MB0042 Complete Wit Problems

8/2/2019 MB0042 Complete Wit Problems

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Master of Business AdministrationSemester I

MB0042 Managerial Economics - 4 Credits(Book ID: B1131)

AssignmentSet- 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 repeatingphenomenon like the swing of the pendulum of a clock. Its timing is random and, to a largedegress, unpredictable.A business cycle is identified as a sequence of four phases:

1) Contraction: A slowdown in the pace of economic activity2) The lower turning point of a business cycle, where a contraction turns into an expansion3) Expansion: A speedup in the pace of economic activity4) 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 ofpromoting 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. Neutrality of Money2. Price Stability3. Economic growth4. Exchange Stability5. Full Employment
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Q3) A firm supplied 3000 pens at the rate of Rs 10. Next month, due to a rise of in the price to 22 rs

per pen the supply of the firm increases to 5000 pens. Find the elasticity of supply of the pens.. ANS:-The elasticity of supply is the increment (difference) in price divided by the increment in quantity.

Elasticity is : (22 - 10)/ (5,000 - 3,000) Rs per item.Note the unites must be given and the numerical value is positive due to the shape of the

supply characteristic.The value of elasicty of supply of the pens is 0.006

Q4. Give a brief description ofA ) Implicit and explicit cost

In economics, an implicit cost, also called an imputed cost, implied cost, or notionalcost, is the opportunity cost equal to what a firm must give up in order to use factors which itneither purchases nor hires. It is the opposite of anexplicit cost, which is borne directly.[1]Inother words, an implicit cost is any cost that results from using an asset instead of renting,

selling, or lending it. The term also applies to forgone income from choosing not to work.Implicit costs also represent the divergence between economic profit (total revenuesminus total costs, where total costs are the sum of implicit and explicit costs) and accountingprofit (total revenues minus only explicit costs). Since economic profit includes these extraopportunity costs, it will always be less than or equal to accounting profit. Lipsey (1975)uses the example of a firm sitting on an expensive plot worth 10,000 a month in rent whichit bought for a mere 50 a hundred years before. If the firm cannot obtain a profit afterdeducting 10,000 a month for this implicit cost, it ought to move premises (or close downcompletely) and take the rent instead.[1]In calculating this figure, the firm ought to ignore thefigure of 50, and remember instead to look at the land's current value.

Explicit cost:-

An explicit cost is a direct payment made to others in the course of running a business,such as wage, rent and materials, as opposed toimplicit costs, which are those where noactual payment is made. It is possible still to underestimate these costs, however: forexample, pension contributions and other "perks" must be taken into account whenconsidering the cost of labour.

Explicit costs are taken into account along with implicit ones when considering economicprofit. Accounting profit only takes explicit costs into account.

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). It is the sacrifice related to the second best choice available tosomeone, or group, who has picked among several mutually exclusive choices. Theopportunity cost is also the cost of the forgone products after making a choice. Opportunitycost is a key concept in economics, and has been described as expressing "the basicrelationship between scarcity and choice". The notion of opportunity cost plays a crucial partin ensuring that scarce resources are used efficiently. Thus, opportunity costs are notrestricted to monetary or financial costs: the real cost of output forgone, lost time, pleasureor any other benefit that provides utility should also be considered opportunity costs
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Actual cost:-

An actual amount paid or incurred, as opposed to estimated cost or standard cost. Incontracting, actual costs amount includes direct labor, direct material, and other direct charges.Actual cost is the total amount of materials, labor costs, and any directly associated overheadcosts that can be charged to a specific project. The actual cost is different from the standard

cost, although both approaches are often used to evaluate the profitability of a given project.With actual costs, the goal is to break down the specifics of the costs involved with the projectand determine if the production process associated with the project is in fact working at optimumefficiency.

Q5)Explain in brief the relationship between TR, AR, and MR under different market condition.

total Average and Marginal Revenue

The revenue of a firm jointly with its costs ascertains profits. Now let us discuss theconcepts of revenue. The term revenue denotes to the receipts obtained by a firm from thescale of definite quantities of a commodity at various prices. The revenue concept relates tototal revenue, average revenue and marginal revenue.

1. Total Revenue It is the total sale proceeds of a firm by selling a commodity at a givenprice. If a firm sells 3 units of an article at $ 24, its total revenue is 3 x 24. Thus totalrevenue is price per unit proliferated by the number of nits sold, i.e. TR = P x Q, whereTR is the total revenue, P the price and Q the quantity.

2. Average Revenue It is the average receipts from the sale of certain units of thecommodity. It is obtained by dividing the total revenue by the number of units sold. Theaverage revenue of a firm is in fact the price of the commodity at each level of output

since TR = P x Q, therefore, AR = TR / Q = P x Q / Q = P.

