MANAGERIAL ECONOMICS

MB0042/MBF105
ASSIGNMENT
FALL 2014
LC-02009
NANDESHWAR SINGH
ROLL NO: 1408001255
Q1. Inflation is a global phenomenon which is associated with high
price cost decline in the value of money. It exits when the amount of
the money in the country is in excess of the physical volume of goods
and services. Explain the reasons for this monetary phenomenon?
Ans. Inflation is a situation of sustainable and rapid increase in the level of price and
consequent deterioration in the value of money over a period of time. It refers to the
average rise in the general level of prices and fall in the value of money. It is upward
movement in average level of price.

CAUSE OF INFLATION- 1. Demand side- Increase in demand is responsible

for the inflation. +When, aggregate demand exceeds aggregate supply of goods and
services. Demand rises much faster than supply by following reasons:

 Increase in money supply-Deficit financing by government,

expansion of public expenditure, expansion in bank credit and repayment of
past debt by government to the people, increase in public borrowings are
reasons to increase a demand of money supply.
 Increase in disposable income- Demand will rises with rise in
disposable income of people. Disposable income rise due to reduction in rates
of taxes, increase in national income and decline in the level of saving
 Increase in exports- With increase in foreign demand for a
country`s export reduces the stock of goods available for home consumption.
This creates shortage in the country leading to a rise in price.
 Increase in foreign exchange reserves- Foreign exchange
reserves increases on an account of inflow of foreign money into the country.
Foreign direct investment may increases and non-resident deposits may also
increases due to the policy of government.
 Increase in population growth- With increase in population the
demand of goods and services will also increases in a country.
 High rates- The other cause to increase in demand is higher rates of
indirect taxes.

2. SUPPLY SIDE- Supply of goods and services are not always keeping
pace with increasing demand of goods and services. Thus they not matched
with demand. Increasing in supply of goods and services may be limited
because of the following reasons:
 Shortage in the supply of factor of production - Due to
shortage of factor of production like raw material, labour, capital equipments,
etc. There will be a rise in prices.
 Operation of law of diminishing returns- In law of
diminishing returns, increase in production is possible only at a higher cost
which demotivates the producers to invest. Thus, production will not increase
proportionately to meet the increase in demand.
 Hoarding by consumers- Sometimes consumer may hoard goods
to avoid to payment of higher prices in future. This leads to an increase in the
current demand, which in turn stimulates prices.
 Role of trade unions- Trade union will lead to industrial unrest in
the form of strikes, lockouts also reduces production. This will lead to
creation of excess demand they eventually brings a rise in price level.
 Role of natural calamities- Earthquake, floods, drought like
natural climates also affect the supply of agricultural products adversely. It
may also lead shortage of food grains; raw-material thus leads inflationary
conditions.
 War – During the period of war, shortage of essential goods creates a
rise in prices.
Q2. Monopoly is the situation there exist single controls over the
market producing a commodity having no substituted with no
possibilities anyone to enter the industry to complete. In that situation
they will not charge a uniform price for the entire customer in the
market and also the price policy will follow in that situation?

Ans. Monopoly refers to single seller and large number of buyers in market. It is the
market form in which a single producer controls the whole supply of a single
commodity which has no close substitutes.

Features of monopoly –

 Anti-thesis of competition – Monopoly creates in market when

there is no or absence of competition, hence the seller faces no threat of
completion.
 Existence of a single seller- In monopoly market there is only
single seller who exercises single control over the market.
 Absence of substitutes- No closes substitute for the seller1s
product with a strong cross elasticity of demand. Hence, buyers have no
alternatives.
 Control over supply of the commodity. - Seller has complete
control over supply and output of the commodity.
 Price maker- Monopolist taking decision independently on price
fixation and the price maker. Hence the monopolist can either change a high
 price for all customers or adopt price discrimination policy.
 Entry barriers- The entry of new firms in market is difficult. Hence,
monopolist will not have direct competitors in the market.
 Natures of firm- Partnership concern, Joint Stock Company or a
public utility are some monopoly firms which pursue an independent price-
output policy.

