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MB0042-Managerial Economics-DE

Semester I-- MBA

Q-1 What is production function and its uses? Explain the two

types of production functions?

Ans- Production function

The entire theory of production centres revolves around the concept of productionfunction. A “production function” expresses the technological or engineering relationshipbetween physical quantity of inputs employed and physical quantity of outputs obtained by a

firm. It specifies a flow of output resulting from a flow of inputs during a specified period oftime. It may be in the form of a table, a graph or an equation specifying maximum output ratefrom a given amount of inputs used. As it relates inputs to outputs, it is also called “inputoutputrelation.” The production is purely physical in nature is determined by the quantum oftechnology, availability of equipments, labour, raw materials, etc. employed by a firm.

A production function can be represented in the form of a mathematical model or equation as! " f #$, %, &'.etc( where ! stands for quantity of output per unit of time and $, %, & etc arethe various factor inputs li)e land, capital, labour, etc which are used in the production ofoutput. The rate of output ! is thus, a function of the factor inputs $, %, & etc, employed by thefirm per unit of time.

It is necessary to note that production function is assumed to be a continuous function, i.e. itis assumed that a change in any of the variable factors produces corresponding changes in theoutput.*enerally spea)ing, there are two types of production functions. They are as follows+

1. Short run production function In this case, the producer will )eep all fixed factors asconstant and change only a few variable factor inputs. In the short run, we come across two)inds of production functions+

!uantities of all inputs both fixed and variable will be )ept constant and only one variable

input will be varied, for example, law of variable proportions.

!uantities of all factor inputs are )ept constant and only two variable factor inputs are

varied, for example, isoquants and isocost curves.

2. Long run production function In this case, the producer will vary the quantities of allfactor inputs, both fixed as well as variable in the same proportion, for example, the laws ofreturns to scale.

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-ach firm has its own production function which is determined by the state of technology,managerial ability, organisational s)ills, etc of a firm. It may be in the following manner+ . The quantity of inputs may be reduced while the quantity of output may remain same./. The quantity of inputs may be reduced while the quantity of output may increase.

0. The quantity of inputs may be )ept constant while the quantity of output may increase.If there are any improvements in the firm, the old production function is disturbed and a newone ta)es its place.

Uses of production function

Though production function may appear as highly abstract and unrealistic, in reality, it is bothlogical and useful. It is of immense utility to the managers and executives in the decisionma)ing process at the firm level.There are several possible combinations of inputs and, decision ma)ers have to choose themost appropriate among them. The following are some of the important uses of productionfunction+

!uantities of all inputs both fixed and variable will be )ept constant and only one variable

input will be varied, for example, law of variable proportions.

!uantities of all factor inputs are )ept constant and only two variable factor inputs are

varied, for example, isoquants and isocost curves.

/. Long run production function In this case, the producer will vary the quantities of allfactor inputs, both fixed as well as variable in the same proportion, for example, the laws ofreturns to scale.

-ach firm has its own production function which is determined by the state of technology,managerial ability, organi1ational s)ills, etc of a firm. It may be in the following manner+. The quantity of inputs may be reduced while the quantity of output may remain same./. The quantity of inputs may be reduced while the quantity of output may increase.0. The quantity of inputs may be )ept constant while the quantity of output may increase.If there are any improvements in the firm, the old production function is disturbed and a newone ta)es its place.

Uses of production function

Though production function may appear as highly abstract and unrealistic, in reality, it is bothlogical and useful. It is of immense utility to the managers and executives in the decisionma)ing process at the firm level.There are several possible combinations of inputs and, decision ma)ers have to choose themost appropriate among them. The following are some of the important uses of productionfunction+

1 .It can be used to calculate or wor) out the least cost input combination for a given output orthe maximum outputinput combination for a given cost.

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2. It is useful in wor)ing out an optimal and economic combination of inputs for getting acertain level of output. The utility of employing a unit of variable factor input in the productionprocess can be better 2udged with the help of production function. Additional employment of avariable factor input is desirable only when the marginal revenue productivity of that variablefactor input is greater than or equal to cost of employing it in an organi1ation.

3. 3roduction function also helps in ma)ing long run decisions. If returns to scale areincreasing, it is wise to employ more factor units and increase production. If returns to scaleare diminishing, it is unwise to employ more factor inputs 4 increase production. 5anagers willbe indifferent whether to increase or decrease production, if production is sub2ect to constantreturns to scale.

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Semester I-- MBA

Q-2 A cost-schedule is a statement of variations in costs

resulting from variations in the levels of Output and it shows

the response of costs to changes in output !f we represent the

relationship "etween changes in the level of output and costs

of production# we get di$erent types of cost curves in the

short run %e&ne the 'inds of cost concepts li'e ()*# (+*# (*#

A)*# A+*# A* and ,* and its corresponding curves with

suita"le diagrams for each?

