imt 20 managerial economics m1

IMT-20: MANAGERIAL ECONOMICS

PART – A Q1. Distinguish between the principles of marginalism and

incrementalism with the help of examples. Ans. Marginalism is the study of marginal theories and relationships within economics, and its key focus is how much extra use is gained from incremental increases in the quantity of goods created, sold, etc. and how those measures relate to consumer choice and demand. The principles of marginalism relies on the assumption of (near) perfect markets, which do not exist in the practical world, but still the core ideas of marginalism are generally accepted by most economic schools of thought, and are still used by businesses and consumers to make choices and substitute goods. The distinction between marginalism and incrementalism are stated through the following:

• Marginal concepts are always defined in' terms of unit changes, but incremental' concepts are defined in terms of chunk changes.

• Incremental concepts are more flexible than marginal concepts. In marginalism, the reference is to one independent variable, but in incrementalism, more than one independent variable can be considered at a time. Marginal revenue is the increase in revenue due to one-unit increase in level of output. But revenue may increase due to a change in not only output, but also price and production process.

• Under special circumstances, incremental and marginal revenue (cost) may be the same.

Incremental revenue and incremental cost are two basic concepts for making optimum economic decisions, and a decision is optimum if it increases revenue more than cost or if it reduces costs more than revenue, like if the net incremental revenue is positive which may be termed as the incremental principle to be followed by management in making decisions. In economic theory, the concept of margin is very useful because it renders the determination/derivation of an equilibrium solution quite simple and easy. However, in the real world of business management, marginalism should better be replaced by incrementalism because in making economic decision, management is interested in knowing the impact of a chuck-change rather than a unit-change. Incremental reasoning involves a measurement of the impact of decision alternatives on economic variables like revenue and costs which refer to the total magnitude of changes in total revenues (or costs) that result from a set of factors like change in prices, products, processes and patterns.

IMT 20 Managerial Economics - Assignment of 21 22/06/2012

Q2. How is the price elasticity of demand measured? Explain the

relationship between price elasticity, average revenue and marginal revenue.

Ans. Price elasticity of demand (PED or Ed) is a measure used in economics to show the responsiveness, or elasticity, of the quantity demanded of a good or service to a change in its price. In general, the demand for a good is said to be inelastic (or relatively inelastic) when the price elasticity demand is less than one, in absolute value, which is, changes in price have a relatively small effect on the quantity of the good demanded. While the demand for a good is said to be elastic or relatively elastic when its PED is greater than one, in absolute value, that is, changes in price have a relatively large effect on the quantity of a good demanded. There are four methods of approaching price elasticity of demand, which are as follows.

1. The Percentage Method: It is determined by thee co-efficient of price elasticity (Ep), and this co-efficient determines the percentage change in the quantity demanded of an article from a specified percentage price change.

2. The Point Method:

This method has been formulated by Prof. Marshall for measuring elasticity at a point on the demand curve.

In the diagram, shows AB being straight line demand curve, if the price falls from PG(=OC) to FH(=OE), the quantity demanded is augmented from OG to OH. Elasticity at Point P on the AB demand curve as per the formulae is Ep = (∆q / ∆p) x p / q, where ∆q represents change in quantity demanded, ∆p change in price level whereas p and q are prime price and quantity levels.

3. The Arc Method:

Any two points in the demand curve is an arc which measures elasticity over a definite array of the price and quantity demanded.


4. The Total Outlay Method:

The total outlay method of ascertaining the elasticity of demand is denoted as price proliferated with the quantity of an article purchased that is denoted as below. Total outlay = Price x Quantity Demanded

Q3. Critically examine the law of diminishing marginal utility. Ans. The law of diminishing marginal utility describes a familiar and fundamental tendency of human behaviour, which states that as a consumer consumes more and more units of a specific commodity, the utility from the successive units goes on diminishing. Thus, the additional benefit which a person derives from an increase of his stock of a thing diminishes with every increase in the stock that already has. The law of diminishing marginal utility is based upon three facts:

1) Total wants of a man are unlimited, but each single want can be satisfied, and as a man gets more and more units of a commodity, the desire of his for that good goes on falling, by which a point is reached when the consumer no longer wants any more units of that good.

2) Different goods are not perfect substitutes for each other in the satisfaction of various particular wants, and the marginal utility will decline as the consumer gets additional units of a specific good.

