MBA First Semester

Session: 2013-2014
Subject: Managerial Economics (NMBA-012)
Questions bank:
1. Define Managerial Economics and discuss the nature and scope of managerial economics in the context of business decisions.
Managerial Economics is the integration of economic theory with business practice for the purpose of facilitating decision making and forward planning by management.
Explain
Sol: Managerial economics is essentially applied economics in the field of business management. It is the economics of business or managerial decisions. It pertains to all
economic aspects of managerial decision making.
Managerial economics is concerned with the application of economics concepts and economics to the problems of formulating rational decision making- Mansfield
Managerial economics may be defined as the integration of economic theory with business practice for the purpose of facilitating decision making and forward planning by
management.- Spencer and Seigelman
It will be useful to understand the meaning of two wards-decision making and forward planning
Decision making-selecting one out of a set of two or more alternatives.
Forward planning- planning for the future.
Management has to make decision and forward plan on the basis of past statistical data, present information and future anticipation. It helps management in making right
decision and planning for future in an atmosphere of uncertainty.
Nature of Managerial Economics

Economic theory-macro and micro economics

Positive vs normative approach
Goal oriented
Conceptual and metrical
Pragmatic approach

Scope of Managerial Economics

Managerial economics may be defined as the integration of economic theory with business practice for the purpose of facilitating decision making and forward planning by
management.
Management is generally concerned with the following types of business decision.
1.
Demand decisions: It is essential for any business to enable it to produce the required Qty at right time and arrange in advance.
2.
Price output decision: Price output decision is taken under various markets. It consists of all firms and individuals who are willing and able to sell
or buy particular product in market
3.
Production decision: A manager is to choose various contributions of factors of production in such a way so as to produce maxi possible output
with given budget & mini cost.
4.
Investment decision: Investment decision are not easily reversible, they generally involve large sum of money, highly futuristic and long gestation
period.
5.
Decision related to economic environment: Survival & success of business depends on it economic environment(external factors & internal
factors)
6.
Personnel decision: Physical factors become useless without personnel and they always contribute their effort to achievement of organization goal.
Following are the core topics of managerial economics:

monopoly, oligopoly and monopolistic competition

Demand Function and Estimation, Demand Elasticity, Demand Forecasting

Production Function and Laws
Cost Analysis
Pricing and Output Determination in different market structures such as perfect competition,
Pricing Policies and Practices in Real Business/risk & uncertainty
Profit Planning and Management
Capital Budgeting and Management
Government and Business

2. Write a detailed note on the economic concepts in managerial economics.

Sol: In applying the economic principles for solving his practical problems, the business economist has to use additional skills and tools to make up the gap b/w economics
theory and bus practice.
1.
Opportunity cost principle and decision rule: It is related to the alternative uses of scarce resources. The scarcity and the alternative uses of
the resources give rise to the concept of opportunity cost. The opportunity cost of anything is the next best alternative that could be produced
instead by the same factors and same cost.
It can be applied to all other kinds of resources involved in business decisions, especially where there are at least two alternative options involving costs and benefits.
2. Incremental principle and decision rule: It is applied to business decisions which involve bulk production and a large increase in total cost and total revenue. Such an
increase in total cost and total revenue is called incremental cost and incremental revenue related to output.
It involves estimating the impact of taking production decision alternatives on cost and revenue. (IR.> IC)
3. Principle of time perspective: The decision maker must give due consideration to time element in his decision making.
It refers to the duration of time period extending from the relevant past and foreseeable future taken in view while taking a business decision. Relevant past refers to the
period of past experience and trends which are relevant for business decisions with long run implications. All business decisions do not have the same time perspective.
4. Discounting principle: Implies affects on cost & revenue at future dates, it is necessary to discount those cost & revenue to PV before a valid comparison of alternative is
possible. A rupee tomorrow worth is less than a rupee today. (PV=100/1+i)
5.
Equi-marginal principle: States that a utility maximizing consumer distributes his consumption expenditure b/w various goods and services (allocation of resource) in
such a way so that result will be equal in term of utility.
In business allocation of resources b/w their alternative uses with a view to maximizing profit in case a firm carries out more than one business activity. This principle
suggests that available resources should be allocated b/w the alternative options that the marginal productivity gains from various activities are equalized

6.

Contribution Analysis: The contribution of a business decision refers to the difference b/w the incremental revenue and incremental cost
associated with that particular decision. It is a useful technique for taking various decisions- acceptance/ rejection, introduce new plant, make/
buy.
7.
Marginal Principle: Marginal refers to the change in total qty or value due to a one unit change in its determinant. Marginality concept assumes special significance
where maximization or minimization problem is involved- maximization of a consumer utility, maximization of a firms profit and minimization of cost etc.
3. Explain the role and responsibilities of a Managerial Economist.
Sol: Role and Responsibilities of a Managerial Economist
A managerial economist in a business firm may carry on a wide range of duties, such as:

Demand estimation and forecasting.

Preparation of business/sales forecasts.

Analysis of the market survey to determine the nature and extent of competition.

Analyzing the issues and problems of the concerned industry.

Assisting the business planning process of the firm.

