MANAGERIAL ECONOMICS BASIC TECHNIQUES IN MANAGERIAL ECONOMICS (ME) 1.

Define managerial economics and explain its interrelationship with other disciplines. A close interrelationship between mgmt & eco has led to the development of ME. ME is concerned with the application of economic principles & methodologies to the decision making process within the firm or orgn under the conditions of uncertainty. Countless firms have used the well established principles of ME to improve their profitability. ME draws on eco analysis for such concepts as cost, demand, profit & competition. It attempts to bridge the gap between the purely analytical problems & the day to day decisions that mgrs must face. The study of eco deals with a fundamental problem which is scarcity, which stems from 2 fundamental facts i.e. Human wants are unltd & insatiable Resources to satisfy these needs are scarce.

On the other hand a firms objective is to make profits & hence has to make decisions in 3 areas i.e. What to produce? How to produce? For whom to produce?

These three problems have become the three central problems of an economy. The science of eco has developed several concepts & analytical tools to deal with the problem of allocation of scarce resources among competing ends. ME is thus the study of allocation of resources available to a firm or a unit of mgmt among the activities of that unit. ME is linked with various other fields of study like: 1. Microeconomic Theory: Roots of ME spring from microeconomic theory. Price theories; demand concepts & theories of mkt structure are new elements of microeconomics used my ME. It has an applied bias as it applies to eco theories in order to solve real life problems of enterprises. Macroeconomic Theory: this field has little relevance for ME but for one part i.e. National income forecasting (NIF). NIF could be an imp aid to business condition analysis which in turn could be a valuable input fro forecasting the demand for specific product groups. Operation Research (OR): This field is used in ME to find out the best of all possibilities. OR is a gr8 aid in decision making in business & industry as it can help in solving problems like distribution of commodities, optimum product mix etc. Theory of Decision Making: Decision theory deals with problems of decision making under uncertainty. It recognises multiplicity of goals & persuasiveness of uncertainty in the real world of mgmt. Statistics: Statistics helps in empirical testing of theory. With its help better decisions relating to demand & cost functions, prodn, sales or distribution are taken. ME is heavily dependent on statistical methods. Mgmt theory & Accounting: Maximisation of profits has been regarded as a central concept in the theory of the firm in microeconomics. In recent years, orgn theorists have talked abt satisfying instead of maximising as an objective of an enterprise. Accounting data & statements constitute the language of business. The link is so close that mgmt accounting is developed as a separate & specialised field in itself.

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2. Explain the characteristics and problems of decision making. Have you personally involved in the making of a decision for a business concerning, what, how or for whom? Explain your rationale for making such decisions. Characteristics of decision making: The problem or the objective should be defined properly. It requires only as much information and analysis as is necessary to resolve a particular dilemma. It must be based on data and must incorporate multiple, knowledgeable points of view Decision should be made at a proper time to meet the competitive advantage. It considers both short term & long term organisation goals. It focuses on what is important. It is logical & consistent. It acknowledges both subjective & objective thinking & blends analytical with intuitive thinking.

Problems in decision making: The objective is not clear: Very often the objective that is being discussed means different to different individuals i.e. the objective is not clearly defined and communicated to the team involved in decision making. Lack of sufficient information: Most often the study conducted or the information collected may not be sufficient to take the right decision & the decision taken in the light of this information may not be always right. Personal biases: Individuals have certain set of beliefs. These beliefs differ depending on the culture, experience, age etc. These beliefs tend to form biases in the mind of the decision taker & may alter his perspective about the problem faced. Peer pressure can really influence decision making: Especially when a situation is uncertain people look to their peers to see what they are doing. Risks involved are high & irreversible: Sometimes the decision when implemented can be irreversible which can prove costly to an organisation if it is wrong. Due to this fear most often the management takes a conservative approach to decision making. Market dynamics: The market dynamics change within a short period of time & hence may prove as a problem in effective decision making.

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3. Explain subject matter and scope of economics. Economics is the science that studies & analyses, how scarce resources are employed for the satisfaction of the needs of men living in the society. It is interested in the essential operations of production, distribution and consumption of goods and service. Scarcity of resources results from 2 fundamental facts in life i.e. 1. Human wants are virtually unlimited & insatiable &

2. Economic resources to satisfy these human demands are ltd. The basic 3 problems of economics are 1. 2. 3. What to produce, How to produce & For whom to produce.

In order to use the limited resources efficiently & provide opportunities & systematic ways economics studies. Thats why economics has to tackle these fundamental problems. Thus the key components of of the subject matter of economics are: 1. The presence of scarcity 2. The behaviour of individuals who are faced with scarcity 3. The interactions of individuals who face scarcity and 4. The existence and operation of institutions to facilitate the interaction of individuals who are faced with scarcity. The scope of economics is the area or boundary of the economics study. Economics is used in our day to day personal as well as business decisions. They are as follows:

1. Market economy: Economics deals with demand, supply & balance of market. It determines price of & quantities of commodities 2. Deals with production, consumption distribution & exchange: Economics focus on different activities like as production, consumption & distribution. Economic instruments such as money, tax, interest rates are necessary for production, consumption,
3. 4. exchange & distribution. Deals with economic activities: Economics is concern with such activities as relate to acquiring wealth & spending wealth. These twos are twos corner-stones of economics. To solve economic problems: The basic 3 problems of economics are what to produce, how to produce & for whom to produce. In order to use the limited resources efficiently & provide opportunities & systematic ways economics studies. Thats why economics has to tackle these fundamental problems.

