ASSIGNMENT

DRIVE

Summer 2015

PROGRAM

MBA

SEMESTER

SUBJECT CODE & NAME

MB0042 Managerial economics

BK ID

B1625

CREDIT & MARKS

Name

4 Credits, 60 marks
DHANIRAM SHARMA

Question 1- Define economies of scale. Discuss the kinds of internal economies

Answer: The study of economies of scale is associated with large scale production. Today
there is a general tendency to organize production on a large scale. Mass production of
standardized goods has become the order of the day. Large scale production is beneficial
and economical in nature. The advantages or benefits that accrue to a firm as a result of
increase in its scale of production are called economies of scale. They have close
relationship with the size of the firm. They influence the average cost over different ranges of
output. They are beneficial to a firm. They help in reducing production cost and establishing
an optimum size of a firm. Thus, they help a lot and, go a long way in the development and
growth of a firm. According to Prof. Marshall, such economies are of two types, viz., internal
economies and external economies.
Kinds of internal economies
Technical economies
These economies arise on account of technological improvements and their practical
application in the field of business. Economies of techniques or technical economies are
further subdivided into five heads as follows:
a) Economies of superior techniques These economies are the result of the application
of the most modern techniques of production. When the size of the firm grows, it becomes
possible to employ bigger and better types of machinery. The latest and improved
techniques give place for specialized production. It is bound to be cost reducing in nature, for
example, cultivating the land with modern tractors instead of using age old wooden ploughs
and bullock carts, use of computers instead of human labor, etc.
b) Economies of increased dimension It is found that a firm enjoys the reduction in cost
when it increases its dimension. A large firm avoids wastage of time and economizes its
expenditure. Thus, an increase in dimension of a firm will reduce the cost of production, for
example, operation of a double-decker bus instead of two separate buses.

