MB0042 Managerial Economics (Book ID B1131) Set 1

Q1. What is a business cycle? Describe the different phases of a business cycle. Answer:
The business cycle phases define long-term pattern of changes in Gross Domestic Product (GDP) that follows four basic stages: expansion, prosperity, contraction, and recession. After a recessionary phase, the expansionary phase starts again. The business cycle phases are characterized by changing employment, industrial productivity, and interest rates. Stock analysts believe that stock prices lead the business cycle phases. This economic cycle provides the strategic framework for business activity and investing. Moreover, the business 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 and making money. Demand for goods -- food, consumer appliances, electronics, and services -- increases to the point where it outstrips supply. This demand 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 and companies curtail their spending, as goods and services are too expensive. This decreases demand. When demand decreases, companies cut expenses that includes laying off workers, since they do not need to make as many goods or provide as much service. Recession Phase: Decreasing demand fuels declining prices, declining GDP, and rising unemployment. This means the economy is in a recession. Expansion Phase begins again: Lower prices eventually spurs demand. As demand picks up, people begin buying again, fueling the need for greater supply, expansion of credit, new jobs and a growing economy.

When the business cycle doesn't run as expected, it can have consequences that can be as disastrous as the Great Depression. That's why governments intervene to try to manage the economy. If it appears that inflation is rising too quickly, the Federal Reserve (the central bank of the U.S. charged with handling monetary policy) may decide to raise interest rates to curtail price increases. On the other hand, if the economy is performing poorly, the government may lower taxes to spur consumption and investment and the Federal Reserve may lower interest rates to reduce the cost of borrowing. Interest rates and the yield curve play a very important role in determining economic activity, the phases of the business cycle and the performance of the stock market. Higher interest rates increase the costs to businesses and individuals. Companies 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 take out to purchase products. Higher interest rates also increase the demand for money to invest in bonds, competing for money to invest in the stock market.

The phases of the business cycle have implications for markets and investors. Broadly, a recession often corresponds with a sustained period of weak stock prices, or a bear market. And a healthy, expanding economy that keeps inflation from rising too quickly often corresponds with a bull market, or period of sustained market growth. Sector Rotation Fortunately, there are investment strategies for each phase of the business cycle. Sam Stovall's Sector Investing, 1996 states that different sectors are stronger at different business cycle phases. The table below describes this theoretical model showing the phases of the business cycle. Phase: Consumer Expectations: Industrial Production: Interest Rates: Yield Curve: Full Recession Reviving Bottoming Out Falling Normal Early Recovery Rising Rising Bottoming Out Normal (Steep) Full Recovery Declining Flat Rising Rapidly (Fed) Flattening Out Early Recession Falling Sharply Falling Peaking Flat/Inverted

The graph below, courtesy of StockCharts.com, shows these relationships and the alignment of the key sectors as they respond to the business cycle. The stock market cycle tends to precede the business cycle by six months on average, as investors try to anticipate when the market will respond to changes in the economy. This means investors are more likely to beat the market, if they invest in the sectors that line up with the current 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 or phases of the business cycle. Since the market leads the economy, investors need to pay particular attention to the early signs of a change in each phase of the business cycle. Many people believe that GDP is the primary indicator of the business cycle. The National Bureau of Economic Research (NBER) gives relatively low weight to GDP as a primary business cycle indicator, since the GDP is subject to frequent revisions after the fact. In addition, it is only reported on a quarterly basis. The NBER is the official organization that defines when the U.S. is in a recession and when it comes out of one. The NBER relies on indicators that are reported monthly to identify the business cycle phases including: Employment, especially new unemployment claims;

Personal income; Industrial production; Sales in key sectors such as housing, autos, durable goods and retail sales; Interest rates and the yield curve; and Commodity prices.

By following these indicators carefully, investors can anticipate when to expect changes in the business cycle. These indicators tend to change their trajectory over several months, giving investors ample time to identify a change in the trend. If you believe a change in the phase of the business cycle is underway then it is time to close out sectors that will go out 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 the business cycle as a guide. Our stock market strategy begins with an understanding of where we are in the business cycle. Assessing the business cycle phases is the first of five steps in our stock market strategy that we use to beat the market.

