Que- What is the Basic Objectives Of

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Que- What is the basic objectives of a firm? Explain the role andresponsibility on Managerial Economics?

Ans. Conventional theory of firm assumes profit maximization is the soleobjective of business firms. But recent researches on this issue reveal that theobjectives the firms pursue are more than one. Some important objectives, other than profit maximization are:(a) Maximization of the sales revenue(b) Maximization of firm’s growth rate(c) Maximization of Managers utility function(d) Making satisfactory rate of Profit(e) Long run Survival of the firm(f) Entry-prevention and risk-avoidance

Profit Business Objectives: Profit means different things to different people. Toan accountant “Profit” means the excess of revenue over all paid out costsincluding both manufacturing and overhead expenses. For all practical purpose,profit or business income means profit in accounting sense plus non-allowableexpenses.

Economist’s concept of profit is of “Pure Profit” called ‘economic profit’ or “Justprofit”. Pure profit is a return over and above opportunity cost, i. e. the incomethat a businessman might expect from the second best alternatives use of hisresources.

Sales Revenue Maximization: The reason behind sales revenue maximizationobjectives is the Dichotomy between ownership & management in large businesscorporations. This Dichotomy gives managers an opportunity to set their goalother than profits maximisation goal, which most-owner businessman pursue.Given the opportunity, managers choose to maximize their own utility function.The most plausible factor in manager’s utility functions is maximisation of thesales revenue.

The factors, which explain the pursuance of this goal by the managers arefollowing:.First: Salary and others earnings of managers are more closely related to salesrevenue than to profitsSecond: Banks and financial corporations look at sales revenue while financingthe corporation.Third: Trend in sales revenue is a readily available indicator of the performanceof the firm.

Maximisation of Firms Growth rate: Managers maximize firm’s balance growthrate subject to managerial & financial constrains balance growth rate defined as:



G = GD – GC

Where GD = Growth rate of demand of firm’s product & GC = growth rate of capital supply of capital to the firm.

In simple words, A firm growth rate is balanced when demand for its product &

supply of capital to the firm increase at the same time.

Maximisation of Managerial Utility function: The manager seek to maximizetheir own utility function subject to the minimum level of profit. Managers utilityfunction is express as:U= f(S, M, ID)Where S = additional expenditure of the staff

M= Managerial emolumentsID = Discretionary Investments

The utility functions which manager seek to maximize include both quantifiable

variables like salary and slack earnings; non- quantifiable variables such asprestige, power, status, Job security professional excellence etc.

Long run survival & market share: according to some economist, the primarygoal of the firm is long run survival. Some other economists have suggested thatattainment & retention of constant market share is an additional objective of thefirm’s. The firm may seek to maximize their profit in the long run through it is notcertain.Entry-prevention and risk-avoidance, yet another alternative objectives of thefirms suggested by some economists is to prevent entry-prevention can be:

a) Profit maximisation in the long run

b) Securing a constant market sharec) Avoidance of risk caused by the un-predictable behavior of the new firms

Micro economist has a vital role to play in running of any business. Microeconomists are concern with all the operational problems, which arise with in thebusiness organization and fall in with in the preview and control of themanagement. Some basic internal issues with which micro-economist areconcerns:

(i) Choice of business and nature of product i.e. what to produce(ii) Choice of size of the firm i. e how much to produce(iii) Choice of technology i.e. choosing the factor-combination(iv) Choose of price i.e. how to price the commodity(v) How to promote sales(vi) How to face price competition(vii) How to decide on new investments(viii) How to manage profit and capital(ix) How to manage inventory i.e. stock to both finished & raw

material



These problems may also figure in forward planning. Micro economist deals withthese questions and like confronted by managers of the enterprises.

Que- Explain the following with examples.

a) Short run versus Long runb) Nature of marginal analysis

Ans a). Short Run & Long Run: The concept of short run and long run is usedin economic theories like production theory, cost theory etc.

In production, theory short run refers to a period of time in which supply of certaininputs such as plant, building, machinery etc is fixed or is inelastic. In the shortrun therefore, increasing the use of only one variable input as labour and rawmaterial can increase production of a commodity.

The long run refers to a period of time in which the supply of all the inputs iselastic, but not enough to permit a change in technology. That is, in the long run,all the inputs are variable. Therefore, in the end, production of or commodity canbe increased by employing more of both variable and fixed inputs.

Short run costs are the costs that vary with the variation in input, the size of thefirm remaining the same. In the other words, short run costs are the same asvariable costs. Long run costs, on the other hand are the costs, which areincurred on the fixed assets like plant, building, machinery etc.

Ans.(b) Nature Marginal analysis: The concept of marginal value is widely usedin economic analysis, for example marginal utility, marginal cost and marginalrevenue. Marginality concept assumes special significance where maximisationor maximization problem is involved e.g. maximization of consumer’s utility,maximisation of firm’s profit, minimization of cost etc. The terun “marginal” refersto the change (increase or decrease) in the total of any quantity due to one unitchange in its determinant e.g. the total cost of production of a commoditydepends on the number of units produced. In this case “marginal cost” or (MC)can be defined as the change in total cost as result of producing one unit less of a commodity thus,Marginal Cost (MC) = TCn – TCn – 1

Where TCn = total cost of producing n unitsTCn-1 = total cost of producing n – 1 units.

Q. No. What is elasticity of demand? How can it be measured?

Ans. The degree of responsiveness of demand to the change in itsdeterminants is called elasticity of demand. The concept of demand elasticity is



used in business decisions are (1) Price elasticity; (2) Cross – elasticity (3)Income elasticity (4) Elasticity of price expectation.

1) Price elasticity of demand is generally defined as the responsiveness or sensitivity of demand for a commodity to change in its price. More

precisely, elasticity of demand is the percentage change in demandbecause of one percent change in the price of the commodity. The priceelasticity of demand (ep) is given as

Ep = Percentage change in quantity demandedPercentage change in price

Ep = Q ÷ P = Q × P ⇒ Q QQ P Q P P P

Q = Changes in quantity Q = Original quantity

P = Change in price P = Original Price

2) Cross Elasticity is the measure of responsiveness of demand for acommodity to the changes in the price of its Substitutes andcomplementary goods .for example, cross elasticity of demand of tea isthe percentage change in its quantity demanded with respect to thechanges in the price of its substitutes coffee. The formula for tea andsame for coffee is given by

Ep = Percentage change in demanded for tea QtPercentage change in price of coffee

Ep = Pc . QtQt Pc

3) Income Elasticity of demand is responsiveness of demand to the changesin income.

