MB0042 Set1

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Subject: MB0042 Managerial Economics
Assignment No: Set 1
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MB0042 Set1

Q.1 What is Price Discrimination? Explain the basis of Price Discrimination.

Answer:

Price discrimination occurs when a firm charges a different price to different groups of
consumers for an identical good or service, for reasons not associated with costs. 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 difference in cost.

Basis of Price discrimination:

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

2. Place: Markets may be divided on the basis of entry barriers. 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

4. Time: Special concession or rebates may be given during festival seasons or on important
occasions.

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

6. Special order: When the goods are made to order it is easy to charge different prices to
different customers.

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

8. Quantity of purchase: When customers buy large quantities, discount will be allowed by
the seller.

9. Geographical area: Business enterprises may charge different prices at the national and
international markets.

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

11. Special classification of consumers: For eg Transpsort authorities such as railway

and roadways show concession to students and daily travelers.

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.

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

15. Convenience of the buyer: If a customer is in a hurry, higher prices would e charged.

16. Sex: In selling certain goods, producers may discriminate between male and female
buyers by charging low prices to females.

17. Peak seasons and off peak seasons services: Hotel and transport authorities charge
different rates during peak season and off- peak seasons.

Q.2 Explain the price output determination under monopoly and oligopoly?

Answer:

Price – Output determination under Monopoly

Assumption

a. The monopoly firm aims at maximizing tit total profit.

b. It is completely free from Govt. controls

c. It charges a single & uniform high price to all customers.

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
on case of the monopoly market. While fixing the price and output, the monopoly firm
generally considers the following important aspects.

In the short run Short period is time period in which there are two types of factors of
production one is the fixed factors and the other is the variable factor. Fixed factors of
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production cannot be changed. In the short period supply can be changed only to some
extent. Volume of production can be changed but capacity of the plant cannot be changed.
In order to earn maximum revenue with marginal cost. If the marginal revenue exceeds
marginal cost of a product, the monopolist can increase his profit by increasing his
production. On the contrary, if MC exceeds MR at a particular level of output, the
monopolist can minimize his losses by reducing his production. So the monopolist is said to
be in equilibrium where marginal revenue is equal or marginal cost.

Price – out put determination in the 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. Supply can be adjusted to demand conditions. Under monopoly,
the AR or demand curve slope downward from left to right. This is because the monopolist
can crease

Generally speaking, monopoly price is slightly higher than that of competitive price because
market price is over and above MC, MR and AC. The single seller has complete control
over the supply as he can successfully prevent the entry of other new firms into the market.
Thus, the monopoly power is reflected on its price. Monopoly price is generally higher than
competitive price and thus detrimental to the interests of the society.

Price output determination under Oligopoly the term oligopoly is derived from tow Greek
words “Oligoi” means a few and ‘Poly” means to sell. Under oligopoly, we come across a
few producers specializing in the production of identical goods or differentiated goods
competing with one another.

Under oligopoly there is no one system of pricing under oligopoly market. Pricing policy
followed by a firm depends on the nature of oligopoly and rival reactions. However, we can
think of types of pricing under oligopoly.

(a) 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. Hence a firm follows
what is called is “Acceptance pricing” in the market.

(b) Pricing Under Collusion: The term collusion means to “ play together” n
economics. It means that the firms co-operate with each other I taking joint
actions to keep therir bargaining position stronger against the consumer. Firms
give place for collusion when they join their hands in order to put an end to
antagonism, uncertainty and its evils.

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(c) Price leadership: Prefect collusion is not possible in practice. Mutual suspicion
and instruct among member-firms and their unwillingness to surrender all their
sovereignty makes the collusion imperfect. Hence the dominating firm becomes
the PRICE LEADER. All other firms following the price policy of the
dominating firm in the industry are called as PRICE FOLLOWERS.

Price – rigidity and kinked demand curve under oligopoly. Each firm by its experience has
learnt what will be the reactions of rivals to actions on her part and may voluntarily avoid
any activity that will lead to the situation of price-war. Each firm is content with present
price-output and profits and it does not want to make any change. The price- leader has an
important part in forecasting the demand and cost conditions to play his role effectively,
accurately and in conformity with confidence of followers.

