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ADL-04 MANAGERIAL ECONOMICS

ASSIGNMENT 'A'
ASSIGNMENT 'B'
ASSIGNMENT 'C'

SUBMITTED BY:
SAHIL JASSAL
PEN:A1921210014(el)
BBA (JULY 2010-11)
 ASSIGNMENT 'A'
Q.1 How does economic theory contribute to managerial decisions?

Ans: Managerial Economics is the integration of economic theory with business practices for the
purpose of facilitating Decision Making and Forward Planning by the management.

As economics provides as a set of concepts, these concepts furnish us the tools and techniques of
analysis. It s in this content economic analysis is an aid to understand business practices in a given
environment.

As decision making is a basic function of manager, economics is a valuable guide to the manager.

Decision making is commonly defined a choosing from among alternatives. Decision is a choice
made from alternative courses of action in order to deal with a problem. A problem is the difference
between a desired situation and the actual situation. Therefore, decision making is the process of
choosing among alternative courses of action to solve a problem.

The Decision making process is construed as searching the environment for conditions calling for a
decision; inventing, developing and analyzing the available courses of action; and choosing one of
the particular courses of action.

A second and more detailed method is the following:

Identify the problem.

Diagnose the situation.
Collect and analyze data relevant to the issue.
Ascertain solution that may be used in solving the problem
Analyze these alternative solutions.
Select the approach that appears most likely to solve the problem
Implement it.

A practical example can be found in the following:

Managers make many decisions, in order to answer the following questions:

What goods shall firm produce?

How should firm raise the necessary capital and what shall be its legal form.
What technique shall be adopted, and what shall be the scale of operations?
Where production is located?
How shall its product be distributed?
How shall resources be combined?
What shall be the size of output?

Q.2 Explain the Law of Demand. Briefly discuss the exception to the Law of demand.

Ans: Demand can be said to be the requirement of a product by consumer (s). It is a multivariate
relationship, that is , it is determined by many factors simultaneously, Some of the most important
determinants of the market demand for a particular product are its own price, consumer's income,
price of other commodities, consumer's tastes, income distribution, total population, consumer's
wealth, credit availability, government policies, past level of demand and past level of income. The
traditional theory of demand depends on four of the above determinants that are the price of the
commodity, other prices, income and tastes,
Demand for a commodity implies:

1. Desire to acquire it,

2. Willingness to pay for it
3. Ability to pay for it

Thus the demand for any commodity is the desire for that commodity backed by the willingness as
well as the ability to pay for it and is always defined with reference to a particular time and given
values of variables on which it depends.

Demands for a commodity can be grouped into various categories for better understanding of its
characteristics. The main categories may be:

A. Demand for consumer goods and producers goods

B. Demand for perishable and durable goods
C. Derived and autonomous demand
D. Firm and Industry demand
E. Demand by total market and industry segments

LAW OF DEMAND

A microeconomic law that states that, all other factors being equal, as the price of a good or service
increases, consumer demand for the good or service will decrease and vice versa.

This law summarizes the effect price changes have on consumer behavior. For example, a consumer
will purchase more pizzas if the price of pizza falls. The opposite is true if the price of pizza
increases.
Q.3 Explain the various components of demand function.

Ans: In economics, aggregate demand is the total demand for goods and services in the economy
(Y) during a specific time period. An aggregate demand curve is the sum of individual demand
curves. The aggregate demand function is represented as :
Yd= C+I+G+Nb.
This function shows that the aggregate demand equal to the sum of consumption (C),
Investment (I), Government spending (G) and the Net export (Nb). In fact, many people would ask
about the relationship between output and the price level. Does changing prices affect the output?
The answer is yes, but many economics books assume that the price level is constant, just to keep
the relationships between the economic factors simple. It is often called effective demand. Put
another way, it is the demand for the gross domestic product of a country when, and only when, it is
in equilibrium (the total new production sold through the market). This demand consists of four
major parts, which can be stated in either nominal or "real" terms:

personal consumption expenditures (C) or "consumption," demand by households and unattached

individuals; its determination is described by the consumption function. The consumption function
is
C= a + (mpc)(Y-T)
a is autonomous consumption, mpc is the marginal propensity to consume, (Y-T) is the disposable
income. Gross private domestic investment (I), demand by business firms and some individuals, for
new factories, machinery, computer software, housing, other structures, and inventories. In addition,
Investment is effected by the output and the interest rate (i). Consequently, we can write it as I(Y,i).
Investment has positive relationship with the output and negative relationship with the interest rate.
For example, when Y goes up, the investment will increase.
gross government investment and consumption expenditures (G).
net exports (Nb and sometimes (b-M)), i.e., net demand by the rest of the world for the country's
output.

