MANAGERIAL ECONOMICS Part- A Q1 Define Managerial Economics Ans: Managerial Economics - Definition 3. Managerial economics is best defined as a.

the study of economics by managers. b. the study of the aggregate economic activity. c. the study of how managers make decisions about the use of scarce resources. d. all of the above are good definitions. Managerial economics is the science of directing scarce resources to manage cost effectively. It consists of three branches: competitive markets, market power, and imperfect markets. A market consists of buyers and sellers that communicate with each other for voluntary exchange. Whether a market is local or global, the same managerial economics apply. A seller with market power will have freedom to choose suppliers, set prices, and use advertising to influence demand. A market is imperfect when one party directly conveys a benefit or cost to others, or when one party has better information than others. Definition. Managerial economics is the science of directing scarce resources to manage cost effectively. Scope. (a) Microeconomics the study of individual economic behavior where resources are costly, e.g., how consumers respond to changes in prices and income, how businesses decide on employment and sales, voters behavior and setting of tax policy. (b) Managerial economies the application of microeconomics to managerial issues (a scope more limited than microeconomics). (c) Macroeconomics the study of aggregate economic variables directly (as opposed to the aggregation of individual consumers and businesses), e.g., issues relating to interest and exchange rates, inflation, unemployment, import and export policies. Competitive markets. (a) Markets. i. a market consists of buyers and sellers that communicate with one another for voluntary exchange. It is not limited by physical structure. ii. in markets for consumer products, the buyers are households and sellers are businesses. iii. in markets for industrial products, both buyers and sellers are businesses. iv. in markets for human resources, buyers are businesses and sellers are households. v. Note: an industry is made up of businesses engaged in the production or delivery of the same or similar items. (b) Competitive markets.

i. markets with many buyers and many sellers, where buyers provide the demand and sellers provide the supply, e.g., the silver market. ii. the demand-supply model - basic starting point of managerial economics, the model describes the systematic effect of changes in prices and other economic variables on buyers and sellers, and the interaction of these choices. (c) Non-competitive markets a market in which market power exists. 8. Market power. (a) Market power - the ability of a buyer or seller to influence market conditions. A seller with market power will have the freedom to choose suppliers, set prices and influence demand. (b) Businesses with market power, whether buyers or sellers, still need to understand and manage their costs. (c) In addition to managing costs, sellers with market power need to manage their demand through price, advertising, and policy toward competitors. 9. Imperfect Market. (a) Imperfect market - where one party directly conveys a benefit or cost to others, or where one party has better information than others. (b) The challenge is to resolve the imperfection and be cost-effective. (c) Imperfections can also arise within an organization, and hence, another issue in managerial economics is how to structure incentives and organizations. Q2 Cross Elasticity Explain Ans: In economics, the cross elasticity of demand and cross price elasticity of demand measures the responsiveness of the demand of a good to a change in the price of another good. It is measured as the percentage change in demand for the first good that occurs in response to a percentage change in price of the second good. For example, if, in response to a 10% increase in the price of fuel, the demand of new cars that are fuel inefficient decreased by 20%, the cross elasticity of demand would be 20%/10% = 2. The formula used to calculate the coefficient cross elasticity of demand is

In the example above, the two goods, fuel and cars(consists of fuel consumption), are complements; that is, one is used with the other. In these cases the cross elasticity of demand will be negative, as shown by the decrease in demand for cars when the price of fuel increased. In the case of perfect complements, the cross elasticity of demand is negative infinity. Q3 What is Economies of Scale in production? Ans: Economies of scale refers to the decreased per unit cost as output increases. More clearly, the initial investment of capital is diffused (spread) over an increasing number of units of output, and therefore, the marginal cost of producing a good or service is less than the average total cost per unit (note that this is only in an industry that is experiencing economies of scale). An example will clarify. AFC is average fixed cost. The advantage is that "buying bulk is cheaper on a per-unit basis." Hence, there is economy (in the sense of "efficiency") to be gained on a larger scale. Examples Economies of scale As a firm doubles output, the total cost of inputs less than doubles Diseconomies of scale As a firm doubles its output, the total cost of inputs more than doubles. In addition to specialization and the division of labor, within any company there are various inputs that may result in the production of a good and/or service.

Lower input costs: When a company buys inputs in bulk - for example, potatoes used to make French fries at a fast food chain - it can take advantage of volume discounts. (In turn, the farmer who sold the potatoes could also be achieving ES if the farm has lowered its average input costs through, for example, buying fertilizer in bulk at a volume discount.)

Costly inputs: Some inputs, such as research and development, advertising, managerial expertise and skilled labor are expensive, but because of the possibility of increased efficiency with such inputs, they can lead to a decrease in the average cost of production and selling. If a company is able to spread the cost of such inputs over an increase in its production units, ES can be realized. Thus, if the fast food chain chooses to spend more money on technology to eventually increase efficiency by lowering the average cost of hamburger assembly, it would also have to increase the number of hamburgers it produces a year in order to cover the increased technology expenditure.

Specialized inputs: As the scale of production of a company increases, a company can employ the use of specialized labor and machinery resulting in greater efficiency. This is because workers would be better qualified for a specific job - for example, someone who only makes French fries - and would no longer be spending extra time learning to do work not within their specialization (making hamburgers or taking a customer's order). Machinery, such as a dedicated French fry maker, would also have a longer life as it would not have to be over and/or improperly used.

Techniques and Organizational inputs: With a larger scale of production, a company may also apply better organizational skills to its resources, such as a clear-cut chain of command, while improving its techniques for production and distribution. Thus, behind the counter employees at the fast food chain may be organized according to those taking in-house orders and those dedicated to drive-thru customers.

Learning inputs: Similar to improved organization and technique, with time, the learning processes related to

production, selling and distribution can result in improved efficiency - practice makes perfect! External economies of scale can also be realized from the above-mentioned inputs as a result of the company's geographical location. Thus all fast food chains located in the same area of a certain city could benefit from lower transportation costs and a skilled labor force. Moreover, support industries may then begin to develop, such as dedicated fast food potato and/or cattle breeding farms. External economies of scale can also be reaped if the industry lessens the burdens of costly inputs, by sharing technology or managerial expertise, for example. This spillover effect can lead to the creation of standards within an industry. What Does Economies Of Scale Mean? The increase in efficiency of production as the number of goods being produced increases. Typically, a company that achieves economies of scale lowers the average cost per unit through increased production since fixed costs are shared over an increased number of goods. There are two types of economies of scale: -External economies - the cost per unit depends on the size of the industry, not the firm. -Internal economies - the cost per unit depends on size of the individual firm.

