Study Material

M.B.A.ForBased on Latest Syllabus of MBA prescribed By Maharshi Dayanand University, Rohtak (DDE)

1st Semester(Part-1)By :Expert Faculties

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PublicationsSCF-181, HUDA Complex, Near New Telephone Exchange, Rohtak (Haryana)

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CONTENTSMANAGERIAL ECONOMICS

UNIT II....................................................................27-77 UNIT III.................................................................78-121 UNIT IV...............................................................122-134 Past Year Question Paper......................................135-139 Worksheet............................................................140-142

ACCOUNTING FOR MANAGERSSyllabus...............................................................143-143 UNIT I.................................................................144-175 UNIT II................................................................176-202 UNIT III...............................................................203-227 UNI IV................................................................228-246 Past Year Question Paper......................................247-253 Worksheet............................................................254-256

INDIAN ETHOS AND VALUESSyllabus...............................................................257-257 UNIT I.................................................................258-270 UNIT II................................................................271-283 UNIT III...............................................................284-298 UNI IV................................................................299-304 Past Year Question Paper......................................305-309 Worksheet............................................................310-312 Syllabus......................................................................5-5 UNIT I.......................................................................6-26

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MANAGERIAL ECONOMICSMBA1st SEMESTER, M.D.U., ROHTAKExternal Marks : 70 Time : 3 hrs. Internal Marks : 30

SYLLABUS

UNIT-INature of managerial economics; significance in managerial decision making, role and responsibility of managerial economist; objectives of a firm; basic concepts - short and long run, firm and industry, classification of goods and markets, opportunity cost, risk and uncertainty and profit; nature of marginal analysis.

UNIT-IINature and types of demand; Law of demand; demand elasticity; elasticity of substitution; consumer's equilibrium utility and indifference curve approaches; techniques of demand estimation.

UNIT-IIIShort-ru n and long-ru n production functions ; optimal input combination; short-run and long-run cost curv es and their interrelationship; e ngineering cost curv es; economies of scale; equilibrium of firm and industry under perfect competition, monopoly, monopolistic competition and oligopoly; price discrimination.

UNIT-IVBaumol's theory of sales revenue maximisation basic techniques of average cost pricing; peak load pricing; limit pricing; multi-product pricing; pricing strategies and tactics; transfer pricing.

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MANAGERIAL ECONOMICSMBA 1st Semester (DDE)

UNIT IQ. What do you mean by Managerial Economics. Explain its Nature and Scope. Ans. Meaning of Managerial Economics : Managerial economics is the study of economic theories, logic and tools of economic analysis that are used in the process of business decision making. Economic theories and techniques of economic analysis are applied to analyse business problems, evaluate business options and opportunities with a view to arriving at an appropriate business decision. Managerial economics is thus constituted of that part of economic knowledge, logic, theories and analytical tools that are used for rational business decision-making. Managerial economics is that subject which describes how economic analysis is used in taking business decisions. The purpose of Managerial Economics is to show how economic analysis can be used in formulating business policies. Managerial economics is that discipline which uses economic concepts, principles and economic analysis in taking business decision and formulating future plans. It integrates economic theory with business practice for choosing business policies. Managerial economics lies on the borderline between economics and business management and bridges the gap between the two. Definition of Managerial Economics According to McNair and Meriam : Managerial economics is the use of economic modes of thought to analyse business situation. According to Mansfield : Managerial economics is concerned with the application of economic concepts and economics analysis to the problems of formulating rational decision making. Nature or Characteristics of Managerial Economics : 1. Managerial Economics is a Science : Managerial economics is a science because it establishes relationship between causes and effects. It studies the6

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MANAGERIAL ECONOMICS

effects of a change in price of a commodity factors and forces on the demand of a particular product. It also studies the effects and implications of the plans, policies and programmes of a firm on its sales and profit. 2. Managerial Economics is an Art : Managerial economics may also be called an art. Because it also develops the best way of doing things. It helps management in the best and most efficient utilization of limited economic resources of the firm. Entire study of 3. Managerial Economics is a Micro Economics : economics may be divided into two segments- Macro economics and Micro economics. Managerial economics is mainly micro-economics. Microeconomics is the study of the behaviour and problems of individual economic unit. In managerial economics unit of study is firm or business organization and an individual industry. It is the problem of business firms such as problem of forecasting demand, cost of production, pricing, profit planning, capital, management etc. Managerial Economics is the Economics of firms : Managerial 4. economics largely use that body of economic concepts and principles which is known as Theory of the Firm or Economics of the Firm. 5. Managerial Economics uses Macro-economic Analysis : Managerial economics also uses macro-economics to analysis and understand the general business environment in which the business firm must operate. Business management must have the adequate knowledge of external forces that affect the business of the firm. The important macro-factors that affect the firm are trends in national income and expenditure, business cycles, economic policies of the government, trends in foreign trade etc. Managerial Economics is Progmatic : It is concerned with practical 6. problems and results. It has nothing to do with abstract economic theory which has no practical application to solve the problems faced by business firms. 7. Managerial Economics is Normative Science : There are two types ofscience-Normative Science and Positive Science. Positive science studies what is being done. Normative science studies what should be done. From this point of view, it can be concluded that managerial economics is normative science because it suggests what should be done under particular circumstances. Scope of Managerial Economics

economic theories in the process of decision-making and formulation of future plans. The management will have to analyse the business problems that are faced by the firm. Thus, the principles relating to following topics constitute the Demand Analysis : A business firm is in an economic organization which is engaged in subject matter of resources into goods that are to be sold scope of transforming productive managerial economics: 1 7

: Managerial economics is the application of

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in the market. A major part of managerial decision-making depends on accurate estimates of demand. A forecast of future sales serves as a guide to management for preparing production schedules and employing resources. It will help management to maintain or strengthen its market position and profitbase. Demand analysis also identifies a number of other factors influencing the demandAnalysis product. Demandare most useful for management occupies a strategic for a : analysis and forecasting Cost Cost estimates decisions. The different factors that cause variations in cost estimates should place in Managerial Economics. be given due consideration for planning purpose. There is the element of 2 uncertainty of cost as other factor influencing cost are either uncontrollable or not Pricing Practices and Policies : always known. As price gives income to the firm, it constitutes as the most important field of Managerial Economics. The success 3 of a business firm depends very much on the correctness of the price decision taken by it. The various aspects that are deal under it cover the price determination in various market forms, pricing policies, pricing method, Profit pricing, : The chief purpose is to earn the differentManagementproductive pricing of a business firmuncertainty about profits maximum profit. There is always an and priceof element forecasting. 4 because of variation in cost and revenue. If knowledge about the future were perfect, profit analysis would have been very easy task. But in this world of uncertainty expectations are not always realized. Hence profit planning and its measurement constitute the most difficult area of managerial economics. Under profit management we study nature and management of profit, profit Capital Management : The problems relating to firms capital investments are perhapsof profit planning like Break Even Analysis. the most complex and the troublesome. Capital policies and techniques management implies planning and control of capital expenditure. The main 5 topics deal with under capital management are cost of capital, rate of return andAnalysis of Business Environment : selection of projects. The environmental factors influence the working and performance of a business undertaking. Therefore, 6the managers will have to consider the environmental factors in the process of decision-making. The factors which constitute economic environment of a country include the following factors:

Economic System of the Country Business Cycles Fluctuations in National Income and National Production

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Industrial Policy of the Government Fiscal Trade andPolicy Policy of the Government Taxation Policy etc. LicensingEnvironment Political Factors Social in labour and capital markets. Trend Q. What do you mean by Managerial Economics? Explain its significance in Managerial Decision Making. Ans. Meaning of Managerial Economics : Managerial economics is the study of economic theories, logic and tools of economic analysis that are used in the process of business decision making. Economic theories and techniques ofeconomic analysis are applied to analyse business problems, evaluate business options and opportunities with a view to arriving at an appropriate business decision. Managerial economics is thus constituted of that part of economic knowledge, logic, theories and analytical tools that are used for rational business decision-making. Managerial economics is that subject which describes how economic analysis is used in taking business decisions. The purpose of Managerial Economics is to show how economic analysis can be used in formulating business policies. Managerial economics is that discipline which uses economic concepts, principles and economic analysis in taking business decision and formulating future plans. It integrates economic theory with business practice for choosing business policies. Managerial economics lies on the borderline between economics and business management and bridges the gap between the two. Definition of Managerial Economics According to McNair and Meriam : Managerial economics is the use of economic modes of thought to analyse business situation. According to Mansfield : Managerial economics is concerned with the application of economic concepts and economics analysis to the problems of formulating rational decision making. Significance of Managerial Economics in Managerial Decision Making The most important function of management of a business firms is decision making and future planning. Business decision-making is essentially a process of selecting the best out of alternative opportunities open to the firm. The process of decision-making comprises following phases : (i) Determining and defining the objective to be achieved9

