Human Resources/Managerial Economics
I am doing MBA General in Annamalai University. If you give me the answers for the below questions related to the subject of Managerial Economics it will be very greatful to you. Thanks in advance
Write a short notes on:
(a) Discounting principle.
(b) Define ‘Law of Demand”
(c) What are Giffen goods?
(d) Break-Even Point.
(e) Customary pricing.
(f) Kinked demand curve.
(g) Gross Domestic product.
(h) What is Iso-Quants?
(a) Discounting principle.
One of the fundamental ideas in Economics is that a rupee tomorrow is worth less than a rupee today.Suppose a person is offered a choice to make between a gift of Rs.100/- today or Rs.100/- next year. Naturally he will chose Rs.100/- today. This is true for two reasons-i) The future is uncertain and there may be uncertainty in getting Rs. 100/- if the present opportunityis not availed of ii) Even if he is sure to receive the gift in future, today’s Rs.100/- can be invested so as to earninterest say as 8% so that one year after Rs.100/- will become 108
Examples of Discounting Principles
You use discounting principles to determine the value of something in the future, compared to its present day value. The reasoning behind the discounting principle is that an amount of money you have in your hands today is worth more than money you have the potential for having at some future time. You would rather have $100 today than wait until tomorrow for the same amount of money.
Discounting Principle Defined
The discounting principle requires you to look at the value of a sum of money in the present day and compare it to the value of the money after an amount of time. You need to do this if you are in a situation where you will use the money at a future date. The value of the future amount of money is known as the present value. To find the present value, you need to discount the amount of interest the money could earn if you were to place it in an interest earning account. The formula used to find the discount factor is PV = Amount/ (1+i). PV means "present value," and "i" stands for the interest on the account.
Saving Money In a Bank
An example of when the discounting principle comes into play is saving money in a bank account that earns interest. If you receive $100 from someone and place it in an account that earns 10 percent interest yearly, you will have $110 in a year's time. But if you wanted to have $100 next year in that same 10 percent interest account, you would need to deposit $90 in the account today.
Determing Value of Future Payments
You also use discounting principles to determine the value of a future payment or future revenue. For example, if a customer wishes to purchase $100 worth of merchandise from you in a year, you will end up with less money than if he were to buy $100 worth of merchandise from you today, as you will not be able to place the money in an account or have it earn interest. To make up for the lost revenue, you may consider increasing the price for future purchases.
The discounting principle is also at play in some types of loans, known as discounted loans. Usually when you borrow money, you borrow a sum, then pay interest on that amount as you repay. You end up re-paying more than the original amount of the loan. With a discount loan, the total interest due on the loan is subtracted from the principal at the start, so you receive the principal minus the interest you will have to pay on the loan. For example, instead of receiving a loan of $5,000 and paying back a total of $5,500, you would receive $4,500 and pay back $5,000. Typically, discount loans are short-term.
(b) Define ‘Law of Demand”
'Law Of Demand'
A microeconomic law that states that, all other factors being equal, as the price of a good or service increases, consumer demand for the good or service will decrease and vice versa.
This law summarizes the effect price changes have on consumer behavior. For example, a consumer will purchase more pizzas if the price of pizza falls. The opposite is true if the price of pizza increases.
In economics, the law of demand is an economic law that states that consumers buy more of a good when its price decreases and less when its price increases .
The greater the amount to be sold, the smaller the price at which it is offered must be, in order for it to find purchasers.
Law of demand states that the amount demanded of a commodity and its price are inversely related, other things remaining constant. That is, if the income of the consumer, prices of the related goods, and tastes and preferences of the consumer remain unchanged, the consumer’s demand for the good will move opposite to the movement in the price of the good.
Every law will have limitation or exceptions. While expressing the law of demand, the assumptions that other conditions of demand were unchanged. If remain constant, the inverse relation may not hold well. In other words, it is assumed that the income and tastes of consumers and the prices of other commodities are constant. This law operates when the commodity’s price changes and all other prices and conditions do not change. The main assumptions are
• Habits, tastes and fashions remain constant.
• Money, income of the consumer does not change.
• Prices of other goods remain constant.
• The commodity in question has no substitute or is not competed by other.
• The commodity is a normal good and has no prestige or status value.
• People do not expect changes in the prices.
(c) What are Giffen goods?
