Business Economics

June 2021 Examination

1. From the give table calculate Elasticity of Price, Total Revenue and Marginal
Revenue. Also, explain the relationship between AR and MR?

Price Quantity Total Marginal

Revenue Revenue

6 0
5 100
4 200
3 300
2 400
1 500
0 600

Answer 1.

INTRODUCTION

Elasticity of Price : A good's price elasticity of demand is a measure of how sensitive the
quantity demanded of it is to its price. The price elasticity gives the percentage change in
quantity demanded when there is a one percent increase in price, holding everything else
constant. If the elasticity is -2, that means a one percent price rise leads to a two percent
decline in quantity demanded. Price elasticities are negative except in special cases. If a good
is said to have an elasticity of 2, it almost always means that the good has an elasticity of -2
according to the formal definition.

CONCEPT AND APPLICATION

Revenue: Total revenue is the total receipts a seller can obtain from selling goods or services
to buyers. It can be written as P × Q, which is the price of the goods multiplied by the
quantity of the sold goods. For example, if an organization sells 50 bed sheet for 50$ each,
then the organization's total revenue will be 2500$.

Total Revenue = Quantity × Price

Average Revenue: The organization's revenue by selling one unit of a good is known as
average revenue. It is calculated by dividing the organization's total revenue by the number of
units sold by the organization. For example, if a firm's total revenue is 10000$ by selling 50
tables, then the firm's average revenue will be 200$.

Average Revenue = Total Revenue / Quantity sold

Marginal Revenue: Marginal revenue describes the additional total revenue generated by
increasing product sales by 1 unit. It is obtained by subtract the revenue figure before the last
unit was sold from the total revenue after the last unit was sold.

Here, n is the number of units sold, and TR is the commodity's total revenue.
Price elasticity of demand: Price elasticity of demand (PED) shows the relationship between
price and quantity demanded and provides a precise calculation of the effect of a change in
price on quantity demanded.

Price elasticity of demand = % change in quantity demanded / % change in price

For example, if the price of a daily newspaper increases from £1.00 to £1.20p, and the daily
sales fall from 500,000 to 250,000, the PED will be:

-50 / +20 = (-) 2.5

Let us calculate the total revenue, marginal revenue, and price elasticity with different prices
and quantities of a commodity.

PRICE QUANTITY TOTAL MARGINAL PRICE

REVENUE REVENUE ELASTICITY

6 0 0 - -

5 100 500 500 -11

4 200 800 300 -3

3 300 900 100 -1.4

2 400 800 -100 -0.7143

1 500 500 -300 -0.333

0 600 0 -500 -0.09

For Price = 5 and Quantity = 100 units

Total Revenue = Q x P

= 100 x 5

= 500

Marginal Revenue = total revenue at 100 units – total revenue at 0 units of the commodity

= 500 – 0

= 500

Price elasticity = 0.5/-0.0455

= -11

One thing should be kept in mind while analyzing the elasticity of demand; we always ignore
the negative sign and consider the absolute value only. Here, the price elasticity of demand is
more than one, which means that the commodity has elastic demand.
Relationship between AR and MR.
The relationship between average revenue and marginal revenue is the same as between any
other average and marginal values. When average revenue falls marginal revenue is less than
the average revenue. When average revenue remains the same, marginal revenue is equal
to average revenue.
Suppose a firm earns total revenue of Rs. 300 by selling 10 units of the commodity. If the
firm increases its sale by one unit or sells 11 units and earns Rs 349, then Rs 19 constitutes its
marginal revenue because it represents the addition to the total revenue due to the sale of the
11th unit.
CONCLUSION
The price elasticity of demand concludes the following things:
At 100, 200, and 300 units, the commodity's demand is elastic because the price elasticity of
demand is more than 1.
At 400, 500, and 600 units, the commodity's demand is inelastic because the price elasticity
of demand for the item is less than 1.
The AR and MR of the table show that both average revenue and marginal revenue fall with
an increase in a commodity's output. And after some time, the average revenue keeps falling
and remains positive, but the marginal revenue after some time starts to become negative.

