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[0042] assignment

NameMEENA

Managerial economics

QUESTION 1.. Most of the firms spend considerable amounts of money on

advertisement .

Explain advertising elasticity of demand and its practical applications in this

context .

ANSWER 1.. EXPLANATION OF ADVERSTISTING ELASTICITY OF DEMANDMost of

the firms, in the present marketing conditions, spend considerable amounts of money on advertisement

and other such sales promotional activities with the object of promoting its sales. Advertising elasticity

refers to the responsiveness of demand or sales to change in advertising or other promotional expenses.

The formula to calculate the advertising elasticity is as follows:

Ea = enditure expent Advertisemin change Percentage sales or demand in change Percentage

Symbolically,

Original sales = 10,000 units Original advertisement expenditure = 800-00New sales = 50,000 units New advertisement expenditure = 2000-00

Practical application of advertising elasticity of demandThe study of advertising elasticity of demand is of paramount importance to a firm in recentyears because of fierce competition. Few examples on the practical application of advertisingelasticity of demand are as follows:1. Helps in determining th e level of prices The level of prices fixed by one firm for its

product would depend on the amount of advertisement expenditure incurred by it in the market.2. Helps in formulat ing appro priate sales promo tional strategy Thevolume of advertisement expenditure also throw light on the sales promotional strategiesadopted by a firm to increase its total sales in the market. Thus, it helps a firm to stimulate itstotal sales in the market.

3. Helps in manip ulat ing the sales It is useful in determining the optimum level of sales inthe market. This is because the sales made by one firm would also depend on the total amountof money spent on sales promotion of other firms in the market .

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QUESTION 2 ..EXPLAIN PRODUCTION FUNCTION IN DETAILS .

ANSWER ..PRODUCTION FUNCTION The entire theory of production centres revolvesaround the concept of production function. A production function expresses the technological

or engineering relationship between physical quantity of inputs employed and physical quantityof outputs obtained by a firm. It specifies a flow of output resulting from a flow of inputs during aspecified period of time. It may be in the form of a table, a graph or an equation specifyingmaximum output rate from a given amount of inputs used. As it relates inputs to outputs, it isalso called input-output relation. The production is purely physical in nature and .A productionfunction can be represented in the form of a mathematical model or equation as Q = f (L, N,K.etc) where Q stands for quantity of output per unit of time and L, N, K etc are the variousfactor inputs like land, capital, labour, etc which are used in the production of output. The rate ofoutput Q is thus, a function of the factor inputs L, N, K etc, employed by the firm per unit of time.

two types of production functions 1. Short run product ion funct ion In this case, the producer will keep all fixed factors asconstant and change only a few variable factor inputs. In the short run, we come across twokinds of production functions:

Quantities of all inputs both fixed and variable will be kept constant and only one variable inputwill be varied, for example, law of variable proportions.

for example, iso-quants and iso-cost curves.

2. Long run produc t ion funct ionIn this case, the producer will vary the quantities of allfactor inputs, both fixed as well as variable in the same proportion, for example, the laws ofreturns to scale.Each firm has its own production function which is determined by the state of technology,managerial ability, organisational skills, etc of a firm. It may be in the following manner:1. The quantity of inputs may be reduced while the quantity of output may remain same.2. The quantity of inputs may be reduced while the quantity of output may increase.3. The quantity of inputs may be kept constant while the quantity of output may increase.If there are any improvements in the firm, the old production function is disturbed and a new onetakes its place.Uses of production function

Though production function may appear as highly abstract and unrealistic, in reality, it is bothlogical and useful. It is of immense utility to the managers and executives in the decision makingprocess at the firm level.There are several possible combinations of inputs and, decision makers have to choose themost appropriate among them. The following are some of the important uses of productionfunction:1. It can be used to calculate or work out the least cost input combination for a given output orthe maximum output-input combination for a given cost.

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2. It is useful in working out an optimal and economic combination of inputs for gettinga certainlevel of output. The utility of employing a unit of variable factor input in the production processcan be better judged with the help of production function. Additional employment of a variablefactor input is desirable only when the marginal revenue productivity ofthat variable factor inputis greater than or equal to cost of employing it in an organisation.3. Production function also helps in making long run decisions. If returns to scale are increasing, it is wise

to employ more factor units and increase production. If returns to scale are diminishing, it is unwise to

employ more factor inputs & increase production. Managers will be indifferent whether to increase or

decrease production, if production is subject to constant returns to scale.