Discovering new and possible fields of business endeavour and its cost-benefit analysis as well as
feasibility studies.
4. What do you understand by law of Demand? Discuss the factors which bring about changes in Demand and its exceptions? Why does the demand curve usually slope
downward to the right?
Sol: Law of Demand: State that when other factor remain the same then price increase, demand decrease
and when price decrease, demand increase.
According to Samuelson, when the price of a commodity is raised less of it is demanded or if a greater
quantity of a commodity is put on the market, then other things being equal it can be sold at a lower price.
Assumptions Underlying the Law of Demand

No change in consumers income

No change in consumers preferences

No change in the fashion

No change in the price of related goods

No expectation of future price changes or shortages

No change in size, age composition and sex ratio of the population

No change in the range of goods available to the consumers

No change in the distribution of income and wealth of the community

No change in government policy

No change in weather conditions

Factors Influencing Individual Demand

Price of a commodity- effect the demand that way before purchasing anything first know the price, after that decide, how much to purchased. When the
price of a commodity is raised less of it is demanded or if a greater quantity of a commodity at lower price.

Income of a consumer- A rise in the consumers income raises the demand for a commodity and a fall in his income reduces the demand for it.

Tastes, habits and preferences (People with different tastes and habits have different preferences for different goods)-when there is a change in the taste of
consumers in favour of a commodity, due to fashion, its demand will rise with no change in its present prevailing price.

Relative prices of other goods substitute and complementary products

Consumers expectation regarding the future- When a consumer expects its price to fall in future, tend to buy less at the present prevailing price.
Similarly if consumer expects its price to rise in future, buy more at present.

Advertisement effect and sales propaganda-demand for many products in the present day are influenced by the seller efforts through advertisements

Climate and weather condition- Demand for certain products are determined by climate and weather conditions. In summer there is a greater demand for
coolers and ACs.

Distribution of income and wealth-If there is equal distribution of wealth, the market demand for any product of common consumption tends to be greater
than in the case of unequal distribution.

Growth of Population and no of buyer- A high growth of population over a period of time tends to imply a rising demand for essential gods and services in
general.

Social customs and festivals- demand for certain goods are determined by social customs, festival etc. during diwali there is greater demand for sweets and
crackers.

Taxation- A progressively high tax would mean a low demand for goods in general while highly taxed commodity will have a relatively lower demand than
untaxed commodity.

Age structure and sex ratio of the population affect the demand for many goods. If the population pyramid of a area is broad based with kids/teenagers then
demand for toys, stationary required by children will be much higher than goods needed by elderly people.
Exceptional Cases

Giffen goods- introduced by Robert giffen when the price falls, quite often less qty will be purchased then before because of the negative income
effect and consumer increasing preferences for a superior commodity with the rise in their real income

Articles of snob appeal-Certain goods are demanded only because they happen to be expensive or prestige goods(status symbol)

Speculation- prices that are rising now. When consumer expects that the price of any commodity will increase in the near future with the prices that
are rising now. In that case buy more at increasing prices. Whereas anticipate that the price will fall in future consumer shall buy less`

Consumers psychological bias that product having high price, is qualitative product.

Necessities- It is not applicable in the case of necessities of life such as food grains, milk etc.

Ignorance and emergency- caused by war, famine political etc. During these periods consumers behave in an abnormal way. They accentuate
scarcities and further price rises by making more purchases even at higher prices
Demand curve slope downward due to following reason

Negative correlation b/w price and qty demanded-As per law of demand, a negative correlation b/w prices and qty. more will be purchased at lower price
and vice versa, makes the demand curve to slope downward toward right.

Law of diminishing marginal utility- According to this law, with the successive increase in the units of consumption of a commodity, every additional unit
gives lesser satisfaction. In order to increase consumption, consumer pays lower prices.

Income effect- Due to fall in prices, consumer can afford to buy more or buy some other commodity, his real income increases. It is called income effect.

Substitution effect- when the commodity becomes dearer consumer tries to substitutes that commodity with other commodity. This is called substitutes
effect.

No. of consumers/potential buyer- those buyers who are ready to buy the commodity, but cannot buy because of high prices. As soon as the price falls, they
put forward their demand and demand increase.

Different uses of a commodity- A commodity of trends to be put to more uses or less important uses when its price is lowered. Increase in price will compel
the consumers to withdraw that from unimportant uses.
5. What do you understand by elasticity of demand? Discuss its different kinds.

Sol: Elasticity of demand:

Elasticity of demand is measured as the ratio of percentage change in the quantity demanded of a product to the percentage change in its price.

Price Elasticity of Demand - The price elasticity is defined as a ratio percentage or proportional change in the quantity demanded to the percentage
or proportional change in price
Income Elasticity of Demand - The income elasticity is defined as a ratio percentage or proportional change in the quantity demanded to the
percentage or proportional change in income
Cross Elasticity of Demand - The cross elasticity is defined as a ratio percentage or proportional change in the quantity demanded to the
percentage or proportional change in price of related product.

Advertising/ promotional Elasticity of Demand- The advertising elasticity is defined as a ratio percentage or proportional change in the quantity
demanded to the percentage or proportional change in advertisement and promotional expenditure for a commodity.

