Managerial economics Essay

Managerial economics Essay
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  • University/College:
    University of Chicago

  • Type of paper: Thesis/Dissertation Chapter

  • Words: 2066

  • Pages: 8

Managerial economics

1. If a firm raises its price for Product X, TR will increase. Uncertain, Total revenue = Price × Quantity Sold. The price elasticity of demand tells us there are two effects, first is price effect. If price increase, each unit sold sells for a higher price, which tends to raise revenue. Second is quantity effect. If price increase, fewer units are sold, which tends to lower revenue. This is determines by which price effect or the quantity effect is stronger

2. When MR > MC, MP (marginal profit) will be positive. True, for each unit sold, marginal profit equals marginal revenue (MR) minus marginal cost (MC). Then, if MR is greater than MC at some level of output, marginal profit is positive and thus a greater quantity should be produced.

3. If a 10% increase in price leads to a 5% increase in TR, demand must be elastic. False, if an increase in price causes an increase in total revenue, then demand can be said to be inelastic, since the increase in price does not have a large impact on quantity demanded.

4. If the cross price elasticity is positive for two goods X and Y, X and Y must be complements. False, if the goods are complements, the value will be negative because quantity demanded increases when the price of complement falls. Example, if the price of petrol decreases to RM2 a litre, sales of cars would increase.

5. Maximizing TR is never a desirable goal for a firm. True, profit is the difference between a firm’s total revenue and its total opportunity cost. Total revenue is the amount of income earned by selling products. But it does not include the total opportunity costs of all inputs into the production process. Hence, it is never a desirable goal for a firm. Firm should consider maximizing Profit instead of TR.

6. The more inelastic the demand, the more likely it is that a firm can have regular price increases. True, if firm have regular increase in price (refer to Appendix 1) from P4 to P5, the decrease in the quantity demanded is relatively small (from Q4 to Q5). It means that, the more inelastic the demand, the percentage change in quantity demanded is less than percentage change price. Hence, firm can have regular price increases.

7. If EP = -1.25 for Group A, and EP = -.375 for Group B, and a firm uses price discrimination, Group A should pay a higher price than Group B. False, Group A is elastic and Group B is inelastic. The consumers in the inelastic sub-market will be charged the higher price, and those in the elastic sub market will be charged the lower price. So Group B should pay higher price. Please refer to Appendix 2 for illustration.

8. A consumer spends 1% of her income on Good A and 25% on Good B. Price Elasticity of Demand should be greater for Good B. True, if the consumer spends less of her income, means that Good A is a necessity good and spends more of her income means that Good B is a luxury good. Luxuries tend to more elastic than necessities as there are more options for consumer.

9. Income elasticity for an inferior good is always negative. True, because quantity demand falls as income rises. Quantity demanded and income move opposite directions, inferior goods have negative elasticity.

10. The more inelastic the demand, the flatter the demand curve. False, inelastic demand have steeper curve because quantity demanded does not respond strongly to price changes. Please refer to Appendix 3 for illustration. For a inelastic demand product such as cigarettes, when price increase by 10%, the quantity demanded will fall by 3.8%. 11. If demand goes from P = 1850 – .05Q to P = 1700 – .05Q, Demand has increased. False. If P = 1850 – .05Q then Qd= 37000-20P and if P = 1700 – .05Q, then Qd= 34000-20P. The demand curve shift to left and hence, the demand decreases. Please refer to Appendix 4 for illustration 12. If TC goes from TC = 1250 + .5Q to TC = 1200 + .6Q, FC have gone up and VC have gone down. False, because TC=TFC+TVC. From the equation above shows that, the FC decreases leads TFC to fall from 1250 to 1200 and the VC increases leads TVC to gone up from 0.5 to 0.6. Part B (Explain in a short Essay (not more than 1 page each))

1) Define demand, discuss various determinants of demand.
Demand is the quantities of good or service that consumers are willing to buy at various prices within some given period of time. Holding all other factors constant, the price of a good or service increases as its demand increases and vice versa. When factors other than price changes, demand curve will shift. There are 5 determinants of the demand curve. First factor is price of related goods. A good or service can be related to another by being a substitute or complement. If price of a substitute changes, we expect the demand for the good under consideration to change in the same direction as the change in the substitute’s price. For instance, if the price of coffee rises, the demand for tea should increase. The complement goods are the goods that can be used together.

Price of complement and demand for the other good are negatively related. Example, if the price of sugar increases, the demand for coffee will fall. Second factor is income, as people’s income rises, it is reasonable to expect their demand for a good to increase and vice versa, the demand curve will shift right. A fall in income will lead to a decrease in demand for normal goods. Goods whose demand varies inversely with income are called inferior goods. Third determinant is future expectation. If enough, buyers expect the price of a good rises in future, the current demand will increase. Also, if consumers’ current demand will increase, they expect higher future income. For example, in 2005 housing prices rose, but people bought more because they expected the price to continue to go up. This drove prices even further, until the bubble burst in 2006 ( n.d.).

Forth factor is tastes and preferences. This is the desire, emotion, or preference for a good or service. If consumer preference is favorable change will leads to an increase in demand. Likewise, unfavorable change leads to a decrease in demand. Example, companies spend thousands on advertising to make you feel strongly that you want a product. Last determinant is number of buyer. If the number of buyers in market rises, the demand increases. For example, the housing bubble case. Low-cost mortgages increased the number of people who were told they could afford a house. The number of buyers actually increased, driving up the demand for housing. When they found they really couldn’t afford the mortgage, especially when housing prices started to fall, they foreclosed. This reduced the number of buyers, and demand also fell.

2) Briefly explain the concept of Law of diminishing returns? Discuss its assumption and importance? The law of diminishing marginal returns means that the productivity of a variable input declines as more is used in short-run production, holding one or more inputs fixed. This law has a direct behavior on market supply, the supply price, and the law of supply. The main reasons the marginal product (MP) of this variable input declines is the fixed input. The fixed input imposes a capacity constraint on short-run production. For example, in a sandwich production, the size of the sandwich-producing kitchen and equipment is fixed. The company employs additional workers, the kitchen becomes increasingly crowded. Only so many workers can use the sandwich-preparation counter to prepare sandwich.

While adding additional workers do increase total sandwich production, the extra production attributable to these workers is certain to fall as the capacity of the fixed input is limited. In fact, adding too many workers actually results in a negative marginal product, hence, total product falls. The law of diminishing marginal returns is reflected in the shapes and slopes of the total product, marginal product, and average product curves. The most important of these being the negative slope of the marginal product curve. Appendix 5 shows the graph three product curves. The total product (TP) curve shows that the total number of Sandwich Company produced per hour for a given amount of labor. The increasingly flatter slope of the TP is attributable to the law of diminishing marginal returns. Also, the marginal product curve indicates how the total production of Sandwich Company changes when an extra worker is hired. The negatively-sloped portion of the MP curve is a direct embodiment of the law of diminishing marginal returns.

Further, the average product curve indicates the average number of Sandwich Company produced by workers. The negatively-sloped portion of the AP curve is indirectly caused by the law of diminishing marginal returns. As marginal product declines, due to the law of diminishing marginal returns, it also causes a decrease in average product. 3) Explain the various economies and diseconomies of scale? Economies of scale are the cost advantages that a business can exploit by expanding the scale of production. The effect is to reduce the long run average (unit) costs of production. Economies of scale have brought down the unit costs of production and feeding through to lower prices for consumers (appendix 6). It could be achieved by buying new machinery, and build a bigger factory. There are two types of economy of scale and depending on the particular characteristics of an industry, some are more important than others.

Firstly, internal economies of scale are a product of how efficient a firm is at producing, that is specific to individual firm. Example, advantages are enjoyed by expansion. Next, external economies of scale occur outside of a firm but within an industry. Example, industry’s scope of operations expand due to better transportation network, will result a decrease in cost for a company working within industry, , external economies of scale have been achieved. Diseconomies of scale are the forces that cause larger firms to produce goods and services at increased per unit costs. The concept is the opposite of economies of scale to a situation which economies of scale no longer function for a firm. Rather than experiencing continued decreasing costs per increase in output, firms see an increase in marginal cost when output is increased (appendix 6).

When a firm expands its production scale beyond a certain level, it suffers certain disadvantages. These disadvantages are called internal diseconomies of scale. The result of these diseconomies of scale is a fall run average cost. There are a number of factors that might give rise to inefficiencies as the size of the firm grows. As the size of the firm grows beyond a certain level, organization, control and planning is needed. This makes the managerial responsibilities more difficult. Delegation of the management functions to lower personnel becomes very common. Since the lower personnel lack the adequate experience to undertake the task, it may result in low output at higher cost. All these lead to an increase in the long-run average cost.

