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These large scale farms are attracting a considerable amount of overseas development aid funding from
organisations such as the World Bank and the European Union as they are seen as being an integral part
of the export earning capacity of the country.
These readings explore the assumption that firms maximize profits, pointing out some of the ambiguities
of this assumption. It then explores how the rules of maximization apply to the firm. It considers two ways
in which the maximization principle can be used: to determine the proper levels of inputs or to determine
the proper level of output. The first leads to the rule that marginal resource cost should equal marginal
revenue product, and the second to the rule that marginal cost should equal marginal revenue. The
readings show that these two rules are equivalent and simply represented different ways of using the
information from the three constraints that a firm faces. Much of this material is quite technical, but it is at
the core of microeconomics.
Profit is maximized where MR = MC.
Profit maximization rule: Produce until the point where the change in revenue from producing 1 more unit
equals the change in cost from producing 1 more unit.
Why?
Suppose MR > MC. If I produce 1 more unit, my revenues increase by more than my costs. Therefore, if
MR > MC, producing more will increase my profit. If I can increase my profit by changing how much I
produce, then when producing where MR > MC can't be profit-maximizing.
Suppose MR < MC. If I produce 1 less unit, my revenues decrease by less than my costs decrease.
Therefor, if MR < MC, I can increase profit by decreasing output. If I can increase profit when MR < MC,
then choosing q such that MR < MC can not be profit-maximizing.
So, in order to maximize profit, I must choose a quantity q such that MR = MC.
MR = MC is an equilibrium in the sense that it is the only place where there is no incentive to change the
production level.
This rule, the profit maximization rule, is just an application of the marginal principle (MB = MC).
Why? This MB of producing an extra unit is the extra revenue you get. MR is the MB. So the 2 statements
are equivalent. The marginal principle is more general, and the profit maximization rule is specific to the
firm production decision.
6. Examine the relationship between revenue concepts and price elasticity of demand.
There is a predictable relationship between revenue and elasticity. Depending on PED, one may raise
revenue either by increasing prices and sacrificing quantity or by reducing them and outputting more.
revenues or revenue is income that a company receives from its normal business activities, usually from
the sale of goods and services to customers. In many countries, such as the United Kingdom, revenue is
referred to as turnover. Some companies receive revenue from interest, dividends or royalties paid to
them by other companies. In general usage, revenue is income received by an organization in the form of
cash or cash equivalents. Sales revenue or revenues is income received from selling goods or services
over a period of time. Tax revenue is income that a government receives from taxpayers. In more formal
usage, revenue is a calculation or estimation of periodic income based on a particular standard
accounting practice or the rules established by a government or government agency. Two common
accounting methods, cash basis accounting and accrual basis accounting, do not use the same process
for measuring revenue. Corporations that offer shares for sale to the public are usually required by law to
report revenue based on generally accepted accounting principles or International Financial Reporting
Standards. Revenues from a business's primary activities are reported as sales, sales revenue or net
sales. This excludes product returns and discounts for early payment of invoices. Most businesses also
have revenue that is incidental to the business's primary activities, such as interest earned on deposits in
a demand account. This is included in revenue but not included in net sales. Sales revenue does not
include sales tax collected by the business. Other revenue (a.k.a. non-operating revenue) is revenue from
peripheral (non-core) operations. For example, a company that manufactures and sells automobiles
would record the revenue from the sale of an automobile as "regular" revenue. If that same company also
rented a portion of one of its buildings, it would record that revenue as “other revenue” and disclose it
separately on its income statement to show that it is from something other than its core operations. A firm
considering a price change must know what effect the change in price will have on total revenue.
Generally any change in price will have two effects: the price effect: an increase in unit price will tend to
increase revenue, while a decrease in price will tend to decrease revenue. The quantity effect: an
increase in unit price will tend to lead to fewer units sold, while a decrease in unit price will tend to lead to
more units sold. Because of the inverse nature of the price-demand relationship the two effects offset
each other; in determining whether to increase or decrease prices a firm needs to know what the net
effect will be. Elasticity provides the answer. In short, the percentage change in revenue is equal to the
change in quantity demanded plus the percentage change in price. In this way, the relationship between
PED and revenue can be described for any particular good:
When the price elasticity of demand for a good is perfectly inelastic (Ed = 0), changes in the price do not
affect the quantity demanded for the good; raising prices will cause revenue to increase.
