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NAME – KAUSHAL KUMAR REGISTRATION NO. – 521101945 LEARNING CENTER NAME – LEARNING CENTER CODE – COURSE – MBA SEMESTER – 1 SUBJECT – MB0042 SET NO. – DATE OF SUBMISSION – MARKS AWARDED–
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MB0042 – Managerial Economics
Assignment Set- 1 ( 60 Marks) Note: Each question carries 10 Marks. Answer all the questions.
Question.1 Price elasticity of demand depends on various factors. Explain each factor with the help of an example.
Answer.1 - Price Elasticity of Demand In the words of Prof. Stonier and Hague, price elasticity of demand is a technical term used by economists to explain the degree of responsiveness of the demand for a product to a change in its price. where Ep is price elasticity . It implies that at the present level with every change in price, there will be a change in demand four times inversely. Generally the co-efficient of price elasticity of demand always holds a negative sign because there is an inverse relation between the price and quantity demanded. Symbolically Ep = Original demand = 20 units original price = 6 – 00 New demand = 60 units New price = 4 – 00 In the above example, price elasticity is – 6. The rate of change in demand may not always be proportionate to the change in price. A small change in price may lead to very great change in demand or a big change in price may not lead to a great change in demand. Based on numerical values of the co-efficient of elasticity, we can have the following five degrees of price elasticity of demand. Determinants of Price Elasticity of Demand The elasticity of demand depends on several factors of which the following are some of the important ones. 1. Nature of the Commodity
Commodities coming under the category of necessaries and essentials tend to be inelastic because people buy them whatever may be the price. For example, rice, wheat, sugar, milk, vegetables etc. on the other hand, for comforts and luxuries, demand tends to be elastic e.g., TV sets, refrigerators etc. 2. Existence of Substitutes Substitute goods are those that are considered to be economically interchangeable by buyers. If a commodity has no substitutes in the market, demand tends to be inelastic because people have to pay higher price for such articles. For example. Salt, onions, garlic, ginger etc. In case of commodities having different substitutes, demand tends to be elastic. For example, blades, tooth pastes, soaps etc. 3. Number of uses for the commodity Single-use goods are those items which can be used for only one purpose and multiple-use goods can be used for a variety of purposes. If a commodity has only one use (singe use product) then demand tends to be inelastic because people have to pay more prices if they have to use that product for only one use. For example, all kinds of. eatables, seeds, fertilizers, pesticides etc. On the contrary, commodities having several uses, [multiple-use-products] demand tends to be elastic. For example, coal, electricity, steel etc. 4. Durability and reparability of a commodity Durable goods are those which can be used for a long period of time. Demand tends to be elastic in case of durable and repairable goods because people do not buy them frequently. For example, table, chair, vessels etc. On the other hand, for perishable and non-repairable goods, demand tends to be inelastic e.g., milk, vegetables, electronic watches etc. 5. Possibility of postponing the use of a commodity In case there is no possibility to postpone the use of a commodity to future, the demand tends to be inelastic because people have to buy them irrespective of their prices. For example, medicines. If there is possibility to postpone the use of a commodity, demand tends to be elastic e.g., buying a TV set, motor cycle, washing machine or a car etc. 6. Level of Income of the people
Generally speaking, demand will be relatively inelastic in case of rich people because any change in market price will not alter and affect their purchase plans. On the contrary, demand tends to be elastic in case of poor. 7. Range of Prices There are certain goods or products like imported cars, computers, refrigerators, TV etc, which are costly in nature. Similarly, a few other goods like nails; needles etc. are low priced goods. In all these cases, a small fall or rise in prices will have insignificant effect on their demand. Hence, demand for them is inelastic in nature. However, commodities having normal prices are elastic in nature. 8. Proportion of the expenditure on a commodity When the amount of money spent on buying a product is either too small or too big, in that case demand tends to be inelastic. For example, salt, newspaper or a site or house. On the other hand, the amount of money spent is moderate; demand in that case tends to be elastic. For example, vegetables and fruits, cloths, provision items etc. 9. Habits When people are habituated for the use of a commodity, they do not care for price changes over a certain range. For example, in case of smoking, drinking, use of tobacco etc. In that case, demand tends to be inelastic. If people are not habituated for the use of any products, then demand generally tends to be elastic. 10. Period of time Price elasticity of demand varies with the length of the time period. Generally speaking, in the short period, demand is inelastic because consumption habits of the people, customs and traditions etc. do not change. On the contrary, demand tends to be elastic in the long period where there is possibility of all kinds of changes. 11. Level of Knowledge Demand in case of enlightened customer would be elastic and in case of ignorant customers, it would be inelastic. 12. Existence of complementary goods Goods or services whose demands are interrelated so that an increase in the price of one of the products results in a fall in the demand for the other. Goods
which are jointly demanded are inelastic in nature. For example, pen and ink, vehicles and petrol, shoes and socks etc have inelastic demand for this reason. If a product does not have complements, in that case demand tends to be elastic. For example, biscuits, chocolates, ice creams etc. In this case the use of a product is not linked to any other products. 13. Purchase frequency of a product If the frequency of purchase is very high, the demand tends to be inelastic. For e.g., coffee, tea, milk, match box etc. on the other hand, if people buy a product occasionally, demand tends to be elastic. For example, durable goods like radio, tape recorders, refrigerators etc. Thus, the demand for a product is elastic or inelastic will depend on a number of factors.
