Economics

Q1. Managerial economics refers to the integration of economic theory with business practice. It deals with application of economic principle to the problems of business firms it modifies or reformulates already existing economic models to suit the specific conditions and serve the specific problem of the business firms .it helps to solve real complex business problems using other related branches.

Definition: According to Prof. Joel Dean The purpose of Managerial Economics is to show how economic analysis can be used in formulating business policies

Nature of Managerial Economics :

It aims in providing help in making decisions by the firms as it draws heavily on the propositions of macro economics

It assists the firm in forecasting as macro economics studies the economy at the aggregate level .It also helps to identify the level of demand at some future point based on the relationship between level of national income & demand for a particular product

It helps on those propositions which are likely to be useful to the management, as decision has to be made without delay. Besides more accurate forecast may not justified on cost considerations

Managerial economics prescriptive in nature and character. It recommends that which should be done on alternative conditions. E.g. if the distribution of income has become more uneven it is stated without indicating what should be done to correct this phenomenon.

Managerial economics to an extent is an applied science e.g. empirical study may suggest that for every one percent raise in expenditure on advertising the demand for the product shall increase by 0.5% .

Scope of Managerial Economics

Demand analysis and forecasting : Demand forecasting is the process of finding the values for demand in future time period. The current values are needed to make optimal current pricing and promotional policies, while future values are necessary for planning future production inventories, new product development etc. Correct estimates of demand is essential for decision making , strengthening market position and enlarging profits. Regression analysis is one of the most common methods of estimating an economic variables which are explanatory variables with the view to estimate and credit the average value of dependent variable.

Cost and Production Analysis: Production deals with the physical aspects of the business investment. It is the process whereby inputs are transformed into outputs. Efficiency of production depends on ratio in which various inputs are employed absolute level of each input and productivity of each input. A production function is the relation which gives us the technically efficient way of producing the output given the inputs. Actually cost is the monetary side of production . Given the production function, one can go for cost estimation and forecasting. While the former refers to the present period cost levels, cost forecasting refers to the levels of cost in a future period. The firm must undertake cost estimation and forecasting to judge the optimality of present output levels and assess the optimal level of production in future.

Inventory Management: It refers to stock of raw materials which a firm keeps. If it is high, capital is unproductively tide up which might, if stock of inventory is reduced, be used for other productive purpose . On the other hand, if the level of inventory is low, production will be hampered. Hence, managerial economics with methods such as ABC analysis a simple simulation exercise and some mathematical models with a view to minimize inventory cost. It also helps in aspects of inventory control and cost of carrying them.

Advertising: Managerial economics helps in determining the total advertising cost and budget, the measuring of economic effects of advertising and form an integral part of decision making and forward planning.

Market Structure and Pricing Policies: Managerial economics helps to clear surplus and excess demand to bring market equilibrium as there is continuos changes in market. Success of business firm depends on correctness of price decisions. Price theory works according to the nature of the market depending on the number of sellers, demand conditions etc.

Resource Allocation: Managerial economics with the help of advanced tools such as linear programming are used to arrive at the best course of action for the maximum use of the available resources and its substitutes.

Capital Budgeting: Capital is scarce and it costs something . Hence, managerial economics helps in decision making and forward planning on allocation of capital to various factors of productions , marketing and management.

Investment Analysis: It involves planning and control capital expenditure. Whether or not to invest funds in purchase of assets or other resources in an attempt to make profit and how to choose among completing uses of funds. Managerial economics help in analysis and decision making on the investment of funds.

Risk and Uncertainty Analysis: As business firm have to operate under conditions of risk and uncertainty both decision making and forward planning becomes difficult. Hence managerial economics helps the business firm in decision making and formulating plans on the basis of past data, current information and future prediction.