3) The marginal utility of money is constant, given the consumer’s wealth.

The basis of the Law of Diminishing Marginal Utility is a fundamental feature of wants which states that when people go to the market for the purchase of commodities, they do not attach equal importance to all the commodities which they buy. In case of some of commodities, they are willing to pay more and in some less. There are two main reasons for this difference in demand:

1) The linking of the consumer for the commodity

2) The quantity of the commodity which the consumer has with himself, by which the marginal utility of a commodity diminishing as the consumer gets larger quantities of it.

In given span of time, the more of a specific product a consumer obtains, the less anxious he is to get more units of that product or that as more units of a good are consumed, additional units will provide less additional satisfaction than previous units.


Q4. Why is an indifference curve for two normal goods convex to origin? Why cannot it be a concave curve or a straight line?

Ans. An indifference curve is a graph showing different bundles of goods between which a consumer is indifferent, that is, at each point on the curve, the consumer has no preference for one bundle over another. One can equivalently refer to each point on the indifference curve as rendering the same level of utility (satisfaction) for the consumer, and utility is then a device to represent preferences rather than something from which preferences come. The main use of indifference curves is in the representation of potentially observable demand patterns for individual consumers over commodity bundles, which shows combination of goods between which a person is indifferent. An indifference curve for two normal goods is convex in origin, and not concave curve or a straight line because its main attributes or properties or characteristics are as follows:

1) Indifference Curves are Negatively Sloped:

The indifference curves must slope down from left to right, which means that an indifference curve is negatively sloped downward because as the consumer increases the consumption of X commodity, one has to give up certain units of Y commodity in order to maintain the same level of satisfaction. Thus, the higher indifference curve that lies above and to the right of another indifference curve represents a higher level of satisfaction and combination on a lower indifference curve yields a lower satisfaction.

2) Indifference Curve are Convex to the Origin:

They are convex to the origin (bowed inward), that as the consumer substitutes commodity X for commodity Y, the marginal rate of substitution diminishes of X for Y along an indifference curve. Thus, the indifference curves cannot intersect each other because at the point of tangency, the higher curve will give as much as of the two commodities as is given by the lower indifference curve.

3) Indifference Curves do not Touch the Horizontal or Vertical Axis:

One of the basic assumptions of indifference curves is that the consumer purchases combinations of different commodities, and not supposed to purchase only one commodity. Thus, in that case indifference curve will touch one axis.


Q5. Why is demand forecasting important? Explain the various types of survey methods of forecasting demand and their usefulness.

Ans. Demand forecasting is important and crucial to any supplier, manufacturer, or retailer because it determines the quantities that should be purchased, produced, and shipped. Demand forecasts are necessary since the basic operations process, moving from the suppliers' raw materials to finished goods in the customers' hands, takes time, by which most firms must anticipate and plan for future demand so that they can react immediately to customer orders as they occur. In other words, most manufacturers make to stock rather than make to order, and they plan ahead and then deploy inventories of finished goods into field locations. Thus, once a customer order materializes, it can be fulfilled immediately, since most customers are not willing to wait the time it would take to actually process their order throughout the supply chain and make the product based on their order. Consequently, companies that offer rapid delivery to their customers will tend to force all competitors in the market to keep finished goods inventories in order to provide fast order cycle times. As a result, virtually every organization involved needs to manufacture or at least order parts based on a forecast of future demand. Furthermore, the ability to accurately forecast demand also affords the firm opportunities to control costs through levelling its production quantities, rationalizing its transportation, and generally planning for efficient logistics operations. In general practice, accurate demand forecasting lead to efficient operations and high levels of customer service, while inaccurate demand forecasting will inevitably lead to inefficient, high cost operations and/or poor levels of customer service. In many supply chains, the most important action one can take to improve the efficiency and effectiveness of the logistics process is to improve the quality of the demand forecasts. Accordingly, demand forecasting may be used in making pricing decisions, in assessing future capacity requirements, or in making decisions on whether to enter a new market, as well as predict future product and service demands so that we can supply our clients’ orders quickly and effectively.


