Business Economics

December 2022 Examination

Ans 1.
Introduction:
Demand forecasting is a technique that allows an organization whether new or old, to predict
for demand of a product or service into market with minimal loss and within a specified time
frame. By hiring agencies and consultants for demand forecasting, an organization find
choices to get raw material, managing cash, deciding product price etc.
Demand forecasting holds good for both new as well as old organization, to expand
production and in the meantime avoiding over production and losses.
An organization may forecast demand for short and long term depending on type and size of
farm as well as product it manufacture. For different type of organization whether it produce
product or service, appropriate demand forecasting methods can be planned from number of
available demand forecasting techniques.
An organization may face various risk and uncertainties that may affect demand of its product
or service like market fluctuation, change in requirement, Preferences and choices, Natural
calamities etc. To reinforce such conditions an organization require to adopt appropriate
demand forecasting techniques.
Capital Investment and expansion decision taken by new or old organization vary with type
of product or service it produce and time horizon required to do the business.
Methods involved in demand forecasting:
Organization may carry out appropriate demand forecasting method, so that desired result can
be achieved for a sustainable business in the market.
1: Identifying the exact process: Before beginning the exercise, the purpose of demand
forecasting has to be determined.
A: Demand of a product for short or long term.
B: Sector demand or demand unique to a particular organization.
C: Demand for the entire market or demand for a specific market segment.
Determining the time horizon: Depending upon the requirement of an organization, demand
may be projected for a short duration(2-3 years) or prolonged duration (more than 10 years).
Long-term demand forecasting requires an organization to consider for steady market
changes and the economy.
Choosing a Forecasting Method: Different type of Demand forecasting method can be
adopted for different type of organization with various product and service. But all types of
Demand forecasting methods cannot be appropriately applied to a particular organization. It
depends type of organization, goals, time horizon, collection data quality and expertise and
experience of forecaster.
Data collection and analysis: Data must be collected from reliable resource after choosing
proper Demand forecasting technique. Source of data either from primary or secondary, but
must be collected from authentic source, which may be in a raw form. It needs further
analysis to get proper information regarding exact demand of a product.
Interpretation of results: After the data has been interpreted, it can be used to estimate
demand of a product or service for predefined years.

To execute Demand forecasting, three types of methods can be followed.

Forecasting at various level like
1: Firm level where demand forecasted at individual organization level for a product or
service.
2: Industry level forecasting can be done for all organization for a product or service.
3: Economy level forecasting can also be done at various economy level for a product or
service.
Duration or time involved.
1: Short term for less than a year in which marketing strategy can be made,
2: Long term 5 years or even 10 years in which major decision made to increase production
capacity and replacement of machinery etc. are made.

Types of Product
Products are classified as consumer or capital items based on their nature.
Consumer goods: These items will retain in high demand. Generally, demand forecasting for
these products is done when a new product is introduced, or an existing product is replaced
with a much better product.
Capital goods: These are products that are essential to produce consumer goods, such as raw
materials. Therefore, these commodities have derived demand. Capital items demand
forecasting is influenced by durable goods demand. Forecasting more demand for consumer
products would imply forecasting greater demand for capital products.
Conclusion:
In spite of demand forecasting has a vast role of applications in an organization, it also have
few limitations. This is because demand forecasting is based upon a review of present and
previous events to determine the best course of action for the future. Past occasions or
incidents may not always be dependable and adequate for future base forecasts. The
performance of demand forecasting is determined by the method utilized to anticipate
demand. The criteria for selecting a demand forecasting technique include precision,
timeliness, affordability, ease of interpretation, flexibility, simplicity of use, and application,
among others.

Ans 2.

Introduction:

An organization produce different types of product consuming raw material as an input by

spending money. The raw material may be workmen, fuel, Power, land etc. which is being
used to produce a product. To produce a final product the items multiplied by price and added
together to obtain a monetary value called cost of production. Cost of production vary with
input material price and a thorough analysis may be required by an organization to get
optimum value. To produce an item and service, an organization require to spend behind
many inputs and cost of production is an important factor of an organization to determine
fixing price of a product.
Fixed Cost
Fixed cost are the cost, which does not change with variation of production and it will remain
fixed even if an organization stops producing a product like Land, Labor and Rent etc.
Variable Cost
Variable Cost are those cost which varies with the output of an organization. Raw material
input may be an example to derive variable cost, as Final product cost will change with
variation in raw material cost. Overhauling and maintenance cost, Fuel cost etc. are more
examples to variable cost as cost of production will vary with the above expenditure.
Total Cost:
Total Cost is the summation of both fixed and variable cost.
Total Cost (TC) = Fixed Cost (FC) + Variable cost (VC).

