Important Questions
UNIT-1
1.What is Demand? Explain determinants of demand.
The 5 Determinants of Demand
The five determinants of demand are:
The price of the good or service
The income of buyers
The prices of related goods or services—either complementary and purchased along with a particular item, or substitutes bought instead of a product
The tastes or preferences of consumers will drive demand
Consumer expectations about whether prices for the product will rise or fall in the future
2.Explain the scope of Managerial Economics.
However, then the following fields may be considered under business economics:
1. Demand Analysis and Forecasting.
2. Cost and Production Analysis.
3. Pricing Decisions, Policies and Practices.
4. Profit Management.
5. Capital Management.
The study of these segments of business economics constitutes its subject matter as well as scope. Recently, managerial economists have started making increased use of Operational Research methods.
Let us make in-depth study of these methods:
1. Demand Analysis and Forecasting:
The foremost aspect regarding its scope is in demand analysis and forecasting. A business firm is an economic unit which transforms productive resources into saleable goods. Since all output is meant to be sold, accurate estimates of demand help a firm in minimizing its costs of production and storage.
A firm must decide its total output before preparing its production schedule and deciding on the resources to be employed. Demand forecasts serves as a guide to the management for maintaining its market share in competition with its rivals, thereby securing its profit. Thus, demand analysis facilitates the identification of the various factors affecting the demand for a firm’s product. This, in turn helps the firm in manipulating the demand for its output.
In fact, demand forecasts are the starting point for a firm’s planning and decision-making. This deals with the basic tools of demand analysis i.e.; Demand Determinants, Demand Distinctions and Demand Forecasting etc.
2. Cost and Production Analysis:
A firm’s profitability depends much on its costs of production. A wise manager would prepare cost estimates of a range of output, identify the factors causing variations in costs and choose the cost-minimising output level, taking also into consideration the degree of uncertainty in production and cost calculations. Production processes are under the charge of engineers but the business manager works to carry out the production function analysis in order to avoid wastages of materials and time. Sound pricing policies depend much on cost control.
The main topics discussed under cost and production analysis are:
Cost concepts, cost-output relationships, Economies and Diseconomies of scale and cost control.
3. Pricing Decisions, Policies and Practices:
Another task before a business manager is the pricing of a product. Since a firm’s income and profit depend mainly on the price decision, the pricing policies and all such decisions are to be taken after careful analysis of the nature of the market in which the firm operates. The important topics covered in this field of study are: Market Structure Analysis, Pricing Practices and Price Forecasting.
4. Profit Management:
Each and every business firms are tended for earning profit; it is profit which provides the chief measure of success of a firm in the long period. Economists tell us that profits are the reward for uncertainty bearing and risk taking. A successful business manager is one who can form more or less correct estimates of costs and revenues at different levels of output. The more successful a manager is in reducing uncertainty, the higher are the profits earned by him. It is therefore, profit-planning and profit measurement that constitutes the most challenging area of business economics.
5. Capital Management:
Still another most challenging problem for a modern business manager is of planning capital investment. Investments are made in the plant and machinery and buildings which are very high. Therefore, capital management requires top-level decisions. It means capital management i.e., planning and control of capital expenditure. It deals with Cost of capital, Rate of Return and Selection of projects.
3.Define managerial economics and law of demand.
Managerial economics is defined as the branch of economics which deals with the application of various concepts, theories, methodologies of economics to solve practical problems in business management
Managerial economics is defined as the branch of economics which deals with the application of various concepts, theories, methodologies of economics to solve practical problems in business management
LAW of Demand:
Law of demand shows the relation between price and quantity demanded of a commodity
in the market. In the words of Marshall, “the amount demand increases with a fall in price
and diminishes with a rise in price”.
A rise in the price of a commodity is followed by a reduction in demand and a fall in price
is followed by an increase in demand, if a condition of demand remains constant.
4.What is demand forecasting and explain any two methods of demand forecasting.