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(ii) Developing and analyzing possible course of action; and (iii) Selecting a particular course of action. Economic analysis helps the management in following ways:(1) Reconciling Theoretical Concepts of economics to the Actual Business Behaviour and Conditions : Managerial economics attempts to

policies for future can be formulated on the basis of economic quantities. Managerial economics helps the management in predicting various economic quantities such as:

reconcile the tools, techniques, models and theories of economics with actual business practices and with the environment in which a firm has to operate. Analytical techniques of economic theory builds models by which we arrive at certain assumptions and conclusions are reached thereon in relation to certain firms. There is need to reconcile the theoretical principles based on simplified assumptions with actual business practice and develop the economic theory, if necessary. Managerial economics plays an (2) Estimating Economic Relationship : important role in business planning and decision making by estimating economic relationship between different business factors- income, elasticity of demand like price elasticity, income elasticity, cross elasticity and cost volume profit analysis etc. The estimates of this economic relationship can be used for purpose of business forecasts. Sound business plans and (3) Predicting Relevant Economic Quantities :

Cost Profit Demand Capital Production Price etc. manager has to work in an environment of uncertainty, Since a business future should be well predicted in the light of these quantities. (4) Understanding Significant External Forces : The management has to identify all the important factors that influence firm. These factors broadlydivided into two parts- Internal Factors and External Factors. External factors are the factors over which a firm cannot have any control. Therefore, the plans, policies and programmes of the firm should be adjusted in the light of these factors. Important external factors affecting decision-making process of a firm are: Economic System of the Country Business Cycles Fluctuations in National Income and National Production Industrial Policy of the Government

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a number of tools and methods which increases the analytical capabilities of the business analysis. Q. Who is Managerial Economist? Discuss the Role and Responsibility of Managerial Economist.

in understanding these factors. (5) Basis of Business Policies : Managerial economics is the foundation of all business policies. All the business policies are prepared on the basis of studies and findings of managerial economics. It warns the management against all the turning points in national as well as international economy. (6) Clear Understanding of Economic Concepts : It gives clear understanding of various economic concepts (i.e, cost, price, demand etc.) used in business analysis. For example , the concept of cost includes total, average, marginal, fixed, variable, actual cost, and opportunity cost. Economics clarifies which cost concepts are relevant and in what context. (7) Increases the Analytical Capabilities : Managerial Economics provides

Trade and Fiscal Policy of the Government Taxation Policy etc. Licensing Policy Managerial economics plays an important role by assisting management

Ans. : Managerial Economist is an expert who counsels business management in economic matters and problems faced by a business organization. Taking business decision and formulating forward plans are two important jobs of business management. Specialized skills are needed to perform these jobs efficiently. The managerial economist can assist the management in using the specialized skill to solve the problems of business to formulate business policies. Role of Managerial Economist

management is to determine the key factor which influences the business over a period of time. This function is performed by a Managerial Economist. In general, the factors which influence the business over a period to come fall under two categories: (A) External Factors : The external factors are beyond the control of management. (B) Internal Factors : The internal factors are well within the control of

: One of the main functions of any

management. Thus, the role of Managerial Economist are : (A) Analysis of The external factors operateFactors the External outside firm and firm has no control over these. Such factors constitute business Managerial Economist11

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environment and include prices, national income and output, business cycle, government policies, international trends, etc. These factors are of great importance to the firm. Managerial economists by studying and analyzing these factors can contribute effectively in determining business policies. Certain relevant question relating to these factors are:(i) What are the present trends in nations and international economics? (ii) What phase of business cycle lies immediately ahead? (iii) Where are the market and customer opportunities likely to expand or contract most rapidly? (iv) What are the possibilities of demand and prices of finished products? (v) Is competition likely to increase or decrease? (vi) What changes are expected in government policies and control? (vii) What are the demand prospects in new and the established markets? (B) Analysis of Internal Factors : Internal factors are known as business operations. In other words internal activities of a firm are called business operations. A managerial economists can also help the management to solve problems re lating the bus iness operation such as price determination, use of installed capacity, investment decision, expansion and diversification of business etc. Relevant questions in this context are as follows:(i) What will be the reasonable sales and profit targets for the next year? (ii) What will be the most appropriate production schedules and the inventory policy for the next five or six months? (iii) What changes in wage and price policies should be made now? (iv) How much cash will be available in the coming months and how it should be invested? (C) Specific Functions : These Specific functions are as under : (i) Sales Forecasting (ii) Market Research (iii) Economic Analysis of competing firms. (iv) Pricing problem of the industry (v) Evaluation of Capital Projects. (vi) Advice on foreign exchange. (vii) Advice on trade and public relations (viii) Environmental forecasting. (ix) Investment analysis and forecasts (x) Production and inventory schedule (xi) Marketing function. (xii) Analysis of underdeveloped economics Responsibilities of a Managerial Economist 1.

: He must have

To make reasonable profits on capital employed :12

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2.

strong conviction that profits are essential and his main obligation is to assist the management in earning reasonable profits on capital invested by the firm. He should always help the management to enhance the capacity of the firm to earn profits. If he fails to discharge this responsibility then his academic knowledge, experience and business skill will be of no use to the firm. Successful Forecasts : It is necessary for the managerial economist to make successful forecasts by making in depth study of internal and external factors that may have influence over the profitability or the working of the firm. A managerial economist is supposed to forecast the trends in the activities of importance to the firm such as sales, profit, demand, costs etc. Knowledge of Sources of Economic Informations : A managerial economist should establish and maintain close contacts with specialists and data sources in order to collect quickly the relevant and valuable information in the field. For this purpose he should develop personal relation with those having specialized knowledge of the field. He should also join professional associations and take active part in their activities. His Status in the Firm : A managerial economist must earn full status in the business ream because only then he can be really helpful to the management in formulating successful business policies.

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4.

Q. What are the objectives of Business Firms? Ans. Introduction : Conv entional theory of firm ass umes profit maximization, as the sole objective of business firms. Recent researchers on this issue reveal that the objectives that business firms pursue are more than one. Some important objectives, other than profit maximization, are:(i) Maximization of Sales Revenue (ii) Maximization of Firms growth rate (iii) Maximization of managers utility function (iv) Long-run survival of the firm Therefore the objectives of the Business firms are Objectives of Business Firms Main Objective Alternative Objectives Profit Maximization Maximization of Sales Revenue Maximization of Firms growth rate Maximization of managers utility function Long-run survival of the firm13

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(A) Main Objectives 1. Profit Maximization Goal of a Business Firm : According to traditionaleconomic theory profit maximization is the sole objective of business firms. The traditional theory suggests a number of reasons as to why does a firm want to maximize profits. All these reasons essentially fall into the following categories: (i) Traditional economic theory assumes that the firm is ownermanaged, and therefore maximizing profit would imply maximizing the income of the owner; Owner would like to have adequate return for his activity as n entrepreneur. (ii) Firm may pursue goals other than profit-maximization, but they can achieve these subsidiary goals much easier if they aim for profit maximization. Under perfect competition individual firms have to maximize their profits at price determined by industry. Under imperfect competition firms search their profit maximizing price output as they are price makers. The profit can be defined as the difference between total revenue and total cost. Profit = Total Revenue - Total Cost. A firm will maximize its profit at that level of output at which the difference between total revenue and total cost is maximum. Generally conventional price theory determines profit maximizing price-output in terms of marginal cost and marginal revenue. Marginal Revenue : Marginal revenue is the addition to total revenue from the sale of an additional unit of a commodity. Marginal Cost : Marginal cost is the addition to total cost from the production of an additional unit of a commodity. The two profit maximizing conditions 1. We take first condition MC = MR : (i) If MCMR the level of total profit is being reduced and firm can increase profit by decreasing production. (iii) If MC = MR the profits could not increase either by increasing or decreasing output and hence profits are maximized. (b) MC cuts MR from below : Now we take the second condition. The second condition of profit maximization requires that MC be rising at the point of its intersection with the MR curve14

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Y P A E MC AR=MR

OM OUTPUT Criticism of profit Maximization Approach :