Further, the external diseconomies of scale are beyond the control of a company increases its total costs, as output in the rest of the industry increases. The increase in costs can be associated with market prices increasing for some or all of the factors of production. For instance, high competition for labor, when there is more firms in industry, there will be increased demand for labor, making the best workers harder to keep (Keat and Young, 2009).

References n.d. DETERMINANTS OF DEMAND. [online] Available at: [Accessed: 28 Mar 2014]. Keat, P.G. and Young, P.K.Y., 2009 ‘Managerial Economics: 6th ed. Economic Tools for Today’s Decision Makers’. Pg. 266-268


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Managerial Economics Essay

Managerial Economics Essay
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  • University/College:
    University of Arkansas System

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  • Words: 2069

  • Pages: 8

Managerial Economics

Chapter 1: Introduction to Managerial Economics

4. Describe the importance of the “other things equal” assumption in managerial economic analysis.
5. Describe what constitutes a market, distinguish competitive from non-competitive markets, and discuss imperfect markets.
6. Emphasize the globalization of markets.
1. Definition. Managerial economics is the science of directing scarce resources to manage cost effectively.
2. Application. Managerial economics applies to:
(a) Businesses (such as decisions in relation to customers including pricing and advertising; suppliers; competitors or the internal workings of the organization), nonprofit organizations, and households.

(b) The “old economy” and “new economy” in essentially the same way except for two distinctive aspects of the “new economy”: the importance of network effects and scale and scope economies.
i. network effects in demand – the benefit provided by a service depends on the total number of other users, e.g., when only one person had email, she had no one to communicate with, but with 100 mm users on line, the demand for Internet services mushroomed.

ii. scale and scope economies – scaleability is the degree to which scale and scope of a business can be increased without a corresponding increase in costs, e.g., the information in Yahoo is eminently scaleable (the same information can serve 100 as well as 100 mm users) and to serve a larger number of users, Yahoo needs only increase the capacity of its computers and links.

iii. Note: the term open technology (of the Internet) refers to the relatively free admission of developers of content and applications. (c) Both global and local markets.
3. Scope.
(a) Microeconomics – the study of individual economic behavior where resources are costly, e.g., how consumers respond to changes in prices and income, how businesses decide on employment and sales, voters’ behavior and setting of tax policy.

(b) Managerial economies – the application of microeconomics to managerial issues (a scope more limited than microeconomics).

(c) Macroeconomics – the study of aggregate economic variables directly (as opposed to the aggregation of individual consumers and businesses), e.g., issues relating to interest and exchange rates, inflation, unemployment, import and export policies.


Chapter 1: Introduction to Managerial Economics

4. Methodology.
(a) Fundamental premise – economic behavior is systematic and therefore can
be studied. Systematic economic behavior means individuals share common motivations and behave systematically in making economic choices, i.e, a person who faces the same choices at two different times will behave in the same way both times.

(b) Economic model – a concise description of behavior and outcomes: i. focuses on particular issues and key variables (e.g., price, salary), omits considerable information, hence unrealistic at times;

ii. constructed by inductive reasoning;
iii. to be tested with empirical data and revised as appropriate. 5. Basic concepts.
(a) Margin vis a vis average variables in managerial economics analyses. i. marginal value of a variable – the change in the variable associated with a unit increase in a driver, e.g., amount earned by working one more hour;

ii. average value of a variable – the total value of the variable divided by the total quantity of a driver, e.g., total pay divided by total no. of hours worked;
iii. driver – the independent variable, e.g., no. of hours worked; iv. the marginal value of a variable may be less that, equal to, or greater than the average value, depending on whether the marginal value is decreasing, constant or increasing with respect to the driver; v. if the marginal value of a variable is greater than its average value, the average value increases, and vice versa.

(b) Stocks and flows.
i. stock – the quantity at a specific point in time, measured in units of the item, e.g., items on a balance sheet (assets and liabilities), the world’s oil reserves in the beginning of a year;
ii. Flow – the change in stock over some period of time, measured in units per time period e.g., items on an income statement (receipts and expenses), the world’s current production of oil per day.

(c) Holding other things equal – the assumption that all other relevant
factors do not change, and is made so that changes due to the factor being studied may be examined independently of those other factors. Having analysed the effects of each factor, they can be put together for the complete picture. 6. Organizational boundaries.

(a) Organizations include businesses, non-profits and households. (b) Vertical boundaries – delineate activities closer to or further from the end user. (c) Horizontal boundaries – relate to economies of scale (rate of production or delivery of a good or service) and scope (range of different items produced or delivered).


Chapter 1: Introduction to Managerial Economics

(d) Organizations which are members of the same industry may choose different vertical and horizontal boundaries.
7. Competitive markets.
(a) Markets.
i. a market consists of buyers and sellers that communicate with one another for voluntary exchange. It is not limited by physical structure. ii. in markets for consumer products, the buyers are households and sellers are businesses.

iii. in markets for industrial products, both buyers and sellers are businesses.
iv. in markets for human resources, buyers are businesses and sellers are households.
v. Note: an industry is made up of businesses engaged in the production or delivery of the same or similar items.
(b) Competitive markets.
i. markets with many buyers and many sellers, where buyers provide the demand and sellers provide the supply, e.g., the silver market. ii. the demand-supply model – basic starting point of managerial economics, the model describes the systematic effect of changes in prices and other
economic variables on buyers and sellers, and the interaction of these choices.

(c) Non-competitive markets – a market in which market power exists. 8. Market power.
(a) Market power – the ability of a buyer or seller to influence market conditions. A seller with market power will have the freedom to choose suppliers, set prices and influence demand.
(b) Businesses with market power, whether buyers or sellers, still need to understand and manage their costs.
(c) In addition to managing costs, sellers with market power need to manage their demand through price, advertising, and policy toward competitors. 9. Imperfect Market.
(a) Imperfect market – where one party directly conveys a benefit or cost to others, or where one party has better information than others. (b) The challenge is to resolve the imperfection and be cost-effective. (c) Imperfections can also arise within an organization, and hence, another issue in managerial economics is how to structure incentives and organizations. 10. Local vis a vis global markets.

(a) Local markets – owing to relatively high costs of communication and trade, some markets are local, e.g., housing, groceries. The price in one local market is independent of prices in other local markets.


Chapter 1: Introduction to Managerial Economics

(b) Global markets – owing to relatively low costs of communication and trade, some markets are global, e.g., mining, shipping, financial services. The price of an item with a global market in one place will move together with the pries elsewhere.

(c) Whether a market is local or global, the same managerial economic principles apply.
(d) Note: Falling costs of communication and trade are causing more markets to be more integrated across geographical border – enabling the opportunity to sell in new markets as well as global sourcing. Foreign sources may provide cheaper skilled labor, specialized resources, or superior quality, resulting in lower production costs and/or improved quality.

1A. The managerial economics of the “new economy” is much the same as that of the “old economy” with two aspects being more important – network effects in demand and scale and scope economies.
1B. Vertical boundaries delineate activities closer to or further from the end user. Horizontal boundaries define the scale and scope of operations. ANSWERS TO REVIEW QUESTIONS
1. Marketing over the Internet is a scaleable activity. Delivery through UPS is somewhat scaleable: UPS already incurs the fixed cost of an international collection and distribution network; it may be willing to give Amazon bulk discounts for larger volumes of business.

2. Number of cars in service January 2002 + production + imports – exports – scrappage during 2002 = Number of cars in service January 2003. Number of cars in service is stock; other variables are flows.

3. [omitted].
4. No, models must be less than completely realistic to be useful. 5. (a) Average price per minute = (210 + 120 x 4)/5 = 138 yen per minute. (b) Price of marginal minute = 120 yen.
6. (a) Flow; (b) Stock; (c) Stock.


Chapter 1: Introduction to Managerial Economics

7. (a) The electricity market includes buyers and sellers. (b) industry consists of sellers only.



8. (a) False. (b) False.
9. [omitted].
10. If there are scale economies, the organization could product at a lower cost on a larger scale, which means wider horizontal boundaries; and vice versa. 11. Yes. Horizontal boundaries: how many product categories should it sell? Vertical boundaries: should it operate its own warehouses and delivery service? 12. Intel has relatively more market power.

