ASSIGNMENTS - MBA - I SEMESTER

MB0026

SET 1

Managerial Economics

Q1. The demand function of a good is as follows:

Q1=100-6P1-4P2+2P3+0.003Y
WHERE P1 and Q1 are the price and quantity values of good 1
P2 and P3 are the prices of good 2 and good 3 and Y is the income of
the consumer. The initial values are given:
P1 =7
P2 =15
P3 =4
Y=8000
Q1 =30
You are required to:
Using the concept of cross elasticity determine the relationship between
good 1 and others
Determine the effect on Q1 due to a 10 % increase in the price of good 2
and good

Answer: Cross elasticity can be defined as the proportionate change in the quantity
demanded of a particular commodity in response to a change in the price of another
related commodity.

a) Cross elasticity between good 1 and product 2 = (dQ1/dP2)*(P2/Q1)

Cross elasticity between good 1 and product 3 = (dQ1/dP3)*(P3/Q1)

Taking the differentiation of the equation:

dQ1/dP2 = -4
dQ1/dP3 = 2

Putting the values in the elasticity equation:

Cross elasticity between good 1 and product 2 = (dQ1/dP2)*(P2/Q1)

= (-4) * (P2/Q1)
= (-4) * (15/30)
= -2

Cross elasticity between good 1 and product 3 = (dQ1/dP3)*(P3/Q)

= (2) * (P3/Q1)
= (2) * (4/30)
= 0.267
b) As per the cross elasticity equation:

E = % Change in demand of product A / % Change in price of product B

% Change in demand of product A = E * % Change in price of product B

Putting the values from

% Change in demand of product A due to 10 % increase of good 2 = -2 * 10
= -20%
% Change in demand of product A due to 10 % increase of good 3 = 0.267 * 10 =
2.67%
Q2. What are the factors that determine the Demand curve? Explain.

Answer: A demand curve is a locus of points showing various alternative prices –

quantity combinations. The total quantity demanded at different prices in a market by
the whole body consumers at a particular period of time is called market demand
schedule. The graphical presentation of the demand schedule is called as a demand
curve.
It represents the functional relationship between quantity 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 the quantity
demanded goes on increasing as price falls and vice versa.
Law of demand: “Other things being equal, a fall in price leads to expansion in
demand and a rise in price leads to contraction in demand”.

The factors that determine the Demand curve are as follows:-

a) Price of the given commodity, prices of other substitutes and complements,
future expected trends in price etc.
b) General Price level existing in the country -inflation or deflation.
c) Level of income and living standards of the people.
d) Size, rate of growth and composition of population.
e) Tastes, preferences, customs, habits, fashion and styles.
f) Publicity, propaganda and advertisements.
g) Quality of the product.
h) Profit margin kept by the sellers.
i) Weather and climatic conditions.
j) Conditions of trade-boom or prosperity in the economy.
k) Terms and conditions of trade.
l) Governments’ taxation policy, liberal or restrictive measures.
m) Level of savings and pattern of consumer expenditure.
n) Total supply of money circulation and liquidity preference of the people.
o) Improvements in educational standards.

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?

Answer:

Price elasticity of demand is a ratio of two pure numbers, the numerator is the
percentage change in the quantity demanded and the denominator is the percentage
change in price of the commodity. It is measured by the following formula:

Ep = Percentage change in quantity demanded/ Percentage changed in price

Applying the provided data in the equation:
Percentage change in quantity demanded = (5000 – 3000)/3000
Percentage changed in price = (22 – 10) / 10

Ep = ((5000 – 3000)/3000) / ((22 – 10)/10) = 1.2

Q4. Briefly explain the profit-maximization model?

Answer: Profit- making is one of the 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 measure of success or failure of a firm in the market.

