MB 0026 Set1

MB 0026 Set 1 Page 1

MANAGERIAL ECONOMICS -MB0026

MBA -1 SEM Assignment – Set 1

L. Megha Syam 510925494

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Q1. Define Managerial Economics and discuss its importance and

functions. Managerial economics is a science that deals with the application of various

economic theories, principles, concepts and techniques to business management in order to solve business and management problems.

It deals with the practical application of economic theory and methodology to decision making problems faced by private, public and non profit making

organizations.

The same idea has been expressed by Spencer and Seigelman in the following

words. “Managerial Economics is the integration of economic theory with business practice for

the purpose of facilitating decision making and forward planning by the management”.

According to Mc Nair and Meriam, “Managerial economics is the use of economic modes of

thought to analyze business situation”.

Brighman and Pappas define managerial economics as,” the application of economic

theory and methodology to business administration practice”. Joel dean is of the opinion

that use of economic analysis in formulating business and management policies

is known as managerial economics.

Managerial economics is a highly specialized and new branch of economics developed in recent years. It highlights on practical application of principles and concepts of economics in to business decision making process in order to find

out optimal solutions to managerial problems. It fills up the gap between abstract economic theory and managerial practice. It lies midway between

economic theory and business practice and serves as a connecting link between the two.

Features of managerial Economics 1. It is a new discipline and of recent origin

2. It is a highly specialized and separate branch by itself. 3. It is basically a branch of microeconomics and as such it studies the

problems of only one firm in detail.

4. It is mainly a normative science and as such it is a goal oriented and prescriptive science.

5. It is more realistic, pragmatic and highlights on practical application of various economic theories to solve business and management problems.


6. It is a science of decision making. It concentrates on decision making process, decision models and decision variables and their relationships.

7. It is both conceptual and metrical and it helps the decision maker by providing measurement of various economic variables and their

interrelationships. 8. It uses various macro-economic concepts like national income, inflation,

deflation, trade cycles etc to understand and adjust its policies to the

environment in which the firm operates. 9. It also gives importance to the study of noneconomic variables having

implications of economic performance of the firm. 10.It uses the services of many other sister sciences like mathematics,

statistics, engineering, accounting, operation research and psychology etc

to find solutions to business and management problems.

Importance of the study of Managerial Economics

Managerial Economics does not give importance to the study of theoretical economic concepts. Its main concern is to apply theories to find solutions to day

–today practical problems faced by a firm. Significance of the study Managerial Economics

1. It gives guidance for identification of key variables in decision making process.

2. It helps the business executives to understand the various intricacies of business and managerial problems and to take right decision at the right time.

3. It provides the necessary conceptual, technical skills, toolbox of analysis and techniques of thinking and other such most modern tools and

instruments like elasticity of demand and supply, cost and revenue, income and expenditure, profit and volume of production etc to solve various business problems.

4. It is both a science and an art.

5. It helps the business executives to become much more responsive, realistic and competent to face the ever changing challenges in the modern business world.

6. It helps in the optimum use of scarce resources of a firm to maximize its

profits. 7. It also helps in achieving other objectives a firm like attaining industry

leadership, market share expansion and social responsibilities etc.

8. It helps a firm in forecasting the most important economic variables like

demand, supply, cost, revenue, price, sales and profit etc and formulate sound business polices.

9. It also helps in understanding the various external factors and forces which affect the decision making of a firm. Thus, it has become a highly useful and practical discipline in recent years to analyze and find solutions

to various kinds of problems in a systematic and rational manner.


Functions of a Managerial Economics

A Managerial Economics helps a manager in analyzing and finding answers to business and managerial problems. It provides in-depth knowledge of the

subject. The major functions of Managerial Economics are Decision making and forward

planning.

1. Decision making ‘Decision’ suggests a deliberate choice made out of several possible alternative courses of action after carefully considering them. The act of choice signifying

solution to an economic problem is economic decision making. It involves choices among a set of alternative courses of action.

Decision making is essentially a process of selecting the best out of many alternative opportunities or courses of action that are open to a management.

2. Forward planning The term ‘planning’ implies a consciously directed activity with certain

predetermined goals and means to carry them out. It is a deliberate activity. It is a programmed action. Basically planning is concerned with tackling future situations in a systematic manner.

Forward planning implies planning in advance for the future. It is associated with

deciding the future course of action of a firm. It is prepared on the basis of past and current experience of a firm. It is prepared in the background of uncertain and unpredictable environment and guess work.

