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Reg.No.

-IIMM/HP/2/2004/2617 Name-Shacheendra Sharma Subject-Managerial Economics

Name : Shacheendra Sharma

Registration No. : IIMM / HP / 2 / 2004 / 2617

Subject : Managerial Economics

Ans-1(a)
Economic Model:

An economic model is a simplified representation of real situation. Economic


theory aims at construction of models which describe the economic behaviour of
individual units and their interaction which create the economic system of region,
a country or the world as a whole. The main characteristics of an economic model
are:

1. it includes main features of the real situation.

2. it implies abstraction from reality and it is achieved by a set of meaningful


assumptions.

3. the assumptions aim at simplification of the phenomenon that the model is


designed to study.

4. the model does not describe the true economic world.

5. an economic world describes the economic behaviour of the individual units


e.g. consumer firms, government agencies, etc.

Purpose of Economic Models:

(a) Analysis: It implies explanation of the behaviour of the economic units,


consumers or producers. From a set of assumptions, we derive certain laws,
which describe and explain with an adequate degree of generality, the
behaviour of consumers and producers.

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(b) Prediction: It implies the possibility of forecasting the effects of change in


some magnitudes in the economy. For example, a model of supply might be
used to predict the effects of imposition of a tax on the sales of firms.

Judging Validity of an Economic Model:

The validity of a model may be judged on several criteria. These are:

(a) Its predictive power: means how closely it can predict the behaviour of the real
world situation without actually going into it (or experiencing it).

(b) The consistency and realism of its assumptions: if the model is very close to
the real situation it depicts, it is more accurate and consistent in its results.

(c) The extent of information it provides: A better model will provide more
information and that too, in details.

(d) Its generality, i.e., the range of cases to which it applies: A good model is more
general, i.e., it applies to more number of cases (or situations).

(e) Its simplicity: The basic purpose of the model is to achieve its objectives in
simplest possible way. A simple model is easy to understand and analyze.

Ans-1(b)
Macro Economics:

Definition: In Greek, the word ‘Makros’ means ‘large’. The word was coined in
1933 by Ragnar Frisch. The English word ‘Macro’ has been derived from the
Greek word ‘Makros’.

Macro-economics implies study of economic aggregates or the wholes. It deals


with the problems like unemployment, economic un-stability and economic growth.
The proper analysis of such problems requires an aggregate thinking and these
are concerned with the entire economic system. Their analysis and solution in the
right perspective can be possible only if a macro approach and aggregate
instruments of analysis and policy are employed.

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Reg.No.-IIMM/HP/2/2004/2617 Name-Shacheendra Sharma Subject-Managerial Economics

Prof. Gardner Ackely states that “Macro-economics concerns itself with such
variables as the aggregate volume of output of an economy, with the extent to
which its resources are employed, with the size of national income, with general
price level”.

Hanson describes Macro-economics as “that branch of economics which


considers relationship between large aggregates such as the volume of
employment, total amount of saving and investment, the national income, etc.”.

This indicates that the scope of our analysis is not restricted to the investigation of
the total magnitudes of the economic variables, but their inter-relations too.

Keyne’s general theory has a tremendously decisive impact on the post


Keynesian aggregate thinking. The main factors which contributed to the growth of
aggregative in 1930s and which sustained the impetus for the development of
such an approach were as follows:

(i) Technological breakthroughs reflected in mass productions;

(ii) Continuous process of industrialization and urbanization in general;

(iii) Increasing complexity and multiplicity of phenomenon influencing the


present day economic life. Its investigation requires more detailed
information.

(iv) Extension of Public Sector in every economy and the resulting growing
importance of the role of government finance for growth, welfare and
stability.

(v) Growing consciousness among the developing nations of the world to


improve the living standard of their people further stimulated aggregative
thinking.

Micro Economics:

Definition: In Greek, the word ‘Micro’ means ‘small’. In Micro-economic approach,


attention is concentrated on a very small part or the individual units.

Hanson terms it as ‘atomistic, individualistic approach’.