4. Explain relationship between managerial economics and other disciplines. Pls refer to Question 1

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5. Concepts and short notes: 1. Incremental concept: Incremental reasoning involves estimating the impact of decision alternatives. The 2 basic concepts in the incremental analysis are Incremental cost (IC) Incremental Revenue (IR)

IC is defined as the change in total cost as a result of change in the level of output, investment, etc. IR is defined as the change in total revenue resulting from a change in the level of output, prices, etc. A manager always determines the worth of his decision on the basis of the criterion that IR>IC. For e.g. Let us take a case where a firm gets an order which can get it additional revenue of Rs. 2000/-. The normal cost of prodn of his order is

Labour Material Overheads S&A expenses Full Cost

Rs 600 : Rs 800

: :

Rs 720 Rs 280 : Rs 2,400

At a glance, the order appears to be unprofitable. But suppose the firm has some idle capacity that can be utilised to produce output for new order. There may be more efficient use of existing labour and no additional selling and administration expenses to be incurred. Then the incremental cost to accept the order will be:

Labour Materials Overheads Total incremental cost

: : : :

Rs 400 Rs 800 Rs 200 Rs 2,400

Incremental reasoning shows that the firm would earn a net profit of Rs 600 (Rs 2,000 1,400), though initially it appeared to result in a loss of Rs 400. The order should be accepted. However the incremental concept does not imply that a firm should accept all orders that cover incremental costs. A decision is profitable according to the incremental concept only when it increases revenue more that it increases costs, or reduces costs more than it reduces revenue. 2. Marginalism: A manager has to use resources of production carefully as they are scarce. The marginalism or the marginal value of a dependent variable is defined as the change in this dependent variable associated with a one unit change in a given independent variable. The 2 important concepts of marginal analysis are Marginal Cost (MC) Marginal Revenue (MR)

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MC is the extra cost of producing one additional unit. It is the ratio between the change in cost & change in output i.e. d(TC)/ dQ MR is the ratio between total revenue & change in output & is given as d(TC)/ dQ Marginalism assumes that either revenue depends on output or cost depends on output. For e.g.: A 5 unit increase in output increases the total cost by Rs 45 (from Rs 350 to Rs 395) & increases revenue by Rs 70 (from Rs 400 to Rs 470) the MC in this case is 45/5 = Rs 9 & the MR = 70/5 = Rs 14. In order to maximise the revenue, do not sell output beyond a point where MR = 0. 3. Equi-marginal concept: The equi-marginal principle states that a rational decision maker would allocate or hire his resources in such a way that the ratio of marginal returns and marginal costs of various uses of a given resource is the same, in a given use. The essence of the equi marginal principle is that purchases, activities or productive resources should be allocated so that the marginal utilities, benefits or value added accruing from each purchase, activity or productive resource are identical in all use. For example: A consumer maximises utility or satisfaction from consumption of successive units of goods X, Y, and Z will allocate his consumption budget such that MUx/ Px = MUy/Py = MUz/Pz Where MU represents the marginal utility and P represents the price of the good. Similarly, a producer seeking maximum profit will use the technique of production which would ensure that MRP1/ MC1 = MRP2/ MC2..= MRPn/ MCn Where MRP is the marginal revenue product of inputs and MC shows marginal cost. For e.g.: Units Item A 1 2 3 4 5 6 10 9 8 7 6 5 Marginal Utilities Item B 9 8 7 6 5 4 Item C 8 7 6 5 4 3

To maximise utility, the consumer will end up with a purchase of 3A + 2B + 1C because that combination satisfies equi marginalism. MUa = MUb = MUc = 8 4. Discounting principle: Discounting principle states that when a decision affects costs and revenues at future dates, it is necessary to discount those costs and revenues to present values before a valid comparison of alternatives is possible. This is because money has time value, that is, a rupee to be received in the future is not worth a rupee today. Therefore, it is necessary to have techniques for measuring the value today (i.e. the present value) of rupee to be received or paid at different points in future.

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If the interest rate is 10% and if the rupee is to be received in 4 years (n = 4), the present value of rupee equals 1/ (1+i) raised to n = 1/(1+10) raised to 4 = 1/ 1.4641 = Rs 0.683 (To understand how the formula is written properly refer to 2.3 Pg 18 - 19) If the receipts are made over a number of years, the formula becomes PV = R1/ (1+i) + R2/ (1+i) raised to 2 + R3/ (1+i) raised to 3 + Rn/ (1+i) raised to n 5. Opportunity cost: The opportunity cost principle states that a decision to accept an employment for any factor of production is profitable if the total reward for the factor in that occupation is greater or at least no less than the factors opportunity cost. This cost arises because most economic resources have more than one use. The opportunity cost is the amount of subjective value foregone in choosing one alternative over the next best alternative. It is the cost of sacrificed alternatives. If there are no sacrifices, there is no cost. Like the opportunity cost of using a machine to produce one product is the earnings foregone which would have been earned from producing other products. Similarly, the opportunity cost of using the premise for ones own business is the rent that would have been earned by giving it on rent. 6. Concepts of profit: Business decision takes into account the foll concepts of profit Accounting Profit/ Gross Profit Economic Profit/ Net Profit Normal Profit Supernormal Profit/ Abnormal Profit

Accounting Profit: Accounting profit is the total revenue obtained by a firm during an accounting period minus all the cost and expenses incurred to produce the goods responsible for getting the revenue. These are known as explicit costs (wages & salaries, S&D expenses, cost of RM, rent, interest, taxes etc) Accounting profit = Total Revenue Total Costs Economic Profit: The economic profit is also defined as TR TC, however the costs includes the explicit costs and the wages of the mgmt (i.e. implicit costs). Implicit costs are costs such as opportunity costs of resources, allowances for the owners own factors of prodn. Normal profit: refers to that portion of profit which is absolutely necessary for the business to remain in operation. In other words, it is the minimum necessary to induce the business to remain and operate. Normal profit forms part of the average cost. The organiser obtains normal profit when average revenue is equal to average cost (AR = AC). Super normal profit or abnormal profit could be treated as any return above the normal profit. It is the residual surplus after paying for explicit costs, implicit costs and normal profit. When average revenue or price is more than the average cost, the entrepreneur gets super-normal profits. The existence of this profit is not obligatory to the firm to remain in business like normal profits. Numerical problems of opportunity cost and discounting principle. (Production possibility chart may come for the exam & discounting principle is the same as present value in Financial Mgmt)