2. Demand forecasting is not a speculative exercise into the unknown. It is essentially a

reasonable judgment of future probabilities of the market events based on scientific
background. Explain the statement by elaborating different qualitative and quantitative
methods of demand forecasting. (10 Marks)

Answer 2.
INTRODUCTION
Demand forecasting: Demand Forecasting is the process in which historical sales data is
used to develop an estimate of an expected forecast of customer demand. To
businesses, Demand Forecasting provides an estimate of the amount of goods and services
that its customers will purchase in the foreseeable future. In simple words, we can say that
after gathering information about various aspect of the market and demand based on the past,
an attempt may be made to estimate future demand. This concept is called forecasting of
demand.

For example, suppose we sold 200, 250, 300 units of product X in the month of January,
February, and March respectively. Now we can say that there will be a demand for 250 units
approx. of product X in the month of April, if the market condition remains the same.

CONCEPT AND APPLICATION

QUALITATIVE METHODS: In this technique, knowledge of product, customer, and market

is applied by the forecaster. Different qualitative techniques of forecasting demand are as
follows:

1. The Delphi Method : The Delphi method, leverages expert opinions on your market
forecast. This method requires engaging outside experts and a skilled facilitator.
You start by sending a questionnaire to a group of demand forecasting experts. You
create a summary of the responses from the first round and share it with your panel.
This process is repeated through successive rounds. The answers from each round,
 shared anonymously, influence the next set of responses. The Delphi method is
complete when the group comes to a consensus.
2. The market research method: Market research demand forecasting is based on data
from customer surveys. It requires time and effort to send out surveys and tabulate
data, You can do this research on an ongoing basis or during an intensive research
period. Market research can give you a better picture of your typical customer. Your
surveys can collect demographic data that will help you target future marketing
efforts. Market research is particularly helpful for young companies that are just
getting to know their customers.
3. Panel consensus technique: In this method also, a board of experts comes together.
But they speculate the demand of the organization's commodity themselves without
any question being asked from them.

QUANTITATIVE METHODS: The different kinds of quantitative methods are as follows:

 Time series forecasting: The term time series refers to a sequential order of
values of a variable called trend at equal time intervals. Using trends, an
organisation can predict the demand for its products and services for the projected
time. There are four main components of the time series analysis that an
organisation must take into consideration while forecasting the demand for its
products and services. These are :
1. Secular trend
2. Cyclical variations
3. Seasonal variations
4. Irregular variations
 Smoothing techniques: In case where time series lacks significant trends,
smoothing techniques can be used for demand forecasting. Smoothing techniques
are used to eliminate a random variation from historical demand. The most
common methods used in smoothing techniques of demand forecasting are simple
moving average method and weighted moving average method.
Simple moving average method: This method calculates the mean of average
prices. These average prices are for some time, and then the mean prices are
plotted on a graph by the evaluator, which helps find out the demand forecast.
Weighted moving average method: In this method, a predefined number of a
 Period is used to calculate the average. For example, an organization can find out
the quarterly moving average of the firm.
 Barometric methods: The barometric method is used to speculate further trends
based on current developments and it is also known as leading indicators approach
to demand forecasting. Under this method, demand forecasting relevant economic
and statistical indicators are formed and these indicators function as the base of
demand forecasting.
 Econometric methods: This method combination of statistical tools with
economic theories to assess various economic variables such as change in
economic policies, income level of consumers, price change. An econometric
model for demand forecasting could be single equation regression analysis or
multiple regression analysis. Econometric methods give more reliable forecasts
than any other demand forecasting method.
 Regression analysis: This method measures the relationship between two
variables. Let’s say X and Y. These two variables are dependent and independent
variables. The dependent variable is quantity demanded and independent variable
can be income of consumer, price of related goods, advertisement. After
establishing relationship the regression equation is derived as follows :
Y = a + bX
Where Y is dependent variable; b is the slope of regression curve; X is the
independent variable, a is the Y-intercept.

