Managerial Economics

ASSIGNMENTS
Assignment A
Q.1. What are indifference curves? Explain the consumers equilibrium
under the assumptions of ordinal approach.

What are indifference curves?

ANSWER:
An indifference curve is a graph showing combination of two goods that
give the consumer equal satisfaction and utility. Each point on an
indifference curve indicates that a consumer is indifferent between the two
and all points give him the same utility.

Explain the consumers equilibrium under the assumptions of ordinal

approach.

ANSWER:
The consumer is in equilibrium when he maximizes his utility, given his
income and the market prices. Two conditions must be fulfilled for the
consumer to be in equilibrium.
The first condition is that the marginal rate of substitution be equal to the
ratio of commodity prices. This is necessary but not sufficient condition.
MU x Pffffffff
MRS x ,y = ffffffffffffffff
= x
MU y P y

The second condition is that the indifference curve be convex to the

origin. This condition is fulfilled by the axiom of diminishing marginal
rate of substitution of x for y and vice versa.

Q.2. Examine the concept and relationship of Total, Average and marginal
costs with the help of suitable diagram.
ANSWER:
Total Cost
Total cost is the total expenditure incurred on the production. It connotes
both explicit and implicit money expenditure and include fixed and
variable costs.
b

C = f X,T,P f ,K

C=

Where

total cost

X=

output

T=

technology

Pf =

prices of factors

K=

fixed factors

TC = TFC + TVC

Total Cost Curves

Average cost
Average cost is obtained by dividing the total cost by the total output.
AC =

TC
ffffffffff
Q

Average cost further can be categorized as average fixed cost (AFC) and
average variable cost (AVC).
TFC
AFC = fffffffffffffff
Q
AVC =

TVC
fffffffffffffff
Q

Average cost curves

Marginal Cost
Marginal cost is the change in the total cost for producing an extra unit
of output.
MC = TC/Q

Marginal Cost Curve

Q.3. Differentiate and elaborate the concepts of returns to scale and law of
variable proportions.
ANSWER:
Law of variable proportions

APL
L
Stage I Capital is
Underutilized and
Successive units of
L add greater
Amounts to TP

Stage II Addition to
TP due to increase in
L continues to be
positive but is falling
with each unit

MPL
Stage III Fixed Input capacity
is reached and additional L
causes output to decline

Under Law of variable proportion: only one variable input varies all other
variable kept constant. Law of variable proportion shows the relationship if
one variable input increase (eg: Labour) by keeping all other variable
constant; total product and marginal product increase upto a certain point
after that it will increase at a diminishing rate. it shows in three stage first
increase then constant and then decrease. Law of variable proportion is for
short period

Laws of Returns to Scale

Under Law of Return to Scale all the variable inputs varies except the
enterprise. Law of return to scale shows the relationship between inputs and
output at three different stages: 1. output increase more than inputs, 2. output
and input are constant, 3. output is less than proportionate input. law of

return to scale is for long period.

Q.4. Why is demand forecasting essential? What are the possible

consequences if a large scale firm places its product in the market without
having estimated the demand for its product?
Answer:
Demand forecasting is essential due to the following:
Better planning and allocation of resources
Appropriate production scheduling
Inventory control
Determining appropriate pricing policies
Setting s les targets and establishing controls and incentives.
Planning a new unit or expanding existing one

Planning long term financial requirements

Planning Human Resource Development strategies.

There are two possible consequences when a firm places its products on
the market without having estimated the demand for its product.
Overestimation is a significant problem when forecasting. If a business
projects demand to be very high for the next period but is turns out to be
unusually low, they could end up with spoiled and wasted stock, too much
inventory and a lack of cash flow.
Underestimating demand can result in missed opportunities and a failure to
exploit a products potential. If a business expects demand to be lower than it
actually is, they may not have enough inventory to meet customer needs. It
can also negatively impact their pricing strategies and can cause a loss of
market share.