13. (b).
14. Both (a) and (b).
15. Competitive markets have large numbers of buyers and sellers, none of which can influence market conditions. By contrast, a buyer or seller with market power can influence market conditions. A market is imperfect if one party directly conveys benefits or costs to others, or if one party has better information than another. WORKED ANSWER TO DISCUSSION QUESTION

Jupiter Car Rental offers two schemes for rental of a compact car. It charges $60 per day for an unlimited mileage plan, and $40 per day for a time-and-mileage plan with 100 free miles plus 20 cents a mile for mileage in excess of the free allowance. a. For a customer who plans to drive 50 miles, which is the cheaper plan. What are the average and marginal costs per mile of rental? (The marginal cost is the cost of an additional mile of usage.)

b. For a customer who plans to drive 150 miles, which is the cheaper plan. What are the average and marginal costs per mile of rental?
c. If Jupiter raises the basic charge for the time-and-mileage plan to $44 per day, how would that affect the average and marginal costs for a customer who drives 50 miles?


Chapter 1: Introduction to Managerial Economics

(a) It is helpful to sketch the total rental cost as a function of the mileage (see figure below). The breakeven between the two plans is at 200 miles per day. For 50 miles, the time-and-mileage plan is cheaper. Average cost = $40/50 = 80 cents per mile. Marginal cost = 0.

Total cost ($)

time-and-mileage plan
unlimited mileage plan





Quantity (miles per day)

(b) For the 150 mile customer, the time-and-mileage plan is still cheaper. Average cost = $(40 + 0.2 x 50)/150 = 33 cents per mile; marginal cost = 20 cents per mile.
(c) After the increase in the basic charge, the average cost = $(44 + 0.2 x 50)/150 = 36 cents per mile, while marginal cost = 20 cents per mile. The increase in the basic charge doesn’t affect the marginal cost.



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Managerial Economics Essay

Managerial Economics Essay
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  • University/College:
    University of Chicago

  • Type of paper: Thesis/Dissertation Chapter

  • Words: 458

  • Pages: 2

Managerial Economics

3-1. Concert Opportunity Cost

You won a free ticket to see a Brice Springsteen concert ( assume the ticket has no resale value). U2 has a concert the same night, and this represents your next best alternative activity. Tickets to the U2 concert cost $80, and on any particular day, you would be willing to pay up to $100 to see this band. Assume that there are no additional costs of seeing either show. Based on the information presented here, what is the opportunity cost of seeing Bruce Springsteen?

When you making a decision between two alternative, you want to choose the one that returns the highest profit. The opportunity cost of one alternative as the forgone opportunity to earn profit from the other. The opportunity cost is what we give up to pursue it. If I made the decision to go to the Bruce Springsteen concert and not the U2 concert my opportunity cost would be $20 because the my next best alternative to the Bruce Springsteen concert is the U2 concert. The U2 concert has a benefit of $100 and a cost of $80 so the net benefit is $20. The net benefit is what you are giving up in order to attend the Springsteen concert. The opportunity cost of seeing the Bruce Springsteen concert is $20.

3-3. Housing Bubble

Due to the housing bubble, many houses are now selling for much less then their selling price just two or three years ago. There is evidence that homeowners with virtually identical houses tend to ask for more if they paid more for the house. What fallacy are they making?

Homeowners that have a higher asking price just because they paid more for the home are making a fixed cost fallacy or a sunk cost fallacy. This is when irrelevant costs are considered.

3-5. Starbucks

Starbucks is hoping to make use of its excess restaurant capacity in the evenings by experimenting with selling beer and wine. It speculates that the only additional costs are hiring more of the same sort of workers to cover the additional hours and costs of the new line of beverages. What hidden costs might emerge?

When a restaurant sells alcohol there are several hidden costs that may arise that the management may have not anticipated. First if all, alcohol causes people to get drunk and that has a tendency to cause problems. Another hidden cost that may emerge is spending more money on security personnel and surveillance cameras and costs.


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Managerial Economics Essay

Managerial Economics Essay
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  • University/College:
    University of Chicago

  • Type of paper: Thesis/Dissertation Chapter

  • Words: 6575

  • Pages: 26

Managerial Economics

Q.1.0) For each of the following events, assume that either the supply curve or the demand curve (not both shifted). Explain which curve shifted and indicate the direction of the shift.

a.From 1950 to 1979 the wages paid to fruit pickers increased while the number of fruit pickers employed decreased.

b.During the same period the price of radio sets declined, while the number of radio sets purchased increased.

c.Housing prices are rising but more houses are sold.

d.Australian Airlines reduces its average plane fare by 30 percent in order to attract more customers.


a) In this case the number of the fruit pickers has decreased while the wages of the fruit pickers has increased. Thus, the demand has not changed. The supply of the fruit pickers has decreased, hence, the fruit pickers supply has shifted to the left.

b) In this case the price of the radio sets declined while the number of radio sets purchased increased. This means the demand has increased. The demand curve has shifted to the right.

c) In this case the housing prices are rising but more houses were sold. The demand of the houses has increased. The demand curve has moved to the right.

d) In this the Australian Airlines reduces its average plane fare by 30 percent in order to attract more customers. The aim here is increase the revenue in the future. The supply is been increased to accommodate the increasing customers. The supply curve is moved to the right.

Q.2.0) Explain the meaning of elasticity? What are the different types of elasticities? What are the factors that affect each type of elasticity? Of what use are these elasticities to business?


Elasticity is a measure of the responsiveness of one variable to changes in another variable; the percentage change in one variable that arises due to a given percentage change in another variable.

The Elasticity is one of the important factors to measure the market condition, the market character and depicts a comprehensive picture of the supply, demand relation.

The different types of Elasticities are Own price elasticity, cross-price elasticity, income elasticity and other elasticity such as own advertisement elasticity and cross-advertisement elasticity.

2.1. Own price elasticity: A measure of the responsiveness of the quantity demanded of a good to a change in the price of that good; the percentage change in quantity demanded divided by the percentage change in the price of the good.

EdQx, Px Percentage change in quantity demanded = %∆Qdx

= Percentage change in price of the good %∆Px

The Own price elasticity of demand is measured in terms of its absolute value, if the absolute value is greater than one (1) is said to be elastic, if the absolute value is less than one (1) is said to be inelastic and if the absolute value is equal to one (1) is said to be unitary.

2.1.1 Elastic demand: Demand is Elastic if the absolute value of the own price elasticity is greater than 1.

│EdQx,Px│> 1

This means that the percentage change in the quantity demanded is more than the percentage change in the price of the good. Generally, the demand is elastic for consumer goods. The important point is when the total revenue increases (decreases) as a result of a fall (rise) in price, demand is elastic.

2.1.2 Inelastic demand: Demand is inelastic if the absolute value of the own price elasticity is less than 1.

│EdQx,Px│< 1

This means that the percentage change in the quantity demanded is less than the percentage change in the percentage change in the price of the good. The demand is elastic for the daily requirement goods, specialty goods. The important point is when the total revenue decrease (increases) as a result of a fall (rise) in price, demand is inelastic.

2.1.3 Unitary elastic demand: Demand is unitary elastic if the absolute value of the own price elasticity is equal to 1.

│EdQx, Px│= 1

This means that the percentage change in the price is equal to the percentage change in quantity demanded of the good. As the percentage change in price is equal to the percentage change in the quantity demanded, the total revenue does not change as price changes.

2.1.4 Perfectly elastic demand: A condition in which a small percentage change in price brings about an infinite percentage change in quantity demanded.

│EdQx, Px│= ∞

2.1.5 Perfectly inelastic demand: A condition in which the quantity demanded does not change as the price changes.

│EdQx, Px│= 0

2.1.6 Influencing factors: The price elasticity is determined the following factors, the availability of the substitutes, time factor and the expenditure share of the product in consumer’s budget.

* Availability of viable options: The price elasticity is very much influenced by the availability of substitutes. The price elasticity is greater when the substitutes are more. This is because of the wider choices consumer has. The minimal changes in the price of one good will result immediate shift of the demand to the other good.

The elasticity for the broadly defined commodities tends to be more inelastic than the demand for specific commodities. This is because the specific products are demanded on the basis of the consumer’s tastes, preferences, likes, passion and need.

* Time factor: The time factor influences the character of the demand of the good. In general, the availability of time allows the consumer to pursue the substitutes, which eventually results in the decline of the demand for the good whose price has increased. In short time, the demand is more likely to be inelastic for the reason that the consumer will not be able to find the substitutes.

