Q1. What is Managerial Economics? What is its scope and importance to a corporate firm?

How would you explain the support of a managerial economist can provide to the top management of a consumer goods manufacturing company?
Ans :- Managerial economics is a science that deals with the application of various economics theories, principles, concepts and techniques to business management in order to solve business and management problems It deals with the practical application of economic theory and methodology to decision-making problems faced by private, public and non profit making organizations.. In the words of Spencer and Seigelman “Managerial Economics is the integration of economic theory with business practice for the purpose of facilitating decision making and forward planning by the management.” Scope of Managerial Economics The term “scope” indicates the area of study, boundaries, subject matter and width of a subject. Business economics is comparatively a new and upcoming subject. The following topics are covered in this subject :1) Objectives of a firm :- Profit maximization has been considered as the main objective of a business unit in olden days, but in the context of present day business environment ,many new objectives have come to the fore. Today, there are multiple objectives and they are multi dimensional in nature. Some of them are competitive while others are supplementary in nature. There are economic, social, organizational, human and national goals. There are managerial and behavioral theories. 2) Demand Analysis and Forecasting :-A firm is basically a producing unit. It produce different kinds of goods and services. It has to meet the requirement of consumers in the market. The basic problems of what to produce where to produce, for whom to produce, how to produce and how to distribute them in the market are to be answered by a firm. 3) Production and Cost Analysis :-Production implies transformation of inputs into outputs. It may be either in physical or monetary terms. Maximization of outputs is one of the basic goals of a firm. Production analysis deals with production function, laws of return, returns to scale, economies of scale etc. Maximization of output with minimum cost is the basic slogan of any firm. 4) Pricing Decisions, Policies and Practices :- Pricing Decision is related to fixing the prices of goods and services. This depends on the pricing policy and practices adopted by a firm. Price setting is one of the most important policies of a firm. The amount of revenue, the level of income and above all the volume of profit earned by a firm directly depend on its pricing decisions. 5) Profit Management :-A firm is basically a commercial or business unit. Consequently, the success or failure of it is measured in terms of the amount of

4) It also helps in understanding the various external factors and forces which effect the decision-making of a firm. 2) It helps the business executives to become much more responsive realistic and competent to face the ever changing challenge in the modern business world. It is now a new addition to the scope of business economics with the emergence of MNC’s. Under profit management. selection of highly profitable project cost. one has to study various theories of profit. Two Major functions of a Managerial Economist 1. cost. 6) Capital Management :-It is another crucial area of business.price . etc. 7) Linear Programming and Theory of Games :-The term linear means that the relationships handled are the same as those represented but straight lines and programming implies systematic planning or decision-making. sometimes in collaboration and consultations with others. cost of capital. Sometimes the manager takes the decision himself. The number of sellers and buyers. Impact of Liberalization. emergence of profit. planning and control of capital expenditure etc. .profit it is able to earn in a competitive market. The firm sets certain long term goals and objectives and selects the strategy to achieve the same. Importance of the Study of Managerial Economics : 1) It gives guidance for identification of key variables in decision-making process. It is a management function. methods of capital mobilization. capital budgeting. functions of profit and its measurement. globalization. revenue . Its a routine affair in any business unit. one has to study capital requirement. It offers actual numerical solution to the problems of making optimum choices. optimal allocation of capital.Decision –making :-it is essentially a process of selecting the best out of many alternative opportunities or courses of action that are open to a management. the nature. etc. 10) Others Areas :-Macro economic management of the country relating to economic system. 5) It helps in the optimum use of scarce resources of a firm to maximize its profits. 3) It helps a firm in forecasting the most important economic variables like demand and supply. Success of any business depends on adequate capital investment and its proper management. 8) Market Structure and Conditions :-The knowledge of market structure and conditions existing in various kinds of markets are of great importance in any business. determines the nature of policies to be adopted by a firm in the market. It involves either maximization of profits or minimization of costs.sales and profit etc. 9) Strategic Planning :-It provides a framework on which long term decisions can be mad which have an impact on the behavior of the firm. return on capital. Under capital management. extent and degree of competition etc.

