SMU-MBA Assignment Set-1 MB0042– Managerial

Economics
Ques1. What is Price Discrimination? Explain the basis of Price iscrimination.(5+5)

Ans.

The policy of price discrimination refers to the practice of a seller to charge different
prices for different customers for the same commodity, produced under a single control
without corresponding differences in cost.

Price Discrimination May Take The Following Forms: (Basis Of Price Discrimination)

1. Personal differences: This is nothing but charging different prices for the same
commodity because of personal differences arising out of ignorance and irrationality of
consumers, preferences, prejudices and needs.

2. Place: Markets may be divided on the basis of entry barriers, for e.g. price of goods
will be high in the place where taxes are imposed. Price will be low in the place where
there are no taxes or low taxes.

3. Different uses of the same commodity: When a particular commodity or service is

meant for different purposes, different rates may be charged depending upon the nature of
consumption. For e.g. different rates may be charged for the consumption of electricity
for lighting, heating and productive purposes in industry and agriculture.

4. Time: Special concessions or rebates may be given during festival seasons or on

important occasions.

5. Distance: Railway companies and other transporters, for e.g., charge lower rates per
KM if the distance is long and higher rates if the distance is short.

6. Special orders: When the goods are made to order it is easy to charge different prices to
different customers. In this case, particular consumer will not know the price charged by
the firm for other consumers.

7. Nature of the product: Prices charged also depends on nature of products e.g., railway
department charge higher prices for carrying coal and luxuries and less prices for cotton,
necessaries of life etc.

8. Quantity of purchase: When customers buy large quantities, discount will be allowed
by the sellers. When small quantities are purchased, discount may not be offered.

9. Geographical area: Business enterprises may charge different prices at the national and
international markets. For example, dumping – charging lower price in the competitive
foreign market and higher price in protected home market.

10. Discrimination on the basis of income and wealth: For e.g., A doctor may charge
higher fees for rich patients and lower fees for poor patients.

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11. Special classification of consumers: For E.g., Transport authorities such as Railway
and Roadways show concessions to students and daily travelers. Different charges for I
class and II class traveling, ordinary coach and air conditioned coaches, special rooms
and ordinary rooms in hotels etc.

12. Age: Cinema houses in rural areas and transport authorities charge different rates for
adults and children.

13. Preference or brands: Certain goods will be sold under different brand names or trade
marks in order to attract customers. Different brands will be sold at different prices even
though there is not much difference in terms of costs.

14. Social and or professional status of the buyer: A seller may charge a higher price for
those customers who occupy higher positions and have higher social status and less price
to common man on the street.

15. Convenience of the buyer: If a customer is in a hurry, higher price would be charged.
Otherwise normal price would be charged.

16. Discrimination on the basis of sex: In selling certain goods, producers may
discriminate between male and female buyers by charging low prices to females.

17. If price differences are minor, customers do not bother about such discrimination.

18. Peak season and off peak season services.

Ques2. Explain the price output determination under monopoly and oligopoly.

Ans:

Price – Output determination under Monopoly

Assumptions
a. The monopoly firm aims at maximizing its total profit.
b. It is completely free from Govt. controls.
c. It charges a single & uniform high price to all customers.
It is necessary to note that the price output analysis and equilibrium of the firm and
industry is one and the same under monopoly.
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 following important aspects.
1. The monopolist can either fix the price of his product or its supply. He cannot fix the
price and control the supply simultaneously. He may fix the price of his product and
allow supply to be determined by the demand conditions or he may fix the output and
leave the price to be determined by the demand conditions.
2. 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

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elasticity of demand for the products.
3. While determining the price, the monopolist has to consider the conditions of demand,
cost of the product, possibility of the emergence of substitutes, potential competition,
import possibilities, government control policies etc.
4. If the demand for his product is inelastic, he can charge a relatively higher price and if
the demand is elastic, he has to charge a relatively lower price.
5. He can sell larger quantities at lower price or smaller quantities at a higher price.
6. He should charge the most reasonable price which is neither too high nor too low.
7. The most ideal price is that under which the total profit of the monopolist is the
highest.
Price – Output Determination under Oligopoly
It is necessary to note that there is no one system of pricing under oligopoly market.
Pricing policy followed by a firm depends on the nature of oligopoly and rivals reactions.
However, we can think of three popular types of pricing under oligopoly. They are as
follows:
Independent pricing: (non-collusive oligopoly)
When goods produced by different oligopolists are more or less similar or homogeneous
in nature, there will be a tendency for the firms to fix a common pricing. A firm generally
accepts the “Going price” and adjusts itself to this price. So long as the firm earns
adequate profits at this price, it may not endeavor to change this price, as any effort to do
so may create uncertainty. Hence, a firm follows what is called is “Acceptance pricing” in
the market.
When goods produced by different firms are different in nature (differentiated oligopoly),
each firm will be following an independent pricing policy as in the case of monopoly. In
this case, each firm is aware of the fact that what it does would be closely watched by
other oligopolists in the industry. However, due to product differentiation, each firm has
some monopoly power. It is referred, to as monopoly behavior of the Oligopolist. On the
contrary, it may lead to Price-wars between different firms and each firm may fix price at
the competitive level. A firm tends to charge prices even below their variable costs. They
occur as a result of one firm cutting the prices and others following the same. It is due to
cut-throat competition in oligopoly. The actual price fixed by a firm may fall in between
the upper limit laid down by the monopoly price and the lower limit fixed by the
competitive price. It may be similar to that of the pricing under monopolistic competition.

