Assignment - MB0026 Managerial Economics

MB0026

Managerial
Economics

Submitted by:
Sreeja .T

Submitted By: Sreeja. T Page 1 of 8

 Assignment - MB0026 Managerial Economics

Assignment 1

The demand function of a good is as follows:

Q1=100-6P1-4P2+2P3+0.003Y
WHERE P1 and Q1 are the price and quantity values of good 1 P2 and
P3 are the prices of good 2 and good 3 and Y is the income of the
consumer. The initial values are given:
P1 =7
P2 =15
P3 =4
Y=8000
Q1 =30

You are required to:

a) Using the concept of cross elasticity determine the relationship
between good 1 and others
b) Determine the effect on Q1 due to a 10 % increase in the price of
good 2 and good 3.

Ans:

A cross elasticity is the effect on the change in demand or supply of one good as a
result of a change in something related to another product

The cross price elasticity of product A with product B is:

(ΔQA/QA)/(ΔPB/PB)

Where QA is the quantity sold of A, ΔQA is the change in the quantity of A sold ,PB is
the price of B and ΔPB is the change in the price of B.

a) Here given Q1=100-6P1-4P2+2P3+0.003Y

P1 =7, P2 =16.5(Since there is 10%increase for good2), P3 =4 Y=8000, Q1 =30

% change in quantity of good 1 & 2 = ΔQ

ΔQ = Q1 –Q2
= 30 – (100-6(7)-4(16.5)+2*4+0.003(8000))
= 30 – 24
= 6

%change in quantity of price good 2 Q = 16.5-15

= 1.5
(ΔQ/Q) = 6/1.5

Cross elasticity = (Δ) Quantity of good1&2 * Price of Q2

(Δ) Price of good1& 2 Q of good1

Submitted By: Sreeja. T Page 2 of 8

 Assignment - MB0026 Managerial Economics

= 6 * 15
1.5 * 30

= 2

b) Determine the effect on Q1 due to a 10 % increase in the price of good 2 and

good 3.

Cross elasticity =
(Δ)Quantity of good1 and good3 * Price of good3
(Δ) Price of goods Quantity of good1

% change of good1 and good3:=100-6(7)-4(15) +2(4.4) +.003(8000) =30.8

I.e. Q3 = 30.8

So Change in quantity of good1 and good3 = Q1-Q3=30-30.8=0.8

Change in price of goods =4.4 - 0.4=0.4

Cross elasticity = 0.8/0.4 * 4/30= 0.2

Here the effect on Q1 due to 10% increase in the price of good2 and good 3

Q1=100-6p1-4p2+2p3+0.003y

P2 and p3 are prices of good 2 and good 3, when 10% increase in price P2 and P3
will be
p2=16.5, p3=4.4

Then
Q1=100-6(7)-4(16.5) +2(4.4) +0.003(8000) = 24.8

1. What are the factors that determine the Demand curve? Explain.

Demand curve can be defined as the graph depicting the relationship between the
price of a certain commodity, and the amount of it that consumers are willing and
able to purchase at that given price. It is a graphic representation of a demand
schedule.[1] The demand curve for all consumers together follows from the demand
curve of every individual consumer: the individual demands at each price are added
together.

Demand curves are used to estimate behaviors in competitive markets, and are
often combined with supply curves to estimate the equilibrium price (the price at
which sellers together are willing to sell the same amount as buyers together are
willing to buy, also known as market clearing price) and the equilibrium quantity (the
amount of that good or service that will be produced and bought without
surplus/excess supply or shortage/excess demand) of that market.

Submitted By: Sreeja. T Page 3 of 8

 Assignment - MB0026 Managerial Economics

The demand curve usually slopes downwards from left to right; that is, it has a
negative association. The negative slope is often referred to as the "law of
demand", which means people will buy more of a service, product, or resource as
its price falls. The shift of a demand curve takes place when there is a change in
any non-price determinant of demand, resulting in a new demand curve.

