ASSIGNMENT-1

MB0042- MANAGERIAL ECONOMICS

Q.1 Inflation is a global Phenomenon which is associated with high price causes decline
in the value for money. It exists when the amount of money in the country is in
excess of the physical volume of goods and services. Explain the reasons for this
monetary phenomenon.

ANS

Inflation is the percentage change in the value of the Wholesale Price Index (WPI) on a yearon year basis. It effectively measures the change in the prices of a basket of goods and
services in a year. In India, inflation is calculated by taking the WPI as base.

Causes for Inflation

1. Over- Expansion of Money Supply: Many a times a remarkable degree of correlation

between the increase in money and rise in the price level may be observed. The
Central Bank (Indias RBI) should maintain a balance between money supply and
production and supply of goods and services in the economy. Money supply exceeds
the availability of goods and services in the economy, it would lead to inflation.
2. Increase in Population: Increase in population leads to increased demand for goods
and services. If supply of commodities are short, increased demand will lead to
increase in price and inflation.
3. Expansion of Bank Credit: Rapid expansion of bank credit is also responsible for the
inflationary trend in a country.
4. Deficit Financing: Deficit financing means spending more than revenue. In this case
government of India accepts more amount of money from the Reserve Bank India
(RBI) to spend for undertaking public projects and only the government of India can
practice deficit financing in India. The high doses of deficit financing which may
cause reckless spending, may also contribute to the growth of the inflationary spiral in
a country.
5. High Indirect Taxes: Incidence of high commodity taxation. Prices tend to rise on
account of high excise duties imposed by the Government on raw materials and
essentials.
6. Black Money: It is widely condemned that black money in the hands of tax evaders
and black marketers as an important source of inflation in a country. Black money
encourages lavish spending, which causes excess demand and a rise in prices.
7. Poor Performance of Farm Sector: If agricultural production especially food grains
production is very low, it would lead to shortage of food grains, will lead to inflation.

8. High Administrative Pricing

9. Other reasons are capital bottleneck, entrepreneurial bottlenecks, infrastructural
bottlenecks and foreign exchange bottlenecks.

Q.2 Monopoly is the situation there exists a single control over the market producing a
commodity having no substitutes with no possibilities for anyone to enter the
industry to compete. In that situation, they will not charge a uniform price for all
the customers in the market and also the pricing policy followed in that situation.

ANS

A situation in which a single company owns all or nearly all of the market for a given type
of product or service. This would happen in the case that there is a barrier to entry into
the industry that allows the single company to operate without competition (for example,
vast economies of scale, barriers to entry, or governmental regulation). In such an
industry structure, the producer will often produce a volume that is less than
the amount which would maximize social welfare.
Features of Monopoly

Only one single seller in the market. There is no competition.

There are many buyers in the market.

The firm enjoys abnormal profits.

The seller controls the prices in that particular product or service and is the price maker.

Consumers dont have perfect information.

There are barriers to entry. These barriers many be natural or artificial.

The product does not have close substitutes.

Kinds of Price Discrimination

Price discrimination is the practice of charging a different price for the same good or service.
There are three types of price discrimination first-degree, second-degree, and third-degree
price discrimination.

First degree
Discrimination, alternatively known as perfect price discrimination, occurs when a firm
charges a different price for every unit consumed.
The firm is able to charge the maximum possible price for each unit which enables the firm
to capture all available consumer surplus for itself. In practice, first-degree discrimination is
rare.

