CASE STUDY I

The Global Recession

Beginning in the United States in December 2007 (and with much greater intensity since September 2008, according to the National Bureau of Economic Research), the industrialized world has been undergoing a Recession, a pronounced deceleration of economic activity. This global recession has been taking place in an economic environment characterized by various imbalances and was sparked by the outbreak of the financial crisis of 2007-2009. Although the late-2000s recession has at times been referred to as "the Great Depression," this same phrase has been used to refer to every recession of the several preceding decades.

The financial crisis has been linked to reckless and unsustainable lending practices resulting from the deregulation and securitization of real estate mortgages in the United States. The US mortgage-backed securities, which had risks that were hard to assess, were marketed around the world. A more broad based credit boom fed a global speculative bubble in real estate and equities, which served to reinforce the risky lending practices. The precarious financial situation was made more difficult by a sharp increase in oil and food prices. The emergence of Sub-prime loan losses in 2007 began the crisis and exposed other risky loans and overinflated asset prices. With loan losses mounting and the fall of Leman Brothers on September 15, 2008, a major panic broke out on the inter-bank loan market. As share and housing prices declined many large and well established Investment and Commercial banks in the United States and Europe suffered huge losses and even faced bankruptcy, resulting in massive public financial assistance.

A global recession has resulted in a sharp drop in international trade, rising unemployment and slumping commodity prices. In December 2008, the National Bureau of Economic Research (NBER) declared that the United States had been in recession since December 2007. Several economists have predicted that recovery may not appear until 2011 and that the recession will be the worst since the Great Depression of the 1930s. The conditions leading up to the crisis, characterized by an exorbitant rise in asset prices and associated boom in economic demand, are considered a result of the extended period of easily available credit, inadequate regulation and oversight, or increasing inequality.

Fiscal and monetary policies have been significantly eased to stem the recession and financial risks. While this has renewed interest in Keynesian economic ideas, the recent policy consensus is for the stimulus to be withdrawn as soon as the economies recover to chart a path to sustainable growth.

Questions

1. What do you understand by Global Recession? How was it triggered? 2. How do you distinguish between Recession, Inflation, Deflation and Stagflation? 3. What has been the adverse impact of the present recession on the world economy and the Indian Economy? 4. How can Recession be fought? What are the immediate measures and policy changes already undertaken by India and major countries like USA, Japan and Germany?

CASE STUDY II

Indias Economic Growth in 2009-10

Displaying unmistakable signs of a surge, the countrys economy grew by a robust 7.9 per cent in the second quarter of the current fiscal (July-September 2009), prompting experts to project a seven per cent growth for the full fiscal as against 6.5 per cent estimated earlier. Planning Commission deputy chairman Mr. Montek Singh Ahluwalia described the happy development as being above expectations. There is also scope to revise the growth projections, Mr. Ahluwalia said, alluding to the prospect of an upward fine-tuning of the Plan panels earlier estimate.

The economy had registered a 6.1 per cent growth in the first quarter of this fiscal and took the cumulative expansion for the first half of the current fiscal (April-September) to seven per cent, the Central Statistical Organization (CSO) said in a statement here. The growth registered last fiscal was 6.7 per cent.

The bulk of the recovery was led by a 9.2-per cent growth in manufacturing, while mining and construction activities expanded by 9.5 per cent and 6.5 per cent, respectively. The news also enthused the markets and helped the Sensitive Index (Sensex) of the Bombay Stock Exchange (BSE) gain.

The growth rate is the fastest in 18 months, making experts wonder if it was not time to introduce an interest rate rise and cut stimulus spending in the face of mounting inflation. This data could be a green light for the Reserve Bank of India to hike rates, and there are greater chances of this by the end of the calendar year, said Mr. Robert Prior-Wandesforde, senior Asia economist at HSBC in Singapore.

