SET 1.

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

Answer: 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.

Answer: 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?

Answer:

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?

Answer: 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 behaviour 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 behaviour theory? What are the demerits?

Answer: - Cyert and March’s behaviour makes an attempt to explain the

behaviour of inter group conflicts and their multiple objectives in an
organization. Basically, this theory explains the usual and normal behaviour 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, behavioural 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 behaviour of the firm but it simply predicts the
future expected behaviour 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 behaviour 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?

Answer: - 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 maximize would
generally incur higher amounts of advertisement expenditure than a profit
maximize. 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 behaviour 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.