QX

At point E both the conditions are satisfied. a) The real world business environment is more complex than what convention theory of firm thought. The modern business firms face lot of risk and uncertainty. Long-run survival is more important than short-run profit. b) The other objectives such as sales maximization, growth rate maximization etc. describe real business behavior more accurately. c) Profit maximization objective cannot be realized without the exact measurement of marginal cost and marginal revenue. d) Profits are not only measure of firms efficiency. e) Profit maximization assumption may require expansion of business which means more risks. But firms may prefer less profit instead of bearing additional uncertainties. (B) Alternative Objectives of Business Firms : There are the following objectives: (1) Baumols Hypothesis of Sales Revenue Maximization :

(2)

Baumols theory of sales maximization is an alternative theory of firms behaviour. The basic premise of his theory is that sales maximization, rather than profit maximization, is the plausible goal of the business firms. He argues that there is no reason to believe that all firms seek to maximize their profits. Business firms, in fact, pursue a number of objectives and it is not easy to single out one as the most common objective pursued by the firms. However, from his experience as a consultant to many big business houses, Baumol finds that most managers seek to maximize sales revenue rather than profits. Maximization of firms growth rate : According to Robin Marris managers maximize firms balanced growth rate. He defines firms balanced growth rate (G) as15

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G = G =CG D Where G = DGrowth rate of demand for firms product GC= Growth rate of capital supply to the firm In simple words, a firms growth rate is balance when demand for its product and supply of capital to the firm increase at the same rate. (3) Maximization of Managerial Utility Function : According to this concept managers seek to maximize their own utility function subject to a minimum level of profit. Long-Run Survival of the firm : According to this concept, the primary goal of the firm is long-run survival. The managers, therefore, seek to secure their market share and long-run survival. The firms may seek to maximize their profit in the long-run though it is not certain. (A) Short-Run (B) Long-Run (C) Firm (D) Industry (E) Classification of Goods (F) Classification of Markets (G) Opportunity Cost (H) Risk (I) Uncertainty (J) Profit (K) Nature of Marginal Analysis. Ans. (A) :Short-Run Short-Run refers to that time period in which supply of a commodity can be increased only up to its existing production capacity. If demand has increased, there is not enough time for a firm to install new machines nor for the new firms to enter the industry. The main features of short-run are (1) In the short-run there are two types of factors of production:-

(4)

Q. Write a short note on the following :

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(2) In the short-run supply can be changed only by varying variable factors. (3) The fixed factors cannot be changed. (4) In short-run demand plays greater role than supply in the determination of price.16

Fixed Factors Variable Factors

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(5) The price that is determined in the short period is called Sub-normal price. (6) There are two types of cost in the short-run: Fixed Cost : The costs of fixed inputs are called fixed costs. Fixed costs are costs which do not change with changes in the quantity of output. Variable Cost : Variable costs are those costs which are incurred on the use of variable factors of production.

Example : Supposing you have a carpet manufacturing factory. If you run your factory for full 24 hours, you can produce 10 carpets at the most. Supposing demand for carpets increases to 20 carpets per day for two days only. You will be unable to meet this additional demand. Your maximum production capacity is limited to 10 carpets only. You do not have time to install new looms to increase your production. (B) :Long-Run Long-Run refers to that time period in which supply of a commodity can be increased or decreased according to the changed conditions of demand. The increased demand can be met with increasing the supply by installing machines. Or new firms can enter the industry. On the contrary, if demand has gone down, some firms will discontinue their production. Price, in the long-run is therefore, more influence by supply than demand. Price that comes to prevail in the long-run is called Normal Price. The main features of long-run are:(1) In the long-run all factors are variable. (2) In the long-run supply can be changed by varying all factors of production. (3) In long-run demand and supply both plays equal role in the determination of price. (4) The price that is determined in the long period is called Normal Price. (5) In the long-run supply can be increased or decreased according to the demand. (6) In the long-run new firms can enter the industry and old firms can leave it. (C) :Firm A firm is a unit engaged in the production for sale at a profit and with the objective of maximizing the profit. A firm is in equilibrium when it is satisfied with its existing amount of output. A firm is in equilibrium has no tendency either to increase or to decrease its output. The objectives of a firm are:17

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Objectives of Business Firms Main Objective Alternative Objectives Profit Maximization Maximization of Sales Revenue Maximization of Firms growth rate Maximization of managers utility function Long-run survival of the firm (D) :Industry The group of firms producing homogenous products is called industry. Homogeneous products are those products in which it is not possible to make any distinction between the units of the commodity being sold by different sellers. Such firms are found only under perfect competition. Perfect competition is that situation of the market in which there are large number of buyers and sellers of homogeneous product. Under perfect competition, price of the commodity is determined by the industry. In perfect competition market firm is a price-taker and not a price-maker. Equilibrium of Industry : An industry is in equilibrium when it has no

tendency to change its size. There are two conditions of an industrys equilibrium: (1) Constant Number of Firms : An industry will be in equilibriumwhen the number of its firms remains constant. In this situation, no new firm will enter and no old firm will leave the industry. Equilibrium of Firms : Another condition of an Industrys equilibrium is that all firms operating in it are in equilibrium and have no tendency either to increase or to decrease their output. Conditions of equilibrium of firm are:

(2)

(i) MC=MR (ii) MC curve cuts MR curve from below Y P A E MC AR=MR

OM OUTPUT

QX

At point E both the conditions are satisfied.

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(E) 1.

Classification of Goods

: There are basically three types of goods :

Consumers Goods : Those goods which are directly put to use are called consumers goods. These goods are used in our daily life. For example:Bread, Cloth, Medicines etc. Shopping Goods :

2.

items. Shopping goods purchase are characterized by Pre-Planning, information search & price comparisons. It is divided into: (i) Homogeneous Goods : Homogeneous products are those goods inwhich it is not possible to make any distinction between the units of the commodity being sold by different sellers.

This classification includes durable or semi-durable

(ii)

Heterogeneous Goods : Heterogeneous goods mean that goods are close substitutes but are not homogeneous. They differ in colour, name, packing, shape, size, quality etc.

3.

Producer or Capital Goods : Those goods which are used in production by other industries are capital goods. Huge amount is invested in these goods. For Example:- Machinery, Plant, etc. Intermediate Goods : Some industries manufacture such goods as are processed in some other industry to produce some need goods. Such goods are called intermediate goods. For example : Plastic, rubber, aluminum etc. Specialty Goods : The purchase of specialty goods is characterized by extensive search to accept substitutes once the purchase choice has been made. The market for such goods is small but price & profits are high. Normal Goods : Normal goods are those goods the demand for which tends to increase following increase in consumers income, and tends to decrease following decrease in his income. So, there is a positive relationship between consumers income and quantity demanded. Inferior Goods : Inferior goods are those goods the demand for which tends to decline following a rise in consumers income, and tends to increase following a fall in his income. So there is an inverse relationship between income of the consumer and demand for a commodity. Necessaries of Life and Inexpensive Goods : In case of necessaries of life and inexpensive goods, the demand remains almost constant irrespective of the level of income. Luxury Good : A luxury good means an increase in income causes a bigger % increase in demand. Classification of Market : In economics the term market refers not necessarily to a particular place but to the mechanism by which buyers and sellers are brought together. The classification of markets are:19

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9. (F)

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Classification of Market

Perfect Competition Imperfect Competition Monopoly

Monopolistic Competition Oligopoly 1. Perfect Competition : Perfect competition refers to a market situation where there is a large number of buyers and seller. The sellers sell homogeneous product at a uniform price. The price is determined not by the firm but by the industry. Features of Perfect Competition (i) Large Number of Buyers and Sellers (ii) Homogeneous Products (iii) Free entry and exit of firms (iv) Perfect Knowledge (v) Absence of Selling costs (vi) Price Taker. Imperfect Competition :

market

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:

2.

competition : (a) Monopolistic Competition :

There are two types of market under imperfect

Monopolistic competition is a market structure in which there are many sellers of a commodity, but the product of each seller differs from that of the other sellers on one respect or the other. Thus product differentiation is the main feature of monopolistic competition. The main feature of this (i) Large Number of Buyers and Sellers (ii) Product Differentiation. (iii) Freedom of Entry and Exit of firms (iv) Higher Selling Costs (v) Price Control. (vi) Imperfect Knowledge. (vii) Non-Price Competition

market

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(b) oligopoly is a: Oligopoly market structure in which there are few sellers selling a homogenous or differentiated products and large number of buyers. The main features (i) Small number of sellers (ii) Interdependence of decision-making. (iii) Barriers to Entry20

