Master of Business Administration MBA Semester 1 MB0042 Managerial Economics - 4 Credits (Book ID:B1131) Assignment Set- 2

Q1. Discuss the various measures that may be taken by a firm to counteract the evil effects of a trade cycle. Ans.
FACTORS THAT SHAPE BUSINESS CYCLES For centuries, economists in both the United States and Europe regarded economic downturns as "diseases" that had to be treated; it followed, then, that economies characterized by growth and affluence were regarded as "healthy" economies. By the end of the 19th century, however, many economists had begun to recognize that economies were cyclical by their very nature, and studies increasingly turned to determining which factors were primarily responsible for shaping the direction and disposition of national, regional, and industry-specific economies. Today, economists, corporate executives, and business owners cite several factors as particularly important in shaping the complexion of business environments. VOLATILITY OF INVESTMENT SPENDING Variations in investment spending is one of the important factors in business cycles. Investment spending is considered the most volatile component of the aggregate or total demand (it varies much more from year to year than the largest component of the aggregate demand, the consumption spending), and empirical studies by economists have revealed that the volatility of the investment component is an important factor in explaining business cycles in the United States. According to these studies, increases in investment spur a subsequent increase in aggregate demand, leading to economic expansion. Decreases in investment have the opposite effect. Indeed, economists can point to several points in American history in which the importance of investment spending was made quite evident. The Great Depression, for instance, was caused by a collapse in investment spending in the aftermath of the stock market crash of 1929. Similarly, prosperity of the late 1950s was attributed to a capital goods boom.

There are several reasons for the volatility that can often be seen in investment spending. One generic reason is the pace at which investment accelerates in response to upward trends in sales. This linkage, which is called the acceleration principle by economists, can be briefly explained as follows. Suppose a firm is operating at full capacity. When sales of its goods increase, output will have to be increased by increasing plant capacity through further investment. As a result, changes in sales result in magnified percentage changes in investment expenditures. This accelerates the pace of economic expansion, which generates greater income in the economy, leading to further increases in sales. Thus, once the expansion starts, the pace of investment spending accelerates. In more concrete terms, the response of the investment spending is related to the rate at which sales are increasing. In general, if an increase in sales is expanding, investment is spending rises, and if an increase in sales has peaked and is beginning to slow, investment spending falls. Thus, the pace of investment spending is influenced by changes in the rate of sales. MOMENTUM Many economists cite a certain "follow-the-leader" mentality in consumer spending. In situations where consumer confidence is high and people adopt more free-spending habits, other customers are deemed to be more likely to increase their spending as well. Conversely, downturns in spending tend to be imitated as well. TECHNOLOGICAL INNOVATIONS Technological innovations can have an acute impact on business cycles. Indeed, technological breakthroughs in communication, transportation, manufacturing, and other operational areas can have a ripple effect throughout an industry or an economy. Technological innovations may relate to production and use of a new product or production of an existing product using a new process. The video imaging and personal computer industries, for instance, have undergone immense technological innovations in recent years, and the latter industry in particular has had a pronounced impact on the business operations of countless organizations. However, technological innovationsand consequent increases in investmenttake place at irregular intervals. Fluctuating investments, due to variations in the pace of technological innovations, lead to business fluctuations in the economy.

There are many reasons why the pace of technological innovations varies. Major innovations do not occur every day. Nor do they take place at a constant rate. Chance factors greatly influence the timing of major innovations, as well as the number of innovations in a particular year. Economists consider the variations in technological innovations as random (with no systematic pattern). Thus, irregularity in the pace of innovations in new products or processes becomes a source of business fluctuations. VARIATIONS IN INVENTORIES Variations in inventoriesexpansion and contraction in the level of inventories of goods kept by businessesalso contribute to business cycles. Inventories are the stocks of goods firms keep on hand to meet demand for their products. How do variations in the level of inventories trigger changes in a business cycle? Usually, during a business downturn, firms let their inventories decline. As inventories dwindle, businesses ultimately find themselves short of inventories. As a result, they start increasing inventory levels by producing output greater than sales, leading to an economic expansion. This expansion continues as long as the rate of increase in sales holds up and producers continue to increase inventories at the preceding rate. However, as the rate of increase in sales slows, firms begin to cut back on their inventory accumulation. The subsequent reduction in inventory investment dampens the economic expansion, and eventually causes an economic downturn. The process then repeats itself all over again. It should be noted that while variations in inventory levels impact overall rates of economic growth, the resulting business cycles are not really long. The business cycles generated by fluctuations in inventories are called minor or short business cycles. These periods, which usually last about two to four years, are sometimes also called inventory cycles. FLUCTUATIONS IN GOVERNMENT SPENDING Variations in government spending are yet another source of business fluctuations. This may appear to be an unlikely source, as the government is widely considered to be a stabilizing force in the economy rather than a source of economic fluctuations or instability. Nevertheless, government spending has been a major destabilizing force on several occasions, especially during and after wars. Government spending increased by an enormous amount during World War II, leading to an economic expansion that continued for several years after the war. Government spending also increased, though to a smaller extent

compared to World War II, during the Korean and Vietnam wars. These also led to economic expansions. However, government spending not only contributes to economic expansions, but economic contractions as well. In fact, the recession of 1953-54 was caused by the reduction in government spending after the Korean War ended. More recently, the end of the Cold War resulted in a reduction in defense spending by the United States that had a pronounced impact on certain defense-dependent industries and geographic regions. POLITICALLY GENERATED BUSINESS CYCLES Many economists have hypothesized that business cycles are the result of the politically motivated use of macroeconomic policies (monetary and fiscal policies) that are designed to serve the interest of politicians running for reelection. The theory of political business cycles is predicated on the belief that elected officials (the president, members of congress, governors, etc.) have a tendency to engineer expansionary macroeconomic policies in order to aid their re-election efforts. MONETARY POLICIES Variations in the nation's monetary policies, independent of changes induced by political pressures, are an important influence in business cycles as well. Use of fiscal policyincreased government spending and/or tax cutsis the most common way of boosting aggregate demand, causing an economic expansion. Moreover, the decisions of the Federal Reserve, which controls interest rates, can have a dramatic impact on consumer and investor confidence as well. FLUCTUATIONS IN EXPORTS AND IMPORTS The difference between exports and imports is the net foreign demand for goods and services, also called net exports. Because net exports are a component of the aggregate demand in the economy, variations in exports and imports can lead to business fluctuations as well. There are many reasons for variations in exports and imports over time. Growth in the gross domestic product of an economy is the most important determinant of its demand for imported goodsas people's incomes grow, their appetite for additional goods and services, including goods produced abroad, increases. The opposite holds when foreign economies are growinggrowth in incomes in foreign countries also leads to an increased demand for imported goods by the residents of these countries. This, in turn,

