The change in one variable leads to change in other variable to a certain degree. Elasticity of demand is generally defined as the responsiveness or sensitiveness of demand to a given change in the price of a commodity. It refers to the capacity of demand either to stretch or shrink to a given change in price. It indicates the ratio of relative changes in two quantities I. E. Price and demand. According to proof. Building. ” Elasticity of demand measures the responsiveness of demand to changes in price”.
In the words of Marshall,” The elasticity(or responsiveness) of demand in a market is great or small according to the amount emended much or little for a given fall in price, and diminishes much or little for a given rise in price” Determinants of price elasticity of demand: a. Nature of the commodity: Commodities coming under the category of necessaries Managerial Economics. Dock By divvy price. For example, rice, milk etc. On other hand comfort and luxuries, demand tends to be elastic.
For example, TV set. B. Existence of Substitutes: Substitute goods are those that are considered to be economically interchangeable by buyers.
If a commodity has no substitute in the market, demand tends to be inelastic. In case of modify having different substitute in the market, demand tends to be elastic. C. Number of uses for the commodity: If a commodity has only one use then demand tends to be inelastic because people have to pay more prices if they have to use that product for only one use.
On the contrary, commodities having several use demand tends to be elastic. For ex: coal, steel etc. D. Durability and reparability of a commodity: Demand tends to be elastic in case of durable and repairable goods.
For ex: table, chair etc. On the other hand perishable goods demands tends to be inelastic. For ex: milk, vegetables etc. E. Possibility of postponing the use of a commodity: In case there is no possibility to postpone the use of a commodity to future, the demand tends to be inelastic. For ex: medicines. If there is possibility to postpone the use of a commodity to future, the demand tends to be elastic. For ex: motor cycle, car etc. F. Level of the income of people: Demand will be inelastic in case of rich people. On the contrary demand tends to be inelastic in case of poor g.
Range of price: There are certain goods or products like imported cars, computers etc which are costly in nature. Similarly, a few other goods like nails; needles etc. N all these cases a small fall or rise in prices will have insignificant effect on their demand. Hence demand for them is inelastic in nature. Commodities having normal prices are elastic in nature. H. Proportion of the expenditure on commodity: When the amount of money spent on buying a product is either too small or too big, in that case demand tends to be inelastic.
On the other hand, the amount of money spent is moderate; demand in that case tends to be elastic. I. Habits: When people are habituated for the use of a commodity, they do not care for price changes over a certain range. In that case demand tends to be inelastic. If people are not habituated for the use of any products, then demand generally tends to be elastic. J. Period of time: In the short period demand is inelastic because consumption habit of the people, customs etc do not change. On the contrary, demand tends to be elastic in the long period. K.
Level of knowledge: Demand in case of enlightened customer would be elastic and in case of ignorant customers, it would be inelastic. L. Existence of complimentary goods: Goods which are Jointly demanded are inelastic in nature. For ex: pen &ink, vehicle & petrol. If a product does not have complements in that case demand tends to be elastic. . Purchase frequency of a product: If a frequency of purchase is very high, the demand tends to be inelastic. For ex: coffee, tea etc. On the other hand if people buy a product occasionally demand tends to be elastic. For ex: radio, refrigerator etc. ) How is demand forecasting useful for managers? Answer: Demand forecasting is generally associated with forecasting sales. A firm can make use of the sales forecasts made by the industry as a powerful tool for formulating sales policy and sales strategy. Managerial uses of demand forecasting: In a short run: Demand forecasts for short periods are made on the assumption that he company has a given production capacity and the period is too short to change Production planning: It helps in determining the level of output at various periods and avoiding under or over production. Helps to formulate right purchase policy: It helps in better material management, of buying inputs and control its inventory level which cuts down cost of operation. * Helps to frame realistic pricing policy: A rational pricing policy can be formulated to suit short run and seasonal variations in demand. * Sales forecasting: It helps the company to set realistic sales targets for ACH individual salesman and for the company as a whole. * Helps in estimating short run financial requirements: It helps the company to plan the finances required for achieving the production and sales targets.