In Keynesian economics, not all of gross private domestic investment counts as part of aggregate
demand. Much or most of the investment in inventories can be due to a short-fall in demand
(unplanned inventory accumulation or "general over-production"). (Inventory accumulation would
correspond to an excess supply of products; in the National Income and Product Accounts, it is
treated as a purchase by its producer.) Thus, only the planned or intended or desired part of
investment (Ip) is counted as part of aggregate demand.

In sum, for a single country at a given time, aggregate demand (D or AD) = C + Ip + G + (b-M).
Strictly speaking, it is questionable whether this aggregation is possible, as it is impossible to form
such macro variables from some micro variables: how do you add up litres of gasoline and
toothbrushes? In the sense of nominal monetary values (prices) this is possible; but in the sense of
real goods it is not. Therefore it might be argued that an "aggregate demand curve" does not even
exist in an (income,spending)-space.

Q.4 (i) Given the demand function

Qd =12-p
a) Find the demand and revenue schedules.
b) Find the MR when p -10, 6 and 2.
Ans: (a) DEMAND FUNCTION:
Qd (Quantity Demanded) = 12 – p (Price)

DEMAND AND REVENUE SCHEDULE:

S.No. Price (P) Quantity Demanded (Qd) Revenue (MR)=P * Qd

1. 0 Qd = 12 – 0 = 12 0 * 12 = 0
2. 1 Qd = 12 – 1 = 11 1 * 11 = 11
3. 5 Qd = 12 – 5 = 7 5 * 7 = 35
4. 8 Qd = 12 – 8 = 4 8 * 4 = 36
5. 10 Qd = 12 – 10 = 2 10 * 2 = 20

(b) Qd = 12 – p
MR = Qd * p
WHEN:
P = -10
Qd = 12 + 10 =22
MR = 22 * 2 = 44

P=6
Qd = 12 – 6 = 6
MR = 6 * 6 = 36

P=2
Qd = 12 – 2 = 10
MR = 2 * 10 = 20

4 ii) Distinguish between linear and non linear demand functions.

Ans: Demand might be represented by a linear demand function such as

Q(d) = a - bP

Q(d) represents the demand for a good

P represents the price of that good.
Economists might consider how sensitive demand is to a change in price.
This is a typical downward sloping demand
curve which says that demand declines as
price rises.

This is a special case of a horizontal demand

curve which says at any price above P*
demand drops to zero. An example might be
a competitor's product which is considered
just as good.
 This is a special case of a vertical demand
curve which says that regardless of the price
quantity demanded is the same. An example
might be medicine as long as the price does
not exceed what the consumer can afford.
Supply might be represented by a linear supply function such as
Q(s) = a + bP

Q(s) represents the supply for a good

P represents the price of that good.

NON - LINEAR DEAMAND FUNCTION:

Often in economics a linear function cannot explain the relationship between variables. In
such cases a Non-linear function must be used. Non-linear means the graph is not a straight line.
The graph of a non-linear function is a curved line. A curved line is a line whose direction
constantly changes. Although the slope of a linear function is the same no matter where on the line
it is measured, the slope of a non-linear function is different at each point on the line. Thus there is
no single slope for a non-linear function. However the slope can be determined at any point on the
line.
Finding the slope of a linear function is straightforward. Furthermore the slope is the same
at each point on the function. However this is not the case with non-linear functions. A non-linear
function does not have a constant slope.

AN EXAMPLE TO SHOW THAT A NON – LINEAR DEMAND FUNCTION CAN TAKE ANY
SHAPE.

Consider the non-linear function shown below. What is the slope at some point such as P?
(P can be at any point along the curve.) It can be seen that the slope of the function depends on the
position of P on the curve.

A Non - Linear Function

The problem is to find the slope of the function at point P. A possible solution is to draw a
line tangent to the non-linear function at point P as shown in the following chart. The tangent line
touches the function but does not intersect it. The slope of this tangent line is the same as the slope
of the non-linear function at point P.