Ea= % change in qty demanded/ % change in the advertisement expenditure

Factors Influencing Elasticity of Demand:

Nature of commodity

Availability of substitutes

Number of uses

Consumers income

Height of price and range of price change

Proportion of expenditure

Durability of the commodity

Habit

Complementary goods

Time

Recurrence of demand

Possibility of postponement
Managerial uses of price elasticity of demand

Determination of price

Bases of price discrimination

Determination of wages

Determination of prices of public utilities

Distribution of burden of taxation

Effect on employment

Importance for the government

Importance in the international trade

6. Define demand forecasting. Explain the purposes of short-term and long-term forecasting?
Sol: Demand forecasting:
forecasting: Prediction of probable demand for the quantity produced for the market or an estimation of future demand. The importance of demand forecasting to
business planning.
Good production and sales planning require forecasts of the business conditions and of their relationship to demand. In fact it is to minimize the uncertainties of the unknown future
that these forecasts are needed. The more realistic the forecasts more effective decisions can be taken for tomorrow.

Expectations about the future course of the market demand for a product.

It is based on the statistical data about past behaviour and empirical relationships of the determinants.
Features
1. Estimation for specified future period.
2. Only prediction, not necessarily an accurate quantification.
3. Heavily based on historical data.
4. Influenced by micro and macro factor.
Purpose of demand forecasting

Production planning

Sales forecasting

Control of business

Inventory control

Growth and long term investment programmes

Stability

Economic planning and policy making

7. Explain law of supply. Describe the factors affecting supply of a commodity.
Sol: Law of supply state that when price of a commodity rises, supply also rises and when price falls, supply also falls provided other factors remain unchanged. Other thing
being constant, Qty supplied of a commodity is directly related to the price of a commodity.

Assumptions:

Price of related goods should not change.

Cost of factors of production should remain the same

Technology of production should not change

Technology of production should not change

Goal of the firm should not change

Determinants of supply:

Price of the commodity

Change in technology

Change in price of inputs

Change in excise duty

Objective of the firm

Price of other related goods

No of firm(sellers) of a good in the market

Technological changes.
8. What are the salient features of perfect competition? How is the price policy determined under perfect competition?
Sol: Perfect Competition
It refers to the market structure characterized by many firms to compete in producing identical goods and the market-entry is free no market-barriers.
Characteristics of Perfect Competition

Large number of sellers.

Large number of buyers.

Product homogeneity.

Free entry and exit of firms.

Perfect knowledge of market conditions

Perfect mobility of factors of production.

Government non-intervention.

Absence of transport costs element.

Uniform Price

Price taker not a maker(Price decided by industry on the basis of demand and supply)
Price determination under perfect competition market
Short Run Equilibrium:
In short duration if demand increases, a firm can increase the production by increasing the variable factors only. It is not possible to change the amount of fixed factors of
production like machinery, land, factory building etc. the factors whose quantity cannot be changed, neither new firm can enter the industry nor can the old firms leave it in
short term.
Price of a commodity determined by total demand and total supply of the industry. This price is given for the firms. .At a prevailing market price, the firm determines its
quantity of output by equating short run marginal cost with short run marginal re-venue. Some firms may earn super normal profit, some forms may suffer losses and some
firms may earn normal profit only.
Super normal profit: At the equilibrium level of output a firm may get a abnormal profit f its average revenue exceeds the average cost of production

Normal profit: When the firm just meets its average total cost, it earns normal profits.(MR=MC) AR=ATC or OP= EQ
Losses: A firm may suffer loss because of the fact that a part of the FC may not be recovered in the short run. In spite of these losses the firm would decide to produce, and
recover only AVC.(AR<AC)
Shut Down Point: When firms average variable costs tend to be much higher than the market price of its product, and there are no chances of improvement

If AR,AVC

Long Run Full Equilibrium

In long run, the firm will be earning just normal profits. If they make supernormal profits, new firms will be attracted in the industry and old firms
expand so as a result supply increase and price fall. Due to reduction in prices firms marginal and average revenue declines and their super normal profit vanishes and this
condition continues till all the firms start earning normal profit. Where P= LAR=LMR=LMC=LAC. Firms long term equilibrium can be seen with the help of below
mentioned fig.

1.
2.
3.
4.

2)

9. Explain the meaning and features of monopolistic competition.

Sol:Meaning and features of monopolistic competition.
It refers to the market structure characterized by product differentiation of many monopolistically competitive firms in a particular line of production.
Ex: Automobiles, Electronics
The monopolist has, therefore, completed hold over the market supply and price determination.
Large no. of seller and buyers.
Product differentiation.
Freedom of entry and exits
Huge selling cost
Lack of perfect knowledge
Product differentiation- It is a unique feature of monopolistic competition.
Product quality and characteristics of the product can have a wide dimension, implying real as well as spurious or imaginary differences. Products of
different firms have different mode of use and operations etc size, design and style, strength and durability, quality, composition, brand name, trade marks, advertisement and
workmanship influence the minds of buyers.
Due to the conditions of sale and marketing- in this regard location, attitude, terms of sale, guarantee of services and repairs are the important aspect of
product differentiation.
Product differentiation at a point of time aims at identifying the product of the seller from the product of rivals.
Product development is in quality variation/ adjusted more sensitively to the tastes and preference of consumers which would ensure their strong
patronage.
Price and output determination under monopolistic competition in the short period:
The short period is so short that firms cannot increase their scales of production and new firms cannot enter in the production too. A firm can change the quantity of production
in short period by changing the variable factors of production. A firm can increase his demand by increasing advertisement and improvement the quality and design. A firm
determines the quality of its production and the price by its demand in the short period. A firm keeps on increasing production till the cost of producing one extra unit is less than
the revenue received by selling one more unit of the product. When MR=MC.
In short period in monopolistic competition a firm can be
Earning super normal profit. At the equilibrium level of output a firm may get a abnormal profit f its average revenue exceeds the average cost of production
Condition of neither profit or loss: When the firm just meets its average total cost, it earns normal profits.MR=MC
Condition of loss in the short period :A firm may suffer loss because of the fact that a part of the FC may not be recovered in the short run-In spite of these
losses the firm would decide to produce, and recover only AVC.(AR<AC)
In monopolistic competition in short term all the firms do not produce the same quantity nor do they charge the same price. Qty of production and price can be different in
different firms.

