Q.No. 1: What is Managerial Economics? Explain the nature and scope of Managerial Economics?

Answer: Managerial Economics generally refers to the integration of economic theory with business practice. While economics provides the tool which explains various concepts such as demand, supply, price, competition etc. Managerial economics applies these tools to the management of business, in this sense managerial economics is also understood to refer to business economics or applied economics. Managerial economics lies on the border line of management and economics. It is a hybrid of two disciplines and it is primarily an applied branch of knowledge. Management deals with principles which help in decision making under uncertainty and improve effectiveness of organisation. Economics on the other hand provides a set of propositions for optimum allocation of scare resources to achieve the desired objectives. Definitions of Managerial Economics According to Prof. Spencer Sigelman, Managerial Economics deals with integration of economic theory with business practice for the purpose of facilitating decision making and forward planning by management. According to Prof. Hauge, Managerial Economics is concerned with using logic of economics, mathematics & statistics to provide effective ways of thinking about business decision problems. According to Prof. Joel Dean, The purpose of Managerial Economics is to show how economic analysis can be used in formulating business policies. Nature of Managerial Economics: It is true that managerial economics aims at providing help in decision making by firms. For this purpose it draws heavily on the prepositions of micro economic theory. Note that micro economics studies the phenomenon at the individuals level and behavior of consumers, firms. The concepts of micro economics used frequently in managerial economics are elasticity, marginal cost, managerial revenue, market structure and their significance in primary policies. Some of these concepts however provide only the logical base and have to be modified in practice. Micro economics assists firms in forecasting. Note that micro economics theory studies the economy at the aggregative level and ignores the distinguishing features of individual observations. For example micro economics indicates the relationship between the Magnitude of Investment and Level of National Income Level of National Income and Level of Employment Level of Consumption and National Income etc.

Therefore the postulates of microeconomics can be used to identify the level of demand at some future point in time, based on the relationship between the level of national income and demand for electric motors. Also the demand for durable goods such as refrigerators, air-conditioners, motor cars depends upon the level of national income. Managerial economics is decidedly applied branch of knowledge. Therefore the emphasis is laid on those prepositions which are likely to be useful to the management. The precision of a scientist is not motivating factor in research activity. Improvement in the quality of results is attempted, provided the

additional cost is not very high and the decision maker can wait. For example it may be possible to have more accurate data on demand for the firms product by taking into consideration, additional factors. But this may not be the attempted because the decision has to be made without delay. Besides more accurate forecasts may not be justified on cost considerations. Management economics is perspective in nature and character. It recommends that it should be done alternate conditions. For example if the price of the synthetic yarn falls by 50% it may be desirable to increase its use in producing different types of textiles. Thus managerial economics is one of the normative sciences and reflects upon the desirability or otherwise of the prepositions. For example if the analysis suggests that the benefit-cost ratio is used as the criterion for project appraisal it is recommended that the firm should not install a large plant. Contract this with the positive sciences which state the prepositions without connecting upon what should be done. For example if the distribution of income has become more uneven it is stated without indicating what should be done to correct this phenomenon. Managerial economics to the extent that it is uses economic thought is a science, but it is an applied science. Economic thought uses deductive logic (if X is true, then Y is true). For example if the triangles ate congruent then angles are equal. To have confidence in the findings, the prepositions deducted are subject empirical verification. For example empirical studies try to verify whether cost curves faced by a firm are really U shaped as suggested by the theory. Furthermore there is an attempt to generalize the prepositions which provide a predictive character. For example empirical studies may suggest that every 1% rise in expenditure on advertising, the demand for the product shall increase by 5%. Managerial economics uses scientific approach. In practice, some firms may use simple rules based on past experience. However the quality of decisions made can be improved using a systematic approach. Scope of Managerial Economics: Scope means province or an area of study. There is hardly any uniform pattern as regards the scope of managerial economics as it is comparatively a new subject. However, the scope of managerial economics may be discussed under following points. Whether managerial economics is normative or positive economics: Economics is divided in to positive economics and normative economics. Positive economics is that branch of economics which studies the things as they are. Normative economics deals with the things they ought to be or should be. Positive economics is descriptive in nature where as normative economics is prescriptive in nature. Managerial economics is considered to be the part of normative economics. It lays more emphasis on prescribing choice and action and less on explaining what happened. Managerial economics draws descriptive economics and tries to pass judgments to value in the context of time. Area of Study: Broadly speaking managerial economics deals with the following topics. Demand Analysis and Forecasting: Effective decision making at the firm level depends on accurate estimates of demand. Demand analysis aims at discovering the forces that determine sales. The demand analysis mainly relates to the study of demand, determinants, demand distinctions and demand forecasting. Cost and Production Analysis: Cost estimates are also essential for effective decision making and production planning at the firm level. Profit planning, cost control and sound pricing practices call for accurate cost and production analysis. Cost relations are production function and cost control.

