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1. “Profit Maximisation is the main objective of a firm” Discuss this statement with the help of an example.

A firm's main objective should be to make decisions that maximize the value of the company for its owners, and as the
owners of a company are its shareholders, the main financial objective should be 'the maximization of shareholder wealth'.
Since shareholders receive their wealth through dividends and capital gains, shareholder wealth will be maximized by
maximizing the value of dividends and capital gains that shareholders receive over time.

Problems with the 'maximization of profits' objective:

Firstly, there are quantitative difficulties associated with profit. Maximization of profits as a financial objective requires the
profit to be defined and measured accurately, and that all the factors contributing to it are known and can be taken into
account. It is very doubtful that this requirement can be met on a regular basis.
E.g- If 5 auditors go into the same company, it is very likely that each will come out with a completely different profit figure.

A second problem concerns the timescale over which the profit should be maximized.
Should profit be maximized in the short term or the long term?? Given that profit considers one year at a time, the focus is
likely to be on short-term profit maximization at the expense of long-term investment, putting the long term survival of the
company into doubt.
There are many examples of companies going into liquidation shortly after declaring high profits. Check out - Polly Peck
Plc's dramatic failure in 1990! (good example)

The third problem is that profit does not take account of or make any allowance for risk! It would be inappropriate to
concentrate efforts on maximizing accounting profit when this objective does not consider one of the key determinants of
shareholder wealth.

So the 'maximization of profit' is not a suitable core objective for a company. That is not to say that a company does not need
to pay attention to its profit figures, since falling profits of profit warnings are taken by the financial markets as a sign of
financial weakness.
Instead these sort of profit targets/objectives should can serve a useful purpose in helping a company to achieve short-term or
operational objectives within its overall strategic plan.

The traditional approach of financial management was all about profit maximization.The main objective of companies was to
make profits.

The traditional approach of financial management had many limitations:

1.Business may have several other objectives other than profit maximization.Companies may have goals like: a larger market
share, high sales,greater stability and so on.The traditional approach did not take into account so many of these other aspects.

2.Profit Maximization has to defined after taking into account many things like:

a.Short term,mid term,and long term profits

b.Profits over period of time


The traditional approach ignored these important points.

3.Social Responsibility is one of the most important objectives of many firms.Big corporates make an effort towards giving back
something to the society.The big companies use a certain amount of the profits for social causes.It seems that the traditional
approach did not consider this point.

Modern Approach is about the idea of wealth maximization.This involves increasing the Earning per share of the shareholders
and to maximize the net present worth.Wealth is equal to the the difference between gross present worth of some decision or
course of action and the investment required to achieve the expected benefits.

Gross present worth involves the capitalised value of the expected benefits.This value is discounted a some rate,this rate depends
on the certainty or uncertainty factor of the expected benefits.

The Wealth Maximization approach is concerned with the amount of cash flow generated by a course of action rather than the
profits.

Any course of action that has net present worth above zero or in other words,creates wealth should be selected.

