Managerial Economics

ASSIGNMENTS

Assignment ‘A’ Q.1. What are indifference curves? Explain the consumers’ equilibrium

under the assumptions of ordinal approach.

What are indifference curves?

ANSWER:

An indifference curve is a graph showing combination of two goods that

give the consumer equal satisfaction and utility. Each point on an

indifference curve indicates that a consumer is indifferent between the two

and all points give him the same utility.

Explain the consumers’ equilibrium under the assumptions of ordinal

approach.

ANSWER:

The consumer is in equilibrium when he maximizes his utility, given his

income and the market prices. Two conditions must be fulfilled for the

consumer to be in equilibrium.

The first condition is that the marginal rate of substitution be equal to the

ratio of commodity prices. This is necessary but not sufficient condition.

MRS x ,y =MU x

MU y

ffffffffffffffff=Px

P y

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The second condition is that the indifference curve be convex to the

origin. This condition is fulfilled by the axiom of diminishing marginal

rate of substitution of x for y and vice versa.

Q.2. Examine the concept and relationship of Total, Average and marginal

costs with the help of suitable diagram.

ANSWER:

Total Cost

Total cost is the total expenditure incurred on the production. It connotes

both explicit and implicit money expenditure and include fixed and

variable costs.

C = f X,T,P f ,Kb c

Where C = total cost

X = output

T = technology

P f = prices of factors

K = fixed factors

TC = TFC + TVC

Total Cost Curves

Average cost

Average cost is obtained by dividing the total cost by the total output.

AC =TCQffffffffff

Average cost further can be categorized as average fixed cost (AFC) and

average variable cost (AVC).

AFC =TFC

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AVC =TVC

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Average cost curves

Marginal Cost

Marginal cost is the change in the total cost for producing an extra unit

of output.

MC = ∂TC/∂Q

Marginal Cost Curve

Q.3. Differentiate and elaborate the concepts of returns to scale and law of

variable proportions.

ANSWER:

Law of variable proportions

Under Law of variable proportion: only one variable input varies all other

variable kept constant. Law of variable proportion shows the relationship if

one variable input increase (eg: Labour) by keeping all other variable

constant; total product and marginal product increase upto a certain point

after that it will increase at a diminishing rate. it shows in three stage first

increase then constant and then decrease. Law of variable proportion is for

short period

Laws of Returns to Scale

Under Law of Return to Scale all the variable inputs varies except the

enterprise. Law of return to scale shows the relationship between inputs and

output at three different stages: 1. output increase more than inputs, 2. output

and input are constant, 3. output is less than proportionate input. law of

Stage I – Capital is Underutilized and Successive units of L add greater Amounts to TP

MPL

APL

L

Stage II – Addition to TP due to increase in L continues to be positive but is falling with each unit

Stage III – Fixed Input capacity is reached and additional L causes output to decline

return to scale is for long period.

Q.4. Why is demand forecasting essential? What are the possible

consequences if a large scale firm places its product in the market without

having estimated the demand for its product?

Answer: Demand forecasting is essential due to the following: •Better planning and allocation of resources •Appropriate production scheduling •Inventory control •Determining appropriate pricing policies •Setting s les targets and establishing controls and incentives. •Planning a new unit or expanding existing one

•Planning long term financial requirements •Planning Human Resource Development strategies. There are two possible consequences when a firm places its products on the market without having estimated the demand for its product.

Overestimation is a significant problem when forecasting. If a business projects demand to be very high for the next period but is turns out to be unusually low, they could end up with spoiled and wasted stock, too much inventory and a lack of cash flow.

Underestimating demand can result in missed opportunities and a failure to exploit a products potential. If a business expects demand to be lower than it actually is, they may not have enough inventory to meet customer needs. It can also negatively impact their pricing strategies and can cause a loss of market share.

Q.5. Discuss the various steps involved in a managerial decision making

process. Explain, in detail, any two group decision making techniques.

