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MBA- I Semester Managerial Economics MB0026

1. Mention the demand function. What is elasticity of demand? Describe the determinants of elasticity of demand. A behavioral relationship between quantity consumed and a person's maximum willingness to pay for incremental increases in quantity. It is usually an inverse relationship where at higher (lower) prices, less (more) quantity is consumed. Other factors which influence willingness-topay are income, tastes and preferences, and price of substitutes. Demand function specifies what the consumer would buy in each price and wealth situation, assuming it perfectly solves the utility maximization problem. The quantity demanded of a good usually is a storng function of its price. Suppose an experiment is run to determine the quantity demanded of a particular product at different price levels, holding everything else constant. Presenting the data in tabular form would result in a demand schedule. Elasticity of demand is the economist’s way of talking about how responsive consumers are to price changes. For some goods, like salt, even a big increase in price will not cause consumers to cut back very much on consumption. For other goods, like vanilla ice cream cones, even a modest price increase will cause consumers to cut back a lot on consumption. Elasticity of demand is an elasticity used to show the responsiveness of the quantity demanded of a good or service to a change in its price. More precisely, it gives the percentage change in demand one might expect after a one percent change in price. Elasticity is almost always negative, although analysts tend to ignore the sign even though this can lead to ambiguity. Only goods which do not conform to the law of demand, such as Veblen and Giffen goods, have a positive elasticity demand. Goods with a small elasticity demand (less than one) are said to be inelastic: changes in price do not significantly affect demand e.g. drinking water. Goods with large elasticity demand’s (greater than one) are said to be elastic: even a slight change in price may cause a dramatic change in demand. Revenue is maximised when price is set so as to create a ED of exactly one; elasticity demand‘s can also be used to predict the incidence of tax. Various research methods are used to calculate price elasticity, including test markets, analysis of historical sales data and conjoint analysis. There is a neat way of classifying values of elasticity. When the numerical value of elasticity is less than one, demand is said to be “inelastic”. When the numerical value of elasticity is greater than one, demand is “elastic”. So “elastic” demand means that people are relatively responsive to price changes (remember the vanilla ice cream cone). “Inelastic” demand means that people are relatively unresponsive to price changes (remember salt). An important relationship exists between the elasticity of demand for a good and the amount of money consumers want to spend on it at different prices. Spending is price times quantity, p times Q. In general, a decrease in price leads to an increase in quantity, so if price falls spending may either increase or decrease, depending on how much quantity increases. If demand is elastic, then a drop in price will increase spending, because the percent increase in quantity is larger than the percent decrease in price. On the other hand, if demand is inelastic a drop in price will decrease spending because the percent increase in quantity is smaller than the percent decrease in price. The price elasticity of demand measures how responsive the quantity demanded of a good is to a change in its price. The value illustrates if the good is relatively elastic (PED is greater than 1) or relatively inelastic (PED is less than 1). A good's PED is determined by numerous factors, these include; Number of substitutes: the larger the number of close substitutes for the good then the easier the household can shift to alternative goods if the price increases. Generally, the larger the number of close substitutes, the more elastic the price elasticity of demand. Degree of necessity: If the good is a necessity item then the demand is unlikely to change for a given change in price. This implies that necessity goods have inelastic price elasticities of demand. Price of the good as a proportion of income: It can be argued that goods that account for a large proportion of disposable income tend to be elastic. This is due to consumers being more aware of small changes in price of expensive goods compared to small changes in the price of inexpensive goods. The following example illustrates how to determine the price elasticity of demand for a good. The price elasticity of demand for supermarket own produced strawberry jam is likely to be elastic. This is because there are a very large number of close substitutes (both in jams and

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in MBA. Market response effect The effect of market events that are within and beyond a retailer’s control. Often forecasting demand is confused with forecasting sales. a production function can be defined as the For more solved assignments. Demand forecasting may be used in making pricing decisions. Regardless of the stimuli. sales for that model are typically lower than the sales for models on display. Therefore. Heckscher-Ohlin-Samuelson theory in international trade theory also presupposes production function. once the stock level of a particular sweater falls to the point where standard sizes are no longer available. Demand forecast modeling considers the size of the market and the dynamics of market share versus competitors and its effect on firm demand over a period of time. The resulting sales increase reflects a change in demand as a result of consumers responding to stimuli that potentially drive additional sales. In this sense. In this case demand forecasting uses techniques in causal modeling. And in fashion retailing. an industry. sales of that item are diminished. or an entire economy for all combinations of inputs. failing to forecast demand ignores two important phenomena[1]. Alternatively. For example. A production function is a function that specifies the output of a firm. Almost of all macroeconomic theories. Stock effects The effects that inventory levels have on sales.