1
EXECUTIVE DIPLOMA EXAMINATIONS
EXECUTIVE MBA
MANAGERIAL ECONOMICS
Ans 1) Managerial economics is a science that deals with the application of various economic
theories, principles, concepts and techniques to business management in order to solve business
and management problems. It deals with the practical application of economic theory and
methodology to decision-making problems faced by private, public and non-profit making
organizations.
The same idea has been expressed by Spencer and Seigelman in the following words.
“Managerial Economics is the integration of economic theory with business practice for the
purpose of facilitating decision making and forward planning by the management” .According
to Mc Nair and Meriam, “Managerial economics is the use of economic modes of thought to
analyze business situation”. Brighman and Pappas define managerial economics as,” the
application of economic theory and methodology to business administration practice”.Joel
dean is of the opinion that use of economic analysis in formulating business and management
policies is known as managerial economics.
Managerial economics is a highly specialized and new branch of economics developed in recent
years. It highlights on practical application of principles and concepts of economics in to
business decision making process in order to find out optimal solutions to managerial problems.
It fills up the gap between abstract economic theory and managerial practice. It lies mid-way
between economic theory and business practice and serves as a connecting link between the two.
Ans 2)
Necessary conditions for price discrimination
Condition 1
There must be some imperfection of the market. If there were perfect competition, price
discrimination would be impossible since the individual producer could have no influence on
price. At least some degree of monopoly power is therefore necessary so that producers have
some ability to make rather than take the market price.
Condition 2
The discriminating supplier must be able to split the market into separate sections and keep them
separate, such that it is difficult to transfer the seller?s product from one sector to another i.e.
there must be no „seepage? between markets in the sense that goods can be bought in the cheaper
market and re-sold in the dearer.
Barriers between markets may be:
2
o Geographical in that customers are separated by distance e.g. the international dumping of
cheap goods, where goods are sold overseas at prices below those in the home market, and often
below the cost of production e.g. the East European Communist block countries used to sell their
exports to the West at lower prices than those prevailing in domestic markets to earn hard foreign
currency.
o Temporal in that customers are separated by time e.g. it may be cheaper to travel by train after
9.30am than before 9.30 am, and the two markets can be kept separate as ticket office staff will
not sell the cheaper tickets until after this time
o According to customer type so that customers are separated according to some easily identified
feature of the customers themselves e.g. age, sex, income or occupation; examples of this would
include cheaper theatre tickets for children, old age pensioners and the unemployed, reduced
price rail travel for students and higher private physician consultation fees for those who are
perceived as being able to pay more.
The two conditions discussed so far would make price discrimination possible, but for it to also
be profitable a third condition must also be satisfied:
Condition 3
Price elasticity of demand in each market must be different; if this were the case , the
discriminating supplier would increase price in the market with an inelastic demand curve, and
reduce price where demand is elastic in order to increase total revenue and profits. If the
elasticity of demand in each market was the same at each and every price, a common price would
be charged in both markets as this price would represent the profit maximising price in each
market where MC = MR. You might wish to refer back at this stage to where we discussed the
relationship between price elasticity of demand and total revenue.
Third Degree (Multi-Market) Price Discrimination
This is the most frequently found form of price discrimination and involves charging different
prices for the same product in different segments of the market.
The key is that third degree discrimination is linked directly to consumers’ willingness and
ability to pay for a good or service. It means that the prices charged may bear little or no relation
to the cost of production.
he market is usually separated in two ways: by time or by geography. For example, exporters
may charge a higher price in overseas markets if demand is estimated to be more inelastic than it
is in home markets.
In the peak market the firm will produce where MRa = MC and charge price Pa, and in the off-
peak market the firm will produce where MRb = MC and charge price Pb. Consumers with an
inelastic demand will pay a higher price (Pa) than those with an elastic demand who will be
charged Pb.
3
Ans 3)Utility of demand analysis for business firms
Demand is driven by utility – the pleasure or satisfaction that a consumer obtains from
consuming a good or service. Total utility is a function of the quantities of goods/services
consumed and the quantities of work done. What is more relevant is the notion of marginal
utility – the additional utility that comes from consuming one additional unit of a good or
service. This feeds into the law of diminishing marginal utility – at some point, marginal utility
will always decrease. (For related reading, see Economic Basics: Utility.)