Q.5 Explain the trend projection method of demand forecasting?

Ans: Demand forecast is a must for a firm operating its business as today's market is competitive,
dynamic and volatile.

Specific purposes of demand forecasting

1. Better planning and allocation of resources

2. Appropriate production scheduling
3. Inventory control
4. Determining appropriate pricing policies
5. Setting s les targets and establishing controls and incentives.
6. Planning a new unit or expanding existing one
7. Planning long term financial requirements
8. Planning Human Resource Development strategies.

Trend projection method under the trend method the time series data on the variable under
forecast are used to fit a trend line or curve either graphically or by means of a statistical
technique known as the Least Squares method. Trend projection method can be used
when there is some sort of correlation between the two variables. It could be linear,
logarithmic or power correlation. The linear regression model will take the form of

Y = a + bX

a. Fitting a trend line by observation: This method involves the plotting of the data on the
graph and estimating where the trend line lies. The line can be extrapolated and the forecast
 read from the graph.

b. Trend through least squares method: This method uses statistical formulae to find the trend
line which best fits the available data. The trend line is the estimating equation, which can
be used for forecasting demand by extrapolating the line for future and reading the
corresponding values of variables on the graph.

c. Time series analysis: This is an extension of linear regression which attempts to build
seasonal and cyclical variations into the estimating equation. This method assumes that past
data can be used to predict future sales. This is one of the most frequently used forecasting
methods. It refers to he values of variable arrange chronologically by days, weeks, months,
quarters or years. The first step in time series analysis is usually to plot past values of the
variable that we seek to forecast on vertical axis and the time on the horizontal axis in order
to visually inspect the movement of the time series over time. It assumption is that the time
series will continue to move as in the past. For this reason time series analysis is often
referred as "native forecasting"

Reasons for fluctuations in time series data

• Changes in secular trend i.e. long run increase or decrease in data series.

• Cyclical fluctuations: There are the major expansions and contractions in most economic
time series data that seem to re-occur every several years.. A typical cycle could last 15-20
years.

• Seasonal variation: refers to regularly recurring fluctuations in economic activity during

each year e.g. a typical factor could be weather and social customs.

• Irregular and random variation: is variations I the data series resulting from unique events
like wars, natural disasters or strikes.

The total variation in the time series is the result of all the above four factors operating together.
They are usually examined separately by qualitative techniques.
 ASSIGNMENT 'B'
Q.1 Explain the concepts of return to scale and returns to a factor.

Ans: Returns to scale refers to a technical property of production that examines changes in output
subsequent a proportional change in all inputs. Where all inputs increase by a constant. If output
increases by that same proportional change then there are constant returns to scale (CRTS),
sometimes referred to simply as returns to scale. If output increases by less than that proportional
change, there are decreasing returns to scale (DRS). If output increases by more than that
proportion, there are increasing returns to scale (IRS)...

Short example:
Where all inputs increase by a factor of 2, new value for output should be:

Two times previous output given constant returns to scale (CRTS)

Less than twice previous output given decreasing returns to scale (DRS)

More than two times previous output given increasing returns

Economies of scale in production means that production at a larger scale (more output) can be
achieved at a lower cost (i.e. with economies or savings). A simple way to formalize this is to
assume that the unit-labour requirement in production of a good is a function of the level of output
produced. In the adjoining diagram we present a graph of the unit-labour requirement in steel
production as a function of the scale (level of output) of production. At production level Q1S, the
unit-labour requirement is given by a1LS. If production were to rise to Q2S, then the unit-labour
requirement would fall to a2LS. This means that at the higher level of output, it requires less labour
(i.e. fewer resources or cost) per unit of output than it required at the smaller scale.

With a simple adjustment it is possible to show that economies of scale in production is equivalent
to increasing returns to scale. Increasing returns to scale in production means that an increase in
resource usage , by say b%, results in an increase in output by more than b%. In the adjoining
diagram we plot labour productivity in steel production when production exhibits increasing returns
to scale. [This graph is derived by plotting the reciprocal of the unit-labour requirement (i.e. 1/aLS)
for each output level in the diagram below.]
As output (scale) increases from Q1S to Q2S, labour productivity (given by the reciprocal of the
unit-labour requirement) also rises. In other words, output per unit of labour input increases as the
scale of production rises, hence increasing returns to scale.

