Summer 2015

SUBJECT CODE & NAME- MB0042- MANAGERIAL ECONOMICS

Qus:1 Define economies of scale. Discuss the kinds of internal economies.

Definition of economies of scale

Kinds of internal economies

Answer:
Definition of economies of scale:
Mass production of standardized goods has become the order of the day. Large scale
production is beneficial and economical in nature. The advantages or benefits that accrue to a
firm as a result of increase in its scale of production are called economies of scale.
Kinds of internal economies:

Technical economies: These economies arise on account of technological improvements

and their practical application in the field of business.
Economies of superior techniques These economies are the result of the
application of the most modern techniques of production. When the size of the firm
grows, it becomes possible to employ bigger and better types of machinery.
Economies of increased dimension It is found that a firm enjoys the reduction in
cost when it increases its dimension. A large firm avoids wastage of time and
economizes its expenditure.

Managerial Economies: They arise because of better, efficient, and scientific

management of a firm. Such economies arise in two different ways as follows:
Delegation of details The general manager of a firm cannot look after the working
of all processes of production. In order to keep an eye on each production process he
has to delegate some of his powers or functions to trained or specialized personnel
and thus relieve himself for co-ordination, planning and executing the plans.
Functional specialisation It is possible to secure economies of large scale
production by dividing the work of management into several separate departments.
Each department is placed under an expert and the rest of the work is left into the
hands of specialists.

Marketing or commercial economies: These economies arise on account of buying and

selling goods on large scale basis at favourable terms. A large firm can buy raw materials
and other inputs in bulk at concessional rates.

Financial economies: They arise from advantages secured by a firm in mobilizing huge
financial resources. A large firm on account of its reputation, name and fame can mobilize
huge funds from money market, capital market, and other private financial institutions at
concessional interest rates.

Labour economies: These economies arise as a result of employing skilled, trained,

qualified and highly experienced persons by offering higher wages and salaries. As a firm
expands, it can employ a large number of highly talented persons and get the benefits of
specialisation and division of labour.

Transport and storage economies: They arise on account of the provision of better,
highly organised and cheap transport and storage facilities and their complete utilisation.
A large company can have its own fleet of vehicles or means of transport which are more
economical than hired ones.

Overhead economies: These economies arise on account of large scale operations. The
expenses on establishment, administration, book-keeping, etc, are more or less the same
whether production is carried out on a small or large scale.

Q2. Consumers' interview method is a survey method used for estimating the demand
for new products. This method is very important with regard to collect the relevant
information directly from the consumers with regard to their future purchase plans.
Opinion surveys and direct interview method are the two important techniques among
all. Describe these two methods in detail.

Explanation of consumers interview method

Opinion survey method
Direct interview method and any two types of it

Answer:
Consumers interview method:
Under this method, efforts are made to collect the relevant information directly from the
consumers with regard to their future purchase plans. In order to gather information from
consumers, a number of alternative techniques are developed from time to time.
Opinion survey method:
This is a variant of the survey method. This method is also known as Salesforce polling or
Opinion poll method. Under this method, sales representatives, professional experts, the
market consultants and others are asked to express their considered opinions about the
volume of sales expected in the future. The logic and reasoning behind the method is that

these salesmen and other people connected with the sales department are directly involved in
the marketing and selling of the products in different regions.
Direct interview method:
Experience shows that due to varied reasons, many customers do not respond to
questionnaires addressed to them, even if it is simple. Hence, an alternative method is
developed. Under this method, customers are directly contacted and interviewed. Direct and
simple questions are asked to them. They are requested to answer specifically about their
budget, expenditure plans, particular items to be selected, the quality and quantity of
products, relative price preferences, etc. for a particular period of time. There are two
different methods of direct personal interviews. They are as follows:

Complete enumeration method: Under this method, all potential customers are
interviewed in a particular city or a region. The answers elicited are consolidated and
carefully studied to obtain the most probable demand for a product. The management
can safely project the future demand for its products. This method is free from all
types of prejudices. The result mainly depends on the nature of questions asked and
answers received from the customers. However, this method cannot be used
successfully by all sellers in all cases.

Sample survey method or the consumer panel method: Experience of the experts
show that it is impossible to approach all customers therefore, careful sampling of
representative customers is essential. Hence, another variant of complete enumeration
method has been developed, which is popularly known as sample survey method.
Under this method, different cross sections of customers that make up the bulk of the
market are carefully chosen. Only such consumers, who are selected from the relevant
market through some sampling method, are interviewed or surveyed. In other words, a
group of consumers are chosen and queried about their preferences in concrete
situations. The selection of a few customers is known as sampling. The selected
consumers form a panel.This method uses either random sampling or the stratified
sampling technique. The method of survey may be direct interview or mailed
questionnaire to the selected consumers.