Question.2 A company is selling a particular brand of tea and wishes to introduce a new flavor. How will the company forecast demand for it? Answer 2 :- To deliver the right products to the right customers portably
requires a fundamental shift in retail decision making from art to science; and from one that is based on human intuition to one that is driven by customer data. Demand Forecasting for a New Product Demand forecasting for new products is quite different from that for established products. Here the firms will not have any past experience or past data for this purpose. An intensive study of the economic and competitive characteristics of the product should be made to make efficient forecasts. Professor Joel Dean, however, has suggested a few guidelines to make forecasting of demand for new products. a) Evolutionary approach The demand for the new product may be considered as an outgrowth of an existing product. For e.g., Demand for new Tata Indica, which is a modified version of Old Indica can most effectively be projected based on the sales of
the old Indica, the demand for new Pulsar can be forecasted based on the a sales of the old Pulsor. Thus when a new product is evolved from the old product, the demand conditions of the old product can be taken as a basis for forecasting the demand for the new product. b) Substitute approach If the new product developed serves as substitute for the existing product, the demand for the new product may be worked out on the basis of a ‘market share’. The growths of demand for all the products have to be worked out on the basis of intelligent forecasts for independent variables that influence the demand for the substitutes. After that, a portion of the market can be sliced out for the new product. For e.g., A moped as a substitute for a scooter, a cell phone as a substitute for a land line. In some cases price plays an important role in shaping future demand for the product. c) Opinion Poll approach Under this approach the potential buyers are directly contacted, or through the use of samples of the new product and their responses are found out. These are finally blown up to forecast the demand for the new product. d) Sales experience approach Offer the new product for sale in a sample market; say supermarkets or big bazaars in big cities, which are also big marketing centers. The product may be offered for sale through one super market and the estimate of sales obtained may be ‘blown up’ to arrive at estimated demand for the product. e) Growth Curve approach According to this, the rate of growth and the ultimate level of demand for the new product are estimated on the basis of the pattern of growth of established products. For e.g., An Automobile Co., while introducing a new version of a car will study the level of demand for the existing car. f) Vicarious approach A firm will survey consumers’ reactions to a new product indirectly through getting in touch with some specialized and informed dealers who have good knowledge about the market, about the different varieties of the product already available in the market, the consumers’ preferences etc. This helps in making a more efficient estimation of future demand.
These methods are not mutually exclusive. The management can use a combination of several of them, supplement and cross check each other.
