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

) Note: Each question carries 10 Marks. Answer all the questions. Q 1. Explain what is price elasticity of demand and outline the determinants of price elasticity of demand with examples.

Ans:- Price Elasticity of Demand In the words of Prof. Stonier and Hague, price elasticity of demand is a technical term used by economists to explain the degree of responsiveness of the demand for a product to a change in its price.

where Ep is price elasticity

. It implies that at the present level with every change in price, there will be a change in demand four times inversely. Generally the co-efficient of price elasticity of demand always holds a negative sign because there is an inverse relation between the price and quantity demanded.

Symbolically Ep = Original demand = 20 units original price = 6 00 New demand = 60 units New price = 4 00 In the above example, price elasticity is 6. The rate of change in demand may not always be proportionate to the change in price. A small change in price may lead to very great change in demand or a big change in price may not lead to a great change in demand. Based on numerical values of the co-efficient of elasticity, we can have the following five degrees of price elasticity of demand.

Determinants of Price Elasticity of Demand The elasticity of demand depends on several factors of which the following are some of the important ones. 1. 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. For example, rice, wheat, sugar, milk, vegetables etc. on the other hand, for comforts and luxuries, demand tends to be elastic e.g., TV sets, refrigerators etc. 2. Existence of Substitutes Substitute goods are those that are considered to be economically interchangeable by buyers. If a commodity has no substitutes in the market, demand tends to be inelastic because people have to pay higher price for such articles. For example. Salt, onions, garlic, ginger etc. In case of commodities having different substitutes, demand tends to be elastic. For example, blades, tooth pastes, soaps etc. 3. 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. 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. For example, all kinds of. eatables, seeds, fertilizers, pesticides etc. On the contrary, commodities having several uses, [multiple-use-products] demand tends to be elastic. For example, coal, electricity, steel etc. 4. Durability and reparability of a commodity Durable goods are those which can be used for a long period of time. Demand tends to be elastic in case of durable and repairable goods because people do not buy them frequently. For example, table, chair, vessels etc. On the other hand, for perishable and non-repairable goods, demand tends to be inelastic e.g., milk, vegetables, electronic watches etc. 5. Possibility of postponing the use of a commodity In case there is no possibility to postpone the use of a commodity to future, the demand tends to be inelastic because people have to buy them irrespective of their prices. For example, medicines. If there is possibility to postpone the use of a commodity, demand tends to be elastic e.g., buying a TV set, motor cycle, washing machine or a car etc.

6. Level of Income of the people Generally speaking, demand will be relatively inelastic in case of rich people because any change in market price will not alter and affect their purchase plans. On the contrary, demand tends to be elastic in case of poor. 7. Range of Prices There are certain goods or products like imported cars, computers, refrigerators, TV etc, which are costly in nature. Similarly, a few other goods like nails; needles etc. are low priced goods. In all these cases, a small fall or rise in prices will have insignificant effect on their demand. Hence, demand for them is inelastic in nature. However, commodities having normal prices are elastic in nature. 8. Proportion of the expenditure on a commodity When the amount of money spent on buying a product is either too small or too big, in that case demand tends to be inelastic. For example, salt, newspaper or a site or house. On the other hand, the amount of money spent is moderate; demand in that case tends to be elastic. For example, vegetables and fruits, cloths, provision items etc. 9. Habits When people are habituated for the use of a commodity, they do not care for price changes over a certain range. For example, in case of smoking, drinking, use of tobacco etc. In that case, demand tends to be inelastic. If people are not habituated for the use of any products, then demand generally tends to be elastic. 10. Period of time Price elasticity of demand varies with the length of the time period. Generally speaking, in the short period, demand is inelastic because consumption habits of the people, customs and traditions etc. do not change. On the contrary, demand tends to be elastic in the long period where there is possibility of all kinds of changes. 11. Level of Knowledge Demand in case of enlightened customer would be elastic and in case of ignorant customers, it would be inelastic. 12. Existence of complementary goods

Goods or services whose demands are interrelated so that an increase in the price of one of the products results in a fall in the demand for the other. Goods which are jointly demanded are inelastic in nature. For example, pen and ink, vehicles and petrol, shoes and socks etc have inelastic demand for this reason. If a product does not have complements, in that case demand tends to be elastic. For example, biscuits, chocolates, ice creams etc. In this case the use of a product is not linked to any other products. 13. Purchase frequency of a product If the frequency of purchase is very high, the demand tends to be inelastic. For e.g., coffee, tea, milk, match box etc. on the other hand, if people buy a product occasionally, demand tends to be elastic. For example, durable goods like radio, tape recorders, refrigerators etc. Thus, the demand for a product is elastic or inelastic will depend on a number of factors. Q 2. In the newspapers we read about mergers between companies in the same line of business. What are the economies of scale that can be availed of with mergers. Ans:- Merger refers to the process of combination of two companies, whereby a new company is formed. An acquisition refers to the process whereby a company simply purchases another company. In this case there is no new company being formed. Benefits of mergers and acquisitions are quite a handful. Mergers and acquisitions generally succeed in generating cost efficiency through the implementation of economies of scale. It may also lead to tax gains and can even lead to a revenue enhancement through market share gain. Economies of Scale The study of economies of scale is associated with large scale production. To-day there is a general tendency to organize production on a large scale basis. Mass production of standardized goods has become the order of the day. Large scale production is beneficial and economical in nature. 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 have close relationship with the size of the firm. They influence the average cost over different ranges of output. They are gain to a firm. They help in reducing production cost and establishing an optimum size of a firm. Thus, they help a lot and go a long way in the development and growth of a firm. According to Prof. Marshall these economies are of two types, viz Internal Economies and External Economics. Now we shall study both of them in detail.