causes U.S. exports to grow. Currency exchange rates can also have a dramatic impact on international tradeand hence, domestic business cyclesas well. KEYS TO SUCCESSFUL BUSINESS CYCLE MANAGEMENT Small business owners can take several steps to help ensure that their establishments weather business cycles with a minimum of uncertainty and damage. "The concept of cycle management may be relatively new," wrote Matthew Gallagher in Chemical Marketing Reporter, "but it already has many adherents who agree that strategies that work at the bottom of a cycle need to be adopted as much as ones that work at the top of a cycle. While there will be no definitive formula for every company, the approaches generally stress a longterm view which focuses on a firm's key strengths and encourages it to plan with greater discretion at all times. Essentially, businesses are operating toward operating on a more even keel." Specific tips for managing business cycle downturns include the following: Flexibility According to Gallagher, "part of growth management is a flexible business plan that allows for development times that span the entire cycle and includes alternative recession-resistant funding structures." Long-Term PlanningConsultants encourage small businesses to adopt a moderate stance in their long-range forecasting. Attention to Customersthis can be an especially important factor for businesses seeking to emerge from an economic downturn. "Staying close to the customers is a tough discipline to maintain in good times, but it is especially crucial coming out of bad times," stated Arthur Daltas in Industry Week. "Your customer is the best test of when your own upturn will arrive. Customers, especially industrial and commercial ones, can give you early indications of their interest in placing large orders in coming months." ObjectivitySmall business owners need to maintain a high level of objectivity when riding business cycles. Operational decisions based on hopes and desires rather than a sober examination of the facts can devastate a business, especially in economic down periods. Study"Timing any action for an upturn is tricky, and the consequences of being early or late are serious," said Daltas. "For example, expanding a sales force when the markets don't materialize not only places big

demands on working capital, but also makes it hard to sustain the motivation of the sales-people. If the force is improved too late, the cost is decreased market share or decreased quality of the customer base. How does the company strike the right balance between being early or late? Listening to economists, politicians, and media to get a sense of what is happening is useful, but it is unwise to rely solely on their sources. The best route is to avoid trying to predict the upturn. Instead, listen to your customers and know your own response-time requirements."

Q2: Define the term equilibrium. Explain the changes in market equilibrium and effects of shifts in supply and demand. Ans: Meaning 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. Changes in Market Equilibrium: The changes in equilibrium price will occur when there will be shift either in demand 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 the income, tastes, prices of substitutes and complements, size of the population etc. If demand raises due to a change in any one of these conditions the demand curve shifts upward to the right. If, on the other hand, demand falls, the demand curve shifts downward to the left. Such rise and fall in demand are referred to as increase and decrease in demand. A change in the market equilibrium caused by the shifts in demand can be explained with the help of a diagram.

Effects of Changes in Demand and Supply: Changes can occur in both demand and supply conditions. The effects of such changes on the market equilibrium depend on the rate of change in the two variables. If the rate of change in demand is matched with the rate of change in supply there will be no change in the market equilibrium, the new equilibrium shows expanded market with increased quantity of both supply and demand at the same price. This is made clear from the diagram below:

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

Q3 What do you mean by pricing policy? Explain the various objective of pricing policy of a firm. Ans : A detailed study of the market structure gives us information about the
way in which prices are determined under different market conditions. However, in reality, a firm adopts different policies and methods to fix the price of its products. Pricing policy refers to the policy of setting the price of the product or products and services by the management after taking into account of various internal and external factors, forces and its own business objectives. Pricing Policy basically depends on price theory that is the corner stone of economic theory. Pricing is considered as one of the basic and central problems of economic theory in a modern economy. Fixing prices are the most important aspect of managerial decision making because market price charged by the company affects the present and future production plans, pattern of distribution, nature of marketing etc. Objectives of the Pricing Policy The following objectives are to be considered while fixing the prices of the product. 1. Profit maximization in the short term The primary objective of the firm is to maximize its profits. Pricing policy as an instrument to achieve this objective should be formulated in such a way as to maximize the sales revenue and profit. Maximum profit refers to the highest possible of profit. In the short run, a firm not only should be able to recover its total costs, but also should get excess revenue over costs. This will build the morale of the firm and instill the spirit of confidence in its operations. It may follow skimming price policy, i.e., charging a very high price when the product is

launched to cater to the needs of only a few sections of people. It may exploit wide opportunities in the beginning. But it may prove fatal in the long run. It may lose its customers and business in the market. Alternatively, it may adopt penetration pricing policy i.e., charging a relatively lower price in the latter stages in the long run so as to attract more customers and capture the market. 2. Profit optimization in the long run The traditional profit maximization hypothesis may not prove beneficial in the long run. With the sole motive of profit making a firm may resort to several kinds of unethical practices like charging exorbitant prices, follow Monopoly Trade Practices (MTP), Restrictive Trade Practices (RTP) and Unfair Trade Practices (UTP) etc. This may lead to opposition from the people. In order to over come these evils, a firm instead of profit maximization, aims at profit optimization. Optimum Profit refers to the most ideal or desirable level of profit. Hence, earning the most reasonable or optimum profit has become a part and parcel of a sound pricing policy of a firm in recent years. 3. Price Stabilization Price stabilization over a period of time is another objective. The prices as far as possible should not fluctuate too often. Price instability creates uncertain atmosphere in business circles. Sales plan becomes difficult under such circumstances. Hence, price stability is one of the pre requisite conditions for steady and persistent growth of a firm. A stable price policy only can win the confidence of customers and may add to the good will of the concern. It builds up the reputation and image of the firm. 4. Facing competitive situation One of the objectives of the pricing policy is to face the competitive situations in the market. In many cases, this policy has been merely influenced by the market share psychology. Wherever companies are aware of specific competitive products, they try to match the prices of their products with those of their rivals to expand the volume of their business. Most of the firms are not merely interested in meeting competition but are keen to prevent it. Hence, a firm is always busy with its counter business strategy.

5. Maintenance of market share Market share refers to the share of a firm's sales of a particular product in the total sales of all firms in the market. The economic strength and success of a firm is measured in terms of its market share. In a competitive world, each firm makes a successful attempt to expand its market share. If it is impossible, it has to maintain its existing market share. Any decline in market share is a symptom of the poor performance of a firm. Hence, the pricing policy has to assist a firm to maintain its market share at any cost. 6. Capturing the Market Another objective in recent years is to capture the market, dominate the market, command and control the market in the long run. In order to achieve this goal, sometimes the firm fixes a lower price for its product and at other times even it may sell at a loss in the short term. It may prove beneficial in the long run. Such a pricing is generally followed in price sensitive markets. 7. Entry into new markets. Apart from growth, market share expansion, diversification in its activities a firm makes a special attempt to enter into new markets. Entry into new markets speaks about the successful story of the firm. Consequently, it has to bear the pioneering and subsequent risks and uncertainties. The price set by a firm has to be so attractive that the buyers in other markets have to switch on to the products of the candidate firm. 8. Deeper penetration of the market The pricing policy has to be designed in such a manner that a firm can make inroads into the market with minimum difficulties. Deeper penetration is the first step in the direction of capturing and dominating the market in the latter stages. 9. Achieving a target return A predetermined target return on capital investment and sales turnover is another long run pricing objective of a firm. The targets are set according to the position of individual firm. Hence, prices of the products are so calculated as to earn the target return on cost of production, sales and capital investment. Different target returns may be fixed for different products or brands or markets but such returns should be related to a single overall rate of return target. 10. Target profit on the entire product line irrespective of profit level of individual products.