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DEMAND AND SUPPLY 1) What are the types of Demand? In order to understand the types of demands, it is important to classify the goods & services available in every economy. Consumer Goods and Producer Goods: Goods and services used for final consumption are called consumer goods. These include, goods consumed by human-beings, animals, birds etc. Producer goods refer to the goods used for production of other goods, like plant and machines, factory buildings, services of employees, raw materials etc. Perishable and Durable Goods: Perishable goods become unusable after sometimes, others are durable goods. Durable goods pose more complicated problems for demand analysis than do non-durables. Sales of nondurables are made largely to meet current demands which depend on current conditions. In contrast, sales of durable goods go partly to satisfy new demand and partly to replace old items. The types of demand are as follows: Autonomous and Derived Demand: The goods whose demand is not tied with the demand for some other goods are said to have autonomous demand, while the rest have derived demand. Thus the demand for all producer goods is derived demands as they are needed to obtain consumer or producer goods. Individuals Demand and Market Demand: Market demand is the summation of demand for a good by all individual buyers in the market. A firm would be interested in the market demand for its products while each consumer would be concerned basically with only his own individual demand. (For e.g. & graph refer to 3.3.4, table 3.1 Pg 26) Firm and Industry Demand: Goods are produced by more than one firm and so there is a difference between the demand facing an individual firm and that facing an industry. (All firms producing a particular good constitute an industry engaged in the production of that good). For example, demand for Fiat car alone is a firms demand and demand for all kinds of cars is industrys demand. Demand by Market Segments and by Total Market: If the market is large in terms of geographical spread, product uses, distribution channels, etc., and if any one or more of these differences were significant in terms of product price, profit margins, competition, seasonal patterns etc. then it may be worthwhile to distinguish the market by specific segments for a meaningful analysis. In that case, the total demand would mean the total demand for the product from all market segments while a particular market segment demand would refer to demand for the product in that specific market segment.

2) Demand function and Demand Curve: The demand for a commodity arises from the consumers willingness and ability to purchase the commodity. The Demand Theory postulates that the quantity demanded of a commodity is a function of or depends on not only the price of a commodity, but also income, price of related goodsboth substitutes and complements, taste of consumer, price expectation and all other factors. Demand function is a comprehensive formulation which specifies the factors that influence the demand for the product. Dx = D (Px, Py, Pz, B, A, E, T, U) Where Dx = Demand for item X Px = Price of substitutes Pz = Price of complements B = Income of consumer E = Price expectation of the user T = Taste or preference of user

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U = all other factors. Demand curve considers only the price-demand relation, other factors remaining the same. The inverse relationship between the price and the quantity demanded for the commodity per time period is the DEMAND SCHEDULE for the commodity and the plot of the data (with price on the vertical axis and quantity on the horizontal axis) gives the DEMAND CURVE of the individual. (Refer to Table 3.2 & graph, pg 28) The Demand curve is negatively sloped, indicating that the individual purchases more of the commodity per time period at lower prices (other factors being constant). The inverse relationship between the price of the commodity and the quantity demanded per time period is referred to as the LAW OF DEMAND. A fall in Px leads to an increase in Dx (so that the slope is negative) because the lowering of prices brings in new buyers. Another reason for the increase in demand with the fall in price is due to the substitution effect (when the price of the commodity falls while prices of all the other commodities remain constant, the commodity becomes relatively cheaper. This induces the customer to substitute the commodity they are already using with the cheaper one ) and income effect (when the price of the commodity declines, the purchasing power of the consumers increases which induces them to buy the product). 3) Individual and Market demand: Refer to types of demand & draw the chart & the graph as well if this comes as an independent question (refer to table & graph 3.1, pg 26) 4) Non-price determinants of demand. Demand function is a comprehensive formulation which specifies the factors that influence the demand for the product. Dx = D (Px, Py, Pz, B, A, E, T, U) where Dx = Demand for item X Px = Price of substitutes Pz = Price of complements B = Income of consumer E = Price expectation of the user T = Taste or preference of user U = all other factors. The impact of the non price determinants on Demand is: 1. Substitution effect on demand: If y is a substitute of x, then as price of y increases, demand for x also increases. Dx/Py > 0

2. Complementary effect on demand: If z is a complement of x, then as the price of z falls, the demand
for z goes up and thus the demand for x also tends to rise. Dx/Py < 0

3. Price expectation effect on demand: Here the relation may not be definite as the psychology of the
consumer comes into play.

4. Income effect on demand: As income rises, consumers buy more of normal goods (positive effect) and
less of inferior goods (negative effect). Dx/B > or < 0

5. Promotional effect on demand: Advertisement increases the sale of a firm up to a point.

Dx/ Da > or < 0

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6. Customs & Religious festivals: During a particular festival, due to customs the demand for a product
may go up despite the price being constant or increasing. For e.g. the demand for crackers during Diwali. 6) Define the guiding and rationing function of price. Why do you think it is necessary for price to serve this function? Supply and demand is an

economic model of price determination in a market. It concludes that in a

competitive market, price will function to equalize the quantity demanded by consumers, and the quantity supplied by producers, resulting in an economic equilibrium of price and quantity.
The demand curve & the supply curve only consider the demand/ supply price relation, other factors remaining the same. The inverse relationship between the price and the quantity demanded for the commodity per time period is the Demand schedule for the commodity and the plot of the data (with price on the vertical axis and quantity on the horizontal axis) gives the Demand Curve of the individual. This inverse relation between price & quantity demanded is known as the law of demand (Refer to table & graph 3.2, pg 28) The Demand curve is negatively sloped, indicating that the individual purchases more of the commodity per time period at lower prices (other factors being constant). According to the Law of Supply, more of a good will be supplied the higher its price, other things constant or less of a good will be supplied the lower its price, other things remaining constant. Price regulates quantity supplied just as it regulates quantity demanded. When the price of a good rises, individuals and firms can rearrange their activities in order to supply more of that good to the market. (Refer to graph 5.2, pg 50) The demand of a commodity implies the desire, willingness & the ability to pay for a commodity. Needless to mention the price of the product plays a very crucial role in defining the demand for the product. An individual may have the desire to purchase the commodity & also has the ability to pay for it; however he does not have the will to pay for it since he does not see the value in the product for the price charged. Similarly, Supply is the willingness & ability of producers to make a specific qty of output available to consumers at a particular price over a given period of time. The firms objective is to earn profits. & therefore the producer has to ensure that the price of his goods & services is right to ensure sale as well as to cover the cost of production plus profits.