PART – B Q1. Diagramatically explain the three stages of the law of

diminishing marginal returns. Ans. The law of diminishing marginal returns states that an increase in the capital and labour applied to the cultivation of land causes in general a loss than the proportionate increase in the amount of produce raised unless, it happens to coincide with an improvement in the art of agriculture. This law also pertains to physical returns simply stating that with an increase in variable inputs applied, the production initially increases with increasing rate, then at constant rate and eventually it declines. However, this law will not hold true (limitation) when there is:

• An improvement in technology, • Efficient management and • Residual effect

There are three stages of the law of diminishing returns, and they are: Stage – I

1) This stage starts from origin and ends where AP & MP curves intersect each other.

2) The TP is increasing at increasing rate at first then at decreasing rate.

3) PP and MP both increase but MP is grater than IP. 4) The EP is greater than 1 (one)

Stage – II

1) It starts where PP & MP intersect each other and EP = l. It ends when MP = 0

2) TP increases but at decreasing rate. 3) MP Starts to decline continuously and AP also start to decline but it

is greater than MP 4) The elasticity of production (EP) is greater than zero but less than

1. Stage – III

1) This stage starts when MP is zero and TP is at maximum. 2) TP starts to decline and it declines continuously. 3) MP becomes negative, remains positive. 4) EP is always less than zero.

The law of diminishing returns states that a point will be reached when further additions of a variable input will yield diminishing marginal returns per unit of that variable, which is one of the most fundamental principles in economics.


Q2. What are isoquants and isocost lines? Explain graphically Ans. In economics an isocost line shows all combinations of inputs which cost the same total amount, and although similar to the budget constraint in consumer theory, its use pertains to cost-minimization in production, as opposed to utility-maximization. The isocost line is combined with the isoquant map to determine the optimal production point at any given level of output, and specifically, the point of tangency between any isoquant and an isocost line gives the lowest-cost combination of inputs that can produce the level of output associated with that isoquant.

The absolute value of the slope of the isocost line, with capital plotted vertically and labour plotted horizontally, equals the ratio of unit costs of labour and capital. An isoquant is a contour line drawn through the set of points at which the same quantity of output is produced while changing the quantities of two or more inputs, and are typically drawn on capital-labour graphs, showing the technological trade-off between capital and labour in the production function, and the decreasing marginal returns of both inputs. Thus, adding one input while holding the other constant eventually leads to decreasing marginal output, and this is reflected in the shape of the isoquant. A family of isoquants can be represented by an isoquant map, a graph combining a number of isoquants, each representing a different quantity of output, also called equal product curves. An isoquant graph can also indicate decreasing or increasing returns to scale based on increasing or decreasing distances between the isoquant pairs of fixed output increment, as output increases.


Conversely, if the distance is decreasing as output increases, the firm is experiencing increasing returns to scale; doubling both inputs results in placement on an isoquant with more than twice the output of the original isoquant.

An isoquant map where Q3 > Q2 > Q1, which is a typical choice of inputs would be labour for input X and capital for input Y, and more of input X, input Y, or both is required to move from isoquant Q1 to Q2, or from Q2 to Q3. Q3. Distinguish between implicit cost and explicit cost with the

help of example. Ans. Implicit cost and explicit cost are terms used in accounting, which are usually called relative cost to each transaction. However as these costs are measured, the most common types being mentioned are implicit and explicit cost. Implicit cost is considered as the cost that has occurred on an enterprise but is not initially reflected and reported as a direct expenditure which is usually referred to as the deficit from a potential revenue, a result when the person renounces his capacity to gain higher profitability, or when a company forgoes the satisfaction and benefits that a specific project might generate. Explicit cost is the cost that is solidly reported based on numbers and statistics, very detailed in terms of the figures that were generated which provides a clear and continuous cash flow from expenses that do not necessarily proved to be obvious about it and establish the right from the thought of profitability. Difference between implicit cost and explicit cost can be attributed this way, implicit cost is an anticipated loss of revenue even before the whole transaction pushed through, and these are not in reflected in cash but rather this is based on benefits that a certain investment seems very promising. While explicit cost on the other hand, is measured by its monetary value or any of its equivalent which can be counted and verified in a report, and definite in nature and very exact.


In addition, implicit cost and explicit cost are also distinguished through:

� Implicit cost is considered as the cost that has occurred on an enterprise, but is not initially reflected and reported as a direct expenditure.

� Explicit cost is the cost that is solidly reported based on numbers and statistics. This actual cost is very detailed in terms of the figures that were generated.

� Implicit cost is an anticipated loss of revenue even before the whole transaction pushed through.

� Explicit cost on the other hand is the black and white accountability of all the profit.

