enjoyed by all firms. raw materials. These economies or gains will arise on account of the overall growth of an industry or a region or a particular area. External Economies or Pecuniary Economies External economies are those economies which accrue to the firms as a result of the expansion in the output of whole industry and they are not dependent on the output level of individual firms. They arise due to improvement in external factors. The following benefits of localization of industry is enjoyed by all the firmsprovision of better and cheap labor at low or reasonable rates. 1. Stonier & Hague points out that external economies are those economies in production which depend on increase in the output of the whole industry rather than increase in the output of the individual firm The following are some of the important aspects of external economies. They arise due to collective efforts of an industry. 3. it is better to use different processes or methods to produce the same commodity so as to avoid the loss arising out of the failure of any one process. Economies of concentration or Agglomeration They arise because in a particular area a very large number of firms which produce the same commodity are established. 4. They arise due to benefit of localization and specialized progress in the industry or region. educated and skilled labor. They are beyond the control of management of a firm. Kinds of External Economies 1. SUBJECT CODE-MB042. expansion & growth of an industry or a region. financial assistance through private and public institutions at low RATI BHAN. They are dependent on the size of industry. power. Prof. In other words. trained. II. MBA (1ST SEM).MANAGERIAL ECONOMICS · Diversification of the process of manufacture: Instead adopting only one process of production to manufacture a commodity. 6. 7. 2.
Similarly. information papers etc have helped a lot in the dissemination of quick information. SET-1Page 20 8/10/2010 . Thus. When inter-firm relationship strengthens. Economies of Information These economies will arise as a result of getting quick. the government in order to encourage the development of private industries has come up with several kinds of assistance. in cotton textiles industry. New subsidiary units may grow up to serve the needs of the main industry. In recent years. seminars. better use of byproducts and other such benefits. subsidies. mobile phones. 4. symposiums. a few others in printing. Revolution in the field of information technology. Since a large number of firms are located in a region. training camps. it helps a lot to economize the expenditure of a single firm. it helps in reducing the cost of operation of a firm. and some others in dyeing and coloring etc. magazines. Another form of benefit that arises due to localization of industry is economies of information. to organize lectures. in that case. MBA (1ST SEM). to have discussions with others. it becomes necessary to split it in to small units. it becomes possible for them to exchange their views frequently. 2. 3. etc.MANAGERIAL ECONOMICS interest rates. tax-exemptions. Statistical. When an industry grows beyond a limit. marketing facilities. e-mails. technical and other market information becomes more readily available to all firms. RATI BHAN. video conferences. some firms may specialize in manufacturing threads. development rebates. publication of journals. maintenance and service shops. This will help in developing contacts between different firms. financial assistance at low interest rates etc. For example. latest and up to date information from various sources. benefits of common repairs. workshops. services of specialists or outside experts. tax-holidays. demonstrations on topics of mutual interest. expansion in inter-net facilities. Economies of Government Action These economies will arise as a result of active support and assistance given by the government to stimulate production in the private sector units. This will certainly enhance the efficiency in the working of a firm and cut down unit costs considerably. SUBJECT CODE-MB042. has helped in the free flow of latest information from all parts of the globe in a very short span of time. Economies of Disintegration These economies will arise as a result of dividing one big unit in to different small units for the sake of convenience of management and administration. It is granting tax-concessions.