Investopedia explains Economies Of Scale Economies of scale gives big companies access to a larger market by allowing them to operate with greater geographical reach. For the more traditional (small to medium) companies, however, size does have its limits. After a point, an increase in size (output) actually causes an increase in production costs. This is called "diseconomies of scale". Q4 Write short note on Opportunity Cost. Ans: Opportunity cost is the value of the next-best choice available to someone who has picked between several mutually exclusive choices. It is a key concept in economics. It is a calculating factor used in mixed markets which favour social change in favour of purely individualistic economics. It has been described as expressing "the basic relationship between scarcity and choice. What Does Opportunity Cost Mean? 1. The cost of an alternative that must be forgone in order to pursue a certain action. Put another way, the benefits you could have received by taking an alternative action. 2. The difference in return between a chosen investment and one that is necessarily passed up. What are Opportunity Costs? Answer: Unlike most costs discussed in economics, an opportunity cost is not always a number. The opportunity cost of any action is simply the next best alternative to that action - or put more simply, "What you would have done if you didn't make the choice that you did". I have a number of alternatives of how to spend my Friday night: I can go to the movies, I can stay home and watch the baseball game on TV, or go out for coffee with friends. If I choose to go to the movies, my opportunity cost of that action is what I would have chose if I had not gone to the movies - either watching the baseball game or going out for coffee with friends. Note that an opportunity cost only considers the next best alternative to an action, not the entire set of alternatives. Q5 Explain Monopolistic Competition. Ans: Monopolistic competition is the market situation where many sellers provide similar yet not perfectly substitutable products, thereby giving each seller some monopoly power. Thus, in monopolistic competition production does not take place at the lowest possible cost. Examples of monopolistic competition include restaurants, books, clothing. Monopolies are unfair, big bullies on the playground of business. Say we both were in the same industry, but I had more money than you did. I wanted to get your customers away from you so that I could make even more money. One way I might do that is to drop my prices so low that you can't afford to lower your prices to equal mine. All of your customers come to me to save money. You go out of business. I raise my prices back to normal--or even higher now because you're not there as my competition anymore. I keep doing this to everyone in our industry until I'm the only choice around, and everyone has to pay whatever I want to charge. Monopolies were a huge problem in the late 19th century in the U.S., and many would argue certain companies around today have too much of a monopoly on an industry. Monopolistic competition is a common market structure where many competing producers sell products that are differentiated from one another (that is, the products are substitutes, but are not exactly alike, similar to brand loyalty). Many markets are monopolistically competitive; common examples include the markets for restaurants, cereal, clothing, shoes, and service industries in large cities. The "founding father" of the theory of monopolistic competition was Edward Hastings Chamberlin in his pioneering book on the subject Theory of Monopolistic Competition (1933) Monopolistically competitive markets have the following characteristics: There are many producers and many consumers in a given market, and no business has total control over the market price. Consumers perceive that there are non-price differences among the competitors' products. There are few barriers to entry and exit Producers have a degree of control over price.

The characteristics of a monopolistically competitive market are almost the same as in perfect competition, with the exception of monopolistic competition having heterogeneous products, and that monopolistic competition involves a great deal of non-price competition (based on subtle product differentiation). A firm making profits in the short run will break even in the long run because demand will decrease and average total cost will increase. This means in the long run, a monopolistically competitive firm will make zero economic profit. This gives the amount of influence over the market; because of brand loyalty, it can raise its prices without losing all of its customers. This means that an individual firm's demand curve is downward sloping, in contrast to perfect competition, which has a perfectly elastic demand schedule.

Long-run equilibrium of the firm under monopolistic competition Major characteristics There are six characteristics of monopolistic competition (MC): product differentiation many firms free entry and exit in long run Independent decision making Market Power Buyers and Sellers have perfect information What Does Monopolistic Competition Mean? A type of competition within an industry where: 1. All firms produce similar yet not perfectly substitutable products. 2. All firms are able to enter the industry if the profits are attractive. 3. All firms are profit maximizers. 4. All firms have some market power, which means none are price takers.

Monopolistic competition refers to a market structure that is a cross between the two extremes of perfect competition and monopoly. The model allows for the presence of increasing returns to scale in production and for differentiated (rather than homogeneous or identical) products. However the model retains many features of perfect competition, such as the presence of many many firms in the industry and the likelihood that free entry and exit of firms in response to profit would eliminate economic profit among the firms. As a result, the model offers a somewhat more realistic depiction of many common economic markets. The model best describes markets in which numerous firms supply products which are each slightly different from that supplied by its competitors. Examples include automobiles, toothpaste, furnaces, restaurant meals, motion pictures, romance novels, wine, beer, cheese, shaving cream and many more. The model is especially useful in explaining the motivation for intra-industry trade, i.e. trade between countries that occurs within an industry rather than across industries. In other words the model can explain why some countries export and import automobiles simultaneously. This type of trade, although frequently measured is not readily explained in the context of the Ricardian or Heckscher-Ohlin models of trade. In those models a country might export wine and import cheese, but it would never export and import wine at the same time. Q6 Define Capital Budgeting Ans: The process of determining which potential long-term projects are worth undertaking, by comparing their expected discounted cash flows with their internal rates of return. Capital budgeting is the process by which the financial manager decides whether to invest in specific capital projects or assets. In some situations, the process may entail in acquiring assets that are completely new to the firm. In other situations, it may mean replacing an existing obsolete asset to maintain efficiency. Q7 Explain Peak-Load Pricing. Ans: Peak-load pricing is a policy of raising prices when the demand for a service is at its highest. The most recent analysis of this pricing policy stems from American research in the 1960s and 1970s. Peak-load pricing is often used by electricity and telephone utilities as a means of reflecting the investment they have made to meet peak demand for their services. Peak Load Pricing A system of price descrimination whereby peak time users pay higher prices to reflect the higher marginal cost of supplying them Over the last couple of months, the topic of user fees has come up on our EWOT blog a few different times (see here and here, for example). In putting together my MBA Micro exams, I got wondering why user fees and peak-load pricing aren't used a lot more often. Here are three cases in point: (1) Food consumption probably peaks with dinner. Putting the drunks and others with munchies aside, it must be lowest between midnight and 5 am. Why don't restaurants use more "smart" pricing during these off-peak hours? If it can be done in the heavily regulated electricity market, why not in the food market? (2) An extremely ugly side of people comes out when it comes to overhead bins on full flights. Those with briefcases are asked to cram their feet for the sake of those who want to take large carry-on bags on board. This problem has gotten much worse since the introduction of fees for checked bags. Why aren't airlines being entrepreneurial and also charging for bin space? (3) Why don't rental car companies pro-rate the first and last days of rentals? If you go over by even an hour on your final day, you're usually charged for a full day. Wouldn't a profit-maximizing company have a strong incentive to cut prices substantially on the final day, attract more customers, and still the car around right away? Q8 Distinguish between GDP and GNP. Ans: Generally the students do not keep the difference between gross national product (GNP) and gross domestic product (GDP) in view which can culminate into the various conceptual errors. There are various production sectors in every country and each sector produces a particular quantity of goods. Different raw materials are used in producing the goods. For instance, cotton is used for producing cloth, for which the farmer uses the seeds, fertilizers, insecticides, pesticides, etc. The production, in this manner, is divided into different parts. It should be noted that on every next stage of production, the value is added in the production. For example, the value of the yarn as compared to raw cotton, cloth as compared to yarn and garments as compared to cloth is always higher. In other words, the total value of finished goods is nothing but the aggregate of the stage wise additions. The total quantity of product, in this way, is called 'Gross Domestic Product'.

