Master of Business Administration Semester I MB0042 – Managerial Economics - 4 Credits (Book ID: B1131) Assignment Set- 1 (60 Marks) Q1) What is a business

cycle? Describe the different phases of a business cycle. Parkin and Bade's text "Economics" gives the following definition of the business cycle: The business cycle is the periodic but irregular up-and-down movements in economic activity, measured by fluctuations in real GDP and other macroeconomic variables. If you're looking for information on how various economic indicators and their relationship to the business cycle, please see A Beginner's Guide to Economic Indicators. Parkin and Bade go on to explain: A business cycle is not a regular, predictable, or repeating phenomenon like the swing of the pendulum of a clock. Its timing is random and, to a large degress, unpredictable. A business cycle is identified as a sequence of four phases: 1) Contraction: A slowdown in the pace of economic activity 2) The lower turning point of a business cycle, where a contraction turns into an expansion 3) Expansion: A speedup in the pace of economic activity 4) Peak: The upper turning of a business cycle

Q2. What is monetary policy? Explain the general objectives and instruments of monetary policy? Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability. The official goals usually include relatively stable prices and low unemployment. Monetary theory provides insight into how to craft optimal monetary policy. It is referred to as either being expansionary or contractionary, where an expansionary policy increases the total supply of money in the economy more rapidly than usual, and contractionary policy expands the money supply more slowly than usual or even shrinks it. Expansionary policy is traditionally used to try to combat unemployment in a recession by lowering interest rates in the hope that easy credit will entice businesses into expanding. Contractionary policy is intended to slow inflation in hopes of avoiding the resulting distortions and deterioration of asset values. Various objectives or goals of monetary policy are: 1. 2. 3. 4. 5. Neutrality of Money Price Stability Economic growth Exchange Stability Full Employment

The term also applies to forgone income from choosing not to work. it will always be less than or equal to accounting profit.000 . If the firm cannot obtain a profit after deducting £10.10)/ (5. where total costs are the sum of implicit and explicit costs) and accounting profit (total revenues minus only explicit costs). also called an imputed cost. or notional cost. Explicit cost:An explicit cost is a direct payment made to others in the course of running a business. as opposed to implicit costs. pleasure or any other benefit that provides utility should also be considered opportunity costs .000 a month for this implicit cost. opportunity costs are not restricted to monetary or financial costs: the real cost of output forgone. The value of elasicty of supply of the pens is 0. and remember instead to look at the land's current value.Q3) A firm supplied 3000 pens at the rate of Rs 10. It is the sacrifice related to the second best choice available to someone. .000) Rs per item. It is the opposite of an explicit cost. Explicit costs are taken into account along with implicit ones when considering economic profit. Give a brief description of A ) Implicit and explicit cost In economics. selling. due to a rise of in the price to 22 rs per pen the supply of the firm increases to 5000 pens. Implicit costs also represent the divergence between economic profit (total revenues minus total costs. which are those where no actual payment is made. Opportunity cost is a key concept in economics. it ought to move premises (or close down completely) and take the rent instead. and has been described as expressing "the basic relationship between scarcity and choice". or lending it. implied cost. It is possible still to underestimate these costs. rent and materials. The opportunity cost is also the cost of the forgone products after making a choice. however: for example. which is borne directly. ANS:The elasticity of supply is the increment (difference) in price divided by the increment in quantity. or group. who has picked among several mutually exclusive choices. Lipsey (1975) uses the example of a firm sitting on an expensive plot worth £10. B) Actual and opportunity cost:Opportunity cost:It is the cost of any activity measured in terms of the value of the next best alternative forgone (that is not chosen).3. Since economic profit includes these extra opportunity costs.006 Q4.[1] In calculating this figure. Elasticity is : (22 . an implicit cost. the firm ought to ignore the figure of £50. pension contributions and other "perks" must be taken into account when considering the cost of labour. Accounting profit only takes explicit costs into account. Note the unites must be given and the numerical value is positive due to the shape of the supply characteristic. lost time.000 a month in rent which it bought for a mere £50 a hundred years before. Thus. The notion of opportunity cost plays a crucial part in ensuring that scarce resources are used efficiently. Next month. an implicit cost is any cost that results from using an asset instead of renting. such as wage.[1] In other words. is the opportunity cost equal to what a firm must give up in order to use factors which it neither purchases nor hires. Find the elasticity of supply of the pens.