Second degree
Second-degree price discrimination means charging a different price for different quantities,
such as quantity discounts for bulk purchases.
Third degree
Third-degree price discrimination means charging a different price to different consumer
groups. For example, rail and tube travellers can be subdivided into commuter and casual
travellers, and cinema goers can be subdivide into adults and children. Splitting the market
into peak and off peak use is very common and occurs with gas, electricity, and telephone
supply, as well as gym membership and parking charges. Third-degree discrimination is the
commonest type.
Necessary conditions for successful discrimination
Price discrimination can only occur if certain conditions are met.
1. The firm must be able to identify different market segments, such as domestic users
and industrial users.
2. Different segments must have different price elasticities (PEDs).
3. Markets must be kept separate, either by time, physical distance and nature of use,
such as Microsoft Office Schools edition which is only available to educational
institutions, at a lower price.
4. There must be no seepage between the two markets, which means that a consumer
cannot purchase at the low price in the elastic sub-market, and then re-sell to other
consumers in the inelastic sub-market, at a higher price.
5. The firm must have some degree of monopoly power.

Q.3 Define monopolistic competition and explain its characteristics.

ANS

Pure monopoly and perfect competition are two extreme cases of market structure. In reality,
there are markets having large number of producers competing with each other in order to

sell their product in the market. Thus, there is monopoly on one hand and perfect competition
on other hand. Such a mixture of monopoly and perfect competition is called as monopolistic
competition. It is a case of imperfect competition.
Monopolistic competition has been introduced by American economist Prof. Edward
Chamberlin, in his book 'Theory of Monopolistic Competition' published in 1933.

The following are the characteristics of monopolistic competition

1. Large Number of Sellers

There are large number of sellers producing differentiated products. So, competition among
them is very keen. Since number of sellers is large, each seller produces a very small part of
market supply. So no seller is in a position to control price of product. Every firm is limited
in its size.
2. Product Differentiation
It is one of the most important features of monopolistic competition. In perfect competition,
products are homogeneous in nature. On the contrary, here, every producer tries to keep his
product dissimilar than his rival's product in order to maintain his separate identity. This
boosts up the competition in market. So, every firm acquires some monopoly power.
3. Freedom of Entry and Exit
This feature leads to stiff competition in market. Free entry into the market enables new firms
to come with close substitutes. Free entry or exit maintains normal profit in the market for a
longer span of time.
4. Selling Cost
It is a unique feature of monopolistic competition. In such type of market, due to product
differentiation, every firm has to incur some additional expenditure in the form of selling
cost. This cost includes sales promotion expenses, advertisement expenses, salaries of
marketing staff, etc.
But on account of homogeneous product in perfect competition and zero competition in
monopoly, selling cost does not exist there.
5. Absence of Interdependence

Large numbers of firms are different in their size. Each firm has its own production and
marketing policy. So no firm is influenced by other firm. All are independent.
6. Two Dimensional Competition
Monopolistic competition has two types of competition aspects viz.
i.

Price competition i.e. firms compete with each other on the basis of price.

ii.

Non price competition i.e. firms compete on the basis of brand, product quality
advertisement.

7. Concept of Group
In place of Marshallian concept of industry, Chamberlin introduced the concept of Group
under monopolistic competition. An industry means a number of firms producing identical
product. A group means a number of firms producing differentiated products which are
closely related.
8. Falling Demand Curve
In monopolistic competition, a firm is facing downward sloping demand curve i.e. elastic
demand curve. It means one can sell more at lower price and vice versa.

Q.4 When should a firm in perfectly competitive market shut down its operation?

ANS
Perfect competition describes a market structure where competition is at its greatest possible
level. To make it more clear, a market which exhibits the following characteristics in its
structure is said to show perfect competition. Perfect competition is a hypothetical situation
which cannot possibly exist in a market. However, perfect competition is used as a base to
compare with other forms of market structure. No industry exhibits perfect competition in
India.

A perfectly competitive firm is presumed to shut down production and produce no output in
the short run, if price is less than average variable cost. This is one of three short-run
production alternatives facing a firm. The other two are profit maximization (if price exceeds
average total cost) and loss minimization (if price is greater than average variable cost but
less than average total cost).

A perfectly competitive firm guided by the pursuit of profit is inclined to produce no output if
the quantity that equates marginal revenue and marginal cost in the short run incurs an
economic loss greater than total fixed cost. The key to this loss minimization production
decision is a comparison of the loss incurred from producing with the loss incurred from not
producing. If price is less than average variable cost, then the firm incurs a smaller loss by
not producing that by producing.

