ms-09 solved assignment dec 2014

8/10/2019 MS-09 Solved Assignment Dec 2014

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ASSIGNMENT

Course Code : MS-9

Course Title : Managerial Economics

Assignment Code : 9/TMA/SEM-II/2013

Coverage : All Blocks

Note: Attempt all the questions and submit this assignment on or before 31stOctober, 2013 to the

coordinator of your study centre.

1. Explain the discounting principle. Using the discounting principle calculate the present

value of an annuity of five years at Rs. 500 payments made at the end of each of the next

five years at 10% interest.

2. With reference to the marketing approach of demand measurement explain any two

important sources of data used in demand forecasting.

3. How are Isoquants different from Isocost? Illustrate using graphs.

4. An analytical tool frequently employed by managerial economists is the break even chart,

an important application of cost functions. Discuss this statement giving examples from

any firm.

5. Describe how oligopolistic competition exists in the real world giving examples from

FMCG Companies.

6. Write short notes on the following:

(a) Product Differentiation

(b) Equi - Marginal Principle

(c) The Price Elasticity of Demand
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1. Explain the discounting principle.Using the discounting principlecalculate the present value of an

annuity of five years at Rs. 500payments made at the end of each ofthe next five years at 10% interest.

One of the fundamental ideas in economics is that adollar tomorrow is worth less than a dollar today. Thisseems similar to the saying that a bird in hand is worth

two in the bush. A simple example would make thispoint clear. Suppose a person is offered a choice tomake between a gift of 100$ today or 100$ next year.Naturally he will choose the 100$ today.

This is true for two reasons. First, the future isuncertain and there may be uncertainty in getting

100$ if the present opportunity is not availed of.Secondly, even if he is sure to receive the gift infuture, todays 100$ can be invested so as to earninterest, say, at 8 percent so that. one year after the100$ of today will become 108$ whereas if he doesnot accept 100$ today, he will get 100$ only in the

next year. Naturally, he would prefer the firstalternative because he is likely to gain by 8$ in future.Another way of saying the same thing is that the valueof 100$ after one year is not equal to the value of100$ of today but less than that. To find out how muchmoney today is equal to 100$ would earn if onedecides to invest the money. Suppose the rate of
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interest is 8 percent. Then we shall have to discount100$ at 8 per cent in order to ascertain how muchmoney today will become 100$ one year after.

( Source :http://www.mbaknol.com/managerial-economics/discounting-principle-in-managerial-economics/)

The formula is:

PV = 100/(1+i)

where,

PV = Present Value

i = Rate of Interest.

Now, applying the formula, we get PV = 92.59$

If we multiply 92.59$ by 1.08, we shall get the amountof money, which will accumulate at 8 per cent afterone year.

The same reasoning applies to longer periods. A sumof 100$ two years from now is worth:

PV= 100/(1+i)2

Similarly, we can also check by computing how muchthe cumulative interest will be after two years. Theprinciple involved in the above discussion is called thediscounting principleand is stated as follows: If adecision affects costs and revenues at future dates, itis necessary to discount those costs and revenues to
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present values before a valid comparison ofalternatives is possible.===================================================

calculate the present value of an annuity offive years at Rs. 500 payments made at theend of each of the next five years at 10%interest.

The answer is

1 year =454.5

2.year ==867.7

3.year===1234.3

4.year====1584.1

5.year=====1894.6

######################

2. With reference to the marketingapproach of demand measurement

explain any two important sources ofdata used in demand forecasting.

Delphi METHOD.


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The Delphi technique helps to capture the knowledge of

diverse experts while avoiding the disadvantages of

traditional group meetings. The latter include bullying and

time-wasting.

To forecast with Delphi the administrator should recruitbetween five and twenty suitable experts and poll them for

their forecasts and reasons. The administrator then

provides the experts with anonymous summary statistics

on the forecasts, and experts reasons for their forecasts.

The process is repeated until there is little change in

forecasts between roundstwo or three rounds are usually

sufficient. The Delphi forecast is the median or mode of the

experts final forecasts.

The forecasts from Delphi groups are substantially more

accurate than forecasts from unaided judgement and

traditional groups, and are somewhat more accurate than

combined forecasts from unaided judgement.

========================================Extrapolation METHOD

Extrapolation methods use historical data on that which

one wishes to forecast. Exponential smoothing is the most

popular and cost effective of the statistical extrapolation

methods. It implements the principle that recent data

should be weighted more heavily and smoothes out

cyclical fluctuations to forecast the trend. To useexponential smoothing to extrapolate, the administrator

should first clean and deseasonalise the data, and select

reasonable smoothing factors. The administrator then

calculates an average and trend from the data and uses

these to derive a forecast


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Statistical extrapolations are cost effective when forecasts

are needed for each of hundreds of inventory items. They

are also useful where forecasters are biased or ignorant of

the situation .

Allow for seasonality when using quarterly, monthly, ordaily data. Most firms do this . Seasonality adjustments led

to substantial gains in accuracy in the large-scale study of

time series .

Uncertainties in Demand Forecasting

Demand forecasts are subject to error anduncertainty which arise from three differentsources:

Data about past and present market

Methods of forecasting

Environment change

Data about past and present market:

The analysis of past and present markets, whichserve as the springboard for the projection exercise,may be vitiated by the following inadequacies ofdata:


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Lack of Standardization: Data pertaining tomarket features like product, price, quantity, cost,income, etc. may not reflect uniform concepts andmeasures.

Few observations: observations available toconduct meaningful analysis may not be enough.

Influence of abnormal factors: Some of theobservations may be influenced by abnormal factorslike war or natural calamity.

Method of forecasting:

Methods used for demand forecasting arecharacterized by the following limitations:

Inability to handle unquantifiable factors:mostof the forecasting methods, being quantitative innature, cannot handle unquantifiable factors which

sometimes can be of immense significance.

Unrealistic assumptions: Each forecastingmethod is based on certain assumptions. Forexample, the trend projection method is based onthe mutually compensating affects premise and theend use method is based on the constancy of

technical coefficients. Uncertainty arises when theassumptions underline the chosen method tend tobe realistic and erroneous.