Exceptions to the law of demand
Generally, the amount demanded of good increases with a decrease in price of the good and vice versa. In some cases, however, this may not be true. Such situations are explained below.
As noted earlier, if there is an inferior good of which the positive income effect is greater than the negative substitution effect, the law of demand would not hold. For example, when the price of potatoes (which is the staple food of some poor families) decreases significantly, then a particular household may like to buy superior goods out of the savings which they can have now due to superior goods like cereals, fruits etc., not only from these savings but also by reducing the consumption of potatoes. Thus, a decrease in price of potatoes results in decrease in consumption of potatoes. Such basic good items (like bajra, barley, grain etc.) consumed in bulk by the poor families, generally fall in the category of Giffen goods. It should be noted that not all inferior goods are giffen goods, but all giffen goods are inferior goods. This is similar to how all men are humans but not all humans are men. A walkman is considered an inferior good but would not be a Giffen good.
Commodities which are used as status symbols
Some expensive commodities like diamonds, air conditioned cars, etc., are used as status symbols to display one’s wealth. The more expensive these commodities become, the higher their value as a status symbol and hence, the greater the demand for them. The amount demanded of these commodities increase with an increase in their price and decrease with a decrease in their price. Also known as a Veblen good.
(d) Break-Even Point.
The BREAK EVEN POINT is , in general ,the point at which the gains equal
the losses. A break even point defines when an investment
will generate a positive return. The point where sales or revenues equal expenses. Or also the point where total costs equal total revenues. There is no profit made or loss incurred at the break-even point. This is important for anyone that manages a business, since the break¬even point is the lower limit of profit when prices are set and margins are determined.
(b) Achieving Break-even today does not return the losses occurred in the past. Also it does not build up a reserve for future losses. And finally it does not provide a return on your investment (the reward for exposure to risk).
(c) The Break-even method can be applied to a product, an investment, or the entire company's operations and is also used in the options world. In options, the Break-even Point is the market price that a stock must reach for option buyers to avoid a loss if they exercise. For a Call, it is the strike price plus the premium paid. For a Put, it is the strike price minus the premium paid.
(d) THE RELATIONSHIP BETWEEN FIXED COSTS, VARIABLE COSTS AND RETURNS
(e) Break-even analysis is a useful tool to study the relationship between fixed costs, variable costs and returns. The Break-even Point defines when an investment will generate a positive return. It can be viewed graphically or with simple mathematics. Break-even analysis calculates the volume of-production at a given price necessary to cover all costs. Break-even price analysis calculates the price necessary at a given level of production to cover all costs. To explain how break-even analysis works, it is necessary to define the cost items.
(f) Fixed costs, which are incurred after the decision to enter into a business activity is made, are not directly related to the level of production. Fixed costs include, but are not limited to, depreciation on equipment, interest costs, taxes and general overhead expenses. Total fixed costs are the sum of the fixed costs.
(g) Variable costs change in direct relation to volume of output. They may include cost of goods sold or production expenses, such as labor and electricity costs, feed, fuel, veterinary, irrigation and other expenses directly related to the production of a commodity or investment in a capital asset. Total variable costs (TVC) are the sum of the variable costs for the specified level of production or output. Average variable costs are the variable costs per unit of output or of TVC divided by units of output.
(h) The Break-even Point analysis must not be mistaken for the Payback Period, the time it takes to recover an investment.
(i) In Value Based Management terms, a break-even point should be defined as the Operating Profit margin level at which the business / investment is earning exactly the minimum acceptable Rate of Return, that is, its total cost of capital.
(j) BREAK-EVEN POINT CALCULATION
(k) Calculation of the BEP can be done using the following formula:
(l) BEP = TFC / (SUP - VCUP)
(n) • BEP = break-even point (units of production)
(o) • TFC = total fixed costs,
(p) • VCUP = variable costs per unit of production,
(q) • SUP = selling price per unit of production.
(r) BENEFITS OF BREAK-EVEN ANALYSIS
(s) The main advantage of break-even analysis is that it explains the relationship between cost, production volume and returns. It can be extended to show how changes in fixed cost-variable cost relationships, in commodity prices, or in revenues, will affect profit levels and break-even points. Break-even analysis is most useful when used with partial budgeting or capital budgeting techniques. The major benefit to using break-even analysis is that it indicates the lowest amount of business activity necessary to prevent losses.