It is essential to distinguish between forecasts of demand and forecasts of sales. Sales
forecast is important for estimating revenue cash requirements and expenses. Demand
forecasts relate to production, inventory control, timing, reliability of forecast etc.
However, there is not much difference between these two terms.
Types of demand Forecasting:
Based on the time span and planning requirements of business firms, demand forecasting
can be classified in to 1. Short-term demand forecasting and
2. Long – term demand forecasting.
1. Short-term demand forecasting:
Short-term demand forecasting is limited to short periods, usually for one year. It relates
to policies regarding sales, purchase, price and finances. It refers to existing production
capacity of the firm. Short-term forecasting is essential for formulating is essential for
formulating a suitable price policy. If the business people expect of rise in the prices of
raw materials of shortages, they may buy early. This price forecasting helps in sale policy
formulation. Production may be undertaken based on expected sales and not on actual
sales. Further, demand forecasting assists in financial forecasting also. Prior information
about production and sales is essential to provide additional funds on reasonable terms.
2. Long – term forecasting:
In long-term forecasting, the businessmen should now about the long-term demand for
the product. Planning of a new plant or expansion of an existing unit depends on longterm demand. Similarly a multi product firm must take into account the demand for
different items. When forecast are mode covering long periods, the probability of error is
high. It is vary difficult to forecast the production, the trend of prices and the nature of
competition. Hence quality and competent forecasts are essential.
5.What are the different types of elasticity of demand.
ELASTICITY OF DEMAND
Elasticity of demand explains the relationship between a change in price and consequent
change in amount demanded. “Marshall” introduced the concept of elasticity of demand.
Elasticity of demand shows the extent of change in quantity demanded to a change in
price.
In the words of “Marshall”, “The elasticity of demand in a market is great or small
according as the amount demanded increases much or little for a given fall in the price
and diminishes much or little for a given rise in Price”
Elastic demand: A small change in price may lead to a great change in quantity
demanded. In this case, demand is elastic.
In-elastic demand: If a big change in price is followed by a small change in demanded
then the demand in “inelastic”.
Types of Elasticity of Demand:
There are three types of elasticity of demand:
1. Price elasticity of demand
2. Income elasticity of demand
3. Cross elasticity of demand
1. Price elasticity of demand:
Marshall was the first economist to define price elasticity of demand. Price elasticity of
demand measures changes in quantity demand to a change in Price. It is the ratio of
percentage change in quantity demanded to a percentage change in price.
Proportionate change in the quantity demand of commodity
Price elasticity = ------------------------------------------------------------------
Proportionate change in the price of commodity
There are five cases of price elasticity of demand
A. Perfectly elastic demand:
When small change in price leads to an infinitely large change is quantity demand, it is
called perfectly or infinitely elastic demand. In this case E=∞
The demand curve DD1 is horizontal straight line. It shows the at “OP” price any amount
is demand and if price increases, the consumer will not purchase the commodity.
B. Perfectly Inelastic Demand
In this case, even a large change in price fails to bring about a change in quantity
demanded.
When price increases from „OP‟ to „OP‟, the quantity demanded remains the same. In
other words the response of demand to a change in Price is nil. In this case „E‟=0.
C. Relatively elastic demand:
Demand changes more than proportionately to a change in price. i.e. a small change in
price loads to a very big change in the quantity demanded. In this case
E > 1. This demand curve will be flatter.
When price falls from „OP‟ to „OP‟, amount demanded in crease from “OQ‟ to “OQ1‟ which
is larger than the change in price.
D. Relatively in-elastic demand.
Quantity demanded changes less than proportional to a change in price. A large change in
price leads to small change in amount demanded. Here E < 1. Demanded carve will be
steeper.
When price falls from “OP‟ to „OP1 amount demanded increases from OQ to OQ1, which is
smaller than the change in price.
E. Unit elasticity of demand:
The change in demand is exactly equal to the change in price. When both are equal E=1
and elasticity if said to be unitary.