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3. Monopoly is a : Monopoly market situation in which there is a single seller, there are no close substitutes for commodity it produces, there are barriers to entry. The main features of this market are:(i) One Seller and Large Number of Buyers (ii) Monopoly is also an Industry (iii) Restriction on the entry of the new firms (iv) Price Maker (v) Price Discrimination (G) Opportunity Cost : The concept of opportunity cost is extremely important in economic analysis. We know that the cost is the value of inputs in the process of production. An input has got value because it is scarce or limited. If we use the input to produce one good, it is not available to produce something else. The cost of producing one thing is measured in terms of what was given up in terms of next best alternative that is sacrificed. If several opportunities are given up for producing a particular commodity, it is the value of the next best foregone opportunity that constitutes cost. Thus it is called opportunity cost. The opportunity cost is the cost of next best alternative foregone. It is also called alternative cost. Example : Supposing a farmer can grow both wheat and gram on a farm. If on a farm measuring one-hectare land he grows only wheat, he foregoes the production of gram. If the price of quantity of gram that he foregoes is Rs. 1,000, then the opportunity cost of growing wheat will be Rs. 1,000. Thus, the price of gram which the farmer has to forgo in order to produce wheat is called opportunity cost of wheat. Definition of Opportunity Cost : According to Leftwitch Opportunity cost of a particular product is the value of the foregone alternative product that resources used in its production, could have produce Diagram of Opportunity Cost : Y P

12 10 8 6 4 2O

X-Commodity

PX 2 4 6 8 10 1221

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Explanation : In this figure the production line PP shows that if a given quantity of resources is employed to produce both X and Y, it can produce

OR (a) 12 units of Y and nothing of X (b) 6 units of X and nothing of Y OR (c) Any combination of X and Y long the line. This line shows that to produce X, we must forego the opportunity ofproducing some of Y. This is called the opportunity cost of X in terms of Y. In this figure the opportunity cost of one unit of X is 12Y/6 = 2Y. This means that the same amount of factors of production that can produce 1 unit of X can produce 2 units of Y. Likewise, the opportunity cost of producing one unit of Y in term of X is 6X/12= 0.5 X. The same amount of factors of production employed in the production of 1 unit of Y can produce 0.5 units of X. The opportunity cost of Y interns of X is 0.5. (H) :Risk In common practice, risk means a low profitability of an expected outcome. From business decision-making point of view, risk refers to a situation in which business decision is expected to yield more than one outcome and the profitability of each outcome is known to the decision makers or can be reliably estimated. Example : If a company doubles its advertisement expenditure, there are three probable outcomes:(i) Its sales may more than double (ii) It may just double (iii) It may less than double. The company has the knowledge of these probabilities of the three outcomes on the basis of its past experience as (i) more than double- 10% (ii) almost double- 40% (iii) Less than double-50% It means that there is 90 % risk in more than doubling the sales and in doubling the sale, the risk is 60% and so on. There are two approaches to estimate probabilities of outcomes of a business decision, viz. (i) (ii) (I) A priori This approach based on intuition. approach This approach is based on past data. Posteriori approach : :

Uncertainty : Uncertainty refers to a situation in which there is more than one outcome of a business decision and the probability of outcome is not known or not meaningful. The unpredictability of outcome may be due to : 22

Lack of Reliable market information

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MANAGERIAL ECONOMICS

Inadequate past experience

Some Examples of Uncertainties : (i) Life of new plant and future maintenance are unpredictable. (ii) Technological changes are highly unpredictable. (iii) The size of the market may not turn out to be as anticipated due to a number of reasons like, changes in the pattern or fashions, tastes of the people, etc. (iv) It is not possible to base scientific judgments about the following factors which affect the extent of prospective yields in the distant future:

The extent of new competition The prices which may fluctuate from year to year The size of export market during the years to come. Change in fiscal policies particularly in individual taxation and corporate taxation, and policies with regard to labour and wages. Conditions in the labour market, changes in labour legislation, level of wages, the possibilities of lockouts and strikes etc. Political, climate etc.

The long term investment involves a great deal of uncertainty with unpredictable outcome. But, in really investment decisions involving uncertainty have to be taken on the basis of whatever information can be collected, generated. For the purpose of decision-making, the uncertainty is classified as Complete Ignorance : In case of complete ignorance, investment (i)decisions are taken by the investors using their own judgment. Partial Ignorance : In case of partial ignorance, on the other hand, there is some knowledge about the future market conditions, some information can be obtained from the experts in the field and some probability estimates can be made. The available information can be incomplete and unreliable. (J) Profit means different things to different people. The word profit Profit : has different meaning to businessmen, accountants, tax collectors, workers and economists. In a general sense, profit is regarded as income accruing to the equity holders, in the same sense as wages accrue to the labour, rent accrues to the owners of rentable assets and interest accrues to the money lenders. Concepts of Profit : The two important concepts of profit in business decisions are economic profit and accounting profit. It will be useful to understand the difference between the two concepts of profit.23

:

(ii)

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(1)

Accounting Profit : Accounting profit is surplus of revenue over and above all paid-out costs, including both manufacturing and overhead expenses. Accounting profit may be calculated as follows: Accounting Profit = TR (W +R + I + M) Where TR= Total Revenue W= Wages and Salaries I=Interest R= Rent M=Cost of materials

Obvious, while calculating accounting profit, only explicit or book costs, i.e., the cost recorded in the books of accounts, are considered. (2) Economic Profit or Pure Profit : The concept of economic profit differsfrom that of accounting profit. Economic profit takes into account also the implicit or imputed costs. The implicit cost is opportunity cost. Opportunity cost is the income foregone which a businessman could expect from the second best alternative use of his resources. There are the following examples of opportunity cost: (i) If an entrepreneur uses his capital in his own business, he foregoes interest which he might earn by purchasing debentures of other companies or by depositing his money with joint stock companies for a period. (ii) Furthermore, if an entrepreneur uses his labour in his own business, he foregoes his income (Salary) which he might earn by working as a manager in another firm. (iii) Similarly, by using productive assets (land and building) in his own business, he sacrifices his market rent. These foregone incomes-interest, salary and rent are called opportunity costs or transfer costs. Accounting profit does not take into account the opportunity cost. Economic Profit = Total Revenue (Explicit Costs Implicit Costs) (K) Nature of Margin Analysis : The concept of marginal is widely used in economic analysis. The nature of marginal analysis : (1) Marginal analysis is related to a unit change in independent variable, say,

increase in cost as a result of a unit change in output, increase in product as a result of a unit change in labour, increase in revenue as a result of a unit change in sale, increase in utility as a result of a unit change in consumption of units. These are explained in the following: (a) Marginal Utility (MU) : The marginal utility can be defined as the

24

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change in total utility from the consumption of an additional or less unit of a commodity. TU MU= DQ MU= Marginal Utility TU = Change in Total Utility D DQ = Change in Quantity (b) Marginal Cost (MC) : Marginal cost can be defined as the change in to total cost as result of producing one more or less unit of a commodity. D TC MC= DQ MC= Marginal Cost TC = Change in Total Cost D DQ = Change in Quantity (c) Marginal Product (MP) : Marginal Product can be defined as the change in total product as result of increasing or decreasing one more unit of labour. MR D TP = MP DL MP= Marginal Product TP = Change inD Total Product DL = Change in Labour (d) Marginal Revenue (MR) : Marginal product can be defined as the change in total revenue due to the sale of one additional unit of a product. D TR MR= DQ MR= Marginal Revenue TR = Change in D Total Revenue DQ = Change in Quantity (2) There are certain cases where marginal analysis is superior to any other analysis. These include the (a) best product-mix, in cases where substitution between products occurs at a decreasing rate., selection of :

25

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(b) least cost input-mix where inputs are substitutable at a decreasing rate. (c) Optimum input-level where input-output relationship faces diminishing returns, and (d) Optimum maturity of assets, having value decreasing over time. (3) Whenever the cost and revenue functions are curvilinear, it is more appropriate to use marginal analysis. Marginal analysis calls for unit-tounit comparison and would, therefore be able to capture the impact of all points. (4) In case of those functions which are linear, in such a case only the end points of a range are to be compared, and marginal analysis would not give any different results. (5) In case of those alternatives, which are discrete, marginal analysis cannot be used. If a producer wants to produce a particular level of output and wants to make a choice between different technologies for the purpose, it is not possible to compare these processes in terms of marginal cost of moving from one process to another.