It may grant concessions to its workers. It is the single most ideal model that can explain the normal behavior of a firm.? Profit Maximization Model Profit-making is one of the most traditional. fertility of the soil. computer centers and educational institutions of all types. MBA (1ST SEM). cost cutting and cost minimization has become the slogan of a modern firm. basic and major objectives of a firm. training centers. It is the primary measure of success or failure of a firm in the market. For example. 5. A big industry is in a better position to provide welfare facilities to the workers. Main propositions of the profit-maximization model RATI BHAN. All these measures would help in raising the overall efficiency and productivity of workers. Climate. Profit-motive is the driving-force behind all business activities of a company. It may also establish health care units. Economies of Physical Factors These economies will arise due to the availability of favorable physical factors and environment. Both small and large firms consistently make an attempt to maximize their profit by adopting novel techniques in business. It is a very simple and unambiguous model. It may get land at concessional rates and procure special facilities from the local governments for setting up housing colonies for the workers. Profit earning capacity indicates the position. Q5. Specific efforts have been made to maximize output and minimize production and other operating costs. Cost reduction. 6. SUBJECT CODE-MB042.MANAGERIAL ECONOMICS It is quite clear from the above detailed description that both internal and external economies arise on account of large scale production and they are benefits to a firm and cost reducing in nature. As the size of an industry expands. Economies of Welfare These economies will arise on account of various welfare programs under taken by an industry to help its own staff. profit maximization has remained as one of the single most important objectives of the firm even today. Discuss the profit maximization model. SET-1Page 21 8/10/2010 . physical environment in a particular place may help all firms to enjoy certain physical benefits. performance and status of a firm in the market. In spite of several changes and development of several alternative objectives. positive physical environment may help to reduce the costs of all firms working in the industry. weather conditions.
MANAGERIAL ECONOMICS The model is based on the assumption that each firm seeks to maximize its profit given certain technical and market constraints. But in the long run. There should be proper balance between short run and long run objectives. it can expand and add to the existing capacities build up new plants. A firm will select that alternative course of action which helps to maximize consistent profits 5. in the long run. Thus. a firm has its own technical and managerial constraints. SUBJECT CODE-MB042. A firm makes an attempt to change its prices. 1. A firm is a producing unit and as such it converts various inputs into outputs of higher value under a given technique of production. in the short run. RATI BHAN. input and output quantity to maximize its profit. employ additional workers etc to meet the rising demand in the market. The basic objective of each firm is to earn maximum profit. it can increase its production and sales by intensive utilization of existing plants and machineries. In the short run a firm is able to make only slight or minor adjustments in the production process as well as in business conditions. A firm operates under a given market condition. Thus. having over time work for the existing staff etc. They are as follows – 1. MBA (1ST SEM). as there is plenty of time at the disposal of a firm. The model Profit-maximization implies earning profits during a given period of time. a firm will have adequate time and ample opportunity to make all kinds of adjustments and readjustments in production process and in its marketing strategies. 4. Pricing and business strategies of rival firms and its impact on the working of the given firm. It is to be noted with great care that a firm has to maximize its profits after taking in to consideration of various factors in to account. The plant capacity in the short run is fixed and as such. 3. SET-1Page 22 8/10/2010 . The following are the main propositions of the model. highest possible amount of A firm has to generate largest amount of profits by building optimum productive capacity both in the short run and long run depending upon various internal and external factors and forces. 2.
Maintaining its reputation. Profits of a firm are estimated by making comparison between total revenue and total costs. fame and image in the market. a firm is a price-taker and under imperfect market it becomes a price-searcher. 10. Determination of profit – maximizing price and output Profit maximization of a firm can be explained in two different ways. In a perfect market. Assumptions of the model The profit maximization model is based on tree important assumptions. SET-1Page 23 8/10/2010 . Without resorting to monopolistic and exploitative practices inviting government controls and takeovers. Without inducing the workers to demand higher wages and salaries leading to rise in operation costs. MBA (1ST SEM). 4. Adopting a stable business policy. 3. Profit is the difference between TR and TC. In other words. name. a) Total Revenue and Total Cost approach. 6. They are as follows – 1. Taking various kinds of risks and uncertainties in the changing business environment. Avoiding any sort of clash between short run and long run profits in the business policy and maintaining proper balance between them. 8. The firm is managed by owner-entrepreneur. Maintaining the quality of the product and services to the customers. SUBJECT CODE-MB042. 5. 9. 3. 2. Rational behavior on the part of the firm to achieve its goal of profit maximization. RATI BHAN. Profit maximization is the main goal of the firm. Profit maximization is necessary in both perfect and imperfect markets.MANAGERIAL ECONOMICS 2. b) Marginal Revenue and Marginal Cost approach. 7. Aggressive sales promotion policies adopted by rival firms in the market.