Q2. What is monetary policy? Explain the general objectives and instruments of monetary policy Answer:
Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability.[1] [2] The official goals usually include relatively stable prices and low unemployment. Monetary theory provides insight into how to craft optimal monetary policy. It is referred to as either being expansionary or contractionary, where an expansionary policy increases the total supply of money in the economy more rapidly than usual, and contractionary policy expands the money supply more slowly than usual or even shrinks it. Expansionary policy is traditionally used to try to combat unemployment in a recession by lowering interest rates in the hope that easy credit will entice businesses into expanding. Contractionary policy is intended to slow inflation in hopes of avoiding the resulting distortions and deterioration of asset values. Goals of Monetary policy The goals of monetary policy have developed with the evolution central banking thought and the changes in both the behaviour and performance of different economies. There is worldwide agreement that the ultimate goals of monetary policy at present in both the developed and developing countries are price stability and high employment rates, enhancing economic growth rates and controlling imbalances in external payments, including the protection of the external purchasing power of the currency through maintaining relatively stable levels of exchange rates. These goals, though interrelated by their nature, may be contradictory. This explains the importance of co-ordination among different economic policies on the one hand, and the importance of diagnosing the economic problem before taking appropriate treatment measures on the other. The significance of this issue becomes evident when we stress the need to apply rational monetary policies, particularly with regard to the practicality of goals pursed by the monetary authorities and the possibility of achieving these goals without economic consequences that might aggravate economic problems. Besides the above goals, some people believe that monetary policy should have other 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 system and maintaining the soundness of the banking system. In fact, each of these goals has special significance and directly relates either to the monetary policy goals discussed above or to the intermediate objectives of monetary policy, which represent the

link between monetary procedures and the influence of these procedures on the path of economic activity. I believe, however, that despite the differences in viewpoints towards the goals of monetary policy, the goal of increasing the efficiency of the financial system and maintaining the soundness and stability of the banking system should rank first. This conviction may be supported by the fact that the effects of monetary policy measures on the economy occur through the banking and financial systems, which makes the systems response to monetary variables a very important issue. Furthermore, the increased relative importance of deposit money makes the protection of the banking system and enhancing confidence in it one of the major goals of central banks, as it means protecting the mechanism of the payments system in the economy. Talking about the monetary policy goals as shown above should not mitigate the important role central banks may play in other economic areas, especially in the area of developing money and capital markets in countries where these markets are lacking. The development of such markets will enable central banks to use one of the important instruments of monetary policy, i.e. open market operations. Monetary Policy Instruments The set of instruments available to monetary authorities may differ from one country to another, according to differences in political systems, economic structures, statutory and institutional procedures, development of money and capital markets and other considerations. In most advanced capitalist countries, monetary authorities use one or more of the following key instruments: changes in the legal reserve ratio, changes in the discount rate or the official key bank rate, exchange rates and open market operations. In many instances, supplementary instruments are used, known as instruments of direct supervision or qualitative instruments. Although the developing countries use one or more of these instruments, taking into consideration the difference in their economic growth levels, the dissimilarity in the patterns of their production structures and the degree of their of their link with the outside world, many resort to the method of qualitative supervision, particularly those countries which face problems arising from the nature of their economic structures. Although the effectiveness of monetary policy does not necessarily depend on using a wide range of instruments, coordinated use of various instruments is essential to the application of a rational monetary policy. Intermediate Objectives of Monetary Policy The intermediate objectives of monetary policy are defined as a number of variables linking the instruments of monetary policy with their ultimate goals. These variables are money supply, interest rates, disposable credit, the monetary base or any other variable deemed by the monetary authorities as an appropriate intermediate objective for monetary policy. In many instances, these objectives can be used as indicators of the effects of the applied monetary policy. This issue, thought it is a major pivot of the monetary policy framework, is still a subject of major viewpoint differences among economists. While monetarists believe that monetary authorities must select quantitative targets for their monetary policy through controlling growth levels in money supply and thereby adopting mostly the monetary base approach, non-monetarists, despite their recognition of the importance of money, see that changes in different components of aggregate demand have significant impact on the level of economic activity and, therefore, they give basic consideration to the adoption of price objectives through the selection of the interest rate as an intermediate objective representing a link between money and production. The monetarists choice of money supply as a target is based on a number of hypotheses or principles. For instance, they believe that money supply is an exogenous variable that is controllable in the long run, and that the direction of causal relations in the exchange equation moves from money to prices and production. Furthermore, the strongest final effect will be represented by high prices, given the stability in the function of demand for money

