BUSINESS ECONOMICS

SELF-LEARNING MATERIAL
COURSE: B. TECH – CIVIL ENGINEERING

COURSE: TITLE: BUSINESS ECONOMICS
CREDITS: 2
COURSE: CODE GEA4404
SYLLABUS
MODULE 1: INTRODUCTION TO ECONOMICS (6)

Introduction to Economics- Flow in an economy, Law of supply and demand, Concept of
Engineering Economics – Engineering efficiency, Economic efficiency, Scope of engineering
economics.
MODULE 2: COST ANALYSIS (6)
Types of Cost, Element of costs, Marginal cost, Marginal Revenue, Sunk cost, Opportunity
cost, Break-even analysis, Economies of Scale Cost Classification.
MODULE 3: CONSUMER’S AND PRODUCER’S BEHAVIOUR (6)
Consumer Behavior: Law of Diminishing Marginal utility – Equi marginal Utility –
Consumer’s Equilibrium – Indifference Curve – Production: Law of Variable Proportion –
Laws of Returns to Scale – Producer ‘s equilibrium – Economies of Scale Cost Classification
MODULE 4: BUDGET (6)
Process of budgeting in India –classification of budgets trends – evaluation systems – types
of deficits– fiscal policy – indicators –– taxation – centre, state and local – public debt and
management.
MODULE 5: FINANCE (6)
Basics of finance and financial environment – instruments of financial markets – financial
intermediation – investment banking and brokerage services – securities – types of securities
–
market for securities – how and where traded – initial public offering (IPO) – secondary
markets –trading on exchanges and trading with margins.
TEXT BOOKS
1 S.Shankaran, Business Economics – Margham Publications.
2 H.L. Ahuja, Business Economics – Micro & Macro – Sultan Chand & Sons – New Delhi – 55.
REFERENCE BOOKS
1 S.A.Ross, R.W.Westerfield, J.Jaffe and Roberts: Corporate Finance, McGraw-Hill.
2 Joseph E Stiglitz: Economics of the Public Sector.
E BOOKS
Notes Prepared by Prof. Dr.M.RAMESH, HITS.

1 https://sites.google.com/site/readbookpdf7734/pdf-download-business-economics-by---m
ark-taylor-read-online
MODULE – I
Part – A
1. Define Business economics
According to Spencer and Siegelman “The integration of economic theory with business
practice for the purpose of facilitating decision-making and forward planning by
management”.
According to McNair & Meriam “Managerial economics deals with the use of economic
modes of thought to analyse business situation".
2. What are the fundamental concepts of Business economics?
The Incremental Concept
The Concept of Time Perspective
The Opportunity Cost Concept
The Discounting Concept
The Equi-marginal Concept
3. Whether Business economics is positive or normative?
Positive economics is descriptive in character. W h i l e n o r m a t i v e
e c o n o m i c s p a s s e s j u d g m e n t s o f v a l u e . Managerial economics draws from
descriptive economics and tries to pass judgments of value in the context of the firm.
Managerial economics is mainly normative in nature.
4. What is Business economics?
Managerial economics generally refers to the integration of economic theory with business
practice. Economics provides tools managerial economics applies these tools to the
management of business.
5. Give any three importance of Business economics.
Useful in Business Organization
Helpful in Chalking Out Business Policies
Help in Business Planning
Helpful in Cost Control
Useful in Coordination of Business Activities
6. What is demand analysis?
A firm's performance and profitability depend upon accurate estimates of demand. The firm
will prepare its production schedule on the basis of demand forecast. Demand analysis helps
to identify the factors influencing the demand for a firm's product and thus helps a manager
in business planning. Demand analysis and forecasting thus help him in the choice of the
product and in planning output levels.
7. What is meant by demand forecasting?

Accurate demand forecasting is essential for a firm to enable it to produce the required
quantities at the right time and arrange well in advance for the various factors of production
e.g., raw materials, equipment, machine accessories etc. Forecasting helps a firm to access
the probable future demand for its products and plan its production accordingly. Forecasting
is an important aid in effective and efficient planning.
8. Write a short note on the term ‘Risk’.
Risk is the possibility that an outcome will not be as expected, specifically in reference
to returns on investment in finance. However, there are several different kinds or risk,
including investment risk, market risk, inflation risk, business risk, liquidity risk and more.
9. Give a short note on the term ‘Uncertainty’.
Uncertainty exists when the outcomes of managerial decisions cannot be predicted with
absolute accuracy but all possibilities and their associated probabilities are known. Under
conditions of uncertainty, informed managerial decisions are possible. Experience, insight,
and prudence allow managers to devise strategies for minimizing the chance of failing to
meet business objectives.
10. What is a Risk and Uncertainty?
Risk is the possibility that an outcome will not be as expected, specifically in reference
to returns on investment in finance. Uncertainty exists when the outcomes of managerial
decisions cannot be predicted with absolute accuracy but all possibilities and their associated
probabilities are known.
11. Give a short note on efficiency.
Efficiency is all about making the best possible use of available resources and about quality
and eliminating wastefulness. Efficient companies maximize outputs from given inputs, thus
minimizing their costs. When a company’s efficiency improves, its costs are reduced and its
competitiveness is enhanced.
12. What is Profit Management?
The chief purpose of a business firm is to earn the maximum profit. There is always an
element of uncertainty about profits because of variation in costs and revenues. If knowledge
about the future were perfect, profit analysis would have been very easy task. But in this
world of uncertainty expectations are not always realized. Hence profit planning and its
measurement constitute the most difficult area of Managerial Economics. Under profit
management we study nature and management of profit, profit policies and techniques of
profit planning like Break Even Analysis.
Part – B

1. Distinguish between managerial economics and traditional economics.
 The traditional Economics has both micro and macro aspects whereas Managerial
Economics is essentially micro in character.
 Economics is both positive and normative science but the Managerial Economics is
essentially normative in nature.
 Economics deals mainly with the theoretical aspect only whereas Managerial
Economics deals with the practical aspect.
 Managerial Economics studies the activities of an individual firm or unit. Its analysis
of problems is micro in nature, whereas Economics analyses problems both from
micro and macro point of views.
 Economics studies human behaviour on the basis of certain assumptions but these
assumptions sometimes do not hold good in Managerial Economics as it concerns
mainly with practical problems.
 Under Economics we study only the economic aspect of the problems but under
Managerial Economics we have to study both the economic and non-economic
aspects of the problems.
 Sound decision-making in Managerial Economics is considered to be the most
important task for the improvement of efficiency of the business firm; but in
Economics it is not so.
 It is obvious that Managerial Economics is very closely related to Economics but its
scope is narrow as compared to Economics.
2. Explain briefly Nature of Managerial economics.
Art and Science
Managerial economics requires a lot of logical thinking and creative skills for
decision making or problem-solving. It is also considered to be a stream of science by some
economist claiming that it involves the application of different economic principles,
techniques and methods, to solve business problems.
Micro Economics
Managerial economics, generally deal with the problems related to a particular
organisation or a firm instead of the whole economy. Therefore, it is considered to be
microeconomics in character.
It Uses Macro Economic Concepts
A business functions in an external environment, i.e. it serves the market, which is a
part of the economy as a whole. Therefore, it is essential for managers to analyse the different
factors of macroeconomics such as market conditions, economic reforms, government
policies, taxation, business cycle etc. and their impact on the organisation.
Multi-disciplinary
It uses many tools and principles belonging to various disciplines such as accounting,
finance, statistics, mathematics, production, operation research, human resource, marketing,
etc. Hence, Managerial Economics is a multidisciplinary.
It is Prescriptive rather than Descriptive
It aims at goal achievement and deals with practical situations or problems by
implementing corrective measures. Management Oriented. It acts as a tool in the hands of
managers to deal with business-related problems and uncertainties appropriately. It also
provides for goal establishment, policy formulation and effective decision making.
It is Pragmatic

It is a practical and logical approach towards the day to day business problems. The
tools and concepts of Economics theories are used in decision making in business to solve the
practical problems of a business firm. So, Managerial Economics is Pragmatic.
3. Explain briefly Scope of Managerial Economics.

Demand analysis
A business firm is an economic organization 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 analysis
Cost estimates arc most useful for management decisions. The different factors that
cause variations in cost estimates should be given due consideration for planning purposes.
There is the clement of uncertainty of cost as other factors influencing cost arc either
uncontrollable or not always known. If one is able to measure cost it is very important for
more sound profit planning, cost control and often for sound pricing practices.
Pricing practices and policies
As price gives income to the firm, it constitutes as the most important field of
Managerial Economics. The success of a business firm depends very much on the correctness
of the price decisions taken by it. The various aspects that are dealt under it cover the price
determination in various market forms, pricing policies, pricing method, differential pricing,
productive pricing and price forecasting.
Profit management
The chief purpose of a business firm is to earn the maximum profit. There is always
an element of uncertainty about profits because of variation in costs and revenues. If
knowledge about the future were perfect, profit analysis would have been very easy task. But
in this world of uncertainty expectations are not always realized. Hence profit planning and
its measurement constitute the most difficult area of Managerial Economics. Under profit
Capital management
The problems relating to firm’s 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 of
arc so complex that they require considerable time and labour. The main topics dealt with
under capital management arc cost of capital, rate of return and selection of projects. The
topics discussed under headings from 1 to 5 are related with operational issues of a firm.
Analysis of business environment
The environmental factors influence the working and performance of a business
undertaking. Therefore, the managers will have to consider the environmental factors in the
process of decision-making. Decisions taken in isolation of environmental factors would
prove harmful to the firm. Therefore, the management must be fully aware of economic
environment, particularly those economic factors which constitute the business climate.

4. Describe the concept of Decision making and forward planning.
 The primary function of management executive in a business organisation is
decision making and forward planning.
 Decision making and forward planning go hand in hand with each other.
Decision-making means the process of selecting one action from two or
more alternative courses of action. Forward planning means establishing plans
for the future to carry out the decision so taken.
 The problem of choice arises because resources at the disposal of a
business unit (land, labour, capital, and managerial capacity) are limited and the
firm has to make the most profitable use of these resources.
 The decision-making function is that of the business executive, he takes the
decision which will ensure the most efficient means of attaining a desired
objective, say profit maximisation. After taking the decision about the particular
output, pricing, capital, raw-materials and power etc., are prepared. Forward
planning and decision-making thus go on at the same time.
5. Explain the concept of Risk and Uncertainty.