It is associated with decision the future course of action of a firm.2. . It is prepared on the basis of past and current experience of a firm.Forward Planning – It implies planning in advance for the future.

. The term inputs refers to all those things or terms which are required by the firm to produce a particular product. 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. Hence. after a point. beyond a particular point. shipping and insurance etc. fuel. Four factors of production are land. Explain the relationship between TP. In production Input also include other terms like raw materials of all kinds. water. capital. All factor inputs are not available in plenty. Benham. labor. banking. power.Q2. marketing. and organization. Describe the production function with one variable input. Production Function – The concept of Production can be represented in the following manner INPUTS TRANSFORMATION PROCESS OUTPUTS ENTRY INTO FIRMS EXIT OF FIRMS The term production means transformation of physical inputs into physical outputs. average and total output eventually decline. This law is stated by various economists in the following manner-According to Prof. 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. ”As the proportion of one factor in a combination of factors is increased. MP and AP curves and the three stages of production. It gives us one of the key insights to the working out of the most ideal combination of factor inputs. The law of variable proportions is the new name for the famous “Law of Diminishing Returns” of classical economists. Assumptions of the law Only one variable factor unit is to be varied while all other factors should be kept constant. The law of variable proportions This law is one of the most fundamental laws of production. the marginal. warehousing. 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. first the marginal and then the average product of that factor will diminish. in order to expand the output.

MP increases in the beginning reaches the highest point and diminishes at the end. 2. Techniques of production remain constant. 3. Marginal Product or Output (MP) : It is the output derived from the employment of an additional unit of variable factor unit. AP & MP. Total output goes on increasing as long as MP is positive. AP will also have the same tendencies as the MP. both fixed and variable employed by the producer. The law will hold good only for a short and a given period. Variable factor = labor Units of Variable TP in units AP in units MP in units inputs (Labor) 0 0 0 0 1 10 10 10 2 24 12 14 3 39 13 15 4 52 13 13 5 60 12 8 6 66 11 6 7 70 10 4 8 72 9 2 9 72 8 0 10 70 7 -2 Total Product or Output (TP) : It is the output derived from all factors units. It is the highest when MP is zero and TP declines when MP becomes negative. It is also a sum of marginal output. Fixed factors = 1 Acre of land + Rs 5000-00 capital. There are possibilities for varying the proportion of factor inputs. In the beginning MP will be higher than AP but at the end AP will be higher than MP.• • • • Different units of a variable factor are homogenous. 1. Average Product or Output (AP) : It can be obtained by dividing total output by the number of variable factors employed. Trends in Output From the table. 114) . Illustration A hypothetical production schedule is worked out to explain the operation of the law. Diagrammatic Representation (Pg no. one can observe the following tendencies in the TP.

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

2. the producer can postpone the occurrence of diminishing returns. the producer will select the II stage (which is described as the most economic region) where he can maximize the output. Hence. the III stage is a theoretical possibility because no producer would like to come to this stage. The law gives guidance that by making continuous improvements in science and technology. The producer being rational will not select either the stage 1 (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). output declines. Practical Application of the law 1. in practice we normally refer this law as the Law of Diminishing Returns. Hence. The negative returns are the result of excessive quantity of variable factors to a constant quantity of fixed factors. Since the second stage is the most important.The III stage The stage of Negative Returns: In this case. During this stage. The II stage represents the range of production decision. Generally. . AP continues to diminish and MP becomes negative. It is useful to a businessman in the short run production planning at the microlevel. It is clear that in the above example. TP starts diminishing. output becomes negative. The stage 1 & III are described as Non-Economic Region or Uneconomic Region. the most ideal or optimum combination of factor units = 1 Acre of land + Rs 5000-00 capital and 9 laborers. 3. as the quantity of variable input is increased to a given quantity of fixed factors. The proverb “Too many cooks spoil the broth” and “Too much is too bad” aptly applies to this stage. All the 3 stages together constitute the law of variable proportions. It helps the producer to work out the most ideal combination of factor inputs or the least cost combination of factor inputs.