These goods are produced in the country but are exported to other countries, are deduced from the Gross Domestic Product and what ever is earned by the local people from other countries is added. In this way, what ever is achieved finally is called 'Gross National Product' GDP is the market value of everything produced within a country; GNP is the value of what's produced by a country's residents, no matter where they live. The difference between GDP and GNP comes down to two factors: ownership and location. GDP measures economic output based on location. If economic output occurs in the United States, then it is included in the GDP. GNP measures economic output based on ownership. If the resources that produce the economic output are owned by an American entity, they are included in the GNP. Gross Domestic Product (GDP) The Gross Domestic Product measures the value of economic activity within a country. Strictly defined, GDP is the sum of the market values, or prices, of all final goods and services produced in an economy during a period of time. There are, however, three important distinctions within this seemingly simple definition:

1. GDP is a number that expresses the worth of the output of a country in local currency. 2. GDP tries to capture all final goods and services as long as they are produced within the country, thereby
assuring that the final monetary value of everything that is created in a country is represented in the GDP. 3. GDP is calculated for a specific period of time, usually a year or a quarter of a year. Taken together, these three aspects of GNP calculation provide a standard basis for the comparison of GDP across both time and distinct national economies. The important distinction between GDP and GNP rests on differences in counting production by foreigners in a country and by nationals outside of a country. The distinction between GDP and GNP is theoretically important, but not often practically consequential. Since the majority of production within a country is by nationals within that country, GDP and GNP are usually very close together. In general, macroeconomists rely on GDP as the measure of a country's total output. GDP (Gross Domestic Product) is a commonly used calculator of national income and measures the economic activity in a country. Essentially, the GDP is a figure which measures the value of the goods and services produced in a country in a given time period (usually one year). GNP (Gross National Product) is also a calculator of economic activity. However, GNP also encompasses the value of net income made abroad. Moreover, when calculating GNP, the value of what foreign countries earn in the given country is subtracted from the value. Gross domestic product (GDP) is defined as the "value of all final goods and services produced in a country in 1 year" Gross National Product (GNP) is defined as the market value of all goods and services produced in one year by labour and property supplied by the residents of a country Part-B Q9 a) Managerial Economics is economics applied in decision making Justify Ans: Managerial Economics Managerial economics, meaning the application of economic methods in the managerial decision-making process, is a fundamental part of any business or management course. This textbook covers all the main aspects of managerial economics: the theory of the firm; demand theory and estimation; production and cost theory and estimation; market structure and pricing; game theory; investment analysis and government policy. It includes numerous and extensive case studies, as well as review questions and problem-solving sections at the end of each chapter. Nick Wilkinson adopts a user-friendly problem-solving approach which takes the reader in gradual steps from simple problems through increasingly difficult material to complex case studies, providing an understanding of how the relevant principles can be applied to real-life situations involving managerial decision-making. This book will be invaluable to business and economics students at both undergraduate and graduate levels who have a basic training in calculus and quantitative methods The Business Economics and Managerial Decision Making analyses the growth and development of privately owned firms and also the decisions made by firms operating in both private and public sector enterprises. Coverage is clear and concise, and avoids specialist techniques such as linear programming, which in a European context tend to belong in courses dealing with operations research. The book also avoids straying into areas of industrial economics, instead