Part – C
1. Explain Nature and Scope of Managerial Economics.
Art and Science
Managerial economics requires a lot of logical thinking and creative skills for
decision making or problem-solving. It is also considered to be a stream of science by some
economist claiming that it involves the application of different economic principles,
techniques and methods, to solve business problems.
Micro Economics
Managerial economics, generally deal with the problems related to a particular
organisation or a firm instead of the whole economy. Therefore, it is considered to be
microeconomics in character.
It Uses Macro Economic Concepts

A business functions in an external environment, i.e. it serves the market, which is a
part of the economy as a whole. Therefore, it is essential for managers to analyse the different
factors of macroeconomics such as market conditions, economic reforms, government
policies, taxation, business cycle etc. and their impact on the organisation.
Multi-disciplinary
It uses many tools and principles belonging to various disciplines such as accounting,
finance, statistics, mathematics, production, operation research, human resource, marketing,
etc. Hence, Managerial Economics is a multidisciplinary.
It is Prescriptive rather than Descriptive
It aims at goal achievement and deals with practical situations or problems by
implementing corrective measures. Management Oriented. It acts as a tool in the hands of
managers to deal with business-related problems and uncertainties appropriately. It also
provides for goal establishment, policy formulation and effective decision making.
It is Pragmatic
It is a practical and logical approach towards the day to day business problems. The
tools and concepts of Economics theories are used in decision making in business to solve the
practical problems of a business firm. So, Managerial Economics is Pragmatic.
Demand analysis
A business firm is an economic organization 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 analysis
Cost estimates arc most useful for management decisions. The different factors that
cause variations in cost estimates should be given due consideration for planning purposes.
There is the clement of uncertainty of cost as other factors influencing cost arc either
uncontrollable or not always known. If one is able to measure cost it is very important for
more sound profit planning, cost control and often for sound pricing practices.

Pricing practices and policies
As price gives income to the firm, it constitutes as the most important field of
Managerial Economics. The success of a business firm depends very much on the correctness
of the price decisions taken by it. The various aspects that are dealt under it cover the price
determination in various market forms, pricing policies, pricing method, differential pricing,
productive pricing and price forecasting.
Profit management
The chief purpose of a business firm is to earn the maximum profit. There is always
an element of uncertainty about profits because of variation in costs and revenues. If
knowledge about the future were perfect, profit analysis would have been very easy task. But
in this world of uncertainty expectations are not always realized. Hence profit planning and
its measurement constitute the most difficult area of Managerial Economics. Under profit
Capital management
The problems relating to firm’s 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 of
arc so complex that they require considerable time and labour. The main topics dealt with
under capital management arc cost of capital, rate of return and selection of projects. The
topics discussed under headings from 1 to 5 are related with operational issues of a firm.
2. Elucidate the Concept of Efficiency.
Efficiency is all about making the best possible use of available resources and about
quality and eliminating wastefulness. Efficient companies maximize outputs from given
inputs, thus minimizing their costs. When a company’s efficiency improves, its costs are
reduced and its competitiveness is enhanced.
Efficiency is the organization's degree of success in using the least possible inputs in
order to produce the highest possible outputs. For example, if one business is able to produce
10 units of its products by spending $3 per unit, it is more efficient in production than a
similar business that produces 10 units of the same product spending $4 per unit.
Organizational efficiency is gauged using a number of quantitative figures such as production
costs and production times
Resources include both concrete items such as cash and more abstract concepts such
as human capital. Factors that influence the efficiency of the organization's use of its
resources can be both internal and external to the organization. For example, the quality of an
organization's labour is often dependent in part on the general education of the region in
which that organization is based. Quality of management is perhaps the most influential
factor on organizational efficiency since it is management that chooses how to implement
strategic plans including selecting what methods and resources to use, and leading employees
in order to make the most of their labour.

3. Explain how the managerial economics related to other subjects.
Managerial Economics and Economics

Managerial Economics is economics applied to decision making. It is a special branch
of economics, bridging the gap between pure economic theory and managerial practice.
Economics has two main branches—micro-economics and macro-economics.
Managerial Economics and Operations Research
The techniques and concepts such as Linear Programming, Dynamic Programming,
Input-output Analysis, Inventory Theory, Information Theory, Probability Theory, Queuing
Theory, Game Theory and Decision Theory are widely used in modern business decision
making.
Managerial Economics and Statistics
Statistics is important to managerial economics. It provides the basis for the empirical
testing of theory. It provides the individual firm with measures of appropriate functional
relationship involved in decision making. Statistics is a very useful science for business
executives because a business runs on estimates and probabilities. Statistics supplies many
tools to managerial economics. Suppose forecasting has to be done. For this purpose, trend
projections are used. Similarly, multiple regression technique is used. In managerial
economics, measures of central tendency like the mean, median, mode, and measures of
dispersion, correlation, regression, least square, estimators are widely used.
Managerial Economics and Accounting
Managerial economics is closely related to accounting. It is recording the financial
operation of a business firm. A business is started with the main aim of earning profit. Capital
is invested or employed for purchasing properties such as building, furniture, etc and for
meeting the current expenses of the business. Goods are bought and sold for cash as well as
credit. Cash is paid to credit sellers. It is received from credit buyers. Expenses are met and
incomes derived. This goes on the daily routine work of the business. The buying of goods,
sale of goods, payment of cash, receipt of cash and similar dealings are called business
transactions.
Managerial Economics and Mathematics
Mathematics is another important subject closely related to managerial economics.
For the derivation and exposition of economic analysis, we require a set of mathematical
tools. Mathematics has helped in the development of economic theories and now
mathematical economics has become a very important branch of economics. Mathematical
approach to economic theories makes them more precise and logical. For the estimation and
prediction of economic factors for decision making and forward planning, mathematical
method is very helpful. The important branches of mathematics generally used by a
managerial economist are geometry, algebra and calculus.

4. Describe Decision making process and its nature in business management.
Decision Making Process
Managerial Economics serves as a link between traditional economics and the
decision-making sciences for the purpose of business decision making. It directly deals with
real people and real business situations.
It facilitates the decision-making process by applying economic principles and
methodologies and helps in attaining desired economic goals which could be related to
minimization of cost, maximization of revenue or profit and many more. Managerial
economics rely on traditional economics and decision sciences to analyze any business
problem and study the impact of alternative courses of action on the optimum utilization of
resources. It deals with the application of knowledge and understanding of economic
principles, concepts, tools and techniques to facilitate a decision-making process in the
presence of uncertainty.
It also bridges the gap between pure analytical problem dealt in economic theory and
the real business problem faced in day to day business situations. It provides tools and
techniques to make the manager competent enough to take effective decision in real business
situations. Well said by Milton H. Spensor and Louis Seigelman that “Managerial Economics
is the integration of economic theory with the business practice for the purpose of facilitating
decision making and forward planning in management”.

MODULE -II
Part – A
1. What is Demand?
Demand for a commodity refers to the desire backed by ability to pay and willingness to buy
it.
Dx = F (Px, Ps, Y, T, W)
Where, Dx represents demand for good x Px is price of good X Ps is price of related goods Y
is income T refers to tastes and preferences of the consumers W refers to wealth of the
consumer.
2. Define Law of Demand.
Alfred Marshall stated that “the amount demanded increases with a fall in price and
diminishes with rise in price”. According to Ferguson, the law of demand is that the quantity
demanded varies inversely with price.
3. What is Giffen paradox?
Sir Robert Giffen discovered that the poor people will demand more of inferior goods if their
prices rise and demand less if their prices fall. Inferior goods are those goods which people
buy in large quantities when they are poor and in small quantities when they become rich. For
example, poor people spend the major part of their income on coarse grains (e.g. ragi,
cholam) and only a small part on rice. When the price of coarse grains rises, they will buy
less rice.
4. What is Veblen effect?
Veblen has pointed out that there are some goods demanded by very rich people for their
social prestige. When price of such goods rises, their use becomes more attractive and they
are purchased in larger quantities. Demand for diamonds from the richer class will go up if
there is increase in price. If such goods were cheaper, the rich would not even purchase.
5. Define Elasticity of Demand.
The concept of elasticity of demand was introduced by Alfred Marshall. According to him
“the elasticity (or responsiveness) of demand in a market is great or small according as the
amount demanded increases much or little for a given fall in price, and diminishes much or
little for a given rise in price”.
6. What is Price Elasticity of Demand?

7. Distinguish between Substitutes and Complimentary goods
Substitutes are goods that are used in place of each other. If a price increase for
one good leads to an increase in demand for a related good, then the two goods are
considered substitutes. An increase in Coffee prices, for example, followed by higher
demand for Tea. Tea is a substitute for Coffee.
Complementary goods are those that are often used together, such as motor
vehicles and Petrol, or DVDs and DVD player. When the price of one good declines (or
increases) and the demand for a related good increase (or decreases), then the two goods
are considered complementary.
8. What meant by Income Elasticity of Demand?
9. What do you mean by Cross Elasticity of Demand?
10. Give a short note about Consumer Goods with examples.

Consumer goods are tangible goods that are purchased for direct consumption to satisfy a
human need or want. These goods are offered to household and ultimate consumer e.g.,
shirts, cars, watches etc. This is in contrast to producer goods, which are purchased as an
input to produce another good.
11. What is meant by Supply?
Supply means the goods offered for sale at a price during a specific period of time. It is the
capacity and intention of the producers to produce goods and services for sale at a specific
price. The supply of a commodity at a given price may be defined as the amount of it which
is actually offered for sale per unit of time at that price.

12. Define Law of Supply.
The law of supply establishes a direct relationship between price and supply. Firms will
supply less at lower prices and more at higher prices. “Other things remaining the same, as
the price of commodity rises, its supply expands and as the price falls, its supply contracts”.
13. What are Consumer Goods?
Consumer goods are tangible goods that are purchased for direct consumption to satisfy a
human need or want. These goods are offered to household and ultimate consumer e.g.,
shirts, cars, watches etc. This is in contrast to producer goods, which are purchased as an
input to produce another good.
14. What are Capital Goods?
Capital goods are Producer goods used by businesses to produce goods and services used by
consumers. Capital goods are usually considered fixed goods that are not easily converted
into cash. Heavy equipment (such as excavators, forklifts, generators, metal-forming or
metal-working machines, vehicles) which (in contrast to consumer goods) require a relatively
large investment, and are bought to be used over several years. Also called producer goods.
15. Define Consumer Surplus.
Marshall defines Consumer’s surplus as follows: “The excess of price which a person would
be willing to pay rather than go without the thing, over that which he actually does pay, is the
economic measure of this surplus of satisfaction. It may be called consumer’s surplus.”
Consumer’s surplus = Potential price – Actual price

Part – B
1. Explain Price, Income, Cross Elasticity of Demand.
Price Elasticity of Demand
Income Elasticity of Demand
Cross Elasticity of Demand

