University of Mahatma Gandhi

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Scheduled unit details
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MP 103

Unit title

Managerial Economics
Year
2015/2016
Study period
2015
Mr.Brian Paul

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Managerial Economics Assignment

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3000

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15th August 2015
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this material elsewhere, I have not presented it for examination / assessment in any other course
or unit at this or any other institution
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ABSTRACT

This report has been prepared for the Managerial Economics assignment.
Which includes some important theories and the use of the consumer demand
to supply. The report signifies the answers to the given questions in the
assignment.
The directions of Mr. Brian Paul and the authorized literal sources have been
used to address the requested matters and answering questions. I must thank
the provided directions of Mahathma Gandhi University and whoever
supported me to conclude this assignment successfully.

Thank You!

TABLE OF CONTENTS
ABSTRACT.............................................................................................................................3
1.

QUESTION ONE.............................................................................................................5
1.1.

Demand......................................................................................................................5

1.2.

Supply......................................................................................................................10

1.3.

Answer for question A.........................................................................................13

2.

QUESTION TWO..........................................................................................................15

3.

QUESTION THREE......................................................................................................16

4.

5.

3.1.

Types of exchange rate.............................................................................................16

3.2.

Long-term trends......................................................................................................17

3.3.

China's exchange rate policy....................................................................................18

3.4.

Reasons for a stable exchange rate..........................................................................18

3.5.

By-products of a fixed exchange rate......................................................................18

3.6.

Effects from sterilized intervention.........................................................................19

QUESTION FOUR........................................................................................................20
4.1.

Budget deficit...........................................................................................................20

4.2.

Public debt...............................................................................................................20

REFERENCES...............................................................................................................21

1. QUESTION ONE
1.1.

Demand

The demand can be defined as the quantity of a product an individual is willing to purchase
at a specific time and at a specific amount of money. Demand implies a desire supported by
an ability and
1) Desire.
2) Willingness.
3) Ability of an individual to pay for the product.

Demand is also influenced by a number of factors which determine the relationship between
demand and the willingness of a person to buy that product. These determinants are as
shown in below figure.

Tastes and
Preferences of
Consumers
Distribution of
Income in the
Society

Effect of
Advertisements

Price of a
Product or
Service

Determinants
of Demand
Income

Expectations of
Consumers

Price of Related
Goods

Figure 1: Determinnts of Demand

Following are the determinants of demand for a product:

1) Price of a Product or Service:

Affects the demand of a product to a large extent. There is an inverse relationship between
the price of a product and quantity demanded. The demand for a product decreases with
increase in its price, while other factors are constant, and vice versa.
For example, consumers prefer to purchase a product in a large quantity when the price of
the product is less. The price-demand relationship marks a significant contribution in
oligopolistic market where the success of an organization depends on the result of price war
between the organization and its competitors.
2) Income:

Constitutes one of the important determinants of demand. The income of a consumer affects
his/her purchasing power, which, in turn, influences the demand for a product. Increase in
the income of a consumer would automatically increase the demand for products by him/her,
while other factors are at constant, and vice versa.
For example, if the salary of Mr. X increases, then he may increase the pocket money of his
children and buy luxury items for his family. This would increase the demand of different
products from a single family. The income-demand relationship can be analyzed by
grouping goods into four categories, namely,
I.

Essential consumer goods

II.

Inferior goods

III.

Normal goods

IV.

Luxury goods.

3) Tastes and Preferences of Consumers:

Play a major role in influencing the individual and market demand of a product. The tastes
and preferences of consumers are affected due to various factors, such as life styles,
customs, common habits, and change in fashion, standard of living, religious values, age,
and sex.