Allaying fears about food inflation, Mr. Ahluwalia said: I dont believe there are serious worries on inflation, except food prices. Food prices are a matter of concern, but I dont think conventional monetary policy will take care of that problem. He also reiterated the government stance that stimulus would remain in place. Personally, I dont think the second quarter numbers suggest any change in the (fiscal) policy in the current year, he said. However, RBI Deputy Governor, Mr. Subir Gokarn said he would not be surprised if growth slowed in the December quarter. While it is a recovery and it seems to be gaining strength, we should not ignore the fact that it is still being driven substantially by public spending, he said.

Mr. Rajeev Malik, economist at Macquarie in Singapore, said that the central bank would use liquidity management rather than rate rises in December and January as farming output was likely to fall. I dont think they are going to be swung by what agriculture has done, he said. However, the farm sector grew less than one per cent in the second quarter of this fiscal from 2.7 per cent a year earlier, mainly due to the twin impact of drought and subsequent floods. The growth in agriculture, forestry and fishing is estimated at 0.9 per cent in the July-September quarter, the Central Statistical Organization (CSO) data said.

The finance minister, Mr. Pranab Mukherjee, is all smiles at the nation posting a robust growth. Im happy about the figures released by CSO. If you compare it with the earlier two quarters, its a very heartening progress, he told reporters outside Parliament.

However, Mr. Mukherjee hastened to caution, even then, I will keep my fingers crossed till the third quarter result comes in. The results that have come out today show that the stimulus package we provided has started paying dividends... The negative trend in exports is coming down. Im happy. We will wait for the next quarter, Mr. Mukherjee said.

Questions 1. What are the projections made above for Indias future growth? Why were the policy-makers optimistic about it? 2. How is the growth of the economy measured and calculated? Why it is not measured in terms of National Income or Net National Product? 3. What are the reasons for a very low growth in the Agricultural Sector? What was the future prospect for Indian Agriculture?

DEMAND FORECASTING FOR M/s BENGAL CABLE COMPANY The market research department of M/s. Bangal Cable Company, Kolkota was entrusted with forecasting the demand for cables of the company. It was felt that the demand for cables is considerably influenced by the pace of industrialization, power development and building activity. Cables are used for different purpose such as power transmission and industrial and house wiring. Bengal Cable Company was exclusively engaged in the manufacturing of cable required by industry and housing. While many factors such as the rate of building activity purchasing power, etc. are important in determining the demand for cables, it was felt that most of the demand for cables can be explained in terms of the growth of power consumption in the country. As cables are a must for industry and building the price factor was not considered as significant variable in determining the demand for cables. After all this products has no substitute. The market research department of M/s Bengal Cable Company, Kolkata, developed a model relating all India cable sales (industrial and housing cables) to the peak demand for power in the country. The analysis based on time series data had shown a strong positive correlation between all India cable sales and the peak demand for the corresponding year. The estimating equation was as follows:Yt. = 1173 + 28.5 Xt. Where Yt. = annual cable sales (in thousand coils) for all India in year t Xt. = peak demand in million K.W. in year t r2 = 0.94 The Central Electricity Authority of the Government of India has estimated the peak demand for the year 2004 as 98.5 million K.W., taking into account likely industrial and building growth and the availability of power on an all India basis. As there were no marked seasonal fluctuation, it was considered proper to assume uniform monthly cable sales throughout the year. It was estimated that Bengal Cables market share in 2004 will be about 20 per cent. Question 1. Find out the all India cable demand for the year 2004 and monthly estimated sales of Bengal Cable Company. Question 2. The Price factor was not considered important in forecasting all India demand for cables. Will the same be true in estimating demand for the company's cables? Question 3. Suppose the market share of the company during the previous two years was 10 and 15 percent respectively, was the company justified in assuming the market share as 20 percent?

Mc Donalds holds nearly 30 percent share of $65 billion US restaurant business and 46 percent of its $2.6 billion burger business. It serves more than 22 million customers per day and with sales of nearly $15 billion it dwarfs its competitors. After nearly three decades of double digit gains, however, domestic sales at Mc Donalds have been growing slowly since 1986 as a result of higher prices, changing tastes, slow growth of the domestic economy, demographic changes, and increased competition from other fast food chains and other forms of delivering fast foods.