The price set by a firm should increase the sale of all the products rather than yield a profit on one product only. A rational pricing policy should always keep in view the entire product line and maximum total sales revenue from the sale of all products. A product line may be defined as a group of products which have similar physical features and perform generally similar functions. In a product line, a few products are regarded as less profit earning products and others are considered as more profit earning. Hence, a proper balance in pricing is required. 11. Long run welfare of the firm A firm has multiple objectives. They are laid down on the basis of past experience and future expectations. Simultaneous achievement of all objectives are necessary for the over all growth of a firm. Objective of the pricing policy has to be designed in such a way as to fulfill the long run interests of the firm keeping internal conditions and external environment in mind. 12. Ability to pay Pricing decisions are sometimes taken on the basis of the ability to pay of the customers, i.e., higher price can be charged to those who can afford to pay. Such a policy is generally followed by those people who supply different types of services to their customers. 13. Ethical Pricing Basically, pricing policy should be based on certain ethical principles. Business without ethics is a sin. While setting the prices, some moral standards are to be followed. Although profit is one of the most important objectives, a firm cannot earn it in a moral vacuum. Instead of squeezing customer, a firm has to charge moderate prices for its products. The pricing policy has to secure reasonable amount of profits to a firm to preserve the interests of the community and promote its welfare.

Q4. Critically examine the Marris growth maximization model. Ans. Marris Growth Maximization Model:
Working on the principle of segregation of managers from owners, Marris proposed that owners (shareholders) aim at profits and market share, whereas managers aim at better salary, job security and growth. These two sets of goals can be achieved by maximising balanced growth of the firm (G), which is dependent on the growth rate of demand for the firm's products (GD) and growth rate of capital supply to the firm (GC). Hence growth rate of the firm is

balanced when the demand for its product and the capital supply to the firm grow at the same rate. Marris further said that firms face two constraints in the objective of maximization of balanced growth, which are explained below. 1. Managerial Constraint: Among managerial constraints, Marris stressed on the importance of the role of human resource in achieving organizational objectives. According to him, skills, expertise, efficiency and sincerity of team managers are vital to the growth of the firm. Non availability of managerial skill sets in required size creates constraints for growth: organizations on their high levels of growth may face constraint of skill ceiling among the existing employees. New recruitments may be used to increase the size of the managerial pool with desired skills; however new recruits lack experience to make quick decisions, which may pose as another constraint. 2. Financial Constraint: This relates to the prudence needed in managing financial resources. Marris suggested that a prudent financial policy will be based on at least three financial ratios, which in turn set the limit for the growth of the firm. In order to prove their discretion managers will normally create a tradeoff and prefer a moderate debt equity ratio (rj), moderate liquidity ratio (r2) and moderate retained profit ratio (r3). A brief description is given here under: (a) Debt equity ratio (r1) - This is the ratio between borrowed capital and owners* capital. High value of debt equity ratio may cause insolvency; hence a low value of this ratio is usually preferred by managers to avoid insolvency. However, a low value of r, may create a constraint to the growth of the firm in terms of dependence on high cost capital, i.e., equity. (b) Liquidity ratio (r2) - This is the ratio between current assets and current liabilities and is an indicator of coverage provided by current assets to current liabilities. According to Marris, a manager would try to operate in a region where there is sufficient liquidity and safety and hence would prefer a high liquidity ratio. But a high r2 would imply low yielding assets, since liquid assets either do not earn at all (like cash and inventory), or earn low returns (like short term securities).

(c) Retention ratio (r3) - This is the ratio between retained profits and total profits. In other words, it is the inverse of dividend payout ratio, i.e., the retained profits are that portion of net profit which is not distributed among shareholders. A high retention ratio is good for growth, as retained profits provide internal source of funds. However, a higher r3 would imply greater volume of retained profits, which may antagonize the shareholders. Hence managers cannot afford to keep a very high value of retention ratio.

Q5. Explain how a product would reach equilibrium position with the help of ISO - Quants and ISO-Cost curve. Ans.
When producing a good or service, how do suppliers determine the quantity of factors to hire? Below, we work through an example where a representative producer answers this question. Lets begin by making some assumptions. First, we shall assume that our producer chooses varying amounts of two factors, capital (K) and labor (L). Each factor was a price that does not vary with output. That is, the price of each unit of labor (w) and the price of each unit of capital (r) are assumed constant. Well further assume that w = $10 and r = $50. We can use this information to determine the producers total cost. We call the total cost equation an iso-cost line (its similar to a budget constraint). The producers iso-cost line is: 10L + 50K = TC (1) The producers production function is assumed to take the following form: q = (KL) 0.5 (2) Our producers first step is to decide how much output to produce. Suppose that quantity is 1000 units of output. In order to produce those 1000 units of output, our producer must get a combination of L and K that makes (2) equal to 1000. Implicitly, this means that we must find a particular isoquant.

Set (2) equal to 1000 units of output, and solve for K. Doing so, we get the following equation for a specific iso-quant (one of many possible iso-quants): K = 1,000,000/L (2a)

For any given value of L, (2a) gives us a corresponding value for K. Graphing these values, with K on the vertical axis and L on the horizontal axis, we obtain the blue line on the graph below. Each point on this curve is represented as a combination of K and L that yields an output level of 1000 units. Therefore, as we move along this iso-quant output is constant (much like the fact that utility is constant as A basic understanding of statistics is a critical component of informed decision making.

Q6. Suppose your manufacturing company planning to release a new product into market, Explain the various methods forecasting for a new product. Ans.
When a manufacturing companies planning to release a new product into themar ket, it should perform the demand forecasting to check the demand of the product in the market and also the availability of similar product in the market. Demand forecasting for new products is quite different from that for established products. Here the firms will not have any past experience or past data for this purpose. An intensive study of the economic and competitive characteristics of the product should be made to make efficient forecasts. As per Professor Joel Dean, few guidelines to make forecasting of demand for new products are: a. Evolutionary approach The demand for the new product may be considered as an outgrowth of an existing product. For e.g., Demand for new Tata Indica, which is a modified version of Old Indica can most effectively be projected based on the sales of the old Indica, the demand for new Pulsor can be forecasted based on the sales of the old Pulsar. Thus when a new product is evolved from the old product, the demand conditions of the old product can be taken as a basis for forecasting the demand for the new product. b. Substitute approach If the new product developed serves as substitute for the existing product, the demand for the new product may be worked out on the basis of a market share. The growths of demand for all the products have to be worked out on the basis of intelligent forecasts for independent variables that influence the demand for

the substitutes. After that, a portion of the market can be sliced out for the new product. For e.g., A moped as a substitute for a scooter, a cell phone as a substitute for a land line. In some cases price plays an important role in shaping future demand for the product. c. Opinion Poll approach Under this approach the potential buyers are directly contacted, or through the use of samples of the new product and their responses are found out. These are finally blown up to forecast the demand for the new product. d. Sales experience approach Offer the new product for sale in a sample market; say supermarkets or big bazaars in big cities, which are also big marketing centers. The product may be offered for sale through one super market and the estimate of sales obtained may be blown up to arrive at estimated demand for the product. e. Growth Curve approach According to this, the rate of growth and the ultimate level of demand for the new product are estimated on the basis of the pattern of growth of established products. For e.g., An Automobile Co., while introducing a new version of a car will study the level of demand for the existing car. f. Vicarious approach A firm will survey consumers reactions to a new product indirectly through getting in touch with some specialized and informed dealers who have good knowledge about the market, about the different varieties of the product already available in the market, the consumers preferences etc. This helps in making a more efficient estimation of future demand.