Pricing Decisions, Policies and Practices: Pricing is an important area of managerial economics. Success of a business firm largely depends on the accuracy of price decisions. Price determinations under different markets, pricing methods policies, product line pricing and price forecasting are some of the topics of this area. Profit Management: Business firms are mainly profit hunting institutions. The success of the firm is always measured in terms of profits. Nature and management of profit, profit policies and techniques and profit planning are the important aspects covered in this area. Capital Management: The most complex, troublesome problem faced by the business manager is the capital management. Capital management implies planning and control of capital expenditure. Cost of capital rate of return and selection of projects are the important points under this. Linear Programming and Theory of Games: Since managerial economics and operations research are closely connected with each other, managerial economics has started using such techniques of operations research as linear programming and the theory of games. Recently the linear programming and the theory of games have been brought as part of managerial economics. Profits a central point in managerial economics: Profit in other words is the central concept of managerial economics. Without profits business firms can not run. The maximization of profits is the main objective of any firm or a business unit. The survival of the firm is determined by the ability of a firm to earn profits. Profit is the main indicator of firms success. Optimisation: Optimisation is another important concept used in economic theory and managerial economics. Managerial economics often aims at optimising a given objective. In recent years, a new concept was found out called Sub-Optimisation. The greatest merit of this concept is its flexibility.

Q.No.1 (b): Define Business Cycle. Explain various phases of business cycle. Answer: The term trade cycle or Business Cycle in economics refers to the wave-like fluctuations in the aggregate economic activity, particularly in employment, output and income. Mitchell defined trade cycle as a fluctuation in aggregate economic activity. According to Haberler, The business cycle in the general sense may be defined as an alternation of periods of prosperity and dispersion, of good and bad trade. Keynes points out A trade cycle is composed of periods of good trade characterized by rising prices and low unemployment percentages, altering with periods of bad trade characterized by falling prices and high unemployment percentages. Phases of Business Cycle The ups and downs in the economy are reflected by the fluctuation in aggregate economic magnitudes, such as, production, investment, employment, prices, wages, bank credits, etc. The upward and downward movement in these magnitudes shows different phases of business cycle. Basically there are only two phases in a cycle, viz., prosperity and depression. But considering the intermediate stages between prosperity and depression, the various phases of trade cycle may be enumerated as follows: 1. 2. 3. 4. Expansion Peak Recession Trough

5. Recovery and expansion The five phases of a business cycle have been presented in the figure. The steady growth line shows the growth of the economy when there are no economic fluctuations. The various phases of business cycles are shown by the line of cycle which moves up and down the steady growth line. The line of cycle moving above the steady growth line marks the beginning of the period of expansion or prosperity in the economy. The phase of expansion is characterized by increase in output, employment, investment, aggregate demand, sales, profits, bank credits, wholesale and retail prices, per capital output and a rise in standard of living. The growth rate eventually slows down and reaches the peak. The phase of peak is generally characterized by slacking in the expansion rate, the highest level of prosperity, and downward slide in the economic activities from the peak.

Steady Growth Line Peak Expansion Prosperity Depression Line of Cycle Trough Recession Expansion Prosperity

Recovery

The phase of recession begins when the downward slide in the growth rate becomes rapid and steady. Output, employment, prices, etc. register a rapid decline, though the realized growth rate may still remain above the steady growth line. So long as growth rate exceeds or equals the expected steady growth rate, the economy enjoys the period of prosperity high and low. When the growth rate goes below the steady growth rate, it makes the beginning of depression in the economy. In a stagnated economy, depression begins when growth rate is less than zero, i.e. the total output, employment, prices, bank advances, etc., decline during the subsequent periods. The span of depression spreads over the period growth rate stays below the secular growth rate or zero growth rate in a stagnated economy. Trough is the phase during which the down trend in the economy slows down and eventually stops, and the economic activities once again register an upward movement. Trough is the period of most severe strain on the economy. When the economy registers a continuous and repaid upward trend in output, employment, etc., it enters the phase of recovery though the growth rate may still remain below the steady growth rate. And, when it exceeds this rate, the economy once again enters the phase of expansion and prosperity. If economic fluctuations are not controlled by the government, the business cycle continues to recur.