Price increase at Mc Donalds exceeded inflation in each year since 1986 and in 0 of the last 17 years. The average check at McDonalds is now $4 a far cry from the 15cent hamburger on which Mc Donalds got rich and sent customers streaming to lower pricing customers. Concern over cholestrol and calories, as well as slowing down of growth of the economy and in personal incomes have also reduced growth. In addition the proportion of 15 to 29 year olds (the primary fast food consumers) in the total population has shrunk from 27.5 to 22.5 percent during the past decade. Increased competition from other fast food chains, and other fast food options (pizza, chicken tacos and so on) frozen fast foods, mobile units and the vending machines have also slowed the growth of Big Macs. Mc Donalds did not sit idle and tried to meet its challenges head on by introducing a value menu in 1990 with small hamburgers selling for as little as 59 cents(down from 89 cents) and a combination of burger, French fries, and soft drinks for as much half as off. IN response to the increased public concern about cholestrol and calories, Mc Donalds began publicizing the nutritional content of its menu offerings, substituted vegetable oils for beef tallow in frying French fries, replaced ice cream with low fat yoghurt, introduced bran muffins and cereals in breakfast menu, and even (unsuccessfully) introduced Mac Lean Deluxe a new reduced fat, quarter pound hamburger on which Mc Donalds spent from $50 to $70 to develop and promote. Furthermore, in response to increased competition from frozen foods, mobile units, and vending machines, an increasing number of Mc Donalds franchises have drive throughs from which they now generate almost half their business. Mc Donalds is also expanding very rapidly abroad. When it faces much less competition and where there is much more room for growth. Questions 1. How are sales of burgers related to determinants of demand? 2. What is value Menu ? 3. Do you think a decrease in price by 30 cents was a step in right direction?

CASE STUDY
Michael Wolfson, a computer programmer had a decent job with the financial powerhouse Bear, Steams & Co. Now, he refurbishes computers at the basement in his house and sells it through e-bay. He plans to join as a school teacher. Michael lost his job in 2003. He was told that his job is being outsourced to India. Paul Schwartz, a mainframe programmer, who was earning $ 80,000 a year was told that his services were no longer required. He suspects that his job has been outsourced to India. There is growing dissent among the Americans against the increasing practice of outsourcing. It has become an electoral issue in the coming presidential elections in the US. The Democratic candidate, John Kerry has made it an emotive issue, despite economists trying to portray the positive aspects of outsourcing. There are numerous reasons for the growing apathy towards outsourcing. The prevailing economic situation and the increasing joblessness in the US have added fuel to the fire. However, many analysts feel that joblessness in the US is cyclical in nature resulting from the recession of 2001 and hence, a recovery will create job opportunities. Moreover, according to the U.S.-India Business Council, the increasing unemployment is also due to corporate restructuring and just a quarter of the job loss is due to outsourcing. Since, the beginning of 2001, the real job