Some of the more important factors are the prices of related goods (both
substitute and complementary), income, population and expectations. However, as
demand is the willingness and ability of a consumer to purchase a good under the
prevailing circumstances, so any relevant circumstance can be a non price
determinant of demand. As an example, weather could be factor in the demand for
beer at a baseball game. When income rises, the demand curve for normal goods
shifts out as more will be demanded at all price levels, while the demand curve for
inferior goods shifts in due to the increased attainability of superior substitutes.
With respect to related goods, when the price of a good (e.g. a hamburger) rises,
the demand curve for substitute goods (e.g. chicken) shifts out, while the demand
curve for complementary goods (e.g. tomato sauce) shifts in (i.e. there is more
demand for substitute goods as they become more attractive in terms of value for
money, while demand for complementary goods contracts in response to the
contraction of demand with the underlying good)

2. A firm supplied 3000 pens at the rate of Rs 10. Next month, due to a
rise of in the price to 22 Rs per pen the supply of the firm increases to
5000 pens. Find the elasticity of supply of the pens

Price elasticity of demand is the percentage change in quantity demanded divided by

the percentage change in a good’s price.

Here Elasticity = change in supply * original price

Change in price original supply

Change in supply = 5000 – 3000 = 2000

Change in price = 22 – 10 = 12

I.e. Elasticity = 2000 * 10

12 3000

Submitted By: Sreeja. T Page 4 of 8

 Assignment - MB0026 Managerial Economics

= 2 *5
6 3
= 0.5555 ~= 0.56

3. Briefly explain the profit-maximization model.

Profit Maximization is the process by which a firm determines the price and output
level that returns the greatest profit. There are several approaches to this problem.
The total revenue—total cost method relies on the fact that profit equals revenue
minus cost, and the marginal revenue—marginal cost method is based on the fact
that total profit in a perfectly competitive market reaches its maximum point where
marginal revenue equals marginal cost. Profit maximization model explicitly
evaluates decisions such as where to incur tax liabilities and how to set intra-company
prices may be required to develop an integrated global manufacturing and distribution
plan.

Profit-maximization implies earning highest possible amount of profits

during a given period of time. A firm has to generate largest amount of profits by
building optimum productive capacity both in the short run and long run depending
upon various internal and external factors and forces. There should be proper
balance between short run and long run objectives. In the short run a firm is able to
make only slight or minor adjustments in the production process as well as in
business conditions. The plant capacity in the short run is fixed and as such, it can
increase its production and sales by intensive utilization of existing plants and
machineries, having over time work for the existing staff etc. Thus, in the short run,
a firm has its own technical and managerial constraints. But in the long run, as there
is plenty of time at the disposal of a firm, it can expand and add to the existing
capacities build up new plants; employ additional workers etc to meet the rising
demand in the market. Thus, in the long run, a firm will have adequate time and
ample opportunity to make all kinds of adjustments and readjustments in production
process and in its marketing strategies.

It is to be noted with great care that a firm has to maximize its profits after taking in
to consideration of various factors in to account. They are as follows-

1. Pricing and business strategies of rival firms and its impact on the working of
the given firm.
2. Aggressive sales promotion policies adopted by rival firms in the market.
3. Without inducing the workers to demand higher wages and salaries leading to
rise in operation costs.
4. Without resorting to monopolistic and exploitative practices inviting
government controls and takeovers.
5. Maintaining the quality of the product and services to the customers.
6. Taking various kinds of risks and uncertainties in the changing business
environment.
7. Adopting a stable business policy.
8. Avoiding any sort of clash between short run and long run profits in the
business policy and maintaining proper balance between them.
9. Maintaining its reputation, name, fame and image in the market.

Submitted By: Sreeja. T Page 5 of 8

 Assignment - MB0026 Managerial Economics

10. Profit maximization is necessary in both perfect and imperfect markets. In a

perfect market, a firm is a price-taker and under imperfect market it becomes
a price-searcher.

Assumptions of the model

The profit maximization model is based on tree important assumptions. They are as
follows