KINDS OF PRICE DISRIMINATION: There are three kinds of price

discrimination are as followings:

 Discrimination of the first degree- In price discrimination of the first

stage, the monopolist will not allow any consumer`s surplus to the consumer. The
producer exploits the consumers to the maximum possible extent, by asking to
pay the maximum they prepared to pay rather than go without commodity.
 Discrimination of the second degree- This method is adopted by
railway companies, in second degree of discrimination monopolist charge
different prices for markets of the same commodity, but not a maximum possible
rate but at a lower rate. The monopolist will leave a certain amount of
consumer`s surplus with the consumers.
 Discrimination of the third stage- This method is the most commonly
followed by a monopolist, under this market will divided into many sub-markets
or sub-groups. The price charged in each case roughly depends on the ability to
pay of different subgroups in the market.

Q3.Define monopolistic competition and explain its characters?

Ans. Monopolistic completion is a market structure in which a large number of small

sellers sell differentiated products which are close, but not perfect substitutes for one
another. In this market, product produced and sold are different, but they are close
substitute for one another.

Characteristics of monopolistic competition-

1.Existence of a large number of firms - In monopolistic completion, there is

large number of firms producing a product at large. The size of each firm is small. No
one can influence the market price; hence, each firm will act independently without
worrying about the policies followed by other firms.

2. Market is characterized by imperfections- Advertisements, difference in

transport cost, irrational preference of customers, ignorance about the availability of
different brands of products and their prices. Sellers have inadequate knowledge about
the market.

3. Free entry and exists of firms- Each firm produces close substitute for the
existing brand of a product. It provides opportunity for a firm to enter with the group
or an industry.

4. Element of monopoly and competition- Every firm enjoy some sort of

monopoly power over the product they produce. However, It is absolute not identical
because each products faces competition from rival sellers selling different brands of
the product.

5. Similar products but not identical – In monopolistic competition, the firm

produces commodities which are similar to one another but identical or homogenous.
For example toothpastes, blades, shoes, etc

6. Non- price competition- In monopolistic market there is competition among

‘Mini-monopolists’ for their products and not for the price of the product. Thus, there
is product competition rather than ‘price competition’.

7. Product differentiation- Under monopolistic competition main feature is

product differentiation. Firm adopt different techniques to differentiation their products
from one another. It may be Real product difference or Imaginary product difference.

Q.4 when should a firm in perfectly competitive market shut down

there operations?

Ans. Prefect competition is a comprehensive term in which the number of buyers and
sellers are large, all engaged in buying and selling a homogeneous product without any
artificial restriction and, possessing perfect knowledge of the market at a time.

Short-run equilibrium under Prefect Competition - When Marginal

revenue is equal Marginal cost under perfect competition so there is an equilibrium
position at a point, at this point, equilibrium output and price is determined.

Y Y

D S P3
E3 SAC

B AVC

R COST/ P2
E2

REVENUE P2 E1

S D P4

O O

Demand and supply Output

In perfect competition firm will not produce any output unless the price is at least
equal to the minimum AVC. If short run price is just equal to AVC, it will not cover
fixed costs and hence, there will be losses. However, it will continue in the industry
with the people with the hope that it will recover the fixed costs in the future.

If price is above the AVC and below the AC, it is called `Loss minimization’ zones. If
the price is lower than AVC, the firm is compelled to stop production altogether.
If AC=price, there will be normal profits. If AC is greater than price, there will be
losses and if AC is lower than price, then there will be supernormal profits. If the firm
will never cover AFC nor AVC and hence it has to wind up its operations. It is
regarded as shut-down point.

Long-run Firm Equilibrium under Perfect Competition

 If firm produce that level of output in which MR = MC and MC curves
cuts MR curve from below.

PRICE = MC = MR

 If firm cover its full costs and should earn only normal profits. This is
possible when normal price is equal to long run average cost of production.
Hence,

Price = AR = AC

 If AR > AC, supernormal profits earned. This leads to the entry of new
firms, increase in the total number of firms, expansion in the output, increase in
the supply, fall in the price and fall in the ratio of profits.
On other hand, when AC<AR, the industry will be incurring losses, This leads
to the exit of old firms, decrease in the numbers of firms, contraction on output,
rise in price. Thus, losses and profits are incompatible with the position of
equilibrium.

