Enrollment No.

: MBISMCT11118178

MBA Information Systems 1st Year Assignment

Annamalai University

2: Managerial Economics

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Question #3: Explain how inflation will affect the economy of a
country with suitable examples.
Answer:-

What is Inflation?
Everyone is familiar with the term Inflation as rising prices. This means the
same thing as fall in the value of money. Inflation is a monetary ailment in an
economy and it is defined by economists in so many ways. When there is
persistent and appreciable rise in the general level or average prices, we
have inflation. Economists have defined inflation as follows
Based on phenomenon of rising prices
State in which the value of money is falling, i.e., the prices are rising.
Crowther
I define inflation as substantial rise in prices. Harry G. Johnson
Inflation is a persistent and appreciable rise in the general level or average
of prices. Gardner Ackley
Based on Monetary phenomenon
Inflation is always and everywhere a monetary phenomenon. Friedman
Too much money chasing too few goods. Coulborn
Issue of too much currency. Hawtrey
Inflation is too much money and deposit currency, that is, too much
currency in relation to the physical volume of business being done."
Kemmerer
All these definitions indicate one basic phenomenon in the economy. Too
much of money in circulation compared to too little goods produced leading
to extraordinary increase in prices. It should be noted that inflation is not all
about high prices, but it is a persistence increase in prices to an abnormal
extent.
Keynesian View
While increase in volume of money is responsible for rise in the price level,
Keynes related inflation and rise in prices as follows
a) It comes into existence after the stage of full employment.
b) Rise in prices may be accomplished by increase in production.
c) Rise in prices not accompanied by increase in production.
Keynes defined inflation as a phenomenon of full employment. According to
him, inflation is the result of the excess of aggregate demand over the
available aggregate supply and true inflation starts only after full
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employment. So long, there is unemployment, employment will change in
the same proportion as the quantity of money and when there is full
employment, and prices will change in the same proportion as the quantity
of money.
Keynes does not deny that prices may rise even before full employment,
mainly due to the existence of certain bottlenecks in the expansion of
output. However, he termed such a rise in prices as semi-inflation. It is the
true inflation (after full employment), which poses a real threat to the
economy and is to be worried about. Hence in Keynesian sense, inflation
refers to a rise in the price level after full employment is reached.
But in an underdeveloped country, the term inflation cannot be used in the
Keynesian sense.
For Example:
In a country like India, we can witness inflation and unemployment
existing side by side. Abnormal rise in prices and persistent rise in prices is
not an indication of prosperity and that the country is moving towards full
employment. On the other hand, the backlog of unemployment is mounting
up year by year.