3. Marginal Revenue MR In addition to total revenue as a result of a small hike in the saleof a firm. Algebraically it is the total revenue earned by selling N units of the commodityinstead of N-1 i.e., MRn = TRn TRn-1.

Relation Between AR and MR Curves

1. Under Ideal Rivalry The average revenue curve is a horizontal straight line parallel to Xaxis and the marginal revenue curve coincides with it. This is since under ideal rivalrythe number of firms selling an identical product is very huge. The price is determined themarket forces of supply and demand so that only one price tends to prevail for the whole

industry.
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Q6) Distinguish between a firm and an industry. Explain the equilibrium of a firm and industryunder perfect competition

An industry is a type of business in the economy while a firm is a unit or entity carrying a portionof the business in an economy.

A firm generally thought of as one company. An industry is a generalization for the type ofbusiness in which a company engages. For example, General Motors is a company that buildscars. Automobile manufacturing is the industry.

A firm is the smallest unit of production or sale. Microeconomic theory is anequilibriumanalysis. It is concerned with the behavior of demand and supply forces. Marshall is reported tohave said that demand and supply are like two blades of a pair of scissors. Demand is a resultof the utility-maximizing behavior of a consumer in rational bounds. Similarly supply is anoutcome of the profit-maximizing behavior of a firm, again in rational bounds.

Equilibrium of firm:-

Firms may have different organizational forms. A firm may be an individual enterprise, apartnership, a joint stock company, a corporate body, a cooperative enterprise or a public utilityagency. Again a firm may be a producer, seller, trader, exporter or a financier. In any one ofthese capacities, firms show similar basic tendencies. In order to maximize its profits a firm hasto 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. The difference between the twois the firms profit. So the firm has to keep its cost of production as low as possible. On the otherhand, it has to charge a high price and sell as much quantity of products as possible. In thisrespect, the firms actions are related to the behaviorof consumers. Besides the limitation ofcost of production, the capacity of a firm to charge a suitable price is restricted by theconsumers willingness to pay.

Equilibrium of industry:-
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When we speak of market equilibrium in economics it refers to level of prices at which thequantity demanded by the customers is same as the quantity offered for for supply by thesuppliers. Thus the market equilibrium has has two dimensions. (1) price, and (2) quantity soldand purchased. Please note that the we are talking about quantity actual sold and purchased.Unlike quantities demanded and quantity offered for supply, the actual quantity sold andpurchased is always equal.In a monopoly market, the entire market supply is accounted by one

firm. Therefore, equilibrium point for the market and for the firm are the same. In a perfectlycompetitive market, individual firms have no influence on the market price as the demand curvefor the firm is a horizontal line at the level of the market price. Thus same price is applicable tofirm level equilibrium. However the quantity supplied by each firm at this equilibrium pricedepends on the cost structure of the firm. The firm can supply as much as it wishes, therefore itsupplies a quantity that maximizes its profit. This occurs when the marginal cost of the firm justequals the marginal revenue. In a perfectly competitive market the marginal cost and revenue atthis point are also same as the market price. Since marginal cost for every firm operating in aperfect competition is same as market price, the combined marginal cost for all the firms in aperfectly competitive market is also same as market equilibrium price.

Master of Business Administration

Semester IMB0042 Managerial Economics - 4 Credits

(Book ID: B1131)Assignment

Set- 2 (60 Marks)

Q1. Suppose your manufacturing company planning to release a new product into market,

Explain the various methods forecasting for a new product.

Methods of forecasting

Broadly Speaking, there are two methods of demand forecasting. They are1. Survey methods2 Statistical methodsSurvey MethodsSurvey methods helps us in obtaining information about the future purchase plans of potentialbuyers through collecting the opinions of experts or by interviewing the consumers. Thesemethods are extensively used in short run and estimating the demand for new productsA) Consumer's Interview Method: Efforts are made to collect the relevant information directlyfrom the consumers with regard to their future purchase plans.B) Opinion survey method : Under this method, sales representatives, professional expertsand the market consultants and others are asked to express their considered opinions about thevolume of sales expected in the future.

C) Experts Opinion Method : Under this method, outside experts are appinted. They aresupplied with all kinds of information and statistical data. The management requests the expertsto express their considered opinions and views about the expected future sales of the companyD) Output Method - Under this method, the sale of the product under consideration is projectedon the basis of demand surveys of the industries using the given product as an intermediateproductStatistical MethodStatistical, mathematical models, equations etc are extensively sed in order to estimate futuredemand of a particular product


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1 Trend Projection Method-On the basis of time series, it is possible to project the future sales of a company2 Economic Indicator An economic indicator indicates change in the magnitude of aneconomic variable. It gives the signal about the direction of change in an economic variable.