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MANAGERIAL ECONOMICSMBA 1st Semester (DDE)

UNIT IIQ. Explain Demand and its various types. Also Explain the Determinants of Demand. Ans. Meaning of Demand : Demand is defined as the quantities of a product which a consumer is not only desiring to purchase and able to purchase but is also ready to purchase at given prices at a given point of time. Definition of Demand According to Ferguson Demand refers to the quantities of a commodity that the consumers are able and willing to but at each possible price during a given period of time, other things being equal. Constituents of Demand : (i) Desire for a thing. (ii) Money to satisfy the desire. (iii) Willingness to spend the money. (iv) Relationship of the price and the quantity of the commodity demanded. (v) Relationship of time and the quantity of the commodity demanded. Types of Demand : There are various types of demand: :

1. Demand for Consumers Goods and Producers Goods : i) Goods and services for final consumption are called consumers goods. These include those consumed by human beings such as food items, clothes, medicines etc. Demand for consumers goods is direct. ii) Producers goods refer to the ones used for the production of other goods such as plant and machines, factory buildings, raw materials etc. Demand for producers goods is derived. 2. Demand for Perishable Goods and Durable Goods : i) Perishable Goods are those goods which can be consumed only once. For example:- bread, milk and vegetables etc.27

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ii) Durable Goods are those goods the utility from which accrues over a period of time. For example refrigerator, car, furniture etc. 3. Direct and Indirect Demand : (i) (ii) Direct Demand : direct demand. Goods that are demanded for their own sake have

Indirect Demand : Goods that are needed in order to obtain some other goods possess indirect demand. Short Run Demand : Short-run demand represents the existing demand which is based on immediate reaction to price changes, income fluctuations and other explanatory variables. Long Run Demand : Long-run demand on the other hand, is that demand which emerges after the influence of price changes, product improvement, promotional efforts and other factors over time is allowed to adjust the market to the new situation. In the long run, new customers may start purchasing the product. Some products may not be demanded any more. Joint Demand : When two goods are demanded in conjunction with one another at the same time to satisfy a single want, they are said to be joint demand. For Example:- Pens and ink, camera and film, Car and petrol etc. Composite Demand : A commodity is said to be in composite demand when it is wanted for several different uses. Individual Demand : Individual demand schedule is defined as the table which shows quantities of a given commodity which an individual consumer will buy at all possible prices at a given time. Market Demand : Market demand schedule is defined as the quantities of a given commodity which all consumers will buy at all possible prices at a given moment of time. Price Demand : Price demand refers to the various quantities of a product purchased by the consumer at alternative prices. D= f (P)

4. Short-Run Demand and Long-Run Demand : (i)

(ii)

5. Joint Demand and Composite Demand : (i)

(ii)

6. Individual Demand and Market Demand : (i)

(ii)

7. Price Demand, Income Demand and Cross Demand : (i)

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MANAGERIAL ECONOMICS

(ii)

Income Demand : Income demand refers to the various quantities of a commodity demanded by the consumer at alternative levels of his changing money income. D= f (Y)

(iii) Cross Demand : Cross demand refers to the various quantities of commodity (say coffee) purchased by the consumer in relation to change in the price of a related commodity (say tea) which may either be a substitute or a complementary product. D b= f (P ) a Determinants of Demand : Demand of a consumer for a particular

commodity is determined by the following factors: (1) Price of Commodity : There is an inverse relationship between price anddemand for a commodity. When Price increases, then demand decreases and when price decreases, then demand increases. It is also explained with the help of following diagram :YP1

D

P D

O Q1 Q X

Quantity

(2)

Price of Related Goods :

its own price, but also upon the prices of related goods. Related goods are broadly classified into two categories (i) Substitute Goods : Substitutes goods are those goods which can besubstituted for each other, such as tea and coffee. Demand of tea is related to the price of coffee. If price of coffee is raised people may shift to tea, and vice-versa. In other words, in case of substitute the demand of one good is positively related to the price of the other good.YP1

Demand for a commodity depends not only on

:

D

P D X

O Q Q1

Quantity of Tea 29

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(ii)

Complementary Goods : Complementary goods are those goods which complete the demand for each other, such as car and petrol. There is an inverse relationship between the demand for first good and the price of the second good.YP1

D

P D

Quantity of Petrol

O Q1 Q X

(3)

Income of the Consumer :

the consumer and his demand for a good in case of normal goods. But there is a negative relation between income of the consumer and demand for a good in case of inferior goods. (i) Normal Goods : There is a positive relation between income of theconsumer and his demand for a good in case of normal goods.YY1

There is a positive relation between income of

D

Y DO Q Q1

X

Quantity

(ii)

Inferior Goods : There is a negative relation between income of the consumer and demand for a good in case of inferior goods.DY1

Y D

Quantity of Inferior Goods

O Q1 Q X

(4)

Tastes and Preferences : The demand for any goods and service depends on individuals tastes and preferences. Demand for those goods increases for which consumers develop tastes and preferences.30

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(5)

Expectations : If the consumer expects that price will rise in future, he will buy more goods in the present even when price is high. In case, he expects that prices will fall in future, he will either buy less in the present. Climate and Weather Conditions : Demand for certain products is determined by climate or weather conditions. For example, in summer, there is a greater demand for cold drinks, fans, coolers, etc. Size of Population : Market demand is influenced by change in size of population. Increase in population leads to more demand and decrease in population means less demand for them.

(6)

(7)

Q. Explain the difference between Increase in Demand and Extension of Demand and Decrease in Demand and Contraction of demand. OR Q. Explain the Change in Demand. Ans . (A) : Change in demand of two types : : Other things remaining the same, when the quantity demanded changes consequent upon the change in price only, then this change is shown by different points along the same demand curve. Fall in price is followed by extension of demand and rise in price is followed by contraction of demand. Change in Price alone Change in Quantity Demanded Movement along the Demand Curve (1) Extension of Demand : Extension of demand refers to a rise in quantity demanded as a result of fall in price, other things remaining the same. This can be explained with the help of following table and diagram: Extension of Demand Price (Rs.) Quantity Demanded Description Change in Demand 5 1Kg Movement Along Demand Curve 1 5 Kg

Fall in Price Extension of Demand

As shown in the above table, when price of apples is Rs.5 per Kg demand is for 1 Kg of apples, when it falls to Re. 1 per Kg demand extends to 5 Kg of apples.31

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A 5 4 Extension of Demand

3 21 O12345 Quantity

B

In this figure AB is the demand curve of apples. When price of apples is Rs.5 per Kg demand is for 1 Kg of apples. The consumer is at point A of the demand curve. As the price of apples falls to Re. 1 per Kg demand extends to 5 Kg and the consumer moves to point B of the demand curve. Movement along the demand curve from higher point (A) to lower point (B) is called extension of demand. (2) Contraction of Demand : Contraction of demand refers to a fall in quantity demanded as a result of rise in price, other things remaining the same. This can be explained with the help of following table and diagram: Extension of Demand Price (Rs.) Quantity Demanded Description 1 5 5Kg 1 Kg Rise in Price Contraction of Demand

As shown in the above table, when price of apples is Rs.1 per Kg demand is for 5 Kg of apples, when it rises to Re. 5 per Kg demand contracts to 1 Kg of apples.A 5

4 3 2 1O12345 Quantity

Contraction of Demand

B

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MANAGERIAL ECONOMICS

In this figure AB is the demand curve of apples. When price of apples is Rs.1 per Kg demand is for 5 Kg of apples. The consumer is at point B of the demand curve. As the price of apples rises to Re. 5 per Kg demand contracts to 1 Kg and the consumer moves to point A of the demand curve. Movement along the demand curve from lower point (B) to higher point (A) is called contraction of demand. (B) Shift in Demand Curve : A change in any determinants of the demand other than price will shift the entire demand curve to the right or to the left. An increase in demand is shown as rightward shift. A decrease in demand is a leftward shift of the entire demand curve. Change in Income, Tastes or Price of other goods Change in Demand Shift of Demand Curve (1) Increase in Demand :

response to change in determinants of demand other than price of the product. Increase in demand refers to rightward shift in demand curve. Thus, demand may increase in two ways: (i) Same Price more Demand : When price of ice cream is Rs. 3 perunit, demand is for 3 units. If price remains the same, i.e., Rs. 3 per unit but demand goes up to 4 units, then it will be an instance of increase in demand. More Price same Demand : When price of ice cream is Rs. 3 per unit, demand is for 3 units. If price rises to Rs. 4 per unit but demand remains the same, that is, 3 units, then it will also be an instance of increase in demand.