Price and output determination under monopolistic competition in the long period:
Long period of time in which all the firms working in monopolistic market can change their production by changing all factors of factors of production. Normally entry of firms
is not restricted in monopolistic competition. If the operating firms are earning super normal profit then new firms will enter the industry. If some of the operating firms are
suffering losses they will leave the industry. Therefore firms will be earning only normal profit in long run.

10. Explain the meaning and features of monopolistic competition. How is the price policy determined under monopoly competition?
Sol: Monopoly: It refers to the market structure in which there is only a single producer or supplier of a product and the entire market supply is in his control. Monopoly is
antithesis of competition.

Features of Monopoly

There exists only one seller but there are many buyers.

The monopoly firm is the industry.

There are many entry barriers such as natural, economic, technological or legal, which do not allow competitors to enter the market.

Full control over the price.

A monopoly firm is a price-maker. In a monopoly market, the price is solely determined at the discretion of the monopolist, since he has control
over the market supply.

Possibility of price discrimination

There are no closely competitive substitutes for the product of the monopolist. So the buyers have no alternative or choice. They have to either
buy the product from the monopolist or go without it.

Monopoly is a complete negation of competition.

Since a monopolist has a complete control over the market supply in the absence of a close or remote substitute for his product, he can fix the
price as well as quantity of output to be sold in the market. Though a monopolist is a price-maker, he has no unlimited power to charge a high price for his product in the
market.
Types of Monopoly

Pure and imperfect monopoly

Legal, natural, technological and joint monopolies
Simple and discriminating monopoly
Private and public monopoly

Price and output determination under monopoly competition in the short period:
In short period increase or decrease the use of variable means of production to increase or decrease the production. If monopolist needs to produce more then he can use more
laborers, increase the qty of fixed materials and fuel, but cannot change the quantity of fixed factors in short period.

Abnormal profit: In short run monopoly equilibrium is at E where the MC curve cuts the MR curve from below. The monopoly sells OQ output at
OP price. The OQ, being above AC, the monopoly earns AP profit per unit of output. Thus profit= PCAB

Normal profit: The short equilibrium of the monopoly is shown when he earns only normal profit .(ATC=AR)

Minimum loss: If a monopoly faces a very low demand or his product and his cost condition (ATC=AR) It will not making profit but incur losses.
Short Run Monopoly Equilibrium: Try to maximized profit or minimized losses

Long Run Monopoly Equilibrium:

In long pd , firm increase his plant size or use his existing plant to maximize profit.
In absence of competition, they need not to produce at optimum level but need to reach minimum LAC where profit is maximized. At this equilibrium point firm could be
earning super profit or normal profit, but in any condition could not be suffering a loss. Normally firm is earning normal profit. To make super profit in long run as entry of
outside firms is blocked.

Price Discrimination: It is a practice of changing different prices from different customers for the same good or services. (1) By charging different prices for the same
product (2) by not setting prices of different varieties of products or different products in relation to their cost differences.
Forms of price discrimination:

Personal discrimination

Age discrimination

Sex discrimination

Location or territorial discrimination

Size discrimination

Quality variation discrimination

Special service or comforts

Use and time discrimination

Nature of commodity discrimination

First degree price discrimination: Under this, they charges different prices to different buyers for each different unit of the same product. The price charged for each unit, in
each case, in accordance with the marginal utility the buyer estimates and thus at what maximum price he is willing to pay for it. The entire consumers surplus of the buyer is
converted into revenue and profits.
Second degree price discrimination: Under this, the monopolist sells blocks of output at different prices. Here, the possible maximum price is charged for some given block of
output purchased by the buyer and then additional blocks are sold at successively lower prices. And the units in a particular block will be uniformly priced.
Third degree price discrimination: under this the firm divides its total output into many submarkets and sets different prices for its product in each market segment in relation
to the demand elasticitys.
11. Define oligopoly market structure. Also explain various features and pricing models of oligopoly market.
Sol: Oligopoly: It refers to the market structure comprised by a few producers or suppliers.(cement, steel, petrol,chemicals,gas)

Either homogeneous or differentiated products.

High degree of interdependence regarding policies in fixing price and determining output.

Always the fear of retaliation by rivals.

Advertising & selling costs have strategic importance.

Competition is of unique type.

Strong restrictions on entry or exist.

High cross elasticity and merger & takeover

Patent right & control over certain raw material

Huge capital investment

Imperfect dissemination of information

Price determination:

Due to interdependence, oligopolistic firm cannot keep its price and output constant.

