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Managerial Economics

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What is Managerial Economics.? Explain the nature and scope of Managerial Economics.? Answer: Managerial Economics generally refers to the integration of economic theory with business practice. While economics provides the tool which explain various concepts such as demand, supply, price, competition etc. Managerial economics applies these tools to the management of business, in this sense managerial economics is also understood to refer to business economics or applied economics. Managerial economics lies on the border line of management and economics. It is a hybrid of two disciplines and it is primarily an applied branch of knowledge. Management deals with principles which help in decision making under uncertainty and improve effectiveness of organisation. Economics on the other hand provides a set of propositions for optimum allocation of scare resources to achieve the desired objectives. Nature of Managerial Economics: It is true that managerial economics aims at providing help in decision making by firms. For this purpose it draws heavily on the prepositions of micro economic theory. Note that micro economics studies the phenomenon at the individuals level and behavior of consumers, firms. The concepts of micro economics used frequently in managerial economics are elasticity, marginal cost, managerial revenue, market structure and their significance in primary policies. Some of these concepts however provide only the logical base and have to be modified in practice. Micro economics assists firms in forecasting. Note that micro economics theory studies the economy at the aggregative level and ignores the distinguishing features of individual observations. For example micro economics indicates the relationship between the  Magnitude of Investment and Level of National Income  Level of National Income and Level of Employment
Managerial Economics

Honoursinfo.blogspot.com  Level of Consumption and National Income etc. Therefore the postulates of microeconomics can be used to identify the level of demand at some future point in time, based on the relationship between the level of national income and demand for electric motors. Also the demand for durable goods such as refrigerators, air-conditioners, motor cars depends upon the level of national income. Managerial economics is decidedly applied branch of knowledge. Therefore the emphasis is laid on those prepositions which are likely to be useful to the management. The precision of a scientist is not motivating factor in research activity. Improvement in the quality of results is attempted, provided the additional cost is not very high and the decision maker can wait. For example it may be possible to have more accurate data on demand for the firm’s product by taking into consideration, additional factors. But this may not be the attempted because the decision has to be made without delay. Besides more accurate forecasts may not be justified on cost considerations. Management economics is perspective in nature and character. It recommends that it should be done alternate conditions. For example if the price of the synthetic yarn falls by 50% it may be desirable to increase its use in producing different types of textiles. Thus managerial economics is one of the normative sciences and reflects upon the desirability or otherwise of the prepositions. For example if the analysis suggests that the benefit-cost ratio is used as the criterion for project appraisal it is recommended that the firm should not install a large plant. Contract this with the positive sciences which state the prepositions without connecting upon what should be done. For example if the distribution of income has become more uneven it is stated without indicating what should be done to correct this phenomenon. Managerial economics to the extent that it is uses economic thought is a science, but it is an applied science. Economic thought uses deductive logic (if X is true, then Y is true). For example if the triangles ate congruent then angles are equal. To have confidence in the findings, the prepositions deducted are subject empirical verification. For example empirical studies try to verify whether cost curves faced by a firm are really U shaped as suggested by the theory. Furthermore there is an attempt to generalize the prepositions which provide a predictive character. For example empirical studies may suggest that every 1% rise in expenditure on advertising, the demand for the product shall increase by 5%. Managerial economics uses scientific approach. In practice, some firms may use simple rules based on past experience. However the quality of decisions made can be improved using a systematic approach. Scope of Managerial Economics: 3

Managerial Economics

Honoursinfo. 4 However. profit policies and techniques and profit planning are the important aspects covered in this area.blogspot. Profit planning. Managerial economics draws descriptive economics and tries to pass judgments to value in the context of time. Demand analysis aims at discovering the forces that determine sales. Nature and management of profit. Capital management implies planning and control of capital expenditure. Positive economics is descriptive in nature where as normative economics is prescriptive in nature. Policies and Practices: Pricing is an important area of managerial economics. demand distinctions and demand forecasting. Whether managerial economics is normative or positive economics: Economics is divided in to positive economics and normative economics. Profit Management: Business firms are mainly profit hunting institutions. Cost and Production Analysis: Cost estimates are also essential for effective decision making and production planning at the firm level. Demand Analysis and Forecasting: Effective decision making at the firm level depends on accurate estimates of demand. The demand analysis mainly relates to the study of demand. pricing methods policies. The success of the firm is always measured in terms of profits. Success of a business firm largely depends on the accuracy of price decisions.com Scope means province or an area of study. cost control and sound pricing practices call for accurate cost and production analysis. Price determinations under different markets. Managerial economics is considered to be the part of normative economics. product line pricing and price forecasting are some of the topics of this area. the scope of managerial economics may be discussed under following points. Cost of capital rate of return and selection of projects are the important points under this. troublesome problem faced by the business manager is the capital management. managerial economics has started using such techniques of operations research as linear programming Managerial Economics . Capital Management: The most complex. determinants. Area of Study: Broadly speaking managerial economics deals with the following topics. Cost relations are production function and cost control. It lays more emphasis on prescribing choice and action and less on explaining what happened. There is hardly any uniform pattern as regards the scope of managerial economics as it is comparatively a new subject. Positive economics is that branch of economics which studies the things as they are. Normative economics deals with the things they ought to be or should be. Linear Programming and Theory of Games: Since managerial economics and operations research are closely connected with each other. Pricing Decisions.

