Course Code
Course Title
Assignment Code
Assignment Coverage
MS-09
Managerial Economics
MS-09/ TMA/SEM - II/2016
All Blocks
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1. Describe Incremental Cost. Differentiate between Incremental Cost and Equi- Marginal Principle.
Explain how does consumer maximize utility with the help of Equi-Marginal Principle?
Incremental CostAn incremental cost ----------------------------------------------------------------------------------------------- production or other activity.
For instance, if a company's total -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- hours is $40,000.
The incremental cost is also referred to as the differential cost. The incremental cost is the relevant cost for making a short run
decision between two alternatives.
Incremental cost can be defined as the ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------might
not exist if an extra unit was not produced.
Example
A very simple example of incremental ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------cost for
shipping the additional widget to a consumer.
Calculating Incremental Cost
Calculating the incremental cost is helpful for the business to determine their proper production amounts. The key steps involved
in computation of the incremental cost are:
1. Review the formula for -------------------------------------------------------------------------------------------------------) Total cost of
producing two total cost of producing one = incremental cost.
2. Determine the amount incurred as the cost -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------of producing one item. Let us assume the cost of producing one good be $500.
3. Determine the cost of producing two items. Due to economies of scale, it might cost less in producing two items than what
was incurred in producing each ---------------------------------------------------------------------- two items simultaneously.
4. Estimate the incremental cost by computing the difference between the two figures. The result is: total cost of producing two
($950) total cost of ------------------------------------------------------------------------------------------- item and two items.
Incremental cost
Incremental Revenue
How does consumer maximize utility with the help of Equi-Marginal Principle
The equi-marginal principle states that consumers will choose a combination of goods to maximise their total utility. This will
occur where
(Marginal Utility of A)
--------------------
--------------------------------
(Price of B)
MUX and MUY schedules show ----------------------------------------------------------------------------------------------------------------------------- prices we obtain weighted marginal utility or marginal utility of money expenditure. This has been shown in Table 2.7.
2. A firms demand function is given as P=32-6Q and the average cost function as AC=Q2 7.5Q+50+2/Q.
Calculate the level of output Q which:a) Maximizes total revenue
=PXQ
-----------------------------------------------------= --------------------------------------
To maximise TR, we find the derivative and set it to 0 (the first order or necessary condition)
Now, dR/dQ = ------------------------------------= 32 12 Q = 0
Thus, -------------------------------------The second order condition (sufficient condition) needs
--------------------------------------Since
dR/dQ
= ---------------------------------
-------------------------------------------
p =TR TC
------------------------------------------------------= (Q2 7.5Q + 50 + ------------------------------------------------------------TR = -------------------------------------------------------= 32 Q 6 Q2
After substituting TR and TC, we get
p=
------------------------------------------- + 7.5 Q2 - 50 Q 2
- Q3 + 1.5 -----------------------------------
dP/dQ = -------------------------------------------------
-3Q2 + -------------------------------------------Divide by -3
-----------------------------------
=0
Q2 3Q + ----------------------------
=0
----------------------------------- ( Q 3 ) = 0
(Q + 2---------------------------------
=0
3. Discuss Long- Run Cost Functions. Why long run cost curve is called a planning curve and explain
how does it help in future decision making process?
Long run costs are ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------. The land, labor, capital
goods, and entrepreneurship all vary to reach the the long run cost of producing a good or service.
The long run is a planning and implementation stage for producers. -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
The long run cost output relationship can be shown with the help of a long run cost curve. The long run average cost curve
(LRAC) is derived from short run average cost -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------.
The long run average cost function for this firm is defined by the minimum average cost of each level of output.
For example, output rate Q1 could be produced by the plant size-1 at an average cost of C1 or by plant size-2 at a cost of C2.
Clearly, the average cost is lower for plant size-1, and thus point a is one point on the long run average cost curve. By repeating
this process for various rates of output, the long run ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------. Consider a firm currently operating plant size-2 and producing Q1 units at a cost of C2 per unit. If output is expected to
remain at Q1, the firm will plan to adjust to plant size-1, thus reducing average cost to C1.
In the long run, all the factors ---------------------------------------------------- plant or building can be increased in case of long run.
There are no fixed inputs or ---------------------------------------------- costs change as all the factors of production are variable.
There is no distinction between the Long run Total Costs (LTC) and long run variable cost as there are no fixed costs. It should
be noted that the ability of an organization of changing inputs enables it to produce at lower cost in the long run.
1. Long Run Total Cost:
Long run Total Cost (LTC) refers to the --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------quantities of output. LTC is always less than or equal to short run total cost, but it is never more than short run cost.
The LTC curve is shown in Figure-10:
As shown in Figure-10, short run total -------------------------------------------------------------------------------------------------------------------------------------------------------------- of short run total cost curves. Therefore, LTC envelopes the STC curves.
Suppose there are three sizes of the plant -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------. However, in the long run, the organization
can select among the plants which help in achieving minimum possible cost at a given level of output.