retaining a sharp focus on relevant issues such as the theory of the firm and the varying objectives that may be adopted in practice. Key sections are supported by case studies of real firms and actual decisions made. Q9b) Define Demand Forecasting. Discuss critically any four important methods of demand forecasting. Ans: Demand Forecasting the activity of estimating the quantity of a product or service that consumers will purchase. Demand forecasting involves techniques including both informal methods, such as educated guesses, and quantitative methods, such as the use of historical sales data or current data from test markets. Demand forecasting may be used in making pricing decisions, in assessing future capacity requirements, or in making decisions on whether to enter a new market. The better a company can assess future demand, the better it can plan its resources. Each company is exposed to three types of factors influencing demand: company, competitive and macroeconomic factors. Company factors include market share trends, changes in strategy and implementation, changes in brand value. Competitive factors include competitor advertising, competitor product offerings, market share. Macroeconomic changes include income, economic growth and shocks. There are several methods to assess and forecast demand. None yields demand numbers that are a 100% guaranteed. However, using more than one method improves accuracy and confidence levels. Most companies use Simple Sales Analysis and Forecasting. Most companies also use Market Size and Market Share Research. One of the most accurate method used today is the combination of Market Size Research and Mind Share Research. Demand forecasting is the activity of estimating the quantity of a product or service that consumers will purchase. Demand forecasting involves techniques including both informal methods, such as educated guesses, and quantitative methods, such as the use of historical sales data or current data from test markets. Demand forecasting may be used in making pricing decisions, in assessing future capacity requirements, or in making decisions on whether to enter a new market. Microeconomic, Macroeconomic and Competitive Methods Market Size & Mind Share Research Market Size Research combined with Mind Share Research is a good way to forecast corporate demand. It combines macroeconomic trends with microeconomic and competitive performance. It is based on the fact that customers will only buy your product if they 1. need your product or service - macroeconomic trends 2. are able to pay for your product or service - macroeconomic trends 3. are aware of your product or service offerings - microeconomic performance 4. perceive your company's offerings to have the best value - microeconomic plus competitive performance Market Size Research quantifies the first two issues while Mind Share Research quantifies the last two. Together they quantify or forecast future corporate demand as well as future market share. Market Size & Market Share Research Market Size Research combined with Market Share Research is often used to forecast corporate demand. It combines macroeconomic trends with competitive performance. It is based on the fact that customers will only buy your product if they need your product or service and are able to pay for it (macroeconomic trends). It also assumes that your company's market share will not change in the future. The advantage of this method is that this information is often well known and publicized. Several companies offer syndicated reports on these issues. Customized studies can be performed whenever the information of your market segment is not published. The disadvantage lies in the assumption that your market share stays stable. Microeconomic methods Simple Sales Analysis and Forecasting Past sales can be used to forecast future demand. Past sales are broken into: trend analysis: used for long-term forecasting; obtained by curve-fitting past sales with either linear or nonlinear regression. cycle analysis: used for intermediate range forecasting; up and down swings in sales.

 seasonality analysis: used for short-term forecasting; hourly, weekly, monthly, quarterly, etc sales patterns. While this method is easy to use, it is based on past behavior and does not include new company, competitor or macroeconomic developments.

Microeconomic Statistical Time-Series Analysis Sales numbers from several time periods are correlated to one or several factors such as price, advertising, market share, competitor price demographics, product life stage, etc. Regression analysis and curve fitting is then used to predict future demand. The advantage of this method is that it includes relevant strategy as well as competitor and macroeconomic trends. The disadvantage is that the outcome may be biased because of important variables being left out, variables not being completely independent, new competitive actions not being included. Macroeconomic methods Delphi Method or Expert Opinions This method gathers information from industry experts until a consensus is reached about where the market is headed. The advantage of this method is that the information comes from the sources most involved with the market and thus represents the most accurate information available. The disadvantage of the Delphi method is the risk of competitive bias and a tendency toward known information. Macroeconomic Statistical Time-Series Analysis This method is a macroeconomic statistical time-series analysis and purely quantitative in nature. It fits linear and nonlinear curves into time series and then extrapolating future values. Time series may be correlated to identify leading and lagging indicators. The advantage of this method is that recurring trends can be captured and extrapolated easily. Econometric Modeling Economists define sets of equations that describe underlying economic behavior and laws. The coefficients are then fitted statistically. This method contains fundamental insight and yields qualitative superior forecasts than pure mathematical models. Q10A) What is Product Function? Clearly explain Cobb-Douglas Production Function. Ans: a production function is a function that specifies the output of a firm, an industry, or an entire economy for all combinations of inputs The production function relates the output of a firm to the amount of inputs, typically capital and labor. Cobb-Douglas Production Function If you have not already done so, look at how the parameters of a Cobb-Douglas production function can be estimated: Estimating a Cobb-Douglas production function. The three factor Cobb-Douglas production function is: q = A * (L^alpha) * (K^beta) * (M^gamma) = f(L,K,M). where L = labour, K = capital, M = materials and supplies, and q = product. The symbol "^" means "raise to the power," i.e. L^alpha means "raise the value of L to the power of the value of alpha." Production functions need to have certain properties, to ensure that we can solve the least-cost problem: Check any of the many textbooks. If for given values of L,K, and M, the Hessian of the production function f is negative definite, then its isoquants at that point are concave to the origin. David Hillary thinks we can use a Cobb-Douglas production function to estimate the effects of income taxes (incidentally, Fred Foldvary's succinct post today is devastating). He says: This post examines the effect of Income Tax on rent using the Cobb-Douglas production and Solow Growth Model. The Cobb-Douglas Production function is normally said to be Y=t*K^a*L^(1-a) but I will use the Y=t*K^a*L^b*N^(1-a-b) form where N is land (K is capital and L is labour). We will use a=0.227, b=0.523 and N=65967. Here he introduces N (land) as a factor of production whose contribution to output is said (in his version) to be proportional to its share of national income (assumed here to be 1-a-b = 0.25). The fundamental fallacy in this approach is to assume that what factors are paid is a measure of what they contribute to income (Y). It is particularly dubious in the case of land. The supply of land is fixed. Thus it cannot explain any of the