therefore. 3. although both approaches are often used to evaluate the profitability of a given project. Thus total revenue is price per unit proliferated by the number of nits sold. and other direct charges. The average revenue of a firm is in fact the price of the commodity at each level of output since TR = P x Q. AR. average revenue and marginal revenue. Actual cost is the total amount of materials. The term revenue denotes to the receipts obtained by a firm from the scale of definite quantities of a commodity at various prices. In contracting. TR = P x Q. The revenue concept relates to total revenue.. P the price and Q the quantity. and MR under different market condition. Q5)Explain in brief the relationship between TR. Under Ideal Rivalry – The average revenue curve is a horizontal straight line parallel to X axis and the marginal revenue curve coincides with it. and any directly associated overhead costs that can be charged to a specific project. the goal is to break down the specifics of the costs involved with the project and determine if the production process associated with the project is in fact working at optimum efficiency. Algebraically it is the total revenue earned by selling N units of the commodity instead of N-1 i. If a firm sells 3 units of an article at $ 24. direct material. The actual cost is different from the standard cost. Marginal Revenue MR – In addition to total revenue as a result of a small hike in the sale of a firm. Now let us discuss the concepts of revenue. With actual costs. The price is determined the market forces of supply and demand so that only one price tends to prevail for the whole industry. . where TR is the total revenue. Total Revenue – It is the total sale proceeds of a firm by selling a commodity at a given price.e. labor costs. Average Revenue – It is the average receipts from the sale of certain units of the commodity. its total revenue is 3 x 24. i.e.Actual cost:An actual amount paid or incurred. MRn = TRn – TRn-1. 1. This is since under ideal rivalry the number of firms selling an identical product is very huge. as opposed to estimated cost or standard cost. total Average and Marginal Revenue The revenue of a firm jointly with its costs ascertains profits. It is obtained by dividing the total revenue by the number of units sold. actual costs amount includes direct labor. AR = TR / Q = P x Q / Q = P. Relation Between AR and MR Curves 1. 2.

a partnership. again in rational bounds.Q6) Distinguish between a firm and an industry. General Motors is a company that builds cars. On the other hand. It is concerned with the behavior of demand and supply forces. a corporate body. An industry is a generalization for the type of business in which a company engages. In any one of these capacities. seller. Equilibrium of industry:- . In this respect. Automobile manufacturing is the industry. A firm generally thought of as one company. In order to maximize its profits a firm has to maintain as large a difference between what it spends on resources or cost of production and what it earns by selling goods in the form of revenue or returns. Microeconomic theory is anequilibrium analysis. A firm may be an individual enterprise. A firm is the smallest unit of production or sale. Besides the limitation of cost of production. Marshall is reported to have said that demand and supply are like two blades of a pair of scissors. a joint stock company. exporter or a financier. So the firm has to keep its cost of production as low as possible. it has to charge a high price and sell as much quantity of products as possible. the capacity of a firm to charge a suitable price is restricted by the consumer’s willingness to pay. The difference between the two is the firm’s profit. For example. Again a firm may be a producer. firms show similar basic tendencies. Equilibrium of firm:Firms may have different organizational forms. Demand is a result of the utility-maximizing behavior of a consumer in rational bounds. a cooperative enterprise or a public utility agency. the firm’s actions are related to the behavior of consumers. Similarly supply is an outcome of the profit-maximizing behavior of a firm. Explain the equilibrium of a firm and industry under perfect competition An industry is a type of business in the economy while a firm is a unit or entity carrying a portion of the business in an economy. trader.