Question .3 The supply of a product depends on the price. What are the other factors that will affect the supply of a product. Answer.3 :- Factors Determining Elasticity of Supply (Determinants)
1. Time period: Time has a greater influence on elasticity of supply than on demand. Generally supply tends to be inelastic in the short run because time available to organize and adjust supply to demand is insufficient. Supply would be more elastic in the long run. 2. Availability and mobility of factors of production : When factors of production are available in plenty and freely mobile from one occupation to another, supply tends to be elastic and vice - versa. 3. Technological improvements: Modern methods of production expand output and hence supply tends to be elastic. Old methods reduce output and supply tends to be inelastic. 4. Cost of production: If cost of production rises rapidly as output expands, then there will not be much incentive to increase output as the extra benefit will be choked off by the increase in cost. Hence supply tends to be inelastic and vice-versa. 5. Kinds and nature of markets: If the seller is selling his product in different markets, supply tends to be elastic in any one of the market because, a fall in the price in one market will induce him to sell in another market. Again, if he is producing several types of goods and can switch over easily from one to another, then each of his products will be elastic in supply. 6. Political conditions: Political conditions may disrupt production of a product. In that case, supply tends to become inelastic. 7. Number of sellers : Supply tends to become more elastic if there are more sellers freely selling their products and vice-versa. 8. Prices of related goods : A firm can charge a higher price for its products, if prices of other products are higher and vice-versa. 9. Goals of the firm : If the seller is happy with small output, supply tends to be inelastic and vice-versa.
Thus, several factors influence the elasticity of supply. Practical Importance 1. The concept of elasticity of supply is of great importance to the finance minister while formulating the taxation policy of the country. If the supply is inelastic, the imposition of tax may not bring about any change in the supply. If supply is elastic, reasonable taxes are to be levied. 2. The price of a commodity depends upon the degree of elasticity of demand and supply. 3. It is used in the theory of incidence of taxation. The money burden of taxation is shared by the tax payers and the sellers in the ratio of elasticity of supply and demand.
Question.4 Show how producers equilibrium is achieved with isoquants and isocost curves. Answer.4:- ISO-Quants and ISO-Costs
The prime concern of a firm is to workout the cheapest factor combinations to produce a given quantity of output. There are a large number of alternative combinations of factor inputs which can produce a given quantity of output for a given amount of investment. Hence, a producer has to select the most economical combination out of them. Iso-product curve is a technique developed in recent years to show the equilibrium of a producer with two variable factor inputs. It is a parallel concept to the indifference curve in the theory of consumption. Meaning and Definitions The term “Iso – Quant” has been derived from ‘Iso’ meaning equal and ‘Quant’ meaning quantity. Hence, Iso – Quant is also called Equal Product Curve or Product Indifference Curve or Constant Product Curve. An Iso – product curve represents all the possible combinations of two factor inputs which are capable of producing the same level of output. It may be defined as – “ a curve which shows the different combinations of the two inputs producing the same level of output .”
Each Iso – Quant curve represents only one particular level of output. If there are different Iso–Quant curves, they represent different levels of output. Any point on an Iso – Quant curve represents same level of output. Since each point indicates equal level of output, the producer becomes indifferent with respect to any one of the combinations. PRODUCERS EQUILIBRIUM (Optimum factor combination or least cost combination). The optimal combination of factor inputs may help in either minimizing cost for a given level of output or maximizing output with a given amount of investment expenditure. In order to explain producer’s equilibrium, we have to integrate Iso-quant curve with that of Iso-cost line. Iso-product curve represent different alternative possible combinations of two factor inputs with the help of which a given level of output can be produced. On the other hand, Iso-cost line shows the total outlay of the producer and the prices of factors of production. The intention of the producer is to maximize his profits. Profits can be maximized when he is producing maximum output with minimum production cost. Hence, the producer selects the least cost combination of the factor inputs. Maximum output with minimum cost is possible only when he reaches the position of equilibrium. The position of equilibrium is indicated at the point where Iso-Quant curve is tangential to Iso-Cost line. The following diagram explains how the producer reaches the position of equilibrium. It is quite clear from the diagram that the producer will reach the position of equilibrium at the point E where the Iso-quant curve IQ and Iso-cost line AB is tangent to each other. With a given total out lay of Rs. 5,000 the producer will be producing the highest output, i.e. 500 units by employing 25 units of factors X and 50 units of factor Y. (assuming Rs. 2,500 each is spent on X and Y) The price of one unit of factor X is Rs.100-00 and that of Y is Rs. 50-00.. Rs.100 x 25 units of 2500 - 00 and Rs. 50 x 50 units of Y = 2500 - 00. He will not reach the position of equilibrium either at the point E1 and E2 because they are on a higher Iso-cost line. Similarly, he cannot move to the left side of E, because
they are on a lower Iso-Cost line and he will not be able to produce 500 units of output by any combinations which lie to the left of E. Thus, the point at which the Iso-Quant is tangent to the Iso-Cost line represents the minimum cost or optimum factor combination for producing a given level of output. At this point, MRTS between the two points is equal to the ratio between the prices of the inputs.
