MB0026: Economics

[Assignment – SET1 & SET2]


Name : P. Srinath SMDUE ID : 520923307 Center : Mehbub College Campus, Secunderabad Subject Code : MB0026 Subject : Managerial Economics

ASSIGNMENT – MBA – SEM I – 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 Cross elasticity can be defined as the proportionate change in the quantity demanded of a particular commodity in response to a change in the price of another related commodity. a) Cross elasticity between good 1 and product 2 = (dQ1/dP2)*(P2/Q1) Cross elasticity between good 1 and product 3 = (dQ1/dP3)*(P3/Q1) Taking the differentiation of the equation: dQ1/dP2 = -4 dQ1/dP3 = 2 Putting the values in the elasticity equation: Cross elasticity between good 1 and product 2 = (dQ1/dP2)*(P2/Q1) = (-4) * (P2/Q1) = (-4) * (15/30)
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= -2 Cross elasticity between good 1 and product 3 = (dQ1/dP3)*(P3/Q) = (2) * (P3/Q1) = (2) * (4/30) = 0.267 b) As per the cross elasticity equation: E = % Change in demand of product A / % Change in price of product B % Change in demand of product A = E * % Change in price of product B Putting the values from % Change in demand of product A due to 10 % increase of good 2 = -2 * 10 = -20% % Change in demand of product A due to 10 % increase of good 3 = 0.267 * 10 = 2.67% 2. What are the factors that determine the Demand curve? Explain. A demand curve is a locus of points showing various alternative prices – quantity combinations. The total quantity demanded at different prices in a market by the whole body consumers at a particular period of time is called market demand schedule. The graphical presentation of the demand schedule is called as a demand curve. It represents the functional relationship between quantity demanded and prices of a given commodity. The demand curve has a negative slope or it slope downwards to the right. The negative slope of the demand curve clearly indicates the quantity demanded goes on increasing as price falls and vice versa. Law of demand: “Other things being equal, a fall in price leads to expansion in demand and a rise in price leads to contraction in demand”. The factors that determine the Demand curve are as follows:• Price of the given commodity, prices of other substitutes and complements, future expected trends in price etc. • General Price level existing in the country -inflation or deflation. • Level of income and living standards of the people.
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• • • • • • • • • • • •

Size, rate of growth and composition of population. Tastes, preferences, customs, habits, fashion and styles. Publicity, propaganda and advertisements. Quality of the product. Profit margin kept by the sellers. Weather and climatic conditions. Conditions of trade-boom or prosperity in the economy. Terms and conditions of trade. Governments’ taxation policy, liberal or restrictive measures. Level of savings and pattern of consumer expenditure. Total supply of money circulation and liquidity preference of the people. Improvements in educational standards.

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? Price elasticity of demand is a ratio of two pure numbers, the numerator is the percentage change in the quantity demanded and the denominator is the percentage change in price of the commodity. It is measured by the following formula: Ep = Percentage change in quantity demanded/ Percentage changed in price Applying the provided data in the equation: Percentage change in quantity demanded = (5000 – 3000)/3000 Percentage changed in price = (22 – 10) / 10 Ep = ((5000 – 3000)/3000) / ((22 – 10)/10) = 1.2

4. Briefly explain the profit-maximization model? Profit- making is one of the traditional, basic and major objectives of a firm. Profit- motive is the driving force behind all business activities of a
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company. It is the primary measure of success or failure of a firm in the market. Profit-maximization implies earning highest possible amount of profits during the given 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 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. There are various factors that contribute to the maximization of profits of a firm. Some of them are listed below:• Pricing and business strategies of rival firms and its impact on the working of the given firm. • Aggressive sales promotion policies adopted by rival firms in the market. • Without inducing the workers to demand higher wages and salaries leading to rise in operation costs. • Without resorting to monopolistic and exploitative practices inviting government controls and takeovers. • Maintaining the quality of the product and services to the customers. • Taking various kinds of risks and uncertainties in the changing business environment. • Adopting a stable business policy. • Avoiding any sort of clash between short run and long run profits in the business policy and maintaining proper balance between them. • Maintaining its reputation, name, fame and image in the market.
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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.