Recently the linear programming and the theory of games have been brought as part of managerial economics.Honoursinfo. a new concept was found out called “Sub-Optimisation”. Optimisation: Optimisation is another important concept used in economic theory and managerial economics. Without profits business firms can not run. while rise in price causes the household to buy less of this commodity & more of the competing commodities” The law of demand indicates only the direction of change of demand corresponding the change in the price. Profit is the main indicator of firm’s success.Law Y P P R I C E M P1 M1 Managerial Economics .It explains the general tendency of the consumers to buy more of a good at a lower price and less of it at a higher price lower price attracts consumers to buy more goods .thus law of demand expresses an inverse relationship b/w the price and the quantity demanded of a commodity other things being equal. This can be illustrated through a demand curve.DD is the demand curve of the good under consideration. 5 of demand is one of the important laws of economic theory . Profits – a central point in managerial economics: Profit in other words is the central concept of managerial economics.blogspot. In recent years. Managerial economics often aims at optimising a given objective.According to Lipsey “A fall in the price of a commodity cause a household to buy more of that commodity and less of the other commodity which compete with it. The greatest merit of this concept is its flexibility. The maximization of profits is the main objective of any firm or a business unit.At price OP1the quantiy demanded is OQ1 if price of the good falls into OP2 the quantity demanded rises to OQ2 the demand curve is sloping downwards which is in accordance to the law of demand all the determinants of demand are assumed to be constant . The survival of the firm is determined by the ability of a firm to earn profits. Price is measured in theY axis&quantity in the X axis.com and the theory of games.

other things remaining the same. These factors explain the operations of the Law of Demand. The commodity having several uses is set to have composite demand. Thus a fall in the price of this commodity increases its demand. (d) Changes in the number of consumers: Many people cannot afford to buy a commodity at a high price. The important of these factors depends upon the circumstances of the case. When the price of a commodity falls it becomes relatively cheaper than other commodity whose prices have not fallen. He will spend a part of this money on buying some more units of the same commodity whose price has fallen. the number of persons who could not afforded at a higher price can purchase it at a reduced price. (e) Diverse Uses of the commodity: Many commodities can be put to several uses. That is why the demand curve slopes downward. in otherwords the consumer has to spend less to buy the same quantity of the commodity as before. (c) Substitution effect: This also increases demand as a result of a fall in the price of the commodity and viceversa. Some of the important exceptions are : Managerial Economics . The factors responsible for the downward slope of demand curve are : (a) Law of diminishing marginal utility: The law of diminishing marginal utility states that as the consumption of a commodity by a consumer increases the satisfaction obtained by the consumer from each additional unit of the commodity goes on diminishing. The money so saved because of a fall in the price of the commodity can be spent by the consumer in ways he likes.Honoursinfo. Exceptions to the Law of Demand: Under certain circumstances the inverse relationship between price and demand does not hold good. All the above factors are responsible for the downward slope of demand curve.blogspot. This is called income effect. This increases the consumer of the commodity. When price of a commodity falls. So the consumer substitute this commodity for other commodities which are now relatively dearer. The demand of a commodity is more at a lower price and less at a higher price. Thus at a lower price the quantity demand of the commodity increases because of increase in the number of consumers of the commodity and vice versa. (b) Income effect: A fall in the price of the commodity increase the purchasing power of the consumer. These are know as the exceptions to the law of demand.com O Q Q1 Quantity X 6 Law of demand states the inverse relationship between price of a commodity and quantity demanded. This is know as substitution or complementarily effect.

The law of demand does not apply. The bajra will be considered as gifen goods to which law demand does not apply. A poor household who spends a major portion of his money on an inferior goods like coarse grain.g. say bajra. Eventhough their price rises continuously their demand does show any tendency to fall. purchased by rich persons of the society because the prices of those goods are so high that they are beyond the reach of the common man. flood etc. (b)Conspicuous necessities: Another exception occur in case of such commodities as though their constant use is because of fashion or prestige value attached to them have become necessity of life. A rise in the price of giffen 7 goods leads to a rise in their demand and viceversa. (f)Change in fashion: A change fashion entails effect demand for a commodity. The household will be forced to cut down the consumption of other commodities still further to compensate itself for the loss of consumption of bajra. famine. on the other hand. Managerial Economics . This happens when the consumer thinks that a high price commodity is better in quality than low price commodity. E. At such time the household may behave in a abnormal way. E. Likewise when prices are expected to fall further a reduced price may not be sufficient incentive to induce the household to buy more. Conversely. share market. (e)Emergencies: Emergencies like war. ©Conspicuous consumption: A few goods like diamond etc. During depression. (d)Future changes in price: Household also act as speculators when the price are rising. may negate the operations of lay of demand. Household accentuate scarcity and induce further price rises by making increase purchases even at higher prices during such period. he will be left with lesser income to spend on other commodities that he used to consume earlier. More of these commodities is demanded when their prices go up very high.com (a)Giffen Goods: These are special type of inferior goods.blogspot.Honoursinfo. (g)Ignorance: Consumer’s ignorance is another factor that at times induces him to buy more of commodity at a higher price. If the price of bajra goes up the household will be forced to maintain the earlier consumption level of consumption of this good.g. a fall in price of bajra will enable the household to release more money for other commodities and may substitute consumption of bajra by consumption of other superior commodities. the house hold tend to buy larger quantity of the commodity out of apprehension that the prices may go up further. no amount of falling price is sufficient inducement for consumer to demand more.