Economies of scale give information about the various benefits that a firm will get when it goes for large scale production. Economies of scope on the other hand tells us how there will be certain specific advantages when one firm produces more than two products jointly than two or three firms produce them separately. Diseconomies of scale and diseconomies of scope tells us that there are certain limitations to expansion in output Cost analysis on the other hand, indicates the various amounts of costs incurred to produce a particular quantity of output in monetary terms. The various kinds of cost concepts help a manager to take right decisions. Cost function explains the relationship between the amounts of costs to be incurred to produce a particular quantity of output. Short run cost function gives information about the nature and behavior of various cost curves. Long run cost function tells us how it is possible to obtain more output at lower costs in the long run. Thus, the knowledge of both production function and cost functions help a business executive to work out the best possible factor combinations to maximize output with minimum costs. Economies of scale, in merger, refers to the cost advantages that a business obtains due to expansion. There are factors that cause a producers average cost per unit to fall as the scale of output is increased. Economies of scale is a long run concept and refers to reductions in unit cost as the size of a facility and the usage levels of other inputs increase. Diseconomies of scale are the opposite. The common sources of economies of scale are purchasing (bulk buying of materials through long-term contracts), managerial (increasing the specialization of managers), financial (obtaining lower-interest charges when borrowing from banks and having access to a greater range of financial instruments), marketing (spreading the cost of advertising over a greater range of output in media markets), and technological (taking advantage of returns to scale in the production function). Each of these factors reduces the long run average costs (LRAC) of production by shifting the short-run average total cost (SRATC) curve down and to the right. Economies of scale are also derived partially from learning by doing. Economies of scale is a practical concept that is important for explaining real world phenomena such as patterns of international trade, the number of firms in a market, and how firms get too big to fail. The exploitation of economies of scale helps explain why companies grow large in some industries. It is also a justification for free trade policies, since some economies of scale may require a larger market than is possible within a particular country for example, it would not be efficient for Liechtenstein to have its own car maker, if they would only sell to their local market. A lone car maker may be profitable, however, if they export cars to global markets in addition to selling to the local market. Economies of scale also play a role in a natural monopoly.

Q 3. Discuss the features of monopolistic competition and the method of price determination in monopolistic competition.

Ans:- Features of Monopolistic Competition: Monopolistic competition refers to the market situation in which many producers produce goods which are close substitutes of one another. Two important distinguishing features of monopolistic competition are: Product differentiation, and Existence of many firms supplying the market.

Product Differentiation: In contrary to perfect competition where there is only one homogeneous commodity, in monopolistic competition there is differentiation of products. In monopolistic competition, products are not homogenous nor are they only remote substitutes. These are the products produced by competing monopolists that have separate identity, brand, logos, patents, quality and such other product features. Product differentiation does not mean that goods are completely different. Rather it means that products are different in some ways, but not altogether so. These imaginary differences are created through advertising, marketing, packaging and the use of trademarks and brand names. Existence of Many Firms: Under monopolistic competition, there is fairly large number of sellers, let say 25 to 70. Each individual firm has relatively small part of the total market so that each has a very limited control over the price of the product. And each firm determines its own price-output policy without considering the reactions of rival firms. In monopolistic competition, in the long run, there is freedom of entry and exit. The commodity sold in a monopolistic competitive market is not a standardised product but a differentiated product. Hence competition is no longer exclusive on price basis. Buyers are buying a combination of physical product and the services which go with it. Because of consumers attachment to a particular brand, the seller acquires a monopolistic influence on the market. Thus, the demand curve facing a firm under monopolistic competition is a downward sloping curve, i.e., if he wants to sell more, he has to lower his price. The demand curve or AR curve under monopoly also slopes downwards, but there is a difference between demand curves facing under monopolistic competition and pure monopoly. The demand curve faced by a competing monopolist is more elastic than the demand curve faced by the monopolist, because there are no close substitutes available for the monopolist commodity. Price Determination under Monopolistic Competition:

Under monopolistic competition, the firm will be in equilibrium position when marginal revenue is equal to marginal cost. So long the marginal revenue is greater than marginal cost, the seller will find it profitable to expand his output, and if the MR is less than MC, it is obvious he will reduce his output where the MR is equal to MC. In short run, therefore, the firm will be in equilibrium when it is maximising profits, i.e., when MR = MC. Short run equilibrium : Short period is a period of time where time is inadequate to make all sorts of changes and adjustments in the productive process. The demand & cost conditions may vary substantially forcing the firm either to charge a higher or lower price leading to supernormal profits or losses. However, each firm fixes such price and produce output which maximizes its profit. The equilibrium price and output is determined at the point where Short run Marginal cost equals Marginal revenue. Thus, the first condition for Short run equilibrium is MC = MR in both diagrams.