Reaction to price reduction: If the Oligopolist reduces his price while followers keep their
price as constant, rival firms experience reduction in their demand and sales and a drift of
customers to the Oligopolist, , they will also reduce their price to match the price reduction
of the Oligopolist.

Reaction to price increase: When the Oligopolist incre3ases his price, the followers do not
increase their prices. Hence without increasing their prices, the followers, will earn more
income.

Q.3 Give a brief Description of

(a) Total revenue and marginal revenue

(b) Implicit and Explicit Cost

Answer:

(a) Total revenue and marginal revenue

Total revenue: Total revenue refers to the total amount of money that the firm
receives from the sale of its products, i.e gross revenue. In other words, it is the total sales
receipts earned from the sale of its total output produced over a given period of time. We
may show total revenue as a function of the total quantity sold at a given price as below

TR= f(q). It implies that higher the sales larger would be the TR. Thus, TR=PxQ.
For e.g a firm sells 5000 units of a commodity at the rate of Rs 5 per unit then the TR
would be

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TR= P x Q= 5 X 5000= 25000.00

Marginal revenue (MR) Marginal revenue is the net increase in total revenue realized from
selling on more unit of a product. It is the additional revenue earned by selling an additional
unit of output by the seller.

Marginal revenue can be directly calculated by finding out the difference between the total
revenue before and after selling the additional unit of the product. Thus, marginal revenue
of the nth unit= difference in total revenue in increasing the sale from n-1 to n unit or

Marginal revenue= price of nth unit minus loss in revenue on previous units. Resulting from
price reduction.

Therefore Marginal Revenue= (Change in total revenue) divided by ( change in sales)

(b) Implicit and Explicity cost:

Implicit cost: The costs associated with an action's tradeoff. It is related to explicit costs,
which represent the actual costs of an activity, and represents a cost that is not recorded but
instead implied. For example, an employee could take a vacation and travel. The explicit
costs would include travel expenses, the cost of a hotel room, and costs related to
entertainment. The implicit costs relate to the tradeoff, namely the wages that the employee
could have earned if the vacation was not taken.

Implicit costs are what a company or individual could have earned had a different
decision been made. For example, suppose an independent consultant has two clients and
she spends some time working on the first client's project. The implicit costs are what the
consultant would have made had she worked on the second client's project instead. Implicit
costs contrast with explicit costs, which are what someone actually spends on an activity. It
is also called an indirect cost.

Explicit Cost: that is contractual in nature and definite in amount, such as rent, salaries,
wages, or utility bills. Explicit costs are easily recognizable for classification and recording.
A direct expense that the business incurs in conducting an activity. Examples of explicit
costs include salaries, wages, materials, etc. An explicit cost can be recurring, or it can be a
one-off expense. Likewise, it can be predictable, like the rent, or it can vary from time to
time, like the electric bill. Less commonly, an explicit cost is called an outlay cost.

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Q. 4 Explain the law of variable proportion.

Answer:

Assumptions of the law

1. Only one variable factor unit is to be varied while all other factors should be kept
constant.

2. Different units of a variable factor are homogeneous

3. Techniques of production remain constant

4. The law will hold good only for a short and a given period.

5. There are possibilities for varying the production of factor inputs.

The law can be stated as the following “As the quantity of different units of only one factor
input is increased to a given quantity of fixed factors, beyond a particular point, the
marginal average an total output eventually decline”

A hypothetical production schedule is worked out to explain the operation of the law.

Fixed factors-= 1 Acre of land,+ Rs 5000- capital, Variable factor = Labour

Units of
Variable
inputs TP in AP in MP in
(Labour) units units units
0 0 0 0
1 10 10 10
2 24 12 14
3 39 13 15
4 52 13 13
5 60 12 8
6 66 11 6
7 70 10 4
8 72 9 2
9 72 8 0
10 70 7 -2
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Stage I. The law of increasing returns. The total output increases at an increasing rate (more
than proportionately)

Stage II. The law of diminishing returns: In this stage as the quantity of variable inputs in
increased to a given quantity of fixed factors, output increases less than proportionately.

Stage III. The stage of negative returns: In this stage as the quantity of variable input is
increased to a given quantity of fixed factors, output becomes negative.