[1] In either case. when a consumer electronics retailer does not display a particular flat-screen TV.onlinequestionpapers.oqp. demand coming into your store is not converted to sales due to a lack of availability. These promotions can be modeled with intervention models or use a consensus to aggregate intelligence using internal collaboration with the Sales and Marketing functions. given the set of all technically feasible combinations of output and inputs. only the combinations encompassing a maximum output for a specified set of inputs would constitute the production function.oqp.www. such as educated guesses. or an entire economy for all combinations of inputs. neoclassical growth theory (classical and new) presuppose (aggregate) production function. In the extreme case of stock-outs. and quantitative methods. In the manufacturer to retailer model. an industry. Demand is also untapped when sales for an item are decreased due to a poor display location. promotional events are an important causal factor in influencing demand. or in making decisions on whether to enter a new market. Assignment and project help – visit – www.com 1 . But. It is also important to know that there is a subversive criticism on the very concept of production function. Demand for an item will likely rise if a competitor increases the price or if you promote the item in your weekly circular. How is it useful for business? A production function is a function that specifies the output of a firm. The main question is whether we should use the history of outbound shipments or customer orders or a combination of the two as proxy for the demand. A meta-production function (sometimes metaproduction function) compares the practice of the existing entities converting inputs X into output y to determine the most efficient practice production function of the existing entities. the maximum output of a technologically-determined production process is a mathematical function of input factors of production. since the historical demand forms the basis of forecasting. in assessing future capacity requirements.I Semester Managerial Economics MB0026 other preserves). real business cycle theory. 2. and the good is not a necessity item. such as the use of historical sales data or current data from test markets. There is a lot of debate in demand-planning literature about how to measure and represent historical demand. 3. whether the most efficient feasible practice production or the most efficient actual practice production. Put another way. these forces need to be factored into planning and managed within the demand forecast. Explain production function. production function is one of the key concepts of necoclassical macroeconomic theories.in or www. How is demand forecasting useful for managers? Demand forecasting is the activity of estimating the quantity of a product or service that consumers will purchase. like macroeconomic theory. consumers can and will easily respond to a change in price. Demand forecasting involves techniques including both informal methods. or because the desired sizes are no longer available.

and only labour variable. the firm may face even a choice of technologies. capital may be assumed to be fixed or constant in the short run. including error. possible production functions. The specialized knowledge that is crucial to success in innovative industries comes from: Research and development efforts Reverse engineering Informal exchange of information and ideas As firms become larger and their scale of operations increase they are able to experience reductions in their average costs of production. But. The firm enjoys benefits called internal economies of scale. for example. A localized industrial cluster can solve this problem by bringing together many firms that provide a large enough market to support specialized suppliers. Knowledge Spillovers Knowledge is one of the important input factors in highly innovative industries. economists using a production function in analysis are abstracting away from the engineering and managerial problems inherently associated with a particular production process. see production theory basics). These are cost reductions accruing to the firm as a result of the growth of the firm itself. which implies an ideal division of the income generated from output into an income due to each input factor of production. As a consequence its average costs fall. the production of goods and services and the development of new products requires the use of specialized equipment or support services. the production function is not a full model of the production process: it deliberately abstracts away from essential and inherent aspects of physical production processes. A decision frame. The firm is assumed to be making allocative choices concerning how much of each input factor to use. Assignment and project help – visit – www. a production function relates physical inputs to physical outputs. It is an advantage for: Producers They are less likely to suffer from labor shortages. Workers They are less likely to become unemployed.www. Labor Market Pooling A cluster of firms can create a pooled market for workers with highly specialized skills. The primary purpose of the production function is to address allocative efficiency in the use of factor inputs in production and the resulting distribution of income to those factors. entropy or waste. Moreover. Thus initially the firm's long run average cost curve slopes downward as the scale of the enterprise expands.com 1 . given the price of the factor and the technological determinants represented by the production function. in which one or more inputs are held constant. Increasing returns to scale results in the firm's output increasing at a greater proportion than its inputs and hence its total costs. In many industries. the production function can be used to derive a marginal product for each factor.oqp. An individual company does not provide a large enough market for these services to keep the suppliers in business. that is. Under certain assumptions.I Semester Managerial Economics MB0026 specification of the minimum input requirements needed to produce designated quantities of output. How do external and internal economies affect returns to scale? Economies of scale external to the firm (or industry wide scale economies) are only considered examples of network externalities if they are driven by demand side economies. The relationship of output to inputs is non-monetary. so that analysis can focus on the problems of allocative efficiency. both capital and labour factors are variable. while in the long run. either. By assuming that the maximum output technologically possible from a given set of inputs is achieved. The engineering and managerial problems of technical efficiency are assumed to be solved. ignoring the role of management.in or www.in MBA. while in the very long run. (An external For more solved assignments.onlinequestionpapers. but the production function itself remains fixed. It is usually presumed that unique production functions can be constructed for every production technology. 4. This phenomenon has been extensively documented in the semiconductor industry located in Silicon Valley. given available technology.oqp. (For a primer on the fundamental elements of microeconomic production theory. production functions do not ordinarily model the business processes. may be used. of sunk cost investments and the relation of fixed overhead to variable costs. and prices and costs are not considered. The firm is said to be experiencing increasing returns to scale. represented by various.