ANSWER:

STEP 1

Problem identification -for it is what determines the direction that the

decision making process takes, and, ultimately, the decision that is made.

STEP 2

Generating the alternative course of action

This step involves identifying items or activities that could reduce or eliminate the difference between the actual situation and the desired situation. For this step to be effective, the decision makers must allot enough time to generate creative alternatives as well as ensure that all individuals involved in the process exercise patience and tolerance of others and their ideas.

STEP 3

Evaluating the alternative

In the Pursuit of “quick fix” managers too often shortchange this step by

failing to consider more than one or two alternatives, which reduces the

opportunity to identify effective solutions. After generating a list of

alternatives, the arduous task of evaluating each of them begins.

Numerous methods exist for evaluating the alternatives, including

determining the pros and cons of each; performing a cost-benefit

analysis for each alternative; and weighting factors important in the

decision, ranking each alternative relative to its ability to meet each

factor, and then multiplying cumulatively to provide a final value for

each alternative.

STEP 4

Selecting the Best Alternative

After the decision-makers have evaluated all the alternatives, it is time for

the fourth step in the decision-making process; choosing the best alternative.

Depending on the evaluation method used, the selection process can be

fairly straightforward. The best alternative could be the one with the most

"pros" and the fewest "cons"; the one with the greatest benefits and the

lowest costs; or the one with the highest cumulative value, if using

weighting

STEP 5

Implementing the Decision

This is the step in the decision making process that transforms the

selected alternative from an abstract situation into reality. Implementing

the decision involves planning and executing the actions that must take

place so that the selected alternative can actually solve the problem.

STEP 6

Evaluating the Decision

In evaluating the decision, the sixth and final step in the decision-making

process, managers gather information to determine the effectiveness of

their decision. Has original problem identified in the first step been

resolved? If not, is the company closer to the situation it desired than it

was at the beginning of the decision-making process?

Two group Decision Techniques Brainstorming Brainstorming is a technique in which group members spontaneously suggest keys to solve a problem. Its primary purpose is to generate a multitude of creative alternatives, regardless of the likelihood of their being implemented. Delphi Group Technique The Delphi group Technique employs a written survey to gather expert opinions from a number of people without holding a group meeting. Unlike in brainstorming and nominal groups, Delphi group participants never meet fact to face; in fact, they may be located in different cities and never see each other.

Assignment ‘B’

Q.1. Why a firm is price taker and not a price maker under perfect market

conditions?

ANSWER

In perfect market conditions a firm is a price taker because other firms can enter the market easily and produce a product that is indistinguishable from every other firm’s product. This makes it impossible for any firm to set its own prices. There are two main reasons why a firm cannot get away with

setting its prices above the market price. First, there is no difference between its product and that of every other firm in the market. Therefore, no one will pay extra for a firm’s product the way that they might pay extra for something like Nike shoes. Second, if firms were to succeed in setting a higher price, more firms would enter the market, attracted by the higher profits that were available. This would increase supply and drive down the price of the firm’s product.

Q.2. Profit maximization is theoretically the most sound but practically

unattainable objective of business firms. In the light of this statement

critically appraise the Baumol’s sales revenue maximization theory as an

alternative objective of the firm.

ANSWER

The Baumol’s Sales Revenue Maximisation Theory states that; • Manager’s rewards are more closely linked to Sales rather than

Profits. • Firms aim to maximize Sales Revenue, but subject to a Profit

Constraint. • Profit constraint is exogenously determined by the demand and

expectations of the shareholders, banks and other financial institutions.

• A Sales Revenue Maximizing firm, in general, produces a greater output than a Profit Maximizing Firm and sells at a price lower than the profit maximiser.

• The maximum sales revenue will be where e = 1 (and hence MR = 0) and will be earned only if the profit constraint is not operative.

• If the profit constraint is operative the sales revenue maximiser will operate in the area where price elasticity is greater than unity.