A change in any of these factors leads to change in the tastes and preferences of consumers.
Consequently, consumers reduce the consumption of old products and add new products for
their consumption. For example, if there is change in fashion, consumers would prefer new
and advanced products over old- fashioned products, provided differences in prices are
proportionate to their income.
Apart from this, demand is also influenced by the habits of consumers. For instance, most of
the Muslims are non-pork consumers; therefore, the demand for non-pork products is higher
in Muslim populated areas. In addition, sex ratio has a relative impact on the demand for
many products.
For instance, if females are large in number as compared to males in a particular area, then
the demand for feminine products, such as make-up kits and cosmetics, would be high in
that area.

4)

Price of Related Goods:

Refer to the fact that the demand for a specific product is influenced by the price of related
goods to a greater extent.
Related goods can be of two types, namely, substitutes and complementary goods, which are
explained as follows:
A. Substitutes:

Refer to goods that satisfy the same need of consumers but at a different price. For example,
tea and coffee and groundnut oil and sunflower oil are substitute to each other. The increase
in the price of a good results in increase in the demand of its substitute with low price.
Therefore, consumers usually prefer to purchase a substitute, if the price of a particular good
gets increased.
B. Complementary Goods:

Refer to goods that are consumed simultaneously or in combination. In other words,

complementary goods are consumed together. For example, pen and ink, car and petrol, and
tea and sugar are used together. Therefore, the demand for complementary goods changes
simultaneously. The complementary goods are inversely related to each other. For example,
increase in the prices of petrol would decrease the demand of cars.

5)

Expectations of Consumers:

Imply that expectations of consumers about future changes in the price of a product affect
the demand for that product in the short run. For example, if consumers expect that the
prices of petrol would rise in the next week, then the demand of petrol would increase in the
present.
On the other hand, consumers would delay the purchase of products whose prices are
expected to be decreased in future, especially in case of non-essential products. Apart from
this, if consumers anticipate an increase in their income, this would result in increase in
demand for certain products. Moreover, the scarcity of specific products in future would also
lead to increase in their demand in present.

6)

Effect of Advertisements:

Refers to one of the important factors of determining the demand for a product. Effective
advertisements are helpful in many ways, such as catching the attention of consumers,
informing them about the availability of a product, demonstrating the features of the product
to potential consumers, and persuading them to purchase the product. Consumers are highly
sensitive about advertisements as sometimes they get attached to advertisements endorsed
by their favorite celebrities. This results in the increase demand for a product.

7)

Distribution of Income in the Society:

Influences the demand for a product in the market to a large extent. If income is equally
distributed among people in the society, the demand for products would be higher than in
case of unequal distribution of income. However, the distribution of income in the society
varies widely.
This leads to the high or low consumption of a product by different segments of the society.
For example, the high income segment of the society would prefer luxury goods, while the
low income segment would prefer necessary goods. In such a scenario, demand for luxury
goods would increase in the high income segment, whereas demand for necessity goods
would increase in the low income segment.
8

8) Growth of Population:

Acts as a crucial factor that affect the market demand of a product. If the number of
consumers increases in the market, the consumption capacity of consumers would also
increase. Therefore, high growth of population would result in the increase in the demand
for different products.

9)

Government Policy:

Refers to one of the major factors that affect the demand for a product. For example, if a
product has high tax rate, this would increase the price of the product. This would result in
the decrease in demand for a product. Similarly, the credit policies of a country also induce
the demand for a product. For example, if sufficient amount of credit is available to
consumers, this would increase the demand for products.

10) Climatic Conditions:

Affect the demand of a product to a greater extent. For example, the demand of ice-creams
and cold drinks increases in summer, while tea and coffee are preferred in winter. Some
products have a stronger demand in hilly areas than in plains. Therefore, individuals demand
different products in different climatic conditions.
Supply refers to the quantity of a product available in the market for sale at a specified price
at a given point of time. Unlike demand the supply refers to the willingness of a seller to sell
the specified amount of product within a particular price and time. Supply is always defined
in relation to price and time. For example, if a seller agrees to sell 500 kgs of wheat, it
cannot be considered as supply of wheat as the price and time factors are missing.
Apart from this, the supply also depends on the stock and market price of the product. Stock
of a product refers to quantity of a product available in the market for sale within a specified
point of time.

