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MANAGERIAL ECONOMICS

Q2. What are the factors determine the demand curve?

Explain?

Ans. Demand curve & factors effected :

A demand curve is a locus of points showing various alternative

price- quality combinations. In short, the graphical
presentation of the demand schedule is called as a
demand curve.

D
0
X
Price

Demand

It represents the functional relationship between quality

demanded and prices of a given commodity. The demand curve
has a negative slope or it slope downwards to the right. The
negative slope of the demand curve clearly indicates that quality
 demanded goes on increasing as price falls and vice versa, factor
demand & price which determine demand curves.

The law of demand

It explains the relationship between price and quality demanded
of a commodity. It says that demand various inversely with the
price. The law can be explained in the following manner: “Other
things being equal, a fall in price leads to expansion in
demand and a rise in price leads to contraction in
demand”. The law can be expressed in mathematical terms as
“demand is a decreasing function of price”. Symbolically, thus D
= F (p) where, D represents Demand, P stands for Price
and F denotes the Functional relationship. The law
explains the cause and effect relationship between the
independent variable [price] and the dependent variable
[demand]. There is no rule that a consumer has to buy more
whenever price of the commodity falls and vice-versa. There law
explains only the general tendency of consumers while buying a
product. Thus, the law does not have universal validity.
A consumer would buy more when price falls due to the following
reasons:
1. A product becomes cheaper. [Price Effect]
2. Purchasing power of a consumer would go up. [Income
Effect]
3. Consumers can save some amount of money.
4. Cheaper products are substitute for costly products.
[Substitution Effect]

Important features of law of demand

1. There is an inverse relationship between price and

demand.
2. Price is an independent variable and demand is a
dependent variable
3. It is only a qualitative statement and as such it does not
indicate quantitative changes in price and demand.
4. Generally, the demand curve slopes downwards from left
to right.

The operation if the law is conditioned by the phrase “Other

things being equal”. It indicates that given certain conditions,
certain results would follow. The inverse relationship between
price and demand would be valid only when tastes and
performances, customs and habits of consumers, prices of
related goods, and income of consumers would remain constant.
EXCEPTIONS TO THE LAW OF DEMAND
Generally speaking, customers would buy more when price falls
in accordance with the law of demand. Exceptions to law of
demand states that with a fall in price, demand also falls and
with a rise in price demand also rises. This can be represented
by rising demand curve. In other words, the demand curve
slopes upwards from left to right. It is known as an exceptional
demand curve or unusual demand curve.
Y D
It is clear
5.00from the diagram that as price rises from Rs. 4.00 to
Rs. 5.00, quantity demanded also expands from 10 units to 20
units. 4.00

X
Demand 10 20
Price

Following are the exceptions to the law of demand

1. Giffen’s Paradox
A paradox is a foolish or absurd statement, but it will be
true. Sir Robert Giffen, an Irish economist, with the help of his
own example (inferior goods) disapproved the law of demand.
The Giffen’s paradox holds that “Demand is strengthened
with a rise in price or weakened with a fall in price”. He
gave the example of poor people of Ireland who were using
potatoes and meat as daily food articles. When price of potatoes
declined, customers instead of buying larger quantities of
potatoes started buying more of meat (superior goods). Thus,
the demand for potatoes declined in spite of fall in its price.

2. Veblen’s effect
Thorstein Veblen, a noted American economist contends that
there are certain commodities which are purchased by rich
people not for their direst satisfaction, but for their ‘snob –
appeal’ or ‘ostentation’. Veblen’s effect states that demand
for status symbol goods would go up with a rise in price and
vice-versa. In case of such status symbol commodities it is not
the price which is important but the prestige conferred by that
commodity on a person makes him to go for it. More commonly
cited examples of such goods are diamonds and precious stones,
world famous paintings, commodities used by world famous
personalities etc. Therefore, commodities having ‘snob- appeal’
are to be considered as exceptions to the law of demand.

3. Fear of shortage
When serious shortages are anticipated by the people, (e.g.,
during the war period) they purchases more goods at present
even though the current price is higher.

4. Fear of Future Rise on Price

If people except future hike in prices, they buy more even
though they feel that current prices are higher. Otherwise, they
have to pay a still high price for the same product.

5. Speculation
Speculation implies purchase or sale of an asset with the
hope that its price may rise or fall and make speculative
profit. Normally speculations witnessed in the stock exchange
market. People buy more shares only when their prices show a
rising trend. This is because they get more profit, if they sell
their shares when the prices actually rise. Thus, speculation
becomes an exception to the law of demand.

