Managerial Economics Notes

Honoursinfo.blogspot.com 1 Only some of the important question of ME are been explained The full fledge notes will be released soon on Honoursinfo.blogspot.com Managerial Economics Honoursinfo.blogspot.com 2 What is Managerial Economics.? Explain the nature and scope of Managerial Economics.? Answer: Managerial Economics generally refers to the integration of economic theory with business practice. While economics provides the tool which explain various concepts such as demand, supply, price, competition etc. Managerial economics applies these tools to the management of business, in this sense managerial economics is also understood to refer to business economics or applied economics. Managerial economics lies on the border line of management and economics. It is a hybrid of two disciplines and it is primarily an applied branch of knowledge. Management deals with principles which help in decision making under uncertainty and improve effectiveness of organisation. Economics on the other hand provides a set of propositions for optimum allocation of scare resources to achieve the desired objectives. Nature of Managerial Economics: It is true that managerial economics aims at providing help in decision making by firms. For this purpose it draws heavily on the prepositions of micro economic theory. Note that micro economics studies the phenomenon at the individuals level and behavior of consumers, firms. The concepts of micro economics used frequently in managerial economics are elasticity, marginal cost, managerial revenue, market structure and their significance in primary policies. Some of these concepts however provide only the logical base and have to be modified in practice. Micro economics assists firms in forecasting. Note that micro economics theory studies the economy at the aggregative level and ignores the distinguishing features of individual observations. For example micro economics indicates the relationship between the  Magnitude of Investment and Level of National Income  Level of National Income and Level of Employment Managerial Economics Honoursinfo.blogspot.com  Level of Consumption and National Income etc. Therefore the postulates of microeconomics can be used to identify the level of demand at some future point in time, based on the relationship between the level of national income and demand for electric motors. Also the demand for durable goods such as refrigerators, air-conditioners, motor cars depends upon the level of national income. Managerial economics is decidedly applied branch of knowledge. Therefore the emphasis is laid on those prepositions which are likely to be useful to the management. The precision of a scientist is not motivating factor in research activity. Improvement in the quality of results is attempted, provided the additional cost is not very high and the decision maker can wait. For example it may be possible to have more accurate data on demand for the firm’s product by taking into consideration, additional factors. But this may not be the attempted because the decision has to be made without delay. Besides more accurate forecasts may not be justified on cost considerations. Management economics is perspective in nature and character. It recommends that it should be done alternate conditions. For example if the price of the synthetic yarn falls by 50% it may be desirable to increase its use in producing different types of textiles. Thus managerial economics is one of the normative sciences and reflects upon the desirability or otherwise of the prepositions. For example if the analysis suggests that the benefit-cost ratio is used as the criterion for project appraisal it is recommended that the firm should not install a large plant. Contract this with the positive sciences which state the prepositions without connecting upon what should be done. For example if the distribution of income has become more uneven it is stated without indicating what should be done to correct this phenomenon. Managerial economics to the extent that it is uses economic thought is a science, but it is an applied science. Economic thought uses deductive logic (if X is true, then Y is true). For example if the triangles ate congruent then angles are equal. To have confidence in the findings, the prepositions deducted are subject empirical verification. For example empirical studies try to verify whether cost curves faced by a firm are really U shaped as suggested by the theory. Furthermore there is an attempt to generalize the prepositions which provide a predictive character. For example empirical studies may suggest that every 1% rise in expenditure on advertising, the demand for the product shall increase by 5%. Managerial economics uses scientific approach. In practice, some firms may use simple rules based on past experience. However the quality of decisions made can be improved using a systematic approach. Scope of Managerial Economics: 3 Managerial Economics Positive economics is that branch of economics which studies the things as they are. Area of Study: Broadly speaking managerial economics deals with the following topics. Cost of capital rate of return and selection of projects are the important points under this. Demand analysis aims at discovering the forces that determine sales. pricing methods policies. cost control and sound pricing practices call for accurate cost and production analysis. The success of the firm is always measured in terms of profits. Pricing Decisions. managerial economics has started using such techniques of operations research as linear programming Managerial Economics . Linear Programming and Theory of Games: Since managerial economics and operations research are closely connected with each other. Whether managerial economics is normative or positive economics: Economics is divided in to positive economics and normative economics. There is hardly any uniform pattern as regards the scope of managerial economics as it is comparatively a new subject. Price determinations under different markets. Success of a business firm largely depends on the accuracy of price decisions. The demand analysis mainly relates to the study of demand. Capital Management: The most complex. profit policies and techniques and profit planning are the important aspects covered in this area. product line pricing and price forecasting are some of the topics of this area. Policies and Practices: Pricing is an important area of managerial economics. the scope of managerial economics may be discussed under following points. Managerial economics is considered to be the part of normative economics.com Scope means province or an area of study. Nature and management of profit. 4 However. demand distinctions and demand forecasting. determinants. Positive economics is descriptive in nature where as normative economics is prescriptive in nature. troublesome problem faced by the business manager is the capital management. Profit Management: Business firms are mainly profit hunting institutions. Capital management implies planning and control of capital expenditure. Demand Analysis and Forecasting: Effective decision making at the firm level depends on accurate estimates of demand. Cost relations are production function and cost control. Cost and Production Analysis: Cost estimates are also essential for effective decision making and production planning at the firm level. Profit planning.Honoursinfo. Managerial economics draws descriptive economics and tries to pass judgments to value in the context of time.blogspot. It lays more emphasis on prescribing choice and action and less on explaining what happened. Normative economics deals with the things they ought to be or should be. while rise in price causes the household to buy less of this commodity & more of the competing commodities” The law of demand indicates only the direction of change of demand corresponding the change in the price. The greatest merit of this concept is its flexibility. 