Enrollment No.: Pugazhendi (Moorthy)

MBA Information Systems 1st Year - Assignment Annamalai University

2: Managerial Economics

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Question #3: Explain how inflation will affect the economy of a country with suitable examples.

Answer:-Inflation in brief

Inflationmeans a reduction in the value of money; in other words, a rise in general price levels. The literal meaning of the word inflation is to blow up or get bigger. If the amount of money in a country - the money supply - grows faster than production in that country, the average price will rise as a result of the increased demand for goods and services. Inflation can also be caused by higher costs being charged on to the end-user. These might be raw material costs or production costs which have risen, but could also be higher tax rates. These price rises cause the value of money to fall. You can therefore buy less with the same amount of money. But this does not need to have an immediate effect on purchasing power. Purchasing power only declines if wages rises less rapidly than prices.

Affect of Inflation on CurrencyWesternized countries have economies based on the value of the currency used to purchase goods. The economic system of the country relies on the value of the money they use to stay the same. For example, imagine going to the store and purchasing a 1 dollar candy bar, only to have the clerk tell you the candy bar now costs 5 dollars. The candy bar hasn't gotten more expensive, your money is simply worth less. This is an extreme example of how inflation can affect the economy, but nonetheless demonstrates the importance of 1 dollar consistently holding the same monetary value. Typically, inflation occurs at a much more gradual, but still noticeable rate.Currency and EconomyIf the money you have becomes worth less, in terms of the goods and services you are able to purchase with it, you will need to rearrange your budget. However, the primary reason that inflation affects the economy so negatively is the loss of value. For example, you still have the same amount of actual currency, you are not making more or less money at your job or splurging for excessive, unnecessary items. Since it is worth less, you need to use more currency to purchase the same items you always have. The result is a snowball effect, because inflation affects your boss too, so the company cannot simply compensate you with additional currency to compensate for the loss of value.Impact of Inflation on EconomyInflation impacts the economy so significantly because economies are organized based on the value of currency, both within and outside of the country. Therefore, we negotiate all financial interactions based on the worth of our dollar to another country's currency. For example, America may pay a company in another country to manufacture items and pay their employees 10 dollars a week. While most Americans would scoff at that type of compensation, due to our currency having a higher value, this is acceptable to those receiving the payment. Following an extreme period of inflation without recovering to economic stability, America may need to pay these same workers 20 dollars a week to provide the same value that 10 dollars once did.

Types of Inflation

Inflationis when the prices of goods and services increase. There are four main types of inflation, categorized by their speed: creeping, walking, galloping, and hyperinflation. There are also many types of asset inflation and of course wage inflation. Many experts consider demand-pullandcost-pushto be types of inflation, but they are actuallycauses of inflation, as is expansion of the money supply.

Creeping InflationCreeping or mild inflation is when prices rise 3% a year or less. According to the U.S. Federal Reserve, when prices rise 2% or less, it's actually beneficial to economic growth. That's because this mild inflation sets expectations that prices will continue to rise. As a result, it sparks increaseddemandas consumers decide to buy now before prices rise in the future. By increasing demand, mild inflation drives economic expansion.

Walking InflationThis type of strong, or pernicious, inflation is between 3-10% a year. It is harmful to the economy because it heats up economic growth too fast. People start to buy more than they need, just to avoid tomorrow's much higher prices. This drives demand even further, so that suppliers can't keep up. More important, neither can wages. As a result, common goods and services are priced out of the reach of most people.

Galloping InflationWhen inflation rises to ten percent or greater, it wreaks absolute havoc on the economy. Money loses value so fast that business and employee income can't keep up with costs and prices. Foreign investors avoid the country, depriving it of neededcapital. The economy becomes unstable, and government leaders lose credibility. Galloping inflation must be prevented.

HyperinflationHyperinflation is when the prices skyrocket more than 50% -- a month. It is fortunately very rare. In fact, most examples of hyperinflation have occurred when the government printed money recklessly to pay for war. Examples of hyperinflation includeGermanyin the 1920s, Zimbabwe in the 2000s, and during the American Civil War.