7) Why do you think it is important for the managers to understand the mechanics of demand and supply both in the short run and long run? Pls elaborate on the following points Pricing of goods & services. Determining the right costs to be incurred Government decisions on tax policies. Allocation of scarce resources Decision making with respect to introduction of new product. Foresee opportunities & risks

(Pls feel free to add more)

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ELASTICITY OF DEMAND 2. What are the important factors influencing the elasticity of demand. The important factors that determine the elasticity of demand are: Luxury or necessity goods: Luxury goods tend to have an elastic demand, while necessity goods have an inelastic demand. Purchasers can stop buying the luxury goods when their prices rise. Percentage of income: Big items in a budget tend to have a more elastic demand than small items. For example, consumers may be affected by 1 per cent rise or fall in price of a flat but are insensitive to such fluctuations in prices of pens. Substitutes: Items that can be substituted easily have a more elastic demand than those that do not. Time: The demand for a product becomes more elastic the longer the time period under consideration. It takes time to decide about other product before buying it as one develops a habit of using a particular product.

3. Graphically illustrate a case of elasticity on price and quantity. Changes in qty demanded of X may show different degrees of responsiveness to a change in its price i.e. when the price of X changes the demand for it may change either exactly proportionately or more than or less than proportionately or, at other extremes the demand may not change at all or even change infinitely. It is this degree of responsiveness of qty demanded of a commodity to the change in price which is called the price elasticity of demand. Price elasticity of demand is the degrees of responsiveness of qty demanded of commodity X to the change in price of X itself. Ed = %age change in qty demanded of X / %age change in price of X There are 5 types of elasticity on price & qty. They are: (Refer to fig 4.1 pg 35 & fig 4.2 pg 36)

1. Perfectly inelastic demand curves (graph a in fig 4.1): When a change in price has no effect on
qty demanded, then demand is said to be perfectly inelastic or Ed = 0, where Ed stand for the elasticity coefficient. E.g. If price changes by 10% & demand does not change at all then, Ed = %QdX / %PX Where Ed stands for elasticity in demand, %QdX stands for %age change in qty demanded for X & %PX stands for %age change in price of X. Therefore

2. Inelastic demand curves/ Relatively inelastic demand curve (graph a in fig 4.2): Demand
curves which have an elasticity coefficient between 0 and 1 are called relatively inelastic or simply inelastic. When the price falls, the quantity demanded expands but total revenue still decreases. Ed < 1

3. Unitary elastic demand curves (graph b in fig 4.1): When price decreases from $10 to $5 the
total revenue remains unaffected at $500. Such a demand curve is said to be Unitary Elastic and has the property that when price increases or decreases, the total revenue remains constant. Ed = 1 Examples: The unitary elastic demand curve occurs when a person budgets a certain amount of money for, say, meat or magazines and will not deviate from that figure regardless of price.

4. Elastic demand curves/ Relatively elastic demand curve (graph b in fig 4.2): When change in
price brings abt more than proportionate change in qty demanded, then demand is relatively elastic or Ed > 1. Such demand curves have an elasticity coefficient between 1 and have the property that when price decreases total revenue increases and vice-versa.

5. Perfectly elastic demand curve (graph c in fig 4.1): When a slight change in price brings abt
infinite change in qty demanded, then the demand becomes perfectly elastic. Ed = (infinity)

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4. Explain different aspects of point elasticity and arc elasticity. Elasticity of demand is generally indicated by the steepness of the demand curve, flatter slope indicates more elastic demand. The steepness of the demand curve can be compared only if they are drawn on the same scale. Point elasticity & Arc elasticity are the 2 measures of elasticity. Point Elasticity: Price elasticity of demand can be expressed as ratio of percentage change in qty demanded of X to percentage change in price of X. However this measure can be used when the price changes are infinitesimally small. Point elasticity is also known as the percentage method & is calculated as Ep = %age change in qty demanded of X / %age change in price of X Arc Elasticity (refer to table 4.2 & fig 4.3, pg 39): Although the %age method is simple yet it is not very reliable; because it is useful only when the price changes are infinitesimally small. This is rare. Normally prices do not just change by small amounts. When price changes from Rs. 4 to Rs. 3, P = Rs. 4 3 = Rs. 1. The change in quantity demanded is Q = 16 25 = -9 Therefore Ed as per the point elasticity method is -2.25 Now if we calculate the elasticity when price increases from Rs. 3 to Rs. 4 we find that for the same stretch of the demand curve, elasticity would be different. i.e. Ed = -1.08 There is a difference in the elasticity in both cases because our initial quantity demanded and price has been different. When we calculate for price fall, they are 16 for initial quantity demanded and Rs. 4 for initial price. When we calculate it for price rise they are 25 for initial quantity demanded and Rs. 3 for initial price. Hence elasticity tends to depend on our choice of the initial situation. However, demand response should be the same for the same finite stretch of the demand curve. To get rid of this dilemma created by the choice of the initial situations, we take the arithmetic mean of the two quantities Q and the mean of the two prices P. This gives us a concept of arc elasticity of demand. Therefore arc elasticity is calculated as Ed = (Q/ ((Q1 + Q2)/2)) / (P/ ((P1 + P2)/2)) Or (Q/P) X ((P1+P2)/ (Q1+Q2))

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DEMAND FORECASTING 1. What are prerequisites of a good forecast? Refer to Suchis notes 2. Explain various methods of demand forecasting.