Q. 5 What is Elasticity of Demand? Explain the factors determining it.

Answer:

In economic the term elasticity refers to a ratio of the relative changes in two quantities. It
measures the responsiveness of one variable to the changes in another variable.

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. Elasticity of demand indicates a ratio
of relative changes in two quantities. i.e., price and demand. Elasticity of demand measures
the responsiveness of demand to changes in price. The elasticity of demand in a market is
great or small according to the amount demanded much or little for a given fall in price, and
diminishes much or little for a given rise in price.

There are different types of elasticity of demand.

a) Price elasticity of demand

b) Income elasticity of demand

c) Cross elasticity of demand.

d) Promotional elasticity of demand.

f) Substitution Elasticity.

Factors determining Elasticity of demand

a) Substitutes: The more substitutes, the higher the elasticity, as people can easily
switch from one good to another if a minor price change is made

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b) Percentage of income: The higher the percentage that the product's price is of the
consumer's income, the higher the elasticity, as people will be careful with
purchasing the good because of its cost

c) Amount of income available to spend on the good - This factor affecting demand
elasticity refers to the total a person can spend on a particular good or service. Thus,
if the price of a can of Coke goes up from $0.50 to $1 and income stays the same,
the income that is available to spend on coke, which is $2, is now enough for only
two rather than four cans of Coke. In other words, the consumer is forced to reduce
his or her demand of Coke. Thus if there is an increase in price and no change in the
amount of income available to spend on the good, there will be an elastic reaction in
demand; demand will be sensitive to a change in price if there is no change in
income.

d) Necessity: The more necessary a good is, the lower the elasticity, as people will
attempt to buy it no matter the price, such as the case of insulin for those that need
it.

e) Duration: The longer a price change holds, the higher the elasticity, as more and
more people will stop demanding the goods (i.e. if you go to the supermarket and
find that blueberries have doubled in price, you'll buy it because you need it this
time, but next time you won't, unless the price drops back down again.

Q. 6 What is marginal efficiency of capital? Decribe the factor determine MEC.

Answer:

Marginal Efficiency Of Capital It refers to productivity of capital. It may be defined as

the highest rate of return over cost accruing from a 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.

a) Prospective yield from the capital asset and

b) 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 life time. After deducting the variable cost
laid cost of raw materials, wages etc from the marginal revenue productivity of capital and
investor can estimate the prospective income from the capital asset.

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The MEC of a particular type of asset means what an investor expects to earn from an
additional unit of it compared with what it cost him.

The MEC can be calculated with the half of the following formula,

Cr = Q1 Q2 Q3 Qn

(1+r)1 (1+r)2 (1+r)3 (1+r)n

In the above formula Cr represents Supply price or replacement cost of the new capital
asset. Q1, Q2, Q3 indicate the prospective yields in the various year 123… and n represents
the rate of discounts which will make the present value of the series of the annual returns
just equal to the supply price of capital asset. Thus, r denotes the rate of discount or MEC.

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 arise in investment and vice =versa.

3. Higher propensity to consume: leading to a rise in MEC encourages higher

investment.

4. Change in income: An increase in income will simulate investment and thus MEC
will decline in the level of incomes will discourage investment.

5. Current state of expectation: If the current rates of returns are high the MEC is
bound to be high for new projects of investment and vice-versa.

6. State of business confidence: During the period of optimism (Boom) the MEC will
be generally be high and during period of pessimism (depression0, it will be
generally less.

7. Rate of growth of population: In a capitalist economy, a high rate of population

growth leads to an increase in MEC because it leads to an increase in the demand for
both consumption and investment goods.

8. Development of new areas: Developments activities in the new fields like transport
and communications, generally of electricity, construction of irrigations projects,
ports etc would lead to a rise in MEC.

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9. Technological progress: Technological progress would lead to the development and

use of highly sophisticated and latest machines equipments and instruments.

10. Productive capacity of existing capital equipment: Under utilized existing capital
assets may be fully utilized if the demand for goods increases in the economy.

11. The rate of current investment: If the current rate of investment is already high, there
would be little scope for furthered investment and as such the MEC declines.

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