One of Three Alternatives

Shutting down is one of three short-run
production alternatives facing a perfectly
competitive firm.All three are displayed in the
table to the right. The other two are profit
maximization and loss minimization.

Production Alternatives
Price and Cost

Result

P > ATC

Profit Maximization

With profit maximization, price

ATC > P >
exceeds average total cost at the
quantity that equates marginal revenue AVC
and marginal cost. In this case, the firm
generates an economic profit.
P < AVC

Loss Minimization
Shutdown

With loss minimization, price is greater than average variable cost but is less than
average total cost at the quantity that equates marginal revenue and marginal cost. In
this case, the firm incurs a smaller loss by producing some output than by not
producing any output.

The marginal approach to analysing a perfectly competitive firm's short-run production

decision can be used to identify the shutdown alternative. The exhibit displayed here
illustrates the short-run production decision by Phil the perfectly competitive zucchini
grower.
The three U-shaped cost curves used in this analysis provide all of the information needed on
the cost side of the firm's decision. The demand curve facing the firm (which is also the firm's
average revenue and marginal revenue curves) provides all of he information needed on the
revenue side.
Q.5 Discuss the practical application of Price elasticity and Income elasticity
of demand.
Practical applications of the price elasticity of demand.

2. 3. Demand for cocaine is highly inelastic and presents problems for law
enforcement. Stricter enforcement reduces supply, raises prices and revenues
for sellers, and provides more incentives for sellers to remain in business.
Crime may also increase as buyers have to find more money to buy their
drugs.
a. Opponents of legalization think that occasional users or dabblers have a
more elastic demand and would increase their use at lower, legal prices.
b. Removal of the legal prohibitions might make drug use more socially
acceptable and shift demand to the right.
4. The impact of minimum-wage laws will be less harmful to employment if the

demand for minimum-wage workers is inelastic.

1.Production planning It helps a producer to decide about the volume of production. If the
demand for his products is inelastic, specific quantities can be produced while he has to
produce different quantities, if the demand is elastic.
2. Helps in fixing the prices of different goods It helps a producer to fix the price of his
product. If the demand for his product is inelastic, he can fix a higher price and if the demand
is elastic, he has to charge a lower price.
3. Helps in fixing the rewards for factor inputs Factor rewards refer to the price paid for
their services in the production process. It helps the producer to determine the rewards for
factors of production. If the demand for any factor unit is inelastic, the producer has to pay
higher reward for it and vice-versa.
4. Helps in determining the foreign exchange rates Exchange rate refers to the rate at
which currency of one country is converted in to the currency of another country. It helps in
the determination of the rate of exchange between the currencies of two different nations.
5.Helps in determining the terms of trade t is the basis for deciding the terms of trade
between two nations. The terms of trade implies the rate at which the domestic goods are
exchanged for foreign goods.
6.Inelastic demand for agricultural products helps to explain why bumper crops depress the
prices and total revenues for farmers.
7.Governments look at elasticity of demand when levying excise taxes. Excise taxes on
products with inelastic demand will raise the most revenue and have the least impact on
quantity demanded for those products.
8.Demand for cocaine is highly inelastic and presents problems for law enforcement. Stricter
enforcement reduces supply, raises prices and revenues for sellers, and provides more
incentives for sellers to remain in business. Crime may also increase as buyers have to find
more money to buy their drugs.
a. Opponents of legalization think that occasional users or dabblers have a
more elastic demand and would increase their use at lower, legal prices.

b. Removal of the legal prohibitions might make drug use more socially
acceptable and shift demand to the right.