The company will be able to raise the required finance well in advance at reasonable rates of interest * Reduce the dependence on chances: The firm would be able to plan its production properly and face the challenges of competition efficiently * Helps to evolve a suitable labor policy: A proper sales and production policies help to determine the exact number of laborers to be employed in the short run. In the long run: Long run forecasting of probable for a product of a company is generally for a period of 3 to 5 or 10 years. Business planning: It helps to plan expansion of the existing unit or a new production unit. Capital budgeting of a firm is based on long run demand forecasting. Financial planning: it helps to plan long run financial requirements and investment programs by floating shares and debentures in the open market. * Manpower planning: It helps in preparing long term planning for imparting training to the existing staff and recruit skilled and efficient labor force for its long run growth.
Business control: Effective control over total costs and revenues of a company helps to determine the value and volume of business. This in its turn helps to estimate the total profits of the firm. Thus it is possible to regulate business effectively to meet the challenges of the market. * Determination of the growth rate of the firm: A steady and well conceived forecasting determine the speed at which the company can grow. * Establishment of stability in the working of the firm: Fluctuations in production cause ups and down in business which retards smooth functioning of the firm.
Demand forecasting reduces production uncertainties and help in stabilizing the activities of the firm. * Indicates interdependence of different industries: demand forecasting of particular products become the basis for demand forecasts of other related industries. * More useful in case of developed nations: It is of great use in industrially advanced countries where demand conditions fluctuate much more than supply conditions. 3) Explain production function. How is it useful for business?
Production function: The entire theory of production centre round the concept of production function. A production function” expresses 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 in the form of a table, a graph or an equation specifying maximum output rate from a given amount of inputs used. Since it relates inputs to outputs, it is also called “input-output relation”.
The production is purely physical in nature and is determined by the quantum of technology, availability of reduction function can be represented in the form of a mathematical model or equation as Q= f( L, N, K….. Etc) where Q stands for quantity of output per unit of time and L N K etc are the various factor inputs like land, capital, labor etc which are used in the production of output. The rate of output Q is thus, a function of the factor inputs L N K etc, employed by the firm per unit of time. Factor inputs are of two types: 1.
Fixed inputs: Fixed inputs are those factors the quantity of which remains constant irrespective of the level of output produced by a firm. For ex: land, building, canines, tools, equipments 2. Variable inputs: Variable inputs are those factors the quantity of which varies with variations in the levels of output produced by a firm. For ex: raw materials, power, fuel, water, transport etc Generally speaking, there are two types of production functions. They are as follows * Short Run Production Function: In this case, he producer will keep all fixed factors as constant and change only a few variable factor inputs. 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 function: Though production function may appear as highly abstract and unrealistic, in reality, it is both logical and useful. It is of immense utility to the managers and executives in the decision making process at the firm level. There are several possible combinations of inputs and decision makers have to choose the most appropriate among them. The following are some of the important uses of production function. It can be used to calculate or work out the least cost input combination for a given output or the maximum output -input combination for a given cost * It is useful in irking out an optimum, and economic combination of inputs for getting a certain level of output. The utility of employing a unit of variable factor input in the production process can be better Judged with the help of production function. Additional employment of a variable factor input is desirable only when the marginal revenue productivity of that variable factor input is greater than or equal to cost of employing it in an organization. Production function also helps in making long run decisions. If returns to scale are increasing, it is wise to employ more factor units and increase production. If returns to scale are diminishing, it is unwise to employ more factor inputs & increase production. Managers will be indifferent whether to increase or decrease production, if production is subject to constant returns to scale. 4) How do external and internal economies affect returns to scale? Answer: Law of returns to scale: The concept of returns to scale is a long run phenomenon.
In this case, we study the change in output when all factor inputs are changed or made available in required quantity. An increase in scale means that all factor inputs are increased in the same proportion. In returns to scale, all the necessary factors inputs are increased or decreased to the same extent so that whatever the scale of production, the The advantage or benefits that accrue to a firm as a result of increase in its scale of production are called economies of scale. They have close relationship with the size of the firm.