StagflationStagflationis just like its name says: when economic growth is stagnant, but there still is price inflation. This seems contradictory, if not impossible. Why would prices go up when there isn't enough demand to stoke economic growth? It happened in the 1970s when the U.S. went off thegold standard. Once the dollar's value was no longer tied to gold, the number of dollars in circulation skyrocketed. This increase in themoney supplywas one of the causes of inflation. Stagflation didn't end until then-Federal Reserve ChairmanPaul Volckerraised theFed funds rateto the double-digits -- and kept it there long enough to dispel expectations of further inflation. Because it was such an unusual situation, it probably won't happen again.

Core InflationThecore inflation ratemeasures rising prices in everythingexceptfood and energy. That's because gas prices tend to escalate every summer, usually driving up the price of food and often anything else that has large transportation costs. TheFederal Reserveuses the core inflation rate to guide it in settingmonetary policy. The Fed doesn't want to adjustinterest ratesevery time gas prices go up -- and you wouldn't want it to.

DeflationDeflation is the opposite of inflation -- it's when prices fall. It's caused when an asset bubble bursts. That's what happened in housing in 2006. Deflation in housing prices trapped those who bought their homes in 2005. In fact, the Fed was worried about overall deflation during the recession. That's because deflation can turn a recession into a depression. During theGreat Depression of 1929, prices dropped 10% -- a year. Once deflation starts, it is harder to stop than inflation.

Wage InflationWage inflation is when workers' pay rises faster than the cost of living. This occurs when there is a shortage of workers, when labor unions negotiate ever-higher wages, or when workers effectively control their own pay. A worker shortage occurs whenever unemployment is below 4%. Labor unions negotiated higher pay for auto workers in the 90s. CEOs effectively control their own pay by sitting on many corporate boards, especially their own. All of these situations created wage inflation. Of course, everyone thinks their wage increases are justified. However, higher wages are one element of cost-push inflation, and can cause prices of the company's goods and services to rise.

Asset InflationAn asset bubble, or asset inflation, occurs in one asset class, such as housing, oil orgold. It is often overlooked by the Federal Reserve and other inflation-watchers when the overall rate of inflation is low. However, as we saw in thesubprime mortgage crisisand subsequent global financial crisis, asset inflation can be very damaging if left unchecked.

Asset Inflation -- GasGas prices rise each spring in anticipation of the summertime vacation driving season. In fact, you can expect gas prices to rise ten cents per gallon each spring. However, political uncertainty in the oil-exporting countries drove gas prices higher in 2011 and 2012. Prices hit an all-time peak of $4.17 in July 2008, thanks to economic uncertainty. What do oil prices have to do with gas prices? A lot. In fact, oil prices are responsible for 72% of gas prices. The rest is distribution and taxes, which aren't asvolatileas oil prices.Effects of Inflation

Inflation has good as well as bad effects on the economy. In the initial stages, mild inflation may create an all-round expansion of business activity and this proves beneficial to the economy. Inflation is good up to the stage of full employment. But the trouble is that the rise in prices is not uniform throughout the economy and there may be distortions due to inflation causing many imbalances. Lets see effects of inflation on various sections of the society

On producersInflation is a period of boom and prosperity for the producing classes. All businessmen, traders, speculators gain during inflation because of (a) windfall profits and (b) appreciation in the value of their stock. Normally, there is a time-lag between a rise in the prices of commodities and rise in the cost of production. Prices of goods increase at faster rate during the period of inflation and the cost of production lags behind as wages, interest, insurance etc. are almost fixed. This gives enormous scope for windfall gain. Further, with the fall in the value of money, businessmen try to appreciate the value of their stock. Thus, inflation is a blessing in disguise to the business class at the initial stages.

On Working ClassWorking class suffer during inflation, as their wages do not rise proportionately with the rise in prices and cost of living. These days workers of the organized group do not suffer much as they react faster during the inflation. Whereas other unorganized groups like self employed and agriculture labours find it very difficult during inflation. The condition is equally distressing for those workers, who have little bargaining power from their organizations.