Practical application of income elasticity of demand

1. Helps in determining the rate of growth of the firm.

If the growth rate of the economy and income growth of the people is reasonable
forecasted, in that case it is possible predict expected increase in the sales of a firm and vice
versa.
2. Helps in the demand forecasting of a firm.
It can be in estimating future demand provided the rate of increase in income and Ey for the
products are known. Thus, it helps in demand forecasting activities of a firm.
3. Helps in production planning and marketing.
The knowledge of Ey is essential for production planning, formulating marketing
strategy, deciding advertising expenditures and nature of distribution channel etc in the long
run.
4. Helps in ensuring stability in production.
Proper estimation of different degrees of income elasticity of demand for different types of
product helps in avoiding over-production or under-production of a firm. One should know
whether rise or fall in income is permanent or temporary.
5. Helps in estimating construction of houses.
The rate of growth in incomes of people also helps in housing programs in a country.

Q.6 Discuss the scope of managerial economics.

Managerial Economics

Managerial economics is a science that deals with the application of various economic
theories, principles, concepts and techniques to business management in order to solve
business and management problems. It deals with the practical application of economic
theory and methodology in decision-making problems faced by private, public and non-profit
making organisations. Managerial economics is the use of economic modes of thought to
analyse business situation.

Scope of Managerial Economics

Consequently, there is no unanimity among different economists with respect to the exact
scope of business economics. However, the following topics are explained in this subject:-

Objectives of a firm
Historically, profit maximisation has been considered as the main objective of a business
unit. All business organisations have multiple objectives which are multidimensional out of
which some are supplementary and some are competitive.

Demand Analysis and Forecasting

A business firm is an economic organisation which is engaged in transforming productive
resources into goods that are to be sold in the market. A major part of managerial decision
making depends on accurate estimates of demand. A forecast of future sales serves as a guide
to management for preparing production schedules and employing resources. It will help
management to maintain or strengthen its market position and profit base. Demand analysis
also identifies a number of other factors influencing the demand for a product. Demand
analysis and forecasting occupies a strategic place in Managerial Economics.
Cost and production analysis
A firms profitability depends much on its cost of production. A wise manager would prepare
cost estimates of a range of output, identify the factors causing are cause variations in cost
estimates and choose the cost-minimising output level, taking also into consideration the
degree of uncertainty in production and cost calculations. Production processes are under the
charge of engineers but the business manager is supposed to carry out the production function
analysis in order to avoid wastages of materials and time. Sound pricing practices depend
much on cost control. The main topics discussed under cost and production analysis are: Cost
concepts, cost-output relationships, Economics and Diseconomies of scale and cost control.
Pricing decisions, policies and practices
Pricing is a very important area of Managerial Economics. In fact, price is the genesis of the
revenue of a firm ad as such the success of a business firm largely depends on the correctness
of the price decisions taken by it. The important aspects dealt with this area are: Price
determination in various market forms, pricing methods, differential pricing, product-line
pricing and price forecasting.
Profit management
Business firms are generally organized for earning profit and in the long period, it is profit
which provides the chief measure of success of a firm. Economics tells us that profits are the

reward for uncertainty bearing and risk taking. A successful business manager is one who can
form more or less correct estimates of costs and revenues likely to accrue to the firm at
different levels of output. The more successful a manager is in reducing uncertainty, the
higher are the profits earned by him. In fact, profit-planning and profit measurement
constitute the most challenging area of Managerial Economics.
Capital management
The problems relating to firms capital investments are perhaps the most complex and
troublesome. Capital management implies planning and control of capital expenditure
because it involves a large sum and moreover the problems in disposing the capital assets off
are so complex that they require considerable time and labour. The main topics dealt with
under capital management are cost of capital, rate of return and selection of projects.
Linear programming and theory of games
It implies maximisation or minimisation of a linear function of variables subject to a
constraint of linear inequalities.
Market structure and conditions
The information on market structure and conditions of various markets is the most important
part of the business.
Strategic planning
It provides long term decisions, which will have a huge impact on the behaviour of the firm.
The firm fixes up some long-term goals and objectives and selects a different strategy to
achieve them.