axis. the price line which is equal to AR and MR. “the perfect competition is characterized by the presence of many firms: They all sell identically the same product. . changes in supply made by a particular firm will not affect the total output and price. will be horizontal and parallel to OX.The industry is the Price-maker or giver and a firm is a price-taker or acceptor and quantity adjuster. s a part of the industry. all engaged in buying and selling a homogeneous product without any artificial restriction and possessing perfect knowledge of market at a time. 2. irrespective of changes in demand. no one particular buyer can influence the price of the commodity because the quantity purchased by him is a very small fraction of total quantity. it has to simply charge the price which is determined by the industry. Equilibrium or Market Price = AR = MR Difference between Firm and Industry A firm is a single manufacturing unit producing and selling either a commodity or service. a firm will not have any independence to fix the price of its own product . The seller is the price taker”. no firm can raise its price above the general level. Output of a seller (firm) will be so small that it is a negligible fraction of the output of the industry.A firm under a perfect competition is a price-taker and not a price –maker Under perfect competition. absence of friction. Knight perfect competition entails “Rational conduct on the part of buyers and sellers. In case of the firm. This is because same price has to be charged by the firm for all the units supplied. perfect mobility and perfect divisibility of factors of production and completely static conditions”. full knowledge. Homogenous products Different firms constituting the industry produce homogenous goods. MEANING AND DEFINITION OF PERFECT COMPETITION A perfectly competitive market is one in which the number of buyers and sellers are very large. They are identical in character. Similarly. According to Bilas. hence . Existence of very large number of buyers and sellers A perfectly competitive market will have large number of sellers and buyer. FEATURES OF THE PERFECT COMPETITION 1.. Hence. Hence. Profit making is the basic objective of a firm was profit maximization and now profit optimization has become the main objective.Explain the following statement with suitable examples: “A firm under a perfect competition is a price-taker and not a price-maker”. Ans.Q3. According to Prof. F.

Existence of single price Each unit bought and sold. Normal Profit As the market price is equal to cost of production. Full and unrestricted competition Perfectly competitive market is free from all sorts of monopoly. oligopoly conditions. an illusion and purely theoretical in nature. each firm acts independently. It is a part of total cost of production because it is the price paid for the services of the entrepreneur. industry or the Government. 8. price is not affected by the sellers. 6. 7. Thus. The market price is flexible over a period of time Market price changes only because of changes in either demand or supply force or both. it is difficult for them to join together and form cartels or some other forms of organizations. i. It should not place any barriers in the way of smooth exchange. Hence. Sellers cannot influence buyers and buyers cannot influence sellers. 4. they are also free to come out of the occupation or industry if they feel that they are under remunerated. in the market commands the same price since products are homogeneous. If the industry is making profits.3. Absence of artificial Government controls The Government should not interfere in matters pertaining to supply and price.e. the firm can earn only normal profits under perfect competition. ii. Similarly. Free entry and exit of firms There is absolute freedom to firms to get in or get out of the industry.. It is an extreme form of market situation rarely to be found in the real world. This results in the realization of normal profits by all the firms in the long run. firms will quit the industry if there are losses. 5. new firms are attracted into the industry. firm. Market price charged by the sellers should not vary because of differences in the cost of transportation. It is the minimum reasonable level of profit which the entrepreneur must get in the long run. Perfect knowledge of the market All sellers and buyers will have perfect knowledge of the market. Absence of transport cost All firms will have equal access to the market. Since there are very large number of buyers and sellers. . Perfect mobility of factors of Production Factors of production are free to move into any use or occupation in order to earn higher rewards. a myth. It is a mere concept. buyers. profit is an item of expenditure to a firm. 10. SPECIAL FEATURES OF PERFECT COMPETITION i. 11. Normal profits are those which are just sufficient to induce the firms to stay in business. Conversely. 9. Price of a commodity must be determined only by the interaction of supply and demand forces.