On fixed income groupsThis is the worst hit class during inflation. People living on past savings, fixed interest, on investments, pensioners, salaried class like teachers and government employees find inflation and rising in prices very agonising, as their fixed purchasing power decline in the face of mounting cost of living. This class of people, called the middle income group, which form the bulk of the society become the worst sufferers.

On DistributionInflation has bad effect on distribution too. Since rise in price and rise in income may not be uniform in all sectors and sections of the economy there will be distortions and imbalances causing bottlenecks in distribution and fluctuation in production and effective distribution. For instance, during inflation the price of industrial goods go up rapidly and prices of agriculture produce are not so flexible. The returns of farmers diminish and their economic condition deteriorates due to mounting cost of commodities and industrial product which they must buy. The net result will be that some classes enjoy the benefits of inflation while others suffer from it.On debtors and creditorsDuring the inflationary period the debtors (borrowers) gain much while creditors (lenders) lose heavily. When prices rise, the real value of money falls and the debtors have to pay money which has less purchasing power. This will be beneficial to debtor while the creditor will be getting back amount whose value of purchasing power has declined.

On GovernmentThe government too will be affected by the inflation. The public sector undertaking may have to raise the expenditure level due to a fall in the value of money. Alternatively they would cut the size of the projects and programmes to meet with the original budgeted expenditure. On other hand government will be benefited during inflationary period, as it is a largest borrower as we have in the case of debtors.

Social ConsequenceIf inflation is persistent and severe, it has baneful influence on society. It makes rich richer and poor poorer. There is an all-round frustration among the salaried and fixed income groups. The producing and trading classes gain at the expense of salaried fixed income groups. Thus there is transference of income from poor to rich. Due to enormous rise in prices and scarcity of essential commodities, there is black-marketing, hoarding and profiteering. Inflation becomes social menace and political problem if necessary steps are not taken.

Effects of inflation on Economy of a country

Inflation and the economy of a country are closely related. The effect on the economy of any country is not immediate or it does not affect the economy overnight. There is a cumulative effect. Several such changes build up to bring about a big change. The economy of a country is affected by inflation in a number of ways.

Inflation and the economy both influence all the major macroeconomic indicators of a country. The various macroeconomic indicators include the following:

Gross domestic product or GDP, Producer price index (industrial), Consumer price indices, Industrial production, Capital Investment, Agricultural production, Export, Import, Demography, Debt

Inflation not only affects the macroeconomic indicators, it affects the living standards of the people. The exchange rates of all currencies also change. This in turn influences trade. When exchange rates are affected, the interest rates cannot be far behind.

Inflation and its effect on economy are enormous. In other words, all events are interlinked and the entire economic cycle gets upset.

For Example: The mortgage crisis of 2007 in USA could best illustrate the ill effects of inflation. Housing prices increases substantially from 2002 onwards, resulting in a dramatic decrease in demand.India after independence has had a more stable record with respect to inflation than most other developing countries. Since 1950, the inflation in Indian economy has been in single digits for most of the years, as shown in the following tablePeriodAvg. Inflation rate

1950-19602.00%

1960-19707.20%

1970-19808.50%

In early 2007, in India, the inflation rate, as measured by the wholesale price index (WPI), hovered around 6-6.8%, well above the level of 5-5.5% that would have been acceptable to the Reserve Bank of India (RBI), the country's central bank. On February 15, 2007, the inflation rate reached a two-year high of 6.73%. In the past, the main cause of high inflation in India used to be rises in global oil prices. However, in early 2007, the chief component of the inflation was the increase in the prices of food articles - caused by increased demand as well as supply constraints. According to analysts, the increased demand was due to high economic growth and increased money supply, while stagnant agricultural productivity was behind the supply constraints.Apart from the rise in prices of food articles, fuel and cement prices too recorded high increases. The Government of India, together with the RBI, took several measures to contain inflation. For example, the RBI increased the Cash Reserve Ratio (CRR) and repo rates in an effort to check money supply; the Government of India reduced import duties on several food products and cut the price of diesel and petrol.The RBI also chose not to intervene when the Indian Rupee rallied against the US Dollar between March 2007 and May 2007. The decision not to intervene was based on the idea that a stronger Rupee would bring down the cost of imports, which, in turn, would help reduce domestic prices of goods. Though the measures taken by the GoI were targeted at inflation, some analysts feared that some of these measures, especially the ones leading to higher interest rates, might induce recession in the Indian economy. There were others who felt that letting the Rupee rise would not only have a negative effect on the bottom lines of companies that earn a substantial percent of their profits from exports, but also impact the long-term competitiveness of Indian exports.Inflation in India a menace a few years ago is at a 30 year low. The inflation ended at a low of 0.61% in the week ended May 9, 2009 this after reaching a 16 year high of 12.91 % in August 2008, bringing in a sigh of relief to policymakers. Following diagram illustrates current inflation rates in India.

