1. List out the significance of elasticity of demand in managerial decision making.

Ans: 1. Elasticity of demand refers to the change in demand when there is a change
in another factor such as price or income or any relative factor of elasticity of
demand.

1- In the Determination of Output Level:

For making production profitable, it is essential that the quantity of goods and
services should be produced corresponding to the demand for that product. Since the
changes in demand is due to the change in price, the knowledge of elasticity of
demand is necessary for determining the output level.

2. In the Determination of Price:

The elasticity of demand for a product is the basis of its price determination. The
ratio in which the demand for a product will fall with the rise in its price and
vice versa can be known with the knowledge of elasticity of demand. If the demand
for a product is inelastic, the producer can charge high price for it, whereas for
an elastic demand product he will charge low price.

3- In Demand Forecasting:
The elasticity of demand is the basis of demand forecasting. The knowledge of
income elasticity is essential for demand forecasting of producible goods in
future. Long- term production planning and management depend more on the income
elasticity because management can know the effect of changing income levels on the
demand for his product.

 4- In Price Determination of Factors of Production:

The concept of elasticity for demand is of great importance for determining prices
of various factors of production. Factors of production are paid according to their
elasticity of demand. In other words, if the demand of a factor is inelastic, its
price will be high and if it is elastic, its price will be low.

5-In Price Discrimination by Monopolist:

Under monopoly discrimination the problem of pricing the same commodity in two
different markets also depends on the elasticity of demand in each market. In the
market with elastic demand for his commodity, the discriminating monopolist fixes a
low price and in the market with less elastic demand, he charges a high price.

6- Helpful in Adopting the Policy of Protection:

The government considers the elasticity of demand of the products of those
industries which apply for the grant of a subsidy or protection. Subsidy or
protection is given to only those industries whose products have an elastic demand.
As a consequence, they are unable to face foreign competition unless their prices
are lowered through subsidy or by raising the prices of imported goods by imposing
heavy duties on them.

 7- In the Determination of Government Policies:

The knowledge of elasticity of demand is also helpful for the government in
determining its policies. Before imposing statutory price control on a product, the
government must consider the elasticity of demand for that product.

8- Helpful In Determining International Trade-

In International trade, price elasticity plays a very important role as any
successful transaction of trade between two countries is dependent on price
elasticity of demand.

Q- Explain the concept of income elasticity of demand and discuss the importance of
income elasticity of demand for a business firm.
Ans- The elasticity of demand measures how factors such as price and income affect
the demand for a product. The income elasticity of demand measures how the change
in a consumer’s income affects the demand for a specific product. You can express
the income elasticity of demand mathematically as follows:
Income Elasticity of Demand (YED) = % change in quantity demanded / % change in
income
The higher the income elasticity of demand for a specific product, the more
responsive it becomes the change in consumers’ income.
Now, we can measure the income elasticity of demand for different products by
categorizing them as inferior goods and normal goods. The income elasticity of
demand for a particular product can be negative or positive, or even unresponsive.

Measuring the income elasticity of demand is important for industries and business
units as they can then forecast how the demand for their products may change in
response to consumer incomes.

As luxury goods are more income-elastic, manufacturers of luxury goods can change
their marketing and advertising strategies based on the change in consumers’
income. Measuring the income elasticity can also help businesses to predict the
sales cycles of their goods and services.

3. What is Break- even point? Explain the important managerial uses of break-even
analysis. 

Ans • In economics, the breakeven point is calculated by dividing the fixed costs
of production by the price per unit minus the variable costs of production.
• The breakeven point is the level of production at which the costs of production
equal the revenues for a product.
• Breakeven=Fixed cost/ Gross Profit Margin
 
Managerial uses of break-even analysis:

1. Safety Margin:
The break-even chart helps the management to know at a glance the profits generated
at the various levels of sales. The safety margin refers to the extent to which the
firm can afford a decline before it starts incurring losses.
The formula to determine the sales safety margin is:
Safety Margin = (Sales – BEP)/Sales x 100

2. Target Profit:
The break-even analysis can be utilised for the purpose of calculating the volume
of sales necessary to achieve a target profit.
When a firm has some target profit, this analysis will help in finding out the
extent of increase in sales by using the following formula:
Target Sales Volume = Fixed Cost + Target Profit/Contribution Margin Per Unit.