Profit-maximization implies earning highest possible amount of profits during the given
time. A firm has to generate largest amount of profits by building optimum productive
capacity both in the short run and long run depending upon various internal and external
factors and forces. There should be proper balance between short run and long run
objectives. In the short run a firm is able to make only slight or minor adjustments in
the production process as well as in business conditions. The plant capacity in the short
run is fixed and as such, it can increase its production and sales by intensive utilization
of existing plants and machineries, having over time work for existing staff etc. Thus, in
the short run, a firm has its own technical and managerial constraints. But in the long
run, as there is plenty of time at the disposal of a firm, it can expand and add to the
existing capacities build up new plants; employ additional workers etc to meet the rising
demand in the market. Thus, in the long run, a firm will have adequate time and ample
opportunity to make all kinds of adjustments and readjustments in production process
and in its marketing strategies.

There are various factors that contribute to the maximization of profits of a

firm. Some of them are listed below:-

Pricing and business strategies of rival firms and its impact on the working of the given
firm.
Aggressive sales promotion policies adopted by rival firms in the market.
Without inducing the workers to demand higher wages and salaries leading to rise in
operation costs.
Without resorting to monopolistic and exploitative practices inviting government controls
and takeovers.
Maintaining the quality of the product and services to the customers.
Taking various kinds of risks and uncertainties in the changing business environment.
Adopting a stable business policy.
Avoiding any sort of clash between short run and long run profits in the business policy
and maintaining proper balance between them.
Maintaining its reputation, name, fame and image in the market.
Profit maximization is necessary in both perfect and imperfect markets. In a perfect
market, a firm is a price-taker and under imperfect market it becomes a price-searcher.

Assumptions of the model:-

The profit maximization model is based on three important assumptions. They are as
follows:-

Profit maximization is the main goal of the firm.

Rational behaviour on the part of the firm to achieve its goal of profit maximization.
The firm is managed by owner-entrepreneur

Q5. What is Cyert and March’s behaviour theory? What are the demerits?

Answer: - Cyert and March’s behaviour makes an attempt to explain the behaviour of
inter group conflicts and their multiple objectives in an organization. Basically, this
theory explains the usual and normal behaviour of different groups of people who work
in an organization having mutually opposite goals.
Cyert and March explain how complicated decisions are taken in big industrial houses
under various kinds of risks and uncertainties in an imperfect market in the background
of limited data and information. The organizational structure, goals of different
departments, behavioural pattern and internal working of a big and multi-product firm
differs from that of small organizations. The various kinds of internal conflicts and
problems faced by these organizations. They also explain how there are certain common
problems faced by similar organizations in an industry and their effects on internal
working of each individual organization and their decision making process.

Cyert and March consider that a modern firm is a multi-product, multi-goal and multi-
Decision making coalition business unit. Like a coalition government, it is managed by a
number of groups. The group consists of share holders, managers, workers, customers,
suppliers, distributors, financiers, legal experts and so on. Each group is independent by
itself and has its own set of objectives and they try to maximize their individual benefits.
Cyert and March points out the goals of a business organization would depend upon the
multiple objectives of each group and their collective demands. Demands of each group
would depend on their aspirations levels, expectations, actual performance of the
organization, bargaining power of each group, past success in their demands, etc.

As all of them change over a period of time, the demands of each group would all of
them change over a period of time, the demands of each group would also undergo
changes. If actual performance and achievements of the organization is much better
than expected aspirations and target level, in that case, there will upward revision in
their demands and vice-versa.

Thus, there is a strong linkage between the expected and actual demand of each group
in the organization, past success and future environment. Each group makes an attempt
to achieve its demand in its own way.

Cyert and March are of the opinion that out of several objectives a firm has five
important goals. They are:-

Production goal: Production is to be organized on the basis of demand in the market.

Neither there should be over production nor under production but just that much to meet
the required demand in the market, avoid excess capacity, over utilization of capital
assets, lay-off of workers etc.

Inventory goal: Inventory refers to stock of various inputs. In order to ensure

continuity in production and supply, certain minimum level of inventory has to be
maintained by a firm. Neither there should be surplus stock or shortage of different
inputs. Proper balance between demand and supply should be maintained.

Sales goal: There should be adequate sales in any organization to earn reasonable
amounts of profits. In order to create demand, sales promotion policies may be adopted
from time to time.

Market-share goal: Each firm has to make consistent effort to increase its market
share to compete successfully with other firms and make sufficient profits.