5 of demand is one of the important laws of economic theory .At price OP1the quantiy demanded is OQ1 if price of the good falls into OP2 the quantity demanded rises to OQ2 the demand curve is sloping downwards which is in accordance to the law of demand all the determinants of demand are assumed to be constant . Recently the linear programming and the theory of games have been brought as part of managerial economics. In recent years. Price is measured in theY axis&quantity in the X axis. This can be illustrated through a demand curve.DD is the demand curve of the good under consideration. Optimisation: Optimisation is another important concept used in economic theory and managerial economics.com and the theory of games. The maximization of profits is the main objective of any firm or a business unit. Profits – a central point in managerial economics: Profit in other words is the central concept of managerial economics. Managerial economics often aims at optimising a given objective. Profit is the main indicator of firm’s success.According to Lipsey “A fall in the price of a commodity cause a household to buy more of that commodity and less of the other commodity which compete with it.It explains the general tendency of the consumers to buy more of a good at a lower price and less of it at a higher price lower price attracts consumers to buy more goods .Law Y P P R I C E M P1 M1 Managerial Economics .blogspot.thus law of demand expresses an inverse relationship b/w the price and the quantity demanded of a commodity other things being equal. Without profits business firms can not run.Honoursinfo. The survival of the firm is determined by the ability of a firm to earn profits. a new concept was found out called “Sub-Optimisation”. Thus at a lower price the quantity demand of the commodity increases because of increase in the number of consumers of the commodity and vice versa. These factors explain the operations of the Law of Demand. in otherwords the consumer has to spend less to buy the same quantity of the commodity as before. other things remaining the same. He will spend a part of this money on buying some more units of the same commodity whose price has fallen. The demand of a commodity is more at a lower price and less at a higher price. This increases the consumer of the commodity. The commodity having several uses is set to have composite demand. That is why the demand curve slopes downward. This is know as substitution or complementarily effect. When price of a commodity falls. When the price of a commodity falls it becomes relatively cheaper than other commodity whose prices have not fallen. These are know as the exceptions to the law of demand. The important of these factors depends upon the circumstances of the case. The factors responsible for the downward slope of demand curve are : (a) Law of diminishing marginal utility: The law of diminishing marginal utility states that as the consumption of a commodity by a consumer increases the satisfaction obtained by the consumer from each additional unit of the commodity goes on diminishing. the number of persons who could not afforded at a higher price can purchase it at a reduced price. Some of the important exceptions are : Managerial Economics . (d) Changes in the number of consumers: Many people cannot afford to buy a commodity at a high price.Honoursinfo. The money so saved because of a fall in the price of the commodity can be spent by the consumer in ways he likes.com O Q Q1 Quantity X 6 Law of demand states the inverse relationship between price of a commodity and quantity demanded. All the above factors are responsible for the downward slope of demand curve. So the consumer substitute this commodity for other commodities which are now relatively dearer. Thus a fall in the price of this commodity increases its demand. (b) Income effect: A fall in the price of the commodity increase the purchasing power of the consumer. Exceptions to the Law of Demand: Under certain circumstances the inverse relationship between price and demand does not hold good. This is called income effect. (e) Diverse Uses of the commodity: Many commodities can be put to several uses. (c) Substitution effect: This also increases demand as a result of a fall in the price of the commodity and viceversa.blogspot. E.g. Likewise when prices are expected to fall further a reduced price may not be sufficient incentive to induce the household to buy more.blogspot. Eventhough their price rises continuously their demand does show any tendency to fall. purchased by rich persons of the society because the prices of those goods are so high that they are beyond the reach of the common man. At such time the household may behave in a abnormal way. (e)Emergencies: Emergencies like war. on the other hand. (b)Conspicuous necessities: Another exception occur in case of such commodities as though their constant use is because of fashion or prestige value attached to them have become necessity of life. famine. ©Conspicuous consumption: A few goods like diamond etc. A rise in the price of giffen 7 goods leads to a rise in their demand and viceversa. he will be left with lesser income to spend on other commodities that he used to consume earlier. The bajra will be considered as gifen goods to which law demand does not apply. During depression. (g)Ignorance: Consumer’s ignorance is another factor that at times induces him to buy more of commodity at a higher price. If the price of bajra goes up the household will be forced to maintain the earlier consumption level of consumption of this good. Managerial Economics . share market. (f)Change in fashion: A change fashion entails effect demand for a commodity. This happens when the consumer thinks that a high price commodity is better in quality than low price commodity. flood etc. E. More of these commodities is demanded when their prices go up very high. say bajra.g.com (a)Giffen Goods: These are special type of inferior goods.Honoursinfo. a fall in price of bajra will enable the household to release more money for other commodities and may substitute consumption of bajra by consumption of other superior commodities. The household will be forced to cut down the consumption of other commodities still further to compensate itself for the loss of consumption of bajra. no amount of falling price is sufficient inducement for consumer to demand more. The law of demand does not apply. A poor household who spends a major portion of his money on an inferior goods like coarse grain. Household accentuate scarcity and induce further price rises by making increase purchases even at higher prices during such period. (d)Future changes in price: Household also act as speculators when the price are rising. the house hold tend to buy larger quantity of the commodity out of apprehension that the prices may go up further. may negate the operations of lay of demand. Conversely. should be aware of the factors favoring one method over another in a given demand forecasting situation in some cases mgr’s are interested in the total demand for a product service in other circumstances the projection may focus on the firm’s probable mkt share forecasts can also provide inft. Its essence is estimating future events acc to the past patterns and applying judgement to those projections .Honoursinfo.blogspot.Demand forecasts methods vary acc to whether they apply to a large aggregate such as the whole economy(macro forecasts)or to a component of this aggregate