5. Managerial Economics Ass-1

7/30/2019 5. Managerial Economics Ass-1

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Spring / February 2012

Master of Business Administration MBA Semester 1

MB0042 Managerial Economics 4 Credits

(Book ID: B1131)

AssignmentSet 1 (60 Marks)

Q1). Define Managerial Economics and explain its maincharacteristics.

Answer:Managerial Economics

Managerial economics is a science that deals with the application of variouseconomic theories, principles, concepts and techniques to businessmanagement in order to solve business and management problems. It deals

with the practical application of economic theory and methodology todecision-making problems faced by private, public and non-profit makingorganizations.

The same idea has been expressed by Spencer and Seigelman in thefollowing words. Managerial Economics is the integration of economic theorywith business practice for the purpose of facilitating decision making andforward planning by the management. According to Mc Nair and Meriam,Managerial economics is the use of economic modes of thought to analyzebusiness situation. Brighman and Pappas define managerial economics as,the application of economic theory and methodology to businessadministration practice. Joel dean is of the opinion that use of economicanalysis in formulating business and management policies is known asmanagerial economics.

Features of managerial Economics

1. It is more realistic, pragmatic and highlights on practical application ofvarious economic theories to solve business and management problems.

2. It is a science of decision-making. It concentrates on decision-makingprocess, decision-models and decision variables and their relationships.

3. It is both conceptual and metrical and it helps the decision-maker byproviding measurement of various economic variables and theirinterrelationships.

4. It uses various macro economic concepts like national income, inflation,deflation, trade cycles etc to understand and adjust its policies to theenvironment in which the firm operates.

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5. It also gives importance to the study of non-economic variables havingimplications of economic performance of the firm. For example, impact oftechnology, environmental forces, socio-political and cultural factors etc.

6. It uses the services of many other sister sciences like mathematics,statistics, engineering, accounting, operation research and psychology etc to

find solutions to business and management problems.

It should be clearly remembered that Managerial Economics does not provideready-made solutions to all kinds of problems faced by a firm. It provides onlythe logic and methodology to find out answers and not the answersthemselves. It all depends on the managers ability, experience, expertiseand intelligence to use different tools of economic analysis to find out thecorrect answers to business problems.

Q2). State and explain the law of demand.

Answer:

The term of demand is different from desire, want, will or wish. In thelanguage of economics, demand has different meaning. Any want ordesire will not constitute demand. The term demand refers to total orgiven quantity of a commodity or a service that are purchased by theconsumer in the market at a particular price and at a particular time.The Law of Demand:

It explains the relationship between price and quantity demanded of acommodity. It says that demand varies inversely with the price. The lawcan be explained in the following manner: Keeping other factors that

affect demand constant, a fall in price of a product leads to increase inquantity demanded and a rise in price leads to decrease in quantitydemanded for the product. The law can be expressed in mathematicalterms as Demand is a decreasing function of price. Symbolically, thusD = F (p) where, D represents Demand, P stands for Price and F denotesthe Functional relationship. The law explains the cause and effectrelationship between the independent variable [price] and thedependent variable [demand]. The law explains only the generaltendency of consumers while buying a product. A consumer would buymore when price falls due to the following reasons:A product becomes cheaper.[Price effect]

Purchasing power of a consumer would go up.[Income effect]

Consumers can save some amount of money.

Cheaper products are substituted for costly products [substitutioneffect].Important Features of Law of Demand:

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There is an inverse relationship between price and quantity demanded.

Price is an independent variable and demand is a dependent variable

It is only a qualitative statement and as such it does not indicatequantitative changes in price and demand.

Generally, the demand curve slopes downwards from left to right.

The operation of the law is conditioned by the phrase Other thingsbeing equal. It indicates that given certain conditions, certain resultswould follow. The inverse relationship between price and demand wouldbe valid only when tastes and preferences, customs and habits ofconsumers, prices of related goods, and income of consumers wouldremain constant.Exceptions to the Law of Demand:

Generally speaking, customers would buy more when price falls inaccordance with the law of demand. Exceptions to law of demand states

that with a fall in price, demand also falls and with a rise in pricedemand also rises. This can be represented by rising demand curve. Inother words, the demand curve slopes upwards from left to right. It isknown as an exceptional demand curve or unusual demand curve.

Q3). What is Demand Forecasting? Explain in brief various methods offorecasting demand.