QUESTION 3.. EXPLAIN Marris Growth Maximisation Model in detail.

ANSWER EXPLANATION OF THE MODEL ..growth maximisation model by Prof.Marris. Profit-maximisation is a traditional objective of a firm. Sales maximisation objective is explainedby Prof. Baumol. On similar lines, Prof. Marris has developed an alternative growth maximisation model.

It is commonly seen that each firm aims at maximising its growth rate, because this goal would answer

many of the objectives of a firm. Marris points out that a firm has to maximise its balanced growth rate

over a period of time.

Utility function of the owners and that of the managers are expressed in the following mannerUo = f [size of output, market share, volume of profit, capital, public esteem etc.] Um = f[salaries, power, status, prestige, job security, etc.]Where, Uo is the utility function of owner and Um is the utility function of managers.Marris notes that the realisation of these two functions would depend on the size of the firm. Larger the

firm, greater would be the realisation of these functions and vice-versa. Size of the firm, according to

Marris, depends on the amount of corporate capital, which includes total volume of assets, inventory

levels, cash reserves, etc. He further points out that managers always aim at maximising the rate of

growth of the firm rather than maximising the growth in absolute size of the firm. Generally, managers

like to stay in a growing firm .

Marris identifies two constraints in the rate of growth of a firm as follows:

1. There is a limit up to which the output of a firm can be increased more economically, limit tomanage the firm efficiently, limit to employ highly qualified and experienced managers, limit to

research, development and innovation, etc.2. The ambition of job security puts a limit to the growth rate of the firm itself, deliberately. Ifgrowth reaches the maximum, then there would be no opportunity to expand further and thenthe managers may lose their jobs. Rapid growth and financial soundness should go together.Managers hesitate to take unwanted risks and uncertainties in the organisation at the cost oftheir jobs

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The Marris growth maximisation model highlights the achievement of a balanced growth rate ofa firm. Maximum growth rate [g] is equal to two important variables:1. The rate of demand for the products [gd]

2. Growth rate of capital[gc]

Hence, Max g = gd = gc.The growth rate of the firm depends on two factors- a] the rate of diversification and b] theaverage profit margin.The diversification rate depends on the number of newproducts introduced per unit of time and the rate

of success of new products in the market. The success of new products is determined by changes in

fashion, consumption habits, the range of products offered, etc. Moreover, diminishing marginal returns

would operate in any business and thereafter, there is a limit

diversification. Similarly, market price of the given product, availability of alternative substitute products

and their relative prices, publicity, propaganda and advertisements, R&D expenses, utility and

comparative value of the product, etc

1. The management has to maintain a low liquidity ratio, i.e., liquid asset / total assets. But, this

ratio should not create any financial embarrassment to meet the required payments to all theconcerned parties.

2. The management has to maintain a proper leverage ratio between value of debts / totalassets, so that it will have enough money to invest in order to stimulate growth.

3. The management has to keep a high level of retained profits for further expansion anddevelopment but it should not displease the shareholders i.e. by giving low dividends Prof itsTotal Prof its Retained

Demerits

There are some demerits of Marris growth maximisation model. They are as follows:1. It is doubtful whether both managers and owners would maximise their utility functionssimultaneously, always.

2. The assumption of constant price and production costs are not correct.

3. It is difficult to achieve both growth maximisation and profit maximisation together.

Thus, Marris growth maximisation model also has some drawbacks.

QUESTION 4.. Explain price - output determination under monopoly ?

Answer EXPLANATION ..Price - output determination in the short runShort run is a time period in which there are two types of factors of production. One is the fixed factors

and the other is the variable factors. In the short period, production can be changed only by changing

the variable factors of production. In other words, in the short period, supply can be changed only to

some extent, which is determined essentially by the capacity created. In this period, volume of

production can be changed but capacity of the plant cannot be changed. The firm can increase the

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supply only with the help of existing machines and plants. New factories and plant-equipment cannot be

installed.

In the short period, a monopoly firm can earn supernormal profits, normal profits or incur losses. In case

of losses, price must cover at least the average variable costs. Otherwise, the firm will stop production.