Master of Business Administration MBA Semester 1 MB0042 Managerial Economics - 4 Credits (Book ID:B1131) Assignment Set- 1 Note: Each Question carries 10 marks. Answer all the questions.

Q1. Distinguish between a firm and an industry. Explain the equilibrium of a firm and industry under perfect competition. Ans. Distinguish between a firm and an industry
An industry is the name given to a certain type of manufacturing or retailing environment. For example, the retail industry is the industry that involves everything from clothes to computers, anything in the shops that get sold to the public. The retail industry is very vast and has many sub divisions, such as electrical and cosmetics. More specialized industries deal with a specific thing. The steel industry is a more specialized industry, dealing with the making of steel and selling it on to buyers. The difference between this and a firm is that a firm is the company that operates within the industry to create the product. The firm might be a factory, or the chain of stores that sells the clothes, within its industry. For example, one firm that makes steel might be Aveda steel. They create the steel in that firm for the steel industry. A firm is usually a corporate company that controls a number of chains in the industry it is operating within. For example in retail, the firm Arcadia stores own the clothing chains Top shop, Dorothy Perkins, Miss Selfridge, and Evans. These all operate for the firm Arcadia within the industry of retail. Several firms can operate in one industry to ensure that there is always competition to keep prices reasonable and stop the market becoming a monopoly, which is where one firm is in charge of the whole industry. Sometimes, a firm is not necessary within the industry and independent chains and retailers can enter straight into the market without a firm behind them, although this is risky. This is because one of the advantages of having a firm behind you is that it is a safeguard against possible bankruptcy because the firm can support the chain that it owns.

The equilibrium of a firm and industry under perfect competition

According to Miller, Firm is an organization that buys and hires resources and sells goods and services. Lipsey has defined as firm is the unit that employs factors of production to produce commodities that it sells to other firms, to households, or to the government. Industry is a group of firms producing standardized products in a market. According to Lipsey, Industry is a group of firms that sells a well defined product or closely related set of products. Conditions of Equilibrium of the Firm and Industry A firm is in equilibrium when it has no propensity to modify its level of productivity. It requires neither extension nor retrenchment. It wants to earn maximum profits in by equating its marginal cost with its marginal revenue, i.e. MC = MR. Diagrammatically, the conditions of equilibrium of the firm are (1) the MC curve must equal the MR curve. This is the first order and essential condition. But this is not a sufficient condition which may be fulfilled yet the firm may not be in equilibrium. (2) The MC curve must cut the MR curve from below and after the point of equilibrium it must be above the MR. This is the second order condition. Under conditions of perfect competition, the MR curve of a firm overlaps with the AR curve. The MR curve is parallel to the X axis. Hence the firm is in equilibrium when MC = MR = AR.

The first order figure (1), the MC curve cuts the MR curve first at point X. It contends the condition of MC = MR, but it is not a point of maximum profits

for the reason that after point X, the MC curve is beneath the MR curve. It does not pay the firm to produce the minimum output OM when it can earn huge profits by producing beyond OM. Point Y is of maximum profits where both the situations are fulfilled. Amidst points X and Y it pays the firm to enlarges its productivity for the reason that its MR > MC. It will nevertheless stop additional production when it reaches the OM1 level of productivity where the firm fulfils both the circumstances of equilibrium. If it has any plants to produce more than OM1 it will be incurring losses, for its marginal cost exceeds its marginal revenue beyond the equilibrium point Y. The same finale hold good in the case of straight line MC curve and it is presented in the figure.

An industry is in equilibrium, first when there is no propensity for the firms either to leave or either the industry and next, when each firm is also in equilibrium. The first clause entails that the average cost curves overlap with the average revenue curves of all the firms in the industry. They are earning only normal profits, which are believed to be incorporated in the average cost curves of the firms. The second condition entails the equality of MC and MR. Under a perfectly competitive industry these two circumstances must be fulfilled at the point of equilibrium i.e. MC = MR. (1), AC = AR. (2), AR = MR. Hence MC = AC = AR. Such a position represents full equilibrium of the industry.

SHORT RUN EQUILIBRIUM OF THE FIRM AND INDUSTRY 1. Short Run Equilibrium of the Firm A firm is in equilibrium in the short run when it has no propensity to enlarge or contract its productivity and needs to earn maximum profit or to incur minimum losses. The short run is an epoch of time in which the firm can vary its productivity by changing the erratic factors of production. The number of firms in the industry is fixed since neither the existing firms can leave nor new firms can enter it. Postulations All firms use standardised factors of production Firms are of diverse competence Cost curves of firms are dissimilar from each other All firms sell their produces at the equal price ascertained by demand and supply of the industry so that the price of each firm, P (Price) = AR = MR Firms produce and sell various volumes The short run equilibrium of the firm can be described with the helps of marginal study and total cost revenue study.

Marginal Cost, Marginal Revenue analysis During the short run, a firm will produce only its price equals average variable cost or is higher than the average variable cost (AVC). Furthermore, if the price is more than the averages total costs, ATC, i.e. P = AR > ATC the firm will be earning super normal profits. If price equals the average total costs, i.e. P = AR = ATC the firm will be earning normal profits or break even. If price equals AVC, the firm will be incurring losses. If price drops even a little below AVC, the firm will shut down since in order to produce it must cover atleast its AVC through short run. So during the short run, under perfect competition, affirm is in equilibrium in all the above mentioned stipulations. Super normal profits The firm will be earning super normal profits in the short run when price is higher than the short run average cost. Normal Profits = The firm may earn normal profits when price equals the short run average costs.

Total Cost Total Revenue Analysis The short run equilibrium of the firm can also be represented with the help of total cost and total revenue curves. The firm is able to maximise its profits when the positive discrimination between TR and TC is the greatest. Short Run Equilibrium of the Industry An industry is in equilibrium in the short run when its total output remains steady there being no propensity to enlarge or contract its productivity. If all firms are in equilibrium the industry is also in equilibrium. For full equilibrium of the industry in the short run all firms must be earning normal profits. But full equilibrium of the industry is by sheer accident for the reason that in the short rum some firms may be earning super normal profits and some losses. Even then the industry is in short run equilibrium when its quantity demanded and quantity supplied is equal at the price which clears the market.