c) Economies of linked processes It is quite possible that a firm may not have
various processes of production within its own premises. Also, it is possible that
different firms through mutual agreement may decide to work together and derive the
benefits of linked processes, for example, in dairy farming, printing press, nursing homes,
etc.
d) Economies arising out of research and by-products A firm can invest adequate
funds for research and, the benefits of research and its costs can be shared by that firm as
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well as all other firms in the industry. Similarly, a large firm can make use of its wastes and
by-products in the most economical manner by producing other products. For example, cane
pulp, molasses, and bagasse of sugar factory can be used for the production of paper,
varnish, etc.
e) Inventory economies Inventory management is a part of better materials
management. A big firm can save a lot of money by adopting latest inventory management
techniques. For example, Just-In-Time or zero level inventory techniques. The rationale of
the Just-In-Time technique is that instead of having huge stocks worth of lakhs and crores of
rupees, it can ask the seller of the inputs to supply them just before the commencement of
work in the production department each day.
Managerial Economies
They arise because of better, efficient, and scientific management of a firm. Such economies
arise in two different ways as follows:
a) Delegation of details The general manager of a firm cannot look after the working of all
processes of production. In order to keep an eye on each production process he has to
delegate some of his powers or functions to trained or specialized personnel and thus relieve
himself for co-ordination, planning and executing the plans. This will enable him to bring
about improvements in production process and in bringing down the cost of production.
b) Functional specialization It is possible to secure economies of large scale production
by dividing the work of management into several separate departments. Each department is
placed under an expert and the rest of the work is left into the hands of specialists. This will
ensure better and more efficient productive management with scientific business
administration. This would lead to higher efficiency and reduction in the cost of production.
Thus managerial economies are mainly governed by proper delegation of details and by
functional specialization.
Marketing or commercial economies
These economies arise on account of buying and selling goods on large scale basis at
favorable terms. A large firm can buy raw materials and other inputs in bulk at concessional
rates. As the bargaining capacity of a big firm is much greater than that of small firms, it can
get quantity discounts and rebates. In this way, economies may be secured in the purchase
of different inputs.
Financial economies
They arise from advantages secured by a firm in mobilizing huge financial resources. A large
firm on account of its reputation, name and fame can mobilize huge funds from money
market, capital market, and other private financial institutions at concessional interest rates.
It can borrow from banks at relatively cheaper rates. It is also possible to have large
overdrafts from banks. A large firm can float debentures and issue shares and get
subscriptions from the general public. Another advantage will be that the raw material
suppliers, machine suppliers etc., are willing to supply materials and components at
comparatively low prices, because they are likely to get bulk orders. Thus, a big firm has an
edge over small firms in securing sufficient funds more easily and cheaply.
Labor economies
These economies arise as a result of employing skilled, trained, qualified and highly
experienced persons by offering higher wages and salaries. As a firm expands, it can
employ a large number of highly talented persons and get the benefits of specialization and
division of labor. It can also impart training to existing labor force in order to raise skills,
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efficiency and productivity of workers. New schemes may be chalked out to speed up the
work, conserve scarce resources, economise on expenditure and save labor time. It can
provide better working conditions, promotional opportunities, restrooms, sports rooms etc.,
and create facilities like subsidized canteen, crches for infants, recreations. All these
measures will definitely raise the average productivity of a worker and reduce the cost per
unit of output.
Transport and storage economies
They arise on account of the provision of better, highly organized and cheap transport and
storage facilities and their complete utilization. A large company can have its own fleet of
vehicles or means of transport which are more economical than hired ones. Similarly, a firm
can also have its own storage facilities which reduce cost of operations.
Overhead economies
These economies arise on account of large scale operations. The expenses on
establishment, administration, book-keeping, etc., are more or less the same whether
production is carried out on a small or large scale. Hence, cost per unit will be low if
production is organized on a large scale.
Economies of vertical integration
A firm can also reap this benefit when it succeeds in integrating a number of stages of
production. It secures the advantage that the flow of goods through various stages in
production processes is more readily controlled. Because of vertical integration, most of the
costs become controllable costs which help an enterprise to reduce cost of production.
Risk-bearing or survival economies
These economies arise as a result of avoiding or minimizing several kinds of risks and
uncertainties in a business. A manufacturing unit has to face a number of risks in the
business. Unless these risks are effectively tackled, the survival of the firm may become
difficult. Hence, many steps are taken by a firm to eliminate or to avoid or to minimize
various kinds of risks. A large firm secures risk-spreading advantages in either of the
following four ways or through all of them:
Diversification of output
Diversification of market.
Diversification of source of supply
Diversification of the process of manufacture
Generally speaking, the risk-bearing capacity of a big firm will be much greater than that of a
small firm. Risk is avoided when few firms amalgamate or join together or when competition
between different firms is either eliminated or reduced to the minimum by expanding the size
of the firm.
Question 2 - Consumers' interview method is a survey method used for estimating the
demand for new products. This method is very important with regard to collect the
relevant information directly from the consumers with regard to their future purchase
plans. Opinion surveys and direct interview method are the two important techniques
among all. Describe these two methods in detail.