*Expenditure on the product: The amount spent by the consumer on a particular product determines the character of the demand elasticity of the product. The products on which the consumer spends fewer amounts are likely to be inelastic conversely the products on which the consumer spends large amount are likely to be elastic. This is because the slightest increase in their prices would have a great impact on the consumer’s budget.

2.1.7 Uses to the business: The own price elasticity is very much essential to the business to analyze the market and further to formulate the strategies to gain maximum benefit from the given situation. The price elasticity enables the firm to asses the relationship between the price of its product and the demand. The firm can be able to gauge the relationship between their products and other products in the market. This helps the firm to identify which are the competing products and complementing products.

The firm by assessing the price elasticity can be able to define fine price strategies, promotion strategies and as well can contemplate about the synergies with the other firms whose products are in complementary relationship with the firm’s products.

2.2 Income elasticity: A measure of the responsiveness of the demand for a good to changes in consumer income; the percentage change in quantity demanded divided by the percentage change in income.

EmQx, M Percentage change in quantity demanded %∆Qdx

= Percentage change in the consumer income = %∆M

If EmQx, M > 0, then X is a normal good, an increase in income leads to an increase in the consumption of X.

If EmQx, M < 0, then X is an inferior good, an increase in income leads to a decrease in the consumption of X.

2.2.1 Influencing factors: The important factors influencing this elasticity are the income level of the consumers and the nature of the product. If the product is not having the perceived value or not having the perceived image, the product will be purchased more when the income level of consumer decreases conversely the products will be purchased less when the income level of the consumer increases.

2.2.2 Uses: The firms will be able to identify their product’s perceived value. This assists the firms to modify their product’s features, promote well or position their product well in the market.

In general, the firms are interested in making their products a normal good, the demand increases with the increase in the income level of the consumer. This elasticity helps the firms to define their pricing strategy to suit the consumer’s perceived value.

2.3 Cross-price elasticity: A measure of the responsiveness of the demand for a good to changes in the price of a related good; the percentage change in the quantity demanded of one good divided by the percentage change in the price of a related good.

EdQx, Py = Percentage change in quantity demanded of one good = %∆Qdx

Percentage change in price of related good %∆Py

This elasticity helps in understanding the relationship between two goods. This elasticity explains whether two goods are complement or substitute to each other.

If EdQx, Py > 0, the two goods are substitutes to each other, the larger the positive coefficient, the greater the substitutability between the two goods.

If EdQx, Py < 0, the two goods are complement to each other, the larger the negative coefficient, the greater the complementary relationship between the two goods.

The important point is the sign of the coefficient is important when mentioning the Cross-price elasticity.

2.3.1 Influencing factors: The close relationship between the products has a great impact on the elasticity. If the product has many competing or substitutes which offer similar benefits mix, the demand changes highly even with a minor changes in the price of the product or the changes in the price of the substitutes. This elasticity is also influenced by the price of the complementing products; if the price of the complementing products increases (decreases) the demand for the firm’s product decreases (increases).

2.3.2 Uses: This helps the firms to handle the competition by formulating a well defined pricing strategy. The firms will be able to assess the relationship with the other products. The firms can identify the competing as well complementing products in the market.

The demand of the product is highly influenced by the competing and contemplating product’s price. The firm by assessing the cross-price elasticity will be able to handle the competition and as well can form synergies with the firms offering complementary products. This will enable the firms to operate efficiently in the market.

2.4 Price elasticity of supply: The ratio of the percentage change in the quantity supplied of a product to the percentage change in its price.

Es = percentage change in quantity supply = %∆Qsx

percentage change in price %∆P

Es > 1, elastic supply, the percentage change in quantity supply is more than the percentage change in price.

Es < 1, inelastic supply, the percentage change in quantity supply is less than the percentage change in price.

Es = 1, unitary elastic, the percentage change in quantity supply is equal to the percentage change in price.

2.4 Influencing factors: The influencing factors are the price of the product, the nature of the market. The ultimate objective of the firm is to make maximum profits, the firm will supply according to the rise in price and demand in the market to gain optimum profits.

2.5 Uses: This elasticity helps the firms to strike a balance among the price of the product, demand and supply of the product. This also helps the firms to define their production and supply str0ategy so as to address the given situation.

Q.3.0) Read the New Economy Index dealing with the effects of internet and increased competition on business competition (

a. List factors that are said to be driving the increased competition between firms? Do these factors suggest that the structures of the markets in which firms operate are taking on more of the characteristics of the perfectly competitive market structures?

b. Is there information on these pages that gives an indication of whether increased competition is having an effect on the profitability of the firm?

Ans. a) The factors that are said to be driving the increased competition between the firms are:

i. Emergence of global market place.

ii. The number of increased firms.

iii. Technology that makes the entry easy for new entrants.

iv. Ever increasing from securities markets to increase shareholders value.

v. Frenetic atmosphere of mergers.

vi. Increased number of large institutional investors.

Yes, these factors suggest that the structures of the market are taking on more of the characteristics of the perfectly competition. The major characteristics are the increased number of firms, more number of players. The easy entry for the new entrants suggests that the market is not having any entry barriers.

b) Yes, the information on these pages indicates the effect of the competition on the profitability of the firms. The average price mark-up over the cost ration in manufacturing in United States had declined from about 19 percent in 1970 to 15 percent between 1980 and 1992.

Q.4.0) Evaluate the economic case for economic integration in either South Asia or ASEAN region (chose the region which you live). Will this be beneficial for your country? Why or why not?


I am from India and India is an active participant in South Asian regional development and welfare programs. The economic integration is an important factor influencing the prosperity of the nations worldwide. The economic integration is one most successful tool exploited by many countries to gain economic benefits and welfare.

The movement of South Asian countries; India, Pakistan, Bangladesh, Nepal, Sri Lanka, Bhutan and Maldives towards the economic integration in the South Asian region will be a big step towards their economic welfare.

The India has already signed Free Trade Agreement (FTA) with Thailand, one more similar agreement with Association of South East Asian Nations (ASEAN) and another trade agreement with Singapore in early next year. This is the initiative taken by India to bring close the nations of this part of the world and leap towards the economic integration.

The developed have already formed their Regional Trade Agreement (RTA) such as North American Free Trade Agreement, European Union accord. The South Asian countries must formulate a similar platform to present their argument with one consented voice and craft own free trade agreement to counter the growing competition from these countries.

According a world bank report the success of the RTA is that the RTA were successful in eliminating the trade barriers thus, paving way for the free flow of goods and services, which ultimately benefits the masses. The trade barriers segment the market, restricts the free flow of goods, service, investments, development schemes which call for a joint venture. Therefore wide range policy measures are required to facilitate the economic integration.

A direct shift from closed to open regionalism will enable the countries to operate in more liberal market. The increased relations between the nations allows the free flow of ideas, fosters alternative thinking and exchange of technology.

In a liberal trade regime, the South Asian countries will reap benefits in terms increased volume of trade, larger investments and increased production but, also the new technologies which were hitherto unknown at work place.

India, with a one fifth of worlds population has been successful in gearing the interaction between the South Asian countries, has a larger part to play and as well the biggest beneficiary from the economic integration in this region.

There are some competitive complications in the integrations. Most of the countries are having rivalry among them as they offer similar products to the international market. India and Sri Lank compete in agro-products; tea, coffee, rubber and jute, Malaysia and Singapore in clothing, Japan and South Korea in electronics.

At present the integration trade among SAARC is less than 5 percent, where as it is 55 percent in European Union countries and 65 percent in North American countries. The trade between India and Pakistan is currently at US$ 251; with the integration trade it would go up to US$ 4 billion.

Q.5.0) What is a market failure? What are the different types of market failures? Discuss and give an example.

Ans. The situation in which the following characteristics developed in the market is termed as Market failure.

The different types of market failures are

Market power


Public goods

Incomplete information

5.1 Market power: The ability of a firm to set its price above marginal cost. The main aim of the government is to create a perfect competition in the market. But, many a times it is not possible. There always exist some firms who have an advantage over the other firms operating in the same industry. These firms gain sustainable competitive advantage by having larger market share, high technology, competitive market position and/or financial support.

The firm which has sustainable competitive advantage will exercise power to influence the market prices. The firm will keep its price higher than the marginal cost, the resources required to produce that unit good, thus decreasing the social welfare. The government will intervene in these instances to regulate these firms to increase the social welfare.

When the firms exercise the market power, the social welfare will minimize, the consumer has to pay more than the cost incurred by the producer to produce that extra unit.