When firm changes its price, its rival firms will have to react, which would affect the demand of the former firm.Therefore, firm cannot have a
definite demand curve. It keeps shifting as the rivals change their prices in reaction to the prices changes made by it.
Models to determine price output:

Due indefinite demand curve, the price and output cannot be ascertained by economic analysis.

Price is based on numbers of models, depending on the behavior pattern of the members of the group are..

Rivals may decide to cooperate

Fight each other to increase their market share

Based on varieties of agreements.

1.
Non collusive model of sweezy (kinked demand curve)
2.
Collusive model-Cartels, price leadership, market share.
Oligopoly: kinked demand curve or AVC is made of two segments
1.
Relatively elastic demand curve
2.
Relatively inelastic demand curve
There is a kink at point K on DD. Thus DK is elastic segment and KD is inelastic segment

The Curve have more elastic demand above the kink Point and Less elastic demand below.
Before the kink point, the DC is flatter, after the kink it becomes steeper


period of time

Under this, once a general price level is reached whether by collusion, price leadership or some formal agreement, it remain unchanged over a
It can be seen when MC curve can fluctuate b/w MC1 and MC2 within the range of gap in MR, without disturbing the EP and output.

Pattern of Behavior in Oligopolistic Markets

1. Price Leadership: Leader in oligopoly announces price changes from time to time, other competitor follow.
Dominant- firm may assume the price leadership; it claims a substantial share of the market.
Initiative: When the firm develops a product or a new sale territory.
Aggressive: When the firm fixed price aggressively and force the other firm to accept or go out.(to capture market)
Reputation: When the firm acquires reputation for sound pricing policies, other may accept its leadership.
Barometric: price fixed by the wisest producer.
2. Price Wars: Never planned, occur as a consequence of one firm cutting the prices and other following.
3. Price Cuts to Weed out Competition: A financially strong firm may deliberately resort to price cuts to eliminate competitors from the
market and secure its position.
4. May cut price to eliminate competitors and secure its position.
5. Collusion: Group or trusts may be formed by competing firms and agree to charge a uniform price, thereby to eliminate price cut
competition. It considered illegal under anti-trust laws. (Such as MRTP act).
6. Cartel: It is agreement among different firms to regulate the prices and output of the group. Firms sell such output at agreed price fixed by
cartel board. But it is not be possible on permanently bases of the different behavior and opinion. The OPEC is an international cartel in the
world petroleum market.
7. Secret Price Concessions: May offer secret price concessions for selected buyer instead of having an open price cut.
8. Non-price Competition: Except price competition by competing in sales promotion efforts, advertising, and product improvement.
12. Explain the law of returns to factor and law of variable proportions with suitable examples and graph. How it is differ from return to scale
Sol: Law of Variable Proportion

It is assumed that only one factor of production is variable while other factors are fixed.
As a producer goes on increasing the qty of variable input, which is combined with other fixed factors, then in the
beginning the marginal productivity of that input increase at increasing rate, at constant and at last MP increasing by decreasing rate.
Assumptions:

One of the factors is variable while all other factor is fixed.

All units of variable factor are homogeneous.

Proportion of the factors can be changed.

Technology &methods of production are constant.

Short period operation.

Land
1
1
1
1
1
1
1
1
1
1

Labour
1
2
3
4
5
6
7
8
9
10

TP
20
50
90
120
150
175
190
200
200
197

AP
20
25
30
30
30
29.1
27.1
25
22.1
19.7

MP
20
30
40
30
30
25
15
10
0
-3

Product Curves

Return to Scale

Long run concept.

In order to increase the productivity, all factor of production are raised simultaneously in a same proportion.

Output resulting on account of a proportional increase in the whole set of inputs.

By increasing all factors, the output may rise initially at a more rapid rate than the rate of increase in inputs, then output may increase in the same
proportion of input and ultimately, output increase less proportionately.

L+K

AP

1L+2K

10

2L+4K

100%

30

200%

3L+6K

50%

60

100%

4L+8K

33%

90

50%

5L+10K

25%

100

11.11%

6L+12K

20%

110

10%

7L+14K

16%

120

9%

8L+16K

14%

125

4%

Assumptions:

Technological advancement.
All units of factors are homogenous
Returns are measured in physical terms.
Causes for increasing return:
Increased efficiency of labour & capital
Use of sophisticated machinery, better technology
Improvement in large scale operation
Causes for constant return:
Given a constant result & factors are perfectly substitutable.
All factors are infinitely divisible.
Supply of all factors is perfectly elastic at the given price
Causes for diminishing return
All factor input increase proportionately; organization & management factor cannot be increased in equal proportion.
Business risk
Production increase beyond a limit.
Increasing difficulties & coordination of managing a big firm.
Imperfect substitutability of factors

13. Define inflation. Explain the stages and types of inflation.

Sol: Inflation: It is a sustained rise in price level over a period of time. It can be measured in terms of percentage increase in the price index as a rate percent per unit of time
say, a month or a year.
Inflation is state with high prices, which causes decline in the purchasing power or the value of money, rapid increase in the general price level. Prices keep on rising due to
excess supply of money and lower r output of transferable goods.

Features:

Associated with a sustained rise in prices.

Price rise is persistent and irreversible immediately.

Qty of money is increasing but the production is not increased accordingly.

Real value of money shows a falling trend

Stages of inflation:

Pre-full employment stage

Full employment stage

Post full employment

Types of inflation:
1.
Inflation on the basis of price
Creeping inflation

Walking inflation
Running inflation
Galloping or hyper inflation.