Q2) Define the term equilibrium. Explain the changes in market equilibrium and effects to shiftsin supply and demand.

Market Equilibrium Price

In this note we bring the forces of supply and demand together to consider the determination ofequilibrium prices.

The Concept of Market Equilibrium

Equilibrium means a state of equality or a state of balance between market demand andsupply. Without a shift in demand and/or supply there will be no change in market price. In the


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diagram above, the quantity demanded and supplied at price P1 are equal. At any price aboveP1, supply exceeds demand and at a price below P1, demand exceeds supply. In other words,prices where demand and supply are out of balance are termed points of disequilibrium.

Changes in the conditions of demand or supply will shift the demand or supply curves. This willcause changes in the equilibrium price and quantity in the market.

Demand and supply schedules can be represented in a table. The example below provides anillustration of the concept of equilibrium. The weekly demand and supply schedules for T-shirts(in thousands) in a city are shown in the next table:

Price per unit () 8 7 6 5 4 3 2 1

Demand (000s) 6 8 10 12 14 16 18 20

Supply (000s) 18 16 14 12 10 8 6 4

New Demand(000s)

10 12 14 16 18 20 22 24

New Supply (000s) 26 24 22 20 18 16 14 12

1. The equilibrium price is 5 where demand and supply are equal at 12,000 units2. If the current market price was 3 there would be excess demand for 8,000 units3. If the current market price was 8 there would be excess supply of 12,000 units4. A change in fashion causes the demand for T-shirts to rise by 4,000 at each price. The

next row of the table shows the higher level of demand. Assuming that the supplyschedule remains unchanged, the new equilibrium price is 6 per tee shirt with anequilibrium quantity of 14,000 units

5. The entry of new producers into the market causes a rise in supply of 8,000 T-shirts ateach price. The new equilibrium price becomes 4 with 18,000 units bought and sold

Changes in Market Demand and Equilibrium Price


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The demand curve may shift to the right (increase) for several reasons:

1. A rise in the price of a substitute or a fall in the price of a complement2. An increase in consumers income or their wealth3. Changing consumer tastes and preferences in favour of the product4. A fall in interest rates (i.e. borrowing rates on bank loans or mortgage interest rates)

5. A general rise in consumer confidence and optimism

The outward shift in the demand curve causes a movement (expansion) along the supply curveand a rise in the equilibrium price and quantity. Firms in the market will sell more at a higherprice and therefore receive more in total revenue.

The reverse effects will occur when there is an inward shift of demand. A shift in the demandcurve does not cause a shift in the supply curve! Demand and supply factors are assumed tobe independent of each other although some economists claim this assumption is no longervalid!

Changes in Market Supply and Equilibrium Price


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The supply curve may shift outwards if there is

1. A fall in the costs of production (e.g. a fall in labour or raw material costs)2. A government subsidy to producers that reduces their costs for each unit supplied3. Favourable climatic conditions causing higher than expected yields for agricultural

commodities4. A fall in the price of a substitute in production5. An improvement in production technology leading to higher productivity and efficiency in

the production process and lower costs for businesses6. The entry of new suppliers (firms) into the market which leads to an increase in total

market supply available to consumers

Q3. Explain how a product would reach equilibrium position with the help of ISO - Quants and ISO-

Cost curveWhen producing a good or service, how do suppliers determine the quantity of factors to hire?Below, we work through an example where a representative producer answers thisquestion.Lets begin by making some assumptions. First, we shall assume that our producer chooses varyingamounts of two factors, capital (K) and labor (L). Each factor was a price that does not vary withoutput. That is, the price of each unit of labor (w) and the price of each unit of capital (r) areassumed constant. Well further assume that w = $10 and r = $50. We can use this information todetermine the producers total cost. We call the total cost equation an iso cost line (its similar to abudget constraint).The producers iso cost line is:10L + 50K = TC


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(1)The producers production function is assumed to take the following form:q = (KL)0.5(2)Our producers first step is to decide how much output to produce.

Suppose that quantity is1000 units of output. In order to produce those 1000 units of output, ourproducer must get a combination of L and K that makes (2) equal to 1000. Implicitly, this meansthat we must find a particular iso quant. Set (2) equal to 1000 units of output, and solve for K. Doing so,

we get the following equation for a specific iso quant (one of many possible iso quants):

K = 1,000,000/L(2a)For any given value of L, (2a) gives us a corresponding value for K. Graphing these values, with K onthe vertical axis and L on the horizontal axis, we obtain the blue line on the graph below. Eachpoint on this curve is represented as a combination of K and L that yields an output level of 1000

units. Therefore, as we move along this iso quant output is constant(much like the fact that utility isconstant as A basic understanding of statistics is a critical component of informed decision making.