According to Proof. Marshall these economies are of two types’ internal economies and external economies. Internal economies or real economies: Internal economies are those economies which arise because of the actions of an individual firm to economies cost. They arise due to increased division of labor or visualization and complete utilization of indivisible factor inputs. Proof. Crisscross points out that internal economy are open to a single factory or a single firm independently of the actions of other firms.
They arise on account of an increase in the scale of output of a firm and cannot be achieved unless output increases. The following are some of the important aspects of internal economies. 1. They arise “with in” or “inside” a firm 2. They arise due to improvements in internal factors 3. They arise due to specific efforts of one firm 4. They are particular too firm and enjoyed by only one firm 5. They arise due to increase in the scale of production 6. They are dependent on the size of the firm 7. They can be effectively controlled by the management off firm 8.
They are called as business secrets off firm Kinds of internal economies: a) Technical economies: These economies arise on account of technological improvements and its practical application in the field of business. This further subdivided in to five heads I) Economies of superior techniques: when size of firm grows, it becomes possible to employ bigger and better types of machinery. It is bound to be cost reducing in nature. T) Economies of increased dimension: A large firm avoids wastage of time and economizes its expenditure.
Thus, an increase in dimension of a firm will reduce to cost of production. Iii) Economies of linked process: it is quite possible that a firm may not have various process of production within its own premises. Also it is possible that different firms through mutual agreement may decide to work together and derive the benefits of linked processes. ‘v) Economies arising out of research and by-products: a large firm can make use of its wastage and byproducts in the most economical manner by producing other products. Inventory economies: a big firm can save a lot of money by adopting latest inventory management techniques. B) Managerial economies: They arise because of better, efficient, and scientific management of a firm. Such economies vi) Delegation of details: the general manager of a firm cannot arise two types: look after the working of all processes of production. In order to keep an eye on each production process he has to delegate some of his powers or functions to trained or specialized personnel and thus relieve himself for co-ordination plans. This will enable to improvement in production process. Ii) Functional specialization: It is Seibel to secure economies of large scale production by dividing the work of management into several separate departments. This will ensure better and more efficient production management with scientific business administration. C) Marketing or commercial economies: These economies will arise on account of raw material and other inputs in bulk at confessional rates. As the bargaining capacity of a big firm is much greater than that of small firms, it can get quantity discounts and rebates. A firm can reduce selling cost also. ) Financial economies: They arise because of the advantages secured by firm in monopolizing huge financial resources. A large firm on account of its reputation, name and fame can mobile huge founds from money market, capital market at confessional rates. It can borrow from banks at relatively cheaper rates. E) Labor economies: these economies will arise as a result of employing skilled, trained, qualified and experienced persons by offering higher wages and salaries. It can provide good working condition, rest rooms, canteen etc. All these measures will definitely raise the average production. ) Transport and storage economies: They arise on account of the provision of better, highly organized and cheap transport and storage facilities and their complete utilization. G) Over head economies: These economies will arise on account of large scale operation. H) Economies of vertical integration: A firm can also reap this benefit when it succeeds in integrating a number of stages of production. Risk bearing or survival economies: These economies will arise as a result of avoiding or minimizing several kinds of risks and uncertainties in a business.
A large firm secures risk spreading advantages in either of the four ways or through all of them. They are diversification of output, diversification of market, diversification of source of supply, diversification of the process of manufacture. External economies or Pecuniary economies: External economies are those economies which accrue to the firms as a result of the expansion in the output of whole industry and they are not dependent on the output level of individual firms. They arise due to benefit of localization and specialized progress in the industry or religion.
Kinds of external economies: 1) Economies of concentration or agglomeration: They arise because in a particular area a very large number of firms which produce the same commodity are established. In the other word this is an advantage which arises from what is called collocation of industry. This enjoyed the benefits of cheap labor, skilled labor, marketing felicities, services, better use of by-products etc. Thus it helps in reducing cost of operation of firm 2) Economies of information: these economies will arise as a result of getting quick, latest and up to date information from various sources.