Please note that the we are talking about quantity actual sold and purchased. They are supplied with all kinds of information and statistical data. The management requests the experts to express their considered opinions and views about the expected future sales of the company D) Output Method . This occurs when the marginal cost of the firm just equals the marginal revenue.4 Credits (Book ID: B1131) Assignment Set. equilibrium point for the market and for the firm are the same. Thus the market equilibrium has has two dimensions. Methods of forecasting Broadly Speaking. the entire market supply is accounted by one firm. Therefore. The firm can supply as much as it wishes. These methods are extensively used in short run and estimating the demand for new products A) Consumer's Interview Method: Efforts are made to collect the relevant information directly from the consumers with regard to their future purchase plans. Master of Business Administration Semester I MB0042 – Managerial Economics . Thus same price is applicable to firm level equilibrium. Suppose your manufacturing company planning to release a new product into market.When we speak of market equilibrium in economics it refers to level of prices at which the quantity demanded by the customers is same as the quantity offered for for supply by the suppliers. individual firms have no influence on the market price as the demand curve for the firm is a horizontal line at the level of the market price. B) Opinion survey method : Under this method. In a perfectly competitive market. outside experts are appinted. In a perfectly competitive market the marginal cost and revenue at this point are also same as the market price.Under this method. professional experts and the market consultants and others are asked to express their considered opinions about the volume of sales expected in the future. C) Experts Opinion Method : Under this method.2 (60 Marks) Q1.In a monopoly market. the sale of the product under consideration is projected on the basis of demand surveys of the industries using the given product as an intermediate product Statistical Method Statistical. there are two methods of demand forecasting. therefore it supplies a quantity that maximizes its profit. They are 1. equations etc are extensively sed in order to estimate future demand of a particular product . and (2) quantity sold and purchased. However the quantity supplied by each firm at this equilibrium price depends on the cost structure of the firm. Explain the various methods forecasting for a new product. Unlike quantities demanded and quantity offered for supply. the combined marginal cost for all the firms in a perfectly competitive market is also same as market equilibrium price. the actual quantity sold and purchased is always equal. Since marginal cost for every firm operating in a perfect competition is same as market price. Survey methods 2 Statistical methods Survey Methods Survey methods helps us in obtaining information about the future purchase plans of potential buyers through collecting the opinions of experts or by interviewing the consumers. mathematical models. sales representatives. (1) price.

1 Trend Projection MethodOn the basis of time series. Without a shift in demand and/or supply there will be no change in market price. Explain the changes in market equilibrium and effects to shifts in supply and demand. It gives the signal about the direction of change in an economic variable. The Concept of Market Equilibrium Equilibrium means a state of equality or a state of balance between market demand and supply. Market Equilibrium Price In this note we bring the forces of supply and demand together to consider the determination of equilibrium prices. Q2) Define the term equilibrium. In the . it is possible to project the future sales of a company 2 Economic Indicator An economic indicator indicates change in the magnitude of an economic variable.

000 at each price. The example below provides an illustration of the concept of equilibrium. The new equilibrium price becomes £4 with 18.000 units If the current market price was £3 – there would be excess demand for 8. 2.000 units 5. demand exceeds supply. Assuming that the supply schedule remains unchanged.000 T-shirts at each price. In other words. At any price above P1. 3. 8 6 18 10 26 7 8 16 12 24 6 10 14 14 22 5 12 12 16 20 4 14 10 18 18 3 16 8 20 16 2 18 6 22 14 1 20 4 24 12 The equilibrium price is £5 where demand and supply are equal at 12. This will cause changes in the equilibrium price and quantity in the market. Demand and supply schedules can be represented in a table. Changes in the conditions of demand or supply will shift the demand or supply curves. The entry of new producers into the market causes a rise in supply of 8. the quantity demanded and supplied at price P1 are equal. 4.000 units bought and sold Changes in Market Demand and Equilibrium Price . The weekly demand and supply schedules for T-shirts (in thousands) in a city are shown in the next table: Price per unit (£) Demand (000s) Supply (000s) New Demand (000s) New Supply (000s) 1. prices where demand and supply are out of balance are termed points of disequilibrium.000 units If the current market price was £8 – there would be excess supply of 12.diagram above. The next row of the table shows the higher level of demand.000 units A change in fashion causes the demand for T-shirts to rise by 4. the new equilibrium price is £6 per tee shirt with an equilibrium quantity of 14. supply exceeds demand and at a price below P1.