Types of internal economies of scale Types of internal economies of scale Financial Marketing Technical Managerial Risk bearing The farm has been able to gain loans and assistance at preferential interest rates from the EIB. a firm must deal with three constraints: the demand for its product. When the firm successfully deals with these constraints.onlinequestionpapers. where the long run average cost curves are at their lowest point.I Semester Managerial Economics MB0026 economy of scale is a benefit that the firms experience as a result of the growth of the industry.in MBA. This occurs because the firm is now experiencing internal diseconomies of scale.) After the firm has reached its optimum scale of output. Assignment and project help – visit – www. it makes a profit. Discuss the profit maximization model. continued expansion means that its average costs may start to rise as the firm now experiences decreasing returns to scale. and the supply of its inputs.in or www. Firms may maximize profit by maximizing sales. These large scale farms are attracting a considerable amount of overseas development aid funding from organisations such as the World Bank and the European Union as they are seen as being an integral part of the export earning capacity of the country. summing up (ii) and (iii). The long run average cost curve therefore starts to curve upwards. In order to achieve maximum profit the firm needs to find out the point where the difference between total revenue and total cost is the highest. In order to survive. market share or cash flow.oqp.oqp. The rules that apply for profit maximization are: i.www. increase output as long as marginal profit increases ii. World Bank and the EU It has managed to dedicate resources to its strategy of niche marketing The access to finance has allowed it to invest in sophisticated Israeli irrigation technology It large size enables it to employ specialised personnel such as estate managers The farm has used some of its land to diversify into producing fresh vegetables for export as well as continue producing maize. The business firm is the productive unit in an exchange economy.com 1 . profit will increase as long as marginal revenue (MR) > marginal cost (MC) iii. the production function. 5. profit is maximized when MR = MC Profit Maximization model means a scenario where the busniess is runned by the motive of profit making and keep the cost low. The profit maximization principle stresses on the fact that the motive of business firms to maximize profit is solely justified as being a method of maximizing the income of their shareholders. profit will decline if MR < MC iv. For more solved assignments. stock price.

6. If I produce 1 less unit. A firm considering a price change must know what effect the change in price will have on total revenue. and the profit maximization rule is specific to the firm production decision. If that same company also rented a portion of one of its buildings. Two common accounting methods. The readings show that these two rules are equivalent and simply represented different ways of using the information from the three constraints that a firm faces. revenue is referred to as turnover. non-operating revenue) is revenue from peripheral (non-core) operations. Therefore. Depending on PED. Profit is maximized where MR = MC.a. If I can increase profit when MR < MC. If I can increase my profit by changing how much I produce. if MR < MC. such as interest earned on deposits in a demand account. but it is at the core of microeconomics. In general usage. revenue is a calculation or estimation of periodic income based on a particular standard accounting practice or the rules established by a government or government agency. Why? This MB of producing an extra unit is the extra revenue you get. producing more will increase my profit. Much of this material is quite technical. In more formal usage. Other revenue (a. it would record that revenue as “other revenue” and disclose it separately on its income statement to show that it is from something other than its core operations.I Semester Managerial Economics MB0026 These readings explore the assumption that firms maximize profits.in MBA. then choosing q such that MR < MC can not be profit-maximizing. in order to maximize profit.k. the profit maximization rule. So the 2 statements are equivalent. I must choose a quantity q such that MR = MC. Corporations that offer shares for sale to the public are usually required by law to report revenue based on generally accepted accounting principles or International Financial Reporting Standards. MR is the MB. my revenues increase by more than my costs.oqp. I can increase profit by decreasing output. revenues or revenue is income that a company receives from its normal business activities. Therefor. revenue is income received by an organization in the form of cash or cash equivalents. MR = MC is an equilibrium in the sense that it is the only place where there is no incentive to change the production level. Generally any change in price will have two effects: the price effect: an increase in For more solved assignments. a company that manufactures and sells automobiles would record the revenue from the sale of an automobile as "regular" revenue. and the second to the rule that marginal cost should equal marginal revenue. Most businesses also have revenue that is incidental to the business's primary activities. is just an application of the marginal principle (MB = MC). The marginal principle is more general. Some companies receive revenue from interest. if MR > MC. such as the United Kingdom.com 1 . Sales revenue or revenues is income received from selling goods or services over a period of time. dividends or royalties paid to them by other companies. Assignment and project help – visit – www. Profit maximization rule: Produce until the point where the change in revenue from producing 1 more unit equals the change in cost from producing 1 more unit. Tax revenue is income that a government receives from taxpayers. my revenues decrease by less than my costs decrease. It then explores how the rules of maximization apply to the firm. usually from the sale of goods and services to customers.in or www. It considers two ways in which the maximization principle can be used: to determine the proper levels of inputs or to