2. Briefly explain the marketing approach to Demand measurement.

The vast majority of business decisions involve some degree of uncertainty and
managers seldom know exactly what the outcomes of their choices will be. One
approach to reducing the uncertainty associated with decision making is to devote
resources to forecasting. Forecasting involves predicting future economic
conditions and assessing their effect on the operations of the firm.
Frequently, the objective of forecasting is to predict demand. In some cases,
managers are interested in the total demand for a product. For example, the
decision by an office products firm to enter the home computer market may be
determined by estimates of industry sales growth. In other circumstances, the
projection may focus on the firm’s probable market share. If a forecast suggests
that sales growth by existing firms will make successful entry unlikely, the company
may decide to look for other areas in which to expand.
Forecasts can also provide information on the proper product mix. For an
automobile manufacturer such as Maruti Udyog, managers must determine the
Demand and Revenue
Analysis
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number of Esteems versus Zens to be produced. In the short run, this decision is
largely constrained by the firm’s existing production facilities for producing each
kind of car. However, over a longer period, managers can build or modify
production facilities. But such choices must be made long before the vehicles begin
coming off the assembly line. Accurate forecasts can reduce the uncertainty
caused by this long lead time. For example, if the price of petrol is expected to
increase, the relative demand for Zens or compact cars is also likely to increase.
Forecasting is an important management activity. Major decisions in large
businesses are almost always based on forecasts of some type. In some cases, the
forecast may be little more than an intuitive assessment of the future by those
involved in the decision. In other circumstances, the forecast may have required
thousands of work hours and lakhs of rupees. It may have been generated by the
firm’s own economists, provided by consultants specializing in forecasting, or be
based on information provided by government agencies. Forecasting requires the
development of a good set of data on which to base the analysis. A forecast cannot
be better than the data from which it is derived. Three important sources of data
used in forecasting are expert opinion, surveys, and market experiments.
Expert Opinion
The collective judgment of knowledgeable persons can be an important source of
information. In fact, some forecasts are made almost entirely on the basis of the
personal insights of key decision makers. This process may involve managers
conferring to develop projections based on their assessment of the economic
conditions facing the firm. In other circumstances, the company’s sales personnel
may be asked to evaluate future prospects. In still other cases, consultants may be
employed to develop forecasts based on their knowledge of the industry. Although
predictions by experts are not always the product of "hard data," their usefulness
should not be underestimated. Indeed, the insights of those closely connected with
an industry can be of great value in forecasting.
Methods exist for enhancing the value of information elicited from experts. One of
the most useful is the Delphi technique. Its use can be illustrated by a simple
example. Suppose that a panel of six outside experts is asked to forecast a firm’s
sales for the next year. Working independently, two panel members forecast an 8
percent increase, three members predict a 5 percent increase, and one person
predicts no increase in sales. Based on the responses of the other individuals, each
expert is then asked to make a revised sales forecast. Some of those expecting
rapid sales growth may, based on the judgments of their peers, present less
optimistic forecasts in the second iteration. Conversely, some of those predicting
slow growth may adjust their responses upward. However, there may also be some
panel members who decide that no adjustment of their initial forecast is warranted.
Assume that a second set of predictions by the panel includes one estimate of a 2
percent sales increase, one of 5 percent, two of 6 percent, and two of 7 percent.
The experts again are shown each other’s responses and asked to consider their
forecasts further. This process continues until a consensus is reached or until
further iterations generate little or no change in sales estimates.
The value of the Delphi technique is that it aids individual panel members in
assessing their forecasts. Implicitly, they are forced to consider why their judgment
differs from that of other experts. Ideally, this evaluation process should generate
more precise forecasts with each iteration.
One problem with the Delphi method can be its expense. The usefulness of expert
opinion depends on the skill and insight of the experts employed to make
predictions. Frequently, the most knowledgeable people in an industry are in a
Demand Estimation and
Forecasting
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position to command large fees for their work as consultants or they may be
employed by the firm, but have other important responsibilities, which means that
there can be a significant opportunity cost in involving them in the planning process.
Another potential problem is that those who consider themselves experts may be
unwilling to be influenced by the predictions of others on the panel. As a result,
there may be few changes in subsequent rounds of forecasts.
Surveys
Surveys of managerial plans can be an important source of data for forecasting.
The rationale for conducting such surveys is that plans generally form the basis for
future actions. For example, capital expenditure budgets for large corporations are
usually planned well in advance. Thus, a survey of investment plans by such
corporations should provide a reasonably accurate forecast of future demand for
capital goods.
Several private and government organizations conduct periodic surveys. The annual
National Council of Applied Economic Research (NCAER) survey of Market
Information of Households is well recognized. Many private organizations like
ORG-MARG and TNS-MODE conduct surveys relating to consumer demand
across certain geographical areas.
If data from existing sources do not meet its specific needs, a firm may conduct its
own survey. Perhaps the most common example involves companies that are
considering a new product or making a substantial change in an existing product.
But with new or modified products, there are no data on which to base a forecast.
One possibility is to survey households regarding their anticipated demand for the
product. Typically, such surveys attempt to ascertain the demographic
characteristics (e.g., age, education, and income) of those who are most likely to
buy the product and find how their decisions would be affected by different pricing

