Course: Business Economics

Internal Assignment Applicable for December 2018 Examination

Ques1:

The manager of a company was analyzing the trend of the products of its company (Commodity Y)
getting replaced by another substitute product available in the market which gives the same level of
satisfaction to the consumers. Calculate the rate of Marginal Rate of Substitution and analyze the
result.

Answer: Marginal rate of substitution (MRS) is the rate at which one commodity can be
substituted for another commodity maintaining the same level of satisfaction.
MRS for two substitute goods X and Y may be defined as quantity of commodity X required
to replace one unit of commodity Y (or quantity of commodity Y required to replace one unit
of X) such that utility derived from either combinations remains the same.
This implies that the utility of X (or Y) is equal to the utility of additional units of Y (or X)
added to a combination. MRS of X and Y is denoted as ∆Y/∆X as it continues to diminish as
the consumer continues to substitute X for Y or vice versa.
Combination Combination Change in Y Change in X MRSy,x
Y+X (∆Y) (∆X) (∆Y/∆X)
a 40+10 - - -
b 25+14 -15 4 -3.75
c 17+19 -8 5 -1.6
d 10+27 -7 8 -0.875
e 7+38 -3 11 -0.2727

From above table we can see as the consumer moves from combination a to b, HE/SHE
sacrifice 15 units of commodity Y and gets 4 units of commodity X. Therefore,
MRSy,x = -3.75
Similarly when the consumer moves from combination b to c, HE/SHE sacrifice 8 units of
commodity Y and gets 5 units of commodity X. Therefore,
MRSy,x = -1.6
This shows that as the consumer moves down the combination from point a to b to c, MRS
diminishes from -3.75 to -1.6.
As we calculate further in table for combination d and e, when the consumer moves from
combination c to d, HE/SHE sacrifice 7 units of commodity Y and gets 8 units of commodity
X. Therefore,
MRSy,x = -0.875

When the consumer moves from combination d to e, HE/SHE sacrifice 3 units of commodity
Y and gets 11 units of commodity X. Therefore,
MRSy,x = -0.2727
This again shows that as the consumer moves down the combination from point c to d to e,
MRS diminishes from -0.875 to -0.2727.

According to the ordinal utility approach, MRSy,x (or MRSx,y) decreases which means that
the quantity of a commodity an individual is willing to give up for an additional unit of the
other commodity continues to decrease with each other substitution.

Ques2: Neha has just completed her MBA and joined a startup company. The company was
planning to launch a new product in the market so the management wanted to understand the
different factors that can impact the demand and supply of their products in the market. Help Neha
to prepare a report on the factors impacting demand and supply of products in the market.

Answer: Supply and demand is a fundamental factor in establishing the cost of goods and
services. Supply refers to the quantity of product available in the market for sale at a specified price
and time however demand refers to the how much (quantity) of a product or service is desired by
buyers.

If the supply of a good or service is falling short, the price rises whereas if there is an excess of a good
or service, the price falls because there are more number of suppliers to meet the demand.
Additionally If the price of a product will fall, demand will increase because more buyers will be willing
or able to purchase the product.
The supply of goods and services in the marketplace is predicted on several factors such as price of a
product, industry structure, production capacity, production costs (including wages, interests, raw
materials costs, etc), government policies, market competition, etc.

The demand for products and services is predicated on the basis of a number of factors such as tastes
and preferences of the target market, consumer's purchasing capability, quality of the goods or
services being offered, and the availability of substitute goods or services, etc.

Factors influencing supply of products

Some of the factors that can influence the supply of a product is as mentioned below:

1. Price of a product: Price is one of the main factor that influences the supply of a product. Price of a
product and its supply has a direct relationship i.e. If the price of a product increases, then the supply
of the product also increases and vice versa. Change in supply with respect to the change in price is
termed as the variation in supply of a product.

Speculation about future price can also affect the supply of a product. If the price of a product is
about to rise in future, the supply of the product would decrease in the market in order to get a
higher price and benefit in turn however if the price of a product is predicted to fall in future, supply
of the product would increase in the market.

2. Industry Structure: The industry structure (monopoly or competitive market structure) also plays
an important role in determining supply of a product.

For ex.- If there is monopoly in the industry, supply of goods can be restricted and price can be
increased however if there is competitive market structure, prices has to be kept competitive or low.
Also if the structure is competitive, we need to make our presence felt in the market as supply will be
more in market due to availability of large number of sellers in the market.

3. Cost of Production: Supply of a product would decrease with increase in the cost of production
and vice versa. The supply of a product and cost of production are inversely related to each other.
The cost of production rises due to several factors, such as loss of fertility of land, high wage rates of
labour, and increase in the prices of raw material, transport cost, and tax rate.

For example, a seller would supply less quantity of a product in the market, when the cost of
production exceeds the market price of the product.

4. Natural Conditions: The supply of products is directly influenced by climatic conditions. We need
to factor in the climatic conditions favourable for the product.

For example, the supply & demand of woollen apparels increases in winter season however, the
supply of these products decreases in summer season.
5. Transport Conditions: Easy transport facilities increase the supply of products. Transport is always
a constraint to the supply of products, as the products are not available on time due to poor
transport facilities. Therefore, even if the price of a product increases, the supply would not
increase. In addition the seller can also lose his/her customers because of the delay in the delivery of
products.

