Managerial Economics

Date: 24/10/2021
Name: SUBODH KUMAR SINGH

Individual Assessment 01
Question 1. Companies often change colour, package, design, and advertisements for their
products. Is it because the companies wish to counter the impact of diminishing marginal
utility? Explain with suitable examples that you may have witnessed, heard, or read. Explain
the law of diminishing Marginal Utility.

Ans:

Definition: Marginal Utility

Marginal utility is the incremental increase in utility (total satisfaction received

from consuming a good or service) that results from the consumption of one
additional unit. The utility is an economic term used to represent satisfaction
or happiness.

The law of diminishing marginal utility states that as consumption increases,

the marginal utility derived from each additional unit declines.

Description:

 The law of diminishing marginal utility states that the marginal utility
from each additional unit declines as consumption increases.

 The marginal utility can decline into negative utility, as it may become
entirely unfavourable to consume another unit of any product.

Law of Diminishing Marginal Utility

The law of diminishing marginal utility directly relates to the concept of

diminishing prices. As the utility of a product decreases as its consumption
increases, consumers are willing to pay smaller dollar amounts for more of the
product.

For example, If an individual pays $75 for a Mixer Grinder. Because he has
little value for a second Mixer Grinder, the same individual is willing to pay
only $15 for a second vacuum cleaner.
Example of Diminishing Utility

Example: 1

An individual can purchase a slice of pizza for $2, and is quite hungry, so they
decide to buy five slices of pizza. After doing so, the individual consumes the
first slice of pizza and gains a certain positive utility from eating the food.
Because the individual was hungry and this is the first food consumed, the first
slice of pizza has a high benefit.

Upon consuming the second slice of pizza, the individual’s appetite is

becoming satisfied. They are not as hungry as before, so the second slice of
pizza had a smaller benefit and enjoyment than the first. The third slice, as
before, holds even less utility as the individual is now not hungry anymore.

The fourth slice of pizza has experienced a diminished marginal utility as well,
as it is difficult to be consumed because the individual experiences discomfort
upon being full from food. Finally, the fifth slice of pizza cannot even be
consumed. The individual is so full from the first four slices that consuming the
last slice of pizza results in negative utility.

The five slices of pizza demonstrate the decreasing utility that is experienced
upon the consumption of any good. In a business application, a company may
benefit from having three accountants on its staff. However, if there is no need
for another accountant, hiring another accountant results in a diminished
utility, as there is a minimum benefit gained from the new hire.

Example: 2

A consumer buys a bag of chocolate of same colour and after one or two
pieces their utility rises, but after a few pieces, their utility starts to decline with
each additional piece that's consumed—and eventually, after enough pieces,
will likely result in negative equity.

In the same case if bag contains chocolate with different design, Packaging
and colours then consumer utility margin will diminish at the slow rate and
degree of satisfaction is greater as compared to the case-1.

Conclusion:

With the observation of above examples, we can state that Companies often change
colour, package, design, and advertisements for their products to counter diminishing
marginal utility (decline of enjoyment from consuming or buying one additional good)
of consumers.
Question 2.  Any change in product price done by the company will require the company to
assess the impact on its quantity demanded. Competitor price changes can also influence the
demand of the product of the respondent company. This is because of cross-price elasticity.
A change in our income tends to make us less price sensitive. Explain the concept of
Elasticity - own price elasticity, cross-price elasticity, and Income elasticity with help of
suitable examples.

Soln: Elasticity:

In the economics perspective, Elasticity measures the percentage change in demanded

quantity due to one percent change in the demand interest. Price elasticity is the ratio
between the percentage change in the quantity demanded (Qd) or supplied (Qs) and
the corresponding percent change in price.

An elastic demand or elastic supply is one in which the elasticity is greater than one,
indicating a high responsiveness to changes in price. Elasticities that are less than one
indicates low responsiveness to price changes and correspond to inelastic
demand or inelastic supply.

We can take an example of computing elasticity of demand using the formula is

shown in Example 1. When the price decreases from $10 per unit to $8 per unit, the
quantity sold increases from 30 units to 50 units. The elasticity coefficient is 2.25.
  As a rule of thumb, if the quantity of a product demanded or purchased
changes more than the price changes, the product is termed elastic. (For
example, the price changes by +5%, but the demand falls by -10%).