(t) LIMITATIONS OF BREAK-EVEN ANALYSIS
(u) • It is best suited to the analysis of one product at a time;
(v) • It may be difficult to classify a cost as all variable or all fixed; and
(w) • There may be a tendency to continue to use a break-even analysis after the cost and income functions have changed.
(e) Customary pricing.
Customary pricing:- is where the product "traditionally" sells for a certain price. Candy bars of a certain weight all cost a predictable amount -- unless you purchase them in an airport shop.
• (f) Kinked demand curve.
The assumption behind this theory of kinked demand is that each oligopolistic will act and react in a way that keeps condition tolerable for all members of the industry.Such a situation is most likely to occur where products are quite similar and, therefore their prices almost same.
3. If one firm is selling at a price lower than that of its competitors, these competitors will be compelled to reduce their prices to match this firm’s price.On the other hand if one firm decides to sell at a higher price its competitors do not react by raising their price.So, in the first situation (i.e. Price reduction) the firm does not gain, while the latter the firm loses its customer to its rival.The oligopoly firm probably realises that it is better to accommodate its rival rather than start a price war.So in non-collusive oligopoly the prices is tend to be sticky i.e, there is a price rigidity.3Contd……..
• 4. The most significant aspect of the solution of an oligopoly situation is the presence of kink in the demand curve of the firm.The kink shows that price reduction by a firm is followed by its rival(competitors).Therefore firm will not move away from the kink. 4
• 5. The Key characteristics of an Oligopolistic Market there are few buyers and large number of sellersFew firms sell branded products which are close substitutes of each other. Entry barriers for the other firms are high; the barriers can be due to patents, copyrights, government rules / regulations or ownership of scare resources.Firms are interdependent for decision making. Products can be homogenous (standardized) or heterogeneous (differentiated). The sellers are the price makers and not price takers, since the few sellers mutually dominate the pricing decisions.
• 6. In this graph dd’ is the individual demand curve and the firm market- share DD’ intersecting at E.It is believed that if an oligopolistic reduces his price he expect his competitors will follow the same, while no competitors will follow when he raise the price. The relevant demand curve of the firm is, therefore, dED’ (with a kink at E). For a price reduction below P, the share of the market demand curve D’E is relevant as the countermoves by the rival will keep the market share of the firm constant.And, for prices increases above P, the firm goes alone and, therefore, the relevant demand curve for the firm is its own demand curve dEIf price increases are ignored by other firms but price decreases lead to lowering of prices by competitors the firm will face a kinked demand curve as shown to the right, with the kink at the current market price of P* 6
• 7. For finding out the profit maximizing price-output combination, MR curve corresponding to kinked demand dD has been drawn.MR curve associated with kinked demand curve dD is always is discontinuous The length of this discontinuity depends upon relative elastics of two segments dk and kD of the demand curve.Between MR & dD which has a discontinuous gap HR.When MC curve of the oligopolistic passes through discontinuous HR through point E oligopolist maximizing its profit at prevailing OP price level.Thus it will no encourage to price changes.When the marginal cost curves shifts upwards from MC to MC’ due to rise in cost the output remain unchanged since the new MC’ also passes through HR 7REASONS FOR PRICE RIGIDITYREASON-1Fig:- Changes in the cost within limits do not affect the oligopoly price
• 8. Likewise when demand condition changes the price may remain stable.The demand for oligopolist from dkD to d’k’D’ the marginal cost curve MC also cuts the new MR’ curve within the gapThus same price OP continues to prevail(Mk= M’k’) in the oligopolistic firm8CHANGES IN DEMAND DO NOT AFFECT THE OLIGOPOLY PRICEREASON 2
• 9. Criticism /drawback……The kinked demand curve model has been criticised on several counts:-There are also some other valid explanation for price rigidity, such as nationally advertised prices, catalogued prices, reluctance to disrupt customers relations, and fears that recurrent price cuts may trigger a price war.The model does not explain how the firm arrive at the kink in the first place. 9
• 10. Conclusion:In conclusion, we can opine that mutual interdependence among the firms and price rigidity are two typical features in oligopoly market. Although the firms are rivals, they are mutually interdependent. No firms likes to resort price change which will harm his business. Hence price competition is not significant is oligopoly market.10
• 11. 11
(g) Gross Domestic product.
The monetary value of all the finished goods and services produced within a country's borders in a specific time period, though GDP is usually calculated on an annual basis. It includes all of private and public consumption, government outlays, investments and exports less imports that occur within a defined territory.