Hence. MC curve cut MR curve from below. there will be break even point. A firm will be maximizing its profits when MR= MC and MC curve cuts MR curve from below. 2. If MC curve cuts MR curve from above either under perfect market or under imperfect market. two conditions are necessary for profit maximization1. If TR is equal to TC in that case. 2. MBA (1ST SEM). SET-1Page 24 8/10/2010 . MR = MC. no doubt MR equals MC but total output will not be maximized and hence total profits also will not be maximized. In this case.MANAGERIAL ECONOMICS excess of revenue over costs is the profits. It is clear from the following diagram how profit arises when TR is greater than that of TC. If TR is less than TC. in that case. we take in to account of revenue earned from one unit and cost incurred to produce only one unit of output. a firm will be incurring losses. SUBJECT CODE-MB042. It is clear from the following diagrams. MR and MC approach In this case. Profit = TR – TC. RATI BHAN. we take in to account of total cost and total revenue of the firm while measuring profits.
Basic objective of traditional economic theory. SUBJECT CODE-MB042. 3. plain. realistic. A firm is not a charitable institution. SET-1Page 25 8/10/2010 . Hence. To achieve other objectives. To predict most realistic price-output behavior. MBA (1ST SEM). It is a timehonored hypothesis and there is common agreement among businessmen to make highest possible profits both in the short run and long run. it has to earn reasonable amount of profits. pragmatic and most useful hypothesis in forecasting price output behavior of a firm. A firm is a business unit. 4. it is a very simple. 2. Hence profit-maximization becomes the natural principle of a firm. This model helps to predict usual and general behavior of business firms in the real world as it provides a practical guidance. It also helps in predicting the reasonable behavior of a firm with more accuracy. Necessary for survival It is to be noted that the very existence and survival of a firm depends on its capacity to earn maximum profits. The traditional economic theory assumes that a firm is owned and managed by the entrepreneur himself and as such he always aims at maximum return on his capital invested in the business.MANAGERIAL ECONOMICS Justification for profit maximization 1. 5. It is organized on commercial principles. In recent years several other objectives have become much more popular and all these objectives have become highly RATI BHAN. Thus. A firm is not a charitable institution.
SUBJECT CODE-MB042. no doubt is the basic objective of a firm. Ambiguous term. name. 3. 7. amalgamations and takeovers. spending more time with members of the family. Growth of oligopolistic firms. SET-1Page 26 8/10/2010 . 2. There is no clear cut explanation whether a firm has to maximize its net profit. In many cases. It may not always be possible. In the context of globalization. The term profit maximization is ambiguous in nature. Again maximum amount of profit cannot be precisely defined in quantitative terms. Profit maximization. 6. A firm has several departments and sections headed by experts in their own fields. Difficulty in getting relevant information and data.MANAGERIAL ECONOMICS relevant in the context of modern business set up. 4. Hence. profits may not be maximized. always it may not be possible to get adequate and relevant information to take right decisions in a highly fluctuating business scenario. But in the context of highly competitive business environment. Conflict in inter-departmental goals. Other objectives like sales maximization. market leadership building its own image. to-day we come across the business units are organized on partnership or joint stock company or cooperative basis. ownership and management is clearly separated and they are run and managed by salaried managers who have their own self interests and as such always profit maximization may not become possible. a firm may not be able to cope up with the expectations and adjust its policies and as such profits may not be maximized. MBA (1ST SEM). 5. always it may not be possible for a firm to achieve this objective. Changes in business environment. Separation of ownership and management. growth of oligopoly firms has become so common through mergers. Each one of them will have its own independent goals and many a times there is possibility of clashes between the interests of different departments and as such always profits may not be maximized. But it is to be remembered that they can be achieved only when a firm is making maximum profits. In the context of highly competitive and changing business environment and changes in consumer’s tastes and requirements. fame and reputation. enjoying leisure. In case of many large organizations. In spite of revolution in the field of information technology. also has assumed greater significance in recent years. total profit or the rate of profit in a business unit. Criticisms 1. market share expansion. developing better and cordial relationship with employees and customers etc. Leading firms dominate the market and the small firms have to RATI BHAN.