Income elasticity of demand for product X may be defined asX ÷ Y = Y × X

X Y X Y

Where X = Quantity of X demandedY = Disposable Income

X = Change in quantity demanded



Y = Changes in Income

4) Advertisement Elasticity of sales is defined as responsiveness of demand / sales to the changes in advertisement expenditure

Percentage change in demanded for tea QtPercentage change in Advt expenditure

S / S = S . AA/A A S

Where S = Sales, S = increase in salesA = initial advertisement expenditure

A = additional expenditure on advertisement

5) Elasticity of Price Expectations refers to the expected range in future priceas a result of change in current prices of a product. The elasticity of priceexpectation is defined as measured by the formula

Ex = Pf / Pf = Pf . PcPc/ Pc Pc Pf

Where Pc and Pf are current and future prices respectively.

The co – efficient ex gives the measure of expected percentage changein future price as a result of 1% change in present price, if ex >1, it indicates thatfuture change in price will be greater than the present change in price, and viceversa.

Que- What are the main techniques of demand estimation? What is their

reliability?

Answer: Demand estimation is predicting future demand form a product. Theinformation regarding future demand is essential for planning and schedulingproduction, purchase of raw materials, acquision of finance and advertising.

The various techniques of demand estimation: -



1) Survey Method2) Statistical Method

Survey Method

Survey method is generally used where the purpose is to make short run forecastof demand. Under this method, customer surveys are conducted to collectinformation about their intentions and future purchase plan. This method includes

(a) Consumer survey method(b) Opinion Poll method

Consumer survey methodMay be in form of

a) Consumer enumeration: - In this method, almost all the potential users of the

product are contacted and are asked about the future plan of purchasing theproduct in question. The quantities indicated by the consumers are addedtogether to obtain the probable demand for the product.

b) Sample survey method: - Under this method only a few potential consumersselected from relevant market through a sampling method are surveyed, onthe basis of the information obtained, the probable demand may be estimatedthrough the following formula.

D = HR (H.AD)Hs

Where D = probable demand forecastH = Census number of households from the relevant market.Hs = number of households reporting demand for the product.HR = number of households reporting demand for the product.AD = average expected consumption by the reporting households.

c) End User Method: - The end user method of demand forecasting is used for estimating demand for inputs. Making forecast by this method requiresbuilding up a schedule of probable aggregate future demand for inputs byconsuming industries and various other sectors.

Opinion poll Method

The opinion poll methods aim at collecting opinion of those who are supposed topossess knowledge of the market e.g. sales representative, professionalmarketing experts and consultants. The opinion poll method include



a) Expert opinion method: - Firms having a good network of sales representativecan put them to work of assessing the demand for the product in the areasthat they represent. Sales representative, beings in close touch with theconsumers are supposed to know the future purchase plans of their customer, their reaction to the market changes, their response to the

introduction of new products and the demand for competing products. Theyare, therefore, in a position to provide an estimate of likely demand for their firm’s product in the area. The estimates of demand thus obtained fromdifferent regions are added up to get the overall probable demand for aproduct.

b) Delphi Method: - Delphi method is used to consolidate the divergent expertopinions and arrived at a compromise estimate of future demand.

Under Delphi method the expert are provided information on estimates of

forecast of other experts along with the underlying assumptions. The expertsmay revise their own estimates in the light of forecast made by other experts.The consensus of experts about the forecasts constitutes the final forecast.

Although this method is simple and inexpensive, it has its own limitations.First estimates provided by sales representations and professional expertsare reliable only to extend depending upon their skill to analysis the marketand their experience. Second, demand estimates way involve the subjective

judgement of the which may lead to over or under estimation, finally, theassessment of market demand is usually based on inadequate information’s,such as changes in GNP, available of credit, future prospects of the industry

etc, fall outside their purview.

c) Market studies and Experiments:- It is a method of collecting necessaryinformation regarding demand is to carry out market studies and experimentson consumer’s behavior under actual through controlled market conditions.This method is known in common parlance market conditions. This methodsis known in common parlance as market experiment method under thismethod, firms first select some areas of the representative markets – three or four cities having similar features viz. Population, income levels, cultural andsocial background, occupational distribution, choices and preferences of consumers. Then, they carry out market experiments by changing prices,advt. Expenditure and other controllable variable in the demand functionunder the assumption that other thing remains same. The controlled variablemay by changed over time either simultaneously in all the markets or in all themarkets or in the selected markets. After such changes are introduced in themarket, the consequent changes in the demand over a period of time (aweek, a fortnight or month) are recorded. On the basis of data collectedelasticity coefficient are computed. These coefficients are then used alongwith the variables of the demand function to assess the demand for product



The market experiments methods have certain serious limitations. First, thismethod is very expensive and hence cannot be afforded by small forms.Second, being a costly affair, experiments are usually carried out on a scaletoo small to permit generalization with a high degree of reliability.

Third experimental methods are based on short – term and controlledconditions that may exist in an uncontrolled market. Hence, the results maynot be applicable to the uncontrolled long-term conditions of the market.

Statistical Method

Statistical method of demand projection include the following techniques

1) Trends Projection Method

2) Barometric Method and3) Economic Method

Trends Projection Method

Trend projection method is a classical method of business forecasting. Thismethod is essentially concerned with the study of movement of variable throughtime. The use of this method requires a long and reliable time series data. Thetrend projection method is used under the assumption that the factorsresponsible for the past trends in variables to be projected (e.g. sales and

demand) will continue to play their part in future in the same manner and to thesame extend as they did in the past in determining the magnitude and directionof the variable.

There are three (3) techniques of trend projection based on time – series data.

(a) Graphical Method: - under this method, annual sales data is plotted on agraph paper and a line is drawn through the plotted points. Then a free handline is so drawn that the total distance between the line and the point isminimum.

Sale



YearsTrend Projection

Although this method is very simple and least expensive, the projections madethrough this method are not very reliable. The reason is that the extension of thetrend line involves subjectivity and personal bias of the analysis.

(b) Fitting Trend Equation: Least square method: - Fitting trend equation is aformal technique of projecting the trend in demand. Under this method, atrend line (or curve) is fitted to the time – series data with the aid of statisticaltechniques. The form of the trend equation that can be fitted to the time seriesdata is determined either by plotting the sales data or by trying different formsof trend equations for the best fit.

When plotted, a time series date may show various trends. The mostcommon types of trend equation are 1) liner and 2) exponential trends

Linear Trend: - When a time series data reveals a rising trend in sales than astraight-line trend equation of the following form is fitted

S = A + BTWhere S = annual sales

T = Time (in year)A & B are constant. The parameter b given the measure of annual

increase in sales

Exponential trend:- When sales ( or any dependent variable) have increased over the past years at an increasing rate or at a constant percentage rate, than theappropriate trend equation to be used is an exponential trend equation of any of the following type 1. Y = aebtOr its semi – logarithmic for Log y = = log a + bt

This form of trend equation is used when growth rate is constant.