loss in US is estimated to be 2.3 million. In comparison, the actual job loss due to outsourcing is estimated to be only 200,000. Thus, it can be said that there are various other reasons for joblessness in the US. The outcry against outsourcing seems to be driven more by politics rather than economics. Outsourcing forms a small proportion of the jobs that are regularly churned in the US economy. On an average, 24 million jobs are churned in the US every month. In the process, resources are allocated, for more productive purposes. To come out of the recession and raise the standards of living, higher productivity seems to be the only solution. The debate on outsourcing gathered momentum only in the recent past. A study by Forrester, a research group, in the year 2002, brought the issue into limelight. The report claims that by 2015, 3.3 million white-collar jobs in the US would be transferred to countries like India. The Economics of Outsourcing But is outsourcing so bad for the US economy? Gregory Mankiw, professor of economics at the Harvard University and head of President Bush's Council of Economic Advisers, recently told presspersons that outsourcing of jobs is in better interest of US. According to him, outsourcing lowers the cost for consumers, making the corporations more efficient. There were a series of articles in The Economist, highlighting the advantages of outsourcing. There are many influential groups in the US who are perturbed by the recent outcry against outsourcing. Says Charles E Morrison, President, East West Center, a US based think tank, "Off-shoring is not an economic problem, but an economic opportunity". Many analysts in the US feel that anti off-shoring bills in the US would prove to be ineffective. Similar views were echoed by Michael T Clark of US-India business council. He says that, "Jobs lost to off-shoring were less than a quarter of all jobs lost in the US in 2002. The rest were lost due to corporate restructuring. The current debate in the US on off-shoring is informed by lack of facts". In an article, "Why Your Job Isn't Moving to Bangalore" in the New York Times, Jagdish Bhagwati, a senior fellow at the Council on Foreign Relations and professor at Columbia University writes that the panic and furor over outsourcing is completely unwarranted. He further says that no jobs are being taken away from America. He says that the affect of changes in technology is being felt in the labor intensive industries. According to him, the loss of jobs in the US is due to technological changes. Professor Bhagwati is also critical about politicizing the whole issue. He says that outsourcing will strengthen the competitiveness of the US companies. Firms ignoring the cheaper supplies would lose out. Professor Bhagwati further says that outsourcing service jobs is nothing different from importing of labor-intensive textiles and other goods. According to him, all empirical studies in the US over the last two decades suggest that wage stagnation in the manufacturing industry is more due to automation of the processes, not the cheaper imports. The same is applicable to service industry as well. Jane Linder of Accenture's Institute for Strategic Change says that companies outsourcing the traditional back-office work have more control and discipline over their operations. Moreover, employees of the company can concentrate on framing strategies. Further, outsourcing also results in greater efficiency and lowering costs. This allows companies to offer better services to customers. A study done by McKinsey Global Institute reveals that for every dollar of work outsourced by the US, it gets back $1.14 as income, and the countries to which the work is being outsourced gains 35 cents. This shows that outsourcing is a win-win situation for both the countries. Benefits for US Savings to US investors or customers 0.58 Benefits for India Labor 0.1

Imports of US goods and services by providers in India Transfer of profits by US based providers in India back to US

0.05 0.04

Profits retained in India Suppliers

0.1 0.09

Net direct benefit retained in US

0.67

Central government taxes

0.03

Value for US labor reemployed

0.450.47

State government taxes

0.01

Potential net benefit for US

1.121.14

Net benefit to India

0.33

Source: Mckinsey Global Institute There is a definite cost advantage in off-shoring work to India. These advantages are a result of lower wages in the developing countries along with the development of telecommunications in these countries. A report published by HSBC, which has off-shored more than 4,000 jobs to India, says that the telephone costs from India to America and Britain has decreased by almost 80%, since January 2001. The wage difference between these countries is also a factor that forces the companies to outsource their business processes to India. A study done by NASSCOM, says that the average salary of an IT professional in UK is $96,000, in US it is $75,000, whereas in India it is just $26,000. The wage difference between the low end call center jobs of both the countries is also very wide. An average call center employee in UK earns $20,000 on the average. Whereas, a call center professional in India barely manages to earn one tenth of the earnings of their British counterparts. Offshoring allows companies to work round the clock. It gives ample time to the companies to think about their IT problems. Recently, American Express paid $5,000 to a group of software programmers in India, to develop a package for them. The same would have cost them several million dollars in US. The benefits of outsourcing go much beyond the cost advantage. An article in Mckinsey quarterly suggests that the companies need to look beyond cost savings. The article says that "Companies are merely replicating what they do at home, where labor is expensive and capital is relatively cheap, in countries in which the reverse is true." Alan Greenspan, US Federal Reserve Chairman, is a staunch supporter of outsourcing. He is of the opinion that any move to curb outsourcing of work to countries like India and China, might give just a temporary relief. Reacting to the proposed legislations in the US banning outsourcing, Greenspan said, "A new round of protectionist steps is being proposed against outsourcing. These alleged cures will make matters worse". Greenspan feels that any effort to protect US jobs through legislation would backfire. Not all companies have taken full advantage of outsourcing. According to Harris Miller, president of the Information Technology Association of America (ITAA), a lobby group, so far only 3-4 % of all American companies outsource their processes. The remaining still rests with American firms. A report published by Forrester, in December 2003, says that 60% of the Fortune 1000 companies have a negligible or near nil presence in off-shoring. Report also suggests that 40% of the work of these companies could be outsourced. Thus, the potential for growth in outsourcing is still immense.