Answer:

Demand forecasting seeks to investigate and measure the forces that determine

sales for existing and new products. Generally companies plan their business production or sales in anticipation of future demand. Hence forecasting futuredemand becomes important. The art of successful business lies in avoiding orminimizing the risks involved as far as possible and face the uncertainties in a mostbefitting manner.Methods of Forecasting:

Demand forecasting is a highly complicated process as it deals with the estimationof future demand. It requires the assistance and opinion of experts in the field ofsales management. Demand forecasting, to become more realistic should considerthe two aspects in a balanced manner. Application of commonsense is needed tofollow a pragmatic approach in demand forecasting.

Broadly speaking, there are two methods of demand forecasting.They are:

1) Survey methods and

2) Statistical methods

Figure: Methods of Demand Forecasting Figure: Methods of Demand Forecasting

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1) Survey Methods:

Survey methods help us in obtaining information about the future purchase plansof potential buyers through collecting the opinions of experts or by interviewing theconsumers. These methods are extensively used in short run and estimating thedemand for new products. There are different approaches under survey methods.

They are1. Consumers interview method:

Under this method, efforts are made to collect the relevant information directlyfrom the consumers with regard to their future purchase plans. In order to gatherinformation from consumers, a number of alternative techniques are developed

from time to time. Among them, the following are some of the important ones.a) Survey of buyers intentions or preferences:

Under this method, consumer-buyers are requested to indicate their preferencesand willingness about particular products. They are asked to reveal their futurepurchase plans with respect to specific items.

b) Direct Interview Method:

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Under this method, customers are directly contacted and interviewed. Direct andsimple questions are asked to them.

i. Complete enumeration method:

Under this method, all potential customers are interviewed in a particular city or aregion.

ii. Sample survey method or the consumer panel method:Under this method, different cross sections of customers that make up the bulk ofthe market are carefully chosen. Only such consumers selected from the relevantmarket through some sampling method are interviewed or surveyed.

2. Collective opinion method or opinion survey method:

Under this method, sales representatives, professional experts and the marketconsultants and others are asked to express their considered opinions about thevolume of sales expected in the future.

3. Delphi Method or Experts Opinion Method:

Under this method, outside experts are appointed. They are supplied with all kindsof information and statistical data. The management requests the experts to

express their considered opinions and views about the expected future sales of thecompany.4. End Use or Input Output Method:

Under this method, the sale of the product under consideration is projected on thebasis of demand surveys of the industries using the given product as anintermediate product.

2) Statistical Method:

It is the second most popular method of demand forecasting. It is the best availabletechnique and most commonly used method in recent years. Under this method,statistical, mathematical models, equations etc are extensively used in order toestimate future demand of a particular product. They are used for estimating longterm demand. They are highly complex and complicated in nature. Some of themrequire considerable mathematical background and competence.

1. Trend Projection Method:

An old firm operating in the market for a long period will have the accumulatedprevious data on either production or sales pertaining to different years. If wearrange them in chronological order, we get what is called time series. It is anordered sequence of events over a period of time pertaining to certain variables. Itshows a series of values of a dependent variable say, sales as it changes from onepoint of time to another. In short, a time series is a set of observations taken atspecified time, generally at equal intervals. It depicts the historical pattern undernormal conditions. This method is not based on any particular theory as to whatcauses the variables to change but merely assumes that whatever forcescontributed to change in the recent past will continue to have the same effect. Onthe basis of time series, it is possible to project the future sales of a company.

2. Economic Indicators:

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Under this method, a few economic indicators become the basis for forecasting thesales of a company. An economic indicator indicates change in the magnitude of aneconomic variable. It gives the signal about the direction of change in an economicvariable. This helps in decision making process of a company.

Q4). Define the term equilibrium. Explain the changes in marketequilibrium and effects of shifts in supply and demand.

Answer:

Meaning of equilibrium

The word equilibrium is derived from the Latin word aequilibrium which meansequal balance. It means a state of even balance in which opposing forces ortendencies 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 plansof the various market participants so that no one has a tendency to revise oralter his decision. In the words of professor Mehta: Equilibrium denotes ineconomics absence of change in movement.

Changes in Market Equilibrium:

The changes in equilibrium price will occur when there will be shift either indemand curve or in supply curve or both:

Effects of Shift in demand:

Demand changes when there is a change in the determinants of demand like theincome, tastes, prices of substitutes and complements, size of the populationetc. If demand raises due to a change in any one of these conditions the demandcurve shifts upward to the right. If, on the other hand, demand falls, the demandcurve shifts downward to the left. Such rise and fall in demand are referred to asincrease and decrease in demand.

A change in the market equilibrium caused by the shifts in demand can beexplained with the help of a diagram.

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demand-&-supply-diagram1

Effects of Changes in Demand and Supply:

Changes can occur in both demand and supply conditions. The effects of suchchanges on the market equilibrium depend on the rate of change in the twovariables. If the rate of change in demand is matched with the rate of change insupply there will be no change in the market equilibrium, the new equilibriumshows expanded market with increased quantity of both supply and demand atthe same price.