Explained Introduction Business fluctuations, booms and slumps, in the economic activities form essentially the economic environment of a country. They influence business decisions tremendously and set the trend of future business. The period of prosperity opens up and new larger opportunities for investment, employment

and production and thereby promotes business. On the contrary, the period of depression reduces the business opportunities. A profit-maximizing entrepreneur must therefore analyze the economic environment of the period relevant for his important business decisions, particularly those pertaining to forward planning. Subject Definition of Business or Trade Cycle The term trade cycle in economics refers to the wave like fluctuation in the aggregate economic activity, particularly in employment, output and income. In other words, trades cycles are ups and down in economic activity. Different economists define a trade cycle in various ways. For instance, Mitchell defined trade cycle as a fluctuation in aggregate economic activity. According to Haberler, The business cycle in the general sense may be defined as an alternation of periods of prosperity and depression, of good and bad trade. Phases of Business cycle: The ups and downs in the economy are reflected by the fluctuations in aggregate economic magnitiudes, such as, production, investment, employment, prices, wages, bank credits, etc. The upward and downward movements in these magnitudes show different phases of a business cycle. The various phases of trade cycle may be enumerated as follows, 1. Expansion 2. Peak 3. Recession 4. Trough 5. Recovery and expansion. Prosperity: Expansion and Peak Rise in the national output, rise in consumer and capital expenditure rise in the level of employment characterize the Prosperity phase. Inventories of both input and output increase. Debtors find it more and more convenient to pay off their debts. Bank advances grow rapidly even thought bank rate increases. There is general expansion of credit. Idle funds find their way to productive investment since stock prices increase due to increase in profitability and dividend. Purchasing power continues to flow in and out of all kinds of economic activities. So long as the condition permit, the expansion continues, following the multiplier process.

In the later stages of prosperity, however, inputs start falling short of their demand. Additional workers are hard to find. Hence additional workers can be obtained by bidding a wage rate higher than the prevailing rates. Labour market becomes sellers market. A similar situation appears also in other input markets. This marks reaching the peak.

Turning Point and Recession Once the economy reaches the peak, increase in demand is halted. It even starts decreasing in some sectors, for the reason stated above. Producers, on the other hand, unaware of this fact continue to maintain their existing levels of production and investment. As a result, a discrepancy between output supply and demand arises. The growth of discrepancy, between supply and demand is so slow that it goes unnoticed for some time but producers suddenly realize that their inventories are piling up. This situation might appear in a few industries at the first instance, but later it spreads to other industries also. Initially, it might be taken as a problem arisen out of minor mal-adjustment but persistence of the problem makes the producers believe that they indulged in over-investment and the cancellation of orders for the inputs by the producers of capital goods and raw materials cancel their orders for their input. This is the turning point and the beginning of recession. When investments are curtailed, production and employment decline resulting in further decline in demand for both consumer and capital goods. Borrowings for investment decreases bank credit shrinks, share prices decrease, unemployment gets generated along with a fall in wage rates. At this stage, the process of recession is complete and the economy enters the phase of depression. Depression and Trough During the phase of depression, economic activities slide down their normal level. The growth rate becomes negative. The level of national income and expenditure declines rapidly. Prices of consumer and capital goods decline steadily. Workers lose their jobs. Debtors find it difficult to pay off their debts. Demand for bank credit reaches its low ebb and banks experience mounting of their cash balances. Investment in stock becomes less profitable and least attractive. At the depth of depression, all economic activities touch the bottom and the phase of trough is reached. How is the process reversed? The factors reverse the downswing vary from cycle to cycle like factors responsible for business cycle vary from cycle to cycle. The producers anticipate better future try to maintain their capital stock and offer jobs to some workers here and there. They do so also because they feel encouraged by the halt in decrease in price in the trough phase. Consumers on their part expecting no further decline in price begin to spend on their postponed consumption and hence demand picks up,