Answer: Survey methods help us in obtaining information about the future purchase plans of
potential buyers through collecting the opinions of experts or by interviewing the consumers.
These methods are extensively used in short run and for estimating the demand for new
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products. There are different approaches under survey methods. Let us discuss them in
detail.
A) Consumers interview method
Under this method, efforts are made to collect the relevant information directly from the
consumers with regard to their future purchase plans. In order to gather information from
consumers, a number of alternative techniques are developed from time to time. Among
them, the following are some of the important ones:
Survey of buyers intentions or preferences
It is one of the oldest methods of demand forecasting. It is also called Opinion surveys.
Under this method, consumer-buyers are requested to indicate their preferences and
willingness about particular products. They are asked to reveal their future purchase plans
with respect to specific items. They are expected to give answers to questions like what
items they intend to buy, how much quantity, why, where, when, what quality they expect,
how much money are they planning to spend, etc. Generally, the field survey is conducted
by the marketing research department of the company or by hiring the services of outside
research organizations consisting of learned and highly qualified professionals.
The heart of a survey is the questionnaire. It is a comprehensive one, covering almost all
questions either directly or indirectly in a most intelligent manner. It is prepared by an expert
body who are specialists in the field of marketing.
The questionnaire is distributed among the consumer buyers either through mail or in person
by the company. Consumers are requested to furnish all relevant and correct information.
The next step is to collect the questionnaire from the consumers for the purpose of
evaluation. The material collected is classified, edited and analyzed. If any bias, prejudices,
exaggerations, artificial or excess demand creation, etc., are found at the time of answering,
they are eliminated.
The information so collected is consolidated and reviewed by the top executives with lot of
experience. It is examined thoroughly. Inferences are drawn and conclusions are arrived at.
Finally, a report is prepared and submitted to management for taking final decisions.
The success of the survey method depends on many factors including:
1. The nature of the questions asked
2. The ability of the surveyed
3. The representative of the samples
4. Nature of the product
5. Characteristics of the market
6. Consumer-buyers behavior, their intentions, attitudes, thoughts, motives, honesty etc.
7. Techniques of analysis
8. Conclusions drawn, etc.
The management should not entirely depend on the results of the survey reports to project
the future demand. Consumer buyers may not express their honest and real views and they
may give only the broad trends in the market. In order to arrive at right conclusions, field
surveys should be regularly checked and supervised. This method is simple and useful to
the producers who produce goods in bulk. Here, the burden of forecasting is put on
customers.
However, this method is not very useful in estimating the future demand of the households,
as they run in large numbers and do not express their future demand requirements, freely. It
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is expensive and difficult. Preparation of a questionnaire is not an easy task. At best, it can
be used for short term forecasting.
B) Direct interview method
Experience shows that due to varied reasons, many customers do not respond to
questionnaires addressed to them, even if it is simple. Hence, an alternative method is
developed. Under this method, customers are directly contacted and interviewed. Direct and
simple questions are asked to them. They are requested to answer specifically about their
budget, expenditure plans, particular items to be selected, the quality and quantity of
products, relative price preferences, etc. for a particular period of time. There are two
different methods of direct personal interviews. They are as follows:
i) Complete enumeration method
Under this method, all potential customers are interviewed in a particular city or a region.
The answers elicited are consolidated and carefully studied to obtain the most probable
demand for a product. The management can safely project the future demand for its
products. This method is free from all types of prejudices. The result mainly depends on the
nature of questions asked and answers received from the customers.
However, this method cannot be used successfully by all sellers in all cases. This method
can be employed to only those products whose customers are concentrated in a small
region or locality. In case consumers are widely dispersed, this method may not be
physically adopted or prove costly both in terms of time and money. Hence, this method is
highly cumbersome in nature.
ii) Sample survey method or the consumer panel method
Experience of the experts show that it is impossible to approach all customers therefore,
careful sampling of representative customers is essential. Hence, another variant of
complete enumeration method has been developed, which is popularly known as sample
survey method.
Under this method, different cross sections of customers that make up the bulk of the market
are carefully chosen. Only such consumers, who are selected from the relevant market
through some sampling method, are interviewed or surveyed. In other words, a group of
consumers are chosen and queried about their preferences in concrete situations. The
selection of a few customers is known as sampling. The selected consumers form a panel.
This method uses either random sampling or the stratified sampling technique. The method
of survey may be direct interview or mailed questionnaire to the selected consumers. On the
basis of the views expressed by these selected consumers, the most likely demand may be
estimated. The advantage of a panel lies in the fact that the same panel is continued and a
new expensive panel does not have to be formulated, every time a new product is
investigated.
As compared to the complete enumeration method, the sample survey method is less
tedious, less expensive, much simpler and less time consuming. This method is generally
used to estimate short run demand by government departments and business firms.
Success of this method depends upon the sincere co-operation of the selected customers.
Hence, selection of suitable consumers for the specific purpose is of great importance.
Even with careful selection of customers and the truthful information about their buying
intention, the results of the survey can only be of limited use. A sudden change in price,
inconsistency in buying intentions of consumers, number of sensible questions asked and