Advancement in the technology can give a further push to the off-shoring activity. The inflexible architecture of the current technologies is acting as a hindrance in off-shoring, says Simon Heap of Bain & Co, a consultancy firm. The advancement in software and hardware would enable the companies to off-shore even small activities. Firms would be able to off-shore the activities of the entire department, say billing of customers. However, not everyone seems to agree with the supporters of outsourcing. Stephen Roach, the chief economist at Morgan Stanley, says that it is only the wage difference that is encouraging companies to outsource work to India or any other developing country. He further says that joblessness is taking away the charm of recovery in the US. Many analysts also feel that companies should take some concrete steps to minimize the affects of outsourcing. Companies should make the process of job transfers to offshore destinations more smooth. British Telecom exhibited a process of outsourcing that can be used as a model by other companies. In 2003, when BT announced that it is planning to open two call centers in India, with a capacity of 2200 people, it was criticized from all corners. It was said that BT was not acting in a socially responsible manner. Realizing the gravity of the situation, BT approached Sustainability, an international consultancy, specializing in business strategy and sustainable development. The consultancy firm was asked to find whether or not outsourcing and corporate social responsibility (CSR) co-exist. Sustainability noted that the immediate impact of outsourcing would be job loss for the employees, and the resulting affect on the society. The consultancy firm was of the opinion that before outsourcing, companies should address the negative impact of outsourcing. In order to check the negative impact of off-shoring, firms should consult with employees, trade unions, communities and other key stakeholders. Employees should be involved in the process of any such decision making. Sustainability also suggested that firms should be transparent and make the employees know the services that are being outsourced. Firms should also make an attempt to redeploy the employees in some other departments. This would minimize layoffs. An attempt should be made to retrain the redundant workers. A part of the savings from off-shoring should be invested for this purpose. As per the suggestion made by McKinsey Global Institute, 4-5% of the resulting savings from off-shoring should be used for insurance policy for employees to cover the lost wages. US was one of the prime supporters of free trade. US was least bothered about the concerns of many other developing countries when they raised their voices against job losses as a result of the cheap exports. But, this aggressiveness seems to have mellowed down in recent days. It always propagated that inefficient industries should be closed. One of the primary tasks of the U.S. Trade Representative's office was to keep a check on the world markets. It assesses the markets which are opening up and which are getting closed as a result of high tariffs and other quantitative restrictions. Now, with the growing efficiency of developing countries in the service sectors, many jobs in these sectors are being transferred to developing countries (of which a major chunk is coming to India). US is worried about the increasing joblessness but that seems paradoxical. It hails globalization but when it comes to the developing countries trying to reap the benefits of globalization, it raises all sorts of issues. Recently the US government has tightened the visa norms. The number of H-1B visas issued to Indian software programmers fell to 65,000 from 1,95,000 in 2003. Analysts feel that this would increase outsourcing of jobs further, particularly to India. According to Craig Barrett, the chief executive of Intel, granting of fewer visas would force the companies to shift their jobs to countries like India, where there is no dearth of qualified engineers.