though gradually. On the other hand, stock prices begin to rise for the simple reason that fall in stock prices comes to an end and optimism is underway in the stock market. The Recovery As the recovery gathers momentum, some firms plan additional investment, some undertake renovation programs, some undertake both. These activities generate construction activities in both consumers and capital good sectors. Individuals who had postponed their plans to construct houses undertake it now, lest cost of construction mounts up. As a result, more and more employment is generated in the construction sector. As employment increases despite wage rates moving upward the total wage income increase at a rate higher than employment rate. Wage income rises, so does the consumption expenditure. Businessmen realize quick turnover and an increase in profitability. Hence, they speed up the production machinery. Over the period, as the factors of production become more fully employed wages and other input prices move upward rapidly. Investors therefore, become discriminatory between alternative investments. As prices, wages and other factor prices increase, a number of related development begin to take place. Businessmen start increasing their inventories, consumers start buying more and more of durable goods and variety items. With this process catching up, the economy enters the phase of expansion and prosperity. The cycle is thus complete. Conclusion Trade cycle has become one of the important factors in determining a countries status, most of the developing countries are in Expansion and Peak as many developed countries are shifting their operations in these countries to cut the cost and increase the profit margin. Q.No.1 (C): Explain in detail Law of Demand Law of demand is one of the important laws of economic theory .It explains the general tendency of the consumers to buy more of a good at a lower price and less of it at a higher price lower price attracts consumers to buy more goods .thus law of demand expresses an inverse relationship b/w the price and the quantity demanded of a commodity other things being equal. According to Lipsey A fall in the price of a commodity cause a household to buy more of that commodity and less of the other commodity which compete with it, while rise in price causes the household to buy less of this commodity & more of the competing commodities The law of demand indicates only the direction of change of demand corresponding the change in the price. This can be illustrated through a demand curve. Price is measured in the Y axis & quantity in the X axis.DD is the demand curve of the good under consideration. At price OP1the quantity demanded is OQ1 if price of the good falls into OP2 the quantity demanded rises to OQ2 the demand curve is sloping downwards which is in accordance to the law of demand all the determinants of demand are assumed to be constant Y

P R I C E

P1

M2

Q1 Quantity

Law of demand states the inverse relationship between price of a commodity and quantity demanded, other things remaining the same. The demand of a commodity is more at a lower price and less at a higher price. That is why the demand curve slopes downward. The factors responsible for the downward slope of demand curve are: (a) Law of diminishing marginal utility: The law of diminishing marginal utility states that as the consumption of a commodity by a consumer increases the satisfaction obtained by the consumer from each additional unit of the commodity goes on diminishing. (b) Income effect: A fall in the price of the commodity increase the purchasing power of the consumer, in other words the consumer has to spend less to buy the same quantity of the commodity as before. The money so saved because of a fall in the price of the commodity can be spent by the consumer in ways he likes. He will spend a part of this money on buying some more units of the same commodity whose price has fallen. Thus a fall in the price of this commodity increases its demand. This is called income effect.
(c)

Substitution effect: This also increases demand as a result of a fall in the price of the commodity and vice versa. When the price of a commodity falls it becomes relatively cheaper than other commodity whose prices have not fallen. So the consumers substitute this commodity for other commodities which are now relatively dearer. This is known as substitution or complementarily effect. Changes in the number of consumers: Many people cannot afford to buy a commodity at a high price. When price of a commodity falls, the number of persons who could not afforded at a higher price can purchase it at a reduced price. This increases the consumer of the commodity. Thus at a lower price the quantity demand of the commodity increases because of increase in the number of consumers of the commodity and vice versa. Diverse Uses of the commodity: Many commodities can be put to several uses. The commodity having several uses is set to have composite demand.

(d)

(e)

All the above factors are responsible for the downward slope of demand curve. These factors explain the operations of the Law of Demand. The important of these factors depends upon the circumstances of the case.

Exceptions to the Law of Demand: Under certain circumstances the inverse relationship between price and demand does not hold good. These are known as the exceptions to the law of demand. Some of the important exceptions are : (a)Giffen Goods: These are special type of inferior goods. A rise in the price of giffen goods leads to a rise in their demand and vice versa. E.g. A poor household who spends a major portion of his money on an inferior goods like coarse grain, say bajra. If the price of bajra goes up the household will be forced to maintain the earlier consumption level of consumption of this good, he will be left with lesser income to spend on other commodities that he used to consume earlier. The household will be forced to cut down the consumption of other commodities still further to compensate itself for the loss of consumption of bajra. Conversely, a fall in price of bajra will enable the household to release more money for other commodities and may substitute consumption of bajra by consumption of other superior commodities. The bajra will be considered as gifen goods to which law demand does not apply. (b)Conspicuous necessities: Another exception occur in case of such commodities as though their constant use is because of fashion or prestige value attached to them have become necessity of life. Even though their price rises continuously their demand does show any tendency to fall. (c)Conspicuous consumption: A few goods like diamond etc. purchased by rich persons of the society because the prices of those goods are so high that they are beyond the reach of the common man. More of these commodities is demanded when their prices go up very high. The law of demand does not apply. (d)Future changes in price: Household also act as speculators when the price are rising, the house hold tend to buy larger quantity of the commodity out of apprehension that the prices may go up further. Likewise when prices are expected to fall further a reduced price may not be sufficient incentive to induce the household to buy more. E.g. share market. (e)Emergencies: Emergencies like war, famine, flood etc. may negate the operations of lay of demand. At such time the household may behave in a abnormal way. Household accentuate scarcity and induce further price rises by making increase purchases even at higher prices during such period. During depression, on the other hand, no amount of falling price is sufficient inducement for consumer to demand more. (f)Change in fashion: A change fashion entails effect demand for a commodity. (g)Ignorance: Consumers ignorance is another factor that at times induces him to buy more of commodity at a higher price. This happens when the consumer thinks that a high price commodity is better in quality than low price commodity. Q.No. 2: Answer briefly the following. 2(a): How would you distinguish between a firm and industry? Answer: For understanding the difference between a firm and industry, it would be advisable to understand the nature of a competitive industry. A competitive industry has three basic characteristics. Large Number of Firms, Homogeneous Product and Freedom of Entry and Exit.