Q.5 Discuss the full cost pricing and marginal cost pricing method. Explain how the two methods differ from each other. Answer.5 Full – Cost pricing or Cost Plus Pricing Method
Full cost pricing is one of the simplest and common methods of pricing adopted by different firms. Hall and Hitch of the Oxford University in their empirical study of actual business behavior found that business firms do not determine price and output by comparing MR and MC. On the other hand, under Oligopoly and monopolistic conditions they base their market price on full cost conditions. According to this principle, businessmen charge price that cover their average cost in which are included normal or conventional profits. Cost refers to full allocated costs. According to Joel Dean, it has three components – i) Actual cost which refers to the actual or total expenses incurred in production. For e.g., wage bills, raw material cost, overhead charges etc. ii) Expected cost refers to the forecast for the pricing period on the basis of expected prices, output rate and productivity. iii) Standard cost refers to cost incurred at the normal level of output. In brief, a firm computes the selling price of its product by adding certain percentage to the average total cost of the product. The
percentage added to costs is called margin or mark-ups. Hence, this method is also called Margin – pricing and Mark – up pricing. Cost +pricing = Cost + Fair profit Fair profit means a fixed percentage of profit markups. It is arbitrarily determined. The margin of profits included in the price of a product differs from industry to industry and commodity to commodity on account of differences in competitive strength, cost of production, total turnover, accounting practices etc. Past traditions, directives from trade associations, guidelines from the government may also decide the percentage of profits. This method envisages covering the total costs incurred in producing and selling a commodity In this case businessmen do not seek supernormal profit. Hence, a price based on full average cost is the „right cost‟, the one which ought to be charged based on the idea of fairness under Oligopoly and Monopolistic competition. Illustration Production = 8000 units. Total Fixed Cost = Rs 30,000 Total Variable Cost = Rs. 50,000 Total Cost = Rs. 80,000 Per Unit Cost = 80,000 / 8000 = Rs 10 20% Net Profit Margin On Cost = 10 . 2 100 20 Rs Cost Price = Rs 10 20% NPM on Cost = Rs. 10 Selling Price = + Rs. 2 Rs. 12 Evaluation of the full cost pricing
Generally, the firms will not have information about demand conditions, nature and degree of competition, technology used etc., further modern business conditions are extremely uncertain. Besides a firm may be producing or selling innumerable varieties of goods and to calculate prices on the basis of profit maximization may be almost impossible. The cost plus method is convenient since the firms have only to add some standard markup to their cost. Over a period of time, through trial and error, they can find out the proper mark – up. The supreme merit of this method lies in its mechanical simplicity and its apparent fairness. It is safer, cheaper and imparts competitive stability particularly when there is tough competition in the market. It is useful particularly in product tailoring and public utility pricing. It is justified on moral grounds because price based on costs is a just price. According to Professor Joel Dean, it is the best method of pricing in case of new products because if the firm is able to realize its normal profits, then only it can take a decision to produce and market a product otherwise not. This method attaches too much of significance to allotted costs and markups. It tends to diminish the interest of the producer in cost control. However, many firms adopt this method of pricing due to its inherent benefits.