When the price elasticity of demand for a good is inelastic (|Ed| < 1), the percentage change in quantity
demanded is smaller than that in price. Hence, when the price is raised, the total revenue of producers
rises, and vice versa.
When the price elasticity of demand for a good is unit elastic (or unitary elastic) (|Ed| = 1), the percentage
change in quantity is equal to that in price and a change in price will not affect revenue.
When the price elasticity of demand for a good is elastic (|Ed| > 1), the percentage change in quantity
demanded is greater than that in price. Hence, when the price is raised, the total revenue of producers
falls, and vice versa.
When the price elasticity of demand for a good is perfectly elastic (Ed is infinite i.e. undefined), any
increase in the price, no matter how small, will cause demand for the good to drop to zero. Hence, when
the price is raised, the total revenue of producers falls to zero.
Hence, to maximise revenue, a firm ought to operate close to its unit-elasticity price.
MB0042
Set- 2
5. Explain briefly the phases of business cycle. Through what phase did the world pass in 2009-
09.
The business cycle is the periodic but irregular up-and-down movements in economic activity, measured
by fluctuations in real GDP and other macroeconomic variables.
If you're looking for information on how various economic indicators and their relationship to the business
cycle, please see A Beginner's Guide to Economic Indicators.
A business cycle is not a regular, predictable, or repeating phenomenon like the swing of the pendulum of
a clock. Its timing is random and, to a large degress, unpredictable. A business cycle is identified as a
sequence of four phases:
Contraction (A slowdown in the pace of economic activity)
Trough (The lower turning point of a business cycle, where a contraction turns into an expansion)
Expansion (A speedup in the pace of economic activity)
Peak (The upper turning of a business cycle)
A recession occurs if a contraction is severe enough... A deep trough is called a slump or a depression.
The difference between a recession and a depression, which is not well-understood by non-economists,
is explained in the article "Recession? Depression? What's the difference?". The following articles are
also useful for understanding the business cycle, and why recessions happen:
Why Don't Prices Decline During A Recession?
Do Changes in Stock Prices Cause Recessions?
Are Recessions Good For the Economy?
A Beginner's Guide to Economic Indicators
Business cycle phase 2009 is slow or negative economic growth and perhaps falling prices. As the
slowdown or recession progresses, credit demand surges as businesses run low on cash. Consumers
pay down their debts and businesses get rid of workers and reduce inventories to bring production into
line with demand.
Raw material prices fall sharply and after a lag, consumer prices slow their ascent. Finally, when the pain
of recession grows too severe for the government to tolerate, the Fed eases credit and of course the
cycle begins all over again.
Some business cycles are more severe and therefore more distinct than others. But regardless, there are
certain types of investments that are best in each stage of the business cycle. For instance, in phase one,
at the bottom of a recession, common stocks are the best place to be while bonds, real estate and
commodities are okay but gold and collectibles should be avoided.
In phase two when the economy accelerates and prices begin to climb, all commodities, including gold,
are the best investments; stocks are good and bonds are fair. During phase three of the cycle with rising
interest rates and a coming recession, equities start to weaken and bonds begin to move up.
Finally, in phase four the slowdown or recession is progressing full steam ahead. This is when fixed
income instruments, like bonds provide great returns. Late in this phase, stocks start looking good again.
Commodities and real estate should be avoided during this phase.
In January, the economy entered the second year of its recession. The magnitude of the downturn is not
unprecedented by any means. Several of the past recessions brought larger decreases in gross domestic
product and higher levels of unemployment. But the speed of the current deterioration is daunting. The
bulk of it took place in the last quarter of 2008. AIER’s statistical indicators of business-cycle conditions
continue to point to further contraction. It seems unlikely that the recession has reached its trough.
The percentage of primary leading indicators appraised as expanding fell to 17 from 20 last month. Only
two primary leading indicators—M1 money supply and the yield curve index— are appraised as
expanding, but they reflect only the expansionary monetary policy. Employment situation remains grim
and production continues to contract. As a response to a slowdown, both consumer and producer prices
began to fall.
