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Q1. What is a business cycle? Describe the different phases of a business cycle. The business cycle phases define long-term pattern of changes in Gross Domestic Product (GDP) that follows four basic stages: expansion, prosperity, contraction, and recession. After a recessionary phase, the expansionary phase starts again. The business cycle phases are characterized by changing employment, industrial productivity, and interest rates. Stock analysts believe that stock prices lead the business cycle

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Q1. What is a business cycle? Describe the different phases of a business cycle. The business cycle phases define long-term pattern of changes in Gross Domestic Product (GDP) that follows four basic stages: expansion, prosperity, contraction, and recession. After a recessionary phase, the expansionary phase starts again. The business cycle phases are characterized by changing employment, industrial productivity, and interest rates. Stock analysts believe that stock prices lead the business cycle phases. This economic cycle provides the strategic framework for business activity and investing. Moreover, the business cycle phases affect employees, employers and investors. A business cycle is identified as a sequence of four phases:

Expansion Phase: The economy is strong, people are employed and making money. Demand for goods -- food, consumer appliances, electronics, services -- increases to the point where it outstrips supply. This demand fuels a rise in prices, or inflation. Prosperity Phase: As prices increase, people ask for higher wages. Higher employment costs translate into higher prices for goods, fueling an upward spiral effect. Contraction Phase: When prices get too high, consumers and companies curtail their spending, as goods and services are too expensive. This decreases demand. When demand decreases, companies cut expenses that includes laying off workers, since they do not need to make as many goods or provide as much service. Recession Phase: Decreasing demand fuels declining prices, declining GDP, and rising unemployment. This means the economy is in a recession. Expansion Phase begins again: Lower prices eventually spurs demand. As demand picks up, people begin buying again, fueling the need for greater supply, expansion of credit, new jobs and a growing economy.

When the business cycle doesn't run as expected, it can have consequences that can be as disastrous as the Great Depression. That's why governments intervene to try to manage the economy. If it appears that inflation is rising too quickly, the Federal Reserve (the central bank of the U.S. charged with handling monetary policy) may decide to raise interest rates to curtail price increases. On the other hand, if the economy is performing poorly, the government may lower taxes to spur consumption and investment and the Federal Reserve may lower interest rates to reduce the cost of borrowing. Interest rates and the yield curve play a very important role in determining economic activity, the phases of the business cycle and the performance of the stock market. Higher interest rates increase the costs to businesses and individuals. Companies must pay more to borrow

money for capital investments or to fund daily business operations. Individuals pay more for mortgages, as well as other loans they may take out to purchase products. Higher interest rates also increase the demand for money to invest in bonds, competing for money to invest in the stock market. The phases of the business cycle have implications for markets and investors. Broadly, a recession often corresponds with a sustained period of weak stock prices, or a bear market. And a healthy, expanding economy that keeps inflation from rising too quickly often corresponds with a bull market, or period of sustained market growth. Sector Rotation Fortunately, there are investment strategies for each phase of the business cycle. Sam Stovall's Sector Investing, 1996 states that different sectors are stronger at different business cycle phases. The table below describes this theoretical model showing the phases of the business cycle. Phase: Consumer Expectations: Industrial Production: Interest Rates: Yield Curve: Full Recession Reviving Bottoming Out Falling Normal Early Recovery Rising Rising Bottoming Out Normal (Steep) Full Recovery Declining Flat Rising Rapidly (Fed) Flattening Out Early Recession Falling Sharply Falling Peaking Flat/Inverted

The graph below, courtesy of StockCharts.com, shows these relationships and the alignment of the key sectors as they respond to the business cycle. The stock market cycle tends to precede the business cycle by six months on average, as investors try to anticipate when the market will respond to changes in the economy. This means investors are more likely to beat the market, if they invest in the sectors that line up with the current and next phase of the business cycle. Sector Rotation Model:

Legend: Market Cycle Economic Cycle As shown above the stock market is a leading indicator of the economic or phases of the business cycle. Since the market leads the economy, investors need to pay particular attention to the early signs of a change in each phase of the business cycle. Many people believe that GDP is the primary indicator of the business cycle. The National Bureau of Economic Research (NBER) gives relatively low weight to GDP as a primary business cycle indicator, since the GDP is subject to frequent revisions after the fact. In addition, it is only reported on a quarterly basis. The NBER is the official organization that defines when the U.S. is in a recession and when it comes out of one. The NBER relies on indicators that are reported monthly to identify the business cycle phases including:

Employment, especially new unemployment claims; Personal income; Industrial production; Sales in key sectors such as housing, autos, durable goods and retail sales; Interest rates and the yield curve; and Commodity prices.