Q2.Law of demand is one of the important laws of economic theory .It explains the general tendency of the consumers to buy more of a good at a lower price and less of it at a higher price lower price attracts consumers to buy more goods .thus law of demand expresses an inverse relationship b/w the price and the quantity demanded of a commodity other things being equal.According to Lipsey A fall in the price of a commodity cause a household to buy more of that commodity and less of the other commodity which compete with it, while rise in price causes the household to buy less of this commodity & more of the competing commodities

The law of demand indicates only the direction of change of demand corresponding the change in the price. This can be illustrated through a demand curve. Price is measured in theY axis&quantity in the X axis.DD is the demand curve of the good under consideration.At price OP1the quantiy demanded is OQ1 if price of the good falls into OP2 the quantity demanded rises to OQ2 the demand curve is sloping downwards which is in accordance to the law of demand all the determinants of demand are assumed to be constant

Y

P M

P

R

I P1 M1

C

E

O QQ1

X

Quantity

Law of demand states the inverse relationship between price of a commodity and quantity demanded, other things remaining the same. The demand of a commodity is more at a lower price and less at a higher price. That is why the demand curve slopes downward. The factors responsible for the downward slope of demand curve are :

Law of diminishing marginal utility: The law of diminishing marginal utility states that as the consumption of a commodity by a consumer increases the satisfaction obtained by the consumer from each additional unit of the commodity goes on diminishing.

Income effect: A fall in the price of the commodity increase the purchasing power of the consumer, in otherwords the consumer has to spend less to buy the same quantity of the commodity as before. The money so saved because of a fall in the price of the commodity can be spent by the consumer in ways he likes. He will spend a part of this money on buying some more units of the same commodity whose price has fallen. Thus a fall in the price of this commodity increases its demand. This is called income effect.

Substitution effect: This also increases demand as a result of a fall in the price of the commodity and viceversa. When the price of a commodity falls it becomes relatively cheaper than other commodity whose prices have not fallen. So the consumer substitute this commodity for other commodities which are now relatively dearer. This is know as substitution or complementarily effect.

Changes in the number of consumers: Many people cannot afford to buy a commodity at a high price. When price of a commodity falls, the number of persons who could not afforded at a higher price can purchase it at a reduced price. This increases the consumer of the commodity. Thus at a lower price the quantity demand of the commodity increases because of increase in the number of consumers of the commodity and vice versa.

Diverse Uses of the commodity: Many commodities can be put to several uses. The commodity having several uses is set to have composite demand.

All the above factors are responsible for the downward slope of demand curve. These factors explain the operations of the Law of Demand. The important of these factors depends upon the circumstances of the case.

Exceptions to the Law of Demand:

Under certain circumstances the inverse relationship between price and demand does not hold good. These are know as the exceptions to the law of demand. Some of the important exceptions are :

(a)Giffen Goods: These are special type of inferior goods. A rise in the price of giffen goods leads to a rise in their demand and viceversa. E.g. A poor household who spends a major portion of his money on an inferior goods like coarse grain, say bajra. If the price of bajra goes up the household will be forced to maintain the earlier consumption level of consumption of this good, he will be left with lesser income to spend on other commodities that he used to consume earlier. The household will be forced to cut down the consumption of other commodities still further to compensate itself for the loss of consumption of bajra. Conversely, a fall in price of bajra will enable the household to release more money for other commodities and may substitute consumption of bajra by consumption of other superior commodities. The bajra will be considered as gifen goods to which law demand does not apply.

(b)Conspicuous necessities: Another exception occur in case of such commodities as though their constant use is because of fashion or prestige value attached to them have become necessity of life. Eventhough their price rises continuously their demand does show any tendency to fall.

Conspicuous consumption: A few goods like diamond etc. purchased by rich persons of the society because the prices of those goods are so high that they are beyond the reach of the common man. More of these commodities is demanded when their prices go up very high. The law of demand does not apply.

(d)Future changes in price: Household also act as speculators when the price are rising, the house hold tend to buy larger quantity of the commodity out of apprehension that the prices may go up further. Likewise when prices are expected to fall further a reduced price may not be sufficient incentive to induce the household to buy more. E.g. share market.

(e)Emergencies: Emergencies like war, famine, flood etc. may negate the operations of lay of demand. At such time the household may behave in a abnormal way. Household accentuate scarcity and induce further price rises by making increase purchases even at higher prices during such period. During depression, on the other hand, no amount of falling price is sufficient inducement for consumer to demand more.

(f)Change in fashion: A change fashion entails effect demand for a commodity.

(g)Ignorance: Consumers ignorance is another factor that at times induces him to buy more of commodity at a higher price. This happens when the consumer thinks that a high price commodity is better in quality than low price commodity.