In a competitive industry, there is a large number of firms so that he action of a single firm has no effect on the price and output of the whole industry. Every firm therefore enjoys the freedom to increase or decrease its output substantially by taking the price of the product as given. Secondly every firm in a purely competitive industry must be making a product which is accepted by customers as being identical with that made by all the other producers. In the industry. This is known as the condition of homogeneity. This ensures that all firms have to charge the same price. The buyers, of course are to decide that the product is the same. The buyers should not find any real or imaginary differences between the products sold by any two pair of firms. There should be no barriers to the entry of new firms or exit of old firms to the industry. We considered competitive industry because we wanted to contrast such an industry with a monopoly. Under monopoly there is only one firm producing a product. Entry into the industry is not free, because if entry of an additional firm is allowed, monopoly no longer remains. Thus under monopoly, the firm is the industry or the distinction between the firm and the industry disappears under the conditions of monopoly. Between these two extremes, we get a wide range of marked structures where there are more than one firms product. Strictly speaking, all firms producing the same i.e. homogeneous product make an industry and whatever all such firms supply becomes the supply of the industry. In practice however, we speak of the cotton textile industry, through all cotton textile units do not produce identical textile products. Though the sugar produced by sugar factories might have different grades of quality, we speak of one sugar industry. Similarly we speak of the automobile industry, steel industry, cement industry and so on. It should, therefore be clear that all firms producing a given product, together make an industry. 2(b): What are the determinant of Demand? Answer: Demand for a commodity depends upon number of factors. Factors influencing individual demand. An individuals demand for a commodity is generally determined by factors such as: Price of the Product: Price is always a basic consideration in determining the demand for a commodity. Normally a larger quantity is demanded at a lower price than at a higher price. Income: Income is an equally important determinant of demand. Obviously with the increase in income one can buy more goods. Thus a rich consumer usually demands more goods than poor consumer. Tastes and Habits: Demand for many goods depend on the persons tastes, habits and preferences. Demand for several products like ice-creams, chocolates, cool drinks etc., depend on an individuals taste. Demand for tea, betel, tobacco etc., is a matter of habit. People with different tastes and habits have different preferences for different goods. A strict vegetarian will have no demand for meat at any price., whereas a non-vegetarian who has liking for chicken may demand it even at a high price. Similar is the case with demand for cigarettes by smokers and non-smokers. Relative prices of Other Goods: How much the consumer would like to buy of a given commodity, however also depends on the relative prices of other related goods such as substitutes or complementary goods to a commodity. When a want can be satisfied by alternate similar goods, they are called substitutes. For example, peas and beans, ground nuts oil and sun-flower oil, tea and coffee etc., are substitutes of each other. The demand for commodity depends on the relative process f its substitutes. If the substitutes are relatively costly, then there will be more demand for the commodity is question at a given price than in case its substitutes are relatively cheaper.