increase (or decrease) in Y. It is labour, capital and, especially, entrepreneurship and innovating activities, that explain growth. Land is entirely passive, but is needed, and hence gets a "reward" (income) in the form of rent-as-surplus. Q11 B) Distinguish between Balance of Trade and Balance of Payments. Explain the policy measures to correct disequilibrium in BOP. Ans: Balance of trade is actually the legally imports and exports of the country is in equilibrium states.means the total export done by nation and total import coming from another nation is equal or equilibrium.while the balance of payment is slightly different form balance of payment,balance of payment is actually based on current account,capital account and official settelments acount,balance of payment is,doing payment to abroad and the payment which comes from the abroad is balanced.balance of trade is the part of balance oy payment. Balance of Payments is the difference between the money coming into a country and the money leaving the same country. In economics, the balance of payments, (or BOP) measures the payments that flow between any individual country and all other countries. It is used to summarize all international economic transactions for that country during a specific time period, usually a year. The BOP is determined by the country's exports and imports of goods, services, and financial capital, as well as financial transfers. It reflects all payments and liabilities to foreigners (debits) and all payments and obligations received from foreigners (credits). Balance of payments is one of the major indicators of a country's status in international trade, with net capital outflow. Balance of trade represents the net of imports and exports, while balance pf payments includes trade as well as capital flows. The balance of payments accounts of a country record the payments and receipts of the residents of the country in their transactions with residents of other countries. If all transactions are included, the payments and receipts of each country are, and must be, equal. Any apparent inequality simply leaves one country acquiring assets in the others. For example, if Americans buy automobiles from Japan, and have no other transactions with Japan, the Japanese must end up holding dollars, which they may hold in the form of bank deposits in the United States or in some other U.S. investment. The payments of Americans to Japan for automobiles are balanced by the payments of Japanese to U.S. individuals and institutions, including banks, for the acquisition of dollar assets. Put another way, Japan sold the United States automobiles, and the United States sold Japan dollars or dollar-denominated assets such as Treasury bills and New York office buildings.... BALANCE OF TRADE: The difference between the value of goods and services exported out of a country and the value of goods and services imported into the country. The balance of trade is the official term for net exports that makes up the balance of payments. The balance of trade can be a "favorable" surplus (exports exceed imports) or an "unfavorable" deficit (imports exceed exports). The official balance of trade is separated into the balance of merchandise trade for tangible goods and the balance of services.... A balance of trade surplus is most favorable to domestic producers responsible for the exports. However, this is also likely to be unfavorable to domestic consumers of the exports who pay higher prices. Alternatively, a balance of trade deficit is most unfavorable to domestic producers in competition with the imports, but it can also be favorable to domestic consumers of the exports who pay lower prices.... An open economy is an economy which interacts with other nations to exchange goods, services, and investments. Trade between open economies can be strengthened by economic integration. To protect domestic industries from competition, government imposes barriers. The barriers can be both tariff and nontariff. Tariff barriers include advalorem duties, specific duties and compound duties. Non-tariff barriers include quotas, subsidies, licensing, administered protection, and health and safety standards. The world is becoming an integrated market place and trade equations are changing rapidly. Realizing the importance of private capital inflow for the development of a country, many countries are taking numerous measures to attract foreign investors. Balance of Payment (BoP) can be defined as a systematic record of all economic transactions between the residents of the reporting country and the residents of the rest of the world. Disequilibrium in the BoP can be corrected with the help of both monetary and non-monetary measures. Monetary measures include deflation, exchange rate depreciation, devaluation and exchange control. Non-monetary measures include tariffs (import duties), import quotas and export promotion polices and programmes. Exchange rate means the

price of one currency in terms of another. Exchange rates are either fixed by governments or determined by the market forces. The two basic exchange rate regimes are the fixed exchange rate and the floating/flexible exchange systems. Q12A) Briefly explain the different methods of measuring national income. Explain the relevance of national income statistics in business decisions. Ans; The names of all of the measures discussed here consist of one of the words "Gross" or "Net", followed by one of the words "National" or "Domestic", followed by one of the words "Product", "Income", or "Expenditure". All of these terms can be explained separately. "Gross" means total product, regardless of the use to which it is subsequently put. "Net" means "Gross" minus the amont that must be used to offset depreciation ie., wear-and-tear or obsolescence of the nation's fixed capital assets. "Net" gives an indication of how much product is actually available for consumption or new investment. "Domestic" means the boundary is geographical: we are counting all goods and services produced within the country's borders, regardless of by whom. "National" means the boundary is defined by citizenship (nationality). We count all goods and services produced by the nationals of the country (or businesses owned by them) regardless of where that production physically takes place. The output of a French-owned cotton factory in Senegal counts as part of the Domestic figures for Senegal, but the National figures of France. "Product", "Income", and "Expenditure" refer to the three counting methodologies explained earlier: the product, income, and expenditure approaches. However the terms are used loosely. "Product" is the general term, often used when any of the three appraoches was actually used. Sometimes the word "Product" is used and then some additional symbol or phrase to indicate the methodology; so, for instance, we get "Gross Domestic Product by income", "GDP (income)", "GDP(I)", and similar constructions. "Income" specifically means that the income approach was used. "Expenditure" specifically means that the expenditure approach was used. Measuring national income To measure how much output, spending and income has been generated in a given time period we use national income accounts. These accounts measure three things: 1. Output: i.e. the total value of the output of goods and services produced in the UK. 2. Spending: i.e. the total amount of expenditure taking place in the economy. 3. Incomes: i.e. the total income generated through production of goods and services. What is National Income? National income measures the money value of the flow of output of goods and services produced within an economy over a period of time. Measuring the level and rate of growth of national income (Y) is important to economists when they are considering: measuring national income To measure how much output, spending and income has been generated we use national income accounts. These accounts measure the: 1. Total value of the output of goods and services produced in the UK 2. Total amount of expenditure taking place in the economy 3. Total amount of income generated through production of goods and services National Income is a term used to measure the monetary value of the flow of output of goods and services produced within the economy over a period of time. Measuring the level and rate of growth of national income (Y) is important to economists when they are considering: The rate of economic growth and where the economy is in the business cycle Changes to overall living standards of the population Looking at the distribution of national income (i.e. measuring income and wealth inequalities) Gross Domestic Product (GDP) GDP measures the value of output produced within the domestic boundaries of the UK. It includes the output of the many foreign owned firms that are located in the UK following the high levels of foreign direct investment in the UK economy in the 1980s and 1990s. Read this article on 100 years of UK GDP There are three ways of calculating GDP - all of which should sum to the same amount since by identity: National Output = National Expenditure (Aggregate Demand) = National Income Under the new definitions introduced in 1998, GDP is now known as Gross Valued Added. i) The Expenditure Method (Aggregate Demand)