determine the proper level of output. The first leads to the rule that marginal resource cost should equal marginal revenue product. Why? Suppose MR > MC. one may raise revenue either by increasing prices and sacrificing quantity or by reducing them and outputting more. This rule. then when producing where MR > MC can't be profitmaximizing. For example. There is a predictable relationship between revenue and elasticity.www. This excludes product returns and discounts for early payment of invoices. In many countries.onlinequestionpapers. Revenues from a business's primary activities are reported as sales. cash basis accounting and accrual basis accounting. If I produce 1 more unit.oqp. This is included in revenue but not included in net sales. So. Sales revenue does not include sales tax collected by the business. sales revenue or net sales. pointing out some of the ambiguities of this assumption. Suppose MR < MC. do not use the same process for measuring revenue. Examine the relationship between revenue concepts and price elasticity of demand.

to maximise revenue. the total revenue of producers falls. no matter how small. any increase in the price. Assignment and project help – visit – www. undefined).com 1 .onlinequestionpapers. a firm ought to operate close to its unit-elasticity price. will cause demand for the good to drop to zero. When the price elasticity of demand for a good is elastic (|Ed| > 1). when the price is raised. when the price is raised. the percentage change in revenue is equal to the change in quantity demanded plus the percentage change in price.in or www. In this way. changes in the price do not affect the quantity demanded for the good.I Semester Managerial Economics MB0026 unit price will tend to increase revenue.e. and vice versa. For more solved assignments. Hence. When the price elasticity of demand for a good is inelastic (|Ed| < 1). and vice versa. while a decrease in unit price will tend to lead to more units sold. the relationship between PED and revenue can be described for any particular good: When the price elasticity of demand for a good is perfectly inelastic (Ed = 0). in determining whether to increase or decrease prices a firm needs to know what the net effect will be. Because of the inverse nature of the price-demand relationship the two effects offset each other. when the price is raised. the percentage change in quantity demanded is smaller than that in price. Hence. while a decrease in price will tend to decrease revenue.oqp.oqp. When the price elasticity of demand for a good is unit elastic (or unitary elastic) (|Ed| = 1). the total revenue of producers falls to zero. the total revenue of producers rises. When the price elasticity of demand for a good is perfectly elastic (Ed is infinite i. raising prices will cause revenue to increase. Elasticity provides the answer. The quantity effect: an increase in unit price will tend to lead to fewer units sold. In short.in MBA. the percentage change in quantity is equal to that in price and a change in price will not affect revenue. Hence. the percentage change in quantity demanded is greater than that in price.www. Hence.

in or www. Some subset of these conditions is presented in most textbooks as defining perfect competition.the price that consumers are paying in the markwet reflects the factor cost of resouces used up in producing/providing the good or service. that is whether or not firms treat price as a parameter or a choice variable. Infinite producers with the willingness and ability to supply the product at a certain price.www. perfectly-competitive markets are productively inefficient as output will not occur where marginal cost is equal to average cost. Nonetheless. It should be noted that a general rigorous proof that the above conditions indeed suffice to guarantee price taking is still lacking.I Semester Managerial Economics MB0026 SET II 1. More advanced textbooks try to reconcile these conditions with the definition of perfect competition as equilibrium price taking. This is not achieved int eh short runfirms can be operating at any point on their short run average total cost curve. the concept of perfect competition can serve as a useful benchmark against which to measure real life.oqp. Transactions are Costless . as output will always occur where marginal cost is equal to marginal revenue.onlinequestionpapers. This implies that a factor's price equals the factor's marginal revenue product. there are few if any perfectly competitive markets.in MBA. In both the short and long run. a perfectly competitive market exists when every participant is a "price taker.oqp. In the short term. and therefore where marginal cost equals average revenue. price is equal to marginal cost (P=MC) and therefore allocative efficientcy is achieved . Perfect Information . Homogeneous Products – The characteristics of any given market good or service do not vary across suppliers. Differences in price elasticity of demand between markets: There must be a For more solved assignments. therefore. It is important to stress that charging different prices for similar goods is not pure price discrimination. Assignment and project help – visit – www. for reasons not associated with costs. but allocatively efficient. such markets are both allocatively and productively efficient. Because the conditions for perfect competition are strict. very specific conditions such as that of monopolistic competition. Under perfect competition.com 1 . Productive efficiency occurs when price is equal to average cost at its minimum point.dynamic efficiency . Specific characteristics may include: Infinite Buyers/Infinite Sellers – Infinite consumers with the willingness and ability to buy the product at a certain price. perfect competition occurs in markets in which no participant has market power. Under what conditions is price discrimination possible? Price discrimination or yield management occurs when a firm charges a different price to different groups of consumers for an identical good or service." and no participant influences the price of the product it buys or sells.which relates to aspects of market competition such as the rate of innovation in a market. 