Increase in demand means rise in demand in

(ii)

This can be explained with the help of following Table and Diagram : Price of Ice Cream (Rs.) Same Price 3 3 More Price 3 4 Quantity Purchased More Purchase 3 4 Same Purchase 3 333

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C 5 A Increase of Demand

4 3 2 1O12345 Quantity

D B

Causes of Increase in Demand : (i) Increase in Income (ii) Rise in Price of Substitute Good (iii) Fall in the price of complementary good (iv) Favourable changes in tastes and preferences (v) Expectation of rise in price (vi) Increase in population. (2) Decrease in Demand : Decrease in demand means fall in demand in

response to change in determinants of demand other than price of the product. Decrease in demand refers to leftward shift in demand curve. Thus, demand may increase in two ways: (i) Same Price Less Demand : When price of ice cream is Rs. 3 perunit, demand is for 3 units. If price remains the same, i.e., Rs. 3 per unit but demand goes down to 2 units, then it will be an instance of decrease in demand.

Less Price same Demand : When price of ice cream is Rs. 3 per unit, demand is for 3 units. If price falls to Rs. 2 per unit but demand remains the same, that is, 3 units, then it will also be an instance of decrease in demand. This can be explained with the help of following Table and Diagram : Price of Ice Quantity Cream (Rs.) Purchased Same Price Less Purchase 3 3 Less Price Same Purchase 3 234

(ii)

3 2 3 3

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MANAGERIAL ECONOMICSA

5 4 3 21

C

Decrease of Demand

B D O12345 Quantity

Causes of Increase in Demand : (i) Decrease in Income (ii) Fall in Price of Substitute Good (iii) Rise in the price of complementary good (iv) UnFavourable changes in tastes and preferences (v) Expectation of Fall in price (vi) Decrease in population. Difference between Extension and Increase in Demand

:

Extension of Demand : Extension of demand means rise in demand response to fall in the price of a commodity, other things being equal. It is expressed by the movement from a higher point to a lower point along the same demand curve. Increase in Demand : On the other hand, increase in demand refers to rise in demand response to change in the determinants of demand other than the price. It is expressed by the upward shift of the entire demand curve. This difference can be explained with the help of following diagram :D1

D

P P1

AEx t e ns io n i n De ma n d

Increase of Demand C BD1

D OQ Q1

Quantity

This figure shows the distinction between extension and increase in demand. DD is the initial Demand Curve. This figure shows that from the point A of the demand curve DD two quite different rise in demand are possible. One35

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is a rise in the quantity demanded from OQ to OQ , moving along the same 1 curve from point A to B. Such a rise in quantity demanded results from consumers adjustment to a reduction in price from OP to OP . It is called 1 extension of demand. The second is the shift in the entire demand curve from DD to D D . At the initial price OP the consumer used to purchase OQ, as shown by point A but now purchases OQ as shown by point C. This change in demand is the 1 response to change in any determinant of demand, other than the price. This change is called increase in demand. Difference between Contraction and Decrease in Demand : Contraction of demand : Contraction in demand means fall in demand in response to a rise in the price of a commodity, other things being equal. It is expressed by the movement from a lower point to a higher point on the same demand curve. Decrease in Demand : On the other hand, decrease in demand refers to fall in demand response to change in the determinants of demand other than the price. It is expressed by the downward shift of the entire demand curve. This difference can be explained with the help of following diagram :

11

DD1

P1 PDecrease in Demand

B C

Contraction of Demand A DD1

O

Q 1Q Quantity

This figure shows the distinction between Contraction and decrease in demand. DD is the initial Demand Curve. This figure shows that from the point A of the demand curve DD two quite different reduction in demand are possible. One is a fall in the quantity demanded from OQ to OQ , moving along the same 1 curve from point A to B. Such a fall in quantity demanded results from consumers adjustment to a rise in price from OP to OP . It is called contraction 1 of demand. The second is the shift in the entire demand curve from DD to D D . At the initial price OP the consumer used to purchase OQ. But now purchases OQ . This change in demand is the response to change in any determinant of demand, other than the price. This change is called decrease in demand.36

11 1

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MANAGERIAL ECONOMICS

Q. Explain the Law of Demand. OR Q. Why does the demand curve slope downwards to the right? Ans. Meaning of Demand : Demand is defined as the quantities of a product which a consumer is not only desiring to purchase and able to purchase but is also ready to purchase at given prices at a given point of time. Law of Demand : Meaning : Law of demand states that, other things being equal, the demand for a good extends with a fall in price and contracts with a rise in price. According to law of demand there is an inverse relationship between price and demand for a commodity. Definition : According to Marshall The law of demand states that amount demanded increases with a fall in price and diminishes when price increases, other things being equal. Assumption : Assumptions of the law of demand are that all the determinants of demand other than the price of good remain unchanged. There are the following assumptions:(1) There should be no change in the price of related goods (2) There should be no change in the income of the consumer (3) There should be no change in the tastes and preference of consumer (4) The consumer does not expect any change in the price of the commodity in the near future. (5) There is no change in weather conditions. Explanation of Law of Demand

help of schedule and diagram : (A) Demand Schedule : Demand schedule is a table that shows differentprices of a good and the quantity of that good demanded at each of these prices. It has two aspects:-

:Law of demand can be explained with the

(1)

Individual Demand Schedule : Individual demand schedule is defined as the table which shows quantities of a given commodity which an individual consumer will buy at all possible prices at a given time. The following table shows Individual demand schedule: Price Per Unit (in Rs.) Quantity Demanded (Units) 1 2 3 4 4 3 2 137

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demand tends to contract. (2) Market Demand Schedule :

Above schedule indicates that as the price of Ice cream increases, its Market demand schedule is defined as the quantities of a given commodity which all consumers will buy at all possible prices at a given moment of time. The following table show market demand schedule. The schedule is based on the assumption that there are, in all two consumers A and B. Price of Demand Demand Market Commodity of A of B 1 2 3 4 4 5 4+5=9 3 4 3+4=7 2 3 2+3=5 1 2 1+2=3 Demand (A+B)

Above schedule indicates that as the price of Ice Cream increases, its market demand tends to contract. (B) Demand Curve : The demand curve is a graphic presentation of ademand schedule. The curve which shows the relation between the price of a commodity and the amount of the commodity that the consumer wishes to purchase, is called demand curve. It has two aspects:-

(1)

Individual Demand Curve : Individual demand curve is a curve which shows quantities of a given commodity which an individual consumer will buy at all possible prices at a given time. The following figure shows Individual demand curve:Y 4 3 2 1 D O 1 2 3 Quantity 4 X Individual Demand D

Quantity demanded is shown on OX-axis. And the price is shown on OY-axis. DD is the demand curve. Each point on the demand curve expresses the38

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MANAGERIAL ECONOMICS

relation between price and demand. At a price of Rs. 1 per unit, demand is for 4 units and at a price of Rs. 4 per unit, demand is for 1 unit. (2) Market Demand Curve : Market demand curve is defined as thequantities of a given commodity which all consumers will buy at all possible prices at a given moment of time. The following curve shows market demand. The curve is based on the assumption that there are, in all two consumers A and B.Y 4 3 2 1 D O 2 4 6 Quantity 8 10 X Market Demand D

Quantity demanded is shown on OX-axis. And the price is shown on OY-axis. DD is the demand curve. Each point on the demand curve expresses the relation between price and demand. At a price of Rs. 1 per unit, market demand is for 9 units and at a price of Rs. 4 per unit, demand is for 3 units. Causes of Law of Demand OR Why does Demand Curve slope downward : 1. Law of Diminishing Marginal Utility : A consumer demands a commodity because it has utility. As he consumes more and more units of a commodity, in a given time, the utility derived from each successive unit goes on diminishing. Obviously, a consumer will buy an additional unit of a commodity only if he has to pay less price for it compared to the previous unit. Income Effect : Income effect is the effect that a change in a persons real income caused by change in the price of a commodity has on the quantity of that commodity. When the relative price of a good decrease, less of a persons income would need to be spent to purchase exactly the same amount of the good; therefore it is possible to purchase more because of this rise in purchasing power. For Example : Suppose your income is Rs. 15 per day. You want to buy apples whose price is Rs. 5 per Kg. It means with your fixed income of Rs. 15 you can buy three Kg. In case, the price of apples comes down to Rs. 339

2.

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per Kg then after buying 3Kg of apples you will be left with Rs.6. This increased income may be spent on buying two more Kg of apples. Thus fall in price causes increase in real income and so extension in demand. On the contrary, rise in price causes decrease in real income and so contraction in demand. 3. Substitution Effect : The substitution effect is the effect that a change in relative prices of substitute goods has on the quantity demanded. Substitutes are goods that can be used in place of each other. For example, tea and coffee, coca cola and Pepsi cola are substitutes. In order to get maximum satisfaction with a fixed income, a consumer will substitute a lower priced goods for higher priced one. For Example : Tea and coffee are substitutes of each other. If price of tea goes down, the consumers may substitute tea for coffee, although price of coffee remains the same.