Q4. Graphically explain the relationship between change in

output and AVC, AC and MC. Ans. Average Variable Cost (AVC) is found by dividing total variable cost (TVC) by the corresponding output which declines initially, reaches a minimum, and then increases again. While the Average Cost (AC) can be found by dividing total cost (TC) by total output (Q) or, by adding AFC and AVC for each level of output. On the other hand, Marginal Cost (MC) is defined as the extra, or additional, cost of producing one more unit of output which can be determined for each additional unit of output simply by noting the change in total cost which that unit’s production entails: Change in TC ∆TCMC = Change in Q ∆Q. It is notable that the relationship between change in output and that marginal cost cuts through AVC, AC and MC at their minimum, and when both the marginal and average variable costs are falling, average will fall at a slower rate. Thus, when MC and AVC are both rising, MC will rise at a faster rate. As a result, MC will attain its minimum before the AVC, and when MC is less than AVC, the AVC will fall, and when MC exceeds AVC, AVC will increase, which means that so long as MC lies below AVC, the latter will fall and where MC is above AVC, AVC will rise. Therefore, at the point of intersection where MC=AVC, AVC has just ceased to fall and attained its minimum, but has not yet begun to rise. Similarly, the marginal cost curve cuts the average total cost curve at the latter’s minimum point, since MC can be defined as the addition either to total cost or to total cost or to total variable cost resulting from one more unit of output. However, no such relationship exists between MC and the average fixed cost, because the two are not related, and by definition, marginal cost includes only those costs which change with output and fixed costs by definition are independent of output.


Q5. Describe the long run average cost (LAC) curve according to the modern cost theory.

Ans. The Long-run Average Cost (LAC) curves are derived from the long-run production functions in which all inputs are variable, but in the long run none of the factors are variable and all can be varied to increase the level of output. The long run average cost of production is the least possible average cost of production of producing any given level of output when all inputs are variable, including of course the size of the plant, and in the long run there is only the variable cost as total cost, by which there is no dichotomy of total cost into fixed and variable costs. Thus we study the shape and relationship of long run average cost curve and long run marginal cost curve. Long run is a planning horizon, and it is only a perspective view for the future course of action which comprises all possible short run situations from which a choice is made for the actual course of operation. The features of Long Run Average Cost (LAC) Curve are:

• Tangent curve: By joining the loci of various plant curves relating to different operational short run phases, the LAC curve is drawn as a tangent curve.

• Envelope curve: It is also referred to as the envelope curve because it is the envelope of a group of short run curves.

• Planning curve: It denotes the least unit cost of producing each possible level of output and the size of the plant in relation to LAC curve.

• Minimum cost combination: It is derived as a tangent to various SAC’s curve under consideration, so the cost level presented by LAC curve for different level of output reflect minimum cost combination at each long run level of output.

• Flatter U-shaped: It is less shaped or rather dish shaped. It gradually slopes downward and then after reaching a certain level, gradually begins to slope upwards


PART – C Q1. Explain the Cyert-March Hypothesis of satisficng behaviour. Ans. Cyert and March Hypothesis of satisfying behaviour explicitly stated that they developed their framework for dealing with the large, multi-product firm, and in discovering how BTF can be applied to the development of a BTEF, it needs to boil down Cyert and March’s ideas to key elements, then examined in greater detail. The Behavioural Theory of Cyert-March is a theory that is built around a political conception of organizational goals, a bounded rationality conception of expectations, an adaptive conception of rules and aspirations, and a set of ideas about how the interactions among these factors affect decisions in a firm. Modern perspectives often rely, implicitly or explicitly, on the behavioural ideas from Cyert and March’s hypothesis, and their ideas about goal conflict, behavioural conceptions of information search and expectation formulation, and the adaptive adjustment of choice variables provided the supporting architecture of firm decision-making essential to strategic theories of firms. Cyert-March Hypothesis’ also helped to extend the understanding of competitive interaction and the performance of individual firms as well as industries, and served to propagate modern research on individual behaviour in firms and markets. Central to Cyert and March’s hypothesis is the idea that decision making consists in finding a satisfactory solution (satisficing) rather than in evaluating the best possible alternative (optimization). Thus, making management the art of dealing effectively with the reality of bounded rationality in a changing environment, by which these themes remain as fresh and relevant today as they were when Cyert and March launched upon their endeavour in the early 1960s. However, with very few exceptions, very little has been said by researchers in the tradition of Cyert and March about the behaviour of entrepreneurial firms, whether they are conceptualized as small firms, young firms, or pre-firms. There are three ideas that parallel key concepts in the Cyert and March’s hypothesis:

1. Accumulating stakeholder commitments under goal ambiguity 2. Achieving control through non-predictive strategies 3. Having a predominately exaptive orientation in the entrepreneurial

firm. Together, all these ideas can be collated into a model of entrepreneurial firm behaviour that emphasizes transforming current realities to fabricate new environments rather than acting within extant environments.


