Managerial Economics (MB0042) Q.1 Income elasticity of demand has various applications.

Explain each application with the help of an example. Ans- 1. Helps in determining the rate of growth of the firm. If the growth rate of the economy and income growth of the people is reasonably forecasted, in that case it is possible to predict expected increase in the sales of a firm and vice-versa. 2. Helps in the demand forecasting of a firm. It can be used in estimating future demand provided the rate of increase in income and Ey for the products are known. Thus, it helps in demand forecasting activities of a firm. 3. Helps in production planning and marketing The knowledge of Ey is essential for production planning, formulating marketing strategy, deciding advertising expenditure and nature of distribution channel etc in the long run. 4. Helps in ensuring stability in production Proper estimation of different degrees of income elasticity of demand for different types of products helps in avoiding over-production or under production of a firm. One should also know whether rise or fall in income is permanent or temporary. 5. Helps in estimating construction of houses The rate of growth in incomes of the people also helps in housing programs in a country. Thus, it helps a lot in managerial decisions of a firm. Q.2 When is the opinion survey method used and what is the effectiveness of the method. Ans--- Collective opinion method or opinion survey method This is a variant of the survey method. This method is also known as Sales force polling or Opinion poll method. Under this method, sales representatives, professional experts and the market consultants and others are asked to express their considered opinions about the volume of sales expected in the future. The logic and reasoning behind the method is that these salesmen and other people connected with the sales department are directly involved in the marketing and selling of the products in different regions. Salesmen, being very close to the customers, will be in a position to know and feel the customers reactions towards the product. They can study the pulse of the people and identify the specific views of the customers. These people are quite capable of estimating the likely demand for the products with the help of their intimate and friendly contact with the customers and their personal judgments based on the past experience. Thus, they provide approximate, if not accurate estimates. Then, the views of all salesmen are aggregated to get the overall probable demand for a product. Further, these opinions or estimates collected from the various experts are considered, consolidated and reviewed by the top executives to eliminate the bias or optimism and pessimism of different salesmen. These revised estimates are further examined in the light of
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factors like proposed change in selling prices, product designs and advertisement programs, expected changes in the degree of competition, income distribution, population etc. The final sales forecast would emerge after these factors have been taken into account. This method heavily depends on the collective wisdom of salesmen, departmental heads and the top executives. It is simple, less expensive and useful for short run forecasting particularly in case of new products. The main drawback is that it is subjective and depends on the intelligence and awareness of the salesmen. It cannot be relied upon for long term business planning. Q.3 Show how price is determined by the forces of demand and supply, by using forces of equilibrium. Ans-- price is determined in the industry through the interaction of the forces of demand and supply. This price is given to the firm. Hence, the firm is a price taker and not price maker. On the basis of this price, a firm adjusts its output depending on the cost conditions. An industry under perfect competition in the short run, reaches the position of equilibrium when the following conditions are fulfilled: 1. There is no scope for either expansion or contraction of the output in the entire industry. This is possible when all firms in the industry are producing an equilibrium level of output at which MR = MC. In brief, the total output remains constant in the short run at the equilibrium point. Thus a firm in the short run has only temporary equilibrium. 2. There is no scope for the new firms to enter the industry or existing firms to leave the industry. 3. Short run demand should be equal to short run supply. The price so determined is called as subnormal price. Normal price is determined only in the long run. Hence, short run price is not a stable price. Equilibrium of the competitive firm in the short run A competitive firm will reach equilibrium position at the point where short run MR equals MC. At this point equilibrium output and price is determined. The firm in the short run will have only temporary equilibrium. The short run equilibrium price is not a stable price. It is also called as sub normal price.

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The competitive firm, in the short run, will not be in a position to cover its fixed costs. But it must recover short run variable costs for its survival and to continue in the industry. A firm will not produce any output unless the price is at least equal to the minimum AVC. If short run price is just equal to AVC, it will not cover fixed costs and hence, there will be losses. But it will continue in the industry with the hope that it will recover the fixed costs in the future.

