ASSIGNMENT

SESSION JUL/AUG 2021

PROGRAM MASTER OF BUSINESS ADMINISTRATION (MBA) SEMESTER I
COURSE CODE & NAME DMBA105 – MANAGERIAL ECONOMICS

Set – 1 Questions
1. Define the term ‘managerial economics’. Explain significance of the study of
managerial economics.
Ans:
Managerial economics is a stream of management studies that emphasizes primarily
solving business problems and decision-making by applying the theories and principles
of microeconomics and macroeconomics. It is a specialized stream dealing with an
organization’s internal issues using various economic theories. Economics is an
indispensable part of any business. This single concept derives all the business
assumptions, forecasting, and investments. This is managerial economics, meaning in a
nutshell.

Significance of the study of managerial economics :

1. Business Planning : Managerial economics assists business organizations
in formulating plans and better decision making. It helps in analyzing the
demand and forecasting future business activities.
2. Cost Control: Controlling the cost is another important role played by
managerial economics. It properly analyses and decides production
activities and the cost associated with them. Managerial economics ensure
that all resources are efficiently utilized which reduces the overall cost.
3. Price Determination: Setting the right price is one of the key decisions to
be taken by every business organization. Managerial economics supplies
all relevant data to managers for deciding the right prices for products.
4. Business Prediction: Managerial economics through the application of
various economic tools and theories helps managers in predicting various
future uncertainties. Timely detection of uncertainties helps in taking all
possible steps to avoid them.
5. Profit Planning And Control: Managerial economics enables in planning
and managing the profit of the business. It makes an accurate estimate of
all cost and revenue which helps in earning the desired profit.
6. Inventory Management: Proper management of inventory is a must for
ensuring the continuity of business activities. It helps in analyzing the
demand and accordingly, production activities are performed. Managers
can arrange and ensure that the proper quantity of inventory is always
available within the business organization.
7. Manages Capital: Managerial economics helps in taking all decisions
relating to the firm’s capital. It properly analyses investment avenues
before investing any amount into it to ensure the profitability of an
investment.
2. Define production function. State types and functions of production function.

Ans:

Production is a process whereby some goods and services, called inputs are
transformed into other goods and services called output. The production function refers
to the relationship between the input of factor services and the output of the resultant
product. The production function is based on the idea that the amount of output in a
production process depends upon the amount of inputs used in the process.

Output depends upon an input or a set of inputs in such a way that there is one unique
amount of output resulting from each set of inputs. This unique relationship between
output and inputs is termed as production function.

Halcrow defines production function as follows:

“Production function is the technical relationship between inputs & output indicating the
amount of output that can be produced with each and every set or combination of the
specified inputs”. A production function always assumes as given, a state of knowledge
and technology.

A production function may be expressed in three forms:

(a) It can be expressed in the form of an arithmetic table where first few columns show
the input of the factors and the last column shows total output of the product as has
been depicted below. Here, for the sake of simplicity, we take only one input.)
In the above table, fertilizer is the variable input (applied to a fixed price of land with
other fixed inputs). Total corn yield is increasing (column 2) as more units of fertilizers
are applied.

(b) The production function can also be illustrated geometrically by means of a simple
graph as shown in Fig. 1. Input level is measured along the horizontal axis and the total
output upon he vertical axis.

The points on the curve OT indicate different quantities of output associated with
particular levels of the input used.

(c) The production function may be shown through an algebraic expression in which
output is a dependent variable and input, the independent variable.

In algebraic form, it can be expressed as:

Y =f(x),

where Y represents the output, x, the input and ‘f’ means is a function of, or ‘depends
upon, or is determined by’. Here, it is assumed that output depends upon a single factor.
However, it must be understood that in actual life, agricultural output (and for that
matter, any output) is never a function of a single factor. It rather depends upon a variety
of factors, such as seeds, amount of fertilizers used, irrigation, nature of soil and so on.
This can be written as:

Y = f (x1, x2, x3………………….. xn) + u

This function means that output depends upon all factors represented by x1, x2 etc.,
and also the level of unknown or uncontrollable factors represented by u. It is not
feasible to consider all controllable factors simultaneously in any one study.