Q4) Critically examine the Marris growth maximising model.

Profit-maximization is a traditional objective of a firm. Sales maximization objective is explainedby Prof. Boumal. On similar lines, Prof. Marris has developed another alternative growthmaximization model in recent years. It is a common factor to observe that each firm aims atmaximizing its growth rate as this goal would answer many of the objectives of a firm. Marrispoints out that a firm has to maximize its balanced growth rate over a period of time.

Marris assumes that the ownership and control of the firm is in the hands of two groups ofpeople, ie, owners and managers. He further points out that both of them have two distinctivegoals. Managers have a utility function in which the amount of salary, status, position, power,prestige and security of job etc are the most important variables where as in case of owners aremore concerned about the size of output, volume of profits, market share and salesmaximization etc.

Utility function of the managers and that the owners are expressed in the following manner

Uo = f [size of output, market share, volume of profit, capital, public esteem etc.]

Um = f [salaries, power, status, prestige, job security etc.].

In view of Marris the realization of these two functions would depend on the size of the firm.Larger the firm, greater would be the realization of these functions and vice-versa. Size of thefirm according to Marris depends on the amount of corporate capital which includes total volumeof assets, inventory levels, cash reserves etc. He further points out that the managers alwaysaim at maximizing the rate of growth of the firm rather than growth in absolute size of the firm.Generally managers like to stay in a growing firm. Higher growth rate of the firm satisfy the

promotional opportunities of managers and also the share holders as they get more dividends.

Marris identifies two constraints in the rate of growth of a firm:

1. There is a limit up to which output of a firm can be increased more economically, limit tomanage the firm efficiently, limit to employ highly qualified and experienced managers, limit toresearch and development and innovation etc.

2. The ambition of job security puts a limit to the growth rate of the firm itself deliberately. Ifgrowth reaches the maximum, then there would be no opportunity to expand further and as


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such the managers may loose their jobs. Rapid growth and financial soundness should gotogether. Managers hesitate to take unwanted risks and uncertainties in the organization at thecost of their jobs They would like to avoid risky investment projects, concentrate on generatingmore internal funds and invest more finance on only those products and services which bringsmore profits Hence, managers would like to seek their job security through adoption of acautious and prudent financial policy.

He further points out that a high risk-loving management would like to maintain a relatively lowamount of cash on hand and invest more on business, borrow more external funds and investmore in business expansion and keep low profit levels. On the other hand, a highly risk-avertingmanagement may have exactly opposite policy. Ultimately, it is the job security which puts aconstraint on business decisions by the managers.

The Marris growth maximization model. highlights on achieving a balanced growth rate of a firm.Maximum growth rate [g] is equal to two important variables-

1. The rate of demand for the products [gd]

2. Growth rate of capital[gc]

Hence, Max g = gd = gc.

The growth rate of the firm depends on two factors- a] the rate of diversification [d]and b] theaverage profit margin.

The diversification rate depends on the number of new products introduced per unit of time andthe rate of success of new products in the market. The success of new products is determinedby its changes in fashion styles, consumption habits, the range of products offered etc. Moreover diminishing marginal returns would operate in any business and as such there is a limit todiversification. Similarly, market price of the given product, availability of alternative substituteproducts and their relative prices, publicity, propaganda and advertisements, R&D expensesand utility and comparative value of the product etc would decide the profit ratio. Higherexpenditure on sales promotion and R&D would certainly reduce profits level as there are limitsto them.

The rate of capital growth is determined by either issue of new shares to obtain additional fundsand external funds and generation of more internal surplus. Generally a firm would select thelast one to avoid higher degrees of risks in the business.

The Marris model states that in order to maximize balanced growth rate or reach equilibriumposition, there should be equality between the growth rate in demand for the products andgrowth rate in supply of capital. This implies the satisfaction of three conditions.

1. The management has to maintain a low liquidity ratio, ie, liquid asset / total assets. But this

ratio should not create any financial embarrassment to meet the required payments to all theconcerned parties.

2. The management has to maintain a proper leverage ratio between value of debts/Totalassets so that it will have enough money to invest in order to stimulate growth.


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3. The management has to keep a high level of retained profits for further expansion and

development but it should not displease the shareholders i.e. by giving lowdividends.In this case, the mangers would maximize their utility function and the owners would maximize

their utility functions. The managers are able to get their job security with a high rate of growthof the firm and share holder would become happy as they get higher amount of dividends.