The government formulates certain laws to avert the concentration in the market, which eventually results in Market power. In most of the countries,
the governments formulate laws to control the formation of market power by legislating antitrust policy and price regulation.

Example: The formation of a monopoly is a clear case of market power. Most of the firms attempt to build a monopoly. In monopoly market, the entry is restricted and the firms can charge high price than the marginal cost.

In the above figure it shows the monopolist’s demand, marginal cost, and marginal cost and marginal revenue curves. In a perfect competitive market all the consumers are charged similar. But, in this case the monopolist charges PM price for the profit maximizing out put units of QM. At this price the consumer is pays higher amount for the last unit produced than the cost to produce it. Total social welfare in monopoly is the sum of producer and consumer surplus, the region W in the above figure. The triangle ABC represents the dead weight loss.

5.1.1 Antitrust policy: Government policies designed to keep firms from monopolizing their markets.

The main aim of the antitrust policy is to eliminate the dead weight loss and discourage the mangers to exercise price-fixing agreements and other collusive practices by declaring it as an illegal to foster monopoly.

The first successful antitrust act was used against United States and Trans-Missouri Freight Association agreement, which the Supreme Court declared as illegal.

Standard Oil of New Jersey along with Standard Oil of Ohio was charged with attempting to fix the prices of petroleum products and the prices at which the products would be shipped. Standard Oil, in particular, was accused of numerous activities designed to enhance monopoly.

5.1.2 Price regulation:

In many instances a single firm may be able to service the market or the government may wish to allow the firm to practice monopoly. When the economies of scale are larger, the government may allow the firm to practice monopoly but choose to regulate the price of the firm’s products.

Example: In India, the government has allowed the Maruti Udyog Ltd., au automobile manufacturing firm, to practice monopoly in small car segment till 1998. This was mainly to support this PSU, to gain the strength in the market and as was the capacity of the firm was made to address the demand of the market. Even though the Maruti was the only car manufacturer in the small car segment, the government has practiced strong price regulation in order to eliminate the dead weight loss.

Regulating a Monopolist’s price at the Socially Efficient Level

5.2 Externalities: Effects on the third party who is not the part in decision making process is termed as the Externalities. There are two types of externalities; positive externalities and negative externalities.

5.2.1 Positive externalities: The benefits are received by the party which is not involved in the production or consumption of a good.

Example: The benefits of the immunization of the public, which eventually leads to building a health society, benefits all the people irrespective of their participation in the process.

The government programs aiming at imparting education to every one leads to the building a knowledgeable society. This initiative benefits the whole nation.

5.2.2 Negative externalities: The costs borne by parties who are not involved in the production or consumption of a good.

Example: The pollution in the air, water and soil. The public in general suffers with out directly involving in the process. The society will be bearing some costs of this damage to the environment, but eventually the impact will on everyone.

5.2.3 The Clean Air Act: The Clean Air Act was formed to address the much devastating issue of the pollution. The new act covers the industry which releases over 10 tons per year of any of the listed pollutants or 25 tons per year of any combination of those pollutants.

The firms under this act are required to obtain permit to pollute. The permit is issued to the industry on the basis of its nature, level of pollution in that area and the calculated level of pollution that would be emitted by the firm at a fee. The act also supports the new entrants to find efficient ways to decrease the pollution in the industrial process.

The Act’s another important feature is, a firm can sell its limit to the other firm if the firm has lower level pollution than the permitted level. This is to encourage the firms to find the new ways to minimize the pollution in their firms.

5.3 Public goods: A good that is nonrival and nonexclusionary in consumption.

Public goods are the goods, which can be consumed by everyone. The goods are not paid by any one or the benefits are received by everyone. These benefits cannot be allocated to any single person; clean air, sunlight etc.

In general, if no one pays for these goods, as everyone along with the purchaser will be benefited. Thus, there is little or no major incentive for the purchaser. This very factor leads to free ride phenomenon.

5.3.1 Nonrival consumption: A good is nonrival in consumption if the consumption of the good by one person does not preclude other people from also consuming the good.

Example: street lights, public parks, radio signals, national defense.

5.3.2 Nonexclusionary consumption: A good or service is nonexclusionary if, once provided, no one can be excluded from consuming it.

Example: clean air, roads.

It would be advantageous for a firm to contribute to public goods in its market place to create goodwill in the market. The same thing goes with the individuals as well. The benefit arising from paying for the public good is not exclusive for any individual, thus everyone would be willing not to pay for them, which eventually results in failure of the market in providing public goods.

In conclusion, if the firm’s goal is to maximize profits, the last dollar spent on contributions to public projects should bring in one additional dollar in revenue.

5.4 Incomplete information:

The information about the product and services to all the interested parties is important for the market to operate efficiently. The participants must have good knowledge about the product or service’s features, price, benefits, the risks and the available technologies. The incomplete information will eventually result in inefficiencies in the market functioning, usage and the firm’s output.

The severe causes of market failure are asymmetric information, a situation where some market participants have better information than others. The presence of asymmetric information can lead buyers to refuse to purchase from sellers ort of fear that the seller is attempting to dump the product because it worth less than they are willing to pay and in some cases, may lead to the market collapse.

The government has formulated policies to address this issue.

5.4.1 Rules Against Insider Trading:

The regulation to avert the asymmetric information problem is by formulating rules against insider trading. The insiders will have more information about the company; can take better decisions about its stock trading. This if continues, the traders may reject the company’s shares. There will be little or no chance to the outsiders in the market which is dominated by the insiders; this will eventually result in market failure.

To prevent insider trading form destroying the market for financial assets, the government has enacted rules against insider trading. The regulation is in Section 16 of the Securities and Exchange Act (1934) and amended in1990 and effective form May 1, 1991.

Example: The manger has who has got a better knowledge about the company’s inside information may utilize to gain profits. If the company is contemplating to form a merger which would increase the value of the company, will buy the share in advance and sell them when actually the share value increase after the merger. Thus, gains maximum profits.

5.4.2 Certification: To eliminate the asymmetric information problems, the other devise is the certification. The government issues the certification of authenticity to the product or services after confirming to prescribe standards. This will ensure the consumers to get a fare deal in their transactions.

Example: The issue of certification of authenticity by the government to the schools, colleges, industries etc.

5.4.3 Truth in lending: The little or no comprehensive information about the barrowings has resulted in financial crisis across the world. The government has passes legislation on the barrowing and repaying criteria to simplify the issue, Truth in Lending Simplification Act (1980).

The truth in lending act affects both the supply and demand of credit. The barrowers have more information about the credit criteria, reduces the risk involved in repayment of the loan. The availability of information to the barrowers increases the demand, thus, the demand curve for the loans moves towards the right. The suppliers are affected mainly by the increased cost in complying with the government regulations, hence the supply curve of the loan moves towards the left. This movement eventually results in increase in the price of the loan (interest).

5.4.4 Truth in advertising: Advertisement is one of the important means of communicating with the potential and actual buyers. The main aim of the advertisement is to turn viewers into buyers. Under the pressure to push the product in the market, the companies will indulge in providing the false information or too much from too little truth.

When the consumers understand this, they will switch to competitor’s product or service. To alleviate this problem the government formulated the truth in advertisement. The main aim of this regulation is to cease the company’s from giving false information and to compensate the consumer who has incurred damages from a misguiding advertisement.

5.4.5 Enforcing contracts: Today’s markets are so dynamic, the relationships changes very quickly. In the attempt to gain the maximum benefit from a given situation, the companies become opportunists. To preserve the best interest of both parties the government has formed enforcing contracts regulation.

In most of the instances the end-of-period is a crucial thing. The firms often violate the contract principles to gain instant benefit from a changing situation with out due concern to the other party’s interest.

To solve this problem the government has formed Enforcing contracts, requires dishonest people to honor the terms of contracts.

5.4.6 Rent seeking: Selfishly motivated efforts to influence another party’s decision.

The government always intervenes into the market in order to avert the market failure. The government’s aim to intervene the market is to improve the allocation of resources in the economy by alleviating the problems associated with market power, externalities, public goods and incomplete information. The government policies benefits one party at the expense of other party.

For this reason the lobbyists send huge amount of money in attempts to influence government policies.

Q.6.0) Define CPI and Unemployment. What is the limitations/criticism of the following?

a. CPI as a measure of change in prices.

b. Unemployment rate as a measure of true employment.

Ans. 6.1) The inflation and deflation are the two vital determining factors of the macroeconomics.

Inflation: An increase in the general (average) price level of goods and services in the economy.

