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ASSIGNMENT MANAGEMENT ECONOMICS - MB0042

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ASSIGNMENT

MANAGEMENT ECONOMICS

REG NO :

NAME : MOHAMMED THOUFEEQ

COURSE : MBA

SEMESTER : FIRST SEMISTER

SUBJECT CODE : MB 0042

SUBJECT NAME : MANAGEMENT ECONOMICS

SET NO : 1&2

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ASSIGNMENT SET-1

Q.1 Price elasticity of demand depends on various factors. Explain

each factor with the help of an example.

A behavioral relationship between quantity consumed and a person's

maximum willingness to pay for incremental increases in quantity. It is usually an

inverse relationship where at higher (lower) prices, less (more) quantity is

consumed. Other factors which influence willingness-to- pay are income, tastes

and preferences, and price of substitutes. Demand function specifies what the

consumer would buy in each price and wealth situation, assuming it perfectly

solves the utility maximization problem. The quantity demanded of a good usually

is a storng function of its price. Suppose an experiment is run to determine the

quantity demanded of a particular product at different price levels, holding

everything else constant. Presenting the data in tabular form would result in a

demand schedule.

Elasticity of demand is the economists way of talking about how responsive

consumers are to price changes. For some goods, like salt, even a big increase in

price will not cause consumers to cut back very much on consumption. For other

goods, like vanilla ice cream cones, even a modest price increase will cause

consumers to cut back consumption. Elasticity of demand is used to show the

responsiveness of the quantity demanded of a good or service to a change in its

price. More precisely, it gives the percentage change in demand one might expect

after a one percent change in price. Elasticity is almost always negative, although

analysts tend to ignore the sign even though this can lead to ambiguity. Only

goods which do not conform to the law of demand, such as Veblen and Giffen

goods, have a positive elasticity demand. Goods with a small elasticity demand(less than one) are said to be inelastic: changes in price do not significantly affect

demand e.g. drinking water. Goods with large elasticity demands (greater than

one) are said to be elastic: even a slight change in price may cause a dramatic

change in demand. Revenue is maximised when price is set so as to create a ED

of exactly one; elasticity demands can also be used to predict the incidence of tax.

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Various research methods are used to calculate price elasticity, including test

markets, analysis of historical sales data and conjoint analysis. There is a neat way

of classifying values of elasticity. When the numerical value of elasticity is less than

one, demand is said to be inelastic. When the numerical value of elasticity is

greater than one, demand is elastic. So elastic demand means that people are

relatively responsive to price changes (remember the vanilla ice cream cone).

Inelastic demand means that people are relatively unresponsive to price changes

(remember salt). An important relationship exists between the elasticity of demand

for a good and the amount of money consumers want to spend on it at different

prices. Spending is price times quantity, p times Q. In general, a decrease in price

leads to an increase in quantity, so if price falls spending may either increase or

decrease, depending on how much quantity increases. If demand is elastic, then adrop in price will increase spending, because the percent increase in quantity is

larger than the percent decrease in price. On the other hand, if demand is inelastic

a drop in price will decrease spending because the percent increase in quantity is

smaller than the percent decrease in price.

The price elasticity of demand measures how responsive the quantity

demanded of a good is to a change in its price. The value illustrates if the good is

relatively elastic (PED is greater than 1) or relatively inelastic (PED less than 1).

A good's PED is determined by numerous factors, these include;

Number of substitutes: the larger the number of close substitutes for the good,the

easier household can shift to alternative goods if price increases. The larger the

number of close substitutes, the more elastic the price elasticity of demand.

Price of the good as a proportion of income: It can be argued that goods that

account for a large proportion of disposable income tend to be elastic. This is due

to consumers being more aware of small changes in price of expensive goods

compared to small changes in the price of inexpensive goods.

The example illustrates how to determine price elasticity of demand for a good.

The price elasticity of demand for supermarket strawberry jam is likely to be

elastic. This is because of large number of close substitutes and the good is not a

necessity item. Therefore, consumers will easily respond to a change in price.

