22722354 Managerial Economics Complete

SMUASSIGNMENT

SEMESTER – 1MB0026

MANAGERIAL ECONOMICS

SUBMITTED BY:

ANIL KUMAR JOSHIMBA

ROLL NO.- 520949950

ASSIGNMENTS- MBA Sem-I MB0026 – MANAGERIAL ECONOMICS

SET - 1

Q1. The demand function of a good is as follows: Q1=100-6P1-4P2+2P3+0.003Y WHERE P1 and Q1 are the price and quantity values of good 1 P2 and P3 are the prices of good 2 and good 3 and Y is the income of the consumer. The initial values are given: P1 =7 P2 =15 P3 =4 Y=8000 Q1 =30 You are required to:Using the concept of cross elasticity determine the relationship between good 1 and othersDetermine the effect on Q1 due to a 10 % increase in the price of good 2 and good

Answer:- Cross elasticity can be defined as the proportionate change in the quantity demanded of a particular commodity in response to a change in the price of another related commodity.

a) Cross elasticity between good 1 and product 2 = (dQ1/dP2)*(P2/Q1) Cross elasticity between good 1 and product 3 = (dQ1/dP3)*(P3/Q1) Taking the differentiation of the equation:dQ1/dP2 = -4dQ1/dP3 = 2 Putting the values in the elasticity equation: Cross elasticity between good 1 and product 2 = (dQ1/dP2)*(P2/Q1) = (-4) * (P2/Q1) = (-4) * (15/30) = -2 Cross elasticity between good 1 and product 3 = (dQ1/dP3)*(P3/Q) = (2) * (P3/Q1) = (2) * (4/30) = 0.267

b) As per the cross elasticity equation: E = % Change in demand of product A / % Change in price of product B% Change in demand of product A = E * % Change in price of product B Putting the values from% Change in demand of product A due to 10 % increase of good 2 = -2 * 10= -20% % Change in demand of product A due to 10 % increase of good 3 = 0.267 * 10 = 2.67%

ASSIGNMENTS- MBA Sem-I MB0026 – MANAGERIAL ECONOMICS

Q2. What are the factors that determine the Demand curve? Explain.

Answer: - Demand is the quantity of a good buyers wish and are able to purchase at each conceivable price over a given period of time. Law of demand says, when the price of a good rises, the quantity demanded will fall, other things being equal. Quantity demanded – the amount of a good that a consumer is willing and able to buy at a given price over a given period of time. DEMAND CURVE: DEFINITION

Demand schedule for an individual economic agent is a table reflecting different quantities that an agent is willing and able to buy at a various prices over a given period of time

Market demand schedule is a table showing the different total quantities of a good that consumers are willing and able to purchase over a given period of time

Demand curve is a graph showing the relationship between the price of a good and the quantity of the good demanded over a given period of time. Graph curve that normally slopes downward towards the right of the chart (except for a Giffen good, where it slopes toward the left), showing quantity of a product (good or service) demanded at different price levels. Customarily, the price is plotted on vertical ('Y') axis and quantity on the horizontal ('X') axis, and it is assumed that (in the short run) income levels, price of substitutes, and customer preferences, remain unchanged. Demand curves of the individual products are aggregated to give a market demand curve and, when drawn together with the supply curves, show the equilibrium price at the intersection of the two curves.

Factors that shift demand curve:

Causes of shifts in demand

Changes in disposable income

Changes in taste and fashion (changes in preferences) - tastes and preferences are assumed to be fixed in the short-run. This assumption of fixed preferences is a necessary condition for aggregation of individual demand curves to derive market demand.

The availability and cost of credit

Changes in the prices of related goods (substitutes and complements)

Population size and composition

Expectations

Change in education level

Change in the geographical situation of buyers - in the basic model there are no barriers to entry and consumers and factors of production possess instantaneous mobility.

Change in climate or weather - e.g. The demand for umbrellas increases when rain is predicted. However, this illustrates the constant shifting from practice to theory and back where the assumptions of the model are relaxed whenever necessary or convenient. A basic assumption of the standard model is that all economic factors have perfect knowledge so a consumer would never leave home without an umbrella on days when it rained.