However small firms cannot afford these sophisticated techniques . supplies &classroom requirements . (micro forecasts) a frequent practice is to translate forecasts of overall levels into industry forecasts by trade associations &to use this in turn to generate co. School administrators use Enrolment forecasts to determine faculty sizes. Demand forecasts may be passive or active the former predict the future demand by extrapolating the demands of the previous years in the absence of any action by the firm Here the things are assumed to continue the way they have been in the past these forecasts are used only to assess the impact of new policies on the market while the latter estimate the future scenario inclusive of own future actions &strategies of the firm itself These forecasts are more meaningful as they take into account the likely changes in the relevant variable in estimating future demand here the firm manipulates the demand by changing price. Its essence is estimating future events acc to the past patterns and applying judgement to those projections .Honoursinfo.Demand forecasting is a crucial activity for planning survival &growth of a corporate unit.It is an essential tool in developing new products scheduling production determining necessary inventory levels&creating a distribution system .blogspot.Thus no forecasting method is suitable for all situations. Methods of demand forecasting : The imp. urgency data availability .social &business engage in some type of demand forecasting the goal of course is better mgt ability to plan &control operations churches try to predict future revenues from member’s contributions to develop reasonable budgets. forecasts.product quality etc. Of selecting the right type of forecasting method cannot be overstated however the choice is complicated bcoz each situation might require a different method mgt.Selection of a forecasts has to be appropriate to the situation that is objective. Demand forecasting is an attempt to foresee the future by examining the past .Business firms can estimate and minimize the future risk & uncertainty through 8 forecasting &forward planning . on the product mix major decisions in large business houses are generally based on forecasts on some type in some cases the forecasts may be little more than an intuitive assessment or value judgement of the future by those involved in the decision . The firm can afford acurracy level required.com Q3. should be aware of the factors favoring one method over another in a given demand forecasting situation in some cases mgr’s are interested in the total demand for a product service in other circumstances the projection may focus on the firm’s probable mkt share forecasts can also provide inft.nature of the product etc.Demand forecasts methods vary acc to whether they apply to a large aggregate such as the whole economy(macro forecasts)or to a component of this aggregate such as an industry or a co. Managerial Economics .Virtually all types of national & intl organisations – Govt .

firms or industries) opinion of experts or of mkt .While in sample survey a selected subset of them are surveyed and through their study. are drawn .M Collective opinion method Market experiment method Time series Analysis Regression analysis Graphical Semi-average Moving average Least square Survey methods : Under this approach are conducted about the intentions of the consumers (individuals.Under census survey. If the product happens to be a consumer good Managerial Economics . inferences abt the whole popln. a firm can ask consumers what & How much they are planing to buy it at various prices of the product for the forthcoming time period.These methods are usually suitable for short-term forecast due to volatile nature of consumers intentions. Consumer Survey Method: Surveys of managerial plans can be one of the impt. all consumers\ experts mkts are surveyed.New products demand forecasting also makes use of survey approach.Honoursinfo.The rationale for conducting such surveys is that plans generally form the basis for future actions by using this method. usually a year.as data availability problem is overcome through surveys of consumers. Methods of forecasting .com 9 Forecasting Methods Survey Methods Statistical Methods Consumer S.blogspot.

etc are identified. whose demand is to be 10 forecasted.mgr sales. being the closest to the customers. as it takes advantage of the collective wisdom of the salesmen. This method is useful in forecasting population. consumption.e.departmental heads like prod. Graphical Methods: This method gives the basic tendency of a series to grow. Semi Average Method: According to this method the date is divided into two parts preferably with the same number of years.where the future is not too much different from average of the past.e customer reaction to the product of the firm &their sales trends the estimates of individual salesman are averaged or consolidated to find out the total estimated sales the final sales forecast would emerge after these factors are being taken into account. in accordance with its time of occurrence. These are used for long term forecasting and for products for larger levels of aggregation. They are based on scientific base of estimation which are logical. production. economic and commerce be it a series related to price.Honoursinfo.mgr etc&the top executives.com the consumers are firms or industries using that product the survey may involve a complete enumeration of all consumers of the given product. demand etc. are likely to have the most intimate feel of the market i. advt. packaging. salesman or experts are required to estimate expected future demand of the product in their respective territories &sections the rationale of this method is that salesman. decline or remain steady over a period of time. Theperiod time in the trend analysis is always long. unbiased and proven to be useful.force polling). Most of the variables in business. projects. Time series analysis: It is an arrangement of statistical data in a chronological order. Market Experiments Method: Under this method. but the concept of trend does not include short time oscillations and fluctuations. at all time series data spread over long period of time.This method is known as the collective opinion method. i.sales. the main determinants of the demand of a product like prices. The averages of the first and second part Managerial Economics . The data a may also be analyzed through econometric models.blogspot. Statistical methods: These methods make use of historical data as a basis for extrapolating quantitative relationships to arrive at the future demand pattern and trends. It reflects the dynamic pace of steady movement of a phenomenon over a period of time. The effect of the experiment on consumer behaviour is studied under actual or controlled mkt conditions which is used for overall forecasting purpose. These factors are then varied separately over different markets or time periods holding other factors constant. Collective Opinion Method: Under this method(also called sales. product design. etc.

The averaging process smoothens out fluctuation as well as the ups and down in the given data. Thus. The forecaster must identify the phase of product cycle at which the industry is operating at the time of prediction.com are calculated separately. The selected area must have an average competition. optimum size of population. This approach is useful when the new product is nearly an improvement of an existing product. Survey of Consumer Intention: This method involves interviewing the consumer by sending questionnaires to elicit replies so as to make short term prediction of demand. Samples may be given for this purpose. Th number of area selected depends on the representatives and cost of marketing. Product Life Cycle Analysis:Many products ar distinct when it degenerates over the years into a common product. the competitive situation and cost of testing. Regression Analysis:This is also a popular method of forecasting among the economists. Here the burden of forecasting is shifted to consumer. presence of chain of departmental stores. It is a mathematical analysis of the average relation between two or more variables in terms of original units of the data. in such situation. Here the data analysis should be based on logic of economic theory. Least square method:The principle of least squares provides us an analytical tool to obtain an objective fit to the trend of the given time series.blogspot. Managerial Economics . The duration of testing depends upon the average purchase period. Evolutionary Approach: The demand for a new product may be projected as an outgrowth and evolution of an existing old product. Moving Averages Method: This is a very simple and flexible method of measuring trend which consists of obtaining a series of moving averages of successes overlapping groups of the time series. This method is most useful when bulk of the sales is made to industrial producers. These averages are called semi averages which are plotted as 11 points against middle point of the respective time period covered by each part.Honoursinfo. etc. trend fittings will be most reliable way of forecasting. Most of the data relating to economic and business time series conform to definite laws of growth or decay. Test Markting:Under test marketing the product is introduced in selected area often at different prices. Demand Forecasting of New Products:Projecting demand of new products is different from those of established products. This requires an intensive study of the economic and competitive characteristics of the product. Innovation of a new product and its degeneration into a common product is termed as Life Cycle of a Product.