 If the change in quantity purchased is the same as the price change

(say, 10%/10% = 1), the product is said to have unit (or unitary) price
elasticity.
 Finally, if the quantity purchased changes less than the price (say, -5%
demanded for a +10% change in price), then the product is termed
inelastic.

Own Price Elasticity:

It is the percentage change in quantity demanded of a good or service divided by the
percentage change in the price. It is better measure of responsiveness of quantity
demanded to a price change as compared to slope.

So, we can associate that:

If….

% Change in quantity > % change in price, then:

(% Change in quantity)/ (% change in price) > 1 (It is called Elastic)

Factors affecting Own price elasticity of demand:

(1) availability of substitutes,

(2) if the good is a luxury or a necessity,

(3) the proportion of income spent on the good

(4) how much time has elapsed since the time the price changed.

Example For Own Price Elasticity :

Suppose that the price of apples falls by 6% from $1.99 / bushel to

$1.87/ bushel. In response, grocery shoppers increase their apple purchases
by 20%. The elasticity of apples therefore is: 0.20/0.06 = 3.33, The demand
for apples is quite elastic.
Cost Price Elasticity:

The cross  elasticity of demand is an economic concept that measures the

responsiveness in the quantity demanded of one good when the price for another good
changes. Also called cross-price elasticity of demand, this measurement is calculated
by taking the percentage change in the quantity demanded of one good and dividing it
by the percentage change in the price of the other good.

In another words, the cross elasticity of demand refers to how sensitive the demand
for a product is to changes in the price of another product. It is a measure of the
responsiveness of the demand for a good X to a change in the price of good Y.

Exy= Percentage Change in Price of Y
Percentage Change in Quantity of X

= ΔQx/Qx × Py/ΔPy

Exy= ΔQx/ ΔPy×Py/Qx

For Substitute Exy >0

For Complements Exy <0

where: Qx=Quantity of good

 XPy =Price of good

 YΔ=Change

Example:

If the price of coffee increases, the quantity demanded for coffee stir sticks
drops as consumers are drinking less coffee and need to purchase fewer
sticks. In the formula, the numerator (quantity demanded of stir sticks) is
negative and the denominator (the price of coffee) is positive. This results in a
negative cross elasticity.
Income elasticity:

Income elasticity of demand refers to the sensitivity of the quantity demanded

for a certain good to a change in the real income of consumers who buy this
good.

The formula for calculating income elasticity of demand is the percent change

in quantity demanded divided by the percent change in income. With income
elasticity of demand, we can tell if a particular good represents a necessity or
a luxury.

Types of Income Elasticity of Demand

There are five types of income elasticity of demand:

1. High: A rise in income comes with bigger increases in the quantity

demanded.
2. Unitary: The rise in income is proportionate to the increase in the
quantity demanded. 
3. Low: A jump in income is less than proportionate to the increase in the
quantity demanded. 
4. Zero: The quantity bought/demanded is the same even if income
changes
5. Negative: An increase in income comes with a decrease in the quantity
demanded. 

Example of Income Elasticity of Demand

Consider a local car dealership that gathers data on changes in demand and
consumer income for its cars for a particular year. When the average real
income of its customers falls from $50,000 to $40,000, the demand for its cars
plummets from 10,000 to 5,000 units sold, all other things unchanged.

The income elasticity of demand is calculated by taking a negative 50%

change in demand, a drop of 5,000 divided by the initial demand of 10,000
cars, and dividing it by a 20% change in real income—the $10,000 change in
income divided by the initial value of $50,000. This produces an elasticity of
2.5, which indicates local customers are particularly sensitive to changes in
their income when it comes to buying cars.

Question 3. Let’s assume you are planning to buy a new car. Explain the demand
determinants. Which of the demand determinant will have higher weightage and why?

Soln:

DETERMINANTS OF DEMAND
The demand for a commodity by a buyer is generally not a fixed quantity. It is
affected by many factors. The factors that influence the demand are called
the determinants of demands. The determinants of demand are also known as demand
shifters. The following factors affect an individual's demand for a commodity:

1. Prices of related commodities

When a change in price of the other commodity leaves the amount demanded of the
commodity under consideration unchanged, we say that the two commodities are
unrelated, otherwise these are related. The related commodities are of two types’
substitutes and complements. When the price of one commodity and the quantity
demanded of the other commodity move in the same direction (i.e., both increase
together and decrease together).

2. Income of the individual

The amount demanded of a commodity also depends upon the income of an
individual. With an increase in income, increased amount of most of the commodities
in his consumption bundle, though the extent of the increase may differ between
commodities.

