Summer / May 2012
Master of Business Administration
Semester I
MB0042 – Managerial Economics - 4 Credits
(Book ID: B1131)
Assignment
Set- 1 (60 Marks)
Note: Each Question carries 10 marks. Answer all the questions.
Q1. Distinguish between a firm and an industry. Explain the equilibrium of a firm and
industry under perfect competition.
An : An industry is the name given to a certain type of manufacturing or retailing
environment. For example, the retail industry is the industry that involves everything from
clothes to computers, anything in the shops that get sold to the public. The retail industry is
very vast and has many sub divisions, such as electrical and cosmetics. More specialised
industries deal with a specific thing. The steel industry is a more specialised industry, dealing
with the making of steel and selling it on to buyers.
The difference between this and a firm is that a firm is the company that operates within the
industry to create the product. The firm might be a factory, or the chain of stores that sells the
clothes, within its industry. For example, one firm that makes steel might be Avida steel.
They create the steel in that firm for the steel industry.
A firm is usually a corporate company that controls a number of chains in the industry it is
operating within. For example in retail, the firm Arcadia stores owns the clothing chains Top
shop, Dorothy Perkins, Miss Selfridge, and Evans. These all operate for the firm Arcadia
within the industry of retail.
Several firms can operate in one industry to ensure that there is always competition to keep
prices reasonable and stop the market becoming a monopoly, which is where one firm is in
charge of the whole industry. Sometimes, a firm is not necessary within the industry and
independent chains and retailers can enter straight into the market without a firm behind
them, although this is risky. This is because one of the advantages of having a firm behind
you is that it is a safeguard against possible bankruptcy because the firm can support the
chain that it owns.
Profit maximization is one of the important assumptions of economics. It is assumed that the
entrepreneur always tries to maximize profit. Hence the firm or entrepreneur is said to be in
equilibrium if the profit is maximized. According to Tibor Sitovosky "A market or an
economy or any other group of persons and firms is in equilibrium when none of its
member's fells impelled to change his behaviour". Naturally, the firm will not try to change
its position when it is in equilibrium by maximizing profit.
There are two approaches to explain the equilibrium of the firm regards to profit
maximization. They are - total revenue-total cost approach and marginal revenue-marginal
cost approach. Here we concentrate only on MR - MC approach.
The equilibrium of firm on the basis of MR - MC approach has been presented in the table
below
According to MT -MC approach, when marginal revenue equals marginal cost the firm is in
equilibrium and gets maximum profit. Hence, a rational producer determines the quality of
output where marginal revenue equals marginal cost.
The difference between total revenue and total cost is highest 210, at four units of output. At
this output, both marginal revenue and marginal cost are equal, 80. Hence profit is
maximized. The firm is in equilibrium. It should be noted that the table relates to imperfect
competition, when price is reduced to sell more.
The following two conditions are necessary for a firm to be in equilibrium.
(a) The marginal revenue should be equal to marginal cost.
(b) The marginal cost curve should cut marginal revenue curve from below.
The equilibrium of a under to MR - MC approach has been presented in figure:-
The figure depicts the equilibrium of a firm under perfect competition. The same is
applicable to the firms under imperfect competition. The only difference is that the AR & MR
curves under imperfect competition are different and they are downward sloping.
In the figure 'OP' is the given price. Since, under perfect competition, average revenue equals
marginal revenue, the AR and MR curves are horizontal from P. The profit-maximizing
output is OM. Here, marginal revenue and marginal cost are equal. It is because MC and MR
curves intersect each other at point E. The firm earns profit equal to PEBC.
The first condition necessary for firm's equilibrium is that marginal cost should be equal to
marginal revenue. But this is not a sufficient condition. It is because the firm may not be in
equilibrium even if this condition is fulfilled. In the figure, this condition is fulfilled at point
F. but the firm is not in equilibrium. The profit is maximized only at output OM which is
higher than output ON.
The second condition necessary for equilibrium is that the marginal cost curve must cut
marginal revenue curve from below. This implies that marginal cost should be rising at the
point of intersection with MR curve. Hence, both the conditions have been fulfilled at point
E. In the figure, MC curve cuts MR curve from at point F from above. Hence, this point
cannot be the point of stable equilibrium. It is because before that point marginal cost exceeds
marginal revenue. It shows that it is not reasonable to increase output. After point F, the MR
curve lies above MC curve. This shows that it is reasonable to increase output.
Q2. Give a brief description of
a. Implicit and explicit cost
b. Actual and opportunity cost
a. Implicit and explicit cost
An : Explicit cost
An Explicit cost is a business expense accounted cost that can be easily identified such as
wage, rent and materials. Explicit costs gives clear and evident cash outflows from business
that decreases its end result profitability. This cost directly effect the revenue. Intangible
expenses such as goodwill and amortization are not explicit expense because these expenses
don't show clear effects on a business's revenue and expenses.
Implicit cost
An implicit cost results if the person who at first fo
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Q3. A firm supplied 3000 pens at the rate of Rs 10. Next month, due to a rise of in the price
to 22 rs per pen the supply of the firm increases to 5000 pens. Find the elasticity of supply of
the pens.