Exercise data requirement:In general, the moreadvanced a method, the greater the datarequirement. For example, to use an econometric


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model one has to forecast the future values ofexplanatory variables in order to project theexplained variable.

Environmental Changes:

The environment in which a business functions ischaracterized by numerous uncertainties. Theimportant sources of uncertainty are mentionedbelow:

Technological Change: This is a very important

and very hard-to-predict factor which influencesbusiness prospects. A technological advancementmay create a new product which performs the samefunction more efficiently and economically, therebycutting into the market for the existing product. Forexample, electronic watches are encroaching on themarket for mechanical watches.

Shift in Government Policy: Governmentresolution of business may be extensive. Changes ingovernment policy, which may be difficult toanticipate, could have a telling effect on thebusiness environment.

Development on the International Scene:

Development on the International Scene may havea profound effect on industries.

Discovery of New Sources of Raw Material:Discovery of new sources of raw materials,particularly hydrocarbons, can have a significanteffect on the market situation of several products.


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Vagaries of Monsoon: Monsoon, if plays animportant role in the economy of a country, issomewhat unpredictable. The behavior of monsooninfluences, directly or indirectly, the demand for a

wide range of products.

Coping with Uncertainties:

Given the uncertainties in demand forecasting,adequate efforts, along the following lines, may bemade to cope with uncertainties.

Conduct analysis with data based on uniformand standard definitions.

In identifying trends, coefficients, andrelationships, ignore the abnormal and out-of-the-ordinary observations.

Critically evaluate the assumptions of the

forecasting methods and choose a methodwhich is appropriate to situation.

Adjust the projections derived from quantitativeanalysis in the light of unquantifiable, butsignificant, influences.

Monitor the environment imaginatively toidentify important changes.

Consider likely alternative scenarios and theirimpact on market and competition.

Conduct sensitivity analysis to access theimpact on the size of demand for unfavorable


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and favorable variations of the determiningfactors from their most likely levels.

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3. How are Isoquants different fromIsocost? Illustrate using graphs.

Isoquant is also called as equal product curve or

production indifference curve or constant product curve.

Isoquant indicates various combinations of two factors ofproduction which give the same level of output per unit of

time. The significance of factors of productive resources

is that, any two factors are substitutable e.g. labour is

substitutable for capital and vice versa. No two factors are

perfect substitutes. This indicates that one factor can be

used a little more and other factor a little less, without

changing the level of output.

It is a graphical representation of various combinations of

inputs say Labour(L) and capital (K) which give an equal

level of output per unit of time. Output produced by

different combinations of L and K is say, Q, then Q=f (L,

K). Just as we demonstrate the MRSxy in respect of

indifference curves through hypothetical data, wedemonstrate the Marginal Rate of Technical Substitution

of factor L for K (MRTSL,K )

Assumptions


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1.There are two factor inputs labour and capital2.The proportions of factor are variable.3.Physical production conditions are given4.The Scale of operation is variable

5.The state of technology remains constant

The shape of Isoquant

In this section we examine the characteristics of

isoquants, define the economic region ofproduction and

consider the special cases where the commodities can

only be produced with least cost factor combination.We can see that the shape of isoquant plays an important

a role in the production theory as the shape of indifference

curve in the consumption theory. Iso quant map shows all

the possible combinations of labour and capital that can

produce different levels of output. The iso quant closer to

the origin indicates a lower level of output. The slope ofiso quant is indicated as =MRSLk=

Table indicating various combinations of Labour and

Capital to produce 1500 Units of Output

COMBINATIONSUNITS OF

CAPITAL

UNITS OF

LABOUR

TOTAL

OUTPUT

A 50(OK) 1 (OL1) 1500(IQ1)

B 45(OK2) 2(OL2) 1500(IQ1)


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C 41(OK3) 3(OL3) 1500(IQ1)

D 38(OK4) 4(OL4) 1500(IQ1)

Properties/Characteristics of Isoquants

Isoquants, abbreviated as IQs, possess the same properties as

those of the indifference curves. For the convenience of the

students, we can state them as follows.

1.Two isoquants do not intersect each other:
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1. No isoquant can touch either axis

1. Isoquant is oval in shape
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1. A higher IQ implies a higher level of output
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1.IQs are never parallel to each other. Interspacingbetween them is least at the ends and maximum in

the middle.

2.IQs are convex to the origin: convex isoquantspossess continuous substitutability of K and L over astretch. Beyond this stretch, K and L are not

substitutable foe each other.

3.IQs may be linear when labour and capital areperfect substitute. A linear isoquant implies that

either factor can be used in proportion. If isoquant

has several linear segments separated by kinks, theisoquant is called kinked isoquant or activity analysis

isoquant or linear programming isoquant. Such

isoquants are used in linear programming.

4.If Land K are prefect complements to each other,the IQ is L-shaped. Such isoquant is known a input-

output isoquant or Leontief isoquant. There is only

one combination of L and K available for

production. It is the corner point of L-shaped

isoquant.

5.If marginal product of one of the two factors is zero,IQ is parallel to the axis on which the factor with

zero marginal products is represented.

6.If one of the two factors has negative marginalproduct the IQ slopes upwards from left to right.7.If both the factors have negative marginal products,

the IQ is concave to the origin.

8.If the producer has a preference for a factor ofproduction, the IQ is quasi linear.


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9.If the factors to be employed in whole numbers unitsonly. The IQ is discontinuous.

Isocost curves:

Isocost curve is the locus traced out by various

combinations of L and K, each of which costs the

producer the same amount of money (C ) Differentiating

equation with respect to L, we have dK/dL = -w/rThis

gives the slope of the producers budget line (isocost

curve). Iso cost line shows various combinations of

labour and capital that the firm can buy for a given factorprices. The slope of iso cost line = PL/Pk. In this

equation , PL is the price of labour and Pk is the price of

capital. The slope of iso cost line indicates the ratio of the

factor prices. A set of isocost lines can be drawn for

different levels of factor prices, or different sums of

money. The iso cost line will shift to the right when

money spent on factors increases or firm could buy moreas the factor prices are given.