Types of Inflation
Based on different considerations and categories which result in inflation, it
can be classified as follows
1. On the Basis of Speed
On the basis of speed or rapidity with which prices increase, inflation is
divided into
(a) Creeping inflation. (b) Walking inflation. (c) Running inflation. (d)
Galloping inflation or Hyper-inflation.
a. Creeping inflation as name itself suggests, is slow-moving and very
mild. The rise in prices will be perceptible but spread over long
period of time. This type of inflation is not dangerous to the
economy. Economists consider this type of inflation as favorable for
development and preventing stagnation. This has attracted
attention in some countries for example: Germany and USA.
b. Walking inflation takes place when creeping inflation takes
momentum. In this case, the rise in prices becomes more marked
and it is danger signal.
c. Running inflation will have sharp and vigorous rise in prices.
d. In the case of Galloping or Hyper-inflation, the prices will not only
rise sharply but they rise in fits and starts. This type of inflation is
dangerous to the economy and cannot be controlled easily. It ruins
fixed middle income group for example: First World War Germany.
2. On the Basis of Inducement
a. Deficit-induced inflation: This is caused by the adoption of
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unbalanced budgetary policies. The government would resort to
deficit financing which means government spending in excess of its
revenue receipts.
b. Wage-induced inflation: This denotes a rise in prices due to an
increase in money wages. A small general increase in the price level
may induce the labor organizations to clamor for more wages or any
change in monetary or fiscal policies if the government resulting in
increase of price level will make the laborers demand more wages.
c. Profit-induced inflation: This occurs on account of increase in the
profits of manufacturers. This is possible when there is general
increase in the price level or an increase in the price level of new
capital goods.
3. On the Basis of Time
Emergencies like war or preparations for war will create inflationary
conditions in the economy. Sudden launching of war will strain the
economy, as all the factor resources have to be pooled for war
purposes. The government would resort to deficit-financing and there
will be massive expansion of money supply for producing materials and
ammunition for war, besides food for defence personnel and also for
the people.
Besides war, the post-war period will also breed inflation due to
rehabilitation and development work undertaken by the government to
set right the war-torn economy. Thus inflation can be classified as wartime inflation and post-war inflation and inflation due to development
activities.
4. On the Basis of Extent of Coverage
In this category inflation can be classified as
a. Economy wide: It signifies inflation of a very comprehensive nature
covering the entire economy. No section of the economy will be left
untouched by the rising prices and the impact will be felt by the
nation as a whole.
b. Sporadic: It is partial in character and sectional in nature. It occurs
only in specified sectors or sections of the economy due to
abnormal but temporary shortage of some specific goods. The
defect may not be fundamental but only superficial.
For Example: increase in prices of food products as a result of crop
failure in the season.
c. Open Inflation: Means price rise will be uninterrupted. If it is allowed
to have its own way will reach to dizzy heights as in case of
Germany, Austria during the 20s.
d. Suppressed Inflation: Occurs when government controls and
prevents goods prices and money wages from rising, so the excess
demand is not reduced but suppressed.
5. Based on causes
Based on two important forces demand and cost, which would create
inflation are classified as follows
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a. Demand-Pull inflation: This type of inflation occurs when there is
excess demand force acting in the economy leading to rise in prices.
It emerges when the aggregate demand exceeds the level of full
employment output. Keynes calls this as bottleneck inflation.
Generally, demand-pull inflation occurs due to heavy government
expenditure either for financing war or financing development
projects.
b. Cost-Push inflation: When there is an increase in the cost of
production of goods and services, it is likely that cost-push inflation
will occur. Increase in cost of production mainly occurs due to an
increase in the employees wages.
For Example: OPEC reduces oil supply; prices are artificially driven
up and result in higher prices at the pump. This Type of Inflation is
also known as Supply shock inflation.

Effects of Inflation
Inflation has good as well as bad effects on the economy. In the initial stages,
mild inflation may create an all-round expansion of business activity and this
proves beneficial to the economy. Inflation is good up to the stage of full
employment. But the trouble is that the rise in prices is not uniform
throughout the economy and there may be distortions due to inflation
causing many imbalances. Lets see effects of inflation on various sections
of the society
i.
On producers: Inflation is a period of boom and prosperity for the
producing classes. All businessmen, traders, speculators gain during
inflation because of (a) windfall profits and (b) appreciation in the value
of their stock. Normally, there is a time-lag between a rise in the prices
of commodities and rise in the cost of production. Prices of goods
increase at faster rate during the period of inflation and the cost of
production lags behind as wages, interest, insurance etc. are almost
fixed. This gives enormous scope for windfall gain. Further, with the fall
in the value of money, businessmen try to appreciate the value of their
stock. Thus, inflation is a blessing in disguise to the business class at
the initial stages.
ii.
On Working Class: Working class suffer during inflation, as their
wages do not rise proportionately with the rise in prices and cost of
living. These days workers of the organized group do not suffer much
as they react faster during the inflation. Whereas other unorganized
groups like self employed and agriculture labours find it very difficult
during inflation. The condition is equally distressing for those workers,
who have little bargaining power from their organizations.
iii.
On fixed income groups: This is the worst hit class during inflation.
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iv.

v.

vi.

vii.