2. Double log trend equation of equationY = aTB

Or it’s double logarithmic formLog y = log a + b log t

This form of trend equation is used when growth rate is increasing.





Regression analysis is the most popular method of demand estimation. Thismethod combines economic theory and statistical techniques of estimation.Economic theory is employed to specify the determinants of demand and todetermine the nature of the relationship between the demand for a product andits determinants. Economics theory thus helps in determining the general form of

demand function. Statistical techniques are employed to estimate the values of parameters in the estimation equation.

Simultaneous Equation MethodIt involves estimating several behavioral equations. These equations aregenerally behavioral equations, Mathematical equations and Market – clearingequations. The first step in this technician is to develop a complete model andspecify the behavioral assumption regarding the variables included in the model.The variables that are included in the model are1) Endogenous variables2) Exogenous variables

Endogenous variables – the variables that are determined within the model arecalled endogenous variables. Endogenous variables are included in the model asdepended variables that are the variables that are to be explained by the model.These are also called controlled variables. The number of equations included inthe model must be equal to number of endogenous variables.

Exogenous variables – are those that are determined outside the model.Exogenous variables are inputs of the model whether a variable is treatedendogenous variables or exogenous variables depend on the purpose of themodel. The examples of exogenous variables are “ Money Supply”, tax rates,

govt. spending etc. The exogenous variables are also known as uncontrolledvariables.

Que- Explain the inter–relationship between the various short run costcurve of a firm. Why is average cost curve U – shaped?

Answer:The basic analytical cost concepts used in the analysis of cost behavior are total,

average and Marginal costs. The total cost (TC) is defined as the actual cost thatmust be incurred to produce a given quantity of output. The short – run total costis composed of two major elements

I. Total fixed cost (TFC)II. Total variable cost (TVC)



TC = TFC + TVC

For a given quantity of output (q), the average total cost (TAC), average fixedcost (AFC) and average variable cost (AVC) can be defined as

TAC = TC/ Q= TFC + TVC/Q

AFC = TFC/Q; AVC = TVC / Q

TAC = AFC + AVC

Marginal cost (MC) is defined as the change in the total cost divided by change intotal output.

i.e. ▲TC / ▲Q

As the first derivative of cost function i.e. DTC / DQ

The total fixed cost (TFC) remains fixed for whole range of output, and hence,takes the form of a horizontal line – TFC. The total variable cost (TVC) curveshows that the total variable cost first increases at decreasing rate and then atincreasing rate with the increases in the output. The pattern of change in TVCstems directly from the law of increasing and diminishing returns to the variableinputs, as the output increases, larger quantity of variable inputs are required toproduce the same quantity of output due to diminishing returns. This causes asubsequent increase in the variable cost for producing the same output. The totalvertical addition to TFC and TVC; and as the TFC is constant; the TC and TVCcurve will be parallel.

TC

TVC

TFC

OutputO

Cost



COST

OOutput

The AFC curve will fall steeply in the beginning and will tend to touch thehorizontal axis, but will never become zero. The AVC curve slopes downwardsand then rises. As AFC and AVC curves are falling in the initial stages, the ACcurve registers a deep fall in the beginning. Its minimum point comes after the

AVC curve has reached its minimum. The reason for this is that the AFC curvecontinues to decline. In the rising phase, both the AC and AVC curve tends toapproach each other but never exactly merge into each other, for the AFC curveis above the zero axes. Generally, the average cost curve lies above the AVC –curve at a distance equal to the corresponding height of AFC curve.

The marginal curve represents the change in both TVC and TC curves due tochange in output. It downward trend in MC shows increasing marginalproductivity of the variable input mainly due to internal economy resulting fromincrease in production. Similarly, an upward trend in the MC shows increase inTVC, on the one hand, and decreasing marginal productivity of the variable inputon the other.



Que- Discuss the equilibrium of a firm under monopoly. What are theconditions of equilibrium?

Answer: Monopoly refers to a market situation on where there is only one seller who has complete control over the supply of a commodity, which has no close

substitutes. The monopoly firm can adopt any price it likes; it can charge uniformprice, or it can charge different prices from different consumers. It is able toprevent others from entering the industry. The firm and industry refer to one andthe same thing; a single firm constitutes the entire industry.

Determination of price and output (Equilibrium under Monopoly)

Marginal cost and marginal revenue – Under monopoly, the firm is a price –maker, a firm can therefore fix the price of its products, given the output. Thedemand curve (AR curve is therefore, downward sloping under monopoly, and sothe MR curve is below the AR curve.

MC = MR and MC cure cuts MR curve from below

Short Run

AR

MR

AR

MR

Output (Units)

A monopoly can make either normal profits or supernormal profits in the short –run. If monopolists making sub – normal profit in the short – run so long as it AVCis covered. Thus, in the short run under monopoly there are three possibilities.



AC

Price and MC/ Revenue

A1P1

Normal Profits

E1AR

MR

O Q1 Output (units)

E1 is the point of equilibrium, OQ1 is he equilibrium output and OP1 is theequilibrium price.

AC = A1Q1AC = AR, the firm makes normal profits

Super normal profits

AC

Price and MC/ Revenue P2

C1 A2

E2

O

Q2 Output (units)E2 is the point of equilibrium, OQ2 is the equilibrium output, OP2 is equilibriumprice,

AC = A2Q2



AR = R2Q2

AR>AC, the firm makes super – normal profits equal to the area given byP2R2A2C2

Sub normal Profits covering AVC

E3 is the point of equilibrium, OQ3 is the equilibrium Output, OP3 is theequilibrium price.

AC – A3Q3AR – R3Q3 AVC – R3Q3

AR<AC, the firm makes sub – normal profits equal to C3AS3R3P3. Even thoughthe firm makes losses. It continues to produce in the short run because AVC isrecovered.



Long run equilibrium under Monopoly: A firm under monopoly may make normalprofits in the long – run; however, it tries to super – normal (abnormal)profits in the long run. LRAC is flatter than the short run average cost curve,but the conditions of equilibrium are the same as in short run.

AR – R0Q0; AC- C0Q0, AR, AC so the firm makes super normal profits equal to

P0R0C0P.

Que- Explain Baumol’s theory of sales revenue maximization what are itsassumptions?