Consumers maximize their utility by consuming up to the point where the marginal utility is at
zero. Consumption is a byproduct of disposable income, where disposable income equals gross
income minus net taxes. Expressed differently, disposable income is also equal to the sum of
consumption and saving.
The total demand for goods and services within an economy is the aggregate demand. Aggregate
demand (often expressed as "Y") is the sum of consumer demand, investment spending,
government spending and net exports. The curve of aggregate demand is downward-sloping, as
demand declines as prices increase.
a)Promotional elasticity
Promotional Elasticity of Demand is a relatively new concept introduced thru innovative
Marketing Techniques. As a pure theory it is not acceptable. Practically it can be stated as a
Short Period fluctuations in demand. Promotional Elasticity is found once in a Life Cycle of the
Product.
Promotional Elasticity of Demand may be defined as "sum of relative change (ealier being Zero)
found in the demand with direct reference to the promotional aspects over a small period of
4
observation". It is mostly useful in testing the crowd-demand pulling strength of a Model
choosen to promote a market.
Recent Example: Bank of Baroda used Rahul Dravid to have unprecendented growth in Savings
Bank Accounts opened in a very short period. Infact they had exceeded all targets. This was the
direct effect of using "Promotion" and the demand was positively perfect elastic, with Rahul
Dravid's promotional presence.
b)Cross elasticity
he relative response of a change in the demand for one good to a change in the price of another
good. More specifically the cross elasticity of demand is percentage change in the demand for
one good due to a percentage change in the price of another good. This notion of elasticity
captures the other prices demand determinant. Three other notable elasticities are the price
elasticity of demand, the price elasticity of supply, and the income elasticity of demand.
The cross elasticity of demand quantifies the theoretical relationship between the price of one
good and the demand for another good as identified by the other prices demand determinant. A
positive cross elasticity indicates a substitute good and a negative cross elasticity exists for
a complement good.
cross elasticity of demand is often summarized by this handy formula:
cross elasticity
of demand
=
percentage change
in demand for good 1
percentage change
in price of good 2
In theory, the cross elasticity of demand is specified in terms of the "percentage change in
demand." The reason is that other prices affect demand not quantity demanded.
However, in practice, the cross elasticity of demand is calculated as the percentage change in
"quantity" resulting from the percentage change the price of another good. In other words, the
calculation is based on the change in quantity from one value to another.
c)Demand schedules vs demand functions
Difference Between a Demand Function and a Demand Curve
Demand curve
Demand is what the consumer can and is willing to buy at a given price over a given time period.
Analyzing demand is a complicated process that takes into account many variables. Economists
and businesses use the demand curve and its functions to calculate demand and price for
services, labor, goods and other economic factors. Demand indicates the desirability of a specific
product. Gauging demand correctly allows a business to determine how to supply the demand
without surplus.
5
Demand Function
The demand function is what the consumer prefers regarding goods and services. Every person
has an individual demand for the goods and services available in the market. The level of
demand depends on the value a specific consumer places on the product and its product. If the
purchase and consumption of the product satisfy the consumer, the business has successfully met
the demand.
Ans 4) “Can a monopolist charge any price for their product”?
Be careful of saying that "monopolies can charge any price they like" - this is wrong. It is true
that a firm with monopoly has price-setting power and will look to earn high levels of profit.
However the firm is constrained by the position of its demand curve. Ultimately a monopoly
cannot charge a price that the consumers in the market will not bear.
A pure monopolist is the sole supplier in an industry and, as a result, the monopolist can take the
market demand curve as its own demand curve. A monopolist therefore faces a downward
sloping AR curve with a MR curve with twice the gradient of AR. The firm is a price maker and
has some power over the setting of price or output. It cannot, however, charge a price that the
consumers in the market will not bear. In this sense, the position and the elasticity of the demand
curve acts as a constraint on the pricing behaviour of the monopolist. Assuming that the firm
aims to maximise profits (where MR=MC) we establish a short run equilibrium as shown in the
diagram below.