The maximum loss can be equal to fixed costs. Figure 10.1, 10.2 and 10.3 depict the three cases of

monopoly equilibrium

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Question 5 investment is the second important c omponent of effective

demand . explain investment function .

ANSWER .Investment Function Investment is the second important component ofeffective demand. In Keynesian economics, the term investment has a different meaning. In the ordinary

language, it refers to financial investment. i.e. purchase of stocks, shares, debentures, bonds, etc. In this

case, there is only transfer of rights or titles from one person to another

Investment, according to Keynes, refers to real investment. It implies creation of new capital assets oradditions to the existing stock of productive assets. It refers to that part of the aggregate income, which

is used for the creation of new structures, new capital equipments, machines, etc that help in the

production of final goods and services in an economy.

Types of investmentKeynes speaks of 5 types of investment. They are as follows:1. Private investment

It is made by private entrepreneurs on the purchase of different capital assets like machinery, plants,

construction of houses and factories, offices, shops, etc. It is influenced by MEC and interest rate. It is

profitelastic.

2. Public investmentIt is undertaken by the public authorities like central, state and local authorities.

the basic criterion and motto is social net gain, social welfare and not profits. The principle of

maximum social advantage would governpublic expenditure. It is also influenced by social and political

considerations.

3. Foreign investment

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It consists of excess of exports over the imports of a country. It depends on many factorssuch as propensity to export of a given country, foreigners capacity to import, prices of expo rtsand imports, state tradingand other factors.

5.Induced investmentFigure 1..shows that as income increases, investment also increases andvice-versa.

Figure..1

Induced investment is another name for private investment. Investment, which varies with the changes

in the level of national income, is called induced investment.

Therefore, we can say that induced investment is incomeelastic i.e., it increases as income increases

and vice-versa.

5. Autonomous investmentAutonomous investment is another name for public investment. The investment, which is independent

of the level of income, is called as autonomous investment.

Figure 2.. depicts that though income changes, investment more orless remains constant.

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Figure 2: Autonomous Investment Curve

Autonomous investment depends upon population growth, technological progress, discovery of new

resources, etc. For example, expenditure on public buildings, transport and communications.

Determinants of investmentInvestment decisions taken by entrepreneurs depend upon a number of factors like; interestrate, level of uncertainty, political environment, rate of growth of population, level of existingstock of capital, and the necessity of new products. It also depends on investors levelofincome, level of inventions and innovations, level of consumer demand, availability of capitaland liquid assets of the investors, government policy, etc.It is necessary to note that investment is more volatile and unpredictable. It is highly unstable inthe short run because the factors determining it are highly complex and uncertain in their nature.The above-mentioned factors no doubt generally affect the volume of investment. However, themost important inducement to invest is the consideration of the profit. The profitability ofinvestment depends mainly on two factors:

It relates to the cost-benefit analysis. The businessman while investing capital has to calculatethe cost of borrowing and the expected rate of profits from it.

Question 6 ..Write a short notes on

a] monetary policy

b] Physical policy or control policy

AnswerA] Monetary Policy .. Monetary policy is a part of the overall economicpolicy of a country. It is employed by the government as an effective tool to promote economicstability and achieve certain predetermined objectives.

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Monetary policy deals with the total money supply and its management in an economy. It isessentially a programme of action undertaken by the monetary authorities, generally the centralbank, to control and regulate the supply of money with the public, and the flow of credit with aview to achieving economic stability and certain predetermined macroeconomic goals.Monetary policy can be explained in two different ways.Monetary policy is passive when the central bank decides to abstain deliberately from applying

monetary measures. It is active when the central bank makes use of certain instruments toachieve the desired objectives. It may be positive or negative. It is positive when it promoteseconomic activities and it is negative when it restricts or curbs economic activities.

Parameters of monetary policy:Broadly speaking, there are three parameters of monetary policy of a country. It is through theseparameters that the monetary policy has to operate. They are:1. Total money supply available in a country.2. Cost of borrowings or the level of interest rates.3. The nature of credit control measures.

All the three put together determine the nature of working of monetary policy.

Objectives of monetary policyObjectives of monetary policy must be regarded as part of the overalleconomic objectives of thegovernment. It should be designed and directed to achieve different macroeconomic goals. Theobjectives may be manifold in relation to the general economic policy of a nation. The variousobjectives may be interrelated, interdependent and mutually complementary to each other. Theymay also be mutually inconsistent and clash with each other. Hence, very often, the monetaryauthorities are concerned with a careful choice between alternative ends. The priorities of theobjectives depend on the nature of economic problems, its magnitude and economic policy of a

nation. The various objectives also change over a time period.