INDIA STOCK MARKET (SENSEX)

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Question #4: Explain pricing methods and which method will be suitable in present age?

Answer:-

Introduction

There are many practical pricing methods adopted by the firms, based on different considerations. While fixing the price, the firm is guided by some objectives such as, profit maximisation, sales maximisation, establishing a favourable image with the public or limiting competition, etc. Every firm sets certain objectives and tries to accomplish them.

Formulating price policy and adopting a particular pricing method is often a critical factor in the successful operation of a business organization. Even though the basic problem of pricing is the same for all firms (i.e. Costs, Competition, Demand, and Profit), the optimum mix of these factors varies according to the nature of the products markets and the overall objective of the firm. Thus, the job for the management is to develop and adopt an appropriate pricing method that meets the needs of the company.

Pricing MethodsGenerally businessmen prefer a pricing procedure which is easy to implement and requires only few assumptions on demand. The various pricing methods usually employed by businessmen are

Methods Based on Cost Cost-Plus or Full-Cost pricing Target pricing or pricing for a rate of return Marginal pricing

Methods Based on Competition and Market Going-rate pricing Customary pricing Differential pricing

Methods Based on Cost

Cost-Plus or Full-Cost pricing: The full-cost pricing method is generally adopted by many of the firms for its simplicity and ease. This method is also called Cost-plus pricing, Margin pricing and Mark-up pricing. Under this method, the price is set to cover all costs (material, labour and overhead) and predetermined percentage for profit. Which means the selling price of the product is computed by adding percentage to the average total cost of the product. The percentages added to the cost are called margins or mark-ups. These percentages vary from firm to firm and product to product in the same firm. Firms using this method should take the following costs into consideration.

Variable and fixed production costs Variable and fixed selling and administrative costs

The mark-up of profit is determined based on variety of considerations. It may be based on common tradition laid down in particular business or it may be determined by trade associations or guide lines if any provided by the government.

For example: The fixed costs to produce an item are Rs300000, the variable costs add up to Rs100000, and the estimated number of units to be produced is 50,000. Add Rs100000 to Rs300000, divide by 50000, and the true unit cost equals Rs8. If the desired return on sales is 20%, divide Rs8 by 1 minus .20, and the cost-plus price for this item will be Rs10.

Advantages It helps in setting fair and plausible prices. It is easy for application by all types of firms. This method safeguards the interest of the firm against risks due to uncertain demands. It economical for decision making. If adopted by all businessmen, it may help protect the firms against price wars or self damaging price competition and at the same time it provides flexibility to adjust price based on variation of costs. This method is best while dealing with uncertainty and ignorance.

Drawbacks Totally ignores influence of demand. Fails to reflect the forces of competition adequately. Cost is regarded the main factor influencing the price. Undue importance is given for the precision of allocating of costs. This method is based on circular reasoning. Which means price determines quantity demanded; price charged is dependent upon cost per unit and the cost, in turn, depends upon the quantity demanded. It ignores marginal or incremental cost and uses average cost instead.In spite of drawbacks this method is useful in product tailoring, custom design products, monopsony buying and public utility buying.

Target pricing or pricing for a rate of return:This method of pricing is only a refinement of the full-cost pricing. According to this method manufacturer considers a pre-determined target rate of return on capital invested. In the case of full-cost pricing, the percentage of profit is marked up arbitrarily. In the case of rate of return method, the companies determine the average mark-up on costs necessary to produce a desired rate of return on the companys investment.