Assuming that the firm aims to maximise profits (where MR=MC) we establish a short run
equilibrium as shown in the diagram below.
6
The profit-maximising output can be sold at price P1 above the average cost AC at output Q1.
The firm is making abnormal "monopoly" profits (or economic profits) shown by the yellow
shaded area. The area beneath ATC1 shows the total cost of producing output Qm. Total costs
equals average total cost multiplied by the output.
Ans 5)
a) Marginal cost vs incremental costs
According to "The Free Dictionary," incremental cost is the cost of adding or subtracting one
extra unit of product or output. For example, a restaurant is only allowed to seat 100 people, per
the fire department regulations. The restaurant is doing well, and wants to seat 101 people or
more. The owners will have to build an addition with extra fire escape doors. The restaurant will
have to incur thousands of dollars of building costs for the addition, just to seat one extra person.
Understanding Marginal Cost
? A marginal cost is slightly different from an incremental cost. According to the National
Productivity Council of India, or NPCI, marginal cost is the original cost plus the extra cost of
producing an extra unit of output, resulting in a total cost. In the restaurant example, the original
pre-existing building costs are added in to the new cost of building the addition, resulting in a
total cost.
Differences of Costs
? The NPCI notes that a small difference does exist between the two costs. This difference is more
philosophical in nature than in "hard numbers." Marginal costs deal with adding or subtracting
output. Incremental costs are based on the decision to add or subtract output. In the restaurant
example, the owners calculate the cost of building the addition. The question, however, is to
whether build the addition or not.
b) Business costs vs full costs
Business costs are the expenses which are related to the operation of a business, or to the
operation of a device, component, piece of equipment or facility. They are the cost of resources
used by an organization just to maintain its existence. For a commercial interprise, operating
costs fall into two broad categories:
? fixed costs, which are the same whether the operation is closed or running at 100% capacity.
Fixed Costs include items such as the rent of the building. These generally have to be paid
regardless of what state the business is in.
? variable costs, which may increase depending on whether more production is done, and how
it is done
Full cost
A managerial accounting method that describes when all fixed and variable costs, including
manufacturing costs, are used to compute the total cost per unit. Full costing includes these costs
7
when computing the amount of money it takes to produce and distribute one unit of output.
Full costing is also known as "full costs" or "absorption costing".
c) Actual costs vs Imputed costs
A cost that is incurred by virtue of using an asset instead of investing it or undertaking an
alternative course of action. An imputed cost is an invisible cost that is not incurred directly, as
opposed to an explicit cost, which is incurred directly.
Imputed cost is also known as "implied cost" or "opportunity cost".
Actual costs
An actual amount paid or incurred, as opposed to estimated cost or standard cost. In
contracting, actual costs amount includes direct labor, direct material, and other direct charges.
he cost a company pays or is paid for a good or service. The actual cost may be more or less than
the estimated cost. For example, acar shop may estimate that repairs will cost $700, but the actu
al cost may in fact be $800. One often is not informed of the actual costuntil it is incurred
d)Private vs social cost
he difference between these two is that private costs are only one part of overall social costs.
Social costs take into account not only private costs, but also the externalities that come as a
result of a given economic decision.
Private costs are the costs with which we are all familiar. These are the costs that we actually
have to pay when we decide to do something. Let us take the example of owning and driving a
car. Clearly, there are many private costs involved here. If I own and drive a car, I have to buy
the car. Then I have to pay for the gas I use. I have to maintain the car. I have to buy
insurance. I have to spend time in the car being unable to do much else other than driving.
These are all private costs because I actually have to pay them and they are specific to me.
Social costs also include the externalities of driving my car. When I drive my car, it contributes
to some extent to polluting the atmosphere. I do not directly pay for this, but it affects society.
When I drive my car, I contribute to traffic congestion. Again, I do not pay for this, but I have at
least a marginal effect on many other people who are also stuck in congestion, wasting their
time.