Ans. According to Baumol, every business firm aims at maximization it salesrevenue (price x quantity0 rather than its profit. Hence his hypothesis has cometo be known as sales maximization theory & revenue maximization theory.According to baumol, sales have become an end by themselves and accordinglysales maximization has become the ultimate objective of the firm. Hence, themanagement of a firm directs its energies in promoting and maximizing its salesrevenue instead of profit.

The goal of sales maximization is explained by the management’s desire tomaintain the firm’s competitive position, which is dependent to a large extent onits size. Unlike the shareholders who are interested in profit, the management isinterested in sales revenue, either because large sales revenue is a matter of prestige or because its remuneration is often related to the size of the firm’s



operations than to its profits. Baumol, however does not ignore the cost of production which has to be covered and also a margin of profit. In fact, headvocates the adoption of a price, which will cover the cost and also will yield aminimum rate of profits. That is, while the firm is maximizing its revenue fromsales, it should also “enough or more than enough profits” to keep the

shareholders satisfied. According to Baumol the typical digopolists objective canusually be characterized approximately as sales maximization output does notyield adequate profit, the firm will have to choose that output which will yieldadequate profit even through it may not achieve sales maximization.

According to sales revenue maximization theory, graphs, cost and revenuecurves are given as in conventional theory of pricing, suppose that the total cost(TC) and the total revenue (TR) curves are given, the profit curves (TP) isobtained by plotting the difference between TR and TC curves. Profit are zerowhere TR = TC. The total sales revenue is maximization where slope of TRcurve i.e MR = is equal to zero. Such a point lies at the highest point of the

TR curve. The highest point on the TR curve can be obtained easily by drawing aline parallel to the horizontal axis and tangent to the TR curve. The point H on theTR curve represents the total maximum sales revenue. A line drawn from point Hto output axis shows sales revenue is maximized at output OQ3 and its priceequals HQ3 / DQ3.

Profit Constraint and Revenue maximization :At output OQ3, the firmmaximizes the total revenue and makes profit HM = TQ3. If the profit is enough or more than enough to satisfy the shareholders, the firm will produce output OQ 3

and charge a price = HQ / OQ3. But if profit at output OQ3 is not enough to satisfythe shareholders, then the firm’s output must be say OQ2 which yields a profitLQ2> TQ3.



Thus, there are two types of probable equilibrium: one is which the profitconstraint does not provide as effective barriers to sales maximization, andsecond in which profit constraint does provide as effective barriers to salesmaximization. In the second type of equilibrium, the firm will produce an outputwhich yields a satisfactory ar target profit. It may be an output between OQ1 and

OQ2 .e.g if minimum required profit is OP1, than the firm will stick to its salesmaximization goal and produce output OQ3 which yields a profit much greater than the required minimum.Since actual profit (TQ3) is much greater than the minimum required, theminimum profit constraint is not operative, But, if required minimum profit level isOP2, OQ3 will not yield sufficient profit to met the profit target. The firm will,therefore, produce an output OQ2 where its profit is just sufficient to meetrequirement of minimum profit. This output OQ2 is less than the salesmaximization output OQ3. Evidently the profit maximization output OQ1 is lessthan the sales maximization output OQ2. (with profit constraint)

Q. No. Explain the technique of multi-product pricing. What is the rationaleof the technique?

Ans. Almost all the firms have more than one product in their line of production.Even the most specialized firms produce a commodity in multiple models, stylesand size, each so much differentiated from the other that each moder or size of the product may be considered a different products e.g. the various models of television, refrigerators etc produced by the same company may be treated asdifferent product for at least pricing purpose. The various models are sodifferentiated that consumers view them as different products. Hence each modelor product has different average revenue (AR) and Marginal Revenue curves and

that one product of the firm concepts against the other product. The pricing under this condition is known as multi-product pricing or product line pricing. In multi-product pricing, each product has a separate demand curve. But, since all of them are produced under one organization by interchangeable productionfacilities, they have only one inseparable marginal cost curve. That is, while

revenue curves, AR and MR, are separate for each product, cost curves AC andMC are inseparable.

A B C D MC

D1 D2 D3 D4

costand

P1 P2 P3 P4

RevenueEMR

MR1 MR2 MR3 MR4



QQ1 Q2 Q3 Q4

Quantities demanded per time unitSuppose a firm has four different products A, B, C and D in its line of production.

The marginal cost of all the products can be taken together as curve MC, whichis the factory marginal cost curve. When the MRs. For the individual products aresummed up, the aggregate MR passes through point C on MC curve. If a lineparallel to the X – axies, is drawn from point C to the Y- axis through the MRs,the intersecting point will show the points where MC and MRs are equal for eachproduct, represented by the line EMR and MRs determine the output level andprice for each product, the output of the four product are given as OQ1 of productA; QQ2 of B; Q2Q3 of C; and Q3Q4 of D. The respective prices for the four products are P1Q1 for product A; P2 Q2 for B; P3Q3 for C; and P4q4 for D, These

Que- What is Managerial Economics? Discuss the characteristics and

Scope of managerial economics. How does economic theory con--

tribute to managerial decision?

Ans. Economics is a social science, which studies human behavior

in relation to optimizing allocation of available resources to achieve the

given ends .

The application of economic science is all

Pervasive .More specifically economic laws and tools of economic

Analysis are applied a great deal in the progress of business deci-sion making. This has led to the emergence of a separate branch

of study called Managerial Economics .

“Managerial Economics is the study of eco--nomics theories, logic and tools of economic analysis that are

used in the process of business decision making . Economic theory

and technique of economic analysis are applied to analyze business

problems , evaluate business options and opportunities with a viewto arriving at appropriate business decision . Managerial economic

is thus constituted as that part of economic knowledge , logic ,

theories and analytical tools that are used for rational business

decision making . Economics through, variously defined is ess-

-entially the study of logic , tools and techniques of making opti--mum use of the available resources to achieve the given ends. Economics

thus provides analytical tool and technique that managers need to

achieve the goals of the organization they manage .



Baumaol has pointed out there main contributions of economic

theory to business. First one of the most important !Unexpected End of

Formula

Things which the economic theories can contribute to the manage-

-ment science is building analytical models which help to recog-

-nize the structure of managerial problems , eliminate the minor details which might obstruct decision making and help to concen-

-trate on the main issue . Secondly, Economic theory contributes

to the business analysis & set of analytical methods which may not be applied directly to specific business problems, but they do

Entrance the analytical capabilities of the business analyst .

Thirdly, Economic theories offer clarity to

the various concepts used in business analysis , which enables thethe managers to avoid conceptual pitfalls .

The areas of business issues to which eco-

-nomics theories can be directly applied may be broadly divided

into two categories :- (a) Operational or internal issues and(b) Environmental or external issues .