GDP = C + G + I + NX
"C" is equal to all private consumption, or consumer spending, in a nation's economy
"G" is the sum of government spending
"I" is the sum of all the country's businesses spending on capital
"NX" is the nation's total net exports, calculated as total exports minus total imports. (NX = Exports - Imports)
GDP is commonly used as an indicator of the economic health of a country, as well as to gauge a country's standard of living. Critics of using GDP as an economic measure say the statistic does not take into account the underground economy - transactions that, for whatever reason, are not reported to the government. Others say that GDP is not intended to gauge material well-being, but serves as a measure of a nation's productivity, which is unrelated.
What is GDP and why is it so important?
The gross domestic product (GDP) is one the primary indicators used to gauge the health of a country's economy. It represents the total dollar value of all goods and services produced over a specific time period - you can think of it as the size of the economy. Usually, GDP is expressed as a comparison to the previous quarter or year. For example, if the year-to-year GDP is up 3%, this is thought to mean that the economy has grown by 3% over the last year.
Measuring GDP is complicated (which is why we leave it to the economists), but at its most basic, the calculation can be done in one of two ways: either by adding up what everyone earned in a year (income approach), or by adding up what everyone spent (expenditure method). Logically, both measures should arrive at roughly the same total.
The income approach, which is sometimes referred to as GDP(I), is calculated by adding up total compensation to employees, gross profits for incorporated and non incorporated firms, and taxes less any subsidies. The expenditure method is the more common approach and is calculated by adding total consumption, investment, government spending and net exports.
As one can imagine, economic production and growth, what GDP represents, has a large impact on nearly everyone within that economy. For example, when the economy is healthy, you will typically see low unemployment and wage increases as businesses demand labor to meet the growing economy. A significant change in GDP, whether up or down, usually has a significant effect on the stock market. It's not hard to understand why: a bad economy usually means lower profits for companies, which in turn means lower stock prices. Investors really worry about negative GDP growth, which is one of the factors economists use to determine whether an economy is in a recession.
(h) What is Iso-Quants?
An isoquant is a curve that shows all combinations of inputs that will produce the same level of output, provided that the inputs are used in a technologically efficient manner (i.e., it is the maximum output you can get for a combination of inputs (L,K)).
The quantities of the two inputs (usually K and L in our examples, but they can be other inputs) are measured on the axes.
The relationship is that an isoquant is a graphical representation of a production function such as Q = f(K,L,F). If we change the production function to be Q = g(K,L,F) then we’d get a different isoquant map.
2. Isoquants are downward-sloping, non-intersecting, convex curves. Explain the basis for each of these characteristics.
Isoquants must slope downward so long as each input is productive and has a positive marginal product. Hence, the only way to maintain constant output after increasing the quantity of one input is to decrease the quantity of the other.
Isoquants cannot intersect. If they did, it would mean that the same combination of inputs produces two technically efficient (maximum) levels of output, which is not possible.
Isoquants are convex because, as the first input becomes scarcer and the second input more abundant, it becomes more difficult to substitute one input for another and keep output constant. That is, as you downward (to the right) along a convex isoquant, for one-unit increases in Labor, the decline in capital becomes less and less (since labor becomes less and less productive; diminishing MPL). Or similarly, as you move downward (to the right) along a convex isoquant, for one unit decreases in Capital, the increase in labor necessary to stay at the same production level is greater and greater (because of diminishing MPL).
3. For a particular combination of capital and labor we know that the marginal product of capital is 6 units of output and that the marginal rate of technical substitution is 3 units of capital per unit of labor. What is the marginal product of labor?
MRTS = MPL/MPK so 3 = MPL/6 thus MPL = 18.
4. If a firm’s isoquants were straight lines, what would that imply about the two inputs? Is this realistic – give an example of why or why not?
This would indicate that they are perfectly substitutable, which is not particularly realistic since for most products it typically takes at least some labor to make them, even if it’s just a person to maintain or program a machine.
5. If a firm’s isoquants were L-shaped, what would that imply about the two inputs? Is this realistic – give an example of why or why not?
This would indicate that they are perfect complements and will be used in fixed proportions, which is more realistic since many production processes require a given ratio of L to K, such as 1 worker per 1 computer. One could also think of products for which 2 workers utilize one machine, or vice versa.