The cyclical score, which is based on a separate purely mathematical analysis of the leaders, decreased
to 28 from 33 last month. Both the cyclical score and the percentage of leaders expanding continue to
signal that further contraction is likely.
The primary roughly coincident indicators strongly confirm that the economy is in recession. None of the
indicators is appraised as expanding. The cyclical score for the coinsiders fell to 23 from 36 last month,
reinforcing the view that the economy is in recession.
6. What are the causes of inflation? What were the causes that affected inflation in India during
the last quarter of 2009?
A sustained rise in the prices of commodities that leads to a fall in the purchasing power of a nation is
called inflation. Although inflation is part of the normal economic phenomena of any country, any increase
in inflation above a predetermined level is a cause of concern.
High levels of inflation distort economic performance, making it mandatory to identify the causing factors.
Several internal and external factors, such as the printing of more money by the government, a rise in
production and labor costs, high lending levels, a drop in the exchange rate, increased taxes or wars, can
cause inflation.
Different schools of thought provide different views on what actually causes inflation. However, there is a
general agreement amongst economists that economic inflation may be caused by either an increase in
the money supply or a decrease in the quantity of goods being supplied. The proponents of the Demand
Pull theory attribute a rise in prices to an increase in demand in excess of the supplies available. An
increase in the quantity of money in circulation relative to the ability of the economy to supply leads to
increased demand, thereby fuelling prices. The case is of too much money chasing too few goods. An
increase in demand could also be a result of declining interest rates, a cut in tax rates or increased
consumer confidence.
The Cost Push theory, on the other hand, states that inflation occurs when the cost of producing rises and
the increase is passed on to consumers. The cost of production can rise because of rising labor costs or
when the producing firm is a monopoly or oligopoly and raises prices, cost of imported raw material rises
due to exchange rate changes, and external factors, such as natural calamities or an increase in the
economic power of a certain country.
An increase in indirect taxes can also lead to increased production costs. A classic example of cost-push
or supply-shock inflation is the oil crisis that occurred in the 1970s, after the OPEC raised oil prices. The
US saw double digit inflation levels during this period. Since oil is used in every industry, a sharp rise in
the price of oil leads to an increase in the prices of all commodities. However, the central bank indicated
that, in the wake of an expected improvement in agricultural production as well as low international
commodity prices, inflationary pressures are expected to remain at a low level through the greater part of
the 2009-10. According to the report, global crude oil prices are expected to remain stable during the
current financial year, at the current level of $50 per barrel.
"If global economic recovery begins earlier and is stronger, there is an upside risk of even higher oil
prices from the current level. Assuming that there are no major crude oil supply disruptions, average WTI
(West Texas Intermediate) prices are expected to be $52.6 per barrel in 2009, which is 47 per cent lower
than the average price for the year 2008 ($99.6 per barrel). In view of the relatively tight demand supply-
balance over the long run, the long-term outlook for oil, however, remains highly uncertain," the apex
bank said.
Price-rise down due to base effect
Driven by the reduction in the administered prices of petroleum products and electricity, as well as the
decline in prices of freely priced minerals, oil items, iron & steel, oilseeds, edible oils, oil cakes and raw
cotton, year-on-year (y-o-y) headline inflation in the country showed a sharp correction from a historic
peak of 12.90 per cent on August 2, 2008 to 0.3 per cent as on March 28, 2009.
"A significant part of the end year reduction in WPI inflation could also be attributed to the base effect
reflecting the rapid increase in inflation recorded during the last quarter of 2007-08," the report said.
With the decline in prices of sugar, edible oils/oil cakes, textiles, chemicals, iron & steel and machinery &
machine tools, manufactured products' inflation fell to 1.4 per cent on March 28, 2009 compared with 7.3
per cent a year ago.
While money growth is considered to be a principal long-term determinant of inflation, non-monetary
sources, such as an increase in commodity prices, have played a key role in triggering inflation in the past
four decades.
Inflation has become a major concern worldwide in 2008, with global prices rises in oil, food, steel and
other commodities being the culprit.