ASSIGNMENT

Name S.AMEER ABBAS

Roll No. 520955311

Course MBA-Semester-1

Subject MANAGERIAL ECONOMICS

Subject Code MB0026-Set-2

1. What is pricing policy? What are the internal and external factors of the
policy?
Ans.
Pricing policy can be defined as a standard procedure used by a firm to
set wholesale and retail prices for its products or services.

Pricing policy is based upon few factors such as a firm's overall marketing
objectives, consumer demand, product attributes, competitors' pricing, and
market and economic trends.

Internal and external factors of pricing policy:

• Determine primary and secondary market segments. This helps

to better understand the offering's value to consumers. Segments are
important for positioning and merchandising the offering to ensure
maximized sales at the established price point.

• Assess the product's availability and near substitutes. Under

pricing hurts the product as much as overpricing does. If the price is too
low, potential customers will think it can't be that good. This is particularly
true for high-end, prestige brands. One client under priced its subscription
product, yielding depressed response and lower sales. The firm
underestimated the uniqueness of its offering, the number of close
substitutes, and the strength of the consumer's bond with the product. As
a result, the client could increase the price with only limited risk to its
customer base. In fact, the initial increase resulted in more subscribers as
the new price was more in line with its consumer-perceived value.

• Survey the market for competitive and similar products.

Consider whether new products, new uses for existing products, or new
technologies can compete with or, worse, leap frog offering. Examine all
possible ways consumers can acquire the product. Don't limit the analysis
to online distribution channels.

Competitors may define one’s price range. In this case, one can price
higher if consumers perceive the product and/or brand is significantly
better; price on parity if the product has better features; or price lower if
the product has relatively similar features to existing products. An
information client faced this situation with a premium product. Its direct
competitors established the price for a similar offering. As the third player
in this segment, its choices were price parity with an enhanced offering or
a lower price with similar features.

• Examine market pricing and economics. A paid, ad-free site

should generate more revenue than a free ad-supported one, for example.
In considering this option, remember to incorporate the cost of forgone
revenue, especially as advertisers find paying customers more attractive.

To gain additional insight from this analysis, observe consumers interacting

with your product to better understand their connection to it. This can yield
insights into how to package and promote the offering that can affect on
pricing, features, and incentives.

• Test different price points if possible. This is important if we enter

a new or untapped market, or enhance an offering with consumer-oriented
benefits. To determine price, MarketingExperiments.com tested three
different price points for a book. It found the highest price yielded the
greatest product revenue. Interestingly, the middle price yielded greater
revenue over time, as it generated more customers to whom other related
products could be marketed.

• Monitor the market and the competition continually to reassess

pricing. Market dynamics and new products can influence and change
consumer needs.
2. Mention three crucial objectives of price policies
Ans.

The main three objectives that are to be considered while fixing the prices of
the product are as follows:

1. Profit maximization in the short term

The primary objective of the firm is to maximize its profits. Pricing

policy as an instrument to achieve this objective should be formulated in
such a way as to maximize the sales revenue and profit. Maximum profit
refers to the highest possible of profit. In the short run, a firm not only
should be able to recover its total costs, but also should get excess revenue
over costs. This will build the morale of the firm and instill the spirit of
confidence in its operations. It may follow skimming price policy, i.e.,
charging a very high price when the product is launched to cater to the needs
of only a few sections of people. It may exploit wide opportunities in the
beginning. But it may prove fatal in the long run. It may lose its customers
and business in the market. Alternatively, it may adopt penetration pricing
policy i.e., charging a relatively lower price in the latter stages in the long
run so as to attract more customers and capture the market

2. Profit optimization in the long run

The traditional profit maximization hypothesis may not prove beneficial

in the long run. With the sole motive of profit making a firm may resort to
several kinds of unethical practices like charging exorbitant prices, follow
Monopoly Trade Practices (MTP), Restrictive Trade Practices (RTP) and Unfair
Trade Practices (UTP) etc. This may lead to opposition from the people. In
order to over come these evils, a firm instead of profit maximization, aims at
profit optimization.

Optimum profit refers to the most ideal or desirable level of

profit.Hence, earning the most reasonable or optimum profit has become a
part and parcel of a sound pricing policy of a firm in recent years.

3. Price Stabilization

Price stabilization over a period of time is another objective. The prices

as far as possible should not fluctuate too often. Price instability creates
uncertain atmosphere in business circles. Sales plan becomes difficult under
such circumstances. Hence, price stability is one of the pre requisite
conditions for steady and persistent growth of a firm. A stable price policy
only can win the confidence of customers and may add to the good will of the
concern. It builds up the reputation and image of the firm.