Marginal cost pricing
It is based on a pure economic concept of equilibrium of a firm, where marginal cost is equal to marginal revenue. Under this method price is determined on the basis of marginal cost which refers to the cost of producing additional units. Price based on marginal cost will be much more aggressive than the one based on total cost. A firm with large unused capacity will have to explore the possibility of producing and selling more. If the price is sufficient to cover the marginal cost, particularly in times of recession the firm should be able to produce and sell the commodity and can think of recovering the total cost in the long run. This method though sounds excellent theoretically has the serious limitation of ascertaining the marginal cost
Q.6 Discuss the price output determination using profit maximization under perfect competition in the short run. Answer.6:Price output determination under perfect competition
Equilibrium of the Industry in the short run The term „Equilibrium‟ in physical science implies a state of balance or rest. In economics, it refers to a position or situation from which there is no incentive to change. At the equilibrium point, an economic unit is maximizing its benefits or advantages. Hence, always there will be a tendency on the part of each economic unit to move towards the equilibrium condition. Reaching the position of equilibrium is a basic objective of all firms. In the short period, time available is too short and hence all types of adjustments in the production process are impossible. As plant capacity is fixed, output can be increased only by intensive utilization of existing plants and machineries or by having more shifts. Fixed factors remain the same and only variable factors can be changed to expand output. Total number of firms remains the same in the short period. Hence, total supply of the product can be adjusted to demand only to a limited extent. In the short run, price is determined in the industry through the interaction of the forces of demand and supply. This price is given to the firm. Hence, the firm is a price taker and not price maker. On the basis of this price, a firm adjusts its output depending on the cost conditions. An industry under perfect competition in the short run, reaches the position of equilibrium when the following conditions are fulfilled: 1. There is no scope for either expansion or contraction of the output in the entire industry. This is possible when all firms in the industry are producing an equilibrium level of output at which MR = MC. In brief, the total output remains constant in the short run at the equilibrium point. Thus a firm in the short run has only temporary equilibrium.
2. There is no scope for the new firms to enter the industry or existing firms to leave the industry. 3. Short run demand should be equal to short run supply. The price so determined is called as „subnormal price‟. Normal price is determined only in the long run. Hence, short run price is not a stable price. Equilibrium of the competitive firm in the short run A competitive firm will reach equilibrium position at the point where short run MR equals MC. At this point equilibrium output and price is determined. The firm in the short run will have only temporary equilibrium. The short run equilibrium price is not a stable price. It is also called as sub - normal price. A competitive firm will reach equilibrium position at the point where short run MR equals MC. At this point equilibrium output and price is determined. The firm in the short run will have only temporary equilibrium. The short run equilibrium price is not a stable price. It is also called as sub - normal price.
The competitive firm, in the short run, will not be in a position to cover its fixed costs. But it must recover short run variable costs for its survival and to continue in the industry. A firm will not produce any output unless the price is at least equal to the minimum AVC. If short run price is just equal to AVC, it
will not cover fixed costs and hence, there will be losses. But it will continue in the industry with the hope that it will recover the fixed costs in the future
If price is above the AVC and below the AC, it is called as “Loss minimization” zone. If the price is lower than AVC, the firm is compelled to stop production altogether. While analyzing short term equilibrium output and price, apart from making reference to SMC and AVC, we have to look into AC also. If AC = price, there will be normal profits. If AC is greater than price, there will be losses and if AC is lower than price, then there will be super normal profits. In the short run, a competitive firm can be in equilibrium at various points E1, E2 and E3 depending upon cost conditions and market price. At these various unstable equilibrium points, though MR = MC, the firm will be earning either super normal profits or incurring losses or earning normal profits. In the case of the firm: 1. At OP4 price the firm will neither cover AFC nor AVC and hence it has to wind up its operations. It is regarded as shut-down point.
2. At OP1 price, OQ1 is the equilibrium output. E1 indicates the price or AR = AVC only. It does not cover fixed costs. The firm is ready to suffer this loss and continue in business with the hope that price may go up in the future. 3. At OP2 price, OQ2 is the equilibrium output. E2 indicates the price = AR = AC. At this point MR is also equal to MC. At this level of output total average revenue = total average cost hence, the firm is earning only normal profits. It is also known as Break - even point of the firm, a zone of no loss or no profit. The distance between two equilibrium points E2 and E1 indicates lossminimization zone. 4. At OP3 price, OQ3 is the output produced by the firm. At E3, MR = MC. But AR is greater than AC. For OQ3 output, the total cost is OQ3AB. The total revenue is OQ3E3P3. Hence, P3E3AB is the total super normal profits. Thus in the short run, a firm can either incur losses or earn super normal profits. The main reason for this is that the producer does not have adequate time to make all kinds of adjustments to avoid losses in the short run. In case of the industry, E indicates the position of equilibrium where short run demand is equal to short run supply. OR indicates short run price and OQ indicates short run demand and supply.
Master of Business Administration - MBA Semester I MB0042 – Managerial Economics - 4 Credits
Assignment Set- 2 (60 Marks)
Note: Each question carries 10 Marks. Answer all the questions.