This will help in developing contact between different firms. When inter-firm relationship strengthens, it helps a lot to economies the expenditure of a single firm. 3) Economies of disintegration: These economies will arise as a result of dividing one gig unit in to different small units for the sake of convenience of management and administration. This will certainly enhance the efficiency in the working of a firm and cut down unit costs considerably. ) Economies of government action: these economies will arise as a result of active support and assistance given by the government to stimulate production in the private sector units. 5) Economies of physical factors: These economies will arise due to the availability of favorable physical factors and environment. As a size of industry expands, positive physical environment may help to reduce the costs of all firms working in the industry. ) Economies of welfare: These economies will arise on account of various welfare better position to provide welfare facilities to the workers.
All these would help in raising the overall the efficiency and productivity of workers 5) Discuss the profit minimization model. Profit -making is one of the most 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 earning capacity indicates the position , performance and status of a firm in the market. Both small ND large firms consistently make an attempt to maximize their profit by adopting novel techniques in business.
Cost reduction, cost minimization has become the slogan of a modern firm. Profit minimization model is a very simple and unambiguous model. It is the single most ideal model that can explain the normal behavior of a firm. The model profit minimization implies earning highest possible amount of profits during a given period of time. A firm has to generate largest amount of profits by building optimum productive capacity both in 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 has its own technical and managerial constraints. But in the long run 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. It is to be noted with great care that a firm has to maximize its profits after taking in to consideration of various factors in to account.
They are as follows I) Pricing and business strategies of rival firms and its impact on the working of the given firm t) Aggressive sales promotion policies adopted by rival firms in the market iii) Without inducing the workers to demand higher wages and salaries leading to rise in operation costs ‘v) Without resorting to monopolistic practices inviting gobo controls and take over v) Maintain the quality of the services to the customers v’) Taking various kinds of risks and vii) Adopting a stable business policy uncertainties viii) Avoiding any sort of clash between short run and long run profits in the business policy ‘x) Maintaining its reputation x) Profit minimization is necessary in both perfect and imperfect market Assumptions: ) Profit minimization is the main goal of the firm it) Rational behavior on the part of the firm to achieve its goal of profit minimization iii) The firm is managed by owner Determination of profit-minimization price and output Profit-minimization of a firm can be explained in two different ways 1) Total revenue and total cost approach: Profit of a firm is estimated by taking comparison between total revenue and total costs. Profit is the difference between TRY and ETC. In other words excess of revenue over costs is the profit. Profit=TRY-ETC. If TRY is equal to ETC in that case, there will be break-even point. If TRY is less than ETC, in that case a firm will be incurring losses. 2) Marginal revenue and marginal cost approach: In this case we take into account of revenue earned from one unit and cost incurred to MAC curves cuts MR. curve from below.
Two conditions are necessary for profit minimization- a) MR. = MAC b) MAC curve cut MR. curve from below Justification for profit minimization: 1) Basic objective of traditional economy theory 2) A firm is not a charitable institution 3) To predict most realistic price output behavior 4) Necessary for survival 5) To achieve other objectives Criticism: ) Ambiguous term: there is no clear cut explanation whether a firm has to maximize its net profit, total profit or the rate of profit in a business unit. 2) Profit minimization is may no possible always 3) Separation of ownership and management 4) Difficulty in getting relevant information and data 5) Conflict in inter departmental goals 6) Changes in business environment 7) Growth of oligopolies firms 8) Significance of other managerial gains 9) Emphasis on non profit goals 10) Official restriction over profits of public utilities 6) Examine the relationship between revenue concepts and price elasticity of demand. Answer: There is a very useful relationship between elasticity of demand, average revenue and marginal revenue at any level of output.