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Reg.No.-IIMM/HP/2/2004/2617 Name-Shacheendra Sharma Subject-Managerial Economics

Boulding has described micro-economics as the ‘Study of the particular firms,


households, individual prices, wages, incomes, individual industries and specific
commodities’.

William Fellner has termed micro-economics as a study of ‘individual decision


making units’. It implies that an individual buyer or seller’s behaviour in the market
in the face conditions of demand or supply of a particular commodity is the object
of study in micro-economics.

According to Brooman, ‘Micro-economics seeks to explain the working of markets


for individual commodities and the behaviour of the individual buyer and seller’.
The typical market in this analysis is for a single commodity. At a given price of
the commodity, the buyer demands a certain amount of it. The seller may or may
not be willing to sell that quantity. In case the consumer is willing to pay a
premium, other sellers will also enter the market and place a large amount of
output which will bring down the price of that commodity. Thus a process of price
and supply adjustment will be initiated between the individual buyer and sellers.

Thus micro-economics is the study of the behaviour of individual consumer’s firms


or workers. It studies, e.g. the motive of a businessman in diverting his capital
from the cotton textile industry to the weaving industry.

Scope of Micro-economics:

Micro-economic analysis explains the allocation of resources assuming that the


total resources are given. The following chart gives the view of the scope of micro-
economics:

Micro-economic analysis

Theory of Theory of Factor Welfare


Commodity Pricing Pricing Economics

Theory of Theory of Rent Wages Interest Profit


Demand Supply

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Ans-2(a)
Demand of a product implies:

(a) desire to acquire it

(b) willingness to pay for it

(c) ability to pay for it

All three criteria must be checked to identify and establish demand.

The demand function: the demand function is a comprehensive formulation which


specifies their influence on the demand of the product. If Dx is demand then:

Dx=f(Px, Py, Pz, B, W, A, E, T, U)

Here Dx = demand for item x

Px = Price of item x

Py = Price of substitute y of x

Pz = Price of complements

B = income of purchaser

W = the wealth of the purchaser

A = advertisement for the product

E = the price expectation of the user

T = taste or preferences of the user

V = miscellaneous factors

The Law of Demand:

The general tendency of the consumer’s behaviour in demanding a commodity in


relation to changes in its price is described by the law of demand. The law of
demand expresses the nature of functional relationship between two variables of
the demand, the price and quantity.

The law of demand is usually referred to the market demand.

It simply states that demand varies inversely with change in price.

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Reg.No.-IIMM/HP/2/2004/2617 Name-Shacheendra Sharma Subject-Managerial Economics

Statement of the law: “Other things being equal, the higher the price of a
commodity, the smaller is the quantity demanded and lower the price, higher is
the quantity demanded”.

The conventional law of demand, however, is much simplified function:

Dx = f(Px), that is, the demand for x is a function of its price Px only.

In the slope-intercept form, the demand curve may be represented as:

Dx = a + b * P x

Where a = the intercept on Price axis (y axis on plot).

b = slope, which is negative due to inverse relationship between Dx and Px

Demand Schedule:

It is a tabular statement narrating the quantities of a commodity demanded in


aggregate by all the buyers in the market at different prices in a given period of
time. Following table is a typical example of relationship between the demand and
price of a commodity x:

Price Px per unit (Rs) Quantity Dx of x demanded per week


2 12
3 10
4 8
5 6
6 4

It may be observed from the demand schedule that the price of x and its demand
move in opposite directions.

It the data of demand schedule is plotted graphically, it will look like that given in
the following figure. The slope of this curve is negative because of the inverse
relationship between Dx and Px.

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Reg.No.-IIMM/HP/2/2004/2617 Name-Shacheendra Sharma Subject-Managerial Economics

Demand Curve
Demand Dx Linear (Demand Dx)
14
12
10
Demand Dx

8
6
4
2
0
0 2 4 6 8 10 12 14
Price Px

Ans-2(b)
Demand Analysis:
In simple terms, demand analysis seeks to identify and measure the forces that
determine sales. It reflects market conditions for the firm’s product. Once demand
analysis id done, alternative measures of creating, controlling and managing it can
be derived.