Assumptions of the model:The profit maximization model assumptions. They are as follows:• •






Profit maximization is the main goal of the firm. Rational behavior on the part of the firm to achieve its goal of profit maximization. • The firm is managed by owner-entrepreneur 5. What is Cyert and March’s behavior theory? What are the demerits? Cyert and March’s behavior makes an attempt to explain the behavior of inter group conflicts and their multiple objectives in an organization. Basically, this theory explains the usual and normal behavior of different groups of people who work in an organization having mutually opposite goals. Cyert and March explain how complicated decisions are taken in big industrial houses under various kinds of risks and uncertainties in an imperfect market in the background of limited data and information. The organizational structure, goals of different departments, behavioral pattern and internal working of a big and multi-product firm differs from that of small organizations. The various kinds of internal conflicts and problems faced by these organizations. They also explain how there are certain common problems faced by similar organizations in an industry and their effects on internal working of each individual organization and their decision making process. Cyert and March consider that a modern firm is a multi-product, multigoal and multidecision making coalition business unit. Like a coalition government, it is managed by a number of groups. The group consists of share holders, managers, workers, customers, suppliers, distributors, financiers, legal experts and so on. Each group is independent by itself and has its own set of objectives and they try to maximize their individual benefits. Cyert and March points out the goals of a business organization would depend upon the multiple objectives of each group and their collective demands. Demands of each group would depend on their aspirations
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levels, expectations, actual performance of the organization, bargaining power of each group, past success in their demands, etc. As all of them change over a period of time, the demands of each group would all of them change over a period of time, the demands of each group would also undergo changes. If actual performance and achievements of the organization is much better than expected aspirations and target level, in that case, there will upward revision in their demands and vice-versa. Thus, there is a strong linkage between the expected and actual demand of each group in the organization, past success and future environment. Each group makes an attempt to achieve its demand in its own way. Cyert and March are of the opinion that out of several objectives a firm has five important goals. They are:Production goal: Production is to be organized on the basis of demand in the market. Neither there should be over production nor under production but just that much to meet the required demand in the market, avoid excess capacity, over utilization of capital assets, lay-off of workers etc. Inventory goal: Inventory refers to stock of various inputs. In order to ensure continuity in production and supply, certain minimum level of inventory has to be maintained by a firm. Neither there should be surplus stock or shortage of different inputs. Proper balance between demand and supply should be maintained. Sales goal: There should be adequate sales in any organization to earn reasonable amounts of profits. In order to create demand, sales promotion policies may be adopted from time to time. Market-share goal: Each firm has to make consistent effort to increase its market share to compete successfully with other firms and make sufficient profits. Profit goal: This is one of the basic objectives of any firm. The very survival and success of the firm would depend upon the volume of profits earned by it. The above mentioned objectives also would undergo changes over a period of time in the background of modern business environment. Hence, decision making would become complex and complicated.
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The demerits are as follows:• The theory fails to analyze the behavior of the firm but it simply predicts the future expected behavior of different groups. • It does not explain equilibrium of the industry as a whole. • It fails to analyze the impact of the potential entry of the new firms into the industry and the behavior of the well established firms in the market. • It highlights only on short run goals rather than long run objectives of an organization. Thus, there are certain limitations to this theory. 6. What is Boumal’s Static and Dynamic? 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. Maximization of sales does not mean maximization of physical sales but maximization of total sales revenue. Hence, the managers are more interested in increasing the sales rather than profit. The basic philosophy is that when sales are maximized automatically profits of the company would also go up. Prof. Boumal has developed two models. The first is static model and the second one is the dynamic model. The Static model:The model is based on the following assumptions. • The model is applicable to a particular time period and the model does not operate at different periods of time. • The firm aims at maximizing its sales revenue subject to a minimum profit constraint. • The demand curve of the firm slope downwards from left to right. • The average cost curve of the firm is U-shaped one.

Sales Maximization (dynamic model):8|Page
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Many changes take place which affects business decisions of a firm. In order to include such changes, Boumal developed 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. This model is based on certain assumptions. They are as follows:• Higher advertisement expenditure would certainly increase sales revenue of a firm. • Market price remains constant. • Demand and cost curves of the firm are conventional in nature. 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. By introducing, a non-price variable into this model, Boumal makes a successful attempt to analyze the behavior 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.