3.Mention the bases of price discrimination

Ans.
Price discrimination is the process of charging a different price for a

different product or to a different buyer without any true cost differential to

justify the different price. An agreement to charge a better price for the same

product to one buyer versus another may constitute a violation of antitrust

laws . A marketer may charge more for one model of a product than for

another in order to add perceived value to the product. For example, makers

of designer jeans charge a premium price for a product that costs no more to

manufacture than no-name jeans.

Price discrimination exists when sales of identical goods or services

are transacted at different prices from the same provider. In a theoretical

market with perfect information, no transaction costs or prohibition on

secondary exchange (or re-selling) to prevent arbitrage, price discrimination

can only be a feature of monopoly and oligopoly markets[1], where market

power can be exercised.

Basis of price discrimination

Price discrimination can exist when three conditions are met:
consumers differ in their demands for a given good or service, a firm has
market power, and the firm can prevent or limit arbitrage. If consumers had
identical demands for a good, then all consumers would demand the same
amount of the good for each price, and the price and quantity of the good
would depend only on the number of consumers in the market and
the ability of firms to supply the good (the supply curve). If firms have no
market power, that is, no ability to affect the price of the goods they sell, the
theory of perfect competition implies that all goods would be sold at one
price (the law of one price). Finally, if consumers can arbitrage price
differences, any attempt to charge higher prices to some group would be
defeated by resale.
The basic theory of price discrimination is the theory of monopoly,
applied to more than one market or group.

The purpose of price discrimination is generally to capture the

market's consumer surplus. This surplus arises because, in a market with a
single clearing price, some customers (the very low price elasticity segment)
would have been prepared to pay more than the single market price. Price
discrimination transfers some of this surplus from the consumer to the
producer/marketer. Strictly, a consumer surplus need not exist, for example
where some below-cost selling is beneficial due to fixed costs or economies
of scale. An example is a high-speed internet connection shared by two
consumers in a single building; if one is willing to pay less than half the cost,
and the other willing to make up the rest but not to pay the entire cost, then
price discrimination is necessary for the purchase to take place.

It can be proved mathematically that a firm facing a downward sloping

demand curve that is convex to the origin will always obtain higher revenues
under price discrimination than under a single price strategy. This can also be
shown diagrammatically.

The more prices that are introduced, the greater the sum of the
revenue areas, and the more of the consumer surplus is captured by the
producer.

It is very useful for the price discriminator to determine the optimum

prices in each market segment.

The firm decides what amount of the total output to sell in each
market by looking at the intersection of marginal cost with marginal revenue
(profit maximization). This output is then divided between the two markets,
at the equilibrium marginal revenue level.
4.What do you mean by the fiscal policy? What are the instruments of fiscal
policy? Briefly comment on India’s fiscal policy.

Ans.

In economics, fiscal policy is the use of government spending and

revenue collection to influence the economy. It can also be referred as
government spending policies that influence macroeconomic conditions.
These policies affect tax rates, interest rates and government spending, in an
effort to control the economy.

Fiscal policy can be contrasted with the other main type of economic
policy, monetary policy, which attempts to stabilize the economy by
controlling interest rates and the supply of money. The two main instruments
of fiscal policy are government spending and taxation. Changes in the level
and composition of taxation and government spending can impact on the
following variables in the economy:

• Aggregate demand and the level of economic activity;

• The pattern of resource allocation;
• The distribution of income.

The two main instruments of fiscal policy are

---Government Spending

----Taxation

Taxation is the most effective instrument of fiscal policy in curbing the

increased demand of consumer goods. Direct taxes curtail consumption of
higher income groups while indirect taxes on goods reduce the consumption
of the low income
groups as well. Thus the government is able to transfer resources through
taxation from private consumption to public investment

Fiscal policy refers to the overall effect of the budget outcome on

economic activity. The three possible stances of fiscal policy are neutral,
expansionary and contractionary:

• A neutral stance of fiscal policy implies a balanced budget where G = T

(Government spending = Tax revenue). Government spending is fully
funded by tax revenue and overall the budget outcome has a neutral
effect on the level of economic activity.

• An expansionary stance of fiscal policy involves a net increase in

government spending (G > T) through rises in government spending
or a fall in taxation revenue or a combination of the two. This will lead
to a larger budget deficit or a smaller budget surplus than the
government previously had, or a deficit if the government previously
had a balanced budget. Expansionary fiscal policy is usually associated
with a budget deficit.

• A contractionary fiscal policy (G < T) occurs when net government

spending is reduced either through higher taxation revenue or reduced
government spending or a combination of the two. This would lead to
a lower budget deficit or a larger surplus than the government
previously had, or a surplus if the government previously had a
balanced budget. Contractionary fiscal policy is usually associated with
a surplus.