Q3. Demand forecasting is an attempt to foresee the future by examining the past .Business firms can estimate and minimize the future risk & uncertainty through forecasting &forward planning .It is an essential tool in developing new products scheduling production determining necessary inventory levels&creating a distribution system . Its essence is estimating future events acc to the past patterns and applying judgement to those projections .Virtually all types of national & intl organisations Govt ,social &business engage in some type of demand forecasting the goal of course is better mgt ability to plan &control operations churches try to predict future revenues from members contributions to develop reasonable budgets. School administrators use

Enrolment forecasts to determine faculty sizes, supplies &classroom requirements .Demand forecasting is a crucial activity for planning survival &growth of a corporate unit. Demand forecasts may be passive or active the former predict the future demand by extrapolating the demands of the previous years in the absence of any action by the firm Here the things are assumed to continue the way they have been in the past these forecasts are used only to assess the impact of new policies on the market while the latter estimate the future scenario inclusive of own future actions &strategies of the firm itself

These forecasts are more meaningful as they take into account the likely changes in the relevant variable in estimating future demand here the firm manipulates the demand by changing price,product quality etc.Demand forecasts methods vary acc to whether they apply to a large aggregate such as the whole economy(macro forecasts)or to a component of this aggregate such as an industry or a co. (micro forecasts) a frequent practice is to translate forecasts of overall levels into industry forecasts by trade associations &to use this in turn to generate co. forecasts.However small firms cannot afford these sophisticated techniques .

Methods of demand forecasting : The imp. Of selecting the right type of forecasting method cannot be overstated however the choice is complicated bcoz each situation might require a different method mgt. should be aware of the factors favoring one method over another in a given demand forecasting situation in some cases mgrs are interested in the total demand for a product service in other circumstances the projection may focus on the firms probable mkt share forecasts can also provide inft. on the product mix major decisions in large business houses are generally based on forecasts on some type in some cases the forecasts may be little more than an intuitive assessment or value judgement of the future by those involved in the decision .Thus no forecasting method is suitable for all situations.Selection of a forecasts has to be appropriate to the situation that is objective, urgency data availability ,nature of the product etc. The firm can afford acurracy level required.

Forecasting Methods

Survey Methods Statistical Methods

Consumer Collective Market experiment

S.M opinion method method

Time series Analysis Regression analysis

Graphical Semi-average Moving average Least

square

Survey methods : Under this approach are conducted about the intentions of the consumers (individuals, firms or industries) opinion of experts or of mkt .Under census survey, all consumers\ experts mkts are surveyed.While in sample survey a selected subset of them are surveyed and through their study, inferences abt the whole popln. are drawn .These methods are usually suitable for short-term forecast due to volatile nature of consumers intentions.New products demand forecasting also makes use of survey approach,as data availability problem is overcome through surveys of consumers.

Consumer Survey Method: Surveys of managerial plans can be one of the impt. Methods of forecasting .The rationale for conducting such surveys is that plans generally form the basis for future actions by using this method, a firm can ask consumers what &

How much they are planing to buy it at various prices of the product for the forthcoming time period, usually a year. If the product happens to be a consumer good the consumers are firms or industries using that product the survey may involve a complete enumeration of all consumers of the given product, whose demand is to be forecasted.

Collective Opinion Method: Under this method(also called sales- force polling), salesman or experts are required to estimate expected future demand of the product in their respective territories &sections the rationale of this method is that salesman, being the closest to the customers, are likely to have the most intimate feel of the market i.e customer reaction to the product of the firm &their sales trends the estimates of individual salesman are averaged or consolidated to find out the total estimated sales the final sales forecast would emerge after these factors are being taken into account.This method is known as the collective opinion method, as it takes advantage of the collective wisdom of the salesmen,departmental heads like prod.mgr sales.mgr etc&the top executives.

Market Experiments Method: Under this method, the main determinants of the demand of a product like prices, advt, product design, packaging,etc are identified. These factors are then varied separately over different markets or time periods holding other factors constant. The effect of the experiment on consumer behaviour is studied under actual or controlled mkt conditions which is used for overall forecasting purpose.

Statistical methods:

These methods make use of historical data as a basis for extrapolating quantitative relationships to arrive at the future demand pattern and trends. The data a may also be analyzed through econometric models. These are used for long term forecasting and for products for larger levels of aggregation. They are based on scientific base of estimation which are logical, unbiased and proven to be useful.

