Q1. What is a business cycle? Describe the different phases of abusiness cycle.

The business cycle phases define long-term pattern of changes in GrossDomestic P roduct (GDP) that follows four basic stages: expansion, prosperity, contraction, and recession. After a recessionary phase, theexpansion ary phase starts again. The business cycle phases are characterized by changing employment, industrial productivity, and interest rates. Stock analysts believe thatstock pr ices lead the business cycle phases. This economic cycle providesthe strategic f ramework for business activity and investing. Moreover, thebusiness cycle phases affect employees, employers and investors. A business cycle is identified as a sequence of four phases: Expansion Phase: The economy is strong, people are employed andmaking money. Dem and for goods -- food, consumer appliances, electronics, services -- increases to the point where it outstripssupply. This d emand fuels a rise in prices, or inflation. Prosperity Phase: As prices increase, people ask for higher wages. Higher employment costs translate into higher prices for goods, fueling an upward spiral effect. Contraction Phase: When prices get too high, consumers andcompanies curtail thei r spending, as goods and services are tooexpensive. This decreases demand. When demand decreases, companies cut expenses that includes laying off workers, since theydo not need t o make as many goods or provide as much service. Recession Phase: Decreasing demand fuels declining prices, declining GDP, and rising unemployment. This means the economyis in a recession. Expansion Phase begins again: Lower prices eventually spursdemand. As demand pic ks up, people begin buying again, fuelingthe need for greater supply, expansion of credit, new jobs and agrowing economy. When the business cycle doesn't run as expected, it can haveconsequences that ca n be as disastrous as the Great Depression. That'swhy governments intervene to t ry to manage the economy. If it appearsthat inflation is rising too quickly, the Federal Reserve (the central bank ofthe U.S. charged with handling monetary pol icy) may decide to raiseinterest rates to curtail price increases. On the other hand, if the economyis performing poorly, the government may lower taxes to spur consumption and investment and the Federal Reserve may lower interestrates to re duce the cost of borrowing. Interest rates and the yield curve play a very important role indetermining econ omic activity, the phases of the business cycle and theperformance of the stock market. Higher interest rates increase the coststo businesses and individuals. C ompanies must pay more to borrow

money for capital investments or to fund daily business operations. Individuals pay more for mortgages, as well as other loans they may takeout to p urchase products. Higher interest rates also increase the demandfor money to inv est in bonds, competing for money to invest in the stockmarket. The phases of the business cycle have implications for markets andinvestors. Bro adly, a recession often corresponds with a sustained periodof weak stock prices, or a bear market. And a healthy, expandingeconomy that keeps inflation from ris ing too quickly often correspondswith a bull market, or period of sustained mark et growth. Sector Rotation Fortunately, there are investment strategies for each phase of thebusiness cycle . Sam Stovall's Sector Investing, 1996 states that different sectors are stronger at different business cycle phases. The table belowdescribe s this theoretical model showing the phases of the business cycle. Phase: Full Recession Early RecoveryFull RecoveryEarly RecessionConsumer Revivin gRisingDecliningFalling SharplyExpectations:Bottoming OutRisingFlat FallingIndus trial FallingBottoming OutRising RapidlyPeakingProduction: Normal Normal (Steep) (Fed)Flat/Inverted Interest Rates: Flattening Out Yield Curve: The graph below, courtesy of StockCharts.com, shows these relationshipsand the a lignment of the key sectors as they respond to the businesscycle. The stock mark et cycle tends to precede the business cycle by sixmonths on average, as investo rs try to anticipate when the market willrespond to changes in the economy. This means investors are more likelyto beat the market, if they invest in the sector s that line up with thecurrent and next phase of the business cycle. Sector Rotation Model:

Legend: Market Cycle Economic Cycle As shown above the stock market is a leading indicator of the economic orphases of the business cycle. Since the market leads the economy, investors need to pay particular attention to the early signs of a change ineach phase of the business cycle. Many people believe that GDP is the primary indicator of the businesscycle. The National Bureau of Economic Research (NBER) gives relativelylow weight to GDP as a primary business cycle indicator, since the GDP issubject to frequent revisio ns after the fact. In addition, it is only reportedon a quarterly basis. The NBE R is the official organization that defineswhen the U.S. is in a recession and w hen it comes out of one. The NBER relies on indicators that are reported monthly to identify thebusiness cycle phases including: Employment, especially new unemployment claims; Personal income; Industrial production; Sales in key sectors such as housing, autos, durable goods andretail sales; Interest rates and the yield curve; and Commodity prices. By following these indicators carefully, investors can anticipate when toexpect changes in the business cycle. These indicators tend to changetheir trajectory o ver several months, giving investors ample time toidentify a change in the trend . If you believe a change in the phase of thebusiness cycle is underway then it is time to close out sectors that will goout of favor and start new positions in sectors that will come into favour. This strategy will position you to beat the market using the phases of thebusine ss cycle as a guide. Our stock market strategy begins with an understanding of where we arein the the business cycle. Assessing the business cycle phases is the firstof five steps i n our stock market strategy that we use to beat the market. Q2. What is monetary policy? Explain the general objectives andinstruments of mo netary policy Monetary policy is the process by which the monetary authority of acountry contr ols the supply of money, often targeting a rate of interest forthe purpose of pr omoting economic growth and stability.[1] [2] The officialgoals usually include relatively stable prices and low unemployment. Monetary theory provides insight into how to craft optimal monetarypolicy. It is referred to as either being expansionary or contractionary,

where an expansionary policy increases the total supply of money in theeconomy m ore rapidly than usual, and contractionary policy expands themoney supply more s lowly than usual or even shrinks it. Expansionarypolicy is traditionally used to try to combat unemployment in a recessionby lowering interest rates in the hope that easy credit will enticebusinesses into expanding. Contractionary policy is intended to slowinflation in hopes of avoiding the resulting distortions and de terioration ofasset values. Goals of Monetary policy The goals of monetary policy have developed with the evolution centralbanking th ought and the changes in both the behaviour and performanceof different economie s. There is worldwide agreement that the ultimategoals of monetary policy at pre sent in both the developed and developingcountries are price stability and high employment rates, enhancingeconomic growth rates and controlling imbalances in e xternal payments, including the protection of the external purchasing power of the currencythrough maintaining relatively stable levels of exchange rates. Thesegoals, though inte rrelated by their nature, may be contradictory. Thisexplains the importance of c o-ordination among different economicpolicies on the one hand, and the importanc e of diagnosing the economicproblem before taking appropriate treatment measures on the other. Thesignificance of this issue becomes evident when we stress the need toapply rational monetary policies, particularly with regard to thepractica lity of goals pursed by the monetary authorities and the possibilityof achieving these goals without economic consequences that mightaggravate economic problems . Besides the above goals, some people believe that monetary policyshould have oth er important goals, such as high and stable share prices, while others would include the maintenance of low interest rates as a major goal. Others stress increasing the efficiency of the financial systemand m aintaining the soundness of the banking system. In fact, each ofthese goals has special significance and directly relates either to themonetary policy goals dis cussed above or to the intermediate objectivesof monetary policy, which represen t the link between monetaryprocedures and the influence of these procedures on t he path of economicactivity. I believe, however, that despite the differences in viewpointstowards the goals of monetary policy, the goal of increasing the effi ciencyof the financial system and maintaining the soundness and stability of the banking system should rank first. This conviction may be supported by thefact th at the effects of monetary policy measures on the economy occurthrough the banki ng and financial systems, which makes the system sresponse to monetary variables a very important issue. Furthermore, theincreased relative importance of deposit money makes the protection ofthe banking system and enhancing confidence in it o ne of the major goalsof central banks, as it means protecting the mechanism of t he paymentssystem in the economy.

Talking about the monetary portant role central banks ea of developing money and acking. The development of he important instrumentsof Monetary Policy Instruments

policy goals as shown above should notmitigate the im may play in other economicareas, especially in the ar capital markets incountries where these markets are l suchmarkets will enable central banks to use one of t monetary policy, i.e. open market operations.