By following these indicators carefully, investors can anticipate when to expect changes in the business cycle. These indicators tend to change their trajectory over several months, giving investors ample time to identify a change in the trend. If you believe a change in the phase of the business cycle is underway then it is time to close out sectors that will go out of favor and start new positions in sectors that will come into favour. This strategy will position you to beat the market using the phases of the business cycle as a guide. Our stock market strategy begins with an understanding of where we are in the the business cycle. Assessing the business cycle phases is the first of five steps in our stock market strategy that we use to beat the market. Q2. What is monetary policy? Explain the general objectives and instruments of monetary policy

Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability.[1] [2] The official goals usually include relatively stable prices and low unemployment. Monetary theory provides insight into how to craft optimal monetary policy. It is referred to as either being expansionary or contractionary,

where an expansionary policy increases the total supply of money in the economy more rapidly than usual, and contractionary policy expands the money supply more slowly than usual or even shrinks it. Expansionary policy is traditionally used to try to combat unemployment in a recession by lowering interest rates in the hope that easy credit will entice businesses into expanding. Contractionary policy is intended to slow inflation in hopes of avoiding the resulting distortions and deterioration of asset values. Goals of Monetary policy The goals of monetary policy have developed with the evolution central banking thought and the changes in both the behaviour and performance of different economies. There is worldwide agreement that the ultimate goals of monetary policy at present in both the developed and developing countries are price stability and high employment rates, enhancing economic growth rates and controlling imbalances in external payments, including the protection of the external purchasing power of the currency through maintaining relatively stable levels of exchange rates. These goals, though interrelated by their nature, may be contradictory. This explains the importance of co-ordination among different economic policies on the one hand, and the importance of diagnosing the economic problem before taking appropriate treatment measures on the other. The significance of this issue becomes evident when we stress the need to apply rational monetary policies, particularly with regard to the practicality of goals pursed by the monetary authorities and the possibility of achieving these goals without economic consequences that might aggravate economic problems. Besides the above goals, some people believe that monetary policy should have other important goals, such as high and stable share prices, while others would include the maintenance of low interest rates as a major goal. Others stress increasing the efficiency of the financial system and maintaining the soundness of the banking system. In fact, each of these goals has special significance and directly relates either to the monetary policy goals discussed above or to the intermediate objectives of monetary policy, which represent the link between monetary procedures and the influence of these procedures on the path of economic activity. I believe, however, that despite the differences in viewpoints towards the goals of monetary policy, the goal of increasing the efficiency of the financial system and maintaining the soundness and stability of the banking system should rank first. This conviction may be supported by the fact that the effects of monetary policy measures on the economy occur through the banking and financial systems, which makes the systems response to monetary variables a very important issue. Furthermore, the increased relative importance of deposit money makes the protection of the banking system and enhancing confidence in it one of the major goals of central banks, as it means protecting the mechanism of the payments system in the economy.

Talking about the monetary policy goals as shown above should not mitigate the important role central banks may play in other economic areas, especially in the area of developing money and capital markets in countries where these markets are lacking. The development of such markets will enable central banks to use one of the important instruments of monetary policy, i.e. open market operations. Monetary Policy Instruments The set of instruments available to monetary authorities may differ from one country to another, according to differences in political systems, economic structures, statutory and institutional procedures, development of money and capital markets and other considerations. In most advanced capitalist countries, monetary authorities use one or more of the following key instruments: changes in the legal reserve ratio, changes in the discount rate or the official key bank rate, exchange rates and open market operations. In many instances, supplementary instruments are used, known as instruments of direct supervision or qualitative instruments. Although the developing countries use one or more of these instruments, taking into consideration the difference in their economic growth levels, the dissimilarity in the patterns of their production structures and the degree of their of their link with the outside world, many resort to the method of qualitative supervision, particularly those countries which face problems arising from the nature of their economic structures. Although the effectiveness of monetary policy does not necessarily depend on using a wide range of instruments, coordinated use of various instruments is essential to the application of a rational monetary policy. Intermediate Objectives of Monetary Policy The intermediate objectives of monetary policy are defined as a number of variables linking the instruments of monetary policy with their ultimate goals. These variables are money supply, interest rates, disposable credit, the monetary base or any other variable deemed by the monetary authorities as an appropriate intermediate objective for monetary policy. In many instances, these objectives can be used as indicators of the effects of the applied monetary policy. This issue, thought it is a major pivot of the monetary policy framework, is still a subject of major viewpoint differences among economists. While monetarists believe that monetary authorities must select quantitative targets for their monetary policy through controlling growth levels in money supply and thereby adopting mostly the monetary base approach, non-monetarists, despite their recognition of the importance of money, see that changes in different components of aggregate demand have significant impact on the level of economic activity and, therefore, they give basic consideration to the adoption of price objectives through the selection of the interest rate as an intermediate objective representing a link between money and production.