Social costs is a category that includes both the more tangible private costs and the external costs
of any given economic activity.
doc_938149516.docx
EXECUTIVE DIPLOMA EXAMINATIONS
EXECUTIVE MBA
MANAGERIAL ECONOMICS
Ans 1) Managerial economics is a science that deals with the application of various economic
theories, principles, concepts and techniques to business management in order to solve business
and management problems. It deals with the practical application of economic theory and
methodology to decision-making problems faced by private, public and non-profit making
organizations.
The same idea has been expressed by Spencer and Seigelman in the following words.
“Managerial Economics is the integration of economic theory with business practice for the
purpose of facilitating decision making and forward planning by the management” .According
to Mc Nair and Meriam, “Managerial economics is the use of economic modes of thought to
analyze business situation”. Brighman and Pappas define managerial economics as,” the
application of economic theory and methodology to business administration practice”.Joel
dean is of the opinion that use of economic analysis in formulating business and management
policies is known as managerial economics.
Managerial economics is a highly specialized and new branch of economics developed in recent
years. It highlights on practical application of principles and concepts of economics in to
business decision making process in order to find out optimal solutions to managerial problems.
It fills up the gap between abstract economic theory and managerial practice. It lies mid-way
between economic theory and business practice and serves as a connecting link between the two.
Ans 2)
Necessary conditions for price discrimination
Condition 1
There must be some imperfection of the market. If there were perfect competition, price
discrimination would be impossible since the individual producer could have no influence on
price. At least some degree of monopoly power is therefore necessary so that producers have
some ability to make rather than take the market price.
Condition 2
The discriminating supplier must be able to split the market into separate sections and keep them
separate, such that it is difficult to transfer the seller?s product from one sector to another i.e.
there must be no „seepage? between markets in the sense that goods can be bought in the cheaper
market and re-sold in the dearer.
Barriers between markets may be:
2
o Geographical in that customers are separated by distance e.g. the international dumping of
cheap goods, where goods are sold overseas at prices below those in the home market, and often
below the cost of production e.g. the East European Communist block countries used to sell their
exports to the West at lower prices than those prevailing in domestic markets to earn hard foreign
currency.
o Temporal in that customers are separated by time e.g. it may be cheaper to travel by train after
9.30am than before 9.30 am, and the two markets can be kept separate as ticket office staff will
not sell the cheaper tickets until after this time
o According to customer type so that customers are separated according to some easily identified
feature of the customers themselves e.g. age, sex, income or occupation; examples of this would
include cheaper theatre tickets for children, old age pensioners and the unemployed, reduced
price rail travel for students and higher private physician consultation fees for those who are
perceived as being able to pay more.
The two conditions discussed so far would make price discrimination possible, but for it to also
be profitable a third condition must also be satisfied:
Condition 3
Price elasticity of demand in each market must be different; if this were the case , the
discriminating supplier would increase price in the market with an inelastic demand curve, and
reduce price where demand is elastic in order to increase total revenue and profits. If the
elasticity of demand in each market was the same at each and every price, a common price would
be charged in both markets as this price would represent the profit maximising price in each
market where MC = MR. You might wish to refer back at this stage to where we discussed the
relationship between price elasticity of demand and total revenue.
Third Degree (Multi-Market) Price Discrimination
This is the most frequently found form of price discrimination and involves charging different
prices for the same product in different segments of the market.
The key is that third degree discrimination is linked directly to consumers’ willingness and
ability to pay for a good or service. It means that the prices charged may bear little or no relation
to the cost of production.
he market is usually separated in two ways: by time or by geography. For example, exporters
may charge a higher price in overseas markets if demand is estimated to be more inelastic than it
is in home markets.
In the peak market the firm will produce where MRa = MC and charge price Pa, and in the off-
peak market the firm will produce where MRb = MC and charge price Pb. Consumers with an
inelastic demand will pay a higher price (Pa) than those with an elastic demand who will be
charged Pb.
3
Ans 3)Utility of demand analysis for business firms
Demand is driven by utility – the pleasure or satisfaction that a consumer obtains from
consuming a good or service. Total utility is a function of the quantities of goods/services
consumed and the quantities of work done. What is more relevant is the notion of marginal
utility – the additional utility that comes from consuming one additional unit of a good or
service. This feeds into the law of diminishing marginal utility – at some point, marginal utility
will always decrease. (For related reading, see Economic Basics: Utility.)