Despite no ban from the federal authorities on outsourcing, many States have initiated the process of putting restrictions on outsourcing government work to foreign countries. The lawmakers in the state of New Jersey have proposed a bill that stops firms to outsource any government related work to a foreign country. Succumbing to the public pressure, the government was forced to bring back a helpline for welfare recipients that was being outsourced to India. Similarly, the state of Indiana withdrew a $ 15 million contract from an American subsidiary of an Indian IT firm. Commenting on the move, the Indiana governor said that contract was not in tune with Indiana's vision of providing better and more job opportunities to local companies and workers. However, analysts feel that these decisions have been influenced by political pressure in the backdrop of coming presidential elections in the US. The Indian Response The Indian BPO industry is not taking the outcry against outsourcing in the US seriously. Indian BPO firms are no longer just call centers. Their activities now cover marketing and knowledge based services. These companies are now aspiring to become strategic partners for US companies. There is a sudden spurt in the number of venture capitalists willing to invest in different areas. Though, some software companies can't hide their concern over the legislations banning government related off-shoring in the long-run but, for now they are clear that, these legislature will have negligible effect on the current contracts with the private companies. Reacting to the whole issue, Narayana Murthy, Chairman and Chief Mentor of Infosys said that there is no issue to worry about. He termed the outcry as normal. He suggested that rather than getting worried and agitated, Indians should put forward their point of view and explain the advantages of off-shoring. He said that the present uncertain economic situation is responsible for the concern over the job losses in the US. Many analysts feel that the opposition to outsourcing may not end with the US presidential elections. With many of the American States, coming out with legislations banning government contracts to other countries, the issue of off-shoring is going to be alive. Conditions for off-shoring may become favorable with the improvement in the performance of the US economy. Question for discussion: Que. Give your opinion on outsourcing and its impact on the prospects of growth of the economy of home Nation and host nation. Guidelines for the answer: Discuss the issue in the perspective of opportunity and threats faced by developing and developed nations.

Case Study
Electron Control, Inc., sells voltage regulators to other manufacturers, who then customize and distribute the products to quality assurance labs for their sensitive test equipment. The yearly volume of output is 15,000 units. The selling price and cost per unit are shown below: Selling price $200 Costs: Direct material $35 Direct labor 50 Variable overhead 25 Variable selling expenses 25

Fixed selling expenses 15 150 Unit profit before tax $ 50 Management is evaluating the alternative of performing the necessary customizing to allow Electron Control to sell its output directly to Q/A labs for $275 per unit. Although no added investment is required in productive facilities, additional processing costs are estimated as: Direct labor $25 per unit Variable overhead $15 per unit Variable selling expenses $10 per unit Fixed selling expenses $100,000 per year Question A. Calculate the incremental profit Electron Control would earn by customizing its instruments and marketing directly to end users.

CASE STUDY - 1

In 1997, over $700 billion purchases were charged on credit cards, and this total is increasing at a rate of over 10 per cent a year. At first glance, the credit card market would seem to be a rather concentrated industry. Visa, MasterCard and American Express are the most familiar names, and over 60 per cent of all charges are made using one of these three cards. But on closer examination, the industry seems to exhibit most characteristics of perfect competition. Consider first the size and distribution of buyers and sellers. Although Visa, Mastercard and American Express are the choices of the majority of consumers, these cards do not originate from just three firms. In fact, there are over six thousand enterprises (primarily banks and credit unions) in the US that offer charge cards to over 90 million credit card holders. One person's Visa card may have been issued by his company's credit union in Los Angeles, while a next door neighbour may have acquired hers from a Miami Bank when she was living in Florida. Creditcards are a relatively homogenous product. Most Visa cards are similar in appearance, and they can all be used for the same purposes. When the charge is made, the merchant is unlikely to notice who it was that actually issued the card. Entry into and exit from the credit card market is easy as evidenced by the 6000 institutions that currently offer cards. Although a new firm might find it difficult to enter the market, a financially sound bank, even one of modest size, could obtain the right to offer a MasterCard or a Visa card from the present companies with little difficulty. If the bank wanted to leave the field, there would be a ready market to sell its accounts to other credit card suppliers. Thus, it would seem that the credit card industry meets most of the characteristics for a perfectly competitive market.

Questions: 1. What are the characteristics of perfect competition that are exhibited by the credit card industry?

2. Discuss the price and output condition of a perfect competition.

3. Do you think the same competitive state is applicable to the Indian scenario? CASE STUDY - 2 The past fifteen years have seen numerous mergers of banks in every part of the US. Invariably, bank managers point to significant cost reduction (increasing returns to scale) associated with consolidation of computer systems, combining neighbouring branch outlets and reduction of corporate overhead expenses as justification. Many of these mergers involved multibillion dollar banks, which appeared to be inconsistent with existing empirical research on bank costs that showed significant diseconomies of scale for banks with more than $2550 million in deposits. Unfortunately, these studies used data only for banks with less than $1 billion in deposits. In a more recent study, Sherrill Shaffer and Edmond David used data for large banks ( those with $2.5 to $121 billion in deposits) and found increasing returns to scale (i.e., declining per unit costs) up to a bank size of $15 to $37 billion. Clearly, the owners and managers of the merged banks knew more about their actual cost functions than did the earlier economic analysts. The consistent pattern of mergers of banks much larger than $24 to $50 million in deposits was strong evidence that the existing research was incorrect.