such as an industry or a co.Demand forecasting is a crucial activity for planning survival &growth of a corporate unit.product quality etc. Managerial Economics . supplies &classroom requirements .Business firms can estimate and minimize the future risk & uncertainty through 8 forecasting &forward planning .Virtually all types of national & intl organisations – Govt . Demand forecasting is an attempt to foresee the future by examining the past .nature of the product etc. Demand forecasts may be passive or active the former predict the future demand by extrapolating the demands of the previous years in the absence of any action by the firm Here the things are assumed to continue the way they have been in the past these forecasts are used only to assess the impact of new policies on the market while the latter estimate the future scenario inclusive of own future actions &strategies of the firm itself These forecasts are more meaningful as they take into account the likely changes in the relevant variable in estimating future demand here the firm manipulates the demand by changing price.It is an essential tool in developing new products scheduling production determining necessary inventory levels&creating a distribution system . forecasts. School administrators use Enrolment forecasts to determine faculty sizes.com Q3. The firm can afford acurracy level required.However small firms cannot afford these sophisticated techniques . on the product mix major decisions in large business houses are generally based on forecasts on some type in some cases the forecasts may be little more than an intuitive assessment or value judgement of the future by those involved in the decision . urgency data availability . Methods of demand forecasting : The imp.Thus no forecasting method is suitable for all situations.social &business engage in some type of demand forecasting the goal of course is better mgt ability to plan &control operations churches try to predict future revenues from member’s contributions to develop reasonable budgets.Selection of a forecasts has to be appropriate to the situation that is objective. (micro forecasts) a frequent practice is to translate forecasts of overall levels into industry forecasts by trade associations &to use this in turn to generate co. Of selecting the right type of forecasting method cannot be overstated however the choice is complicated bcoz each situation might require a different method mgt. inferences abt the whole popln. Methods of forecasting .These methods are usually suitable for short-term forecast due to volatile nature of consumers intentions.M Collective opinion method Market experiment method Time series Analysis Regression analysis Graphical Semi-average Moving average Least square Survey methods : Under this approach are conducted about the intentions of the consumers (individuals.Honoursinfo.While in sample survey a selected subset of them are surveyed and through their study. a firm can ask consumers what & How much they are planing to buy it at various prices of the product for the forthcoming time period.com 9 Forecasting Methods Survey Methods Statistical Methods Consumer S.as data availability problem is overcome through surveys of consumers. If the product happens to be a consumer good Managerial Economics .blogspot. usually a year.New products demand forecasting also makes use of survey approach.Under census survey. are drawn . all consumers\ experts mkts are surveyed.The rationale for conducting such surveys is that plans generally form the basis for future actions by using this method. Consumer Survey Method: Surveys of managerial plans can be one of the impt. firms or industries) opinion of experts or of mkt . The effect of the experiment on consumer behaviour is studied under actual or controlled mkt conditions which is used for overall forecasting purpose. Most of the variables in business. decline or remain steady over a period of time. at all time series data spread over long period of time.com the consumers are firms or industries using that product the survey may involve a complete enumeration of all consumers of the given product. unbiased and proven to be useful. are likely to have the most intimate feel of the market i. The data a may also be analyzed through econometric models. Semi Average Method: According to this method the date is divided into two parts preferably with the same number of years. The averages of the first and second part Managerial Economics . Collective Opinion Method: Under this method(also called sales. Time series analysis: It is an arrangement of statistical data in a chronological order. Graphical Methods: This method gives the basic tendency of a series to grow. demand etc. but the concept of trend does not include short time oscillations and fluctuations. i.e. economic and commerce be it a series related to price.mgr etc&the top executives. whose demand is to be 10 forecasted. Statistical methods: These methods make use of historical data as a basis for extrapolating quantitative relationships to arrive at the future demand pattern and trends. These are used for long term forecasting and for products for larger levels of aggregation.where the future is not too much different from average of the past. consumption.force polling).This method is known as the collective opinion method. as it takes advantage of the collective wisdom of the salesmen. It reflects the dynamic pace of steady movement of a phenomenon over a period of time.blogspot.etc are identified.mgr sales.sales. product design. projects. Market Experiments Method: Under this method.e customer reaction to the product of the firm &their sales trends the estimates of individual salesman are averaged or consolidated to find out the total estimated sales the final sales forecast would emerge after these factors are being taken into account. They are based on scientific base of estimation which are logical. production. etc. These factors are then varied separately over different markets or time periods holding other factors constant. This method is useful in forecasting population. being the closest to the customers.departmental heads like prod. Theperiod time in the trend analysis is always long. salesman or experts are required to estimate expected future demand of the product in their respective territories &sections the rationale of this method is that salesman.Honoursinfo. packaging. in accordance with its time of occurrence. the main determinants of the demand of a product like prices. advt. Survey of Consumer Intention: This method involves interviewing the consumer by sending questionnaires to elicit replies so as to make short term prediction of demand. optimum size of population. This method is most useful when bulk of the sales is made to industrial producers. Regression Analysis:This is also a popular method of forecasting among the economists. Moving Averages Method: This is a very simple and flexible method of measuring trend which consists of obtaining a series of moving averages of successes overlapping groups of the time series. trend fittings will be most reliable way of forecasting. Managerial Economics .com are calculated separately. Demand Forecasting of New Products:Projecting demand of new products is different from those of established products. Here the data analysis should be based on logic of economic theory. This approach is useful when the new product is nearly an improvement of an existing product. The selected area must have an average competition. Evolutionary Approach: The demand for a new product may be projected as an outgrowth and evolution of an existing old product.blogspot. The averaging process smoothens out fluctuation as well as the ups and down in