This is the sum of the final expenditure on UK produced goods and services measured at current market prices. The full equation for GDP using this approach is GDP = C + I + G + (X-M) C: Household spending (consumption) I: Capital Investment spending G: General Government spending X: Exports of Goods and Services M: Imports of Goods and Services ii) The Income Method (Sum of Factor Incomes) Here GDP is the sum of the final incomes earned through the production of goods and services. Main Factor Incomes Income from employment and self-employment Added to Profits of companies Added to Rent income = Gross Domestic product (by factor income) Only factor incomes generated through the production of output are included in the calculation of GDP by the income approach. Therefore, we exclude from the accounts the following items: Transfer payments (e.g. the state pension, income support and the Jobseekers' Allowance) Private Transfers of money from one individual to another Income that is not registered with the Inland Revenue (note here the effects of the Black or shadow economy where goods and services are exchanged but the value of these transactions is hidden from the authorities and therefore does not show up in the official statistics!) iii) The Output Method This measures the value of output produced by each of the productive sectors in the economy using the concept of value added. Value added is the increase in the value of a product at each successive stage of the production process. We use this approach to avoid the problems of double-counting the value of intermediate inputs. The main sectors of the economy are the service industries, manufacturing and construction, and extractive industries such as mining, oil together with agriculture The Difference between GDP and GNP Gross National Product (GNP) measures the final value of output or expenditure by UK owned factors of production whether they are located in the UK or overseas. GDP is only concerned with incomes generated within the geographical boundaries of the country. So output produced by Nissan in the UK counts towards our GDP but some of the profits made by Nissan here are sent back to Japan - adding to their GNP. GNP = GDP + Net property income from abroad (NPIA) NPIA is the net balance of interest, profits and dividends (IPD) coming into the UK from UK assets owned overseas matched against the flow of profits and other income from foreign owned assets located within the UK. Q12 b) Explain the significance and importance of Capital Budgeting decisions Ans: The key function of the financial management is the selection of the most profitable assortment of capital investment and it is the most important area of decision-making of the financial manger because any action taken by the manger in this area affects the working and the profitability of the firm for many years to come. 1. Meaning o The process through which different projects are evaluated is known as capital budgeting o Capital budgeting is defined as the firms formal process for the acquisition and investment of capital. It involves firms decisions to invest its current funds for addition, disposition, modification and replacement of fixed assets. o Capital budgeting consists in planning development of available capital for the purpose of maximising the long term profitability of the concern Lynch o The main features of capital budgeting are o a. potentially large anticipated benefits o b. a relatively high degree of risk o c. relatively long time period between the initial outlay and the anticipated return. o o Significance of capital budgeting o The success and failure of business mainly depends on how the available resources are being utilised. o Main tool of financial management o All types of capital budgeting decisions are exposed to risk and uncertainty.

They are irreversible in nature. Capital rationing gives sufficient scope for the financial manager to evaluate different proposals and only viable project must be taken up for investments. o Capital budgeting offers effective control on cost of capital expenditure projects. o It helps the management to avoid over investment and under investments. o o Capital budgeting process involves the following o 1. Project generation : Generating the proposals for investment is the first step. o The investment proposal may fall into one of the following categories: o Proposals to add new product to the product line, o proposals to expand production capacity in existing lines o proposals to reduce the costs of the output of the existing products without altering the scale of operation.
o o o o o o o o o o o o o o o o o o o o o o o o o o o

Factors influencing capital budgeting Availability of funds Structure of capital Taxation policy Government policy Lending policies of financial institutions Immediate need of the project Earnings Capital return Economical value of the project Working capital Accounting practice Trend of earnings Methods of capital budgeting Traditional methods Payback period Accounting rate of return method Discounted cash flow methods Net present value method Profitability index method Internal rate of return Pay back period method It refers to the period in which the project will generate the necessary cash to recover the initial

investment. o It does not take the effect of time value of money. o It emphasizes more on annual cash inflows, economic life of the project and original investment. o The selection of the project is based on the earning capacity of a project. o It involves simple calcuation, selection or rejection of the project can be made easily, results obtained is more reliable, best method for evaluating high risk projects. 2. o Internal Rate of Return o It is that rate at which the sum of discounted cash inflows equals the sum of discounted cash outflows. It is the rate at which the net present value of the investment is zero. o It is the rate of discount which reduces the NPV of an investment to zero. It is called internal rate because it depends mainly on the outlay and proceeds associated with the project and not on any rate determined outside the investment.

Merits of IRR method It consider the time value of money Calculation of casot of capital is not a prerequisite for adopting IRR IRR attempts to find the maximum rate of interest at which funds invested in the project could be repaid out of the cash inflows arising from the project. o It is not in conflict with the concept of maximising the welfare of the equity shareholders. o It considers cash inflows throughout the life of the project.
o o o o

The Importance Of Capital Budgeting Capital budgeting (or investment appraisal) is the planning process used to determine a firms expenditures on assets whose cash flows are expected to extend beyond one year such as new machinery, equipments, etc. It is also the process of identifying, analyzing and selecting investment projects whose cash flows are expected to extend beyond one year such as research and development project. Capital expenditures can be very large and have a significant impact on the firms financial performance. Besides, the investments take time to mature and capital assets are long-term, therefore, if a mistake were done in the capital budgeting process, it will affect the firm for a long period of time. Basically, the importance of capital budgeting are as follow: 1) Avoid forecast error The future success of a business largely depends on the investment decisions that corporate managers make today. Investment decisions may result in a major departure from what the company has been doing in the past. Through making capital investments, firm acquires the long-lived fixed assets that generate the firms future cash flows and determine its level of profitability. Thus, this decision greatly influences a firms ability to achieve its financial objectives. For example, if the firm invests too much it will cause higher depreciation and expenses. On the other hand, if the firm does not invest enough, the firm will face a problem of inadequate capacity and thus, lose its market share to its competitors. 2) Helps firm to plan its financing Proper capital budgeting analysis is critical to a firms successful performance because capital investment decisions can improve cash flows and lead to higher stock prices. Yet, poor decisions can lead to financial distress and even to bankruptcy. Although a tactical investment decision generally involves a relatively small amount of funds, strategic investment decisions may require large... Importance of Capital Budgeting: Proper decision on capital budget will increase a firms value as well as shareholders wealth Capital budgeting is critical to a firm as it helps the firm to stay competitive as it is expanding its business like proposing to purchase equipments to produce additional or new products, renting or owning premises for opening new branches, etc

MANAGERIAL ECONOMICS --- JUNE 2009 Part-A Q2 What is profit function Ans: In our cost-minimization exercise, we were able to derive a cost function C(w, y) and a compensated factor demand function x = x(w, y). There are analogues in the profit-maximization case. The first is the profit function, which is defined as :