Q6. marginal revenue and elasticity of demand at any level of output. durability of products. RATI BHAN. With the help of the point elasticity of demand. Aversion to reduction in power. security of jobs. promotions. There is a very useful relationship between elasticity of demand. Average Revenue and Marginal Revenue. emphasis has been shifted from profit maximization to other practical aspects. MBA (1ST SEM). Some of them are unable to forecast the right type of changes and meet the market challenges. and other types of benefits. They are more worried about their salaries. it is clear that a firm cannot maximize its profits always. the owners do not want to share their powers with many new partners and hence. SUBJECT CODE-MB042. Emphasis on non-profit goals. They may lack strong motivations to make higher profits as profits would go to the organization. They may be contented with only satisfactory level of profits rather than maximum profits. they try to keep maximum powers in their hands. Elasticity of demand at any point on a consumer’s demand curve is the same thing as the elasticity on the given point on the firm’s average revenue curve. there are limited chances for making maximum profits. Salaried managers have limited freedom in decision making process. From the point of view of today’s business environment. There are many constraints in the background of multiple objectives. productivity. 10. Elasticity of Demand. in many cases. 8. SET-1Page 27 8/10/2010 . have gained importance to cope with business competition. average revenue and marginal revenue at any level of output. 11.MANAGERIAL ECONOMICS follow the policies of the leading firms. higher quality of products and services etc. efficiency. In such cases. we can study the relationship between average revenue. Many organizations give more stress on non-profit goals. 9. In case of several small business units. Official restrictions over profits of public utilities. keeping more power becomes more important than profit maximization. Public utilities or public corporations are legally prohibited to make huge profits in many developing countries like India. Each one of the objectives has its own merits and demerits and a firm has to strike a balance between all kinds of objectives. Thus. better management. Hence. Examine the relationship between revenue concepts and price elasticity of demand. customer satisfaction. Hence. Significance of other managerial gains. perquisites.
MANAGERIAL ECONOMICS In the diagram AR and MR respectively are the average revenue and the marginal revenue curves. triangles PtK and RQK are congruent (i. Hence RT / Rt = RM / tP In the triangles PtK and KRQ PK = RK PKt = RKQ (vertically opposite) tPK = KRQ (right angles ) Therefore. equal in all respects). triangles PtR and MRT are equiangular. Hence Pt = RQ Elasticity at R = RT / Rt = RM / tP = RM / RQ It is clear from the diagram that Hence elasticity at R = RM / RM – QM RATI BHAN. Elasticity of demand at point R on the average revenue curve = RT/Rt Now in the triangles PtR and MRT. tPR = RMT (right angles) tRP = RTM (corresponding angles) PtR= MRT (being the third angle) Therefore. MBA (1ST SEM).. SUBJECT CODE-MB042. SET-1Page 28 8/10/2010 .e.
With the help of these formulae. provided we know the point elasticity of demand on the average revenue curve. Thus. Suppose that the price of a product is Rs..e. e= This can be changed into (through cross multiplication) eA – eM = A bringing A’s together. Therefore elasticity at R = Average Revenue / Average Revenue – Marginal Revenue If A stands for Average Revenue. MBA (1ST SEM). M stands for Marginal Revenue and e stands for point elasticity on the average revenue curve Then e = A / A – M. The marginal revenue formula can be written straight away as M = A ((e – 1) / e) The general rule therefore is: at any output. SET-1Page 29 8/10/2010 . SUBJECT CODE-MB042. elasticity of demand is equal to AR over AR minus MR. e stands for point elasticity of demand on the average revenue curve.8 and the elasticity is 4 at that price. By using the above elasticity formula. AR) per unit is equal to marginal revenue x elasticity over elasticity minus one. we can find marginal revenue at any point from average revenue at the same point. Marginal revenue will be: RATI BHAN. we have eA – A = eM A ( e – 1 ) = eM A = eM / e – 1 A =M (e / e – 1) Therefore Average Revenue or price = M (e / e – 1) Thus the price (i. Average Revenue = Marginal Revenue x (e / e – 1) and Marginal Revenue = Average Revenue x (e – 1 / e) Where. we can derive the formula for AR and MR separately.MANAGERIAL ECONOMICS It is also clear from the diagram that RM is average revenue and QM is the marginal revenue at the output OM which corresponds to the point R on the average revenue curve.