Q2. Explain the profit maximizing conditions of a firm with the help of marginal revenue and marginal cost.

Ans. The profit maximizing conditions of a firm with the help of marginal revenue is shown in the amount by which a firm's revenue increases when it expands output by one unit, taking into account that to sell one more unit it may need to reduce price on all units, and such benefits can be seen in terms of utility/satisfaction/or dollar amounts. In addition, the maximizing benefit of marginal revenue is the extra revenue that an additional unit of product will bring a firm which can also be described as the change in total revenue/change in number of units sold. Relatively, marginal revenue is equal to the change in total revenue over the change in quantity when the change in quantity is equal to one unit (or the change in output in the bracket where the change in revenue has occurred). For a firm facing perfectly competitive markets, price does not change with quantity sold, so marginal revenue is equal to price, and for a monopoly, the price received will decline with the quantity sold, so marginal revenue is less than price which means that the profit-maximizing quantity, for which marginal revenue is equal to marginal cost, will be lower for a monopoly than for a competitive firm, while the profit-maximizing price will be higher. While marginal cost is the increase in cost that accompanies a unit increase in output, by which the partial derivative of the cost function with respect to output. Moreover, marginal cost is also known as incremental cost or differential cost. A simple definition of marginal cost (MC) would be, "The change in total costs arising from a change in the managerial control variable" (Baye, 2006). According to the Blackwell Encyclopedic Dictionary of Managerial Economics "The marginal cost is the change in total costs due to a unit (or incremental) change in output. Basically, marginal cost is the change in total cost that arises when the quantity produced changes by one unit, and mathematically, the function is expressed as the derivative of the total cost (TC) function with respect to quantity (Q), which may change with volume, and so at each level of production, the marginal cost is the cost of the next unit produced. Q3. Explain why does a perfectly competitive firm reaps normal

profits in the long run. Ans. A perfectly competitive firm reaps normal profits in the long run because ease of entry and exit in monopolistically competitive markets forces firms into a slightly more competitive mode, in which many potential suppliers compete vigorously with makers of close, but not perfect, substitutes for their “brand-name” products.


Competitors do not base decisions on the anticipated individual reactions of their many competitors, so they are not mutually interdependent in the way others are, by which product differentiation (e.g., packaging, advertising, or styling), however, gives them some control over prices. Pure competition allows easy entry or exit, but differs because each firm produces a differentiated good, and have:

1. Large numbers of potential buyers and suppliers. 2. Differentiated products that are close substitutes. 3. Easy entry or exit in the long run.

Successful product differentiation creates market power by expanding the demand curve the firm faces and decreasing its price elasticity which can allow a competitor to act a little like a monopolist that has some control over price, but like normal competitors, monopolistic competitors earn only normal profit in the long run because entry by potential competitors is easy. Regardless of market structure, all firms maximize profit by producing where marginal revenue equals marginal cost, and in the short run, this successful firm's economic profit equals the shaded area. A perfectly competitive firm may also suffer short-run losses, and profits would be impossible if a firm's average cost curve were always above the demand curve, but like all firms, a competitor would minimize losses by selling that output where marginal revenue equals marginal cost, as long as the price it could set (average revenue) exceeded average variable costs. A competitive firm differentiate products to exploit short-run profit opportunities, and would like their profits to persist, and these hopes are usually frustrated because typical competitors earn only normal profits in the long run; the long-run industry adjustments parallel those for pure competition. Thus, wntry of new firms seeking profits cannot be prevented, which may increase production costs, by which profits are also dissipated because prices fall when new competitors expand output and take customers from existing firms. 4. What is price discrimination? How does a discriminating monopolist allocate his output in different markets to charge different price. Ans. Most businesses charge different prices to different groups of consumers, for what is more or less the same good or service, normally known as price discrimination which has become widespread in nearly every market.