ASSIGNMENTS- MBA Sem-I MB0026 – MANAGERIAL ECONOMICS

Q3. A firm supplied 3000 pens at the rate of Rs 10. Next month, due to a rise of in the price to 22 rs per pen the supply of the firm increases to 5000 pens. Find the elasticity of supply of the pens?

Answer:- Of course, consumption is not the only thing that changes when prices go up or down. Businesses also respond to price in their decisions about how much to produce. Economists define the price elasticity of supply as the responsiveness of the quantity supplied of a good to its market price.

More precisely, the price elasticity of supply is the percentage change in quantity supplied divided by the percentage change in price.

Suppose the amount supplied is completely fixed, as in the case of perishable pen brought to market to be sold at whatever price they will fetch. This is the limiting case of zero elasticity, or completely inelastic supply, which is a vertical supply curve.

At the other extreme, sat that a tiny cut in price will cause the amount supplied to fall to zero, while the slightest rise in price will coax out an indefinitely large supply. Here, the ratio of the percentage change in quantity supplied to percentage change in price is extremely large and gives rise to a horizontal supply curve. This is because the polar case of infinitely elastic supply.

Between these extremes, we call elastic or inelastic depending upon whether the percentage change in quantity is larger or smaller than the percentage change in price. Price elasticity of demand is a ratio of two pure numbers, the numerator is the percentage change in the quantity demanded and the denominator is the percentage change in price of the commodity. It is measured by the following formula: Ep = Percentage change in quantity demanded/ Percentage changed in price Applying the provided data in the equation: Percentage change in quantity demanded = (5000 – 3000)/3000Percentage changed in price = (22 – 10) / 10 Ep = ((5000 – 3000)/3000) / ((22 – 10)/10) = 1.2

ASSIGNMENTS- MBA Sem-I MB0026 – MANAGERIAL ECONOMICS

Q4. Briefly explain the profit-maximization model?

Answer: - Profit maximization is the process by which a firm determines the price and output level that returns the greatest profit. There are several approaches to this problem. The total revenue–total cost method relies on the fact that profit equals revenue minus cost, and the marginal revenue–marginal cost method is based on the fact that total profit in a perfectly competitive market reaches its maximum point where marginal revenue equals marginal cost.

Basic definitionsAny costs incurred by a firm may be classed into two groups: fixed cost and variable cost. Fixed costs are incurred by the business at any level of output, including zero output. These may include equipment maintenance, rent, wages, and general upkeep. Variable costs change with the level of output, increasing as more product is generated. Materials consumed during production often have the largest impact on this category. Fixed cost and variable cost, combined, equal total cost. Revenue is the total amount of money that flows into the firm. This can be from any source, including product sales, government subsidies, venture capital and personal funds. Marginal cost and revenue, depending on whether the calculus approach is taken or not, are defined as either the change in cost or revenue as each additional unit is produced, or the derivative of cost or revenue with respect to quantity output. It may also be defined as the addition to total cost as output increase by a single unit. For instance, taking the first definition, if it costs a firm 400 USD to produce 5 units and 480 USD to produce 6, the marginal cost of the sixth unit is approximately 80 dollars, although this is more accurately stated as the marginal cost of the 5.5th unit due to linear interpolation. Calculus is capable of providing more accurate answers if regression equations can be provided.

Total cost-total revenue method

Profit Maximization - The Totals Approach

To obtain the profit maximising output quantity, we start by recognizing that profit is equal to total revenue (TR) minus total cost (TC). Given a table of costs and revenues at each quantity, we can either compute equations or plot the data directly on a graph. Finding the profit-maximizing output is as simple as finding the output at which profit reaches its maximum. That is represented by output Q in the diagram.

ASSIGNMENTS- MBA Sem-I MB0026 – MANAGERIAL ECONOMICS

There are two graphical ways of determining that Q is optimal. Firstly, we see that the profit curve is at its maximum at this point (A). Secondly, we see that at the point (B) that the tangent on the total cost curve (TC) is parallel to the total revenue curve (TR), the surplus of revenue net of costs (B,C) is the greatest. Because total revenue minus total costs is equal to profit, the line segment C,B is equal in length to the line segment A,Q.Computing the price at which to sell the product requires knowledge of the firm's demand curve. The price at which quantity demanded equals profit-maximizing output is the optimum price to sell the product.