Under demand analysis, we study the following:

(1) Definition of demand

(2) The demand function

(3) The concept of demand

(4) The law of demand

(5) Increase/ decrease and Contraction/ Extension of demand

(6) Demand with reference to Market Structure

(7) Determinants of demand

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(8) Significance of demand analysis

1. Definition of demand: Demand is the desire for a product backed by


willingness and ability to pay for it. It is always defined with reference to a
particular time, place, price and values of other variables which affect it.

A commodity is a ‘bundle of utilities’ which has some value or usefulness for


the consumer.

2. The Demand Function: It is a comprehensive formulation which specifies


the influence of various variables on demand.

Dx=f(Px, Py, Pz, B, W, A, E, T, U)


Here Dx = demand for item x
Px = Price of item x
Py = Price of substitute y of x
Pz = Price of complements
B = income of purchaser
W = the wealth of the purchaser
A = advertisement for the product
E = the price expectation of the user
T = taste or preferences of the user
V = miscellaneous factors
3. The concept of Demand: Dx = f(Px), i.e. the demand for x is a function of
the price Px of x only. In the slope-intercept form:
Dx = a + b * Px, where a is the length of intercept on y axis and b is the
slope, which is negative due to inverse relationship between Dx and Px.
4. Law of Demand: As price rises, the demand contracts. As price falls,
demand expands. The statement holds under ceteris paribus assumption,
i.e., other things remaining constant.

5. Increase/ decrease and Contraction/ Extension of demand: There is a


conceptual difference between increase and extension of demand and
between decrease and contraction of demand. The law of demand refers to
extension and contraction of demand and we move along the Price-
Demand curve. In case of increase or decrease of demand, we talk of

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change in demand for the same price. Thus, in this case, if the demand
increases, we get a price-demand curve shifted towards right to the original
curve. In case of decrease, the curve shifts to the left of original curve.

6. Demand with reference to Market Structure: The important market


structures are distinguished on the basis of product differentiation and
number of sellers.

In a monopoly, the company’s demand is the same as the industry’s


demand because a single firm constitute the industry.

Under perfect competition, the firm’s demand is completely divorced from


the industry’s demand. A company can sell as much as it wishes to, at the
ruling price, which is determined by the interplay of the forces of industry’s
demand and supply.

In monopolistic competition, there are many sellers with differentiated


products. In this case, the industry’s demand is relatively stable compared
to that of a firm.

Under homogenous oligopoly, sellers are few and products are identical,
business is transferable among rivals and the company’s own demand is
influenced by rival’s actions.

In differentiated oligopoly, the demand of an individual firm’s product is to


industry’s demand but this relationship is less close compared to the
homogeneous oligopoly, because the same customers have definite
preferences for some particular brands.

7. Determinants of Demand: Demand is a multivariate function. The most


important determinant being price of commodity in question, price of other
similar commodities, consumer’s income and tastes. Apart from these,
demand is affected by distribution of income, total population 7 its
composition, wealth, credit, validity, stocks 7 habits. The last two factors
allow for the influence of past behaviour on the present, thus rendering
dam analysis dynamic.
8. Significance of Demand Analysis: Demand is one of the critical
requirements for the functioning of any business, its survival and growth.

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Reg.No.-IIMM/HP/2/2004/2617 Name-Shacheendra Sharma Subject-Managerial Economics

Information on the size and type of demand helps management in planning


its requirements for manpower, materials, machines and funds.

Significance of Demand Analysis in Managerial Economics:

In successfully running modern businesses, a manager has to take so many


crucial decisions related to planning of resources like requirement of manpower,
procurement and stock of material, installation of new machinery and investment.
The whole range of planning by the firm e.g. Production planning, inventory cost,
budgeting, purchase planning, market research, pricing, advertising budget, profit
planning and product launch timing and its positioning, all these call for an
accurate analysis of demand. Demand analysis is one of the areas of economics
which has been used most extensively by the managers to arrive at meaningful
decisions. The decisions which the higher management managers take with
reference to any functional area, always hinge on analysis of demand.
Demand analysis seeks to identify and measure the forces that determine sales. It
reflects market conditions for firm’s product. Once demand analysis is done,
alternative ways of creating, managing and controlling the demand can be inferred.