Slope of iso cost line

With the change in the factor prices the slope of iso cost

lien will change. If the price of labour falls the firm could

buy more of labour and the line will shift away from theorigin. The slope depends on the prices of factors of

production and the amount of money which the firm

spends on the factors. When the amount of money spent

by the firm changes, the isocost line may shift but its

slope remains the same. A change in factor price makes


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changes in the slope of isocost lines as shown in the

figure.


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Least Cost Factor Combination or Producers

Equilibrium or Optimal Combination of Inputs

The firm can achieve maximum profits by choosing that

combination of factors which will cost it the least. Thechoice is based on the prices of factors of production at a

particular time. The firm can maximize its profits either

by maximizing the level of output for a given cost or by

minimizing the cost of producing a given output. In both

cases the factors will have to be employed in optimal

combination at which the cost of production will be

minimum. The least cost factor combination can bedetermined by imposing the isoquant map on isocost line.

The point of tangency between the isocost and an

isoquant is an important but not a necessary condition for

producers equilibrium. The essential condition is that the

slope of the isocost line must equal the slope of the

isoquant. Thus at a point of equilibrium marginal

physical productivities of the two factors must be equal

the ratio of their prices. The marginal physical product

per rupee of one factor must be equal to tht of the other

factor. And isoquant must be convex to the origin. The

marginal rate of technical substitution of labour for

capital must be diminishing at the point of equilibrium.


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The Economicregion of production

The firm would not operate on the positively sloped

portion of an isoquant because it could produce the same

level of quantity with less capital and labour. Economic

region of Production:

Ridge lines: separate the relevant (i.e. negatively sloped)from the irrelevant (or the positively sloped) portion of

the isoquant.

Ridge lines joins points on the various isoquants where

the isoquants have zero slope (and thus zero MRTSlk) .
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Isoquants

In economics, an isoquant(derived from quantity

and the Greek word iso, meaning equal) is a

contour linedrawn through the set of points at

which the same quantity of output is produced

while changing the quantities of two or moreinputs. While an indifference curve mapping helps

to solve the utility-maximizing problem of

consumers, the isoquant mapping deals with the

cost-minimization problem of producers. Isoquants

are typically drawn on capital-labor graphs,

showing the technological tradeoff between capitaland labor in the production function, and the

decreasing marginal returns of both inputs. Adding

one input while holding the other constant

eventually leads to decreasing marginal output,

and this is reflected in the shape of the isoquant. A

family of isoquants can be represented by anisoquant map, a graph combining a number of

isoquants, each representing a different quantity of

output. Isoquants are also called equal product

curves.
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An isoquant map where Q3 > Q2 > Q1. A typical choice of inputs would be laborfor input Xand capital for input Y. More of input X, input Y, or both is required to move from isoquant Q1

to Q2, or from Q2 to Q3.

A) Example of an isoquant map with two inputs that are perfect substitutes.

B) Example of an isoquant map with two inputs that are perfect complements.

Ineconomics,an isoquant(derived from quantity and the Greek word iso,
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Production Isoquant/IsocostCurve

An isoquant shows the extent to which the firm inquestion has the ability to substitute between thetwo different inputs at will in order to produce thesame level of output. An isoquant map can alsoindicate decreasing or increasing returns to scalebased on increasing or decreasing distancesbetween the isoquant pairs of fixed outputincrement, as output increases. If the distancebetween those isoquants increases as outputincreases, the firm's production function isexhibiting decreasing returns to scale; doublingboth inputs will result in placement on an isoquantwith less than double the output of the previousisoquant. Conversely, if the distance is decreasingas output increases, the firm is experiencingincreasing returns to scale; doubling both inputs
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results in placement on an isoquant with morethan twice the output of the original isoquant.

As with indifference curves, two isoquants cannever cross. Also, every possible combination ofinputs is on an isoquant. Finally, any combinationof inputs above or to the right of an isoquantresults in more output than any point on theisoquant. Although the marginal product of aninput decreases as you increase the quantity of theinput while holding all other inputs constant, themarginal product is never negative in theempirically observed range since a rationalfirmwould never increase an input to decrease output.

Shapes of Isoquants

If the two inputs are perfect substitutes, theresulting isoquant map generated is represented in

fig. A; with a given level of production Q3, input Xcan be replaced by input Y at an unchanging rate.The perfect substitute inputs do not experiencedecreasing marginal rates of return when they aresubstituted for each other in the productionfunction.

If the two inputs are perfect complements, theisoquant map takes the form of fig. B; with a levelof production Q3, input X and input Y can only becombined efficiently in the certain ratio occurringat the kink in the isoquant. The firm will combinethe two inputs in the required ratio to maximizeprofit.
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Isoquants are typically combined withisocostlinesin order to solve a cost-minimization problem forgiven level of output. In the typical case shown inthe top figure, with smoothly curved isoquants, a

firm with fixed unit costs of the inputs will haveisocost curves that are linear and downwardsloped; any point of tangency between an isoquantand an isocost curve represents the cost-minimizing input combination for producing theoutput level associated with that isoquant. A line

joining tangency points of isoquants and isocosts

(with input prices held constant) is called theexpansion path.

The only relevant portion of the isoquant is theone that is convex to the origin, part of the curvewhich is not convex to the origin implies negativemarginal product for factors of production. Thehigher the isoquant, the higher the production

=========================

Isocost

In economicsan isocostline shows allcombinations of inputs which cost the same totalamount. Although similar to the budget constraint
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in consumer theory, the use of the isocost linepertains to cost-minimization in production, asopposed to utility-maximization. For the twoproduction inputslabour and capital, with fixed

unit costs of the inputs, the equation of the isocostline is

where w represents the wage rate of labour, rrepresents the rental rate of capital, K is theamount of capital used, L is the amount of labour

used, and C is the total cost of acquiring thosequantities of the two inputs.