Q.5. Discuss the various steps involved in a managerial decision making

process. Explain, in detail, any two group decision making techniques.
ANSWER:
STEP 1
Problem identification -for it is what determines the direction that the
decision making process takes, and, ultimately, the decision that is made.

STEP 2
Generating the alternative course of action
This step involves identifying items or activities that could reduce or
eliminate the difference between the actual situation and the desired
situation. For this step to be effective, the decision makers must allot enough
time to generate creative alternatives as well as ensure that all individuals
involved in the process exercise patience and tolerance of others and their
ideas.

STEP 3
Evaluating the alternative
In the Pursuit of quick fix managers too often shortchange this step by
failing to consider more than one or two alternatives, which reduces the
opportunity to identify effective solutions. After generating a list of
alternatives, the arduous task of evaluating each of them begins.
Numerous methods exist for evaluating the alternatives, including
determining the pros and cons of each; performing a cost-benefit
analysis for each alternative; and weighting factors important in the
decision, ranking each alternative relative to its ability to meet each
factor, and then multiplying cumulatively to provide a final value for
each alternative.

STEP 4
Selecting the Best Alternative
After the decision-makers have evaluated all the alternatives, it is time for
the fourth step in the decision-making process; choosing the best alternative.
Depending on the evaluation method used, the selection process can be
fairly straightforward. The best alternative could be the one with the most
"pros" and the fewest "cons"; the one with the greatest benefits and the
lowest costs; or the one with the highest cumulative value, if using
weighting
STEP 5
Implementing the Decision
This is the step in the decision making process that transforms the
selected alternative from an abstract situation into reality. Implementing
the decision involves planning and executing the actions that must take
place so that the selected alternative can actually solve the problem.

STEP 6
Evaluating the Decision
In evaluating the decision, the sixth and final step in the decision-making
process, managers gather information to determine the effectiveness of
their decision. Has original problem identified in the first step been
resolved? If not, is the company closer to the situation it desired than it
was at the beginning of the decision-making process?

Two group Decision Techniques

Brainstorming
Brainstorming is a technique in which group members spontaneously
suggest keys to solve a problem. Its primary purpose is to generate a
multitude of creative alternatives, regardless of the likelihood of their being
implemented.
Delphi Group Technique
The Delphi group Technique employs a written survey to gather expert
opinions from a number of people without holding a group meeting. Unlike
in brainstorming and nominal groups, Delphi group participants never meet
fact to face; in fact, they may be located in different cities and never see
each other.

Assignment B
Q.1. Why a firm is price taker and not a price maker under perfect market
conditions?
ANSWER
In perfect market conditions a firm is a price taker because other firms can
enter the market easily and produce a product that is indistinguishable from
every other firms product. This makes it impossible for any firm to set its
own prices. There are two main reasons why a firm cannot get away with

setting its prices above the market price. First, there is no difference
between its product and that of every other firm in the market. Therefore, no
one will pay extra for a firms product the way that they might pay extra for
something like Nike shoes. Second, if firms were to succeed in setting a
higher price, more firms would enter the market, attracted by the higher
profits that were available. This would increase supply and drive down the
price of the firms product.

Q.2. Profit maximization is theoretically the most sound but practically

unattainable objective of business firms. In the light of this statement
critically appraise the Baumols sales revenue maximization theory as an
alternative objective of the firm.

ANSWER
The Baumols Sales Revenue Maximisation Theory states that;
Managers rewards are more closely linked to Sales rather than
Profits.
Firms aim to maximize Sales Revenue, but subject to a Profit
Constraint.
Profit constraint is exogenously determined by the demand and
expectations of the shareholders, banks and other financial
institutions.
A Sales Revenue Maximizing firm, in general, produces a greater
output than a Profit Maximizing Firm and sells at a price lower than
the profit maximiser.
The maximum sales revenue will be where e = 1 (and hence MR = 0)
and will be earned only if the profit constraint is not operative.
If the profit constraint is operative the sales revenue maximiser will
operate in the area where price elasticity is greater than unity.
Q
QS
QRS

=
=
=
=

Profit Maximising Output

Sales Maximising Output
Constrained Sales Maximizing Output
Profit Curve

Q.3. Distinguish between skimming price and penetration price policy.

