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Sourav Biswas
1311005099
WINTER 2013
MBA: 1
MB0042- Managerial
Economics

MANAGERIAL ECONOMICS
Question 1: Most of the firms spend considerable amount of
money in advertisement. Explain advertising elasticity of
demand and its practical application in this context.
Answer 1: In this competitive world, generally most of the firms,
spends considerable amount of money on their advertisement
and other sales promotional with the object of promoting its
sales. Thus it can be said that, advertising elasticity refers to
the responsiveness of demand or sales to change in advertising
or other promotional expenses. Thus the formula to calculate
the advertising elasticity is as follows:
Percentage change in demand or sales
Ea=
Percentage change in Advertisement expenditure
Practical application of advertising elasticity of demand:
In the recent years, the study of advertising elasticity of
demand is of paramount importance to a firm because of fierce
competition. The practical applications of advertising elasticity
of demand are as follows:
(1)

(2)

Helps in determining the level of prices- The level of


prices fixed by one firm for its product would depend on
the amount of advertisement expenditure incurred by it
in the market.
Helps in formulating appropriate sales promotional
energy- The mass of advertisement expenditure also

(3)

throw light on the sales promotional strategies adopted


by a firm to increase its total sales in the market. Thus
it helps a firm to stimulate its total sales in the market.
Helps in manipulating the sales- It helps in determining
the optimum level of sales in the market. This is
because the sales made by one firm would also depend
on the total amount of money spent on sales promotion
of other firms in the market.

Question 2: Explain production function in detail.


Answer: The whole theory of production centres revolves
around the concept of production function. A production
function is the technological or engineering relationship
between physical quantity of inputs employed and physical
quantity of outputs obtained by a firm. It specifies a flow of
output resulting from a flow of inputs during a specified period
of time. It may be represented in the form of a table, a graph or
an equation specifying maximum output rate from a given
amount of inputs used. As it relates to input to output, it is also
called input-output relation. The production is truly physical
in nature and is determined by the quantum of technology,
availability of equipments, labour, raw materials, etc employed
by a firm.
Factors inputs are of two types as follows:
(1)

(2)

Fixed inputs- These are those factors in which the


quantity of which remains constant irrespective of the
level of output produced by a firm. For example: land ,
buildings, machines, tools, equipments.
Variable inputs- Variable inputs are those factors in
which the quantity of which varies with variations in the
levels of output produced by a firm. For example: raw
materials, power, fuel, water, transport and etc.

The distinction between the two holds good only in short run,
whereas in the long run all factor input become variable in
nature.
Short run is a period of time in which only the variable factors
can be varied while fixed factors like plants, machines, top
management etc would remain constant. Long run is a period
of time wherein the producer will have adequate time to make
changes in the factor combinations.
It is important to note that production function is assumed to be
a continuous function i.e. it is assumed that a change in any of
the variable factors produces corresponding changes in the
output.
There are two types of production functions. They are as
follows:
(1)

Short run production function- In this case , the


producer will keep all fixed factors as constant and
change only a few variable factor inputs. In short run,
two kinds of production functions:(a) Quantities of all inputs both fixed and variable will
be kept constant and only variable input will be
varied.
(b) Quantities of all factor inputs are kept constant
and only two variables factor inputs are varied.

(2)

Long run production function- In this case, the producer


will vary the quantities of all factor inputs, both fixed as
well as variable in the same proportion.

Uses of production fuction:


The following are the important uses of production function:
It can be used to calculate out the least cost input
combination for a given output or the maximum outputinput combination for a given cost.

It is useful in working out an optimal and economic


combination of inputs for getting a certain level of output.
It also helps in making long run decisions.