Q4. What is monetary policy? Explain the general objectives and instruments of monetary
policy
Q5. Explain in brief the relationship between TR, AR, and MR under different market
condition.
Q6. What is a business cycle? Describe the different phases of a business cycle.
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Summer / May 2012
Master of Business Administration
Semester I
MB0042 – Managerial Economics - 4 Credits
(Book ID: B1131)
Assignment
Set- 2 (60 Marks)
Note: Each Question carries 10 marks. Answer all the questions.
Q1. Discuss the various measures that may be taken by a firm to counteract the evil effects of
a trade cycle.
An : FACTORS THAT SHAPE BUSINESS CYCLES
For centuries, economists in both the United States and Europe regarded economic downturns
as “diseases" that had to be treated; it followed, then, that economies characterized by growth
and affluence were regarded as "healthy" economies. By the end of the 19th century,
however, many economists had begun to recognize that economies were cyclical by their
very nature, and studies increasingly turned to determining which factors were primarily
responsible for shaping the direction and disposition of national, regional, and industry-
specific economies. Today, economists, corporate executives, and business owners cite
several factors as particularly important in shaping the complexion of business environments.
VOLATILITY OF INVESTMENT SPENDING
Variations in investment spending is one of the important factors in business cycles.
Investment spending is considered the most volatile component of the aggregate or total
demand (it varies much more from year to year than the largest component of the aggregate
demand, the consumption spending), and empirical studies by economists have revealed that
the volatility of the investment component is an important factor in explaining business
cycles in the United States. According to these studies, increases in investment spur a
subsequent increase in aggregate demand, leading to economic expansion. Decreases in
investment have the opposite effect. Indeed, economists can point to several points in
American history in which the importance of investment spending was made quite evident.
The Great Depression, for instance, was caused by a collapse in investment spending in the
aftermath of the stock market crash of 1929. Similarly, prosperity of the late 1950s was
attributed to a capital goods boom.
There are several reasons for the volatility that can often be seen in investment spending. One
generic reason is the pace at which investment accelerates in response to upward trends in
sales. This linkage, which is called the acceleration principle by economists, can be briefly
explained as follows. Suppose a firm is operating at full capacity. When sales of its goods
increase, output will have to be increased by increasing plant capacity through further
investment. As a result, changes in sales result in magnified percentage changes in
investment expenditures. This accelerates the pace of economic expansion, which generates
greater income in the economy, leading to further increases in sales. Thus, once the
expansion starts, the pace of investment spending accelerates. In more concrete terms, the
response of the investment spending is related to the rate at which sales are increasing. In
general, if an increase in sales is expanding, investment is spending rises, and if an increase
in sales has peaked and is beginning to slow, investment spending falls. Thus, the pace of
investment spending is influenced by changes in the rate of sales.
MOMENTUM
Many economists cite a certain "follow-the-leader" mentality in consumer spending. In
situations where consumer confidence is high and people adopt more free-spending habits,
other customers are deemed to be more likely to increase their spending as well. Conversely,
downturns in spending tend to be imitated as well.
TECHNOLOGICAL INNOVATIONS
Technological innovations can have an acute impact on business cycles. Indeed,
technological breakthroughs in communication, transportation, manufacturing, and other
operational areas can have a ripple effect throughout an industry or an economy.
Technological innovations may relate to production and use of a new product or production
of an existing product using a new process. The video imaging and personal computer
industries, for instance, have undergone immense technological innovations in recent years,
and the latter industry in particular has had a pronounced impact on the business operations
of countless organizations. However, technological innovations —and consequent increases
in investment—take place at irregular intervals. Fluctuating investments, due to variations in
the pace of technological innovations, lead to business fluctuations in the economy. There are
many reasons why the pace of technological innovations varies. Major innovations donor
occur every day. Nor do they take place at a constant rate. Chance factors greatly influence
the timing of major innovations, as well as the number of innovations in a particular year.
Economists consider the variations in technological innovations as random (with no
systematic pattern). Thus, irregularity in the pace of innovations in new products or processes
becomes a source of business fluctuations.
VARIATIONS IN INVENTORIES
Variations in inventories—expansion and contraction in the level of inventories of goods kept
by businesses—also contribute to business cycles. Inventories are the stocks of goods firms
keep unhand to meet demand for their products. How do variations in the level of inventories
trigger changes in a business cycle? Usually, during a business downturn, firms let their
inventories decline. As inventories dwindle, businesses ultimately find themselves short of
inventories. As result, they start increasing inventory levels by producing output greater than
sales, leading to an economic expansion. This expansion continues as long as the rate of
increase in sales holds up and producers continue to increase inventories at the preceding
rate. However, as the rate of increase insoles slows, firms begin to cut back on their inventory
accumulation. The subsequent reduction in inventory investment dampens the economic
expansion, and eventually causes an economic downturn. The process then repeats itself all
over again. It should be noted that while variations in inventory levels impact overall rates of
economic growth, the resulting business cycles are not really long. The business cycles
generated by fluctuations in inventories are called minor or short business cycles. These
periods, which usually last about two to four years, are sometimes also called inventory
cycles.