Q2. What is elasticity of demand? Explain the different degree of price

elasticity with suitable examples. Elasticity of Demand

Elasticity of demand is generally defined as the responsiveness or sensitiveness

of demand to a given change in the price of a commodity. It refers to the capacity of demand either to stretch or shrink to a given change in price.

Elasticity of demand indicates a ratio of relative changes in two quantities.ie,

price and demand. According to prof. Boulding. “Elasticity of demand measures the

responsiveness of demand to changes in price”. In the words of Marshall,” The elasticity (or

responsiveness) of demand in a market is great or small according to as the amount demanded

much or little for a given fall in price, and diminishes much or little for a given rise in price”

Kinds of elasticity of demand

1. Price Elasticity Of Demand 2. Cross Elasticity Of Demand

3. Income Elasticity Of Demand 4. Promotional Elasticity Of Demand 5. Substitution Elasticity Of Demand


Price Elasticity of Demand Elasticity which is used to describe the effect of change in price on quantity

demanded. Price elasticity of demand is a technical term used by economists to explain the

degree of responsiveness of the demand for a product to a change in its price. Price elasticity of demand is a ratio of two pure numbers, the numerator is the percentage change in quantity demanded and the denominator is the percentage

change in price of the commodity. It is measured by using the following formula.

Ep=( Percentage change in quantity demanded )/( Percentage change in price.)

Different Degree of Price Elasticity of Demand 1. Perfectly Elastic Demand: In this case, a very small change in price leads

to an infinite change in demand. The demand cure is a horizontal line and parallel to OX axis. The numerical coefficient of perfectly elastic demand is infinity (ED=00)

2. Perfectly Inelastic Demand: In this case, what ever may be the change in

price, quantity demanded will remain perfectly constant. The demand curve is a vertical straight line and parallel to OY axis. Quantity demanded would be 10

units, irrespective of price changes from Rs. 10.00 to Rs. 2.00. Hence, the numerical coefficient of perfectly inelastic demand is zero. ED = 0

3. Relative Elastic Demand: In this case, a slight change in price leads to more than proportionate change in demand. One can notice here that a change

in demand is more than that of change in price. Hence, the elasticity is greater than one. For e.g., price falls by 3 % and demand rises by 9 %. Hence, the numerical coefficient of demand is greater than one.

4. Relatively Inelastic Demand In this case, a large change in price, say 8 %

fall price, leads to less than proportionate change in demand, say 4 % rise in demand. One can notice here that change in demand is less than that of change in price. This can be represented by a steeper demand curve. Hence, elasticity is

less than one.

5. Unitary elastic demand: In this case, proportionate change in price leads to equal proportionate change in demand. For e.g., 5 % fall in price leads to exactly 5 % increase in demand. Hence, elasticity is equal to unity. It is possible

to come across unitary elastic demand but it is a rare phenomenon.

Out of five different degrees, the first two are theoretical and the last one is a rare possibility. Hence, in all our general discussion, we make reference only to two terms relatively elastic demand and relatively inelastic demand.

Q3. Suppose your manufacturing company planning to release a new

product into market, Explain the various methods forecasting for a new product.

When a manufacturing companies planning to release a new product into the market, it should perform the demand forecasting to check the demand of the

product in the market and also the availability of similar product in the market.


Demand forecasting for new products is quite different from that for established

products. Here the firms will not have any past experience or past data for this purpose. An intensive study of the economic and competitive characteristics of

the product should be made to make efficient forecasts. As per Professor Joel Dean, few guidelines to make forecasting of demand for

new products are:

a. Evolutionary approach The demand for the new product may be considered as an outgrowth of an existing product. For e.g.,

Demand for new Tata Indica, which is a modified version of Old Indica can most effectively be projected based on the sales of the old Indica, the demand for new

Pulsor can be forecasted based on the sales of the old Pulsor. Thus when a new product is evolved from the old product, the demand conditions of the old product can be taken as a basis for forecasting the demand for the new product.

b. Substitute approach

If the new product developed serves as substitute for the existing product, the demand for the new product may be worked out on the basis of a ‘market

share’. The growths of demand for all the products have to be worked out on the basis of intelligent forecasts for independent variables that influence the demand for the substitutes. After that, a portion of the market can be sliced out for the

new product. For e.g., A moped as a substitute for a scooter, a cell phone as a substitute for a land line. In some cases price plays an important role in shaping

future demand for the product. c. Opinion Poll approach

Under this approach the potential buyers are directly contacted, or through the use of samples of the new product and their responses are found out. These are

finally blown up to forecast the demand for the new product. d. Sales experience approach