The first diagram shows supernormal profits. In this case, price (AR) is greater than AC (cost Per Unit). MQ is the cost per unit and total cost for OQ output is = MQ X OQ = ONMQ. PQ is the price or revenue per unit and the total revenue for OQ output is = PQ X OQ = ORPQ. Supernormal profit = TR (ORPQ) TC (ONMQ). Hence, NRPM is the total profit. The second diagram shows losses. In this case, AC is greater than AR. PQ is the cost per unit and the total cost is PQ x OQ = ORPQ. MQ is the revenue per unit & the total revenue for OQ output is MQ X OQ = ONMQ. Total losses = TC (ORPQ) TR (ONMQ) = NRPM. Thus, in the Short run, there will be place for supernormal profits or losses. Price output determination in the long run : Long run is a period of time where a firm will get adequate time to make any changes in the productive process or business. A firm can initiate several measures to minimize its production costs and enjoy all the benefits of large scale production.The cost conditions, as a result differ slightly in the long run. While fixing the price, a firm in the long run should consider its AC & AR. Generally speaking in the long run a firm can earn only normal profits. If AR is greater than AC, there will be super normal profits. This leads to entry of new firms increase in the total number

of firms total production fall in prices decline in profit ratio. On the other hand, if AC is greater than AR, there will be losses. This leads to exit of old firms decrease in the number of firms total production rise in prices increase in profit ratio. Thus, the entry and exit of firms continue till AR becomes equal to AC. Thus, in the long run, two conditions are required for the equilibrium of the firm 1) MR=MC and 2) AR=AC. However, it should be noted that price is greater than MR & MC.

In the diagram E is the equilibrium position where MR = MC and MC curve cuts MR curve from below. At P, AR = AC = price. It is necessary to understand that a firm under monopolistic competition in the long run also can earn supernormal normal profits. Prof. Stonier & Hague suggest that a firm can go for innovation to introduce new changes in the context of a modern competitive business. This appears to be more realistic because today almost all firms make heavy profits. Hence, it is regarded as one of the most practical forms of market situations in the present day world. Q 4. If you were to buy a car, what are the factors that would affect the demand for your purchase.

Ans:- Demand is a relationship between two variables, price and quantity demanded, with all other factors that could affect demand being held constant. Well defined - The key phrase in the first element is well defined. The purpose of the phrase is to ensure that we are examining the relationship between price and quantity demanded for the same good. If we are interested in demand for a particular good there is no reason to compare the relationship between the price of the good and the change in quantity demanded of a different goods. Goods are well defined if they share the same characteristics - brand, model, age, quality and performance to name a few. For example a Cadillac CTS-V is a high performance car

manufactured by General Motors. The defining feature of the car is its engine - a supercharged OHV 6.2 liter L V-8. The engine produces 556 horsepower and 551 lbft of torque. The engine enables the vehicle to go from zero to 60 in 3.9 seconds. The car cost about 65,000.00. If we are interested in the demand for the CTS-V we need to compare the price of a CTS-V to the quantity demanded for a CTS-V and not a Ford Festiva. Willing and able - to participate in the market a consumer must not only be willing to buy a good she must be able to buy as well. For example, John may want to buy a Cadillac CTS. However unless he has the cash or credit to consummate the purchase his unrealized desires are irrelevant. Particular time period - demand measures the rate at which goods are being purchased during a specified period of time. For example to say that four thousand units are sold at a price of 65,000 does not tell us the level of demand unless we specify the time period per day per week per month. Nature of the relationship - this portion of the definition establishes that the price and quantity demanded have a negative or inverse relationship along the demand curve. held constant ; there are innumerable factors other than price than can affect the level of demand. Some of the more important are income, price of related goods, number of buyers, expectations and tastes and preferences. To focus on the cause and effect relationship between the good's own price and the quantity of the good demanded all these other factors must be held constant. To hold a variable constant means to freeze its value and not allow it to change.

Factors affecting demand Innumerable factors and circumstances could affect a buyer's willingness or ability to buy a good. Some of the more common factors are: Good's own price:The basic demand relationship is between potential prices of a good and the quantities that would be purchased at those prices. Generally the relationship is negative meaning that an increase in price will induce a decrease in the quantity demanded. This negative relationship is embodied in the downward slope of the consumer demand curve. The assumption of a negative relationship is reasonable and intuitive. If the price of a new novel is high, a person might decide to borrow the book from the public library rather than buy it. Or if the price of a new piece of equipment is high a firm may decide to repair existing equipment rather than replacing it.

Price of related goods: The principal related goods are complements and substitutes. A complement is a good that is used with the primary good. Examples include hotdogs and mustard, beer and pretzels, automobiles and gasoline. (Perfect complements behave as a single good.) If the price of the complement goes up the quantity demanded of the other good goes down. Mathematically, the variable representing the price of the complementary good would have a negative coefficient in the demand function. For example, Qd = a - P - Pg where Q is the quantity of automobiles demanded, P is the price of automobiles and Pg is the price of gasoline. The other main category of related goods are substitutes. Substitutes are goods that can be used in place of the primary good. The mathematical relationship between the price of the substitute and the demand for the good in question is positive. If the price of the substitute goes down the demand for the good in question goes down. Personal Disposable Income: In most cases, the more disposable income (income after tax and receipt of benefits) you have the more likely you buy. Tastes or preferences:The greater the desire to own a good the more likely you are to buy the good. There is a basic distinction between desire and demand. Desire is a measure of the willingness to buy a good based on its intrinsic qualities. Demand is the willingness and ability to put one's desires into effect. It is assumed that tastes and preferences are relatively constant. Consumer expectations about future prices and income: If a consumer believes that the price of the good will be higher in the future he is more likely to purchase the good now. If the consumer expects that her income will be higher in the future the consumer may buy the good now. In other words positive expectations about future income may encourage present consumption. This list is not exhaustive. All facts and circumstances that a buyer finds relevant to his willingness or ability to buy goods can affect demand. For example, a person caught in an unexpected storm is more likely to buy an umbrella than if the weather were bright and sunny. Q 5. When factors of production are combined to produce a particular level of output, what would be the effect on total product when all factors are kept fixed and only one factor is varied. For example, when the amount of land used for producing a particular crop is kept the same, and the other factors of production like labour, fertilisers, etc is increased. Ans:- Production is one of the most important activities of a firm in the circle of economic activity. The main objective of production is to satisfy the demand for different kinds of goods and services of the community. The concept of production can be represented in the following manner.