The monetarists choice of money supply as a target is based on a number of hypotheses or principles. For instance, they believe that money supply is an exogenous variable that is controllable in the long run, and that the direction of causal relations in the exchange equation moves from money to prices and production. Furthermore, the strongest final effect will be represented by high prices, given the stability in the function of demand for money and a time lag for the effect of monetary policy, thus avoiding the adoption of fiscal policies as a stimulus. This is a lengthy issue, and it would not be appropriate to discuss it in detail here. We can sum up our point of view as follows: a. The selection of intermediate objectives for monetary policy should be made according to the structural characteristics of the concerned economies and according to analytical studies on economic behaviour, including the demand function for money and the directions of the general economic policy. The dispute arising between monetarists and non-monetarists relates to other issues than simply the behaviour of the monetary policy to be applied. These issues may affect the nature of the role to be played by the state in the economy. b. The choice of a certain intermediate objective by the monetary authorities does not necessarily mean that these authorities should adhere to that objective all the time. The objective should be reviewed in the light of structural and behavioural changes in the economy. Further, both the prevailing economic situation and the change in the priorities of monetary policy objectives may provide the monetary authorities with sufficient justification to shift from one objective to another. c. Central banking is an art, which gives a strong reason to believe that the effects of monetary procedures may be transferred through several channels, such as the volume of disposable credit, interest rates, money supply and the general liquidity position in the economy. We believe that the estimation based on all relevant data is still the best approach for formulating monetary policy. Q3. A firm supplied 3000 pens at the rate of Rs 10. Next month, due to a rise of in the price to 22 rs per pen the supply of the firm increases to 5000 pens. Find the elasticity of supply of the pens. Price elasticity of demand is a ratio of two pure numbers, the numerator is the percentage change in the quantity demanded and the denominator is the percentage change in price of the commodity. It is measured by the following formula: Ep = Percentage change in quantity demanded/ Percentage changed in price Applying the provided data in the equation: Percentage change in quantity demanded = (5000 3000)/3000Percentage changed in price = (22 10) / 10 Ep = ((5000 3000)/3000) / ((22 10)/10) = 1.2

Q4. Give a brief description of a. Implicit and explicit cost b. Actual and opportunity cost Implicit and Explicit cost Explicit costs are those costs which are in the nature of contractual payments and are paid by an entrepreneur to the factors of production [excluding himself]in the form of rent, wages, interest and profits, utility expenses, and payments for raw materials etc. They can be estimated and calculated exactly and recorded in the books of accounts. Implicit or imputed costs are implied costs. They do not take the form of cash outlays and as such do not appear in the books of accounts. They are the earnings of owner employed resources. For example, the factor inputs owned by the entrepreneur himself like capital can be utilized by him or can be supplied to others for a contractual sum if he himself does not utilize them in the business. It is to be remembered that the total cost is a sum of both implicit and explicit costs. (b) Actual and opportunity cost Actual costs are also called as outlay costs, absolute costs and acquisition costs. They are those costs that involve financial expenditures at some time and hence are recorded in the books of accounts. They are the actual expenses incurred for producing or acquiring a commodity or service by a firm. For example, wages paid to workers, expenses on raw materials, power, fuel and other types of inputs. They can be exactly calculated and accounted without any difficulty. Opportunity cost Opportunity cost of a good or service is measured in terms of revenue which could have been earned by employing that good or service in some other alternative uses. In other words, opportunity cost of anything is the cost of displaced alternatives or costs of sacrificed alternatives. It implies that opportunity cost of anything is the alternative that has been foregone. Hence, they are also called as alternative costs. Opportunity cost represents only sacrificed alternatives. Hence, they can never be exactly measured and recorded in the books of accounts. The knowledge of opportunity cost is of great importance to management decision. They help in taking a decision among alternatives. While taking a decision

among several alternatives, a manager selects the best one which is more profitable or beneficial by sacrificing other alternatives