habits and preferences. Obviously with the increase in income one can buy more goods.Honoursinfo. Relative prices of Other Goods: How much the consumer would like to buy of a given commodity. A strict vegetarian will have no demand for meat at any price. Similar is the case with demand for cigarettes by smokers and non-smokers. People with different tastes and habits have different preferences for different goods. tea and coffee etc.blogspot. An individual’s demand for a commodity is generally determined by factors such as: Price of the Product: Price is always a basic consideration in determining the demand for a commodity. cool drinks etc. peas and beans. ground nuts oil and sun-flower oil.? Answer: Demand for a commodity depends upon number of factors.. When a want can be satisfied by alternate similar goods. are substitutes of each other. depend on an individual’s taste. Managerial Economics . chocolates.. Factors influencing individual demand. whereas a non-vegetarian who has liking for chicken may demand it even at a high price. tobacco etc. If the substitutes are relatively costly. Tastes and Habits: Demand for many goods depend on the person’s tastes. The demand for commodity depends on the relative process f its substitutes. Demand for several products like ice-creams. however also depends on the relative prices of other related goods such as substitutes or complementary goods to a commodity.com Growth Curve Approach: Roll of growth and demand for new product may be estimated on the basis of pattern of growth of some existing substitute established 12 product. Normally a larger quantity is demanded at a lower price than at a higher price. they are called substitutes. betel. For example. Thus a rich consumer usually demands more goods than poor consumer. then there will be more demand for the commodity is question at a given price than in case its substitutes are relatively cheaper. What are the determinant of Demand. Demand for tea. Income: Income is an equally important determinant of demand. is a matter of habit...

It is based on the experience. tea and sugar. Techniques or methods of Demand Forecasting: Method of Demand Forecasting is based on whether the good is Established Good or new good. Forecast can be done for several things. pen and ink. Thus demand for many products like tooth pastes. these goods are referred as complementary goods.? Briefly review the methods of Demand Forecasting? Answer: Demand Forecasting is the method of predicting the future demand for the firm’s product. Thus if a given commodity is a complementary product. Complementary goods are always in joint demand. Methods of Demand Forecasting for established goods: Information of the established good is available so the forecast can be based on this information. Similarly if they expects its prices to rise in future they will tend to buy more at present. toilet soaps. When the price of one commodity decreases the demand for its complementary product will tend to increase and vice versa. albeit to certain extent only. Consumers Expectations: Consumers expectations about the future changes in the price of a given commodity also may affect its demand. When consumer expects its prices to fall in future. Two basic methods of demand forecasting for the established goods are: Interview and Survey Approach (for short period forecast): Interview and Survey Approach collects information in the different way. are complementary products to each other. shoes and sacks.com Substitutes and Complementary Products: The demand for a commodity is also affected by its complementary products. two or more goods are 13 needed in combination. is particularly caused by the advertisement effect. than otherwise. It is guess or anticipation or prediction of what is likely to happen in the future.Honoursinfo. For example. . gun and bullets etc. its demand will be relatively high when its related commodity’s price is lower. Depending upon how the information is collected. Advertisement Effect: In modern times the preferences of a consumer can be altered by advertisement and sales propaganda. In order to satisfy a given want. processed foods etc. they will tend to buy less at the present prevailing price. we have different sub methods as follows: Opinion-Polling Method: This method tries to collect information from the customer directly or indirectly through market research department of the Managerial Economics . washing powder.blogspot.. Similarly a steep rise in the price of petrol will cause a decrease in demand of petrol driven cars and its accessories. What is Demand Forecasting. a fall in price of cars will lead to increase in the demand for petrol. For example car and petrol.

Limitations:  Information collected may not be accurate. Sample Survey Method: The total number of consumers for the firm’s product is very large called as population.com firm or through the whole sellers or the retailers.blogspot. Only few of them are contacted and this forms the sample. Limitations:  It is difficult and costly to contact all the customers  It is suitable only for short period  Consumers are not sure of their purchase plans Collective Opinion Method: Large firms have organized sales department.Honoursinfo. This information is further used for forecasting the demand. Panel of experts: Panel of experts consists of persons either from within the firm or from outside the firm.  Consumers do not have the correct idea of their purchases in future. The salesman has the technical training as how to collect the information from the buyers. Limitations:  It is difficult and costly to contact all the customers  It is suitable only for short period  This is based on judgment & has no scientific basis. Composite management opinion: The opinions of the experienced person within the firm are collected and manger analyses this information. This method is useful when consumers are small in number. Consumers are contacted through mails or phones or Internet and information regarding their 14 expected expenditure is collected. These experts come together and forecast the demand for their product that is purely based on the judgment of these experts so they are less accurate. It is practically not possible to contact all the consumers. This Managerial Economics . The sample forecasts are then generalized for the whole population through advanced statistical methods available.  Sample is not a random sample. But if based on the scientific method the forecast would be accurate.

The relationship between these variables is correlation and the technique of establishing this relationship is regression. In simple Managerial Economics . Correlation and Regression Analysis: Past data regarding the factors affecting the demand can be collected. Example: If we collect the past data about the sales and advertising expenditure of the firm. It is possible to express this on the graph. but is not based on the scientific 15 analysis and thus may not give very accurate results. This is a scatter diagram. In this method past Projection Approach(for long period forecast): experience is projected into the future.blogspot.com method is quick. Here Advertisement Expenditure is the independent variable and Sales is the dependent variable. it is possible to express in the form of scatter diagram as shown below: Y A * * ** * * * * * * * ** Sales A X O Advertisement Expenditure In the above diagram we get the functional relationship as line AA. easy and saves time. This can be done with the help of statistical methods.Honoursinfo.