policies.
Although surveys of consumer demand can provide useful data for forecasting,
their value is highly dependent on the skills of their originators. Meaningful surveys
require careful attention to each phase of the process. Questions must be precisely
worded to avoid ambiguity. The survey sample must be properly selected so that
responses will be representative of all customers. Finally, the methods of survey
administration should produce a high response rate and avoid biasing the answers
of those surveyed. Poorly phrased questions or a nonrandom sample may result in
data that are of little value.
Even the most carefully designed surveys do not always predict consumer demand
with great accuracy. In some cases, respondents do not have enough information to
determine if they would purchase a product. In other situations, those surveyed
may be pressed for time and be unwilling to devote much thought to their answers.
Sometimes the response may reflect a desire (either conscious or unconscious) to
put oneself in a favorable light or to gain approval from those conducting the
survey. Because of these limitations, forecasts seldom rely entirely on results of
consumer surveys. Rather, these data are considered supplemental sources of
information for decision making.
Market Experiments
A potential problem with survey data is that survey responses may not translate
into actual consumer behavior. That is, consumers do not necessarily do what they
say they are going to do. This weakness can be partially overcome by the use of
market experiments designed to generate data prior to the full-scale introduction of
a product or implementation of a policy.
Demand and Revenue
Analysis
10
To set up a market experiment, the firm first selects a test market. This market
may consist of several cities; a region of the country, or a sample of consumers
taken from a mailing list. Once the market has been selected, the experiment may
incorporate a number of features. It may involve evaluating consumer perceptions
of a new product in the test market. In other cases, different prices for an existing
product might be set in various cities in order to determine demand elasticity. A
third possibility would be a test of consumer reaction to a new advertising
campaign.
There are several factors that managers should consider in selecting a test market.
First, the location should be of manageable size. If the area is too large, it may be
expensive and difficult to conduct the experiment and to analyze the data. Second,
the residents of the test market should resemble the overall population of India in
age, education, and income. If not, the results may not be applicable to other areas.
Finally, it should be possible to purchase advertising that is directed only to those
who are being tested.
Market experiments have an advantage over surveys in that they reflect actual
consumer behavior, but they still have limitations. One problem is the risk involved.
In test markets where prices are increased, consumers may switch to products of
competitors. Once the experiment has ended and the price reduced to its original
level, it may be difficult to regain those customers. Another problem is that the firm
cannot control all the factors that affect demand. The results of some market
experiments can be influenced by bad weather, changing economic conditions, or
the tactics of competitors. Finally, because most experiments are of relatively short
duration, consumers may not be completely aware of pricing or advertising
changes. Thus their responses may understate the probable impact of those
changes.

3. From the demand function P = 200 – 0.25Q or Q = 800 – 4P. Calculate point price elasticities at (i)P = 20 and Q =
240 and (ii) P = 125.

4. “An analytical tool frequently employed by managerial economists is the break even chart, an important
application of cost function.” Explain this statement.
5. “Classification of markets is based on their characteristics.” Substantiate this statement with reference to Monopoly and
Oligopoly market structures.
6. Write short notes on the following :-

a) Alternative Objectives of Firms


b) Direct Costs and Indirect Costs

c) Bundling

Bundling

One method of taking advantage of information goods is bundling. That is the strategy of
grouping multiple items together and selling them as a group. Bundling allows sellers to better
predict the demand for the bundle. While it is difficult to know which items in the group an
individual person wants, they are likely to value some of the items enough to purchase the
bundle, even if they don't value any of the items enough to buy it separately. However, this
only works when it doesn't cost much to sell extra items in a bundle that are unwanted.
Information goods fit this profile since it doesn't cost anything to make extra copies.
You must have come across campaigns of the following kind. “Buy one, get the
second at half-price”. A camera is sold in a box with a free film; a hotel room
often comes with accompanying breakfast. These are examples of Bundling.
Bundling is the practice of selling two or more separate products together for a
single price i.e. bundling takes place when goods or services which could be sold
separately are sold as a package. A codification of bundling practices and
definitions of selling strategies is:
� Pure bundling: products are sold only as bundles;