Another way to characterize economies of scale is with a decreasing average cost curve. Average
costs, AC, are calculated as the total costs to produce output Q, TC(Q), divided by total output.
Thus AC(Q) = TC(Q)/Q. When average costs decline as output increases it means that it becomes
cheaper to produce the average unit as the scale of production raises, hence economies of scale.

Economies of scale are most likely to be found in industries with large fixed costs in production.
Fixed costs are those costs that must be incurred even if production were to drop to zero. For
example fixed costs arise when large amounts of capital equipment must be put into place even if
only one unit is to be produced and if the costs of this equipment must still be paid even with zero
output. In this case the larger the output, the more the costs of this equipment can be spread out
among more units of the good. Large Fixed costs and hence economies of scale are prevalent in
highly capital intensive industries such as chemicals, petroleum, steel, automobiles etc.

RETURNS TO A FACTOR - The terms "returns to a factor" and "marginal product of a factor" are
therefore equivalent.

We distinguish between the cases where the returns to a factor are constant, increasing and
decreasing.

• Constant Returns to a Factor. CRTF occurs when equal increments in a factor result in equal
increments in output (other factors held Fixed).

• Increasing returns to a factor, IRTF, occur when equal increments in a factor result in successively
larger increments in output.

• Decreasing returns, DRTF, occur when equal increments in a factor result in successively smaller
increments in output.

To determine the returns to, say, labor, we fib K at a particular value. We then draw a line across
and read off the levels of L associated with equal increments in output.

Returns to a factor In this case we see that we have increasing returns to labor, since the equal
increments in output are achieved with successively smaller increments in labor Thus (b-a)>(c-b)
Q.2 Explain the following:

Ans: Opportunity cost, or economic cost, is the cost of something in terms of an opportunity
forgone (and the benefits that could be received from that opportunity), or the most valuable
forgone alternative, i.e. the second best alternative. For ebample, if a city decides to build a hospital
on vacant land that it owns, the opportunity cost is some other thing that might have been done with
the land and construction funds instead. In building the hospital, the city has forgone the
opportunity to build a sporting center on that land, or a parking lot, or the ability to sell the land to
reduce the city's debt, and so on.

Opportunity cost need not be assessed in monetary terms, but rather can be assessed in terms of
anything that is of value to the person or persons doing the assessing. For ebample, a person who
chooses to watch, or to record, a television program cannot watch (or record) any other at the same
time. (The rule still applies if the recording device can simultaneously record multiple programs;
there is going to be a limit, and if the number of desired programs ebceeds the capacity of the
recorder, some of them will not be saved, and thus cannot be seen.) In any case, at the time the
person chooses to watch a program, either live or on a recording, they cannot watch something else,
and if they are not able to record another program showing at the same time, the opportunity to
view it is lost (presuming the particular program is not repeated). Or another ebample, someone
having a video game can choose to watch a program or play the video game on the TV; they can't
do both simultaneously. Whichever one they choose is a lost opportunity to ebperience the other.

Fixed cost:- fixed costs are expenses that do not change in proportion to the activity of a business,
within the relevant period or scale of production. For example, a retailer must pay rent and utility
bills irrespective of sales. Unit fixed costs, called average fixed costs (AFC), decline with volume,
following a rectangular hyperbola as the inverse of the volume of production.

Fixed costs are "fixed" only within a certain range of activity or over a certain period of time. If
enough time passes, all costs become variable. Similarly, not all indirect costs are fixed costs; for
example, advertising expenses or labour costs are indirect costs that are variable over a slightly
longer time frame, as they may not be subject to change in the short term, but may be easily
adjustable over a longer time frame. For example, a firm may not be able to vary the number of
employees (and hence labour costs) in the short term due to contract obligations, but be able to lay
employees off or otherwise change these costs.

Social and private cost: - Social cost, in economics, is generally defined in opposition to "private
cost". In economics, theorists model individual decision-making as measurement of costs and
benefits. Rational choice theory often assumes that individuals consider only the costs they
themselves bear when making decisions, not the costs that may be born by others. In most cases, the
costs carried by the individuals involved are the only economically meaningful costs. The choice to
purchase a glass of lemonade at a lemonade stand has little consequence for anyone other than the
seller or the buyer. The costs involved in this economic activity are the costs of the lemons and the
sugar and the water that are ingredients to the lemonade, the opportunity cost of the labor to
combine them into lemonade, as well as any transaction costs, such as walking to the stand.