The set of instruments available to monetary authorities may differ fromone coun try to another, according to differences in political systems, economic structures, statutory and institutional procedures, developmentof money and capital markets and other considerations. In most advancedcapitalist countr ies, monetary authorities use one or more of the followingkey instruments: chang es in the legal reserve ratio, changes in thediscount rate or the official key b ank rate, exchange rates and openmarket operations. In many instances, supplemen tary instruments areused, known as instruments of direct supervision or qualitat iveinstruments. Although the developing countries use one or more of theseinstru ments, taking into consideration the difference in their economicgrowth levels, the dissimilarity in the patterns of their productionstructures and the degree o f their of their link with the outside world, many resort to the method of qualitative supervision, particularly thosecountrie s which face problems arising from the nature of their economic structures. Although the effectiveness of monetary policy does notnecessarily de pend on using a wide range of instruments, coordinated useof various instruments is essential to the application of a rationalmonetary policy. Intermediate Objectives of Monetary Policy The intermediate objectives of monetary policy are defined as a numberof variabl es linking the instruments of monetary policy with their ultimategoals. These va riables are money supply, interest rates, disposable credit, the monetary base or any other variable deemed by the monetaryauthorities as an appropriate intermediate objective for monetary policy. In many instances, these objectives can be used as indicators of theeffects of t he applied monetary policy. This issue, thought it is a majorpivot of the moneta ry policy framework, is still a subject of majorviewpoint differences among econ omists. While monetarists believe thatmonetary authorities must select quantitat ive targets for their monetarypolicy through controlling growth levels in money supply and therebyadopting mostly the monetary base approach, non-monetarists, d espitetheir recognition of the importance of money, see that changes indifferent components of aggregate demand have significant impact on thelevel of economic activity and, therefore, they give basic consideration tothe adoption of price o bjectives through the selection of the interest rateas an intermediate objective representing a link between money andproduction.

The monetarists choice of money supply as a target is based on a numberof hypothe ses or principles. For instance, they believe that money supplyis an exogenous v ariable that is controllable in the long run, and that thedirection of causal re lations in the exchange equation moves from moneyto prices and production. Furth ermore, the strongest final effect will berepresented by high prices, given the stability in the function of demandfor money and a time lag for the effect of mo netary policy, thus avoidingthe adoption of fiscal policies as a stimulus. This is a lengthy issue, and itwould not be appropriate to discuss it in detail here. We can sum up ourpoint of view as follows: a. The selection of intermediate objectives for monetary policy shouldbe made accor ding to the structural characteristics of the concernedeconomies and according t o analytical studies on economicbehaviour, including the demand function for mon ey and thedirections of the general economic policy. The dispute arisingbetween monetarists and non-monetarists relates to other issues than simply the behaviour of the monetary policy to be applied. These issues may affect the nature of the role to be played by thestate in the e conomy. b. The choice of a certain intermediate objective by the monetaryauthorities doe s not necessarily mean that these authorities shouldadhere to that objective all the time. The objective should be reviewed inthe light of structural and behavi oural changes in the economy. Further, both the prevailing economic situation and the change in the priorities ofmoneta ry policy objectives may provide the monetary authorities withsufficient justifi cation to shift from one objective to another. c. Central banking is an art, which gives a strong reason to believe thatthe eff ects of monetary procedures may be transferred through severalchannels, such as the volume of disposable credit, interest rates, moneysupply and the general liq uidity position in the economy. We believe thatthe estimation based on all relev ant data is still the best approach forformulating monetary policy. 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 firmincreases t o 5000 pens. Find the elasticity of supply of the pens. Price elasticity of demand is a ratio of two pure numbers, the numerator isthe p ercentage change in the quantity demanded and the denominator isthe percentage c hange in price of the commodity. It is measured by thefollowing formula: Ep = Percentage change in quantity demanded/ Percentage changed inprice Applying the provided data in the equation: Percentage change in quantitydemande d = (5000 3000)/3000Percentage changed in price = (22 10) / 10 Ep = ((5000 3000)/3000) / ((22 10)/10) = 1.2

Q4. Give a brief description of a. Implicit and explicit cost b. Actual and opportunity cost Implicit and Explicit cost Explicit costs are those costs which are in the nature of contractual payments and arepaid by a n entrepreneur to the factors of production [excluding himself]inthe form of ren t, wages, interest and profits, utility expenses, andpayments for raw materials etc. They can be estimated and calculatedexactly and recorded in the books of ac counts. Implicit or imputed costs are implied costs. They do not take the form of cash outlays and as suchdo not a ppear in the books of accounts. They are the earnings of owneremployed resources . For example, the factor inputs owned by theentrepreneur himself like capital c an be utilized by him or can be suppliedto others for a contractual sum if he hi mself does not utilize them in the business. It is to be remembered that the total cost is a sum of both implicit and explicit costs. (b) Actual and opportunity cost Actual costs are also called as outlay costs, absolute costs and acquisition costs. Theyare t hose costs that involve financial expenditures at some time andhence are recorde d in the books of accounts. They are the actualexpenses incurred for producing o r acquiring a commodity or service by afirm. For example, wages paid to workers, expenses on raw materials, power, fuel and other types of inputs. They can be exactly calculated andaccount ed without any difficulty. Opportunity cost Opportunity cost of a good or service is measured in terms of revenuewhich could have been earned by employing that good or service in someother alternative use s. In other words, opportunity cost of anything is thecost of displaced alternat ives or costs of sacrificed alternatives. It impliesthat opportunity cost of any thing is the alternative that has beenforegone. Hence, they are also called as a lternative costs. Opportunitycost represents only sacrificed alternatives. Hence , they can never beexactly measured and recorded in the books of accounts. The k nowledgeof opportunity cost is of great importance to management decision. Theyh elp in taking a decision among alternatives. While taking a decision