Substitutes and Complementary Products: The demand for a commodity is also affected by its complementary products. In order to satisfy a given want, two or more goods are needed in combination, these goods are referred as complementary goods. For example car and petrol, pen and ink, tea and sugar, shoes and sacks, gun and bullets etc., are complementary products to each other. Complementary goods are always in joint demand. Thus if a given commodity is a complementary product, its demand will be relatively high when its related commoditys price is lower, than otherwise. When the price of one commodity decreases the demand for its complementary product will tend to increase and vice versa. For example, a fall in price of cars will lead to increase in the demand for petrol. Similarly a steep rise in the price of petrol will cause a decrease in demand of petrol driven cars and its accessories. Consumers Expectations: Consumers expectations about the future changes in the price of a given commodity also may affect its demand. When consumer expects its prices to fall in future, they will tend to buy less at the present prevailing price. Similarly if they expects its prices to rise in future they will tend to buy more at present. Advertisement Effect: In modern times the preferences of a consumer can be altered by advertisement and sales propaganda, albeit to certain extent only. Thus demand for many products like tooth pastes, toilet soaps, washing powder, processed foods etc. is particularly caused by the advertisement effect. Q.No. 2(g): State the causes of Inflation? Answer: The causes for inflation can be studied from demand side and supply side. Factors from Demand side: Increase in public expenditure: There may be an increase in the expenditure of the government because of wars or for developing the economy. This increase in governmental expenditure means an increase in the total demand, which leads to rise in price. This demand is in addition to the normal demand, which leads to a rise in price. Increase in private expenditure: When optimism prevails in the business world, businessmen are eager to spend more money on capital goods. This increase the demand for capital goods and in turn brings about an increase in the demand for consumers goods. This is because there is an increase in the income of the people who work in capital goods industries. Therefore they are in a position to spend more and thus, there is an increase in the demand for the both type of goods. Increase in foreign demand: When there is an increase in foreign demand for the goods manufactured in the country, exports increase and the prices of commodities in the country increase as their supply cannot be increased instantaneously. Reduction in taxation: If there is a reduction in the taxes levied by the government, people are left with more money which can be spent. This increases their expenditure as well as the prices of commodities. Repayment of internal debts: When the government repays old loans, more purchasing power is placed at the disposal of people. Part of the amount obtained in this manner may be re invested in various assets, but the rest of it may be spent on consumer goods and services. It is responsible for increase in prices to the extent. This repayment of loans leads to an increase in the total demand. Changes in expectations: In the context of price rise the expectations of people play a very important role. When people expect a rise in prices, businessmen increase their investment and this leads to an

increase in the demand for capital goods. If the consumers think that there will be an increase in prices in the future, they will start purchasing commodities which they will require in the near future. This increases the demand for consumer goods. The increase in demand for both consumers and producers leads to the rise in price. Factors from Supply side: Scarcity of the factors of the production: If one or more factors of production are in short supply, there is a reduction in production or hurdles may be created in the expansion of production. This reduces the total supply and causes the rise in price. Bottlenecks: Sometimes, all factors may be avoidable. But bottlenecks are created and this makes it difficult to make these factors available at the right time and place, for actual production. For example iron ore and coal ore available at mines, but the transport facilities required to transport these raw materials to the production site are not available. Transportation then becomes bottleneck. Therefore in this case production will suffer. Similarly the credit facilities, labor unrest and strikes, unavailability of transport and several other difficulties may rise and make production impossible or difficult. This may cause as increase in prices. Natural calamities: There are several natural calamities which may reduce production. Excess of rains, droughts, earthquakes, cyclones man substantially reduce the total annual production. Agricultural production suffers and all other agro based industries such as sugar industry, textile industry, oil industry, biscuits industry etc., also will suffer. This results in the reduction of production and leads to the rise of prices. Hoarding by merchants: When traders and merchants know that there is a short supply of of any commodity, they will purchase and stock large quantities of these commodities. These commodities then go underground and are not available in the open market. Thus there is shortage of other commodities too and this leads to a rise in prices. Rise in costs: Rise in costs due to increase in factors prices is another cause from the supply side. Rent, interest and wages can rise due to number of reasons. The central bank may rise interest rate or unions may cause a wage-rise. This may lead to inflation. Q.No. 3: What is Demand Forecasting? Briefly review the methods of Demand Forecasting? Answer: Demand Forecasting is the method of predicting the future demand for the firms product. It is guess or anticipation or prediction of what is likely to happen in the future. Forecast can be done for several things. It is based on the experience. Techniques or methods of Demand Forecasting: Method of Demand Forecasting is based on whether the good is Established Good or new good. Methods of Demand Forecasting for established goods: Information of the established good is available so the forecast can be based on this information. Two basic methods of demand forecasting for the established goods are: Interview and Survey Approach (for short period forecast): Interview and Survey Approach collects information in the different way. Depending upon how the information is collected, we have different sub methods as follows:

Opinion-Polling Method: This method tries to collect information from the customer directly or indirectly through market research department of the firm or through the whole sellers or the retailers. Consumers are contacted through mails or phones or Internet and information regarding their expected expenditure is collected. This method is useful when consumers are small in number. Limitations: It is difficult and costly to contact all the customers It is suitable only for short period Consumers are not sure of their purchase plans

Collective Opinion Method: Large firms have organized sales department. The salesman has the technical training as how to collect the information from the buyers. This information is further used for forecasting the demand. Limitations: It is difficult and costly to contact all the customers It is suitable only for short period This is based on judgment & has no scientific basis.