The term Production means transformation of physical Inputs into physical Outputs. The term Inputs refers to all those things or items which are required by the firm to produce a particular product. Four factors of production are land, labor, capital and organization. In addition to four factors of production, inputs also include other items like raw materials of all kinds, power, fuel, water, technology, time and services like transport and communications, warehousing, marketing, banking, shipping and Insurance etc. It also includes the ability, talents, capacities, knowledge, experience, wisdom of human beings. Thus, the term inputs have a wider meaning in economics. What we get at the end of productive process is called as Outputs. In short, Outputs refer to finished products. Production always results in either creation of new utilities or addition of values. It is an activity that increases consumer satiability of goods and services. Production is undertaken by producers and basically it depends on cost of production. Production analysis is always made in physical terms and it shows the relationship between physical inputs and physical outputs. It is to be noted that higher levels of production is an index of progress and growth of an organization and that of a society. It leads to higher income, employment and economic prosperity. Production of different types of goods and services in different nations indicates the nature of economic inter dependence between different nations. 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. It specifies a flow of output resulting from a flow of inputs during a specified period of time. It may be in the form of a table, a graph or an equation specifying maximum output rate from a given amount of inputs used. Since it relates inputs to outputs, it is also called Input-output relation. The production is purely physical in nature and is determined by the quantum of technology, availability of equipments, labor, and raw materials, and so on employed by a firm.

A production function can be represented in the form of a mathematical model or equation as Q = f (L, N, K.etc) where Q stands for quantity of output per unit of time and L N K etc are the various factor inputs like land, capital, labor etc which are used in the production of output. The rate of output Q is thus, a function of the factor inputs L N K etc, employed by the firm per unit of time. Factor inputs are of two types 1. Fixed Inputs. Fixed inputs are those factors the quantity of which remains constant irrespective of the level of output produced by a firm. For example, land, buildings, machines, tools, equipments, superior types of labor, top management etc. 2. Variable inputs. Variable inputs are those factors the quantity of which varies with variations in the levels of output produced by a firm For example, raw materials, power, fuel, water, transport and communication etc. The distinction between the two will hold good only in the short run. In the long run, all factor inputs will become variable in nature. Short run is a period of time in which only the variable factors can be varied while fixed factors like plants, machineries, 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. 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. It is necessary to note that production function is assumed to be a continuous function, i.e. it is assumed that a change in any of the variable factors produces corresponding changes in the output. Production Function with One Variable Input Case The Law of Variable Proportions This law is one of the most fundamental laws of production. It gives us one of the key insights to the working out of the most ideal combination of factor inputs. All factor inputs are not available in plenty. Hence, in order to expand the output, scarce factors must be kept constant and variable factors are to increased in greater quantities. Additional units of a variable factor on the fixed factors will certainly mean a variation in output. The law of variable proportions or the law of non-proportional output will explain how variation in one factor input give place for variations in outputs.

The law can be stated as the following. As the quantity of different units of only one factor input is increased to a given quantity of fixed factors, beyond a particular point, the marginal, average and total output eventually decline. The law of variable proportions is the new name for the famous Law of Diminishing Returns of classical economists. This law is stated by various economists in the following manner According to Prof. Benham, As the proportion of one factor in a combination of factors is increased, after a point, first the marginal and then the average product of that factor will diminish1. The same idea has been expressed by Prof.Marshall in the following words. An increase in the quantity of a variable factor added to fixed factors, at the end results in a less than proportionate increase in the amount of product, given technical conditions. Assumptions of the Law Only one variable factor unit is to be varied while all other factors should be kept constant Different units of a variable factor are homogeneous. Techniques of production remain constant. The law will hold good only for a short and a given period. There are possibilities for varying the proportion of factor inputs.

Illustration A hypothetical production schedule is worked out to explain the operation of the law. Fixed factors = 1 Acre of land + Rs 5000-00 capital. Variable factor = labor.

Total Product or Output: (TP) It is the output derived from all factors units, both fixed & variable employed by the producer. It is also a sum of marginal output. Average Product or Output: (AP) It can be obtained by dividing total output by the number of variable factors employed. Marginal Product or Output: (MP) It is the output derived from the employment of an additional unit of variable factor unit Trends in output From the table, one can observe the following tendencies in the TP, AP, & MP. 1. Total output goes on increasing as long as MP is positive. It is the highest when MP is zero and TP declines when MP becomes negative. 2. MP increases in the beginning, reaches the highest point and diminishes at the end. 3. AP will also have the same tendencies as the MP. In the beginning MP will be higher than AP but at the end AP will be higher than MP. Diagrammatic Representation

In the above diagram along with OX axis, we measure the amount of variable factors employed and along OY axis, we measure TP, AP & MP. From the diagram it is clear that there are III stages. Stage Number I. The Law of Increasing Returns