 (p, w) = maxx p (x) - wx where the terms follow their traditional definitions (w and x are vector of factor prices and factor demands respectively). Notice that output price (p) and factor prices (w) the only parameters entering into profit-function. Q3 Define the law of supply. Ans: Supply by definition: those quantities of goods and services that are produced to meet consumer's "demand" at a given price and at a given point in time; the "law" of supply simply states that supply shows the relationship between quantities supplied and and the quantity a firm is willing to supply! What Does Law of Supply Mean? A microeconomic law that states that all things being equal, as the price of a good or service increases, the quantity of that good or service offered by suppliers increases and vice versa. Q4 What is elasticity? Ans: Elasticity is the amount of stretch that an object contains. It is property by virtue of which matter keeps its shape from deforming into another. When an external force is applied to an object the size and shape of the object may change, for example, an appropriate force is applied to a spring can elongate it. If the force ceases to act the object may restore to its original size and shape. An object is said to be elastic if it restores its original size and shape. This property of an object is known as elasticity. In economics, elasticity is the ratio of the percent change in one variable to the percent change in another variable. It is a tool for measuring the responsiveness of a function to changes in parameters in a relative way. Commonly analyzed are elasticity of substitution, price and wealth. Elasticity is a popular tool among empiricists because it is independent of units and thus simplifies data analysis. An "elastic" good is one whose price elasticity of demand has a magnitude greater than one. Similarly, "unit elastic" and "inelastic" describe goods with price elasticity having a magnitude of one and less than one respectively. Q5 What is business cartel Ans: Business cartel A group of companies or countries acting together to control the supply and price of certain goods or services. Cartels are formed to produce higher profits than would ordinarily be earned. formal organization set up by a group of firms that produce and sell the same product for the purpose of exacting and sharing monopolistic rents. Q6 What is cost of capital Ans: The rate of return an enterprise has to offer to induce investors to provide it with capital. The cost of loan capital is the rate of interest that has to be paid. The cost of equity capital is the expected yield needed to induce investors to buy shares. The cost of capital is the cost of a company's funds (both debt and equity), or, from an investor's point of view "the expected return on a portfolio of all the company's existing securities." It is used to evaluate new projects of a company as it is the minimum return that investors expect for providing capital to the company, thus setting a benchmark that a new project has to meet. What Does Cost Of Capital Mean? The required return necessary to make a capital budgeting project, such as building a new factory, worthwhile. Cost of capital includes the cost of debt and the cost of equity. Q7 What is GNP Ans: Definition Gross National Product. GNP is the total value of all final goods and services produced within a nation in a particular year, plus income earned by its citizens (including income of those located abroad), minus income of non-residents located in that country. Basically, GNP measures the value of goods and services that the country's citizens produced regardless of their location. GNP is one measure of the economic condition of a country, under the assumption that a higher GNP leads to a higher quality of living, all other things being equal. Q8 Define inflation.

Ans: Inflation: Inflation is an upward movement in the average level of prices. The boundary between inflation and deflation is price stability. Because inflation is a rise in the general level of prices, it is intrinsically linked to money, as Captured by the often heard refrain "Inflation is too much money chasing too few goods". inflation is caused by a combination of four factors: 1. The supply of money goes up. 2. The supply of other goods goes down. 3. Demand for money goes down. 4. Demand for other goods goes up. Causes of inflation: The main cause of inflation is the increase of paper money in circulation in an economy. When there is an increase in an economies currency, the value of the currency decreases, which then has a negative effect on the prices of goods and services. There are different schools of thought as to what causes inflation. Most can be divided into two broad areas: quality theories of inflation, and quantity theories of inflation. Many theories of inflation combine the two. The quality theory of inflation rests on the expectation of a buyer accepting currency to be able to exchange that currency at a later time for goods that are desirable as a buyer. The quantity theory of inflation rests on the equation of the money supply, its velocity, and exchanges. Adam Smith and David Hume proposed a quantity theory of inflation for money, and a quality theory of inflation for production. The role of inflation in the economy: In the long run, inflation is generally believed to be a monetary phenomenon, while in the short and medium term, it is influenced by the relative elasticity of wages, prices and interest rates. [1] The question of whether the short-term effects last long enough to be important is the central topic of debate between monetarist and Keynesian schools. In monetarism, prices and wages adjust quickly enough to make other factors merely marginal behavior on a general trendline. In the Keynesian view, prices and wages adjust at different rates, and these differences have enough effects on real output to be "long term" in the view of people in an economy. A great deal of economic literature concerns the question of what causes inflation and what effect it has. A small amount of inflation is often viewed as having a positive effect on the economy. One reason for this is that it is difficult to renegotiate some prices, and particularly wages, downwards, so that with generally increasing prices it is easier for relative prices to adjust. Many prices are "sticky downward" and tend to creep upward, so that efforts to attain a zero inflation rate (a constant price level) punish other sectors with falling prices, profits, and employment. Efforts to attain complete price stability can also lead to deflation, which is generally viewed as a negative outcome because of the significant downward adjustments in wages and output that are associated with it. Inflation is also viewed as a hidden risk pressure that provides an incentive for those with savings to invest them, rather than have the purchasing power of those savings erode through inflation. In investing, inflation risks often cause investors to take on more systematic risk, in order to gain returns that will stay ahead of expected inflation. Inflation is also used as an index for cost of living adjustments and as a peg for some bonds. In effect, inflation is the rate at which previous economic transactions are discounted economically. Inflation also gives central banks room to maneuver, since their primary tool for controlling the money supply and velocity of money is by setting the lowest interest rate in an economy - the discount rate at which banks can borrow from the central bank. Since borrowing at negative interest is generally ineffective, a positive inflation rate gives central bankers "ammunition", as it is sometimes called, to stimulate the economy. However, in general, inflation rates above the nominal amounts required to give monetary freedom, and investing incentive, are regarded as negative, particularly because in current economic theory, inflation begets further inflationary expectations. Increasing uncertainty may discourage investment and saving. Redistribution ** It will redistribute income from those on fixed incomes, such as pensioners, and shifts it to those who draw a variable income, for example from wages and profits which may keep pace with inflation. o Similarly it will redistribute wealth from those who lend a fixed amount of money to those who borrow. For example, where the government is a net debtor, as is usually the case, it will reduce this debt redistributing money towards the government. Thus inflation is sometimes viewed as similar to a hidden tax. International trade: If the rate of inflation is higher than that abroad, a fixed exchange rate will be undermined through a weakening balance of trade. Shoe leather costs: Because the value of cash is eroded by inflation, people will tend to hold less cash during times of inflation. This imposes real costs, for example in more frequent trips to the bank. (The term is a humorous reference to the cost of replacing shoe leather worn out when walking to the bank.) Menu costs: Firms must change their prices more frequently, which imposes costs, for example with restaurants having to reprint menus.