The reverse effects will occur when there is an inward shift of demand. Firms in the market will sell more at a higher price and therefore receive more in total revenue.The demand curve may shift to the right (increase) for several reasons: 1. 4.e. A shift in the demand curve does not cause a shift in the supply curve! Demand and supply factors are assumed to be independent of each other although some economists claim this assumption is no longer valid! Changes in Market Supply and Equilibrium Price . 3. 5. 2. borrowing rates on bank loans or mortgage interest rates) A general rise in consumer confidence and optimism The outward shift in the demand curve causes a movement (expansion) along the supply curve and a rise in the equilibrium price and quantity. A rise in the price of a substitute or a fall in the price of a complement An increase in consumers’ income or their wealth Changing consumer tastes and preferences in favour of the product A fall in interest rates (i.

we shall assume that our producer chooses varying amounts of two factors. Explain how a product would reach equilibrium position with the help of ISO . how do suppliers determine the quantity of factors to hire? Below. An improvement in production technology leading to higher productivity and efficiency in the production process and lower costs for businesses 6. Each factor was a price that does not vary with output. Well further assume that w = $10 and r = $50.The producers iso cost line is:10L + 50K = TC . Lets begin by making some assumptions. That is. We call the total cost equation an iso cost line (its similar to a budget constraint). we work through an example where a representative producer answers thisquestion. A fall in the costs of production (e. The entry of new suppliers (firms) into the market which leads to an increase in total market supply available to consumers Q3. First. Favourable climatic conditions causing higher than expected yields for agricultural commodities 4.g. a fall in labour or raw material costs) 2.The supply curve may shift outwards if there is 1. A fall in the price of a substitute in production 5. the price of each unit of labor (w) and the price of each unit of capital (r) are assumed constant.Quants and ISOCost curve When producing a good or service. We can use this information to determine the producers total cost. capital (K) and labor (L). A government subsidy to producers that reduces their costs for each unit supplied 3.

If growth reaches the maximum. volume of profit. status. Marris assumes that the ownership and control of the firm is in the hands of two groups of people. limit to employ highly qualified and experienced managers. Marris points out that a firm has to maximize its balanced growth rate over a period of time. 2. as we move along this iso quant output is constant(much like the fact that utility is constant as A basic understanding of statistics is a critical component of informed decision making. Utility function of the managers and that the owners are expressed in the following manner – Uo = f [size of output. cash reserves etc.]. inventory levels. our producer must get a combination of L and K that makes (2) equal to 1000. limit to manage the firm efficiently. Higher growth rate of the firm satisfy the promotional opportunities of managers and also the share holders as they get more dividends. On similar lines. position. market share. prestige and security of job etc are the most important variables where as in case of owners are more concerned about the size of output. The ambition of job security puts a limit to the growth rate of the firm itself deliberately. greater would be the realization of these functions and vice-versa. Graphing these values. and solve for K. then there would be no opportunity to expand further and as . job security etc.] Um = f [salaries. we obtain the blue line on the graph below. Marris identifies two constraints in the rate of growth of a firm: 1. (2a) gives us a corresponding value for K. power. Marris has developed another alternative growth maximization model in recent years. public esteem etc. with K on the vertical axis and L on the horizontal axis. we get the following equation for a specific iso quant (one of many possible iso quants): K = 1. Generally managers like to stay in a growing firm. In order to produce those 1000 units of output. Profit-maximization is a traditional objective of a firm. owners and managers. prestige. There is a limit up to which output of a firm can be increased more economically. capital. 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.000. market share and sales maximization etc. Larger the firm. In view of Marris the realization of these two functions would depend on the size of the firm. Therefore. Managers have a utility function in which the amount of salary. 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 firm. Boumal. Doing so. power. this means that we must find a particular iso quant. Sales maximization objective is explained by Prof. status. volume of profits. Q4) Critically examine the Marris growth maximising model.(1)The producers production function is assumed to take the following form:q = (KL)0. limit to research and development and innovation etc. Suppose that quantity is1000 units of output. Size of the firm according to Marris depends on the amount of corporate capital which includes total volume of assets. Set (2) equal to 1000 units of output. Each point on this curve is represented as a combination of K and L that yields an output level of 1000 units. ie.000/L (2a)For any given value of L. He further points out that both of them have two distinctive goals. Implicitly.5 (2)Our producer¶s first step is to decide how much output to produce. Prof.