Which of these policies is relevant in pricing a new product under different
competitive conditions in the market?
Skimming Pricing: This pricing strategy is adopted when close
substitutes of a new product are not available in the market. To extract
the consumer surplus, setting up a very high price initially and then a
subsequent lowering of prices in a series of reduction.
Penetration Pricing: This pricing policy is generally adopted in case of
the availability of close substitutes of the new product in the market. To
penetrate in the market, initially a lower price is designed, as soon the
product captures the market, and price is gradually raised up.

Penetration pricing will be relevant in the pricing of new product under

different competitive conditions in the market.

CASE STUDY

Introduction
Michael Wolfson, a computer programmer had a decent job with the financial
powerhouse Bear, Stearns & Co. Now, he refurbishes computers at the basement in his
house and sells it through e-bay. He plans to join as a school teacher. Michael lost his job
in 2003. He was told that his job is being outsourced to India. Paul Schwartz, a
mainframe programmer, who was earning $ 80,000 a year was told that his services were
no longer required. He suspects that his job has been outsourced to India.
There is growing dissent among the Americans against the increasing practice of
outsourcing. It has become an electoral issue in the coming presidential elections in the
US. The Democratic candidate, John Kerry has made it an emotive issue, despite
economists
trying
to
portray
the
positive
aspects
of
outsourcing.
There are numerous reasons for the growing apathy towards outsourcing. The
prevailing economic situation and the increasing joblessness in the US have added fuel
to the fire. However, many analysts feel that joblessness in the US is cyclical in nature
resulting from the recession of 2001 and hence, a recovery will create job opportunities.
Moreover, according to the U.S.-India Business Council, the increasing unemployment is
also due to corporate restructuring and just a quarter of the job loss is due to
outsourcing. Since, the beginning of 2001, the real job loss in US is estimated to be 2.3
million. In comparison, the actual job loss due to outsourcing is estimated to be only
200,000. Thus, it can be said that there are various other reasons for joblessness in the
US. The outcry against outsourcing seems to be driven more by politics rather than
economics.
Outsourcing forms a small proportion of the jobs that are regularly churned in the US
economy. On an average, 24 million jobs are churned in the US every month. In the
process, resources are allocated, for more productive purposes. To come out of the
recession and raise the standards of living, higher productivity seems to be the only
solution. The debate on outsourcing gathered momentum only in the recent past. A
study by Forrester, a research group, in the year 2002, brought the issue into limelight.
The report claims that by 2015, 3.3 million white-collar jobs in the US would be
transferred to countries like India.
The Economics of Outsourcing

But is outsourcing so bad for the US economy? Gregory Mankiw, professor of economics
at the Harvard University and head of President Bush's Council of Economic Advisers,
recently told presspersons that outsourcing of jobs is in better interest of US. According
to him, outsourcing lowers the cost for consumers, making the corporations more
efficient. There were a series of articles in The Economist, highlighting the advantages of
outsourcing.
There are many influential groups in the US who are perturbed by the recent outcry
against outsourcing. Says Charles E Morrison, President, East West Center, a US based
think tank, "Off-shoring is not an economic problem, but an economic opportunity".
Many analysts in the US feel that anti off-shoring bills in the US would prove to be
ineffective. Similar views were echoed by Michael T Clark of US-India business council.
He says that, "Jobs lost to off-shoring were less than a quarter of all jobs lost in the US in
2002. The rest were lost due to corporate restructuring. The current debate in the US on
off-shoring is informed by lack of facts".
In an article, "Why Your Job Isn't Moving to Bangalore" in the New York Times, Jagdish
Bhagwati, a senior fellow at the Council on Foreign Relations and professor at Columbia
University writes that the panic and furor over outsourcing is completely unwarranted.
He further says that no jobs are being taken away from America. He says that the affect
of changes in technology is being felt in the labor intensive industries. According to him,
the loss of jobs in the US is due to technological changes.
Professor Bhagwati is also critical about politicizing the whole issue. He says that
outsourcing will strengthen the competitiveness of the US companies. Firms ignoring
the cheaper supplies would lose out. Professor Bhagwati further says that outsourcing
service jobs is nothing different from importing of labor-intensive textiles and other
goods. According to him, all empirical studies in the US over the last two decades
suggest that wage stagnation in the manufacturing industry is more due to automation
of the processes, not the cheaper imports. The same is applicable to service industry as
well.
Jane Linder of Accenture's Institute for Strategic Change says that companies
outsourcing the traditional back-office work have more control and discipline over their
operations. Moreover, employees of the company can concentrate on framing strategies.
Further, outsourcing also results in greater efficiency and lowering costs. This allows
companies to offer better services to customers. A study done by McKinsey Global
Institute reveals that for every dollar of work outsourced by the US, it gets back $1.14 as
income, and the countries to which the work is being outsourced gains 35 cents. This
shows that outsourcing is a win-win situation for both the countries.