the given data. The duration of testing depends upon the average purchase period. Here the burden of forecasting is shifted to consumer. The forecaster must identify the phase of product cycle at which the industry is operating at the time of prediction. This requires an intensive study of the economic and competitive characteristics of the product. the competitive situation and cost of testing. in such situation. presence of chain of departmental stores.Honoursinfo. Innovation of a new product and its degeneration into a common product is termed as Life Cycle of a Product. Th number of area selected depends on the representatives and cost of marketing. Least square method:The principle of least squares provides us an analytical tool to obtain an objective fit to the trend of the given time series. Product Life Cycle Analysis:Many products ar distinct when it degenerates over the years into a common product. It is a mathematical analysis of the average relation between two or more variables in terms of original units of the data. Thus. Most of the data relating to economic and business time series conform to definite laws of growth or decay. Samples may be given for this purpose. Test Markting:Under test marketing the product is introduced in selected area often at different prices. These averages are called semi averages which are plotted as 11 points against middle point of the respective time period covered by each part. etc. whereas a non-vegetarian who has liking for chicken may demand it even at a high price. Demand for several products like ice-creams. are substitutes of each other. then there will be more demand for the commodity is question at a given price than in case its substitutes are relatively cheaper. Tastes and Habits: Demand for many goods depend on the person’s tastes. ground nuts oil and sun-flower oil.Honoursinfo. Factors influencing individual demand. Normally a larger quantity is demanded at a lower price than at a higher price. Demand for tea. When a want can be satisfied by alternate similar goods. A strict vegetarian will have no demand for meat at any price. Income: Income is an equally important determinant of demand. An individual’s demand for a commodity is generally determined by factors such as: Price of the Product: Price is always a basic consideration in determining the demand for a commodity. The demand for commodity depends on the relative process f its substitutes.. Managerial Economics . however also depends on the relative prices of other related goods such as substitutes or complementary goods to a commodity. People with different tastes and habits have different preferences for different goods. habits and preferences. they are called substitutes. Similar is the case with demand for cigarettes by smokers and non-smokers... For example. If the substitutes are relatively costly.blogspot. depend on an individual’s taste. What are the determinant of Demand. is a matter of habit. tobacco etc. tea and coffee etc. peas and beans.com Growth Curve Approach: Roll of growth and demand for new product may be estimated on the basis of pattern of growth of some existing substitute established 12 product. Relative prices of Other Goods: How much the consumer would like to buy of a given commodity. chocolates.? Answer: Demand for a commodity depends upon number of factors.. Obviously with the increase in income one can buy more goods. Thus a rich consumer usually demands more goods than poor consumer. betel. cool drinks etc. It is based on the experience. a fall in price of cars will lead to increase in the demand for petrol. Complementary goods are always in joint demand. When the price of one commodity decreases the demand for its complementary product will tend to increase and vice versa. toilet soaps. are complementary products to each other. Thus demand for many products like tooth pastes. Similarly if they expects its prices to rise in future they will tend to buy more at present.Honoursinfo. than otherwise. is particularly caused by the advertisement effect. Techniques or methods of Demand Forecasting: Method of Demand Forecasting is based on whether the good is Established Good or new good. two or more goods are 13 needed in combination. pen and ink.. albeit to certain extent only. shoes and sacks.? Briefly review the methods of Demand Forecasting? Answer: Demand Forecasting is the method of predicting the future demand for the firm’s product. Depending upon how the information is collected. For example car and petrol. It is guess or anticipation or prediction of what is likely to happen in the future. tea and sugar.com Substitutes and Complementary Products: The demand for a commodity is also affected by its complementary products. its demand will be relatively high when its related commodity’s price is lower. Consumers Expectations: Consumers expectations about the future changes in the price of a given commodity also may affect its demand. they will tend to buy less at the present prevailing price. In order to satisfy a given want. processed foods etc. Two basic methods of demand forecasting for the established goods are: Interview and Survey Approach (for short period forecast): Interview and Survey Approach collects information in the different way. Thus if a given commodity is a complementary product. Similarly a steep rise in the price of petrol will cause a decrease in demand of petrol driven cars and its accessories. Forecast can be done for several things. . When consumer expects its prices to fall in future.blogspot. washing powder. Advertisement Effect: In modern times the preferences of a consumer can be altered by advertisement and sales propaganda. For example. Methods of Demand Forecasting for established goods: Information of the established good is available so the forecast can be based on this information. these goods are referred as complementary goods. What is Demand Forecasting. gun and bullets etc. we have different sub methods as follows: Opinion-Polling Method: This method tries to collect information from the customer directly or indirectly through market research department of the Managerial Economics . Honoursinfo. Sample Survey Method: The total number of consumers for the firm’s product is very large called as population. This Managerial Economics . Consumers are contacted through mails or phones or Internet and information regarding their 14 expected expenditure is collected. Only few of them are contacted and this forms the sample. The salesman has the technical training as how to collect the information from the buyers.blogspot. Composite management opinion: The opinions of the experienced person within the firm are collected and manger analyses this information. Panel of experts: Panel of experts consists of persons either from within the firm or from outside the firm. These experts come together and forecast the demand for their product that is purely based on the judgment of these experts so they are less accurate. But if based on the scientific method the forecast would be accurate. This method is useful when consumers are small in number. This information is further used for forecasting the demand. Limitations:  It is difficult and costly to contact all the customers  It is suitable only for short period  This is based on judgment & has no scientific basis.  Consumers do not have the correct idea of their purchases in future.  