Ans- *ost-output relationship and nature and "ehaviour of

cost curves in the short run

In order to study the relationship between the leel o! output and corresponding

cost o! production" we hae to prepare the cost schedule o! the #rm$ A cost-

schedule is a statement o! ariations in costs resulting !rom ariations in the leels

o! output$ It shows the response o! costs to changes in output$ %able &$' represents

a hypothetical cost schedule o! a #rm$

In the short run" we will study the !ollowing (inds o! cost concepts and cost cures$

(otal &xed cost ()*.

%)* re!ers to total money e+penses incurred on #+ed inputs li(e plant" machinery"

tools and e,uipments in the short run$ %otal #+ed cost corresponds to the #+ed

inputs in the short run production !unction$ %)* remains the same at all leels o!

output in the short run$ It is the same een when output is nil$ It indicates that

whateer may be the ,uantity o! output" whether ' to & units" %)* remains

constant$ )igure &$' depicts the total #+ed cost cure$ %he %)* cure is horiontal

and parallel to ./-a+is" showing that it is constant regardless o! output per unit o!

time$ %)* starts !rom a point on -a+is indicating that the total #+ed cost will be

incurred een i! the output is ero$ In our e+ample" 1s$ &0 is the %)*$ It is obtained

by summing up the product or ,uantities o! the #+ed !actors multiplied by their

respectie unit price$

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y

()*/(*-(+*

cost of production 0

()*

Output x

(otal varia"le cost (+*.

%3* re!ers to total money e+penses incurred on the ariable !actor inputs li(e raw

materials" power" !uel" water" transport and communication" etc" in the short run$ %otal ariable cost corresponds to ariable inputs in the short run production

!unction$ It is obtained by summing up the ,uantities o! ariable inputs multiplied

by their prices$ %he !ormula to calculate %3* is as !ollows$ (+* / (* - ()* (+* /

f Q.# i$e$" %3* is an increasing !unction o! output$ In other words %3* aries with

output$ It is nil" i! there is no production$ %hus" it is a direct cost o! output$ )igure

&$2 depicts the total ariable cost cure$ %3* rises sharply in the beginning"

gradually in the middle and sharply at the end in accordance with the law o!

ariable proportions$ %he law o! ariable proportions e+plains that in the initial

stages" to obtain a gien ,uantity o! output" the relatie change ariation5 in

ariable !actors that are needed are in lower proportion" but a!ter a point when the

diminishing returns operate" ariable !actors are to be employed in a larger

proportion to increase the same leel o! output$ %3* cure slope upwards !rom le!t

to right$ %3* cure rises as output is e+panded$ 6hen output is ero" %3* also will

be ero$ 7ence" the %3* cure starts !rom the origin$ 3

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*ost of production

O4(54( 6

(otal cost (*.

%otal cost re!ers to the aggregate money e+penditure incurred by a #rm to produce

a gien ,uantity o! output$ %he total cost is measured in relation to the production

!unction by multiplying the !actor ,uantities with their prices$ %* 8 ! 95 which

means that %* aries with output$ %heoretically spea(ing" %* includes all (inds o!

money costs" both e+plicit and implicit cost$ :ormal pro#t is included in the total

cost as it is an implicit cost$ It includes #+ed as well as ariable costs$ 7ence" (* /()* 7(+*

3

*ost of production

0 ()*

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Average &xed cost A)*.

Aerage #+ed cost is the #+ed cost per unit o! output$ 6hen %)* is diided by total

units o! output" A)* is obtained" %hus" A)* / ()*8Q$ *ost o! production &0 +

.utput %)* 0 %* 8 %)* ; %3* %* *ost o! <roduction .utput / A)* 0 %3* A)*

and output hae inerse relationship$ It is higher at smaller leels and lower at

higher leels o! output in a gien plant$ %he reason is simple to understand$ Since

A)* / ()*8Q# it is a pure mathematical result that the numerator remaining

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unchanged" the increasing denominator causes diminishing cost$ 7ence" with the

increase in output" %)* spreads oer each unit o! output$ *onse,uently" A)*

diminishes continuously$ %his relationship between output and #+ed cost is

uniersal !or all types o! business concerns$

%he A)* cure has a negatie slope$ %he cure slopes downwards throughout thelength$ %he A)* cure goes ery nearer to / a+is" but neer touches the /-a+is$

=raphically" it will !all steeply in the beginning" gently in middle and tend to

become parallel to ./-a+is$ Mathematically spea(ing" as output increases" A)*

diminishes$ But A)* will neer become ero because the %)* is a positie amount$

A)* will neer !all below a minimum amount because in the short run" plant

capacity is #+ed and output cannot be e+panded to an unlimited e+tent$

3

*ost of production

6

O4(54(

Average varia"le cost A+*.