Sample Survey Method: The total number of consumers for the firms product is very large called as population. It is practically not possible to contact all the consumers. Only few of them are contacted and this forms the sample. The sample forecasts are then generalized for the whole population through advanced statistical methods available. Limitations: Information collected may not be accurate. Sample is not a random sample. Consumers do not have the correct idea of their purchases in future.

Panel of experts: Panel of experts consists of persons either from within the firm or from outside the firm. These experts come together and forecast the demand for their product that is purely based on the judgment of these experts so they are less accurate. But if based on the scientific method the forecast would be accurate. Composite management opinion: The opinions of the experienced person within the firm are collected and manger analyses this information. This method is quick, easy and saves time, but is not based on the scientific analysis and thus may not give very accurate results. Projection Approach (for long period forecast): In this method past experience is projected into the future. This can be done with the help of statistical methods. Correlation and Regression Analysis: Past data regarding the factors affecting the demand can be collected. It is possible to express this on the graph. This is a scatter diagram.

Example: If we collect the past data about the sales and advertising expenditure of the firm, it is possible to express in the form of scatter diagram as shown below: Y

Sales

* * ** * * * * * * * ** A

X O Advertisement Expenditure

In the above diagram we get the functional relationship as line AA. Here Advertisement Expenditure is the independent variable and Sales is the dependent variable. The relationship between these variables is correlation and the technique of establishing this relationship is regression. In simple correlation we establish relationship between 2 variables and more than 2 variables in multiple correlation. Limitations: Assumption made is that correlation between two variables will continue in future also, this might not happen.

Time Series Analysis: Demand forecasts for a period of 2-3 years are based on time series analysis. It is similar to the correlation analysis. It is based on the assumption that the relationship between the dependent and the independent variable continues to hold in the future. Methods of Demand forecasting for new products: Indirect methods of forecasting are used to estimate demand for new products. Following are the methods suggested:

Evolutionary Method: Some new goods evolve from already established goods. Demand forecast for such new good is based on already established good from which they are evolved. For example Demand for the color TV can be calculated from Demand for the black and white TV, from which it is actually evolved. Limitations: The product should have been evolved from the existing product. It ignores the problem of how the new product differs from the old product.

Substitution Method: Some new goods are substituted of already established goods. For example VCR substituted with VCD player. Limitations: New product may have many uses and each use has different substitutability When the substitute is added is added into market existing firm may react by changing the prices.

Opinion Polling Method: Expected buyers and the consumers are directly contacted and opinion about the product is directly taken from them. If the population is large then sample is selected and results are generalized for the population. Limitations: It is difficult and costly to contact all the customers It is suitable only for short period Consumers are not sure of their purchase plans

Sample Survey Method: New product are first introduced in the sample market and the results seen in the sample market are generalized for the total market. Limitations: Information collected may not be accurate Tastes and the preferences may differ from market to market

Indirect Opinion Polling Method: Opinion of the consumers is indirectly collected through the dealers who are aware of the needs of the customers. Limitations: It is based on the judgment Limited Scope

Q.No. 5: Write Short Notes On: Answer: e) Fiscal Policy:

It is one of the important economic policies to achieve economic stability. Fiscal Policy refers to variation in taxation and public expenditure programs by the government to achieve predetermined objectives. Taxation is transferring of funds from private purses to public (Government) coffers. It is the withdrawal of funds from private use. Public expenditure on the other hand increases the flow of funds into the private economy. Since the tax-revenue and public expenditure form two sides of the government budget, the taxation and public expenditure policies are also jointly called the Budgetary Policy. Fiscal or Budgetary Policy is regarded as powerful instrument of economic stabilization. The importance of fiscal policy as an instrument of economic stabilization rests on the fact that government activities in the modern economies are greatly enlarged, and government taxrevenue and expenditure account for a considerable proportion of GNP, ranging from 10-25 per cent. Therefore the government may affect the private economic activities to same extent through variation in taxation and public expenditure. Besides fiscal policy is considered to be more effective than monetary policy because the former directly affects the private decisions while later does so indirectly. If the fiscal policy is formulated that it is during the period of expansion, it is known as counter-cyclical fiscal policy.