2.
Inflation on the basis of govt reaction

Open inflation: When prices rise, without any interruption of govt. Under this free market mechanism is permitted to fulfill its historic function, short supply
of goods and distribute them according to consumer ability to pay.

Repressed /suppressed inflation: Under this price increase are prevented and control by adopting different policy.
3.

prices.

4.

Inflation on the basis of demand and supply of money

Excess supply of money- in relation to the availability of real goods and services.
Cost inflation-When money income expands more than real productivity, workers demand higher wages, cost increase which the producer meets by raising
Deficit inflation- When the govt budgets contain heavy deficit financing, through print new currency, the purchasing power increases and price rise.
Demand pull inflation-

Price level is zooming on account of the excessive demand for goods and services.
5.
Cost push inflation-Continually rising input costs leading to rising prices of goods and services

6.
Stag inflation
7.
Mark up inflation
8.
True inflation
13. Discuss the causes of inflation. How can inflation be controlled?
Sol: Demand related factors

Increase in disposable income of the people

Increase in money supply

Excessive speculation

Increase in foreign demand and hence exports

Increase in population leading to higher demand.

Supply related factors

Increase in exports for earning foreign exchange

Draught, famine or any other natural calamity adversely affecting agricultural production.

Scarcity of capital other complementary factors of production

Prolonged industrial unrest resulting in reduction of industrial production.

Speculative hoarding by the producers, traders and middlemen

Psychological expectations
Causes of inflation in India:

Increase in govt expenditure

Expansion of money supply

Deficit financing

Bank credit

Black money

Population growth

Over-dependence on agriculture


Natural calamities

Dependence on imports
Measures to control inflation:

Monetary policy

Fiscal policy

Control over investment

Price control and rationing

Increased production

Compulsory saving
14. Explain the concept of business cycle and its various phases.
Sol: A business cycle refers to regular fluctuations in economic activities in the economy as a whole. It signifies wavelike fluctuations in aggregate economic activity
particularly in national income, employment and output. A business cycle is a period of up and down movement in aggregate measure of current economic output and income.

Features:

A business cycle is a wavelike movement of economics activities.

Business cycle are repetitive and rhythmic

Peak and trough of a business cycle are not symmetrical

It is an economy wide phenomenon and self reinforcing

Business differ in time, prices and production generally rise or fall together

Business cycle are more marked in capital goods industries than consumer goods industries.
Phases of business cycle:

Prosperity: There is full employment in the economy representing around stability of output, wages, prices, income etc. All the factors of production are
fully employed. There is no involuntary unemployment. There is a high level of output, trade employment, income and profits are quite high. Business failures are very few.
Thus there is a feeling of optimism in the whole economy.

Recession: Is a turn from boom to depression. During this pd, businessmen lose their confidence and failure of some business houses discourages fresh
investments. A recession, once starts, tends to build upon itself much as forest fire, once under way tends to create its own draft and give internal impetus to its destructive
ability.

Depression: means a state of affairs in which real income consumed or volume of production per head and the rate of employment are falling or are
subnormal in the sense that there are idle resources and unused capacity, especially unused labor.

Recovery: After lowest point is reached, the economic situation begins to improve as a result of monetary and fiscal measure. Recovery first appears in the
capital goods industries, then an increase in investment, income and employment. Increased income with the people pushes up the demand for goods and services.
15. What are the causes of business cycles? Explain the measures have been suggested to control business cycle.
Sol: Various causes that lead to business cycle are:

Expansion and contraction of loans by banks

Change in the volume of investment

Under consumption or excessive saving

Lack of adjustment b/w demand and supply

Innovation

Feelings of entrepreneurs

Seasonal fluctuations

Other factors
Measures for controlling business cycle:
Business cycle brings about instability in the economy. That why modern economies follow stabilization policy to avoid the evil effects of business cycles. It means to prevent
the extremes ups and downs or boom and depression in the economy without preventing factors of economic growth to operate.

Monetary policy measures

Fiscal policy measures

Other measures(direct control by the govt)

16. Explain meaning & methods of measuring NI. Why measurement of NI is important for a country?
Sol: NI is the total market value of all final goods and services produced with in domestic territory including net factor income abroad during an accounting year. It also refers to
the aggregate of factor income earned by the normal residents of a nation during a given period.
Various concept of NI includes: GDPmp, GDPfc, NDPfc, NDPmp, Personal income private income, personal disposable income and per capita income.
Methods of measurement of NI

Value added method(production method)

Income method

Expenditure method

Gross value added in primary sectorCompensation of employees

+ Gross value added in secondary sector
+ Operating surplus
+ Gross value added in tertiary sector=
+Mixed income
=Domestic income(NDPfc)
+NFIA
(-)Dep
+ NI
(-)Net indirect taxes
(+) NFIA
=NI

Personal final consumption expenditure

+Gross domestic capital formation
+ Govt final consumption expenditure
+Net exports
=GDPmp
(-) Dep
(-)Net indirect taxes
(+) NFIA
=NI

Importance of national income: national income is a most important index of the overall economics situation of a country.
1.Economic policy: National income figures are an important tool of macro-economic analysis and policy, national income estimates are the most comprehensive measures of
aggregate economic activity in an economy. It is through such estimates that we know the aggregate yield of the economy and lay down future economic policy for
development.