Marginal cost-marginal revenue method

Profit Maximization - The Marginal Approach

If total revenue and total cost figures are difficult to procure, this method may also be used. For each unit sold, marginal profit equals marginal revenue minus marginal cost. Then, if marginal revenue is greater than marginal cost, marginal profit is positive, and if marginal revenue is less than marginal cost, marginal profit is negative. When marginal revenue equals marginal cost, marginal profit is zero. Since total profit increases when marginal profit is positive and total profit decreases when marginal profit is negative, it must reach a maximum where marginal profit is zero - or where marginal cost equals marginal revenue. This is because the producer has collected positive profit up until the intersection of MR and MC (where zero profit is collected and any further production will result in negative marginal profit, because MC will be larger than MR). The intersection of marginal revenue (MR) with marginal cost (MC) is shown in the next diagram as point A. If the industry is competitive (as is assumed in the diagram), the firm faces a demand curve (D) that is identical to its Marginal revenue curve (MR), and this is a horizontal line at a price determined by industry supply and demand. Average total costs are represented by curve ATC. Total economic profits are represented by area P,A,B,C. The optimum quantity (Q) is the same as the optimum quantity (Q) in the first diagram.

If the firm is operating in a non-competitive market, minor changes would have to be made to the diagrams. For example, the Marginal Revenue would have a negative gradient, due to the overall market demand curve. In a non-competitive environment, more complicated profit maximization solutions involve the use of game theory.

ASSIGNMENTS- MBA Sem-I MB0026 – MANAGERIAL ECONOMICS

Maximizing revenue method

In some cases a firm's demand and cost conditions are such that marginal profits are greater than zero for all levels of production. In this case the Mπ = 0 rule has to be modified and the firm should maximize revenue. In other words the profit maximizing quantity and price can be determined by setting marginal revenue equal to zero. Marginal revenue equals zero when the marginal revenue curve has reached its maximum value = topped out. An example would be a scheduled airline flight. The marginal costs of flying the route are negligible. The airline would maximize profits by filling all the seats. The airline would determine the p-max conditions by maximizing revenues.

Mathematical Example

A promoter decides to rent an arena for concert. The arena seats 20,000. The rental fee is 10,000. The arena owner gets concessions and parking and pays all other expenses related to the concert. The promoter has properly estimated his demand to be Q = 40,000 - 2000P. What is the profit maximizing ticket price? Because the promoter’s marginal costs are zero the promoter maximizes profits by charging a ticket price that will maximize revenue. Total revenue equals price, P, times quantity, Q or PQ = (40,000 - 2000P)P = 40,000P - 2000(P)2. Total revenue reaches it maximum value when marginal revenue is zero. Marginal revenue is the first derivative of the total revenue function so

MR ‘ = 40,000 - 2(2000)P = 40,000 - 4000P

MR’ = 0

40,000 - 4000P = 0

4000P = - 40,000

P = 10

Profit = TR -TC

Profit = [40,000P - 2000(P)2] - 10,000

Profit = [40,000(10) - 2000(10)2] - 10,000

Profit = 400,000 - 200,000 - 10,000

Profit = 190,000

What if the promoter had charged 12 per ticket?

Q = 40,000 - 2000P.

Q = 40,000 - 2000(12)

ASSIGNMENTS- MBA Sem-I MB0026 – MANAGERIAL ECONOMICS

Q = 40,000 - 24,000 = 16,000 (tickets sold)

Profits at 12:

Q = 16,000(12) = 192,000 - 10,000 = 182,000

Changes in fixed costs and profit maximization

A firm maximizes profit by operating where marginal revenue equal marginal costs. A change in fixed costs has no effect on the profit maximizing output or price. The firm merely treats short term fixed costs as sunk costs and continues to operate as before. This can be confirmed graphically. Using the diagram illustrating the total cost total revenue method the firm maximizes profits at the point where the slope of the total cost line and total revenue line are equal. A change in total cost would cause the total cost curve to shift up by the amount of the change. There would be no effect on the total revenue curve or the shape of the total cost curve. Consequently, the profit maximizing point would remain the same. This point can also be illustrated using the diagram for the marginal revenue marginal cost method. A change is fixed cost would have no effect on the position or shape of these curves.