2. Explain the Importance of Consumer Surplus.
 Consumer’s Surplus is useful to the Finance Minister in formulating taxation policies.
 It is also helpful in fixing a higher price by a monopolist in the market, based on the
extent of consumer’s surplus enjoyed by consumers.
 Consumer’s Surplus enables comparison of the standard of living of people of
different regions or countries.
 This comparison helps to distinguish consumption levels between the people, who are
living in rich countries and poor countries.
 For example, a middleclass person in New York enjoys more consumers’ surplus than
a similar person in Chennai.
 Alfred Marshall has stated that a middle-class person in a modern city enjoys more
consumer’s surplus than a king of the Medieval Ages.
3. Explain Exceptions of Law of Demand.
The Law of demand is a general statement telling that prices and quantities of a
commodity are inversely related. There are certain peculiar cases in which the law of demand
will not hold good. In those cases, more will be demanded at a higher price and less will be
demanded at a lower price. The demand curves in those cases slope upwards showing a
positive relationship between price and quantity demand.
Veblen Effect
Veblen has pointed out that there are some goods demanded by very rich people for
their social prestige. When price of such goods rises, their use becomes more attractive and
they are purchased in larger quantities. Demand for diamonds from the richer class will go up
if there is increase in price. If such goods were cheaper, the rich would not even purchase.
Giffen Paradox
Sir Robert Giffen discovered that the poor people will demand more of inferior goods
if their prices rise and demand less if their prices fall. Inferior goods are those goods which
people buy in large quantities when they are poor and in small quantities when they become
rich. For example, poor people spend the major part of their income on coarse grains (e.g.
ragi, cholam) and only a small part on rice. When the price of coarse grains rises, they will
buy less rice.
4. Why demand curve slopes downwards?
New Buyers
When price is high, only a few people can buy a commodity. When price falls,
people who could not buy up to now can also buy the commodity. A fall in the price of a
commodity encourages new persons to buy it. As a result, demand for it increases.
Income Effect
Demand curve slopes downwards due to the income effect. When price of a
commodity falls, the consumers get that commodity by paying less money. Their money is
saved to some extent. As a result, they can get more units of the same commodity with the
same amount. This is known as income effect.
Substitution effect
Substitution effect is another cause of the downward slope of the demand curve. Let
us suppose that coffee and tea are substitutes. When the price of coffee rises, the demand for

tea increases. People reduce the demand for coffee and buy tea as tea become relatively
cheaper. The substitute tea for coffee.
Different Uses
Demand curve slopes downwards because of the different uses of a commodity.
Certain commodities like electricity, sugar, wheat etc. have different uses. For instance,
electricity can be used for domestic lighting, for running business enterprises or for street
lighting purposes. When the price of electricity is high, people use it for limited purposes
only.
5. Differentiate between Consumer Durables and Capital goods with examples.
Consumer Durables
Consumer Durables i.e. goods which used by consumers and are durable for long time
period (generally more than 3 years). These goods are more expensive than non-durable
goods as they are being used again and again by same consumer or different consumers.
Refrigerator, washing Machine and Furnitures are examples for consumer goods. It is being
used for years by single consumer or can also be used by multiple consumers.
Capital goods
Capital goods are any tangible assets used by one business to produce goods or
services as an input for other businesses to produce consumer goods. They are also known as
intermediate goods, durable goods, or economic capital. The most common capital goods are
property, plant, and equipment or fixed assets such as buildings, machinery and equipment,
tools, and vehicles.
6. What are the methods of measuring Price Elasticity of Demand?

Important methods for calculating price elasticity of demand are:
Percentage method
Point method
Total outlay method
Arc method
Percentage method
This is measured as the relative change in demand divided by relative change in price
(or) percentage change in demand divided by percentage change in price.
For example, the price of rice rises by 10% and the demand for rice falls by 15% Then ep =
15/10 = 1.5 This means that the demand for rice is elastic. If the demand falls to 5% for a
10% rise in price, then ep = 5/10 = 0.5. This means that the demand for rice is inelastic.
Point method
We can calculate the price elasticity of demand at a point on the linear demand curve.
Formula to find out ep through point method is,
Total outlay method

We can measure elasticity through a change in expenditure on commodities due to a
change in price.
Demand is elastic, if total outlay or expenditure increases for a fall in price (ep > 1)

Demand is inelastic, if total outlay or expenditure falls for a fall in price (ep < 1)
Elasticity of demand is unitary, if total expenditure does not change for a fall in price (e p= 1)
Arc method
Segment of a demand curve between two points is called an Arc. Arc elasticity is
calculated from the following formula
7. State Law of Demand and give its assumptions.

The law of demand states that there is a negative or inverse relationship between the
price and quantity demanded of a commodity over a period of time.
demanded varies inversely with price. Thus, the law of demand states that people will buy
more at lower prices and buy less at higher prices, other things remaining the same. By other
things remaining the same, we mean the following assumptions
Assumptions of the Law
No change in the consumer’s income
No change in consumer’s tastes and preferences
No changes in the prices of other goods
No new substitutes for the goods have been discovered
People do not feel that the present fall in price is a prelude to a further decline in price.
8. Briefly explain the importance of Elasticity of Demand.
Price discrimination
If the demand for a product has different elasticities in different markets, then the
monopolist can fix different prices in different markets. This price discrimination is possible
due to different price elasticities
Levy of taxes
The government will get higher revenue if tax is increased on goods having inelastic
demand. Conversely, the government, will get lower revenue if tax is increased on goods
having elastic demand.
International Trade
Terms of trade refer to the rate at which domestic commodities are exchanged for
foreign commodities. The terms of trade will be favourable to a country if its exports enjoy
inelastic demand in the world market.
Determination of volume of output
1Volume of goods and services must be produced in accordance with the demand for
the commodity. When the demand is inelastic, the producer will produce more goods to take

the advantage of higher prices. Hence the nature of elastic and inelastic demand helps in the
determination of the volume of output.
Part – C
1. Explain in detail the types of Elasticity of Demand.

2. State and explain Law of Demand in detail.
The law of demand states that there is a negative or inverse relationship between the
price and quantity demanded of a commodity over a period of time.
demanded varies inversely with price. Thus, the law of demand states that people will buy
more at lower prices and buy less at higher prices, other things remaining the same. By other
things remaining the same, we mean the following assumptions
No change in the consumer’s income
No change in consumer’s tastes and preferences
No changes in the prices of other goods
No new substitutes for the goods have been discovered
People do not feel that the present fall in price is a prelude to a further decline in
price.
Demand Schedule
Demand schedule is a tabular statement showing how much of a commodity is
demanded at different prices.
Demand Schedule and Demand curve

The following Table is a hypothetical demand schedule of an individual consumer. It
shows a list of prices and corresponding quantities demanded by an individual consumer.
This is an individual demand schedule.
Demand Schedule
Demand Curve
The demand schedule can be converted into a demand curve by measuring price on
vertical axis and quantity on horizontal axis as shown in Figure. DD1 is the demand curve.
The curve slopes downwards from left to right showing that, when price rises, less is
demanded and vice versa. Thus, the demand curve represents the inverse relationship
between the price and quantity demanded, other things remaining constant.
Individual demand and market demand schedules

Individual demand schedule tells the quantities demanded by an individual consumer
at different prices.
Individual demand schedule

It is clear from the schedule that when the price of orange is Rs.5/ - the consumer
demands just one orange. When the price falls to Rs.4 he demands 2 oranges. When the price
falls further to Rs 3, he demands 3 oranges. Thus, when the price of a commodity falls, the
demand for that commodity increases and vice versa. market demand schedule A demand
schedule for a market can be constructed by adding up demand schedules of the individual
consumers in the market. Suppose that the market for oranges consists of 2 consumers. The
market demand is calculated as follows.
Demand Schedule for two consumers and the market Demand Schedule
The market demand also increases with a fall in price and vice versa. In Figure, the quantity
demanded by consumer I and consumer II are measured on the horizontal axis and the market
price is measured on the vertical axis. The total demand of these two consumers i.e. D1 + D2
= DD M. - DDM – the market demand curve - also slopes downwards just like the individual
demand curve. Like normal demand curves, it is convex to the origin. This reveals the inverse
relationship.
Individual Demand and Market Demand Curves

3. Explain the types of price elasticity of demand.
Relatively Elastic demand, if the value of elasticity is greater than 1
Relatively Inelastic demand, if the value of elasticity is less than 1
Unitary elastic demand, if the value of elasticity is equal to 1.
Perfectly inelastic demand, if the value of elasticity is zero.
Perfectly elastic demand, if the value of elasticity is infinity.

4. Explain the determinants of Demand
Tastes and preferences of the consumer
Demand for a commodity may change due to a change in tastes, preferences and
fashion. For example, the demand for dhoties has come down and demand for trouser cloth
and jeans has gone up due to change in fashion.
Income of the consumer
When the income of the consumer increases, more will be demanded. Therefore, we
can say that as income increases, other things being equal, the demand for a commodity also
increases. Comforts and luxuries belong to this category.
Price of substitutes
Some goods can be substituted for other goods. For example, tea and coffee are
substitutes. If the price of coffee increases while the price of tea remains the same, there will
be increase in the demand for tea and decrease in the demand for coffee. The demand for
substitutes moves in the opposite direction.
Number of consumers
Size of population of a country is an important determinant of demand. For instance,
larger the population, more will be the demand, for certain goods like food grains, and pulses
etc. When the number of consumers increases, there will be greater demand for goods.
Expectation of future price change
If the consumer believes that the price of a commodity will rise in the future, he may
buy a larger quantity in the present. Suppose he expects the price to fall, he may defer some
of his purchases to a future date.
Distribution of income
Distribution of income affects consumption pattern and hence the demand for various
goods. If the government attempts redistribution of income to make it equitable, the demand
for luxuries will decline and the demand for necessities of life will increase.
Climate and Weather Conditions
Demand for a commodity may change due to a change in climatic conditions. For
example, during summer, demand for cool drinks, cotton clothes and air conditioners will
increase. In winter, demand for woollen clothes increases.
State of Business
During boom, demand will expand and during depression demand will contract. 9.
consumer innovativeness When the price of wheat flour or price of electricity falls, the
consumer identifies new uses for the product. It creates new demand for the product.

5. Briefly, Explain Forecasting Demand for a new product.
The demand of a new product can be forecasted by anyone of the following techniques.
6. Elucidate Methods of Demand Forecasting.