2. Economys structure: National income statistics enable us to have a correct idea about the structure of the economy. It enables us to know the
relative importance of the various sectors of the economy and their contribution towards national income. From these studies we learn how
income is produced and how it is distributed, how much is spent, solved or taxed.
3. Economic planning: National income statistics are the most important tools for long-term and short- term economic planning. A country cannot
possibly frame a plan without having a prior knowledge of the trends in national income. The Planning Commission in India also kept in view the
national income. The national income estimate before formulating the five year plans.
4. Inflationary and deflationary gaps: National income and national product figures enable us to have an idea of the inflationary and deflationary
gaps. For accurate and timely anti-inflationary and deflationary policies, we need regular estimates of national income.
5. National expenditure: National income studies show as to how national expenditure is dividend between consumption expenditure and
investment expenditure. It enables us to provide for reasonable depreciation to maintain the capital stock of a community. Too liberal allowance
of depreciation may prove harmful as it may unnecessarily lead to a reduction in consumption.
6. Distribution of grants-in aid: National income estimates help a fair distribution of grants-in-aid by the federal governments to the state
governments and other constituent units.
7. Standard of living: National income studies help us to compare the standards of living of people in different countries and of people living in
the same country at different times.
8. International sphere: National Income studies are important even in the international sphere as these estimates not only help us to fix the
burden of international payments equitably among different nations but also they enable us to determine the subscriptions of different countries to
international organizations like U.N.O., I.M.F., I.B.R.D., etc.
9. Budgetary policies: Modern governments try to prepare their budgets within the framework of national income data and try to formulate anticyclical policies according to the facts revealed by the nation income estimates. Even the taxation and borrowing policies are so framed as to
avoid fluctuations in national income.
10. Public sector: National income figures enable us to know the relative roles of public and private sectors in the economy. If most of the
activities are performed by the state, we can easily conclude that public sector is playing a dominant role.
11. Defence and development: National income estimates help us to divide the national product between defense and development purposes.
From such figures, we can easily know how much can be spread for war by the civilian population.
According to Samuelsons- By means of statistics of NI we can chart the movement of a country from depression to
prosperity, its steady long term rate of economic growth and development and finally its material standard of living in

comparison with other nations

17. What do you understand by types and cost output relationship? Explain short run an long run cost output relationship.
Sol: Costs: A producer requires various factors of production or inputs for producing a commodity.

He pays them in the form of money(rent, wages etc)

Money incurred by a firm in the production of a commodity is its cost.

In economics money exp alone do not constitute cost but some other factor also include in cost(cost bear by owner)
Costs Function: It is mathematical expression of functional relationship between the costs and out-put level with determinants.

size of plant

Output level

Prices of inputs

State of technology (capital output ratio)

Managerial & administrative efficiency

Types of Costs

Real cost: Payment made to the factor of production to compensate for his utility of rendering services including troubles, pains and discomfort).
Opportunity cost: Forgone value from the use or application of a given resource from its next best application
Future cost: based on forecasts, involve appraisal of capital expenditure decision on new project.
Direct cost: are prime cost, having a direct relationship with a unit of operation
Indirect cost: indirectly incurred in production process.
Incremental cost: Additional cost associate due to change in method or technique.
Sunk cost: Which is made once and for all, cannot altered, increased or decreased, by varying the rate of output, nor can be recovered.
Historical cost: cost incurred in past on the acquisition of productive assets..
Replacement cost: Outlay that has to be made for replacing an old assets.
Social cost: Cost bear by the society.(cost of resources for which firm is not compelled to pay a price)
Explicit costs: Actually incurred expenses to buy or hire the productive resources, it needs in the production process.
Implicit costs: Deemed expenses or costs arise when the firm or owner supplies certain factors owned by himself.
Accounting costs: Include explicit costs only.
Economic costs: Include both explicit & implicit costs.
Fixed costs: Costs remaining unchanged, irrespective of the level of output.
Variable costs: Cost varying with output variation.

Marginal Costs: The additional costs relating to each successive unit-wise increment in total output. It is measured on the ratio of change in total cost to one unit change in total
output. Symbolically, thus, MC = where, D denote change in output assumed to change by 1 unit only.
Costs Function: It is mathematical expression of functional relationship between the costs and out-put level with determinants.

size of plant

Output level

Prices of inputs

State of technology (capital output ratio)

Managerial & administrative efficiency

Cost- output relationship: Cost output relationship helps in determining optimum level of production.
Short period: Short run is the period during which fixed assets like land, building plant etc remain unchanged. In this period production can be increased within the limit of
available production capacity by increasing the Qty of variable factors of production.
Short-run Average cost (SAC) Curve
U shaped indicating declining SAC in the beginning, then remaining constant for a while and then rising.

1) AFC= TFC/No. of units produced

There is inverse relationship b/w production and AFC If production increases, AFC decreases and if production decrease AFC increases.
2) AVC= TVC/ No. of unit
There is an inverse relationship b/w production and AVC. If production increase AVC decrease, this relationship holds true only up to the optimum levels of production.
Beyond optimum level, efficiency of variable factors of production decreases and wastage increase. AVC increases if production is increased beyond the optimum level.
3) ATC= AVC+AFC or TC/No. of units
It declining on an increase in production to a certain extent but beyond this extent, it starts
to increase. It starts to increase when the decrease in AFC is less than the increase in AVC.
Derivation:

AFC curve continues to fall from left to right but it never touches zero.