From Figure-11, it can be noted that till OB amount of production, it is beneficial for the organization to operate on the plant
SAC2 as it entails lower costs -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------. The LAC curve
is derived from joining the lowest minimum costs of the short run average cost curves.
It first falls and then rises, thus it is U- shaped curve. --------------------------------------------------------------------------------------------------------------------------- in inputs. In the long run, the output changes with respect to change in all inputs of production.
In case of increasing returns to scale (IRS), ----------------------------------------------------------------------------------------------------------------------------------------- of constant returns to scale (CRS), organizations can double the output by using inputs twice.
LTC increases proportionately to the output; ---------------------------------------------------------------------------------------------------------------------------- more than twice. Thus, LTC increases more than the increase in output. As a result, LAC increases.
Figure-12 shows the effect on LAC because of returns to scale:
4. Why is there a kink in the market demand curve of oligopolists? Explain price rigidity of the Kinked
Demand Curve.
Kinked-Demand Theory of Oligopoly
There are two forms of oligopoly structure;
i.
Collusive Oligopoly: In such oligopoly few firms unite together through a formal or informal agreement. The example
for formal agreement is cartels --------------------------------------------------------------------------- model.
ii.
ii. Non-Collusive Oligopoly: If the firm ------------------------------------------------------------------------------------------- mutual
understanding or without collaboration with any other firm then such oligopolistic firm is non-collusive.
There is no single theory of oligopoly. The ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------face
two market demand curves for its product. At high prices, the firm faces the relatively elastic market demand curve, labelled MD
1 in Figure.
Corresponding to MD 1 is the marginal revenue curve labelled MR 1. At low prices, the firm faces the relatively inelastic market
demand curve labelled MD 2. Corresponding to MD 2 is the marginal revenue curve labelled MR 2.
The two market demand curves ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------revenue with
marginal cost, which results in an equilibrium output of Q units and an equilibrium price of P.
The oligopolistic faces a kinked-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------elastic market
demand curve MD 1.
The oligopolies market demand curve -------------------------------------------------------------------------------------------------------------------------------------------------------- by the other oligopolists in the market. Consequently, the demand for the oligopolies
output falls off more quickly at prices above P; in other words, the demand for the oligopolies output becomes more elastic.
If the oligopolistic reduces its price below P, it is assumed ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------the price changes of its competitors.
The kinkeddemand theory of oligopoly illustrates the high degree of interdependence that exists among the firms that make up
an oligopoly. The market demand curve --------------------------------------------------------------------------------- of the other firms in
the oligopoly; this is the major contribution of the kinkeddemand theory.
The kinkeddemand theory, however-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------collude in
setting output and price. The possibility of collusive behavior is captured in the alternative theory known as the cartel theory of
oligopoly.
Price rigidity under OligopolyEvery firm in an oligopoly market is -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------. The main factors which contribute to price
rigidity in an oligopoly market are discussed below:
Firstly under oligopoly each seller is faced with a Kinked Demand Curve. The point of kink divide the demand or AR curve into
two distinct parts. ---------------------------------------------------------------------------------------------------------- curve. The lower part
or the portion of demand curve to the right of the kink is less elastic. The market price corresponds to the point of the kink.
The price that corresponds to the -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------oligopoly, faced with the Kinked Demand Curve is
extremely reluctant to change the prevailing price. Therefore, there is rigidity or stickiness of the prevailing price under
oligopoly.
Secondly, since the oligopolistic firm is -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------of output and price which corresponds to the
kink, the oligopolist is not interested in changing the price.
Thirdly, small variations in cost do not ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- revenue at a point above E, there is a case for
price rise.
Fourthly, the price remains same even when ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- range of discontinuity or gap in the new marginal revenue curve.
Our study of pricing and market structure has so far suggested that a firm maximizes profit by setting MR = MC. While this is
also true for oligopoly firms, it needs to be supplemented by other behavioural features of firm rivalry. This becomes necessary
because the distinguishing feature of oligopolistic ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------if a firm reduces the price of its products whereas they show the non-cooperative behaviour if a firm increases the price of its
products.
Let us start from P1 in Figure 13.3. If one firm ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------curve, DD, then the price reduction from P1 to P2 only increases sales to Q2 1.
Here we assume that P1 is the initial price of ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------existing price P1. The demand curve has two linear curves, which are joined at price P.
Associated with the kinked demand curve is a ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------The new MC curve will be MC1 or MC2 and will remain in the discontinued area and the equilibrium price remains the same at
P.
5. Briefly describe the characteristics of perfect competition, monopoly, monopolistic competition, and
oligopoly markets. Identify any four products one each from these markets.
Perfect competition
A perfectly competitive market is a hypothetical market where competition is at its greatest possible level. classical economists
argued that perfect competition would produce the best possible outcomes for consumers, and society.
Key characteristics
Perfectly ----------------------------------------------------------------- characteristics:
1.
2.