dropouts from the panel for various reasons put a serious limitation on the practical
usefulness of the panel method.

Question 3 - A cost-schedule is a statement of variations in costs resulting from

variations in the levels of Output and it shows the response of costs to changes in
output. If we represent the relationship between changes in the level of output and
costs of production, we get different types of cost curves in the short run. Define
the kinds of cost concepts like TFC, TVC, TC, AFC, AVC, AC and MC and its
corresponding curves with suitable diagrams for each.
Answer: In order to study the relationship between the level of output and corresponding
cost of production, we have to prepare the cost schedule of the firm. A cost-schedule is a
statement of variations in costs resulting from variations in the levels of output. It shows the
response of costs to changes in output.
On the basis of the cost schedule, we can analyze the relationship between changes in the
level of output and costs of production. If we represent the relationship between the two in a
graphical manner, we get different types of cost curves in the short run.
In the short run, we will study the following kinds of cost concepts and cost curves.
Total fixed cost (TFC)
TFC refers to total money expenses incurred on fixed inputs like plant, machinery, tools and
equipments in the short run. Total fixed cost corresponds to the fixed inputs in the short run
production function. TFC remains the same at all levels of output in the short run. It is the
same even when output is nil. It indicates that whatever may be the quantity of output,
whether 1 to 6 units, TFC remains constant.

Total Variable Cost (TVC)

TVC refers to total money expenses incurred on the variable factor inputs like raw materials,
power, fuel, water, transport and communication, etc., in the short run. Total variable cost
corresponds to variable inputs in the short run production function. It is obtained by summing
up the quantities of variable inputs multiplied by their prices. The formula to calculate TVC is
as follows. TVC = TC - TFC. TVC = f (Q), i.e., TVC is an increasing function of output. In
other words TVC varies with output. It is nil, if there is no production. Thus, it is a direct cost
of output.

Total cost (TC)

Total cost refers to the aggregate money expenditure incurred by a firm to produce a given
quantity of output. The total cost is measured in relation to the production function by
multiplying the factor quantities with their prices. TC = f (Q) which means that TC varies with
output. Theoretically speaking, TC includes all kinds of money costs, both explicit and
implicit cost. Normal profit is included in the total cost as it is an implicit cost. It includes fixed
as well as variable costs. Hence, TC = TFC +TVC.

Average fixed cost (AFC)

Average fixed cost is the fixed cost per unit of output. When TFC is divided by total units of
output, AFC is obtained, Thus, AFC = TFC/Q. AFC and output have inverse relationship. It is
higher at smaller levels and lower at higher levels of output in a given plant. The reason is
simple to understand. Since AFC = TFC/Q, it is a pure mathematical result that the
numerator remaining unchanged, the increasing denominator causes diminishing cost.
Hence, with the increase in output, TFC spreads over each unit of output. Consequently,
AFC diminishes continuously. This relationship between output and fixed cost is universal for
all types of business concerns.

.
Average variable cost (AVC)
The average variable cost is variable cost per unit of output. AVC can be computed by
dividing the TVC by total units of output. Thus, AVC = TVC/Q. The AVC will come down in
the beginning and then rise as more units of output are produced with a given plant. This is
because, as we add more units of variable factors in a fixed plant, the efficiency of the inputs
first increases and then decreases.
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Average total cost (ATC) or average cost (AC)

AC refers to cost per unit of output. AC is also known as the unit cost since it is the cost per
unit of output produced. AC is the sum of AFC and AVC. Average total cost or average cost
is obtained by dividing the total cost by total output produced. AC = TC/Q. Also, AC is the
sum of AFC and AVC.
In the short run, AC curve also tends to be U-shaped. The combined influence of AFC and
AVC curves will shape the nature of AC curve.

Marginal cost (MC)

Marginal Cost may be defined as the net addition to the total cost as one more unit of output
is produced. In other words, it implies additional cost incurred to produce an additional unit.
For example, if it costs Rs. 100 to produce 50 units of a commodity and Rs. 105 to produce
51 units, then MC would be Rs. 5. It is obtained by calculating the change in total costs as a
result of a change in the total output. Also, MC is the rate at which total cost changes with
output. Hence, MC = TC / TQ. Where, TC stands for change in total cost and TQ
stands for change in total output. Also MCn = TCn TC n-1