In this case the company estimates future sales, future costs, and arrives at a mark-up that will achieve a target return on the companys investment.

Davis and Hughes have used the following formula to calculate the desired rate of return when a mark-up is applied on cost

Percentage mark-up on cost=Capital employedxPlanned rate of return

Total annual cost

For Example:Suppose the capital employed by a firm is Rs.6 lakhs and total annual cost id Rs.12 lakhs with a planned rate of return of 20 percent.

Then percentage mark-up is = (6/12) * 20 = 10%Now suppose the total cost per unit in the firm is Rs.20 with 10 percent mark-up the selling price would be Rs.22.

In any business price policy is profit oriented. A company cannot blindly stick to the mark-up which has been decided based on the capital employed. Change of costs compels company to revise the prices. To overcome this problem, three different methods are followed

Revising the prices to maintain constant percentage mark-up over costs. Revising the prices to achieve estimated sales to maintain percentage of profit. Revising the prices to achieve a constant rate of return on capital invested

Changed percentage may be computed as below

Percentage over cost = Profits / Costs Percentage on sales = Profits / Earnings from sales Percentage on capital employed = Profits / Capital employed

The major drawback of this procedure is that it ignores demand condition.

Marginal Cost PricingUnder marginal cost pricing method, the price of a product is determined on the basis of the marginal or variable costs. In this method fixed costs are totally ignored and only variable costs are taken in to consideration. This is done on the assumption that fixed costs are caused by outlays which are historical and sunk. Their relevance to pricing decision is limited, as pricing decision requires planning the future. Under marginal cost pricing, the objective of the firm is to maximise its total contribution to fixed costs and profit.

For Example:Aircraft flying from Delhi to KochiTotal Cost (including normal profit) = Rs15,000 of which Rs13,000 is fixed cost*Number of seats = 160, average price = Rs93.75MC of each passenger = 2000/160 = Rs12.50If flight not full, better to offer passengers chance of flying at Rs12.50 and fill the seat than not fill it at all!

Advantages Marginal cost pricing is highly useful for public utility undertakings. It helps them in maximising output and better capacity utilization. This is possible only when lowest possible price is charged. The lowest limit is set by marginal cost of the product, which helps in maximising public welfare. This method enables the firms to face competition. This is the reason why export prices are based on marginal costs since international market is highly competitive. This method helps in optimum allocation of resources and as such it is the most efficient and effective pricing technique and it is useful when demand conditions are slack. Marginal cost pricing is suitable for pricing over the life-cycle of a product. Each stage of the life-cycle has separate fixed cost and short-term marginal cost.

In the modern business marginal is cost pricing method is more effective compares to full-cost method due to following two characteristics

The prevalence of multi-product, multi-process and multi-maker concerns makes the absorption of fixed costs into product costs is absurd. The total cost of separate products can never be estimated perfectly and satisfactorily, and the optimal relationship between costs and prices will vary substantially both among different products and different markets. In this type of business, proposals to changing the prices in terms of sales and segmentation of the market can be profitability employed only with short-run problems and marginal pricing is the most suitable method of short-run pricing. In business, dominant force is innovation combined with constant technology. The long-run situations are often unpredictable. Hence, short-run marginal cost pricing is most suitable.Limitations Firms may find it difficult to cover up costs and earn a fair return on capital employed when they follow marginal cost principle in times of recessions when demand is slack and price reduction becomes inevitable to retain business. When production takes place under decreasing costs, marginal cost pricing is unsuitable since MC curve will be below the AC curve and marginal cost pricing is bound to lead to deficits. Marginal cost pricing requires a better understanding of marginal cost technique. Some accountants are not fully conversant with the marginal techniques themselves. Therefore, they are not capable of explaining their use to the management.

In spite of its advantages, due to its inherent weakness of not ensuring the coverage of fixed costs, marginal pricing has not been adopted extensively. It is confined to cases of special orders only.