%he aerage ariable cost is ariable cost per unit o! output$ A3* can be computed

by diiding the %3* by total units o! output$ %hus" A3* 8 %3*>9$ %he A3* will come

down in the beginning and then rise as more units o! output are produced with a

gien plant$ %his is because" as we add more units o! ariable !actors in a #+ed

plant" the e?ciency o! the inputs #rst increases and then decreases$ )igure &$@

depicts the aerage ariable cost cure$ %he A3* cure is a -shaped cost cure$ It

has three phases$

3 A3*

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A *

*ost of production

B

6

O4(

Average total cost A(*. or average cost A*.

A* re!ers to cost per unit o! output$ A* is also (nown as the unit cost since it is the

cost per unit o! output produced$ A* is the sum o! A)* and A3*$ Aerage total cost

or aerage cost is obtained by diiding the total cost by total output produced$ A*

/ (*8Q$ Also" A* is the sum o! A)* and A3*$ In the short run" A* cure also tends

to be -shaped$ %he combined inuence o! A)* and A3* cures will shape the

nature o! A* cure$ )igure &$& depicts the aerage cost cure$ )igure &$&C Aerage

*ost *ure *ost o! production A* A(* / A)* 7 A+*

y

*ost of production

x

O4(54(

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,arginal cost

Marginal cost may be de#ned as the net addition to the total cost as one more

unit o! output is produced$ In other words" it implies additional cost incurred toproduce an additional unit$ )or e+ample" i! it costs 1s$ '00 to produce @0 units o! a

commodity and 1s$ '0@ to produce @' units" then M* would be 1s$ @$ It is obtained

by calculating the change in total costs as a result o! a change in the total output$

Also" M* is the rate at which total cost %* stands !or∆ %9$ 6here" ∆ %* > ∆changes

with output$ 7ence" M* 8 %9 stands !or change in total output$ Also M*n

8∆change in total cost and %*n %* n-' It is necessary to note that M* is

independent o! %)* and it is directly related to %3* as we calculate the cost o!

producing only one unit$ In the short run" the M* cure also tends to be -shaped$

%he shape o! the M* cure is determined by the laws o! returns$ I! M* is !alling"production will be under the conditions o! increasing returns and i! M* is rising"

production will be subect to diminishing returns$

3

*ost of production A M*

B *

x

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Output

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Semester I-- MBA

Q-0 !n9ation is a glo"al 5henomenon which is associated with

high price causes decline in the value for money !t exists when

the amount of money in the country is in excess of the physical

volume of goods and services Explain the reasons for this

monetary phenomenon?

Ans- !n9ation - ,eaning and :inds

Ination has become a global phenomenon in recent years$ Deelopment

economics is ery much associated with ination$ An in-depth study o! ination is

o! paramount importance to a student o! managerial economics$ %he term ination

is used in many senses and hence it is ery di?cult to gie a generally accepted"

uniersally agreeable" and precise de#nition to the term ination$ <opularly"

ination is associated with high prices" which causes a decline in the alue o!

money$ Ination is commonly understood as a situation o! substantial and rapid

increase in the leel o! prices and conse,uent deterioration in the alue o! money

oer a period o! time$ It re!ers to the aerage rise in the general leel o! prices and

!all in the alue o! money$ Ination is an upward moement in the aerage leel o!

prices$ %he opposite o! ination is deation" a downward moement in the aerage

leel o! prices$ %he common !eature o! ination is rise in prices and the degree o!

ination may be measured by price indices$ Ination is statistically measured in

terms o! percentage increase in the price inde+" as a rate percent5 per unit o!

time- usually a year or a month$ %he trend o! price indices reeals the course o!

ination in the economy$ sually" the 6holesale <rice Inde+ 6<I5 numbers are

used to measure ination$ Alternatiely" the *onsumer <rice Inde+ *<I5 or the cost

o! liing inde+ can be adopted to measure the rate o! ination$ In order to measurethe percentage rate o! ination" the !ollowing !ormula can be usedC

