Economics Imp

Importance of economics and business economics.

BUSINESS ECONOMICS ECONOMICS

1. Managerial Economics involves application
of economic principles to the problems of the
firm.
2. Managerial Economics is microeconomics in
character.
3. Managerial Economics, though micro in
character, deals only with the firm and has
nothing to do with an individual’s economic
problems.
4. In Managerial Economics, mainly profit
theory issued; other distribution theories have
not much use in Managerial Economics.
5. Managerial Economics is a narrow concept.
6. Managerial Economics modifies and
enlarges model because Managerial Economics
adopts, modifies and reformulates economic
models to suit the specific conditions and
serves the specific problem-solving process.
7. Managerial Economics introduces certain
feedbacks such as objectives of the firm etc.
and then attempt to solve the real life, complex
business problems with the aid to tool subjects
e.g., Mathematics and so on.
1. Economics deals with the body of the
principles itself.
2. Economics is both micro and macro-
economic in character.
3. Micro Economics as a branch of economics
deals with both economics of the individual as
well as economics of the firm.
4. Micro Economics as a branch of Economics,
distribution theories, viz., wages, interest and
profit are also delt with.
5. Economics is a wider concept.
6. Economics gives the simplified model
because Economics Theory hypothesizes
economic relationship and builds economic
model:
7. Economics Theory makes certain
assumptions.

Opportunity Cost

 Since resources are limited, every time you make a choice about how to use them.
Economists use the term opportunity cost to indicate what must be given up to obtain
something that’s desired.
 A fundamental principle of economics is that every choice has an opportunity cost.
Examples

 At the ice cream Parlor, you have to choose between Chocolate and strawberry. When
you choose Chocolate, the opportunity cost is the enjoyment of the strawberry.
 For a farmer choosing to plant corn, the opportunity cost would be any other crop he
may have planted, like wheat
Rahul decides to quit working and go to school to get further training. The opportunity cost of this
decision is the lost wages for a year.

 Opportunity Cost = FO−CO

 Where: FO=Return on best foregone option CO=Return on chosen option
 The formula for calculating an opportunity cost is simply the difference between the
expected returns of each option.
Difference between macro and micro economics.

Time Value of Money

 The time value of money (TVM) is the idea that money available at the present time is worth
more than the same amount in the future due to its potential earning capacity. This core
principle of finance holds that, provided money can earn interest, any amount of money is
worth more the sooner it is received.
 Time Value of Money (TVM) is an important concept in financial management. It can be used
to compare investment alternatives and to solve problems involving loans, leases, savings

Marginal analysis: This is an analysis of additional benefits based on an activity in comparison to

additional costs incurred by the same activity. Marginal basically refers to the cost or benefit of
producing one more product or profit gained by adding one more worker. This is commonly used by
companies trying to maximize the profits by determining the effect of minor changes to the whole
business. It also helps in making a decision between two or more investment options especially
where funds are limited

Incrementalism: The concept of ‘incrementalism’ is basic in undertaking business decisions. It is

similar to ‘Marginalism’ but with a difference. In the discussion above, it was stated that the
‘marginal’ concept is associated with ‘a unit’ change. However, in most of the cases, business firms
produce and sell their products in bulk and not in units. Therefore, the business firms take their
decisions on the basis of incremental revenue and incremental cost and not on the basis of marginal
revenue and marginal cost.
Risk: A probability or threat of damage, injury, liability, loss, or any other negative occurrence that is
caused by external or internal reason, and that may be avoided through preventative action.

Types of Risk

1. Systematic Risk - Systematic risk influences a large number of assets. A significant

political event, for example, could affect several of the assets in your portfolio. It is
virtually impossible to protect yourself against this type of risk.
2. Unsystematic Risk - Unsystematic risk is sometimes referred to as "specific risk". This
kind of risk affects a very small number of assets. An example is news that affects a
specific stock such as a sudden strike by employees.
3. Credit or Default Risk - Credit risk is the risk that a company or individual will be
unable to pay the contractual interest or principal on its debt obligations.
4. Country Risk - Country risk refers to the risk that a country won't be able to honour its
financial commitments.
5. Foreign-Exchange Risk - When investing in foreign countries you must consider the fact
that currency exchange rates can change the price of the asset as well.
6. Interest Rate Risk - Interest rate risk is the risk that an investment's value will change as a result
of a change in interest rates.
7. Political Risk - Political risk represents the financial risk that a country's government will
suddenly change its policies.
8. Market Risk - This is the most familiar of all risks. Also referred to as volatility, market risk is
the day-to-day fluctuations in a stock's price.