The absolute value of the slope of the isocost line,with capital plotted vertically and labour plottedhorizontally, equals the ratio of unit costs of labourand capital. The slope is:

The isocost line is combined with the isoquantmapto determine the optimal production point at anygiven level of output. Specifically, the point oftangency between any isoquant and an isocost linegives the lowest-cost combination of inputs that

can produce the level of output associated withthat isoquant. Equivalently, it gives the maximumlevel of output that can be produced for a giventotal cost of inputs. A line joining tangency pointsof isoquants and isocosts (with input prices heldconstant) is called the expansion path.[
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The cost-minimization problem

The cost-minimization problem of the firm is tochoose an input bundle (K,L) feasible for theoutput level ythat costs as little as possible. Acost-minimizing input bundle is a point on theisoquant for the given ythat is on the lowest

possible isocost line. Put differently, a cost-minimizing input bundle must satisfy twoconditions:

1.it is on the y-isoquant2.no other point on the y-isoquant is on a lower

isocost line.


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The case of smooth isoquants convex to theorigin

If the y-isoquant is smooth and convex to theorigin and the cost-minimizing bundle involves apositive amount of each input, then at a cost-minimizing input bundle an isocost line is tangentto the y-isoquant. Now since the absolute value ofthe slope of the isocost line is the input cost ratio

, and the absolute value of the slope of an

isoquant is the marginal rate of technicalsubstitution(MRTS), we reach the followingconclusion: If the isoquants are smooth andconvex to the origin and the cost-minimizing inputbundle involves a positive amount of each input,then this bundle satisfies the following twoconditions:
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It is on the y-isoquant (i.e. F(K, L) = ywhere Fis theproduction function), and

the MRTS at (K, L) equals w/r.

The condition that the MRTS be equal to w/rcanbe given the following intuitive interpretation. Weknow that the MRTS is equal to the ratio ofthemarginal products of the two inputs. So thecondition that the MRTS be equal to the input costratio is equivalent to the condition that themarginal product per dollar is equal for the two

inputs. This condition makes sense: at a particularinput combination, if an extra dollar spent on input1 yields more output than an extra dollar spent oninput 2, then more of input 1 should be used andless of input 2, and so that input combinationcannot be optimal. Only if a dollar spent on eachinput is equally productive is the input bundle

optimal.

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4. An analytical tool frequentlyemployed by managerial economists isthe break even chart, an importantapplication of cost functions. Discuss

this statement giving examples fromany firm.
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Break-even analysis is a technique widely used by production

management and management accountants. It is based on

categorising production costs between those which are

"variable" (costs that change when the production output

changes) and those that are "fixed" (costs not directly related to

the volume of production).

Total variable and fixed costs are compared with sales revenue

in order to determine thelevel of sales volume, sales value or

production at which the business makes neither a profit nor

a loss (the "break-even point").

The Break-Even Chart

In its simplest form, the break-even chart is a graphicalrepresentation of costs at various levels of activity shown on the

same chart as the variation of income (or sales, revenue) with

the same variation in activity. The point at which neither profit

nor loss is made is known as the "break-even point" and is

represented on the chart below by the intersection of the two

lines:

The BREAK EVEN POINT is , in general ,the point atwhich the gains equalthe losses. A break even point defines when aninvestmentwill generate a positive return. The point where sales orrevenues equal expenses. Or also the point where totalcosts equal total revenues. There is no profit made or lossincurred at the break-even point. This is important foranyone that manages a business, since the breakevenpoint is the lower limit of profit when prices are set andmargins are determined.

Achieving Break-even today does not return the lossesoccurred in the past. Also it does not build up a reserve forfuture losses. And finally it does not provide a return onyour investment (the reward for exposure to risk).


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The Break-even method can be applied to a product, aninvestment, or the entire company's operations and is alsoused in the options world. In options, the Break-even Pointis the market price that a stock must reach for optionbuyers to avoid a loss if they exercise. For a Call, it is the

strike price plus the premium paid. For a Put, it is thestrike price minus the premium paid.

THE RELATIONSHIP BETWEEN FIXED COSTS,VARIABLE COSTS AND RETURNSBreak-even analysis is a useful tool to study therelationship between fixed costs, variable costs andreturns. The Break-even Point defines when an

investment will generate a positive return. It can be viewedgraphically or with simple mathematics. Break-evenanalysis calculates the volume of-production at a givenprice necessary to cover all costs. Break-even priceanalysis calculates the price necessary at a given level ofproduction to cover all costs. To explain how break-evenanalysis works, it is necessary to define the cost items.

Fixed costs,which are incurred after the decision to enter

into a business activity is made, are not directly related tothe level of production. Fixed costs include, but are notlimited to, depreciation on equipment, interest costs, taxesand general overhead expenses. Total fixed costs are thesum of the fixed costs.

Variable costschange in direct relation to volume ofoutput. They may include cost of goods sold or productionexpenses, such as labor and electricity costs, feed, fuel,

veterinary, irrigation and other expenses directly related tothe production of a commodity or investment in a capitalasset. Total variable costs (TVC) are the sum of thevariable costs for the specified level of production oroutput. Average variable costs are the variable costs perunit of output or of TVC divided by units of output.

The Break-even Point analysis must not be mistaken for


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the Payback Period, the time it takes to recover aninvestment.

In Value Based Management terms, a break-even pointshould be defined as the Operating Profit margin level atwhich the business / investment is earning exactly theminimum acceptable Rate of Return, that is, its total costof capital.

BREAK-EVEN POINT CALCULATIONCalculation of the BEP can be done using the followingformula:

BEP =TFC / (SUP - VCUP)

where:

BEP = break-even point (units of production) TFC = total fixed costs, VCUP = variable costs per unit of production, SUP = selling price per unit of production.

BENEFITS OF BREAK-EVEN ANALYSIS

The main advantage of break-even analysis is that itexplains the relationship between cost, productionvolume and returns. It can be extended to show howchanges in fixed cost-variable cost relationships, incommodity prices, or in revenues, will affect profit levelsand break-even points. Break-even analysis is mostuseful when used with partial budgeting or capitalbudgeting techniques. The major benefit to using break-

even analysis is that it indicates the lowest amount ofbusiness activity necessary to prevent losses.