Question.1 Income elasticity of demand has various applications. Explain each application with the help of an example.
Anawer.1: Income elasticity of demand may be defined as the ratio or proportionate change in the quantity demanded of a commodity to a given proportion change in the income. In short, it indicates the extent to which demand changes with a variation in consumer‘s income. Thefollowing formula helps to measure the income elasticity (Ey).
Where · Ey is income elasticity of demand · D is change in demand · D is original demand · Y is change in income · Y is original income Example Original demand=400 units Original income= 4000 units
New demand =700 units New income= 6000 units Change in demand= 700-400= 300 units change in income=6000-4000=2000 Hence Ey=300/2000*4000/400=1.5 Generally speaking Ey is positive. This is because there is a direct relationship between income and demand, i.e. higher the income; higher would be the demand and vice versa. On the basis of the numerical value of the co-efficient, Ey is classified as greater than one, less than one, equal to one, equal to zero and negative. The concept of ey helps us in classifying commodities in to different categories 1. When Ey is positive, the commodity is normal (used in day-to-day life) 2. When Ey is negative, the commodity is inferior. ( for example jowar, beedi etc) 3. When Ey is positive and greater than one, the commodity is luxury. 4. When Ey is positive but less than one, the commodity is essential. 5. When Ey is zero, the commodity is neutral. E.g. salt, match box etc. Practical application of income elasticity of demand 1. Helps in determining the rate of growth of the firm. If the growth rate of the economy and income growth of the people is reasonable forecasted, in that case it is possible predict expected increase in the sales of a firm and vice versa 2. Helps in the demand forecasting of a firm. It can be in estimating future demand provided the rate of increase in income and Ey for the products are known. Thus, it helps in demand forecasting activities of a firm. 3. Helps in production planning and marketing. The knowledge of Ey is essential for production planning, formulating marketing strategy, deciding advertising expenditures and nature of distribution channel etc in the long run. 4. Helps in ensuring stability in production. Proper estimation of different degrees of income elasticity of demand for different types of product helps in avoiding over-production or under-
production of a firm. One should know whether rise or fall in income is permanent or temporary. 5. Helps in estimating construction of houses. The rate of growth in incomes of people also helps in housing programs in a country. Thus it helps a lot in managerial decisions of a firm.
Q.2 When is the opinion survey method used and what is the effectiveness of the method. Answer.2 Survey of buyer‘s intention or preference is one of the important
methods of demand forecasting. It is also called ―Opinion Survey Method Under this method, consumer buyers are requested to indicate their preference and willingness about a particular product. They are about to reveal their future purchase plans with respect to specific items. They are expected to give answer to question like what items they intends to buy, in what quantity, why, where, what quality they expect, how much they are planning to spend etc. Generally, the field surveys are conducted by the marketing research departments of the company or hiring the services of outside research organization consisting of learned and highly qualified professionals The heart of the survey is questionnaire. It is a comprehensive one covering almost all questions either directly or indirectly in a most intelligent manner. It is prepared by an expert body who are specialist in the field or marketing. The questionnaire is distributed among the consumer either through mail or in person by the company. Consumers are requested to furnish all relevant and correct information. The next step is to collect the questionnaire from the consumers for the purpose of evaluation. The materials collected will be classified, edited and analyzed. If any bias prejudices, exaggerations, artificial or excess demand creation are found at the time of answering they would be eliminated.
The information so collected will now be consolidated and reviewed by the top executives with lot of experiences. It will be examined thoroughly. Inferences are drawn and conclusions are arrived at. Finally a report is prepared and submitted to the management for taking final decisions The success of the survey method depends on many factors: 1. The nature of the question asked. 2. The ability of the surveyed. 3. The representative of the sample 4. Nature of the product 5. Characteristics of the market 6. Consumer behavior 7. Techniques of analysis 8. Conclusion drawn etc. The management should not entirely depend on the result of survey reports t project future demand. Consumer may not express their honest and real views and as such they may give only the broad trends in the market. In order to arrive, at right conclusion, field surveys should be regularly checked and supervised. This method is simple and useful to the producers who produce goods in bulk. Here the burden of forecasting is put on the customers. However this method is not much useful in estimating the future demand of the household as they run in a large numbers and also do not freely express their future demand requirements. It is expensive and so difficult. Preparation of questionnaire is not an easy task. At best it can be used for short term forecasting
Question.3 Show how price is determined by the forces of demand and supply, by using forces of equilibrium.