Supply can be influenced by a number of factors that are termed as determinants of supply.
Generally, the supply of a product depends on its price and cost of production. In simple
terms, supply is the function of price and cost of production.
1.2.

Supply

Price

Govt's
policies

Factor prices
and their
availability

Cost of
Production

Determinants
of supply

Transport
Conditios

Natural
Conditions

Technology

Figure 2: Determinants of Supply

Some of the factors that influence the supply of a product are described as follows:

10

1) Price:
Refers to the main factor that influences the supply of a product to a greater extent. Unlike
demand, there is a direct relationship between the price of a product and its supply. If the
price of a product increases, then the supply of the product also increases and vice versa.
Change in supply with respect to the change in price is termed as the variation in supply of a
product.
Speculation about future price can also affect the supply of a product. If the price of a
product is about to rise in future, the supply of the product would decrease in the present
market because of the profit expected by a seller in future. However, the fall in the price of a
product in future would increase the supply of product in the present market.
2) Cost of Production:
Implies that the supply of a product would decrease with increase in the cost of production
and vice versa. The supply of a product and cost of production are inversely related to each
other. For example, a seller would supply less quantity of a product in the market, when the
cost of production exceeds the market price of the product.
In such a case the seller would wait for the rise in price in future. The cost of production
rises due to several factors, such as loss of fertility of land, high wage rates of labor, and
increase in the prices of raw material, transport cost, and tax rate.
3) Natural Conditions:
Implies that climatic conditions directly affect the supply of certain products. For example,
the supply of agricultural products increases when monsoon comes on time. However, the
supply of these products decreases at the time of drought. Some of the crops are climate
specific and their growth purely depends on climatic conditions. For example Paddy Rice
are well grown at the time of summer, while Cabbage are produce well in winter season.
4) Technology:
Refers to one of the important determinant of supply. A better and advanced technology
increases the production of a product, which results in the increase in the supply of the
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product. For example, the production of fertilizers and good quality seeds increases the
production of crops. This further increase the supply of food grains in the market.
5) Transport Conditions:
Refer to the fact that better transport facilities increase the supply of products. Transport is
always a constraint to the supply of products, as the products are not available on time due
to poor transport facilities. Therefore even if the price of a product increases, the supply
would not increase.
In Sri Lanka sellers usually use road transport and the poorly maintained road makes it
difficult to reach the destination on time the products that are manufactured in one part of
the city need to be spread in the whole country through road transport This may result in the
damage of most of the products during the journey, which can cause heavy loss for a seller.
In addition the seller can also lose his/her customers because of the delay in. the delivery of
products.

6) Factor Prices and their Availability:

Act as one of the major determinant of supply. The inputs, such as raw material man,
equipment, and machines, required at the time of production are termed as factors. If the
factors are available in sufficient quantity and at lower price, then there would be increase in
production.
This would increase the supply of a product in the market. For example, availability of
cheap labor and raw material nearby the manufacturing plant of an organization would help
in reducing the labor and transportation costs. Consequently, the production and supply of
the product would increase.
7) Governments Policies:
Implies that the different policies of government, such as fiscal policy and industrial policy,
has a greater impact on the supply of a product. For example, increase in tax on excise duties
would decrease the supply of a product. On the other hand, if the tax rate is low, then the
supply of a product would increase.
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8) Prices of Related Goods:

Refer to fact that the prices of substitutes and complementary goods also affect the supply of
a product. For example, if the price of wheat increases, then farmers would tend to grow
more wheat than nee. This would decrease the supply of rice in the market.
The interaction between demand and supply helps in determining the market equilibrium
price of a product. Equilibrium price refers to the price where the quantity demanded of a
product by buyers is equal to the quantity supplied by sellers. In other words, equilibrium
price is a price when there is a product can change due to various conditions, such as
reduction in cost of production, fall in the price of substitutes, and unfavorable climatic
conditions.