7. Technology: It is one of the important determinant of supply. A better and advanced technology
increases the production of a product, which results in the increase in the supply of the product.

Ex.- Advanced machines used in manufacturing a product will decrease the time consumed in
preparing a product.

8. Government’s Policies: Policies imposed by the government such as industrial policy, taxation
policies, etc policies has a greater impact on the supply of a product.

For example, increase in tax on excise duties would decrease the supply of a product. On the other
hand, if the tax rate is low, then the supply of a product would increase.

9. Prices of Related Goods: Refer to fact that the prices of substitutes and complementary goods
also affect the supply of a product. For example, if the price of wheat increases, then farmers would
tend to grow more wheat than nee. This would decrease the supply of rice in the market.

Factors influencing demand of a product

The demand for products and services is predicated on the basis of a number of factors such as
tastes and preferences of the target market, consumer's purchasing capability, quality of goods or
services being offered, etc. The demand changes as a result of changes in price for a product.

Major factors that can influence the demand of a product are as mentioned below:

1.Tastes and Preferences of the target consumers: This is one of the important factor influencing
demand of a product. The goods which are very popular among the consumers will have a higher
demand. The changes in demand for various goods occur due to the changes in fashion and also due
to the marketing strategies such as advertisements followed by the manufacturers and sellers of
different products. On the contrary, when certain goods go out of fashion or people’s tastes and
preferences no longer remain favourable to them, the demand for them decreases.

2. Purchasing capability of the consumers: The demand for goods also depends upon the incomes
of the people. The greater the incomes of the people, the greater will be their demand for goods.
Therefore, when incomes of the people increase, they can afford to buy more. It is because of this
reason that increase in income has a positive effect on the demand for a good. When the incomes of
the people fall, they would demand less of a good and as a result the demand curve will shift
downward.

3.Changes in Prices of the Related Goods: The demand for a good is also affected by the prices of
other goods, especially those which are related to it as substitutes or complements. When we draw
the demand schedule or the demand curve for a good we take the prices of the related goods as
remaining constant. When the prices of the related goods or substitutes change, the demand curve
will shift upward or downward whereas when the price of a substitute for a good falls, the demand
for that good will decline and when the price of the substitute rises.

For example, Tea and coffee are very close substitutes. When price of tea and incomes of the
people remain the same but the price of coffee falls, the consumers would demand less of tea than
before.

4. Marketing strategy for promoting the product such as advertisements, etc: The purpose of
advertisement is to influence the consumers in favour of a product. Advertisements are given in
various media such as newspapers, radio, and television. Advertisements for goods are repeated
several times so that consumers are convinced about their superior quality. When advertisements
prove successful they cause an increase in the demand for the product.

5. The Number of Consumers in the Market: The market demand for a good is obtained by adding up
the individual demands of the present as well as prospective consumers of a good at various possible
prices. The greater the number of consumers of a good, the greater the market demand for it.
6. Consumers’ Expectations with Regard to Future Prices: One of the other important factor
influencing the demand for a commodity is the expectations about future prices. If people expect that
price of a commodity is likely to go up in future, they will demand greater quantities of the goods so
that in the future they should not have to pay higher prices and vice versa.

Ques 3. Alpha Ltd market share was declining due to high competition in the market so it decided to
enter a new segment. It wanted to determine the relationship between change in the quantity
demanded of the product due to change in the price of the product in the market. Assume that at
the price of ₹100, the demand for the product is 400 units. If the price of the product increases to
₹120, the demand decreases to 250 units.

Calculate the price elasticity:

a) Using Arc elasticity method (5 Marks)

b) Using Percentage method (5 Marks)

Answer:

a) Using Arc elasticity method: This method is used to calculate the elasticity of demand at
the mid point of an arc on the demand curve. Average of prices & quantities are calculated
for finding elasticity. Formula is as mentioned below:

Ep = Change in quantity/Change in price * P + P1/Q + Q1

Where, Change in quantity refers to (Q1 – Q)

Change in price refers to (P1 – P)

P Refers to original price

P1 Refers to new price

Q Refers to Original quantity demanded

Q1 is new quantity demanded

Here in the given example, P = 100, Q= 400, P1 = 120 & Q1 = 250

Change in quantity = 250 – 400 = - 150

Change in price = 120 – 100 = 20

Ep = -150/20 * 100+120/400+250

= -150/20 * 220/650

= - 2.535

= 2.54 approx. (ignoring the negative sign as price and demand are inversely related)

Hence Ep> 1.

b) Using Percentage method : Percentage method also known as the ratio method is used to
calculate the elasticity of demand using a ratio of proportionate change in quantity
demanded to the price of the product.

Ep = (Q1 – Q)/Q ÷ (P1 – P)/P

Where P refers to original price

P1 refers to new price

Q refers to original quantity demanded

Q1 refers to new quantity demanded

Here in the given example, P = 100, P1 = 120, Q = 400 & Q1 = 250

Ep = 250 – 400/400 ÷ 120 – 100/100

=- 150/400 ÷ 20/100

= - 1.875

= 1.88 approx. (ignoring the negative sign as price and demand are inversely related)

Hence Ep> 1.