Benefits for US

Benefits for India

Savings to US investors or customers

Imports of US goods and services by providers in
India
Transfer of profits by US based providers in India
back to US

0.58

Net direct benefit retained in US

0.67

Value for US labor reemployed

0.450.47

0.05
0.04

Labor
Profits retained in
India

0.1

Suppliers

0.09

Central government
0.03
taxes
State government
taxes

1.12Net benefit to India

1.14
Source: Mckinsey Global Institute

Potential net benefit for US

0.1

0.01

0.33

There is a definite cost advantage in off-shoring work to India. These advantages are a
result of lower wages in the developing countries along with the development of
telecommunications in these countries. A report published by HSBC, which has offshored more than 4,000 jobs to India, says that the telephone costs from India to America
and Britain has decreased by almost 80%, since January 2001. The wage difference
between these countries is also a factor that forces the companies to outsource their
business processes to India. A study done by NASSCOM, says that the average salary of
an IT professional in UK is $96,000, in US it is $75,000, whereas in India it is just $26,000.
The wage difference between the low end call center jobs of both the countries is also
very wide. An average call center employee in UK earns $20,000 on the average.
Whereas, a call center professional in India barely manages to earn one tenth of the
earnings of their British counterparts.
Offshoring allows companies to work round the clock. It gives ample time to the
companies to think about their IT problems. Recently, American Express paid $5,000 to a
group of software programmers in India, to develop a package for them. The same
would have cost them several million dollars in US.
The benefits of outsourcing go much beyond the cost advantage. An article in Mckinsey
quarterly suggests that the companies need to look beyond cost savings. The article says
that "Companies are merely replicating what they do at home, where labor is expensive
and capital is relatively cheap, in countries in which the reverse is true."
Alan Greenspan, US Federal Reserve Chairman, is a staunch supporter of outsourcing.
He is of the opinion that any move to curb outsourcing of work to countries like India
and China, might give just a temporary relief. Reacting to the proposed legislations in
the US banning outsourcing, Greenspan said, "A new round of protectionist steps is