What if the arena owner in the example above triples the fee for the next concert but all other factors are the same. What price should the promoter now charge for tickets in light of the fee increase?

The same price of $10. The fee is a fixed cost which the promoter should consider as a sunk cost and simply ignore it in calculating his profit maximizing price. The only effect is that the promoter’s profit will be reduced by $20,000.

Markup pricing

In addition to using methods to determine a firm’s optimal level of output, a firm can also set price to maximize profit. The optimal markup rules is:

(P - MC)/P = 1/ -Ep

or

P = (Ep/1 + Ep) MC

Where MC equals marginal costs and Ep equals price elasticity of demand. Ep is a negative number. Therefore, -Ep is a positive number.

In English the rule is that the size of the markup is inversely related to the price elasticity of demand for a good.

MPL, MRPL and profit maximization

The general rule is that firm maximizes profit by producing that quantity of output where marginal revenue equals marginal costs. The profit maximization issue can also be approached from the input side. That is, what is the profit maximizing usage of the variable input? To maximize profits the firm should increase usage "up to the point where the input’s marginal revenue product equals its marginal costs". So mathematically the profit maximizing rule is MRPL = MCL The marginal revenue product is the change in

ASSIGNMENTS- MBA Sem-I MB0026 – MANAGERIAL ECONOMICS

total revenue per unit change in the variable input assume labor. That is MRP L = ∆TR/∆L. MRPL is the product of marginal revenue and the marginal product of labor or MRPL = MR x MPL.

Derivation: MR = ∆TR/∆Q

MPL = ∆Q/∆L

MRPL = MR x MPL = (∆TR/∆Q) x (∆Q/∆L) = ∆TR/∆L

There are various factors that contribute to the maximization of profits of a firm. Some of them are listed below:-

Pricing and business strategies of rival firms and its impact on the working of the given firm. Aggressive sales promotion policies adopted by rival firms in the market. Without inducing the workers to demand higher wages and salaries leading to rise in operation

costs. Without resorting to monopolistic and exploitative practices inviting government controls and

takeovers. Maintaining the quality of the product and services to the customers. Taking various kinds of risks and uncertainties in the changing business environment. Adopting a stable business policy. Avoiding any sort of clash between short run and long run profits in the business policy and

maintaining proper balance between them. Maintaining its reputation, name, fame and image in the market. Profit maximization is necessary in both perfect and imperfect markets. In a perfect market, a

firm is a price-taker and under imperfect market it becomes a price-searcher.

Assumptions of the model:-

The profit maximization model is based on three important assumptions. They are as follows:-

Profit maximization is the main goal of the firm. Rational behavior on the part of the firm to achieve its goal of profit maximization. The firm is managed by owner-entrepreneur

ASSIGNMENTS- MBA Sem-I MB0026 – MANAGERIAL ECONOMICS

Q5. What is Cyert and March’s behavior theory? What are the demerits?

Answer: - Cyert and March’s behavior makes an attempt to explain the behavior of inter group conflicts and their multiple objectives in an organization. Basically, this theory explains the usual and normal behavior of different groups of people who work in an organization having mutually opposite goals.

Cyert and March explain how complicated decisions are taken in big industrial houses under various kinds of risks and uncertainties in an imperfect market in the background of limited data and information. The organizational structure, goals of different departments, behavioral pattern and internal working of a big and multi-product firm differs from that of small organizations. The various kinds of internal conflicts and problems faced by these organizations. They also explain how there are certain common problems faced by similar organizations in an industry and their effects on internal working of each individual organization and their decision making process.

Cyert and March consider that a modern firm is a multi-product, multi-goal and multi-decision making coalition business unit. Like a coalition government, it is managed by a number of groups. The group consists of share holders, managers, workers, customers, suppliers, distributors, financiers, legal experts and so on. Each group is independent by itself and has its own set of objectives and they try to maximize their individual benefits.

Cyert and March points out the goals of a business organization would depend upon the multiple objectives of each group and their collective demands. Demands of each group would depend on their aspirations levels, expectations, actual performance of the organization, bargaining power of each group, past success in their demands, etc.