2. any profit-maximizing producer faces a market price equal to its marginal cost. Generally. In the long term.Buyers and sellers incur no costs in making an exchange Firms Aim to Maximize Profits .Firms aim to sell where marginal costs meet marginal revenue. exhibits levels of static economic efficiency. imperfectly competitive markets. The abandonment of price taking creates considerable difficulties to the demonstration of existence of a general equilibrium except under other. where they generate the most profit. The long run of perfect competition. Under perfect competition how is equilibrium price determined in the short and long run? In economics. Zero Entry/Exit Barriers – It is relatively easy to enter or exit as a business in a perfectly competitive market.Prices and quality of products are assumed to be known to all consumers and producers. the quality of output provided over time. There is of course another form of economic efficiency . but productive efficiency is attained in the long run because the profit maximixing ouput is achieved at a level where average revenue is tagential to the average total cost curve. Perfect competition is used as a yardstick to compare with other market structure (such monopoly and oligopoly) because it displays high levels of economic efficiency. This allows for derivation of the supply curve on which the neoclassical approach is based.

the firm separates the whole market into each individual consumer and charges them the price they are willing and able to pay. is unlikely to occur in the real world. This can be done in a number of ways.oqp. with perfect price discrimination.in or www. Second Degree Price Discrimination This type of price discrimination involves businesses selling off packages of a product deemed to be surplus capacity at lower prices than the previously published/advertised price. – and is probably easier to achieve with the provision of a unique service such as a haircut rather than with the exchange of tangible goods. always providing that the cheaper price that adds to revenue at least covers the marginal cost of each unit. the firm can increase its total revenue and profits (i. The transactions costs involved in finding out through market research what each buyer is prepared to pay is the main block or barrier to a businesses engaging in this form of price discrimination. If successful. If the monopolist is able to perfectly segment the market. People who book late often regard travel to their intended destination as a necessity and they are therefore likely to be willing and able to pay a much higher price very close to departure.e.onlinequestionpapers. This is impossible to achieve unless the firm knows every consumer’s preferences and. Assignment and project help – visit – www. it can also be an effective way of securing additional market share within an oligopoly as the main suppliers’ battle for market dominance. The expansion of e-commerce by both well established businesses and new entrants to online retailing has seen a further growth in second degree price discrimination. as a result. The reality is that. Barriers to prevent consumers switching from one supplier to another: The firm must be able to prevent “market seepage” or “consumer switching” – defined as a process whereby consumers who have purchased a good or service at a lower price are able to re-sell it to those consumers who would have normally paid the expensive price. If there are unsold airline tickets or hotel rooms.com 1 . And. (a) Perfect Price Discrimination – charging whatever the market will bear Sometimes known as optimal pricing. achieve a higher level of producer surplus).www. Seepage might be prevented by selling a product to consumers at unique and different points in time – for example with the use of time specific airline tickets that cannot be resold under any circumstances. the firm will seek to set marginal revenue = to marginal cost in each separate (segmented) market.I Semester Managerial Economics MB0026 different price elasticity of demand from each group of consumers. To profit maximise. Customers booking early with carriers such as EasyJet will normally find lower prices if they are prepared to commit themselves to a flight by booking early. Early-bird discounts – extra cash-flow The low cost airlines follow a different pricing strategy to the one outlined above. then the average revenue curve effectively becomes the marginal revenue curve for the firm.oqp. At the same time the marginal or variable costs are small and predictable. For more solved assignments. on the simple justification that consumer’s demand for a flight becomes more inelastic the nearer to the time of the service. By adopting such a strategy. In these types of industry. It is a classic part of price competition between firms seeking a market advantage or to protect an established market position. The monopolist will continue to see extra units as long as the extra revenue exceeds the marginal cost of production. Examples of price discrimination Price discrimination is an extremely common type of pricing strategy operated by virtually every business with some discretionary pricing power. Firms may be quite happy to accept a smaller profit margin if it means that they manage to steal an advantage on their rival firms. the firm can extract all consumer surplus that lies beneath the demand curve and turn it into extra producer revenue (or producer surplus). Closer to the date and time of the scheduled service. This gives the airline the advantage of knowing how full their flights are likely to be and a source of cash-flow in the weeks and months prior to the service being provided. the price rises.in MBA. the fixed costs of production are high. There is nearly always some supplementary profit to be made from this strategy. although optimal pricing can and does take place in the real world. it is often in the businesses best interest to offload any spare capacity at a discount prices. Examples of this can often be found in the hotel and airline industries where spare rooms and seats are sold on a last minute standby basis. The firm is then able to charge a higher price to the group with a more price inelastic demand and a relatively lower price to the group with a more elastic demand. most suppliers and consumers prefer to work with price lists and price menus from which trade can take place rather than having to negotiate a price for each unit of a product bought and sold.