f) Monetary Policy: Monetary Policy refers to the program of Central Banks variations, in the total supply of money and cost of money to achieve certain predetermined objectives. One of the primary objectives of monetary policy is to achieve economic stability. The traditional instrument through which Central Bank carries out the Monetary Policies are: Quantitative Credit Control measures such as open market operations, changes in bank rates (or discount rates), and changes in the statutory reserve ratios, Briefly speaking, open market operations by the Central Bank are the sale and purchase of government bonds, treasure bills, securities, etc., to and from public. Bank rate is the rate at which Central Bank discounts the commercial banks bills of exchange or first class bill. The statutory reserve ratio is the proportion of commercial banks time and demand deposit, which they are required to deposit with Central Bank or keep cash-in-vault. All these instruments when operated by the Central Bank reduce (or enhance) directly and indirectly the credit creation capacity of the commercial banks and thereby reduce (or increase) the flow of funds from the banks to the public. In addition these instruments, Central Bank use also various selective credit control measures and moral suasion. The selective credit controls are intended to control the credit flows to particular sectors without affecting the total credit, and also to change the composition of credit from undesirable to desirable pattern. Moral suasion is a persuasive method to convince the commercial banks to behave in accordance with the demand of the time and in the interest of the nation. The fiscal and monetary policies may be alternatively used to control the business cycles in the economy, though monetary policy is considered to be more effective to control inflation than to control depression. It is however, always desirable to adopt a proper mix of fiscal and monetary policies to check the business cycles.

k) Economic Problem and its universal nature: The same basic economic problem unlimited wants and relatively limited resources arises at all levels of human organization. Thus whether we are thinking of grampanchayat, or of zilla parishad, or club or hospital or national government, all have to face the basic economic problem. Thus whether it is Government of India or America, the problem of economy is always there. The Government of India with annual revenue of about 1,00,000/- crores has innumerable demands on its resources such as meeting mounting defense expenditure, expanding expenditure in respect of development that is to be brought about in various sectors like agriculture, industries, transport, education and so on. The Government of India therefore continually faces the basic problem of economy of how to make best use of its limited resources. In the same way, the federal government of America, the richest government faces some basic economic problem. Though in absolute terms, its annual revenues are enormous running into billions or trillions of dollars, its needs are also unlimited. Expanding and modernizing the defense forces, establishing military bases all over the world giving military assistance to the friendly countries, expenditure on space and military research etc., and therefore even the richest government of US is always confronted by the same basic economic problem of limited resources to fulfill unlimited wants. Every nation, poor or rich, small or big with small or huge population, has to face the basic economic problem. No nation can escape it. Thus we can conclude that that there is something universal about problem of economy. The basic economic arises in the case of an native, a villager, a city resident, in the case of poor or rich, in case of associations like clubs, schools, hospitals and government organization right from the village level to national level. The problem of economy unlimited wants and limited means with alternative uses - has been forever confronting the mankind. The economic problem is the universal problem. Economy problem does not recognize boundaries of caste, creed, color, religion and culture.

l) Profit maximization goal: The conventional economic theory assumes profit maximization as the only objective of the business firms. It forms the basis for the conventional price theory. Profit maximization is regarded as the most reasonable and analytically most productive business objective. Besides, profit maximization assumption has a great predictive power. It helps in predicting the behavior of business firms in the real world and also the behavior of the price and output under different market conditions. There are two conditions that must be fulfilled for the profit maximization: The necessary condition requires that Marginal Revenue (MR) must be equal to marginal cost (MC). Marginal Revenue is obtained from production and sales of one additional unit of output. Marginal cost is the cost incurred due to one additional unit of output. The secondary condition requires that necessary condition must be satisfied under the condition of decreasing MR and increasing MC. The fulfillment of two condition makes the sufficient condition.

Objections to this approach: Profit maximization assumption is too simple to explain the business phenomenon in the real world. In fact, businessman themselves are not aware of this objective attributed to them. It is claimed that there are alternative and equally simple objectives of business firms that explains better the real world business phenomenon. Ex: Sales maximization, Market share. and MC. Firm do not have the necessary knowledge and priori data to equalize MR

In defense of Profit Maximization assumption: Firms continue to survive in the long run in a competitive market, which are able to make reasonable profit. firm. This assumption has been accurate in predicting the firms behavior. It is time honored objective of firm Profit is one of the most efficient and reliable measures of efficiency of a