Profit goal: This is one of the basic objectives of any firm. The very survival and
success of the firm would depend upon the volume of profits earned by it.

The above mentioned objectives also would undergo changes over a period of time in the
background of modern business environment. Hence, decision making would become
complex and complicated.
The demerits are as follows:-

The theory fails to analyze the behaviour of the firm but it simply predicts the future
expected behaviour of different groups.
It does not explain equilibrium of the industry as a whole.
It fails to analyze the impact of the potential entry of the new firms into the industry and
the behaviour of the well established firms in the market.
It highlights only on short run goals rather than long run objectives of an organization.
Thus, there are certain limitations to this theory.

Q6. What is Boumal’s Static and Dynamic?

Answer: - 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. Maximization of sales does not mean maximization of
physical sales but maximization of total sales revenue. Hence, the managers are more
interested in increasing the sales rather than profit. The basic philosophy is that when
sales are maximized automatically profits of the company would also go up.

Prof. Boumal has developed two models. The first is static model and the second one is
the dynamic model.

The Static model:-

The model is based on the following assumptions.

The model is applicable to a particular time period and the model does not operate at
different periods of time.
The firm aims at maximizing its sales revenue subject to a minimum profit constraint.
The demand curve of the firm slope downwards from left to right.
The average cost curve of the firm is U-shaped one.

Sales Maximization (dynamic model):-

Many changes take place which affects business decisions of a firm. In order to include
such changes, Boumal developed 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.

This model is based on certain assumptions. They are as follows:-

Higher advertisement expenditure would certainly increase sales revenue of a firm.

Market price remains constant.
Demand and cost curves of the firm are conventional in nature.

Under competitive conditions, a firm in order to increase its volume of sales and sales
revenue would go for aggressive advertisements. This leads to a shift in the demand
curve to the right. Forward shift in demand curve implies increased advertisement
expenditure resulting in higher sales and sales revenue. A price cut may increase sales in
general. But increase in sales mainly depends on whether the demand for a product is
elastic or inelastic. A price reduction policy may increase its sales only when the demand
is elastic and if the demand is inelastic; such a policy would have adverse effects on
sales.
Hence, to promote sales, advertisements become an effective instrument today. It is the
experience of most of the firms that with an increase in advertisement expenditure,
sales of the company would also go up. A sales maximize would generally incur higher
amounts of advertisement expenditure than a profit maximize. However, it is to be
remembered that amount allotted for sales promotion should bring more than
proportionate increase in sales and total profits of a firm. Otherwise, it will have a
negative effect on business decisions.

By introducing, a non-price variable into this model, Boumal makes a successful attempt
to analyze the behaviour of a competitive firm under oligopoly market conditions. Under
oligopoly conditions as there are only a few big firms competing with each other either
producing similar or differentiated products, would resort to heavy advertisements as an
effective means to increase their sales and sales revenue.
 ASSIGNMENTS - MBA - I SEMESTER

MB0026

SET 2

Managerial Economics

Q.7 What is pricing policy? What are the internal and external factors of the
policy?
Ans: Pricing Policies:
Pricing Policies refer to the policy of setting the price of the
product or product & services by the management after taking into account of various
internal and external factors, forces and its own business objectives. The decision of
pricing is very important in any business. Price once fixed is never permanent. It needs
to be reviewed and revised according to the market conditions.
Internal factors which can affect the pricing decisions of the company include suppliers,
employee’s efficiency, profit margin, production cost and other expenses, brand image
and expectations of the company. Suppliers provide the raw materials to the company
and good relations with suppliers can make the company to buy quality products at
reasonable prices. Employees' efficiency can also reduce the costs of the company and
company can charge lower prices. Product cost also determines the prices of the
products because all of the companies have to cover up the product costs. Moreover,
image of the company also plays an important role in the price decisions of the company
because a global brand will usually charge premium prices. On the other hand, the
external factors include government policies, competitors' prices, costs of raw materials,
consumer’s expectations and demand and supply of the product. Government sets the
price floors to save the interest of the borrowers and the sellers, therefore, government
policies should be also take into consideration. Expectations of the consumers or
consumer reservation prices are also considered in the price decisions. Costs of raw
materials in the market also determine the pricing strategies. Moreover, the prices
offered by the competitors can also impact the pricing decisions of the company.