India fiscal policy—Over view

 India faced a severe macroeconomic crisis in 1991. A series of economic
reforms, implemented in response, have, arguably, supported higher growth
and a more secure external payments situation. At times, structural reforms
seem to have stalled, and little progress has been made in areas such as
labor market and bankruptcy reforms. Perhaps the most striking aspect of
reform is the lack of progress in restoring fiscal balance. A high fiscal
deficit of around 9.5% of GDP, widely perceived as unsustainable,
contributed to the crisis of 1991. India’s current fiscal situation is potentially
grave, and could lead to an economic crisis (fiscal, monetary and/or external)
with severe short-term losses of output and even political turmoil, or,
alternatively and more subtly, many years of continued underperformance of
the economy. The prima facie solution to the looming problem is obvious:
control fiscal deficits. One complicating factor is the existence of off-budget
items that are not accurately measured or monitored. The uncertainty
associated with these items makes formulating budgetary policies more
challenging. Besides, fiscal policy obviously cannot be analyzed in isolation.
Monetary and exchange rate policies have to be considered in conjunction
with it. Beyond projecting aggregate outcomes of (e.g., revenue,
expenditure) India’s fiscal policy adjustment, there are issues of
distributional impacts and hence of politics.

Crisis resolution is almost always contentious as well as painful. For

example, crises in Argentina and Indonesia have had very high economic and
social costs. India, at least for the moment, does not appear to face an
imminent crisis, especially on the external front. Since crises very often arise
from adverse shifts in expectations or confidence than from deterioration in
fundamentals, this favorable situation could change rapidly if there is a
negative shock that affects confidence. Comparing the 2001-02 actual figures
with the Tenth Plan average targets (the first and last rows in the below
table) indicates that the goal is reduction of the Central and State gross
deficits by 1.2 and 1.3 percentage points respectively. The Plan envisages
substantial cuts in revenue deficits as the avenue for achieving the required
fiscal deficit reductions. The Center’s revenue deficit is supposed to be
reduced from 4.2% of GDP in 2001-02 to an average of 2.9% the Plan
period, while the corresponding figures for the States are 2.5%, and 1.3%

Recently, various income transfer and social insurance schemes that reach
into rural areas and the informal sector of the economy have been
announced. While the objectives of such policies are laudable, they introduce
yet additional demands on the budget, which will be difficult to reverse, as
they become viewed as entitlements. Srinivasan (2002) and Rajaraman
(2004) emphasize that the Pay Commission award was not an exogenous
shock, but one that was predictable in the context of institutional and
political economy considerations. Thus, one can argue that pay, pensions and
social insurance are all areas in which there is virtually no uncertainty about
their future costs so that the government will have to do long term planning.
While we have suggested that the broad outlines of technical solutions to
India’s short run fiscal problems are well understood, leaving only the
political difficulties of implementation, in the case of long-term budgetary
commitments, there seems to be a need for an integrated analysis of the
various possibilities. For example, the last Pay Commission award was
followed by increases in the pensions of those who had already retired –
while such ex post adjustments may again have laudable motives, they
represent a contingency that must be allowed for in projecting the future
liabilities of the government. The announcement in the interim budget for
2004-05 of the merger of 50% of dearness allowance of civil servants into
their basic salary is not a good signal. Even more broadly, India’s federal
system needs to develop revenue assignments and authorities that match
expenditure responsibilities more closely. This, in general, can be a positive
step in controlling fiscal laxity. We may note here that in addition to altering
the pattern of existing assignments, some long-run progress may also be
made by redrawing the boundaries of the larger States. In general,
therefore, looking at the longer term and at broader public welfare concerns
can have three benefits. First, it allows for better inter temporal planning of
public expenditures within and across categories. Second, it improves the
pattern of near-term public expenditures toward spending that reduces the
chances of larger expenditures in the future. Third, it emphasizes the need
for a fiscal cushion or self-insurance to meet unavoidable expenditures
should they occur in the future. India’s fiscal situation requires immediate
attention: high growth and low interest rates will not take care of the
problem of long run sustainability of the debt, nor the risks of a crisis in the
short or medium run. However, high reserves and a conservative monetary
policy may not be sufficient insurance against a crisis of confidence. There
are theoretical reasons and previous empirical evidence of high domestic
debt and deficits being associated with such a crisis. Furthermore, there are
numerous potential sources of risk, including interest rate volatility, as well
as exogenous shocks.

One can simply state that there needs to be some short run fiscal
adjustment, otherwise the probability of a crisis or collapse may soon
increase dramatically. Furthermore, there are some obvious expenditure
adjustments that can be made, such as cutting or overhauling poorly
designed subsidies, and at least improving the efficiency of government
expenditures. There are also some steps that can be taken to enhance
revenues while simultaneously cutting distortions in the tax system, including
improving the efficiency of tax collection.