and a time lag for the effect of monetary policy, thus avoiding the adoption of fiscal policies as a stimulus. This is a lengthy issue, and it would not be appropriate to discuss it in detail here. We can sum up our point of view as follows: a. The selection of intermediate objectives for monetary policy should be made according to the structural characteristics of the concerned economies and according to analytical studies on economic behaviour, including the demand function for money and the directions of the general economic policy. The dispute arising between 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 the state in the economy. b. The choice of a certain intermediate objective by the monetary authorities does not necessarily mean that these authorities should adhere to that objective all the time. The objective should be reviewed in the light of structural and behavioural changes in the economy. Further, both the prevailing economic situation and the change in the priorities of monetary policy objectives may provide the monetary authorities with sufficient justification to shift from one objective to another. c. Central banking is an art, which gives a strong reason to believe that the effects of monetary procedures may be transferred through several channels, such as the volume of disposable credit, interest rates, money supply and the general liquidity position in the economy. We believe that the estimation based on all relevant data is still the best approach for formulating 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 firm increases to 5000 pens. Find the elasticity of supply of the pens. Answer:
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. 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 are paid by an entrepreneur to the factors of production [excluding himself]in the form of rent, wages, interest and profits, utility expenses, and payments for raw materials etc. They can be estimated and calculated exactly and recorded in the books of accounts. Implicit or imputed costs are implied costs. They do not take the form of cash outlays and as such do not appear in the books of accounts. They are the earnings of owner employed resources. For example, the factor inputs owned by the entrepreneur himself like capital can be utilized by him or can be

supplied to others for a contractual sum if he himself 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. They are those costs that involve financial expenditures at some time and hence are recorded in the books of accounts. They are the actual expenses incurred for producing or acquiring a commodity or service by a firm. For example, wages paid to workers, expenses on raw materials, power, fuel and other types of inputs. They can be exactly calculated and accounted without any difficulty. Opportunity cost Opportunity cost of a good or service is measured in terms of revenue which could have been earned by employing that good or service in some other alternative uses. In other words, opportunity cost of anything is the cost of displaced alternatives or costs of sacrificed alternatives. It implies that opportunity cost of anything is the alternative that has been foregone. Hence, they are also called as alternative costs. Opportunity cost represents only sacrificed alternatives. Hence, they can never be exactly measured and recorded in the books of accounts. The knowledge of opportunity cost is of great importance to management decision. They help in taking a decision among alternatives. While taking a decision among several alternatives, a manager selects the best one which is more profitable or beneficial by sacrificing other alternatives.

Q5. Explain in brief the relationship between TR, AR, and MR under different market condition. Answer:
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 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 as below. TR = f (q). It implies that higher the sales, larger would be the TR 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 TR = 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 can be 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 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 seller s 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. Mathematical y 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. 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. Marginal revenue can also be directly calculated by finding out the difference between the total revenue before and after selling the additional unit of the product. Total revenue when 4 units are sold at the price of Rs.14 = 4 X 14 = Rs.56 Total revenue when 5 units are sold at the price of Rs.12 = 5 X 12 = Rs.60 Therefore, Marginal revenue or the net revenue earned by the 5th unit = 6056 = Rs.4. Thus, Marginal revenue of the nth unit = difference in total revenue in increasing the sale from n-1 to n units or Marginal revenue = price of nth unit minus loss in revenue on previous units resulting from price reduction. The concept is important in micro economics because a firm's optimal output (most profitable) is where its marginal revenue equals its marginal cost i.e. as long as the extra revenue from selling one more unit is greater than 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 level of a firm and that of a market, because lower prices are needed to achieve higher sales or demand respectively. MR = TR = where TR represents change in TR Q And Q indicates change in total quantity sold. Also MR = TRn TRn-1 Marginal revenue is equal to the change in total revenue over the change in quantity. Marginal Revenue = (Change in total revenue) divided by (Change in sales) There is another way to see why marginal revenue will be less than price when a demand curve slopes downward. Price is average revenue. If the firm 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 this can only happen if the marginal revenue is below price, pulling the average down. If one knows marginal revenue, one can tell what happens to total revenue if

sales change. If selling another unit increases total revenue, the marginal revenue 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. This relationship exists because marginal revenue measures the slope of the total revenue curve. 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. 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. 2. 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.