Methods Based on Competition and Market

Going-Rate pricingThis method of pricing conforms to the system of pricing in oligopoly where a firm initiates price changes and other firms in the industry follow the pattern set by the leader. Other firm accepts the leadership. The emphasis here is on the market. Firms make necessary price adjustment to suit the general price structure in the industry. Hence this going-rate pricing method is also called as Acceptance-pricing. Normally, under this method, the industry tries to determine the lowest price that the seller can afford to accept considering various alternatives.

For Example:Going-rate pricing include industries like clothing, automobile, long-playing records, etc., where the products have reached a stage of maturity and where both customers and rival produces have become accustomed to stable price-relationship.

When products are identical, unique selling price will rule. When they are differentiated, prices will form a series, set at discrete intervals.

Advantages It helps in avoiding cut-throat competitions among the firms. It is a rational pricing method when costs are difficult to measure. Going-rate or acceptance pricing is less troublesome and less costly since exact calculation of costs and demand is not necessary. It is suitable to avoid price hazards in oligopoly market.

Customary PricingPrice of certain goods becomes more or less fixed for a considerable period of time, not by deliberate action on the sellers part, but as a result of their having prevailed for a considerable period of time. Only when the costs change significantly, the customary prices of these goods are changed. While changing the customary price, it is necessary to study the pricing policies and practices adopted by the competing firms. Another approach is to effect price change only in a limited market segment and know the customer reaction to decide whether any change would be digested by the market.

Customary price may be maintained even when products are changed.

For Example:The new model of a mobile phone may be priced at the same level as the discontinued model. This is usually so even in the face of lower costs. A low price may cause an adverse reaction on the competitors leading them to a price war as also on the consumers who may think that quality of the new model is inferior. Hence, going along with the old price is the easiest thing to do.

Differential PricingIdentical products are priced differently for different types of customers, markets or buying situations. An important aspect of differential price is price discrimination.

Differential pricing enables companies to profit from their customers' unique valuations by offering different customers different prices for the same product.

For Example:At a cinema, customers who paid full price, used coupons, received discounts (senior, student, under 12 and AAA etc.) or purchased prepaid discount passes from Super Market can all be sitting next to each other watching the same movie. Offering this spectrum of prices enables cinemas to maximize profits by serving customers with a variety of different valuations.

Consider the pricing behaviour at an auction. Everyone has the same information and bids on the same item. As prices increase, bidders drop out. Those who drop out are in essence saying, "I know others are willing to pay higher prices, but I just don't value the item as much as they do."

Differential pricing tactics can be grouped as:

Requiring customers to jump hurdles (coupons, rebates, sales, price match guarantees, time in sales cycle, distribution outlet). Customer characteristics (different prices based on where customer lives, readily available traits such as age, affiliations, purchasing history). Selling characteristics (discounts for volume purchases, bundles, different next best alternatives). Selling strategy (negotiation, razor/razor blade pricing, metering, and dynamic pricing).

The range of prices created by differential pricing contributes to the pricing windfall with larger margins from higher prices and growth by using discounts to sell to more customers.

The end result of implementing these four strategies is a multi-price strategy. By this, I mean a set of publicly known prices and plans for a company's products composed of: (1) a value-based price, (2) new pricing plans, (3) versions, and (4) a range of prices.

Tips for Successful Pricing

Good product prices are important to any successful business. Pricing takes creativity, time, research, good recordkeeping and flexibility. You need to balance the costs of producing a product with competition and the perceptions of your target customer to select the right product price. Follow these tips to ensure greater pricing success. Be Creative: Think of new ways to sell more to existing customers or to attract new customer groups. Listen to the Customer: Make a point of noting customer comments in a journal or file. Review them periodically to glean new ideas. Do the Homework: Keep good notes of how the price arrived so it can make similar assumptions in the future. Boost the Records: Good recordkeeping will help to set a price and to track the performance of the pricing. Cover the Basics: The three basics of pricing are product price, competition and customers. Blend pricing methods to ensure the three basics are in balance. Be flexible: Constantly review both internal and external factors and calculate how a price change would affect the new situation.

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