There is no easy or simple formula to forecast the demand. Proper judgment along with
the scientific formula is needed to correctly predict the future demand for a product or service.
Survey of Buyer’s Choice
When the demand needs to be forecasted in the short run, say a year, then the most
feasible method is to ask the customers directly that what are they intending to buy in the
forthcoming time period. Thus, under this method, potential customers are directly interviewed.
This survey can be done in any of the following ways:
i) Complete Enumeration Method: Under this method, nearly all the potential buyers
are asked about their future purchase plans.
ii) Sample Survey Method: Under this method, a sample of potential buyers are
chosen scientifically and only those chosen are interviewed.
Collective Opinion Method
Under this method, the salesperson of a firm predicts the estimated future sales in their
region. The individual estimates are aggregated to calculate the total estimated future sales.
These estimates are reviewed in the light of factors like future changes in the selling price,

product designs, changes in competition, advertisement campaigns, the purchasing power of the
consumers, employment opportunities, population, etc.
The principle underlying this method is that as the salesmen are closest to the
consumers, they are more likely to understand the changes in their needs and demands. They can
also easily find out the reasons behind the change in their tastes.
Barometric Method
This method is based on the past demands of the product and tries to project the past into
the future. The economic indicators are used to predict the future trends of the business. Based
on future trends, the demand for the product is forecasted. An index of economic indicators is
formed.
Market Experiment Method
Another one of the methods of demand forecasting is the market experiment method.
Under this method, the demand is forecasted by conducting market studies and experiments on
consumer behavior under actual but controlled, market conditions.
Certain determinants of demand that can be varied are changed and the experiments are done
keeping other factors constant. However, this method is very expensive and time-consuming.
Expert Opinion Method
Under this method, experts are given a series of carefully designed questionnaires and
are asked to forecast the demand. They are also required to give the suitable reasons. The
opinions are shared with the experts to arrive at a conclusion. This is a fast and cheap technique.
7. Describe the Objectives of Demand Forecasting.
The objectives of demand forecasting are divided into short and long-term objectives,
which are shown in Figure.
Short-term Objectives
Formulating production policy
Helps in covering the gap between the demand and supply of the product. The
demand forecasting helps in estimating the requirement of raw material in future, so that the
regular supply of raw material can be maintained.
Formulating price policy
Refers to one of the most important objectives of demand forecasting. An
organization sets prices of its products according to their demand. For example, if an
economy enters into depression or recession phase, the demand for products falls. In such a
case, the organization sets low prices of its products.
Controlling sales
Helps in setting sales targets, which act as a basis for evaluating sales performance.
An organization make demand forecasts for different regions and fix sales targets for each
region accordingly.
Arranging finance
Implies that the financial requirements of the enterprise are estimated with the help of
demand forecasting. This helps in ensuring proper liquidity within the organization.

Long-term Objectives
Deciding the production capacity
Implies that with the help of demand forecasting, an organization can determine the
size of the plant required for production. The size of the plant should conform to the sales
requirement of the organization.
Planning long-term activities
Implies that demand forecasting helps in planning for long term. For example, if the
forecasted demand for the organization’s products is high, then it may plan to invest in
various expansion and development projects in the long term.
MODULE – III
Part – A
1. What is Cost?
The term ‘cost denotes cost of production’ which means expenses incurred in the production
of a commodity. This refers to the total amount of money spent on the production of a
commodity. The determinants of cost of production are: the size of plant, the level of
production, the nature of technology used, the quantity of inputs used, managerial and labour
efficiency.
2. Define Opportunity Cost.
The opportunity cost of any good is the next best alternative good that is sacrificed. For
example, a farmer who is producing wheat can produce potatoes with the same factors.
Therefore, the opportunity cost of a quintal of wheat is the amount of output of potatoes
given up.
3. What is meant by Incremental Cost?
The Incremental Cost refers to the additional cost that a company incurs in undertaking
certain actions such as expanding the level of production or adding a new variety of product
to the product line, etc. The concept of incremental cost is quite similar to the concept of
marginal cost. Incremental costs refer to the total additional cost incurred in taking a certain
action.
4. Differentiate between fixed cost and Variable Cost.
Fixed costs are those which are independent of output, that is, they do not change with
changes in output. These costs are a ‘fixed’ amount, which must be incurred by a firm in the
short run whether the output is small or large.
Variable costs are those costs, which are incurred on the employment of variable factors of
production whose amount can be altered in the short run. Thus, the total variable costs change
with the level of output.
5. What is meant by Marginal Cost?
Marginal cost is defined as the addition made to the total cost by the production of one
additional unit of output.
MCn = TCn – TCn-1
where MCn = Marginal cost TC n = Total cost of producing n units TC n-1 = Total cost of
producing n-1 units

6. Give any two Determinants of Cost.
Rate of output
Size of plant,
Prices of inputs (materials and labour),
Technology,
Stability of output, and
Efficiency of management and labour.
7. What is Cost function?
The relationship between output and costs is expressed in terms of cost function. By
incorporating prices of inputs into the production function, one obtains the cost function since
cost function is derived from production function.
A cost function may be written as:
Cq = f (Qf Pf)
Where Cq is the total production cost, Qf is the quantities of inputs employed by the firm, and
Pf is the prices of relevant inputs.
8. What is Break – Even Point?
The break-even point refers to the level of output at which total revenue equals total cost.
Management is no doubt interested in this level of output. It is the point of no loss and no
profit. The net income is zero.
9. What are the equilibrium Conditions for Profit Maximization?
SAC and SMC are the Short run Average and Marginal Cost curves. The firm is in
equilibrium at point ‘E’ where MR = MC and MC curve cuts MR curve from below at the
point of equilibrium. Therefore, the firm will be producing a particular level of output and it
earns maximum profits.
10. What is SAC?
The Shor run Average Cost Curve is a curve, which is U shaped curve. The, short run average
cost curve falls in the beginning, reaches a minimum and then begins to rise. The reasons for
the average cost to fall in the beginning of production are that the fixed factors of a firm
remain the same. The change only takes place in the variable factors such as raw material,
labour, etc.
11. What is Planning curve?
The long run average cost curve is called ‘planning curve’ of a firm as it helps in choosing a
plant on the decided level of output. The long- run average cost curve is also called envelope
curve as it supports or envelops a group of short-run cost curves.

Part – B
1. Explain various costs incurred by the firm.
Money Cost and Real Cost
Money cost or nominal cost is the total money expenses incurred by a firm in
producing a commodity. It includes
(i) Cost of raw materials (ii) Wages and salaries of labour (iii) Expenditure on machinery and
equipment (iv) Depreciation on machines, buildings and such other capital goods (v) Interest
on capital (vi) Other expenses like advertisement, insurance premium and taxes (vii) Normal
profit of the entrepreneur. Real cost is a subjective concept. It expresses the pains and
sacrifices involved in producing a commodity. The money paid for securing the factors of
productions is money cost whereas the efforts and sacrifice made by the capitalists to save
and invest, by the workers in foregoing leisure and by the landlords constitute real costs.
Opportunity Cost
The opportunity cost of any good is the next best alternative good that is sacrificed.
For example, a farmer who is producing wheat can produce potatoes with the same factors.
Therefore, the opportunity cost of a quintal of wheat is the amount of output of potatoes
given up.
Accounting Cost or Explicit Cost
Accounting costs or explicit costs are the payments made by the entrepreneur to the
suppliers of various productive factors. The accounting costs are only those costs, which are
directly paid out or accounted for by the producer i.e. wages to the labourers employed,
prices for the raw materials purchased, fuel and power used, rent for the building hired for the
production work, the rate of interest on the borrowed capital and the taxes paid.
Economic Cost
The Economic Cost includes not only the explicit cost but also the implicit cost. The
money rewards for the own services of the entrepreneur and the factors owned by himself and
employed in production are known as implicit costs or imputed costs. The normal return on
money capital invested by the entrepreneur, the wages or salary for his own services and rent
of the land and buildings belonging to him and used in production constitute implicit cost.
Thus, Economic cost = Explicit cost + Implicit cost.
2. What are the implications of cost output relationship in a short run?
Time element plays an important role in price determination of a firm. During short
period two types of factors are employed. One is fixed factor while others are variable factors
of production. Fixed factor of production remains constant while with the increase in
production, we can change variable inputs only because time is short in which all the factors
cannot be varied.
Raw material, semi-finished material, unskilled labour, energy, etc., are variable
inputs which can be changed during short run. Machines, capital, infrastructure, salaries of
managers and technical experts are included in fixed inputs. During short period an individual
firm can change variable factors of production according to requirements of production while
fixed factors of production cannot be changed.
In the short-run a change in output is possible only by making changes in the variable
inputs like raw materials, labour etc. Inputs like land and buildings, plant and machinery etc.
are fixed in the short-run.

3. Describe various Determinants of Cost.
Determinants of Costs
Level of Output
Size of the plant
Prices of inputs
Technology
Managerial and Administrative Efficiency.
i) Level of Output
Total output and total cost are positively related to each other. As the level of output
increases total cost also rises. However, this is not applying to average cost and marginal
cost. As the level of output increases marginal cost and [2] average cost decline initially, and
rise thereafter.
ii) Size of the Plant

Size of the plant or the scale of operation is inversely related to cost. As the size of the
plant increases costs decline and vice - verse. How much the costs will decline as a result of
increase in the scale of operation depends upon the different sizes of plants.
iii) Prices of Inputs
Increases in the input prices bring a simultaneous rise in the cost.
iv) Technology
The nature of technology also influences cost. Modern technology is cost efficient and
cost saving.
v) Managerial and Administrative Efficiency
Managers are the controllers and monitors of the firm. Though Efficient Supervision,
control and Administration they can improve efficiency and productivity of factors inputs and
thus economies the cost.
5. Illustrate how Total cost, average cost and marginal cost curves depicts in long run.
The Concept of the Long Run
The long run refers to that time period for a firm where it can vary all the factors of
production. Thus, the long run consists of variable inputs only, and the concept of fixed inputs
does not arise. The firm can increase the size of the plant in the long run.
Long Run Total Costs
Long run total cost refers to the minimum cost of production. It is the least cost of
producing a given level of output. Thus, it can be less than or equal to the short run average
costs at different levels of output but never greater.
In graphically deriving the LTC curve, the minimum points of the STC curves at different levels
of output are joined. The locus of all these points gives us the LTC curve.
Long Run Average Cost Curve
Long run average cost (LAC) can be defined as the average of the LTC curve or the cost
per unit of output in the long run. It can be calculated by the division of LTC by the quantity of
output. Graphically, LAC can be derived from the Short run Average Cost (SAC) curves.
While the SAC curves correspond to a particular plant since the plant is fixed in the short-run,
the LAC curve depicts the scope for expansion of plant by minimizing cost.
Long Run Marginal Cost

Long run marginal cost is defined at the additional cost of producing an extra unit of the
output in the long-run i.e. when all inputs are variable. The LMC curve is derived by the points
of tangency between LAC and SAC.
6. Explain how to prepare break-even chart.
Meaning of Break-Even Chart
The Break-Even Chart is a graphical representation between cost, volume and profits.
No doubt it is an important tool which helps to make profit planning. It has been defined
as “a chart which shows the profitability or otherwise of an undertaking at various
levels of activity and as a result indicates the point at which neither profit nor loss is
made.”
Break-Even Chart
As shown in the above Figure TFC is equals to FE, which is a fixed cost line. The
vertical distance between TC and TFC line equals TVC. As quantity of output increases, the
vertical distance between TC and TFC increases. This implies that TVC increases with
change in TC and TFC.
Until Qb of the quantity is produced, total cost exceeds the total revenue, which
implies that an organization will suffer losses if it produces less than Qb. At Qb output level,
total revenue equals total cost. At this point, an organization never makes profit nor loss
implying that it is a break-even point. Thus, Qb is a break-even level of output. Producing
more than Qb will be profitable for organizations as TR is greater than TC.
Part – C
1. Elaborate Break – Even Analysis.
Break-even analysis is a technique widely used by production management and
management accountants for profit planning. It is based on categorising production costs
between those which are "variable" (costs that change when the production output changes)
and those that are "fixed" (costs not directly related to the volume of production).
Total variable and fixed costs are compared with sales revenue in order to determine
the level of sales volume, sales value or production at which the business makes neither a
profit nor a loss (the "Break-Even Point"). A Break-Even Point (BEP) is used to determine

the number of units or dollars of revenue needed to cover total costs (fixed and variable
costs).
Formula for Break Even Analysis
Break even quantity = Fixed costs / (Sales price per unit – Variable cost per unit)
Where
 Fixed costs are costs that do not change with varying output (i.e. salary, rent, building
machinery).
 Sales price per unit is the selling price (unit selling price) per unit.
 Variable cost per unit is the variable costs incurred to create a unit.
Meaning of Break-Even Chart
No doubt it is an important tool which helps to make profit planning. It has been defined
as “a chart which shows the profitability or otherwise of an undertaking at various
levels of activity and as a result indicates the point at which neither profit nor loss is
made.”
Break-Even Chart
As shown in the above Figure TFC is equals to FE, which is a fixed cost line. The
vertical distance between TC and TFC line equals TVC. As quantity of output increases, the
vertical distance between TC and TFC increases. This implies that TVC increases with
change in TC and TFC.
implies that an organization will suffer losses if it produces less than Qb. At Qb output level,
total revenue equals total cost. At this point, an organization never makes profit nor loss
implying that it is a break-even point. Thus, Qb is a break-even level of output. Producing
more than Qb will be profitable for organizations as TR is greater than TC.