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ASSIGNMENT – MBA – SEM I – Subject Code: MB0026 – SET 2
7. What is pricing policy? What are the internal and external factors of the

Pricing Policies Pricing Policies refer to the policy of setting the price of the product or product & services by the management after taking into account of various internal and external factors, forces and its own business objectives. The decision of pricing is very important in any business. Price

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once fixed is never permanent. It needs to be reviewed and revised according to the market conditions. Internal factors which can affect the pricing decisions of the company include suppliers, employee’s efficiency, profit margin, production cost and other expenses, brand image and expectations of the company. Suppliers provide the raw materials to the company and good relations with suppliers can make the company to buy quality products at reasonable prices. Employees' efficiency can also reduce the costs of the company and company can charge lower prices. Product cost also determines the prices of the products because all of the companies have to cover up the product costs. Moreover, image of the company also plays an important role in the price decisions of the company because a global brand will usually charge premium prices. On the other hand, the external factors include government policies, competitors' prices, costs of raw materials, consumer’s expectations and demand and supply of the product. Government sets the price floors to save the interest of the borrowers and the sellers, therefore, government policies should be also take into consideration. Expectations of the consumers or consumer reservation prices are also considered in the price decisions. Costs of raw materials in the market also determine the pricing strategies. Moreover, the prices offered by the competitors can also impact the pricing decisions of the company. 8. Mention three crucial objectives of price policies. Price policy has certain objectives:•

To maximize profits: - Every firm tries to maximize their profits. So they should have a price policy, which fetches them maximum revenue. Every firm should have a price policy keeping the long run prospects in mind. Price Stability: - Always fluctuating price is not for the goodwill of the company. A stable price always wins the confidence of customers. Ability to pay: - The price should be fixed according to the ability of consumer to pay; high price for rich customers and low for poor

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customers. This can be applied in case of services given by doctors, lawyers etc. 9. Mention the bases of price discrimination. PRICE DISCRIMINATION The monopoly seller has the advantage of price discrimination, as he is the only producer in the market. Price discrimination is charging different price to different buyer for the same product. DEGREES OF PRICE DISCRIMINATION 1. First degree price discrimination – It is also called perfect price discrimination, as it involves maximum exploitation of the consumer in the interest of the seller. It happens when the seller is able to sell each unit separately and at a different price. Each buyer is made to pay the amount he is willing to pay rather going without it. The seller will make different bargain with each buyer. Such type of price discrimination enjoyed by the seller is called first degree price discrimination. 2. Second degree price discrimination – It happens when the monopoly seller will charge separate price in such a way that the buyer is divided into different groups according to the price elasticity of demand for his product. 3. Third degree price discrimination – When the seller will be divided into sub-market and charge different price depending on the output sold in the market and the demand condition of that sub-market. The seller practising price discrimination between the domestic market and international market, the seller will charge higher price in the domestic market, where he enjoys monopoly and charge low price in the international market, where he has to face more competition.

