Final Term Examination

Course Title:    Managerial Economics

Student Name:  SUNAINA SHEIKH
Student Registration/roll No: 1807192
Class/Session:  BBA VI (C)   
EVENING
Semester: VI
Date of submission: 18- March-2021
Faculty Name:  MISS SANA

 
 1. What are the concepts of Firm, Explain its existence?
Answer: The Concepts of Firm and its existence:
The concept of firm consists of a number of economic theories that
describe the nature of the firm, company, or corporation, including its
existence, behavior, structure, and relationship to the market.

Traditionally firm is considered as the integration of resources that are

being converted to the products as per the demand of the customers. The
cost incurred by the Firm in converting the resources in to product depends
on the technology used and the amount of the products produced. The
prices fixed for such products are influenced by the forces of market. The
difference between the revenue and the cost of the firm is termed as the
profit for the firm. But the modern theory believes in the existence of firm.
The main focus of the modern theory is on the questions such as why the
firm performs certain functions internally and other function with the help of
the market. The size of firm are also put on question mark by such theories
as the size is not being decided by the technological factors. Within its
dealing with the market, the firm incurs transaction cost, which is incurred
when the firm enters in contract with other entities. The transaction cost is
high when the opportunistic behavior is shown by either party which means
that one party efforts to take the advantage of the other party. Thus it could
be said that firm efforts to minimize its cost that are incurred within its
transactions with the market through minimizing the internal cost.

A. What Is the Theory of the Firm in Managerial Economics?

The Theory of Firm in Managerial Economics:

In neoclassical economics, the theory of the firm is a microeconomic
concept that states that a firm exists and make decisions to maximize
profits. ... Modern takes on the theory of the firm sometimes distinguish
between long-run motivations, such as sustainability, and short-run
motivations, such as profit maximization.

B. What are various theories of firm, Describe any two also draw
the model?
Model

Theories of Firm:
The following points highlight the three main theories of firm. The
theories are:

1. Profit-Maximizing Theories 

2. Other Optimizing Theories

3. Non-Optimizing Theories

Profit-Maximizing Theories 
The traditional objective of the business firm is profit-maximization.
The theories based on the objective of profit maximization are derived
from the neo-classical marginalist theory of the firm.

The common concern of such theories is to predict optimal price and

output decisions which will maximize profit of the firm. We have
already discussed these decisions in relation to the different forms of
competitive structure from pure (perfect) competition at one end of
the spectrum to monopoly at the other.

In essence the theories based on the profit- maximization goal

suggests that firm seeks to make the difference between total
revenue (or sales receipt) and total cost (outgo) as large as possible.

Other Optimizing Theories

There are various alternative approaches to profit maximization. Here
we restrict ourselves to the most important ones.

Baumol’s Single Period Sales (Revenue) Maximization subject to

Profit Constraint:

One alternative to profit maximization has been suggested by W.J.

Baumol that firms operating in oligopoly will seek to maximize sales
revenue subject to a profit constraint.

His argument is largely, if not entirely, based on “public statements by

businessmen and on a number of a priori arguments as to the
disadvantages of declining sales, for example, fear of customers
shunning a less popular product, less favourable treatment from
banks, loss of distributors and a poorer ability to adopt a counter
strategy against a competitor.”

2. Define market Structure?

Answer: Definition of Market Structure
The Market Structure refers to the characteristics of the market either
organizational or competitive, that describes the nature of competition and the
pricing policy followed in the market.

Thus, the market structure can be defined as, the number of firms producing
the identical goods and services in the market and whose structure is
determined on the basis of the competition prevailing in that market.

The term “market” refers to a place where sellers and buyers meet and
facilitate the selling and buying of goods and services. But in economics, it is
much wider than just a place. It is a gamut of all the buyers and sellers, who
are spread out to perform the marketing activities.

3. Explain types of Market, Explain each of the following?

Answer: Types of Market:
1. Physical Markets - Physical market is a set up where buyers can
physically meet the sellers and purchase the desired merchandise
from them in exchange of money. Shopping malls, department stores,
retail stores are examples of physical markets.
2. Non Physical Markets/Virtual markets - In such markets, buyers
purchase goods and services through internet. In such a market the
buyers and sellers do not meet or interact physically, instead the
transaction is done through internet. Examples - Rediff shopping,
eBay etc.
3. Auction Market - In an auction market the seller sells his goods to
one who is the highest bidder.
4. Market for Intermediate Goods - Such markets sell raw materials
(goods) required for the final production of other goods.
5. Black Market - A black market is a setup where illegal goods like
drugs and weapons are sold.
6. Knowledge Market - Knowledge market is a set up which deals in
the exchange of information and knowledge based products.
7. Financial Market - Market dealing with the exchange of liquid assets
(money) is called a financial market.

4. Which economic principle is related to supply and demand?

Answer: Principle related to Supply and Demand:

 The scarcity principle is an economic theory that explains the price
relationship between dynamic supply and demand.
 According to the scarcity principle, the price of a good, which has low
supply and high demand, rises to meet the expected demand.
 Marketers often use the principle to create artificial scarcity for a
given product or good—and make it exclusive—in order to generate
demand for it.
 5. What is application of Demand and Supply?