5ercentage rate of in9ation# 5;t< / *hange in 5r ice;t<

5rice ;t-1< =1

*hange in price FtG 8 < FtG < Ft-'G$

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7ere" < 8 price leel

FtG" Ft-'G 8 periods o! calendar time in which the obserations are made$

Most o! the economists considered ination as a purely monetary phenomenon$

According to this approach" it is the increase in the ,uantity o! money whichcauses an inationary rise in the price leel$ An e+pansion in money supply

unaccompanied by an e+pansion in the supply o! goods and serices ineitably

results in price rise$ Ination e+ists when the amount o! money in the country is in

e+cess o! the physical olume o! goods and serices$ It is a situation where too

much o! money chases too !ew goods$ Money supply and rising price leel are both

causes and eHects by themseles$

Ination is that state o! dise,uilibrium in which an e+pansion o! purchasing power

tends to cause or is the eHect o! an increase o! the price leel$ Some economists

state that ination is always and eerywhere a monetary phenomenon$ %heclassical economists adocated ,uantity theory o! money and they analysed the

causes o! ination in terms o! money$ %his approach !ailed to e+plain the causes o!

hyperination" which appeared in =ermany a!ter the )irst 6orld 6ar$

According to another approach" the sole cause o! ination is the e+istence o! a

persistent e+cess demand in the economy$ Ination is the e+cess demand oer the

supply o! eerything a!ter the limits o! the supply hae been reached$

*auses of in9ation

1-%emand side

Increase in aggregatie eHectie demand is responsible !or ination$ In this case"

aggregate demand e+ceeds aggregate supply o! goods and serices$

Demand rises much !aster than supply$ 6e can enumerate the

!ollowing reasons !or increase in eHectie demand$

!ncrease in money supply >

Supply o! money in circulation increases• on account o! the !ollowing reasonsC

de#cit #nancing by the goernment" e+pansion in public e+penditure" e+pansion in

ban( credit and repayment o! past debt by the goernment to the people" increase

in legal tender money and public borrowing$

!ncrease in disposa"le income >

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Aggregate eHectie demand rises• when disposable income o! the people

increases$ Disposable income rises on account o! the !ollowing reasonsC reduction

in the rates o! ta+es" increase in national income while ta+ leel remains constant"

and decline in the leel o! saings$

!ncrease in private consumption expenditure and investment

expenditure >

An increase in priate e+penditure both on consumption and on inestment leads

to emergence o! e+cess demand in an economy$ 6hen business is prosperous"

business e+pectations are optimistic and prices are rising$ More inestments are

made by priate entrepreneurs causing an increase in !actor prices$

!ncrease in exports >

An increase in the !oreign demand !or a countrys e+ports reduces the stoc( o!goods aailable !or home consumption$ %his creates shortages in the country

leading to a rise in price leel$

Existence of "lac' money-

%he e+istence o! blac( money in a country due to corruption" ta+ easion" blac(-

mar(eting" etc$ increases the aggregate demand$ <eople spend such unaccounted

money e+traagantly and create unnecessary demand !or goods and serices thus

causing ination$

!ncrease in foreign exchange reserves >

%his may increase on the• account o! inow o! !oreign money into the country$

)oreign direct inestment may increase and non-resident deposits may also

increase due to the policy o! the goernment$

!ncrease in population growth >

%his creates an increase in demand !or many types o! goods and serices in a

country$

igh rates >

7igher rates o! indirect ta+es would lead to a rise in prices$

@eduction in the rates of direct taxes >

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%his would leae more cash in the hands o! people inducing them to buy more

goods and serices leading to an increase in prices$

@eduction in the level of savings >

%his creates more demand !or goods and serices$

!! upply side

=enerally" the supply o! goods and serices do not (eep pace with the eer

increasing demand !or goods and serices$ %hus" supply does not match the

demand$ Supply !alls short o! demand$ Increase in supply o! goods and serices

may be limited because o! the !ollowing reasons$

hortage in the supply of factors of production >

6hen there is shortage in the supply o! !actors o! production li(e raw materials"

labour " capital e,uipments" etc$ there will be a rise in their prices$ %hus" when

supply !alls short o! demand" a situation o! e+cess demand emerges creating

inationary pressures in an economy$

Operation of law of diminishing returns >

6hen the law o! diminishing returns operates" increase in production is possibleonly at a higher cost which demotiates the producers to inest in large amounts$

%hus" production will not increase proportionately to meet the increase in demand$

7ence" supply !alls short o! demand$

oardings "y traders and speculators >

During the period o! shortage and rise in prices" hoardings o! essential

commodities by traders and speculators with the obectie o! earning e+tra pro#ts

in the !uture creates an arti#cial scarcity o! commodities$ %his creates a situation o!

e+cess demand paing the way !or !urther ination$

oardings "y consumers >

*onsumers may also hoard essential goods to aoid payment o! higher prices in

the !uture$ %his leads to an increase in the current demand" which in turn

stimulates prices$

@ole of trade unions >

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%rade union actiities leading to industrial unrest in the !orm o! stri(es and

loc(outs also reduce production$ %his will lead to creation o! e+cess demand that

eentually brings a rise in the price leel$

@ole of natural calamities >

:atural calamities such as earth,ua(e" oods" and drought conditions also aHect

the supplies o! agricultural products adersely$ %hey also create shortage o! !ood

grains and raw materials" which in turn creates inationary conditions$

War >

During the period o! war" shortage o! essential goods creates a rise in prices$

International !actors %hese !actors would cause either shortage o! goods and

serices or rise in the prices o! !actor inputs leading to ination$


Semester I-- MBA

Q-B %e&ne revenue Explain the types of revenue and the

relationship "etween (@# A@ and ,@ with an example of a

hypothetical revenue schedule?