When price falls from „OP‟ to „OP1‟ quantity demanded increases from „OP‟ to „OP1‟,
quantity demanded increases from „OQ‟ to „OQ1‟. Thus a change in price has resulted in an
equal change in quantity demanded so price elasticity of demand is equal to unity.
2. Income elasticity of demand:
Income elasticity of demand shows the change in quantity demanded as a result of a
change in income. Income elasticity of demand may be slated in the form of a formula.
Proportionate change in the quantity demand of commodity
Income Elasticity = ------------------------------------------------------------------
Proportionate change in the income of the people
Income elasticity of demand can be classified in to five types.
A. Zero income elasticity:
Quantity demanded remains the same, even though money income increases.
Symbolically, it can be expressed as Ey=0. It can be depicted in the following way:
As income increases from OY to OY1, quantity demanded never changes.
B. Negative Income elasticity:
When income increases, quantity demanded falls. In this case, income elasticity of
demand is negative. i.e., Ey < 0.
When income increases from OY to OY1, demand falls from OQ to OQ1.
c. Unit income elasticity:
When an increase in income brings about a proportionate increase in quantity demanded,
and then income elasticity of demand is equal to one. Ey = 1
When income increases from OY to OY1, Quantity demanded also increases from OQ to
OQ1.
d. Income elasticity greater than unity:
In this case, an increase in come brings about a more than proportionate increase in
quantity demanded. Symbolically it can be written as Ey > 1.
It shows high-income elasticity of demand. When income increases from OY
to OY1, Quantity demanded increases from OQ to OQ1.
E. Income elasticity leas than unity:
When income increases quantity demanded also increases but less than proportionately.
In this case E < 1.
An increase in income from OY to OY, brings what an increase in quantity demanded from
OQ to OQ1, But the increase in quantity demanded is smaller than the increase in income.
Hence, income elasticity of demand is less than one.
3. Cross elasticity of Demand:
A change in the price of one commodity leads to a change in the quantity demanded of
another commodity. This is called a cross elasticity of demand. The formula for cross
elasticity of demand is:
Proportionate change in the quantity demand of commodity “X”
Cross elasticity = -----------------------------------------------------------------------
Proportionate change in the price of commodity “Y”
a. In case of substitutes, cross elasticity of demand is positive. Eg: Coffee and Tea
When the price of coffee increases, Quantity demanded of tea increases. Both are
substitutes.
Price of Coffee
b. Incase of compliments, cross elasticity is negative. If increase in the price of one
commodity leads to a decrease in the quantity demanded of another and vice versa.
When price of car goes up from OP to OP!, the quantity demanded of petrol decreases
from OQ to OQ!. The cross-demanded curve has negative slope.
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c. In case of unrelated commodities, cross elasticity of demanded is zero. A change in
the price of one commodity will not affect the quantity demanded of another.
Quantity demanded of commodity “b” remains unchanged due to a change in the price of
„A‟, as both are unrelated goods
6.Explain the concept of supply and law of supply.
The law of supply and demand is a theory that explains the interaction between the sellers of a resource and the buyers for that resource. The theory defines the relationship between the price of a given good or product and the willingness of people to either buy or sell it. Generally, as price increases, people are willing to supply more and demand less and vice versa when the price falls.
The theory is based on two separate "laws," the law of demand and the law of supply. The two laws interact to determine the actual market price and volume of goods on the market.
Demand
The law of demand states that if all other factors remain equal, the higher the price of a good, the fewer people will demand that good. In other words, the higher the price, the lower the quantity demanded. The amount of a good that buyers purchase at a higher price is less because as the price of a good goes up, so does the opportunity cost of buying that good.
As a result, people will naturally avoid buying a product that will force them to forgo the consumption of something else they value more. The chart below shows that the curve is a downward slope.
Supply
Like the law of demand, the law of supply demonstrates the quantities sold at a specific price. But unlike the law of demand, the supply relationship shows an upward slope. This means that the higher the price, the higher the quantity supplied. From the seller's perspective, each additional unit's opportunity cost tends to be higher and higher. Producers supply more at a higher price because the higher selling price justifies the higher opportunity cost of each additional unit sold.