CONCLUSION
Thus both method quantitative and qualitative methods of demand forecasting show demand
forecasting and judgement of market future of an organisation with some scientific
backgrounds.

3. a. Define elasticity of supply and find the price from the given statement:

If Es of a good is 2 and a firm supplies 200 units at price of Rs 8 per unit, then at what
price will the firm supply 250 units. (5 Marks)

Answer 3a.

INTRODUCTION
Elasticity of supply: It is supply change of a commodity due to price variation. It is an
important parameter in determining how the supply of a particular product is affected by
fluctuation in market price. The elasticity of supply is calculated by dividing the percentage
change in quantity supplied by the percentage change in the commodity price.

Elasticity of supply = % change in supply of a commodity/ % change in price of a commodity

CONCEPT AND APPLICATION

The point to be noted is that elasticity of supply is always a positive number. Negative sign is
not considered in price elasticity of supply and its value lies between 0 and infinity. 0
considered as perfectly inelastic supply while infinite is considered as perfectly elastic
supply.

There are 5 types of elasticity of supply, these are

Perfectly Elastic Supply, more than unit elastic supply, unit elastic supply, less than unit
elastic supply, perfectly inelastic supply

As per the calculation of the price of the given commodity with given quantity supplied and
the price elasticity of supply. The following values are shown as below :

R = 200 units

R’ = 250 units

S = Rs 8 per unit

S’ = ?

Es = 2

%age change in quantity supplied of commodity =

= 25%

%age change in price of the commodity =

=

Price elasticity of supply = % change in supply of commodity/% change in price of commodity

2( ) = 25%

= 25%

(S` - 8) * 25 = 25

S` - 8 = 1

S` = 9

As per the solution the price at which organization is supplying 250 units is Rs 9 per unit.

CONCLUSION
As per high price elasticity of supply, the firm needs to improve the organization's ability to
respond quickly and effectively to the changes in the market conditions. The action may
include maintain sufficient stocks, change in providing necessary stocks, having better
storage system, using trained manpower for distribution system, easy transportation to
market.

3. b. Calculate the elasticity of supply if a 15 %increase in the price of soya bean oil
increases its supply from 300 to 345 units (5 Marks)

Answer 3b.

INTRODUCTION

Elasticity of supply: There is direct relationship between price and quantity supplied of a
commodity. If price increases the supply will also increases. Price is primary factor affecting
the supply of a product. It’s the reason we calculate price elasticity of supply. The elasticity
of supply can be defined as ratio of percentage change in quantity supplied of the commodity
to the percentage change in factors affecting the commodity's supply.

CONCEPT AND APPLICATION

Elasticity of supply = % change in supply of a commodity/ % change in price of a commodity

Let us calculate the price elasticity of supply for the soya bean oil.

T = 300 units

T’ = 345 units

%age increase in price of soya bean oil = 15%

Es = ?

%age change in quantity supplied of the commodity =

= 15%

Percentage change in price of commodity = 15%

So, as per definition

Price elasticity of supply = % change in supply of a commodity/ % change in price of commodity

= 15% / 15%

=1

Es = 1

If a product has a price elasticity of supply between 0 and 1, the product is inelastic. It means
that the percentage change in the commodity supply is smaller than the percentage change in
that commodity price. If a product has a price elasticity of supply equal to 1, then the product
is unit elastic. It means the percentage change in price and percentage change in the
commodity supply are the same.

CONCLUSION
As per solution soya bean oil, supply elasticity is equal to 1. It means that soya bean oil has a
unit elastic supply. Hence, the percentage change in the price of soya bean oil is the same as
the percentage change in soya bean oil supply.