Q6. Distinguish between a firm and an industry. Explain the equilibrium of a firm and industry under perfect competition. Answer:
Monopolistic competition An industry in monopolistic competition is one made up of a large number of small firms who produce goods which are only slightly different from that of all other sellers. It is similar to perfect competition with freedom of entry and exit for firms and any supernormal profits earned in the short-run will be competed away in the long-run as new firms enter the industry and compete away the profits. Short Run Equilibrium

Short-run equilibrium of the firm under monopolistic competition. The firm maximizes its profits and produces a quantity where the firms marginal revenue (MR) is equal to its marginal cost (MC). The firm is able to collect a price based on the average revenue (AR) curve. The difference between the firms average revenue and average cost, multiplied by the quantity sold (Qs), gives the total profit. Long Run Equilibrium

Long-run equilibrium of the firm under monopolistic competition. The firm still produces where marginal cost and marginal revenue are equal; however, the demand curve (and AR) has shifted as other firms entered the market and increased competition. The firm no longer sells its goods above average cost and can no longer claim an economic profit. b) Perfect Competition is a more desirable market form than monopolistic competition. Discuss. Perfect competition is considered as the ideal or the standard against which everything is judged. Perfect competition is characterized as having: Many buyers and sellers. Nobody has power over the market. Perfect knowledge by all parties. Customers are aware of all the products on offer and their prices. Firms can sell as much as they want, but only at the price ruling. Thus sellers have no control over market price. They are price takers, not price makers. All firms produce the same product, and all products are perfect substitutes 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, if any. Firms can, and will come and go as they wish. Companies in perfect competition in the long-run are both productively and allocatively 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 and supply) and the firm is modelled by the cost model (standard average and marginal cost curves). The firm as a price taker simply

takes and charges the market price (P* in Figure 1 below). This price represents their average and marginal revenue curve. Onto this we superimpose the marginal and average cost curves and this gives us the equilibrium of the firm. 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 since profits 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 the resources they are using in their current use. In other words it is enough profit to keep them in the industry. Anything in excess of normal profits is called abnormal or supernormal profits. Any profit above normal profit is a bonus for the firms, as it is more than they need to keep them in the industry. We call this supernormal (or abnormal) profit. However, this supernormal profit will be a signal to other firms and will attract more firms into the industry. If firms are making consistently below normal profits then they will choose to leave the industry.

MB0042 Managerial Economics (Book ID B1131) Set 2

Q1.Suppose your manufacturing company planning to release a new product into market, Explain the various methods forecasting for a new product. Answer:

To deliver the right products to the right customers portably requires a fundamental shift in retail decision making from art to science; and from one that is based on human intuition to one that is driven by customer data. Demand Forecasting for a New Product 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. Professor Joel Dean, however, has suggested a few guidelines to make forecasting of demand for new products. a) Evolutionary approachThe 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 Pulsar canbe forecasted based on the a sales of the old Pulsor. 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 approachIf the new product developed serves as substitute for the existing product, the demand for t h e n e w p r o d u c t m a y b e w o r k e d o u t o n t h e b a s i s o f a m a r k e t s h a r e . T h e g r o w t h s o f 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 approachUnder this approach the potential buyers are directly c o n t a c t e d , o r t h r o u g h t h e u s e o f 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 approachOffer 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 o n e s u p e r m a r k e t a n d the estimate of sales obtained may be blown up to arrive a t 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 productare 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 approachA 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. These methods are not mutually exclusive. The management can use a combination of several of them, supplement and cross check each other.