2. Explain short run cost output relationship with diagram.
Average Fixed cost (AFC)
The average fixed cost is the fixed cost per unit of output. It is obtained by dividing
the total fixed cost by the number of units of the commodity produced.
Symbolically
AFC = TFC / Q
Where, AFC = Average fixed Cost TFC = Total Fixed cost Q = number of units
of output produced.
Suppose for a firm the total fixed cost is Rs 2000 when output is 100 units, AFC will
be Rs 2000/100 = Rs 20 and when output is 200 units, AFC will be Rs 2000/200 = Rs10/-
Since total fixed cost is a constant quantity, average fixed cost will steadily fall as output
increases; when output becomes very large, average fixed cost approaches zero.
Average Variable cost (AVC): Average variable cost is the variable cost per unit of output. It
is the total variable cost divided by the number of units of output produced.
AVC = TVC / Q
Where, AVC = Average Variable Cost TVC = Total Variable Cost Q = number of
units of output produced.
Average variable cost curve is ‘U’ Shaped. As the output increases, the AVC will fall upto
normal capacity output due to the operation of increasing returns. But beyond the normal
capacity output, the AVC will rise due to the operation of diminishing returns.
Average Total Cost or Average Cost
Average total cost is simply called average cost which is the total cost divided by the
number of units of output produced.
AC = TC / Q
Where, AC = Average Cost TC = Total Cost Q = number of units of output produced
Average cost is the sum of average fixed cost and average variable cost. i.e. AC =
AFC+AVC
The average cost is also known as the unit cost since it is the cost per unit of output produced.
The following figure shows the shape of AFC, AVC and ATC in the short period.

From the above figure it can be understood that the behaviour of the average total cost
curve depends on the behaviour of AFC and AVC curves. In the beginning, both AFC and
AVC fall. So, ATC curve falls. When AVC curve begins rising, AFC curve falls steeply i.e.,
fall in AFC is more than the rise in AVC. So, ATC curve continues to fall. But as output
increases further, there is a sharp increase in AVC, which is more than the fall in AFC. Hence
ATC curve rises after a point. The ATC curve like AVC curve falls first, reaches the
minimum value and then rises. Hence it has taken a U shape.
3. Explain long run cost output relationship with diagram
In the long-run all factors are variable. Therefore, the firm can change the size of the
plant (capital equipment, machinery etc) to meet the changes in demand. A long-run average
cost curve depicts the functional relationship between output and the long-run cost of
production.
Long-run average cost curve
The Long run Average Cost (LAC) Curve is based on the assumption that in the long
run a firm has a number of alternatives with regard to the scale of operations. For each scale
of production or plant size, the firm has an appropriate short-run average cost (SAC) curve.
The pattern of these short-run average cost curves is shown in the above figure. We have
assumed that technologically there are only three sizes of plants – small, medium and large.
SAC1 is relevant for a small size plant, SAC2 for a medium size plant and SAC3 for a large
size plant.
In the short period, when the output demanded is OA, the firm will choose the
smallest size plant. But for an output beyond OB, the firm will choose medium size plant as
the average cost of small size plant is higher for the same output (JC>KC). For output beyond
OD, the firm will choose large size plant (SAC3). In the short-run, the firm is tied with a
given plant but in the long-run, the firm moves from one plant to another. As the scale of
production is changed, a new plant is added. The long-run cost of production is the least
possible cost of production of any given level of output, when all inputs become variable,
including the size of the plant.
The long run average cost curve is called ‘planning curve’ of a firm as it helps in
choosing a plant on the decided level of output. The long- run average cost curve is also
called envelope curve as it supports or envelops a group of short-run cost curves (in the

above Figure). From the figure we can understand that the long run average cost curve
initially falls with increase in output and after a certain point it rises making a boat shape.
4. Analyse and discuss knight’s uncertainty theory of profit.

Knight’s Theory of Profit
Definition
The Knight’s Theory of Profit was proposed by Frank. H. Knight, who believed
profit as a reward for uncertainty-bearing, not to risk bearing. Simply, profit is the residual
return to the entrepreneur for bearing the uncertainty in business.
Knight had made a clear distinction between the risk and uncertainty. The risk can be
classified as a calculable and non-calculable risk. The calculable risks are those whose
probability of occurrence can be anticipated through a statistical data. Such as risks due to the
fire, theft, or accident are calculable and hence can be insured in exchange for a premium.
Such amount of premium can be added to the total cost of production.
While the non-calculable risks are those whose probability of occurrence cannot be
determined. Such as the strategies of a competitor cannot be accurately assessed as well as
the cost of eliminating the completion cannot be precisely calculated. Thus, the risk element
of such events is not insurable. This incalculable area of risk is the uncertainty.
Due to the uncertainty of events, the decision-making becomes a crucial function of

an entrepreneur or manager. If the decisions prove to be correct by the subsequent events, an
entrepreneur makes a profit and vice-versa. Thus, the Knight’s theory of profit is based on the
premise that profit arises out of the decisions made under the conditions of uncertainty.
Knight believes that profit might arise out of the decisions made concerning the state
of the market, such as decisions with respect to increasing the degree of monopoly in the
market, decisions regarding holding stocks that might result in the windfall gains, decisions
taken to introduce new product and technique, etc.
The major criticism of the knight’s theory of profit is, the total profit of an
entrepreneur cannot be completely attributed to uncertainty alone. There are several functions
that also contribute to the total profit such as innovation, bargaining, coordination of business
activities, etc.

MODULE – IV
Part – A
1. Give a short note on Production.
Production refers to the creation of wealth. Strictly speaking, it refers to the creation of
utilities. Production refers to all activities which are undertaken to produce goods which
satisfy human wants.
2. What is Production function?
The functional relationship between inputs and outputs is known as production function. the
production function shows how a certain amount of inputs will result in the production of a
certain amount of output of a commodity. The production function is given as
Q = f (x1, x2, x 3…. xn)
3. What do you mean by Isoquant?
An isoquant or Iso-product curve represents different combinations of two factors of
production that yield the same level of output. The isoquant is downward sloping from left to
right i.e. it is negatively sloped.
4. Define law of variable proportion.
As the proportion of one factor in a combination of factors is increased, after a point, first the
marginal and then the average product of that factor will diminish.
5. Define Returns to Scale?
In the long run, all factors can be changed. Returns to scale studies the changes in output
when all factors or inputs are changed. An increase in scale means that all inputs or factors
are increased in the same proportion.
6. What do you mean by Economies of Scale?
‘Economies’ mean advantages. Scale refers to the size of unit. ‘Economies of Scale’ refers to
the cost advantages due to the larger size of production. As the volume of production
increases, the overhead cost will come down. The bulk purchase of inputs will give a better
bargaining power to the producer which will reduce the average variable cost too. All these
advantages are due to the large-scale production and these advantages are called economies
of scale.
7. What are constant returns to scale?
If we increase all the factors (i.e. scale) in a given proportion, the output will increase in the
same proportion i.e. a 5% increase in all the factors will result in an equal proportion of 5%
increase in the output.
8. Give a short note on factors of production.

Resources required for generation of goods or services, generally classified into four major groups:
Land (including all-natural resources),
Labour (including all human resources),
Capital (including all man-made resources), and
Enterprise (which brings all the previous resources together for production).
9. What is point of inflexion?
At the point of inflexion, the total product stops increasing at an increasing rate and starts
increasing at the diminishing rate is called the point of inflection. At this point of inflection
marginal product is maximum, after which it starts diminishing.
10. What do you mean by fixed and variable factor?

Short run is a period of time over which certain factors of production cannot be changed, and
such factors are called fixed factors. The factors whose quantity can be changed in the short
run are variable factors.
11. Define Production function.
The functional relationship between inputs and outputs is known as production function. the
production function shows how a certain amount of inputs will result in the production of a
certain amount of output of a commodity. The production function is given as
Q = f (x1, x2, x 3…. xn)
12. What are the assumptions law of variable proportion?
Only one factor is made variable and other factors are kept constant.
This law does not apply in case all factors are proportionately varied.
The state of technology does not change
The entire operation is only for short-run.
13. What is internal Economies of scale.
‘Internal economies of scale’ are the advantages enjoyed within the production unit. These
economies are enjoyed by a single firm independently of the action of the other firms. For
instance, one firm may enjoy the advantage of good management; another may have the
advantage of more up-to-date machinery.
Part – B
1. Explain cobb-Douglas Production Function.
The Cobb-Douglas production function is based on the empirical study of the American
manufacturing industry made by Paul H. Douglas and C.W. Cobb. It is a linear homogeneous
production function of degree one which takes into account two inputs, labour and capital, for
the entire output of the manufacturing industry.
The Cobb-Douglas production function is expressed as
Q = ALa Cβ
where Q is output and L and С are inputs of labour and capital respectively. A, a and
β are positive parameters where = a > O, β > O.