Nudges Theory
 Nudges Theory is a concept in economics and behaviour sciences.
 It proposes positive reinforcement.
 It influences the behaviour and decision making of group and individuals.
 Nudge Theory was developed in cybernetics by James Wilk (before 1995) and D.J. Stevert.
 This theory improves decisions about health, wealth and happiness.
 It influences choices of people.

Cross elasticity of demand - 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.

Percentage Change∈Quality of X
Exy =
Percentage Change∈ Price of Y
Sweezy Kinked Demand Curve Model - American economist Sweezy came up with the kinked demand curve
hypothesis to explain the reason behind this price rigidity under oligopoly.
According to the kinked demand curve hypothesis, the demand curve facing an oligopolist has a kink at the
level of the prevailing price. This kink exists because of two reasons:
 The segment above the prevailing price level is highly elastic.
 The segment below the prevailing price level is inelastic.
Distinguish b/w Private cost and social cost –
 Private costs are the costs facing individual decision-makers based on actual market prices.
 Social costs are the private costs plus the costs of externalities. The prices are derived from market
prices, where opportunity costs are taken into account.
Law of return to scale - Returns to scale refer to the change in output that results from a change in the factor
inputs simultaneously in the same proportion in the long run. Simply put, when a firm changes the quantity of
all inputs in the long run, it changes the scale of production for the goods.

Production Function - Production function is a concept in economics that explains the relationship between
physical output and input. Output refers to the number of goods or services produced in a given time period.
Input, on the other hand, is the number of resources or materials that are used to produce output.
Short run production function:
 Capital is a Fixed Factor
 Law of Variable Proportions is applied - It is referred to as the law which states that when the quantity
of one factor of production is increased, while keeping all other factors constant, it will result in the
decline of the marginal product of that factor.
Long run production function:
 All variable factors
 Law of returns to scale is applied - Changes in output when all factors change in the same proportion
are referred to as the law of return to scale. This law applies only in the long run when no factor is
fixed, and all factors are increased in the same proportion to boost production.

What are the characteristics of monopolistic competition? Compare the characteristics of monopolistic
competition with those of perfect competition.
Characteristics of monopolistic competition
 A large number of buyers and sellers in a given market act independently.
 There is a limited control of price because of product differentiation.
 Sellers offer differentiated products or similar but not identical products.
 New firms can enter the market easily. However, there is a greater competition in the sense that new
firms have to offer better features of their products.
 Economic rivalry centres not only upon price but also upon product variation and product promotion.

BASIS FOR
PERFECT COMPETITION MONOPOLISTIC COMPETITION
COMPARISON
Meaning A market structure, where there are many Monopolistic Competition is a market structure,
sellers selling similar goods to the buyers, is where there are numerous sellers, selling close
perfect competition. substitute goods to the buyers.
Product Standardized Differentiated
Price Determined by demand and supply forces, Every firm offer products to customers at its own
for the whole industry. price.
Entry and Exit No barrier Few barriers
Demand Curve slope Horizontal, perfectly elastic. Downward sloping, relatively elastic.
Relation between AR = MR AR > MR
AR and MR
Situation Unrealistic Realistic
What is meant by envelope Curve (LAC)? Explain Graphically.

LAC curve is also known as “planning curve” or envelope curve. In the words of G.L. Thioketal,
“LAC is the average cost per unit of output when the entrepreneur has time to vary all the factors of
production so that he has the most profitable size of the plant & the best proportion of fixed &
variable factors for any given output.

LAC is derived by combining the SAC curve. In fig., plants operate with SAC denoted by SAC 1, SAC2,
SAC3 respectively. Each plant is suitable for a particular range of output. If the firm starts production
with small plant (SAC1) can operate this plant with the least possible cost for various levels of output
up to OQ1.

It is clear from figure that LAC curve is tangent to the whole set of SAC curves. To the left minimum
point ‘A’ of LAC, this point of tangency is on the falling part of SAC. To the right of the minimum
point ‘A’, the point of tangency is on the rising part of the SAC. At the point A, LAC=SAC. At falling
part of LAC, the plants are not worked to full capacity & to the rising part of the LAC, the plants are
overworked. Only at the minimum point A, the plant is optimally used. So the plant represented by
SAC2 is optimum size of the plant, since its minimum cost of production is the least of the minimum
cost of all other plants. In other words, this plant is more efficient as compared to other plant sizes.

Explain Demand schedule, Demand curve and Demand function. Derive a demand curve from the
demand function: Q = 50- 10P

A demand schedule is a table that shows the quantity demanded of a good or service at different price levels. A
demand schedule can be graphed as a continuous demand curve on a chart where the Y-axis represents price
and the X-axis represents quantity.

A demand curve is a graphic display of the change in demand of a good resulting from a change in price in a
given time period.