QΠ = Profit Maximising Output QS = Sales Maximising Output QRS = Constrained Sales Maximizing Output Π = Profit Curve

Q.3. Distinguish between skimming price and penetration price policy.

Which of these policies is relevant in pricing a new product under different

competitive conditions in the market?

Skimming Pricing: This pricing strategy is adopted when close

substitutes of a new product are not available in the market. To extract

the consumer surplus, setting up a very high price initially and then a

subsequent lowering of prices in a series of reduction.

Penetration Pricing: This pricing policy is generally adopted in case of

the availability of close substitutes of the new product in the market. To

penetrate in the market, initially a lower price is designed, as soon the

product captures the market, and price is gradually raised up.

Penetration pricing will be relevant in the pricing of new product under different competitive conditions in the market.

CASE STUDY

Introduction

Michael Wolfson, a computer programmer had a decent job with the financial powerhouse Bear, Stearns & Co. Now, he refurbishes computers at the basement in his house and sells it through e-bay. He plans to join as a school teacher. Michael lost his job in 2003. He was told that his job is being outsourced to India. Paul Schwartz, a mainframe programmer, who was earning $ 80,000 a year was told that his services were no longer required. He suspects that his job has been outsourced to India.

There is growing dissent among the Americans against the increasing practice of outsourcing. It has become an electoral issue in the coming presidential elections in the US. The Democratic candidate, John Kerry has made it an emotive issue, despite economists trying to portray the positive aspects of outsourcing. There are numerous reasons for the growing apathy towards outsourcing. The prevailing economic situation and the increasing joblessness in the US have added fuel to the fire. However, many analysts feel that joblessness in the US is cyclical in nature resulting from the recession of 2001 and hence, a recovery will create job opportunities.

Moreover, according to the U.S.-India Business Council, the increasing unemployment is also due to corporate restructuring and just a quarter of the job loss is due to outsourcing. Since, the beginning of 2001, the real job loss in US is estimated to be 2.3 million. In comparison, the actual job loss due to outsourcing is estimated to be only 200,000. Thus, it can be said that there are various other reasons for joblessness in the US. The outcry against outsourcing seems to be driven more by politics rather than economics.

Outsourcing forms a small proportion of the jobs that are regularly churned in the US economy. On an average, 24 million jobs are churned in the US every month. In the process, resources are allocated, for more productive purposes. To come out of the recession and raise the standards of living, higher productivity seems to be the only solution. The debate on outsourcing gathered momentum only in the recent past. A study by Forrester, a research group, in the year 2002, brought the issue into limelight. The report claims that by 2015, 3.3 million white-collar jobs in the US would be transferred to countries like India.

The Economics of Outsourcing

But is outsourcing so bad for the US economy? Gregory Mankiw, professor of economics at the Harvard University and head of President Bush's Council of Economic Advisers, recently told presspersons that outsourcing of jobs is in better interest of US. According to him, outsourcing lowers the cost for consumers, making the corporations more efficient. There were a series of articles in The Economist, highlighting the advantages of outsourcing. There are many influential groups in the US who are perturbed by the recent outcry against outsourcing. Says Charles E Morrison, President, East West Center, a US based think tank, "Off-shoring is not an economic problem, but an economic opportunity". Many analysts in the US feel that anti off-shoring bills in the US would prove to be ineffective. Similar views were echoed by Michael T Clark of US-India business council. He says that, "Jobs lost to off-shoring were less than a quarter of all jobs lost in the US in 2002. The rest were lost due to corporate restructuring. The current debate in the US on off-shoring is informed by lack of facts".

In an article, "Why Your Job Isn't Moving to Bangalore" in the New York Times, Jagdish Bhagwati, a senior fellow at the Council on Foreign Relations and professor at Columbia University writes that the panic and furor over outsourcing is completely unwarranted. He further says that no jobs are being taken away from America. He says that the affect of changes in technology is being felt in the labor intensive industries. According to him, the loss of jobs in the US is due to technological changes.