The total output increases at an increasing rate (More than proportionately) up to the point P because corresponding to this point P the MP is rising and reaches its highest point. After the point P, MP decline and as such TP increases gradually. The first stage comes to an end at the point where MP curve cuts the AP curve when the AP is maximum at N. The I stage is called as the law of increasing returns on account of the following reasons. 1. The proportion of fixed factors is greater than the quantity of variable factors. When the producer increases the quantity of variable factor, intensive and effective utilization of fixed factors become possible leading to higher output. 2. When the producer increases the quantity of variable factor, output increases due to the complete utilization of the Indivisible Factors. 3. As more units of the variable factor is employed, the efficiency of variable factors will go up because it creates more opportunity for the introduction of division of labor and specialization resulting in higher output. Stage Number II. The Law of Diminishing Returns In this case as the quantity of variable inputs is increased to a given quantity of fixed factors, output increases less than proportionately. In this stage, the T.P increases at a diminishing rate since both AP & MP are declining but they are positive. The II stage comes to an end at the point where TP is the highest at the point E and MP is zero at the point B. It is known as the stage of Diminishing Returns because both the AP & MP of the variable factor continuously fall during this stage. It is only in this stage, the firm is maximizing its total output. Diminishing returns arise due to the following reasons: 1. The proportion of variable factors is greater than the quantity of fixed factors. Hence, both AP & MP decline. 2. Total output diminishes because there is a limit to the full utilization of indivisible factors and introduction of specialization. Hence, output declines. 3. Diseconomies of scale will operate beyond the stage of optimum production. 4. Imperfect substitutability of factor inputs is another cause. Up to certain point substitution is beneficial. Once optimum point is reached, the fixed factors cannot be compensated by the variable factor. Diminishing returns are bound to appear as long as one or more factors are fixed and cannot be substituted by the others.

The III Stage The Stage of Negative Returns: In this case, as the quantity of variable input is increased to a given quantity of fixed factors, output becomes negative. During this stage, TP starts diminishing, AP continues to diminish and MP becomes negative. The negative returns are the result of excessive quantity of variable factors to a constant quantity of fixed factors. Hence, output declines. The proverb Too many cooks spoil the broth and Too much is too bad aptly applies to this stage. Generally, the III stage is a theoretical possibility because no producer would like to come to this stage. The producer being rational will not select either the stage I (because there is opportunity for him to increase output by employing more units of variable factor) or the III stage (because the MP is negative). The stage I & III are described as NON-Economic Region or Uneconomic Region. Hence, the producer will select the II stage (which is described as the most economic region) where he can maximize the output. The II stage represents the range of rational production decision. It is clear that in the above example, the most ideal or optimum combination of factor units = 1 Acre of land+ Rs. 5000 00 capital and 9 laborers. All the 3 stages together constitute the law of variable proportions. Since the second stage is the most important, in practice we normally refer this law as the law of Diminishing Returns.

Q 6. A company wishes to project the production requirements of a particular product in the coming years. How will the company forecast the demand in the coming years, using the trend projection method. Ans:- 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. Generally it would be one year period. Important features of demand forecasting

Production planning: It helps in determining the level of output at various periods and avoiding under or over production. Helps to formulate right purchase policy: It helps in better material management, of buying inputs and control its inventory level which cuts down cost of operation. Helps to frame realistic pricing policy: A rational pricing policy can be formulated to suit short run and seasonal variations in demand. Sales forecasting: It helps the company to set realistic sales targets for each individual salesman and for the company as a whole.

Helps in estimating short run financial requirements: It helps the company to plan the finances required for achieving the production and sales targets. The company will be able to raise the required finance well in advance at reasonable rates of interest. Reduce the dependence on chances: The firm would be able to plan its production properly and face the challenges of competition efficiently. Helps to evolve a suitable labour policy: A proper sales and production policies help to determine the exact number of labourers to be employed in the short run.

Methods Or Techniques Of Forecasting Demand forecasting is a highly complicated process as it deals with the estimation of future demand. It requires the assistance and opinion of experts in the field of sales management. While estimating future demand, one should not give too much of importance to either statistical information, past data or experience, intelligence and judgment of the experts. Demand forecasting, to become more realistic should consider the two aspects in a balanced manner. Application of commonsense is needed to follow a pragmatic approach in demand forecasting. Broadly speaking, there are two methods of demand forecasting. They are: 1.Survey methods and 2 Statistical methods.

Statistical Method It is the second most popular method of demand forecasting. It is the best available technique and most commonly used method in recent years. Under this method, statistical, mathematical models, equations etc are extensively used in order to estimate future demand of a particular product. They are used for estimating long term demand. They are highly complex and complicated in nature. Some of them require considerable mathematical back ground and competence. They use historical data in estimating future demand. The analysis of the past demand serves as the basis for present trends and both of them become the basis for calculating the future demand of a commodity in question after taking into account of likely changes in the future. There are several statistical methods and their application should be done by some one who is reasonably well versed in the methods of statistical analysis and in the interpretation of the results of such analysis. Trend Projection Method An old firm operating in the market for a long period will have the accumulated previous data on either production or sales pertaining to different years. If we arrange them in chronological order, we get what is called as time series. It is an ordered sequence of events over a period of time pertaining to certain variables. It shows a series of values of a dependent variable say, sales as it changes from one point of time to another. In short, a time series is a set of observations taken at specified time, generally at equal intervals. It depicts the historical pattern under normal conditions. This method is not based on any particular theory as to what causes the variables to change but merely assumes that whatever forces contributed to change in the recent past will continue to have the same effect. On the basis of time series, it is possible to project the future sales of a company. Further, the statistics and information with regard to the sales call for further analysis. When we represent the time series in the form of a graph, we get a curve, the sales curve. It shows the trend in sales at different periods of time. Also, it indicates fluctuations and turning points in demand. If the turning points are few and their intervals are also widely spread, they yield acceptable results. Here the time series show a persistent tendency to move in the same direction. Frequency in turning points indicates uncertain demand conditions and in this case, the trend projection breaks down. The major task of a firm while estimating the future demand lies in the prediction of turning points in the business rather than in the projection of trends. When turning points occur more frequently, the firm has to make radical changes in its basic policy with respect to future demand. It is for this reason that the experts give importance to identification of turning points while projecting the future demand for a product.