Q2.Define the term equilibrium. Explain the changes in market equilibrium and effects to shifts in supply and demand. Answer:
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. Market Equilibrium There are two approaches to market equilibrium viz., partial equilibrium approach and the general equilibrium approach. The partial equilibriumapproach to pricing explains price determination of a single commodity keeping the prices of other commodities constant. On the other hand, the general equilibrium approach explains the mutual and simultaneous determination of the prices of all goods and factors. Thus it explains a multi market equilibrium position. Earlier to Marshall, there was a dispute among economists on whether the force of demand or the force of supply is more important in determining price. Marshall gave equal importance to both demand and supply in the determination of value or price. He compared supply and demand to a pair of scissors We might as reasonably dispute whether it is the upper or the under blade of a pair of scissors that cuts a piece of paper, as whether value is governed by utility or cost of production. Thus neither

the upper blade nor the lower blade taken separately can cut the paper; both have their importance in the process of cutting. Likewise neither supply alone, nor demand alone can determine the price of a commodity, both are equally important in the determination of price. But the relative importance of the two may vary depending upon the time under consideration. Thus, the demand of all consumers and the supply of all firms together determine the price of a commodity in the market. Equilibrium between demand and supply price: Equilibrium between demand and supply price is obtained by the interaction of these two forces. Price is an independent variable. Demand and supply are dependent variables. They depend on price. Demand varies inversely with price; arise in price causes a fall in demand and a fall in price causes a rise in demand. Thus the demand curve will have a downward slope indicating the expansion of demand with a fall in price and contraction of demand with a rise in price. On the other hand supply varies directly with the changes in price, a rise in price causes arise in supply and a fall in price causes a fall in supply. Thus the supply curve will have an upward slope. At a point where these two curves intersect with each other the equilibrium price is established. At this price quantity demanded is equal to the quantity demanded. This we can explain with the help of a table and a diagram.
Price in Rs 30 25 20 10 5 Demand in units 5 10 15 20 30 Supply in units 25 20 15 10 5 State of market D<S D<S D=S D>S D>S Pressure on price PPNeutral P P-

In the table at Rs.20 the quantity demanded is equal to the quantity supplied. Since the price is agreeable to both the buyer and sellers, there will be no tendency for it to change; this is called equilibrium price. Suppose the price falls to Rs.5 the buyer will demand 30 units while the seller will supply only 5 units. Excess of demand over supply pushes the

price upward until it reaches the equilibrium position supply is equal to the demand. On the other hand if the price rises to Rs.30 the buyer will demand only 5 units while the sellers are ready to supply 25 units. Sellers compete with each other to sell more units of the commodity. Excess of supply over demand pushes the price downward until it reaches the equilibrium. This process will continue till the equilibrium price of Rs.20 is reached. Thus the interactions of demand and supply forces acting upon each other restore the equilibrium position in the market. In the diagram DD is the demand curve, SS is the supply curve. Demand and supply are in equilibrium at point E where the two curves intersect each other. OQ is the equilibrium output. OP is the equilibrium price. Suppose the price OP2 is higher than the equilibrium price OP. at this point price quantity demanded is P2D2. ThusD2S2 is the excess supply which the seller wants to push into the market, competition among the sellers will bring down the price to the equilibrium level where the supply is equal to the demand. At price OP1, the buyers will demand P1D1 quantity while the sellers are ready to sell P1S1. Demand exceeds supply. Excess demand for goods pushes up the price; this process will go until equilibrium is reached where supply becomes equal to demand. 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 Both 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 rateo f c h a n g e i n d e m a n d i s 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 insupply on the market equilibrium

Q3.Explain how a product would reach equilibrium position with the help of ISO-Quants and ISO-Cost curve. Answer:
Economies of scale external to the firm (or industry wide scale economies) are only considered examples of network externalities if they are driven by demand side economies. In many industries, the production of goods and services and the development of new products requires the use of specialized equipment or support services. An individual company does not provide a large enough market for these services to keep the suppliers in business. A localized industrial cluster can solve this problem