Forecasting of demand is done for knowing the future demand of the product. The commonly used methods of demand forecasting are as follows: 1) Survey Methods a. Opinion Poll Method b. Consumer Survey Methods 2) Statistical Methods a. Trend Projection Methods b. Barometric Method c. Econometric Method. a) Opinion Poll Method: In these methods the expert opinion is surveyed. For e.g., the future demand of a car can be forecasted by taking opinions of experts of automobile industry or research orgns where such researches are carried. Opinion Poll methods are of 2 types: Experts Opinion Method: The experts opinion method is a subjective method as it is based on analysis by experts. The experts on a particular product whose demand has to be forecasted are requested to give their opinion on the future demand of the product Delphi Methods: Demand forecasting by Delphi method attempts to arrive at a consensus about the future demand of a product by repeatedly questioning. The experts are also provided with info abt opinion given by other experts on the future demands of the product. The assumption is that the expert may revise his earlier opinion in the light of the forecasts made by other experts. This may result in narrowing down of different views. The consensus of experts abt the forecast constitutes the final forecast. b) Consumer Survey methods: Demand forecasting by consumer survey methods is done by taking the view of the consumers directly abt the future plans abt a product. The various methods in consumer survey methods are as follows: Complete enumeration method: In this method the forecaster undertakes a complete survey of all potential consumers whose demands he intends to forecast. They are asked abt their future plans of purchasing a product. The quantities given by the consumers are then added together to obtain the probable future demand of the product. Sample survey method: In this method a sample is selected to represent the entire popn of consumers. The probable demand of a product expressed by each unit of the sample is added to get the total demand of the product.

a) Trend Projection methods: Demand forecasting by the trend method is based on analysis of the past
sales pattern. A series of data taken on an eco variable (e.g. sales) at various past pts (e.g. yrs) in time forms a time series data or historical data. The trend method is basedc on the assumption that future events are a continuation of the past. Thus the historical data can be used to predict the future. 2 methods are used for trend projection based on the basis of time series data. They are: Graphical Method Least Squares Method b) Barometric method: Barometric method uses eco indicators as barometer to forecast trends in business activities. The eco indicators are classified into 3 categories: Leading indicators, (which move up & down ahead of other related variable) Coincidental indicators (care the variable that move up & down simultaneously with eco activity or mkt trends) and Lagging indicators (which fall behind other related variables.)

c) Econometric Method: the econometric method consists of a single equation regression model or a system
of simultaneous equations. Single equation regression serves the purpose of demand forecasting in case of many commodities. But, in case of eco variable due to complex relationships, a single equation regression model is not appropriate. In this case a system of simultaneous equations is used to estimate & forecast. (No need to get in to the details of this method. Not taught by the professor)

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1. Discuss the benefits and drawbacks of the following methods of forecasting. a. Jury of executive opinion b. The Delphi method c. Opinion poll The benefits of the above mentioned methods are as follows a. Jury of executive opinion a. Combines managerial experience with statistical models b. Relatively quick c. Take intangible factors into consideration. d. Useful when there are little data available (new product, new market, new business unit). b. The Delphi method: a. Rapid consensus b. Facilitates the maintenance of anonymity of the respondents identity throughout the course. c. Saves time and other resources in approaching a large number of experts for their views as participants can reside anywhere in the world d. Coverage of wide range of expertise e. Avoids groupthink f. Forecasting a specific, single dimension question g. Extremely suitable when past data is unavailable. h. Suitable for a new technology c. Opinion Poll: a. Simple no statistical techniques. b. Based on first hand knowledge. c. Quite useful in forecasting sales of new products. d. Time saving. Refer to Suchis notes for drawbacks

Numerical problem (as solved in the class most likely the time series method may come for the exam).

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THEORY OF PRODUCTION FUNCTION 1. Define production function and explain the difference between short run and long run production function. Refer to Suchis notes

2. Define three stages of production function and explain why a rational firm always tries to operate in stage II. The three stages of production can be explained with the help of the following diagram. (Refer to table 6.3 & diagram 6.2, Pg 63 & 64 ). TP: Total product is the qty produced by that many units of a variable factor AP: Avg product is the total output divided by the number of units of the variable factor. MP: Marginal product is the change in total output resulting from the change (using one more or one less) of the variable factor. In the diagram the TP curve rises first to an increasing rate up to a point 1, and later at a diminishing rate up to point 2. At point 2, the TP remains constant. Thus, the total output increases more than proportionately until X units of labour are employed; between X units and Y units of labour use, the total output rises with every additional unit of labour but this increase is less than proportionate. If labour units increases beyond level Y, the total output eventually starts declining. Correspondingly when TP is rising at an increasing rate, MP and AP curves rise; and when total product is rising at a diminishing rate, this MP and AP curves are declining. At Y, where TP becomes constant, the MP becomes zero, and additional labour beyond Y makes MP negative. (Refer to the dia in atmanands text book pg 210. it is better) This means that as a firm changes the amount of labour services only, it alters the proportion between the fixed input & the variable input. As a firm keeps on altering this proportion by changing the amount of labour it experiences the law of variable proportion, or diminishing marginal returns which is As more & more of the factor input is employed, all other input quantities remaining constant, a pt will eventually be reached where additional quantities of varying input will yield diminishing marginal contributions to the total product. No firm will choose to operate either in Stage I or Stage III. In Stage I the marginal product is rising, i.e., each additional unit of the variable factor is contributing to output more than the earlier units of the factor; it is therefore profitable for the firm to keep on increasing the use of labour. In Stage III, marginal contribution to output of each additional unit of labour is negative. It is therefore, inadvisable to use any additional labour. Even if cost of labour use is zero, it is still unprofitable to move into the Stage III. Thus, Stage II is the only relevant range for a rational firm in a competitive situation. (Important pts while drawing the graph MP declines before AP AP never touches 0)

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3. Explain the importance of production function in managerial decision making. (VVIP) For managers, an understanding of the basic concepts of production provides a solid conceptual framework for decisions involving the allocation of a firms resources both in the short-run and in the long-run as it serves as a foundation for the analysis of cost. Given below are two such key management principles:

1. Careful planning can help a firm to use its resources in a rational manner: In the short-run
analysis, we see that a firm has three stages of production and the stage II is the only stage for a rational firm to operate. However, the firm may find itself in stage I or III as the production levels do not depend on how much a company wants to produce but on how much its customer wants to buy. In order to avoid operating at stage I or III there must be careful planning regarding the fixed inputs to be used along with the variable ones. This is called capacity planning. Good capacity planning requires two basic elements: (1) accurate forecasts of Production Function demand, and (2) effective communication between the production and marketing functions. The first one is rather obvious but the second one is not very easy to achieve especially for those who have not had work experience in large orgn. For e.g. (Refer to graph 6.16, pg 78) The above graph shows a short-run production function where stage II applies to production levels between Q1 = 200 and Q2 = 275. If people want to buy less than 200 units or more than 275 units, for example, then in the short-run the firm would be forced to operate in either stage I or stage III. However, if the firm anticipated the demand to be greater than 275, it would have to consider increasing its capacity so that stage II would include the higher level of output. Similarly, if the firm forecasts a demand less than 200, it would have to consider decreasing its capacity. These alternative capacity levels are shown below (Pls refer to Fig. 6.17, pg 78)

2. Managers must understand the marginal benefits and cost of each decision involving the
allocation of scarce resources: The production function tells managers about allocation of scarce resources; that certain trade-offs in terms of benefits and costs are involved. In the real world analysis of production, the data on the marginal products of each input may not be known. Thus, a manager may be unable to find the optimal combination of inputs. Nonetheless, managers can utilize the concept of trade-offs in their decision-making regardless of whether detailed quantitative information exists.

3. (No need to mention the example in the exam) e.g. The capital-labour trade offIf a company is
considering the installation of a new voice-messaging system, it would greatly reduce the need for receptionists, operators or secretaries. The question is whether the cost of installing such a system is outweighed by the cost savings resulting from the elimination of certain support personnel. Similarly, there exists the following: (a) The labour labour trade off. (b) The raw material raw materials trade off. (c) The capital capital trade off. These are only a few of the many types of decisions managers must make involving the trading off of benefits and costs.)

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COST ANALYSIS

1. Explain the importance of cost in managerial decision. The costs which the firm incurs in the process of prodn of goods & services are an important variable in decision making. Total costs together with total revenues determine the profit level of a business concern. In order to maximise profits a firm endeavours to increase its revenue & lower its costs. To this end, mgrs try to produce optimum levels of output, use the least cost combination factors of prodn, increase factor productivities & improve organisational efficiency. The solution of various economic problems needs cost figures different from what are available in the balance sheets, income-statements, etc. of the firm. The accounting cost figures serve the legal, financial and tax needs of the firm but are not directly very helpful for managerial decisions. For managerial decision making, the management needs costs in terms of their source, period, rate of change with respect to output, the degree of their controllability etc. It is the future costs that matters most in managerial decision-making. Cost of production provides the floor to pricing. It provides a basis for managerial decision with respect to the price the firm must quote to its prospective customers; in deciding whether to accept a particular order or not; whether to abandon an old or establish a new product line; whether or not to increase the volume of specific outputs; to use idle capacity or rent facilities to outsiders; and whether to make a particular product or buy it. There are no straight and simple rules for such decisions and it is necessary to study production and cost analysis thoroughly to arrive at these decisions. The costs which firms incur are payments to various factors of production and hence they indicate incomes of these factors also. An understanding of cost thus helps to understand the distribution of factor incomes as well. Making of effective and right decisions depends much on the proper calculation of costs. If different types of costs are not properly understood, the managerial decisions are bound to be wrong and misleading. 2. Define and compare the following types of cost: Sunk cost versus incremental cost: Sunk cost is one which is not affected or altered by a change in the level or nature of business activity. It will remain the same whatever the level of activity. The most important example of sunk cost is the amortization of past expenses, e.g. depreciation. Sunk costs are irrelevant for decision-making as they do not vary with the changes contemplated for future by the management. Incremental costs are defined as the change in overall costs that result from particular decision being made. Incremental costs may include both fixed and variable costs. In the short period, incremental cost will consist of variable costcosts of additional labour, additional raw materials, power, fuel etc., which is the result of a new decision being taken by the firm. Since these costs can be avoided by not bringing about any change in the activity, the incremental costs are also called avoidable costs or escapable costs. Moreover, since incremental costs may also be regarded as the difference in total costs resulting from a contemplated change, they are also called differential costs. Fixed cost versus variable cost Fixed costs are those which are independent of output, i.e., they do not change with changes in output. These costs are a fixed amount which must be incurred by a firm in the short-run, whether the output is small or large. Fixed costs are also known as overhead costs and include charges such as contractual rent, insurance fee, maintenance costs, property taxes, interest on the capital invested, minimum administrative expenses such as managers salary, watchmans wages, etc. Thus, fixed costs are those which are incurred in hiring the fixed factors of production whose amount cannot be altered in the shortrun. Variable costs, on the other hand, are those costs which are incurred on the employment of variable factors of production whose amount can be altered in the short-run. Thus the total variable costs change with changes in output in the short-run. These costs include payments such as wages of labour employed, the price of the raw material, fuel and power used, the expenses incurred on transporting and the like. Variable costs are also called prime costs. Total costs of a business of the sum of its total variable costs and total fixed costs.