Therefore, each factor may be studied in combination with some factors considered as
fixed. For illustration, a farmers may be interested in knowing how the output of wheat
will change as the two inputs namely, the seeds and fertilizers are changed while other
factors are held constant at fixed levels.

Types of Production Function:

We should note that a production function expresses a unique relationship between
total output and the various inputs. Generally, the total output increases with an
increase in inputs. Like any other function, all such functions where total output increase
as the inputs increase, are known as increasing production functions,

There are also situations in the real world where an increase in inputs, instead of
bringing about an increase in the total output, may decrease it. Such a production
function will be known as decreasing production function.

It is necessary to explain these two types of functions in some detail:

(A) Increasing Production Function:

Though, in case of such functions, the mathematicians do not generally discuss the way
the production increases when the inputs increase, an economist has to give
considerable attention to this aspect.

From his point of view, it is important to know whether the rate of increase in production
in response to successive equi-proportional changes in all inputs taken together
(expressed in terms of returns to scale) or to successive changes in the amount of
single input taken in isolation (expressed in terms of returns to a variable factor), is itself
increasing, is constant or is decreasing. In other words, he is deeply interested in
knowing whether the marginal returns to scale or the marginal returns to a variable
factor are increasing, constant or decreasing.

We may note here that in case of productions planning, it is the marginal returns to a
variable factor which are the main focus of attention. As such, in the paragraphs that
follow, we shall be explaining the increasing production function by categorizing it into
parts, on the basis of constant, increasing, and decreasing marginal returns to a
variable input (For this purpose, we consider change in production in response to
change in one input only. We assume other variable inputs to be constant. Such an
approach simplifies the analysis. At a later stage, we shall see that analysis pertaining
to one input can be easily extended to over other inputs also).
(i) Increasing production function with constant marginal returns to the variable input. In
this function, the total production increases by the same magnitude for each additional
unit of input used. For example, consider the following hypothetical relationship between
fertilizers used and the total yield of wheat.

Graphic representation of this function will be a linear increasing function as shown in

Fig. 2.

The diagram shows that each successive dose of 10 Kg. fertilizers makes a contribution
of 60 kgs. Of wheat to the total output. We rarely come across this type of relationship in
agriculture.

(ii) Increasing production function with increasing marginal returns on the variable input:
In this case, every successive dose of input brings about an increasing addition to the
total output i.e., the output increasing rate when more and more units of an input are
used. This type of relationship generally emerges when the fixed factors being used in
production are having an excess capacity and use of additional units of the variable
input results in a better utilisation of these fixed factors. The following table shows this
type of production function.

Graphically this functional relation appears in the form of a curve. The curve becomes
steeper as the input increases. Fig. 3 shows the increasing production with increasing
marginal returns to the variable input. The curve that emerges in case of such a
production function is concave downwards to X-axis as shown in the following diagram.

This type of relationship has been observed in agriculture but only over fairly short
ranges of production.
(iii) Increasing production function with decreasing marginal returns to the variable
factor:

In this case, we find that though the total production increases as the input increases,
each successive increase in output brought about by an additional dose of input
declines. In other words, marginal returns to the input, though positive are declining.
The following schedule shows his type of increasing production function.

Diagrammatically, the curve representing this type of production function will be

concave upwards with regard to X-axis. Fig. 4 shows this curve.
We find that as each successive increase in output due to the use of an additional dose
of input is declining, the curve becomes flatter as it moves towards the right.

(B) Decreasing Production Function:

A decreasing production function is one in which the total output declines when the
input increase. In terms of marginal returns to the variable factor, one could say that it is
negative (less than zero).

The decreasing production function could also be divided into three categories on the
basis of increasing, decreasing or constant rate of decrease in output. However, as we
shall see later, no rational producer will ever operate in a situation (or stage) of
decreasing production function i.e., where the total production declines as the input is
increased.

As such, the exercise concerning categorization of the decreasing production function

on the basis of the nature of its (negative) marginal returns to the variable input will
have no practical utility.