Time series analysis: It is an arrangement of statistical data in a chronological order, i.e. in accordance with its time of occurrence. It reflects the dynamic pace of steady movement of a phenomenon over a period of time. Most of the variables in business, economic and commerce be it a series related to price, production, consumption, projects,sales, etc. at all time series data spread over long period of time.

Graphical Methods: This method gives the basic tendency of a series to grow, decline or remain steady over a period of time. This method is useful in forecasting population, demand etc.where the future is not too much different from average of the past. Theperiod time in the trend analysis is always long; but the concept of trend does not include short time oscillations and fluctuations.

Semi Average Method: According to this method the date is divided into two parts preferably with the same number of years. The averages of the first and second part are calculated separately. These averages are called semi averages which are plotted as points against middle point of the respective time period covered by each part.

Moving Averages Method: This is a very simple and flexible method of measuring trend which consists of obtaining a series of moving averages of successes overlapping groups of the time series. The averaging process smoothens out fluctuation as well as the ups and down in the given data.

Least square method:The principle of least squares provides us an analytical tool to obtain an objective fit to the trend of the given time series. Most of the data relating to economic and business time series conform to definite laws of growth or decay. Thus, in such situation, trend fittings will be most reliable way of forecasting.

Regression Analysis:This is also a popular method of forecasting among the economists. It is a mathematical analysis of the average relation between two or more variables in terms of original units of the data. Here the data analysis should be based on logic of economic theory.

Demand Forecasting of New Products:Projecting demand of new products is different from those of established products. This requires an intensive study of the economic and competitive characteristics of the product.

Product Life Cycle Analysis:Many products ar distinct when it degenerates over the years into a common product. Innovation of a new product and its degeneration into a common product is termed as Life Cycle of a Product. The forecaster must identify the phase of product cycle at which the industry is operating at the time of prediction.

Test Markting:Under test marketing the product is introduced in selected area often at different prices. Th number of area selected depends on the representatives and cost of marketing. The selected area must have an average competition, presence of chain of departmental stores, optimum size of population, etc. The duration of testing depends upon the average purchase period, the competitive situation and cost of testing.

Survey of Consumer Intention: This method involves interviewing the consumer by sending questionnaires to elicit replies so as to make short term prediction of demand. Samples may be given for this purpose. This method is most useful when bulk of the sales is made to industrial producers. Here the burden of forecasting is shifted to consumer.

Evolutionary Approach: The demand for a new product may be projected as an outgrowth and evolution of an existing old product. This approach is useful when the new product is nearly an improvement of an existing product.

Growth Curve Approach: Roll of growth and demand for new product may be estimated on the basis of pattern of growth of some existing substitute established product.

Q4. Pure monopoly or simple monopoly is a market structure in which there is a single seller of a good with no close substitutes. Being the sole supplier of the commodity, the monopolist has complete control over the supply of and can independently supply& can independently determine equilibrium price &output eg.railways, electricity etc.There may be different reasons for the emergence of monopoly few of the causes for the emergence of monopoly are:

Natural causes: A firm may enjoy monopoly bcoz of its control over a crucial raw material or mineral eg petrol uranium etc.

Legal factor: A firm can legally procure monopoly power eg patent copy right etc

Cost factor: A firm may produce at such low cost at which no other firm can produce a commodity

Market factors: Sometimes the size of market is so small that it cannot accommodate more than one firm.

Heavy investment: Certain industries like iron &steel locomotives etc need heavy investment which only a particular firm can afford to arrange

Protection of public rights: Motivated by public welfare&public interest the Govt. itself can assume monopoly power eg.railways post&telegraph etc

Equilibrium of the monopoly Firm

Equilibrium of a monopoly firm is to maximize its profits or minimise losses. Equilibrium of a monopoly firm is attained at that level of output at which it maximizes its profits & minimises losses there are 2 approaches to study equilibrium of a monopoly firm, these are (a) total revenue total cost approach,&(b) marginal revenue marginal cost approach

(a)Total revenue total cost approach: Acc to this approach a monopoly firm attains equilibrium when the difference between its total revenue &total cost is the maximum at the equillibrium point, monopolist get the maximum profit & suffer the minimum loss.

(b)Marginal revenue marginal cost approach: According to the marginal revenue marginal cost approach, equilibrium of monopoly firm is obtained at that level of output at which its marginal cost equals marginal revenue.