Higher expenditure on sales promotion and R&D would certainly reduce profits level as there are limits to them. R&D expenses and utility and comparative value of the product etc would decide the profit ratio. concentrate on generating more internal funds and invest more finance on only those products and services which brings more profits Hence. managers would like to seek their job security through adoption of a cautious and prudent financial policy. consumption habits. This implies the satisfaction of three conditions. market price of the given product. Ultimately. Similarly. The growth rate of the firm depends on two factors. Managers hesitate to take unwanted risks and uncertainties in the organization at the cost of their jobs They would like to avoid risky investment projects. The management has to maintain a low liquidity ratio. The success of new products is determined by its changes in fashion styles. 1. there should be equality between the growth rate in demand for the products and growth rate in supply of capital. The Marris model states that in order to maximize balanced growth rate or reach equilibrium position. Rapid growth and financial soundness should go together. borrow more external funds and invest more in business expansion and keep low profit levels. The rate of demand for the products [gd] 2. publicity.such the managers may loose their jobs. The rate of capital growth is determined by either issue of new shares to obtain additional funds and external funds and generation of more internal surplus. Max g = gd = gc. availability of alternative substitute products and their relative prices. More over diminishing marginal returns would operate in any business and as such there is a limit to diversification. 2. the range of products offered etc. . highlights on achieving a balanced growth rate of a firm. Maximum growth rate [g] is equal to two important variables1. On the other hand. Generally a firm would select the last one to avoid higher degrees of risks in the business. The management has to maintain a proper leverage ratio between value of debts/Total assets so that it will have enough money to invest in order to stimulate growth. it is the job security which puts a constraint on business decisions by the managers. The Marris growth maximization model. Growth rate of capital[gc] Hence. propaganda and advertisements.a] the rate of diversification [d]and b] the average profit margin. He further points out that a high risk-loving management would like to maintain a relatively low amount of cash on hand and invest more on business. ie. But this ratio should not create any financial embarrassment to meet the required payments to all the concerned parties. liquid asset / total assets. The diversification rate depends on the number of new products introduced per unit of time and the rate of success of new products in the market. a highly risk-averting management may have exactly opposite policy.

