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Managerial Economics Essay Sample

Managerial Economics Pages
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1. Explain the importance of managerial economics.

The following points illustrate the importance of managerial economics.

It gives guidance for identification of key variables in decision-making process. It helps the business executives to understand the various intricacies of business and managerial problems and to take right decisions at the right time. It provides the necessary conceptual, technical skills, toolbox of analysis and techniques of thinking and other such modern tools and instruments like elasticity of demand and supply, cost and revenue, income and expenditure, profit and volume of production, etc to solve various business problems. It is both a science and an art. In the context of globalisation, privatisation, liberalisation and marketisation and a highly competitive dynamic economy, it helps in identifying various business and managerial problems, their causes and consequence, and suggests various policies and programmes to overcome them.

It helps the business executives to become much more responsive, realistic and competent to face the dynamic challenges in the modern business world. It helps in the optimum use of scarce resources of a firm to maximize its profits. It also helps in achieving other objectives a firm likes attaining industry leadership, market share expansion and social responsibilities, etc. It helps a firm in forecasting the most important economic variables like demand, supply, cost, revenue, price, sales and profit, etc and formulate sound business policies . It also helps in understanding the various external factors and forces which affect the decision-making of a firm.

2.Discuss the determinants of price elasticity of demand.

Following are the determinants of price elasticity.

Nature of the commodity – Commodities coming under the category of necessaries and essentials tend to be inelastic, because people buy them whatever may be the price. For example, rice, wheat, sugar, milk, vegetables, etc.; on the other hand, for comforts and luxuries,

demand tends to be elastic, e.g., TV sets, refrigerators, etc.

Existence of substitutes – Substitute goods are those that are considered to be economically interchangeable by buyers. If a commodity has no substitutes in the market, demand tends to be  inelastic because people have to pay higher price for such articles. For example, salt, onions, garlic, ginger, etc. In case of commodities having different substitutes, demand tends to be elastic. For example, blades, tooth pastes, soaps, etc.

Number of uses for the commodity – Single-use goods are those, which can be used for only one purpose and multiple-use goods can be used for a variety of purposes. If a commodity has only one use (single use product), demand tends to be inelastic because people have to pay more prices if they have to use that product for only one use, for example, all kinds of eatables, seeds, fertilizers, pesticides, etc. On the contrary, for commodities having several uses, [multiple- use-products] demand tends to be elastic, for example, coal, electricity, steel, etc.

Durability and reparability of a commodity – Durable goods are those, which can be used for a long period of time. Demand tends to be elastic in case of durable and repairable goods, because people do not buy them frequently, e.g., table, chair, vessels etc. On the other hand, for perishable and non-repairable goods, demand tends to be inelastic e.g., milk, vegetables, electronic watches, etc.

Possibility of postponing the use of a commodity – In case there is no possibility to postpone the use of a commodity, demand tends to be inelastic because people have to buy them irrespective of their prices, e.g., medicines. If there is a possibility to postpone the use of a commodity, demand tends to be elastic, e.g., buying TV set, motor cycle, washing machine, car, etc.

Level of income of the people – Generally speaking, demand will be relatively inelastic in case of rich people, because any change in market price will not alter and affect their purchase plans. On the contrary, demand tends to be elastic in case of poor.

Range of prices – There are certain goods or products like imported cars, computers, refrigerators, TV, etc, which are costly in nature. Similarly, a few other goods like nails, needles, etc. are low priced goods. In all these cases, a small fall or rise in prices will have insignificant effect on their demand. Hence, demand for them is inelastic in nature. However, commodities having normal prices are elastic in nature.

Proportion of the expenditure on a commodity – When the amount of money spent on buying a product is either too small or too big, demand tends to be inelastic. For example, salt, newspaper or a site or house. On the other hand, if the amount of money spent is moderate, demand tends to be elastic. For example, vegetables and fruits, cloths, provision items etc.