5.Comment on the consequences of environmental degradation on the

economy of a community.
Ans

Environmental degradation is the deterioration of the environment

through depletion of resources such as air, water and soil; the destruction of
ecosystems and the extinction of wildlife.

Environmental degradation is one of the ten threats officially cautioned

by the High Level Threat Panel of the United Nations. The World Resources
Institute (WRI), UNEP (the United Nations Environment Programme), UNDP
(the United Nations Development Programme) and the World Bank have
made public an important report on health and the environment worldwide.

Environmental degradation is of many types. When natural habitats

are destroyed or natural resources are depleted, environment is degraded.

If vast improvements are made in human health, millions of people

will be living longer, healthier lives than ever before. In these poorest regions
of the world an estimated one in five children will not live to see their fifth
birthday, primarily because of environment-related diseases. Eleven million
children die worldwide annually, equal to the combined populations of
Norway and Switzerland, and mostly due to malaria, acute respiratory
infections or diarrhoea — illnesses that are largely preventable.

Thus the rural poor face an increasing challenge to meet their basic
needs, the most basic of which is food security. This situation is exacerbated
by ongoing environmental impoverishment, which may in turn lead to a loss
of forest products, the depletion of soil nutrients, the pollution of soils and
the contamination of water. The impact of these problems is especially felt by
rural women, whose livelihood depends on access to natural resources, which
are the factors of production.

Inequalities between the sexes in access to resources, entitlements

and in the division of labour in the household, have made women the poorest
of the poor. Poor women have:

· fewer social, economic, constitutional/legislative and political rights,

including rights of access to such essentials as food, health care and
education

· reduced access to labour markets and lower economic returns for

their work
 · fewer legal and customary rights over land, property, water, credit
and other productive resources, such as energy, technology and
information

· multiple burdens, including economic contributions through their

productive work, resource management and conservation, household
and community responsibilities, as well as the care of children and the
elderly

This already unfair situation is worsened when increasing

impoverishment leads to male migration or even abandonment, leaving
women to manage the livelihood of their families entirely on their own. If the
expected remittances from the migrating male family members do not come,
the family suffers increased chances of falling into debt. These women and
their families are among the most likely to become destitute, and it is no
coincidence that women number over 60 percent of the absolutely poor and
destitute in rural areas.

Poverty is a state of resource deprivation relative to basic needs. In

rural areas, if one has little access to land or other capital resources, labour
becomes the only asset that can be sold or mobilised through work, and by
the reproduction of children. Research indicates that the relatively higher
fertility rate found in the rural sector is often a response on the part of the
rural population to impoverishment on the one hand, and high infant and
child mortality on the other. In shoe, the poor tend to have more children
because they are poor and because more of their children die before reaching
maturity (see, for example, Caldwell 1982, Ruzicka 1984, and Handwerker
1986).

For the poor, the family is the significant unit of economic production.
The labour of its members is maximised and pooled through the family. This
mode of organising labour at the micro level shapes gender relations and the
role of women as the biological reproducers of labour High infant and child
mortality thus constitutes a compounding factor that further spurs fertility
towards the goal of labour maximisation. This is especially so for smallholder
agricultural producers and landless rural workers. In their labour-intensive
mode of production, children are producers, labour recruits, workers,
parental investments for upward social mobility, and pension providers for
the elderly family members.

Such coping strategies at the micro level, however, inevitably have

consequences at the macro level because the maintenance, or increase, of
high fertility further degrades limited environmental resources. It is clear that
macro-level planning for sustainable development must thus necessarily
address the micro-level needs of poor households, especially those of poor
women. If sustainable development is to be achieved, such planning must
also address the serious imbalances between urban and rural areas.

The unequal distribution of development resources between the rural

and urban sectors deprives the rural population of the determinants of
general well-being, including:

· access to health care services

· adequate nutrition

· potable water

· decent sanitation

· adequate rest and relief from hard physical labour and drudgery

The excessively high mortality rates among the rural population are a
result of unequal life chances between rural and urban populations, and
between rich and poor. The rural population's poor health conditions account
for the higher infant and child mortality rates as compared to those of the
urban population.
 All these badly effect the total economy of the community.

Rapid industrialization has become one of the main objectives in recent

years. Industrial development and economic development are used as
synonymous words today. Industrialization has brought several benefits to
the man kind and accelerated the process of economic development. At the
same time, it has posed several challenges to the entire world. Sustainable
economic development has become the major goal in many countries of the
world. It demands higher rates of economic growth with environmental
preservation. Environmental degradation in the process of rapid growth has
become the main concern in recent times. Global warming and damage to
the ozone layer are the talk of the day. There is great need for taking extra
care to maintain ecological balance in the entire world. A healthy globe can
emerge only with a healthy environment. Business has close relationships
with natural environment and business units have greater responsibilities in
this direction. Maintenance of reasonable ecological balance has become one
of the pre-requisite conditions for any business to flourish.