Relative Price Distortions: Firms do not generally synchronize adjustment in prices. If there is higher inflation, firms that do not adjust their prices will have much lower prices relative to firms that do adjust them. This will distort economic decisions, since relative prices will not be reflecting relative scarcity of different goods. Hyperinflation: if inflation gets totally out of control (in the upward direction), it can grossly interfere with the normal workings of the economy, hurting its ability to supply. Inflation tax when a government can improve its net financial position by allowing inflation, then this represents a "stealth" tax on holders of the currency. Bracket Creep is related to the inflation tax. By allowing inflation to move upwards, certain sticky aspects of the tax code are met by more and more people. Commonly income tax brackets, where the next dollar of income is taxed at a higher rate than previous dollars. Governments that allow inflation to "bump" people over these thresholds are, in effect, allowing a tax increase because the same real purchasing power is being taxed at a higher rate. Some economists see moderate inflation as a benefit; some business executives see mild inflation as "greasing the wheels of commerce." A very few economists have advocated reducing inflation to zero as a monetary policy goal particularly in the late 1990s at the end of a long disinflationary period, when the policy seemed within reach. Part-B Q9A) State the scope and importance of managerial economics in a business organization Ans: Managerial Economics deals with allocating the scarce resources in a manner that minimizes the cost. As we have already discussed, Managerial Economics is different from microeconomics and macro-economics. Managerial Economics has a more narrow scope - it is actually solving managerial issues using micro-economics. Wherever there are scarce resources, managerial economics ensures that managers make effective and efficient decisions concerning customers, suppliers, competitors as well as within an organization. The fact of scarcity of resources gives rise to three fundamental questionsa. What to produce? b. How to produce? c. For whom to produce? Scope of Business Economics: 1. Consumer analysis focusing on demand 2. Production analysis 3. Equilibrium analysis focusing cost and revenue 4. Structure of markets and its imperfection 5. Pricing of products and services 6. Capital and profit management.

Differences between Perfect competition and Monopoly Number of sellers: Under perfect competition there are alarge no. of sellers each selling in a small quantity of total supply it consists of large no. of firms. Monopoly consists of of a single seller the total supply of the product is in the hands of a single seller. Nature of the product: The product offered by the firm in perfect competition is homogenous while in monopoly it not homogenous i.e it does not have any substitutes Entry & exit conditions: Entry as well as exit in case of perfect competition is said to be free but in case of monopoly entry is assumed to be blocked . Decision Variables:The decision variables variable of the firm is the determination of of its output but a monopoly has to determine eithervits output or price. Equilibrium: A perfectly competitive firm equilibrium is possible only when the MC curve is rising at the point of equilibrium but monopoly equilibrium can be very well established whether MC curve is rising falling or remaining constant at the equilibrium curve. Capacity Utilisation:Perfectly competitive firm is a long run equilibrium at the minimum point of the long average cost curve.There are neither unexhausted economies of scale or diseconomies of large scale production. In case of monopoly the firm may not necessarily produce at minimum point of of the long run avg cost.

Supply curve: As perfectly competitve firm produces where MR=Price=Rising MC the firms short run supply curve is given by the rising portion of its MC curve over &above its avg variable cost.A monopolist however has no unique supply curve Its maximises its profits by producing an output at which it isMR=MC Price output Comparision:Price charged under P.C is invariably low than the one under monopoly assuming same demand & cost conditions Change in demand: In P.C an increase in the in mkt demand will push the price& output but it is not the same in case of monopoly Change in Variable cost :Increase in variable costs shifts the marginal cost upward reduces the output & increases the price in both the mkt structures. Differences between perfect competition & pure competition Pure competition is unalloyed by monopoly elements .It is much simpler & less exclusive concept than perfect competition for latter may be interpreted to involve perfect in many other aspects than in the case of absence of monopoly .Pure competition involves purity only in one respect i.e absence of control over the price.It is said to exist in an industry where there are a large no. of sellers & buyers producing homogenous product. It may be found in real life situations. Perfect competition is a broader term & involves absence of monopoly as well as presence of other perfections like perfect mobility of the factors of production , absence of transportation & selling costs etc Q4. Pure monopoly or simple monopoly is a market structure in which there is a single seller of a good with no close substitutes. Being the sole supplier of the commodity, the monopolist has complete control over the supply of and can independently supply& can independently determine equilibrium price &output eg.railways, electricity etc.There may be different reasons for the emergence of monopoly few of the causes for the emergence of monopoly are: Natural causes: A firm may enjoy monopoly bcoz of its control over a crucial raw material or mineral eg petrol uranium etc. Legal factor: A firm can legally procure monopoly power eg patent copy right etc Cost factor: A firm may produce at such low cost at which no other firm can produce a commodity Market factors: Sometimes the size of market is so small that it cannot accommodate more than one firm. Heavy investment: Certain industries like iron &steel locomotives etc need heavy investment which only a particular firm can afford to arrange Protection of public rights: Motivated by public welfare&public interest the Govt. itself can assume monopoly power eg.railways post&telegraph etc Equilibrium of the monopoly Firm Equilibrium of a monopoly firm is to maximize its profits or minimise losses. Equilibrium of a monopoly firm is attained at that level of output at which it maximizes its profits & minimises losses there are 2 approaches to study equilibrium of a monopoly firm, these are (a) total revenue total cost approach,&(b) marginal revenue marginal cost approach (a)Total revenue total cost approach: Acc to this approach a monopoly firm attains equilibrium when the difference between its total revenue &total cost is the maximum at the equillibrium point, monopolist get the maximum profit & suffer the minimum loss. (b)Marginal revenue marginal cost approach: According to the marginal revenue marginal cost approach, equilibrium of monopoly firm is obtained at that level of output at which its marginal cost equals marginal revenue. Monopoly price during short-run During short run monopolist cannot expand or contract the size of this plant nor can he change the structure of the fixed costs. In order to be in equilibrium of monopoly from would like to product that level of output at which it is marginal revenue is equal to marginal cost . In the short run the monopoly firm may get abnormal profit and may suffer loss. Monopoly price during long run: The long rum equilibrium of the monopoly firm is attained at that level of output where its marginal cost equals the marginal lrevenue. Monopoly in the long run gets abnormal profit. It is Los because the new firms are not allowed to enter the market. Monopoly does not suffer loss in the long run because all the costs in

the long run are variable and these must be recovered. In case a monopoly firm fails to recover the variable in the long run, it would better stop production and quit the market