Q2. Give a brief description of: a. Implicit and explicit cost b. Actual and opportunity cost Ans. A. IMPLICIT AND EXPLICIT COST Implicit cost
In economics, an implicit cost, also called an imputed cost, implied cost, or notional cost, is the opportunity cost equal to what a firm must give up in order using factors which it neither purchases nor hires. It is the opposite of an explicit cost, which is borne directly. In other words, an implicit cost is any cost that results from using an asset instead of renting, selling, or lending it. The term also applies to forgone income from choosing not to work. Implicit costs also represent the divergence between economic profit (total revenues minus total costs, where total costs are the sum of implicit and explicit costs) and accounting profit (total revenues minus only explicit costs). Since economic profit includes these extra opportunity costs, it will always be less than or equal to accounting profit

Explicit cost
An explicit cost is a direct payment made to others in the course of running a business, such as wage, rent and materials, as opposed to implicit costs, which are those where no actual payment is made. It is possible still to underestimate these costs, however: for example, pension contributions and other "perks" must be taken into account when considering the cost of labour. Explicit costs are taken into account along with implicit ones when considering economic profit. Accounting profit only takes explicit costs into account. B. ACTUAL AND OPPORTUNITY COST

Actual cost
An actual amount paid or incurred, as opposed to estimated cost or standard cost. In contracting, actual costs amount includes direct labor, direct material, and other direct charges. Cost accounting information is designed for managers. Since managers are taking decisions only for their own organization, there is no need for the information to be comparable to similar information from other organizations. Instead, the important criterion is that the information must be relevant for decisions that managers operating in a particular environment of business including strategy make. Cost accounting information is commonly used in financial accounting information, but first we are concentrating in its use by managers to take decisions. The accountants who handle the cost accounting information generate add value by providing good information to managers who are taking decisions. Among the better decisions, the better performance of one's organization, regardless if it is a manufacturing company, a bank, a nonprofit organization, a government agency, a school club or even a business school. The cost-accounting system is the result of decisions made by managers of an organization and the environment in which they make them.

Opportunity cost
Opportunity cost is the cost of any activity measured in terms of the value of the next best alternative forgone (that is not chosen). It is the sacrifice related to the second best choice available to someone, or group, who has picked among several mutually exclusive choices. The opportunity cost is also the cost of the

forgone products after making a choice. Opportunity cost is a key concept in economics, and has been described as expressing "the basic relationship between scarcity and choice". The notion of opportunity cost plays a crucial part in ensuring that scarce resources are used efficiently. Thus, opportunity costs are not restricted to monetary or financial costs: the real cost of output forgone, lost time, pleasure or any other benefit that provides utility should also be considered opportunity costs. Opportunity costs in production Opportunity costs may be assessed in the decision-making process of production. If the workers on a farm can produce either one million pounds of wheat or two million pounds of barley, then the opportunity cost of producing one pound of wheat is the two pounds of barley forgone (assuming the production possibilities frontier is linear). Firms would make rational decisions by weighing the sacrifices involved.

Q3. A firm supplied 3000 pens at the rate of Rs 10. Next month, due to a rise of in the price to 22 Rs. per pen the supply of the firm increases to 5000 pens. Find the elasticity of supply of the pens. Ans. Of course, consumption is not the only thing that changes when prices go
up or down. Businesses also respond to price in their decisions about how much to produce. Economists define the price elasticity of supply as the responsiveness of the quantity supplied of a good to its market price. More precisely, the price elasticity of supply is the percentage change in quantity supplied divided by the percentage change in price. Suppose the amount supplied is completely fixed, as in the case of perishable pen brought to market to be sold at whatever price they will fetch. This is the limiting case of zero elasticity, or completely inelastic supply, which is a vertical supply curve. At the other extreme, say that a tiny cut in price will cause the amount supplied to fall to zero, while the slightest rise in price will coax out an indefinitely large supply. Here, the ratio of the percentage change in quantity supplied to percentage change in price is extremely large and gives rise to a horizontal supply curve. This is because the polar case of infinitely elastic supply. Between these extremes, we call elastic or inelastic depending upon whether the percentage change in quantity is larger or smaller than the percentage change in

price. Price elasticity of demand is a ratio of two pure numbers, the numerator is the percentage change in the quantity demanded and the denominator is the percentage change in price of the commodity. It is measured by the following formula: Ep = Percentage change in quantity demanded/ Percentage changed in price Applying the provided data in the equation: Percentage change in quantity demanded = (5000 3000)/3000Percentage changed in price = (22 10) / 10 Ep = ((5000 3000)/3000) / ((22 10)/10) = 1.2.

Q4. What is monetary policy? Explain the general objectives and instruments of monetary policy? Ans: Monetary Policy
Monetary policy is a part overall economic policy of a country. It is employed by the government as an effective tool to promote economic stability and achieve certain predetermined objectives. Meaning and Definition: Monetary Policy deals with the total money supply and its management in an economy. It is essentially a programme of action undertaken by the monetary authorities generally the central bank to control and regulate the supply of money with the public and the flow of credit with a view to achieving economic stability and certain predetermined macroeconomic goals. Monetary policy can be explained in two different ways In a narrow sense, it is concerned with administering and controlling a countrys money supply including currency notes and coins, credit money, level of interest rates and managing the exchange rates. In a broader sense, monetary policy deals with all those monetary and nonmonetary measures and decisions that affect the total money supply and its circulation in an economy. It also includes several non-monetary measures like wages and price control, income policy, budgetary operations taken by the government which indirectly influence the monetary situations in an economy.

General Objectives of Monetary Policy 1. Neutral money policy: Prof. Wicksteed, Hayak, Robertson and others have advocated this policy. This objective was in vogue during the days of gold standard. According to this policy, money is only a technical devise having no other role to play. It should be a passive factor having only one function, namely to facilitate exchange. It should not inject any disturbances. It should be neutral in its effects on prices, income, output, and employment. They considered that changes in total money supply are the root cause for all kinds of economic fluctuations and as such if money supply is stabilized and money becomes neutral, the price level will vary inversely with the productive power of the economy. If productivity increases, cost per unit of output declines and prices fall and vice-versa. According to this policy, money supply is not rigidly fixed. It will change whenever there are changes in productivity, population, improvements in technology etc to neutralize fundamental changes in the economy. Under these conditions, increase or decrease in money supply is allowed to result in either fall or raise in general price level. In a dynamic economy, this policy cannot be continued and it is highly impracticable in the present day economy. 2. Price stability: With the suspension of the gold standard, maintenance of domestic price level has become an important aim of monetary policy all over the world. The bitter experience of 1920s and 1930s has made all most all economies to go for price stability. Both inflation and deflation are dangerous and detrimental to smooth economic growth. They distort and disturb the working of the economic system and create chaos. Both of them are bad as they bring unnecessary loss to some groups where as undue advantage to some others. They have potential power to create economic inequality, political upheavals and social unrest in any economy. In view of this, price stability is considered as one of the main objectives of monetary policy in recent years. It is to be remembered that price stability does not mean that prices of all commodities are kept constant or fixed over a period of time. It refers to the absence of sharp variations or fluctuations in the average price level in the country. A hundred percent price stability is neither possible nor desirable in any economy. It simply implies relative price stability. A policy of price stability checks cyclical fluctuations and smoothen production and distribution, keeps the value of money stable, prevent artificial scarcity or prosperity, makes economic calculations possible, introduces an element of certainty, eliminate socio-economic disturbances, ensure equitable distribution of income and wealth, secure social justice and promote economic welfare. On account of all these benefits, monetary authorities have to take concrete steps to check price oscillations. Price stability is considered as one of