3. Change in Price:
The management is often faced with a problem of whether to reduce prices or not.
Before taking a decision on this question, the management will have to consider a
profit. A reduction in price leads to a reduction in the contribution margin.
This means that the volume of sales will have to be increased even to maintain the
previous level of profit. The higher the reduction in the contribution margin, the
higher is the increase in sales needed to ensure the previous profit.

The formula for determining the new volume of sales to maintain the same profit,
given a reduction in price, will be
New Sales Volume = Total Fixed Cost + Total Profit/New Selling Price – Average
Variable Cost
4. Change in Costs:
When costs undergo change, the selling price and the quantity produced and sold
also undergo changes.
Changes in cost can be in two ways:
(i) Change in variable cost, and
(ii) Change in fixed cost.

(i) Variable Cost Change:

An increase in variable costs leads to a reduction in the contribution margin. This
reduction in the contribution margin will shift the break-even point downward.
Conversely, with the fall in the proportion of variable costs, contribution margins
increase and break-even point moves upwards.

ii) Fixed Cost Change:

An increase in fixed cost of a firm may be caused either due to a tax on assets or
due to an increase in remuneration of management, etc. It will increase the
contribution margin and thus push the break-even point upwards. Again to maintain
the earlier level of profits, a new level of sales volume or new price has to be
found out.

5. Decision on Choice of Technique of Production:

A firm has to decide about the most economical production process both at the
planning and expansion stages. There are many techniques available to produce a
product. These techniques will differ in terms of capacity and costs.
The breakeven analysis is the most simple and helpful in the case of decision on a
choice of technique of production. For example, for low levels of output, some
conventional methods may be most probable as they require minimum fixed cost.

6- Advertising and Promotion Mix Decisions:

The main objective of advertisement is to stimulate or increase sales to all
customers—former, present and future. If there is keen competition, the firm has to
undertake vigorous campaign of advertisement. The management has to examine those
marketing activities that stimulate consumer purchasing and dealer effectiveness.

Discuss the short run cost output relationship with the graph.
COST OUTPUT RELATIONSHIP IN THE SHORT RUN
In the short-run a change in output is possible only by making changes in the
variable inputs like raw materials, labour etc. Inputs like land and buildings,
plant and machinery etc. are fixed in the short-run. It means that short-run is a
period not sufficient enough to expand the quantity of fixed inputs. Thus Total
Cost (TC) in the short-run is composed of two elements – Total Fixed Cost (TFC) and
Total Variable Cost (TVC).
TFC remains the same throughout the period and is not influenced by the level of
activity. The firm will continue to incur these costs even if the firm is
temporarily shut down. Even though TFC remains the same fixed cost per unit varies
with changes in the level of output.
On the other hand TVC increases with increase in the level of activity, and
decreases with decrease in the level of activity. If the firm is shut down, there
are no variable costs. Even though TVC is variable, variable cost per unit is
constant.
So in the short-run an increase in TC implies an increase in TVC only. Thus:
TC = TFC + TVC
TFC = TC – TVC
TVC = TC – TFC
TC = TFC when the output is zero.
The graph below shows Short-run cost output relationship.
 

                      
        In the graph X-axis measures output and Y-axis measures cost. TFC is a
straight line parallel to X-axis, because TFC does not change with increase in
output.
          TVC curve is upward rising from the origin because TVC is zero when there
is no production and increases as production increases. The shape of TVC curve
depends upon the productivity of the variable factors. The TVC curve above assumes
the Law of Variable Proportions, which operates in the short-run.
          TC curve is also upward rising not from the origin but from the TFC line.
This is because even if there is no production the TC is equal to TFC.
          It should be noted that the vertical distance between the TVC curve and
TC curve is constant throughout because the distance represents the amount of fixed
cost which remains constant. Hence TC curve has the same pattern of behaviour as
TVC curve.