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Q.2 A company is selling a particular brand of tea and wishes to

introduce a new flavor. How will the company forecast demand for it?

Methods, such as educated guesses, and quantitative methods, such as theuse of historical sales data or current data from test markets. Demand forecasting

may be used in making price decisions, in assessing future capacity requirements,

or in making decisions to enter new market. Often forecasting demand is confused

with forecasting sales. But, failing to forecast demand ignores 2 important

phenomena. There is a lot of debate indemand - planning literature about how to

measure and represent historical demand, since the historical demand forms the

basis of forecasting. The main question is whether we should use the history of

outbound shipments or customer orders or a combination of the two as proxy for

the demand. Stock effects. The effects that inventory levels have on sales. In the

extreme case of stock-outs, demand coming into your store is not converted to

sales due to a lack of availability. Demand is also untapped when sales for an item

are decreased due to a poor display location, or because the desired sizes are no

longer available. For example, when a consumer electronics retailer does not

display a particular flat-screen TV, sales for that model are typically lower than the

sales for models on display. And in fashion retailing, once the stock level of a

particular sweater falls to the point where standard sizes are no longer available,

sales of that item are diminished.

Market response effect : The effect of market events that are within and beyond a

retailers control. Demand for an item will likely rise if a competitor increases the

price or if you promote item in your weekly circular. The resulting sales increase

reflects a change in demand as a result of consumers responding to stimuli that

potentially drive additional sales. Regardless of the stimuli, these forces need to be

factored into planning and managed within demand forecast.. Demand forecast

modeling considers the size of market and dynamics of market share versus

competitor and its effect on firm demand over period of time. In the manufacturer to

retailer model, promotional events important causal factor in influencing demand.

eaggregate intelligence using collaboration with Sales & Marketing function.

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Q.3 The supply of a product depends on the price. What are the other

factors that will affect the supply of a product.

Apart from price, many factors bring about changes in supply. Among themthe important factors are

1. Natural factors: Favourable natural factors like gud climatic conditions ,

timely, adequate, well distributed rainfall results in higher production and

expansion in supply. On the other hand adverse factors like bad weather

conditions , earthquakes, droughts,untimely ill distributed, inadequate

rainfall, pests etc., may cause decline in production and contradiction in

supply.

2. Change in techniques of production: An improvement in techniques ofproduction and use of modern highly sophasticated machines and

equipments will go a long way in raising the output and expansion in supply.

On the contrary, primitive techniques are responsible for lower and hence

lower supply.

3. Cost of production: Given the market price of a product, if the cost of

production rises, due to higher wages, interest and price of inputs, supply

decreases.If the cost of production falls, on account of lower wages, interest

and price of input supply rises

4. Prices of related goods: If prices of related goods fall, the seller of a given

commodity offer more units in the market even though the price of his

product has not gone up. Opposite will be the case when the price of related

goods rises.

5. Government policy: When the government follows a positive policy it

encourages production in the private sector. Consequently supplyexpands.For ex, granting of subsidy development rebates tax concession

extra.. on the other hand output and supply cripples when the government

adopts a negative policy, for example withdrawal of all concessions and

incentives, imposition of high taxes, introduction of controls and quota

systems extra.

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6. Monopoly power : Supply tends to be low when the market is controlled by

monopolists or a few sellers as in the case ofoligopoly.Generally supply

would be more under competetive conditions.

7. Number of sellers or firms: Supply would be more when there are a large

number of sellers.Similarly production and supply tends to be more when

production is organized on large scale basis.If rate or speed of production is

high supply expands.opposite will be the case when number of sellersis

lesssmall scale production and low rate of production

8. Complementary goods: In case of joint demand the production and sale of

one product may lead to production and sale of other product also.

9. Discovery of new source of inputs: Discovery of new source of inputs

helps the producers to supply more at the same price and viseversa.

10. Improvements in transport and communication: This will facilitate free

and quick movement of goods and services from production centers to

marketing centers.