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Reg.No.-IIMM/HP/2/2004/2617 Name-Shacheendra Sharma Subject-Managerial Economics

Ans-3(a)
Price Elasticity of Demand:
Market demand curves vary with regard to the sensitivity of quantity demanded to
price. For some goods, a small change in price results in a big change in quantity
demanded; for other goods, a big change in price may result in a very small
change in quantity demanded.

To indicate how sensitive quantity demanded is to change in price, economists


use a measure called price elasticity of demand. The price elasticity of demand is
defined to be the percentage change in quantity demanded resulting from a one
percent change in price. More precisely, it equals

wQ P
K - u
wP Q
Suppose that a 1 percent reduction in the price of cotton shirt results in a 1.5
percent increase in the quantity demanded in our country. If so, the price elasticity
of demand for cotton shirts is 1.5. Convention dictates that we give the elasticity a
positive sign despite the fact that the change in price is negative and the change
in quantity demanded is positive.

The price elasticity of demand generally will vary from one point to another on a
demand curve. For instance, the price elasticity of demand may be higher when
price of cotton shirts is high than when it is low. Similarly, the price elasticity of
demand will vary from market to market. For example, India may have a different
price elasticity of demand for cotton shirts from United States.

The price elasticity of demand for a commodity must lie between zero and infinity.
If the price elasticity is zero, the demand curve is a vertical line; that is, the
quantity demanded is unaffected by price. If the price elasticity is infinite, the
demand curve is a horizontal line; that is, an unlimited amount can be sold at a
particular price. But nothing can be sold if the price is raised even slightly.

The following figure shows these two limiting cases:

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Demand curve with Zero and Infinite Price Elasticity of Demand

Demand curve, price


elasticity = 0

elasticity = f
15 Demand curve, price
Price (Rs) Æ

0
Quantity Æ

Point Elasticity of Demand:


If we have a market demand schedule showing the quantity of a commodity
demanded in the market at various prices, we can estimate the elasticity of
demand by the following method:

Let+P be a change in the price of a commodity and +Q be the resulting


change in its quantity demanded. If + P is very small (as depicted in the following
table), we can compute the point elasticity of demand:

'Q 'P
Kp  y
Q P
Quantity demanded at various Prices (small increment in price)
Price (in Rs. Per unit of commodity ) Quantity demanded (units)

99.95 20002
100.00 20000
100.05 19998
If we want to estimate the price elasticity of demand when the price is between
99.95 and 100.00, we obtain the following result:

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20002  20000 99.95  100


K  y 0.2
20000 100
Note that we used 100.00 as P and 20000 as Q. We could have used 99.95 as P
and 20002 as Q, but it would have made no real difference to the result.

For large changes in prices, this method is not accurate as the results vary a lot.
In that case we use Arc Elasticity of Demand method, which uses average values
of P and Q.

Point Elasticity of Linear Demand at a Point:

Graphically, the point elasticity of demand of a linear demand curve is shown by


the ratio of the segments of the curves to the right and to the left of the particular
point. In the following figure, the elasticity of the linear demand curve at point F is
FD ’
the ratio .
FD
Proof:
P

F
P1

G E
P2

Q
O Q1 D’
Q2

From figure, we see that:

'P P1 P2 FG
'Q Q1 Q2 GE
P OP1
Q OQ1

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If we consider very small changes in P and Q then 'P | dP and 'Q | dQ .

Thus substituting in the formula for the point elasticity, we obtain:

'Q 'P dQ P Q1Q2 OP1 GE OP1


Kp  y  u  u  u
Q P dP Q PP
1 2
OQ1
GF OQ1
From the figure, we can also see that the triangles FEG and FQ1D’ are similar
(corresponding angles being equal). Thus

GE Q1D ’ Q1D ’
GF Q1F OP1
Q1D ’ OP1 Q1D ’ QD’ FD ’
ep  u   1 
OP1 OQ1 OQ1 PF
1
FD

Given this graphical measurement of point elasticity, it is obvious that at the mid
point of a linear demand curve, ep=1, at point D, it is infinity and at D’, it is equal to
zero.