2. Write short notes on the following:

a) Phillips curve
b) Stagflation
Ans.
An economic concept developed by A. W. Phillips stating that inflation
and unemployment have a stable and inverse relationship. According to the
Phillips curve, the lower an economy's rate of unemployment, the more
rapidly wages paid to labor increase in that economy. The theory states that
with economic growth comes inflation, which in turn should lead to more jobs
and less unemployment

In economics, the Phillips curve is a historical inverse relation

between the rate of unemployment and the rate of inflation in an economy.
Stated simply, the lower the unemployment in an economy, the higher the
rate of increase in nominal wages in the economy.
 The Phillips curve equation can be derived from the (short-run) Lucas
aggregate supply function. The Lucas approach is very different from that the
traditional view. Instead of starting with empirical data, he started with a
classical economic model following very simple economic principles.

Start with the aggregate supply function:

where Y is log value of the actual output, Yn is log value of the "natural" level
of output, a is a positive constant, P is log value of the actual price level, and
Pe is log value of the expected price level. Lucas assumes that Yn has a
unique value.

This differs from other views of the Phillips curve, in which the failure to
attain the "natural" level of output can be due to the imperfection or
incompleteness of markets, the stickiness of prices, and the like. In the non-
Lucas view, incorrect expectations can contribute to aggregate demand
failure, but they are not the only cause. To the "new Classical" followers of
Lucas, markets are presumed to be perfect and always attain equilibrium
(given inflationary expectations).

We re-arrange the equation into:

Next we add unexpected exogenous shocks to the world supply v:

Subtracting last year's price levels P-1 will give us inflation rates, because

and
where π and πe are the inflation and expected inflation respectively.

There is also a negative relationship between output and unemployment (as

expressed by Okun's law). Therefore using

where b is a positive constant, U is unemployment, and Un is the natural rate

of unemployment or NAIR U, we arrive at the final form of the short-run
Phillips curve:

This equation, plotting inflation rate π against unemployment U gives the

downward-sloping curve in the diagram that characterizes the Phillips curve.

Stagflation:

Stagflation is an economic situation in which inflation and economic

stagnation occur simultaneously and remain unchecked for a significant
period of time. The portmanteau stagflation is generally attributed to British
politician Iain Macleod, who coined the term in a speech to Parliament in
1965. The concept is notable partly because, in postwar macroeconomic
theory, inflation and recession were regarded as mutually exclusive, and also
because stagflation has generally proven to be difficult and costly to
eradicate once it gets started.

Economists offer two principal explanations for why stagflation occurs.

First, stagflation can result when an economy is slowed by an unfavorable
supply shock, such as an increase in the price of oil in an oil importing
country, which tends to raise prices at the same time that it slows the
economy by making production less profitable. This type of stagflation
presents a policy dilemma because most actions to assist with fighting
inflation worsen economic stagnation and vice versa. Second, both
stagnation and inflation can result from inappropriate macroeconomic
policies. For example, central banks can cause inflation by permitting
excessive growth of the money supply and the government can cause
stagnation by excessive regulation of goods markets and labor markets,
Together, these factors can cause stagflation; equally, either can, if taken to
such an extreme that it must be reversed. Both types of explanations are
offered in analyses of the global stagflation of the 1970s: it began with a
huge rise in oil prices, but then continued as central banks used excessively
stimulative monetary policy to counteract the resulting recession, causing a
runaway wage-price spiral.

Stagflation undermined faith in a Keynesian consensus, and placed

renewed emphasis on microeconomic behavior, particularly neoclassical
economics with its attempt to root macroeconomics in microeconomic
formalisms. The rise of conservative theories of economics, including
monetarism, can be traced to the perceived failure of Keynesian policies to
combat stagflation or explain it to the satisfaction of economists and policy-
makers

Actually it is a condition of slow economic growth and relatively high

unemployment - a time of stagnation - accompanied by a rise in prices, or
inflation. Stagflation occurs when the economy isn't growing but prices are,
which is not a good situation for a country to be in.