11.Future rise in prices: When seller anticipate a further rise in price, in that

case current supply tends to fall. Opposite will be the case when the seller

expect a fall in price.

Thus many factors influence the supply of a product in market. A firm

should have a thorough knowledge of all the factors because it helps in

preparing its production plan and sale strategy.

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Q.4 Show how producers equilibrium is achieved with isoquants and

isocost curves.

Economies of scale external to the firm (or industry wide scale economies)are only considered examples of network externalities if they are driven by

demand side economies. In many industries, the production of goods and

services and the development of new products requires the use of specialized

equipment or support services. An individual company does not provide a large

enough market for these services to keep the suppliers in business. A localized

industrial cluster can solve this problem by bringing together many firms that

provide a large enough market to support specialized suppliers. This

phenomenon has been extensively documented in

The semiconductor industry located in Silicon Valley

Labour market pooling

A cluster of firms can create a pooled market for specialized skilled workers.

It is an advantage for

Producers: They are less likely to suffer from labour shortages.

Workers: They are less likely to get unemployed.

Knowledge spillovers: Knowledge is one of the important input factors in highly

Innovative industries:

The specialized knowledge that is crucial to success in innovative industries

comes from

Research & development

Reverse engineering:

Informal exchange of information and ideas.

As firms become larger and their scale of operations increase they are able

to experience reductions in their average costs of production. The firm is said to

be experiencing increasing returns to scale. Increasing returns to scale results in

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the firm's output increasing at a great proportion than its inputs and hence its total

costs. As a consequence its average costs fall.

Thus initially the firm's long run average cost curve slopes downward as the

scale of the enterprise expands. The firm enjoys benefits called internal

economies of scale. These are cost reductions accruing to the firm as a result of

the growth of the firm itself. (An external economy of scale is a benefit that the

firms experience as a result of the growth of the industry.)

After the firm has reached its optimum scale of output, where the long run

average cost curves are at their lowest point, continued expansion means that its

average costs may start to rise as the firm now experiences decreasing returns to

scale. The long run average cost curve therefore starts to curve upwards. This

occurs because the firm is now experiencing internal diseconomies of scale.

Types of internal economies of scale types

Financial

The farm has been able to gain loans and assistance at farm has been able to

preferential interest rates from the EIB, world bank and the EU

MarketingIt has managed to dedicate resources to its strategy of niche marketing

Technical

The access to finance has allowed it to invest in sophisticated Israeli irrigation

Managerial

It large size enables it to employ specialized personnel such as estate managers

Risk Bearing

The farm has used some of its land to diversify into producing fresh vegetables for

export as well as continue producing maize. These large scale farms are attracting

a considerable amount of overseas development aid funding from organization

such as the world bank and the European union as they are seen as being an

integral part of the export earning capacity of the country.

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Q.5 Discuss the full cost pricing and marginal cost pricing method.

Explain how the two methods differ from each other

The profit maximization principle stresses on the fact that the motive ofbusiness firms to maximize profit is solely justified as being a method of

maximizing the income of their shareholders. Firms may maximize profit by

maximizing sales, stock price, market share or cash flow. In order to achieve

maximum profit the firm needs to find out the point where the difference between

total revenue and total cost is the highest.

The rules that apply for profit maximization are:

i. increase output as long as marginal profit increases

ii. Profit will increase as long as marginal revenue (MR) > marginal cost (MC)

iii. Profit will decline if MR < MC

iv. Summing up (ii) and (iii), profit is maximized when MR = MC

Profit Maximization model means a scenario where the business is runned

by the motive of profit making and keep the cost low. The business firm is the

productive unit in an exchange economy. In order to survive, a firm must deal with

three constraints: the demand for its product, the production function, and the

supply of its inputs. When the firm successfully deals with these constraints, it

makes a profit. These readings explore the assumption that firms maximize

profits, pointing out some of the ambiguities of this assumption. It then explores

how the rules of maximization apply to the firm. It considers two ways in which the

maximization principle can be used: to determine the proper levels of inputs or to

determine the proper level of output. The first leads to the rule that marginal

resource cost should equal marginal revenue product, and the second to the rule

that marginal cost should equal marginal revenue. The readings show that these

two rules are equivalent and simply represented different ways of using the

information from the three constraints that a firm faces. Much of this material is

quite technical, but it is at the core of microeconomics.