Ans-3(b)
Derivation of the Equation MR = d(TR) / dQ = q0 – 2 * q1 * Q

(Total Revenue, Marginal Revenue, and Price Elasticity)

To its producers, the total amount of money spent on a product equals their total
revenue. Thus, to the Ford Motor Company, the total amount spent on its cars
(and other products) is its total revenue. Let us assume that the demand curve of
a firm is linear; that is,

P = q0 – q1 * Q

Where q0 is the intercept on the price axis, and q1 is the slope (in absolute terms),
as shown in the figure on next page. Thus the firm’s total revenue equals
TR =P*Q

= (q0 – q1 * Q) * Q

= q0 * Q – q1 * Q2

An important concept is marginal revenue, which is defined as dTR/dQ.

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MR = d TR / dQ

= d(q0 * Q – q1 * Q2) / dQ

MR = q0 – 2 * q1 * Q

which is also shown in the figure. Comparing the marginal revenue curve with the
demand curve, we see that both have the same intercept on the vertical axis (this
intercept being q0), but the marginal revenue curve has a slope that, in absolute
terms, is twice that of the demand curve.

Relationship between Price Elasticity, Marginal Revenue and Total Revenue

Price (P)

q0
MR = q0 – 2 * q1 * Q

P = q0 – q1 * Q

0 q0 / 2q1 Quantity
q0 / q1
demanded (Q)

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Reg.No.-IIMM/HP/2/2004/2617 Name-Shacheendra Sharma Subject-Managerial Economics

Ans-4(a)
Techniques of Demand Forecasting

There are basically two broad categories of techniques:

A. Simple Survey Methods

B. Complex Statistical Methods

A. Simple Survey Methods

1. Expert’s Opinion Poll: In this method, the experts are requested to give
their opinion or feel on the particular product whose demand is under study.
Experts use their experience to predict the future sales. If the number of
experts is large and their experience based reactions are different, then an
average-sample or weighted value is found to forecast the sales.

Limitations:The results of this methods can be subjective in nature.

2. Reasoned Opinion: Here, an attempt is made to arrive at consensus in an


uncertain area by questioning a group of experts repeatedly until their
responses appear to converge at a point.

Limitations: It is a poor proxy of market behaviour of economic variables.

3. Consumer’s Survey- Complete Enumeration Method: Under this method,


the forecaster undertakes a complete survey of all consumers. Once the
information is collected, the sales forecasts are obtained by simply adding
the probable demands of all consumers.

If there are N consumers, each demanding Di, then the total demand forecast

¦D .
N
is i
i 1

Merits: The forecaster does not introduce any bias or value judgement of his
own.

Limitations: It is a very tedious method and not feasible in case of large


number of consumers.

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4. Consumer Survey- Simple Survey Method: The forecaster selects a few


consuming units out of relevant population and then collects data on their
probable demand. The total demand of sample units is blown up to
generate total demand forecast.

Merits: This method is less tedious and less costly, and subject to les data
error.

Limitations: The choice of sample is critical otherwise it will generate sampling


errors.

5. Consumer’s Clinics: In this method, a number of potential buyers are


invited and given money to purchase various products. The price tags are
altered and response of the participants is observed. This method assumes
the applicability of revealed preference approach- choice reveals
preference.

Merits: This method simulates the market conditions, hence more accurate
than previous survey methods.

Limitations:

(i) The potential buyers may not take the things seriously.

(ii) It is expensive so large numbers of buyers can not be involved.

(iii) The design of clinic is critical.

6. End-use method of Consumer’s Survey: Under this method, the sales of a


product are projected though a survey of its end-users. A product is used
for final consumption, or as an intermediate product. It can be exported or
imported.

Limitations: It is an indirect method and many intermediate steps can creep in


errors.