being proposed against outsourcing. These alleged cures will make matters worse".
Greenspan feels that any effort to protect US jobs through legislation would backfire.
Not all companies have taken full advantage of outsourcing. According to Harris Miller,
president of the Information Technology Association of America (ITAA), a lobby group,
so far only 3-4 % of all American companies outsource their processes. The remaining
still rests with American firms. A report published by Forrester, in December 2003, says
that 60% of the Fortune 1000 companies have a negligible or near nil presence in offshoring. Report also suggests that 40% of the work of these companies could be
outsourced. Thus, the potential for growth in outsourcing is still immense.
Advancement in the technology can give a further push to the off-shoring activity. The
inflexible architecture of the current technologies is acting as a hindrance in off-shoring,
says Simon Heap of Bain & Co, a consultancy firm. The advancement in software and
hardware would enable the companies to off-shore even small activities. Firms would be
able to off-shore the activities of the entire department, say billing of customers.
However, not everyone seems to agree with the supporters of outsourcing. Stephen
Roach, the chief economist at Morgan Stanley, says that it is only the wage difference
that is encouraging companies to outsource work to India or any other developing
country. He further says that joblessness is taking away the charm of recovery in the US.
Many analysts also feel that companies should take some concrete steps to minimize the
affects of outsourcing. Companies should make the process of job transfers to offshore
destinations more smooth. British Telecom exhibited a process of outsourcing that can
be used as a model by other companies.
In 2003, when BT announced that it is planning to open two call centers in India, with a
capacity of 2200 people, it was criticized from all corners. It was said that BT was not
acting in a socially responsible manner. Realizing the gravity of the situation, BT
approached Sustainability, an international consultancy, specializing in business
strategy and sustainable development. The consultancy firm was asked to find whether
or not outsourcing and corporate social responsibility (CSR) co-exist.
Sustainability noted that the immediate impact of outsourcing would be job loss for the
employees, and the resulting affect on the society. The consultancy firm was of the
opinion that before outsourcing, companies should address the negative impact of
outsourcing. In order to check the negative impact of off-shoring, firms should consult
with employees, trade unions, communities and other key stakeholders. Employees
should be involved in the process of any such decision making. Sustainability also
suggested that firms should be transparent and make the employees know the services
that are being outsourced.
Firms should also make an attempt to redeploy the employees in some other
departments. This would minimize layoffs. An attempt should be made to retrain the

redundant workers. A part of the savings from off-shoring should be invested for this
purpose. As per the suggestion made by McKinsey Global Institute, 4-5% of the
resulting savings from off-shoring should be used for insurance policy for employees to
cover the lost wages.

US was one of the prime supporters of free trade. US was least bothered about the
concerns of many other developing countries when they raised their voices against job
losses as a result of the cheap exports. But, this aggressiveness seems to have mellowed
down in recent days. It always propagated that inefficient industries should be closed.
One of the primary tasks of the U.S. Trade Representative's office was to keep a check on
the world markets. It assesses the markets which are opening up and which are getting
closed as a result of high tariffs and other quantitative restrictions. Now, with the
growing efficiency of developing countries in the service sectors, many jobs in these
sectors are being transferred to developing countries (of which a major chunk is coming
to India). US is worried about the increasing joblessness but that seems paradoxical. It
hails globalization but when it comes to the developing countries trying to reap the
benefits of globalization, it raises all sorts of issues.
Recently the US government has tightened the visa norms. The number of H-1B visas
issued to Indian software programmers fell to 65,000 from 1,95,000 in 2003. Analysts feel
that this would increase outsourcing of jobs further, particularly to India. According to
Craig Barrett, the chief executive of Intel, granting of fewer visas would force the
companies to shift their jobs to countries like India, where there is no dearth of qualified
engineers.
Despite no ban from the federal authorities on outsourcing, many States have initiated
the process of putting restrictions on outsourcing government work to foreign countries.
The lawmakers in the state of New Jersey have proposed a bill that stops firms to
outsource any government related work to a foreign country. Succumbing to the public
pressure, the government was forced to bring back a helpline for welfare recipients that
was being outsourced to India. Similarly, the state of Indiana withdrew a $ 15 million
contract from an American subsidiary of an Indian IT firm. Commenting on the move,
the Indiana governor said that contract was not in tune with Indiana's vision of
providing better and more job opportunities to local companies and workers. However,
analysts feel that these decisions have been influenced by political pressure in the
backdrop of coming presidential elections in the US.

The Indian Response

The Indian BPO industry is not taking the outcry against outsourcing in the US
seriously. Indian BPO firms are no longer just call centers. Their activities now cover
marketing and knowledge based services. These companies are now aspiring to become

strategic partners for US companies. There is a sudden spurt in the number of venture
capitalists willing to invest in different areas. Though, some software companies can't
hide their concern over the legislations banning government related off-shoring in the
long-run but, for now they are clear that, these legislature will have negligible effect on
the current contracts with the private companies. Reacting to the whole issue, Narayana
Murthy, Chairman and Chief Mentor of Infosys said that there is no issue to worry
about. He termed the outcry as normal. He suggested that rather than getting worried
and agitated, Indians should put forward their point of view and explain the advantages
of off-shoring. He said that the present uncertain economic situation is responsible for
the concern over the job losses in the US.