Q5) What do you mean by pricing policy? Explain the various objective of pricing policy of a firm.

A detailed study of the market structure gives us information about the way in which prices aredetermined under different market conditions. However, in reality, a firm adopts different policiesand methods to fix the price of its products. Pricing policy refers to the policy of setting the priceof the product or products and services by the management after taking into account of variousinternal and external factors, forces and its own business objectives. Pricing Policy basicallydepends on price theory that is the corner stone of economic theory. Pricing is considered asone of the basic and central problems of economic theory in a modern economy. Fixing prices

are the most important aspect of managerial decision making because market price charged bythe company affects the present and future production plans, pattern of distribution, nature ofmarketing etc.

Factors Involved In pricing Policy

The pricing of the product involves consideration of the following factors:

1. Cost: Cost data occupy an important place in the price setting process. Cost are two types

fixed cost and variable cost. In the short period which a firm wants to establish itself. The firm

may not cover the fixed costs but it must cover the variable costs. But in the long run, all costs

must be covered. If the entire costs are not covered, the producer stops production

consequently, the supply is reduced which in turn may lead to higher price.

2.CompetitorsIf the business is a monopolist, then it can set any price. At the other extreme, if a firm operates

under conditions of perfect competition, it has no choice and must accept the market price. The

reality is usually somewhere in between. In such cases the chosen price needs to be very

carefully considered relative to those of close competitors.

(3) Customers

Consideration of customer expectations about price must be addressed. Ideally, 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.

Business cycles affect the smooth growth of an economy. Expansionary phase has, however, a

favorable impact on income, output and employment. But recession and depression imply

slackness in growth, contraction of economic activity, increasing unemployment, falling incomes

and so on.Business cycles have their effects on individual business firms, as well. During
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expansionary phase, there is a business boom. The firm gains due to rising demand, rising

prices and increasing profits. Prosperity makes the business firms prosperous. But in a capitalist

economy prosperity digs its own grave.

During this period, a firm may have to face some adverse effects. Rising prices and optimism inthe market may encourage many new firms to enter the market and the existing firms to expandtheir output. Competition becomes intense. Increased demand for factors may cause a rise intheir prices. Marketing and distribution costs may go up. Demand for investment funds increase.All these may result in raising the cost of production causing a rise in the product price.

During this period a business unit should be extraordinarily cautious. Business decisions are tobe made carefully after estimating the market situation properly. Expansion in production andsale of goods should be so organized that they take full advantage of the situation withoutinvolving themselves into any kind of risk. A prudent businessman should adopt all possibleprecautionary measures to avoid and minimize business problems as much as possible. Heshould have knowledge of the economic characteristics of the trade cycles and usual sequence

of events during such periods, the phase of the trade cycle through which business is thenpassing, relation between cyclical changes and general business and cyclical changes and thebusiness of the given enterprise, in particular, cyclical movements in production and sales andin the prices of commodities purchased and sold. A business firm should have a comprehensiveview of the entire market internal and external factors affecting business in order to adopt anefficient business programme and prevent the adverse effects of cyclical changes on business.He should mainly see that the costs are kept under control, avoid over investment,overproduction and over expansion, excessive inventories of raw materials and finished goods.Employ a flexible credit standard, avoid excessive borrowing. Check temporary diversificationprogramme, avoid purchase commitments, maintain satisfactory labour conditions and createsizable reserve fund. Various such measures may help a firm in avoiding the harmful effects ofbusiness expansion.

During the phase of contraction, recession and depression the basic objective is to fight againstpessimism and to give a big boost to all kinds of business activities. There must be a strongpsychological shift during this period. A few measures are to be adopted to mitigate the harmfuleffects of contraction. (1) Quick liquidation of inventories. (2) Reduction of cost of production. (3)Improvement in quality (4) adoption of new selling methods. (5) Development of new methods oforganization etc. (6) Management of the labour force carefully.

Apart from these measures a businessman may also take up a few important steps in the bestinterest of the firm. By adopting a very cautious policy of planning during the period ofcontraction when all costs are low a firm can take up the expansion and extension programmes.The firm will have to restructure its advertising policy to suit the circumstances. Cyclical priceadjustment poses the most challenging job for the firm. It will have to choose a right pricingpolicy keeping in view various factors like changing costs, prices of substitutes, market share,changes in general price level etc.

Thus during different phases of trade cycles a firm has to make careful decisions with regard tofinance,

Capital budgeting, investment, production, distribution, marketing, purchasing, pricing etc. A firmshould gear up itself to face the challenges of cyclical changes in a most befitting manner.


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