Ans- In this section" we will discuss the meaning o! reenue along with its types$

1eenue is the income receied by the #rm$ %here are three concepts o! reenue

total reenue" aerage reenue and marginal reenue$

(otal @evenue (@.

%otal reenue re!ers to the total amount o! money that the #rm receies !rom the

sale o! its products" i$e$ $gross reenue$ In other words" it is the total sales receipts

earned !rom the sale o! its total output produced oer a gien period o! time$ 6e

may show total reenue as a !unction o! the total ,uantity sold at a gien price$

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%1 8 ! 95$ It implies that higher the sales" larger would be the %1$

%hus" %1 8 < / 9$ )or e$g$ a #rm sells @000 units o! a commodity at the rate o! 1s$

@ per unit" then %1 would be %1 8 < + 9 8 @ + @000 8 2@"000

3

(@

5@!*E

x

ACE

Average @evenue

Aerage reenue is the reenue per unit o! the commodity sold$ It can be obtained

by diiding the %1 by the number o! units sold$ %hen A1 8 %1>9" e$g$ I! %1 is '@0 by

selling '0 units" A1 8 '@0>'@8 '0$

%hus" aerage reenue means price$ Since the demand cure shows the

relationship between price and the ,uantity demanded" it also represents the

aerage reenue or price at which the arious amounts o! a commodity are sold"

because the price oHered by the buyer is the reenue !rom the sellers point o!

iew$ %here!ore" aerage reenue cure o! the #rm is the same as demand cure o!

the consumer$ %here!ore" in economics" we use A1 and price as synonymous

e+cept in the conte+t o! price discrimination by the seller$ Mathematically" < 8 A1$

Dum"er ofunits sold

(@@s. A@@s. ,@@s.

' '0 '0 -

2 'J K J

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24 J &

4 2J L 4

@ 0 & 2

& 0 @ 0

L 2J 4 -2

)rom the table" it is clear thatC

'$ M1 !alls as more units are sold$

2$ %1 increases as more units are sold but at a diminishing rate$

$ %1 is the highest when M1 is ero$

4$ %1 !alls when M1 becomes negatie$

@$ A1 and M1 both !all" but !all in M1 is greater than A1 i$e$" M1 !alls more steeply

than A1$ %hus we hae discussed the relationship between total reenue" aerage

reenue and marginal reenue conce


Semester I-- MBA

Q- *onsumersF interview method is a survey method used

for estimating the demand for new products (his method is

very important with regard to collect the relevant information

directly from the consumers with regard to their future

purchase plans Opinion surveys and direct interview method

are the two important techniGues among all %escri"e these

two methods in detail?

Ans- *onsumersH interview method

nder this method" eHorts are made to collect the releant in!ormation directly !rom the

consumers with regard to their !uture purchase plans$ In order to gather in!ormation !rom

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consumers" a number o! alternatie techni,ues are deeloped !rom time to time$ Among

them" the !ollowing are some o! the important onesC

a. urvey of "uyerHs intentions or preferences

It is one o! the oldest methods o! demand !orecasting$ It is also called .pinionsureysN$

nder this method" consumer-buyers are re,uested to indicate their pre!erences

and willingness about particular products$ %hey are as(ed to reeal their !uture

purchase plans with respect to speci#c items$ %hey are e+pected to gie answers to

,uestions li(e what items they intend to buy" how much ,uantity" why" where"

when" what ,uality they e+pect" how much money are they planning to spend" etc$

=enerally" the #eld surey is conducted by the mar(eting research department o!

the company or by hiring the serices o! outside research organiations consisting

o! learned and highly ,uali#ed pro!essionals$

%he heart o! a surey is the ,uestionnaire$ It is a comprehensie one" coeringalmost all ,uestions either directly or indirectly in a most intelligent manner$ It is

prepared by an e+pert body who are specialists in the #eld o! mar(eting$

%he ,uestionnaire is distributed among the consumer buyers either through mail or

in person by the company$ *onsumers are re,uested to !urnish all releant and

correct in!ormation$ %he ne+t step is to collect the ,uestionnaire !rom the consumers !or the purpose o!