1. Neutral money policy:This objective was in vogue during the days of gold standard. According to this policy, money is

only a technical device having no other role to play. It should be a passive factor having onlyone function, namely to facilitate exchange. It should not inject any disturbances

2. Price stability: It refers to the absence of sharp variations or fluctuations in theaverage price level in the country.A hundred percent price stability is neither possible nordesirable in any economy. It simply implies relative price stability. A policy of price stabilitychecks cyclical fluctuations and smoothens production and distribution, keeps the valueof money stable, prevents artificial scarcity or prosperity, makes economic calculationspossible, introduces an element of certainty, eliminates socio-economic disturbances,ensures equitable distribution of income and wealth, secures social justice and promoteseconomic welfare.

3. Exchange rate stability: in order to have a smooth and unhindered international tradeand free flow of foreign capital into a country, it becomes imperative for a county tomaintain exchange rate stability.

4. Control of trade cycles:Operation of trade cycles has become very common in modern economies. High levels offluctuations in overall economic activities are detrimental to the smooth growth of any economy.

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it has become one of the major objectives of monetary authorities to control theoperation of trade cycles and ensure economic stability by effectively regulating totalmoney supply.

5. Full employment:

In recent years, full employment has become another major goal of monetary policy all over theworld, especially with the publication of the general theory by Lord Keynes. Many well-knowneconomists like Crowther, Halm, Gardner Ackley, William, Beveridge and Lord Keynes havestrongly advocated this objective in the context of present day situation in most of the countries.Developed countries normally work at near full employment conditions. Their major problem isto maintain this high level of employment.

6. Equilibrium in the balance of payments:This objective has assumed greater importance in the context of expanding international tradeand globalisation. Today, most of the countries are experiencing adverse balance of paymentson account of various reasons.

7. Rapid economic growth:This is comparatively a recent objective of the monetary policy. Achieving a higher rate of percapita output and income over a long period of time has become one of the supreme goals ofmonetary policies in recent years. A higher rate of economic growth would ensure fullemployment condition, higher output, income and better living standards to the people.

2] Physical Policy or Direct ControlsGovernment interference with the forces of demandand supply in the market, and state regulation of prices of commodities are common features inthese days. Thus, when monetary and fiscal measures are inadequate to control prices,government resorts to direct control. During wars, when inflationary forces are strong, price

control involves imposing ceilings in respect of certain prices and prices are to be stopped fromrising too high. In a planned economy, the objective of price control is to bring about allocationof resources in accordance with the objects of plan. Price control normally involves some controlof supply .

Instruments of physical policyDirect controls are imposed by government to ensure proper allocation of scarce resources likefood, raw materials, consumer goods and capital goods. Government can strictly forbid orrestrict certain kinds of investments or economic activity. During the period of inflation,government can directly exercise control over prices and wagesDuring World War II, price-wagecontrols were employed along with consumer rationing to curb excess demand. Monetary andfiscal controls will have a general impact on theeconomy while physical controls can be

employed to affect specific scarcity areas.Generally, direct controls are of three forms:

rade through import control, import quotas, export control.

During wars, there will be a drastic increase in the demand for certaincommodities causing asteep rise in prices of such commodities. Further, this is intensified by the war financing,

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allowing surplus purchasing power in the economy. Price control attempts to check theinflationary rise in prices enable all citizens to get a minimum of certain basic necessaries of lifeand serves as an effective instrument of resource mobilization.

Control over investment and production is equally essential. Factors of production are allocated

to industrial concerns in accordance with their requirements. Priorities are laid down inaccordance with the importance of commodities produced by different industries.

The disadvantages of direct controls are:1. Direct controls suppress individual initiative and enterprise.

2. They tend to inhibit innovations, such as new techniques of production, new products, etc.

3. Direct controls may induce speculation which may have destabilising effects. It thusencourages the creation of artificial scarcity through large scale hoardings.

4. Direct controls need a cumbersome, honest and efficient administrative organisation if theyare to work effectively.

5. Gross disturbances may appear when the controls are removed .