Sample is not a random sample. Limitations:  Information collected may not be accurate. It is practically not possible to contact all the consumers.com firm or through the whole sellers or the retailers. The sample forecasts are then generalized for the whole population through advanced statistical methods available. Limitations:  It is difficult and costly to contact all the customers  It is suitable only for short period  Consumers are not sure of their purchase plans Collective Opinion Method: Large firms have organized sales department. In simple Managerial Economics . The relationship between these variables is correlation and the technique of establishing this relationship is regression. Example: If we collect the past data about the sales and advertising expenditure of the firm. In this method past Projection Approach(for long period forecast): experience is projected into the future. Correlation and Regression Analysis: Past data regarding the factors affecting the demand can be collected.blogspot. This is a scatter diagram. it is possible to express in the form of scatter diagram as shown below: Y A * * ** * * * * * * * ** Sales A X O Advertisement Expenditure In the above diagram we get the functional relationship as line AA. Here Advertisement Expenditure is the independent variable and Sales is the dependent variable. This can be done with the help of statistical methods. It is possible to express this on the graph. but is not based on the scientific 15 analysis and thus may not give very accurate results.Honoursinfo.com method is quick. easy and saves time. Honoursinfo. Limitations:  Assumption made is that correlation between two variables will continue in future also. this might not happen. It is based on the assumption that the relationship between the dependent and the independent variable continues to hold in the future.com correlation we establish relationship between 2 variables and more than 2 16 variables in multiple correlation. It is similar to the correlation analysis. Time Series Analysis: Demand forecasts for a period of 2-3 years are based on time series analysis.blogspot. Managerial Economics . Limitations:  It is difficult and costly to contact all the customers  It is suitable only for short period  Consumers are not sure of their purchase plans Sample Survey Method: New product are first introduced in the sample market and the results seen in the sample market are generalized for the total market. For example VCR substituted with VCD player. Demand forecast for such new good is based on already established good from which they are evolved.Honoursinfo. Limitations:  The product should have been evolved from the existing product. from which it is actually evolved. If the population is large then sample is selected and results are generalized for the population. Following are the methods suggested: Evolutionary Method: Some new goods evolve from already established goods.  It ignores the problem of how the new product differs from the old product. Limitations:  Information collected may not be accurate  Tastes and the preferences may differ from market to market Managerial Economics 17 . Opinion Polling Method: Expected buyers and the consumers are directly contacted and opinion about the product is directly taken from them.blogspot. For example Demand for the color TV can be calculated from Demand for the black and white TV. Limitations:  New product may have many uses and each use has different substitutability  When the substitute is added is added into market existing firm may react by changing the prices.com Methods of Demand Forecasting for new products: Indirect methods of forecasting are used to estimate demand for new products. Substitution Method: Some new goods are substituted of already established goods. Ans. Stigler) 2. the inputs of other productive services being held.com Indirect Opinion Polling Method: Opinion of the consumers is indirectly 18 collected through the dealers who are aware of the needs of the customers.e. Benham) 3.A. cause output to increase. i. Samulson) Managerial Economics . beyond a certain point the resulting increments of product will decrease. (F. but after a point the extra output resulting from the same additions of extra inputs will become less and less.blogspot. after a point. in a given state of technology. As the proportion of one factor in a combination of factors is increased. first the marginal and then the average product of that factor will diminish. the marginal product will diminish. Statement of the Law: 1. Limitations:  It is based on the judgment  Limited Scope State and explain the Law of Variable Proportion. As equal increments of one input are added. (G. constant. An increase in some inputs relative to other fixed inputs will. (P..Honoursinfo.  The A. goes on decreasing.P.  M.3 13.5 10 12. is maximum M. though the T.  M..P.  Total product is maximum when M.P. falls. is increasing. marginal product would be larger than the average product.P.P.P.com Explanation of the Law of Diminishing Returns (Variable Proportion) with 19 the help of a table: Fixed Factor K K K K K K K K K K K K K Variable Factor 1 2 3 4 5 6 7 8 9 10 11 12 13 Total Product 5 15 30 50 70 90 105 115 120 124 127 127 118 Average Product 5 7.P. The relationship between them is as follows.P.5 14.P. is constant i. This is the phase when the ‘Law of constant returns’ is in operation. when A.Honoursinfo. equals A.4 11. the M.3 12. This is the phase of ‘Diminishing Returns’. is decreasing. 20. becomes negative when T. But first to decline is the marginal product.5 10.P. This is the phase of Increasing Returns. and A. when A. is less than A.  As long as the average product is rising. is zero. are equal.e. Also.  In the table.P.blogspot.07 Marginal Product 5 10 Increasing Returns 15 20 20 Constant Returns 20 15 10 5 4 Diminishing Returns 3 0 -9 Negative Returns Average Marginal Relationship: The above table shows that eventually the total product also starts declining. remains constant when M. Managerial Economics .50 9. the marginal product goes on increasing. when 1 to 4 workers are employed.  When workers 4.P.5 and 6 are employed. M.P.0 15 15 14.  From 7 to 11 workers.P.P. P. rises. Corresponding vertically to this point of inflexion.Honoursinfo. curve starts declining earlier than the A. M.P. The behavior of the output when the varying quantity of one factor is combined with a fixed quantity of other can be divided into three distinct stages.e. slope of the total product curve T. Curve X In the above figure the T.P.P.P. which means that M.P. From the point F onwards during the Stage I. A.P. Curve S A. increases at an increasing rate. M.P. Managerial Economics . T. curves also rise and then decline.P.P.P. curve goes on rising but its slope is declining which means that from point F onwards the T.P. to a point increases at an increasing rate. i. In the figure from the origin to the point F. The point F where the total product stops at an increasing rate and starts increasing at a diminishing rate is called the ‘point of inflexion’. up to the point F.blogspot. curve. curve goes on increasing to a point and after than it starts declining. and M. increases at a diminishing rate i.com 20 Diagrammatic illustration of the law of diminishing returns The following figure is a diagrammatic presentation of the Law of returns roughly representing the figures in the table given before H Y F Stage II Stage I Stage III T.P.P.e. Curve M M. falls but it is positive.P. Stage I: In this stage T.e. the T. is increasing i. curve goes below the X-axis.P.com M. of workers increase as a firm expands its production.Honoursinfo. Stage II: In stage II. Here the stage II ends. of the variable factor is zero. is highest as shown by point H. Stage II is important because the firm will seek to produce in its range. T. of the variable factor increases throughout this stage.P. when T. throughout the three stages fixed variable i. and M. This stage is known as the stage of diminishing returns as both the A.P. which is the highest point of the TP curve. after