The equation tells that output depends directly on L and C, and that part of output
which cannot A which is the ‘residual’, often called technical change.
The production function solved by Cobb-Douglas had 1/4 contribution of capital to
the increase in manufacturing industry and 3/4 of labour so that the C-D production function
is
Q = AL3/4 C1/4
which shows constant returns to scale because the total of the values of L and С is
equal to one: (3/4 + 1/4), i.e., (a + β = 1).
The C-D production function showing constant returns to scale is depicted in Figure
and Labour input is taken on the horizontal axis and capital on the vertical axis.
To produce 100 units of output, ОС, units of capital and OL units of labour are used.
If the output were to be doubled to 200, the inputs of labour and capital would have to be
doubled. ОС is exactly double of ОС1 and of OL2 is double of OL2.
Similarly, if the output is to be raised three-fold to 300, the units of labour and capital
will have to be increased three-fold. OC 3 and OL3 are three times larger than ОС 1, and OL1,
respectively. Another method is to take the scale line or expansion path connecting the
equilibrium points Q, P and R. OS is the scale line or expansion path joining these points.
It shows that the isoquants 100, 200 and 300 are equidistant. Thus, on the OS scale
line OQ = QP = PR which shows that when capital and labour are increased in equal
proportions, the output also increases in the same proportion.
2. Explain the stages of law of variable proportion

Stage 1: Stage of Increasing Returns
In this stage, total product curve TP increases at an increasing rate up to a point. In
Fig. from the origin to the point F, slope of the total product curve TP is increasing, that is, up
to the point F, the total product increases at an increasing rate (the total product curve TP is
concave upward up to the point F), which means that the marginal product MP of the variable
factor is rising.
From the point F onwards during the stage 1, the total product curve goes on rising
but its slope is declining which means that from point F onwards the total product increases at
a diminishing rate (total product curve TP is concave down-ward), i.e., marginal product falls
but is positive.

The point F where the total product stops increasing at an increasing rate and
starts increasing at the diminishing rate is called the point of inflection. At this point of
inflection marginal product is maximum, after which it starts diminishing.
Thus, marginal product of the variable factor starts diminishing beyond OL amount of
the variable factor. That is, law of diminishing returns starts operating in stage 1 from point D
on the MP curve or from OL amount of the variable factor used.
This first stage ends where the average product curve AP reaches its highest point, that is,
point Stage 2: Stage of Decreasing Returns
In stage 2, the total product continues to increase at a diminishing rate until it reaches
its maximum point H where the second stage ends. In this stage both the marginal product
and the average product of the variable factor are diminishing but remain positive.
At the end of the second stage, that is, at point M marginal product of the variable
factor is zero (corresponding to the highest point H of the total product curve TP). Stage 2 is
very crucial and important because as will be explained below the firm will seek to produce
in its range.
Stage 3: Stage of Negative Returns
In stage 3 with the increase in the variable factor the total product declines and
therefore the total product curve TP slopes downward. As a result, marginal product of the
variable factor is negative and the marginal product curve MP goes below the X-axis. In this
stage the variable factor is too much relative to the fixed factor. This stage is called the stage
of negative returns, since the marginal product of the variable factor is negative during this
stage.
It may be noted that stage 1 and stage 3 are completely symmetrical. In stage 1 the
fixed factor is too much relative to the variable factor. Therefore, in stage 1, marginal product
of the fixed factor is negative. On the other hand, in stage 3 the variable factor is too much
relative to the fixed factor. Therefore, in stage 3, the marginal product of the variable factor is
negative.
3. Briefly explain Economies of Scale.

‘Economies’ mean advantages. Scale refers to the size of unit. ‘Economies of Scale’ refers to
the cost advantages due to the larger size of production. As the volume of production
increases, the overhead cost will come down. The bulk purchase of inputs will give a better
bargaining power to the producer which will reduce the average variable cost too. All these
advantages are due to the large-scale production and these advantages are called economies
of scale.
There are two types of economies of scale
a) Internal economies of scale b) External economies of scale
a) Internal Economies of Scale
‘Internal economies of scale’ are the advantages enjoyed within the production unit.
These economies are enjoyed by a single firm independently of the action of the other firms.
For instance, one firm may enjoy the advantage of good management; another may have the
advantage of more up-to-date machinery. There are five kinds of internal economies. They
are
1. Technical Economies:

As the size of the firm is large, the availability of capital is more. Due to this, a firm
can introduce up- to-date technologies; thereby the increase in the productivity becomes
possible. It is also possible to conduct research and development which will help to increase
the quality of the product.
2. Financial Economies:
It is possible for big firms to float shares in the market for capital formation. Small
firms have to borrow capital whereas large firms can buy capital.
3. Managerial Economies:
Division of labour is the result of large-scale production. Right person can be
employed in the right department only if there is division of labour. This will help a manager
to fix responsibility to each department and thereby the productivity can be increased and the
total production can be maximised.
4. Labour Economies:
Large Scale production paves the way for division of labour. This is also known as
specialisation of labour. The specialisation will increase the quality and ability of the labour.
As a result, the productivity of the firm increases.
5. Marketing Economies:
In production, the first buyer is the producer who buys the raw materials. As the size
is large, the quantity bought is larger. This gives the producer a better bargaining power.
Also, he can enjoy credit facilities. All these are possible because of large scale production.
Buying is the first function in marketing.
6. Economies of survival:
A large firm can have many products. Even if one product fails in the market, the loss
incurred in that product can be managed by the profit earned from the other products.
4. What are Iso-quants? Describe their Properties of Isoquant.
The isoquant analysis helps to understand how different combinations of two or more
factors are used to produce a given level of output. an isoquant or iso-product curve
represents different combinations of two factors of production that yield the same level of
output.
Iso-Quant Curve

Properties of Isoquant
 The isoquant is downward sloping from left to right i.e. it is negatively sloped.
 An isoquant is convex to the origin because of the diminishing marginal rate of
technical substitution.
 Marginal rate of technical substitution of factor X (capital) for factor Y (labour) may
be defined as the amount of factor Y (labour) which can be replaced by one unit of
factor X (capital), the level of output remaining unchanged.
5. Briefly explain Law of constant returns to scale.

Constant Returns to Scale
If we increase all the factors (i.e. scale) in a given proportion, the output will increase
in the same proportion i.e. a 5% increase in all the factors will result in an equal proportion of
5% increase in the output. Here the marginal product is constant.

The above figure explains the different phases of returns to scale. When marginal
product increases (AB), total product increases at an increasing rate. So, there is increasing
returns to scale. When Marginal Product remains constant (BC), Total Product increases at a
constant rate and this stage is called constant returns to scale.
Part – C
1. Describe the Law of Variable Proportions.
Law of Variable Proportions

Meaning
Law of variable proportions occupies an important place in economic theory. This law
examines the production function with one factor variable, keeping the quantities of other
factors fixed.
“As the proportion of one factor in a combination of factors is increased, after a point, first
the marginal and then the average product of that factor will diminish.” (F. Benham)

1. First, the state of technology is assumed to be given and unchanged. If there is
improvement in the technology, then marginal and average products may rise instead of
diminishing.
2. Secondly, there must be some inputs whose quantity is kept fixed.
3. Thirdly the law is based upon the possibility of varying the proportions in which the
various factors can be combined to produce a product.
The law of variable proportions is illustrated in the following Table and Fig. We shall
first explain it by considering. Assume that there is a given fixed amount of land, with which
more units of the variable factor labour, is used to produce agricultural output.
Diagram

Stage 1: Stage of Increasing Returns
In this stage, total product curve TP increases at an increasing rate up to a point. In
Fig. from the origin to the point F, slope of the total product curve TP is increasing, that is, up
to the point F, the total product increases at an increasing rate (the total product curve TP is
concave upward up to the point F), which means that the marginal product MP of the variable
factor is rising.
From the point F onwards during the stage 1, the total product curve goes on rising
but its slope is declining which means that from point F onwards the total product increases at
a diminishing rate (total product curve TP is concave down-ward), i.e., marginal product falls
but is positive.
The point F where the total product stops increasing at an increasing rate and
starts increasing at the diminishing rate is called the point of inflection. At this point of
inflection marginal product is maximum, after which it starts diminishing.
Thus, marginal product of the variable factor starts diminishing beyond OL amount of
the variable factor. That is, law of diminishing returns starts operating in stage 1 from point D
on the MP curve or from OL amount of the variable factor used.

This first stage ends where the average product curve AP reaches its highest point, that is,
point Stage 2: Stage of Decreasing Returns
In stage 2, the total product continues to increase at a diminishing rate until it reaches
its maximum point H where the second stage ends. In this stage both the marginal product
and the average product of the variable factor are diminishing but remain positive.
At the end of the second stage, that is, at point M marginal product of the variable
factor is zero (corresponding to the highest point H of the total product curve TP). Stage 2 is
very crucial and important because as will be explained below the firm will seek to produce
in its range.
Stage 3: Stage of Negative Returns
In stage 3 with the increase in the variable factor the total product declines and
therefore the total product curve TP slopes downward. As a result, marginal product of the
variable factor is negative and the marginal product curve MP goes below the X-axis. In this
stage the variable factor is too much relative to the fixed factor. This stage is called the stage
of negative returns, since the marginal product of the variable factor is negative during this
stage.
It may be noted that stage 1 and stage 3 are completely symmetrical. In stage 1 the
fixed factor is too much relative to the variable factor. Therefore, in stage 1, marginal product
of the fixed factor is negative. On the other hand, in stage 3 the variable factor is too much
relative to the fixed factor. Therefore, in stage 3, the marginal product of the variable factor is
negative.
2. Elucidate the Laws of Returns to Scale.

Law of Returns to Scale
Definition and Explanation

The law of returns to scale operates in the long period. It explains the production
behaviour of the firm with all variable factors.
There is no fixed factor of production in the long run. The law of returns to scale
describes the relationship between variable inputs and output when all the inputs, or factors
are increased in the same proportion. The law of returns to scale analysis the effects of scale
on the level of output.
(1) Increasing Returns to Scale

If the output of a firm increases more than in proportion to an equal percentage
increase in all inputs, the production is said to exhibit increasing returns to scale.
For example, if the amount of inputs is doubled and the output increases by more than
double, it is said to be an increasing return to scale. When there is an increase in the scale of
production, it leads to lower average cost per unit produced as the firm enjoys economies of
scale.
(2) Constant Returns to Scale

When all inputs are increased by a certain percentage, the output increases by the
same percentage, the production function is said to exhibit constant returns to scale.
For example, if a firm doubles inputs, it doubles output. The constant scale of production
has no effect on average cost per unit produced.
(3) Diminishing Returns to Scale