Time Series Analysis: Demand forecasts for a period of 2-3 years are based on time series analysis. this might not happen.com correlation we establish relationship between 2 variables and more than 2 16 variables in multiple correlation. It is similar to the correlation analysis.Honoursinfo. Managerial Economics .blogspot. It is based on the assumption that the relationship between the dependent and the independent variable continues to hold in the future. Limitations:  Assumption made is that correlation between two variables will continue in future also.

For example Demand for the color TV can be calculated from Demand for the black and white TV. Demand forecast for such new good is based on already established good from which they are evolved. from which it is actually evolved. Following are the methods suggested: Evolutionary Method: Some new goods evolve from already established goods.blogspot. For example VCR substituted with VCD player. Opinion Polling Method: Expected buyers and the consumers are directly contacted and opinion about the product is directly taken from them. If the population is large then sample is selected and results are generalized for the population.com Methods of Demand Forecasting for new products: Indirect methods of forecasting are used to estimate demand for new products. Limitations:  The product should have been evolved from the existing product. Limitations:  It is difficult and costly to contact all the customers  It is suitable only for short period  Consumers are not sure of their purchase plans Sample Survey Method: New product are first introduced in the sample market and the results seen in the sample market are generalized for the total market.Honoursinfo. Substitution Method: Some new goods are substituted of already established goods.  It ignores the problem of how the new product differs from the old product. Limitations:  Information collected may not be accurate  Tastes and the preferences may differ from market to market Managerial Economics 17 . Limitations:  New product may have many uses and each use has different substitutability  When the substitute is added is added into market existing firm may react by changing the prices.

com Indirect Opinion Polling Method: Opinion of the consumers is indirectly 18 collected through the dealers who are aware of the needs of the customers. Samulson) Managerial Economics . (P. An increase in some inputs relative to other fixed inputs will. Benham) 3. but after a point the extra output resulting from the same additions of extra inputs will become less and less. As equal increments of one input are added. constant. Ans.Honoursinfo. first the marginal and then the average product of that factor will diminish. Limitations:  It is based on the judgment  Limited Scope State and explain the Law of Variable Proportion. the marginal product will diminish.. cause output to increase. in a given state of technology. i. (G. the inputs of other productive services being held. Statement of the Law: 1. beyond a certain point the resulting increments of product will decrease.blogspot. As the proportion of one factor in a combination of factors is increased. after a point.e. (F. Stigler) 2.A.

P.  Total product is maximum when M.P.  In the table.  M. the marginal product goes on increasing.5 10 12. This is the phase of ‘Diminishing Returns’. Managerial Economics . M.3 12. and A.  M.Honoursinfo.blogspot.  From 7 to 11 workers. 20.P.P.com Explanation of the Law of Diminishing Returns (Variable Proportion) with 19 the help of a table: Fixed Factor K K K K K K K K K K K K K Variable Factor 1 2 3 4 5 6 7 8 9 10 11 12 13 Total Product 5 15 30 50 70 90 105 115 120 124 127 127 118 Average Product 5 7.07 Marginal Product 5 10 Increasing Returns 15 20 20 Constant Returns 20 15 10 5 4 Diminishing Returns 3 0 -9 Negative Returns Average Marginal Relationship: The above table shows that eventually the total product also starts declining. are equal. when A.P.50 9. is constant i.P.P. marginal product would be larger than the average product.4 11. when 1 to 4 workers are employed. though the T.5 and 6 are employed.P. But first to decline is the marginal product. equals A. This is the phase of Increasing Returns.P. is increasing.  When workers 4. goes on decreasing.5 10. when A.3 13.P. This is the phase when the ‘Law of constant returns’ is in operation. falls.P.P.0 15 15 14.P.. the M.P.  The A.  As long as the average product is rising. is zero.P. Also. becomes negative when T. The relationship between them is as follows.5 14. is decreasing.e. is less than A. is maximum M. remains constant when M.

P.P. Curve S A.com 20 Diagrammatic illustration of the law of diminishing returns The following figure is a diagrammatic presentation of the Law of returns roughly representing the figures in the table given before H Y F Stage II Stage I Stage III T.P. which means that M.P.P. increases at a diminishing rate i. curve.e.P. rises. Corresponding vertically to this point of inflexion. Managerial Economics .e.P. A. Stage I: In this stage T.P. curve goes on increasing to a point and after than it starts declining. Curve X In the above figure the T.P. curves also rise and then decline.P. M.P.P. the T. curve goes on rising but its slope is declining which means that from point F onwards the T. to a point increases at an increasing rate.P. up to the point F.e. The behavior of the output when the varying quantity of one factor is combined with a fixed quantity of other can be divided into three distinct stages. In the figure from the origin to the point F. Curve M M. The point F where the total product stops at an increasing rate and starts increasing at a diminishing rate is called the ‘point of inflexion’. M. is increasing i.blogspot.Honoursinfo. curve starts declining earlier than the A. T. and M.P. falls but it is positive.P. increases at an increasing rate. From the point F onwards during the Stage I. slope of the total product curve T. i.