Question 3: Explain Marris Growth Maximisation Model in


detail.
Answer: Profit- making is a traditional objective of a firm. Sales
maximisation objective is explained by Prof. Baumol. On the
other hand, Prof Marris has developed an alternative growth
maximisation model. It is commonly seen that each firm aims
at maximising its growth rate, because this goal would answer
many of the objectives of a firm. Marris points out that a firm
has to maximise its balanced growth rate over a period of time.
Marris assumes that the ownership and control of the firm is in
the hands of two group of people, i.e. owners and managers.
He further points out that both of them have two distinctive
goals. Managers have a utility function in which the amount of
salary, status, position, power, prestige, etc are the most
important variables, on the other hand , owners are more
concerned about the size of output , volume of profit, market
share, etc.
Therefore the utility function of the owner and that of the
mangers are expressed in the following mannerUo= f { size of output, market share, volume of profit, capital,
etc}
Um= f { salaries, power, status, prestige, etc}
Here, Uo is the utility function of the owner, and Um is the
utility function of managers.
Marris notes that the realisation of these two function would
depend on the size of the firm. Larger the firm , greater would
be the realisation of these functions and vice-versa.

Marris identifies two constraints in the rate of growth of firm


as follows:
(1)

(2)

There is a limit up to which the output of a firm can be


increased more economically, limit to manage the firm
efficiently, limit to employ highly qualified and
experienced managers, limit to research, development
and innovation, etc.
The ambition of job security puts a limit to the growth
rate of the firm itself, deliberately. If growth reaches
the maximum, then there would be no opportunity to
expand further and the managers may lose their jobs.
Rapid growth and financial soundness should go
together.

The Marris growth maximisation model highlights the


achievements of a balanced growth rate of a firm. Maximum
growth rate {G} is equal to two impotant variables:
(a)
(b)

The rate of demand for the products {E}


Growth rate of capital {F}
Hence, Max G= E=F

The Growth rate of the firm depends on two factors:


(i)
(ii)

The rate of the diversification.


The average profit margin.

There are some demerits of Marris growth maximisation


model. They are as follows:
It is doubtful whether both managers and owners would
maximise their utility functions simultaneously, always.
The assumption of constant price and production costs
are not correct.
It is difficult to achieve both growth maximisation and
profit maximisation together.

Question 4: Explain Price- output determination under


monopoly.
Answer: As output and supply are under the effective control of
the monopolist, the market forces of demand and supply do not
work freely in the determination of equilibrium price and output
in case of the monopoly market. While fixing the price and
output, the monopoly firm generally considers the below
aspects:
The monopoly can either fix the price of their individual
product or its supply. The price and control of the supply
cannot be fixed simultaneously. The price of the product
may be fixed and supply can be determined by the
demand condition, or the output may be fixed and leaves
the price to be determined by the demand condition.
It would be more beneficial to the monopolist to fix the
price of the product rather than fixing the supply ,
because it would be difficult to estimate the accurate
demand and elasticity of demand for the products.
If the demand of the product is inelastic, a relatively
higher price can be charged and if the demand is elastic ,
a relatively lower price has to be charged.
Larger quantities can be sold at lower price or smaller
quantities at a higher price.
The most ideal price is that under which the total profit of
the monopolist is the highest.
Price-output is determined under two run :
a) Short run Short run is time period in which there are
two types of factors of production. One is the fixed
factors and the other is the variable factors. In short
period , production can be changed only by changing
the variable factors of production. In the short
period , supply can be changed only to some extent ,
which is determined by the capacity created. In this
period , volume of production can be changed but
capacity of the plant cannot be changed. The aim of
a monopolist is to earn maximum profits or suffer

minimum losses if the circumstances compel. The


level of profit depends upon the nature and extent of
the demand for the product. In order to earn
maximum profits or suffer minimum losses, a
monopolist compares the marginal revenue (MR) with
marginal cost (MC).
b) Long run- In the long run , there is adequate time to
make all kinds of adjustments in both fixed as well as
variable factor inputs. The total amount of long run
profits will depend on the cost condition under which
the monopolist has to operate and the demand curve
to be faced in the long run.
The assumption of price output determination under
monopoly are as follows:
The monopoly firm aims at maximising its total
profit.
It is completely free from government controls.
It charges a single and uniform high price to all
customers.