by bringing together many firms that provide a large enough market to support specialized suppliers. This phenomenon has been extensively documented in the semiconductor industry located in Silicon Valley. Labor Market Pooling A cluster of firms can create a pooled market for workers with highly specialized skills. It is an advantage for: Producers -- They are less likely to suffer from labor shortages. Workers -- They are less likely to become unemployed. Knowledge Spillovers -- Knowledge is one of the important input factors in highly innovative industries. The specialized knowledge that is crucial to success in innovative industries comes from : Research and development efforts. Reverse engineering. Informal exchange of information and ideas. As firms become larger and their scale of operations increase they are able to experience reductions in their average costs of production. The firm is said to be experiencing increasing returns to scale. Increasing returns to scale results in the firm's output increasing at a great proportion than its inputs and hence its total costs. As a consequence its average costs fall. Thus initially the firm's long run average cost curve slopes downward as the scale of the enterprise expands. The firm enjoys benefits called internal economies of scale. These are cost reductions accruing to the firm as a result of the growth of the firm itself. (An external economy of scale is a benefit that the firms experience as a result of the growth of the industry). After the firm has reached its optimum scale of output, where the long run average cost curves are at their lowest point, continued expansion means that its average costs may start to rise as the firm now experiences decreasing returns to scale. The long run average cost curve therefore starts to curve upwards. This occurs because the firm is now experiencing internal diseconomies of scale. Types of internal economies of scale Financial The farm has been able to gain loans and assistance at preferential interest rates from the EIB, World Bank and the EU. Marketing It has managed to dedicate resources to its strategy of niche marketing. Technical The access to finance has allowed it to invest in sophisticated Israeli irrigation technology.

Managerial Its large size enables it to employ specialized personnel such as estate managers. Risk bearing The farm has used some of its land to diversify into producing fresh vegetables for export as well as continue producing maize. These large scale farms are attracting a considerable amount of overseas development aid funding from organizations such as the World Bank and the European Union as they see as being an integral part of the export earning capacity of the country.

Q4.Critically examine the Marris growth maximizing model. Answer:

Profit maximization is traditional objective of a firm. Sales maximization objective is explained by Prof. Boumal. On similar lines, Prof. Marris has developed another alternative growth maximization model in recent years. It is a common factor to observe that each firm aims at maximizing its growth rate as this goal would answer many of the objectives of a firm. Marris points out that a firm has to maximize its balanced growth rate over a period of time. Marris assumes that the ownership and control of the firm is in the hands of two groups of people, i.e. owner and managers. He further points out that both of them have two distinctive goals. Managers have a utility function in which the amount of salary, status, position, power, prestige and security of job etc are the most import variable where as in case of are more concerned about the size of output, volume of profits, market shares and sales maximization. Utility function of the manager and that the owner are expressed in the following mannerUo= f [size of output, market share, volume of profit, capital, public esteem etc.] Um= f [salaries, power, status, prestige, job security etc.] In view of Marris the realization of these two functions would depend on the size of the firm. Larger the firm, greater would be the realization of these functions and vice-versa. Size of the firm according to Marris depends on the amount of corporate capital which includes total volume of the asset, inventory level, cash reserve etc. He further points out that the managers always aim at maximizing the rate of growth of the firm rather than growth in absolute size of the firms. Generally managers like

to stay in a grouping firm. Higher growth rate of the firm satisfy the promotional opportunity of managers and also the share holders as they get more dividends. Marris identifies two constraints in the rate of growth of a firm: 1. There is a limit up to which output of a firm can be increased more economically, limit t o m a n a g e t h e f i r m e f f i c i e n t l y , l i m i t t o e m p l o y h i g h l y q u a l i f i e d a n d e x p e r i e n c e d managers, limit to research and development and innovation etc. 2. The ambition of job security puts a limit to the g r o w t h r a t e o f t h e f i r m i t s e l f deliberately. If growth reaches the maximum, then there would be no opportunity to e x p a n d further and as such the managers may loose their jobs. R a p i d g r o w t h a n d financial soundness should go together. Managers hesitate to take unwanted risks and uncertainties in the organization at the cost of their jobs they would like to avoid risky investment projects, concentrate on generating more internal funds and invest more finance on only those products and services which brings more profits Hence, managers would like to seek their job security through adoption of a cautious and prudent financial policy. He further points out that a high risk-loving management would like to maintain a relatively low amount of cash on h a n d a n d i n v e s t m o r e o n b u s i n e s s , b o r r o w m o r e external funds and invest more in business expansion and keep low profit levels. On the other hand, a highly risk-averting management may have e x a c t l y o p p o s i t e p o l i c y . Ultimately, it is the job security which puts a constraint on business decisions by the managers. The Marris growth maximization model. Highlights on achieving a balanced growth rate of a firm. Maximum growth rate [g] is equal to two important variables1. The rate of demand for the products [gd] 2. Growth rate of capital [gc] Hence, Max g = gd = gc. The growth rate of the firm depends on two factors- a] the rate of diversification [d]and [b] the average profit margin. The diversification rate depends on the number of new products introduced per unit of time and the rate of success of new products in the market. The success of new products is determined by its changes in fashion styles, consumption habits, the range of products offered etc. More over diminishing marginal returns would operate in any business and as such there is a limit to diversification. Similarly, market price of the given product, a v a i l a b i l i t y o f a l t e r n a t i v e substitute products and their relative prices, publicity, propaganda and advertisements, R&D expenses and utility and comparative value of the product etc would decide the profit ratio.