However, independent pricing in reality leads to antagonism, friction, rivalry, infighting,

price-wars etc., which may bring undesirable changes in the market. The Oligopolist may
realize the harmful effects of competition and may decide to avoid all kinds of wastes. It
encourages a tendency to come together. This leads to pricing under collusion. In other
words independent pricing can be followed only for a short period and it cannot last for a
long period of time.

Ques3. Give a brif description of (5+5)

(a) Total Revenue and Marginal Revenue
(b) Implicit and Explicit Cost
Ans:

(a) Total Revenue and Marginal Revenue

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Total revenue is the total money received from the sale of any given quantity of output.
The total revenue is calculated as the selling price of the firm's product times the quantity
sold, i.e.
total revenue = price × quantity;
or
letting TR be the total revenue function,
TR(Q) = P(Q) × Q
where Q is the quantity of output sold, and P(Q) is the inverse demand function (the
demand function solved out for price in terms of quantity demanded).

Numerical Example
A promoter has properly estimated the demand curve for seats at an event to be
Q = 40,000 − 2000P
where P is the price of a seat. The inverse demand curve, which determines price as a
function of quantity, is therefore represented by
P(Q) = 20 − Q / 2000.
We therefore have
TR(Q) = 20Q − Q2 / 2000

Marginal revenue : is the revenue associated with one additional unit of production.
Whether this is higher, lower or the same as the revenue from the previous unit of
production depends on the demand for the producer's product. In the case of a producer
who supplies a very small percentage of the market, an extra unit of production is
unlikely to have an effect on market prices. In this case, increased production will not
affect marginal revenue. On the other hand, if the producers supplies most or all of the
market (such as in a monopoly or near-monopoly), then increased production is likely to
reduce marginal revenue.
Marginal revenue is the increase in revenue from selling one more unit of a product. It
differs from the price of the product because it takes into account the effect of changes in
price.
For example if you can sell 10 units at £20 each or 11 units at £19 each, then your
marginal revenue from the eleventh unit is (10 × 20) - (11 × 19) = £9.
The concept is important in microeconomics because a firm's optimal output (most
profitable) is where its marginal revenue equals its marginal cost: i.e. as long as the extra
revenue from selling one more unit is greater than the extra cost of making it, it is
profitable to do so.It is usual for marginal revenue to fall as output goes up both at the
level of a firm and that of a market, because lower prices are needed to achieve higher
sales or demand respectively.

(b) Implicit and Explicit Cost

Explicit cost
An Explicit cost is a business expense accounted cost that can be easily identified such as
wage, rent and materials. Explicit costs gives clear and evident cash outflows from
business that decreases its end result profitability. This cost directly effect the revenue.
Intangible expenses such as goodwill and amortization are not explicit expense because
these expenses don't show clear effects on a business's revenue and expenses.

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Implicit cost
An implicit cost results if the person who at first foregoes the satisfaction in the search of
an activity and is not rewarded by money or another form of payment. The implicit cost
begins and ends with foregoing the benefits and satisfaction. When an organization or
owner uses its own equity for company's well-air then that cost is considered as implicit
cost. Goodwill is a good example of implicit cost.

Explicit Cost vs. Implicit Cost

Explicit cost can be counted in terms of money whereas implicit cost can not be traded
and therefore can not be counted in terms of money.
Explicit cost is a direct tangible cost whereas implicit cost is indirect intangible cost.

Ques4. Explain the Law of Variable Propotion.