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Profit is maximized where MR = MC.

Profit maximization rule: Produce until the point where the change in revenue

from producing 1 more unit equals the change in cost from producing 1 more

unit. Why?

Suppose MR > MC. If I produce 1 more unit, my revenues increase by more than my

costs.

Therefore, if MR > MC, producing more will increase my profit. If I can increase

my profit by changing how much I produce, then when producing where MR > MC

can't be profit- maximizing.

Suppose MR < MC. If I produce 1 less unit, my revenues decrease by less than

my costs decrease. Therefore, if MR < MC, I can increase profit by decreasing output.

If I can increase profit when MR < MC, then choosing q such that MR < MC cannot be

profit-maximizing.

So, in order to maximize profit, I must choose a quantity q such that MR = MC.

MR = MC is an equilibrium in the sense that it is the only place where there

is no incentive to change the production level.

This rule, the profit maximization rule, is just an application of the marginal

principle (MB = MC). Why? This MB of producing an extra unit is the extra revenue

you get. MR is the MB. So the 2 statements are equivalent. The marginal principle ismore general, and the profit maximization rule is specific to the firm production

decision.

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Q.6 Discuss the price output determination using profit maximization

under perfect competition in the short run.

There is a predictable relationship between revenue and elasticity. Depending onPED, one may raise revenue either by increasing prices and sacrificing quantity or by

reducing them and outputting more. revenues or revenue is income that a company

receives from its normal business activities, usually from the sale of goods and services

to customers. In many countries, such as the United Kingdom, revenue is referred to as

turnover. Some companies receive revenue from interest, dividends or royalties paid to

them by other companies. In general usage, revenue is income received by an

organization in the form of cash or cash equivalents. Sales revenue or revenues is

income received from selling goods or services over a period of time. Tax revenue is

income that a government receives from taxpayers. In more formal usage, revenue is a

calculation or estimation of periodic income based on a particular standard accounting

practice or the rules established by a government or government agency. Two common

accounting methods, cash basis accounting and accrual basis accounting, do not use

the same process for measuring revenue. Corporations that offer shares for sale to the

public are usually required by law to report revenue based on generally accepted

accounting principles or International Financial Reporting Standards. Revenues from a

business's primary activities are reported as sales,sales revenue or net sales. This

excludes product returns and discounts for early payment of invoices. Most businesses

also have revenue that is incidental to the business's primary activities, such as interest

earned on deposits in a demand account. This is included in revenue but not included

in net sales. Sales revenue does not include sales tax collected by the business. Other

revenue (a.k.a. non-operating revenue) is revenue from peripheral (non- core)

operations. For example, a company that manufactures and sells automobiles would

record the revenue from the sale of an automobile as "regular" revenue. If that same

company also rented a portion of one of its buildings, it would record that revenue as

other revenue and disclose it separately on its income statement to show that it is

from something other than its core operations. A firm considering a price change must

know what effect the change in price will have on total revenue. Generally any change

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in price will have two effects: the price effect: an increase in unit price will tend to

increase revenue, while a decrease in price will tend to decrease revenue. The quantity

effect: an increase in unit price will tend to lead to fewer units sold, while a decrease in

unit price will tend to lead to more units sold. Because of the inverse nature of the

price-demand relationship the two effects offset each other; in determining whether to

increase or decrease prices a firm needs to know what the net effect will be. Elasticity

provides the answer.

In short, the percentage change in revenue is equal to the change in quantity

demanded plus the percentage change in price. In this way, the relationship between

PED and revenue can be described for any particular good:

When the price elasticity of demand for a good is perfectly inelastic (Ed =

0), changes in the price do not affect the quantity demanded for the good; raising

prices will cause revenue to increase.