10. What do you mean by the fiscal policy? What are the instruments of fiscal policy? Briefly comment on India’s fiscal policy. Fiscal policy is a policy, which affects aggregate output, employment, saving, investment etc. A responsible government would contain its
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expenditure within its revenue and thus making the budget balanced. The instruments of Fiscal Policy are Automatic Stabilizer and Discretionary Fiscal Policy: i) Automatic Stabilizer: The tax structure and expenditure are programmed in such a way that there is increase in expenditure and decrease in tax in recession and decrease in expenditure and increase in tax revenue in the period of inflation. It refers to built-in response to the economic condition without any deliberate action on the part of government. It is called built- in- stabilizer to correct and thus restore economic stability. It works in the following manner, Tax revenue: Tax revenue increases when the income increases; as those who were not paying tax go into the higher income tax bracket. When there is depression, the income decreases and many people fall in the no-income-tax bracket and the tax revenue decreases. ii) Discretionary Fiscal Policy: Under this, to stabilize the economy, deliberate attempts are made by the government in taxation and expenditure. It entails definite and conscious actions. Instruments of Fiscal Policy: Some important instruments of fiscal policy are:1. TAXATION: Taxation is always a very important source of revenue for both developed and developing countries. Tax comes under two heading –Tax on individual (direct tax) and tax on commodity (indirect tax or commodity tax).Direct tax includes income tax, corporate tax, taxes on property and wealth. Indirect tax is tax on the consumptions. It includes sales tax, excise duty and custom duties. Direct tax structure can be divided into three bases1. Progressive tax 2. Regressive tax 3. Proportional tax Progressive tax: Progressive tax says that higher the level of income, greater the volume of tax burden you have to bear. This means as income increases, the tax contribution should also increase. Low income group people pay low tax, whereas the high income group people pay higher tax. Regressive tax: It is theoretically possible, though no government implements such tax structure, because that leads to unequal distribution of income. As your income increases, the contribution through tax decreases. Low income people will pay more and high income people will pay less.
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Proportional tax: When the tax imposed is irrespective of the income you earn, every income group, high or low pay the same amount of tax. 2. INDIRECT TAX OR CONSUMPTION TAX: Indirect tax differs from direct tax. Tax which is imposed on every unit of product is known as lump sum tax. E.g. excise tax and sales tax. Taxes depending on the value of particular product are called ‘ad valorem tax’ e.g. tax on airline tickets. A good tax structure has to control and bring stability in economic system. There are few requirement of a good tax structure. They are – • The revenue earned through tax structure should be adequate. • The distribution of tax burden should be equal. • Administration cost should not be more than revenue earned. • Tax burden should be borne by the person who is taxed. 11. Comment on the consequences of environmental degradation on the economy of a community. Environmental Degradation For sustainable economic growth, the environment should be properly preserved and improved. The stocks may remain constant or it can even rise but the environment resources are the base of the country and the quality of air, water and land represents the heritage of a nation. The environment damages in the developing countries are the main concern nowadays. Environmental damages can be in these categoriesWater pollution The water quality is continuously deteriorating due to contamination from the industrial waste, by throwing out chemical waste and heavy metal in the river. It is difficult to remove the pollutants form the water to make it good for drinking purpose. The capacity of the water to preserve the aquatic life is becoming more and more difficult. The under ground water is also getting affected by the industrial waste, as they some times get discharged directly into underground water. Air pollution Air pollution can be contributed to the three man made sources, industrial production, vehicles and the energy. Human suffering increases due to the air pollution. Respiratory disorders and cancers are due to inhalation of polluted air. The vehicle increases the sulpur dioxide
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concentration in the air creating breathing problems for the children and affects their neurological developments. Deforestation Forest is the most important source to protect environment. They protect soil erosion and regulate the ecological balance of the nature. They i affect the nature and the climatic condition of the region. The blind increase in the industrial growth is leading to cutting down of many forest leading to many serious problems for the human being. 12. Write short notes on the following: a) Philips curve b) Stagflation a) Philips curve Philips Curve describes the relationship between inflation and unemployment in an economy. New Zealand-born economist A.W Philips first put this theory forward in 1958 gathered the data of unemployment and changes in wage levels in the UK from 1861 to 1957. He observed that one stable curve represents the trade-off between inflation and unemployment and they are inversely/negatively related. In other words, if unemployment decreases, inflation will increase, and vice versa.

• For example, after the economy has just been in recession, the unemployment level will be fairly high. This will mean that there is a labor surplus.
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• As the economy has just started growing, the aggregate demand (AD) will increase and therefore leading to an increase in employment. In the beginning, there will be little pressure for a raise in wages. However, as the economy grows faster and more people are employed, wages will start rising slowly. b) Stagflation Stagnation + Inflation = Stagflation Stagnation = Slow or no growth. Inflation = Rises in price. Stagflation is an economic trend in which inflation and unemployment rise while general growth of the economy is slow. It can be difficult to correct stagflation, because focusing on one aspect of the problem can exacerbate other aspects. Many governments try to avoid stagflation through fiscal policy, by promoting even and healthy growth and attempting to prevent inflation. If stagflation continues long enough, it will trigger an economic recession and an ultimate self-correction. Stagflation is when the economy experiences slow GDP growth (stagnation) with high inflation and high level of unemployment. This occurred in the 1970's in many countries. When the economy is working normally, slow economic growth reduces demand, which keeps prices low, preventing inflation. Stagflation can only occur when fiscal or monetary policy sustains high prices, and inflation, despite slow growth. Stabilization policies to control stagflation. • The money supply should be tightened to check inflation. • We can control inflationary wage and price increases with direct controls. Government can limit increases by law or constrain them through tax policies. • Protect people against the effects of inflation. All wages, including the minimum wage, could be increased automatically when the Consumer Price Index increases. Government bonds could pay a fixed real interest rate by adjusting the actual interest rate for inflation. Stagflation is difficult to control without government controls. Therefore, political will is necessary for formulating the measures to stop stagflation.
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