LIMITATIONS OF BREAK-EVEN ANALYSIS

It is best suited to the analysis of one product at atime;

It may be difficult to classify a cost as all variable orall fixed; and


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There may be a tendency to continue to usea break-even analysis after the cost and income functionshave changed.

Break-Even and Target Income

CVPanalysis is used to build an understanding ofthe relationship between costs, business volume,

and profitability. This analysis will drive decisionsabout what products to offer and how to price them.CVP is at the heart of techniques used to calculatebreak-even, volume levels necessary to achievetargeted income levels, and similar computations.The starting point for these calculations is thecontribution margin.

The contribution margin is revenues minusvariable expenses. Do not confuse the contributionmargin with gross profit. Gross profit is calculatedafter deducting all manufacturing costs associatedwith sold units, whether fixed or variable.

Instead, the contribution margin reflects the

amount available from each sale, after deducting allvariable costs associated with the units sold. Someof these variable costs are product costs, and someare selling and administrative in nature. Thecontribution margin is generally calculated forinternal use and is not externally reported.


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MARGIN: AGGREGATE, PER UNIT, OR RATIO?

One might refer to contribution margin on anaggregate, per unit, or ratio basis. This point isillustrated for Leyland Sports, a manufacturer ofscoreboards. The production cost is $500 per sign,and Leyland pays its sales representatives $300 persign sold. Thus, variable costs are $800 per sign.Each signs sells for $2,000. Leylands contributionmargin is $1,200 ($2,000 - ($500 + $300)) persign. In addition, assume that Leyland incurs$1,200,000 of fixed cost.

Following are schedules with contribution margininformation, assuming production and sales of1,000, 2,000, and 500 units:


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Notice that changes in volume only impact

certain amounts within the total column.Volume changes did not impact fixed costs, norchange the per unit or ratio calculations. Byreviewing the data, also note that it isnecessary to produce and sell 1,000 units toachieve break-even net income. At 2,000

units, Leyland managed to achieve a$1,200,000 net income. Conversely, if only500 units are produced and sold, the result willbe a $600,000 loss.

BREAK-EVEN CHART


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Leylands management would probably findthe following chart very useful. Dollars arerepresented on the vertical axis and units onthe horizontal.

Be sure to examine this chart, taking note ofthe following items:

The total sales line starts at 0 and rises$2,000 for each additional unit.

The total cost line starts at $1,200,000(reflecting the fixed cost) and rises $800for each additional unit (reflecting the

addition of variable cost). Break-even results where sales equal

total costs.

At any given point, the width of the lossarea (in red) or profit area (in green) is thedifference between sales and total costs.


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BREAK-EVEN ALGEBRA

Break-even occurs when there is no profit orloss. As noted, the break-even point results

where sales and total costs are equal:

Break-Even Sales = Total Variable Costs+ Total Fixed Costs

For Leyland, the math works out this way:

(Units X $2,000) = (Units X $800) +

$1,200,000

Solving:

Step

a:

(Units X $2,000) = (Units X $800) +

$1,200,000

Stepb:

(Units X $1,200) = $1,200,000

Step

c:Units = 1,000

It is possible to jump to step b above bydividing the fixed costs by the contributionmargin per unit. Thus, a break-even short cutis:


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Break-Even Point in Units = Total FixedCosts / Contribution Margin Per Unit

1,000 Units = $1,200,000 / $1,200

Sometimes, one may want to know the break-even point in dollars of sales (rather thanunits). This approach is especially useful forcompanies with more than one product, wherethose products all have a similar contributionmargin ratio:

Break-Even Point in Sales = Total FixedCosts / Contribution Margin Ratio

$2,000,000 = $1,200,000 / 0.60

TARGET INCOME

Breaking even is not a bad thing, but hardly asatisfactory outcome for most businesses. Instead,a manager may be more interested in learning thenecessary sales level to achieve a targeted profit.The approach to solving this problem is to treat thetarget income like an added increment of fixedcosts. In other words, the margin must cover the

fixed costs and the desired profit. Assume Leylandwants to know the level of sales to reach a $600,000target income:

Solving:


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Step

a:

(Units X $2,000) = (Units X $800) + $1,200,000

+ $600,000

Step

b:(Units X $1,200) = $1,800,000

Step

c:Units = 1,500

Again, it is possible tojump to step b by dividing

the fixed costs and target income by the per unitcontribution margin:

Units to Achieve a Target Income

=

(Total Fixed Costs + Target Income) /

Contribution Margin Per Unit1,500 Units = $1,800,000 / $1,200

If one wants to know the dollar level of sales toachieve a target net income:

Sales to Achieve a Target Income

=

(Total Fixed Costs + Target Income) /Contribution Margin Ratio

$3,000,000 = $1,800,000 / 0.60

CRITICAL THINKING ABOUT CVP


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CVP is more than just a mathematical tool tocalculate values like the break-even point. It can beused for critical evaluations about business viability.

For instance, a manager should be aware of themargin of safety. The margin of safety is thedegree to which sales exceed the break-even point.For Leyland, the degree to which sales exceed$2,000,000 (its break-even point) is the margin ofsafety. This will give a manager valuableinformation as he or she plans for inevitablebusiness cycles.

A manager should also understand the scalability ofthe business. This refers to the ability to grow profitswith increases in volume. Compare the incomeanalysis for Leaping Lemming Corporation andLeaping Leopard Corporation:

Both companies broke even in 20X1. Which

company would one rather own? If one knew that

each company was growing rapidly and expected todouble sales each year (without any change in coststructure), which company would be preferred?With the added information, one would expect thefollowing 20X2 outcomes:


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studying sensitivity of profit for shifts infixed costs, variable costs, sales volume,and sales price.