Answer: Application of Demand and Supply

 1. Price Control:
Sometimes the government may think it necessary to interfere in the
market process and set maximum (low) price limits for some basic goods.
These are known as price ceilings. Producers of such goods cannot charge
prices higher than the ceiling prices i.e., the maximum prices fixed by the
government.

Price ceilings are generally imposed on many essential consumer goods

during war or other critical inflationary periods to prevent them from rising
above a certain level.

In the case of such commodities, the maximum prices fixed by the

government are below the equilibrium price. At a price lower than the
equilibrium price, the quantity demanded is more than the quantity supplied
which leads to the shortage of the commodity. This necessitates the
introduction of rationing by the government whereby restriction is imposed
on the quantity of a good that a consumer can buy.

A price ceiling can be illustrated by the normal demand and supply curves.
In Fig. 3, D and S are demand and supply curves respectively. They
intersect at point E where OP is the equilibrium price and OQ equilibrium
quantity.

If the government regards the equilibrium price as too high, it may fix a
ceiling price at OP1 .This will result in a shortage of the good equal to
Q2 Q1 because OP, price indicates excess demand (O Q1) over OQ2 supply.
In this situation, the government may find it necessary to introduce
rationing so that the limited goods may be allocated among all the buyers
who want them.
 2. Black Market:

Black market of a commodity is the market in which a commodity is sold

illegally by the sellers at a price higher than the controlled legal maximum
price or ceiling price. It develops on account of excess demand in the
market. Some buyers are prepared to pay a higher price for procuring more
quantity of the commodity. Sellers are also interested in the black market to
sell the products at higher prices and earn more profits.

The working of black market is shown in Fig. 4 where D and S are demand
and supply curves. They intersect at point E and determine OP market
price and OQ market quantity. But the available quantity of the product is
OQ1 due to OP2 price ceiling. But the demand is OQ2 and Q2 Q1 is the
shortage of the commodity.
Therefore, the buyers are ready to offer OP 1 price for procuring more units
of the commodity. If the total quantity OQ1 is sold in the black market, the
total amount paid by the consumers will be OP1 BQ1 But the receipts of the
producers will only be OP2 AQ1 because of the price ceiling.
Thus, the amount OP1 BO1 – OP2 AO1 = P BAP2 will be the extra gain of
black marketers shown by the shaded area. However, the entire supply is
generally not sold in the black market, because of price laws.

  3. Consumer’s Surplus and Producers’ Surplus:

Demand and supply analysis is very helpful in knowing consumer’s surplus

and producer’s surplus. Consumer’s surplus is the difference between the a
total value that consumer is willing to pay and the payment that they
actually makes for the purchase of that product. The total value that a
consumer is willing to pay is the area under the demand curve.

On the other hand, what he actually pays is the market price line.
Producer’s surplus is the area above the supply curve and below the
market price line. It is the difference between the actual amount that a
producer receives by selling a given quantity of a commodity and the
minimum amount that he expects to receive for its same quantity.

In Fig. 5, DD1 is the demand curve and SS1 is the supply curve. Both
intersect at E and determine OP price and PE is the market price line. OQ
is the equilibrium quantity. The consumer’s surplus on OQ units of the
product is the area EPD and the producer’s surplus on the same units of
the product is ESP. The sum of consumer’s and producer’s surplus will be
the maximum, when the market structure is perfectly competitive.
  4. Minimum Wage Legislation:

Fixation of minimum wages by the government can also be shown by

demand-supply analysis. Fixing minimum wages by the state for sweated
trades tends to remove exploitation of labor.

Minimum wages will so increase the incomes of workers that their

consumption expenditures will increase which will, in turn, lead to
expansion of the consumer’s goods industries and to the capital goods
industries. This will increase employment, output and national income.

Figure 6 illustrates the effects of fixing the minimum wage above the
competitive level. It shows the determination of the equilibrium wage rate
OW1 when the demand and supply curves for labor DL and SL respectively
intersect at point E.
At this wage rate, ON of labor is employed. Suppose the government fixes
a minimum wage of OW2 which is higher than the competitive wage
OW1. The increase in the price of labor to OW2 reduces the demand for
labor to ON2 But the supply of labor increases to ON1 with the fixation of the
higher minimum wage. This excess supply over the demand for labor leads
to N2 – N1 unemployment.
 6. Subsidy:

When the government feels that the market price for the farm product is too
low for the farmers, it decides to pay them a subsidy. They will receive it in
addition to the market price. A subsidy is a government grant given to
producers to reduce the price per unit of a product.

This is to encourage the farmers to produce more which will, in-turn reduce
the market prices. The benefits shift from the producers to the buyers which
depend on the elasticity of demand and supply.

Subsidy shifts the supply curve downward to the right. This is illustrated in
Figure 7 where demand and supply curves are D and S respectively. They
intersect at point E. OP is the equilibrium price and OQ equilibrium
quantity.