which it slopes downward.P.P. is maximum. Stage III: In stage III. Diminishing Returns: The peculiar feature of this stage is that the 2. Fuller utilization of capital is possible due to the addition of a variable factor. continuously fall during this stage. Corresponding vertically is the point h.P. of the variable factor is negative during this stage.P. When the fourth worker joins it is possible to use the full potential of the capital. Explanation of the various stages 1. machinery remains constant. no. curve slopes downward. declines and therefore T. This stage is called the stage of negative returns. of the variable factor in negative and the M. Increasing returns: In the beginning. the third stage is set in by hiring 7th worker who adds only 15 units per day as compared to 20 units per day added by the 6th worker.P. As more and more units of variable factors are added to constant quantity of fixed factor then fixed factor gets more intensively and effectively utilized and production increases at a rapid rate.blogspot. the T. continues to increase at a diminishing rate until it reaches its maximum point H where the second stage ends.P. A worker contributes 5 units per day to the firm’s output. the quantity of fixed factor is abundant relative to the quantity of the variable factor.P.e. The variable factor i.P.P. The stage I ends where the AP curve reaches its highest point S. Total Product increases but gain from 7th worker is not as great as gain from the 6th Managerial Economics .e. The total product reaches 50 units per day when the 4th worker contributes to the production. In the table given. As a result M. and A. since the M. Stage I is known as the stage of ‘increasing 21 returns’ because A. In the given example.P. In this stage both the M. marginal product falls through out the stage and finally touches to zero. Barriers to entry of firm: The basis of monopoly is the barriers or restrictions of new firms into the market. a partnership firm. Explanation to this can be given as once the point is reached at which variable factor is sufficient to ensure full utilization of fixed factor. This means that the crosselasticity of demand for the monopolists product is low.blogspot. those can be either natural barriers or artificial barriers. The large number of variable factors impairs the efficiency of the fixed factor. Negative returns: In this stage. In our example this is set in by hiring 13th worker. The total product falls from 127 units to 118 units. 3.? Answer: The following features are seen under simple or limited monopoly. Demand curve under monopoly: The above mentioned features explain the demand curve or the average revenue(AR) curve under the monopoly. The excessive variable factor as compared to less fixed factor results in a fall of total output.market in the market. In such a situation. negative because total product starts falling. Managerial Economics .e. In stage II fixed factor is scarce as compared to variable factor. No close Substitute: To avoid any possibility of competition in the market. then further 22 increase in variable factor will cause MP as well as AP to fall because fixed factor has now become inadequate relative to the quantity of variable factors. Single Producer: For monopoly to exist only one producer should be in the market. The producer may be an individual. an enterprise. there should be no close substitutes for the product of the monopolist. It is the monopolist who is the price. Explain the features of Monopoly. the government or a joint stock company. marginal product falls below X-axis i. a reduction in the units of the variable factor will increase the total output. The demand curve for a firm(which means the industry under monopoly) is downward sloping.Honoursinfo.com worker. Explain how price is determined under monopoly.Honoursinfo.blogspot. Such monopolies are called natural monopolies. electricity . Since there are no sellers. there is only one seller who controls the entire supply in the market. Since this is the only producer and seller. nowadays cable television system and such other public utilities are usually managed as monopolies. telephone undertaking Managerial Economics . Urban transport. On the other hand if a producer acquires monopoly on the basis of patent laws. monopolies are created under law. Many times. Indeed all buyers are put at that mercy of the monopolist. he can fix the price of his product. In order to maximize his profit. he may rise the price frequently. supply of gas and electricity. He may exploit the consumers by charging an excessive price.com 23 Y Demand Curve under Monopoly Average Revenue Price O Quantity Demanded X Under the monopoly. the buyers have no alternative than to buy from the monopolist. Good example are public unit utility such as water .? Answer: Pure monopoly or simply monopoly is a market situation where there is only a single seller of goods with no close substitutes. it is called an artificial monopoly. the buyers have no alternative than to buy from the monopolist. y MC AC D Cost/ Revenue A C B AR O Q MR OUTPUT X The equilibrium level is determined at the point k where marginal cost = marginal revenue . In order to maximize his profit.  It may earned normal profit. The total profit enjoy by the firm is shown by the shaded area DABC . Since this is the only producer and seller. the firm get profit per unit equal to CB. He may lower the price and increase the quantity soled or he may lower the quantity soled and raise the price thus a monopolist is a price maker or price searcher who is in search of the price – quality combination that will maximize his profit. when firm AR = AC Abnormal Profit: At equilibrium level of output a monopoly firm may earned abnormal profits when the firms average revenue exceeds the average cost of production. when firm AR > AC .  It may suffer losses. Under the monopoly.blogspot. he may rise the price frequently. Since there are no sellers. Managerial Economics .Thus the monopolist will produce OQ output at CQ price . He may exploit the consumers by charging an excessive price. he can fix the price of his product. Thus in the equilibrium situation in the short run a monopolist firm may likely to face three situation :  It may earn abnormal profit. when firm AR < AC. Monopoly price during the short run : During the short run a monopolist cannot expand or contract the size of his plan.Honoursinfo.com Being the sole seller of goods without close substitute the monopolist has substantial 24 control over the price he charges. Losses: At equilibrium level of output a firm may suffer losses when is average revenue is less than average cost . there is only one seller who controls the entire supply in the market. Honoursinfo. The two reason for this are : Managerial Economics . The total loss suffered by the firm is equal to the shaded portion ABCD . equilibrium output is OQ . y MC AC D Cost/ Revenue A C B AR O Q MR OUTPUT X The equilibrium level is determined at point K where marginal cost is equal to marginal revenue . at this our put firms average revenue is equal to average cost . Equilibrium output is OQ Normal Profit: At equilibrium output is determined at the point a firm may earned normal profit when its average revenue is equal to average cost of production.com y MC AC 25 D Cost/ Revenue A C B AR O Q MR OUTPUT X The equilibrium level is determined at point and where marginal cost is equal to marginal revenue. Monopoly price during long period: A monopoly firm during the long run will necessarily receive abnormal profit . there for firm earns only normal profit .blogspot. the total shaded area ABCD represent the profit earned by the firm.blogspot. y LMC LAC D Cost/ Revenue A C B K LAR O Q LMR OUTPUT X The long run equilibrium of the monopoly firm is obtained where the long run marginal cost is equal to long term marginal revenue The equilibrium level is determined at point K where LMR = LMC .  