1.3.

Reasoning

Demand for good is generally associated with the demand for another good. Demand for
complementary goods as automobiles and petrol are consumed jointly. The petrol is the one
of outcomes from crude oil. When crude oil prices fall, this fallen price of one good would
not affect its demand. Until there is a change in the price of its complementary goods.
Similarly with this decline maintaining automobiles has become cheap and due to that
reason automobile demand has grown. Ethanol is used as a fuel and can be used in ordinary
car engines to reduce the use of petrol. And it is considered as the substitute product for
petrol and with the fallen of crude oil prices Ethanol usage become town and consumers
demanding more petrols for automobiles due to cheapness of that. Since demand of the
Ethanol become reduce.
The low of supply scales the direct relationship between the price of product and qty
supplied of the product. In simple words, if the price of a product increases, the quantity
supplied of the product would also increases on the other hand, if there is fall in the price of
product, then the quantity supplied of the product would also decrease. In practical
implications, should need to degree on extend of change in the quantity supplied of a
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product with respect to change in the price of the product. This is known as the elasticity of
the supply. It can be calculated as,

percentage changequantity suppilied

percentage change price

percentage changeqty supplied=

Perentage change price=

New qty supplied

Original qty supplied

New price( P)
Original price( P)

Eg. =

S
S

P
P

S
S

P
P

S
P

P
S

There are different types of elasticity of supplies like perfect elastic supply, relatively elastic
supply, relatively inelastic supply, Unit elastic supply, Perfect inelastic supply.
Apart from this there are functions determining elasticity of supply, numerical value of
elasticity of supply and those are different from different situations such as,
14

Production Technology
Time period
Scale of production
Agriculture product

2. QUESTION TWO
In economics, austerity is a set of policies with the aim of reducing government budget
deficits. Austerity policies may include spending cuts, tax increases, or a mixture of both.
Austerity may be undertaken to demonstrate the government's fiscal discipline to their
creditors and credit rating agencies by bringing revenues closer to expenditures. In most
macroeconomic models, austerity policies generally increase unemployment in the short run,
as government spending falls reducing jobs in the public and private sector or both, while
tax increases reduce household disposable income and thus consumption. The U.S.
Congressional Budget Office illustrated this when comparing unemployment under
alternative fiscal scenarios.
Unemployment increases safety net spending and further reduces tax revenues, partially
offsetting the austerity measures. Government spending contributes to gross domestic
15

product (GDP), so reducing spending may result in a higher debt-to-GDP ratio, a key
measure of the debt burden carried by a country and its citizens. Higher short-term deficit
spending (stimulus) contributes to GDP growth particularly when consumers and businesses
are unwilling or unable to spend. This is because crowding out (i.e., rising interest rates as
government bids against business for a finite amount of savings, slowing the economy) is
less of a factor in a downturn, as there may be a surplus of savings.
In the aftermath of the Great Recession, austerity results in Europe have been as predicted
by macroeconomics, with unemployment rising to record levels and debt-to-GDP ratios
rising, despite reductions in budget deficits relative to GDP. Eurostat reported that
unemployment in the 17 Euro area countries (EA17) reached record levels in March 2013, at
12.1%, up from 11.0% in March 2012 and 10.3% in March 2011; and that the overall debtto-GDP ratio for the EA17 was 70.1% in 2008, 80.0% in 2009, 85.4% in 2010, 87.3% in
2011, and 90.6% in 2012. Further, real GDP in the EA17 declined for six straight quarters
from Q4 2011 to Q1 2013. The U.S. Congressional Budget Office estimated in August 2012
that if the U.S. implemented moderate austerity measures, the unemployment rate would rise
by over 1% and economic growth would be significantly reduced in 2013. The U.S. partially
avoided the "fiscal cliff" through the American Taxpayer Relief Act of 2012. U.S.
unemployment has fallen steadily from a peak of 10% in early 2010 to 5.3% by July 2015.