Offer the new product for sale in a sample market; say supermarkets or big bazaars in big cities, which are also big marketing centres. The product may be

offered for sale through one super market and the estimate of sales obtained may be ‘blown up’ to arrive at estimated demand for the product.

e. Growth Curve approach According to this, the rate of growth and the ultimate level of demand for the

new product are estimated on the basis of the pattern of growth of established products. For e.g., An Automobile Co., while introducing a new version of a car will study the level of demand for the existing car.

f. Vicarious approach

A firm will survey consumers’ reactions to a new product indirectly through getting in touch with some specialized and informed dealers who have good knowledge about the market, about the different varieties of the product already

available in the market, the consumers’ preferences etc. This helps in making a more efficient estimation of future demand.


Q4. Define the term equilibrium. Explain the changes in market equilibrium and effects to shifts in supply and demand.

Equilibrium means equal balance. It means a state of even balance in which

opposing forces or tendencies neutralize each other. It is a position of rest characterized by absence of change. It is a state where

there is complete agreement of the economic plans of the various market participants so that no one has a tendency to revise or alter his decision.

In the words of professor Mehta: “Equilibrium denotes in economics absence of change in movement.”

There are two approaches to market equilibrium. 1. Partial equilibrium approach: The partial equilibrium approach to pricing

explains price determination of a single commodity keeping the prices of other commodities constant.

2. General equilibrium approach: This approach explains the mutual and

simultaneous determination of the prices of all goods and factors. Thus it explains a multi market equilibrium position.

Before Marshall, there was a dispute among economists on whether the force of

demand or the force of supply is more important in determining price. Marshall gave equal importance to both the demand and supply in the determination of value or price. He compared supply and demand to a pair of scissors which

explained that neither supply alone, nor demand alone can determine the price of a commodity, both are equally important in the determination of price. But

the relative importance of the two may vary depending upon the time under consideration. Thus, the demand of all consumers and the supply of all firms together determine the price of a commodity in the market.

Effects of shit in demand

Demand changes when there is a change in the determinants of demand like the income, tastes, prices of substitutes and complements, size of the population etc. If demand raises due to a change in any one of these conditions the demand

curve shifts upward to the right. If, on the other hand, demand falls, the demand curve shifts downward to the left. Such rise and fall in demand are

referred to as increase and decrease in demand. Thus the market equilibrium price and quantity demanded will change when there is an increase or decrease in demand.

Effects of Shifts in Supply

On assuming the demand to remain constant. An increase in supply is represented by a shift of the supply curve to the right and a decrease in supply is represented by a shift to the left. The general rule is, if supply increases, price

falls and if supply decreases price rises. Thus changes in supply, demand remaining constant will cause changes in the

market equilibrium. Effects of Changes in both Demand and Supply

Changes can occur in both demand and supply conditions. The effects of such changes on the market equilibrium depend on the rate of change in the two

variables. If the rate of change in demand is matched with the rate of change in


supply there will be no change in the market equilibrium, the new equilibrium shows expanded market with increased quantity of both supply and demand at

the same price.

If the increase in demand is greater than the increase in supply, the new market equilibrium is at a higher level showing a rise in both the equilibrium price and the equilibrium quantity demanded and supplied. On the other hand if the

increase in supply is greater than the increase in demand, the new market equilibrium is at lower level, showing a lower equilibrium price and a higher

quantity of good supplied and demanded. Similar will be the effects when the decrease in demand is greater than the

decrease in supply on the market equilibrium.

Q5. Give a brief description of (a) Implicit and Explicit cost

Explicit costs are those costs which are in the nature of contractual payments and are paid by an entrepreneur to the factors of production [excluding himself]

in the form of rent, wages, interest and profits, utility expenses, and payments for raw materials etc. They can be estimated and calculated exactly and

recorded in the books of accounts. Implicit or imputed costs are implied costs. They do not take the form of cash

outlays and as such do not appear in the books of accounts. They are the earnings of owner employed resources. For example, the factor inputs owned by

the entrepreneur himself like capital can be utilized by him or can be supplied to others for a contractual sum if he himself does not utilize them in the business. It is to be remembered that the total cost is a sum of both implicit and explicit

costs.

(b) Actual and opportunity cost Actual costs are also called as outlay costs, absolute costs and acquisition costs. They are those costs that involve financial expenditures at some time and

hence are recorded in the books of accounts. They are the actual expenses incurred for producing or acquiring a commodity or service by a firm. For

example, wages paid to workers, expenses on raw materials, power, fuel and other types of inputs. They can be exactly calculated and accounted without any difficulty.