The term 'diminishing' returns to scale refers to scale where output increases in a
smaller proportion than the increase in all inputs.
For example, if a firm increases inputs by 100% but the output decreases by less than
100%, the firm is said to exhibit decreasing returns to scale. In case of decreasing returns to
scale, the firm faces diseconomies of scale. The firm's scale of production leads to higher
average cost per unit produced.
The above figure shows that when a firm uses one unit of labour and one unit of
capital, point a, it produces 1 unit of quantity as is shown on the q = 1 isoquant. When the
firm doubles its outputs by using 2 units of labour and 2 units of capital, it produces more
than double from q = 1 to q = 3.
So, the production function has increasing returns to scale in this range. Another
output from quantity 3 to quantity 6. At the last doubling point c to point d, the production

function has decreasing returns to scale. The doubling of output from 4 units of input, causes
output to increase from 6 to 8 units increases of two units only.
3. Elaborately explain Economies of Scale.
Economies of Scale
‘Economies’ mean advantages. Scale refers to the size of unit. ‘Economies of Scale’
refers to the cost advantages due to the larger size of production. As the volume of
production increases, the overhead cost will come down. The bulk purchase of inputs will
give a better bargaining power to the producer which will reduce the average variable cost
too. All these advantages are due to the large-scale production and these advantages are
called economies of scale.
There are two types of economies of scale
a) Internal economies of scale b) External economies of scale
a) Internal Economies of Scale
‘Internal economies of scale’ are the advantages enjoyed within the production unit.
These economies are enjoyed by a single firm independently of the action of the other firms.
For instance, one firm may enjoy the advantage of good management; another may have the
advantage of more up-to-date machinery. There are five kinds of internal economies. They
are
1. Technical Economies:
As the size of the firm is large, the availability of capital is more. Due to this, a firm
can introduce up- to-date technologies; thereby the increase in the productivity becomes
possible. It is also possible to conduct research and development which will help to increase
the quality of the product.
2. Financial Economies:
It is possible for big firms to float shares in the market for capital formation. Small
firms have to borrow capital whereas large firms can buy capital.
3. Managerial Economies:
Division of labour is the result of large-scale production. Right person can be
employed in the right department only if there is division of labour. This will help a manager
to fix responsibility to each department and thereby the productivity can be increased and the
total production can be maximised.
4. Labour Economies:
Large Scale production paves the way for division of labour. This is also known as
specialisation of labour. The specialisation will increase the quality and ability of the labour.
As a result, the productivity of the firm increases.
5. Marketing Economies:

In production, the first buyer is the producer who buys the raw materials. As the size
is large, the quantity bought is larger. This gives the producer a better bargaining power.
Also, he can enjoy credit facilities. All these are possible because of large scale production.
Buying is the first function in marketing.
6. Economies of survival:
A large firm can have many products. Even if one product fails in the market, the loss
incurred in that product can be managed by the profit earned from the other products.
b) External Economies of Scale
When many firms expand in a particular area – i.e., when the industry grows – they
enjoy a number of advantages which are known as external economies of scale. This is not
the advantage enjoyed by a single firm but by all the firms in the industry due to the structural
growth. They are
a) Increased transport facilities b) Banking facilities c) Development of townships d)
Information and communication development All these facilities are available to all firms in
an industrial region.
4. Explain different types of production function.

Production function may be classified into two:
1. Short-run production function which is studied through Law of Variable Proportions
2. Long-run production function which is explained by Returns to Scale.
Law of Variable Proportions
Meaning
Law of variable proportions occupies an important place in economic theory. This law
examines the production function with one factor variable, keeping the quantities of other
factors fixed.
“As the proportion of one factor in a combination of factors is increased, after a point, first
the marginal and then the average product of that factor will diminish.” (F. Benham)

1. First, the state of technology is assumed to be given and unchanged. If there is
improvement in the technology, then marginal and average products may rise instead of
diminishing.
2. Secondly, there must be some inputs whose quantity is kept fixed.
3. Thirdly the law is based upon the possibility of varying the proportions in which the
various factors can be combined to produce a product.
The law of variable proportions is illustrated in the following Table and Fig. We shall
first explain it by considering. Assume that there is a given fixed amount of land, with which
more units of the variable factor labour, is used to produce agricultural output.

Law of Returns to Scale
Definition and Explanation

The law of returns to scale operates in the long period. It explains the production
behaviour of the firm with all variable factors.
There is no fixed factor of production in the long run. The law of returns to scale
describes the relationship between variable inputs and output when all the inputs, or factors
are increased in the same proportion. The law of returns to scale analysis the effects of scale
on the level of output.
(1) Increasing Returns to Scale

If the output of a firm increases more than in proportion to an equal percentage
increase in all inputs, the production is said to exhibit increasing returns to scale.
For example, if the amount of inputs is doubled and the output increases by more than
double, it is said to be an increasing return to scale. When there is an increase in the scale of
production, it leads to lower average cost per unit produced as the firm enjoys economies of
scale.
(2) Constant Returns to Scale

When all inputs are increased by a certain percentage, the output increases by the
same percentage, the production function is said to exhibit constant returns to scale.
For example, if a firm doubles inputs, it doubles output. The constant scale of production
has no effect on average cost per unit produced.
(3) Diminishing Returns to Scale

The term 'diminishing' returns to scale refers to scale where output increases in a
smaller proportion than the increase in all inputs.
For example, if a firm increases inputs by 100% but the output decreases by less than
100%, the firm is said to exhibit decreasing returns to scale. In case of decreasing returns to
scale, the firm faces diseconomies of scale. The firm's scale of production leads to higher
average cost per unit produced.

MODULE- V
Section A
1. Write a short note on theory of firm.

The theory of the firm is the microeconomic concept founded in neoclassical
economics that states that a firm exists and make decisions to maximize profits. The
theory holds that the overall nature of companies is to maximize profits meaning to
create as much of a gap between revenue and costs. The firm's goal is to determine
pricing and demand within the market and allocate resources to maximize net profits.
2. What are the Objectives of the firm?
Profit Maximization Objective
Wealth Maximization Objective
Value Maximization Objective
Sales Maximization Objective
Growth Maximization Objective
Maximization of ROI
Social Objective
Production Goal
Inventory Goal
Sales Goal
3. Write a short note on Economic theory of firm.
The theory of the firm is the microeconomic concept founded in neoclassical
economics that states that a firm exists and make decisions to maximize profits. The
theory holds that the overall nature of companies is to maximize profits meaning to

create as much of a gap between revenue and costs. The firm's goal is to determine
pricing and demand within the market and allocate resources to maximize net profits.
4. Write a short note on behavioural theory of firm.
The Behavioural theory of the firm (BTF) is a composition of a number
of theories that have emerged within economics, sociology, business and management
studies œ to deal with the issues of how firms behave in a market place and what
determines the inter-firm relationships.
5. Write a short note on Managerial theory of firm.
Managerial theories of the firm place emphasis on various incentive mechanisms in
explaining the behaviour of managers and the implications of this conduct for their
companies and the wider economy. According to traditional theories, the firm is
controlled by its owners and thus wishes to maximise short run profits. The more
contemporary managerial theories of the firm examine the possibility that the firm is
controlled not by its owners, but by its managers, and therefore does not aim to
maximise profits. Although profit plays an important role in these theories as well, it
is no longer seen as the sole or dominating goal of the firm. The other possible aims
might be sales revenue maximisation or growth.
6. What is BEP?
The break-even point (BEP) or break-even level represents the sales amount—in
either unit (quantity) or revenue (sales) terms—that is required to cover total costs,
consisting of both fixed and variable costs to the company. Total profit at the break-
even point is zero.
7. What do you mean by safety margin?

Margin of safety (safety margin) is the difference between the intrinsic value of a
stock and its market price. Another definition: In break-even analysis, from the
discipline of accounting, margin of safety is how much output or sales level can fall
before a business reaches its break-even point.
8. What do you mean by game theory?

Game theory is the process of modelling the strategic interaction between two or more
players in a situation containing set rules and outcomes. While used in a number of
disciplines, game theory is most notably used as a tool within the study of economics.
9. What is saddle point?
A saddle point is a payoff that is simultaneously a row minimum and a column
maximum. To locate saddle points, circle the row minima and box the column
maxima. The saddle points are those entries that are both circled and boxed.
Another Example. Here is another example of a zero-sum game.
10. What is zero-sum game?
In game theory and economic theory, a zero-sum game is a mathematical
representation of a situation in which each participant's gain or loss of utility is
exactly balanced by the losses or gains of the utility of the other participants.
11. What is maximin strategy?

A maximin strategy is a strategy in game theory where a player makes a decision that
yields the 'best of the worst' outcome. All decisions will have costs and benefits, and
a maximin strategy is one that seeks out the decision that yields the smallest loss.
12. What is minimax strategy?
In game theory, minimax is a decision rule used to minimize the worst-case potential
loss; in other words, a player considers all of the best opponent responses to
his strategies, and selects the strategy such that the opponent's best strategy gives a
payoff as large as possible.
Section B
1. Explain profit maximisation model under theory of firm.

In traditional economic model of the firm it is assumed that a firm’s objective
is to maximise short-run profits, that is, profits in the current period which is generally
taken to be a year. In various forms of market structure such as perfect competition,
monopoly, monopolistic competition the traditional microeconomic theory explains
the determination of price and output by assuming that firm’s aim is to maximise
current or short-run profits. This current short-run profit maximisation model of the
firm has provided decision makers with useful framework with regard to efficient
management and allocation of resources.
Profit is a difference between total revenue and total cost. It may be noted that
the concept of cost used in economic theory and managerial economics is different
from the concept of accounting cost used by accountants. This difference in the
concepts of costs makes the concept of profits used in economic theory different from
that used in its calculation by the accountant.
It is to state here that economic profits is the difference between total revenue
and economic costs. Thus,

=TR-TC
Where stands for total economic profits, TR for total revenue and TC for
total economic costs. It is economic profits which firms try to maximise in their
decision making about level of output to be produced and price to be charged for its
product. This is illustrated in Fig.2.1. where TR curve represents total revenue earned
from selling varying amounts of output of a product. TC curve depicts total economic
costs at different levels of output. It will be seen from the upper part of Fig.2.1 at OM
level of output, total revenue equals total economic costs and therefore at this level of
output the firm is just breaking even.
Therefore, point B at which TR curve cuts TC curve is called break-even
point. Beyond this break-even level of output positive profits start accruing to the firm
as it expands its level of output. Profits go on increasing till output level OQ is
reached. It will be seen from the upper part of Figure 2.1 that at output OQ, the
difference between total revenue and total cost is maximum, that is, JH is the largest
distance between the TR and TC curves.
Therefore, JH is the maximum profits that can be earned by the firm, given the
total revenue and total cost conditions.
In the lower part of Figure 2.1 we have drawn a total profit curve TP which
first rises and then beyond point N (corresponding to output level OQ) it starts falling
indicating that profits are maximum at output level OQ.

It can be seen from the upper part of Figure 2.1 that profits start declining as
output is expanded beyond OQ. Therefore, a firm which aims to maximise profits will
produce output level of OQ, and will charge a price of its product which buyers are
prepared to pay depending on the demand conditions.
2. Describe the economic theory of firm.