Price discrimination or yield management occurs when a firm charges a different price to different groups of consumers for an identical good or service, for reasons not associated with costs, which makes it important to stress that charging different prices for similar goods is not pure price discrimination. One must be careful to distinguish between price discrimination and product differentiation, which is when differentiation of the product gives the supplier greater control over price and the potential to charge consumers a premium price because of actual or perceived differences in the quality / performance of a good or service. Price discrimination is an extremely common type of pricing strategy operated by virtually every business with some discretionary pricing power which is a classic part of price competition between firms seeking a market advantage or to protect an established market position, as well as a discriminating monopolist firm allocates its output in different markets to charge different price required for discriminatory pricing:

a) Perfect Price Discrimination: Charging whatever the market will bear, also sometimes known as optimal pricing, and with perfect price discrimination, the firm separates the whole market into each individual consumer and charges them the price they are willing and able to pay.

b) Second Degree Price Discrimination

This type of price discrimination involves businesses selling off packages of a product deemed to be surplus capacity at lower prices than the previously published/advertised price, and in these types of industry, the fixed costs of production are high, at the same time the marginal or variable costs are small and predictable.

c) Third Degree (Multi-Market) Price Discrimination

This is the most frequently found form of price discrimination and involves charging different prices for the same product in different segments of the market, where the key is that third degree discrimination is linked directly to consumers’ willingness and ability to pay for a good or service which means that the prices charged may bear little or no relation to the cost of production.

Q5. Explain how price is determined under oligopoly under

conditions of price leadership. Ans. An oligopoly is a market dominated by a few large suppliers, by which the degree of market concentration is very high, such as a large percentage of the market is taken up by the leading firms.


As such, firms within an oligopoly produce branded products (advertising and marketing is an important feature of competition within such markets) and there are also barriers to entry. Another important characteristic of an oligopoly is interdependence between companies which means that each company must take into account the likely reactions of other businesses in the market when making pricing and investment decisions, creating uncertainty in such markets, which economists seek to model through the use of game theory. Game theory may be applied in situations in which decision makers must take into account the reasoning of other decision makers, and it has been used, for example, to determine the formation of political coalitions or business conglomerates, the optimum price at which to sell products or services, the best site for a manufacturing plant, and even the behaviour of certain species in the struggle for survival. In oligopoly:

• A few firms selling similar product;

• Each firm produces branded products;

• Likely to be significant entry barriers into the market in the long run which allows firms to make supernormal profits;

• Interdependence between competing firms, where businesses have

to take into account likely reactions of rivals to any change in price and output

Price is determined under oligopoly under conditions of price leadership, through:

1) Oligopoly firms collaborate to charge the monopoly price and get monopoly profits;

2) Oligopoly firms compete on price so that price and profits will be

the same as a competitive industry;

3) Oligopoly price and profits will be between the monopoly and competitive ends of the scale;

4) Oligopoly prices and profits are "indeterminate" because of the

difficulties in modelling interdependent price and output decisions.


CASE STUDY – I Estimation of the Demand for Oranges by Market Experiment Researchers at the University of Florida conducted a market experiment in Grand Rapids, Michigan, to determine the price elasticity and the cross-price elasticity of demand for three types of Valencia oranges: those from the Indian River district of Florida, those from the interior district of Florida, and those from California. Grand Rapids was chosen as the site for the market experiment because its size, demographic characteristics, and economic base were representative of other midwestern markets for oranges. Nine supermarkets participated in the experiment, which involved changing the price of the three types of oranges, each day, for 31 consecutive days and recording the quantity sold of each variety. The price changes ranged within ±16 cents in 4-cent increments, around the price of oranges that prevailed in the market at the time of the study. More than 9,250 dozen oranges were sold in the nine supermarkets during the 31 days of the experiment. Each of the participating supermarkets was provided with an adequate supply of each type of orange so that supply effects could be ignored. The length of the experiment was also sufficiently short so as to ensure no change in tastes, incomes, population, the rate of inflation, and determinants of demand other than price. The results, summarized in the following table indicate that the price elasticity of demand for all three types of oranges was fairly high (the boldface numbers in the main diagonal of the table). For example, the price elasticity of demand for the Indian River oranges of -3.07 indicates that a 1 percent increase in their price leads to a 3.07 percent decline in their quantity demanded. More interestingly, the off-diagonal entries in the table, show that while the crossprice elasticities of demand between the two types of Florida oranges were larger than 1, they were close to zero with respect to the California oranges. In other words, while consumers regarded the two types of Florida oranges as close substitutes, they did not view the California oranges as such. In pricing their oranges, therefore, producers of each of the two Florida varieties would have to carefully consider the price of the other (as consumers switch readily among them as a result of price changes) but need not be much concerned about the price of California oranges.