When the price elasticity of demand for a good is inelastic (|Ed| < 1), the

percentage change in quantity demanded is smaller than that in price. Hence, when

the price is raised, the total revenue of producers rises, and vice versa.

When the price elasticity of demand for a good is unit elastic (or unitary elastic)

(|Ed| = 1), the percentage change in quantity is equal to that in price and a change in

price will not affect revenue.

When the price elasticity of demand for a good is elastic (|Ed| > 1), the

percentage change in quantity demanded is greater than that in price. Hence, when

the price is raised, the total revenue of producers falls, and vice versa.

When the price elasticity of demand for a good is perfectly elastic (Ed is infinite

i.e. undefined), any increase in the price, no matter how small, will cause demand for

the good to drop to zero. Hence, when the price is raised, the total revenue of

producers falls to zero.

Hence, to maximize revenue, a firm ought to operate close to its unit-elasticity pric.

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ASSIGNMENT SET 2

Q.1 Income elasticity of demand has various applications. Explain each

application with the help of an example.

Income elasticity of demand may be defined as the ratio or proportionate change in

the quantity demanded of a commodity to a given proportion change in the income. In

short, it indicates the extent to which demand changes with a variation in consumers

income. The following formula helps to measure the income elasticity (Ey).

Or Where

Ey is income elasticity of demand D is change in demand

D is original demand

Y is change in income

Y is original income

Example

Original demand=400 units Original income= 4000 units

New demand =700 units New income= 6000 units

Change in demand= 700-400= 300 units change in income=6000-4000=2000

Hence Ey=300/2000*4000/400=1.5

Generally speaking Ey is positive. This is because there is a direct relationship

between income and demand, i.e. higher the income; higher would be the demand

and vice versa. On the basis of the numerical value of the co-efficient, Ey is

classified as greater than one, less than one, equal to one, equal to zero and

negative. The concept of Ey helps us in classifying commodities in to different categories.

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1. When Ey is positive, the commodity is normal (used in day-to-day life)

2. When Ey is negative, the commodity is inferior. ( for example jowar, beedi etc)

3. When Ey is positive and greater than one, the commodity is luxury.

4. When Ey is positive but less than one, the commodity is essential.

5. When Ey is zero, the commodity is neutral. E.g. salt, match box etc.

Practical application of income elasticity of demand

1. Helps in determining the rate of growth of the firm.

If the growth rate of the economy and income growth of the people is reasonable

forecasted, in that case it is possible predict expected increase in the sales of a firm and

vice versa.

2. Helps in the demand forecasting of a firm.

It can be in estimating future demand provided the rate of increase in income and

Ey for products are known. Thus, it helps in demand forecasting activities of a firm.

3. Helps in production planning and marketing.

The knowledge of Ey is essential for production planning, formulating marketing strategy,

deciding advertising expenditures and nature of distribution channel etc in the long run.

4. Helps in ensuring stability in production.

Proper estimation of different degrees of income elasticity of demand for different

types of product help in avoiding over-production or under-production of a firm.

One should know whether rise or fall in income is permanent or temporary.

5. Helps in estimating construction of houses.

The rate of growth in incomes of people also helps housing programs in a country.

Thus it helps a lot in managerial decisions of a firm.

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Q.2 When is the opinion survey method used and what is the effectiveness

of the method.

Survey of buyers intention or preference is one of the important methods of

demand forecasting. It is also called Opinion Survey Method . Under this method,

consumer buyers are requested to indicate their preference and willingness about a

particular product. They are about to reveal their future purchase plans with respect to

specific items.

They are expected to give answer to question like what items they intends to

buy, in what quantity, why, where, what quality they expect, how much they are planningto spend etc. Generally, the field surveys are conducted by the marketing research

departments of the company or hiring the services of outside research organization

consisting of learned and highly qualified professionals.

The heart of the survey is questionnaire. It is a comprehensive one covering

almost all questions either directly or indirectly in a most intelligent manner. It is prepared

by an expert body who are specialist in the field or marketing.