Question 5: Investment is the second important component of


effective demand. Explain investment function.
Answer: Investment is the second important component of
effective demand. In ordinary words, it refers to financial
investment. i.e. purchase of stocks, shares, bonds, etc. In this
case there is only transfer of rights or titles from one person to
another. It is an investment by one and disinvestment by
another and as such, the value transaction mutually cancels
out each other. They do not add anything to the total stock of
capital of the nation.
Investment implies creation of new capital assets or addition to
the existing stock of productive assets. It refers to that part of
the aggregate of income , which is used for the creation of the

new structures, new capital equipments, machines etc, that


help in the production of final goods and services in an
economy. Creation of income- earning assets is called
investment. Investment must generate income in the economy.
Investment means making an addition to the stock of goods in
existence.
Investment is not a stock but a flow variable because it
highlights the addition to the existing stock of capital. The
productive ability of an economy is measured in terms of its
stock of capital and its capacity to add to the existing stock of
capital. Therefore, it is a crucial factor in the economic
development of the nation.
There are 5 types of investment. They are as follows:
1. Private investment: It is done by private entrepreneurs on
the purchase of different capital assets like machinery,
plants, factories and etc. It is influenced by MEC and
interest rate. It is profit elastic.
2. Public investment: It is undertaken by the public
authorities like central, state and local authorities. In this ,
the basic criterion and motto is social net gain, social
welfare and non profits.
3. Foreign Investment: It consists of excess of exports over
the imports of a country. It depend on many factors such
as propensity to export of a given country, foreigners
capacity to import , prices of exports and imports, state
trading and other factors.
4. Induced investment: It is the another name of for private
investment. Investment which varies with the changes in
the level of national income, is called induced investment.
Induced investment is income-elastic that is it increase as
income increases and vice-versa.
5. Autonomous investment: It is another name of public
investment. The investment , which is independent of the
level of income, is called as autonomous investment. Such
level does not vary with the level of income. Therefore it is
called income-inelastic.

Determinants of investment :
Investment decisions are taken by entrepreneurs depend upon
a number of factors such as interest rate, political environment,
rate of growth of population, the necessity of new products and
etc. This factors affect the volume of investment. The
profitability of investment depends mainly on two factors:
Marginal efficiency of capital.
Interest rate.

Question 6: Write short notes on:


(a) Monetary policy .
(b) Physical policy or direct controls.
Answer: Monetary policy: It is the process by which the
monetary authority of a country controls the supply of
money, often targeting for the rate of interest for the
purpose of promoting economic growth and stability.
Monetary policy is referred to as either being
expansionary or contractionary , where an expansionary
policy increases the total supply of money in the
economy more rapidly than usual, and contractionary
policy expands the money supply more slowly than
usual or even shrinks it.
Parameters of monetary policy are as follows:
Total money supply available in a country.
The nature of credit control measures.
Cost of borrowings or the level of interest rates.
Objectives of monetary policy are as follows:
Neutral money policy
Price stability
Exchange rate stability
Control of trade cycles
Full employment

Equilibrium in the balance of payment


Rapid economic growth.
Physical policy or direct control: Direct control are imposed by
government to ensure proper allocation of scarce resources like
food, raw materials and capital goods. Government can strictly
restrict certain kinds of investment or economic activity. During
the period of inflation , government can directly exercise
control over prices and wages.
Direct control are of three forms:
(-) Control over consumption and distribution through price
control and rationing,
(-) Control over investment and production through licensing
and fixing of quotas and etc,
(-) Control over foreign trade through import control, import
quotas, export control.
The disadvantages of direct control are as follows:
Direct control suppress individual initiative and enterprise
They tend to inhibit innovations,
Direct controls may induce speculation which may have
destabilising effects.
Gross disturbances may appear when the control are
removed.