4.

Different Uses : Some goods have more than one use. Milk, for example, may be used for drinking and for making curd and cheese. At its very high price, an individual consumer may buy milk only for drinking; but at the reduced price more milk may be bought for making curd and cheese as well. 5. Size of Consumer Group : When the price of a commodity falls, then many consumers, who are unable to buy that commodity at its previous price, come forward to but it. Consequently, the total number of consumers goes up. On the contrary, if the price of commodity rises many consumers will withdraw from the market and in this way total demand for apples will go down. Exception of Law of Demand : There are some exceptions of law of demand. Demand curve of such commodities slopes upwards from left to right.Y D

D O Quantity X

(1)

Articles of Distinction : Veblen goods are articles of distinction or luxury goods like jewellery, original works of art by great artists. Articles of distinction according to Veblen, command more demand when their prices are high.40

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MANAGERIAL ECONOMICS

(2) Many a time, : Ignorance consumer out of poor judgment consider a commodity to be of low quality of its price is low and of high quality if its price is high. (3) Giffen Goods : Giffen goods are those inferior goods whose demand falls even when their price falls, so that the law of demand does not hold good.

Q. Define Elasticity of Demand. What are the degrees of Price Elasticity of Demand? Ans . : Law of demand tells us about the direction of change in demand for a commodity as a result of change in its price. Thus this law a qualitative statement. It simply states that when price falls demand extends and when price rises demand contracts. It does not explain how much the demand will change. It is the concept of price elasticity of demand which measurers how much the quantity demanded of a good changes when its price changes. Elasticity of demand is a ratio between a cause and an effect, always in percentage terms. Elasticity of demand is a quantitative statement. Types of Elasticity of Demand : Demand for a good depends upon its price, commodity of the consumer and price of related goods. Therefore, elasticity of demand is of three types:(1) Price Elasticity of Demand (2) Income Elasticity of Demand (3) Cross Elasticity of Demand Price Elasticity of Demand : The price elasticity of demand is equal to the ratio of the percentage change in the quantity demanded to a percentage change in the price, other things being equal. It measures how much the quantity demanded of a good changes when its price changes. Price elasticity of demand denotes the ratio at which the demand contracts with a rise in price and extends with a fall in price. There is an inverse relationship between price and quantity demanded of a good. Accordingly, elasticity of demand is expressed by minus(-) sign. Degrees of Price Elasticity of Demand : There are five degrees of elasticity of

demand:(1) Perfectly

Elastic A perfectly elastic demand is one in which any quantity Elasticity of Demand will be bought at the prevailing price. In this case, a very little rise in price causes the demand to fall to zero and a very little fall in price cause the demand to extend to infinity. In this case Elasticity of demand will be infinity. In this diagram DD represents perfectly elastic demand curve. It is parallel to OX-axis.

Y Demand D D Ed= P

:

O

Quantity41

X

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(2)

Perfectly Inelastic Demand : A perfectly inelastic demand is one in which a change in price produces no change in the quantity demanded. In this case price elasticity of demand will be zero. YP1

D

PP2

Ed =0 D

O

Quantity

X

to OY-axis. (3) Unitary Elastic Demand :

In this diagram DD represents the perfectly inelastic demand. It is parallel Unitary Elastic demand is one in which a percentage change in price produces an equal percentage in quantity demanded. If 5 percent fall in price is followed by 5 percent extension in demand, then it will be a case of unitary elastic demand i.e. 5%/5% = 1 Y P E =1 dP1

D

D X Quantity

O Q Q1

PP (change in price) is equal to OQ (change in quantity). In this case Elasticity of demand will be one. (4) Greater than Unitary Elastic Demand : Greater than unitary elastic1 1

In this diagram DD represents the unitary elastic demand. In this diagram

demand is one which a given percentage change in price produces relatively more percentage change in quantity demanded. If 5 percent fall in price causes 20 percent extension in demand, then it will be an example of greater than unitary demand i.e. 20% / 5%= 442

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MANAGERIAL ECONOMICS

Y PP1

D E >1 d D

O Q Q1

X Quantity

this diagram OQ (change in price) is more than to PP (change in quantity). In this case Elasticity of demand will be greater than one. (5) Less than Unitary Elastic Demand : Less than unitary elastic demand1 1

In this diagram DD represents greater than unitary elastic demand. In

is one in which a given percentage change in price produces relatively less percentage change in demand. When fall in price by 4 percent is followed by 2 percent extension in demand then elasticity of demand will be 2% / 4% = i.e. less than unitary

Y P

D

E 1 Greater than Percentage change in price is d Unitary Elastic less than percentage change in Demand demand 5. E 1 Greater than Price Increases.............Total d Unitary Elastic Expenditure Decreases Demand Price Decreases ...........Total Eexpenditure Increases 3 E < 1 Less than Unitary Price Increases.............Total d Elastic Demand Expenditure Increases Price Decreases ............Total Expenditure Decreases

2.

Proportionate Or Percentage Method : The second method of measuring price elasticity of demand is called percentage method. According to this method, the price elasticity of demand is equal to the ratio of the percentage change in the quantity demanded to a percentage change in the price. Its formula is as under:-

Percentage change in Quantity Demanded of Commodity E = (-) ----------------------------------------------------------------------d Percentage Change in Price of Commodity45

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100 X Change in Quantity Demanded Initial Demand E = (-) -d 100 X Change in Price Initial Price 100 (Q -Q) 1 Q E = (-) d 100 (P -P) 1 P 100 QD Q E = (-) d 100 P D P DQ P E = (-) X d

QP

D

Q = Initial Demand Q = New Demand 1 DQ = Change in Demand (Q -Q) P = Initial Price 1 P = New Price DP = Change in Price (P -P)1 1

3.

Point Elasticity of Demand : Point elasticity refers to price elasticity of demand at any point on the demand curve. Its formula is: Lower Segment E = d Upper Segment

Price elasticity at different points of a straight line shown in the following figure :46

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Y M

Ed= A Ed >1 P E =1 d B E 1 d Upper Segment AM

At point B, lower segment = BN& Upper Segment = BM Lower Segment BN E = = < 1 d Upper Segment BM

4.

At point M, Elasticity of Demand will be infinity. At point N. Elasticity of Demand will be Zero.

Arc Elasticity : Arc Elasticity is a measure of the average responsiveness to price change shown by the demand curve over some definite portion between two points on a demand curve. An arc is the portion between two points on a demand curve. The portion between two points A and C on the demand curve DD as shown in the given figure is called Arc. Change in Quantity Change in Price

E = (-) d (Sum of Quantities) (Sum of Prices)47

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(Q -Q) (P -P)

E = (-) d (Q +Q) (P +P)1 1 1

YP1

D A C D X

1

(Q -Q) (P +P) E = (-) X d (Q +Q) (P -P)11 11

P

(Q -Q) (P +P) 1 1 E = (-) X d (Q +Q) (P -P)1 1

OQ

Q1

Q = Initial Demand Q = New Demand 1 P = Initial Price P = New Price 5. Revenue Method :

products is called its revenue. Supposing by selling 10 meters of cloth, a firm gets Rs. 50 then this amount of Rs. 50 will be called the total revenue of the firm. There are three types of revenue:(i) Total Sale proceeds of a firm is called total revenue. Revenue :

Sales proceeds that a firm is obtained by selling its

1

Average Revenue : When total revenue is divided by the number of units sold we get average revenue. (iii) Marginal Revenue : Addition made to the total revenue by the sale of one more unit of the commodity is called marginal revenue. According to Revenue Method Elasticity of Demand can be measured from the following formula : (ii) A E = d A-M A = Average Revenue M = Marginal Revenue Ed = Elasticity of Demand Q. Write a short note on the following (A) Income Elasticity of Demand. (B) Cross Elasticity Or Elasticity of Substitution.