You can write Profit Maximization Theory or Bamoul’s Sales Maximization Theory
3. Elucidate the Behavioural theory of firm.
Behavioural Theory of Cyert and March
Cyert and March have put forth a systematic behavioural theory of the firm. In
a modem large multiproduct firm, ownership is separate from management. Here the
firm is not considered as a single entity with a single goal of profit maximisation by a
single decision-maker, called the entrepreneur. Instead, Cyert and March regard the
modem business firm as a group of individuals who are engaged in the decision-
making process relating to its internal structure having multiple goals.
They deal not only with the internal organisation of the firm but also with the
problem of uncertainty. They reject the assumption of certainty in the neo-classical
theory of the firm. They emphasise that the modem business firm is so complex that
individuals within it have limited information and imperfect foresight with respect to
both internal and external developments. The following are the key elements of the
model.
Organisational Goals
Cyert and March regard the modem business firm as a complex organisation in
which the decision-making process should be analysed in variables that affect
organisational goals, expectations, and choices. They look at the firm as an
organisational coalition of managers, workers, shareholders, suppliers, customers, and
so on.
Looked at from this angle, the firm can be supposed to have five different goals
Production, inventory, sales, market share and profit goals.
1. Production Goal
The production goal represents in large part the demand of those coalition members
who are connected with production. It reflects pressures towards such things as stable
employment, ease of scheduling, development of acceptable cost performance and
growth. This goal is related to output decisions.
2. Inventory Goal
The inventory goal represents the demands of coalition members who are connected
with inventory. It is affected by pressures on the inventory from salesmen and
customers. This goal is related to decisions in output and sales areas.
3. Sales Goal
The sales goal aims at meeting the demand of coalition members connected with
sales, who regard sales necessary for the stability of the organisation.
4. Market-Share Goal
The market-share goal is an alternative to the sales goal. It is related to the demands
of sales management of the coalition who are primarily interested in the comparative
success of the organisation and its growth. Like the sales goal, the market-share goal
is related to sales decisions.
5. Profit Goal

The profit goal is in terms of an aspiration level with respect to the money amount of
profit. It may also be in the form of profit share or return on investment. Thus, the
profit goal is related to pricing and resource allocation decisions.
4. Explicate the managerial theory of firm.

Baumol’s Sales or Revenue Maximisation
According to Baumol, with the separation of ownership and control in modern
corporations, managers seek prestige and higher salaries by trying to expand company
sales even at the expense of profits.
Being a consultant to a number of firms, Baumol observes that when asked how their
business went last year, the business managers often respond, “Our sales were up to
three million dollars”. Thus, according to Baumol, revenue or sales maximisation
rather than profit maximisation is consistent with the actual behaviour of firms.
The model is based on the following assumptions:
1. There is a single period time horizon of the firm.
2. The firm aims at maximising its total sales revenue in the long run subject to a
profit constraint.
3. The firm’s minimum profit constraint is set competitively in terms of the current
market value of its shares.
By sales maximisation, Baumol means maximisation of total revenue. It does not
imply the sale of large quantities of output, but refers to the increase in money sales (in
rupee, dollar, etc.). Sales can increase up to the point of profit maximization where the
marginal cost equals marginal revenue.
If sales are increased beyond this point money sales may increase at the expense of
profits. But the oligopolistic firm wants its money sales to grow even though it earns
minimum profits. Minimum profits refer to the amount which is less Quantity than
maximum profits. The minimum profits are determined on the basis of firm’s need to
maximize sales and also to sustain growth of sales.
Minimum profits are required either in the form of retained earnings or new capital
from the market. The firm also needs minimum profits to finance future sales. Further,
they are essential for a firm for paying dividends on share capital and for meeting
other financial requirements.
Thus, minimum profits serve as a constraint on the maximisation of a firm’s revenue.
“Maximum revenue will be obtained only” according to Baumol, “at an output at
which the elasticity of demand is unity, i.e. at which marginal revenue is zero.”

This sales maximisation output OK is higher than the profit maximisation output OQ.
But sales maximisation is subject to minimum profit constraint. Suppose the
minimum profit level of the firm is represented by the line MP.
The output OK will not maximise sales as the minimum profits OM are not being
covered by total profits KS. For sales maximisation the firm should produce that level
of output which not only covers the minimum profits but also gives the highest total
revenue consistent with it.
5. Explain the concept break even analysis.

No doubt it is an important tool which helps to make profit planning. It has been
defined as “a chart which shows the profitability or otherwise of an undertaking at
various levels of activity and as a result indicates the point at which neither profit nor
loss is made.”
Break-Even Chart

As shown in the above Figure TFC is equals to FE, which is a fixed cost line.
The vertical distance between TC and TFC line equals TVC. As quantity of output
increases, the vertical distance between TC and TFC increases. This implies that TVC
increases with change in TC and TFC.
implies that an organization will suffer losses if it produces less than Qb. At Qb
output level, total revenue equals total cost. At this point, an organization never makes
profit nor loss implying that it is a break-even point. Thus, Qb is a break-even level of
output. Producing more than Qb will be profitable for organizations as TR is greater
than TC.
6. Explain the role of game theory in business decision making.

Increasingly, companies are utilizing the science of Game Theory to help them make
high risk/high reward strategic decisions in highly competitive markets and situations.
Modern Game Theory has been around for over 50 years old and has demonstrated
an ability to generate the ideal strategic choice in a variety of different situations,
companies and industries. Game Theory principles are leveraged through the use of
strategy games. These games are well-defined mathematical scenarios that
encompass a set of players (individuals or firms), a set of strategies available to those
players, and a payoff specification for each combination of strategies. One simple and well-
known example of a strategy game, familiar to first year psychology students, is the four
quadrant Prisoner’s Dilemma.
Game Theory is a powerful tool for predicting outcomes of a group of
interacting firms where an action of a single firm directly affects the payoff of other
participating players. Given that each firm function as part of a complex web of
interactions, any business decision or action taken by a firm impacts multiple
entities that interact with or within that firm, and vice versa. Said another way, each
decision maker is a player in the game of business.
Therefore, when making a decision or choosing a strategy firms must take
into account the potential choices and payoffs of others, keeping in mind that
while making their choices, other players are likely to think about and take into
account your strategy as well. This understanding – quantified through payoff
calculations – enables a company to formulate their optimal strategy.
Game Theory is ideal for strategic situations where competitive or individual
behaviors can be modelled. These situations include: auctions (e.g., sealed project
bids), bargaining activities (e.g., union vs management, pricing buy-back and revenue-
sharing negotiations), product decisions (e.g., entry or exit markets), principal-agent
decisions (e.g., compensation negotiations, supplier incentives) and supply chain design
(e.g., capacity management, build vs outsource decisions).
Typically, multiple strategy games are played to model different competitors, various
payoffs and potential strategies. The objective of these games is to deliver 1) a
recommended set of strategic decisions to guide competitive behaviour to a desirable
outcome, and; 2) an analysis of how a series of possible strategic moves can predict
various competitive outcomes. Different types of games can be utilized depending on
the strategic situation, the number of players, the amount of information available and
the timing constraints.
These methodologies are not without their shortcomings which need to be
considered in to the strategy development process. Firstly, game theory assumes the
players act rationally and in their self-interest. We know that as humans, this is not
always the case. Secondly, Game Theory assumes players act strategically and
consider the competitive responses of their actions. Again, our experience tells us
that not every manager thinks within a strategic context. Finally, Game Theory is most
effective when managers understand the expected positive and negatives payoffs of
each of their actions. In reality, most companies often do not have enough knowledge
of their own payoffs let alone those of their competition.
Despite its shortcomings, a properly constructed game can perceptibly reduce
business risk, yield valuable competitive insights, improve internal alignment around
decisions and maximize strategic utility.
**************

BUSINESS ECONOMICS

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

BUSINESS ECONOMICS

Uploaded by

Copyright:

Available Formats

SELF-LEARNING MATERIAL

COURSE: B. TECH – CIVIL ENGINEERING

MODULE 1: INTRODUCTION TO ECONOMICS (6)

Notes Prepared by Prof. Dr.M.RAMESH, HITS.

7. What is meant by demand forecasting?

Notes Prepared by Prof. Dr.M.RAMESH, HITS.

Notes Prepared by Prof. Dr.M.RAMESH, HITS.

Notes Prepared by Prof. Dr.M.RAMESH, HITS.

3. Explain briefly Scope of Managerial Economics.

Notes Prepared by Prof. Dr.M.RAMESH, HITS.

Notes Prepared by Prof. Dr.M.RAMESH, HITS.

It Uses Macro Economic Concepts

Notes Prepared by Prof. Dr.M.RAMESH, HITS.

Notes Prepared by Prof. Dr.M.RAMESH, HITS.

Managerial Economics and Economics

Notes Prepared by Prof. Dr.M.RAMESH, HITS.

Notes Prepared by Prof. Dr.M.RAMESH, HITS.

Notes Prepared by Prof. Dr.M.RAMESH, HITS.

9. What do you mean by Cross Elasticity of Demand?

10. Give a short note about Consumer Goods with examples.

Notes Prepared by Prof. Dr.M.RAMESH, HITS.

Notes Prepared by Prof. Dr.M.RAMESH, HITS.

Income Elasticity of Demand

Cross Elasticity of Demand

Notes Prepared by Prof. Dr.M.RAMESH, HITS.

Notes Prepared by Prof. Dr.M.RAMESH, HITS.

6. What are the methods of measuring Price Elasticity of Demand?

Total outlay method

Notes Prepared by Prof. Dr.M.RAMESH, HITS.

7. State Law of Demand and give its assumptions.

Notes Prepared by Prof. Dr.M.RAMESH, HITS.

Notes Prepared by Prof. Dr.M.RAMESH, HITS.

Notes Prepared by Prof. Dr.M.RAMESH, HITS.

Individual demand and market demand schedules

Notes Prepared by Prof. Dr.M.RAMESH, HITS.

Notes Prepared by Prof. Dr.M.RAMESH, HITS.

Notes Prepared by Prof. Dr.M.RAMESH, HITS.

Notes Prepared by Prof. Dr.M.RAMESH, HITS.

6. Elucidate Methods of Demand Forecasting.

Notes Prepared by Prof. Dr.M.RAMESH, HITS.

Notes Prepared by Prof. Dr.M.RAMESH, HITS.

Notes Prepared by Prof. Dr.M.RAMESH, HITS.

Notes Prepared by Prof. Dr.M.RAMESH, HITS.

Notes Prepared by Prof. Dr.M.RAMESH, HITS.

ii) Size of the Plant

Notes Prepared by Prof. Dr.M.RAMESH, HITS.

Meaning of Break-Even Chart

Notes Prepared by Prof. Dr.M.RAMESH, HITS.

Formula for Break Even Analysis

Meaning of Break-Even Chart

Notes Prepared by Prof. Dr.M.RAMESH, HITS.

Notes Prepared by Prof. Dr.M.RAMESH, HITS.

Notes Prepared by Prof. Dr.M.RAMESH, HITS.

4. Analyse and discuss knight’s uncertainty theory of profit.

Due to the uncertainty of events, the decision-making becomes a crucial function of

Notes Prepared by Prof. Dr.M.RAMESH, HITS.

Notes Prepared by Prof. Dr.M.RAMESH, HITS.

10. What do you mean by fixed and variable factor?

The Cobb-Douglas production function is expressed as

Notes Prepared by Prof. Dr.M.RAMESH, HITS.

2. Explain the stages of law of variable proportion

Notes Prepared by Prof. Dr.M.RAMESH, HITS.

3. Briefly explain Economies of Scale.

Notes Prepared by Prof. Dr.M.RAMESH, HITS.