10 and the elasticity coefficient at that price is 1 MR will be: M = A ( ( e-1) / e) =10 ( (1-1) /1) =10 x 0/1 =0 Whenever elasticity of demand is unity. When elasticity coefficient is one for any given price. that is. the higher the elasticity coefficient. MBA (1ST SEM). SET-1Page 30 8/10/2010 . It follows from this that if a demand curve shows unitary elasticity throughout its length the corresponding marginal revenue will be zero throughout. marginal revenue will be zero. 6. the x axis itself will be the marginal revenue curve. whatever be the price(or AR). Thus.MANAGERIAL ECONOMICS M = A (( e – 1) / e) = 8 (( 4 – 1 / 4) = 8 x 3 /4 = 24 / 4 = 6.4 and the elasticity coefficient is 2 then the corresponding MR will be: M = A ( ( e-1) / e) = 4 ( ( 2 – 1) / 4) =4x1/4 =4/4 = 1 Marginal revenue is Rs. SUBJECT CODE-MB042. the corresponding marginal revenue will be zero. RATI BHAN. Suppose that the price of a product is Rs. marginal revenue is always positive when the elasticity coefficient is greater than one and marginal revenue is always negative when the elasticity coefficient is less than one. Marginal Revenue is Rs. the closer is the MR to AR / price. 1 Suppose that the price of commodity is Rs.
but if he lowers the price below B. the demand curve of price cutting firm below B is more inelastic. accordingly the price cutting firm will not be able to increase its sales correspondingly or may not be able to increase its sales at all. Because the demand is elastic from A to B a very small fall in price causes a very big rise in demand. As a result. The corresponding marginal revenue curve initially falls smoothly. it will start at a higher level. though at a greater rate. In certain cases. The corresponding MR curve is not smooth but has a gap or discontinuity between G and L. the rival firms will lower their prices too. but to realize the same increase in demand a very big fall in price is required as the demand curve assumes inelastic shape after point B. The demand curve AD has a kink at point B. the kinked demand curve may show a high elasticity in the lower portion of the demand curve beyond the kink and low elasticity in higher portion of the demand curve before the kink Marginal revenue to such a demand curve will show a gap but instead of at a lower level. RATI BHAN. From A to B it is elastic but from B to D it is inelastic. thus exhibiting two different characteristics. In the diagram there is a gap in MR between output 300 and 350. MBA (1ST SEM). SUBJECT CODE-MB042. SET-1Page 31 8/10/2010 .MANAGERIAL ECONOMICS Kinked Demand curve and the corresponding Marginal Revenue curve We measure quantity on the x axis and price on the Y axis. Generally an Oligopolies who faces a kinked demand curve will make a good gain when he reduces the price a little before the kink (point B).
MR is the marginal revenue curve and OD is the total revenue curve. If the quantity is greater than OQ it will correspond to that portion of the AR curve where e<1 marginal revenue is negative because MR goes below the x axis. Likewise for a quantity less than OQ. On its lower half it is less than one and on the upper half it is greater than one. At the middle point C of average revenue curve elasticity is equal to one. e>1 and the marginal revenue is positive. MR corresponding to the middle point C of the AR curve is zero. SET-1Page 32 8/10/2010 .MANAGERIAL ECONOMICS Relationship between AR. RATI BHAN. MBA (1ST SEM). TR and Elasticity of Demand In the diagram AR is the average revenue curve. SUBJECT CODE-MB042. the total revenue will be diminishing and for a quantity less than OQ the total revenue TR will be increasing. This means that if quantity greater than OQ is sold. Thus the total revenue TR will be maximum at the point H where elasticity is equal to one and marginal revenue is zero. This is shown by the fact that MR curve cuts the x axis at Q which corresponds to the point C on the AR curve. MR.
MANAGERIAL ECONOMICS RATI BHAN. SET-1Page 33 8/10/2010 . MBA (1ST SEM). SUBJECT CODE-MB042.
This action might not be possible to undo. Are you sure you want to continue?
We've moved you to where you read on your other device.
Get the full title to continue reading from where you left off, or restart the preview.