The questionnaire is distributed among the consumer either through mail or in

person by the company. Consumers are requested to furnish all relevant and correct

information.

The next step is to collect the questionnaire from the consumers for the purpose

of evaluation. The materials collected will be classified, edited and analyzed. If any bias

prejudices, exaggerations, artificial or excess demand creation are found at the time of

answering they would be eliminated.

The information so collected will now be consolidated and reviewed by the top

executives with lot of experiences. It will be examined thoroughly. Inferences are drawn

and conclusions are arrived at. Finally a report is prepared and submitted to the

management for taking final decisions.

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The success of the survey method depends on many factors:

1. The nature of the question asked.

2. The ability of the surveyed.

3. The representative of the sample

4. Nature of the product

5. Characteristics of the market

6. Consumer behavior

7. Techniques of analysis

8. Conclusion drawn etc.

The management should not entirely depend on the result of survey reports t

project future demand. Consumer may not express their honest and real views and as

such they may give only the broad trends in the market. In order to arrive, at right

conclusion, field surveys should be regularly checked and supervised.

This method is simple and useful to the producers who produce goods in bulk.

Here the burden of forecasting is put on the customers.

However this method is not much useful in estimating the future demand of the

household as they run in a large numbers and also do not freely express their future

demand requirements. It is expensive and so difficult. Preparation of questionnaire is not

an easy task.

At best it can be used for short term forecasting.

.

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Q.3 Show how price is determined by the forces of demand and supply, by

using forces of equilibrium.

The word equilibrium is derived from the Latin word aequilibrium which means equal

balance. It means a state of even balance in which opposing forces or tendencies

neutralize each other. It is a position of rest characterized by absence of change. It is a

state where there is complete agreement of the economic plans of the various market

participants so that no one has a tendency to revise or alter his decision. In the words of

professor Mehta: Equilibrium denotes in economics absence of change in movement.

Market Equilibrium

There are two approaches to market equilibrium vi z., partial equilibrium approach and the

general equilibrium approach. The partial equilibrium approach to pricing explains price

determination of a single commodity keeping the prices of other commodities constant.

On the other hand, the general equilibrium approach explains the mutual and

simultaneous determination of the prices of all goods and factors. Thus it explains a multi

market equilibrium position.

Earlier to Marshall, there was a dispute among economists on whether the force of

demand or the force of supply is more important in determining price. Marshall gave equal

importance to both demand and supply in the determination of value or price. He

compared supply and demand to a pair of scissors We might as reasonably dispute

whether it is the upper or the under blade of a pair of scissors that cuts a piece of paper,

as whether value is governed by utility or cost of production . Thus neither the upper

blade nor the lower blade taken separately can cut the paper both have their importance

in the process of cutting. Likewise neither supply nor demand alone can determine price

of a commodity, both are equally important in the determination of price. But relative

importance of the two may vary depending upon time under consideration. Thus demand

of consumers and supply of all firms together determine price of commodity in the market.

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Equilibrium between demand and supply price:

Equilibrium between demand and supply price is obtained by the interaction of

these two forces. Price is an independent variable. Demand and supply are dependent

variables. They depend on price. Demand varies inversely with price, a rise in pricecauses a fall in demand and a fall in price causes a rise in demand. Thus the demand

curve will have a downward slope indicating the expansion of demand with a fall in price

and contraction of demand with a rise in price. On the other hand supply varies directly

with the changes in price, a rise in price causes a rise in supply and a fall in price causes

a fall in supply. Thus the supply curve will have an upward slope.At a point where these

two curves intersect with each other the equilibrium price is established. At this price

quantity demanded is equal to the quantity demanded. This we can explain with the help

of a table and a diagram

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In the above table at Rs.20 the quantity demanded is equal to the quantity

supplied. Since the price is agreeable to both the buyer and sellers, there will be no

tendency for it to change; this is called equilibrium price. Suppose the price falls to Rs.5

the buyer will demand 30 units while the seller will supply only 5 units. Excess of demand