ASSIGNMENT
 Name S.AMEER ABBAS

Roll No. 520955311

Course MBA-Semester-1

Subject MANAGERIAL ECONOMICS

Subject Code MB0026-Set-1

1. The demand function of a good is as follows:

Q1=100-6P1-4P2+2P3+0.003Y
WHERE P1 and Q1 are the price and quantity values of good 1
P2 and P3 are the prices of good 2 and good 3 and Y is the
income of the consumer. The initial values are given:
P1 =7
 P2 =15
P3 =4
Y=8000
Q1 =30

You are required to:

a) Using the concept of cross elasticity determine the relationship
between good 1 and others
b) Determine the effect on Q1 due to a 10 % increase in the price of
good 2 and good 3.

2.What are the factors that determine the Demand curve? Explain.
Ans.

In economics, the demand curve is the graph depicting the

relationship between the price of a certain commodity, and the amount of it
that consumers are willing and able to purchase at that given price. It is a
graphic representation of a demand schedule. The demand curve for all
consumers together follows from the demand curve of every individual
consumer: the individual demands at each price are added together.

Demand curves are used to estimate behaviors in competitive

markets, and are often combined with supply curves to estimate the
equilibrium price (the price at which sellers together are willing to sell the
same amount as buyers together are willing to buy, also known as market
clearing price) and the equilibrium quantity (the amount of that good or
service that will be produced and bought without surplus/excess supply or
shortage/excess demand) of that market.

The shift of a demand curve takes place when there is a change in any
non-price determinant of demand, resulting in a new demand curve. A non-
price determinant of demand are those things that will cause demand to
change even if prices remain the same. In other words, what things might
cause a consumer to buy more or less of a good even if the goods own price
remained unchanged. Some of the more important factors are the prices of
related goods (both substitute and complementary), income, population and
expectations. However, demand is the willingness and ability of a consumer
to purchase a good under the prevailing circumstances; so, any relevant
circumstance can be a non price determinant of demand. As an example,
weather could be factor in the demand for beer at a baseball game.

Factors affecting demand curve:

A number of factors may influence the demand for a product, and

changes in one or more of factors may cause a shift in the demand curve.
Some of these factors are:
• Customer preference

• Prices of related goods

a. Complements – an increase in the price of the complement

reduces demand, shifting the demand curve to the right.

b. Substitutes – an increase in the price of a substitute product

increases demand, shifting the demand curve to the right.

• Income - an increase in income shifts the demand curve of normal

goods to the right.

• Number of potential buyers – an increase in population or market size

shifts the demand curve to the right.

• Expectations of a price change – a news report predicting higher prices

in the future can increase the current demand as customers increase
the quantity they purchase in anticipation of the price change.
 • Changes in taste and fashion (changes in preferences) - tastes and
preferences are assumed to be fixed in the short-run. This assumption
of fixed preferences is a necessary condition for aggregation of
individual demand curves to derive market demand.
• The availability and cost of credit
• Population size and composition
• Change in education level
• Change in the geographical situation of buyers - in the basic model
there are no barriers to entry and consumers and factors of production
possess instantaneous mobility.
• Change in climate or weather - e.g. the demand for umbrellas
increases when rain is predicted.

However, this illustrates the constant shifting from practice to theory

and back where the assumptions of the model are relaxed whenever
necessary or convenient. A basic assumption of the standard model is
that all economic factors have perfect knowledge so a consumer would
never leave home without an umbrella on days when it rained.

3.A firm supplied 3000 pens at the rate of Rs 10. Next month, due to a rise
of in the price to 22 rs per pen the supply of the firm increases to 5000
pens. Find the elasticity of supply of the pens.

Ans.

The price elasticity of supply refers to the responsiveness of supply to

a given change in price, with all other factors held constant.

The elasticity of supply, Es

= % change in Supply / % change in Price

Initial Supply = 3000

Final Supply = 5000

% change in supply of pens = 5000 / 3000 = 166.67 %

Initial price = 10

Later price = 22

% change of price = 22 / 10 % = 220 %

Elasticity of supply = 166.67 / 220 = 0.83

4.Briefly explain the profit-maximization model.

Ans.

In economics, profit maximisation is the process by which a firm

determines the price and output level that returns the greatest profit. There
are several approaches to this problem. The total revenue—total cost method
relies on the fact that profit equals revenue minus cost, and the marginal
revenue—marginal cost method is based on the fact that total profit in a
perfectly competitive market reaches its maximum point where marginal
revenue equals marginal cost.