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 Incremental cost versus marginal cost For a note on incremental costs refer to the previous question Marginal cost is the extra cost of producing one additional unit. At a given level of output, one examines the additional costs being incurred in producing one extra unit and this yields the marginal cost. For example, if the total cost of a firm is Rs. 5,000 when it produces 10 units of a good but when 11 units of the good are produced, it increases to Rs. 5,300 then the marginal cost of the eleventh unit is Rs. 5,3005,000 = Rs. 300. In other words marginal cost of nth units (MCn) is the difference between total cost of nth unit (TCn) and total cost of n-1th unit (TCn-1), MCn = TCn TCn1 Opportunity cost versus out of pocket cost

The opportunity costs or alternative costs are the return from the second best use of the firms resources which the firm forgoes in order to avail itself of the return from the best use of the resources. To take an example, a farmer who is producing wheat can also produce potatoes with the same factors. Therefore, the opportunity cost of a quintal of wheat is the amount of the output of potatoes given up. Thus we find that the opportunity cost of anything is the next best alternative that could be produced instead by the same factors or by an equivalent group of factors, costing the same amount of money. Two points must be noted in this definition. Firstly, the opportunity cost of anything is only the next best alternative foregone. Secondly, in the above definition is the addition of the qualification or by an equivalent group of factors costing the same amount of money. Out-of-pocket costs are those that involve immediate payments to & require current cash expenditure. For example, wages and salaries paid to the employees are out-of-pocket costs. This cost arises when the company does not own the factor of production & hence has to make a payment to an outsider for the same since it is hired. Accounting cost and Economic cost

Accounting costs are those expenses which are actually paid by the firm (paid-out-costs). These costs appear in the accounting records of the firm. On the other hand, Economic costs are theoretical costs in the sense that they go unrecognized by the accounting system. These costs may be defined as the earnings of those employed resources which belong to the owner himself. The examples of such costs are opportunity cost of the owners services, say, as the manager of the firm, opportunity cost of land belonging to the owner of the firm, and normal return equal to the market rate of interest on the owners own capital invested in the business. These economic costs are not included by the accountant of the firm in its accounting statements. However, these costs are considered relevant by economists while calculating the economic profits of the firm.

3. Explain various short run cost curves and show its derivation (Numerical as well as descriptive) (VVIP) The short-run is a period of time in which the output can be increased or decreased by changing only the amount of variable factors such as labour, raw materials, etc. In the short-run the firm cannot build a new plant or abandon an old one. If the firm wants to increase output in the short-run, it can only do so by using more labour and more raw materials & not by expanding the capacity of its existing plant or building a new plant with larger capacity. Short-run are the costs that can vary with the degree of utilization of plant and other fixed factors. Short-run costs are therefore, of two types: fixed costs and variable costs. In the short-run, fixed costs remain unchanged while variable costs fluctuate with output. The short-run cost-output relationship refers to a particular scale of operation or to a fixed plant. That is, it indicates variations in cost over output for the plant of a given capacity and their relationship will vary with plants of varying capacity. For decision-making, one needs to know not only the relationship between total cost and output but also separately between various types of costs and output. Thus, the short-run cost-output relationship is discussed in terms of: Total cost and output (Total Cost Curve, Total fixed cost curve & The total variable cost curve)

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Average costs and output (Avg total cost curve, Avg fixed cost curve & Avg variable cost curve) & Marginal cost and output (Marginal cost curve) (Refer to dia 7.4 pg 94)

TC Curve: The total cost of a business is the sum of its total variable costs (TVC) and total fixed
cost (TFC). This is, TC = TFC+TVC The shape of the total cost curve (TC) is exactly the same as that of the total variable cost curve (TVC) because the same vertical distance always separates the two curves. This vertical distance between the TVC and TC curve represents the amount of total fixed cost which remains unchanged as output is increased in the short-run. TFC Curve: Since the total fixed cost remains constant whatever the level of output, the total fixed cost curve (TFC) is parallel to the X-axis. This curve starts from a point on the Y-axis meaning thereby that the total fixed cost will be incurred even if the output is zero. TVC Curve: On the other hand, the total variable cost curve (TVC) rises upward showing thereby that as the output is increased; the total variable cost also increases. The total variable cost (TVC) starts from the origin which shows that when output is zero the variable costs are also nil. ATC/ AC Curve: The average total cost or what is called simply average cost is the total cost divided by the number of units output produced. Therefore, ATC = TC/Q or ATC = AFC + AVC Since the total cost is the sum of total variable cost and total fixed cost, the average total cost is also the sum of average variable cost and average fixed cost. Average total cost is also known as unit cost, since it is cost per unit of output produced. The behaviour of the average total cost curve will depend on the behaviour of the average variable cost curve and average fixed cost curve. In the beginning both AVC and AFC curves fall. The ATC curve therefore falls sharply in the beginning. When AVC curve begins rising, but AFC curve is falling steadily, the ATC curve continues to fall. But as output increases, there is a sharp rise in AVC which more than offsets the fall in AFC. Therefore, the ATC curve rises after a point. AFC Curve Average fixed cost is the total fixed cost divided by the number of units of output produced. Therefore, AFC = TFC/Q Where Q represents the number of units of output produced. Since total fixed cost is a constant quantity, average fixed cost will steadily fall as output increases. Therefore, average fixed cost curve slopes downward throughout its length. As output increases, the total fixed cost spreads over more and more units and therefore average fixed cost becomes less and less. When output becomes very large, average fixed cost approaches zero. Average fixed cost curve, which is a rectangular hyperbola, showing at all its points, the same magnitude, AVC Curve Average variable cost is the total variable cost divided by the number of units of output produced. Therefore, AVC = TVC/ Q Thus average variable cost is variable cost per unit of output. The average variable cost normally falls, reaches a minimum and then rises. It first declines and then rises for reasons similar to those operating in case of TVC. MC Curve Marginal cost is the addition to the total cost caused by producing one more unit of output. Therefore, MCn = TCn TCn-l MC is the slope of the TC curve. As TC curve first rises at a decreasing rate and later on at an increasing rate, MC curve will also, therefore, first decline reach a minimum and then rise. MC equals AVC and ATC when these curves attain their minimum values. Furthermore, MC lies below both AVC and ATC over the ranges in which AVC and ATC decline; it lies above them when they are rising.