over supply pushes the price upward until it reaches the equilibrium position supply is

equal to the demand. On the other hand if the price rises to Rs.30 the buyer will demand

only 5 units while the sellers are ready to supply 25 units. Sellers compete with each

other to sell more units of the commodity. Excess of supply over demand pushes the

price downward until it reaches the equilibrium. This process will continue till the

equilibrium price of Rs.20 is reached. Thus the interactions of demand and supply forces

acting upon each other restore the equilibrium position in the market. In the diagram DD

is the demand curve, SS is the supply curve. Demand and supply are in equilibrium at

point E where the two curves intersect each other. OQ is the equilibrium output. OP is the

equilibrium price. Suppose the price OP2 is higher than the equilibrium price OP. at this

point price quantity demanded is P2D2. Thus D2S2 is the excess supply which the seller

wants to push into the market, competition among the sellers will bring down the price to

the equilibrium level where the supply is equal to the demand. At price OP1, the buyers

will demand P1D1 quantity while the sellers are ready to sell P1S1. Demand exceeds

supply. Excess demand for goods pushes up the price; this process will go until

equilibrium is reached where supply becomes equal to demand.

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Q.4 Distinguish between fixed cost and variable cost using an example.

Fixed cost:

These costs are incurred on fixed factors like land, building, equipments, plants,

superior types of labour, top management etc. fixed costs in the short run remains

constant because the firm does not change the size of plant and the amount of the fixed

factors employed. Fixed costs do not vary with either expansion or contraction in output.

These cost are to be incurred by a firm even output is zero. Even if the firm close down its

operation for some time temporarily in the short run, but remains in business, these cost

have to be borne by it.

Hence, these costs are independent of output and are referred to as unavoidable

contractual cost.

Prof. Marshall called fixed cost as supplementary costs. They include such items as

contractual rent payments, interest on capital borrowed, insurance premium, depreciation

and maintenance allowance, administrative expenses like managers salary or salary of

the permanent staff, property and business taxes, license fees, etc. They are called as

overhead costs because these costs are to incurred whether there is production or not.

These costs are to be distributed on each units of output produced by a firm. Hence, they

are called as indirect costs.

Variable Costs:

The costs corresponding to variable factors are described as variable costs. These

costs are incurred on raw materials, ordinary labour, transport, power, fuel, water etc,

which directly vary in the short runs.

Variable costs are directly and proportionately increases or decreases with the level of

output. If a firm shut down for some times in the short run; then it will not use the variable

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factors of production and will not therefore incurs any variable costs. Variable costs are

incurred only when some amount of output is produced. Total variable cost increases with

the level of increase in the level of production and vice-versa. Prof. Marshall called

variable costs as prime costs or direct costs because the volume of output produced by a

firm depends directly upon them.

It is clear from the above description that a production cost consists of both fixed as well

as variable costs. The difference between the two is meaningful and relevant only in the

short run. In the long run all costs become variable because all factors of production

become adjustable and variable in the long run. However, the distinction between the

fixed and variable costs is very important in the short because it influences the average

costs behavior of the firm. In the short run, even if a firm wants to close down its operation

but wants to remain in the business, it will have to incur fixed costs but it must cover at

least its variable costs.

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Q.5 Discuss Marris Growth Maximization model ?

Profit maximization is traditional objective of a firm. Sales maximization objective is

explained by Prof. Boumal. On similar lines, Prof. Marris has developed another

alternative growth maximization model in recent years. It is a common factor to observe

that each firm aims at maximizing its growth rate as this goal would answer many of the

objectives of a firm.

Marris points out that a firm has to maximize its balanced growth rate over a

period of time. Marris assumes that the ownership and control of the firm is in the hands

of two groups of people, i.e. owner and managers. He further points out that both of them

have two distinctive goals. Managers have a utility function in which the amount of salary,

status, position, power, prestige and security of job etc are the most import variable where

as in case of are more concerned about the size of output, volume of profits, market

shares and sales maximization.