Consumers maximize their utility by consuming up to the point where the marginal utility is at
zero. Consumption is a byproduct of disposable income, where disposable income equals gross
income minus net taxes. Expressed differently, disposable income is also equal to the sum of
consumption and saving.
The total demand for goods and services within an economy is the aggregate demand. Aggregate
demand (often expressed as "Y") is the sum of consumer demand, investment spending,
government spending and net exports. The curve of aggregate demand is downward-sloping, as
demand declines as prices increase.
a)Promotional elasticity
Promotional Elasticity of Demand is a relatively new concept introduced thru innovative
Marketing Techniques. As a pure theory it is not acceptable. Practically it can be stated as a
Short Period fluctuations in demand. Promotional Elasticity is found once in a Life Cycle of the
Product.
Promotional Elasticity of Demand may be defined as "sum of relative change (ealier being Zero)
found in the demand with direct reference to the promotional aspects over a small period of
4
observation". It is mostly useful in testing the crowd-demand pulling strength of a Model
choosen to promote a market.
Recent Example: Bank of Baroda used Rahul Dravid to have unprecendented growth in Savings
Bank Accounts opened in a very short period. Infact they had exceeded all targets. This was the
direct effect of using "Promotion" and the demand was positively perfect elastic, with Rahul
Dravid's promotional presence.
b)Cross elasticity
he relative response of a change in the demand for one good to a change in the price of another
good. More specifically the cross elasticity of demand is percentage change in the demand for
one good due to a percentage change in the price of another good. This notion of elasticity
captures the other prices demand determinant. Three other notable elasticities are the price
elasticity of demand, the price elasticity of supply, and the income elasticity of demand.
The cross elasticity of demand quantifies the theoretical relationship between the price of one
good and the demand for another good as identified by the other prices demand determinant. A
positive cross elasticity indicates a substitute good and a negative cross elasticity exists for
a complement good.
cross elasticity of demand is often summarized by this handy formula:
cross elasticity
of demand
=
percentage change
in demand for good 1
percentage change
in price of good 2
In theory, the cross elasticity of demand is specified in terms of the "percentage change in
demand." The reason is that other prices affect demand not quantity demanded.
However, in practice, the cross elasticity of demand is calculated as the percentage change in
"quantity" resulting from the percentage change the price of another good. In other words, the
calculation is based on the change in quantity from one value to another.
c)Demand schedules vs demand functions
Difference Between a Demand Function and a Demand Curve
Demand curve
Demand is what the consumer can and is willing to buy at a given price over a given time period.
Analyzing demand is a complicated process that takes into account many variables. Economists
and businesses use the demand curve and its functions to calculate demand and price for
services, labor, goods and other economic factors. Demand indicates the desirability of a specific
product. Gauging demand correctly allows a business to determine how to supply the demand
without surplus.
5
Demand Function
The demand function is what the consumer prefers regarding goods and services. Every person
has an individual demand for the goods and services available in the market. The level of
demand depends on the value a specific consumer places on the product and its product. If the
purchase and consumption of the product satisfy the consumer, the business has successfully met
the demand.
Ans 4) “Can a monopolist charge any price for their product”?
Be careful of saying that "monopolies can charge any price they like" - this is wrong. It is true
that a firm with monopoly has price-setting power and will look to earn high levels of profit.
However the firm is constrained by the position of its demand curve. Ultimately a monopoly
cannot charge a price that the consumers in the market will not bear.
A pure monopolist is the sole supplier in an industry and, as a result, the monopolist can take the
market demand curve as its own demand curve. A monopolist therefore faces a downward
sloping AR curve with a MR curve with twice the gradient of AR. The firm is a price maker and
has some power over the setting of price or output. It cannot, however, charge a price that the
consumers in the market will not bear. In this sense, the position and the elasticity of the demand
curve acts as a constraint on the pricing behaviour of the monopolist. Assuming that the firm
aims to maximise profits (where MR=MC) we establish a short run equilibrium as shown in the
diagram below.
