SMU

ASSIGNMENT
SEMESTER – 1
MBO026

MANAGERIAL
ECONOMICS

SUBMITTED BY:
MUSHTAQ AHMAD PARA
MBA
ROLL NO.- 520950361
 ASSIGNMENTS

Subject code – MB0026

Set 1

SUBJECT NAME- MANAGERIAL ECONOMICS

Q1. The demand function of a good is as follows:

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

You are required to:

a) Using the concept of cross elasticity determine the relationship between good 1 and others
b) Determine the effect on Q1 due to a 10 % increase in the price of good 2 and good 3.
Ans. Cross elasticity can be defined as the proportionate change in the quantity demanded of
a particular commodity in response to a change in the price of another related commodity.

a) Cross elasticity between good 1 and product 2 = (dQ1/dP2)*(P2/Q1)

Cross elasticity between good 1 and product 3 = (dQ1/dP3)*(P3/Q1)

Taking the differentiation of the equation:

dQ1/dP2 = -4
dQ1/dP3 = 2

Putting the values in the elasticity equation:

Cross elasticity between good 1 and product 2 = (dQ1/dP2)*(P2/Q1)

= (-4) * (P2/Q1)
= (-4) * (15/30)
= -2

Cross elasticity between good 1 and product 3 = (dQ1/dP3)*(P3/Q)

= (2) * (P3/Q1)
= (2) * (4/30)
= 0.267

b) As per the cross elasticity equation:

E = % Change in demand of product A / % Change in price of product B

% Change in demand of product A = E * % Change in price of product B

Putting the values from

% Change in demand of product A due to 10 % increase of good 2 = -2 * 10

= -20%
% Change in demand of product A due to 10 % increase of good 3 = 0.267 * 10 = 2.67%

Q2. What are the factors that determine the Demand curve?
Explain.
Ans. A demand curve is a locus of points showing various alternative prices – quantity
combinations. The total quantity demanded at different prices in a market by the whole
body consumers at a particular period of time is called market demand schedule. The
graphical presentation of the demand schedule is called as a demand curve.

It represents the functional relationship between quantity demanded and prices of a given
commodity. The demand curve has a negative slope or it slope downwards to the right. The
negative slope of the demand curve clearly indicates the quantity demanded goes on
increasing as price falls and vice versa.

Law of demand: “Other things being equal, a fall in price leads to expansion in demand and
a rise in price leads to contraction in demand”.

The factors that determine the Demand curve are as follows:-

a) Price of the given commodity, prices of other substitutes and complements,

future expected trends in price etc.
b) General Price level existing in the country -inflation or deflation.
c) Level of income and living standards of the people.
d) Size, rate of growth and composition of population.
e) Tastes, preferences, customs, habits, fashion and styles.
f) Publicity, propaganda and advertisements.
g) Quality of the product.
h) Profit margin kept by the sellers.
i) Weather and climatic conditions.
j) Conditions of trade-boom or prosperity in the economy.
k) Terms and conditions of trade.
l) Governments’ taxation policy, liberal or restrictive measures.
m) Level of savings and pattern of consumer expenditure.
n) Total supply of money circulation and liquidity preference of the people.
o) Improvements in educational standards.

Q3. A firm supplied 3000 pens at the rate of Rs 10. Next month,
due to a rise of in the price to 22 rs per pen the supply of the
 firm increases to 5000 pens. Find the elasticity of supply of the
pens.
Ans. Price elasticity of demand is a ratio of two pure numbers, the numerator is the
percentage change in the quantity demanded and the denominator is the percentage
change in price of the commodity. It is measured by the following formula:

Ep = Percentage change in quantity demanded/ Percentage changed in price

Applying the provided data in the equation:

Percentage change in quantity demanded = (5000 – 3000)/3000

Percentage changed in price = (22 – 10) / 10

Ep = ((5000 – 3000)/3000) / ((22 – 10)/10) = 1.2

Q4. Briefly explain the profit-maximization model.

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

There are various factors that contribute to the maximization of profits of a firm.
Some of them are listed below:-

Pricing and business strategies of rival firms and its impact on the working of the given firm.
Aggressive sales promotion policies adopted by rival firms in the market.
Without inducing the workers to demand higher wages and salaries leading to rise in
operation costs.
Without resorting to monopolistic and exploitative practices inviting government controls
and takeovers.
Maintaining the quality of the product and services to the customers.
Taking various kinds of risks and uncertainties in the changing business environment.
Adopting a stable business policy.
Avoiding any sort of clash between short run and long run profits in the business policy and
maintaining proper balance between them.
Maintaining its reputation, name, fame and image in the market.
Profit maximization is necessary in both perfect and imperfect markets. In a perfect market,
a firm is a price-taker and under imperfect market it becomes a price-searcher.

Assumptions of the model:-

The profit maximization model is based on three important assumptions. They are as
follows:-

Profit maximization is the main goal of the firm.

Rational behavior on the part of the firm to achieve its goal of profit maximization.
The firm is managed by owner-entrepreneur.