Habits – When people are habituated to the use of a commodity, they do not care for price changes over a certain range e.g., in case of smoking, drinking, use of tobacco, etc. In that case, demand tends to be inelastic. If people are not habituated to the use of any product, then demand generally tends to be elastic.

Period of time – Price elasticity of demand varies with the length of the time period. Generally speaking, in the short period, demand is inelastic because consumption habits of the people, customs and traditions, etc. do not change. On the contrary, demand tends to be elastic in the long period where there is possibility of all kinds of changes.

Level of knowledge – Demand in case of enlightened customers would be elastic and in case of ignorant customers, it would be inelastic.

Existence of complementary goods – Goods or services whose demands are interrelated such that an increase in the price of one of the products results in a fall in the demand for the other are known as complementary goods. Goods that are jointly demanded are inelastic in nature. For example, pen and ink, vehicles and petrol, shoes and socks, etc. have inelastic demand for this reason. If a product does not have complements, in that case demand tends to be elastic. For

example, biscuits, chocolates, ice creams, etc. In this case, the use of a product is not linked to any other product.

Purchase frequency of a product – If the frequency of purchase is very high, the demand tends to be inelastic, e.g., coffee, tea, milk, match-box, etc. On the other hand, if people buy a product occasionally, demand tends to be elastic, e.g., durable goods like radio, tape recorders, refrigerators, etc.

Thus, the demand for a product being elastic or inelastic will depend on a number of factors.

3.Explain trend projection method of demand forecasting with illustration.

Trend projection method
An old firm operating in the market for a long period will have the accumulated previous data on either production or sales pertaining to different years. If we arrange them in chronological order, we get ‘time series’. It is an ordered sequence of events over a period of time pertaining

to certain variables. It shows a series of values of a dependent variable e.g., sales, as it changes from one point of time to another. In short, a time series is a set of observations taken at specified time, generally at equal intervals. It depicts the historical pattern under normal conditions. This method is not based on any particular theory, which explains the causes for the variables to change; it merely assumes that whatever forces contributed to the change in the recent past will continue to have the same effect. On the basis of time series, it is possible to project the future sales of a company. In addition, the statistics and information with regards to the sales call for further analysis. When we represent the time series in the form of a graph,

we get a curve, the sales curve. It shows the trend in sales at different periods of time. Also, it indicates fluctuations and turning points in demand. If the turning points are few and their intervals are also widely spread, they yield acceptable results. Here, the time series show a persistent tendency to move in the same direction. Frequency in turning points indicates uncertain demand conditions and in this case, the trend projection breaks down.

The major task of a firm while estimating the future demand lies in the prediction of turning points in the business rather than in the projection of trends. When turning points occur more frequently, the firm has to make radical changes in its basic policy with respect to future demand. It is for this reason that the experts give importance to identification of turning points

while projecting the future demand for a product.

The heart of this method lies in the use of time series. Changes in time series arise on account of the following reasons:
1. Secular or long run movements – Secular movements indicate the general conditions and direction in which graph of a time series move in relatively a long period of time.
2. Seasonal movements – Time series also undergo changes during seasonal sales of a company. During festival season, sales clearance season, etc., we come across most unexpected changes.
3. Cyclical Movements – It implies change in time series or fluctuations in  the demand for a product during different phases of a business cycle like depression, revival, boom, etc.
4. Random movements – When changes take place at random, we call them irregular or random movements. These movements imply sporadic changes in time series occurring due to unforeseen events such as floods, strikes, elections, earth quakes, droughts and similar natural

calamities. Such changes take place only in the short run. Still, they have their own impact on the sales of a company.

A statistician, in order to find out the pattern of change in time series, may make use of the following methods. The least squares method
The free hand method
The moving average method
The method of semi-averages

The method of least squares is more scientific, popular and thus, more commonly used when compared to the other methods. It uses the straight line equation Y= a + bx, to fit the trend to the data.

We can find out the trend values for each of the 5 years and also for the subsequent years making use of a statistical equation, the method of least squares. In a time series, x denotes time and y denotes variable. With the passage of time, we need to find out the value of the variable.