Profit Maximization Model

Profit-making is one of the most traditional, basic and major objectives

of a firm. Profit-making is the driving-force behind all business activities of a
company. It is the primary measure of success or failure of a firm in the
market. Profit earning capacity indicates the position, performance and
status of a firm in the market. It is an acid test of economic ability and
performance of an individual firm. There is no place for a firm unless it earns
a reasonable amount of profit in the business. It is necessary to stay in
business and maintain in tact the wealth producing agents. It is a widely
accepted goal and there is nothing bad or immoral about it. Earlier profit
maximization was the sole objective of a firm. This assumption has a long
history in economic literature and the conventional price theory was based on
this very assumption about profit making. In spite of several changes and
development of several alternative objectives, profit maximization has
remained as one of the single most important objectives of the firm even
today. Both small and large firms consistently make an attempt to maximize
their profit by adopting novel techniques in business. Specific efforts have
been made to maximize output and minimize production and other operating
costs. Costs reduction, cost cutting and cost minimization has become the
slogan of a modern firm.
It helps to predict the price-output behavior of a firm under changing
market conditions like tax rates, wages and salaries, bonus, the degree of
availability of resources, technology, fashions, tastes and preferences of
consumers etc. It is a very simple and unambiguous model. It is the single
most ideal model that can explain the normal behavior of a firm. It is often
argued that no other alternative hypothesis can explain and predict the
behavior of business firms better than profit-maximization hypothesis. This
model gives a proper insight in to the working behavior of a firm. There are
well developed mathematical models to explain this hypothesis in a
systematic and scientific manner.

The model

Profit-maximization implies earning highest possible amount of profits

during a given period of time. A firm has to generate largest amount of
profits by building optimum productive capacity both in the short run and
long run depending upon various internal and external factors and forces.
There should be proper balance between short run and long run objectives.
In the short run a firm is able to make only slight or minor adjustments in
the production process as well as in business conditions. The plant capacity
in the short run is fixed and as such, it can increase its production and sales
by intensive utilization of existing plants and machineries, having over time
work for the existing staff etc. Thus, in the short run, a firm has its own
technical and managerial constraints. But in the long run, as there is plenty
of time at the disposal of a firm, it can expand and add to the existing
capacities, build up new plants, employ additional workers etc to meet the
rising demand in the market. Thus, in the long run, a firm will have adequate
time and ample opportunity to make all kinds of adjustments and
readjustments in production process and in its marketing strategies.

It is to be noted with great care that a firm has to maximize its profits after
taking in to consideration of various factors in to account. They are as
follows-
1. Pricing and business strategies of rival firms and its impact on the
working of the given firm.

2. Aggressive sales promotion policies adopted by rival firms in the

market.

3. Without inducing the workers to demand higher wages and salaries

leading to rise in operation costs.

4. Without inducing the workers to demand higher wages and salaries

government controls and takeovers.

5. Maintaining the quality of the product and services to the customers.

6. Taking various kings of risks and uncertainties in the changing

business environment.

7. Adopting a stable business policy.

8. Avoiding any sort of clash between short run and long run profits in
the business policy and maintaining proper balance between them.

9. Maintaining its reputation, name, fame and image in the market.

10. Profit maximization is necessary in both perfect and imperfect

markets. In a perfect market, a firm is a price-taker and under
imperfect market it becomes a price-searcher.

5.What is Cyert and March’s behavior theory? What are the demerits

Ans.

The behavioural theory, as developed in particular by Richard Cyert

and James G. March of the Carnegie School places emphasis on explaining
how decisions are taken within the firm, and goes well beyond neo-classical
economics. Much of this depended on Herbert Simon’s work in the 1950s
concerning behaviour in situations of uncertainty, which argued that “people
possess limited cognitive ability and so can exercise only ‘bounded
rationality’ when making decisions in complex, uncertain situations.” Thus
individuals and groups tend to ‘satisfice’—that is, to attempt to attain realistic
goals, rather than maximise a utility or profit function. Cyert and March
argued that the firm cannot be regarded as a monolith, because different
individuals and groups within it have their own aspirations and conflicting
interests, and that firm behaviour is the weighted outcome of these conflicts.
Organisational mechanisms (such as ‘satisfying’ and sequential decision-
taking) exist to maintain conflict at levels that are not unacceptably
detrimental. Compared to ideal state of productive efficiency, there is
organisational slack

Richard Cyert and James March were the two “founding fathers” who
introduced one of the disciplines that shaped thinking about organizational
learning over the past decades.

The Cyert and March manuscript outlines a behavioral theory of

organizational learning through the development and research surrounding
the decision making process of the firm.

"Organizations learn by memorizing disturbances and reaction

combinations according to decision variables. Standard operating
procedures are referred to as the memory of the organization. By
learning new combinations of external disturbances and internal
decision-making rules, the organization increases its adaptability to
differing environmental states. Any decision rule that leads to a non-
preferred state at one point is less likely to be used in the future."

Perhaps the aforementioned summarization of Cyert and March’s

behavioral theory of organizational learning is an over simplification of the
theory. Perhaps it clears up the ambiguity that is evident in the variables in
the testing processes of the theory development.

An organization uses information strategically in three arenas:

to make sense of change in its environment;

to create new knowledge for innovation;

and to make decisions about courses of action.