People living on past savings, fixed interest, on investments,

pensioners, salaried class like teachers and government employees
find inflation and rising in prices very agonising, as their fixed
purchasing power decline in the face of mounting cost of living. This
class of people, called the middle income group, which form the bulk of
the society become the worst sufferers.
On Distribution: Inflation has bad effect on distribution too. Since rise
in price and rise in income may not be uniform in all sectors and
sections of the economy there will be distortions and imbalances
causing bottlenecks in distribution and fluctuation in production and
effective distribution. For instance, during inflation the price of
industrial goods go up rapidly and prices of agriculture produce are not
so flexible. The returns of farmers diminish and their economic
condition deteriorates due to mounting cost of commodities and
industrial product which they must buy. The net result will be that
some classes enjoy the benefits of inflation while others suffer from it.
On debtors and creditors: During the inflationary period the debtors
(borrowers) gain much while creditors (lenders) lose heavily. When
prices rise, the real value of money falls and the debtors have to pay
money which has less purchasing power. This will be beneficial to
debtor while the creditor will be getting back amount whose value of
purchasing power has declined.
On Government: The government too will be affected by the inflation.
The public sector undertaking may have to raise the expenditure level
due to a fall in the value of money. Alternatively they would cut the
size of the projects and programmes to meet with the original
budgeted expenditure. On other hand government will be benefited
during inflationary period, as it is a largest borrower as we have in the
case of debtors.
Social Consequence: If inflation is persistent and severe, it has
baneful influence on society. It makes rich richer and poor poorer.
There is an all-round frustration among the salaried and fixed income
groups. The producing and trading classes gain at the expense of
salaried fixed income groups. Thus there is transference of income
from poor to rich. Due to enormous rise in prices and scarcity of
essential commodities, there is black-marketing, hoarding and
profiteering. Inflation becomes social menace and political problem if
necessary steps are not taken.

Effects of inflation on Economy of a country

Inflation and the economy of a country are closely related. The effect on the
economy of any country is not immediate or it does not affect the economy
overnight. There is a cumulative effect. Several such changes build up to
bring about a big change. The economy of a country is affected by inflation
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in a number of ways.
Inflation and the economy both influence all the major macroeconomic
indicators of a country. The various macroeconomic indicators include the
following:
Gross domestic product or GDP
Producer price index (industrial)
Consumer price indices
Industrial production
Capital Investment
Agricultural production
Export
Import
Demography
Debt
Inflation not only affects the macroeconomic indicators, it affects the living
standards of the people. The exchange rates of all currencies also change.
This in turn influences trade. When exchange rates are affected, the interest
rates cannot be far behind.
Inflation and its effect on economy are enormous. In other words, all events
are interlinked and the entire economic cycle gets upset.
For Example:
1. The mortgage crisis of 2007 in USA could best illustrate the ill effects
of inflation. Housing prices increases substantially from 2002 onwards,
resulting in a dramatic decrease in demand.
2. India after independence has had a more stable record with respect to
inflation than most other developing countries. Since 1950, the
inflation in Indian economy has been in single digits for most of the
years, as shown in the following table
Period
1950-1960
1960-1970
1970-1980

Avg.
Inflation
rate
2.00%
7.20%
8.50%

In early 2007, in India, the inflation rate, as measured by the wholesale

price index (WPI), hovered around 6-6.8%, well above the level of 55.5% that would have been acceptable to the Reserve Bank of India
(RBI), the country's central bank. On February 15, 2007, the inflation
rate reached a two-year high of 6.73%. In the past, the main cause of
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high inflation in India used to be rises in global oil prices. However, in
early 2007, the chief component of the inflation was the increase in the
prices of food articles - caused by increased demand as well as supply
constraints. According to analysts, the increased demand was due to
high economic growth and increased money supply, while stagnant
agricultural productivity was behind the supply constraints.

Apart from the rise in prices of food articles, fuel and cement prices too
recorded high increases. The Government of India, together with the
RBI, took several measures to contain inflation. For example, the RBI
increased the Cash Reserve Ratio (CRR) and repo rates in an effort to
check money supply; the Government of India reduced import duties
on several food products and cut the price of diesel and petrol.