To calculate the trend values i.e., Yc, the regression equation used is –
Yc = a+ bx.

As the values of ‘a’ and ‘b’ are unknown, we can solve the following two normal equations, simultaneously.
i) Y = Na + bx
ii) XY = ax + bx2

Where,
Y = Total of the original value of sales (y) N = Number of years,
X = Total of the deviations of the years taken from a central period.
XY = Total of the products of the deviations of years and corresponding sales (y)
X2 = total of the squared deviations of X values.
When the total values of X. i.e., X = 0

4.Explain factors determining elasticity of demand.

Following are the determinants of elasticity.

Nature of the commodity – Commodities coming under the category of necessaries and essentials tend to be inelastic, because people buy them whatever may be the price. For example, rice, wheat, sugar, milk, vegetables, etc.; on the other hand, for comforts and luxuries,

demand tends to be elastic, e.g., TV sets, refrigerators, etc.

Existence of substitutes – Substitute goods are those that are considered to be economically interchangeable by buyers. If a commodity has no substitutes in the market, demand tends to be inelastic because people have to pay higher price for such articles. For example, salt, onions, garlic, ginger, etc. In case of commodities having different substitutes, demand tends to be elastic. For example, blades, tooth pastes, soaps, etc.

Number of uses for the commodity – Single-use goods are those, which can be used for only one purpose and multiple-use goods can be used for a variety of purposes. If a commodity has only one use (single use product), demand tends to be inelastic because people have to pay more prices if they have to use that product for only one use, for example, all kinds of eatables, seeds, fertilizers, pesticides, etc. On the contrary, for commodities having several uses, [multiple- use-products] demand tends to be elastic, for example, coal, electricity, steel, etc.

Durability and reparability of a commodity – Durable goods are those, which can be used for a long period of time. Demand tends to be elastic in case of durable and repairable goods, because people do not buy them frequently, e.g., table, chair, vessels etc. On the other hand, for perishable and non-repairable goods, demand tends to be inelastic e.g., milk, vegetables, electronic watches, etc.

Possibility of postponing the use of a commodity – In case there is no possibility to postpone the use of a commodity, demand tends to be inelastic because people have to buy them irrespective of their prices, e.g., medicines. If there is a possibility to postpone the use of a commodity, demand tends to be elastic, e.g., buying TV set, motor cycle, washing machine, car, etc.

Level of income of the people – Generally speaking, demand will be relatively inelastic in case of rich people, because any change in market price will not alter and affect their purchase plans. On the contrary, demand tends to be elastic in case of poor.

Range of prices – There are certain goods or products like imported cars, computers, refrigerators, TV, etc, which are costly in nature. Similarly, a few other goods like nails, needles, etc. are low priced goods. In all these cases, a small fall or rise in prices will have insignificant effect on their demand. Hence, demand for them is inelastic in nature. However, commodities having normal prices are elastic in nature.

Proportion of the expenditure on a commodity – When the amount of money spent on buying a product is either too small or too big, demand tends to be inelastic. For example, salt, newspaper or a site or house. On the other hand, if the amount of money spent is moderate, demand tends to be elastic. For example, vegetables and fruits, cloths, provision items etc.

Habits – When people are habituated to the use of a commodity, they do not care for price changes over a certain range e.g., in case of smoking, drinking, use of tobacco, etc. In that case, demand tends to be inelastic. If people are not habituated to the use of any product, then demand generally tends to be elastic.

Period of time – Price elasticity of demand varies with the length of the time period. Generally speaking, in the short period, demand is inelastic because consumption habits of the people, customs and traditions, etc. do not change. On the contrary, demand tends to be elastic in the long period where there is possibility of all kinds of changes.

Level of knowledge – Demand in case of enlightened customers would be elastic and in case of ignorant customers, it would be inelastic.