A demand function is defined by p=f(x), p = f ( x ) , where p measures the unit price and x measures the number
of units of the commodity in question, and is generally characterized as a decreasing function of x; that is,
p=f(x) p = f ( x ) decreases as x increases.

O
Average AQ C Q
B Output
D1 1
SAC SAC2 SAC3
Y X
What is meant by the term “equilibrium” in Economics?
Economic equilibrium is a condition or state in which economic forces are balanced. In effect, economic
variables remain unchanged from their equilibrium values in the absence of external influences. Economic
equilibrium is also referred to as market equilibrium.

Explain consumer’s Equilibrium by using the Cardinal Utility Approach.

Considering the perception of the cardinal utility approach, we turn to analyzing the consumer’s equilibrium. As
a general rule, when a consumer maximizes the total utility of the expenditure done by. him, then the consumer
reaches his equilibrium. To clarify consumer equilibrium, let’s start with a simple one-object case. Suppose a
fixed income earner spends only on a commodity, X. His income is both utility for income and commodity X, so
he can spend his money on commodity X or it will remain with himself if he keeps all the total money and does
not spend any amount on X, then the marginal utility of money commodity X less than (i.e., MUx) is greater
than marginal utility of money income (MUm), total utility can be increased by exchanging money for the
commodity.

Therefore, a utility maximizing consumer exchanges his money income for the commodity so long as MUx >
MUm. As assumed earlier, marginal utility of commodity of X is subject to diminishing returns, whereas
marginal utility of money income (MUm) remains constant. Therefore, the consumer will exchange his money
income for commodity X so long as MUx > Px (MUm). The utility maximizing consumer reaches his
equilibrium with the level of his maximum satisfaction were

MUx = Px (MUm): (where MUm = 1)

Alternatively, the consumer reaches equilibrium whereas,

Consumer’s equilibrium in a single-commodity case is illustrated graphically in the given figure. The horizontal
line Px (MUm) shows the constant utility of money weighted by Px, the price of commodity X, and MUm curve
represents the diminishing marginal utility of commodity X. The Px (MUm) line and MUx curve intersect at
point E, where MUx – Px (MUm). Therefore, if consumer exchanges his money income for commodity X, he
increases his satisfaction per unity of commodity. At any point below E, MUx < Px (MUm), the consumer can
therefore increase his satisfaction by maximum.

Therefore, point E is the point of consumer’s equilibrium:

What is price discrimination? How price is determined under it? Is price discrimination useful to society?

Price discrimination is a selling strategy that charges customers different prices for the same product or service
based on what the seller thinks they can get the customer to agree to. In pure price discrimination, the seller
charges each customer the maximum price they will pay.
There are three types of price discrimination: first-degree or perfect price discrimination, second-degree, and
third-degree. These degrees of price discrimination are also known as personalized pricing (1st-degree pricing),
product versioning or menu pricing (2nd-degree pricing), and group pricing (3rd-degree pricing).
First-Degree Price Discrimination - First-degree discrimination, or perfect price discrimination, occurs when a
business charges the maximum possible price for each unit consumed. Because prices vary among units, the
firm captures all available consumer surplus for itself or the economic surplus. Many industries involving client
services practice first-degree price discrimination, where a company charges a different price for every good or
service sold.
Second-Degree Price Discrimination
Second-degree price discrimination occurs when a company charges a different price for different quantities
consumed, such as quantity discounts on bulk purchases.
Third-Degree Price Discrimination
Third-degree price discrimination occurs when a company charges a different price to different consumer
groups. For example, a theatre may divide moviegoers into seniors, adults, and children, each paying a different
price when seeing the same movie. This discrimination is the most common.

The question of whether price discrimination is useful to society is complex and depends on various factors.
Different perspectives exist on this issue, and opinions may vary based on economic, ethical, and social
considerations. Here are some arguments for and against the usefulness of price discrimination to society:

Arguments in favour of price discrimination:

1.Efficiency: Proponents argue that price discrimination can lead to a more efficient allocation of resources. By
charging different prices to different consumers, businesses can capture more consumer surplus and
potentially reinvest those profits in product improvement or innovation.

2.Increased output and access: Price discrimination can allow businesses to reach a larger customer base by
tailoring prices to different segments. This may result in increased overall output and broader access to goods
and services.

3.Incentives for innovation: The additional revenue generated through price discrimination may provide
businesses with the financial resources to invest in research and development, leading to innovation and
improved products.

4.Market segmentation: Price discrimination allows firms to target different market segments with different
price elasticities, ensuring that products are more affordable for price-sensitive consumers while still capturing
value from those willing to pay more.