Many analysts feel that the opposition to outsourcing may not end with the US
presidential elections. With many of the American States, coming out with legislations
banning government contracts to other countries, the issue of off-shoring is going to be
alive. Conditions for off-shoring may become favorable with the improvement in the
performance of the US economy.

Question for discussion:

Que. 1 Give your opinion on outsourcing and its impact on the prospects of growth
of the economy of home Nation and host nation.
Guidelines for the answer: Discuss the issue in the perspective of opportunity and
threats faced by developing and developed nations.

ANSWER
Outsourcing means using international cheap labor force and also doing in
the countries with cheapest sources of labor and supplies. Some of the
companies transfer their internal activities and decision rights of action to
outside suppliers or companies. Outsourcing is a situation in which a
company employs another organization to do some of its work, rather than
using its own employees to do it.
Benefits of Outsourcing to the Host Country
1. Improve Economic Growth of Host Country
Call centre Outsourcing brings cost advantages and increase in profits in
macroeconomic terms to both home countries which business undertakings
as well as host country benefits in various aspects. During last few years
India has achieved tremendous growth rate by contributing services of off
shoring. According to market research, India has been benefited extremely

from growth in this outsourcing area and the rate of growth is above the
expectation level.
2. Reduce Unemployment and Create New Employment Opportunities
Outsourcing services will be the good sign for developing countries with
high rate in unemployment. Services off shoring will lead to expand
employment opportunities in developing countries like India. India has
paved the way for a significant number of jobs In terms of growth in off
shoring area. For countries that are outsourcing services to other countries,
there will be loss of jobs in that country.
3. Outsourcing provide motivation for Education
Outsourcing relies on a basis for cheap, but with well educated and highly
skilled workforce. The highly skilled labours are created from well
established education process. In India the payment level provided by
employees who are working in the outsourced companies are above the
industry average range of salary. On other hand this type of employment can
be considered as more respectable job. These factors lead to motivation to be
part of outsourced company.
4. Host country Consumers get Advantages of Quality of Services
Host country customers enjoyed by getting qualitative services which are
normally served to developing counties.
5. Transfer of Advance Technology to Host Country
Outsourcing requires appropriate technical sophistication. For example, it is
essential to have reliable and inexpensive communication links with the rest
of the world when doing outsourcing. Host country can get massive
advantages from latest technology in short term as well as long term. There
is no limitation to transfer technical knowledge.
Conclusion
Host Country will be benefited by transmitting latest technology, global
training for the employees, creation of massive job opportunities and rapid
growth in GDP. On the other hand The benefit arrived for home country due
to outsourcing is , people who live in home country need to less amount of
money to purchase well qualitative goods and services, this lead to improve

greater savings in home country which finally affect positively in home

countrys economy
In particularly while host country is being getting advantages of the
outsourcing at the same time the employees in the home country will be
affected by the facts of unemployment. Because outsourcing the jobs have
possibility to lose. The developing countries like India , Sri lanka get
benefited because of outsourcing , but in other hand the people in the
developed nations will suffer from unemployment. Even though it improve
unemployment level of economy of home country, it positively affect on
home countrys economy by improving GDP. Then this leads to improve
productivity on global economy.

Assignment C

1C
2B
3B
4A
5B
6B
7C
8C
9D
10 D
11 C
12 D
13 B
14 A
15 B
16 A
17 B
18 C
19 A
20 B

21 C
22 D
23 B
24 A
25 B
26 B
27 D
28 C
29 D
30 B
31 B
32 B
33 B
34 B
35 D
36 A
37 A
38 A
39 C
40 A