6. Conspicuous Necessaries
Conspicuous Necessaries are those items which are
purchased by consumers even though their prices are
rising on account of their special uses in our modern style
of life.
In case of articles like wrist watches, scooters, motorcycles, tape
recorders, mobile phones etc, customers buy more in spite of
their high prices.

7. Emergencies
During emergency periods like war, famine, floods, cyclone,
accidents etc., people buy certain articles even though the prices
are quite high.

8. Ignorance
Sometimes people may not be aware of the prices prevailing in
the market. Hence, they buy more at higher prices because of
sheer ignorance.

9. Necessaries
Necessaries are those items which are purchased by consumers
ever may be the price. Consumers would buy more necessaries
in spite of their higher prices.

CHANGES OR SHIFTS IN DEMAND

It is to be clearly understood that if demand changes only

because of changes in the price of the given commodity, in that
case there would be either expansion or contraction in demand.
Both of them can be explained with the help of only one demand
curve. If demand changes not because of price changes
but because of other factors of forces, then in that case
there would be either increase or decrease in demand. If
demand increases, there would be forward shift in the demand
curve to the right and if demand decreases, then there would be
backward shift in the demand curve.

Y D¹
D
D²
Forward
Shift
Price

Backward D¹
0 Shift D² D

DETERMINANTS OF DEMAND (FACTORS THAT EFFECT OR

INFLUENCE THE DEMAND)
Demand for a commodity or service is determined by a number
of factors. All such factors are called ‘demand determinants’.
 1. Price for the given commodity, prices of other substitutes
and /or compliments, future expected trend in prices etc.
2. General Price level existing in the country –inflation or
deflation
3. Level of income and living standards of the people.
4. Size, rate of growth and composition of the population
5. Tastes, preferences, customs, habits, fashion and styles
6. Publicity, propaganda and advertisements.
7. Quality of the product.
8. Profit margin kept by the sellers
9. Weather and climate conditions
10. Conditions of trade –boom or prosperity in the economy
11. Terms & conditions of trade.
12. Government’s policy-taxation, liberal or restrictive
measures.
13. Level of savings & pattern of consumer expenditure
14. Total Supply of money circulation and liquidity preference
the people.
15. Improvements in educational standards etc.

Thus, several factors are responsible for bringing changes

in the demand for a product in the market. A business
executive should have the knowledge and information
about all these factors and forces in order to finalize his
own production, marketing and other business strategies.

Demand function
The law of demand and demand schedule explain only the price-
quantity demand. It is necessary to note that many factors and
forces affect the demand. If these factors are related to demand,
the demand scheduled is transformed into a demand function.

The demand function for a product explains the quantities

of a product demanded due to different factors other than
price in the market at a particular point of time.
Demand function is a comprehensive formulation which specifies
the factors that influence the demand for a product other than
price. Mathematically, a demand function can be represented in
the following manner.

Dx = f (Ps, Pc, Y, Ey, T, W, A, U….etc). Where,

Dx = Demand for commodity X Ps = Price of the
substitutes
Pc = Price of the complements Ep = Expected future
price
Y = Income of the consumer Ey = Expected income
in future
T = Tastes and preferences W = Wealth of the
consumer
A = Advertisement and its impact U = All other
determinants

The knowledge of demand function is more important for a firm

than the law of demand. Demand function explains the various
factors and forces other than price that would affect the demand
for a commodity in the market. In accordance with changes in
different factors or forces, a firm can take suitable measures to
prepare its production, distribution and marketing programs
scientifically.

Q3. A firm supplied 300 pens at the rate of Rs. 10. Next
month, due to a rise of in the price to Rs.22 Per pen
the supply of the firm increases to 5000 pens. Find the
elasticity of supply of the pens.

Q4. Briefly explain the profit – maximization model?

Ans. Profit maximization model

Profit –making is one of the most traditional, basic and major
objectives of a firm. Profit-motive is the driving –force behind all
business activities of a company. It is the primary measures of
success of failure of a firm in the market. Profit earning capacity
indicates the position, performance and status of a firm I the
market. It is an acid test of economic ability and performance of
an individual form. There is no place for a firm unless it earns a
reasonable amount of profit in the business. It is necessary to
stay in business and maintain in tact the wealth producing
agents. It is a widely accepted goal and there is nothing bad or
immoral about it. Earlier profit maximization was the sole
objective of a firm. This assumption has a long history in
economic literature and the conventional price theory was based
on this very assumption about profit making. In spite of several
changes and development of several alternative objectives,
profit maximization has remained as one of the single most
important objectives of the firm even today. Both small and
large firms consistently make an attempt to maximize their profit
by adopting novel techniques in business. Specific efforts have
 been made to maximize output and minimize production and
other operating costs. Cost reduction, cost cutting and cost
minimization has become the slogan of a modern firm.