Competitors If the business is a monopolist. pattern of distribution. The reality is usually somewhere in between. The managers are able to get their job security with a high rate of growth of the firm and share holder would become happy as they get higher amount of dividends. increasing unemployment. The management has to keep a high level of retained profits for further expansion and development but it should not displease the shareholders i. In such cases the chosen price needs to be very carefully considered relative to those of close competitors. output and employment. as well. in reality. the mangers would maximize their utility function and the owners would maximize their utility functions. contraction of economic activity. If the entire costs are not covered. But in the long run. falling incomes and so on. In the short period which a firm wants to establish itself. forces and its own business objectives. Cost: Cost data occupy an important place in the price setting process. a business should attempt to quantify its demand curve to estimate what volume of sales will be achieved at given prices Q6) Discuss the various measures that may be taken by a firm to counteract the evil effects of a trade cycle. Cost are two types fixed cost and variable cost. a favorable impact on income. then it can set any price. The firm may not cover the fixed costs but it must cover the variable costs. Pricing is considered as one of the basic and central problems of economic theory in a modern economy. Pricing policy refers to the policy of setting the price of the product or products and services by the management after taking into account of various internal and external factors.Business cycles have their effects on individual business firms. by giving low dividends. it has no choice and must accept the market price. Expansionary phase has. however. the supply is reduced which in turn may lead to higher price. Fixing prices are the most important aspect of managerial decision making because market price charged by the company affects the present and future production plans. (3) Customers Consideration of customer expectations about price must be addressed. Business cycles affect the smooth growth of an economy. During . However.3. A detailed study of the market structure gives us information about the way in which prices are determined under different market conditions. At the other extreme.e. But recession and depression imply slackness in growth. nature of marketing etc. Q5) What do you mean by pricing policy? Explain the various objective of pricing policy of a firm. Pricing Policy basically depends on price theory that is the corner stone of economic theory. all costs must be covered. In this case. Factors Involved In pricing Policy The pricing of the product involves consideration of the following factors: 1. the producer stops production consequently. if a firm operates under conditions of perfect competition. Ideally. a firm adopts different policies and methods to fix the price of its products. 2.

There must be a strong psychological shift during this period. A firm should gear up itself to face the challenges of cyclical changes in a most befitting manner. recession and depression the basic objective is to fight against pessimism and to give a big boost to all kinds of business activities. a firm may have to face some adverse effects. purchasing. (3) Improvement in quality (4) adoption of new selling methods. Various such measures may help a firm in avoiding the harmful effects of business expansion. distribution. The firm gains due to rising demand. there is a business boom. (1) Quick liquidation of inventories. Increased demand for factors may cause a rise in their prices. He should mainly see that the costs are kept under control. But in a capitalist economy prosperity digs its own grave. Marketing and distribution costs may go up. During this period a business unit should be extraordinarily cautious. (6) Management of the labour force carefully. in particular. maintain satisfactory labour conditions and create sizable reserve fund. cyclical movements in production and sales and in the prices of commodities purchased and sold. production. A few measures are to be adopted to mitigate the harmful effects of contraction. avoid over investment. avoid purchase commitments. By adopting a very cautious policy of planning during the period of contraction when all costs are low a firm can take up the expansion and extension programmes. market share. pricing etc. Capital budgeting. . Rising prices and optimism in the market may encourage many new firms to enter the market and the existing firms to expand their output. the phase of the trade cycle through which business is then passing. rising prices and increasing profits. investment. Employ a flexible credit standard. A business firm should have a comprehensive view of the entire market – internal and external factors affecting business in order to adopt an efficient business programme and prevent the adverse effects of cyclical changes on business. It will have to choose a right pricing policy keeping in view various factors like changing costs. During the phase of contraction. He should have knowledge of the economic characteristics of the trade cycles and usual sequence of events during such periods. (2) Reduction of cost of production. avoid excessive borrowing. Business decisions are to be made carefully after estimating the market situation properly. Check temporary diversification programme. Apart from these measures a businessman may also take up a few important steps in the best interest of the firm. changes in general price level etc. A prudent businessman should adopt all possible precautionary measures to avoid and minimize business problems as much as possible. (5) Development of new methods of organization etc. Thus during different phases of trade cycles a firm has to make careful decisions with regard to finance. During this period. prices of substitutes. All these may result in raising the cost of production causing a rise in the product price. overproduction and over expansion. Cyclical price adjustment poses the most challenging job for the firm.expansionary phase. marketing. Prosperity makes the business firms prosperous. Competition becomes intense. excessive inventories of raw materials and finished goods. relation between cyclical changes and general business and cyclical changes and the business of the given enterprise. Expansion in production and sale of goods should be so organized that they take full advantage of the situation without involving themselves into any kind of risk. The firm will have to restructure its advertising policy to suit the circumstances. Demand for investment funds increase.

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