Utility function of the manager and that the owner are expressed in the following manner-

Uo= f [size of output, market share, volume of profit, capital, public esteem etc.]

Um= f [salaries, power, status, prestige, job security etc.]

In view of Marris the realization of these two functions would depend on the size of the

firm.

Larger the firm, greater would be the realization of these functions and vice-versa.

Size of the firm according to Marris depends on the amount of corporate capital which

includes total volume of the asset, inventory level, cash reserve etc. He further points out

that the managers always aim at maximizing the rate of growth of the firm rather than

growth in absolute size of the firms. Generally managers like to stay in a grouping firm.

Higher growth rate of the firm satisfy the promotional opportunity of managers and also

the share holders as they get more dividends.

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Q.6 Explain how fiscal policy is used to achieve economic stability

In order to achieve a stable economic condition, fiscal policy has to play a positive

and constructive role both in developed and developing nations. The specific role

to be played by fiscal policy can be discussed as follows:

To act as optimum allocator of resources: As most of the resources are

scarce in their supply, careful planning is needed in its allocation so as to achieve

the set targets. Rational allocation would ensure fulfillment of various objectives.

To act as a saver:

1. It should follow a rational consumption policy reduces the MPC and raises MPS.

2. Taxation policy has to be modified to raise the rates of old taxes, introduces new

additional taxes, and extends the tax-nets.

3. Profit earning capacity of public sector units are to be raise substantially to mop-

up financial resources.

4. The government should borrow more money both in and outside the country.

5. Higher the rate of interest is to be offered for government bonds and security.

To act as an investor: Mere mobilization of financial resources is not an end in

itself. It should result in the creation of real resources which are more important in

accelerating the growth process. Rapid economic growth depends upon the volume

of investment. Hence, fiscal policies have to be ensuring higher volume of investment in

both private and public sectors.

To act as price stabilizer: Price stability is of paramount of importance in an

economy. Extreme levels of both inflation and deflation would disrupt and disturb

the normal and regular working of an economic system. This would come in the

way of stable and persistent growth. Hence all measures are to be taken to check

these two dangerous situations so as to create necessary congenial atmosphere to

prepare the background for rapid economic growth.

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To act as an economic stabilizer: Price stability would create the necessary

background for over all economics stability. Upswing and downswing in the level of

economic activities are to be avoided. If an economy is subject to frequent fluctuation in

the form of trade cycle, certainly, it would undermine and disturb the growth process.

Instability would come in the way of persistent and consistent growth in a country. Hence

all measure to be taken to ensure economic stability. To act as an employment generator:

Fiscal policy should help in mobilizing more financial resources, convert them in to

investment and create employment opportunity to absorb huge unemployed man power.

To act as balancer: There must be proper balance between aggregate saving &

aggregate investment, demand and supply, income and output and expenditure,

economic overhead capital and social overhead capital etc. Any sort of imbalance would

result in either surpluses or scarcity in different sectors of the economy leading to fast

growth in some sectors followed by lagging of some other sectors.

To act as growth promoter: The basic objective of any economic policy is to ensure

higher economic growth rates. This is possible when there is higher national savings,

investment, production, employment and income. Hence, fiscal policy is to be designed in

such a manner so as to promote higher growth in an economy.

To act as in come redistribute: Fiscal policy has to minimize inequalities and ensure

distributive justice in an economy. This is possible when a rational taxation and public

expenditure policy is adopted. More money is collected from richer section of the society

through various imaginative taxation policies and a larger amount of money is to be spent

in favor of poorer sections of the society. Thus, inequality is reduced to the minimum.

Thus, fiscal policy has to play a major role in promoting economic growth in a country.

To act as stimulator of living standards of people: the final objective is to raise the

level of living standards of the people. This is possible when there is higher output,

income and employment leading to higher purchasing power in the hands of common

man. Hence, fiscal policy should help in creating more wealth in the economy. If there is

economic prosperity, then it is possible to have a satisfactory, contended and peaceful

life.

mb0042(set 1&2)

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