The government decides that the farmers should get a price of OP 2 for their
product. Accordingly if a subsidy equal to BC is granted, the supply curve
shifts downward to the right to S1 .The new equilibrium is at C. OP1 is the
new equilibrium price and OQ1 the new equilibrium quantity.
Thus, as a result of the subsidy, the price falls to OP 1 and the quantity rises
to OQ1 .The benefit to consumers is equal to PP 1 .They can buy more
quantity OQ1 at a lower price OP1 The benefit to producers is equal to
P1P2 .The subsidy paid by the government is equal to the sum of the
benefits of consumers and producers the shaded area P 1P2BC.
6. Taxation:

The demand and supply analysis is applicable to the problem of incidence

of indirect taxation. The incidence of a tax involves the process of transfer
from the person on whom the tax is imposed initially to the ultimate
taxpayer who bears the money burden of the tax.

The incidence of commodity taxation is shared between the buyers and

sellers in the ratio of the elasticity of supply of the taxed commodity to the
elasticity of demand for it.  

Es/Ed = Incidence on Buyers/Incidence on Sellers

This is explained diagrammatically in Figure 8. Let D be the demand curve
and S be the supply curve of the commodity before the tax is levied. OQ
quantity of the commodity is sold and bought at QA (=OP) price.

Suppose an excise duty equivalent to ET is imposed on per unit of the

commodity, which is collected from the sellers. As a result, the supply curve
shifts upward as S1 and the price of the commodity rises to Q1 T (=OP1).
But the per-unit increase in price is RT. the difference between the new
price (Q1T) and the pre-tax price (QA).
Thus the RT portion of the tax is borne by the buyers and ER portion by the
sellers, ET = ER + RT. Given the elasticity of supply, the greater the
elasticity of demand for a commodity, the greater will be the incidence of
the tax upon the producers and vice versa. Likewise, given the elasticity of
demand, the greater the elasticity of supply, the higher will be the incidence
of tax upon the buyers, and vice versa.

6. How the Fed Impacts IS and LM?

Answer: Fed Impact s of IS and LM:

 The Federal Reserve can move the LM curve by printing money. The
more money the Fed prints, the less aggressively banks have to raise
interest rates to attract deposits. This causes the LM curve to shift
outward.
 The lines will now cross at a new point—one where the interest rate
is lower and the economy is larger. In this way the Fed has the power
to control the level of GDP.
 Although the Fed can increase the strength of the economy by
printing money, that comes at the cost of a higher rate of inflation.
Higher inflation causes the IS curve to shift inwards. This causes
interest rates to rise again and the economy to slow.
 If the Fed is not careful, its actions can backfire and lead to an
economy with high rates of inflation but not very high GDP growth.
 7. What are the pros and cons of IS and LM curve?

Answer: Pros and Cons of IS and LM curve:

The IS-LM model is a controversial economic tool. It has a number of
detractors, including the creator Hicks himself, who said that the model is
best used “as a classroom tool” rather than in any practical application.
There are, however, pros to using the model.

Pros:

 The model is commonly used to explain Keynesian

macroeconomics on a basic level.
 It is a good introduction to and first approximation of policy-making.

Cons:

 Does not take into account a huge variety of factors the come to play
in the modern economy, such as international trade, demand, and
capital flows.
 Takes a simplistic approach to fiscal policy, the money market, and
money supply. Central banks today in most advanced economies
prefer to control interest rates on the open market—for example,
through sales of securities and bonds. This model cannot account for
that should not be used as the sole tool in determining monetary
policy.
 Does not reveal anything about inflation or international trade, and
does not provide insight or recommendations toward formulating tax
rates and government spending.
 The IS-LM model is a great way to explain Keynes’s ideas about how
monetary systems, markets, and governmental actors can work
together to drive economic growth. However, as a practical model to
advise on fiscal or spending policy, it falls short.
 8. Graphical Representation of shifts in Demand and supply?

Graphical Representation of shifts in Demand

Answer:
and Supply
Supply and Demand Shift Right

In this diagram, supply and demand have shifted to the right. This has led
an increase in quantity (Q1 to Q2) but price has stayed the same.

It is possible, that if there is an increase in demand (D1 to D2) this

encourages firms to produce more and so supply increases as well.
Diagram showing Increase in Price

In this diagram, we have rising demand (D1 to D2) but also a fall in supply.
The effect is to cause a large rise in price.

For example, if we run out of oil, supply will fall. However, economic growth
means demand continues to rise.
Increase in Demand

An increase in demand leads to higher price and higher quantity.

Increase in demand with inelastic supply

A Fall in Demand
Fall in demand increase supply

Fall in Supply

Fall in supply causing lower quantity and higher price.

 Increase in supply – inelastic demand

An increase in supply when demand is inelastic only causes a small rise in

demand.

Market equilibrium

Excess supply involves price above the equilibrium

Excess demand
Increase in demand

Rise in demand and rise in supply

Increase in demand causes supply to increase in long term.

Price set below the equilibrium (football)

Inelastic supply and bigger increase in demand

UK Housing market has often seen demand increase at a faster rate than
supply, causing price to rise.
Supply increase same as demand.
Elasticity
The effect of a subsidy depends on the elasticity of demand

The effect of a tax depends on elasticity of demand

The effect of rise in demand depends on elasticity of supply

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