It is a hypothetical model. eBay auctions can be often be seen as perfectly competitive. This. There are very low barriers to entry (anyone can sell a product. a stock exchange resembles this. Free software may be bought or sold at whatever price that the market may allow. Anyone is free to enter and leave the market at no cost. Free software works along lines that approximate perfect competition. provided they have some knowledge of computers and the Internet). many sellers of common products and many potential buyers. Agricultural policies in many countries undermine the requirements for complete Pareto efficiency to apply. By design. All code is freely accessible and modifiable. violates the condition that "no one seller can influence market price". generic advertising (advertising which benefits the industry as a whole and does not mention any brand names) may occur. In the eBay market competitive advertising does not occur. iv. investment banks) may solely influence the market price. Examples Some agricultural markets. with numerous suppliers and almost perfectly substitutable products have been suggested as approximations for the perfect-competition model. not as a complete description (for no markets may satisfy all requirements of the model) but as an approximation. because the products are homogeneous and this would be redundant.iii. of course. The flaw in considering the stock exchange as an example of Perfect Competition is the fact that large institutional investors (e. . It is an ideal market situation.g. However. The extent of its applicability may be dependent on the market in question. Perhaps the closest thing to a perfectly competitive market would be a large auction of identical goods with all potential buyers and sellers present. and individuals are free to behave independently.

profit maximization has remained as one of the single most important objectives of the firm even today. Profit Maximization Model Profit making is one of the most traditional. In spite of several changes and development of several alternatives objectives. 4. Each business unit defines its own objectives which may have to satisfy the needs of those groups whose cooperation makes the continued existence of the business possible the share holders. 3 –A firm operates under a given market condition. Profit motive is the driving-force behind all business activities of a company. cost cutting and cost minimization has become the slogan of a modern firm. performance and status of a firm in the market. 5.A firm makes an attempt to change its prices. management employees. socio-economic conditions and constraints under which a firm operates. They are fundamental to the very existence of a firm.A firm will select that alternative course of action which helps to maximize consistent profits. The objectives are determined by various factors and forces like corporate environment. suppliers and consumers etc. input and output quantity to maximize its profit. basic and major objectives of a firm. Main propositions of this model are as follows :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. 2-The basic objective of each firm is to earn maximum profit. It is the primary measure of success or failure of a firm in the market. . Profit earning capacity indicates the position. Cost reduction. What are the theories underlying the “objective of a firm”? Critically examine the “profit maximization” theory in the light social responsibilities of business firms. Ans :. They are the end –point towards rational activity. specific efforts have been made to maximize output and minimize production and other operating costs. It is an acid test of economic ability and performance of an individual firm.Theory of Objective of a firm :-Each firm lays down its own objectives. Both small and large firms consistently makes an attempt to maximize their profit by adopting novel techniques in business.Q4.

e. 3. The combined action of both multiplier and accelerator will clearly explain how the aggregate national income increases as a result of increase in the volume of investment in an economy. Accelerator B. more capital goods are required. It is always wrong on our part to expect constant ratio between production of consumer goods and capital goods. a) Accelerator :-Multiplier and accelerator are the two parallel concepts. The Multiplier concept is inadequate to explain the process of income generation in a complete manner. Limitations of Accelerator 1. If there is excess capacity in that case. Multiplier Ans. Accelerator is called :Magnification of derived demand because investment depends on employment. Accelerator shows the effect of changes in consumption on induced investment and tells us how the volume of investment depends on the level of consumption. additional production of consumer goods does not require additional capital goods. purchasing power and the demand for consumption goods increases. investments made in capital goods industries do not await changes or increase in consumption. In order to produce more consumption goods. 2. investment in public sector industries. 3. Write a detailed notes on the following: A. It explains why fluctuations in income and employment occur rather violently. It tells us why capital goods industries fluctuate much more than consumption goods industries. There should be no excess capacity in capital goods industries. When income of the people increases.Q5. 2. In many cases. . Importance 1 It explains the process of income generation more clearly as it takes into account of the effect of consumption on investment.g.