The heart of this method lies in the use of time series. Changes in time series arise on account of the following reasons: Secular or long run movements: Secular movements indicate the general conditions and direction in which graph of a time series move in relatively a long period of time. 2. Seasonal movements: Time series also undergo changes during seasonal sales of a company. During festival season, sales clearance season etc., we come across most unexpected changes. 3. Cyclical Movements: It implies change in time series or fluctuations in the demand for a product during different phases of a business cycle like depression, revival, boom etc. 4. Random movement. When changes take place at random, we call them irregular or random movements. These movements imply sporadic changes in time series occurring due to unforeseen events such as floods, strikes, elections, earth quakes, droughts and other such natural calamities. Such changes take place only in the short run. Still they have their own impact on the sales of a company.
1.

An important question in this connection is how to ascertain the trend in time series? A statistician, in order to find out the pattern of change in time series may make use of the following methods. The Least Squares method. The Free hand method. The moving average method. The method of semi averages. The method of Least Squares is more scientific, popular and thus more commonly used when compared to the other methods. It uses the straight line equation Y= a + bx to fit the trend to the data.

Masters of Business Administration- MBA Semester 2 MB0042 Managerial Economics - 4 Credits (Book ID: B1131) Assignment Set- 2 (60 Marks) Note: Each question carries 10 Marks. Answer all the questions. Q 1. The supply of a product depends on the price of the product. This determines the supply curve. What are the factors other than price that cause shifts in the supply curve. Ans:- Factors Determining Elasticity of Supply (Determinants) 1. Time period: Time has a greater influence on elasticity of supply than on demand. Generally supply tends to be inelastic in the short run because time available to organize and adjust supply to demand is insufficient. Supply would be more elastic in the long run. 2. Availability and mobility of factors of production : When factors of production are available in plenty and freely mobile from one occupation to another, supply tends to be elastic and vice - versa. 3. Technological improvements: Modern methods of production expand output and hence supply tends to be elastic. Old methods reduce output and supply tends to be inelastic. 4. Cost of production: If cost of production rises rapidly as output expands, then there will not be much incentive to increase output as the extra benefit will be choked off by the increase in cost. Hence supply tends to be inelastic and vice-versa. 5. Kinds and nature of markets: If the seller is selling his product in different markets, supply tends to be elastic in any one of the market because, a fall in the price in one market will induce him to sell in another market. Again, if he is producing several types of goods and can switch over easily from one to another, then each of his products will be elastic in supply. 6. Political conditions: Political conditions may disrupt production of a product. In that case, supply tends to become inelastic. 7. Number of sellers : Supply tends to become more elastic if there are more sellers freely selling their products and vice-versa. 8. Prices of related goods : A firm can charge a higher price for its products, if prices of other products are higher and vice-versa. 9. Goals of the firm : If the seller is happy with small output, supply tends to be inelastic and vice-versa.

Thus, several factors influence the elasticity of supply. Practical Importance 1. The concept of elasticity of supply is of great importance to the finance minister while formulating the taxation policy of the country. If the supply is inelastic, the imposition of tax may not bring about any change in the supply. If supply is elastic, reasonable taxes are to be levied. 2. The price of a commodity depends upon the degree of elasticity of demand and supply. 3. It is used in the theory of incidence of taxation. The money burden of taxation is shared by the tax payers and the sellers in the ratio of elasticity of supply and demand.

Q 2. Explain with examples the following types of costs: a) Fixed costs b) Variable costs c) Marginal costs d) average costs e) short run costs

Ans:( a ) Fixed costs These costs are incurred on fixed factors like land, buildings, equipments, plants, superior type of labor, top management etc. Fixed costs in the short run remain constant because the firm does not change the size of plant and the amount of fixed factors employed. Fixed costs do not vary with either expansion or contraction in output. These costs are to be incurred by a firm even output is zero. Even if the firm close down its operation for some time temporarily in the short run, but remains in business, these costs have to be borne by it. Hence, these costs are independent of output and are referred to as unavoidable contractual cost. Prof. Marshall called fixed costs as supplementary costs. They include such items as contractual rent payment, interest on capital borrowed, insurance premiums, depreciation and maintenance allowances, administrative expenses like managers salary or salary of the permanent staff, property and business taxes, license fees, etc. They are called as over-head costs because these costs are to be incurred whether there is production or not. These costs are to be distributed on each unit of output produced by a firm. Hence, they are called as indirect costs.