Qus:3 A cost-schedule is a statement of variations in costs resulting from variations in

the levels of output and it shows the response of costs to changes in output. If we
represent the relationship between changes in the level of output and costs of
production, we get different types of cost curves in the short run. Define the kinds of
cost concepts like TFC, TVC, TC, AFC, AVC, AC and MC and its corresponding curves
with suitable diagrams for each.

Kinds of cost concepts like TFC, TVC, TC, AFC, AVC, AC and MC and its
corresponding curves
Suitable diagrams

Answer:
Kinds of cost concepts like TFC, TVC, TC, AFC, AVC, AC and MC and its
corresponding curves:
TFC:
TFC refers to total money expenses incurred on fixed inputs like plant, machinery, tools and
equipments in the short run. Total fixed cost corresponds to the fixed inputs in the short run
production function. TFC remains the same at all levels of output in the short run. It is the
same even when output is nil.

Total Fixed Cost Curve

TVC:
TVC refers to total money expenses incurred on the variable factor inputs like raw materials,
power, fuel, water, transport and communication, etc, in the short run. Total variable cost
corresponds to variable inputs in the short run production function. It is obtained by summing

up the quantities of variable inputs multiplied by their prices. The formula to calculate TVC
is as follows. TVC = TC - TFC.TVC = f (Q)

Total Variable Cost Curve

TC:
Total cost refers to the aggregate money expenditure incurred by a firm to produce a given
quantity of output. The total cost is measured in relation to the production function by
multiplying the factor quantities with their prices. TC = f (Q) which means that TC varies
with output. Hence, TC = TFC +TVC.

Total Cost Curve

AFC:

Average fixed cost is the fixed cost per unit of output. When TFC is divided by total units of
output, AFC is obtained, Thus, AFC = TFC/Q. Figure below depicts the average fixed cost
curve.

Average Fixed Cost Curve

AVC:
The average variable cost is variable cost per unit of output. AVC can be computed by
dividing the TVC by total units of output. Thus, AVC = TVC/Q. The AVC will come down in
the beginning and then rise as more units of output are produced with a given plant. This is
because, as we add more units of variable factors in a fixed plant, the efficiency of the inputs
first increases and then decreases.

Average Variable Cost Curve

AC:

AC refers to cost per unit of output. AC is also known as the unit cost since it is the cost per
unit of output produced. AC is the sum of AFC and AVC. Average total cost or average cost is
obtained by dividing the total cost by total output produced. AC = TC/Q. Also, AC is the sum
of AFC and AVC.

Average Cost Curve

MC:
It is obtained by calculating the change in total costs as a result of a change in the total
output. Also, MC is the rate at which total cost changes with output.

Marginal Cost Curve

Qus:4 Inflation is a global Phenomenon which is associated with high price causes
decline in the value for money. It exists when the amount of money in the country is in
excess of the physical volume of goods and services. Explain the reasons for this
monetary phenomenon.

Define Inflation
Causes for Inflation

Answer:
Define Inflation:
Inflation is commonly understood as a situation of substantial and rapid increase in the level
of prices and consequent deterioration in the value of money over a period of time. It refers to
the average rise in the general level of prices and fall in the value of money.

Causes for Inflation:

I. Demand side:
Increase in aggregative effective demand is responsible for inflation. In this case, aggregate
demand exceeds aggregate supply of goods and services. Demand rises much faster than
supply. We can enumerate the following reasons for increase in effective demand.

Increase in money supply Supply of money in circulation increases on account of

the following reasons: deficit financing by the government, expansion in public
expenditure, expansion in bank credit and repayment of past debt by the government
to the people, increase in legal tender money and public borrowing.

Increase in disposable income Aggregate effective demand rises when disposable

income of the people increases. Disposable income rises on account of the following
reasons: reduction in the rates of taxes, increase in national income while tax level
remains constant, and decline in the level of savings.

Increase in exports An increase in the foreign demand for a countrys exports

reduces the stock of goods available for home consumption. This creates shortages in
the country leading to a rise in price level.

II. Supply side:

Generally, the supply of goods and services do not keep pace with the everincreasing demand
for goods and services. Thus, supply does not match the demand. Supply falls short of
demand. Increase in supply of goods and services may be limited because of the following
reasons.

Hoardings by traders and speculators During the period of shortage and rise in
prices, hoardings of essential commodities by traders and speculators with the
objective of earning extra profits in the future creates an artificial scarcity of
commodities.

Hoardings by consumers Consumers may also hoard essential goods to avoid

payment of higher prices in the future.

Role of trade unions Trade union activities leading to industrial unrest in the form
of strikes and lockouts also reduce production.

Role of natural calamities Natural calamities such as earthquake, floods, and

drought conditions also affect the supplies of agricultural products adversely.