The inflation does not mean that all prices of all products in the economy rise during a given period. Inflation is an increase in the overall average level of prices and not an increase in the price of any specific product.

Deflation: A decrease in the general (average) price level of goods and service in the economy. In genera, the deflation is the reduction in the rate of inflation.

6.2 The Consumer Price Index (CPI):

An index that measure changes in the average prices of consumer goods and services.

The consumer price index is the widely accepted and used scale for measuring the inflation or deflation. The CPI is also called as the cost-of-living index. The CPI will measure the price changes in the consumer goods only. This measurement is considered with the effect of changes in the prices consumer goods on the income of the consumers.

In Australia, the Australian Bureau of Statistics (ABS) prepares the CPI. The ABS price collectors contact a sample of retail stores, other businesses supplying consumer products or services, home owners and tenants in Australia’s capital cities, each quarterly. The items included in the market basket are the items used or consumed by a typical urban family, under the category of food & beverage, clothing, housing expenses, transportation, medical care, entertainment and a range of other goods and services.

The composition of the market basket generally remains unchanged from one period to the next; hence the CPI is also called as fixed-price index.

Computing CPI:

CPI = Cost of the market basket of products at current year prices × 100

Cost of the same market basket of products at base-year prices

Base year: A year chosen as a reference pint for composition with some earlier or later year.

Annual rate of inflation= CPI in given year ─ CPI in previous year × 100

CPI in previous year

6.3 Limitation/criticism of CPI:

The CPI as a measure of change in prices has attracted much criticism because of its limitations. The reasons for the change in price are affluent, the computing of CPI does not consider all these factors as it would be difficult to collect and compile the data.

1. The CPI considers the items consumed by a typical urban family rather than the purchases of the consumers in every area. This very character limits the CPI to present a comprehensive measurement. Even in the family segment, the purchases of different families differ considerably from a typical family, the retired people have different buying criteria, purchases more of medicines and less of children products and the family who have more young children will have different needs.

2. The CPI does not acknowledge the changes in quality which in many instances results in the changes in the prices. Generally, the improving quality or performance of a product costs more to the producer, thus the producer will increase the price, the CPI fails to acknowledge this very fact. The price of television has increased quite highly, but the quality of the picture, sound and the added features are also the new benefits of today’s televisions, the CPI will not take these factors into consideration.

3. The composition of the market basket most of times is unchanged, which results in ignoring the latest trends. The market is more dynamic than ever and every year there are many new and innovative products and service are introduced to the market. The failure to take the changing patterns and preferences, the CPI will not be a comprehensive measure of the change in prices.

b) It is very important for every country to assess the unemployment rate. The countries most important and valuable asset is its labor force. The government has to gauge the productivity of its employment force to develop the country.

6.4 Unemployment rate: The percentage of people in the labor force who are without jobs and are actively seeding jobs. The unemployment is not all the people who do not have jobs, but the people who are part of the labor force who do not have jobs or seeking jobs.

6.5 Civilian labor force: The number of people 15 years of age and older who are employed or who are actively seeking a job, excluding those in the armed forced, home makers, students, discouraged workers and other persons not in the labor force.

6.6 Limitations/criticism:

The calculation of Unemployment rate has attracted much criticism for limitations to give a comprehensive detail of the employment.

The Australian Bureau of Statistics (ABS) computes the unemployment rate in Australia.

1. False response to the ABS survey about the unemployment. The respondents may give false information about their employment. The respondents may give false information about their current position; they might say they are seeking a job even if they are not or employed in illegal activities. This could be because of the benefits of registering oneself as unemployed or job seekers.

2. The official definition of the unemployment understates the unemployment rate by not considering the discouraged workers.

Discouraged worker: A person who wants to work, but who has given up searching for work because he or she believes there will be no job offers. After repeated rejections, discouraged workers often turn to their families, friends and possibly other forms of welfare for support. The ABS counts a discouraged worker as anyone who has looked for work within the last six months, but responds that they no longer looking for a job and includes in ‘not in labor’ category. The number of discouraged workers is likely to rise during a recession; the degree of underestimation of the official unemployment rate is thought to increase during a downturn.

3. Another understating of the unemployment rate occurs because the survey treats the part time workers equal to the full time workers. Some of these part time workers might be willing to go for full time job given a chance. These latter workers are underemployed. Such under-utilization of the employees is great in recession, but is not reflected in the measured unemployment rate.


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Managerial Economics Essay

Managerial Economics Essay
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  • University/College:
    University of California

  • Type of paper: Thesis/Dissertation Chapter

  • Words: 3175

  • Pages: 13

Managerial Economics

1) The elasticity of one variable with respect to another between two given points. It is used when there is no general function to define the relationship of the two variables. Arc elasticity is also defined as the elasticity between two points on a curve. The P arc elasticity of Q is calculated as

The percentage is calculated differently from the normal manner of percent change. This percent change uses the average (or midpoint) of the points, in lieu of the original point as the base.

2) Definition of ‘Law of Diminishing Marginal Returns’
A law of economics stating that, as the number of new employees increases, the marginal product of an additional employee will at some point be less than the marginal product of the previous employee.

The law of diminishing marginal returns means that the productivity of a variable input declines as more is used in short-run production, holding one or more inputs fixed. This law has a direct bearing on market supply, the supply price, and the law of supply. If the productivity of a variable input declines, then more is needed to produce a given quantity of output, which means the cost of production increases, and a higher supply price is needed. The direct relation between price and quantity produced is the essence of the law of supply.

An economic theory that states as additional inputs are put into production, the additional return will be in successively smaller increments. This can be due to crowding, adding less appropriate resources or increasing inputs of lower quality.

In More Laymen Terms

As the saying goes, “Too Many Cooks Spoil the Broth,” in any production there is a point of diminishing returns where just adding more inputs will not give the same income as it once did. Although many industrial firms strive to reach ‘scale,’ where their size gives them a cost advantage at higher production levels, no matter what industry a firm finds itself there will always be a point where the additional gain from added input is reduced.

3) The prisoner’s dilemma is a canonical example of a game analyzed in game theory that shows why two individuals might not cooperate, even if it appears that it is in their best interest to do so. It was originally framed by Merrill Flood and Melvin Dresher working at RAND in 1950. Albert W. Tucker formalized the game with prison sentence payoffs and gave it the “prisoner’s dilemma” name (Poundstone, 1992). A classic example of the prisoner’s dilemma (PD) is presented as follows:

Two men are arrested, but the police do not possess enough information for a conviction. Following the separation of the two men, the police offer both a similar deal—if one testifies against his partner (defects/betrays), and the other remains silent (cooperates/assists), the betrayer goes free and the cooperator receives the full one-year sentence. If both remain silent, both are sentenced to only one month in jail for a minor charge. If each ‘rats out’ the other, each receives a three-month sentence. Each prisoner must choose either to betray or remain silent; the decision of each is kept quiet. What should they do?

If it is supposed here that each player is only concerned with lessening his time in jail, the game becomes a non-zero sum game where the two players may either assist or betray the other. In the game, the sole worry of the prisoners seems to be increasing his own reward. The interesting symmetry of this problem is that the logical decision leads both to betray the other, even though their individual ‘prize’ would be greater if they cooperated.

In the regular version of this game, collaboration is dominated by betraying, and as a result, the only possible outcome of the game is for both prisoners to betray the other. Regardless of what the other prisoner chooses, one will always gain a greater payoff by betraying the other. Because betraying is always more beneficial than cooperating, all objective prisoners would seemingly betray the other.

In the extended form game, the game is played over and over, and consequently, both prisoners continuously have an opportunity to penalize the other for the previous decision. If the number of times the game will be played is known, the finite aspect of the game means that by backward induction, the two prisoners will betray each other repeatedly.

4) Third degree discrimination involves charging different prices to different segments of customers. This method of price discrimination is really an imperfect variation of the perfect type represented by first degree price discrimination. In this method different segments of customers are identified and each segment is charged price base on what price is most profitable for the company in each segment. The most common way of segmentation for this type of price discrimination is by geographic location. A very prominent example of this type price discrimination is charges for operations by surgeons. For the same type of operations surgeons and hospitals charge different fees depending on the type of hospital room and other facilities that the patient chooses during hospitalization for operation. Other common forms of such price discrimination include discounts such as those for students or senior citizens.



1) Demand theory indicates that the determinants of consumption are income (I), the price of the good in question ( pi ), the prices of other goods ( po ) and other variables such as tastes: i i q q ( i o I, p , p , other variables).