Monopoly price during short-run

During short run monopolist cannot expand or contract the size of this plant nor can he change the structure of the fixed costs. In order to be in equilibrium of monopoly from would like to product that level of output at which it is marginal revenue is equal to marginal cost . In the short run the monopoly firm may get abnormal profit and may suffer loss.

Monopoly price during long run: The long rum equilibrium of the monopoly firm is attained at that level of output where its marginal cost equals the marginal lrevenue. Monopoly in the long run gets abnormal profit. It is Los because the new firms are not allowed to enter the market. Monopoly does not suffer loss in the long run because all the costs in the long run are variable and these must be recovered. In case a monopoly firm fails to recover the variable in the long run, it would better stop production and quit the market.

Q.5 Opportunity Cost: Opportunity cost is to cost which is not actually incurred, but would have been incurred in the absence of employment of self owned factors.As expenditure is not currently incurred this cost is often incurred &not recorded in the books of accounts .Opportunity cost occupies a very important place in modern economic analysis .Opportunity cost of any input is the next best alternative use that is sacrificed by its present use it is measured by the value of factors of prod used in producing a good, when put to the next best alternative use O.C reflects the benefits we give up to select the most preferred choice eg if a farmer decides to grow wheat instead of rice, the O.C of the wheat would be the rice, which he might have grown rather .thus ,O.C is the cost of foregone alternative. If he produce more of one thing, resources have to be withdrawn from other uses as these are scrace.Implicit cost incurred by a firm is actually the O.C of the factor owned by him by employing the factor in the firm, the producer loses the opportunity of earning the factor income had it been employed elsewhere. Thus the O.C of a factor input is nothing but a potential return from the next best alternative use of that factor . O.C is also the minimum price necessary to retain a factor in the current employment .O.C of a good is not simply any other alternative good that could be produced with the same factors it is only the most valuable good, which the same factor or nearly the same value of factors could produce. The concept of O.C has some limitations it is only applicable to those factors which have alternative uses thus, if no sacrifice is involved then O.C is 0,Eventhough the actual cost or the acquisition cost or the historical cost was substantial.

Production function : It denotes an efficient combination of inputs & output it shows for a given technological knowledge & managerial ability, the maximum amount of a good that can be obtained from different combinations of productive factors per unit of time or minimum quantities of various inputs required to yield a given quantity of output thus, prod function is a catalogue of output possibilities prices of factors or of the product do not enter into the pro function.The pro fuction of a firm shows the technical methods available to produce a given output of a commodity by combining the factors of production in various possible ways. A rational producer always uses technically most efficient method of prod a method of prod is said to be technically more efficient than other methods, if it uses less of atleast one factor& no more of other factor inputs to produce one unit of the commodity.The production function expresses the way out put is produced by inputs & the way inputs co-operate with each other in varying proportions to produce any given output these relations between inputs&outputs &inputs themselves are determined by technology that rules at any given time the technology is embedded in the production function, which acts as a constraint on decision making thus production function depicts the present limits of the firm.A firm can produce higher output only by using more inputs or with advanced technology at the same time, production function indicates the manner in which a firm can substitute one input or output for the other without altering their total amounts respectively prod function differs from firm to firm, industry to industry any change in the state of technology or managerial ability disturbs the original prod function .Production function can be represented in various forms it can be represented by schedules, tables, graphs total, average etc

Differences between Perfect competition and Monopoly

Number of sellers: Under perfect competition there are alarge no. of sellers each selling in a small quantity of total supply it consists of large no. of firms. Monopoly consists of of a single seller the total supply of the product is in the hands of a single seller.

Nature of the product: The product offered by the firm in perfect competition is homogenous while in monopoly it not homogenous i.e it does not have any substitutes

Entry & exit conditions: Entry as well as exit in case of perfect competition is said to be free but in case of monopoly entry is assumed to be blocked .

Decision Variables:The decision variables variable of the firm is the determination of of its output but a monopoly has to determine eithervits output or price.

Equilibrium: A perfectly competitive firm equilibrium is possible only when the MC curve is rising at the point of equilibrium but monopoly equilibrium can be very well established whether MC curve is rising falling or remaining constant at the equilibrium curve.

