Question 2 : What are the factors that determine the Demand curve? Explain.

Answer : It is to be clearly understood that if demand charges only because of change in

the prices of given commodity, in that case there would be either expansions or
contraction in demand. Both of them can be explained with the help of only one
demand curve. If demand changes not because of price change but because of other
factors or forces , then in that case there would be either increase or decrease in
demand.

Determinants of Demand

Demand for a commodity or a service is determined by a number of factors. All such

factors are called ‘Demand determinants’.

Price of the given commodity, prices of other substitutes and/or complements, further
expected trend in prices etc.
General price level existing in the country inflation or deflation.
Level of income and living standards of the people.
Size, rate of growth and composition of population.
Tastes, preference, customers, habits, fashion and styles.
Publicity, propaganda and advertisements.
Quality of product.
Profit margin kept by the sellers.
Weather and climatic conditions
Condition of trade-boom or prosperity in the economy.
Terms & condition of trade.
Government’s policy taxation, liberal or restrictive measures.
Level of savings & patterns of consumer expenditure.
Total supply of money circulation and liquidity preference of the people.
Improvements in educational standards etc.

3. A firm supplied 3000 pens at the rate of Rs 10. Next month, due to a rise
of in the price to 22 Rs per pen the supply of the firm increases to 5000
pens. Find the elasticity of supply of the pens.

Answer:

Elasticity of Supply (ES) = % change in supply/% change in Price

From the above problem,

 % change in supply=(5000-3000)/3000

=2000/3000=2/3

=66.66%

% change in price =(22-10)/22=54.54%

Hence, ES=66/54=1.2

4. Briefly explain the profit-maximization model.

Answer: Profit maximization Model

In economics, profit maximization is the process by which a firm determines the price
and output level that returns the greatest profit. There are several approaches to this
problem. The total revenue–total cost method relies on the fact that profit equals revenue
minus cost, and the marginal revenue–marginal cost method is based on the fact that total
profit in a perfectly competitive market reaches its maximum point where marginal
revenue equals marginal cost.

Any costs incurred by a firm may be classed into two groups: fixed cost and variable
cost. Fixed costs are incurred by the business at any level of output, including zero
output. These may include equipment maintenance, rent, wages, and general upkeep.
Variable costs change with the level of output, increasing as more product is generated.
Materials consumed during production often have the largest impact on this category.
Fixed cost and variable cost, combined, equal total cost.

TC-Total cost-total revenue method

Profit Maximization - The Totals Approach

To obtain the profit maximizing output quantity, we start by recognizing that profit is
equal to total revenue (TR) minus total cost (TC). Given a table of costs and revenues at
each quantity, we can either compute equations or plot the data directly on a graph.
Finding the profit-maximizing output is as simple as finding the output at which profit
reaches its maximum. That is represented by output Q in the diagram.

There are two graphical ways of determining that Q is optimal. Firstly, we see that the
profit curve is at its maximum at this point (A). Secondly, we see that at the point (B) that
the tangent on the total cost curve (TC) is parallel to the total revenue curve (TR), the
surplus of revenue net of costs (B,C) is the greatest. Because total revenue minus total
costs is equal to profit, the line segment C,B is equal in length to the line segment A,Q.

Computing the price at which to sell the product requires knowledge of the firm's demand
curve. The price at which quantity demanded equals profit-maximizing output is the
optimum price to sell the product.

MC-Marginal cost-marginal revenue method

Profit Maximization - The Marginal Approach

If total revenue and total cost figures are difficult to procure, this method may also be
used. For each unit sold, marginal profit equals marginal revenue minus marginal cost.
Then, if marginal revenue is greater than marginal cost, marginal profit is positive, and if
marginal revenue is less than marginal cost, marginal profit is negative. When marginal
revenue equals marginal cost, marginal profit is zero. Since total profit increases when
marginal profit is positive and total profit decreases when marginal profit is negative, it
must reach a maximum where marginal profit is zero - or where marginal cost equals
marginal revenue. This is because the producer has collected positive profit up until the
intersection of MR and MC (where zero profit is collected and any further production
will result in negative marginal profit, because MC will be larger than MR). The
intersection of marginal revenue (MR) with marginal cost (MC) is shown in the next
diagram as point A. If the industry is competitive (as is assumed in the diagram), the firm
faces a demand curve (D) that is identical to its Marginal revenue curve (MR), and this is
a horizontal line at a price determined by industry supply and demand. Average total
costs are represented by curve ATC. Total economic profits are represented by area
P,A,B,C. The optimum quantity (Q) is the same as the optimum quantity (Q) in the first
diagram.