CHANGING FIXED COSTS

Changes in fixed costs are perhaps theeasiest to analyze. To determine a revisedbreak-even level requires that the newtotal fixed cost be divided by the

contribution margin. Return to theexample for Leyland Sports. Recall one ofthe original break-even calculations:

Break-Even Point in Sales = Total

Fixed Costs / Contribution Margin

Ratio$2,000,000 = $1,200,000 / 0.60

If Leyland added a sales manager at afixed salary of $120,000, the revisedbreak-even would be:

$2,200,000 = $1,320,000 / 0.60

In this case, the fixed cost increased from$1,200,000 to $1,320,000, and sales mustreach $2,200,000 to break even. This


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increase in break-even means that themanager needs to produce at least$200,000 of additional sales to justify his

or her post.CHANGING VARIABLE COSTS

In recruiting the new sales manager,Leyland became interested in anaggressive individual who was willing to

take the post on a 4% of salescommission-only basis. Lets see how thiswould change the break-even point:

Break-Even Point in Sales = Total

Fixed Costs / Contribution Margin

Ratio$2,142,857 = $1,200,000 / 0.56

This calculation uses the revisedcontribution margin ratio (60% - 4% =56%), and produces a lower break-even

point than with the fixed salary($2,142,857 vs. $2,200,000). But, do notassume that a lower break-even definesthe better choice! Consider that the lowercontribution margin will stick no matter


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how high sales go. At the upper extremes,the total compensation cost will be muchhigher with the commission-based

scheme. Following is a graph ofcommission cost versus salary cost atdifferent levels of sales. Note that thecommission begins to exceed the fixedsalary at any point above $3,000,000 insales. In fact, at $6,000,000 of sales, the

managers compensation is twice as highif commissions are paid in lieu of thesalary!

What this analysis does not reveal is how anindividual will behave. The sales manager hasmore incentive to perform, and the addedcommission may be an excellent inducement.For example, the company will make more at$6,000,000 in sales than at $3,000,000 in


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sales, even if the sales manager is paid twiceas much. At a fixed salary, it is hard to predicthow well the manager will perform, since payis not tied to performance.

##########################

5.Describe how oligopolisticcompetition exists in the real worldgiving examples from FMCGCompanies.

OLIGOPOLY

Oligopoly is a fairly common market organization. In the United

States, both the steel and auto industries (with three or so large

firms) provide good examples of oligopolistic market structures.

MAJOR CHARACTERISTICS OF OLIGOPOLY.

An important characteristic of an oligopolistic market structure

is the interdependence of firms in the industry. The

interdependence, actual or perceived, arises from the small

number of firms in the industry. However, unlike monopolistic

competition, if an oligopolistic firm changes its price or output,

it has perceptible effects on the sales and profits of its

competitors in the industry. Thus, an oligopolist firm always

considers the reactions of its rivals in formulating its pricing or

output decisions.

There are huge, though not insurmountable, barriers to entering

an oligopolistic market. These barriers can involve large

financial requirements, availability of raw materials, access to


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the relevant technology, or simply patent rights of the firms

currently in the industry. Several industries in the United States

provide good examples of oligopolistic market structures with

obvious barriers to entry. The U.S. auto industry provides an

example of a market where financial barriers to entry exist. In

order to efficiently operate an automobile plant, one needs

upward of half a billion dollars of initial investment. The steel

industry in the United States, on the other hand, provides an

example of an oligopoly where barriers to entry have been

created by the ownership of raw materials needed for producing

the product. In this industry, a few huge firms own most of the

available iron ore, a necessary raw material for steel production.

An oligopolistic industry is also typically characterized by

economies of scale. Economies of scale in production imply that

as the level of production rises the cost per unit of product falls

for the use of any plant (generally, up to a point). Thus,

economies of scale lead to an obvious advantage for a large

producer. Once again, the automobile industry provides an

example of a market structure where firms experience

economies of scale. It should be noted that there may exist

economies of scale in promotion just as there exist economies of

scale in production. In the automobile industry, the promotion

cost per unit of product falls as sales increase since promotion

costs rise less than proportionately to sales.

ECONOMICS AND DESIRABILITY OF OLIGOPOLY.

There is no single theoretical framework that provides answers

to output and pricing decisions under an oligopolistic market

structure. Analyses exist only for special sets of circumstances.

For example, if an oligopolistic firm cuts its price, it is met with

price reductions by competing firms; however, if it raises the

price of its product, rivals do not match the price increase. For


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this reason, prices may remain stable in an oligopolistic industry

for a prolonged period of time.

It is hard to make concrete statements regarding price charged

and quantity produced under oligopoly. However, from the point

of view of the society, one can say that an oligopolistic marketstructure provides a fair degree of competition in the market

place if the oligopolists in the market do not collude. Collusion

occurs if firms in the industry agree to set price and/or quantity.

In the United States, there are laws that make collusion illegal.

@@@@@@@@@@@@@@@@@@@@@@@

COLA MARKET

Two sellers shares the maximummarket share

Ex: Pepsico and Coco-cola

====================

WASHING SOAP POWDER

1.HINDUSTAN UNILEVER

2.GOOREJ

3.PROCTER & GAMBLE

##########################

6. Write short notes on the following:

(a) Product Differentiation


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A marketing process that showcases the

differences between products. Differentiation looks

to make a product more attractive by contrasting

its unique qualities with other competing products.

Successful product differentiation creates a

competitive advantage for the seller, ascustomers

view these products as unique or superior.

Product differentiation can be achieved in manyways. It may be as simple as packaging the goods

in a creative way, or as elaborate as incorporatingnew functional features. Sometimes differentiationdoes not involve changing the product at all, butcreating a new advertising campaign or other salespromotions instead.

In marketing , product differentiation is theprocess of distinguishing a product or offeringfrom others, to make it more attractive to aparticular target market . This involvesdifferentiating it from competitors' products aswell as one's own product offerings.