(a) Operational problems are of internalnature . They include all those problems which arise within the

business organization and fall within the preview and control of

the management . Some of the basic internal issues are (i) choice

of business and the nature of product i.e. what to produce ;

(ii) choice of size of the firm i.e.. how much to produce (iii) choice

of technology i.e. choosing the factor contribution ; (iv) choice of

price i.e. how to price the common ; (v) how to promote sales ;

(vi) How to face price competition (vii) How to decide on new

investment ; (viii) How to manage profit and capital ; (ix) How to

manage inventory i.e. stock of both finished goods and how mate--rial . The Microeconomic Theories which deals most of these

questions include :-

1. Theory of demand .

2. Theory of production and production decisions.

3. Analysis of market structure and pricing theory.4. Profit analysis and profit management.5. Theory of capital and investment decision .

(b) Environmental issues pertain to the general business environment in

which a business operates . They are related to the overall economic,social and political atmosphere

of the country . The factors which constitute economic environ-

-ment of a country include the following factors :-

1. The type of economic system of the country .

2. General trend in production, employment, income, price ,

Savings and investment etc .

3. Structure of the trends in the working of financial institutes



e.g. banks , financial co-operations , insurance companies

4. Magnitudes of trends in foreign trend

5. Trends in labor and capital markets

6. Government’s economic policies e.g.. industrial policy ,

monetary policy , fiscal policy , price policy etc .

7. Social factors like the value system of the society ,propertyrights, customs and habits .

8. Social organizations like trade unions, customer’s9. co-operatives and producers union .

9. The degree of openness of the economy and the influence

MNCs.

Q What do you understand by Opportunity cost ? Give suitable

Examples to illustrate the use of this concept in the context of

managerial decisions relating to

(a) Production (b) Finance (c) Marketing

Can opportunity cost ever be zero ?

Ans. The concept of opportunity cost is attributed to the alternate uses

of scarce resources . Resources both natural and man made , arescarce in relation to their demand to satisfy the ever growing

human needs and the resources have alternative use . The scarcity

and the alternative uses of the resources give rise to the conceptof opportunity cost .

Opportunity cost of availing an opportunity

is the expected income forgone from the second best opportunityof using the resources e.g.. :-

1. Finance :- Suppose a firm has Rs. 100 million at its

disposal and there are only three alternativeuses :-

Alternative:- (i) To expand the size of the firm(ii) To set up a new production

unit in another locality and(iii) To buy shares in another firm .

Suppose the expected annual return from thethree alternatives uses of finance are :-

Alternative 1:- Expansion of the size of the firm



Rs. 20 million Alternative 2:- Setting up a new production unit

Rs. 18 million Alternative 3:- Buying shares in another firm

Rs. 16 million

All other steps being the same , rational

decision-making would suggest invest the money in alter-

-native – 1 . This implies that the manager would have tosacrifice the annual return of Rs. 18 million expected from

Alternative – 2 .In economic jargon Rs. 18 million is called

annual opportunity cost of an annual income of Rs. 20

million .

2. Production :- Suppose that a firm has a sum of Rs. 100000

which it has only two alternative uses . It can either buy a printing

machine or alternatively a lathe machine, both having a productivelife of 10 years . From the printing machine , the firm expects

an annual income ofRs. 20,000 and from the lathe , Rs.

15,000 . A profit

maximizing firm would invest its money in the printing

machine and forego the expected income from printing

machine is the expected income from the lathe i.e.. Rs.15000 .

Marketing :- Suppose a company can sell a basketof apples for Rs. 1000/- in foreign market for Rs. 600/- in domestic market .

The company hence should export its produce . Hence the

opportunity cost from export market is the expected incomefrom domestic market i.e.. Rs. 600/- per market .

The opportunity cost is also called Alternate Cost, had theresources available to a person , a firm or a society been

unlimited there would be no opportunity cost. But since resources

are limited, hence opportunity cost can

never be zero .

Que- Define price elasticity of demand and distinguish its various types

Discuss the role of price elasticity of demand in managerial

decision?



Ans. Ans. The degree of responsiveness of demand to the change in its

determinants is called elasticity of demand. The concept of demand elasticity is used in

business decisions are (1) Price elasticity; (2) Cross – elasticity (3) Income elasticity (4)Elasticity of price expectation.

1) 1) Price elasticity of demand is generally defined as the responsiveness or sensitivity of demand for a commodity to change in its price. More precisely,

elasticity of demand is the percentage change in demand because of one percent

change in the price of the commodity. The price elasticity of demand (ep) is givenas

Ep = Percentage change in quantity demanded

Percentage change in price

Ep = Q ÷ P = Q × P ⇒ Q Q

Q P Q P P P

Q = Changes in quantity Q = Original quantity

P = Change in price P = Original Price

2) 2) Cross Elasticity is the measure of responsiveness of demand for a

commodity to the changes in the price of its Substitutes and complementary goods

.for example, cross elasticity of demand of tea is the percentage change in itsquantity demanded with respect to the changes in the price of its substitutes

coffee. The formula for tea and same for coffee is given by Ep = Percentage change in demanded for tea Qt

Percentage change in price of coffee

Ep = Pc . QtQt Pc

3) 3) Income Elasticity of demand is responsiveness of demand to the changes in

income.Income elasticity of demand for product X may be defined as

X ÷ Y = Y × XX Y X Y

Where X = Quantity of X demandedY = Disposable Income



X = Change in quantity demanded

Y = Changes in Income

4) 4) Advertisement Elasticity of sales is defined as responsiveness of demand /

sales to the changes in advertisement expenditure

Percentage change in demanded for tea Qt

Percentage change in Advt expenditure

S / S = S . A

A/A A S

Where S = Sales, S = increase in sales

A = initial advertisement expenditure

A = additional expenditure on advertisement

5) 5) Elasticity of Price Expectations refers to the expected range in future price

as a result of change in current prices of a product. The elasticity of priceexpectation is defined as measured by the formula

Ex = Pf / Pf = Pf . PcPc/ Pc Pc Pf

Where Pc and Pf are current and future prices respectively.

The co – efficient ex gives the measure of expected percentage change in future

price as a result of 1% change in present price, if ex >1, it indicates that future change in price will be greater than the present change in price, and vice versa.

Que- What are the objectives of demand forecasting? Critically evaluate

survey methods of demand forecasting?

Ans. Demand estimation is predicting future demand form a product. Theinformation regarding future demand is essential for planning and schedulingproduction, purchase of raw materials, acquision of finance and advertising.