Assuming that the firm aims to maximise profits (where MR=MC) we establish a short run
equilibrium as shown in the diagram below.
6
The profit-maximising output can be sold at price P1 above the average cost AC at output Q1.
The firm is making abnormal "monopoly" profits (or economic profits) shown by the yellow
shaded area. The area beneath ATC1 shows the total cost of producing output Qm. Total costs
equals average total cost multiplied by the output.
Ans 5)
a) Marginal cost vs incremental costs
According to "The Free Dictionary," incremental cost is the cost of adding or subtracting one
extra unit of product or output. For example, a restaurant is only allowed to seat 100 people, per
the fire department regulations. The restaurant is doing well, and wants to seat 101 people or
more. The owners will have to build an addition with extra fire escape doors. The restaurant will
have to incur thousands of dollars of building costs for the addition, just to seat one extra person.
Understanding Marginal Cost
? A marginal cost is slightly different from an incremental cost. According to the National
Productivity Council of India, or NPCI, marginal cost is the original cost plus the extra cost of
producing an extra unit of output, resulting in a total cost. In the restaurant example, the original
pre-existing building costs are added in to the new cost of building the addition, resulting in a
total cost.
Differences of Costs
? The NPCI notes that a small difference does exist between the two costs. This difference is more
philosophical in nature than in "hard numbers." Marginal costs deal with adding or subtracting
output. Incremental costs are based on the decision to add or subtract output. In the restaurant
example, the owners calculate the cost of building the addition. The question, however, is to
whether build the addition or not.
b) Business costs vs full costs
Business costs are the expenses which are related to the operation of a business, or to the
operation of a device, component, piece of equipment or facility. They are the cost of resources
used by an organization just to maintain its existence. For a commercial interprise, operating
costs fall into two broad categories:
? fixed costs, which are the same whether the operation is closed or running at 100% capacity.
Fixed Costs include items such as the rent of the building. These generally have to be paid
regardless of what state the business is in.
? variable costs, which may increase depending on whether more production is done, and how
it is done
Full cost
A managerial accounting method that describes when all fixed and variable costs, including
manufacturing costs, are used to compute the total cost per unit. Full costing includes these costs
7
when computing the amount of money it takes to produce and distribute one unit of output.
Full costing is also known as "full costs" or "absorption costing".
c) Actual costs vs Imputed costs
A cost that is incurred by virtue of using an asset instead of investing it or undertaking an
alternative course of action. An imputed cost is an invisible cost that is not incurred directly, as
opposed to an explicit cost, which is incurred directly.
Imputed cost is also known as "implied cost" or "opportunity cost".
Actual costs
An actual amount paid or incurred, as opposed to estimated cost or standard cost. In
contracting, actual costs amount includes direct labor, direct material, and other direct charges.
he cost a company pays or is paid for a good or service. The actual cost may be more or less than
the estimated cost. For example, acar shop may estimate that repairs will cost $700, but the actu
al cost may in fact be $800. One often is not informed of the actual costuntil it is incurred
d)Private vs social cost
he difference between these two is that private costs are only one part of overall social costs.
Social costs take into account not only private costs, but also the externalities that come as a
result of a given economic decision.
Private costs are the costs with which we are all familiar. These are the costs that we actually
have to pay when we decide to do something. Let us take the example of owning and driving a
car. Clearly, there are many private costs involved here. If I own and drive a car, I have to buy
the car. Then I have to pay for the gas I use. I have to maintain the car. I have to buy
insurance. I have to spend time in the car being unable to do much else other than driving.
These are all private costs because I actually have to pay them and they are specific to me.
Social costs also include the externalities of driving my car. When I drive my car, it contributes
to some extent to polluting the atmosphere. I do not directly pay for this, but it affects society.
When I drive my car, I contribute to traffic congestion. Again, I do not pay for this, but I have at
least a marginal effect on many other people who are also stuck in congestion, wasting their
time.
Social costs is a category that includes both the more tangible private costs and the external costs
of any given economic activity.
doc_938149516.docx