Q5. What is Cyert and March’s behavior theory? What are the
demerits?
Ans. Cyert and March’s behavior makes an attempt to explain the behavior of inter group
conflicts and their multiple objectives in an organization. Basically, this theory explains the
usual and normal behavior of different groups of people who work in an organization having
mutually opposite goals.

Cyert and March explain how complicated decisions are taken in big industrial houses under
various kinds of risks and uncertainties in an imperfect market in the background of limited
data and information. The organizational structure, goals of different departments,
behavioral pattern and internal working of a big and multi-product firm differs from that of
small organizations. The various kinds of internal conflicts and problems faced by these
organizations. They also explain how there are certain common problems faced by similar
organizations in an industry and their effects on internal working of each individual
organization and their decision making process.

Cyert and March consider that a modern firm is a multi-product, multi-goal and multi-
decision making coalition business unit. Like a coalition government, it is managed by a
number of groups. The group consists of share holders, managers, workers, customers,
suppliers, distributors, financiers, legal experts and so on. Each group is independent by
itself and has its own set of objectives and they try to maximize their individual benefits.
Cyert and March points out the goals of a business organization would depend upon the
multiple objectives of each group and their collective demands. Demands of each group
would depend on their aspirations levels, expectations, actual performance of the
organization, bargaining power of each group, past success in their demands, etc.

As all of them change over a period of time, the demands of each group would all of them
change over a period of time, the demands of each group would also undergo changes. If
actual performance and achievements of the organization is much better than expected
aspirations and target level, in that case, there will upward revision in their demands and
vice-versa.

Thus, there is a strong linkage between the expected and actual demand of each group in
the organization, past success and future environment. Each group makes an attempt to
achieve its demand in its own way.

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

Production goal: Production is to be organized on the basis of demand in the market. Neither
there should be over production nor under production but just that much to meet the
required demand in the market, avoid excess capacity, over utilization of capital assets, lay-
off of workers etc.
Inventory goal: Inventory refers to stock of various inputs. In order to ensure continuity in
production and supply, certain minimum level of inventory has to be maintained by a firm.
Neither there should be surplus stock or shortage of different inputs. Proper balance
between demand and supply should be maintained.
Sales goal: There should be adequate sales in any organization to earn reasonable amounts
of profits. In order to create demand, sales promotion policies may be adopted from time to
time.
Market-share goal: Each firm has to make consistent effort to increase its market share to
compete successfully with other firms and make sufficient profits.
Profit goal: This is one of the basic objectives of any firm. The very survival and success of
the firm would depend upon the volume of profits earned by it.
The above mentioned objectives also would undergo changes over a period of time in the
background of modern business environment. Hence, decision making would become
complex and complicated.

The demerits are as follows:-

The theory fails to analyze the behavior of the firm but it simply predicts the future expected
behavior of different groups.
It does not explain equilibrium of the industry as a whole.
It fails to analyze the impact of the potential entry of the new firms into the industry and the
behavior of the well established firms in the market.
It highlights only on short run goals rather than long run objectives of an organization. Thus,
there are certain limitations to this theory.
 Q6.What is Boumal’s Static and Dynamic ?
Ans. The model highlights that the primary objective of a firm is to maximize its sales
rather than profit maximization. It states that the goal of the firm is maximization of sales
revenue subject to a minimum profit constraint. The minimum profit constraint is
determined by the expectations of the share holders. This is because no company can
displease the share holders. Maximization of sales does not mean maximization of physical
sales but maximization of total sales revenue. Hence, the managers are more interested in
increasing the sales rather than profit. The basic philosophy is that when sales are
maximized automatically profits of the company would also go up.

Prof. Boumal has developed two models. The first is static model and the second one is the
dynamic model.

The Static model:-

The model is based on the following assumptions.

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

Sales Maximization (dynamic model):-

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

This model is based on certain assumptions. They are as follows:-

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

Market price remains constant.
Demand and cost curves of the firm are conventional in nature.

Under competitive conditions, a firm in order to increase its volume of sales and sales
revenue would go for aggressive advertisements. This leads to a shift in the demand curve
to the right. Forward shift in demand curve implies increased advertisement expenditure
resulting in higher sales and sales revenue. A price cut may increase sales in general. But
increase in sales mainly depends on whether the demand for a product is elastic or inelastic.
A price reduction policy may increase its sales only when the demand is elastic and if the
demand is inelastic; such a policy would have adverse effects on sales.
Hence, to promote sales, advertisements become an effective instrument today. It is the
experience of most of the firms that with an increase in advertisement expenditure, sales of
the company would also go up. A sales maximizer would generally incur higher amounts of
advertisement expenditure than a profit maximizer. However, it is to be remembered that
amount allotted for sales promotion should bring more than proportionate increase in sales
and total profits of a firm. Otherwise, it will have a negative effect on business decisions.

By introducing, a non-price variable into this model, Boumal makes a successful attempt to
analyze the behavior of a competitive firm under oligopoly market conditions. Under
oligopoly conditions as there are only a few big firms competing with each other either
producing similar or differentiated products, would resort to heavy advertisements as an
effective means to increase their sales and sales revenue.