Price = MR = MC = AR = AC

Q.5 Discuss the practical application of price elasticity and

income elasticity of demand?
Ans. Price elasticity of demand (PED OR ED) is a measures used in economics
to show the representativeness, or elasticity, of the quantity demanded of a
good or services to a change in its price. More precisely, it gives the percentage
change in quantity demanded in response to a one percent change in price i.e.
holding constant all the other determinants of demand, such as income. It is
devised by Alfred Marshall.
Applications of price elasticity:
 Inelastic demand for agricultural products helps to explain why bumper
crops depress the prices and total revenue for farmers.
 Government look at elasticity of demand when levying excise taxes,
Excise taxes on product with inelastic demand will raise the most revenue and
have inelastic demand will raise the most revenue and have the least impact on
quantity demanded for those products.
Income elasticity of demand- It is the ratio or proportionate change in
the quantity demanded of a commodity to a given proportion change in the
income. In other words, the extent to which demand change with a variation in
consumer`s income.
Practical applications of income elasticity of demand are as following:
 If the growth rate of the economy and income growth of the
people is reasonable forecasted, in that case it is possible predict
expected increase in the sales of a firm and vice-versa.
 It helps in demand forecasting of a firm. It estimates future
demand provided the rate of increase in income.
 It helps in production planning and marketing. The knowledge
of Ey is essential for production planning, formulating marketing
strategy, deciding advertising expenditure and nature of distribution
channel etc in long run.
 Helps in stability construction of houses. The rate of growth in
income of people also helps in housing programs in a country. Thus it
helps a lot in managerial decision of a firm.

Q.6 Discuss the scope of the managerial economics?

Ans. Managerial economics may define as the study of economic theory, logic
and methodology which are generally applied to seek solution to the practical
problems of business. Managerial Economics is thus constituted of the part of
 economics knowledge or theories which is used as a tool of analyzing business
problem for rational business decisions. Managerial economics is often called
as business Economics or Economic for firms.

According to McNair and Meriam ‘‘Business Economics is the integration of

economic theory with business practices for the purpose of facilitating decision
making and forward planning by management’’

Scope of Managerial Economics: The scope of managerial economics is not yet

clearly laid out because it is a developing science. Even then the following fields may
be said to generally fall under Managerial Economics:

1. Demand Analysis and Forecasting: A business firm is an

economic orgainisation which is engaged in transforming productive resources
into goods that are to be sold in the market. A Major part of decision making
depends upon accurate estimates of demand. A forecast of future sales serves as a
guide to managerial for preparing production schedules and employing resources.
It will help the 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.
2. Cost and production analysis: A firm`s profitability depends
much on its cost of production. A wise manager would prepare cost estimates of
a range of output, identifying the factors causing are cause variation on coast-
minimizing output level, taking also into consideration the degree of uncertainty
in production and cost calculations. Production processes are under the charge of
engineers but the business manager is supposed to carry out the production
function analysis in order to avoid the wastages of materials and time.
3. Pricing decision, policies and practices : Price is the genesis of
the revenue of a firm as such the successes of the business firm largely depend on
the correctness of price decision dealt by it. The area is: Price determination in
various market forms, pricing method, differential pricing, and product methods.
Differential pricing, product-line pricing and price forecasting.
4. Profit management: Business firms are generally organized for
earning profit and in the long period, it is the profit which provides the chief
measures of success of a firm. A Successful business manager is one who can
form more or less correct estimates of costs and revenues likely to accrue to the
firm at different levels of output. The more successful manager is in reducing
uncertainty, the higher are the profit earned by him. In fact, profit-planning and
profit- measurement constitute the most challenging area of Managerial
Economics.
5. 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 of disposing the capital assets off are so
complex that they require considerable time and labour. The main topic dealt
with under capital, rate of return and selection of projects.