A fixed fee is charged (often with the justification of it contributing to the fixed costs of supply) and then a supplementary “variable” charge based on the number of units consumed. every dollar of current income spent by the consumer is 1(1+r) dollars the consumer will not be able to spend in the second period. Consumers on the net often provide suppliers with a huge amount of information about themselves and their buying habits that then give sellers scope for discriminatory pricing. They may choose to charge one low price for the core product (accepting a lower mark-up or profit on cost) as a means of attracting customers to the components / accessories that have a much higher mark-up or profit margin. Economists often distinguish between the marginal propensity to consume out of permanent income. the concept that the increase in personal consumer spending (consumption) that occurs with an increase in disposable income (income after taxes and transfers). Therefore. Assignment and project help – visit – www.65. If you decide to spend $400 of this marginal increase in income on a new business suit. thus giving us a figure between 0 and 1.oqp. p. as S(1+r) increases with the interest rate. The MPC relies heavily upon the real (inflation-adjusted) rate of interest. In economics. 417-8). There are plenty of examples of this including taxi fares. the household will spend 65 cents and save 35 cents.in or www. particularly manufactured products where there are many closely connected complementary products that consumers may be enticed to buy. For example Dell Computer charges different prices for the same computer on its web pages. One minus the MPC equals the marginal propensity to save (in a two sector closed economy). Peak time pricing – a common feature of many local transport markets Product-line pricing Product line pricing is also becoming an increasingly common feature of many markets. and the marginal propensity to consume is 0. Because a rate increase primarily decreases the present value of lifetime wealth. For example.I Semester Managerial Economics MB0026 The internet and price discrimination A number of recent research papers have argued that the rapid expansion of e-commerce using the internet is giving manufacturers unprecedented opportunities to experiment with different forms of price discrimination. because if a consumer expects a change in income to be permanent. You suddenly have $500 more in income than you did before. Explain the average and marginal propensity to consume. Mathematically.www. your marginal propensity to consume will be 0. Two Part Pricing Tariffs Another pricing policy common to industries with pricing power is to set a two-part tariff for consumers. and it's $500 on top of your normal annual earnings. 3. and the marginal propensity to consume out of temporary income.g. In a two period model. A high rate of interest causes spending in the future to become increasingly attractive due to the intertemporal substitution effect on consumption.onlinequestionpapers. both of which are crucial to Keynesian economics and are key variables in determining the value of the multiplier. The MPC can be more than one if the subject borrowed money to finance expenditures higher than their income. the marginal propensity to consume (MPC) is an empirical metric that quantifies induced consumption. the distinction between permanent and temporary changes in For more solved assignments. amusement park entrance charges and the fixed charges set by the utilities (gas. then they have a greater incentive to increase their consumption (Barro and Grilli. water and electricity). if a household earns one extra dollar of disposable income. It is frequently observed that a producer may manufacture many related products. the marginal propensity to consume (MPC) function is expressed as the derivative of the consumption (C) function with respect to disposable income (Y). For example. so does future income[C= -(1+r)c +we(1+r)]. suppose you receive a bonus with your paycheck. depending on whether the buyer is a state or local government. the consumer relies on becoming a lender to offset this effect. or a small business. discrimination by time). Price discrimination can come from varying the fixed charge to different segments of the market and in varying the charges on marginal units consumed (e. This implies that the Keynesian multiplier should be smaller in response to permanent changes in income than it is in response to temporary changes in income (though the earliest Keynesian analyses ignored these subtleties). then of that dollar.8 ($400 / $500). The marginal propensity to consume is measured as the ratio of the change in consumption to the change in income.oqp. However.in MBA.com 1 .