Capacity Utilisation:Perfectly competitive firm is a long run equilibrium at the minimum point of the long average cost curve.There are neither unexhausted economies of scale or diseconomies of large scale production. In case of monopoly the firm may not necessarily produce at minimum point of of the long run avg cost.

Supply curve: As perfectly competitve firm produces where MR=Price=Rising MC the firms short run supply curve is given by the rising portion of its MC curve over &above its avg variable cost.A monopolist however has no unique supply curve Its maximises its profits by producing an output at which it isMR=MC

Price output Comparision:Price charged under P.C is invariably low than the one under monopoly assuming same demand & cost conditions

Change in demand: In P.C an increase in the in mkt demand will push the price& output but it is not the same in case of monopoly

Change in Variable cost :Increase in variable costs shifts the marginal cost upward reduces the output & increases the price in both the mkt structures.

Differences between perfect competition & pure competition

Pure competition is unalloyed by monopoly elements .It is much simpler & less exclusive concept than perfect competition for latter may be interpreted to involve perfect in many other aspects than in the case of absence of monopoly .Pure competition involves purity only in one respect i.e absence of control over the price.It is said to exist in an industry where there are a large no. of sellers & buyers producing homogenous product. It may be found in real life situations.

Perfect competition is a broader term & involves absence of monopoly as well as presence of other perfections like perfect mobility of the factors of production , absence of transportation & selling costs etc

Q4.Define Business Cycle. Explain various phases of business cycle.

Ans.The term trade cycle or Business Cycle in economics refers to the wave-like fluctuations in the aggregate economic activity, particularly in employment, output and income. Mitchell defined trade cycle as a fluctuation in aggregate economic activity. According to Haberler, The business cycle in the general sense may be defined as an alternation of periods of prosperity and dispersion, of good and bad trade. Keynes points out A trade cycle is composed of periods of good trade characterized by rising prices and low unemployment percentages, altering with periods of bad trade characterized by falling prices and high unemployment percentages.

Phases of Business Cycle

The ups and downs in the economy are reflected by the fluctuation in aggregate economic magnitudes, such as, production, investment, employment, prices, wages, bank credits, etc. The upward and downward movement in these magnitudes shows different phases of business cycle. Basically there are only two phases in a cycle, viz., prosperity and depression. But considering the intermediate stages between prosperity and depression, the various phases of trade cycle may be enumerated as follows:

Expansion

Peak

Recession

Trough

Recovery and expansion

The five phases of a business cycle have been presented in the figure. The steady growth line shows the growth of the economy when there are no economic fluctuations. The various phases of business cycles are shown by the line of cycle which moves up and down the steady growth line. The line of cycle moving above the steady growth line marks the beginning of the period of expansion or prosperity in the economy. The phase of expansion is characterized by increase in output, employment, investment, aggregate demand, sales, profits, bank credits, wholesale and retail prices, per capital output and a rise in standard of living. The growth rate eventually slows down and reaches the peak. The phase of peak is generally characterized by slacking in the expansion rate, the highest level of prosperity, and downward slide in the economic activities from the peak.

The phase of recession begins when the downward slide in the growth rate becomes rapid and steady. Output, employment, prices, etc. register a rapid decline, though the realized growth rate may still remain above the steady growth line. So long as growth rate exceeds or equals the expected steady growth rate, the economy enjoys the period of prosperity high and low. When the growth rate goes below the steady growth rate, it makes the beginning of depression in the economy.

In a stagnated economy, depression begins when growth rate is less than zero, i.e. the total output, employment, prices, bank advances, etc., decline during the subsequent periods. The span of depression spreads over the period growth rate stays below the secular growth rate or zero growth rate in a stagnated economy. Trough is the phase during which the down trend in the economy slows down and eventually stops, and the economic activities once again register an upward movement. Trough is the period of most severe strain on the economy. When the economy registers a continuous and repaid upward trend in output, employment, etc., it enters the phase of recovery though the growth rate may still remain below the steady growth rate. And, when it exceeds this rate, the economy once again enters the phase of expansion and prosperity. If economic fluctuations are not controlled by the government, the business cycle continues to recur.

Q.No. 2(c): Explain the features of Monopoly.?

Answer:

The following features are seen under simple or limited monopoly.

Single Producer: For monopoly to exist only one producer should be in the market. The producer may be an individual, a partnership firm, an enterprise, the government or a joint stock company.