3. Design & Features

It is quite well that the change in design and preferences of consumers in favour of a
commodity result in smaller demand for the commodity. Modern business firms,
which sell product with different brand names, rely a great deal on influencing tastes
and preferences of households in favour of their products (with the help of
advertisements, etc.) in order to bring about increase in demand of their products.

4. Tastes of the consumers

The amount demanded also depends on consumer’s taste. Tastes include fashion,
habit, customs, etc. A consumer’s taste is also affected by advertisement. If the taste
for a commodity goes up, its amount demanded is more even at the same price and
vice-versa.

5. Wealth
The amount demanded of a commodity is also affected by the amount of wealth as
well as its distribution. The wealthier are the people, higher is the demand for normal
commodities. If wealth is more equally distributed, the demand for necessaries and
comforts is more. On the other hand, if some people are rich, while the majority is
poor, the demand for luxuries is generally less.

Major Factors affecting demand to buy Car

Price of relative goods:

Demand for coca cola is also influenced by the change in price of relative
goods. In case of coca cola there are number of substitute goods available
in the market, we have Pepsi, Miranda, limca, spirit, etc. now if the price of
coca cola increases from Rs 12 to Rs 20 whereas the price of other aerated
drinks remains the same then the demand for coca cola will fall down.

INCOME OF THE CONSUMER

There is a direct relationship between income of consumer and demand.

Now coca cola being a normal good, if there’s an increase in income, the
demand will increase and vice versa.
TASTE AND PREFERENCES

Taste and preferences of the consumers also influence the demand to

greater extent. In case of coca cola, if there are hard core consumers who

Source: https://auto.mahindra.com/suv/xuv700/assets/img/brochure.pdf
Prefer the interest of consumers, even if the price of Mahindra XUV700(New
Model) increases, the demand will remain the same. But if the consumers have
no taste or preference of XUV700, then if the price increases the demand
decreases.

Depending on the demand determinants a company formulates its promotion

through- Brochure, advertisements, distribution network keeping in mind that
integrated marketing communication doesn’t go out of sync at any stage.
Design & Safety:
Design & Safety is an important factor that affects most of the demand of
Mahindra XUV 700 e.g., the demand for XUV700 goes up whenever company
launches its new design & safety features in its successive variants.

Source: https://auto.mahindra.com/suv/xuv700/assets/img/brochure.pdf
Design:

Source: https://auto.mahindra.com/suv/xuv700/assets/img/brochure.pdf
Safety:

Source: https://auto.mahindra.com/suv/xuv700/assets/img/brochure.pdf
Question 4. Assume food delivery firms like Swiggy are making huge profits. Higher
profits may attract the entry of new firms into the food delivery industry. Explain
what could be the impact of entry on the firms and the industry as a whole.  
1. The average cost of rendering the delivery service for the existing players 
2. Price/commissions that they charge from their customers 
3. Profitability 
4. How would the break-even point impact due to entry of new firms? 

Ans:

1) Swiggy enters the market by differentiating themselves as app-based food delivery

service by making ease of ordering and choosing from different restaurants and quick
delivery and make them as monopolistic competition for some time and enjoys the
good profits for short time.

Q is the number of customer (Quantity)that can serve to get the profit where their
marginal cost is equal to their marginal revenue and they could get at the average cost
of AC and operating at the price of P and enjoying the profits.

As swiggy is making profits and these profits attracts the other companies like zomato
and uber deliveries to enter into the food delivery industry.
2)Ans:
As the greater number of firms enter into the competition, and it became perfect
competition market, companies have to invest more to sustain in the market in terms
promoting, quick service and offering discounts to customers makes and hence
average cost of firms increases to AC1.

3)Ans:
And also, as the competition increases, price/commission they charge from their
customers will reduce, which in turn effect the profits they operate and now, average
cost of the firm and operating price both are becomes equal and hence firms earn
zero economic profits.

4)Ans:
As the firms reach break-even point at where their total cost is equals to the total
revenue.

Total Revenue = Total Cost

P*Q = TFC+TVC = TFC+AVC*Q

Q(P-AVC) =TFC 0r Q = TFC/(P-AVC), Where P-AVC is Contribution margin.

Due to entering the new firms, Average cost has increases and profits are coming
down its take lot of time and efforts to reach the break-even point.

 
  
THANK YOU!!