Higher expenditure on sales promotion and R&D would certainly reduce profits level as there are limits to them. The rate of capital growth is determined by either i s s u e o f n e w s h a r e s t o o b t a i n additional funds and external funds and generation of more internal surplus. Generally a firm would select the last one to avoid higher degrees of risks in the business. The Marris model states that in order to maximize balanced g r o w t h r a t e o r r e a c h equilibrium position, there should be equality between the growth rate in demand for the p r o d u c t s a n d g r o w t h rate in supply of capital. This implies the satisfaction of t h r e e conditions. 1. The management has to maintain a low liquidity ratio, ie, liquid asset / total assets. B u t t h i s r a t i o s h o u l d n o t c r e a t e a n y f i n a n c i a l e m b a r r a s s m e n t t o m e e t t h e r e q u i r e d payments to all the concerned parties. 2. The management has to maintain a proper leverage ratio between value of debts/Total assets so that it will have enough money to invest in order to stimulate growth. 3. The management has to keep a high level of retained profits for further expansion and development but it should not displease the shareholders i.e. (Retained Profits / Total Profits) by giving low dividends. In this case, the mangers would maximize their utility function and the owners would maximize their utility functions. The managers are able to get their job security with a high rate of growth of the firm and share holder would become happy as they get higher amount of dividends. Demerits 1 . It is doubtful whether both managers and owners would maximize their utility functions simultaneously always. 2. The assumption of constant price and production costs are not correct. 3. It is difficult to achieve both growth maximization and profit maximization together.

Q5.What do you mean by pricing policy? Explain the various objective of pricing policy of a firm. Answer:
Pricing Policies 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. Generally speaking, in economic theory, we take into account of only two parties, i.e., buyers and sellers while fixing the prices. However, in practice many parties are associated with pricing of a product. They are rival competitors, potential rivals, middlemen, wholesalers, retailers, commission agents and above all the Govt. Hence, we should give due consideration to the influence exerted by these parties in the process of price determination. Broadly speaking, the various factors and forces that affect the price are divided into two categories. They are as follows: I External Factors (Outside factors) 1. Demand, supply and their determinants. 2. Elasticity of demand and supply. 3. Degree of competition in the market. 4. Size of the market. 5. Good will, name, fame and reputation of a firm in the market. 6. Trends in the market. 7. Purchasing power of the buyers. 8. Bargaining power of customers. 9. Buyers behavior in respect of particular product. II. Internal Factors (Inside Factors) 1. Objectives of the firm. 2. Production Costs. 3. Quality of the product and its characteristics. 4. Scale of production. 5. Efficient management of resources. 6. Policy towards percentage of profits and dividend distribution. 7. Advertising and sales promotion policies. 8. Wage policy and sales turn over policy etc. 9. The stages of the product on the product life cycle. 10. Use pattern of the product. Objectives of the Price Policy: A firm has multiple objectives today. In spite of several objectives, the ultimate aim of every business concern is to maximize its profits. This is possible when the returns exceed costs. In this context, setting an ideal price for a product assumes greater importance. Pricing objectives has to be established by top management to ensure not only that the companys profitability is adequate but also that pricing is complementary to the total strategy of the organization. While formulating the pricing policy, a firm has to consider various economic, social, political and other factors.

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. 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, and 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 prerequisite 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 firms 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.