Elasticity of demand at any point on a consumers demand curve is the same thing as the elasticity on the given point on the firm’s average revenue curve. With the help of the point elasticity of demand, we can study the relationship between average revenue, marginal revenue and elasticity of demand at any level of output. Price MR. ARC output M T In the diagram AR and MR. respectively are the average revenue and the marginal revenue curves. Elasticity of demand at point R on the average revenue rev = ART/Art now in the triangles Apt and MR.. Tip = ARM (right angles) trap= RTFM (corresponding angles) Apt= MR. (being the third angle) Hence ART/ ARM / tip In the triangles Apt and KERR Pact =ARK (vertically opposite) tip = KERR (right angles) Therefore triangles Apt and ARQ are congruent (I. E. Equal in all respects) Hence, Apt Elasticity at ART / RAW -RPR= ARM/ARQ It is clear from the diagram that ARM/ARQ=ARM/ (ARM-CM) Hence elasticity at R =ARM/ARM-CM It is also clear from the diagram that ARM is average revenue and CM is the marginal revenue at the output MM which corresponds to the point R on the average revenue curve. Therefore elasticity at R= average revenue/ (average revenue- marginal revenue) If A stands for average Revenue , M stands for Marginal Revenue and e stands for point elasticity on the average revenue curve then e=A/A-M Thus, elasticity of demand is equal to AR over AR minus MR. By using the above elasticity formula, we can derive the formula for AR and MR. separately, e = A/ (A-M) this can be changed into (through cross multiplication) Therefore average revenue or price = M (e/E-l) Thus, the price per unit is equal to marginal revenue x elasticity over elasticity minus one. The marginal revenue formula can be written straight away as
A ((e-1)?) The general rule therefore is: at any output, Average Revenue= Marginal Revenue X (e-E -1) and Marginal Revenue = Average Revenue X (e-l/e) Where, e stands for point elasticity of demand on the average revenue curve. Suppose the price of a product is RSI. 8 and the elasticity is 4 at that price, Marginal Revenue will be: 6. Marginal Revenue is RSI. 6 Whenever elasticity of demand is unity, marginal revenue will be zero, whatever will be the price. It follows from this that if a demand curve shows unitary elasticity throughout its length the corresponding marginal revenue will be zero wrought, that is, the x axis itself will be the marginal revenue curve. Thus, the higher the elasticity coefficient, the closer is the MR. to AR/price.
When elasticity coefficient is one for any given price, the corresponding marginal coefficient is greater than one and marginal revenue is always negative when the elasticity coefficient is less than one. SET 2 1. Under perfect competition how is equilibrium price determined in the short and long run? Answer: The spectrum of competition ranges from perfectly competitive markets where there are many sellers who are price takers to a pure monopoly where one single supplier nominates an industry and sets price. We start our analysis of market structures by looking at perfect competition. Perfect competition – a pure market: Perfect competition describes a market structure whose assumptions are extremely strong and highly unlikely to exist in most real-time and real-world markets. The reality is that most markets are imperfectly competitive.
Nonetheless, there is some value in understanding how price, output and equilibrium is established in both the short and the long run in a market that holds true to the tough assumptions of a world of perfect competition. Establishing price and output in the short run under perfect competition: The previous diagram shows the short run equilibrium for perfect competition. In the short run, the twin forces of market demand and market supply determine the equilibrium “market-clearing” price for the industry. In the diagram below, a market price Pl is established and output IQ is produced. This price is taken by each of the firms. The average revenue curve (AR) is their individual demand curve.
Since the market price is constant for each unit sold, the AR curve also becomes the Marginal Revenue curve (MR.). For the firm, the profit maximizing output is at SQ where MAC=MR.. This output generates a total revenue (Pl x SQ). The total cost of producing this output can be calculated by multiplying the average cost of a unit of output (IAC) and the output produced. Since total revenue exceeds total cost, the firm in this example is making abnormal (economic) profits. This is not necessarily the case for all firms. It depends on their short run cost curves. Some firms may be experiencing sub-normal profits if average costs exceed the market price. For these firms, total costs will be greater than total revenue.
Short run losses The adjustment to the long-run equilibrium:elf most firms are making abnormal (or paranormal) profits, this encourages the entry of new firms into the industry, which if it happens will cause an outward shift in market supply forcing down the ruling market price. The increase in supply will eventually reduce the market price until price = long run average cost. At this point, each firm in the industry is making normal profit. Other things remaining the same, there is no further incentive for movement of firms in and out of the industry and a long-run equilibrium has been established. This is shown in the next diagram. We are assuming in the diagram above that there has been no shift in market