AVC curve falls from left to right to certain level of production after this curve starts to rise towards right and takes U shape.

ATC curve also behaves like AVC curve. It also takes u shape but it is more flat than AVC curve.

MC curve also behave like ATC and AVC, take U shape. IT intersects ATC and AVC curve at 1 and 2 points respectively. These points are the minimum
points of ATC and AVC curves
Long period: The period, in which a firm can increase its production capacity, in which the investment in land, building etc can be changed according to the need of
business. In long run all the cost are variable and no cost is fixed. Maximum adjustment is possible. As all the costs are variable there is no use of studying AFC and
AVC. Only the study of ATC is relevant.
Long-Run Average Costs Curve:
It relates to the cost-output relation in the long-run. It is a flatter U-shaped curve.

May not touch all SAC curves at their mini point

It refers to the lowest point on the long-run average cost curve, implying optimum use of factor-input and minimum average cost.
Derivation- The long run average cost curve is the envelope of the various short average cost curves. It is drawn as tangent to the SACs as depicted in below fig:

Tangent curve: By joining the various plant curves relating to different operational short run phases, the LAC curve is drawn as a tangent curve.
Envelope curve: It is the envelope of a group of short run average cost curves appropriate to different levels of output.
Planning curve: LAC curve is regarded as the long run planning device, as it denotes the least unit cost of producing each possible level output
and the size of the plant in relation to the LAC curve. A rational entrepreneur would select the optimum scale of plant.
Mini cost combinations: The cost levels be presented by the LAC curve for different levels of output reflect minimum cost combinations of
resource inputs to be adopted by the firm at each long run level of output.
Flatter U- shaped: The LAC is less U shaped or rather dish- shaped. This means that in the beginning it gradually slopes downwards then after

reaching a certain point, it gradually begins to slope upwards.

Modern theory of LAC

LAC and LMC are L- shaped, not U- shaped.

Consider the vital role of technological progress as a cost minimizing and output maximizing function.

Learning by doing-(Development of skill, shortcuts, machine quality control etc.).

18. Explain the different technique of demand forecasting.
Sol: Prediction of probable demand for the quantity produced for the market or an estimation of future demand.
Demand Forecasting Techniques:

Opinion polls and market research

Expert opinion

Surveys

Trend Analysis

Projection Techniques

Econometric Models
Opinion Polls Opinion polls are conducted on various issues. The issues could be political, economic, product related, market related etc.

Such polls are useful in detecting future trends and changes in trends which quantitative techniques might not be able to capture.

Market research uses the technique extensively to gather information on consumers behavior in the marketplace with respect to a specific product
or product category.
Expert Opinion involves seeking the opinion of experts on a subject matter.

Forecasts are generated by a group of expert executives.

Consumer Surveys:

It involves gathering of information about consumer behavior from a sample of consumers which is analyzed and then further projected onto the population.


Surveys are conducted to assess consumers perception of various aspects, such as new variations in products, variations in prices of the product
and related products, new variations in services provided etc.

The drawback of this method is that the consumer has to respond to hypothetical situations. The information collected through questionnaire,
personal observation and personal interview. Managerial economist can construct important demand relationship, such as- price demand, income and cross demand.
Market experiments:

Seller of a product introduces variations and tries it out in a representative market.

The seller gathers information on the behavior of the consumers in this representative market.

This is a high cost technique.

Advantage of market experiments are that they can be conducted on a large scale to ensure validity of results and consumers are not aware that they are a part
of experiments.
Consumer Clinics:

Consumers are asked to act in a simulated situation, wherein they are given a certain sum of money and made to treat in buying and their behavior is observed.

These are laboratory experiments. Participants have an incentive to purchase the commodity as they are usually allowed to keep the goods
purchased
Virtual Shopping

A representative sample of consumers shop in a virtual store simulated on the computer screen.
By doing so, this method eliminates the high cost in terms of time and money involved in consumer clinics.
Sample customers are asked to take a series of trips through the simulated virtual store.
Prices, packaging, displays and promotions are changed in subsequent trips and consumer reaction recorded.

The Delphi method is a systematic, interactive forecasting method which relies on a panel of independent experts.

The carefully selected experts answer questionnaires in two or more rounds. After each round, a facilitator provides an anonymous summary of the experts forecasts
from the previous round as well as the reasons they provided for their judgments.

Thus, participants are encouraged to revise their earlier answers in light of the replies of other members of the group.

It is believed that during this process the range of the answers will decrease and the group will converge towards the "correct" answer.

Finally, the process is stopped after a pre-defined stop criterion (e.g. number of rounds, achievement of consensus, stability of results) and the

mean or median scores of the final rounds determine the results

Projection Techniques: There are three kinds of projection techniques.

Compound growth rate

Visual time series projection

Time series projection using least square method

Visual Time Series projection: This technique plots the data and on the basis of the same a trend is projected through these data points. This method is better than the
compound growth rate as it considers data between the two end points.
Least square method of time series projection: This method ascertains how the dependent variable moves with time and time becomes the independent variable. This takes
into account trend, seasonal, cyclical and random components. The function could be additive or multiplicative.