Arguments against price discrimination:

1.Equity concerns: Critics argue that price discrimination may lead to unfair outcomes, as individuals or groups
with lower incomes may end up paying higher prices for the same goods or services compared to wealthier
consumers.

2.Consumer confusion and resentment: Price discrimination can lead to confusion and resentment among
consumers who feel they are being treated unfairly. This may negatively impact consumer trust and loyalty.

3.Reduced competition: In some cases, price discrimination may be associated with monopolistic or
oligopolistic behaviour, limiting competition in the market. This can result in higher prices overall and reduced
consumer welfare.

4.Resource misallocation: Critics contend that the practice of price discrimination may distort resource
allocation by encouraging businesses to focus more on pricing strategies than on improving efficiency or
reducing costs.

In conclusion, the impact of price discrimination on society is nuanced, and it depends on various factors,
including the specific context and industry. While price discrimination can lead to efficiency gains and increased
innovation, concerns about fairness, consumer welfare, and market competition should also be considered in
assessing its overall impact on society. Policymakers often need to strike a balance between promoting
economic efficiency and ensuring equitable outcomes.

Profit maximization remains the most important objective of business firms in spite of multiplicity of
alternative business objective. Comment.

Profit maximization refers to the maximization of dollar income of the firm. Under profit maximization
objective, business firms attempt to adopt those investment projects, which yields larger profits, and drop all
other unprofitable activities. In maximizing profits, input-output relationship is crucial, either input is
minimized to achieve a given amount of profit or the output is maximized with a given amount of input. Thus,
this objective of the firm enhances productivity and improves the efficiency of the firm.

The conventional theory of the firm defends profit maximization objective on the following grounds:

 In a competitive market only, those firms survive which are able to make profit. Hence, they always try
to make it as large as possible. All other objectives are subjected to this primary objective.
 Profit maximization objective is a time-honoured objective of a firm and evidence against this
objective is not conclusive or unambiguous.
 Though not perfect, profit is the most efficient and reliable measure of the efficiency of a firm.
 Under the condition of competitive market, profit can be used as a performance evaluation criterion,
and profit maximization leads to efficient allocation of resources.
 Profit maximization objective has been found extremely accurate in predicting certain aspect of firm’s
behaviour and trends; as such the behaviour of most firms are directed towards the objective of profit
maximization.

A monopoly firm can earn super normal profits but will never suffer loses? Comment and substantiate your
views using suitable illustrations.

A monopoly firm is a single seller in a market with no close substitutes for its product. The ability of a
monopoly to earn supernormal profits (economic profits that exceed the opportunity cost of capital) and avoid
losses is primarily influenced by its market power, which allows it to set prices above marginal cost.

Here are the reasons why a monopoly firm can earn supernormal profits and is less likely to suffer losses:

1. Market Power and Price Setting - A monopoly has significant market power, enabling it to be a price maker
rather than a price taker. It can set the price for its product based on its assessment of consumer demand and
willingness to pay.
 - The monopoly's ability to set prices above marginal cost allows it to earn positive economic profits. The
larger the gap between the price and marginal cost, the greater the potential for supernormal profits.

Illustration - If a monopoly's marginal cost of production is $10 and it sets the price at $30, it earns a $20 profit
on each unit sold. The higher the price, the greater the profit margin.

2. Barriers to Entry - Monopolies often maintain their dominant position due to significant barriers to entry
that prevent or discourage other firms from entering the market.

- Barriers can include high startup costs, control over essential resources, legal restrictions, and economies of
scale that give the existing monopoly a cost advantage.

Illustration - If a monopoly has exclusive access to a rare resource required for production, potential
competitors may find it difficult or costly to enter the market and compete.

3. No Direct Competition - Monopolies face no direct competition for their specific product, allowing them to
control the entire market and set prices without fear of undercutting by competitors.

- The absence of substitutes means consumers have limited choices, further strengthening the monopoly's
pricing power.

Illustration - If a monopoly is the sole provider of a unique patented product, consumers have no alternative
but to purchase from that monopoly.

4. Long-Run Profitability - In the long run, a monopoly can adjust its production capacity to meet demand and
maximize profits. It can invest in cost-saving technologies or expand production to take advantage of
economies of scale.

Illustration - A monopoly may invest in advanced technology that reduces its average cost of production,
leading to increased profits.

While a monopoly has the potential to earn supernormal profits, it is important to note that public policy
concerns often arise due to the lack of competition and potential negative effects on consumer welfare.
Governments may intervene to regulate monopolies and promote competition to ensure a more efficient
allocation of resources and prevent excessive market power abuse.

Oligopoly - comes from the Greek word “oligo” which means ‘few’ and “polein” means ‘to sell’.

 small number of sellers, each aware of the action of others.

 All decisions depend on how the firms behave in relation to each other.