Question 4 Inflation is a global phenomenon which is associated with high price

decline in the value of money. It exists when the amount of money in the country
is in excess of physical volume of goods and services. Explain the reasons of this
monetary phenomenon.
Answer: Inflation is commonly understood as a situation of substantial and rapid increase in
the level of prices and consequent deterioration in the value of money over a period of time.
It refers to the average rise in the general level of prices and fall in the value of money.
Inflation is an upward movement in the average level of prices. The opposite of inflation is
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deflation, a downward movement in the average level of prices. The common feature of
inflation is rise in prices and the degree of inflation may be measured by price indices.
Inflation is statistically measured in terms of percentage increase in the price index,
as a rate (percent) per unit of time- usually a year or a month. The trend of price indices
reveals the course of inflation in the economy. Usually, the Wholesale Price Index (WPI)
numbers are used to measure inflation. Alternatively, the Consumer Price Index (CPI) or
the cost of living index can be adopted to measure the rate of inflation. In order to
measure the percentage rate of inflation, the following formula can be used:
Percentage rate of inflation, P[t] = (Change in price [t] / P [t] P [t-1]) x 100
.
Change in price [t] = P[t] P[t-1]
Here, P = price level
[t], [t-1] = periods of calendar time in which the observations are made.
Most of the economists considered inflation as a purely monetary phenomenon. According
to this approach, it is the increase in the quantity of money which causes an inflationary rise
in the price level. An expansion in money supply unaccompanied by an expansion in the
supply of goods and services inevitably results in price rise. Inflation exists when the amount
of money in the country is in excess of the physical volume of goods and services. It is a
situation where too much of money chases too few goods. Money supply and rising price
level are both causes and effects by themselves.
Causes of inflation
I. Demand side
Increase in aggregative effective demand is responsible for inflation. In this case, aggregate
demand exceeds aggregate supply of goods and services.
Demand rises much faster than supply. We can enumerate the following reasons for
increase in effective demand.

Increase in money supply

Increase in disposable income
Increase in private consumption expenditure and investment expenditure
Increase in exports
Increase in foreign exchange reserves
Existence of black money
Increase in population growth
High rates
Reduction in the rates of direct taxes
Reduction in the level of savings

II. Supply side

Generally, the supply of goods and services do not keep pace with the ever-increasing
demand for goods and services. Thus, supply does not match the demand. Supply falls short
of demand. Increase in supply of goods and services may be limited because of the
following reasons.

Shortage in the supply of factors of production

Operation of law of diminishing returns
Hoardings by traders and speculators
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Hoardings by consumers
Role of trade unions
Role of natural calamities
War
International factors
Increase in prices of inputs within the country

III. Role of expectations

Expectations also play a significant role in accentuating inflation. The following points are
worth mentioning:

If people expect further rise in price, the current aggregate demand increases, which
in turn causes a rise in the prices.

Expectations about higher wages and salaries affect the prices of related goods.

Expectations of wage increase often induce some business houses to increase

prices even before upward wage revisions are actually made.

Thus, many factors are responsible for escalation of prices.

Question 5 Describe the perfect competition and its features.

Answer: Perfect competition is a comprehensive term which includes pure competition too.
Before we discuss the details of perfect competition, it is necessary to have a clear idea
regarding the nature and characteristics of pure competition.
Pure Competition is a part of perfect competition. Competition in the market is said to be
pure when the following conditions are satisfied:

Prevalence of a large number of buyers and sellers.

The commodity supplied by each firm is homogeneous.

Free entry and exit of firms.

Absence of any kind of monopoly element.

Under these conditions, no individual producer is in a position to influence the market price
of the product. According to Prof. E.H. Chamberlin Under Pure Competition, as the
individual sellers market is completely merged with the general one, he can sell as
much as he pleases at the going price. Further, he remarks, Pure competition means
unalloyed by monopoly elements. It is a much simpler and less exclusive concept than
perfect competition.
Features of perfect competition
1. Existence of a large number of buyers and sellers
A perfectly competitive market will have large number of sellers and buyers. Output of a
seller (firm) will be so small that it is a negligible fraction of the output of the industry. Hence,
changes in supply made by a particular firm will not affect the total output and price.
Similarly, no single buyer can influence the price of the commodity because the quantity
purchased by him is a small fraction of the total quantity.
2. Homogenous products