Q6.Discuss the various measures that may be taken by a firm to counteract the evil effects of trade cycle. Answer:
Control of trade cycle has become an important objective of all most all economies at present. Broadly speaking, the remedial measures can be classified under three heads, viz., monetary, fiscal and miscellaneous measures. 1. Monetary measuresAccording to hawtrey, Hicks and many others expansion and contraction of supply of money is the major cause of operation of trade cycle. Monetary policy and the expansionary phase: When the economy is moving fast in the upward direction, the monetary measures should aim at (i) restricting the issue of legal tender money. (ii) putting restrictions to the expansion of bank credit by adopting both quantitative and qualitative techniques of credit control. As expansionary phase is mainly supported by bank credit, adoption of a dear money policy can put an effective check on further expansion. A rise in the Bank Rate, by raising the lending rates of the commercial banks, making credit costly will have a discouraging effect on more borrowings. A check can be imposed on the liquidity position of the commercial bank by raising the Cash Reserve Ratio and Statutory Liquidity Ratio. Open market sale of securities can also be conducted to make bank rate more effective. Selective techniques, like raising of margin requirements, rationing of credit, moral suasion, direct action, publicity etc., can also be used efficiently to tighten the credit situation in the economy. Apart from these direct measures indirect measures like wages control, price control etc., can also be adopted to put a check on the inflationary trend in the economy. Such monetary measures are found fairly successful in controlling unwieldy expansion of the economy. Many countries like U.K., U.S.A., France, Germany and India have used monetary measures to control inflation. Monetary policy and the phase of depression: During the period of depression, to enlarge employment opportunities and raise the level of income all out measures are to be adopted to increase the level of investment. To encourage investment activity the central bank has to follow a cheap money policy. The bank rate and the lending rates of the commercial banks should be reduced; money should be made available freely by reducing the CRR and SLR. Through open market sale of securities, Cash reserves with the bank should be increased to enable them to lend money easily for various investment activities. Various qualitative techniques of credit control like reducing the margin requirements, moral suasion etc., may be adopted to encourage businessmen to borrow and invest. Cheap money policy, to induce businessmen to borrow and invest is not very effective as investment is more guided by the marginal efficiency of capital than the rate of interest. Because of low level of income and low price and the low profit margins entrepreneurs do not come forward to borrow and invest in spite of the low rates of interest. One can take a horse to the water but cannot force to have it; a plethora of money cannot induce the public horse to have it. Thus monetary policy as a remedy to solve depression has its own limitations. 2. Fiscal policyDuring the period of inflation or uptrend in the economy, when the private enterprise is over enthusiastic and there is over expansion and over production government can use taxation and licensing policy as very effective instruments to check such unwieldy growth. Price control measures can be adopted. Government should adopt surplus budget, reduce public

expenditure and resort to public borrowing. The cumulative result of these measures would reduce the supply of money in circulation, purchasing power and demand. On the contrary, during the period of depression government should adopt deficit budget, Increase the volume of public expenditure, redeem public debt and resort to external borrowings, indulge in a moderate dose of deficit financing, reduce tax rates, grant subsidies, development rebates, tax-concessions, tax-reliefs and freight concessions etc. as a result of these measures, supply of money in circulation will increase. This in its turn would raise the purchasing power, demand for goods and services, production and employment etc. J.M.Keynes recommended a number of public works programmers to be launched by the government to cure depression. The New Deal policy of President Roosevelt in the U.S.A. and Blum experiment in France were based on this very belief. 3. Physical controlsDuring the period of inflation, a price control policy has to be adopted where as during depression a price-support policy has to be followed. During the period of contraction unemployment insurance schemes, proper management of savings, investments, production, distribution, expansion of income and employment etc., are needed depending upon the nature of economic fluctuations. 4. Miscellaneous measuresi) Introduction of automatic stabilizers: An automatic stabilizer (or built in stabilizer) is an economic shock absorber that helps to smoothen the cyclical business fluctuations of its own accord, without requiring deliberate action on the part of government e.g., progressive taxation policy, unemployment Insurance scheme adopted in the U.S.A. ii) Price support policy followed in the U.S.A. during the post war period to fight the prospects of depression. iii) The policy of stabilization of the prices of agricultural products in India through procurement and building up of buffer stock aim at economic stability. iv) Foreign aid is also used for influencing the aggregate demand and supply of goods in a country. v) Granting of aid might help in recovering from slump. In addition to these, some of the measures can be adopted at international level to mitigate the adverse effects of trade cycle and promote stability in the world economic growth like control of private investment, control and distribution of essential goods, regulation of international investments in developing nations, creation of international buffer stocks etc. thus, several measures are to be taken to smoothen the cyclical movements and to ensure economic stability in an economy.