( b ) Variable costs The cost corresponding to variable factors are discussed as variable costs. These costs are incurred on raw materials, ordinary labor, transport, power, fuel, water etc, which directly vary in the short run. Variable costs directly and proportionately increase or decrease with the level of output. If a firm shuts down for some time in the short run; then it will not use the variable factors of production and will not therefore incur any variable costs. Variable costs are incurred only when some amount of output is produced. Total variable costs increase with increase in the level of production and vice-versa. Prof. Marshall called variable costs as prime costs or direct costs because the volume of output produced by a firm depends directly upon them. It is clear from the above description that production costs consist of both fixed as well as variable costs. The difference between the two is meaningful and relevant only in the short run. In the long run all costs become variable because all factors of production become adjustable and variable in the long run. However, the distinction between fixed and variable costs is very significant in the short run because it influences the average cost behavior of the firm. In the short run, even if a firm wants to close down its operation but wants to remain in business, it will have to incur fixed costs but it must cover at least its variable costs. ( c ) Marginal Cost (MC) Marginal Cost may be defined as the net addition to the total cost as one more unit of output is produced. In other words, it implies additional cost incurred to produce an additional unit. For example, if it costs Rs. 100 to produce 50 units of a commodity and Rs. 105 to produce 51 units, then MC would be Rs. 5. It is obtained by calculating the change in total costs as a result of a change in the total output. Also MC is the rate at which total cost changes with output. Hence, MC = D TC / D TQ. Where D TC stands for change in total cost and D TQ stands for change in total output. Also MCn = TCn TC n-1 It is necessary to note that MC is independent of TFC and it is directly related to TVC as we calculate the cost of producing only one unit. In the short run, the MC curve also tends to be Ushaped. The shape of the MC curve is determined by the laws of returns. If MC is falling, production will be under the conditions of increasing returns and if MC is rising, production will be subject of diminishing returns.

( d ) Average cost average cost or unit cost is equal to total cost divided by the number of goods produced (the output quantity, Q). It is also equal to the sum of average variable costs (total variable costs divided by Q) plus average fixed costs (total fixed costs divided by Q). Average costs may be dependent on the time period considered (increasing production may be expensive or impossible in the short term, for example). Average costs affect the supply curve and are a fundamental component of supply and demand.

( e ) Short run costs Short-run average cost will vary in relation to the quantity produced unless fixed costs are zero and variable costs constant. A cost curve can be plotted, with cost on the y-axis and quantity on the x-axis. Marginal costs are often shown on these graphs, with marginal cost representing the cost of the last unit produced at each point; marginal costs are the first derivative of total or variable costs. A typical average cost curve will have a U-shape, because fixed costs are all incurred before any production takes place and marginal costs are typically increasing, because of diminishing marginal productivity. In this "typical" case, for low levels of production marginal costs are below average costs, so average costs are decreasing as quantity increases. An increasing marginal cost curve will intersect a U-shaped average cost curve at its minimum, after which

point the average cost curve begins to slope upward. For further increases in production beyond this minimum, marginal cost is above average costs, so average costs are increasing as quantity increases. An example of this typical case would be a factory designed to produce a specific quantity of widgets per period: below a certain production level, average cost is higher due to under-utilised equipment, while above that level, production bottlenecks increase the average cost

Q 3. Indian railways is an example of monopoly in India. Discuss the factors that determine price in the different categories of travel in railways.
Ans:-

A number of factors contribute to determining the price of a Regional Rail ticket.

Dynamic Pricing Policy Till recently, IR had a xed price policy, irrespective of demand scenario and competition. In order to be able to eectively face the challenges posed by sti competition, a Dynamic Pricing Policy was introduced for freight as well as passenger, for peak and non-peak seasons, premium and non- premium services, and for busy and non-busy routes. As per this policy the rates for non-peak season, non-premium service and empty ow directions would be less than the general rates and the rates for peak season and premium services could be higher than normal. Tari Rationalization To simplify and rationalize goods tari, the classication of items was reduced from over 4000 to a mere 28 groups of commodities. In 2005-06, the total number of classes in the freight tari schedulewas reduced from 27 to 19. The highest class - 250 for charging freight was lowered to 220 in 2006-07. This was a very clever policy as more classes were put in the higher price category. Thus even though the maximum cost was lower in new tari rates, the nett revenue weighted over the trac in all the classes was larger. Non-peak Season Incremental Freight Discount Scheme The demand for freight transportation typically dips from 1 July to 31 October on account of mon- soon. It was estimated that over 400 trains remain idle in this period due to lack of demand. Hence, during this period, freight rebate of 15% was oered for incremental freight revenues of over Rs. 5 Crore in a month and 10% for incremental earning of less than Rs. 5 Crore. Long term freight discount scheme Merchants want to make transportation arrangement for goods on a long-term basis. Hence, long- term freight discounts were oered to attract new customers and new freight trac. Under

this scheme, zonal railway administrations were able to oer a discount of up to 20% during non-peak season and up to 10% in the peak season for a period of three years. For loading in empty ow direction, the discount was up to 20% and 30% during peak season and non-peak season respectively. Many other schemes have been launched by the IR over the past few years the details of which are available at the Official IR website . Q4. In the case of consumer durables, we find that when the product is introduced, the prices are high, but over time the prices reduce. What is the pricing policy followed? Ans:- New products should be priced and repriced over their life cycle to fit the changing competitive environment. In the pioneer stage manufacturers must estimate demand, decide on market targets, design promotional strategies, and choose distribution channels. Manufacturers must decide between a high initial price which takes advantage of inelastic demand and helps bear the burden of financing and a low initial price which can penetrate mass markets early and raise entry barriers to competitors. Manufacturers must recognize when a product is entering its mature stage so that prices can be reduced promptly to forestall the entry of private-label competitors. We consider that there are following basic components to a successful pricing strategy: Pricing Before You Build : Establishing a pricing strategy is an activity that should be completed before you start product development. The only way to accurately determine how much money you can afford to spend on development, support, promotion and the other costs associated with a product is to analyze how much of that product you will sell, and at what price. That's the heart of a successful pricing strategy. Use the Right Costs: A successful pricing strategy is your means of making a profit today, not of recovering costs spent a year ago. Don't use the cost of developing your current product as the basis for its price. Instead, use the current costs of developing your new products as the basis of the price of your current product. Raise Price to Exploit a Reticence to Switch : Once the customer is yours, the situation switches in your favor. One of the resistance factors your salesforce encounters on a new sale is reticence to switch. An existing customer is still unwilling to learn something new, only now they're afraid to switch FROM you, not TO you. They would much prefer to add the functionality of your product enhancements instead of learning how to use something new. For you, price sensitivity is much lower as comfort and ease factors increase. So you might raise your update pricing accordingly. Study the Competition : Study the competition, but don't react and don't copy them, since they're likely making mistakes anyway. Let them guide you in terms of where you set your