Professor Bhagwati is also critical about politicizing the whole issue. He says that outsourcing will strengthen the competitiveness of the US companies. Firms ignoring the cheaper supplies would lose out. Professor Bhagwati further says that outsourcing service jobs is nothing different from importing of labor-intensive textiles and other goods. According to him, all empirical studies in the US over the last two decades suggest that wage stagnation in the manufacturing industry is more due to automation of the processes, not the cheaper imports. The same is applicable to service industry as well. Jane Linder of Accenture's Institute for Strategic Change says that companies outsourcing the traditional back-office work have more control and discipline over their operations. Moreover, employees of the company can concentrate on framing strategies. Further, outsourcing also results in greater efficiency and lowering costs. This allows companies to offer better services to customers. A study done by McKinsey Global Institute reveals that for every dollar of work outsourced by the US, it gets back $1.14 as income, and the countries to which the work is being outsourced gains 35 cents. This shows that outsourcing is a win-win situation for both the countries.

Benefits for US Benefits for India

Savings to US investors or customers 0.58 Labor 0.1 Imports of US goods and services by providers in

India 0.05

Profits retained in India

0.1

Transfer of profits by US based providers in India back to US 0.04 Suppliers 0.09

Net direct benefit retained in US 0.67 Central government

taxes 0.03

Value for US labor reemployed 0.45-0.47

State government taxes 0.01

Potential net benefit for US 1.12-1.14

Net benefit to India 0.33

Source: Mckinsey Global Institute There is a definite cost advantage in off-shoring work to India. These advantages are a result of lower wages in the developing countries along with the development of telecommunications in these countries. A report published by HSBC, which has off-shored more than 4,000 jobs to India, says that the telephone costs from India to America and Britain has decreased by almost 80%, since January 2001. The wage difference between these countries is also a factor that forces the companies to outsource their business processes to India. A study done by NASSCOM, says that the average salary of an IT professional in UK is $96,000, in US it is $75,000, whereas in India it is just $26,000. The wage difference between the low end call center jobs of both the countries is also very wide. An average call center employee in UK earns $20,000 on the average. Whereas, a call center professional in India barely manages to earn one tenth of the earnings of their British counterparts. Offshoring allows companies to work round the clock. It gives ample time to the companies to think about their IT problems. Recently, American Express paid $5,000 to a group of software programmers in India, to develop a package for them. The same would have cost them several million dollars in US. The benefits of outsourcing go much beyond the cost advantage. An article in Mckinsey quarterly suggests that the companies need to look beyond cost savings. The article says that "Companies are merely replicating what they do at home, where labor is expensive and capital is relatively cheap, in countries in which the reverse is true." Alan Greenspan, US Federal Reserve Chairman, is a staunch supporter of outsourcing. He is of the opinion that any move to curb outsourcing of work to countries like India and China, might give just a temporary relief. Reacting to the proposed legislations in the US banning outsourcing, Greenspan said, "A new round of protectionist steps is