The table 5 shows the decreasing production function: In this Table we have started with
the 11th dose of fertilizers and not with the first dose. This is because it will be rather
unrealistic to assume, that after the very first dose of fertilizers, the output starts
decreasing.

The following diagram shows the decreasing production function:

The decreasing production function implies a line or a curve with negative slope. The
curve can be concave or convex to the origin depending upon whether the output
declines at an increasing rate or at a decreasing rate when more and more doses of an
input are used.

3. Explain different types of cost

Ans: A list and definition of different types of economic costs.

Fixed Costs (FC) The costs which don’t vary with changing output. Fixed costs might
include the cost of building a factory, insurance and legal bills. Even if your output
changes or you don’t produce anything, your fixed costs stay the same. In the above
example, fixed costs are always £1,000.

Variable Costs (VC) Costs which depend on the output produced. For example, if you
produce more cars, you have to use more raw materials such as metal. This is a
variable cost.
Semi-Variable Cost. Labour might be a semi-variable cost. If you produce more cars,
you need to employ more workers; this is a variable cost. However, even if you didn’t
produce any cars, you may still need some workers to look after an empty factory.

Total Costs (TC) = Fixed + Variable Costs

Marginal Costs – Marginal cost is the cost of producing an extra unit. If the total cost of
3 units is 1550, and the total cost of 4 units is 1900. The marginal cost of the 4th unit is
350.

Opportunity Cost – Opportunity cost is the next best alternative foregone. If you invest
£1million in developing a cure for pancreatic cancer, the opportunity cost is that you
can’t use that money to invest in developing a cure for skin cancer.

Economic Cost. Economic cost includes both the actual direct costs (accounting costs)
plus the opportunity cost. For example, if you take time off work to a training scheme.
You may lose a weeks pay of £350, plus also have to pay the direct cost of £200. Thus
the total economic cost = £550.

Accounting Costs – this is the monetary outlay for producing a certain good. Accounting
costs will include your variable and fixed costs you have to pay.

Sunk Costs. These are costs that have been incurred and cannot be recouped. If you
left the industry, you could not reclaim sunk costs. For example, if you spend money on
advertising to enter an industry, you can never claim these costs back. If you buy a
machine, you might be able to sell if you leave the industry. See: Sunk cost fallacy

Avoidable Costs. Costs that can be avoided. If you stop producing cars, you don’t have
to pay for extra raw materials and electricity. Sometimes known as an escapable cost.

Explicit costs – these are costs that a firm directly pays for and can be seen on the
accounting sheet. Explicit costs can be variable or fixed, just a clear amount.

Implicit costs – these are opportunity costs, which do not necessarily appear on its
balance sheet but affect the firm. For example, if a firm used its assets, like a printing
press to print leaflets for a charity, it means that it loses out on revenue from producing
commercial leaflets.

Market Failure

● Social Costs. This is the total cost to society. It will include the private
costs plus also the external cost (cost incurred by a third party). May also
be referred to as ‘True costs’
 ● External Costs. This is the cost imposed on a third party. For example, if
you smoke, some people may suffer from passive smoking. That is the
external cost.
● Private Costs. The costs you pay. e.g. the private cost of a packet of
cigarettes is £6.10
● Social Marginal Cost. The total cost to society of producing one extra unit.
Social Marginal Cost (SMC) = Private marginal cost (PMC) + External
marginal Cost (XMC)

Diagram of Costs

For full diagrams of costs see: Diagrams of cost curves

Average Cost Curves

 ● ATC (Average Total Cost) = Total Cost / quantity
● AVC (Average Variable Cost) = Variable cost / quantity
● MC = Marginal cost.
● AFC (Average Fixed Cost) = Fixed cost / quantity

Total costs

Total cost (TC) = Variable cost (VC) + fixed costs (FC)

Set – 2 Questions
4. Explain causes of inflation in detail.

Ans:Inflation means there is a sustained increase in the price level. The main causes of
inflation are either excess aggregate demand (AD) (economic growth too fast) or
cost-push factors (supply-side factors).