The Treaty provisions also imply that. The following articles are also useful for understanding the business cycle.in or www. In particular. A business cycle is not a regular.I Semester Managerial Economics MB0026 income is often subtle in practice. the Eurosystem should also take into account the broader economic goals of the Community. while contractionary policy involves raising interest rates to combat inflation.[1] Monetary theory provides insight into how to craft optimal monetary policy. (ii) availability of money. Monetary policy is referred to as either being an expansionary policy.www. A business cycle is identified as a sequence of four phases: Contraction (A slowdown in the pace of economic activity) Trough (The lower turning point of a business cycle. Monetary policy can affect real activity only in the shorter term (see the transmission mechanism). measured by fluctuations in real GDP and other macroeconomic variables. 4. the ECB typically should avoid generating excessive fluctuations in output and employment if this is in line with the pursuit of its primary objective. central bank. The natural role of monetary policy in the economy is to maintain price stability (see scope of monetary policy). predictable. which refers to government borrowing. to a large degress. The business cycle is the periodic but irregular up-and-down movements in economic activity. It assigns overriding importance to price stability. where a contraction turns into an expansion) Expansion (A speedup in the pace of economic activity) Peak (The upper turning of a business cycle) A recession occurs if a contraction is severe enough. or repeating phenomenon like the swing of the pendulum of a clock. and a contractionary policy decreases the total money supply. spending and taxation The Treaty establishes a clear hierarchy of objectives for the Eurosystem. But ultimately it can only influence the price level in the economy. Explain briefly the phases of business cycle. What is monetary policy? What are the objectives of such policy? Monetary policy is the process a government. Maintaining stable prices on a sustained basis is a crucial pre-condition for increasing economic welfare and the growth potential of an economy. or a contractionary policy. Assignment and project help – visit – www. credit demand surges as businesses run low on For more solved assignments. These Treaty provisions reflect the broad consensus that the benefits of price stability are substantial (see benefits of price stability). is explained in the article "Recession? Depression? What's the difference?"... unpredictable. A deep trough is called a slump or a depression. given that monetary policy can affect real activity in the shorter term. where an expansionary policy increases the total supply of money in the economy. and (iii) cost of money or rate of interest to attain a set of objectives oriented towards the growth and stability of the economy. What is more.in MBA. or monetary authority of a country uses to control (i) the supply of money.oqp. The difference between a recession and a depression. If you're looking for information on how various economic indicators and their relationship to the business cycle. 5. which is not well-understood by noneconomists. Expansionary policy is traditionally used to combat unemployment in a recession by lowering interest rates. the marginal propensity to consume should also be affected by factors such as the prevailing interest rate and the general level of consumer surplus that can be derived from purchasing. The Treaty makes clear that ensuring price stability is the most important contribution that monetary policy can make to achieve a favourable economic environment and a high level of employment. Monetary policy is contrasted with fiscal policy. Its timing is random and. and it is often quite difficult to designate a particular change in income as being permanent or temporary. and why recessions happen: Why Don't Prices Decline During A Recession? Do Changes in Stock Prices Cause Recessions? Are Recessions Good For the Economy? A Beginner's Guide to Economic Indicators Business cycle phase 2009 is slow or negative economic growth and perhaps falling prices.oqp.onlinequestionpapers. please see A Beginner's Guide to Economic Indicators. As the slowdown or recession progresses. Through what phase did the world pass in 2009-09.com 1 . in the actual implementation of monetary policy decisions aimed at maintaining price stability.