The variable factor i. which is the highest point of the TP curve. A worker contributes 5 units per day to the firm’s output. after which it slopes downward.P. This stage is called the stage of negative returns. As more and more units of variable factors are added to constant quantity of fixed factor then fixed factor gets more intensively and effectively utilized and production increases at a rapid rate. of the variable factor is zero. is highest as shown by point H.P. T.com M. of the variable factor is negative during this stage. Fuller utilization of capital is possible due to the addition of a variable factor. curve goes below the X-axis.P. is maximum. In the given example. since the M. the quantity of fixed factor is abundant relative to the quantity of the variable factor. In this stage both the M.P.Honoursinfo. When the fourth worker joins it is possible to use the full potential of the capital. declines and therefore T. and A. the T. curve slopes downward.P.P. Diminishing Returns: The peculiar feature of this stage is that the 2.P. Stage I is known as the stage of ‘increasing 21 returns’ because A. The stage I ends where the AP curve reaches its highest point S.P. continuously fall during this stage. Increasing returns: In the beginning. The total product reaches 50 units per day when the 4th worker contributes to the production. of the variable factor increases throughout this stage. Total Product increases but gain from 7th worker is not as great as gain from the 6th Managerial Economics . Stage II: In stage II. Explanation of the various stages 1. continues to increase at a diminishing rate until it reaches its maximum point H where the second stage ends. Corresponding vertically is the point h. no. and M. machinery remains constant.e. of workers increase as a firm expands its production. As a result M.P. throughout the three stages fixed variable i. Stage II is important because the firm will seek to produce in its range.e.blogspot. when T. marginal product falls through out the stage and finally touches to zero.P.P.P. This stage is known as the stage of diminishing returns as both the A. the third stage is set in by hiring 7th worker who adds only 15 units per day as compared to 20 units per day added by the 6th worker. of the variable factor in negative and the M. In the table given. Stage III: In stage III. Here the stage II ends.P.

The producer may be an individual.blogspot. 3. there should be no close substitutes for the product of the monopolist. In our example this is set in by hiring 13th worker.market in the market. marginal product falls below X-axis i. an enterprise.? Answer: The following features are seen under simple or limited monopoly. No close Substitute: To avoid any possibility of competition in the market. The demand curve for a firm(which means the industry under monopoly) is downward sloping. Barriers to entry of firm: The basis of monopoly is the barriers or restrictions of new firms into the market.Honoursinfo. negative because total product starts falling.com worker. Negative returns: In this stage.e. It is the monopolist who is the price. a partnership firm. Managerial Economics . those can be either natural barriers or artificial barriers. Single Producer: For monopoly to exist only one producer should be in the market. In stage II fixed factor is scarce as compared to variable factor. the government or a joint stock company. The total product falls from 127 units to 118 units. then further 22 increase in variable factor will cause MP as well as AP to fall because fixed factor has now become inadequate relative to the quantity of variable factors. a reduction in the units of the variable factor will increase the total output. Explain the features of Monopoly. The large number of variable factors impairs the efficiency of the fixed factor. Explanation to this can be given as once the point is reached at which variable factor is sufficient to ensure full utilization of fixed factor. This means that the crosselasticity of demand for the monopolists product is low. The excessive variable factor as compared to less fixed factor results in a fall of total output. In such a situation. Demand curve under monopoly: The above mentioned features explain the demand curve or the average revenue(AR) curve under the monopoly.

supply of gas and electricity. Indeed all buyers are put at that mercy of the monopolist. Since there are no sellers. Urban transport.com 23 Y Demand Curve under Monopoly Average Revenue Price O Quantity Demanded X Under the monopoly.? Answer: Pure monopoly or simply monopoly is a market situation where there is only a single seller of goods with no close substitutes. there is only one seller who controls the entire supply in the market. he can fix the price of his product. nowadays cable television system and such other public utilities are usually managed as monopolies. he may rise the price frequently. On the other hand if a producer acquires monopoly on the basis of patent laws. telephone undertaking Managerial Economics . Good example are public unit utility such as water . electricity . Explain how price is determined under monopoly. Such monopolies are called natural monopolies. Since this is the only producer and seller. the buyers have no alternative than to buy from the monopolist.Honoursinfo. it is called an artificial monopoly. In order to maximize his profit. He may exploit the consumers by charging an excessive price. monopolies are created under law. Many times.blogspot.

blogspot.Thus the monopolist will produce OQ output at CQ price . when firm AR > AC . when firm AR < AC. Losses: At equilibrium level of output a firm may suffer losses when is average revenue is less than average cost . In order to maximize his profit.  It may suffer losses. Thus in the equilibrium situation in the short run a monopolist firm may likely to face three situation :  It may earn abnormal profit. He may lower the price and increase the quantity soled or he may lower the quantity soled and raise the price thus a monopolist is a price maker or price searcher who is in search of the price – quality combination that will maximize his profit.  It may earned normal profit. Since this is the only producer and seller. Managerial Economics . He may exploit the consumers by charging an excessive price. Since there are no sellers. the firm get profit per unit equal to CB. Under the monopoly. he may rise the price frequently. Monopoly price during the short run : During the short run a monopolist cannot expand or contract the size of his plan.Honoursinfo. there is only one seller who controls the entire supply in the market. The total profit enjoy by the firm is shown by the shaded area DABC . the buyers have no alternative than to buy from the monopolist. y MC AC D Cost/ Revenue A C B AR O Q MR OUTPUT X The equilibrium level is determined at the point k where marginal cost = marginal revenue . he can fix the price of his product.com Being the sole seller of goods without close substitute the monopolist has substantial 24 control over the price he charges. when firm AR = AC Abnormal Profit: At equilibrium level of output a monopoly firm may earned abnormal profits when the firms average revenue exceeds the average cost of production.

Honoursinfo.blogspot. The two reason for this are : Managerial Economics . there for firm earns only normal profit . Monopoly price during long period: A monopoly firm during the long run will necessarily receive abnormal profit . equilibrium output is OQ . The total loss suffered by the firm is equal to the shaded portion ABCD .com y MC AC 25 D Cost/ Revenue A C B AR O Q MR OUTPUT X The equilibrium level is determined at point and where marginal cost is equal to marginal revenue. Equilibrium output is OQ Normal Profit: At equilibrium output is determined at the point a firm may earned normal profit when its average revenue is equal to average cost of production. at this our put firms average revenue is equal to average cost . y MC AC D Cost/ Revenue A C B AR O Q MR OUTPUT X The equilibrium level is determined at point K where marginal cost is equal to marginal revenue .