among several alternatives, a manager selects the best one which is moreprofitab le or beneficial by sacrificing other alternatives Q5. Explain in brief the relationship between TR, AR, and MRunder different mark et condition. Revenue is the income received by the firm. There are three concepts of revenue Total revenue, Average revenue and Marginal revenue. 1. Total revenue (TR): Unit 7 Total revenue refers to the total amount of money that the firmreceives from the sale of its products, i.e. .gross revenue. In other words, it is the total sales receipts earned from the sale of itstotal 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 as below. TR = f(q). It implies that higher the sales, larger would be the TR Thus, TR= PX Q. For e.g. a firm sells 5000 units of a commodity at the rate of Rs. 5per unit, then TR would beTR = P x Q = 5 x 5000 = 25,000.00. Y TR 0 Sales X 2. Average revenue (AR) Average revenue is the revenue per unit of the commodity sold. It canbe obtained by dividing the TR by the number of units sold. Then, AR = TR/Q AR = 150/15= 10. Thus average revenue means price. Since the demand curve shows therelationship b etween price and the quantity demanded, it also representsthe average revenue or price at which the various amounts of acommodityare sold, because the price off ered by the buyer is the revenue fromseller. s point of view. Therefore, average revenue curve of the firm is the sameas demand curve of the consumer. Therefore, in economics we use AR and price as synonymous except inthe context o f price discrimination by the seller. Mathematical y P = AR.

3. Marginal Revenue (MR) Marginal revenue is the net increase in total revenue realized from sellingone m ore unit of a product. It is the additional revenue earned by sellingan addition al unit of output by the seller. Suppose a firm is selling 4 units of the output at the price of Rs.14 perunit. Now if it wants to sell 5 units instead of 4 units and thereby the price ofthe product falls to Rs.12 per unit, then the marginal revenue wil not be equal to Rs.12 at which the 5th unit is sold. 4 units, which were sold at the price ofRs. 14 before, wil al have to be sold at the reduced price of Rs.12 and thatwil mean the loss of 2 rupees on each of the previous 4 units. The totalloss on the previous units will be equal to Rs.8. Therefore, this loss of 8 rupeessho uld be deducted from the price of Rs.12 of the 5th unit whilecalculatingthe marg inal revenue. The marginal revenue in this case, therefore, willbe Rs.12 Rs.8 =Rs.4 and not Rs.12 which is the average revenue. Marginal revenue can also be directly calculated by finding out thedifference be tween the total revenue before and after selling theadditional unit of the product. Total revenue when 4 units are sold at the price of Rs.14 = 4 X 14 = Rs.56Total revenue when 5 units are sold at the price of Rs.12 = 5 X 12 = Rs.60Therefore, M arginal revenue or the net revenue earned by the 5th unit = 6056 = Rs.4. Thus, Marginal revenue of the nth unit = difference in total revenue inincreasin g the sale from n-1 to n units orMarginal revenue = price of nth unit minus loss in revenue on previousunits resulting from price reduction. The concept is important in micro economics because a firm's optimaloutput (most profitable) is where its marginal revenue equals its marginalcost i.e. as long as the extra revenue from selling one more unit is greaterthan the extra cost of making it, it is profitable to do so. It is usual for marginal revenue to fall as output goes up both at the levelof a firm and that of a market, because lower prices are needed to achievehigher sa les or demand respectively. MR = .TR = where. TR represents change in TR .Q And . Q indicates change in total quantity sold. TRn-1 Also MR = TRn Marginal revenue is equal to the change in total revenue over the changein quant ity.