The various techniques of demand estimation: -

3) Survey Method4) Statistical Method



Survey Method

Survey method is generally used where the purpose is to make short run forecastof demand. Under this method, customer surveys are conducted to collect

information about their intentions and future purchase plan. This method includes

(c) Consumer survey method(d) Opinion Poll method

Consumer survey methodMay be in form of

d) Consumer enumeration: - In this method, almost all the potential users of theproduct are contacted and are asked about the future plan of purchasing theproduct in question. The quantities indicated by the consumers are added

together to obtain the probable demand for the product.

e) Sample survey method: - Under this method only a few potential consumersselected from relevant market through a sampling method are surveyed, onthe basis of the information obtained, the probable demand may be estimatedthrough the following formula.

D = HR (H.AD)Hs

Where D = probable demand forecastH = Census number of households from the relevant market.

Hs = number of households reporting demand for the product.HR = number of households reporting demand for the product.AD = average expected consumption by the reporting households.

f) End User Method: - The end user method of demand forecasting is used for estimating demand for inputs. Making forecast by this method requiresbuilding up a schedule of probable aggregate future demand for inputs byconsuming industries and various other sectors.

Opinion poll Method

The opinion poll methods aim at collecting opinion of those who are supposed topossess knowledge of the market e.g. sales representative, professionalmarketing experts and consultants. The opinion poll method include

d) Expert opinion method: - Firms having a good network of sales representativecan put them to work of assessing the demand for the product in the areasthat they represent. Sales representative, beings in close touch with the



consumers are supposed to know the future purchase plans of their customer, their reaction to the market changes, their response to theintroduction of new products and the demand for competing products. Theyare, therefore, in a position to provide an estimate of likely demand for their firm’s product in the area. The estimates of demand thus obtained from

different regions are added up to get the overall probable demand for aproduct.

e) Delphi Method: - Delphi method is used to consolidate the divergent expertopinions and arrived at a compromise estimate of future demand.

Under Delphi method the expert are provided information on estimates of forecast of other experts along with the underlying assumptions. The expertsmay revise their own estimates in the light of forecast made by other experts.The consensus of experts about the forecasts constitutes the final forecast.

Although this method is simple and inexpensive, it has its own limitations. Firstestimates provided by sales representations and professional experts are reliableonly to extend depending upon their skill to analysis the market and their experience. Second, demand estimates way involve the subjective judgement of the which may lead to over or under estimation, finally, the assessment of marketdemand is usually based on inadequate information’s, such as changes in GNP,available of credit, future prospects of the industry etc, fall outside their purview.

f) Market studies and Experiments:- It is a method of collecting necessaryinformation regarding demand is to carry out market studies and experiments

on consumer’s behavior under actual through controlled market conditions.This method is known in common parlance market conditions. This methodsis known in common parlance as market experiment method under thismethod, firms first select some areas of the representative markets – three or four cities having similar features viz. Population, income levels, cultural andsocial background, occupational distribution, choices and preferences of consumers. Then, they carry out market experiments by changing prices,advt. Expenditure and other controllable variable in the demand functionunder the assumption that other thing remains same. The controlled variablemay by changed over time either simultaneously in all the markets or in all themarkets or in the selected markets. After such changes are introduced in themarket, the consequent changes in the demand over a period of time (aweek, a fortnight or month) are recorded. On the basis of data collectedelasticity coefficient are computed. These coefficients are then used alongwith the variables of the demand function to assess the demand for product

The market experiments methods have certain serious limitations. First, thismethod is very expensive and hence cannot be afforded by small forms. Second,



being a costly affair, experiments are usually carried out on a scale too small topermit generalization with a high degree of reliability.

Third experimental methods are based on short – term and controlled conditionsthat may exist in an uncontrolled market. Hence, the results may not be

applicable to the uncontrolled long-term conditions of the market.

Statistical Method

Statistical method of demand projection include the following techniques

4) Trends Projection Method5) Barometric Method and6) Economic Method

Trends Projection Method

Trend projection method is a classical method of business forecasting. Thismethod is essentially concerned with the study of movement of variable throughtime. The use of this method requires a long and reliable time series data. Thetrend projection method is used under the assumption that the factorsresponsible for the past trends in variables to be projected (e.g. sales anddemand) will continue to play their part in future in the same manner and to thesame extend as they did in the past in determining the magnitude and direction

of the variable.

There are three (3) techniques of trend projection based on time – series data.

(d) Graphical Method: - under this method, annual sales data is plotted on agraph paper and a line is drawn through the plotted points. Then a free handline is so drawn that the total distance between the line and the point isminimum.

Sale



YearsTrend Projection

Although this method is very simple and least expensive, the projections madethrough this method are not very reliable. The reason is that the extension of thetrend line involves subjectivity and personal bias of the analysis.

(e) Fitting Trend Equation: Least square method: - Fitting trend equation is aformal technique of projecting the trend in demand. Under this method, atrend line (or curve) is fitted to the time – series data with the aid of statisticaltechniques. The form of the trend equation that can be fitted to the time series

data is determined either by plotting the sales data or by trying different formsof trend equations for the best fit.When plotted, a time series date may show various trends. The most commontypes of trend equation are 1) liner and 2) exponential trends

Linear Trend: - When a time series data reveals a rising trend in sales than astraight-line trend equation of the following form is fitted

S = A + BTWhere S = annual sales

T = Time (in year)

A & B are constant. The parameter b given the measure of annualincrease in sales

Exponential trend:- When sales ( or any dependent variable) have increased over the past years at an increasing rate or at a constant percentage rate, than theappropriate trend equation to be used is an exponential trend equation of any of the following type 3. Y = aebtOr its semi – logarithmic for Log y = = log a + bt

This form of trend equation is used when growth rate is constant.

4. Double log trend equation of equationY = aTB

Or it’s double logarithmic formLog y = log a + b log tThis form of trend equation is used when growth rate is increasing.





Regression methodRegression analysis is the most popular method of demand estimation. Thismethod combines economic theory and statistical techniques of estimation.Economic theory is employed to specify the determinants of demand and todetermine the nature of the relationship between the demand for a product and

its determinants. Economics theory thus helps in determining the general form of demand function. Statistical techniques are employed to estimate the values of parameters in the estimation equation.

Simultaneous Equation MethodIt involves estimating several behavioral equations. These equations aregenerally behavioral equations, Mathematical equations and Market – clearingequations. The first step in this technician is to develop a complete model andspecify the behavioral assumption regarding the variables included in the model.The variables that are included in the model are3) Endogenous variables

4) Exogenous variables

Endogenous variables – the variables that are determined within the model arecalled endogenous variables. Endogenous variables are included in the model asdepended variables that are the variables that are to be explained by the model.These are also called controlled variables. The number of equations included inthe model must be equal to number of endogenous variables.