com  Entry of new firm is difficult .blogspot.  If the monopolist does not receive profit he will have no attraction to stay in 26 the market . Managerial Economics . the equilibrium level of output is OQ . the total shaded area ABCD represent the profit earned by the firm. y LMC LAC D Cost/ Revenue A C B K LAR O Q LMR OUTPUT X The long run equilibrium of the monopoly firm is obtained where the long run marginal cost is equal to long term marginal revenue The equilibrium level is determined at point K where LMR = LMC .Honoursinfo. Monopoly price during the long run is always more than long run average cost (P>LAC).

open market operations by the Central Bank are the sale and purchase of government bonds. Taxation is transferring of funds from private purses to public (Government) coffers. and government tax-revenue and expenditure account for a considerable proportion of GNP. Public expenditure on the other hand increases the flow of funds into the private economy. The traditional instrument through which Central Bank carries out the Monetary Policies are: Quantitative Credit Control measures such as open market operations. 27 f) Monetary Policy: Monetary Policy refers to the program of Central Bank’s variations. Fiscal or Budgetary Policy is regarded as powerful instrument of economic stabilization. The importance of fiscal policy as an instrument of economic stabilization rests on the fact that government activities in the modern economies are greatly enlarged. One of the primary objectives of monetary policy is to achieve economic stability. and changes in the statutory reserve ratios. the taxation and public expenditure policies are also jointly called the ‘Budgetary Policy’.. ranging from 10-25 per cent. treasure bills.com Write Short Notes On: Answer: e) Fiscal Policy: It is one of the important economic policies to achieve economic stability. Briefly speaking.blogspot.Honoursinfo. If the fiscal policy is formulated that it is during the period of expansion. changes in bank rates (or discount rates). Fiscal Policy refers to variation in taxation and public expenditure programs by the government to achieve predetermined objectives. It is the withdrawal of funds from private use. Since the tax-revenue and public expenditure form two sides of the government budget. Therefore the government may affect the private economic activities to same extent through variation in taxation and public expenditure. in the total supply of money and cost of money to achieve certain predetermined objectives. Bank rate Managerial Economics . securities. Besides fiscal policy is considered to be more effective than monetary policy because the former directly affects the private decisions while later does so indirectly. it is known as ‘counter-cyclical fiscal policy’. etc. to and from public.

In addition these instruments. the problem of economy is always there. Thus whether it is Government of India or America. always desirable to adopt a proper mix of fiscal and monetary policies to check the business cycles. It is however.blogspot. The statutory reserve ratio is the proportion of 28 commercial banks time and demand deposit. Managerial Economics . all have to face the basic economic problem.Honoursinfo. and also to change the composition of credit from undesirable to desirable pattern. which they are required to deposit with Central Bank or keep cash-in-vault. or club or hospital or national government. or of zilla parishad. The selective credit controls are intended to control the credit flows to particular sectors without affecting the total credit. All these instruments when operated by the Central Bank reduce (or enhance) directly and indirectly the credit creation capacity of the commercial banks and thereby reduce (or increase) the flow of funds from the banks to the public. Central Bank use also various selective credit control measures and moral suasion. Thus whether we are thinking of grampanchayat. k) Economic Problem and its universal nature: The same basic economic problem – unlimited wants and relatively limited resources – arises at all levels of human organization. Moral suasion is a persuasive method to convince the commercial banks to behave in accordance with the demand of the time and in the interest of the nation. though monetary policy is considered to be more effective to control inflation than to control depression.com is the rate at which Central Bank discounts the commercial banks bills of exchange or first class bill. The fiscal and monetary policies may be alternatively used to control the business cycles in the economy.

profit maximization assumption has a great predictive power. a villager. education and so on. its annual revenues are enormous running into billions or trillions of dollars.. Thus we can conclude that that there is something universal about problem of economy. schools. Every nation. expanding expenditure in respect of development that is to be brought about in various sectors like agriculture.Honoursinfo. Though in absolute terms. The Government of India therefore continually faces the basic problem of economy of how to make best use of its limited resources.blogspot. its needs are also unlimited. In the same way. has to face the basic economic problem. Marginal Revenue is obtained from production and sales of one additional unit of output.00. The basic economic arises in the case of an native. color. a city resident. There are two conditions that must be fulfilled for the profit maximization:  The necessary condition requires that Marginal Revenue (MR) must be equal to marginal cost (MC). Economy problem does not recognize boundaries of caste. Expanding and modernizing the defense forces. expenditure on space and military research etc.000/. The problem of economy – unlimited wants and limited means with alternative uses . It forms the basis for the conventional price theory. Besides. creed. poor or rich. l) Profit maximization goal: The conventional economic theory assumes profit maximization as the only objective of the business firms. Managerial Economics .has been forever confronting the mankind. the federal government of America. The economic problem is the universal problem. Marginal cost is the cost incurred due to one additional unit of output. transport. religion and culture. Profit maximization is regarded as the most reasonable and analytically most productive business objective. the richest government faces some basic economic problem. It helps in predicting the behavior of business firms in the real world and also the behavior of the price and output under different market conditions. in the case of poor or rich.crores has innumerable demands on its resources such as meeting mounting defense 29 expenditure.com The Government of India with annual revenue of about 1. industries. establishing military bases all over the world giving military assistance to the friendly countries. hospitals and government organization right from the village level to national level. small or big with small or huge population. and therefore even the richest government of US is always confronted by the same basic economic problem of limited resources to fulfill unlimited wants. in case of associations like clubs. No nation can escape it.