Ans:
In the short-run the level of production can be changed by changing the factor
proportions. This law examines the production function with on factor variable,
keeping the other factors quantities fixed. In other words this law explains the short-
run production function. When the quantity of one input is varied, keeping other
inputs constant, the proportion between factors changes. When the proportion of
variable factors increases, the total output does not always increase in the same
proportion, but in varying proportion. This is why the law is named’ Law of Variable
proportions’. The law of variable proportion is the new name given to the famous
‘Laws of Diminishing Returns. ‘The law of variable proportion’ or the law of
diminishing returns has been defined by a number of economists. In the words of F.
Benham. “As the proportion of one factor in a combination of factors is increased,
after a point, first the marginal and then the average product of that factor will
diminish”. This law explains return to a factor.
Thus, the law states that if more and more units of a variable factor are applied to a
given quantity of fixed factor, the total output may initially increase at an increasing
rate but beyond a certain level the total output, the rate of increase in total output
eventually diminishes in the use of additional units of the variable factor. The
volume of goods produced can be looked at form three different angles viz. :
(i)
Total Product, (ii) Marginal Product and (iii) Average Product.
Total product refers to the total volume of goods produced during a specified period
of time. Total product can be raised only by increasing the quantity of variable
factors employed in production. For instance, more shirts will be produced when
more labour and capital are used. Total product, generally goes on increasing with
an increase in the quantity of the factor services employed. But there is a limit to
which total product can increase with increase in the quantity of variable factors of
production.
Marginal Product (MP). The rate at which total product increases is known as
marginal product. We also define marginal product as the addition to the total
product resulting from a unit increase in the quantity of the variable factor. Initially
marginal product rises, but ultimately it begins to fall down, it becomes zero and at

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last becomes negative. It would be seen that the total product is maximum when
the marginal product is zero.
Average Product (AP). Average product can be known by dividing total product by
the total number of units of the variable factor.
AP=Total Product
Units of variable factor
It can be easily seen that the average product also show almost the same tendency
as does the marginal product. Initially, both the marginal product and the average
product rise but ultimately both of these fall. However, marginal product may be
zero. The output does not increase at a constant rate as more of any one input is
added to the production process. For example on a small plot of land. We can
improve the yield by increasing the fertilizer use to some extent. However,
excessive use of fertilizer beyond the optimum quantity may lead to reduction in
the output instead of any increase as per the law of Diminishing Returns (for
instance, single application of fertilizers may increase the output by 50 per cent, a
second application by another 30 per cent and the third by 20 per cent. However, if
we apply fertilizer five to six times in a year, the output may drop to zero).
The principle of diminishing marginal productivity (returns) states that as additional
units of a variable inputs are added to other inputs that are fixed in supply, the
increment to output eventually decline (for a constant technology). This
phenomenon has been widely observed and there is enough empirical evidence to
support it. For business managers, managers, marginal productivity of an input
plays an important part in determining how much of that input will be employed.

Ques5. What is Elasticity of Demand? Explain the factors determining it.

Ans:
A behavioral relationship between quantity consumed and a person's maximum
willingness to pay for incremental increases in quantity. It is usually an inverse
relationship where at higher (lower) prices, less (more) quantity is consumed. Other
factors which influence willingness-to-pay are income, tastes and preferences, and price
of substitutes. Demand function specifies what the consumer would buy in each price and
wealth situation, assuming it perfectly solves the utility maximization problem. The
quantity demanded of a good usually is a storng function of its price. Suppose an
experiment is run to determine the quantity demanded of a particular product at different
price levels, holding everything else constant. Presenting the data in tabular form would
result in a demand schedule.

Elasticity of demand is the economist’s way of talking about how responsive consumers
are to price changes. For some goods, like salt, even a big increase in price will not cause
consumers to cut back very much on consumption. For other goods, like vanilla ice cream
cones, even a modest price increase will cause consumers to cut back a lot on
consumption. Elasticity of demand is an elasticity used to show the responsiveness of the
quantity demanded of a good or service to a change in its price. More precisely, it gives
the percentage change in demand one might expect after a one percent change in price.
Elasticity is almost always negative, although analysts tend to ignore the sign even though
this can lead to ambiguity. Only goods which do not conform to the law of demand, such