Exogenous variables – are those that are determined outside the model.Exogenous variables are inputs of the model whether a variable is treatedendogenous variables or exogenous variables depend on the purpose of the

model. The examples of exogenous variables are “ Money Supply”, tax rates,govt. spending etc. The exogenous variables are also known as uncontrolledvariables.

Que- What is price discrimination? Under what conditions sellers

Resort to it Do you support it ? Explain.

Ans. A special feature of a monopoly is Price Discrimination i.e.charg-

ing different prices from different customers for the same or

substantially the same commodity at the same time . The mono-

- polist may charge different prices from different groups of con- -sumers if by this method he can increase his total profit .





price discrimination . If price elasticities of demand

in different markets are the same , price discrimi-

-nation would reduce the profit by reducing thedemand in the high price markets .

3. There must be imperfect competition in the market.The firm must have monopoly over the supply of

the product to be able to discrimination between

different class of consumers , and change different prices .

4. Profit maximizing output is much larger than the

quantity demand in a single market or section of consumers .

Price discrimination can be justified if it is

Practiced by government for the purpose of bringing socialequality or to promote specific activities in the society e.g.. rail-

-ways , controlled by government , charge lower fare from childrenand student on their academic tower etc. But if price discrimination

is practiced by private sector to exploit consumers and increase

their own profit margin , then government should device legislative

measure to control such activities .

Que- Explain the types and characteristics of isoquant curves .Show with

the help of illustration , how will you determine the least cost

combination .

Ans. The term “isoquant” has been derived from the Greek word “iso”

meaning equal and Latin word “quantus” meaning “quantity”.

The “isoquant curve” is ,therefore, also known as “ Equal product

curve” or “ Production Intelligence Curve” .An isoquant curve is locus of point representing

various combinations of two inputs – capital and labor – yielding

the same output .

Isoquant curves are drawn on the basis of the

following assumptions :-

(i) There are only two inputs , v12 , labor ( L ) andcapital (K) tom produce a commodity X .

(ii) The two inputs – L and K – can substitute each

other but at diminishing rate .

(iii) The technology of production is given .

Given these assumptions , it is always possible to

produce given quantity of commodity X with various combination



of labor and capital . The factor combinations are so formed that

the substitution of one factor for the other leaves the output

unaffected .The technology is presented through are isoquant curve( IQ1 = 100 ) . The curve IQ1 all along its length represents a fixed

quantity , 100 units of product X . This quantity of output can be

produced with a number of labor-capital combination. For example:- Points A , B , C and D on the isoquant curve IQ1

shows four different combinations of inputs , K

and L , all yielding the same output – 100 units .

The movement from A to B indicates decreasing

Quantity Of K and increasing number of L .This implies substi-

-tution Of labor for capital such that all the input combinations

yield the same quantity of commodity X i.e.. IQ1 = 100 .

Characteristics of Isoquant Curves :-

a) Isoquant have a negative slope :- An isoquant has a ne-

-gative slope in the

economic region or in the relevant range .The negative slope of theisoquant implies substitutability between the inputs .It means if one

of the inputs is reduced , the other input has to be increased suchthat the total output remains unaffected .

b) Isoquant are convex to the origin :- Convexity of isoquantimplies to :-

(i) substitution between the inputs





This is possible only when two factors K and L are perfect substi-

-tutes for one another . A Linear isoquant also implies that theMRTS between K and L remains constant throughout .

b) Fixed factor-proportion or L-shaped isoquant :-

When a production function assumes a fixed

proportion between K and L , the isoquant takes ‘L’ shape .Such an

isoquant implies zero substitutability between K and L . Instead , it

assumes perfect complementarily between K and L . The perfect

complementarily assumption implies that a given quantity of acommodity can be produced by one and only one combination of

K and L and that the proportion of the inputs is fixed . It alsoimplies that if the quantity of an input is increased and the quantity

of the other input is hold constant there will be no change in output

The output can be increasing both the inputs proportionality .



Least cost combination :- In order to determine the best

combination of capital andlabor to produce that output , one has to know the amount of

finance available to the producer to spend on the inputs and also

the prices of the input . Suppose that the producer has at itsdisposal Rs. 10,000 for the two inputs , and that the prices of the

two inputs as Rs. 1000 per unit of capital and Rs. 200 per unit of

labor . The firm will have three alternative possibilities before it .

a) To spend the money only on capital and secure 10units of it .

b) To spend the amount only on labor and secure 50

unit of labor

c) To spend the amount partly on capital and partly onlabor .

The factor price line is also known as iso-

-cost line because it represents various combinations of inputs

that may be purchased for the given amount of money allocated .

The slope of the factor price line shows the price ratio of capital and labor i.e.. 1:5 . By combining the iso-

-quant and the factor price line , one can find out the optimum

combination of factors which will maximize output .



Equal product curves IQ1 , IQ2 , and IQ3 represents output of 1000

units , 2000 units and 3000 units respectively . AB is the factor

price line . At point E the factor-price line is tangent to isoquantIQ2 representing 2000 units of output . Point E indicates the maxi-

-mum amount of capital and labor which the firm can combine to

produce 2000 units of output . The isoquant IQ3 falls outside thefactor price line AB and therefore cannot be chosen by the firm .

On the other hand , Isoquant IQ1 will not be

preferred by the firm even though between R and S it falls within

the factor price line .Points R and S are not suitable because outputcan be increased without increasing additional cost by the selection

of a more appropriate input combination . Point E , therefore ,is the

ideal combination which maximizes output or minimizes cost per unit , it is the point at which the firm is in equilibrium .

Que- Write short notes on the following:-

a) Multi-product pricing

b) Transfer Pricing

c) Average Cost Pricing

Ans. a) Multi-product Pricing :-

Almost all the firms have more than one product in their line of production. Even the most specialized firms produce a commodity in multiplemodels, styles and size, each so much differentiated from the other that eachmoder or size of the product may be considered a different products e.g. thevarious models of television, refrigerators etc produced by the same company



may be treated as different product for at least pricing purpose. The variousmodels are so differentiated that consumers view them as different products.Hence each model or product has different average revenue (AR) and MarginalRevenue curves and that one product of the firm concepts against the other product. The pricing under this condition is known as multi-product pricing or

product line pricing. In multi-product pricing, each product has a separatedemand curve. But, since all of them are produced under one organization byinterchangeable production facilities, they have only one inseparable marginalcost curve. That is, while

revenue curves, AR and MR, are separate for each product, cost curves AC andMC are inseparable.