If the firm is operating in a non-competitive market, minor changes would have to be

made to the diagrams. For example, the Marginal Revenue would have a negative
gradient, due to the overall market demand curve. In a non-competitive environment,
more complicated profit maximization solutions involve the use of game theory.

Maximizing revenue method

In some cases a firm's demand and cost conditions are such that marginal profits are
greater than zero for all levels of production. [1]In this case the Mπ = 0 rule has to be
modified and the firm should maximize revenue. [2]In other words the profit maximizing
quantity and price can be determined by setting marginal revenue equal to zero. Marginal
revenue equals zero when the marginal revenue curve has reached its maximum value =
topped out. An example would be a scheduled airline flight. The marginal costs of flying
the route are negligible. The airline would maximize profits by filling all the seats. The
airline would determine the p-max conditions by maximizing revenues.

Mathematical Example

A promoter decides to rent an arena for concert. The arena seats 20,000. The rental fee is
10,000. The arena owner gets concessions and parking and pays all other expenses
related to the concert. The promoter has properly estimated his demand to be Q = 40,000
- 2000P. What is the profit maximizing ticket price?[3]

Because the promoter’s marginal costs are zero the promoter maximizes profits by
charging a ticket price that will maximize revenue. Total revenue equals price, P, times
quantity, Q or PQ = (40,000 - 2000P)P = 40,000P - 2000(P)2. Total revenue reaches it
maximum value when marginal revenue is zero. Marginal revenue is the first derivative
of the total revenue function so

MR ‘ = 40,000 - 2(2000)P = 40,000 - 4000P

MR’ = 0
40,000 - 4000P = 0
4000P = - 40,000
P = 10
Profit = TR -TC
Profit = [40,000P - 2000(P)2] - 10,000
Profit = [40,000(10) - 2000(10)2] - 10,000
Profit = 400,000 - 200,000 - 10,000
Profit = 190,000
What if the promoter had charged 12 per ticket?
Q = 40,000 - 2000P.
Q = 40,000 - 2000(12)
Q = 40,000 - 24,000 = 16,000 (tickets sold)
 Profits at 12:
Q = 16,000(12) = 192,000 - 10,000 = 182,000

5. What is Cyert and March’s behavior theory? What are the demerits?

Answer: Cyert and March’s behavior theory is non-profit maximizing theory which
attemps to explain the behavior of inter group conflicts and their multiple objectives
in an organization. Prof. Simon has developed the initial behavioural model and Prof.
Cyert and March have ruther elaborated the theoriy in their book “Behavioral theory
of the Firm”, 1993.

Cyert and March explain how complicated decisions are taken in the big industrial house
under various kinds of risks and uncertainties in and imperfect market in the
background of limited data and information.The organizational structure, goal of
different departments, behavioral pattern and intenrla working of big and multi-
product firl differs from that of small organizations. Cyert and March consider that
modern firm is a multi-product,multi-goal and multi-decision making coalition
business unit. Like a coalition government , it is managed by number of groups. The
group consists of shareholders, managers, workers ,customers, suppliers etc. In the
view of several groups the most important ones are the shareholders, workers and
mangers in an organization.

According to Cyert and March , a firm has five important goals.

Production goal
Inventory Goal
Sales Goal
Market share goal
Profile goal

This model highlights on satisfactory levels of performance and achievements of its

multiple objectives as maximization of different goals may not be possible in the
context of complex business worls. Hence, making satisfactory levels of profiles
rather than maximum profiles are become the order of the day.

Demerits

The theory fails to analyze the behavior of the firm but it simply predicts the future
expected behavior of different groups.
It does not explain equilibrium of the industry as a whole
It fails to analyze the impact of the potential entry of new firms into the industry and the
behavior of the well established firms in the market.
It highlights only on short run goals rather than long run objectives of an organization.
Thus, there is certain limitation to this theory.
6. What is Boumal’s Static and Dynamic Model ?

Answer:

7. What is pricing policy? What are the internal and external factors of the
policy?

8. Mention three crucial objectives of price policies

9. Mention the bases of price discrimination.

10. What do you mean by the fiscal policy? What are the instruments of
fiscal policy? Briefly comment on India’s fiscal policy.

11. Comment on the consequences of environmental degradation on the

economy of a community.

12. Write short notes on the following:

a) Philips curve

B) Stagflation