Differentiation is a source of competitive

advantage. Although research in a niche marketmay result in changing your product in order toimprove differentiation, the changes themselvesare not differentiation. Marketing or productdifferentiation is the process of describing thedifferences between products or services, or theresulting list of differences. This is done in order to


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demonstrate the unique aspects of your productand create a sense of value. Marketing textbooksare firm on the point that any differentiation mustbe valued by buyers . The term unique selling

proposition refers to advertising to communicate aproduct's differentiation .

The major sources of product differentiation are asfollows.

1 Differences in quality which are usuallyaccompanied by differences in price

2 Differences in functional features or design

3 Ignorance of buyers regarding the essentialcharacteristics and qualities of goods they arepurchasing

4 Sales promotion activities of sellers and, inparticular, advertising

5 Differences in availability (e.g. timing and

location).

The objective of differentiation is to develop aposition that potential customers see as unique.

Differentiation primarily impacts performancethrough reducing directness of competition: As theproduct becomes more different, categorization

becomes more difficult and hence draws fewercomparisons with its competition. A successfulproduct differentiation strategy will move yourproduct from competing based primarily on priceto competing on non-price factors.

Most people would say that the implication ofdifferentiation is the possibility of charging a price


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premium; however, this is a gross simplification. Ifcustomers value the firm's offer, they will be lesssensitive to aspects of competing offers; price maynot be one of these aspects. Differentiation makes

customers in a given segment have a lowersensitivity to other features (non-price) of theproduct

Significance

Offered under different brandsby competing firms,products fulfilling the same need typically do nothave identical features. The differentiation of

goods along key features and minor detailsisan important strategyfor firms to defend theirprice from levelling down to the bottom part of theprice spectrum.

Within firms, product differentiation is the waymulti-product firms build their own suppliedproducts' range.

At market level, differentiation is the way throughwhich the quality of goods is improved over timethanks to innovation. Launching new goods withentirely new performances is a radical change,often leading to changes in market shares andindustry structures.

In an evolutionarysense, differentiation is astrategy to adapt to a moving environmentandits social groups .

Vertical differentiation

Vertical differentiation occurs in a market wherethe several goods that are present can be ordered


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according to their objective quality from thehighest to the lowest. It's possible to say in thiscase that one good is "better" than another.

Vertical differentiation can be obtained:

1. along one decisive feature;2. along a few features, each of which has a widepossible range of (continuous or discrete) values;3. across a large number of features, each of whichhas only a presence/absence"flag".

In the second and third cases, it is possible to findout a product that is better than another oneaccording to one criteria but worse than it inrespect to another feature.

Vertical differentiation is a property of the suppliedgoods but, as it is maybe needless to say, theperceived difference in qualityby differentconsumer will play a crucial role in the purchase

decisions.In particular, potential consumers can have abiased perceptionof the features of the good

When evaluating a real market, a good startingpoint is a top-down grid of interpretation, we shallpresent first in 3 segments.

Class Price Crucialfeature

Low Low The price islow, theproductsimplyworks


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Middle Middle Use of thegood iscomfortable.Most peopleuse it. Massmarketbrand.

High High Quality,exclusivity,durability(= low life-long price),

To this basic classification, one should add twointermediate classes:


Middle-low Low Thecheapest

nation-widebrand

Middle-high Middle Thecheapestproduct ofhigh quality

Two extreme classes should finally be added:


Extremely low Low It usuallydoes notwork, itdoes not


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last, and ithasimportantdefects

ExtremelyHigh

High Exclusivity,nonpractical,statussymbol

In this way, you can vertically position different brandsand product versions, also using clues fromadvertisingcampaigns.

If you compare widely different goods fulfilling the same(highly-relevant) need, you may distinguish at theextreme of your spectrum necessity goodsand at theother luxury goods. In other cases, what makes thisdifference is, instead, the nature of the need fulfilled.

As a general rule, better products have a higherprice, both because of higher production costs(more

noble materials, longer production, more selective testsfor throughput,...) and bigger expected advantagesfor clients, partly reflected in higher margins.

Thus, the quality-price relationship is typically upwardssloped. This means that consumers without their ownopinion nor the capability of directly judging quality mayrely on the price to infer quality. They will prefer to

pay a higher price because they expect quality tobe better.

This important flaw in knowledge and informationprocessing capability - an instance of boundedrationality- can be purposefully exploited by the seller,with the result that not all highly priced products are ofgood quality .


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Through this mechanism, the demand curve is alwaysdownward sloped, can instead turn out to be in theopposite direction.

Horizontal differentiation

When products are different according to features thatcan't be ordered, a horizontal differentiation emerges inthe market.

A typical example is the ice-cream offered in differenttastes. Chocolate is not "better" than lemon.

Horizontal differentiation can be linked to differentiationin colours (different colour version for the same good), in

styles (e.g. modern / antique), in tastes.

This does not prevent specific consumers to have a stablepreference for one or the other version, since you shouldalways distinguish what belongs to the supply structureand what is due to consumers' subjectivity.

It is quite common that, in horizontal differentiation, thesupplier of many versions decide a unique price for all

of them. Chocolate ice-creams cost as much as lemonones.

When consumers don't have strong stable preferences, arule of behaviour can be to change often the chosengood, looking for variety itself. An example is when yougo to a fast food and ask for what you haven't eaten theprevious time.

Fashion waves often emerge in horizontally-differentiatedmarkets with imitation behaviours among consumersand specific styles going "in" and "out".

Determinants

How a product rates according to different measures ofquality or taste depends on its physical and immaterialcharacteristics. The raw materialfrom which it hasbeen built, the share of high/low quality ingredients /


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components, its engineered design, its productionprocessare typical determinants of product specificity.

More broadly, product differentiation can be:

1 the indirect effect of different endowments in raw

materials, know-how, style preference of different firmsignoring each others;

2 the conscious choice, out of firm strategies, to positioneach product against competitors;

3 the costly, uncertain, and difficult outcome ofinnovation efforts.

PRODUCT Differentiation Strategies-Differentiation strategies rely on some

basis of product differentiation such as

flexibility, specific features, service, time

and availability, low maintenance, etc. as

the basis for competition. Product

development and market research are

generally necessary components of a

differentiation strategy. Generally, asuccessful differentiation strategy allows a

firm to charge a higher price for its

product. Organizations generally need

strong R & D departments with strong

coordination between R & D and


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marketing departments.

