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Show how price is determined by the forces of demand a n d s u p p l y , b y u s i n g f o r c e s o f e q u i l i b r i u m .

Ans: The word equilibrium is derived from the Latin word aequilibrium whichmeans equal balance. It means a state of even balance in which opposing forces or tendenciesneutralize each other. It is a position of rest characterized by absence of change. It is a statewhere there is complete agreement of the economic plans of the various ma rketparticipants so that no one has a tendency to revise or alter his decision. In the words of professor Mehta: Equilibrium denotes in economics absence of change in movement. Market Equilibrium There are two approaches to market equilibrium viz., partial equilibrium approachand the general equilibrium approach. The partial equilibrium approach to pricingexplains price determination of a single commo dity keeping the prices of othercommodities constant. On the other hand, the general equilibrium approach explains themutual and simultaneous determination of the prices of all goods and factors. Thus it explainsa multi market equilibrium position.Earlier to Marshall, there was a dispute among economists on whether the force of demand or the force of supply is more important in determining price. Marshall gaveequal importance to both demand and supply in the determination of value or price. Hecompared supply and demand to a pair of scissors We might as reasonably dispute whetherit is the upper or the under blade of a pair of scissors that cuts a piece of paper, as whether

WithLotsofLucks M a n a g e r i a l E c o n o m i c s M B A - 1 s t

g 5 value is governed by utility or cost of production. Thus neither the upper blade nor thelower blade taken separately can cut the paper; both have their importan ce in the processof cutting. Likewise neither supply alone, nordemand alone can determine the price of a commodity, both are equally important inthe determination of price. But the relative importance of the two may vary dependingupon the time under consideration. Thus, the demand of all consumers and the supplyof all firms together determine the price of a commodity in the market. Equilibrium between demand and supply price: Equilibrium between demand and supply price is obtained by the interaction of these twoforces. Price is an independent variable. Demand and supply are dependent variables. Theydepend on price. Demand varies inversely with price, a rise in price causes a fall in demand anda fall in price causes a rise in demand. Thus the demand curve will have a do wnward slopeindicating the expansion of demand with a fall in price and contra ction of demand with arise in price. On the other hand supply varies directly with the changes in price, a rise in pricecauses a rise in supply and a fall in price causes a fall in supply. Thus the supply curve willhave an upward slope.At a point where these two curves intersect with each other the equilibrium price isestablished. At this price quantity demanded is equal to the quantity demanded. This we canexplain with the help of a table and a diagram.Price in Rs Demand in units Supply in units State of market Pressure o n price 30 5 25 D<S P25 10 20 D<S P20 15 15 D=S Neutral10 20 10 D>S P5 30 5 D>S P

WithLotsofLucks M a n a g e r i a l E c o n o m i c s M B A - 1 s t P a g e | 6 In the table at Rs.20 the quantity demanded is equal to the quantity supplied. Since the price isagreeable to both the buyer and sellers, there will be no tendency for it to change; this is calledequilibrium price. Suppose the price falls to Rs.5 the buyer will demand 30 units while theseller will supply only 5 units. Excess of demand over supply pushes the price upward until itreaches the equilibrium position supply is equal to the demand. On the other hand if the pricerises to Rs.30 the buyer will demand only 5 units while the sellers are ready to supply 25 units.Sellers compete with each other to sell more units of the commodity. Excess of supply overdemand pushes the price downward until it reaches the equilibrium. This process will continuetill the equilibrium price of Rs.20 is reached. Thus the interactions of demand and supply forcesacting upon each other restore the equilibrium position in the market.In the diagram DD is the demand curve, SS is the supply curve. Demand and supply arein equilibrium at point E where the two curves intersect each other. OQ is the equilibriumoutput. OP is the equilibrium price. Suppose the price OP2 is higher than the equilibrium priceOP. at this point price quantity demanded is P2D2. Thus D2S2 is the excess supply which theseller wants to push into the market, competition among the sellers will bring down the price tothe equilibrium level where the supply is equal to the demand. At price OP1, the buyers willdemand P1D1 quantity while the sellers are ready to sell P1S1. Demand exceeds supply. Excessdemand for goods pushes up the price; this process will go until equilibrium is reached wheresupply becomes equal to demand. Q .4 Di s t i n g u i s h b e t we e n f i x e d c o s t a n d v a r i a b l e c o s t u s i n g a n e x a mp l e ?

WithLotsofLucks M a n a g e r i a l E c o n o m i c s M B A - 1 s t P a g e | 7 Ans: Fixed cost: These costs are incurred on fixed factors like land, building, equipments,plants, superior types of labour, top management etc. fixed costs in the short run