the prerequisite condition for economic development and it contributes positively to the attainment of a steady rate of growth in an economy. This is because price stability will build up public morale and instill confidence in the minds of people, boost up business activity, expand various kinds of economic activities and ensure distributive justice in the country. Prof Basu rightly observes, A monetary policy which can maintain a reasonable degree of price stability and keep employment reasonably full, sets the stage of economic development. 3. Exchange rate stability: Maintenance of stable or fixed exchange rate was one of the major objects of monetary policy for a long time under the gold standard. The stability of national output and internal price level was considered secondary and subservient to the former. It was through free and automatic imports and exports of gold that the country was able to remove the disequilibrium in the balance of payments and ensure stability of exchange rates with other countries. The government followed the policy of expanding currency and credit with the inflow of gold and contracting currency and credit with the outflow of gold. In view of suspension of gold standard and IMF mechanism, this object has lost its significance. However, in order to have smooth and unhindered international trade and free flow of foreign capital in to a country, it becomes imperative for a county to maintain exchange rate stability. Changes in domestic prices would affect exchange rates and as such there is great need for stabilizing both internal price level and exchange rates. Frequent changes in exchange rates would adversely affect imports, exports, inflow of foreign capital etc. Hence, it should be controlled properly. 4. Control of trade cycles: Operation of trade cycles has become very common in modern economies. A very high degree of fluctuations in overall economic activities is detrimental to the smooth growth of any economy. Economic instability in the form of inflation, deflation or stagflation etc would serve as great obstacles to the normal functioning of an economy. Basically, changes in total supply of money are the root cause for business cycles and its dampening effects on the entire economy. Hence, it has become one of the major objectives of monetary authorities to control the operation of trade cycles and ensure economic stability by regulating total money supply effectively. During the period of inflation, a policy of contraction in money supply and during the period of deflation, a policy of expansion in money supply has to be adopted. This would create the necessary economic stability for rapid economic development.

5. Full employment: In recent years it has become another major goal of monetary policy all over the world especially with the publication of general theory by Lord Keynes. Many well-known economists like Crowther, Halm. Gardner Ackley, William, Beveridge and Lord Keynes have strongly advocated this objective in the context of present day situations in most of the countries. Advanced countries normally work at near full employment conditions. Their major problem is to maintain this high level of employment situation through various economic policies. This object has become much more important and crucial in developing countries as there is unemployment and under employment of most of the resources. Deliberate efforts are to be made by the monetary authorities to ensure adequate supply of financial resources to exploit and utilize resources in the best possible manner so as to raise the level of aggregate effective demand in the economy. It should also help to maintain balance between aggregate savings and aggregate investments. This would ensure optimum utilization of all kinds of resources, higher national output, income and higher living standards to the common man. 6. Equilibrium in the balance of payments: This objective has assumed greater importance in the context of expanding international trade and globalization. Today most of the countries of the world are experiencing adverse balance of payments on account of various reasons. It is a situation where in the import payments are in excess of export earnings. Most of the countries which have embarked on the road to economic development cannot do away with imports on a large scale. Imports of several items have become indispensable and without these imports their development process will be halted. Hence, monetary authorities have to take appropriate monetary measures like deflation, exchange depreciation, devaluation, exchange control, current account and capital account convertibility, regulate credit facilities and interest rate structures and exchange rates etc. In order to achieve a higher rate of economic growth, balance of payments equilibrium is very much required and as such monetary authorities have to take suitable action in this direction. 7. Rapid economic growth: This is comparatively a recent objective of monetary policy. Achieving a higher rate of per capita output and income over a long period of time has become one of the supreme goals of monetary policy in recent years. A higher rate of economic growth would ensure full employment condition, higher output, income and better living standards to the people. Consequently, monetary authorities have to take the necessary steps to raise the productive capacity of the economy, increase the level of effective demand for various kinds of goods and services and ensure balance between demand for and supply of goods and

services in the economy. Also they should take measures to increase the rate of savings, capital formation, step up the volume of investment, direct credit money into desired directions, regulate interest rate structure, minimize economic and business fluctuations by balancing demand for money and supply of money, ensure price and overall economic stability, better and full utilization of resources, remove imperfections in money and capital markets, maintain exchange rate stability, allow the inflow of foreign capital into the country, maintain the growth of money supply in consistent with the rate of growth of output minimize adversity in balance of payments condition, etc. Depending upon the conditions of the economy money supply has to be changed from time to time. A flexible policy of monetary expansion or contraction has to be adopted to meet a particular situation. Thus, a growth-friendly monetary policy has to be pursued by monetary authorities in order to stimulate economic growth. It is to be noted that the above-mentioned objectives are inter related, inter dependent and inter connected with each other. Each one of the objectives would affect the other and in its turn is influenced by the others. Many objectives would come in clash with others under certain circumstances. A proper balance between different objectives becomes imperative. Monetary authorities have to determine the priorities depending upon the economic environment in a country. Thus, there is great need for compromise between different objectives. INSTRUMENTS OF MONETARY POLICY The instruments of monetary policy used by the Central Bank depend on the level of development of the economy, especially its financial sector. The commonly used instruments are discussed below. 1. Reserve Requirement: The Central Bank may require Deposit Money Banks to hold a fraction (or a combination) of their deposit liabilities (reserves) as vault cash and or deposits with it. Fractional reserve limits the amount of loans banks can make to the domestic economy and thus limit the supply of money. The assumption is that Deposit Money Banks generally maintain a stable relationship between their reserve holdings and the amount of credit they extend to the public. 2. Open Market Operations: The Central Bank buys or sells ((on behalf of the Fiscal Authorities (the Treasury)) securities to the banking and nonbanking public (that is in the open market). One such security is Treasury Bills. When the Central Bank sells securities, it reduces the supply of reserves and when it buys (back) securities-by redeeming them-it increases the supply of reserves to the Deposit Money Banks, thus affecting the supply of money.