Answer.3 The word equilibrium is derived from the Latin word ―equilibrium which means equal balance. It means a state of even balance in which opposing forces or tendencies neutralize each other. It is a position of rest characterized by absence of change. It is a state where there is complete
agreement of the economic plans of the various market participants 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 approach and the general equilibrium approach. The partial equilibrium approach to pricing explains price determination of a single commodity keeping the prices of other commodities constant. On the other hand, the general equilibrium approach explains the mutual and simultaneous determination of the prices of all goods and factors. Thus it explains a 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 gave equal importance to both demand and supply in the determination of value or price. He compared supply and demand to a pair of scissors – ― We might as reasonably dispute whether it is the upper or the under blade of a pair of scissors that cuts a piece of paper, as whether value is governed by utility or cost of production. Thus neither the upper blade nor the lower blade taken separately can cut the paper; both have their importance in the process of cutting. Likewise neither supply alone, nor demand alone can determine the price of a commodity, both are equally important in the determination of price. But the relative importance of the two may vary depending upon the time under consideration. Thus, the demand of all consumers and the supply of 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 two forces. Price is an independent variable. Demand and supply are dependent variables. They depend on price. Demand varies inversely with price, a rise in price causes a fall in demand and a fall in price causes a rise in demand. Thus the demand curve will have a downward slope indicating the expansion of demand with a fall in price and contraction of demand with a rise in price. On the other hand supply varies directly with the changes in price, a rise in price causes a rise in supply and a fall in price causes a fall in supply.
Thus the supply curve will have an upward slope.At a point where these two curves intersect with each other the equilibrium price is established. At this price quantity demanded is equal to the quantity demanded. This we can explain with the help of a table and a diagram
In the table at Rs.20 the quantity demanded is equal to the quantity supplied. Since the price is agreeable to both the buyer and sellers, there will be no
tendency for it to change; this is called equilibrium price. Suppose the price falls to Rs.5 the buyer will demand 30 units while the seller will supply only 5 units. Excess of demand over supply pushes the price upward until it reaches the equilibrium position supply is equal to the demand. On the other hand if the price rises 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 over demand pushes the price downward until it reaches the equilibrium. This process will continue till the equilibrium price of Rs.20 is reached. Thus the interactions of demand and supply forces acting 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 are in equilibrium at point E where the two curves intersect each other. OQ is the equilibrium output. OP is the equilibrium price. Suppose the price OP2 is higher than the equilibrium price OP. at this point price quantity demanded is P2D2. Thus D2S2 is the excess supply which the seller wants to push into the market, competition among the sellers will bring down the price to the equilibrium level where the supply is equal to the demand. At price OP1, the buyers will demand P1D1 quantity while the sellers are ready to sell P1S1. Demand exceeds supply. Excess demand for goods pushes up the price; this process will go until equilibrium is reached where supply becomes equal to demand.
Q.4 Distinguish between fixed cost and variable cost using an example. Answer.4 Fixed cost: These costs are incurred on fixed factors like land,
building, equipments, plants, superior types of labor, top management etc. fixed costs in the short run remains constant because the firm does not change the size of plant and the amount of the fixed factors employed. Fixed costs do not vary with either expansion or contraction in output. These cost are to be incurred by a firm even output is zero. Even if the firm close down its
operation for some time 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 as contractual rent payments, interest on capital borrowed, insurance premium, depreciation and maintenance allowance, administrative expenses like manager‘s salary or salary of the permanent staff, property and business taxes, license fees, etc. They are called as over- head costs because these costs are to incurred whether there is production or not. These costs are to be distributed on each units of output produced by a firm. Hence, they are called as indirect costs. Variable Costs: The costs corresponding to variable factors are described as variable costs. These costs are incurred on raw materials, ordinary labour, transport, power, fuel, water etc, 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 variable factors of production and will not therefore incurs any variable costs. Variable costs are incurred only when some amount of output is produced. Total variable cost increases with the level of increase in the level of production and vice-versa. Prof. Marshall called variable costs as prime costs or direct costs because the volume of output produced by a firm depends directly upon them. It is clear from the above description that a production cost consists of both fixed as well as variable costs. The difference between the two is meaningful and relevant only in the short run. In the long run all costs become variable because all factors of production become adjustable and variable in the long run. However, the distinction between the fixed and variable costs is very important in the short because it influences the average costs behavior of the firm. In the short run, even if a firm wants to close down its operation but wants to remain in the business, it will have to incur fixed costs but it must cover at least its variable costs.