The RBI also chose not to intervene when the Indian Rupee rallied
against the US Dollar between March 2007 and May 2007. The decision
not to intervene was based on the idea that a stronger Rupee would
bring down the cost of imports, which, in turn, would help reduce
domestic prices of goods. Though the measures taken by the GoI were
targeted at inflation, some analysts feared that some of these
measures, especially the ones leading to higher interest rates, might
induce recession in the Indian economy. There were others who felt
that letting the Rupee rise would not only have a negative effect on the
bottom lines of companies that earn a substantial percent of their
profits from exports, but also impact the long-term competitiveness of
Indian exports.

Inflation in India a menace a few years ago is at a 30 year low. The

inflation ended at a low of 0.61% in the week ended May 9, 2009 this
after reaching a 16 year high of 12.91 % in August 2008, bringing in a
sigh of relief to policymakers. Following diagram illustrates latest
inflation rates in India

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Question #4: Explain pricing methods and which method will be
suitable in present age?
Answer:-

Need for Pricing Methods

There are many practical pricing methods adopted by the firms, based on
different considerations. While fixing the price, the firm is guided by some
objectives such as, profit maximisation, sales maximisation, establishing a
favourable image with the public or limiting competition, etc. Every firm sets
certain objectives and tries to accomplish them.
Formulating price policy and adopting a particular pricing method is often a
critical factor in the successful operation of a business organization. Even
though the basic problem of pricing is the same for all firms (i.e. Costs,
Competition, Demand, and Profit), the optimum mix of these factors varies
according to the nature of the products markets and the overall objective of
the firm. Thus, the job for the management is to develop and adopt an
appropriate pricing method that meets the needs of the company.

Pricing Methods
Generally businessmen prefer a pricing procedure which is easy to
implement and requires only few assumptions on demand. The various
pricing methods usually employed by businessmen are
Methods Based on Cost
1. Cost-Plus or Full-Cost pricing
2. Target pricing or pricing for a rate of return
3. Marginal pricing
Methods Based on Competition and Market
4. Going-rate pricing
5. Customary pricing
6. Differential pricing
Methods Based on Cost
1. Cost-Plus or Full-Cost pricing:
The full-cost pricing method is generally adopted by many of the firms
for its simplicity and ease. This method is also called Cost-plus pricing,
Margin pricing and Mark-up pricing. Under this method, the price is set
to cover all costs (material, labour and overhead) and predetermined
percentage for profit. Which means the selling price of the product is
computed by adding percentage to the average total cost of the
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product. The percentages added to the cost are called margins or
mark-ups. These percentages vary from firm to firm and product to
product in the same firm. Firms using this method should take the
following costs into consideration
Variable and fixed production costs
Variable and fixed selling and administrative costs
The mark-up of profit is determined based on variety of considerations.
It may be based on common tradition laid down in particular business
or it may be determined by trade associations or guide lines if any
provided by the government.
For example:
The fixed costs to produce an item are Rs300000, the variable costs
add up to Rs100000, and the estimated number of units to be
produced is 50,000. Add Rs100000 to Rs300000, divide by 50000, and
the true unit cost equals Rs8. If the desired return on sales is 20%,
divide Rs8 by 1 minus .20, and the cost-plus price for this item will be
Rs10.
Advantages
a. It helps in setting fair and plausible prices.
b. It is easy for application by all types of firms.
c. This method safeguards the interest of the firm against risks due
to uncertain demands.
d. It economical for decision making.
e. If adopted by all businessmen, it may help protect the firms
against price wars or self damaging price competition and at the
same time it provides flexibility to adjust price based on variation
of costs.
f. This method is best while dealing with uncertainty and
ignorance.
Drawbacks
a. Totally ignores influence of demand.
b. Fails to reflect the forces of competition adequately.
c. Cost is regarded the main factor influencing the price.
d. Undue importance is given for the precision of allocating of costs.
e. This method is based on circular reasoning. Which means price
determines quantity demanded; price charged is dependent
upon cost per unit and the cost, in turn, depends upon the
quantity demanded.
f. It ignores marginal or incremental cost and uses average cost
instead.
In spite of drawbacks this method is useful in product tailoring, custom
design products, monopsony buying and public utility buying.