Q5. Explain in brief the relationship between TR, AR, and MR under different market condition. Revenue is the income received by the firm. There are three concepts of revenue Total revenue, Average revenue and Marginal revenue. 1. Total revenue (TR): Unit 7 Total revenue refers to the total amount of money that the firm receives from the sale of its products, i.e. .gross revenue. In other words, it is the total sales receipts earned from the sale of its total output produced over a given period of time. We may show total revenue as a function of the total quantity sold at a given price as below. TR = f(q). It implies that higher the sales, larger would be the TR Thus, TR = PXQ. For e.g. a firm sells 5000 units of a commodity at the rate of Rs. 5 per unit, then TR would be TR = P x Q = 5 x 5000 = 25,000.00. Y TR 0 Sales X 2. Average revenue (AR) Average revenue is the revenue per unit of the commodity sold. It can be obtained by dividing the TR by the number of units sold. Then, AR = TR/Q AR = 150/15= 10. Thus average revenue means price. Since the demand curve shows the relationship between price and the quantity demanded, it also represents the average revenue or price at which the various amounts of a commodity are sold, because the price offered by the buyer is the revenue from seller s point of view. Therefore, average revenue curve of the firm is the same as demand curve of the consumer. Therefore, in economics we use AR and price as synonymous except in the context of price discrimination by the seller. Mathematical y P = AR.

3. Marginal Revenue (MR) Marginal revenue is the net increase in total revenue realized from selling one more unit of a product. It is the additional revenue earned by selling an additional unit of output by the seller. Suppose a firm is selling 4 units of the output at the price of Rs.14 per unit. Now if it wants to sell 5 units instead of 4 units and thereby the price of the product falls to Rs.12 per unit, then the marginal revenue wil not be equal to Rs.12 at which the 5th unit is sold. 4 units, which were sold at the price of Rs.14 before, wil al have to be sold at the reduced price of Rs.12 and that wil mean the loss of 2 rupees on each of the previous 4 units. The total loss on the previous units will be equal to Rs.8. Therefore, this loss of 8 rupees should be deducted from the price of Rs.12 of the 5th unit while calculating the marginal revenue. The marginal revenue in this case, therefore, will be Rs.12 Rs.8 =Rs.4 and not Rs.12 which is the average revenue. Marginal revenue can also be directly calculated by finding out the difference between the total revenue before and after selling the additional unit of the product. Total revenue when 4 units are sold at the price of Rs.14 = 4 X 14 = Rs.56 Total revenue when 5 units are sold at the price of Rs.12 = 5 X 12 = Rs.60 Therefore, Marginal revenue or the net revenue earned by the 5th unit = 6056 = Rs.4. Thus, Marginal revenue of the nth unit = difference in total revenue in increasing the sale from n-1 to n units or Marginal revenue = price of nth unit minus loss in revenue on previous units resulting from price reduction. The concept is important in micro economics because a firm's optimal output (most profitable) is where its marginal revenue equals its marginal cost i.e. as long as the extra revenue from selling one more unit is greater than the extra cost of making it, it is profitable to do so. It is usual for marginal revenue to fall as output goes up both at the level of a firm and that of a market, because lower prices are needed to achieve higher sales or demand respectively. MR = TR = where TR represents change in TR Q And Q indicates change in total quantity sold. Also MR = TRn TRn-1 Marginal revenue is equal to the change in total revenue over the change in quantity.