ealuation$ %he material collected is classi#ed" edited and analysed$ I! any bias"

preudices" e+aggerations" arti#cial or e+cess demand creation" etc$" are !ound at

the time o! answering" they are eliminated$

%he in!ormation so collected is consolidated and reiewed by the top e+ecuties

with lot o! e+perience$ It is e+amined thoroughly$ In!erences are drawn and

conclusions are arried at$ )inally" a report is prepared and submitted to

management !or ta(ing #nal decisions$

%he success o! the surey method depends on many !actors includingC '$ %he nature o! the ,uestions as(ed2$ %he ability o! the sureyed$ %he representatie o! the samples4$ :ature o! the product

@$ *haracteristics o! the mar(et&$ *onsumer-buyers behaiour" their intentions" attitudes" thoughts" moties"

honesty etc$L$ %echni,ues o! analysisJ$ *onclusions drawn" etc7oweer" this method is not ery use!ul in estimating the !uture demand o! the

households" as they run in large numbers and do not e+press their !uture demand

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re,uirements" !reely$ It is e+pensie and di?cult$ <reparation o! a ,uestionnaire is

not an easy tas($ At best" it can be used !or short term !orecasting$

a. %irect interview method

E+perience shows that due to aried reasons" many customers do not respond to,uestionnaires addressed to them" een i! it is simple$ 7ence" an alternatie method

is deeloped$ nder this method" customers are directly contacted and interiewed$

Direct and simple ,uestions are as(ed to them$ %hey are re,uested to answer

speci#cally about their budget" e+penditure plans" particular items to be selected"

the ,uality and ,uantity o! products" relatie price pre!erences" etc$ !or a particular

period o! time$ %here are two diHerent methods o! direct personal interiews$ %hey

are as !ollowsC

1 *omplete enumeration method

nder this method" all potential customers are interiewed in a particular city or a

region$ %he answers elicited are consolidated and care!ully studied to obtain the

most probable demand !or a product$ %he management can sa!ely proect the !uture

demand !or its products$ %his method is !ree !rom all types o! preudices$ %he result

mainly depends on the nature o! ,uestions as(ed and answers receied !rom the

customers$

2 ample survey method or the consumer panel method

E+perience o! the e+perts show that it is impossible to approach all customers

there!ore" care!ul sampling o! representatie customers is essential$ 7ence" anotherariant o! complete enumeration method has been deeloped" which is popularly

(nown as sample surey method$ nder this method" diHerent cross sections o!

customers that ma(e up the bul( o! the mar(et are care!ully chosen$ .nly such

consumers" who are selected !rom the releant mar(et through some sampling

method" are interiewed or sureyed$ In other words" a group o! consumers are

chosen and ,ueried about their pre!erences in concrete situations$ %he selection o!

a !ew customers is (nown as sampling$ %he selected consumers !orm a panel$ %his

method uses either random sampling or the strati#ed sampling techni,ue$ %he

method o! surey may be direct interiew or mailed ,uestionnaire to the selected

consumers$ .n the basis o! the iews e+pressed by these selected consumers" themost li(ely demand may be estimated$ %he adantage o! a panel lies in the !act that

the same panel is continued and a new e+pensie panel does not hae to be

!ormulated" eery time a new product is inestigated$

Een with care!ul selection o! customers and the truth!ul in!ormation about their

buying intention" the results o! the surey can only be o! limited use$ A sudden

change in price" inconsistency in buying intentions o! consumers" number o!

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sensible ,uestions as(ed and dropouts !rom the panel !or arious reasons put a

serious limitation on the practical use!ulness o! the panel method$

". *ollective opinion method or opinion survey method

%his is a ariant o! the surey method$ %his method is also (nown as Sales!orce

pollingN or .pinion poll methodN$ nder this method" sales representaties"

pro!essional e+perts" the mar(et consultants and others are as(ed to e+press their

considered opinions about the olume o! sales e+pected in the !uture$ %he logic and

reasoning behind the method is that these salesmen and other people connected

with the sales department are directly inoled in the mar(eting and selling o! the

products in diHerent regions$ Salesmen" being ery close to the customers" will be in

a position to (now and !eel the customers reactions towards the product$ %hey can

study the pulse o! the people and identi!y the speci#c iews o! the customers$

%hese people are ,uite capable o! estimating the li(ely demand !or the products

with the help o! their intimate and !riendly contact with the customers and their

personal udgments based on the past e+perience$ %hus" they proide appro+imate"

i! not accurate estimates$ %hen" the iews o! all salesmen are aggregated to get the

oerall probable demand !or a product$

It is simple" less e+pensie and use!ul !or short run !orecasting" particularly in case

o! new products$

%he main drawbac( is that it is subectie and depends on the intelligence and

awareness o! the salesmen$ It cannot be relied upon !or long term business

planning$

c. %elphi method or experts opinion method

%his method was originally deeloped at 1and *orporation in the late 'K40s by .la!