Q.8 Mention three crucial objectives of price policies.

Ans:
Price policy has certain objectives:-

1. To maximize profits: - Every firm tries to maximize their profits. So they should have
a price policy, which fetches them maximum revenue. Every firm should have a price
policy keeping the long run prospects in mind.

2. Price Stability: - Always fluctuating price is not for the goodwill of the company. A
stable price always wins the confidence of customers.
3. Ability to pay: - The price should be fixed according to the ability of consumer to pay;
high price for rich customers and low for poor customers. This can be applied in case of
services given by doctors, lawyers etc.

Q.9 Mention the bases of price discrimination.

Ans: PRICE DISCRIMINATION:
The monopoly seller has the advantage of price
discrimination, as he is the only producer in the market. Price discrimination is charging
different price to different buyer for the same product.
DEGREES OF PRICE DISCRIMINATION:

1. First degree price discrimination: It is also called perfect price discrimination, as

it involves maximum exploitation of the consumer in the interest of the seller. It happens
when the seller is able to sell each unit separately and at a different price. Each buyer is
made to pay the amount he is willing to pay rather going without it. The seller will make
different bargain with each buyer. Such type of price discrimination enjoyed by the seller
is called first degree price discrimination.

2. Second degree price discrimination:

It happens when the monopoly seller will
charge separate price in such a way that the buyer is divided into different groups
according to the price elasticity of demand for his product.

3. Third degree price discrimination:

When the seller will be divided into sub-
market and charge different price depending on the output sold in the market and the
demand condition of that sub-market. The seller practicing price discrimination between
the domestic market and international market, the seller will charge higher price in the
domestic market, where he enjoys monopoly and charge low price in the international
market, where he has to face more competition.

Q.10 What do you mean by the fiscal policy? What are the instruments of fiscal
policy? Briefly comment on India’s fiscal policy.
Ans: Fiscal policy is a policy, which affects aggregate output, employment, saving,
investment etc. A responsible government would contain its expenditure within its
revenue and thus making the budget balanced. The instruments of Fiscal Policy are
Automatic Stabilizer and Discretionary Fiscal Policy:
i) Automatic Stabilizer:
The tax structure and expenditure are programmed in such a
way that there is increase in expenditure and decrease in tax in recession and decrease
in expenditure and increase in tax revenue in the period of inflation. It refers to built-in
response to the economic condition without any deliberate action on the part of
government. It is called built- in- stabilizer to correct and thus restore economic
stability. It works in the following manner,

Tax revenue:
Tax revenue increases when the income increases; as those who were
not paying tax go into the higher income tax bracket. When there is depression, the
income decreases and many people fall in the no-income-tax bracket and the tax
revenue decreases.

ii) Discretionary Fiscal Policy:

Under this, to stabilize the economy, deliberate
attempts are made by the government in taxation and expenditure. It entails definite
and conscious actions.

Instruments of Fiscal Policy: Some important instruments of fiscal policy are:-

1. TAXATION:
Taxation is always a very important source of revenue for both
developed and developing countries. Tax comes under two heading –Tax on individual
(direct tax) and tax on commodity (indirect tax or commodity tax).Direct tax includes
income tax, corporate tax, taxes on property and wealth. Indirect tax is tax on the
consumptions. It includes sales tax, excise duty and custom duties. Direct tax structure
can be divided into three bases-
1. Progressive tax
2. Regressive tax
3. Proportional tax

Progressive tax:
Progressive tax says that higher the level of income, greater the
volume of tax burden you have to bear. This means as income increases, the tax
contribution should also increase. Low income group people pay low tax, whereas the
high income group people pay higher tax.

Regressive tax:
It is theoretically possible, though no government implements such
tax structure, because that leads to unequal distribution of income. As your income
increases the contribution through tax decreases. Low income people will pay more and
high income people will pay less.

Proportional tax:
When the tax imposed is irrespective of the income you earn, every
income group, high or low pay the same amount of tax.