3. QUESTION THREE
The exchange rate expresses the national currency's quotation in respect to foreign ones. For
example, if one US dollar is worth 10 000 Japanese Yen, then the exchange rate of dollar is
10 000 Yen. If something costs 30 000 Yen, it automatically costs 3 US dollars as a matter of
accountancy. Going on with fictious numbers, a Japan GDP of 8 million Yen would then be
worth 800 Dollars.
Thus, the exchange rate is a conversion factor, a multiplier or a ratio, depending on the
direction of conversion.

16

In a slightly different perspective, the exchange rate is a price. If the exchange rate can
freely move, the exchange rate may turn out to be the fastest moving price in the economy,
bringing together all the foreign goods with it.
3.1.

Types of exchange rate

It is customary to distinguish nominal exchange rates from real exchange rates. Nominal
exchange rates are established on currency financial markets called "forex markets", which
are similar to stock exchange markets. Rates are usually established in continuous quotation,
with newspaper reporting daily quotation (as average or finishing quotation in the trade day
on a specific market). Central bank may also fix the nominal exchange rate.
Real exchange rates are nominal rate corrected somehow by inflation measures. For
instance, if a country A has an inflation rate of 10%, country B an inflation of 5%, and no
changes in the nominal exchange rate took place, then country A has now a currency whose
real value is 10%-5%=5% higher than before [1]. In fact, higher prices mean an appreciation
of the real exchange rate, other things equal.
Another classification of exchange rates is based on the number of currencies taken into
account. Bilateral exchange rates clearly relate to two countries' currencies. They are usually
the results of matching of demand and supply on financial markets or in banking transaction.
In this latter case, the central bank acts usually as one of the sides of the relationship.
Other bilateral exchange rates may be simply computed from triangular relationships: if the
exchange rate dollar/yen is 10 000 and the dollar/Angolan kwanza is 100 000 then, as a
matter of computation, one yen is worth 10 kwanza. No direct yen/kwanza transaction needs
to take place. If, instead, a financial market exists for yen to be exchanged with kwanza, the
expectation is that actions by speculators (arbitrage among markets) will bring the parity of
10 kwanza per yen as an effect.
Multilateral exchange rates are computed in order to judge the general dynamics of a
country's currency toward the rest of the world. One takes a basket of different currencies,

17

select a (more or less) meaningful set of relative weights, then computes the "effective"
exchange rate of that country's currency.
For instance, having a basket made up of 40% US dollars and 60% German marks, a
currency that suffered from a value loss of 10% in respect to dollar and 40% to mark will be
said having faced an "effective" loss of 10%x0.6 + 40%x0.4 = 22%.
Some countries impose the existence of more than one exchange rate, depending on the type
and the subjects of the transaction. Multiple exchange rates then exist, usually referring to
commercial vs. public transactions or consumption and investment imports. This situation
requires always some degree of capital controls.

3.2.

Long-term trends

Some geographical monetary areas have enjoyed long periods of stable exchange rate, with
moments of consensual realignment after divergence in inflation rates. Many countries strive
to keep their currency at a fixed level toward the dollar, the Euro (earlier the German mark)
or a basket with multiple currencies.
Still, most currency progressively devaluate, especially those issued by periphery
countries. The US dollar has extremely wide fluctuations with years of "weak" and
"strong" dollar.

3.3.

China's exchange rate policy

Chinas exchange rate is being controlled by government authorities: the Peoples Bank of
China (PBoC: Chinas central bank) manages the value of the renminbi. They do so by
fixing the USD/CNY-rate on each trading day. This is the exchange rate that applies to trade
flows into and out of China only.

18

3.4.