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Different firms constituting the industry produce homogenous goods. They are identical in
character. Hence, no firm can raise its price above the general level.
3. Free entry and exit of firms
There is absolute freedom for firms to get in or get out of the industry. If the industry is
making profits, new firms are attracted into the industry. Conversely, firms will quit the
industry if there are losses. This results in the realization of normal profits by all the firms in
the long run.
4. Existence of single price
Each unit bought and sold in the market commands the same price since products are
homogeneous.
5. Perfect knowledge of the market
All sellers and buyers will have perfect knowledge of the market. Sellers cannot influence
buyers and, vice versa.
6. Perfect mobility of factors of production
Factors of production are free to move into any industry or occupation in order to earn higher
rewards. Similarly, they are also free to come out of the occupation or industry if they feel
that they are under remunerated.
7. Full and unrestricted competition
Perfectly competitive market is free from all sorts of monopoly and oligopoly conditions.
Since there are a large number of buyers and sellers, it is difficult for them to join together
and form cartels or form organizations. Hence, each firm acts independently.
8. Absence of transport cost
All firms will have equal access to the market. Market price charged by the sellers should not
vary because of the difference in the cost of transportation.
9. Absence of artificial government controls
The government should not interfere in matters pertaining to supply and price. It should not
place any barriers in the way of smooth exchange. Price of a commodity must be determined
only by the interaction of supply and demand forces.
10. The market price is flexible over a period of time
Market price changes only because of changes in either demand or supply force or both.
Thus, price is not affected by the sellers, buyers, firm, industry or the government.
11. Normal profit
As the market price is equal to the cost of production, firms in perfectly competitive markets
can earn only normal profits. Normal profits are those which are just sufficient to ensure the
firms stay in business. It is the minimum reasonable level of profit which the entrepreneur
must get in the long run. It is a part of the total cost of production because it is the price paid
for the services of the entrepreneur, i.e., profit is an item of expenditure for a firm.

Question 6 Define Revenue. Explain the types of revenue and the relationship
between TR, AR and MR with an example of hypothetical revenue schedule.
Answer: Revenue means the sale receipts of the output produced by the firm. It depends
on the market price. The amount of money, which the firm receives by the sale of its output
in the market, is known as its revenue.

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There are three concepts of revenue Total Revenue, Average Revenue and Marginal
Revenue.
Total Revenue (TR)
Total revenue refers to the total amount of money that the firm receives from the sale of its
products, i.e. .gross revenue. In other words, it is the total sales receipts earned from the
sale of its total output produced over a given period of time. We may show total revenue as a
function of the total quantity sold at a given price.
Average revenue (AR)
Average revenue is the revenue per unit of the commodity sold. It can be obtained by
dividing the TR by the number of units sold. Then AR = TR/Q, e.g. If TR is 150 by selling 10
units, AR = 150/15= 10.
Thus, average revenue means price. Since the demand curve shows the relationship
between price and the quantity demanded, it also represents the average revenue or price at
which the various amounts of a commodity are sold, because the price offered by the buyer
is the revenue from the sellers point of view. Therefore, average revenue curve of the firm is
the same as demand curve of the consumer.
Therefore, in economics, we use AR and price as synonymous except in the context of price
discrimination by the seller. Mathematically, P = AR.
Marginal Revenue (MR)
Marginal revenue is the net increase in total revenue realized from selling one more unit of a
product. It is the additional revenue earned by selling an additional unit of output by the
seller. Marginal revenue can also be directly calculated by finding out the difference between
the total revenue before and after selling the additional unit of the product.
Relationship between total revenue, average revenue and marginal revenue concepts
In order to understand the relationship between TR, AR and MR, we can prepare a
hypothetical revenue schedule. Table 8.2 represents a hypothetical revenue schedule that
shows the relationship between TR, AR and MR.

From the table, it is clear that:

1. MR falls as more units are sold.
2. TR increases as more units are sold but at a diminishing rate.
3. TR is the highest when MR is zero.
4. TR falls when MR becomes negative.
5. AR and MR both fall, but fall in MR is greater than AR i.e., MR falls more steeply than AR.
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** THE END **

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