Marginal Revenue = (Change in total revenue) divided by (Change in sales) There is another way to see why marginal revenue will be less than price when a demand curve slopes downward. Price is average revenue. If the firm sells 4 units for Rs.14, the average revenue for each unit is Rs.14.00. But as seller sells more, the average revenue (or price) drops, and this can only happen if the marginal revenue is below price, pulling the average down. If one knows marginal revenue, one can tell what happens to total revenue if sales change. If selling another unit increases total revenue, the marginal revenue must be greater than zero. If marginal revenue is less than zero, then selling another unit takes away from total revenue. If marginal revenue is zero, than selling another does not change total revenue. This relationship exists because marginal revenue measures the slope of the total revenue curve. Relationship between Total revenue, Average revenue and Marginal Revenue concepts In order to understand the relationship between TR, AR and MR, we can prepare a hypothetical revenue schedule. Relationship between AR and MR and the nature of AR and MR curves under difference market conditions 1. Under Perfect Market Under perfect competition, an individual firm by its own action cannot influence the market price. The market price is determined by the interaction between demand and supply forces. A firm can sell any amount of goods at the existing market prices. Hence, the TR of the firm would increase proportionately with the output offered for sale. When the total revenue increases in direct proportion to the sale of output, the AR would remain constant. Since the market price of it is constant without any variation due to changes in the units sold by the individual firm, the extra output would fetch proportionate increase in the revenue. Hence, MR & AR will be equalto each other and remain constant. This will be equal to price. Under perfect market condition, the AR curve wil be a horizontal straight line and parallel to OX axis. This is because a firm has to sell its product at the constant existing market price. The MR cure also coincides with the AR curve. This is because additional units are sold at the same constant price in the market. 2. Under Imperfect Market Under all forms of imperfect markets, the relation between TR, AR, and MR is different. This can be understood with the help of the following imaginary revenue schedule.

Q6. Distinguish between a firm and an industry. Explain the equilibrium of a firm and industry under perfect competition. Monopolistic competition An industry in monopolistic competition is one made up of a large number of small firms who produce goods which are only slightly different from that of all other sellers. It is similar to perfect competition with freedom of entry and exit for firms and any supernormal profits earned in the shortrun will be competed away in the long-run as new firms enter the industry and compete away the profits. Short Run Equilibrium

Short-run equilibrium of the firm under monopolistic competition. The firm maximizes its profits and produces a quantity where the firms marginal revenue (MR) is equal to its marginal cost (MC). The firm is able to collect a price based on the average revenue (AR) curve. The difference between the firms average revenue and average cost, multiplied by the quantity sold (Qs), gives the total profit. Long Run Equilibrium

Long-run equilibrium of the firm under monopolistic competition. The firm still produces where marginal cost and marginal revenue are equal; however, the demand curve (and AR) has shifted as other firms entered the market and increased competition. The firm no longer sells its goods above average cost and can no longer claim an economic profit. b) Perfect Competition is a more desirable market form than monopolistic competition. Discuss.

Perfect competition is considered as the ideal or the standard against which everything is judged. Perfect competition is characterised as having: Many buyers and sellers. Nobody has power over the market. Perfect knowledge by all parties. Customers are aware of all the products on offer and their prices. Firms can sell as much as they want, but only at the price ruling. Thus sellers have no control over market price. They are price takers, not price makers. All firms produce the same product, and all products are perfect substitutes for each other, i.e. goods produced are homogenous. There is no advertising. There is freedom of entry and exit from the market. Sunk costs are few, if any. Firms can, and will come and go as they wish. Companies in perfect competition in the long-run are both productively and allocatively efficient. In perfect competition, the market is the sum of all of the individual firms. The market is modelled by the standard market diagram (demand and supply) and the firm is modelled by the cost model (standard average and marginal cost curves). The firm as a price taker simply takes and charges the market price (P* in Figure 1 below). This price represents their average and marginal revenue curve. Onto this we superimpose the marginal and average cost curves and this gives us the equilibrium of the firm. Firms in equilibrium in perfect competition will make just normal profit. This level of profit is just enough to keep them in the industry and since profits are adequate they have no incentive to leave. Normal profits Normal profit is the level of profit that is required for a firm to keep the resources they are using in their current use. In other words it is enough profit to keep them in the industry. Anything in excess of normal profits is called abnormal or supernormal profits. Any profit above normal profit is a bonus for the firms, as it is more than they need to keep them in the industry. We call this supernormal (or abnormal) profit. However, this supernormal profit will be a signal to other firms and will attract more firms into the industry. If firms are making consistently below normal profits then they will choose to leave the industry.