FLUCTUATIONS IN GOVERNMENT SPENDING
Variations in government spending are yet another source of business fluctuations. This may
appear to be an unlikely source, as the government is widely considered to be a stabilizing
force in the economy rather than a source of economic fluctuations or instability.
Nevertheless, government spending has been a major destabilizing force on several
occasions, especially during and after wars. Government spending increased by an enormous
amount during World War II, leading to an economic expansion that continued for several
years after the war. Government spending also increased, though to a smaller extent
compared to World War II, during the Korean and Vietnam wars. These also led to economic
expansions. However, government spending not only contributes to economic expansions,
but economic contractions as well. In fact, the recession of 1953-54 was caused by the
reduction in government spending after the Korean War ended. More recently, the end of the
Cold War resulted in a reduction in defence spending by the United States that had a
pronounced impact on certain defence-dependent industries and geographic regions.
POLITICALLY GENERATED BUSINESS CYCLES
Many economists have hypothesized that business cycles are the result of the politically
motivated use of macroeconomic policies (monetary and fiscal policies) that are designed to
serve the interest of politicians running for re-election. The theory of political business cycles
is predicated on the belief that elected officials (the president, members of congress,
governors, etc.) have a tendency to engineer expansionary macroeconomic policies in order
to aid their re-election efforts.
MONETARY POLICIES
Variations in the nation's monetary policies, independent of changes induced by political
pressures, are an important influence in business cycles as well. Use of fiscal policy—
increased government spending and/or tax cuts—is the most common way of boosting
aggregate demand, causing an economic expansion. Moreover, the decisions of the Federal
Reserve, which controls interest rates, can have a dramatic impact on consumer and investor
confidence as well.
FLUCTUATIONS IN EXPORTS AND IMPORTS
The difference between exports and imports is the net foreign demand for goods and services,
also called net exports. Because net exports are a component of the aggregate demand in the
economy, variations in exports and imports can lead to business fluctuations as well. There
are many reasons for variations in exports and imports over time. Growth in the gross
domestic product of an economy is the most important determinant of its demand for
imported goods—as people’s incomes grow, their appetite for additional goods and services,
including goods produced abroad, increases. The opposite holds when foreign economies are
growing—growth in incomes in foreign countries also leads to an increased demand for
imported goods by the residents of these countries. This, in turn, causes U.S. exports to grow.
Currency exchange rates can also have a dramatic impact on international trade—and hence,
domestic business cycles—as well.
KEYS TO SUCCESSFUL BUSINESS CYCLE MANAGEMENT
Small business owners can take several steps to help ensure that their establishments weather
business cycles with a minimum of uncertainty and damage. "The concept of cycle
management may be relatively new," wrote Matthew Gallagher in
Chemical Marketing Reporter,
"but it already has many adherents who agree that strategies that work at the bottom of a
cycle need to be adopted as much as ones that work at the top of a cycle. While there will be
no definitive formula for every company, the approaches generally stress a long-term view
which focuses on a firm's key strengths and encourages it to plan with greater discretion at all
times. Essentially, businesses are operating toward operating on a more even keel."Specific
tips for managing business cycle downturns include the following: Flexibility — According
to Gallagher, "part of growth management is a flexible business plan that allows for
development times that span the entire cycle and includes alternative recession-resistant
funding structures."Long-Term Planning—Consultants encourage small businesses to adopt a
moderate stance in their long-range forecasting. Attention to Customers—this can be an
especially important factor for businesses seeking to emerge from an economic downturn.
"Staying close to the customers is a tough discipline to maintain in good times, but it is
especially crucial coming out of bad times," stated Arthur Dalasi Industry Week.
"Your customer is the best test of when your own upturn will arrive. Customers, especially
industrial and commercial ones, can give you early indications of their interest in placing
large orders in coming months."Objectivity—Small business owners need to maintain a high
level of objectivity when riding business cycles. Operational decisions based on hopes and
desires rather than a sober examination of the facts can devastate a business, especially in
economic down periods. Study—"Timing any action for an upturn is tricky, and the
consequences of being early or late are serious," said Deltas. "For example, expanding a sales
force when the markets don't materialize not only places big demands on working capital, but
also makes it hard to sustain the motivation of the sales-people. If the force is improved too
late, the cost is decreased market share or decreased quality of the customer base. How does
the company strike the right balance between being early or late? Listening to economists,
politicians, and media to get a sense of what is happening is useful, but it is unwise to rely
solely on their sources. The best route is to avoid trying to predict the upturn. Instead, listen
to your customers and know your own response-time requirements."
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Q2. Define the term equilibrium. Explain the changes in market equilibrium and effects to
shifts in supply and demand.
Q3. What do you mean by pricing policy? Explain the various objective of pricing policy of a
firm.
Q4. Critically examine the Marris growth maximising model
Q5. Explain how a product would reach equilibrium position with the help of ISO - Quants
and ISO-Cost curve
Q6. Suppose your manufacturing company planning to release a new product into market,
Explain the various methods forecasting for a new product.
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