III. Role of expectations:

Expectations also play a significant role in accentuating inflation. The following points are
worth mentioning:

If people expect further rise in price, the current aggregate demand increases, which

in turn causes a rise in the prices.

Expectations about higher wages and salaries affect the prices of related goods.

Expectations of wage increase often induce some business houses to increase prices
even before upward wage revisions are actually made.

Qus:5 Describe perfect competition and its features.

Definition of perfect competition

Features

Answer:
Definition of perfect competition:
A perfectly competitive market is one in which the number of buyers and sellers are large, all
engaged in buying and selling a homogeneous product without any artificial restriction and,
possessing perfect knowledge of the market at a time. According to Bilas, the perfect
competition is characterised by the presence of many firms; they all sell the same product
which is identical. The seller is the price-taker. According to Prof. F. Knight, perfect
competition entails Rational conduct on the part of buyers and sellers, full knowledge,
absence of friction, perfect mobility and perfect divisibility of factors of production and
completely static conditions.
Features of perfect competition:
1. Existence of a large number of buyers and sellers A perfectly competitive market will
have large number of sellers and buyers. Output of a seller (firm) will be so small that it is a
negligible fraction of the output of the industry.
2. Homogenous products Different firms constituting the industry produce homogenous
goods. They are identical in character. Hence, no firm can raise its price above the general
level.
3. Free entry and exit of firms There is absolute freedom for firms to get in or get out of the
industry. If the industry is making profits, new firms are attracted into the industry.
Conversely, firms will quit the industry if there are losses.
4. Existence of single price Each unit bought and sold in the market commands the same
price since products are homogeneous.
5. Perfect knowledge of the market All sellers and buyers will have perfect knowledge of
the market. Sellers cannot influence buyers and, vice versa.

6. Perfect mobility of factors of production Factors of production are free to move into any
industry or occupation in order to earn higher rewards. Similarly, they are also free to come
out of the occupation or industry if they feel that they are under remunerated.
7. Full and unrestricted competition Perfectly competitive market is free from all sorts of
monopoly and oligopoly conditions. Since there are a large number of buyers and sellers, it is
difficult for them to join together and form cartels or form organisations. Hence, each firm
acts independently.
8. Absence of transport cost All firms will have equal access to the market. Market price
charged by the sellers should not vary because of the difference in the cost of transportation.
9. Absence of artificial government controls The government should not interfere in
matters pertaining to supply and price. It should not place any barriers in the way of smooth
exchange. Price of a commodity must be determined only by the interaction of supply and
demand forces.
10. The market price is flexible over a period of time Market price changes only because
of changes in either demand or supply force or both. Thus, price is not affected by the sellers,
buyers, firm, industry or the government.
Q6. Define revenue. Explain the types of revenue and the relationship between TR, AR
and MR with an example of a hypothetical revenue schedule.

Definition of revenue
Types of revenue
Relationship between TR, MR and AR
Hypothetical revenue schedule

Answer:
Revenue is the income received by the firm. There are three concepts of revenue total
revenue, average revenue and marginal revenue.
Types of Revenue:
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. We may show total revenue as a function of the total quantity
sold at a given price.
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, e.g. If TR is 150 by selling 10 units, AR = 150/15= 10.
Thus, average revenue means price. Since the demand curve shows the relationship between
price and the quantity demanded, it also represents the average revenue or price at which the
various amounts of a commodity are sold, because the price offered by the buyer is the
revenue from the 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.
Marginal Revenue (MR):
Marginal revenue is the net increase in total revenue realised from selling one more unit of a
product. It is the additional revenue earned by selling an additional unit of output by the
seller.Suppose a firm is selling 4 units of the output at the price of Rs.14 per unit.
Now, if it wants to sell 5 units instead of 4 units and thereby the price of the product falls to
Rs.12 per unit, then the marginal revenue will not be equal to Rs.12 at which the 5th unit is
sold. 4 units, which were sold at the price of Rs.14 before, will all have to be sold at the
reduced price of Rs.12 and that will mean the loss of 2 rupees on each of the previous 4 units.
The total loss on the previous units will be equal to Rs. 8. Therefore, this loss of 8 rupees
should be deducted from the price of Rs. 12 of the 5th unit while calculating the marginal
revenue. The marginal revenue in this case, therefore, will be
Rs. 12 Rs. 8 = Rs. 4 and not Rs. 12 which is the average revenue.
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. Table represents a hypothetical revenue schedule that shows
the relationship between TR, AR and MR.

From the table, it is clear that:

1. MR falls as more units are sold.
2. TR increases as more units are sold but at a diminishing rate.
3. TR is the highest when MR is zero.
4. TR falls when MR becomes negative.
5. AR and MR both fall, but fall in MR is greater than AR i.e., MR falls more steeply than
AR.