being proposed against outsourcing. These alleged cures will make matters worse". Greenspan feels that any effort to protect US jobs through legislation would backfire. Not all companies have taken full advantage of outsourcing. According to Harris Miller, president of the Information Technology Association of America (ITAA), a lobby group, so far only 3-4 % of all American companies outsource their processes. The remaining still rests with American firms. A report published by Forrester, in December 2003, says that 60% of the Fortune 1000 companies have a negligible or near nil presence in off-shoring. Report also suggests that 40% of the work of these companies could be outsourced. Thus, the potential for growth in outsourcing is still immense. Advancement in the technology can give a further push to the off-shoring activity. The inflexible architecture of the current technologies is acting as a hindrance in off-shoring, says Simon Heap of Bain & Co, a consultancy firm. The advancement in software and hardware would enable the companies to off-shore even small activities. Firms would be able to off-shore the activities of the entire department, say billing of customers. However, not everyone seems to agree with the supporters of outsourcing. Stephen Roach, the chief economist at Morgan Stanley, says that it is only the wage difference that is encouraging companies to outsource work to India or any other developing country. He further says that joblessness is taking away the charm of recovery in the US. Many analysts also feel that companies should take some concrete steps to minimize the affects of outsourcing. Companies should make the process of job transfers to offshore destinations more smooth. British Telecom exhibited a process of outsourcing that can be used as a model by other companies. In 2003, when BT announced that it is planning to open two call centers in India, with a capacity of 2200 people, it was criticized from all corners. It was said that BT was not acting in a socially responsible manner. Realizing the gravity of the situation, BT approached Sustainability, an international consultancy, specializing in business strategy and sustainable development. The consultancy firm was asked to find whether or not outsourcing and corporate social responsibility (CSR) co-exist. Sustainability noted that the immediate impact of outsourcing would be job loss for the employees, and the resulting affect on the society. The consultancy firm was of the opinion that before outsourcing, companies should address the negative impact of outsourcing. In order to check the negative impact of off-shoring, firms should consult with employees, trade unions, communities and other key stakeholders. Employees should be involved in the process of any such decision making. Sustainability also suggested that firms should be transparent and make the employees know the services that are being outsourced. Firms should also make an attempt to redeploy the employees in some other departments. This would minimize layoffs. An attempt should be made to retrain the

redundant workers. A part of the savings from off-shoring should be invested for this purpose. As per the suggestion made by McKinsey Global Institute, 4-5% of the resulting savings from off-shoring should be used for insurance policy for employees to cover the lost wages.

US was one of the prime supporters of free trade. US was least bothered about the concerns of many other developing countries when they raised their voices against job losses as a result of the cheap exports. But, this aggressiveness seems to have mellowed down in recent days. It always propagated that inefficient industries should be closed. One of the primary tasks of the U.S. Trade Representative's office was to keep a check on the world markets. It assesses the markets which are opening up and which are getting closed as a result of high tariffs and other quantitative restrictions. Now, with the growing efficiency of developing countries in the service sectors, many jobs in these sectors are being transferred to developing countries (of which a major chunk is coming to India). US is worried about the increasing joblessness but that seems paradoxical. It hails globalization but when it comes to the developing countries trying to reap the benefits of globalization, it raises all sorts of issues.

Recently the US government has tightened the visa norms. The number of H-1B visas issued to Indian software programmers fell to 65,000 from 1,95,000 in 2003. Analysts feel that this would increase outsourcing of jobs further, particularly to India. According to Craig Barrett, the chief executive of Intel, granting of fewer visas would force the companies to shift their jobs to countries like India, where there is no dearth of qualified engineers. Despite no ban from the federal authorities on outsourcing, many States have initiated the process of putting restrictions on outsourcing government work to foreign countries. The lawmakers in the state of New Jersey have proposed a bill that stops firms to outsource any government related work to a foreign country. Succumbing to the public pressure, the government was forced to bring back a helpline for welfare recipients that was being outsourced to India. Similarly, the state of Indiana withdrew a $ 15 million contract from an American subsidiary of an Indian IT firm. Commenting on the move, the Indiana governor said that contract was not in tune with Indiana's vision of providing better and more job opportunities to local companies and workers. However, analysts feel that these decisions have been influenced by political pressure in the backdrop of coming presidential elections in the US.

The Indian Response

The Indian BPO industry is not taking the outcry against outsourcing in the US seriously. Indian BPO firms are no longer just call centers. Their activities now cover marketing and knowledge based services. These companies are now aspiring to become

strategic partners for US companies. There is a sudden spurt in the number of venture capitalists willing to invest in different areas. Though, some software companies can't hide their concern over the legislations banning government related off-shoring in the long-run but, for now they are clear that, these legislature will have negligible effect on the current contracts with the private companies. Reacting to the whole issue, Narayana Murthy, Chairman and Chief Mentor of Infosys said that there is no issue to worry about. He termed the outcry as normal. He suggested that rather than getting worried and agitated, Indians should put forward their point of view and explain the advantages of off-shoring. He said that the present uncertain economic situation is responsible for the concern over the job losses in the US.