Social cost incorporates the total of all the costs associated with an economic activity. It includes
both costs borne by the economic agent and also all costs borne by society at large. It includes the
costs reflected in the organization's production function (called private costs) and the costs external
to the firm’s private costs.

If there is a negative externality, then social costs will be greater than private costs. Environmental
pollution is an example of a social cost that is seldom borne completely by the polluter thereby
creating a negative externality. If there is a positive externality, then one will have higher social
benefits than private benefits. Since private costs are incorporated in the social costs the social costs
can not be less than the private costs. An example is when a supplier of educational services
indirectly benefits society as a whole but only receives payment for the direct benefit received by
the recipient of the education: the benefit to society of an educated populace is a positive
externality. In either case, economists refer to this as market failure because resources will be
allocated inefficiently. In the case of negative externalities, private agents will engage in too much
of the activity; in the case of positive externalities, they will engage in too little.

Sunk cost: - sunk costs are costs that have been incurred and which cannot be recovered to any
significant degree. Digital products usually have significant sunk costs (when compared to other
fixed costs) in the form of research & development and intellectual property (patents etc.) for the
product. If the product is not successful in the marketplace, the costs associated with the product
development (intellectual property, labour) cannot be recovered. Thus when making pricing
decisions about the product in the future, one should not factor in the sunk costs. If a product's cost
structure is made up of sunk costs (no other fixed costs) and zero marginal costs then any price
above zero will contribute to the company's bottom line. Other fixed costs that are not sunk (rent,
depreciation on equipment etc.) should be factored in when making pricing decisions in the future,
since these are ongoing costs to the company.

The development of the Netscape browser is a good example of a product whose cost structure was
comprised primarily of sunk costs. Regardless of the success of the product in the market, the major
parts of the costs were already expended (product development). This enabled Netscape tremendous
flexibility as it used its web site to allow users to download the product for free (actually it was
not free, but Netscape did not pursue individual consumers for sales revenue). The only type of cost
this presented to Netscape was the opportunity costs of lost sales from those who downloaded the
browser for free. These free download enabled Netscape to build market share quickly, thus
establishing first mover advantage and significant market leadership (for a short time!)

Q.3 Explain the relationship among the average total cost marginal cost and average variable
costs.

Ans: Total costs are the sum of all costs. By dividing the total costs by the quantity produces, one
gets the average costs: how much a unit of production costs ("unit cost"). Average costs can be
directly compared with price to compute profitability: if the price is higher than average cost, the
production is profitable.

Total profits will be given by multiplying the average profit with the quantity produced and sold.
Identically, total profits can be obtained as total revenues less total costs.

The relationship between total revenue and total costs depending on the production level is analyzed
by the so-called "break-even analysis".

Let's see mathematically what component crucially influences average costs at two widely different
levels of production.

In the simplified situation of a production process characterized by a fixed cost (F) plus a
proportionally-growing variable cost (VC), total costs (TC) are described by the easy formulas
below:

TC = F + VC×q

-Where q is the quantity of good.

Average costs (AC) are thus the following:

AC= TC/q = F/q + VC

The first term of the right side (F/q) decreases systematically the higher the production level (q). At
low production levels, this reduction is quantitatively relevant whereas for a high q it is not.

In fact, for high q, the average cost is practically equal to variable cost VC.

Marginal cost is the change in total cost that arises when the quantity produced changes by one unit.
Mathematically, the marginal cost (MC) function is expressed as the derivative of the total cost
(TC) function with respect to quantity (Q). Note that the marginal cost may change with volume,
and so at each level of production, the marginal cost is the cost of the next unit produced.