B. Complex Statistical Methods:

1. Time Series Analysis or Trend Method: Under this method, the time series
data on the variable under forecast are used to fit a trend line or curve
either graphically or through statistical method of least squares. The trend

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line is worked out by fitting a trend equation to time series data with aid of
an estimation method. The trend equation could take either a linear or any
kind of non-linear form. Some typical trend equations of demand
forecasting are :

Linear Trend: D = a + b * T

Exponential Trend: D = a * ebt or logeD = logea + b * t

Second Degree Polynomials: D = a + b * T + c * T2

Double Log (Cobb-Douglas Type) Trend: D = a * Tb or logeD = logea + b logeT

Merits: This method does not require the formal knowledge of economic theory
and market; it only needs time series data.

Limitations:

(i) This method assumes that past is repeated in future.

(ii) This method is inappropriate for short-run forecasts.

(iii) Sometimes, the time-series analysis may not reveal any kind of trend. In
that case, the moving average method or exponentially weighted moving
average method is used to smoothen the series.

2. Barometric Techniques or Lead-Lag Indicator Method: This method


consists of a set of series of some variables which exhibit a close
association in their movement over a period of time.

There are three kinds of time series:

(i) The leading series are data on the variables, which move up ahead of
some other series;

(ii) The coincident series make up or down behind some other series;

(iii) The lagging series move up or down behind some other series.

The barometric method has been used in some developed countries for
predicting business cycle situations.

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Limitations:

(i) The leading indicator does not tell us anything about the magnitude of the
changes that can be expected in the lagging series, but only the direction of
change;

(ii) The lead period itself may change over time;

(iii) It may not be always possible to find out the leading, lagging or coincident
indicators of the variables for which a demand forecast is being attempted.

3. Correlation Regression: In the case of simple correlation, the regression


equation has one dependent and one independent variable. The analysis
involves:

a. determining the nature of association through a repression equation to


describe the average relationship between the two variables.

b. Determining the extent of association between the variables through the


estimation of correlation coefficient.

Merits:

(i) It is perspective as well as descriptive. Besides generating demand


forecast, it explains what the demand is and why it is.

(ii) Through this method, on can get both time-series data and cross-section
data.

Limitations:

(i) If the explanatory variables are not chosen realistically, they may be
misleading.

(ii) If there is auto-correlation, the regression results may be biased and


incorrect.

(iii) The regression method forecasts on the basis of past average relationship
and so, to the extent the future relationship deviates from past average, the
forecast will be wrong.

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4. Simultaneous Equation Method: This method is used in a macro-level


forecasting for the economy as a whole and is also known as ‘complete
system approach’ or ‘econometric model building’.

Merits: The forecaster needs to estimate the future values of only the
exogenous variables.

Limitations:

(i) This method assumes that the past statistical relationship will hold good in
the prediction period.

(ii) It is highly complicated and costly method.

Ans-4(b)
Elasticity of Production

The Elasticity of production eq is defined as the rate fractional change in total


'Q 'L
product , relative to a slight change in a variable factor, say labour, .
Q L
Thus

'Q 'L 'Q L


eq y u
Q L 'L Q
'Q Q MPL
y
'L L APL

Thus, labour elasticity of production is the ratio of marginal productivity of labour


to average productivity of labour.

Capital elasticity of production is the ratio of marginal productivity to average


productivity of capital.

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Ans-8(a)
Job Security Constraint

Marries suggests that job security is attained by adopting a prudent financial


policy. Managers attach a definite disutility to the risk of being dismissed. The risk
of dismissal is largely avoided by:

(a) Non-involvement with risky investments

(b) Choosing a prudent financial policy. The latter consists of determining


optimal levels for three critical financial ratios:

(i) the leverage or debt ratio

(ii) the liquidity ratio

(iii) retention ratio

The three financial ratios are combined (subjectively by managers) into a single
parameter which is called the ‘financial security constraint’. This is exogenously
determined by the risk attitude of the top management.

A high value implies that the managers are risk takers, while a low value shows
that managers are risk avoiders.