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as Veblen and Giffen goods, have a positive elasticity demand. Goods with a small
elasticity demand (less than one) are said to be inelastic: changes in price do not
significantly affect demand e.g. drinking water. Goods with large elasticity demand’s
(greater than one) are said to be elastic: even a slight change in price may cause a
dramatic change in demand. Revenue is maximised when price is set so as to create a ED
of exactly one; elasticity demand‘s can also be used to predict the incidence of tax.
Various research methods are used to calculate price elasticity, including test markets,
analysis of historical sales data and conjoint analysis. There is a neat way of classifying
values of elasticity. When the numerical value of elasticity is less than one, demand is
said to be “inelastic”. When the numerical value of elasticity is greater than one, demand
is “elastic”. So “elastic” demand means that people are relatively responsive to price
changes (remember the vanilla ice cream cone). “Inelastic” demand means that people are
relatively unresponsive to price changes (remember salt). An important relationship exists
between the elasticity of demand for a good and the amount of money consumers want to
spend on it at different prices. Spending is price times quantity, p times Q. In general, a
decrease in price leads to an increase in quantity, so if price falls spending may either
increase or decrease, depending on how much quantity increases. If demand is elastic,
then a drop in price will increase spending, because the percent increase in quantity is
larger than the percent decrease in price. On the other hand, if demand is inelastic a drop
in price will decrease spending because the percent increase in quantity is smaller than the
percent decrease in price.

The price elasticity of demand measures how responsive the quantity demanded of a good
is to a change in its price. The value illustrates if the good is relatively elastic (PED is
greater than 1) or relatively inelastic (PED is less than 1).

A good's PED is determined by numerous factors, these include;

Number of substitutes: the larger the number of close substitutes for the good then the
easier the household can shift to alternative goods if the price increases. Generally, the
larger the number of close substitutes, the more elastic the price elasticity of demand.

Degree of necessity: If the good is a necessity item then the demand is unlikely to change
for a given change in price. This implies that necessity goods have inelastic price
elasticities of demand.

Price of the good as a proportion of income: It can be argued that goods that account for a
large proportion of disposable income tend to be elastic. This is due to consumers being
more aware of small changes in price of expensive goods compared to small changes in
the price of inexpensive goods.

The following example illustrates how to determine the price elasticity of demand for a
good.

The price elasticity of demand for supermarket own produced strawberry jam is likely to
be elastic. This is because there are a very large number of close substitutes (both in jams

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and other preserves), and the good is not a necessity item. Therefore, consumers can and
will easily respond to a change in price.

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Ques6 What is Marginal effeciency of Capital? Describe the factors determine
MEC.(5+5)

Ans:

Marginal Efficiency of Capital

It refers to productivity of capital. It may be defined as the highest rate of return over cost
accruing from an additional unit of capital asset. Also it refers to the yield expected from
a
new unit of capital. The MEC in its turn depends on two important factors.
1. Prospective yield from the capital asset and
2. The supply price of the capital asset.
The MEC is the ratio of these two factors. The prospective yield of a capital asset means
the
total net returns expected from the asset over its lifetime. After deducting the variable
costs
like cost of raw materials, wages, etc from the marginal revenue productivity of capital,
an
investor can estimate the prospective income (expected annual returns and not the actual
returns)
from the capital asset. Along with it he also has to consider the supply price or
replacement cost
of the capital asset.
Determinants of MEC
Several factors that affect MEC are given below.
1. Short run factors: Expectation of increased demand, higher MEC leads to larger
investment
and vice-versa.
2. Cost and Price: If the production costs are expected to decline and market prices to go
up in
future, MEC will be high leading to a rise in investment and vice-versa.
3. Higher Propensity to consume leading to a rise in MEC encourages higher investment.
4. Changes in income:An increase in income will simulate investment and MEC while a
decline in the level of incomes
will discourage investment.
5. Current state of expectations:
If the current rates of returns are high, the MEC is bound to be high for new projects of
investment and vice-versa. This is because the future expectations to a very great extent
depend
on the current rate of earnings.
6. State of business confidence:
During the period of optimism (boom) the MEC will be generally high and during period
of
pessimism (depression), it will be generally less.
II Long run factors.
1. Rate of growth of population: In a capitalist economy, a high rate of population growth
leads

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to an increase in MEC because it leads to an increase in the demand for both consumption
and
investment goods. On the contrary, a decline in the population growth depresses MEC.
2. Development of new areas: Development activities in the new fields like transport and
communications, generation of electricity, construction of irrigation projects, ports etc
would
lead to a rise in MEC.
3. Technological progress: Technological progress would lead to the development and use
of
highly sophisticated and latest machines, equipments and instruments. This will add to the
productive capacity of the economy leading to an increase in MEC.
4. Productive capacity of existing capital equipments: Under utilised existing capital
assets
may be fully utilized if the demand for goods increases in the economy. In that case the
MEC of
the same asset will definitely rise.
5. The rate of current investment: If the current rate of investment is already high, there
would
be little scope for further investment and as such the MEC declines.
Thus, several factors both in the short run and in the long run affect the MEC of a capital
asset.

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