No close Substitute: To avoid any possibility of competition in the market, there should be no close substitutes for the product of the monopolist. This means that the cross-elasticity of demand for the monopolists product is low.

Barriers to entry of firm: The basis of monopoly is the barriers or restrictions of new firms into the market, those can be either natural barriers or artificial barriers.

Demand curve under monopoly: The above mentioned features explain the demand curve or the average revenue(AR) curve under the monopoly.

The demand curve for a firm(which means the industry under monopoly) is downward sloping. It is the monopolist who is the price- market in the market.

Y

Average Revenue Price

O

Quantity Demanded

X

Under the monopoly, there is only one seller who controls the entire supply in the market. Since this is the only producer and seller, he can fix the price of his product. In order to maximize his profit, he may rise the price frequently. He may exploit the consumers by charging an excessive price. Since there are no sellers, the buyers have no alternative than to buy from the monopolist. Indeed all buyers are put at that mercy of the monopolist.

Many times, monopolies are created under law. Urban transport, supply of gas and electricity, nowadays cable television system and such other public utilities are usually managed as monopolies. Such monopolies are called natural monopolies. On the other hand if a producer acquires monopoly on the basis of patent laws, it is called an artificial monopoly.

Q.No. 2(g): State the causes of Inflation.?

Answer:The causes for inflation can be studied from demand side and supply side.

Factors from Demand side:Increase in public expenditure: There may be an increase in the expenditure of the government because of wars or for developing the economy. This increase in governmental expenditure means an increase in the total demand, which leads to rise in price. This demand is in addition to the normal demand, which leads to a rise in price.

Increase in private expenditure: When optimism prevails in the business world, businessmen are eager to spend more money on capital goods. This increase the demand for capital goods and in turn brings about an increase in the demand for consumers goods. This is because there is an increase in the income of the people who work in capital goods industries. Therefore they are in a position to spend more and thus, there is an increase in the demand for the both type of goods.

Increase in foreign demand: When there is an increase in foreign demand for the goods manufactured in the country, exports increase and the prices of commodities in the country increase as their supply cannot be increased instantaneously.

Reduction in taxation: If there is a reduction in the taxes levied by the government, people are left with more money which can be spent. This increases their expenditure as well as the prices of commodities.

Repayment of internal debts: When the government repays old loans, more purchasing power is placed at the disposal of people. Part of the amount obtained in this manner may be re invested in various assets, but the rest of it may be spent on consumer goods and services. It is responsible for increase in prices to the extent. This repayment of loans leads to an increase in the total demand.

Changes in expectations: In the context of price rise the expectations of people play a very important role. When people expect a rise in prices, businessmen increase their investment and this leads to an increase in the demand for capital goods. If the consumers think that there will be an increase in prices in the future, they will start purchasing commodities which they will require in the near future. This increases the demand for consumer goods. The increase in demand for both consumers and producers leads to the rise in price.

Factors from Supply side:Scarcity of the factors of the production: If one or more factors of production are in short supply, there is a reduction in production or hurdles may be created in the expansion of production. This reduces the total supply and causes the rise in price.

Bottlenecks: Sometimes, all factors may be avoidable. But bottlenecks are created and this makes it difficult to make these factors available at the right time and place, for actual production. For example iron ore and coal ore available at mines, but the transport facilities required to transport these raw materials to the production site are not available. Transportation then becomes bottleneck. Therefore in this case production will suffer. Similarly the credit facilities, labor unrest and strikes, unavailability of transport and several other difficulties may rise and make production impossible or difficult. This may cause as increase in prices.

Natural calamities: There are several natural calamities which may reduce production. Excess of rains, droughts, earthquakes, cyclones man substantially reduce the total annual production. Agricultural production suffers and all other agro based industries such as sugar industry, textile industry, oil industry, biscuits industry etc., also will suffer. This results in the reduction of production and leads to the rise of prices.

Hoarding by merchants: When traders and merchants know that there is a short supply of of any commodity, they will purchase and stock large quantities of these commodities. These commodities then go underground and are not available in the open market. Thus there is shortage of other commodities too and this leads to a rise in prices.

Rise in costs: Rise in costs due to increase in factors prices is another cause from the supply side. Rent, interest and wages can rise due to number of reasons. The central bank may rise interest rate or unions may cause a wage-rise. This may lead to inflation.