If the monopolist does not receive profit he will have no attraction to stay in 26 the market . Managerial Economics .com  Entry of new firm is difficult .Honoursinfo. the equilibrium level of output is OQ . Monopoly price during the long run is always more than long run average cost (P>LAC). ranging from 10-25 per cent. Therefore the government may affect the private economic activities to same extent through variation in taxation and public expenditure. Taxation is transferring of funds from private purses to public (Government) coffers. open market operations by the Central Bank are the sale and purchase of government bonds. Briefly speaking. etc.com Write Short Notes On: Answer: e) Fiscal Policy: It is one of the important economic policies to achieve economic stability.blogspot. The traditional instrument through which Central Bank carries out the Monetary Policies are: Quantitative Credit Control measures such as open market operations. One of the primary objectives of monetary policy is to achieve economic stability. treasure bills.. Public expenditure on the other hand increases the flow of funds into the private economy. Bank rate Managerial Economics . Since the tax-revenue and public expenditure form two sides of the government budget. the taxation and public expenditure policies are also jointly called the ‘Budgetary Policy’. Fiscal or Budgetary Policy is regarded as powerful instrument of economic stabilization. 27 f) Monetary Policy: Monetary Policy refers to the program of Central Bank’s variations. and government tax-revenue and expenditure account for a considerable proportion of GNP. If the fiscal policy is formulated that it is during the period of expansion. securities. to and from public. and changes in the statutory reserve ratios. Besides fiscal policy is considered to be more effective than monetary policy because the former directly affects the private decisions while later does so indirectly. it is known as ‘counter-cyclical fiscal policy’. in the total supply of money and cost of money to achieve certain predetermined objectives. Fiscal Policy refers to variation in taxation and public expenditure programs by the government to achieve predetermined objectives.Honoursinfo. The importance of fiscal policy as an instrument of economic stabilization rests on the fact that government activities in the modern economies are greatly enlarged. changes in bank rates (or discount rates). It is the withdrawal of funds from private use. all have to face the basic economic problem. Managerial Economics . All these instruments when operated by the Central Bank reduce (or enhance) directly and indirectly the credit creation capacity of the commercial banks and thereby reduce (or increase) the flow of funds from the banks to the public. and also to change the composition of credit from undesirable to desirable pattern. It is however.Honoursinfo. the problem of economy is always there. The statutory reserve ratio is the proportion of 28 commercial banks time and demand deposit. which they are required to deposit with Central Bank or keep cash-in-vault. or of zilla parishad. or club or hospital or national government. k) Economic Problem and its universal nature: The same basic economic problem – unlimited wants and relatively limited resources – arises at all levels of human organization. Moral suasion is a persuasive method to convince the commercial banks to behave in accordance with the demand of the time and in the interest of the nation. Thus whether it is Government of India or America. though monetary policy is considered to be more effective to control inflation than to control depression. The selective credit controls are intended to control the credit flows to particular sectors without affecting the total credit. Thus whether we are thinking of grampanchayat. The fiscal and monetary policies may be alternatively used to control the business cycles in the economy.com is the rate at which Central Bank discounts the commercial banks bills of exchange or first class bill. always desirable to adopt a proper mix of fiscal and monetary policies to check the business cycles. In addition these instruments.blogspot. Central Bank use also various selective credit control measures and moral suasion. expenditure on space and military research etc. The Government of India therefore continually faces the basic problem of economy of how to make best use of its limited resources. schools. establishing military bases all over the world giving military assistance to the friendly countries. Though in absolute terms. No nation can escape it.000/. In the same way. a city resident. Besides. the federal government of America. profit maximization assumption has a great predictive power. religion and culture. poor or rich. Economy problem does not recognize boundaries of caste. small or big with small or huge population.00. expanding expenditure in respect of development that is to be brought about in various sectors like agriculture. The economic problem is the universal problem. It forms the basis for the conventional price theory. Marginal Revenue is obtained from production and sales of one additional unit of output. a villager. There are two conditions that must be fulfilled for the profit maximization:  The necessary condition requires that Marginal Revenue (MR) must be equal to marginal cost (MC). industries. The problem of economy – unlimited wants and limited means with alternative uses .has been forever confronting the mankind. Profit maximization is regarded as the most reasonable and analytically most productive business objective. Every nation.. its annual revenues are enormous running into billions or trillions of dollars. creed. the richest government faces some basic economic problem. and therefore even the richest government of US is always confronted by the same basic economic problem of limited resources to fulfill unlimited wants. color. hospitals and government organization right from the village level to national level. The basic economic arises in the case of an native. Managerial Economics .Honoursinfo. l) Profit maximization goal: The conventional economic theory assumes profit maximization as the only objective of the business firms. in the case of poor or rich. Thus we can conclude that that there is something universal about problem of economy.com The Government of India with annual revenue of about 1.blogspot. Expanding and modernizing the defense forces. transport. in case of associations like clubs. Marginal cost is the cost incurred due to one additional unit of output. has to face the basic economic problem. It helps in predicting the behavior of business firms in the real world and also the behavior of the price and output under different market conditions. its needs are also unlimited.crores has innumerable demands on its resources such as meeting mounting defense 29 expenditure. education and so on. Also Cawer Managerial Economics .com  The secondary condition requires that necessary condition must be 30 satisfied under the condition of decreasing MR and increasing MC. The fulfillment of two condition makes the sufficient condition. Objections to this approach:  Profit maximization assumption is too simple to explain the business phenomenon in the real world. Firstly the types of risks involved in the business are not classified. Briefly review the various theories of profit? Ans.) Risk Taking Theory: According to Hawley. which are able to make reasonable profit. Ex: Sales maximization. Market share. businessman themselves are not aware of this objective attributed to them.  