It is important for both supply and demand to understand that time is always a dimension on these charts. The quantity demanded or supplied, found along the horizontal axis, is always measured in units of the good over a given time interval. Longer or shorter time intervals can influence the shapes of both the supply and demand curves.
UNIT-2
1.Explain Law of Variable Proportions.
2.Explain Production Function and returns to scale.
3.What is Cost Analysis? Write the different types of costs.
OST ANALYSIS Profit is the ultimate aim of any business and the long-run prosperity of a firm depends upon its ability to earn sustained profits. Profits are the difference between selling price and cost of production. In general the selling price is not within the control of a firm but many costs are under its control. The firm should therefore aim at controlling and minimizing cost. Since every business decision involves cost consideration, it is necessary to understand the meaning of various concepts for clear business thinking and application of right kind of costs
A managerial economist must have a clear understanding of the different cost concepts for clear business thinking and proper application. The several alternative bases of classifying cost and the relevance of each for different kinds of problems are to be studied. The various relevant concepts of cost are:
1. Opportunity costs and outlay costs: Out lay cost also known as actual costs obsolete costs are those expends which are actually incurred by the firm these are the payments made for labour, material, plant, building, machinery traveling, transporting etc., These are all those expense item appearing in the books of account, hence based on accounting cost concept. On the other hand opportunity cost implies the earnings foregone on the next best alternative, has the present option is undertaken. This cost is often measured by assessing the alternative, which has to be scarified if the particular line is followed. The opportunity cost concept is made use for long-run decisions. This concept is very important in capital expenditure budgeting. This concept is very important in capital expenditure budgeting. The concept is also useful for taking short-run decisions opportunity cost is the cost concept to use when the supply of inputs is strictly limited and when there is an alternative. If there is no alternative, Opportunity cost is zero. The opportunity cost of any action is therefore measured by the value of the most favorable alternative course, which had to be foregoing if that action is taken.
2. Explicit and implicit costs: Explicit costs are those expenses that involve cash payments. These are the actual or business costs that appear in the books of accounts. These costs include payment of wages and salaries, payment for raw-materials, interest on borrowed capital funds, rent on hired land, Taxes paid etc. 48 Implicit costs are the costs of the factor units that are owned by the employer himself. These costs are not actually incurred but would have been incurred in the absence of employment of self – owned factors. The two normal implicit costs are depreciation, interest on capital etc. A decision maker must consider implicit costs too to find out appropriate profitability of alternatives.
3. Historical and Replacement costs: Historical cost is the original cost of an asset. Historical cost valuation shows the cost of an asset as the original price paid for the asset acquired in the past. Historical valuation is the basis for financial accounts. A replacement cost is the price that would have to be paid currently to replace the same asset. During periods of substantial change in the price level, historical valuation gives a poor projection of the future cost intended for managerial decision. A replacement cost is a relevant cost concept when financial statements have to be adjusted for inflation.
4. Short – run and long – run costs: Short-run is a period during which the physical capacity of the firm remains fixed. Any increase in output during this period is possible only by using the existing physical capacity more extensively. So short run cost is that which varies with output when the plant and capital equipment in constant. Long run costs are those, which vary with output when all inputs are variable including plant and capital equipment. Long-run cost analysis helps to take investment decisions.
5. Out-of pocket and books costs: Out-of pocket costs also known as explicit costs are those costs that involve current cash payment. Book costs also called implicit costs do not require current cash payments. Depreciation, unpaid interest, salary of the owner is examples of back costs. But the book costs are taken into account in determining the level dividend payable during a period. Both book costs and out-of-pocket costs are considered for all decisions. Book cost is the cost of self-owned factors of production.