the size of the K also declines.This relationship can be expressed as : K = Cange in income Change in investment K = 25 5 K=5 OR K = 1 1-MPC Assumptions and limitations of the Multipler 1 –Availability of Consumer goods: . there should not be any change in the value of MPC.No change in the Size of MPC –In the process of income generation.Multiplier works satisfactorily if the volume of goods and services on which the additional income may be spent are available in plenty. 4.b) Multiplier :-It may be defined as a ratio of change in income to a change in Investment. . 6-No time gap between successive expenditure on consumption –If there is a gap between receipt of income and expenditure in the short run.the actual multiplier may be greatly restricted and will be different from the Ideal. there should be a net increase in investment. 5 Lakhs causes an increase in income of Rs 30 Lakhs. multiplier. 2 –Maintenance of Investment :-In order to realize the full value of K. 30 Lakhs. If the increase in income is Rs. it is necessary that the various increments in investment be repeated at regular intervals. viz. Increase in investment in one sector of the economy should not be neutralized by decrease in investment in another sector of economy. It gives little insight into the actual process by which the economy achieves a new equilibrium. then the multiplier would be 5. It expresses the relationship between as initial increment in investment and the final increment in income. then the multiplier would be 6. Consequently .In the multiplier theory we analyze only the impact of investment on consumption.It is based on number of assumptions :-These assumptions may not be found in practice. but the reverse. If the accelerator is allowed to operate and effects of Induced consumption on investment are also taken into account. If there is any change in the size of MPC. accelerator is totally ignored. the full value of the K cannot be realized because as MPC falls . It shows by now many times the effect of an initial change in investment is multiplied by causing changes in consumption and finally in the aggregate income.Net Increase in Investment –In order to get the full value of K. 7. 5-No investment from induced consumption. 8-Keynes multiplier is a static concept –It shows the process of income propagation from one point of equilibrium to another and that too under static condition. If an increase in investment of RS. 3. then the value of K also changes.

5) To act as an economic stabilizer:-Price stabilizer would create the necessary background for over all economic stability. What is “Fiscal Policy”? Why some economists consider fiscal policy to be more reliable than the monetary policy? Why is fiscal policy so important in a country like India? Ans :-Fiscal policy is a package of economic measures of the government regarding its public expenditure. careful planning is needed in its allocation so as to achieve the set targets. it would undermine and disturb the growth process. 2) To act as a saver: a) It should follow a rational consumption policy which reduces the MPC and raises the MPS. introduce new and additional taxes and extend the tax-net. c) Higher rates of interests are to be offered for government bonds and securities. Gardner Ackley points out. Role in the economic development. non-essential and speculative activities in the private sector and help in diverting these scarce resources in to highly productive areas 4 ) To act as Price Stabilizer :-Price stabilizer is of paramount importance in an economy. It concerns itself with the aggregate effects of government expenditure and taxation on income. public debt or public borrowings. If an economy is subject to frequent fluctuations in the form of trade cycles. public revenue. b) Taxation policy has to be modified to raise the rates of old taxes. certainly.Q6. d) Introduction and popularization of small savings schemes. production and employment. . Extreme levels of both inflation and deflation would disturb the normal and regular working of an economic system. It should discourage the flow of investments in to unproductive. It should result in the creation of real resources which are more important in accelerating the growth process. “Fiscal policy involves alterations in government expenditure for goods and services or the level of Tax rates”. 1 ) To act as optimum allocates of resources: As most of the resources are source in their supply. e) Introduction of various kinds of insurance scheme. 3) To act as Investor:-Mere mobilization of financial resources is not an end in itself.

8) To act as growth promoter:-The basic objective of any economic policy is to ensure higher economic growth rates.6) To act as an employment generator :-Fiscal policy should help in mobilizing more financial resources. production. economic over head capital and social overhead capital etc. income and employment leading to higher purchasing power in the hands of common men. convert them in to investment and create more employment opportunities to absorb the huge unemployed man power. income. demand and supply. Fiscal policy has to play a major role in promoting economic growth in a country. Thus. 10) To act as stimulator of living standards of people:-The final objective is to raise the level of living standards of the people. 7) To act as balancer :. .There must be proper balance between aggregate savings and aggregate investments. 9) To act as an income redistributors:-Fiscal policy has to minimize economic inequalities and ensure distributive justice in an economy. employment and income. This is possible when a rational taxation and public Expenditure policy is adopted. investment. This is possible when there is higher output. output and expenditure. This is possible when there is higher national savings.

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