Reasons for a stable exchange rate

A prime reason for China to keep the value of its currency low versus its trade partners, is
that it makes Chinas exports cheaper, and thus more attractive. China believes such an
exchange rate policy is required to sustain a high growth rate. As a result of the managed
exchange rate that keeps the renminbi relatively cheap, Chinas growth depends to a large
degree on exports. Moreover, a stable exchange rate eliminates part of the exchange rate
uncertainty for Chinese exporters and importers and their trading partners.
3.5.

By-products of a fixed exchange rate

However, there are also several adverse effects that a fixed exchange rate creates.
Firstly, a necessary by-product of fixing the exchange rates is capital controls. Chinas
financial markets are therefore relatively closed. For example, investments into China can
only be made under strict regulations and requirements.
Secondly, a fixed exchange rate is only attainable if the PBoC stands ready to exchange
renminbi for US dollars and vice versa at the announced USD/CNY-rate. If a Chinese
exporter receives US dollars for its exported products, US dollars are converted into
renminbi, which the Chinese exporter receives. As a result of this demand for renminbi and
the supply of US dollars, in theory the US dollar would have to depreciate in value versus
the renminbi. Subsequently, in order to offset the upward pressure this gives on the
renminbi, Chinas central bank sells renminbi in exchange for US dollars or US dollardenominated assets (most notably US Treasuries). Thereby, the PBoC accumulates foreign
reserves. Unfortunately, these reserves typically have relatively low yields, especially
compared to the yields earned on Chinese investments. This is a not-so-welcome by-product
of controlling the exchange rate.
Moreover, if fixing the exchange rate requires selling renminbi to counter any upward
pressure on the currency, it increases the amount of renminbi in the domestic economy: a
build-up of the domestic money supply. As more currency is available, inflationary pressures
arise. This is very undesirable, given that in the past high inflation has often lead to social
unrest.
19

3.6.

Effects from sterilized intervention

The PBoC can avoid these inflationary pressures if its currency intervention is sterilized.
Sterilized intervention means that the extra renminbi created are mopped up by the central
bank through selling central bank and/or government bonds for which is receives renminbi
in return. Hence, when the PBoC uses sterilized intervention, it reverses the expansion of the
domestic supply of renminbi by issuing central bank bonds and receiving renminbi in
exchange. However, if the central bank issues these bonds, it has to make the required
interest payments to the bond holders. This is another cost of sterilized intervention.
Lastly, there are risks associated to the value of the described foreign reserves build-up. As
the foreign exchange reserves of China are close to, or have already passed, 50% of Chinas
GDP, and given that most of the reserves are denominated in US dollar, a drop in the value
of the dollar or dollar assets imply enormous costs for the Chinese.

4. QUESTION FOUR
4.1.

Budget deficit

A status of financial health in which expenditures exceed revenue. The term "budget deficit"
is most commonly used to refer to government spending rather than business or individual
spending. When referring to accrued federal government deficits, the term "national debt is
used.

20

4.2.

Public debt

Government debt (also known as public debt, national debt and sovereign debt) is the debt
owed by a central government. (In federal states, "government debt" may also refer to the
debt of a state or provincial, municipal or local government.)

Figure 3: Public Debts of Sri Lanka

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5. REFERENCES
Mahathma Ganghi University (2011. Nov). Managerial Economics . 2nd ed. India : Gazette
of Mehghalaya. 28-60.
Merchent, A.T. 2007. Diet, Forex, investors words in terms of forex and contrail economies
[Online] 6. Available at: http://www.investorwords.com/2045/Forex.html
[Accessed: 2 Aug 2015].
Anon, 2013; Austerity https://en.wikipedia.org/wiki/Austerity [Accessed: 2 Aug
2015].
John Wou, 2014; The Facts of Eggs in China; The great empire of Chinas exchange rate
policy http://www.ecrresearch.com/chinas-exchange-rate-policy [Accessed:
2 Aug 2015].
Anon, 2010. Sri Lankan Debt. Indexmundi copyrights reserved SL fact book; CIA fact book,
http://www.indexmundi.com/g/g.aspx?c=ce&v=143 [Accessed: 2 Aug 2015].

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