Opportunity cost of a good or service is measured in terms of revenue which

could have been earned by employing that good or service in some other alternative uses. In other words, opportunity cost of anything is the cost of displaced alternatives or costs of sacrificed alternatives. It implies that

opportunity cost of anything is the alternative that has been foregone. Hence, they are also called as alternative costs. Opportunity cost represents only

sacrificed alternatives. Hence, they can never be exactly measured and recorded in the books of accounts. The knowledge of opportunity cost is of great importance to management

decision. They help in taking a decision among alternatives. While taking a decision among several alternatives, a manager selects the best one which is

more profitable or beneficial by sacrificing other alternatives.


Q6. Critically examine Boumal’s static and dynamic models.

Boumal’s Static And Dynamic Models.

Sales maximization model is an alternative model for profit maximization. This model is developed by Prof. W.J.Boumal, an American economist. This alternative goal has assumed greater significance in the context of the growth of

Oligopolistic firms. The model highlights that the primary objective of a firm is to maximize its sales

rather than profit maximization. It states that the goal of the firm is maximization of sales revenue subject to a minimum profit constraint. The minimum profit constraint is determined by the expectations of the share

holders. This is because no company can displease the share holders. It is to be noted here that maximization of sales does not mean maximization of

physical sales but maximization of total sales revenue. Hence, the managers are more interested in maximizing sales rather than profit. The basic philosophy is that when sales are maximized automatically profits of

the company would also go up. Hence, attention is diverted to increase the sales of the company in recent years in the context of highly competitive markets.

In defence of this model, the following arguments are given.

1. Increase in sales and expansion in its market share is a sign of healthy growth of a normal company.

2. It increases the competitive ability of the firm and enhances its influence in

the market. 3. The amount of slack earnings and salaries of the top managers are directly

linked to it. 4. It helps in enhancing the prestige and reputation of top management,

distribute more dividends to share holders and increase the wages of workers

and keep them happy. 5. The financial and other lending institutions always keep a watch on the sales

revenues of a firm as it is an indication of financial health of a firm. 6. It helps the managers to pursue a policy of steady performance with

satisfactory levels of profits rather than spectacular profit maximization over

a period of time. Managers are reluctant to take up those kinds of projects which yield high level of profits having high degree of risks and uncertainties.

The risk averting and avoiding managers prefer to select those projects which ensure steady and satisfactory levels of profits.

Prof, Boumal has developed two models. The first is static model and the second one is the dynamic model.

The Static Model This model is based on the following assumptions.

1. The model is applicable to a particular time period and the model does not operate at different periods of time.

2. The firm aims at maximizing its sales revenue subject to a minimum profit constraint.

3. The demand curve of the firm slope downwards from left to right.

4. The average cost curve of the firm is unshaped one.


Sales maximization/ dynamic model In the real world many changes takes place which affects business decisions of a

firm. In order to include such changes, Boumal has developed another dynamic model. This model explains how changes in advertisement expenditure, a major

determinant of demand, would affect the sales revenue of a firm under severe competitions.

Assumptions 1. Higher advertisement expenditure would certainly increase sales revenue

of a firm. 2. Market price remains constant. 3. Demand and cost curves of the firm are conventional in nature.

- Generally under competitive conditions, a firm in order to increase its

volume of sales and sales revenue would go for aggressive advertisements. This leads to a shift in the demand curve to the right.

- Forward shift in demand curve implies increased advertisement

expenditure resulting in higher sales and sales revenue. A price cut may increase sales in general. But increase in sales mainly depends on

whether the demand for a product is elastic or inelastic. - A price reduction policy may increase its sales only when the demand is

elastic and if the demand is inelastic; such a policy would have adverse effects on sales. Hence, to promote sales, advertisements become an effective instrument today. It is the experience of most of the firms that

with an increase in advertisement expenditure, sales of the company would also go up.

- A sales maximizer would generally incur higher amounts of advertisement expenditure than a profit maximizer. However, it is to be remembered that amount allotted for sales promotion should bring more than

proportionate increase in sales and total profits of a firm. Otherwise, it will have a negative effect on business decisions

- Thus, by introducing, a non-price variable in to his model, Boumal makes a successful attempt to analyze the behaviour of a competitive firm under oligopoly market conditions. Under oligopoly conditions as there are only a

few big firms competing with each other either producing similar or differentiated products, would resort to heavy advertisements as an

effective means to increase their sales and sales revenue. This appears to be more practical in the present day situations.

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MB 0026 Set1