2. INDIRECT TAX OR CONSUMPTION TAX:

Indirect tax differs from direct tax. Tax
which is imposed on every unit of product is known as lump sum tax. E.g. excise tax and
sales tax. Taxes depending on the value of particular product are called ‘ad valorem tax’
e.g. tax on airline tickets.
A good tax structure has to control and bring stability in economic system. There are few
requirement of a good tax structure. They are –
The revenue earned through tax structure should be adequate.
The distribution of tax burden should be equal.
Administration cost should not be more than revenue earned.
Tax burden should be borne by the person who is taxed.

Q.11 Comment on the consequences of environmental degradation on the

economy of a community.
Ans: Environmental Degradation:
For sustainable economic growth, the
environment should be properly preserved and improved. The stocks may remain
constant or it can even rise but the environment resources are the base of the country
and the quality of air, water and land represents the heritage of a nation. The
environment damages in the developing countries are the main concern nowadays.
Environmental damages can be in these categories-

Water pollution:
The water quality is continuously deteriorating due to contamination
from the industrial waste, by throwing out chemical waste and heavy metal in the river.
It is difficult to remove the pollutants from the water to make it good for drinking
purpose. The capacity of the water to preserve the aquatic life is becoming more and
more difficult. The underground water is also getting affected by the industrial waste, as
they sometimes get discharged directly into underground water.

Air pollution:
Air pollution can be contributed to the three man made sources,
industrial production, vehicles and the energy. Human suffering increases due to the air
pollution. Respiratory disorders and cancers are due to inhalation of polluted air. The
vehicle increases the sulphur dioxide concentration in the air creating breathing
problems for the children and affects their neurological developments.
Deforestation:
 Forest is the most important source to protect environment. They
protect soil erosion and regulate the ecological balance of the nature. They i affect the
nature and the climatic condition of the region. The blind increase in the industrial
growth is leading to cutting down of many forest leading to many serious problems for
the human being.

Q.12 Write short notes on the following:

a) Philips curve
Ans: Philips Curve describes the relationship between inflation and unemployment
in an economy.
New Zealand-born economist A.W Philips first put this theory forward in 1958 gathered
the data of unemployment and changes in wage levels in the UK from 1861 to 1957. He
observed that one stable curve represents the trade-off between inflation and
unemployment and they are inversely/negatively related. In other words, if
unemployment decreases, inflation will increase, and vice versa.

• For example, after the economy has just been in recession, the unemployment
level will be fairly high. This will mean that there is a labor surplus.

• As the economy has just started growing, the aggregate demand (AD) will
increase and therefore leading to an increase in employment. In the beginning,
there will be little pressure for a raise in wages. However, as the economy grows
faster and more people are employed, wages will start rising slowly.

B) Stagflation
Ans: Stagnation + Inflation = Stagflation
Stagnation = Slow or no growth. Inflation = Rises in price.
Stagflation is an economic trend in which inflation and unemployment rise while general
growth of the economy is slow. It can be difficult to correct stagflation, because focusing
on one aspect of the problem can exacerbate other aspects. Many governments try to
avoid stagflation through fiscal policy, by promoting even and healthy growth and
attempting to prevent inflation. If stagflation continues long enough, it will trigger an
economic recession and an ultimate self-correction.
Stagflation is when the economy experiences slow GDP growth (stagnation) with high
inflation and high level of unemployment. This occurred in the 1970's in many countries.
When the economy is working normally, slow economic growth reduces demand, which
keeps prices low, preventing inflation. Stagflation can only occur when fiscal or monetary
policy sustains high prices, and inflation, despite slow growth. Stabilization policies to
control stagflation.
1. The money supply should be tightened to check inflation.
2. We can control inflationary wage and price increases with direct controls. Government
can limit increases by law or constrain them through tax policies.
3. Protect people against the effects of inflation. All wages, including the minimum wage,
could be increased automatically when the Consumer Price Index increases. Government
bonds could pay a fixed real interest rate by adjusting the actual interest rate for
inflation.
Stagflation is difficult to control without government controls. Therefore, political will is
necessary for formulating the measures to stop stagflation.

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