MC= d TC/d Q

In general terms, marginal cost at each level of production includes any additional costs required to
produce the next unit. If producing additional vehicles requires, for example, building a new
factory, the marginal cost of those extra vehicles includes the cost of the new factory. In practice,
the analysis is segregated into short and long-run cases, and over the longest run, all costs are
marginal. At each level of production and time period being considered, marginal costs include all
costs which vary with the level of production, and other costs are considered fixed costs.
In the most simple case, the total cost function and its derivative are expressed as follows, where Q
represents the production quantity, VC represents variable costs (costs that vary with Q), and FC
represents fixed costs:-

TC= FC + VC

MC = d TC/ d Q = d (FC + VC ) /d Q = d VC / d Q

Since (by definition) fixed costs do not vary with production quantity, it drops out of the equation
when it is differentiated. The important conclusion is that marginal cost is not related to fixed costs.
This can be compared with average total cost or ATC, which is the total cost divided by the number
of units produced and does include fixed cost.

ATC = FC + VC / Q

For discrete calculation without calculus, marginal cost equals the change in total (or variable) cost
that comes with each additional unit produced.For instance, suppose the total cost of making 1 shoe
is $30 and the total cost of making 2 shoes is $40. The marginal cost of producing the second shoe
is $40 - $30 = $10.

Average variable cost:-

Average variable cost is the total variable cost per unit of output incurred when a firm engages in
short-run production. It can be found in two ways. Because average variable cost is total variable
cost per unit of output, it can be found by dividing total variable cost by the quantity of output.
Alternatively, because total variable cost is the difference between of total cost and total fixed cost,
average variable cost can be derived by subtracting average fixed cost from average total cost.

In general, average variable cost decreases with additional production at relatively small quantities
of output, then eventually increases with relatively large quantities of output. This pattern is
illustrated by a U-shaped average variable cost curve.

Average variable cost, when combined with price, indicates whether or not a firm should shut down
production in the short run. If price is greater than average variable cost, then the firm is able to pay
all variable cost and a portion of fixed cost. Even though it might be incurring an economic loss, it
will lose less by producing that by shutting down production. If, however, price is less than average
variable cost, then the firm is better off shutting down production.

Calculating Average Variable Cost

The standard method of calculating average variable cost is to divide total variable cost by the
quantity, illustrated by this equation:
 total variable cost
average variable cost =
quantity of output
An alternative specification for average variable cost is found by subtracting average fixed cost
from average total cost:

average variable cost = average total cost - average fixed cost

An alternative equation computes total variable cost from average variable cost:

total variable cost = average variable cost x quantity of output

Case Study
Ans 1. All India Cable Demand

= Yt = 1173 + 28.5 (98.5) = 3980.25 Million KW

Monthly estimated sales of the Bengal Cable Company (20% of Yt)

= 20% of 3980.25 = 66.3375 Million KW

12

Ans 2. False. The Bengal Cable Company accounts for 20% of the total Industry sales. This goes to
prove that the Cable industry is a Monopolistic Competitive industry. In such an Industry the price
would play a major factor in deciding the sales of a firm in the industry. Other firms may not match
a price rise but they will definitely match a price cut. Thus price will be considered important in
estimating demand for the company.

Ans 3. Yes, it may be justified to assume a rise of the market share of Bengal cables by 5 percent.
Bengal cables have experienced a rise of market share by 5 percent last year. This may be due to
aggressive marketing and differentiating of products in the market. That ways, as the market share
is increasing consistently by 5% every year, it is safe to assure a corresponding increase in the share
of the Bengal Cable Company.
 ASSIGNMENT 'C'

Q 1.
Ans. B

Q 2.
Ans. C

Q 3.
Ans. D

Q 4.
Ans. A

Q 5.
Ans. B

Q 6.
Ans. C

Q 7.
Ans. C

Q 8.
Ans. C

Q 9.
Ans. C

Q 10.
Ans. B

Q 11.
Ans. A

Q 12.
Ans. B

Q 13.
Ans. A

Q 14
Ans. A

Q 15.
Ans. B

Q 16
Ans. B

Q 17.
Ans. C
Q 18.
Ans. D

Q 19
Ans. C

Q 20.
Ans. C

Q 21
Ans. D

Q 22
Ans. B

Q 23
Ans. D

Q 24
Ans. D

Q 25
Ans. D

Q 26
Ans. A

Q 27
Ans. B

Q 28
Ans. C

Q 29
Ans. C

Q 30
Ans. B

Q 31
Ans. B

Q 32
Ans. B

Q 33
Ans. A

Q 34
Ans. A
Q 35
Ans. D

Q 36
Ans. D

Q 37
Ans. A

Q 38
Ans. B

Q 39
Ans. A

Q 40
Ans. C