Existence of complementary goods – Goods or services whose demands are interrelated such that an increase in the price of one of the products results in a fall in the demand for the other are known as complementary goods. Goods that are jointly demanded are inelastic in nature. For example, pen and ink, vehicles and petrol, shoes and socks, etc. have inelastic demand for this reason. If a product does not have complements, in that case demand tends to be elastic. For

example, biscuits, chocolates, ice creams, etc. In this case, the use of a product is not linked to any other product.

Purchase frequency of a product – If the frequency of purchase is very high, the demand tends to be inelastic, e.g., coffee, tea, milk, match-box, etc. On the other hand, if people buy a product occasionally, demand tends to be elastic, e.g., durable goods like radio, tape recorders, refrigerators, etc.

Thus, the demand for a product being elastic or inelastic will depend on a number of factors.

5. Explain how a product would reach equilibrium position with  of iso-quants and iso-cost curve.

When producing a good or service, how do suppliers determine the quantity of factors to hire? Below, we work through an example where a representative producer answers this question. Let‘s begin by making some assumptions. First, we shall assume that our producer chooses varying amounts of two factors, capital (K) and labor (L). Each factor was a price that does not vary with output. That is, the price of each unit of labor (w) and the price of each unit of capital (r) are assumed constant. We‘ll further assume that w = $10 and r = $50. We can use this information to determine the producer‘s total cost. We call the total cost equation an iso-cost line (it‘s similar to a budget constraint).The producer‘s iso-cost line is: 10L + 50K = TC (1) The producer‘s production function is assumed to take the following form :q = (KL) 0.5 (2)Our producer‘s first step is to decide how much output to produce. Suppose that quantity is

1000units of output.

In order to produce those 1000 units of output, our producer must get a combination of L and K that makes (2) equal to 1000. Implicitly, this means that we must find a particular isoquant. Set (2) equal to 1000 units of output, and solve for K. Doing so, we get the following equation for a specific iso-quant (one of many possible iso-quants): K = 1,000,000/L (2a) For any given value of L, (2a) gives us a corresponding value for K. Graphing these values, with K on the vertical axis and L on the horizontal axis, we obtain the blue line on the graph below. Each point on this curve is represented as a combination of K and L that yields an output level of1000 units. Therefore, as we move along this iso-quant output is constant (much like the fact that utility is constant as A basic understanding of statistics is a critical component of informed decision making.

6.Explain cost output relationship with reference to:

a. Total fixed cost and output
b. Total variable cost and output

Total fixed cost and output:

TFC refers to total money expenses incurred on fixed inputs like plant, machinery, tools & equipments in the short run. Total fixed cost corresponds to the fixed inputs in the short run production function. TFC remains the same at all levels of output in the short run. It is the same when output is nil. It indicates that whatever may be the quantity of output, whether 1 to 6 units, TFC remains constant. The TFC curve is horizontal and parallel to OX-axis, showing that it is constant regardless of output per unit of time. TFC starts from a point on Y-axis indicating that the total fixed cost will be incurred even if the output is zero. In our example, Rs 360=00 is TFC. It is obtained by summing up the product or quantities of the fixed factors multiplied by their respective unit price.

Total variable cost and output:

TVC refers to total money expenses incurred on the variable factor inputs like raw materials, power, fuel, water, transport and communication etc, in the short run. Total variable cost corresponds to variable inputs in the short run production function. It is obtained by summing up the production of quantities of variable inputs multiplied by their prices. The formula to calculate TVC is as follows. TVC = TC-TFC. TVC = f (Q) i.e. TVC is an increasing function of output. In other words TVC varies with output. It is nil, if there is no production. Thus, it is a direct cost of output. TVC rises sharply in the beginning, gradually in the middle and sharply at the end in accordance with the law of variable proportion. The law of variable proportion explains that in the beginning to obtain a given quantity of output, relative variation in variable factors-needed are in less proportion, but after a point when the diminishing returns operate, variable factors are to be employed in a larger proportion to increase the same level of output.

TVC curve slope upwards from left to right. TVC curve rises as output is expanded. When output is Zero, TVC also will be zero. Hence, the TVC curve starts from the origin.

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