These apparently distinct processes are in fact complementary pieces

of a larger canvas, and the information behaviors analyzed in each approach
interweave into a richer explanation of information use in organizations.
Through sense making, people in an organization give meaning to the events
and actions of the organization. Through knowledge creation, the insights of
individuals are converted into knowledge that can be used to design new
products or improve performance. Finally, in decision making, understanding
and knowledge are focused on the selection of and commitment to an
appropriate course of action.

Demerits:

1. The theory fails to analyze the behavior of the firm, but it simply
predicts the future expected behavior of different groups
2. It does not explain equilibrium of the industry as a whole
3. It fails to analyze the impact of the potential entry of new firms in
to the industry and the behavior of the well established firms in
the market.
4. It highlights only on short run goals rather than long run
objectives of an organisation.

6.What is Boumal’s Static and Dynamic model

Ans.
 Sales maximization model is an alternative model for profit
maximization. This model is developed by Prof. W.J.Boumal, an American
economist. This
alternative goal has assumed greater significance in the context of the
growth of Oligopolistic firms.
The model highlights that the primary objective of a firm is to
maximize its sales rather than profit maximization. It states that the goal of
the firm is maximization of sales revenue subject to a minimum profit
constraint. The minimum profit constraint is determined by the expectations
of the share holders. This is because no company can displease the share
holders.
It is to be noted here that maximization of sales does not mean
maximization of physical sales but maximization of total sales revenue.
Hence, the managers are more interested in maximizing sales rather than
profit. The basic philosophy is that when sales are maximized automatically
profits of the company would also go up. Hence, attention is diverted to
increase the sales of the company in recent years in the context of highly
competitive markets.

In defence of this model, the following arguments are given.

1. Increase in sales and expansion in its market share is a sign of healthy

growth of a normal company.
2. It increases the competitive ability of the firm and enhances its influence
in the market.
3. The amount of slack earnings and salaries of the top managers are directly
linked to it.
4. It helps in enhancing the prestige and reputation of top management,
distribute more dividends to share holders and increase the wages of workers
and keep them happy.
5. The financial and other lending institutions always keep a watch on the
sales revenues of a firm as it is an indication of financial health of a firm.
6. It helps the managers to pursue a policy of steady performance with
satisfactory levels of profits rather than spectacular profit maximization over
a period of time. Managers are reluctant to take up those kinds of projects
which yield high level of profits having high degree of risks and uncertainties.
The risk averting and avoiding managers prefer to select those projects
which ensure steady and satisfactory levels of profits.
Prof. Boumal has developed two models. The first is static model and
the second one is the dynamic model.
The Static Model
This model is based on the following assumptions.
1. The model is applicable to a particular time period and the model does not
operate at different periods of time.
2. The firm aims at maximizing its sales revenue subject to a minimum profit
constraint.
3. The demand curve of the firm slope downwards from left to right.
4. The average cost curve of the firm is unshaped one.
Sales maximization/ dynamic model
In the real world many changes takes place which affects business decisions
of a firm. In order to include such changes, Boumal has developed another
dynamic model. This model explains how changes in advertisement
expenditure, a major determinant of demand, would affect the sales revenue
of a firm under severe competitions.
Assumptions:
1. Higher advertisement expenditure would certainly increase sales revenue
of a firm.
2. Market price remains constant.
3. Demand and cost curves of the firm are conventional in nature.
- Generally under competitive conditions, a firm in order to increase its
volume of sales and sales revenue would go for aggressive
advertisements. This leads to a shift in the demand curve to the right.
- Forward shift in demand curve implies increased advertisement
expenditure resulting in higher sales and sales revenue. A price cut may
increase sales in general. But increase in sales mainly depends on
whether the demand for a product is elastic or inelastic.
- A price reduction policy may increase its sales only when the demand is
elastic and if the demand is inelastic; such a policy would have adverse
effects on sales. Hence, to promote sales, advertisements become an
effective instrument today. It is the experience of most of the firms that
with an increase in advertisement expenditure, sales of the company
would also go up.
- A sales maximizer would generally incur higher amounts of advertisement
expenditure than a profit maximizer. However, it is to be remembered
that amount allotted for sales promotion should bring more than
proportionate increase in sales and total profits of a firm. Otherwise, it will
have a negative effect on business decisions
- Thus, by introducing, a non-price variable in to his model, Boumal makes
a successful attempt to analyze the behaviour of a competitive firm under
oligopoly market conditions. Under oligopoly conditions as there are only a
few big firms competing with each other either producing similar or
differentiated products, would resort to heavy advertisements as an
effective means to increase their sales and sales revenue. This appears to
be more practical in the present day situations.