7elmer" Dal(ey and =ordon$ %his method was used to predict !uture technological

changes$ It has proed more use!ul and popular in !orecasting non-economic rather

than economic ariables$

It is a ariant o! opinion poll and surey method o! demand !orecasting$ nder this

method" outside e+perts are appointed$ %hey are supplied with all (inds o!

in!ormation and statistical data$ %he management re,uests the e+perts to e+presstheir considered opinions and iews about the e+pected !uture sales o! the

company$ %heir iews are generally regarded as most obectie ones$ %heir iews

generally aoid or reduce the 7alo EHectsN and Ego InolementN o! the iews

o! the others$ Since e+perts opinions are more aluable" a #rm gies lot o!

importance to them and prepares their !uture plan on the basis o! the !orecasts

made by the e+perts$

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d. End use or input > output method

nder this method" the sale o! the product under consideration is proected on the

basis o! demand sureys o! the industries using the gien product as an

intermediate product$ %he demand !or the #nal product is the end-user demand o!

the intermediate product used in the production o! the #nal product$ Anintermediate product may hae many end-users" !or e$g$" steel can be used !or

ma(ing arious types o! agricultural and industrial machinery" !or construction" !or

transportation" etc$ It may hae demand both in the domestic mar(et as well as the

international mar(et$ %hus" end use demand estimation o! an intermediate product

may inole many #nal goods industries using this product" at home and in abroad$

A!ter we (now the demand !or #nal consumption o! goods including their e+ports"

we can estimate the demand !or the product which is used as intermediate goods in

the production o! these #nal goods with the help o! inputoutput coe?cients$ %he

inputoutput table containing inputoutput coe?cients !or particular periods is

made aailable in eery country either by the =oernment or by researchorganiations$

%his method is used to !orecast the demand !or intermediate products" only$ It is

,uite use!ul !or industries which are large producers o! goods" li(e aluminium" steel"

etc$

%he main limitation o! the method is that as the number o! end-users o! a product

increase" it becomes more inconenient to use this method$


Semester I-- MBA

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Q- %iscuss the practical application of 5rice elasticity and

!ncome elasticity of demand

Ans- 5ractical application of price elasticity of demand

)ew e+amples on the practical application o! price elasticity o! demand are as !ollowsC

1 5roduction planning >

It helps a producer to decide about the olume o! production$ I! the demand !or his

products is inelastic" speci#c ,uantities can be produced while he has to produce

diHerent ,uantities" i! the demand is elastic$

2 elps in &xing the prices of di$erent goods >

It helps a producer to #+ the price o! his product$ I! the demand !or his product is

inelastic" he can #+ a higher price and i! the demand is elastic" he has to charge a

lower price$ %hus" price-increase policy is to be !ollowed i! the demand is inelastic in

the mar(et and price-decrease policy is to be !ollowed i! the demand is elastic$Similarly" it helps a monopolist to practise price discrimination on the basis o!

elasticity o! demand$

0 elps in &xing the rewards for factor inputs >

)actor rewards re!er to the price paid !or their serices in the production process$ Ithelps the producer to determine the rewards !or !actors o! production$ I! the

demand !or any !actor unit is inelastic" the producer has to pay higher reward !or it

and ice-ersa$

B elps in determining the foreign exchange rates >

E+change rate re!ers to the rate at which currency o! one country is conerted in to

the currency o! another country$ It helps in the determination o! the rate o!

e+change between the currencies o! two diHerent nations$ )or e$g$ i! the demand !or

S dollar to an Indian rupee is inelastic" in that case" an Indian has to pay more

Indian currency to get one unit o! S dollar and ice-ersa$

elps in determining the terms of trade >

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t is the basis !or deciding the Oterms o! trade between two nations$ %he terms o!

trade implies the rate at which the domestic goods are e+changed !or !oreign goods

)or e$g$ i! the demand !or Papans products in India is inelastic" we hae to pay more

in terms o! our commodities to get one unit o! a commodity !rom Papan and ice-

ersa$

elps in &xing the rate of taxes >

%a+es re!er to the compulsory payment made by a citien to the goernment

periodically without e+pecting any direct return bene#t !rom it$ It helps the )inance

Minister to !ormulate sound ta+ation policy o! the country$ 7e can impose more

ta+es on those goods !or which the demand is inelastic and lower ta+es i! the

demand is elastic in the mar(et$

I elps in declaration of pu"lic utilities >

<ublic utilities are those institutions which proide certain essential goods to the

general public at economical prices$ %he goernment may declare a particular

industry as Opublic utility or nationalise it" i! the demand !or its products is inelastic$