This is made clear from the diagram below:


Similar will be the effects when the decrease in demand is greater than thedecrease in supply on the market equilibrium.

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Q5). Explain features of LAC curve with a diagram.

Answer:

Features of long run AC curves:

1. Tangent curve:

Different SAC curves represent different operational capacities of different plants in theshort run. LAC curve is locus of all these points of tangency. The SAC curve can never cLAC curve though they are tangential to each other. This implies that for any given leveoutput, no SAC curve can ever be below the LAC curve. Hence, SAC cannot be lower th

the LAC in the long run. Thus, LAC curve is tangential to various SAC curves.

2. Envelope curve:

It is known as Envelope curve because it envelopes a group of SAC curves appropriate different levels of output.

3. Flatter U-shaped or dish-shaped curve:

The LAC curve is also U shaped or dish shaped cost curve. But It is less pronounced andmuch flatter in nature. LAC gradually falls and rises due to economies and diseconomiescale.4. Planning curve:

The LAC cure is described as the Planning Curve of the firm because it represents the l

cost of producing each possible level of output. This helps in producing optimum level ooutput at the minimum LAC. This is possible when the entrepreneur is selecting theoptimum scale plant. Optimum scale plant is that size where the minimum point of SACtangent to the minimum point of LAC.

5. Minimum point of LAC curve should be always lower than the minimum point of SACcurve:

This is because LAC can never be higher than SAC or SAC can never be lower than LACLAC curve will touch the optimum plant SAC curve at its minimum point.

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Q6). Explain cost output relationship with reference to

a. Total fixed cost and output

b. Total variable cost and output

c. .Total cost and output

Answer:

A. Total fixed cost and output:

TFC refers to total money expenses incurred on fixed inputs like plant, machinery,tools & equipments in the short run. Total fixed cost corresponds to the fixedinputs in the short run production function. TFC remains the same at all levels ofoutput in the short run. It is the same when output is nil. It indicates thatwhatever may be the quantity of output, whether 1 to 6 units, TFC remainsconstant. The TFC curve is horizontal and parallel to OX-axis, showing that it isconstant regardless of output per unit of time. TFC starts from a point on Y-axisindicating that the total fixed cost will be incurred even if the output is zero. Inour example, Rs 360=00 is TFC. It is obtained by summing up the product orquantities of the fixed factors multiplied by their respective unit price.

total-fixed-cost

B. Total variable cost and output:

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TVC refers to total money expenses incurred on the variable factor inputs like rawmaterials, power, fuel, water, transport and communication etc, in the short run.

Total variable cost corresponds to variable inputs in the short run productionfunction. It is obtained by summing up the production of quantities of variableinputs multiplied by their prices. The formula to calculate TVC is as follows. TVC =

TC-TFC. TVC = f (Q) i.e. TVC is an increasing function of output. In other wordsTVC varies with output. It is nil, if there is no production. Thus, it is a direct cost ofoutput. TVC rises sharply in the beginning, gradually in the middle and sharply atthe end in accordance with the law of variable proportion. The law of variableproportion explains that in the beginning to obtain a given quantity of output,relative variation in variable factors-needed are in less proportion, but after apoint when the diminishing returns operate, variable factors are to be employedin a larger proportion to increase the same level of output.

TVC curve slope upwards from left to right. TVC curve rises as output is

expanded. When output is Zero, TVC also will be zero. Hence, the TVC curvestarts from the origin.

total-variable-cost

C. Total cost and output:

The total cost refers to the aggregate money expenditure incurred by a firm toproduce a given quantity of output. The total cost is measured in relation to the

production function by multiplying the factor prices with their quantities. TC = f(Q) which means that the T.C. varies with the output. Theoretically speaking TCincludes all kinds of money costs, both explicit and implicit cost. Normal profit isincluded in the total cost as it is an implicit cost. It includes fixed as well asvariable costs. Hence, TC = TFC +TVC.

TC varies in the same proportion as TVC. In other words, a variation in TC is theresult of variation in TVC since TFC is always constant in the short run.

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total-cost

The total cost curve is rising upwards from left to right. In our example the TCcurve starts from Rs. 360-00 because even if there is no output, TFC is a positiveamount. TC and TVC have same shape because an increase in output increasesthem both by the same amount since TFC is constant. TC curve is derived byadding up vertically the TVC and TFC curves. The vertical distance between TVCcurve and TC curve is equal to TFC and is constant throughout because TFC isconstant.

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5. Managerial Economics Ass-1

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