Questions: 1. How can mergers in the banking industry result in economies of scale (cost reduction)?

2. Do you think the same factors can lead to economies of scale in the banking sector in India?

3. What are the other factors that can lead to economies of scale in the banking sector?

CASE STUDY I

Estimation of the Demand for Oranges by Market Experiment

Researchers at the University of Florida conducted a market experiment in Grand Rapids, Michigan, to determine the price elasticity and the cross-price elasticity of demand for three types of Valencia oranges: those from the Indian River district of Florida, those from the interior district of Florida, and those from California. Grand Rapids was chosen as the site for the market experiment because its size, demographic characteristics, and economic base were representative of other midwestern markets for oranges.

Nine supermarkets participated in the experiment, which involved changing the price of the three types of oranges, each day, for 31 consecutive days and recording the quantity sold of each variety. The price changes ranged within 16 cents in 4-cent increments, around the price of oranges that prevailed in the market at the time of the study. More than 9,250 dozen oranges were sold in the nine supermarkets during the 31 days of the experiment. Each of the participatin supermarkets was provided with an adequate supply of each type of orange so that supply effects could be ignored. The length of the experiment was also sufficiently short so as to ensure no change in tastes, incomes, population, the rate of inflation, and determinants of demand other than price.

The results, summarized in the following table indicate that the price elasticity of demand for all three types of oranges was fairly high (the boldface numbers in the main diagonal of the table). For example, the price elasticity of demand for the Indian River oranges of -3.07 indicates that a 1 percent increase in their price leads to a 3.07 percent decline in their quantity demanded. More interestingly, the off-diagonal entries in the table, show that while the crossprice elasticities of demand between the two types of Florida oranges were larger than 1, they were close to zero with respect to the California oranges. In other words, while consumers regarded the two types of Florida oranges as close substitutes, they did not view the California oranges as such. In pricing their oranges, therefore, producers of each of the two Florida varieties would have to carefully consider the price of the other (as consumers switch readily among them as a result of price changes) but need not be much concerned about the price of California oranges.

Price Elasticity and Cross-Price Elasticity of Demand for Florida Indian River, Florida Interior, and California Oranges Price Elasticities and Cross-Price Elasticities Florida Indian Type of Orange River Florida Indian River Florida Interior California -3.07 +1.16 +0.18 +1.56 -3.01 +0.09 +0.01 +0.14 -2.76 Florida Interior California

Questions (a) In light of the case define a test market? When should a firm take help of market experiments to forecast demand?

(b) Suggest a suitable price policy for the three types of oranges.

CASE STUDY II

A deodorant company manufactures and sells several types of deodorants which are branded as Smell Fresh. The company introduced five years ago, a new type of deodorant and its sales increased rapidly. However, over the past two years, sales have been declining steadily even though the market for deodorants has been expanding. Worried by the declining sales the company conducted a survey of the market, which yielded the following information:

(i) Several new rivals have come up during the past five years, which manufacture and sell almost similar deodorants.

(ii) Other companies have set prices lower than the prices of this company.

(iii) This company had initially set the price of its new brand at Rs 40, for which retailer pays Rs 30, which was never changed.

(iv) The rival firms have set their prices at Rs 37.50, retailers paying Rs 25.

In view of these facts, the company decided to review the cost structure to find out whether the margin to the retailers could be reduced to the level of the rival firms. The company finds that the variable costs (including raw materials and labour) stands at Rs 15 per deodorant. At present the company sells 4, 00,000 deodorants. As to the market prospects, if the price is reduced to Rs 35, the demand would increase by 1,50,000 and if the price is reduced to Rs. 32.50, demand would increase to 6,50,000 units. With such an increase in production, the firm

could use its resources more fully. The bulk of purchase of raw materials and more efficient use of labour would both help to reduce the unit variable cost to Rs. 12.50.