It helps to predict the price-output behavior of a firm under

changing market conditions like tax rates, wages and salaries,
bonus, the degree of availability of resources, technology,
fashions, tastes and preferences of consumers etc. it is a very
simple and unambiguous model. It is the single most ideal model
that can explain the normal behavior if a firm. It is often argued
that no other alternative hypothesis can explain and predict the
behavior of business forms better than profit – maximization
hypothesis. This model gives a proper insight in to the working
behavior of a firm. There are well developed mathematical
models to explain this hypothesis in a systematic and scientific
manner.

Main propositions of the profit-maximization model

The model is based on the assumption that each firm seeks to
maximize its profit given certain technical and market
constraints. The following are the main propositions of the
model.
1. A firm is a producing unit and as such it converts various
inputs into outputs of higher value under a given technique
of production.
2. The basic objective of each firm is to earn maximum profit.
3. A firm operates under a given market condition.
4. A firm will select that alternative course of action which
helps to maximize consistent profits.
5. A firm makes an attempt to change its prices, input and
output quantity to maximize its profit.

5. What is Cyert and March’s behavior theory?

What are the demerits?
Ans. The firm as a complex systemAlthough the neo-classical model of
the firm hasbeen improved over the last two decades,particularly by
the so-called ‘new growth theory’, itstill follows the essentials of the
mainstream paradigm in economic science: atomistic
thinking,homeostatic equilibrium, linear causality andmaximizing
behaviours (Cross, 1995).2However, the second half of the 20th
centuryproduced substantial new research that questionedseriously
these assumptions, although on selectedissues. The work of Simon
(1957) and Cyert and March (1963) on the existence of different
cognitiveactors adopting bounded rationality, the nonequilibrium
theory of the firm by Penrose (1959)and the evolutionist work of
Nelson and Winter(1982) on firms’ routines, opened radically
newdirections in the study of the firm and established arich theoretical
background for the emergence of anew paradigm in economic science.
sustained by internal networks which support circular relationships
among the parts and between each part and the whole system whilst
ensuring the stability of the system within change (Conti and
Dematteis, 1995).4 In this perspective, we can put forward some
elements of our approach to the nature of the firm that are central in
the analytical framework we adopt Novelty emerges from interactions
within the firm and between the firm and the environment. Collective
knowledge is an important emergence resulting from interactive
processes involving cognitive agents (Ngo-Mai and Rocchia, 1999).
This cognitive nature points to the radical difference between
information and knowledge, which has important implications both at
theoretical and policy levels.• Firms develop strategies to improve
their performance in response to the environment or to internal
changes. For this they need memory, to register situations, and
assessment criteria, to compare outcomes and select options.
Therefore, the leadership of the entrepreneur, as coordinator and
motivator of interactions, becomes crucial for the performance of the
firm (Witt, 1998). • Firms are disturbed by shocks produced by
theenvironment. Their effects on the firm can either be
diminished/eliminated by negative feedback or amplified by positive
feedback (Arthur, 1988). A firm’s memory, combined with these
feedback effects, determines the assimilation or the elimination of
innovations.• Redundancy is crucial for the survival of the
firm.Assuming different forms (material resources, information,
competencies), redundancy enables the system to widen the range of
available responses to environment changes. This is opposed to the
mainstream economics idea of an optimizing selection by the markets
that does not even exist in natural systems (Hodgson, 1993). In this
new paradigm the firm lives by a ‘structural coupling’ with its
environment, which means that
‘the environment selects which of the systems attractors becomes
active at any time, what is also called situated or selected self-
organization’ (Lucas, 2001: 20). Therefore, we need to deepen our
analysis of what is the environment of the firm and study the dynamics
of their relationship.
Firms, territories and innovation Recent years have shown a
convergence between industrial economics and economic geography
within regional development studies. Nevertheless, some contributions
experience great difficulty overcoming what has been called ‘one-sided
analysis’ (Oerlemans et al., 1999). For this, we need a new scientific
paradigm that could offer a basis for the advancement of
interdisciplinary research in spatial studies.In fact, the environment is
a vague reality whendefined by reference to the firm, which we
conceive as a complex evolutionary system. However, the environment
can be approached directly under different dimensions (natural,
business, social, institutional) and at different scales. Choosing the
particular dimension of space, we identify the existence of
geographical communities (territories) comprising different types of
agents, individual and collective, which form an evolving social fabric.
So far, the most diffused models of territorial development, the
‘industrial district’ and the ‘innovative milieu’, have concentrated
analytical efforts in identifying the factors of successful evolutions and
explain, by default, the failure of others (Pyke and Sengenberger,
1992; Ratti et al., 1997). From our point of view, the complex systems
approach offers a wider conceptual framework which gives fresh
insights for the understanding of (succeeded or failed) meta-
transitions in territorial communities, which should be understood as
evolutionary social entities (Heylighen and Campbell, 1995). In this
context, the firm performs different roles as it belongs at the same
time to an industrial network and to a territory made up of multiple
networks in interaction. The firm transfers to the industrial network
(frequently global) the knowledge captured in the territory and its local
interactions. However, firms’ positioning in the network influences the
evolution of their territory, not only by using local resources but also
by diffusing in the territory knowledge acquired in the network. This
complex articulation between vertical and horizontal relationships
makes territories much more than a location for the firm, even in the
case of major organizations (Storper, 1997; Kirat and Lung, 1999).
Therefore, territories may be seen as strategic assets for the firms in
their specific way of building Contrasting with the linear model, the
social nature of knowledge and innovation has been established for a
long time, even if the former continues to exert a strong appeal in the
scientific community. Accordingly, research on local productive
systems insists that geographical proximity still matters as far as it
concerns tacit knowledge and some kinds of contextualized codified
knowledge (Maskell and Malmberg, 1999). The results of this research
show that, although codetermined by other types of proximity –
namely technological and organizational – firms’ innovation processes
are to a large extent a territorially based phenomenon (Gertler, 2001).
A last step in the formulation of the analytical framework addresses
some policy implications of
our complex systems approach.
06. What is Boumal’s Static and Dynamic