Calculation of various costs

The total cost is the actual expenditure incurred by a company to produce a product. An
organization's Short-Run Total Cost (SRTC) consists of two significant elements:

TFc (Total Fixed Cost): These costs do not alter due to changes. Even when a factory
produces nothing the fixed cost will remain zero, TFC stays consistent. TFC is drawn as a
horizontal line parallel to the x-axis (result).

TVc (Total Variable Cost): These expenditures are straight related to a firm's result. This
indicates that when production increases variable cost increases, similarly when production or
outcome decreases, total variable cost also decreases.

SRTC is determined by adding the total fixed and variable costs.

TFC + TVC = SRTC

The average cost is calculated by the total cost by the number of systems a business
generates. A firm's short-run average cost (SRAC) describes the cost of results at different
stages of production.

SRAC is calculated by dividing the short-run overall cost by the result.

An organization SRAC is U-shaped. It starts to fall initially, and after that gets to a minimum
and starts to rise upwards. Initially the fixed cost remains same, while only the variable costs,
such as primary material and work and labor costs, etc changes. At later stage as the fixed
costs are distributed manufacturing and average cost starts to reduce. When a company uses
all available resources, the typical cost is maintained to a minimum. The SRAC curve shows
the short-run average cost of creating a particular quantity of outcome. The SRAC curve's
downward slope represents that as output expands, so do average costs. The SRAC contour
begins to slope higher, revealing that typical costs increase at output degrees above Q1.

The marginal cost is the ratio of change in total cost to change in total output. The adjustment
in short-run total cost caused by an adjustment in the company's result is described as
minimal short-run cost. On a chart, the minimal short-run cost is the slope of short-run total
cost and represents the rate of change in overall cost as output modifications. A business's
marginal cost is used to decide whether it can produce more products from regular or not.
Suppose a company can offer the extra unit at a rate more significant than the cost of creating
the added unit (limited cost). In that case, the company may elect to produce the additional
units.

Due to increasing returns at the beginning complied with by lessening returns, the short-run
limited cost (SRMC), the short-run average cost (SRAC), and typical variable cost (AVC) are
U-shaped. The SRMC curve intersects the SRAC contour and the AVC curve on their floors.

Quantity Total Total Total Average Average Average Marginal

Fixed Variable Cost Fixed Variable Total Cost
Cost Cost Cost Cost Cost
0 100 0 100 20
1 100 20 120 100 20 120 10
2 100 30 130 50 15 65 10
3 100 40 140 33.33 13.333 46.6 10
4 100 50 150 25 12.5 37.5 10
5 100 60 160 20 12 32 10

Conclusion:
When a business determines to produce an asset, it has to pay the price for the various inputs
required in the process. To run a company, it requires labor, raw materials, gas, and power,
etc. along with the rent fee and taxes for the production center. Business decisions are made
by evaluating the monetary value of inputs in connection with the output it can produce. The
cash value of inputs is computed by multiplying inputs by their corresponding prices (cost of
production). Cost analysis is essential in business decision-making given that the term cost
has different significances in different circumstances and might be interpreted differently. An
organization should have a strong recognition of the various cost concepts to make efficient
resource appropriation choices.

Ans 3a.
Introduction:
Even if the product's price remains same for a particular period, an increase in consumer
earnings increases demand for it. The term "earnings elasticity of demand" refers to the
amount of demander's reactivity to consumer income. Ratio of the percentage adjustment in
the amount demanded to the percentage adjustment in income is what Watson refers to as
"revenue flexibility of demand." Richard G. Lipsey claims that "earnings elasticity of
demand" refers to how responsively demand adjustments with changes in revenue.