Various theories of profit are as follows: a.  Firm do not have the necessary knowledge and priori data to equalize MR and MC. But his was criticized for several reasons.com  The secondary condition requires that necessary condition must be 30 satisfied under the condition of decreasing MR and increasing MC.  This assumption has been accurate in predicting the firm’s behavior. Ex: Sales maximization. Objections to this approach:  Profit maximization assumption is too simple to explain the business phenomenon in the real world. profit arises because considerable amount of risk is involved in the business.  It is time honored objective of firm  Profit is one of the most efficient and reliable measures of efficiency of a firm. Firstly the types of risks involved in the business are not classified. which are able to make reasonable profit. Briefly review the various theories of profit? Ans. In defense of Profit Maximization assumption:  Firms continue to survive in the long run in a competitive market. Also Cawer Managerial Economics . businessman themselves are not aware of this objective attributed to them. Market share. The fulfillment of two condition makes the sufficient condition.  It is claimed that there are alternative and equally simple objectives of business firms that explains better the real world business phenomenon.blogspot.) Risk Taking Theory: According to Hawley. In fact.Honoursinfo.

accidents. Owner takes the insurance policy by paying the premium for the same. c.com pointed out that profit is not the reward for risk taking but instead it is a reward for risk avoiding. All these factors are uncertain and cannot be insured.) Innovation Theory: According to this theory suggested by Schumpeter. but in the long run they will disappear. Also there can be sudden change in the fashion.Honoursinfo. They may occur due to sudden increase in the price of raw material. b.) Uncertainty-Bearing Theory: In this theory the risks are classified into 2 types:  Insurable Risks: These are the risks covered by the insurance company. He neglected the fact that profit is reward for risk and uncertainty bearing. Successful entrepreneur is the one who earns a 31 good profit by avoiding the risks. But this theory of Schumpeter has been criticized on several grounds. Innovative characteristics of the producer may help him to earn super normal profits in the short run. hence profit can be considered as reward for uncertainty. When the demand for the products suddenly falls large stock remains in the inventory. Managerial Economics . profit is the reward for Innovation. risk of theft etc.  Non-Insurable Risks: The insurance company does not cover these risks. raw material supply may be reduced. Eg: risk of fire. Losses arising of such uncertainty cannot be estimated with precision. It is up to the entrepreneur how he exploits the invention made by the scientist into innovation. introduction of new substitutes. as it will further attract the new firms into the market.blogspot. Thus it is said that profits caused by innovation are disappeared by imitation. while mediocre businessman is not able to earn profit as he is unable to avoid risks.

) Dynamic theory of profit: The renowned economist J. He pointed out that whole world is dynamic and required of changes.blogspot. ________________________________________________________________ Managerial Economics .Honoursinfo. This may reduce the cost of production and improve the profit and output. monetary policy of Central Bank can lead to expansion and contraction of supply of money. These factors may drastically affect the smooth working of the business. He pointed out the following type of changes:      Changes in the quality and quantity of human needs. Thus profit is the reward paid for dynamism. Changes in the techniques of production Changes in the supply of capital Changes in the organization of business Changes in population 32 Techniques of production can be changed and improved machinery may be introduced.B Clark developed this theory. Adding partners or converting the partnership firm into Joint Stock Company can solve this purpose. For this purpose producer has to keep on adjusting himself or he would lag behind in this dynamic everchanging world. This theory was criticized for several reasons. He classified the changes under 5 categories but has failed to look at many other important changes like change in the government policy. Purchasing of improved machinery would involve lot of capital to be raised.com d.

The steady growth line shows the growth of the economy when there are no economic fluctuations. and downward slide in the economic activities from the peak.Honoursinfo. Phases of Business Cycle The ups and downs in the economy are reflected by the fluctuation in aggregate economic magnitudes.blogspot. The phase of peak is generally characterized by slacking in the expansion rate. The upward and downward movement in these magnitudes shows different phases of business cycle. “ The business cycle in the general sense may be defined as an alternation of periods of prosperity and dispersion. viz. prices. investment. the various phases of trade cycle may be enumerated as follows: 1. altering with periods of bad trade characterized by falling prices and high unemployment percentages”. wholesale and retail prices. such as. employment. According to Haberler. Recovery and expansion The five phases of a business cycle have been presented in the figure. Mitchell defined trade cycle as a fluctuation in aggregate economic activity. Recession 4. The term “trade cycle or Business Cycle in economics refers to the wave-like fluctuations in the aggregate economic activity.com 33 Define Business Cycle. the highest level of prosperity. aggregate demand. The line of cycle moving above the steady growth line marks the beginning of the period of expansion or prosperity in the economy. Steady Growth Line Managerial Economics . sales. particularly in employment. wages. profits. Ans. prosperity and depression. etc. bank credits. investment. Keynes points out “A trade cycle is composed of periods of good trade characterized by rising prices and low unemployment percentages. Peak 3. The various phases of business cycles are shown by the line of cycle which moves up and down the steady growth line. The phase of expansion is characterized by increase in output. Expansion 2. production. output and income. Trough 5.. of good and bad trade”. Explain various phases of business cycle. But considering the intermediate stages between prosperity and depression. Basically there are only two phases in a cycle. bank credits. employment. The growth rate eventually slows down and reaches the peak. per capital output and a rise in standard of living.

When the economy registers a continuous and repaid upward trend in output.Honoursinfo. i. the business cycle continues to recur. etc. So long as growth rate exceeds or equals the expected steady growth rate.e. register a rapid decline. When the growth rate goes below the steady growth rate. bank advances. etc. when it exceeds this rate.blogspot. If economic fluctuations are not controlled by the government. decline during the subsequent periods. employment. Managerial Economics .com Peak Expansion Prosperity Recession Prosperity Expansion Recovery 34 Depression Line of Cycle Trough The phase of recession begins when the downward slide in the growth rate becomes rapid and steady.. the total output. prices. the economy once again enters the phase of expansion and prosperity. it enters the phase of recovery though the growth rate may still remain below the steady growth rate. prices. employment. Trough is the phase during which the down – trend in the economy slows down and eventually stops. it makes the beginning of depression in the economy. The span of depression spreads over the period growth rate stays below the secular growth rate or zero growth rate in a stagnated economy. and the economic activities once again register an upward movement. Output. though the realized growth rate may still remain above the steady growth line. employment. In a stagnated economy. depression begins when growth rate is less than zero. etc. Trough is the period of most severe strain on the economy. the economy enjoys the period of prosperity – high and low. And..

blogspot.com 35 Managerial Economics .Honoursinfo.

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