Ans. Boumal’s Static And Dynamic Models.

Sales maximization model is an alternative model for profit maximization.
This
model is developed by Prof. W.J.Boumal, an American economist. This
alternative goal has assumed greater significance in the context of the
growth of
Oligopolistic firms.
The model highlights that the primary objective of a firm is to maximize its
sales
rather than profit maximization. It states that the goal of the firm is
maximization of sales revenue subject to a minimum profit constraint. The
minimum profit constraint is determined by the expectations of the share
holders. This is because no company can displease the share holders.
It is to be noted here that maximization of sales does not mean maximization
of
physical sales but maximization of total sales revenue. Hence, the managers
are
more interested in maximizing sales rather than profit.
The basic philosophy is that when sales are maximized automatically profits
of
the company would also go up. Hence, attention is diverted to increase the
sales
of the company in recent years in the context of highly competitive markets.
In defence of this model, the following arguments are given.
1. Increase in sales and expansion in its market share is a sign of healthy
growth of a normal company.
2. It increases the competitive ability of the firm and enhances its influence
in
the market.
3. The amount of slack earnings and salaries of the top managers are directly
linked to it.
4. It helps in enhancing the prestige and reputation of top management,
distribute more dividends to share holders and increase the wages of workers
and keep them happy.
5. The financial and other lending institutions always keep a watch on the
sales
revenues of a firm as it is an indication of financial health of a firm.
6. It helps the managers to pursue a policy of steady performance with
satisfactory levels of profits rather than spectacular profit maximization over
a period of time. Managers are reluctant to take up those kinds of projects
which yield high level of profits having high degree of risks and uncertainties.
The risk averting and avoiding managers prefer to select those projects
which
ensure steady and satisfactory levels of profits.
Prof, Boumal has developed two models. The first is static model and the
second
one is the dynamic model.
The Static Model
This model is based on the following assumptions.
1. The model is applicable to a particular time period and the model does not
operate at different periods of time.
2. The firm aims at maximizing its sales revenue subject to a minimum profit
constraint.
3. The demand curve of the firm slope downwards from left to right.
4. The average cost curve of the firm is unshaped one.

Sales maximization/ dynamic model

In the real world many changes takes place which affects business decisions
of a
firm. In order to include such changes, Boumal has developed another
dynamic
model. This model explains how changes in advertisement expenditure, a
major
determinant of demand, would affect the sales revenue of a firm under
severe
competitions.