remainsconstant because the firm does not change the size of plant and the amount of the fixed factorsemployed. Fixed costs do not vary with either expansion or contraction in output. These cost areto be incurred by a firm even output is zero. Even if the firm close down its operation for sometime temporarily in the short run, but remains in business, these cost have to be borne by it.Hence, these costs are independent of output and are referred to as unavoidable contractual cost.Prof. Marshall called fixed cost as supplementary costs. They include such items ascontractual rent payments, interest on capital borrowed, insurance premium, depreciation andmaintenance allowance, administrative expenses like managers salary or salary of thepermanent staff, property and business taxes, license fees, etc. They are called as over- headcosts because these costs are to incurred whether there is production or not. These costs are tobe distributed on each units of output produced by a firm. Hence, they are called as indirectcosts. Variable Costs: The costs corresponding to variable factors are described as variablecosts. These costs are incurred on raw materials, ordinary labour, transport, power, fuel, wateretc, which directly vary in the short runs.Variable costs are directly and proportionately increases or decreases with the level of output. If a firm shut down for some times in the short run; then it will not use the variablefactors of production and will not therefore incurs any variable costs. Variable costs areincurred only when some amount of output is produced. Total variable cost increases with thelevel of increase in the level of production and vice-versa. Prof. Marshall called variable costsas prime costs or direct costs because the volume of output produced by a firm depends directlyupon them.It is clear from the above description that a production cost consists of both fixed as wellas variable costs. The difference between the two is meaningful and relevant only in the shortrun. In the long run all costs become variable because all factors of production becomeadjustable and variable in the long run.However, the distinction between the fixed and variable costs is very important in theshort because it influences the average costs behavior of the firm. In the short run, even if a firmwants to close down its operation but wants to remain in the business, it will have to incur fixedcosts but it must cover at least its variable costs.


M a n a g e r i a l E c o n o m i c s M B A - 1 s t P a g e | 8 Q.5 Discuss Marris Growth Maximization model and s h o w h o w i t i s d i f f e r e n t f r o m t h e S a l e s ma x i mi z a t i o n mo d e l ? An s : Profit maximization is traditional objective of a firm. Sales maximization objective isexplained by Prof. Boumal. On similar lines, Prof. Marris has developed another alternativegrowth maximization model in recent years. It is a common factor to observe that each firmaims at maximizing its growth rate as this goal would answer many of the objectives of a firm.Marris points out that a firm has to maximize its balanced growth rate over a period of time.Marris assumes that the ownership and control of the firm is in the hands of two groupsof people, i.e. owner and managers. He further points out that both of them have two distinctivegoals. Managers have a utility function in which the amount of salary, status, position, power,prestige and security of job etc are the most import variable where as in case of are moreconcerned about the size of output, volume of profits, market shares and sales maximization.Utility function of the manager and that the owner are expressed in the following manner-Uo= f [size of output, market share, volume of profit, capital, public esteem etc.]Um= f [salaries, power, status, prestige, job security etc.]In view of Marris the realization of these two functions would depend on the size of the firm.Larger the firm, greater would be the realization of these functions and vice-versa. Size of thefirm according to Marris depends on the amount of corporate capital which includes totalvolume of the asset, inventory level, cash reserve etc. He further points out that the managersalways aim at maximizing the rate of growth of the firm rather than growth in absolute size of the firms. Generally managers like to stay in a grouping firm. Higher growth rate of the firmsatisfy the promotional opportunity of managers and also the share holders as they get moredividends. B o u ma l s S a l e s M a x i mi z a t i o n mo d e l : Sales maximization model is an alternative for profit maximization model. This model isdeveloped by Prof. W.J. Boumal, an American economist. This alternative goal has assumedgreater significance in the context of the growth of the oligopolistic firms. The model highlightsthat the primary objective of the firm is to maximize its sales rather than profit maximization. Itstates that the goal of the firm is maximization of sales revenue subject to a minimum profitconstraint. The minimum profit constraint is determined by the

expectation of the shareholders.This is because no company can displease the shareholders. It is to be noted here that

WithLotsofLucks M a n a g e r i a l E c o n o m i c s M B A - 1 s t P a g e | 9 maximization of sales does not mean maximization of physical sales but maximization of totalsales revenue. Hence, the managers are more interested in increasing sales rather than profit.The basic philosophy is that when sales are maximized automatically profits of the companywould also go up. Hence, attention is diverted to increase the sales of the company in recentyears in the context of highly competitive market.How Profit Maximization model differs from Sales Maximization model:The sale maximization model differs on the following grounds: Emphasis is given on maximizing sales rather than profit.

Increase the competitive and operational ability of the company. The amount of slack earning and salaries of the top managers are directly linked to it. It helps in enhancing the prestige and reputation of top management, distributes moredividends to share holders and increases the wage of the workers and keeps themhappy. The financial and other lending institutions always keep a watch on the sales revenue of a firm as it is an indication of financial health of the firm. Q .6 Ex p l a i n h o w f i s c a l p o l i c y i s u s e d t o a c h i e v e e c o n o mi c s t a b i l i t y? Ans: In order to achieve a stable economic condition, fiscal policy has to play a positive andconstructive role both in developed and developing nations. The specific role to be played byfiscal policy can be discussed as follows: To act as optimum allocator of resources: As most of the resources are scarce in theirsupply, careful planning is needed in its allocation so as to achieve the set targets.Rational allocation would ensure fulfillment of various objectives. To act as a saver: 1. It should follow a rational consumption policy reduces the MPC and raises theMPS. 2.

Taxation policy has to be modified to raise the rates of old taxes, introduces newadditional taxes, and extends the tax-nets.