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MARKET ANALYSIS 1. Describe the key characteristics of four basic market types used in economic analysis. (VVIP) The 4 basic market types used in economic analysis are: 1. Monopoly (absolute mkt power subject to govt regulation): Monopoly is said to exist when one firm is the sole producer or seller of a product which has no close substitutes. Therefore for monopoly to exist, following things are essential: a. One and only one firm produces and sells a particular commodity or a service. b. Unique product or no close substitutes. c. There are no rivals or direct competitors of the firm. d. No other seller can enter the market for whatever reasons legal, technical or economic. e. Monopolist is a price maker. He tries to take the best of whatever demand and cost conditions exist without the fear of new firms entering to compete away his profits. In the case of monopoly one firm constitutes the whole industry. Therefore, the entire demand of the consumers for a product faces the monopolist 2. Monopolistic Competition (market power based on product differentiation): Monopolistic competition is a form of market structure in which a large number of independent firms are supplying products that are slightly differentiated from the point of view of buyers. Thus, the products of the competing firms are close but not perfect substitutes because buyers do not regard them as identical. The features of a monopolistic competition are: a. Large number of relatively small firms acting independently. b. Differentiated product. c. The relative (proportionate) market shares of all sellers are insignificant and more or less equal. That is, seller-concentration in the market is almost non-existent. d. There are neither any legal nor any economic barriers against the entry of new firms into the market. New firms are free to enter the market and existing firms are free to leave the market. e. Non price competition is very important f. E.g. Lux, Lyril, Rexona, Hamam, Glory, etc. brands of toilet soap, or Colgate, Cibaca, Prudent, Promise, etc. brands of toothpaste. 3. Oligopoly (market power based on product differentiation and/ or the firms dominance of the market.): In an oligopolistic market there are a small number of firms, so that the sellers are conscious of their interdependence. The competition is not perfect, yet the rivalry among firms is high. The features of a oligopolistic market are as follows: a. Small number of relatively large firms that are mutually independent b. Differentiated or standardised product. c. Market entry & exit difficult. d. Non price competition very important among firms selling differentiated product. e. E.g. airlines. f. The curve under the oligopoly market is called a kinked demand curve 4. Perfect competition (No market power): Perfect competition is said to prevail where there is a large number firms producing a homogeneous product. Competition is perfect in the sense that every firm considers that it can sell any amount of output it wishes at the prevailing market price, which cannot be affected by the individual producer whose share in the market is very small. With many firms and homogenous product under perfect competition, no individual firm is in a position to influence the price of the product. The features of a perfect competition are as follows: a. Large number of relatively small buyers & sellers. b. Standardised product 1 can be substituted for the other. c. Very easy market entry & exit. d. Non price competition not possible. e. The goal of all firms is profit maximization. No other goals are pursued. f. There is no government intervention in the market (tariffs, subsidies, rationing of production or demand and so on are ruled out). g. The factors of production are free to move from one firm to another throughout the economy. h. The sellers and buyers have complete knowledge of the conditions of the market. i. E.g. The linking road shoes & bags sellers

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2. Explain the marginal revenue and marginal cost approach in finding the optimum level output. The firm will be making maximum profits by expanding output to the level where marginal revenue is equal to marginal cost. This is when the output of the firm is optimum. If it goes beyond the point of equality between marginal revenue and marginal cost, it will be incurring losses on the extra units of output and therefore will be reducing its total profits. Thus, the firm will be in equilibrium when it is producing the amount of output at which marginal revenue equals marginal cost (Refer to fig 8.2 Pg 120) In the graph we can see the firms marginal revenue curve MR is sloping downward and firms marginal cost curve MC is sloping upward and they cut each other at point E which corresponds to output OM. Up to OM level of output MR (Marginal Revenue) exceeds MC (Marginal Cost) and at OM the two are just equal to each other. The firm will be maximizing its profits by producing OM output. The equality between marginal revenue and marginal cost is a necessary but not a sufficient condition of firms equilibrium. The second order condition requires that for a firm to be in equilibrium marginal cost curve most cut marginal revenue curve from below at the point of equilibrium.

3. Explain the various profit possibilities in the perfect competitive short run situations. (VVIP) Refer to Suchis notes

4. Explain the peculiarity of long run situation in a perfect competitive as well as monopoly market Refer to Suchis note

5. Explain the implication of perfect competition and monopoly for managerial decision making. (VVIP) Refer to the sheet provided by the professor. A separate page which only speaks about this question 6. Examine the important features of monopolistic competition and oligopoly. Refer to question 1 for the answer

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BREAK-EVEN ANALYSIS

1. Why this analysis is called volume-cost profit analysis. (VVIP) Refer to Suchis notes

2. What are important differences between customary economic analysis and break-even analysis.

3. Numerical and graphical illustration of break-even point. (VVIP) Break even analysis examines the relationship between the total revenue, total costs and total profits of the firm at various levels of output. It is used to determine the sales volume required for the firm to break even and the total profits and losses at other sales level. It is, therefore, a point where losses cease to occur while profits have not yet begun. That is, it is the point of zero profit. BEP= Fixed Costs/ (Selling price - Variable costs per unit) For E.g. = Fixed Costs Rs 10,000 Selling price Rs 5 per unit Variable costs Rs 3 per unit Therefore, BEP = Rs 10,000/ (5-3) = 5,000 units. The conclusion that can be drawn from the above example is that sales volume of 5000 units will be the accurate point at which the manufacturing unit would not make any loss or profit. Graphically this can be represented as (refer fig 15.1, pg 200) In the figure total revenues and total costs are plotted on the vertical axis whereas output or sales per time period are plotted on the horizontal axis. The slope of the TR curve refers to the constant price at which the firm can sell its output. The TC curve indicates total fixed costs (TFC) (The vertical intercept) and a constant average variable cost (the slope of the TC curve). This is often the case for many firms for small changes in output or sales. The firm breaks even (with TR=TC) at Q1 (point B in the figure) and incurs losses at smaller outputs while earnings profits at higher levels of output. Both the total cost (TC) and total revenue (TR) curves are shown as linear. TR curve is linear as it is assumed that the price is given, irrespective of the output level. Linearity of TC curve results from the assumption of constant variable costs.

PRICING POLICIES

6.

Explain cost plus or mark-up pricing, marginal cost pricing, and discriminate pricing policies. Refer to Suchis notes

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