Consider the case of an illicit commodity such as marijuana. The consumption of marijuana involves risks of fines, in some cases imprisonment and, possibly, other costs associated with the shame of being caught. Consequently, the price of marijuana in its demand function ( p ) m should be interpreted as being made up of the conventional money cost ( p ) mplus the expected “other costs” per unit:

2) Legalization of marijuana would eliminate the criminal sanctions and penalties associated with its consumption. As this would decrease the “full” price, consumption would be expected to rise. Marijuana consumption is significantly higher amongst males than females – 60 percent of all males have consumed it, compared to 46 percent of all females. Consumption of marijuana is estimated to increase by about 4 percent if it were legalised; and by about 11 percent following both legalisation and a 50-percentfall in its price. Price is a significant determinant of marijuana consumption. Whilst marijuana consumption is estimated to be price inelastic, estimates of most of the price elasticities are significantly different from zero.

Two types of price elasticities of demand for marijuana were estimated, gross and net. The gross price elasticity includes the effects of both legalisation and a price change, while the net version excludes the legalisation effect. The price elasticity of demand for marijuana differs significantly with the type of consumer. For more frequent users (daily, weekly and monthly), gross and net price elasticities are estimated to be -.6 and -.4, respectively. Occasional smokers having a gross price elasticity of about -.3 and net elasticity of about -.1. Regarding those who are no longer users, they have gross and net price elasticities close to zero. For a given type of consumer, males and females share the same elasticity value.


1) In my opinion Yes, the Indian companies are running a major risk by not paying attention to cost cutting. To illustrate Comparing major Indian companies in key industries with their global competitors shows that Indian companies are running a major risk. They suffer from a profound bias for growth. The problem is most look more like Essar than Reliance. While they love the sweet of growth, they are unwilling to face the sour of productivity improvement. Nowhere is this more amply borne out than in the consumer goods industry where the Indian giant Hindustan Lever has consolidated to grow at over 50 per cent while its labour productivity declined by around 6 per cent per annum in the same period. Its strongest competitor, Nirma, also grew at over 25 per cent per annum in revenues but maintained its labour productivity relatively stable. Unfortunately, however, its return on capital employed (ROCE) suffered by over 17 per cent.

In contrast, Coca Cola, worldwide, grew at around 7 per cent, improved its labour productivity by 20 per cent and its return on capital employed by 6.7 per cent. The story is very similar in the information technology sector where Infosys, NIIT and HCL achieve rates of growth of over 50 per cent which compares favorably with the world’s best companies that grew at around 30 per cent between 1994-95. NIIT, for example, strongly believes that growth is an impetus in itself. Its focus on growth has helped it double revenues every two years. Sustaining profitability in the face of such expansion is an extremely challenging task What makes this even worse is the Indian companies barely manage to cover their cost of capital, while their competitors worldwide such as Glaxo and Pfizer earn an average ROCE of 65 per cent. In the Indian textile industry, Arvind Mills was once the shining star. Like Reliance, it had learnt to cook sweet and sour.

Between 1994 and 1996, it grew at an average of 30 per cent per annum to become the world’s largest denim producer. At the same time, it also operated a tight ship, improving labour productivity by 20 per cent. Despite the excellent performance in the past, there are warning signals for Arvind’s future. The excess over the WACC is only 1.5 per cent, implying it barely manages to satisfy its investor’s expectations of return and does not really have a surplus to re-invest in the business.

Apparently, investors also think so, for Arvind’s stock price has been falling since Q4 1994 despite such excellent results and, at the end of the first quarter of 1998, is less than Rs 70 compared to Rs 170 at the end of 1994. Unfortunately, Arvind’s deteriorating financial returns over the last few years is also typical of the Indian textile industry. The top three Indian companies actually showed a decline in their return ratios in contrast to the international majors.

2 ) Fast moving consumer goods will become a Rs 400,000-crore industry by 2020. A Booz & Company study finds out the trends that will shape its future

Consider this. The anti-ageing skincare category grew five times between 2007 and 2008. It’s today the fastest-growing segment in the skincare market. Olay, Procter & Gamble’s premium anti-ageing skincare brand, captured 20 per cent of the market within a year of its launch in 2007 and today dominates it with 37 per cent share. Who could have thought of ready acceptance for anti-ageing creams and lotions some ten years ago? For that matter, who could have thought Indian consumers would take oral hygiene so seriously?

Mouth-rinsing seems to be picking up as a habit — mouthwash penetration is growing at 35 per cent a year. More so, who could have thought rural consumers would fall for shampoos? Rural penetration of shampoos increased to 46 per cent last year, way up from 16 per cent in 2001. Consumption patterns have evolved rapidly in the last five to ten years. The consumer is trading up to experience the new or what he hasn’t. He’s looking for products with better functionality, quality, value, and so on. What he ‘needs’ is fast getting replaced with what he ‘wants’

Categories are evolving at a brisk pace in the market for the middle and lower-income segments. With their rising economic status, these consumers are shifting from need- to want-based products. For instance, consumers have moved from toothpowders to toothpastes and are now also demanding mouthwash within the same category. The trend towards mass-customization of products will intensify with FMCG players profiling the buyer by age, region, personal attributes, ethnic background and professional choices. Micro-segmentation will amplify the need for highly customized market research so as to capture the specific needs of the consumer segment targeted, before the actual product design phase gets underway.

3) Industies impressive growth in value added as observed in the previous sub section is not accompanied by a commensurate rise in the level of relative productivity in terms of the cross–country analysis. The fragmented nature of Indian pharmaceutical sector characterized by the operation of a very large number of players, estimated to be about 10,000 units of which just 300 units are medium and large sized7, may be a reason for low level of productivity. The other important factor for low productivity can be due to the nature of technological activities in the sector, which tends to rely more on process than product development. Further, it may be that Indian companies are focusing at the low end of value‐chains in the pharmaceuticals like producing generics than opting for branded products or supply bulk drugs to global players than market formulations of their own.

4) The Indian textile industry has been one of the foremost contributors to the country’s employment, exports, and GDP. The industry has been rated as one of the key drivers of the Indian economy and a bold target of exports of $50 billion (currently it’s $22 billion) had been targeted by the year 2012 by the government after the dismantling of the quota regime in 2005. However we are still far away from that target.

Though now it can be blamed on the worldwide recession, I think we need to do some soul searching as to was it anyways possible. Globally, the Indian industry is recognized for its competitive advantages, especially in the cotton segment. The government has set huge targets for the industry and expects to attract investments of about Rs 1.5 lakh crore during the eleventh Plan period. This would meet the export and domestic targets, while taking various initiatives like setting up textile parks, training centers, and ‘made in India label promotion’ to global markets.

The Indian textile industry is facing tough competition in the US, as exporters from smaller countries like Bangladesh are cornering the lucrative market at a faster pace, a FICCI study said. “In addition to China, countries like Indonesia, Vietnam and Bangladesh have managed to perform better than India in the US market in 2009,” the study said. Bangladesh, Indonesia and Vietnam managed to increase their share in the US textiles and apparel import in 2009 year on year at a faster rate than India.

The Indian textile industry will no doubt survive and move along by the strengths of its traditional position and domestic market. However, the growth envisaged and it being re-classified as sunshine industry over the last three years from a sunset industry may turn out to be a myth

Section C:

1) A vision of the impact of free trade can also be gleaned from Nobel Prize winning economist Paul Samuelson (1970) who confidently asserted that: Free trade promotes a mutually profitable division of labour, greatly enhances the potential real national product of all nations, and makes possible higher standards of living all over the globe.

It promotes a regional division of labor — this means that some regions of the world (or countries) will specialize in certain things. They will specialize in areas where they have a comparative advantage.

It enhances national production — this means that countries will be able to produce more things if there is trade. That is because they focus on producing things they are good at and do not waste resources on things that they are not good at.

It allows higher standards of living because there is more production. If there is more production, there are more things available to be consumed.

Another belief in the importance of free trade can be ascribed to its perceived indirect effect on peace, security and the prevention of war. One of the first articulations of this is by Baron de Montesquieu, who writing in 1748, stated: Peace is the natural effect of trade. Two nations who traffic with each other become reciprocally dependent; for if one has an interest in buying, the other has an interest in selling, and thus their union is founded on their mutual necessities. This theory of mutual interdependence has been explored in some detail by authors such as Keohane and Nye67 and is echoed in attempts to build and protect the mandates of global institutions seeking such co-operation. However few attempts are made to track the results of policy activities on whole population of States, and as a result the overtly negative impact on some groups, usually minorities and indigenous

2) The Decision Trees, used to help with decision making in business ( and many other areas), are a form of diagrammatic analysis. They are used as a tool for helping managers to choose between several courses of action. They provide an effective and clear structure for presenting options and within decision trees the probabilities and financial outcomes of these options can be measured. They also help to form a balanced picture of the risks and potential financial rewards associated with each possible course of action.