#@@@@@@@@@@@@@@@@@@@@@

(b) Equi Marginal Principle

2. Equi-marginal Principle

Marginal Utility is the utility derived from the additional

unit of a commodity consumed. The laws of equi-marginal

utility states that a consumer will reach the stage of

equilibrium when the marginal utilities of various

commodities he consumes are equal. According to themodern economists, this law has been formulated in form

of law of proportional marginal utility. It states that the

consumer will spend his money-income on different goods

in such a way that the marginal utility of each good is

proportional to its price, i.e.,

MUx / Px = MUy / Py = MUz / Pz

Where, MU represents marginal utility and P is the price of

good.

Similarly, a producer who wants to maximize profit (or

reach equilibrium) will use the technique of production

which satisfies the following condition:

MRP1 / MC1 = MRP2 / MC2 = MRP3 / MC3

Where, MRP is marginal revenue product of inputs and MC

represents marginal cost.

Thus, a manger can make rational decision by

allocating/hiring resources in a manner which equalizes the


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ratio of marginal returns and marginal costs of various use

of resources in a specific use.

======================

Equi-marginal principle in managerialeconomics deals with the allocation of theavailable resource among the alternativeactivities. According to equi-marginalprinciple, an input should be allocated in sucha way that the value added by the last unit is

the same in all cases.Suppose a firm has 100 units of labor at itsdisposal. The firm is engaged in four activities,which need labor services, viz., A, B, C and D.It can enhance any one of these activities byadding more labor but sacrificing in return the

cost of other activities. If the value of themarginal product is higher in one activity thananother, then it should be assumed that anoptimum allocation has not been attained.Hence it would, be profitable to shift labor fromlow marginal value activity to high marginal

value activity, thus increasing the total valueof all products taken together.

For example, if the values of certain twoactivities are as follows:


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Value of marginal product of labor for activityA = 20$ and, for activity B = 30$

In this case it will be profitable to shift labor

from A to activity B thereby expanding activityB and reducing activity A. The optimum will bereach when the value of the marginal productis equal in all the four activities or, when insymbolic terms:

VMPLA= VMPLB = VMPLC = VMPLD

Where the subscripts indicate labor inrespective activities.

Certain aspects of the equi-marginal principleneed clarifications, which are as follows:

First, the values of marginal products arenet of incremental costs. In activity B, wemay add one unit of labor with an increasein physical output of 100 units. Each unit isworth 50 cents so that the 100 units willsell for 50$. But the increased outputconsumes raw materials, fuel and other

inputs so that variable costs in activity B(not counting the labor cost) are higher.Let us say that the incremental costs are30$ leaving a net addition of 20$. Thevalue of the marginal product


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Secondly, if the revenues resulting fromthe addition of labor are to occur in future,these revenues should be discountedbefore comparisons in the alternative

activities are possible. Activity A mayproduce revenue immediately but activitiesB, C and D may take 2, 3 and 5 yearsrespectively. Here the discounting of theserevenues will make them equivalent.

Thirdly, the measurement of value of themarginal product may have to be correctedif the expansion of an activity requires analternative reduction in the prices of theoutput. If activity B represents theproduction of radios and it is not possibleto sell more radios without a reduction in

price, it is necessary to make adjustmentfor the fall in price.

Fourthly, the equi-marginal principle maybreak under sociological pressures. Forinstance, due to inertia, activities arecontinued simply because they exist.

Similarly, due to their empire buildingambitions, managers may keep onexpanding activities to fulfill their desire forpower. Departments, which are alreadyover-budgeted often, use some of theirexcess resources to build up propaganda


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machines (public relations offices) to winadditional support. Governmental agenciesare more prone to bureaucratic self-perpetuation and inertia.

@@@@@@@@@@@@@@@@@@@

(c) The Price Elasticity of Demand

Price elasticity of demandis defined as themeasure of responsiveness in the quantitydemanded for a commodity as a result of change

in price of the same commodity. In other words, itis percentage change in quantity demanded as perthe percentage change in price of the samecommodity. In economicsand business studies,the price elasticity of demand(PED) is ameasure of the sensitivity of quantity demanded tochanges in price. It is measured as elasticity, that

is it measures the relationship as the ratio ofpercentage changes between quantity demandedof a good and changes in itsprice. Drinking wateris a good example of a good that has inelasticcharacteristics in that people will pay anything forit (high or low prices with relatively equivalentquantity demanded), so it is not elastic. On the

other hand, demand for sugar is very elasticbecause as the price of sugar increases, there aremany substitutions which consumers may switchto.A price drop usually results in an increase in thequantity demanded by consumers (see Giffen goodfor an exception). The demandfor a good is
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relatively inelasticwhen the change in quantitydemanded is less than change in price. Goods andservices for which no substitutes exist aregenerally inelastic. Demand for an antibiotic, for

example, becomes highly inelastic when it alonecan kill an infection resistant to all otherantibiotics. Rather than die of an infection,patientswill generally be willing to pay whatever isnecessary to acquire enough of the antibiotic to killthe infection.A number of factors determine the elasticity:

Substitutes:The more substitutes, the higher theelasticity, as people can easily switch from onegood to another if a minor price change is made Percentage of income:The higher thepercentage that the product's price is of theconsumers income, the higher the elasticity, aspeople will be careful with purchasing the good

because of its cost Necessity:The more necessary a good is, thelower the elasticity, as people will attempt to buy itno matter the price, such as the case of insulinforthose that need it. 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 thesupermarket and find that blueberries havedoubled in price, you'll buy it because you need itthis time, but next time you won't, unless the pricedrops back down again) Breadth of definition:The broader thedefinition, the lower the elasticity. For example,
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Company X's fried dumplings will have a relativelyhigh elasticity, where as food in general will havean extremely low elasticity (see Substitutes,Necessity above)

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