Many analysts feel that the opposition to outsourcing may not end with the US presidential elections. With many of the American States, coming out with legislations banning government contracts to other countries, the issue of off-shoring is going to be alive. Conditions for off-shoring may become favorable with the improvement in the performance of the US economy.

Question for discussion:

Que. 1 Give your opinion on outsourcing and its impact on the prospects of growth

of the economy of home Nation and host nation.

Guidelines for the answer: Discuss the issue in the perspective of opportunity and threats faced by developing and developed nations.

ANSWER Outsourcing means using international cheap labor force and also doing in the countries with cheapest sources of labor and supplies. Some of the companies transfer their internal activities and decision rights of action to outside suppliers or companies. Outsourcing is a situation in which a company employs another organization to do some of its work, rather than using its own employees to do it. Benefits of Outsourcing to the Host Country

1. Improve Economic Growth of Host Country

Call centre Outsourcing brings cost advantages and increase in profits in macroeconomic terms to both home countries which business undertakings as well as host country benefits in various aspects. During last few years India has achieved tremendous growth rate by contributing services of off shoring. According to market research, India has been benefited extremely

from growth in this outsourcing area and the rate of growth is above the expectation level.

2. Reduce Unemployment and Create New Employment Opportunities

Outsourcing services will be the good sign for developing countries with high rate in unemployment. Services off shoring will lead to expand employment opportunities in developing countries like India. India has paved the way for a significant number of jobs In terms of growth in off shoring area. For countries that are outsourcing services to other countries, there will be loss of jobs in that country.

3. Outsourcing provide motivation for Education

Outsourcing relies on a basis for cheap, but with well educated and highly skilled workforce. The highly skilled labours are created from well established education process. In India the payment level provided by employees who are working in the outsourced companies are above the industry average range of salary. On other hand this type of employment can be considered as more respectable job. These factors lead to motivation to be part of outsourced company.

4. Host country Consumers’ get Advantages of Quality of Services

Host country customers enjoyed by getting qualitative services which are normally served to developing counties.

5. Transfer of Advance Technology to Host Country

Outsourcing requires appropriate technical sophistication. For example, it is essential to have reliable and inexpensive communication links with the rest of the world when doing outsourcing. Host country can get massive advantages from latest technology in short term as well as long term. There is no limitation to transfer technical knowledge.

Conclusion

Host Country will be benefited by transmitting latest technology, global training for the employees, creation of massive job opportunities and rapid growth in GDP. On the other hand The benefit arrived for home country due to outsourcing is , people who live in home country need to less amount of money to purchase well qualitative goods and services, this lead to improve

greater savings in home country which finally affect positively in home country’s economy

In particularly while host country is being getting advantages of the outsourcing at the same time the employees in the home country will be affected by the facts of unemployment. Because outsourcing the jobs have possibility to lose. The developing countries like India , Sri lanka get benefited because of outsourcing , but in other hand the people in the developed nations will suffer from unemployment. Even though it improve unemployment level of economy of home country, it positively affect on home country’s economy by improving GDP. Then this leads to improve productivity on global economy.

Assignment ‘C’

1 C 21 C 2 B 22 D 3 B 23 B 4 A 24 A 5 B 25 B 6 B 26 B 7 C 27 D 8 C 28 C 9 D 29 D 10 D 30 B 11 C 31 B 12 D 32 B 13 B 33 B 14 A 34 B 15 B 35 D 16 A 36 A 17 B 37 A 18 C 38 A 19 A 39 C 20 B 40 A