Given that producers and consumers have perfect knowledge, it is assumed that they make rational decisions to
maximise ------------------------------------------------------------------------------------------------------- their profits.
3.
4.
5.
6.
No single firm can influence the market price, or market conditions. The single firm is said to be a price taker, taking its
price from the whole industry. ---------------------------------------------------------------------------------------------------------------------------------------------------------------- market price given that it can sell all it produces at the market price.
7.
8.
There is no need for government regulation, except to make markets more competitive.
9.
MonopolyMonopoly refers to a market ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- the single seller of the commodity has some kind of
power or control over the supply of a commodity and hence he is in a position to influence the price.
Since under monopoly, there is only one firm selling a commodity, this firm exercises some control over the supply and price of
the commodity.
Characteristics of Monopoly:
1. Single seller:
The producer or seller of the ---------------------------------------------------------------------- control on the output of the commodity.
2. No Close Substitutes:
All the units of a commodity are similar and there are no substitutes to that commodity.
3. No Entry for New Firms:
Monopoly situation in a market ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------. This signifies
that under monopoly there is no difference between a firm and an industry.
ExampleA market dominated by one seller. The cable company is an example of this in India (sort of like it is in America.) The cable
company in India, facing no competition, is notorious for poor quality and poor service.
The first important feature of -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- of firms under monopolistic competition, there exists stiff competition
between them. These firms do not produce perfect substitutes. But the products are close substitute for each other.
(2) Product differentiations:
The various firms under ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------of each other.
Differentiation of the product may be real or fancied.
(3) Some influence over the price:
As the products are close substitutes of ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- increases. It therefore, implies that the demand curve of a
firm under monopolistic competition slopes downward and marginal revenue curve lies below it.
Thus under monopolistic competition a --------------------------------------------------------------------------------------------------------------------- price. Thus under monopolistic competition a firm has to choose a price-output combination that will maximize price.
(4) Absence of firm's interdependence:
Under oligopoly, the firms ------------------------------------------------------------------------------------------------------------------------------------- or less independently. Each firm formulates its own price-output policy upon its own demand cost.
(5) Non-price competition:
Firms under monopolistic -------------------------------------------------------------------------------------------------------------------------------- definite -methods of competing rivals other than price. Advertisement is a prominent example of non-price competition.
(6) Freedom of entry and exit:
In a monopolistic competition it is easy for new firms to enter into an existing firm or to leave the industry. Lured by the profit
of the existing firms new firms enter the industry which leads to the expansion of output. But there exists a difference.
ExampleHere, there are lots of sellers ------------------------------------------------------------------------------------------------------------------------------------------------------ of this is the banking system. After financial sector reforms in 1992, the banking system in India
have become much more competitive with lots more banks offering similar products at similar prices.
Indirect Costs
Costs which cannot be ----------------------------------------------------------------------------------------------------------------------------------------------------- to individual products, activities or departments etc.
Examples: Cost of depreciation---------------------------------------------------------------- incurred in a concrete plant.
Example
Following costs are incurred by a factory on the production of identical cupboards:
1.
3.
5.
7.
9.
11.
Laborers' wages
--------------------------Nails and screws
Handles, --------------------Supervisors' salaries
--------------------------
2.
4.
6.
8.
10.
12.
---------------------------Glass
Factory insurance
Wood
-------------------------------Factory manager's salary
Solution
1.
3.
5.
7.
9.
11.
Direct
---------Indirect
Direct
--------------Indirect
2.
4.
6.
8.
10.
12.
Direct
-------------Indirect
Direct
-----------------Indirect
===========================================================================================
b) Price Leadership
If changes are usually or always introduced by a firm and -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------of these firms. Each firm in the oligopoly recognises this interdependence.
A major policy change on the part of one ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- Oligopoly tends to reduce the freedom of
action a firm has in taking its price decision because the firm is not sure of the reactions of its rivals.
One way to come out of this uncertainty --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- the help of product differentiation. An equal popular alternative
for the firm is to deliberately choose a pattern of price parallelism, i.e., one firm taking the initiative role or leadership.
Example:
Scooter-Bajaj Auto LML, TVS Motor Cycles------------------------------------------------------------------------------------------------------------------ make the collusion of firms imperfect. Most important form of imperfect collusion is Price Leadership.
Kinds:
Types of Price leadership:
There are three kinds of price leadership.
(i) Dominant firm price leadership:
A large firm is the dominant firm ---------------------------------------------------------------------------, i.e., the large firm fixes the
price and other small firms act as Price-takers.
Example:
SAIL vis-a-vis TISCO in Steel Sector.
-------------------------------------------------------------------------------------------------------------------------------------------profit above
what it would be if it charged one price for all periods. It is also efficient; the sum of producer and consumers surplus is greater
because prices are closer to MC.
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KIAN PUBLICATION
Whatsapp- 9580039150
ignousolvedassignmentsmba@gmail.com
kianpublication1@gmail.com
ignou4you@gmail.com