Ans-8(b)
Fisher’s Quantity Theory

Professor Irving Fisher’s simple quantity equation MV=PT is based on the


assumption that money alone has the unique characteristic of being generally
acceptable in return of all the goods and services. He also believed that money
could not be stored and whatever amount of money is received by the economic
unit, is spent entirely without ant time lag.

So in the Fisher Equation, the only reason for the demand of money , is that it can
facilitate the smooth conduct of transactions.

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Reg.No.-IIMM/HP/2/2004/2617 Name-Shacheendra Sharma Subject-Managerial Economics

V is the velocity of circulation of a unit of money for the conduct of transactions


per time period. V in a particular time period, is measured by the number of times
a unit of money appears in the market for buying goods and services. It is thus a
ratio of the aggregate value of transactions or the aggregate value of output to the
supply of money.

P *T
V
M
In Fisher analysis, V is assumed to be stable in the short period. Thus in a system
in which the output is at full employment level, given the short run stability of V,
the price level P will change in proportion to the supply of money, M.

Fisher laid excessive emphasis upon the fact that money acts only as the medium
of exchange and he could not clearly reconcile with the store of value function of
money.

Ans-8(c)
Social Cost Benefit Analysis

Social cost benefit analysis is:

(a) the evaluation of investment proposals in terms of their estimated net impact
on the economy.

(b) It is tool for making investment decisions best suited to the development
strategy and objectives so that scarce resources contribute most towards the
national objective.

The estimated impact is evaluated by using parameters reflecting national goods’


social objectives. It measures the economic, social and environmental costs and
benefits to the society expected to arise from the implementation of the project. It
is an attempt to evaluate the difference to the economy as a result of a specific
investment.

Steps in social cost benefit analysis:

PGDM-DUAL (FINANCE) Page 22 of 24 Assignment # 4


Reg.No.-IIMM/HP/2/2004/2617 Name-Shacheendra Sharma Subject-Managerial Economics

The initial step is to prepare a detailed project report. Based on this report, the
following steps are taken:

1. Identifying costs and benefits

2. Comparing cost and benefits

Ans-8(d)
Isoquants

Isoquants are geometric representation of the production function. The same level
of output can be produced by various combinations of factor inputs. Assuming
continuous variation in the possible combination of labour and capital, we can
draw a curve by plotting all these alternative combinations for a given level of
output. This curve which is the locus of all possible combinations is called
Isoquant or Iso-product curve.

Properties of Isoquants:

CAPITAL ISOQUANT FOR Q=5 CAPITAL ISOQUANT MAP

A(20,1)

B(10,3)
Q=Q3
C(6,5)
Q=Q2
D(2,10)
Q=Q1

LABOUR LABOUR

(1) each isoquant corresponds to a specific level of output and shows different
ways, all technologically efficient, of producing that quantity of output.

(2) The isoquants are downward sloping and convex to the origin. The slope of
an isoquant is significant because it indicates the rate at which factors K and
L can be substituted for each other while a constant level of output is
maintained.

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Reg.No.-IIMM/HP/2/2004/2617 Name-Shacheendra Sharma Subject-Managerial Economics

(3) As we move away from origin, the output level corresponding to each
successive isoquant increases, as a higher level of output usually requires
greater amounts of the two inputs.

(4) Any two isoquants do not intersect each other as it is not possible to have two
output levels for a particular input combination.

Ans-8(e)
Ceteris Paribus

The Cost Function: both in short run and long run, total cost is a multivariable
function. That is, total cost is determined by many factors. Symbolically, we may
write the long-run function as:

C=f(X,T, Pf)

And the short-run cost function as:

C=f(X,T, Pf, K), where C=Total Cost, X= Output, T=Technology, K=Prices of


Factors (Fixed Factors).

Cost curve implies that cost is a function of Output, i.e., C=f(X).

The clause Ceteris Paribus implies that all other factors which determine cost are
constant. If these factors do change, their effect on cost is shown graphically by a
shift of the cost curve. This is the reason why determinants of cost other than
output are called ‘Shift Factors’.

Any point on the cost curve shows the minimum cost at which a certain level of
output may be produced. This is the optimality by the points of a cost curve.

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