3. Lending by the Central Bank: The Central Bank sometimes provide credit to Deposit Money Banks, thus affecting the level of reserves and hence the monetary base. 2 4. Interest Rate: The Central Bank lends to financially sound Deposit Money Banks at a most favourable rate of interest, called the minimum rediscount rate (MRR). The MRR sets the floor for the interest rate regime in the money market (the nominal anchor rate) and thereby affects the supply of credit, the supply of savings (which affects the supply of reserves and monetary aggregate) and the supply of investment (which affects full employment and GDP). 5. Direct Credit Control: The Central Bank can direct Deposit Money Banks on the maximum percentage or amount of loans (credit ceilings) to different economic sectors or activities, interest rate caps, liquid asset ratio and issue credit guarantee to preferred loans. In this way the available savings is allocated and investment directed in particular directions. 6. Moral Suasion: The Central Bank issues licenses or operating permit to Deposit Money Banks and also regulates the operation of the banking system. It can, from this advantage, persuade banks to follow certain paths such as credit restraint or expansion, increased savings mobilization and promotion of exports through financial support, which otherwise they may not do, on the basis of their risk/return assessment. 7. Prudential Guidelines: The Central Bank may in writing require the Deposit Money Banks to exercise particular care in their operations in order that specified outcomes are realized. Key elements of prudential guidelines remove some discretion from bank management and replace it with rules in decision making. 8. Exchange Rate: The balance of payments can be in deficit or in surplus and each of these affect the monetary base, and hence the money supply in one direction or the other. By selling or buying foreign exchange, the Central Bank ensures that the exchange rate is at levels that do not affect domestic money supply in undesired direction, through the balance of payments and the real 3 exchange rate. The real exchange rate when misaligned affects the current account balance because of its impact on external competitiveness.

Q5. Explain in brief the relationship between TR, AR, and MR under different market condition. Ans. Meaning and Different Types of Revenues
Revenue is the income received by the firm. There are three concepts of revenue 1. Total revenue (T.R) 2. Average revenue (A.R) 3. Marginal revenue (M.R) 1. Total revenue (TR): Total revenue refers to the total amount of money that the firm receives from the sale of its products, i.e. .gross revenue. In other words, it is the total sales receipts earned from the sale of its total output produced over a given period of time. In brief, it refers to the total sales proceeds. It will vary with the firms output and sales. We may show total revenue as a function of the total quantity sold at a given price as below. TR = f (q). It implies that higher the sales, larger would be the TR and vice-versa. TR is calculated by multiplying the quantity sold by its price. Thus, TR = PXQ. For e.g. a firm sells 5000 units of a commodity at the rate of Rs. 5 per unit, then TR would be

2. Average revenue (AR) Average revenue is the revenue per unit of the commodity sold. It can be obtained by dividing the TR by the number of units sold.

Then, AR = TR/Q AR = 150/15= 10. When different units of a commodity are sold at the same price, in the market, average revenue equals price at which the commodity is sold for e.g. 2 units are sold at the rate of Rs.10 per unit, then total revenue would be Rs. 20 (210). Thus AR = TR/Q 20/2 = 10. Thus average revenue means price. Since the demand curve shows the relationship between price and the quantity demanded, it also represents the average revenue or price at which the various amounts of a commodity are sold, because the price offered by the buyer is the revenue from sellers point of view. Therefore, average revenue curve of the firm is the same as demand curve of the consumer. Therefore, in economics we use AR and price as synonymous except in the context of price discrimination by the seller. Mathematically P = AR. 3. Marginal Revenue (MR) Marginal revenue is the net increase in total revenue realized from selling one more unit of a product. It is the additional revenue earned by selling an additional unit of output by the seller. MR differs from the price of the product because it takes into account the effect of changes in price. For example if a firm can sell 10 units at Rs.20 each or 11 units at Rs.19 each, then the marginal revenue from the eleventh unit is (10 20) - (11 19) = Rs.9. Relationship between Total revenue, Average revenue and Marginal Revenue concepts In order to understand the relationship between TR, AR and MR, we can prepare a hypothetical revenue schedule.

From the table, it is clear that: MR falls as more units are sold. TR increases as more units are sold but at a diminishing rate.TR is the highest when MR is zero TR falls when MR become negative AR and MR both falls, but fall in MR is greater than AR i.e., MR falls more steeply than AR. Relationship between AR and MR and the nature of AR and MR curves under difference market conditions 1. under Perfect Market Under perfect competition, an individual firm by its own action cannot influence the market price. The market price is determined by the interaction between demand and supply forces. A firm can sell any amount of goods at the existing market prices. Hence, the TR of the firm would increase proportionately with the output offered for sale. When the total revenue increases in direct proportion to the sale of output, the AR would remain constant. Since the market price of it is constant without any variation due to changes in the units sold by the individual firm, the extra output would fetch proportionate increase in the revenue. Hence, MR & AR will be equal to each other and remain constant. This will be equal to price.

Under perfect market condition, the AR curve will be a horizontal straight line and parallel to OX axis. This is because a firm has to sell its product at the constant existing market price. The MR cure also coincides with the AR curve. This is because additional units are sold at the same constant price in the market.

3. Under Imperfect Market

Under all forms of imperfect markets, the relation between TR, AR, and MR is different. This can be understood with the help of the following imaginary revenue schedule.

From the above table it is clear that: In order to increase the sales, a firm is reducing its price, hence AR falls As a result of fall in price, TR increase but at a diminishing rate TR will be higher when MR is zero TR falls when MR becomes negative From the above table it is clear that: In order to increase the sales, a firm is reducing its price, hence AR falls. As a result of fall in price, TR increase but at a diminishing rate. TR will be higher when MR is zero TR falls when MR becomes negative AR and MR both declines. But fall in MR will be greater than the fall in AR.

The relationship between AR and MR curves is determined by the elasticity of demand on the average revenue curve.

Under imperfect market, the AR curve of an individual firm slope downwards from left to right. This is because; a firm can sell larger quantities only when it reduces the price. Hence, AR curve has a negative slope. The MR curve is similar to that of the AR curve. But MR is less than AR. AR and MR curves are different. Generally MR curve lies below the AR curve.

The AR curve of the firm or the seller and the demand curve of the buyer is the same Since, the demand curve represents graphically the quantities demanded by the buyers at various prices it shows the AR at which the various amounts of the goods that are sold by the seller. This is because the price paid by the buyer is the revenue for the seller (One mans expenditure is another mans income). Hence, the AR curve of the firm is the same thing as that of the demand curve of the consumers.

Suppose, a consumer buys 10 units of a product when the price per unit is Rs.5 per unit. Hence, the total expenditure is 10 x 5 = Rs.50/-. The seller is selling 10 units at the rate of Rs.5 per unit. Hence, his total income is 10 x 5 = Rs.50/-. Thus, it is clear that AR curve and demand curve is really one and the same.