Income elasticity of Demand

Ey = Percentage change in quantity demanded/ Percentage change in income
Where Percentage change in quantity demanded = New quantity demanded – Original
quantity demanded (∆Q)/ Original quantity demanded (Q)
Percentage change in Income = New income – Original income (∆Y)/ Original income (Y)
Ey = ∆Q/∆Y × Y/Q
Applying the formula in the present case,
∆Q = 50 – 40 = 10
∆Y = 35,000 – 20,000 = 15,000
Q = 40
Y= 20,000
Ey = 1/3
Demand's income elasticity changes rely on the product and the circumstances. The revenue
flexibility of demand is divided into three groups based upon a numerical value, with the
following descriptions.
Revenue flexibility of demand is considered promising when a consumer's demand increases
in reaction to a proportionate change in revenue and the other way around.
There are three different sorts of positive revenue elasticity of demand: unitary, less than
unitary, and higher than income elasticity.
1: Unitary revenue elasticity of demand: When a proportionate adjustment in a customer's
earnings translates into a relative change in the demand (increase) for a great, the revenue
elasticity of demand is said to be unitary.
2: Less than unitary revenue flexibility of demand: When a proportionate adjustment in a
customer's revenue leads to a minor increase in demand for an excellent, this is when the
income flexibility of demand is smaller than 1.
3: Greater than unitary income flexibility of demand: When a proportionate adjustment in a
customer's revenue leads to an equally significant increase famous for a good, this is when
the earnings flexibility of demand is higher than 1.
4: When a consumer's demand for a product decreases in reaction to a proportionate
modification in their income and vice versa, this is referred to as having an adverse income
elasticity of demand. When the items are subpar, it usually happens.

Conclusion:
Demand's revenue flexibility helps sellers select where to put their fund. In general, sellers
choose purchasing markets where product demand is a lot more sensitive to adjustments in
earnings as a percentage or where the income elasticity of demand is more significant than no
(> 1).

Ans 3b.
Introduction:
Price elasticity of demand is the ratio of percentage change in quantity of a product
demanded to percentage change in price of the product.. Due to reduction of price of a
product, its quantity demanded rises.

It can be specified numerically as:

Price elasticity of demand = Proportional change in the quantity demanded/ Proportional

change in Price
A symbol ∆ denotes a percentage change in demand and price.
As a result, the formula for estimating demand price elasticity is as follows:
Ep = ∆ Q/∆P × P/Q
Where,
Ep = Price elasticity of demand
P = Initial Price
∆P = Change in price
Q = Initial quantity demanded
∆Q = Change in quantity demanded
Applying the formula in the present case,
∆Q = 25000 – 20000 = 5000
∆P = 500 – 400 = 100
P = 500
Q = 20,000
Ep = (5000/100)X (500/20000)= 50X0.025= 1.25

The demand sensitivity does not remains the same with change in price. A product's demand
can be inelastic or elastic, based upon change in demand with respect to change in price of
the product. The price elasticity of demand is categorized right into five significant
classifications

Perfectly elastic demand: When small change in price of a product results in a big change in
demanded quantity, it is called as perfectly elastic demand. Also there is a fall of demand to
zero when price of a product increases a little quantity and small decrease in price results in
demand to infinity. In graphical method Horizontal parallel line along with X axis. It can be
represented as Ep=∞

Perfectly inelastic demand: When demand of a product is not affected with change in price
of a product it is called perfectly inelastic demand, In graphical Price quantity curve, Vertical
parallel line along with X axis. It can be represented as Ep=0

Relatively elastic demand: When a proportionate or percentage change in price results in a

bigger proportionate or percentage adjustment (increase or decrease) in quantity required, the
demand is stated to be extra flexible. But, an adjustment popular outweighs a price change.
Because of this, the elasticity of demand is more than one in this instance, as shown by ep >
1.The demand curve is gradually sloping.

Relatively inelastic demand: When a percentage or proportionate change in price results in

less than a percentage or proportion adjustment in demand, the demand is reasonably
inelastic. The elasticity of demand is less than 1. The demand curve is sudden sloping.

Unitary elastic demand: Unitary elastic demand occurs when an adjustment (increase or
decrease) in price results in an equivalent modification (fall or rise) in demand. The
mathematical value for unitary elastic demand is equal to one.

Conclusion:

Priced elasticity of demand plays important role in economics to take appropriate business
decisions and to avoid economic problems.