Questions (i) What price should the company charge to recapture market lost to rival firms?

(ii) Suggest alternative strategies that the company can adopt to counteract competition.

stimation of the Demand for Oranges by Market Experiment

Researchers at the University of Florida conducted a market experiment in Grand Rapids, Michigan, to determine the price elasticity and the cross-price elasticity of demand for three types of Valencia oranges: those from the Indian River district of Florida, those from the interior district of Florida, and those from California. Grand Rapids was chosen as the site for the market experiment because its size, demographic characteristics, and economic base were representative of other midwestern markets for oranges.

Nine supermarkets participated in the experiment, which involved changing the price of the three types of oranges, each day, for 31 consecutive days and recording the quantity sold of each variety. The price changes ranged within 16 cents in 4-cent increments, around the price of oranges that prevailed in the market at the time of the study. More than 9,250 dozen oranges were sold in the nine supermarkets during the 31 days of the experiment. Each of the participatin supermarkets was provided with an adequate supply of each type of orange so that supply effects could be ignored. The length of the experiment was also sufficiently short so as to ensure no change in tastes, incomes, population, the rate of inflation, and determinants of demand other than price.

The results, summarized in the following table indicate that the price elasticity of demand for all three types of oranges was fairly high (the boldface numbers in the main diagonal of the table). For example, the price elasticity of demand for the Indian River oranges of -3.07 indicates that a 1 percent increase in their price leads to a 3.07 percent decline in their quantity demanded. More interestingly, the off-diagonal entries in the table, show that while the crossprice elasticities of demand between the two types of Florida oranges were larger than 1, they were close to zero with respect to the California oranges. In other words, while consumers regarded the two types of Florida oranges as close substitutes, they did not view the California oranges as such. In pricing their oranges, therefore, producers of each of the two Florida varieties would have to carefully consider the price of the other (as consumers switch readily among them as a result of price changes) but need not be much concerned about the price of California oranges.

Price Elasticity and Cross-Price Elasticity of Demand for Florida Indian River, Florida Interior, and California Oranges Price Elasticities and Cross-Price Elasticities Florida Indian Type of Orange River Florida Indian River Florida Interior California -3.07 +1.16 +0.18 +1.56 -3.01 +0.09 +0.01 +0.14 -2.76 Florida Interior California

Questions (a) In light of the case define a test market? When should a firm take help of market experiments to forecast demand?

(b) Suggest a suitable price policy for the three types of oranges.

CASE STUDY II

A deodorant company manufactures and sells several types of deodorants which are branded as Smell Fresh. The company introduced five years ago, a new type of deodorant and its sales increased rapidly. However, over the past two years, sales have been declining steadily even though the market for deodorants has been expanding. Worried by the declining sales the company conducted a survey of the market, which yielded the following information:

(i) Several new rivals have come up during the past five years, which manufacture and sell almost similar deodorants.

(ii) Other companies have set prices lower than the prices of this company.

(iii) This company had initially set the price of its new brand at Rs 40, for which retailer pays Rs 30, which was never changed.

(iv) The rival firms have set their prices at Rs 37.50, retailers paying Rs 25.

In view of these facts, the company decided to review the cost structure to find out whether the margin to the retailers could be reduced to the level of the rival firms. The company finds that the variable costs (including raw materials and labour) stands at Rs 15 per deodorant. At present the company sells 4, 00,000 deodorants. As to the market prospects, if the price is reduced to Rs 35, the demand would increase by 1,50,000 and if the price is reduced to Rs. 32.50, demand would increase to 6,50,000 units. With such an increase in production, the firm could use its resources more fully. The bulk of purchase of raw materials and more efficient use of labour would both help to reduce the unit variable cost to Rs. 12.50.

Questions (i) What price should the company charge to recapture market lost to rival firms?

(ii) Suggest alternative strategies that the company can adopt to counteract competition.