Price Elasticity and Cross-Price Elasticity of Demand for Florida Indian River, Florida

Interior, and California Oranges

Price Elasticities and Cross-Price Elasticities

Type of Orange Florida Indian

Florida Interior California River

Florida Indian River -3.07 +1.56 +0.01

Florida Interior +1.16 -3.01 +0.14

California +0.18 +0.09 -2.76

Questions: 1) In light of the case define a test market? When should a firm

take help of market experiments to forecast demand? Ans. A test market, in the field of business and marketing, is a geographic region or demographic group used to gauge the viability of a product or service in the mass market prior to a wide scale roll-out, where the criteria used to judge the acceptability of a test market region or group include:

o A population that is demographically similar to the proposed target market; and

o Relative isolation from densely populated media markets so that advertising to the test audience can be efficient and economical.

In addition, the test market ideally aims to duplicate everything, promotion and distribution as well as product, on a smaller scale, by which the technique replicates, typically in one area, what is planned to occur in a national launch, and the results are very carefully monitored, so that they can be extrapolated to projected national results. A firm take help of market experiments to forecast demand sales since it helps business managers determine how many units to create and distribute, as well as vital for determining sales quotas. Also known as the buyer's intentions method, the user expectations method is also a market experiment in demand forecasting which relies on answers from customers regarding their intent to purchase the product during the forecasting time period, and works best when attempting to estimate current market potential as well as to forecast demand, because it does not take into account the company's marketing and advertising efforts which may affect consumers' intent to buy. While the sales force composite method is a forecasting experiment which starts with the forecaster asking for opinions about future sales from every member of the sales staff currently working in the field, where each sales force member states how many sales she thinks she'll make during the given forecasting period.


2) Suggest a suitable price policy for the three types of

oranges. Ans. The concepts of comparative advantage and competitiveness are important foundations for understanding the importance of international trade which illuminate the underlying factors responsible for current trade patterns. Accordingly, comparative advantage and competitiveness are related, but are often mistakenly exchanged for one another, which explain how trade benefits nations through more efficient use of the world's resource base when that trade is totally unrestricted. While competitive advantage defines trading patterns as they exist in the real world including all the barriers to free trade ignored by comparative advantage. The concepts of comparative advantage and competitiveness are important foundations for understanding the importance of international trade, and said concepts illuminate the underlying factors responsible for current trade patterns. The most suitable price policy for the three types of oranges is the California Orange, given that prices of the same commodity under self-sufficient conditions vary substantially among countries even if consumer demand was the same in each of those countries. Such price variation is due to the variable quantity and quality of productive factors such as land and climate, and the presence of skilled labour more suitable for production of certain products than others. And due to these resource variations some goods may be produced only at very high cost, or perhaps not at all, in some nations. Classic example of which is that the production of oranges in Canada could only be accomplished under greenhouse conditions resulting in extremely high unit production costs while oranges are produced in California at relatively low cost due to the immovable factors of climate, water and land favourable for orange production. Considering a world where trade among nations is possible while maintaining the previous assumption of immovable productive resources, consumers will compare prices of locally produced oranges with the prices of the same commodity produced in other nations. Subsequently, consumers will choose to purchase identical type of oranges at the lowest price regardless of where produced, as trade proceeds among nations, commodity prices rise in those nations which had relatively low prices in the absence of trade while prices fall in nations with relatively high pre-trade prices.