boundaries, and in terms of counter offensives you can launch to deal with obvious bonehead pricing on their part. And remember this as well: any move you make can be countered by them just as easily. Don't get caught in a no-win price war--which may hurt your product, their product and devalue your marketplace. Align with the Product Life Cycle : How high or low you set your price is also going to be driven by where your product is in its life cycle. In general, the farther along you go toward the Decline phase the lower your price should be, since your market will be (a) saturated with product and (b) have increased price sensitivity as their knowledge of the products increases. One technique to consider is unbundling support, training and services from the product itself, which will allow you to lower price without discounting. Strategic pricing is the effective, proactive use of product pricing to drive sales and profits, and to help establish the parameters for product development. Used wisely it is a clearly powerful tool for successful marketing strategies Q 5. In the long run, the long run average cost curve is an envelope of the short run cost curves. Discuss the concept behind the same. Ans:- Long run is defined as a period of time where adjustments to changed conditions are complete. It is actually a period during which the quantities of all factors, variable as well as fixed factors can be adjusted. Hence, there are no fixed costs in the long run. In the short run, a firm has to carry on its production within the existing plant capacity, but in the long run it is not tied up to a particular plant capacity. If demand for the product increases, it can expand output by enlarging its plant capacity. It can construct new buildings or hire them, install new machines, employ administrative and other permanent staff. It can make use of the existing as well as new staff in the most efficient way and there is lot of scope for making indivisible factors to become divisible factors. On the other hand, if demand for the product declines, a firm can cut down its production permanently. The size of the plant can also be reduced and other expenditure can be minimized. Hence, production cost comes down to a greater extent in the long run. As all costs are variable in the long run, the total of these costs is total cost of production. Hence, the distinction between fixed and variables costs in the total cost of production will disappear in the long run. In the long run only the average total cost is important and considered in taking long term output decisions. Long run average cost is the long run total cost divided by the level of output. In brief, it is the per unit cost of production of different levels of output by changing the size of the plant or scale of production. The long run cost output relationship is explained by drawing a long run cost curve through short run curves as the long period is made up of many short periods as the day is made up of

24 hours and a week is made out of 7 days. This curve explains how costs will change when the scale of production is varied.

The long run-cost curves are influenced by the laws of return to scale as against the short run cost curves which are subject to the working of law of variable proportions. In the short run the firm is tied with a given plant and as such the scale of operation remains constant. There will be only one AC curve to represent one fixed scale of output in the short run. In the long run as it is possible to alter the scale of production, one can have as many AC curves as there are changes in the scale of operations. In order to derive LAC curve, one has to draw a number of SAC curves, each curve representing a particular scale of output. The LAC curve will be tangential to the entire family of SAC cures. It means that it will touch each SAC curve at its minimum point.

Production cost difference in the short run and long run In the diagram, the LAC curve is drawn on the basis of three possible plant sizes. Consequently, we have three different SAC curves SAC1, SAC2 and SAC3. They represent three different scales of output. For output OM3 the AC will be L2M2 in the short run as well as the long run. When output is to be expanded to OM3, it can be obtained at a higher average cost of production. K3, M3 is the short run AC because, scale of production would remain constant in the short run. But the same output of OM3 can be produced at a lower AC of L3M3 in the long run since the

scale of production can be modified according to the requirements. The distance between K3L3 represent difference between the cost of production in the short run and long run. Similarly, when output is contracted to OM1 in the short run, K1M1 will become the short run AC and L1M1 will be the long run AC. Hence, K1L1 indicates the difference between short run and long run cost of production. If we join points L1, L2 and L3 we get LAC curve. It is known as Envelope curve because it envelopes a group of SAC curves appropriate to different levels of output. The long-run average cost curve is the envelope of an infinite number of short-run average total cost curves, with each short-run average total cost curve tangent to, or just touching, the long-run average cost curve at a single point corresponding to a single output quantity. The key to the derivation of the long-run average cost curve is that each short-run average total cost curve is constructed based on a given amount of the fixed input, usually capital. As such, when the quantity of the fixed input changes, the short-run average total cost curve shifts to a new location.

Q 6. A company wishes to introduce a new flavour of tea in the market. Discuss how the company can forecast demand for the new flavour of tea. Ans;- To deliver the right products to the right customers portably requires a fundamental shift in retail decision making from art to science; and from one that is based on human intuition to one that is driven by customer data.

Demand Forecasting for a New Product 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. Professor Joel Dean, however, has suggested a few guidelines to make forecasting of demand for new products. 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 Pulsar can be forecasted based on the a sales of the old Pulsor. 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. These methods are not mutually exclusive. The management can use a combination of several of them, supplement and cross check each other.