Summary of the main causes of inflation

1. Demand-pull inflation – aggregate demand growing faster than aggregate

supply (growth too rapid)
2. Cost-push inflation – For example, higher oil prices feeding through into
higher costs.
3. Devaluation – increasing cost of imported goods, and also the boost to
domestic demand.
4. Rising wages – higher wages increase firms costs and increase
consumers’ disposable income to spend more.
5. Expectations of inflation – High inflation expectations causes workers to
demand wage increases and firms to push up prices.

Video summary

Factors affecting inflation

1. Demand-pull inflation

If the economy is at or close to full employment, then an increase in aggregate demand

(AD) leads to an increase in the price level (PL). As firms reach full capacity, they
respond by putting up prices leading to inflation. Also, near full employment with labour
shortages, workers can get higher wages which increase their spending power.

AD can increase due to an increase in any of its components C+I+G+X-M

We tend to get demand-pull inflation if economic growth is above the long-run trend rate
of growth. The long-run trend rate of economic growth is the average sustainable rate of
growth and is determined by the growth in productivity. Demand-pull inflation can be
caused by factors such as

● Higher wages.
● Increased consumer confidence.
● Rising house prices – causing positive wealth effect.

Example of demand-pull inflation in the UK

 In the 1980s, the UK
experienced rapid economic growth. The government cut interest rates and also cut
taxes. House prices rose by up to 30% – fuelling a positive wealth effect and a rise in
consumer confidence. This increased confidence led to higher spending, lower saving
and an increase in borrowing. However, the rate of economic growth reached 5% a year
– well above the UK’s long-run trend rate of 2.5 %. The result was a rise in inflation as
firms could not meet demand. It also led to a current account deficit. You can read more
about demand-pull inflation at the Lawson Boom of the 1980s.
2. Cost-push inflation

If there is an increase in the costs of firms, then businesses will pass this on to
consumers. There will be a shift to the left in the SRAS.
Cost-push inflation can be caused by many factors

i) Rising wages If trades unions can present a united front then they can bargain for
higher wages. Rising wages are a key cause of cost-push inflation because wages are
the most significant cost for many firms. (higher wages may also contribute to rising
demand) See also wage-push inflation.

ii) Import prices One-third of all goods are imported in the UK. If there is a devaluation,
then import prices will become more expensive leading to an increase in inflation. A
devaluation/depreciation means the Pound is worth less. Therefore we have to pay
more to buy the same imported goods.
In 2011/12, the UK experienced a rise in cost-push inflation, partly due to the
depreciation of the Pound against the Euro. (also due to higher taxes)

iii) Raw material prices The best example is the price of oil. If the oil price increase by
20% then this will have a significant impact on most goods in the economy and this will
lead to cost-push inflation. E.g., in 1974 there was a spike in the price of oil causing a
period of high inflation around the world.

4. Higher inflation expectations

Once inflation sets in, it is difficult to reduce inflation. For example, higher prices will
cause workers to demand higher wages causing a wage-price spiral. Therefore,
expectations of inflation are important. If people expect high inflation, it tends to be
self-fulfilling. When expectations are low, temporary rise in prices tend to be short-lived
and fade away.

5. Printing more money

If the Central Bank prints more money, you would expect to see a rise in inflation. This is
because the money supply plays an important role in determining prices. If there is
more money chasing the same amount of goods, then prices will rise. Hyperinflation is
usually caused by an extreme increase in the money supply.

However, in exceptional circumstances – such as liquidity trap/recession, it is possible

to increase the money supply without causing inflation. This is because, in a recession,
an increase in the money supply may just be saved, e.g. banks don’t increase lending
but just keep more bank reserves.

See: The link between money supply and inflation

6. Higher taxes

If the government put up taxes, such as VAT and Excise duty, this will lead to higher
prices, and therefore CPI will increase. However, these tax rises are likely to be one-off
increases. There is even a measure of inflation (CPI-CT) that ignores the effect of
temporary tax rises/decreases.
CPI-CT is less volatile because it ignores the effect of taxes. In 2010, some of the UK
CPI inflation was due to rising taxes.

7. Declining productivity

If firms become less productive and allow costs to rise, this invariably leads to higher
prices.