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2. Target pricing or pricing for a rate of return:
This method of pricing is only a refinement of the full-cost pricing.
According to this method manufacturer considers a pre-determined
target rate of return on capital invested. In the case of full-cost pricing,
the percentage of profit is marked up arbitrarily. In the case of rate of
return method, the companies determine the average mark-up on
costs necessary to produce a desired rate of return on the companys
investment.
In this case the company estimates future sales, future costs, and
arrives at a mark-up that will achieve a target return on the companys
investment.
Davis and Hughes have used the following formula to calculate the
desired rate of return when a mark-up is applied on cost
Percentage
mark-up on
cost

Capital employed
=

Total annual cost

Planned
rate of
return

For Example:
Suppose the capital employed by a firm is Rs.6 lakhs and total annual
cost id Rs.12 lakhs with a planned rate of return of 20 percent.
Then percentage mark-up is = (6/12) * 20 = 10%
Now suppose the total cost per unit in the firm is Rs.20 with 10 percent
mark-up the selling price would be Rs.22.
In any business price policy is profit oriented. A company cannot
blindly stick to the mark-up which has been decided based on the
capital employed. Change of costs compels company to revise the
prices. To overcome this problem, three different methods are followed
a. Revising the prices to maintain constant percentage mark-up
over costs.
b. Revising the prices to achieve estimated sales to maintain
percentage of profit.
c. Revising the prices to achieve a constant rate of return on capital
invested
Changed percentage may be computed as below
a. Percentage over cost
= Profits / Costs
b. Percentage on sales
= Profits / Earnings from
sales
c. Percentage on capital employed
= Profits / Capital employed
The major drawback of this procedure is that it ignores demand
condition.
3. Marginal Cost Pricing
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Under marginal cost pricing method, the price of a product is
determined on the basis of the marginal or variable costs. In this
method fixed costs are totally ignored and only variable costs are
taken in to consideration. This is done on the assumption that fixed
costs are caused by outlays which are historical and sunk. Their
relevance to pricing decision is limited, as pricing decision requires
planning the future. Under marginal cost pricing, the objective of the
firm is to maximise its total contribution to fixed costs and profit.
For Example:
Aircraft flying from Bengaluru to Chennai
Total Cost (including normal profit) = Rs15,000 of which Rs13,000 is
fixed cost*
Number of seats = 160, average price = Rs93.75
MC of each passenger = 2000/160 = Rs12.50
If flight not full, better to offer passengers chance of flying at Rs12.50
and fill the seat than not fill it at all!
Advantages
a. Marginal cost pricing is highly useful for public utility
undertakings. It helps them in maximising output and better
capacity utilization. This is possible only when lowest possible
price is charged. The lowest limit is set by marginal cost of the
product, which helps in maximising public welfare.
b. This method enables the firms to face competition. This is the
reason why export prices are based on marginal costs since
international market is highly competitive.
c. This method helps in optimum allocation of resources and as
such it is the most efficient and effective pricing technique and it
is useful when demand conditions are slack.
d. Marginal cost pricing is suitable for pricing over the life-cycle of a
product. Each stage of the life-cycle has separate fixed cost and
short-term marginal cost.
In the modern business marginal is cost pricing method is more
effective compares to full-cost method due to following two
characteristics
I. The prevalence of multi-product, multi-process and multi-maker
concerns makes the absorption of fixed costs into product costs
is absurd. The total cost of separate products can never be
estimated perfectly and satisfactorily, and the optimal
relationship between costs and prices will vary substantially both
among different products and different markets. In this type of
business, proposals to changing the prices in terms of sales and
segmentation of the market can be profitability employed only
with short-run problems and marginal pricing is the most suitable
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II.

method of short-run pricing.

In business, dominant force is innovation combined with constant
technology. The long-run situations are often unpredictable.
Hence, short-run marginal cost pricing is most suitable.