1. Profit maximization is the main goal of the firm.

2. Rational behavior on the part of the firm to achieve its goal of profit maximization.

3. The firm is managed by owner-entrepreneur.

4. What is Cyert and March’s behavior theory? What are the demerits?

Richard Cyert and James March were described by Dierkes, Berthoin Antal, Child,
and Nonaka (2001) as two of the “founding fathers” that introduced one of the
disciplines that shaped thinking about organizational learning over the past
decades.
Cyert and March spent their careers collaborating with scholars and theorists
writing and revising theories related to the topic of organizational learning. The
truly significant collaboration of their respective careers was their collaboration on
their 1963 manuscript. The manuscript acknowledged the talents and works of over
twenty scholars and theorists that contributed to the original manuscript. The Cyert
and March manuscript outlines a behavioral theory of organizational learning
through the development and research surrounding the decision making process of
the firm.
Behavioral Theory of organizational learning:
"Organizations learn by memorizing disturbances and reaction combinations
according to decision variables. Standard operating procedures are referred to
as the memory of the organization. By learning new combinations of external
disturbances and internal decision-making rules, the organization increases its
adaptability to differing environmental states. Any decision rule that leads to a
non-preferred state at one point is less likely to be used in the future."
Perhaps the aforementioned summarization of Cyert and March’s behavioral theory
of organizational learning is an over simplification of the theory. Perhaps it clears
up the ambiguity that is evident in the variables in the testing processes of the
theory development.

Cyert and March are of the opinion that out of several objectives a firm has five
important goals. They are –

1. Production goal. Production is to be organized on the basis of demand in the

market. Neither there should be over production nor under production but just that
much to meet the required demand in the market, avoid excess capacity, over
utilization of capital assets, layoff of workers etc.

Submitted By: Sreeja. T Page 6 of 8

 Assignment - MB0026 Managerial Economics

2. Inventory goal. Inventory refers to stock of various inputs. In order to ensure

continuity in production and supply, certain minimum level of inventory has to be
maintained by a firm. Neither there should be surplus stock or shortage of different
inputs. Proper balance between demand and supply is to be maintained.

3. Sales goal. There should be adequate sales in any organization to earn

reasonable amounts of profits. In order to create demand sales promotion policies
may be adopted from time to time.

4. Market share goal. Each firm has to make consistent effort to increase its
market share to compete successfully with other firms and make sufficient profits

5. Profit goal. This is one of the basic objectives of any firm. The very survival and
success of the firm would depend upon the volume of profits earned by it.

The above mentioned objectives also would under go changes over a period of time
in the background of modern business environment. Hence, decision making would
become complex and complicated.

Demerits.

1. The theory fails to analyze the behavior of the firm but it simply predicts the
future expected behavior of different groups.
2. It does not explain equilibrium of the industry as a whole.
3. It fails to analyze the impact of the potential entry of new firms in to the
industry and the behavior of the well established firms in the market.
4. It highlights only on short run goals rather than long run objectives of an
organization. Thus, there are certain limitations to this theory.
5. What is Boumal’s Static and Dynamic.

Boumal’s Static and Dynamic Models.

Boumal analyses the impact of advertisement expenditures incurred by a firm on

sales promotion and its impact on total sales revenue of a firm. The model
highlights that the primary objective of a firm is to maximize its sales rather than
profit maximization. It states that the goal of the firm is maximization of sales
revenue subject to a minimum profit constraint. This model is developed by Prof.
W.J.Boumal, an American economist. This alternative goal has assumed greater
significance in the context of the growth of Oligopolistic firms. Boumal has developed
two models. The first is static model and the second one is the dynamic model

Static Model

This model is based on the following assumptions.

1. The model is applicable to a particular time period and the model does not
operate at different periods of time.
2. The firm aims at maximizing its sales revenue subject to a minimum profit
constraint.
3. The demand curve of the firm slope downwards from left to right.
4. .The average cost curve of the firm is U-shaped one.

Submitted By: Sreeja. T Page 7 of 8

 Assignment - MB0026 Managerial Economics

Sales maximization [dynamic model]

In the real world many changes takes place which affects business decisions of a
firm. In order to include such changes, Boumal has developed another dynamic
model. This model explains how changes in advertisement expenditure, a major
determinant of demand, would affect the sales revenue of a firm under severe
competitions.

This model is based on the following assumptions

1. Higher advertisement expenditure would certainly increase sales revenue of a

firm.

2. Market price remains constant.

3. Demand and cost curves of the firm are conventional in nature.

The main difference is that in the dynamic model the profit is reinvented allowing for
more growth in the future, so it is a trade off between profit now or higher profits
later, the management will need to get the shareholder to agree on that, a trust
must be established between the shareholders and management. Hence, in the
dynamic model, the minimum profit is not actually a constraint as it is in the static
model.

Submitted By: Sreeja. T Page 8 of 8