Marginal Revenue = (Change in total revenue) divided by (Change insales) There is another way to see why marginal revenue will be less than pricewhen a d emand curve slopes downward. Price is average revenue. If thefirm sells 4 units for Rs.14, the average revenue for each unit is Rs.14.00. But as seller sells more, the average revenue (or price) drops, and thiscan only happen if the marginal revenue is below price, pulling theaverage down. If one knows marginal revenue, one can tell what happens to totalrevenue if sales change. If selling another unit increases total revenue, the marginalreven ue must be greater than zero. If marginal revenue is less than zero, then selling another unit takes away from total revenue. If marginal revenue is zero, than selling another does not change total revenue. Thisrelationshipexi sts because marginal revenue measures the slope of the total revenue curve. Relationship between Total revenue, Average revenue and MarginalRevenue concepts In order to understand the relationship between TR, AR and MR, we canprepare a h ypothetical revenue schedule. Relationship between AR and MR and the nature of AR and MR curvesunder differenc e market conditions 1. Under Perfect Market Under perfect competition, an individual firm by its own action cannotinfluence the market price. The market price is determined by theinteraction between demand and supply forces. A firm can sell any amount of goodsat the exis ting market prices. Hence, the TR of the firm would increaseproportionately with the output offered for sale. When the total revenueincreases in direct proporti on to the sale of output, the AR would remainconstant. Since the market price of it is constant without any variation dueto changes in the units sold by the ind ividual firm, the extra output wouldfetch proportionate increase in the revenue. Hence, MR & AR will beequalto each other and remain constant. This will be equa l to price. Under perfect market condition, the AR curve wil be a horizontal straightline an d parallel to OX axis. This is because a firm has to sell its product atthe cons tant existing market price. The MR cure also coincides with theAR curve. This is because additional units are sold at the same constant pricein th e market. 2. Under Imperfect MarketUnder all forms of imperfect markets, the relation betw een TR, AR, andMR is different. This can be understood with the help of the followingimaginaryreve nue schedule.

Q6. Distinguish between a firm and an industry. Explain theequilibrium of a firm and industry under perfect competition. Monopolistic competition An industry in monopolistic competition is one made up of a large numberof small firms who produce goods which are only slightly different fromthat of all other sellers. It is similar to perfect competition with freedom ofentry and exit for firms and any supernormal profits earned in the shortrun will be competed away in the long-run as new firms enter the industryand com pete away the profits. Short Run Equilibrium Short-run equilibrium of the firmunder monopolistic competition. The firm maximi zes its profits andproduces a quantity where the firm s marginal revenue (MR) is e qual to itsmarginal cost (MC). The firm is able to collect a price based on thea verage revenue (AR) curve. The difference between the firms averagerevenue and a verage cost, multiplied by the quantity sold (Qs), gives thetotal profit. Long Run Equilibrium Long-run equilibrium of the firm under monopolistic competition. The firmstill p roduces where marginal cost and marginal revenue are equal; however, the demand curve (and AR) has shifted as other firms enteredthe market and increased competition. The firm no longer sells its goodsabove average cost and can no longer claim an economic profit. b) Perfect Competition is a more desirable market form than monopolisticcompetit ion. Discuss.

Perfect competition is considered as the ideal or the standard againstwhich ever ything is judged. Perfect competition is characterised ashaving: Many buyers and sellers. Nobody has power over the market. Perfect knowledge by all parties. Customers are aware of all the productson offe r and their prices. Firms can sell as much as they want, but only at the price ruling. Thussellers h ave no control over market price. They are price takers, not pricemakers. All firms produce the same product, and all products are perfectsubstitutes for each other, i.e. goods produced are homogenous. There is no advertising. There is freedom of entry and exit from the market. Sunk costs are few, ifany. F irms can, and will come and go as they wish. Companies in perfect competition in the long-run are both productivelyand alloca tively efficient. In perfect competition, the market is the sum of all of the individual firms. The market is modelled by the standard market diagram (demand andsupply) and the firm is modelled by the cost model (standard average andmarginal cost curves). The firm as a price taker simply takes and chargesthe market price (P* in Figure 1 below). This price represents theiraverage and marginal revenue curve. Onto thi s we superimpose themarginal and average cost curves and this gives us the equil ibrium of thefirm. Firms in equilibrium in perfect competition will make just normal profit. This level of profit is just enough to keep them in the industry and sinceprofit s are adequate they have no incentive to leave. Normal profits Normal profit is the level of profit that is required for a firm to keep thereso urces they are using in their current use. In other words it is enoughprofit to keep them in the industry. Anything in excess of normal profits iscalled abnorma l or supernormal profits. Any profit above normal profit is a bonus for the firms, as it is more thanthey ne ed to keep them in the industry. We call this supernormal (orabnormal) profit. H owever, this supernormal profit will be a signal to otherfirms and will attract more firms into the industry. If firms are makingconsistently below normal profi ts then they will choose to leave theindustry.