Limitations
a. Firms may find it difficult to cover up costs and earn a fair return
on capital employed when they follow marginal cost principle in
times of recessions when demand is slack and price reduction
becomes inevitable to retain business.
b. When production takes place under decreasing costs, marginal
cost pricing is unsuitable since MC curve will be below the AC
curve and marginal cost pricing is bound to lead to deficits.
c. Marginal cost pricing requires a better understanding of marginal
cost technique. Some accountants are not fully conversant with
the marginal techniques themselves. Therefore, they are not
capable of explaining their use to the management.
In spite of its advantages, due to its inherent weakness of not ensuring
the coverage of fixed costs, marginal pricing has not been adopted
extensively. It is confined to cases of special orders only.
Methods Based on Competition and Market
4. Going-Rate pricing
This method of pricing conforms to the system of pricing in oligopoly
where a firm initiates price changes and other firms in the industry
follow the pattern set by the leader. Other firm accepts the leadership.
The emphasis here is on the market. Firms make necessary price
adjustment to suit the general price structure in the industry. Hence
this going-rate pricing method is also called as Acceptance-pricing.
Normally, under this method, the industry tries to determine the lowest
price that the seller can afford to accept considering various
alternatives.
For Example:
Going-rate pricing include industries like clothing, automobile, longplaying records, etc., where the products have reached a stage of
maturity and where both customers and rival produces have become
accustomed to stable price-relationship.
When products are identical, unique selling price will rule. When they
are differentiated, prices will form a series, set at discrete intervals.
Advantages
a. It helps in avoiding cut-throat competitions among the firms.
b. It is a rational pricing method when costs are difficult to
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measure.
c. Going-rate or acceptance pricing is less troublesome and less
costly since exact calculation of costs and demand is not
necessary.
d. It is suitable to avoid price hazards in oligopoly market.
5. Customary Pricing
Price of certain goods becomes more or less fixed for a considerable
period of time, not by deliberate action on the sellers part, but as a
result of their having prevailed for a considerable period of time. Only
when the costs change significantly, the customary prices of these
goods are changed. While changing the customary price, it is
necessary to study the pricing policies and practices adopted by the
competing firms. Another approach is to effect price change only in a
limited market segment and know the customer reaction to decide
whether any change would be digested by the market.
Customary price may be maintained even when products are changed
For Example:
The new model of a mobile phone may be priced at the same level as
the discontinued model. This is usually so even in the face of lower
costs. A low price may cause an adverse reaction on the competitors
leading them to a price war as also on the consumers who may think
that quality of the new model is inferior. Hence, going along with the
old price is the easiest thing to do.
6. Differential Pricing
Identical products are priced differently for different types of
customers, markets or buying situations. An important aspect of
differential price is price discrimination.
Differential pricing enables companies to profit from their customers'
unique valuations by offering different customers different prices for
the same product.
For Example:
At a cinema, customers who paid full price, used coupons, received
discounts (senior, student, under 12 and AAA etc.) or purchased
prepaid discount passes from Super Market can all be sitting next to
each other watching the same movie. Offering this spectrum of prices
enables cinemas to maximize profits by serving customers with a
variety of different valuations.
Consider the pricing behaviour at an auction. Everyone has the same
information and bids on the same item. As prices increase, bidders
drop out. Those who drop out are in essence saying, "I know others are
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willing to pay higher prices, but I just don't value the item as much as
they do."
Differential pricing tactics can be grouped as:
Requiring customers to jump hurdles (coupons, rebates, sales,
price match guarantees, time in sales cycle, distribution outlet).
Customer characteristics (different prices based on where
customer lives, readily available traits such as age, affiliations,
purchasing history).
Selling characteristics (discounts for volume purchases, bundles,
different next best alternatives).
Selling strategy (negotiation, razor/razor blade pricing, metering,
and dynamic pricing).
The range of prices created by differential pricing contributes to the
pricing windfall with larger margins from higher prices and growth by
using discounts to sell to more customers.
The end result of implementing these four strategies is a multi-price
strategy. By this, I mean a set of publicly known prices and plans for a
company's products composed of: (1) a value-based price, (2) new
pricing plans, (3) versions, and (4) a range of prices.

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