Q.No. 5: Write Short Notes On:

Answer:

e) Fiscal Policy:

It is one of the important economic policies to achieve economic stability. Fiscal Policy refers to variation in taxation and public expenditure programs by the government to achieve predetermined objectives. Taxation is transferring of funds from private purses to public (Government) coffers. It is the withdrawal of funds from private use. Public expenditure on the other hand increases the flow of funds into the private economy.

Since the tax-revenue and public expenditure form two sides of the government budget, the taxation and public expenditure policies are also jointly called the Budgetary Policy.

Fiscal or Budgetary Policy is regarded as powerful instrument of economic stabilization. The importance of fiscal policy as an instrument of economic stabilization rests on the fact that government activities in the modern economies are greatly enlarged, and government tax-revenue and expenditure account for a considerable proportion of GNP, ranging from 10-25 per cent. Therefore the government may affect the private economic activities to same extent through variation in taxation and public expenditure.

Besides fiscal policy is considered to be more effective than monetary policy because the former directly affects the private decisions while later does so indirectly. If the fiscal policy is formulated that it is during the period of expansion, it is known as counter-cyclical fiscal policy.

f) Monetary Policy:

Monetary Policy refers to the program of Central Banks variations, in the total supply of money and cost of money to achieve certain predetermined objectives. One of the primary objectives of monetary policy is to achieve economic stability.

The traditional instrument through which Central Bank carries out the Monetary Policies are:

Quantitative Credit Control measures such as open market operations, changes in bank rates (or discount rates), and changes in the statutory reserve ratios. Briefly speaking, open market operations by the Central Bank are the sale and purchase of government bonds, treasure bills, securities, etc., to and from public. Bank rate is the rate at which Central Bank discounts the commercial banks bills of exchange or first class bill. The statutory reserve ratio is the proportion of commercial banks time and demand deposit, which they are required to deposit with Central Bank or keep cash-in-vault. All these instruments when operated by the Central Bank reduce (or enhance) directly and indirectly the credit creation capacity of the commercial banks and thereby reduce (or increase) the flow of funds from the banks to the public.

In addition these instruments, Central Bank use also various selective credit control measures and moral suasion. The selective credit controls are intended to control the credit flows to particular sectors without affecting the total credit, and also to change the composition of credit from undesirable to desirable pattern. Moral suasion is a persuasive method to convince the commercial banks to behave in accordance with the demand of the time and in the interest of the nation.

The fiscal and monetary policies may be alternatively used to control the business cycles in the economy, though monetary policy is considered to be more effective to control inflation than to control depression. It is however, always desirable to adopt a proper mix of fiscal and monetary

l) Profit maximization goal:

The conventional economic theory assumes profit maximization as the only objective of the business firms. It forms the basis for the conventional price theory. Profit maximization is regarded as the most reasonable and analytically most productive business objective.

Besides, profit maximization assumption has a great predictive power. It helps in predicting the behavior of business firms in the real world and also the behavior of the price and output under different market conditions.

There are two conditions that must be fulfilled for the profit maximization:

The necessary condition requires that Marginal Revenue (MR) must be equal to marginal cost (MC). Marginal Revenue is obtained from production and sales of one additional unit of output. Marginal cost is the cost incurred due to one additional unit of output.

The secondary condition requires that necessary condition must be satisfied under the condition of decreasing MR and increasing MC. The fulfillment of two condition makes the sufficient condition.

Objections to this approach:

Profit maximization assumption is too simple to explain the business phenomenon in the real world. In fact, businessman themselves are not aware of this objective attributed to them.

It is claimed that there are alternative and equally simple objectives of business firms that explains better the real world business phenomenon. Ex: Sales maximization, Market share.

Firm do not have the necessary knowledge and priori data to equalize MR and MC.

In defense of Profit Maximization assumption:

Firms continue to survive in the long run in a competitive market, which are able to make reasonable profit.

This assumption has been accurate in predicting the firms behavior.

It is time honored objective of firm

Profit is one of the most efficient and reliable measures of efficiency of a firm.

Steady Growth Line

Peak

Prosperity

Recession

Expansion

Expansion

Recovery

Prosperity

Depression

Line of Cycle

Trough

Demand Curve under Monopoly