Q.5 Discuss Marris Growth Maximization model and show how it is different from the Sales maximization model. Answer.5 Profit maximization is traditional objective of a firm. Sales
maximization objective is explained by Prof. Boumal. On similar lines, Prof. Marris has developed another alternative growth maximization model in recent years. It is a common factor to observe that each firm aims 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 groups of people, i.e. owner and managers. He further points out that both of them have two distinctive goals. 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 more concerned 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 mannerUo= 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 viceversa. Size of the firm according to Marris depends on the amount of corporate capital which includes total volume of the asset, inventory level, cash reserve etc. He further points out that the managers always 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 firm satisfy the promotional opportunity of managers and also the share holders as they get more dividends
Q.6 Explain how fiscal policy is used to achieve economic stability. Answer.6 In order to achieve a stable economic condition, fiscal policy has
to play a positive and constructive role both in developed and developing nations. The specific role to be played by fiscal policy can be discussed as follows: To act as optimum allocator of resources: As most of the resources are scarce in their supply, 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 the MPS. 2. Taxation policy has to be modified to raise the rates of old taxes, introduces new additional taxes, and extends the tax-nets. 3. Profit earning capacity of public sector units are to be raise substantially to mop-up financial resources. 4. The government should borrow more money both in the country and outside the country. 5. Higher the rate of interest are to be offered for government bonds and security. To act as an investor: Mere mobilization of financial resources is not an end in itself. It should result in the creation of real resources which are more important in accelerating the growth process. Rapid economic growth depends upon the volume of investment. Hence, fiscal policies have to be ensuring higher volume of investment in both private and public sectors. · To act as price stabilizer: price stability is of paramount of importance in an economy. Extreme levels of both inflation and deflation would disrupt and disturb the normal and regular working of an economic system. This would
come in the way of stable and persistent growth. Hence all measures are to be taken to check these two dangerous situations so as to create necessary congenial atmosphere to prepare the background for rapid economic growth To act as an economic stabilizer: Price stability would create the necessary background for over all economics stability. Upswing and downswing in the level of economic activities are to be avoided. If an economy is subject to frequent fluctuation in the form of trade cycle, certainly, it would undermine and disturb the growth process. Instability would come in the way of persistent and consistent growth in a country. Hence all measure to be taken to ensure economic stability. To act as an employment generator: Fiscal policy should help in mobilizing more financial resources, convert them in to investment and create more employment opportunity to absorb the huge unemployed man power. To act as balancer: There must be proper balance between aggregate saving and aggregate investment, demand and supply, income and output and expenditure, economic overhead capital and social overhead capital etc. Any sort of imbalance would result in either surpluses or scarcity in different sectors of the economy leading to fast growth in some sectors followed by lagging of some other sectors. To act as growth promoter: The basic objective of any economic policy is to ensure higher economic growth rates. This is possible when there is higher national savings, investment, production, employment and income. Hence, fiscal policy is to be designed in such a manner so as to promote higher growth in an economy. To act as in come redistribute: Fiscal policy has to minimize inequalities and ensure distributive justice in an economy. This is possible when a rational taxation and public expenditure policy is adopted. More money is collected from richer section of the society through various imaginative taxation
policies and a larger amount of money is to be spent in favor of poorer sections of the society. Thus, inequality is to be reduced to the minimum To act as stimulator of living standards of people: the final objective is to raise the level of living standards of the people. This is possible when there is higher output, income and employment leading to higher purchasing power in the hands of common man. Hence, fiscal policy should help in creating more wealth in the economy. If there is economic prosperity, then it is possible to have a satisfactory, contended and peaceful life. Thus, fiscal policy has to play a major role in promoting economic growth in a country.
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