8. Profit push inflation

When firms push up prices to get higher rates of inflation. This is more likely to occur
during strong economic growth.

9. Monetary and fiscal policy

The attitude of the monetary authorities is important; for example, if there was an
increase in AD and the monetary authorities accommodated this by increasing the
money supply then there would be a rise in the price level.

5. Explain different objectives of pricing policies.

Ans:

The pricing policy of the firm may vary from firm to firm depending on its objective.
Objectives of a properly planned pricing policy should be logically related to overall
managerial goals. Pricing involves a number of decisions related to setting the price of a
product.

Objectives of Pricing Policy

Formulation of pricing policy begins with the classification of the basic objectives of the
firm. Pricing objectives provide guidance to decision-makers in formulating price
policies, planning etc. Pricing objectives have to be in conformity with overall
organizational objectives. The most important objective of companies is to have
maximum profits. In most of the situation, profit maximization is the main objective of
price policy, but it is only one objective. Following may be other objectives of pricing
policy in an organization:

● Achieving a Target Return on Investments.

● Pricing the goods based on reasonable costs.
● Stabilization of Price and Margin.
● Increase the market share or growth rate at the expense of immediate profits.
● The Creation of a Broad Market.
● Avoid adverse public reaction consequent on charging a high price.
● Price Differentiation within a Geograph­ical Area.
● Ethical consideration not to reap a high profit.
● Immediate survival of the firm.
● Charge reasonable price so as to have good relations with the government and
public at large.
● Maximization of the prestige of the firm rather than profit.
● To safeguard against the emergence of new producers in the same line.
● Although its importance varies from firm to firm, pricing is one of the tools that a
firm has at its disposal in its attempt to reach the stated objectives.

6. Define monetary policy. State the objectives of monetary policy in developing

countries.
Ans:

Monetary policy is a set of tools that a nation's central bank has available to promote
sustainable economic growth by controlling the overall supply of money that is available
to the nation's banks, its consumers, and its businesses.

The U.S. Treasury Department has the ability to create money, but the Federal Reserve
influences the supply of money in the economy, largely through open market operations
(OMO). Essentially, this means buying financial securities when easing monetary policy
and selling financial securities when tightening monetary policy. The Fed's preferred
securities for OMO are U.S. Treasuries and agency mortgage-backed securities.

The goal is to keep the economy humming along at a rate that is neither too hot nor too
cold. The central bank may force up interest rates on borrowing in order to discourage
spending or force down interest rates to inspire more borrowing and spending.

The main weapon at its disposal is the nation's money. The central bank sets the rates it
charges to loan money to the nation's banks. When it raises or lowers its rates, all
financial institutions tweak the rates they charge all of their customers, from big
businesses borrowing for major projects to home buyers applying for mortgages.

All of those customers are rate-sensitive. They're more likely to borrow when rates are
low and put off borrowing when rates are high.

Monetary policy implies those measures designed to ensure an efficient operation of the
economic system or set of specific objectives through its influence on the supply, cost
and availability of money.

The concept of monetary policy has been defined in a different manner according to
different economists;

R.P. Kent has defined the monetary policy as “The management of the expansion and
contraction of the volume of money in circulation for the explicit purpose of attaining a
specific objective such as full employment.”

Dr.D.C. Rowan remarked, “The monetary policy is defined as discretionary action

undertaken by the authorities designed to influence:

(a) The supply of money,

(b) Cost of Money or rate of interest and

(c) The availability of money.”

Objectives of Monetary Policy:

The monetary policy in developed economies has to serve the function of stabilization
and maintaining proper equilibrium in the economic system. But in case of
underdeveloped countries, the monetary policy has to be more dynamic so as to meet
the requirements of an expanding economy by creating suitable conditions for economic
progress. It is now widely recognized that monetary policy can be a powerful tool of
economic transformation.

As the objective of monetary policy varies from country to country and from time to time,
a brief description of the same has been as following:

(i) Neutrality of money

(ii) Stability of exchange rates

(iii) Price stability

(iv) Full Employment

(v) Economic Growth

(vi) Equilibrium in the Balance of Payments.