Ans. (A) Income Elasticity of Demand

: The income elasticity of demand is equal to the ratio of the percentage change in the quantity demanded to a percentage change in the income, other things being equal. It measures

48

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how much the quantity demanded of a good changes when consumers income changes. Definition of Income Elasticity of Demand According to Watson Income Elasticity of demand means the ratio of the percentage change in the quantity demanded to the percentage change in income. Measurement of Income Elasticity : Income Elasticity can be measured by the following formula:Percentage Change in Quantity Demanded Ey = Percentage Change in Income :

100 Q D Q Ed = 100 Y D Y

DQ Y Ed = X QY D

Q = Initial Demand Q = New Demand 1 DQ = Change in Demand (Q -Q) Y = Initial Income 1 Y = New Income DP = Change in Income (P -P) 1 Degrees of Income Elasticity of Demand

1

is of three types: (1) Positive Income Elasticity of Demand :

:Income Elasticity of demand

Income Elasticity of demand for a good is positive when with an increase in the income of a consumer his demand for the good increases and with a decrease in the income of a consumer his demand for the good decreases. Income elasticity of demand is positive in case of normal goods.49

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Y A B

D

Dy

Dy

O Q Q1

X Quantity

In this figure DY DY curve represents positive income elasticity of demand. It shows that when income increased form OB to OA then demand also increase from OQ to OQ . It slopes upward from left to right i.e. positive 1 slope. (2) Negative Income Elasticity of Demand : Income Elasticity of demand for a good is Negative when with an increase in the income of a consumer his demand for the good decreases and with a decrease in the income of a consumer his demand for the good increases. Income elasticity of demand is positive in case of inferior goods YDy

A BDy

O

Q1 X

Q

Quantity In this figure Dy Dy curve represents negative income elasticity of demand. It shows that when income increased form OB to OA then demand decrease from OQ to OQ . It slopes downward right to left i.e. 1 negative slope. (3) Zero Income Elasticity of Demand : Income elasticity of demand is zero, when change in the income of consumer evokes no change in his demand50

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MANAGERIAL ECONOMICS

Y A B

Dy

Dy

OQ Quantity

X

In this figure Dy, Dy curve represents zero income elasticity of demand. It shows that when income increased form OB to OA then demand constant at point OQ. In this case demand curve will be parallel to OY-axis. (B) Cross Elasticity of Demand OR Elasticity of Substitution : There is a mutual relationship between change in price and quantity demanded of two related goods. Change in the price of one good can cause change in the demand for the related good. For example, change in the price of tea ordinarily causes change in demand for coffee. The cross elasticity of demand is the proportional change in the quantity demanded of good X divided by the proportional change in the price of the related good Y. Measurement of Cross Elasticity of Demand : Cross elasticity of demand is measure by the following formula:Percentage Change in Quantity Demanded of good X Ec = Percentage Change in the Price of good Y 100 X Change in Quantity Demanded of X Initial Demand of X E = c 100 X Change in Price of Y Initial Price of Y 100 QD x Qx E = c 100 Py D Py51

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DQx Py E = X c Q x Py D DQx = Change in the quantity of good X Qx = Initial demand of good X DPy = Change in price of good Y Py = Initial price of good Y Ec = Cross Elasticity of Demand

be of three types: 1. Positive Cross Elasticity of Demand :

Degrees of Cross Elasticity of Demand :

Cross elasticity of demand can

Cross Elasticity of demand is positive in case of substitutes. In other words when goods are substitutes of each other, then a given percentage rise in the price of a good will lead to a given percentage increase in the demand for the substitute good. For example, rise in the price of coffee will lead to increase in demand for tea, because the two are close substitute of each other. Y A BDs

D

Ds

O Q Q1

X

Quantity fo Tea

2.

In this figure DS DS curves represents cross elasticity of demand. In this diagram quantity of tea is shown on OX-axis and price of coffee on OYaxis. When price of coffee is OB, demand for tea is OQ. When price of coffee rises to OA, demand for tea increases to OQ1. This curve slopes upward from left to right. Negative Cross Elasticity of Demand : Price Elasticity of demand is negative in case of complementary goods. In case of complementary goods. Percentage rise in the price of one good leads to percentage fall in the demand for the other.52

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YDc

A BDc

O Q Q1 X

Quantity of Butter In this figure Dc, Dc curve represents the negative cross elasticity demand. In this diagram quantity of butter is shown on OX-axis and price of bread on OY-axis. When price of bread is OB, demand for butter OQ1. When the price of bread rises to OA, demand for butter decreases to OQ. It slopes downward from left to right. Zero Elasticity of Demand : Cross elasticity of demand is zero when two goods are not related to each other. For example, rise in the price of wheat will have no effect on the demand for books. Their cross elasticity of demand will be called zero.

3.

Q. Discuss factors which influence the Price Elasticity of demand.

Ans. : (1) Nature of the Commodity : In economics all goods are divided into three categories: (i) Necessaries : Demand for necessaries like salt, kerosene oil, matchboxes etc. is less than unitary elastic or inelastic. Comfort Goods : etc. is unitary (ii) Price elasticity of comfort goods ,i.e. cooler, fan

(iii) Price elasticity of luxuries goods is greater than unitary Luxuries : elastic. Change in the price of these goods has a great impact on the demand. (2) Availability of Substitutes : (i) There are two possibilities:When Substitutes are available : The greater the number of substitutes available for the product the greater will be its elasticity of demand. When Substitutes are not available : have any substitutes have inelastic demand. Commodities that do not :

(ii) (3)

Goods with Goods that can be put to different uses have uses Different Factors Determining the Price Elasticity of Demand53

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elastic demand. For instance, electricity has many uses. It can be used for heating, lighting, cooling etc. When electricity charges are high, it is used for lighting purpose only and so its demand for other less urgent uses will fall considerably. (4) Postponement of the Use : Goods whose demand can be postponed to a future period have elastic demand. On the other hand, goods whose demand cannot be postponed have inelastic demand. Income of the Consumer : People having very high or very low income have inelastic demand. On the other hand demand of middle-income people is elastic. Habit of the Consumer : Demand for those goods is inelastic to which consumers become habituated e.g. cigarette, coffee, etc.

(5)

(6)

(7) Elasticity of demand tends to be more elastic in long period than Time : in short period. The longer the time, the more elastic will be the demand. (8) Complementary Goods : Goods demanded jointly or complementary goods, have relatively inelastic demand, e.g. car and petrol, pen and ink. Rise in the price of petrol may not contract its demand if there is no fall in the demand for cars. :

Q. What is the Importance of Price Elasticity of Demand?

Ans. (1) Determination of Price under Monopoly :

A monopolist always takes into consideration the price elasticity of demand of his product while determining its price. There are two (i) If demand is elastic, he will fix low price per unit. (ii) If demand is inelastic, he will fix high price per unit. Price Discrimination : When a monopolist sells the same product at different prices, it is called price discrimination. A monopolist can practice price discrimination when price elasticity of demand for his product for different uses and for different consumers is different. There are two possibilities (i) He will charge more price from those consumers whose demand is inelastic (ii) He will charge less price form those consumers whose demand is elastic.

possibilities

:

(2)

:

(3)

Price Determination of Goods which are produced Joint Importance of in the same act of production are called joint-supply Price Elasticity of Demand simultaneously goods. Elasticity of demand of such goods is taken into consideration while fixing their price.54

Supply

:

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(4)

Advantage to Finance Minister : While planning new taxes, a finance minister takes into consideration elasticity of demand: (i) Taxes on goods having elastic demand will be low (ii) Taxes on goods having inelastic demand will be high. International Trade : The concept of elasticity of demand is also important in the field of international trade. A country will gain by increasing the price of exports if their demand in the importing country is inelastic. If their demand in the importing country is elastic then the exporting country will reduce the price. Wage Determination : If the demand of their service of the labourers is elastic, the possibility of getting their wages raised is less. If, on the other hand, demand for their services is inelastic then labour unions succeed in getting their wages increased

(5)

(6)

Q. What do you mean by consumers equilibrium? Explain it with the help of utility analysis? Ans. : Consumers equilibrium refers to a situation wherein a consumer gets maximum satisfaction out of his limited income and he has no tendency to make any change in his existing expenditure. Assumptions

the following assumptions: 1. Rational Consumer :

: Consumers equilibrium through utility analysis is based on

Consumer is assumed to be rational. A rational consumer is one who is keen to get maximum satisfaction out of his limited income. Cardinal Utility : Utilit of every commodity can be measured in terms of cardinal numbers, such as, 1,2,3,4 etc. Independent Utility : It is assumed that the utility derived from one good is not depend on the utility derived from other goods.

2. 3.

4. Marginal Utility of money is constant 5. Fixed Income and Price : It is assumed that the income of the consumerand the price of the commodity remain fixed. 6. 7. Tastes are Tastes of the consumer also remain unchanged. Constant : Perfect Knowledge : The consumer knows the different goods on which he can spend his income.

Determination of Consumers Equilibrium : Consumers equilibrium through utility analysis can be ascertained under tow diffe