Q6. What is a business cycle? Describe the different phases of a business cycle. Ans: Business Cycle:
The term business cycle refers to a wave like fluctuation in the overall level of economic activity particularly in national output, income, employment and prices that occur in a more or less regular time sequence. It is nothing but rhythmic fluctuations in the aggregate level of economic activity of a nation. Different writers have defined business cycles in different ways. According to Prof. Haberler: The business cycle in the general sense may be defined as an alternation of periods of prosperity and depression of good and bad trade. In the words of Prof. Gordon: Business cycles consists of recurring alternations of expansion and contraction in aggregate economic activity, the alternating movements in each direction being self- reinforcing and pervading virtually all parts of the economy. According to Keynes: A trade cycle is composed of periods of good trade characterized by rising prices and low unemployment percentages, alternating with periods of bad trade characterized by falling prices and high unemployment percentages. Thus, one can notice a common feature in all these definitions, i.e., variations in the aggregate level of economic activities in different magnitudes. Phases of a Business Cycle: A Business Cycle has Five Phases. They are as follows: 1. Depression, contraction or downswing

It is the first phase of a trade cycle. It is a protracted period in which business activity is far below the normal level and is extremely low. According to Prof. Haberler depression is a state of affairs in which the real income consumed or volume of production per head and the rate of employment are falling and are sub-normal in the sense that there are idle resources and unused capacity, especially unused labor. During depression, all construction activities come to a more or less halting stage. Capital goods industries suffer more than consumer goods industries. Since costs are sticky and do not fall as rapidly as prices, the producers suffer heavy losses. Prices of agricultural goods fall rapidly than industrial goods. During this period purchasing power of money is very high but the general purchasing power of the community is very low. Thus, the aggregate level of economic activity reaches its rock bottom position. It is the stage of trough. The economy enters the phase of depression, as the process of depression is complete. It is also called, the period of slump. During this period, there is disorder, demoralization, dislocation and disturbances in the normal working of the economic system. Consequently, one can notice all-round pessimism, frustration and despair. The entire atmosphere is gloomy and hopes are less. It is a period of great suffering and hardship to the people. Thus, it is the worst and most fearful phase of the business cycle. 2. Recovery or revival Depression cannot last long, forever. After a period of depression, recovery starts. It is a period where in, economic activities receive stimulus and recover from the shocks. This is the lower turning point from depression to revival towards upswing. Depression carries with itself the seeds of its own recovery. After sometime, the rays of hope appear on the business horizon. Pessimism is slowly replaced by optimism. Recovery helps to restore the confidence of the business people and create a favorable climate for business ventures. As a result of these factors, business people take more risks and invest more. Low wages and low interest rates, low production costs, recovery in marginal efficiency of capital etc induce the business people to take up new ventures. In the early phase of the revival, there is considerable excess capacity in the economy so, the output increases without a proportionate increase in total costs. Repairs, renewals and replacement of plants take place. Increase in government expenditure stimulates the demand for consumption goods, which in its turn pushes up the demand for capital goods. Construction activity receives an impetus. As a result, the level of output, income, employment, wages, prices, profits, start rising. Rise in dividends induce the producers to float fresh investment proposals in the stock market. Recovery in stock market begins.

Share prices go up. Optimistic expectations generate a favorable climate for new investment. Attracted by the profits, banks lend more money leading to a high level of investment. The upward trends in business give a sort of fillip to economic activity. Through multiplier and acceleration effects, the economy moves upward rapidly. It is to be noted that revival may be slow or fast, weak or strong; the wave of recovery once initiated begins to feed upon itself. Generally, the process of recovery once started takes the economy to the peak of prosperity. 3. Prosperity or Full-employment The recovery once started gathers momentum. The cumulative process of recovery continues till the economy reaches full employment. Full employment may be defined as a situation where in all available resources are fully employed at the current wage rate. Hence, achieving full employment has become the most important objective of all most all economies. Now, there is all round stability in output, wages, prices, income, etc. According to Prof. Haberler Prosperity is a state of affair in which the real income consumed, produced and the level of employment are high or rising and there are no idle resources or unemployed workers or very few of either. 4. Boom or Over full Employment or Inflation The prosperity phase does not stop at full employment. It gives way to the emergence of a boom. It is a phase where in there will be an artificial and temporary prosperity in an economy. Business optimism stimulates further investment leading to rapid expansion in all spheres of business activities during the stage of full employment, unutilized capacity gradually disappears. Idle resources are fully employed. Hence, rise in investment can only mean increased pressure for the available men and materials. Factor inputs become scarce commanding higher remuneration. This leads to a rise in wages and prices. Production costs go up. Consequently, higher output is obtained only at a higher cost of production. Once full employment is reached, a further increase in the demand for factor inputs will lead to an increase in prices rather than an increase in output and income. Demand for Loanable funds increases leading to a rise in interest rates. Now there will be hectic economic activity. Soon a situation develops in which the number of jobs exceed the number of workers available in the market. Such a situation is known as overfull employment or hyper-employment. The boom carries with it the gems of its own destruction. The prosperity phase comes to an end when the forces favoring expansion becomes progressively weak. Bottlenecks begin to appear. Scarcity of factor inputs and rise in their prices disturb the cost calculations of the entrepreneurs. Now the entrepreneurs

realize that they have over stepped the mark and become over cautious and their over-optimism paves the way for their pessimism. Thus, prosperity digs its own grave. Generally the failure of a company or a bank bursts the boom and ushers in a recession. 5. Recession A turn from prosperity to Depression The period of recession begins when the phase of prosperity ends. It is a period of time where in the aggregate level of economic activity starts declining. There is contraction or slowing down of business activities. After reaching the peak point, demand for goods decline. Over investment and production creates imbalance between supply and demand. Inventories of finished goods pile up. Future investment plans are given up. Orders placed for new equipments and raw materials and other inputs are cancelled. Replacement of worn out capital is postponed. The cancellation of orders for the inputs by the producers of consumer goods creates a chain reaction in the input market. Incomes of the factor inputs decline this creates demand recession. In order to get rid of their high inventories, and to clear off their bank obligations, producers reduce market prices. In anticipation of further fall in prices, consumers postpone their purchases. Production schedules by firms are curtailed and workers are laid-off. Banks curtail credit. Share prices decline and there will be slackness in stock and financial market. Consequently, there will be a decline in investment, employment, income and consumption. Liquidity preference suddenly develops. Multiplier and accelerator work in the reverse direction. Unemployment sets in the capital goods industries and with the passage of time, it spreads to other industries also. The process of recession is complete. The wave of pessimism gets transmitted to other sectors of the economy. The whole economic system thereby runs in to a crisis. Failure of some business creates panic among businessmen and their confidence is shaken. Business pessimism during this period is characterized by a feeling of hesitation, nervousness, doubt and fear. Prof. M. W. Lee remarks, A recession, once started, tends to build upon itself much as forest fire. Once under way, it tends to create its own drafts and find internal impetus to its destructive ability. Once the recession starts, it becomes almost difficult to stop the rot. It goes on gathering momentum and finally converts itself in to a full- fledged depression, which is the period of utmost suffering for businessmen. Thus, now we have a full description about a business cycle. A detailed study of the various phases of a business cycle is of paramount importance to the management. It helps the management to formulate various anti-cyclical measures to be taken up to check the adverse effects of a trade cycle and create the necessary conditions for ensuring stability in business.