CASE STUDY – II A deodorant company manufactures and sells several types of deodorants which are branded as ‘Smell Fresh’. The company introduced five years ago, a new type of deodorant and its sales increased rapidly. However, over the past two years, sales have been declining steadily even though the market for deodorants has been expanding. Worried by the declining sales the company conducted a survey of the market, which yielded the following information: (i) Several new rivals have come up during the past five years, which manufacture and sell almost similar deodorants. (ii) Other companies have set prices lower than the prices of this company. (iii) This company had initially set the price of its new brand at Rs 40, for which retailer pays Rs 30, which was never changed. (iv) The rival firms have set their prices at Rs 37.50, retailers paying Rs 25. In view of these facts, the company decided to review the cost structure to find out whether the margin to the retailers could be reduced to the level of the rival firms. The company finds that the variable costs (including raw materials and labour) stands at Rs 15 per deodorant. At present the company sells 4, 00,000 deodorants. As to the market prospects, if the price is reduced to Rs 35, the demand would increase by 1,50,000 and if the price is reduced to Rs. 32.50, demand would increase to 6,50,000 units. With such an increase in production, the firm could use its resources more fully. The bulk of purchase of raw materials and more efficient use of labour would both help to reduce the unit variable cost to Rs. 12.50. Questions: 1) What price should the company charge to recapture market

lost to rival firms? Ans. In order for the deodorant company to charge and recapture market lost to rival firms, predatory pricing may be the solution for the firm deliberately setting prices to incur losses for a sufficiently long period of time to eliminate, discipline, or deter entry by a competitor, in the expectation that they will subsequently be able to recoup its losses by charging prices above the level that would have prevailed in the absence of the impugned conduct, with the effect that competition would be substantially lessened or prevented. Competition delivers many economic benefits, including competitive prices and product choices, where low prices are usually a good indication of vigorous competition.


However, while competitive prices are beneficial to consumers, certain anti-competitive pricing behaviour, such as predatory pricing, can harm the economy, making predatory pricing to have short-term benefits for consumers, but it can ultimately lead to higher prices or other anti-competitive effects in the long run. Relatively, in today’s fast-paced, global economy, markets are constantly changing, demanding flexible and innovative responses to competitive challenges. Asset position of the deodorant company impacts the competitive strategies, and in order to cope up with the resource constraints and earn for livelihoods, small and medium sized firms like this case rely upon own labour and target the medium and low-price segments. In order to be able to recapture market lost to rival firms, the company’s product mixes should comprise of single varieties and medium qualities of the fast moving product lines, mixed lot sizes, negotiate for prices and offer periodic price discounts since overhead costs are nearly negligible for them, and manage their product purchases from several sources to keep the cost prices low. Consequently, due to the company’s financial and physical constraints, it then attempts to minimize the risks, and content with their businesses that provide a stable flow of income. However, in contrast, large sized firms target the upper and medium price segments. 2) Suggest alternative strategies that the company can adopt

to counteract competition. Ans. There are alternative strategies that the deodorant company can adopt to counteract competition, where they tailor their competitive strategies to the demographics features, purchase, capacity and taste preferences of the target markets. Accordingly, they design the merchandise mixes, depth and breadth of product lines, product quality, lot sizes, fix prices, advertise product promotion, add services, operate for suitable business hours, and manage for logistic, etc. The alternative strategies that the company in this case, can adopt to counteract competition, is presented below, namely:

1) PRODUCT DIFFERENTIATION

Product differentiation along a single/multiple attributes takes a comparatively longer time to change than price that could be changed at a very short notice and plays merely a tactical role. Thus, the company should focus on single varieties of the seasonal products mainly of medium qualities with an average size of 2.43 products.


2) MARKET DEVELOPMENT

The deodorant company must also focus high on the low and medium and low on the high price segments, and medium sized companies are high on the medium and moderate on the low and high price segments. Thus, quite often all sized firms influence customer purchase decisions through salesmanship, and depending upon the sizes and characteristics of the target markets they adapt the marketing mixes, by which within each market segment, customers comprise of two groups, regular and floating.

3) PRODUCT PRICING

Difficulty of controlling the product quality and volume, intra and inter seasonality, proper temperature throughout the distribution system limits the evolution of true consumer franchises for specific brands that makes the dynamics of fresh produce markets largely commodity like and most firms act as price-takers. However, the company’s purchase choices, lot sizes and the product supply positions at any point of time impact theirs' offer prices for the seasonal products in the wholesale markets, where they use the principle of "cost plus" and "competitive" pricing for pricing products. Said costs set the price floor while customers' and competitors' characteristics impact the actual price fixation.


imt 20 managerial economics m1

Economy & Finance

competitiveness areimportant foundations

total outlay method

suitable price policy

solidly reported based

profit maximizing conditions

diminishing marginal utility

perfect price discrimination

predatory pricing