6. Fixed and variable costs: Fixed cost is that cost which remains constant for a certain level to output. It is not affected by the changes in the volume of production. But fixed cost per unit decrease, when the production is increased. Fixed cost includes salaries, Rent, Administrative expenses depreciations etc. 49 Variable is that which varies directly with the variation is output. An increase in total output results in an increase in total variable costs and decrease in total output results in a proportionate decline in the total variables costs. The variable cost per unit will be constant. Ex: Raw materials, labour, direct expenses, etc. 7. Post and Future costs: Post costs also called historical costs are the actual cost incurred and recorded in the book of account these costs are useful only for valuation and not for decision making. Future costs are costs that are expected to be incurred in the futures. They are not actual costs. They are the costs forecasted or estimated with rational methods. Future cost estimate is useful for decision making because decision are meant for future.
8. Traceable and common costs: Traceable costs otherwise called direct cost, is one, which can be identified with a products process or product. Raw material, labour involved in production is examples of traceable cost. Common costs are the ones that common are attributed to a particular process or product. They are incurred collectively for different processes or different types of products. It cannot be directly identified with any particular process or type of product.
9. Avoidable and unavoidable costs: Avoidable costs are the costs, which can be reduced if the business activities of a concern are curtailed. For example, if some workers can be retrenched with a drop in a product – line, or volume or production the wages of the retrenched workers are escapable costs. The unavoidable costs are otherwise called sunk costs. There will not be any reduction in this cost even if reduction in business activity is made. For example cost of the ideal machine capacity is unavoidable cost.
10. Controllable and uncontrollable costs: Controllable costs are ones, which can be regulated by the executive who is in change of it. The concept of controllability of cost varies with levels of management. Direct expenses like material, labour etc. are controllable costs. Some costs are not directly identifiable with a process of product. They are appointed to various processes or products in some proportion. This cost varies with the variation in the 50 basis of allocation and is independent of the actions of the executive of that department. These apportioned costs are called uncontrollable costs.
4.Discuss the concept of break even analysis.
BREAKEVEN ANALYSIS The study of cost-volume-profit relationship is often referred as BEA. The term BEA is interpreted in two senses. In its narrow sense, it is concerned with finding out BEP; BEP is the point at which total revenue is equal to total cost. It is the point of no profit, no loss. In its broad determine the probable profit at any level of production.
Assumptions:
1. All costs are classified into two – fixed and variable.
2. Fixed costs remain constant at all levels of output.
3. Variable costs vary proportionally with the volume of output.
4. Selling price per unit remains constant in spite of competition or change in the volume of production.
5. There will be no change in operating efficiency.
6. There will be no change in the general price level.
7. Volume of production is the only factor affecting the cost.
8. Volume of sales and volume of production are equal. Hence there is no unsold stock.
9. There is only one product or in the case of multiple products. Sales mix remains constant.
Merits:
1. Information provided by the Break Even Chart can be understood more easily then those contained in the profit and Loss Account and the cost statement.
2. Break Even Chart discloses the relationship between cost, volume and profit. It reveals how changes in profit. So, it helps management in decision-making.
3. It is very useful for forecasting costs and profits long term planning and growth
4. The chart discloses profits at various levels of production.
5. It serves as a useful tool for cost control.
6. It can also be used to study the comparative plant efficiencies of the industry.
7. Analytical Break-even chart present the different elements, in the costs – direct material, direct labour, fixed and variable overheads.
Demerits:
1. Break-even chart presents only cost volume profits. It ignores other considerations such as capital amount, marketing aspects and effect of government policy etc., which are necessary in decision making.
2. It is assumed that sales, total cost and fixed cost can be represented as straight lines. In actual practice, this may not be so. 56
3. It assumes that profit is a function of output. This is not always true. The firm may increase the profit without increasing its output.
4. A major draw back of BEC is its inability to handle production and sale of multiple products.
5. It is difficult to handle selling costs such as advertisement and sale promotion in BEC.
6. It ignores economics of scale in production.
7. Fixed costs do not remain constant in the long run.
8. Semi-variable costs are completely ignored.
9. It assumes production is equal to sale. It is not always true because generally there may be opening stock.
10.When production increases variable cost per unit may not remain constant but may reduce on account of bulk buying etc.
5.Explain the concept of economies of scale.