It is time honored objective of firm  Profit is one of the most efficient and reliable measures of efficiency of a firm. In fact.Honoursinfo. profit arises because considerable amount of risk is involved in the business. But his was criticized for several reasons.  Firm do not have the necessary knowledge and priori data to equalize MR and MC. Various theories of profit are as follows: a.blogspot.  This assumption has been accurate in predicting the firm’s behavior. In defense of Profit Maximization assumption:  Firms continue to survive in the long run in a competitive market.  It is claimed that there are alternative and equally simple objectives of business firms that explains better the real world business phenomenon. Eg: risk of fire. hence profit can be considered as reward for uncertainty. It is up to the entrepreneur how he exploits the invention made by the scientist into innovation. raw material supply may be reduced. Also there can be sudden change in the fashion. All these factors are uncertain and cannot be insured. Successful entrepreneur is the one who earns a 31 good profit by avoiding the risks. introduction of new substitutes. Losses arising of such uncertainty cannot be estimated with precision. Owner takes the insurance policy by paying the premium for the same. as it will further attract the new firms into the market.  Non-Insurable Risks: The insurance company does not cover these risks. c.blogspot. but in the long run they will disappear. risk of theft etc. b. He neglected the fact that profit is reward for risk and uncertainty bearing. Innovative characteristics of the producer may help him to earn super normal profits in the short run.Honoursinfo. profit is the reward for Innovation. Managerial Economics . When the demand for the products suddenly falls large stock remains in the inventory.com pointed out that profit is not the reward for risk taking but instead it is a reward for risk avoiding. Thus it is said that profits caused by innovation are disappeared by imitation. But this theory of Schumpeter has been criticized on several grounds.) Innovation Theory: According to this theory suggested by Schumpeter. accidents. while mediocre businessman is not able to earn profit as he is unable to avoid risks. They may occur due to sudden increase in the price of raw material.) Uncertainty-Bearing Theory: In this theory the risks are classified into 2 types:  Insurable Risks: These are the risks covered by the insurance company. ________________________________________________________________ Managerial Economics . Adding partners or converting the partnership firm into Joint Stock Company can solve this purpose.com d. Changes in the techniques of production Changes in the supply of capital Changes in the organization of business Changes in population 32 Techniques of production can be changed and improved machinery may be introduced.blogspot. Purchasing of improved machinery would involve lot of capital to be raised. This may reduce the cost of production and improve the profit and output.Honoursinfo. These factors may drastically affect the smooth working of the business. He pointed out that whole world is dynamic and required of changes.B Clark developed this theory.) Dynamic theory of profit: The renowned economist J. This theory was criticized for several reasons. For this purpose producer has to keep on adjusting himself or he would lag behind in this dynamic everchanging world. He pointed out the following type of changes:      Changes in the quality and quantity of human needs. Thus profit is the reward paid for dynamism. He classified the changes under 5 categories but has failed to look at many other important changes like change in the government policy. monetary policy of Central Bank can lead to expansion and contraction of supply of money. bank credits. of good and bad trade”. wholesale and retail prices. Peak 3. production. profits. the various phases of trade cycle may be enumerated as follows: 1. Ans. Mitchell defined trade cycle as a fluctuation in aggregate economic activity. bank credits. Trough 5. Recovery and expansion The five phases of a business cycle have been presented in the figure. Keynes points out “A trade cycle is composed of periods of good trade characterized by rising prices and low unemployment percentages. investment. prices. output and income. According to Haberler. The term “trade cycle or Business Cycle in economics refers to the wave-like fluctuations in the aggregate economic activity. wages. such as. per capital output and a rise in standard of living. “ The business cycle in the general sense may be defined as an alternation of periods of prosperity and dispersion. But considering the intermediate stages between prosperity and depression. aggregate demand.Honoursinfo. Basically there are only two phases in a cycle. particularly in employment. The upward and downward movement in these magnitudes shows different phases of business cycle.blogspot. The growth rate eventually slows down and reaches the peak. viz. sales. employment.. etc. Recession 4. The phase of peak is generally characterized by slacking in the expansion rate. prosperity and depression. The line of cycle moving above the steady growth line marks the beginning of the period of expansion or prosperity in the economy. employment.com 33 Define Business Cycle. Expansion 2. Phases of Business Cycle The ups and downs in the economy are reflected by the fluctuation in aggregate economic magnitudes. the highest level of prosperity. The steady growth line shows the growth of the economy when there are no economic fluctuations. The various phases of business cycles are shown by the line of cycle which moves up and down the steady growth line. Steady Growth Line Managerial Economics . and downward slide in the economic activities from the peak. altering with periods of bad trade characterized by falling prices and high unemployment percentages”. The phase of expansion is characterized by increase in output. Explain various phases of business cycle. investment. depression begins when growth rate is less than zero. In a stagnated economy. And.e. the total output.Honoursinfo. the economy once again enters the phase of expansion and prosperity. when it exceeds this rate. though the realized growth rate may still remain above the steady growth line. register a rapid decline. Output. bank advances. employment. i. etc. etc. When the economy registers a continuous and repaid upward trend in output. decline during the subsequent periods.blogspot.com Peak Expansion Prosperity Recession Prosperity Expansion Recovery 34 Depression Line of Cycle Trough The phase of recession begins when the downward slide in the growth rate becomes rapid and steady. it makes the beginning of depression in the economy. prices.. etc. the business cycle continues to recur. prices. The span of depression spreads over the period growth rate stays below the secular growth rate or zero growth rate in a stagnated economy. and the economic activities once again register an upward movement. Trough is the phase during which the down – trend in the economy slows down and eventually stops. Managerial Economics . the economy enjoys the period of prosperity – high and low. If economic fluctuations are not controlled by the government.. it enters the phase of recovery though the growth rate may still remain below the steady growth rate. Trough is the period of most severe strain on the economy. employment. employment. So long as growth rate exceeds or equals the expected steady growth rate. When the growth rate goes below the steady growth rate. blogspot.Honoursinfo.com 35 Managerial Economics .