In many business decision making situations chance (or probability) plays an important role, and the use of decision trees helps build probability into the decision making process. Pictorial representation of a decision situation, normally found in discussions of decision-making under uncertainty or risk. It shows decision alternatives, states of nature, probabilities attached to the state of nature, and conditional benefits and losses. The tree approach is most useful in a sequential decision situation. For example, assume XYZ Corporation wishes to introduce one of two products to the market this year. The probabilities and present values (PV) of projected cash inflows follow:

A decision tree analyzing the two products follows:

Based on the expected net present value, the company should choose product A over product B.


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Managerial Economics Essay

Managerial Economics Essay
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  • University/College:
    University of Chicago

  • Type of paper: Thesis/Dissertation Chapter

  • Words: 1284

  • Pages: 5

Managerial Economics

Economics can be divided into two broad categories: microeconomics and macroeconomics. Macroeconomics is the study of the economic system as a whole. It includes techniques for analysing changes in total output, total employment, the consumer price index, the unemployment rate, and exports and imports. Macroeconomics addresses questions about the effect of changes in investment, government spending, and tax policy on exports, output, employment and prices. Only aggregate levels of these variables are considered.

But concealed in the aggregate data are countless changes in the output levels of individual firms, the consumption decisions of individual consumers, and prices of particular goods and services. Although macroeconomic issues and policies command much attention in the media, the microeconomics of the economy also are important and often are of more direct application to the day-to-day problems facing the manager. Microeconomics focuses on the behaviour of individual actors on the economic stage: firms and individuals and their interaction in the markets.

Managerial Economics should be thought of as applied microeconomics. That is, managerial economics is an application of that part of microeconomics focusing on those topics of greatest interest and importance to managers. These topics include demand, production, cost, pricing, market structure, and government regulation. A strong grasp of the principles that govern the economic behaviour of firms and individuals is an important managerial talent. In general, managerial economics can be used by the goal oriented managers in two ways.

First, given an existing economic environment, the principle of managerial economics provide a framework for evaluating whether resources are being allocated efficiently within a firm. For example, economics can help the manager determine if reallocating labour from a marketing activity to the production line could increase profit. Second, these principles help managers respond to various economic signals. These signals, for example, are innovation of low cost technology, changes in the prices of different inputs etc.

The tools developed in managerial economics increase the effectiveness of decision making by expanding and sharpening the analytical framework used by managers to take decision. Thus, a working knowledge of the principles of managerial economics can increase the value of both the firm and the manager. Individuals and firms are the fundamental participants in a market economy. Individuals own or control resources that have value to firms because they are necessary inputs in the production process. These resources are broadly classified as labour, capita, and natural resources.

Of course, there are many types and grades of each resource. Labour specialities vary from street sweepers to brain surgeons; capital goods range from broom to electronic computers. Most people have labour resources to sell, any many own capital and / or natural resources that are rented, loaned, or sold to firms to be used as inputs in the production process. The money received by an individual from the sale of these resources is called a factor payment. This income to individuals then is used to satisfy their consumption demands for goods and services.

The interaction between individuals and firms occurs in two distinct arenas. First, there is a product market where goods and services are bought and sold. Second, there is a market for factors of production where labour, capital, and natural resources are traded. Subject Matter of Managerial Economics: Managerial Economics- also called Business Economics- is the application of economic theory and methodology to business. Business involves decision-making. Different aspects of business need the attention of the chief executive; he may be called upon to choose an option among the many open to him.

For this purpose the executive has to decide upon various aspects. Business decision can be classified into different categories as follows: Financial decisions: These relate to costing, budgeting, accounting, auditing, tax planning, portfolio composition, capital structure, dividend distribution, etc. Production decisions: These relate to quantity of raw materials as well as output, inventory control, choice of technology, technicians, plant location and layout, production scheduling, maintenance, pollution control, etc.

Personnel decisions: These relate to recruitment, selection, training, development, placement, promotion, transfer, retirement or retrenchment of staff, etc. Marketing decisions: These relate to sales volume, sales promotion, market research, packaging, after sales service, new product positioning, etc. Miscellaneous decisions: These relate to information systems, data processing, public relations, etc. It would be in the interest of the business firm to reach the optimal decision- the one that will promote that goal of the business firm.

A scientific formulation of the business problem and finding its optimal solution requires that the business firm may be equipped with a rational methodology and appropriate tools. Managerial economics meets these needs of the business firm. Managerial economics serves as a bridge between economic theory and business decision -making. Definitions of Managerial Economics Different economists have defined managerial economics differently. Some important views have been as follows: McNair and Merian define managerial economics as ” the use of economic models of thought to analyse business situation. According to Spencer and Siegelmaqn, ” managerial economics is the integration of economic theory with business practice for the purpose of facilitating decision-making and forward planning by management. “

In the words of D. S. Watson, managerial economics is ” price theory in the service of business executives. ” Brigham and Pappas view that managerial economics is ” the application of economic theory and methodology to business administration practice. ” Hague belives that managerial economics is ” a fundamental academic subject which seeks to understand and to analyse the problems of business decision- making. E. Mansfield says, “Managerial economics is concerned with application of economic concepts and economic analysis to the problems of formulating material managerial decisions. ” According to Hailstones and Rothwell, ” Managerial economics is the application of economic theory and analysis to practices of business firms and other institutions, such as health care facilities and government agencies. ” McGuigan and Moyer put it as “Managerial economics deals with the application of economic theory and methodology to decision-making problems faced by public, private and non-profit institutions.

Managerial economics extracts from economic theory those concepts and techniques that enable the decision maker to allocate efficiently the resources of the organisation. ” In the words of Mark Hirschey and James Pappas, “Managerial economics applies economic theory and methods to business and administrative decision -making. Because it uses the tools and techniques of economic analysis to solve managerial problems, managerial economics links, traditional economics with the decision-sciences to develop vital tools for managerial decision-making. Evans J. Douglas says. ” Managerial economics is concerned with the application of economic principles and methodologies to the decision-making process within the firm or organisation under conditions of uncertainty. ” These different definitions bring out clearly the following features of the subject: Managerial economics is concerned with decision-making, i. e. , it deals with identification of economic choices and allocation of scare resources. It is goal-oriented and prescriptive.

It deals with how decisions should be made by business firms to achieve the organisational goals. It is prescriptive. It is concerned with those analytical tools which are useful in improving decision-making. Managerial economics is both conceptual and metrical. Managerial economics provides a link between traditional economics and the decision sciences for managerial decision-making. In short, managerial economics is the integration of economic theory and business practice for the purpose of facilitating decision-making and forward planning by management.


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Managerial Economics Essay

Managerial Economics Essay
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  • University/College:
    University of Arkansas System

  • Type of paper: Thesis/Dissertation Chapter

  • Words: 296

  • Pages: 1

Managerial Economics

There are quite a few differences between Economics and Managerial Economics. Managerial Economics is micro in character while Economics is both micro and macro in character. Economics is both positive and normative science but the Managerial Economics is essentially normative in nature. Under Economics we study only the economic aspect of the problems but under Managerial Economics we have to study both the economic and non-economic aspects of the problems. Those are just a few distinct differences amongst many others. Economics is defined as the study of goods and services; the study of the production, distribution, and consumption of goods and services while Managerial Economics is a study of application of managerial skills in economics.

The field of economics is broken down into two distinct areas of study: microeconomics and macroeconomics. Microeconomics looks at the smaller picture and focuses more on basic theories of supply and demand and how individual businesses decide how much of something to produce and how much to charge for it. Macroeconomics, on the other hand, looks at the big picture (hence “macro”). It focuses on the national economy as a whole and provides a basic knowledge of how things work in the business world.

Microeconomics/ Macroeconomics and Managerial Economics have plenty in common. They all overlap in some form or fashion. Managerial economics is applied theory. Much of managerial economics applies the theories set forth in microeconomic theory. The relationship between the Microeconomics and the Macroeconomics are based on the result of choices made by each household and firms and some models of macroeconomics especially while originating the collective of production and consumption levels among both the branches of economics.


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