If price is above the AVC and below the AC, it is called as Loss minimization zone. If the price is lower than AVC, the firm is compelled to stop production altogether. While analyzing short term equilibrium output and price, apart from making reference to SMC and AVC, we have to look into AC also. If AC = price, there will be normal profits. If AC is greater than price, there will be losses and if AC is lower than price, then there will be super normal profits. In the short run, a competitive firm can be in equilibrium at various points E1, E2 and E3 depending upon cost conditions and market price. At these various unstable equilibrium points, though MR = MC, the firm will be earning either super normal profits or incurring losses or earning normal profits. Q.4 Distinguish between fixed cost and variable cost using an example. Ans-- Fixed costs are those costs which do not vary with either expansion or contraction in output. They remain constant irrespective of the level of output. They are positive even if there is no production. They are also called as supplementary or over head costs. On the other hand, variable costs are those costs which directly and proportionately increase or decrease with the level of output produced. They are also called as prime costs or direct costs. Q.5 Discuss Marris Growth Maximization model and show how it is different from the Sales maximization model.
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Ans--Profit-maximization is a traditional objective of a firm. Sales maximization objective is explained by Prof. Boumal. On similar lines, Prof. Marris has developed another alternative growth maximization model in recent years. It is a common factor to observe that each firm aims at maximizing its growth rate as this goal would answer many of the objectives of a firm. Marris points 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 of people, ie, owners and managers. He further points out that both of them have two distinctive goals. 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 are more concerned about the size of output, volume of profits, market share and sales maximization 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 the firm according to Marris depends on the amount of corporate capital which includes total volume of assets, inventory levels, cash reserves etc. He further points out that the managers always aim 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 Q.6 Explain how fiscal policy is used to achieve economic stability. Ans-- Fiscal policy is an important part of the overall economic policy of a nation. It is being increasingly used in modern times to achieve economic stability and growth throughout the world. Lord Keynes for the first time emphasized the significance of fiscal policy as an instrument of economic control. It exerts deep impact on the level of economic activity of a nation. Meaning The term fisc in English language means treasury, and as such, policy related to treasury or government exchequer is known as fiscal policy. Fiscal policy is a package of economic measures of the government regarding its public expenditure, public revenue, public debt or public borrowings. It concerns itself with the aggregate effects of government expenditure and taxation on income, production and employment. In short it refers to the budgetary policy of the government. Definitions 1. In the words of Ursula Hicks, Fiscal policy is concerned with the manner in which all the different elements of public finance, while still primarily concerned with carrying out their own duties [as the first duty of a tax is to raise revenue] may collectively be geared to forward the aims of economic policy.
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2. Gardner Ackley points out, Fiscal policy involves alterations in government expenditures for goods and services or the level of tax rates. Unlike monetary policy, these measures involve direct government interference in to the market for goods and services [in case of public expenditure] and direct impact on private demand [in case of taxes]. Instruments of Fiscal Policy 1. Public Revenue: It refers to the income or receipts of public authorities. It is classified into two parts Tax-revenue and non-tax revenue. Taxes are the main source of revenue to a government. There are two types of taxes. They are direct taxes like personal and corporate income tax, property tax and expenditure tax etc and indirect taxes like customs duties, excise duties, sales tax now called VAT etc. Administrative revenues are the bi-products of administrate functions of the government. They include Fees, license fees, price of public goods and services, fines, escheats, special assessment etc. 2. Public expenditure policy: It refers to the expenditure incurred by the public authorities like central, state and local governments. It is of two kinds, development or plan expenditure and non-development or non-plan expenditure. Plan expenditure include income-generating projects like development of basic industries, generation of electricity, development of transport and communications, construction of dams etc Non-plan expenditure include defense expenditure, subsidies, interest payments and debt servicing changes etc. 3. Public debt or public borrowing policy: All loans taken by the government constitutes public debt. It refers to the borrowings made by the government to meet the ever-rising expenditure. It is of two types, internal borrowings and external borrowings. 4. Deficit financing: It is an extraordinary technique of financing the deficits in the budgets. It implies printing of fresh and new currency notes by the government by running down the cash balances with the central bank. The amount of new money printed by the government depends on the absorption capacity of the economy. 5. Built in stabilizers or automatic stabilizers: [BIS] The automatic or built in stabilizers imply, automatic changes in tax collections and transfer payments or public expenditure programmes so that it may reduce destabilizing effect on aggregate effective demand. When income expands, automatic increase in taxes or reduction in transfer payments or government expenditures will tend to moderate the rise in income. On the contrary, when the income declines, tax falls automatically and transfers and government expenditure will rise and thus built in stabilisers cushions the fall in income. Fiscal tools: Subsidies, development rebates, tax reliefs, tax concessions, tax exemptions, and tax holidays, freight concessions, relief expenditures, debt reliefs, transfer payments, public works programmes etc. are some of the main tools of the fiscal policy. Keynes insisted that public finance should be adjusted to the changing conditions of the economy, to fight inflationary pressures and deflationary tendencies. The role of fiscal policy can be compared to the driving of a car. While driving up a gradient (i.e., stepping up production and productivity), what is needed is an increase in power (promotion of higher savings and investment through fiscal measures).On the other hand, when it moves against the national interest, it is necessary to control the supply of power (to combat inflationary and
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foreign exchange crisis through higher taxation) and also to apply brakes judiciously to ensure that the vehicle does not slip out of control but keeps on moving all the same. The national exchequer should see that the brakes are not pressed so much as to bring the vehicle to a stop. In short, it is the function of public finance to make economy grow; maintain it in good health and to protect it from internal and external dangers.

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