� Mixed-bundling: products are sold both separately and as a bundle; and

� Tying: The purchase of the main product (tying product) requires the purchase

of another product (tied product) which is generally an additional complementary


product.
This is not an exhaustive list but covers the most frequently encountered cases.
Pure bundling involves selling two products only as a package and not separately. For example, Reliance
WLL -cellphone instrument (handset) and connection are
only available together and not available separately. Microsoft’s bundle of Windows
and Internet Explorer could be considered a pure bundle. Also Cable TV Channels
are an example of pure bundling. In North America it is not possible to get only
Disney Channel has it is always bundled with other premium channels. In India, the
prospective CAS(Conditional Access System) also has similar channel packages
where some of the channels can’t be purchased separately like Zee TV, would only
be available with other, Zee Channels. Mixed Bundling involves selling products separately as well as a
bundle.
McDonald’s Value Meals and Microsoft Office are examples of Mixed Bundling.
In a recently introduced offer, The Times of India and The Economic Times can be
purchased together for weekdays for a price much less than if purchased
separately. This is also an example of mixed bundling. In most cases mixed
bundling provides price savings for consumersA well known example is that used by IBM in 1930s
wherein if you purchased
IBM tabulating machines agreed to purchase IBM punchcards. As a result, IBM
was trying to extend its monopoly from one market to another. But it had to
abandon this practice of it in 1936 due to antitrust cases. In 1950’s customers who
leased a Xerox Copying Machine had to buy Xerox Paper. Another case of tying
was that by Kodak in which Kodak held a monopoly in the market for Kodak
Copier Parts. Kodak engaged in tying when it refused to sell it’s parts to
consumers or independent service providers except in connection with a Kodak
Service Contract. Today when you buy a Mach3 razor, you must buy the tied
product i.e. the cartridge that fits into the Mach3 razor.
Financial bundling has become widespread. It has been suggested that
manufacturers such as GE, General Motors and Lucent grow ever more involved in
providing finance, so “manufacturing is becoming the loss-leader of the profit chain
for many companies.” In other words, give away the product; make money on the
lending that is bundled with it. In India too, a number of automobile companies are
providing finance and bundling the automobile with financing.
Bundling can be good for consumers. It can reduce “search costs” (the bundled
goods are in the same place), as well as the producer’s distribution costs. There are
lower “transaction costs” (because a single purchase is cheaper to carry out than
multiple ones). And the producer may be a more efficient bundler than the
customer: few of us choose, after all, to buy the individual parts of a computer to
assemble them ourselves.
In perfectly competitive markets, bundling should happen only if it is more efficient
than selling the products separately. Where there is less than perfect competition -
that is, most markets - economic models suggest that bundling sometimes benefits
consumers and sometimes producers. When firms have a measure of market
power, they can engage in price discrimination, charging different prices to different
customers. Bundling can play a part in price discrimination, as different bundles of
goods and prices may appeal to different customers.
In a celebrated case that caught much media attention, Microsoft was accused of
anti-competitive conduct in ‘bundling’ Internet Explorer and Windows as a pure
bundle. Microsoft claimed they are not a bundle at all, rather a single product
incapable of being broken into parts. It is of course difficult to settle such
arguments and these go beyond the economic domain to the judicial domain, and
are settled in courts. But the interesting aspect is that the company does not

consider its product (Windows and Internet Explorer) as being capable of being

broken into parts.