A B C D MC

D1 D2 D3 D4

cost

and P1 P2 P3 P4

RevenueEMR

MR1 MR2 MR3 MR4

QQ1 Q2 Q3 Q4

Quantities demanded per time unit

Suppose a firm has four different products A, B, C and D in its line of production.The marginal cost of all the products can be taken together as curve MC, whichis the factory marginal cost curve. When the Mrs. For the individual products aresummed up, the aggregate MR passes through point C on MC curve. If a lineparallel to the X – axies, is drawn from point C to the Y- axis through the MRs,the intersecting point will show the points where MC and MRs are equal for eachproduct, represented by the line EMR and MRs determine the output level andprice for each product, the output of the four product are given as OQ1 of productA; QQ2 of B; Q2Q3 of C; and Q3Q4 of D. The respective prices for the four products are P1Q1 for product A; P2 Q2 for B; P3Q3 for C; and P4q4 for D, Theseprice and output combinations maximize the profit from each product and hencethe overall profit of the firm.

b) Transfer Pricing :- The large size firms divide

their operation very often into

Product decisions or subsidiaries. Growing firms add new



Divisions or departments to the existing ones .The firm then

Transfer some of their activities to other division .The goods

or services produced buy other divisions are used by the parent organization.

In other word, the parent div-

-ision buys the product of its subsidiaries. Such firms facethe problem of determining the appropriate price for the

product transferred from one division or subsidiary to the

other . Specifically, the problem is of determining the priceof a product produced by one division of the same firm .

This problem becomes much

More difficult when each division has a separate profit

function to maximize .Price of intra-firm ‘transfer product’

is referred to as “Transfer pricing” .

c) Average cost Pricing :- Average cost pricing is also

is also known as “make-up Pricing” or “Cost plus pricing” . Average cost pricing is

the most common method of pricing used by the manu--factoring firms . The general practice under this method is

to add a “fair” percentage of profit margin to the average

variable cost ( AVC ) . The formula for setting the price is

given as :-

P = AVC + AVC ( m )

Where AVC = average variable cost;

m = make up percentage and AVC ( m ) = gross profitmargin ( GPM )

The make-up percentage (m)

is fixed so as to cover average Fixed cost ( AFC ) and net

Profit margin ( NPM ) . Thus,

AVC ( m ) = AFC + NPM

The procedure for arriving at

AVC and price fixation may be summarized as follows:-

Step-1 :- Estimate the average variable cost . For this,

the firm as to ascertain the volume of its

Output for a given period of time, usually one accounting or

fixed period . To ascertain the output the firm uses figuresof its “Planned” or “Budgeted” output or take into account

its normal level of production . If the firm is in a position

to compute its optimum level of output or the capacityOutput, the same is used as standard output in computing

the average cost .

Step-2 :- is to complete total variable cost ( TVC ) of



the “Standard output” . The TVC includes

direct cost i.e.. the cost of labor and raw material ,and other

Variable costs. These costs added together give the totalvariable cost . The average variable cost ( AVC) is then

Obtained by dividing the total variable cost (TVC ) by the

standard output ( Q ) i.e.. AVC = TVC / Q

After AVC is obtained ,a ‘make-up’ of some percentage of AVC is added to it as profit margin and the

price is fixed . While determining the make-up , firms alw-

-ays take into account ‘ what the market will bear ’ and the

competition in the market .

Que- Given the demand and total cost functions specified determine

the Optimal output , price P , total profit T and total revenue R a) under sales maximization

Ans. Ans. According to Baumol, every business firm aims atmaximization it sales revenue (price x quantity0 rather than its profit. Hence hishypothesis has come to be known as sales maximization theory & revenuemaximization theory. According to baumol, sales have become an end bythemselves and accordingly sales maximization has become the ultimateobjective of the firm. Hence, the management of a firm directs its energies inpromoting and maximizing its sales revenue instead of profit.

The goal of sales maximization is explained by the management’s desire tomaintain the firm’s competitive position, which is dependent to a large extent onits size. Unlike the shareholders who are interested in profit, the management isinterested in sales revenue, either because large sales revenue is a matter of prestige or because its remuneration is often related to the size of the firm’soperations than to its profits. Baumol, however does not ignore the cost of production which has to be covered and also a margin of profit. In fact, headvocates the adoption of a price, which will cover the cost and also will yield aminimum rate of profits. That is, while the firm is maximizing its revenue fromsales, it should also “enough or more than enough profits” to keep theshareholders satisfied. According to Baumol the typical digopolists objective can

usually be characterized approximately as sales maximization output does notyield adequate profit, the firm will have to choose that output which will yieldadequate profit even through it may not achieve sales maximization.

According to sales revenue maximization theory, graphs, cost and revenuecurves are given as in conventional theory of pricing, suppose that the total cost(TC) and the total revenue (TR) curves are given, the profit curves (TP) isobtained by plotting the difference between TR and TC curves. Profit are zero



where TR = TC. The total sales revenue is maximization where slope of TRcurve i.e MR = is equal to zero. Such a point lies at the highest point of theTR curve. The highest point on the TR curve can be obtained easily by drawing aline parallel to the horizontal axis and tangent to the TR curve. The point H on theTR curve represents the total maximum sales revenue. A line drawn from point H

to output axis shows sales revenue is maximized at output OQ3 and its priceequals HQ3 / DQ3.

Profit Constraint and Revenue maximization :At output OQ3, the firmmaximizes the total revenue and makes profit HM = TQ3. If the profit is enough or more than enough to satisfy the shareholders, the firm will produce output OQ 3

and charge a price = HQ / OQ3. But if profit at output OQ3 is not enough to satisfythe shareholders, then the firm’s output must be say OQ2 which yields a profitLQ2> TQ3.

Thus, there are two types of probable equilibrium: one is which the profitconstraint does not provide as effective barriers to sales maximization, andsecond in which profit constraint does provide as effective barriers to salesmaximization. In the second type of equilibrium, the firm will produce an outputwhich yields a satisfactory ar target profit. It may be an output between OQ1 andOQ2 .e.g if minimum required profit is OP1, than the firm will stick to its salesmaximization goal and produce output OQ3 which yields a profit much greater

than the required minimum.Since actual profit (TQ3) is much greater than the minimum required, theminimum profit constraint is not operative, But, if required minimum profit level isOP2, OQ3 will not yield sufficient profit to met the profit target. The firm will,therefore, produce an output OQ2 where its profit is just sufficient to meetrequirement of minimum profit. This output OQ2 is less than the sales

i i ti t t OQ E id tl th fit i i ti t t OQ i l

Documents

Que- What is the Basic Objectives Of