In January. The cyclical score for the coinsiders fell to 23 from 36 last month.I Semester Managerial Economics MB0026 cash. cost of imported raw material rises due to exchange rate changes.oqp. This is when fixed income instruments. Several internal and external factors. An increase in the quantity of money in circulation relative to the ability of the economy to supply leads to increased demand. Employment situation remains grim and production continues to contract. The percentage of primary leading indicators appraised as expanding fell to 17 from 20 last month. such as natural calamities or an increase in the economic power of a certain country. a cut in tax rates or increased consumer confidence. on the other hand. During phase three of the cycle with rising interest rates and a coming recession. The cost of production can rise because of rising labor costs or when the producing firm is a monopoly or oligopoly and raises prices. like bonds provide great returns. states that inflation occurs when the cost of producing rises and the increase is passed on to consumers. As a response to a slowdown. consumer prices slow their ascent. increased taxes or wars. Both the cyclical score and the percentage of leaders expanding continue to signal that further contraction is likely. An increase in demand could also be a result of declining interest rates. The cyclical score. The proponents of the Demand Pull theory attribute a rise in prices to an increase in demand in excess of the supplies available. However.www. and external factors. But the speed of the current deterioration is daunting. Assignment and project help – visit – www. all commodities. there is a general agreement amongst economists that economic inflation may be caused by either an increase in the money supply or a decrease in the quantity of goods being supplied. In phase two when the economy accelerates and prices begin to climb. when the pain of recession grows too severe for the government to tolerate. at the bottom of a recession. including gold.com 1 . thereby fuelling prices. common stocks are the best place to be while bonds. The magnitude of the downturn is not unprecedented by any means. But regardless. Commodities and real estate should be avoided during this phase. The bulk of it took place in the last quarter of 2008. decreased to 28 from 33 last month. making it mandatory to identify the causing factors. Consumers pay down their debts and businesses get rid of workers and reduce inventories to bring production into line with demand. are the best investments. Several of the past recessions brought larger decreases in gross domestic product and higher levels of unemployment. high lending levels. The case is of too much money chasing too few goods. in phase one. It seems unlikely that the recession has reached its trough. Only two primary leading indicators—M1 money supply and the yield curve index— are appraised as expanding. What are the causes of inflation? What were the causes that affected inflation in India during the last quarter of 2009? A sustained rise in the prices of commodities that leads to a fall in the purchasing power of a nation is called inflation. Different schools of thought provide different views on what actually causes inflation. but they reflect only the expansionary monetary policy. Although inflation is part of the normal economic phenomena of any country. The Cost Push theory. Some business cycles are more severe and therefore more distinct than others. Finally. a drop in the exchange rate. a rise in production and labor costs. High levels of inflation distort economic performance. can cause inflation. the economy entered the second year of its recession. For instance. AIER’s statistical indicators of business-cycle conditions continue to point to further contraction. None of the indicators is appraised as expanding. Finally. stocks start looking good again. equities start to weaken and bonds begin to move up. the Fed eases credit and of course the cycle begins all over again. any increase in inflation above a predetermined level is a cause of concern. which is based on a separate purely mathematical analysis of the leaders. such as the printing of more money by the government. stocks are good and bonds are fair. there are certain types of investments that are best in each stage of the business cycle. Late in this phase. Raw material prices fall sharply and after a lag.in or www.in MBA. in phase four the slowdown or recession is progressing full steam ahead.onlinequestionpapers. reinforcing the view that the economy is in recession. both consumer and producer prices began to fall. 6. For more solved assignments.oqp. The primary roughly coincident indicators strongly confirm that the economy is in recession. real estate and commodities are okay but gold and collectibles should be avoided.

While money growth is considered to be a principal long-term determinant of inflation.oqp. after the OPEC raised oil prices. however. nonmonetary sources. textiles. have played a key role in triggering inflation in the past four decades. global crude oil prices are expected to remain stable during the current financial year. chemicals. "If global economic recovery begins earlier and is stronger. A classic example of cost-push or supply-shock inflation is the oil crisis that occurred in the 1970s. edible oils. steel and other commodities being the culprit. average WTI (West Texas Intermediate) prices are expected to be $52. 2009 compared with 7.www. 2009. For more solved assignments.4 per cent on March 28. at the current level of $50 per barrel. in the wake of an expected improvement in agricultural production as well as low international commodity prices. Since oil is used in every industry. Price-rise down due to base effect Driven by the reduction in the administered prices of petroleum products and electricity. there is an upside risk of even higher oil prices from the current level. Assignment and project help – visit – www." the apex bank said.onlinequestionpapers. iron & steel and machinery & machine tools. Inflation has become a major concern worldwide in 2008. manufactured products' inflation fell to 1.6 per barrel). a sharp rise in the price of oil leads to an increase in the prices of all commodities. food. remains highly uncertain.in MBA.oqp.90 per cent on August 2. which is 47 per cent lower than the average price for the year 2008 ($99.in or www. inflationary pressures are expected to remain at a low level through the greater part of the 2009-10.3 per cent a year ago.3 per cent as on March 28. With the decline in prices of sugar. 2008 to 0. such as an increase in commodity prices. the long-term outlook for oil. "A significant part of the end year reduction in WPI inflation could also be attributed to the base effect reflecting the rapid increase in inflation recorded during the last quarter of 200708. However. with global prices rises in oil. iron & steel.com 1 . year-on-year (y-o-y) headline inflation in the country showed a sharp correction from a historic peak of 12. edible oils/oil cakes. According to the report.I Semester Managerial Economics MB0026 An increase in indirect taxes can also lead to increased production costs.6 per barrel in 2009. oil items. Assuming that there are no major crude oil supply disruptions. the central bank indicated that. The US saw double digit inflation levels during this period. as well as the decline in prices of freely priced minerals. oilseeds. In view of the relatively tight demand supply-balance over the long run." the report said. oil cakes and raw cotton.