J 5overty in the midst of plenty >

%he concept e+plains the parado+ o! poerty in the midst o! plenty$ A bumper crop

o! rice or wheat" instead o! bringing prosperity to !armers" may actually bring

poerty to them because the demand !or rice and wheat is inelastic$

%hus" the concept o! price elasticity o! demand has great practical application ineconomic theory$

!ncome elasticity of demand

Income elasticity o! demand may be de#ned as the ratio or percentage change in

the ,uantity demanded o! a commodity to a gien percentage change in the

income$ In short" it indicates the e+tent to which demand changes with a ariation

in consumers income$

5ractical application of income elasticity of demand

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)ew e+amples on the practical application o! income elasticity o! demand are as

!ollowsC

1 elps in determining the rate of growth of the &rm >

I! the growth rate o! the economy and income growth o! the people is reasonably!orecasted" in that case" it is possible to predict e+pected increase in the sales o! a

#rm and ice-ersa$

2 elps in the demand forecasting of a &rm >

It can be used in estimating !uture demand proided that the rate o! increase in

income and the Ey !or the products are (nown$ %hus" it helps in demand !orecasting

actiities o! a #rm$

0 elps in production planning and mar'eting >

%he (nowledge o! Ey is essential !or production planning" !ormulating mar(eting

strategy" deciding adertising e+penditure and nature o! distribution channel" etc$ in

the long run$

B elps in ensuring sta"ility in production >

<roper estimation o! diHerent degrees o! income elasticity o! demand !or diHerent

types o! products helps in aoiding oer-production or under production o! a #rm$

.ne should also (now whether rise or !all in income is permanent or temporary$

elps in estimating construction of houses >

%he rate o! growth in incomes o! the people also helps in housing programmes in a

country$ %hus" it helps a lot in managerial decisions o! a #rm$

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,arginal @evenue ,@.

Marginal reenue is the net increase in total reenue realised !rom selling

one more unit o! a product$ It is the additional reenue earned by selling

an additional unit o! output by the seller$ Suppose a #rm is selling 4 units

o! the output at the price o! 1s$'4 per unit$ :ow" i! it wants to sell @ units

instead o! 4 units and thereby the price o! the product !alls to 1s$'2 per

unit" then the marginal reenue will not be e,ual to 1s$'2 at which the @th

unit is sold$ 4 units" which were sold at the price o! 1s$'4 be!ore" will all

hae to be sold at the reduced price o! 1s$'2 and that will mean the loss

o! 2 rupees on each o! the preious 4 units$ %he total loss on the preious

units will be e,ual to 1s$ J$ %here!ore" this loss o! J rupees should bededucted !rom the price o! 1s$ '2 o! the @th unit while calculating the

marginal reenue$ %he marginal reenue in this case" there!ore" will be 1s$

'2 1s$ J 8 1s$ 4 and not 1s$ '2 which is the aerage reenue$

Marginal reenue can also be directly calculated by #nding out the

diHerence between the total reenue be!ore and a!ter selling the

additional unit o! the product$

%otal reenue when 4 units are sold at the price o! 1s$'4 8 4 / '4 8 1s$ @&

%otal reenue when @ units are sold at the price o! 1s$'2 8 @ / '2 8 1s$ &0

%here!ore" Marginal reenue or the net reenue earned by the @th unit 8

&0- @& 8 1s$4$

%hus" Marginal reenue o! the nth unit 8 diHerence in total reenue in increasing

the sale !rom n-' to n units

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or

Marginal reenue 8 price o! nth unit minus loss in reenue on preious units

resulting !rom price reduction$ %he concept is important in microeconomics

because a #rmQs optimal output most pro#table output5 is where its marginal

reenue e,uals its marginal cost i$e$" as long as the e+tra reenue !rom selling onemore unit is greater than the e+tra cost o! ma(ing it" it is pro#table to do so$

It is usual !or marginal reenue to !all as output goes up both at the leel o! a #rm

and that o! a mar(et because" lower prices are needed to achiee higher sales or

demand respectiely$ M1 8 9 %1 ∆ ∆ %1 represents change in %1∆8 where 9

indicates change in total ,uantity sold$

@elationship "etween total revenue# average revenue and marginal

revenue concepts

In order to understand the relationship between %1" A1 and M1" we can prepare a

hypothetical reenue schedule$ %able J$2 represents a hypothetical reenue

schedule that shows the relationship between %1" A1 and M1

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Q-3 Inflation is a global 3henomenon which is associated with high price causes decline inthe value for money. It exists when the amount of money in the country is in excess of thephysical volume of goods and services. -xplain the reasons for this monetary phenomenon6

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