As all of them change over a period of time, the demands of each group would all of them change over a period of time, the demands of each group would also undergo changes. If actual performance and achievements of the organization is much better than expected aspirations and target level, in that case, there will upward revision in their demands and vice-versa.

Thus, there is a strong linkage between the expected and actual demand of each group in the organization, past success and future environment. Each group makes an attempt to achieve its demand in its own way.

Cyert and March are of the opinion that out of several objectives a firm has five important goals. They are:-

Production goal: Production is to be organized on the basis of demand in the market. Neither there should be over production nor under production but just that much to meet the required demand in the market, avoid excess capacity, over utilization of capital assets, lay-off of workers etc.

Inventory goal: Inventory refers to stock of various inputs. In order to ensure continuity in production and supply, certain minimum level of inventory has to be maintained by a firm. Neither there should be surplus stock or shortage of different inputs. Proper balance between demand and supply should be maintained.

Sales goal: There should be adequate sales in any organization to earn reasonable amounts of profits. In order to create demand, sales promotion policies may be adopted from time to time.

Market-share goal: Each firm has to make consistent effort to increase its market share to compete successfully with other firms and make sufficient profits.

ASSIGNMENTS- MBA Sem-I MB0026 – MANAGERIAL ECONOMICS

Profit goal: This is one of the basic objectives of any firm. The very survival and success of the firm would depend upon the volume of profits earned by it.

The above mentioned objectives also would undergo changes over a period of time in the background of modern business environment. Hence, decision making would become complex and complicated.

The demerits are as follows:-

The theory fails to analyze the behavior of the firm but it simply predicts the future expected behavior of different groups.It does not explain equilibrium of the industry as a whole.It fails to analyze the impact of the potential entry of the new firms into the industry and the behavior of the well established firms in the market.It highlights only on short run goals rather than long run objectives of an organization. Thus, there are certain limitations to this theory.

ASSIGNMENTS- MBA Sem-I MB0026 – MANAGERIAL ECONOMICS

Q6. What is Boumal’s Static and Dynamic?

Answer: - The model highlights that the primary objective of a firm is to maximize its sales rather than profit maximization. It states that the goal of the firm is maximization of sales revenue subject to a minimum profit constraint. The minimum profit constraint is determined by the expectations of the share holders. This is because no company can displease the share holders. Maximization of sales does not mean maximization of physical sales but maximization of total sales revenue. Hence, the managers are more interested in increasing the sales rather than profit. The basic philosophy is that when sales are maximized automatically profits of the company would also go up.

Prof. Boumal has developed two models. The first is static model and the second one is the dynamic model.

The Static model:-

The model is based on the following assumptions:-

The model is applicable to a particular time period and the model does not operate at different periods of time.

The firm aims at maximizing its sales revenue subject to a minimum profit constraint. The demand curve of the firm slope downwards from left to right. The average cost curve of the firm is U-shaped one.

Sales Maximization (dynamic model):-

Many changes take place which affects business decisions of a firm. In order to include such changes, Boumal developed dynamic model. This model explains how changes in advertisement expenditure, a major determinant of demand, would affect the sales revenue of a firm under severe competitions.

This model is based on certain assumptions. They are as follows:-

Higher advertisement expenditure would certainly increase sales revenue of a firm.Market price remains constant.Demand and cost curves of the firm are conventional in nature.

Under competitive conditions, a firm in order to increase its volume of sales and sales revenue would go for aggressive advertisements. This leads to a shift in the demand curve to the right. Forward shift in demand curve implies increased advertisement expenditure resulting in higher sales and sales revenue. A price cut may increase sales in general. But increase in sales mainly depends on whether the demand for a product is elastic or inelastic. A price reduction policy may increase its sales only when the demand is elastic and if the demand is inelastic; such a policy would have adverse effects on sales.

Hence, to promote sales, advertisements become an effective instrument today. It is the experience of most of the firms that with an increase in advertisement expenditure, sales of the company would also go up. A sales maximizer would generally incur higher amounts of advertisement expenditure than a profit maximizer. However, it is to be remembered that amount allotted for sales promotion should bring more than proportionate increase in sales and total profits of a firm. Otherwise, it will have a negative effect on business decisions.

ASSIGNMENTS- MBA Sem-I MB0026 – MANAGERIAL ECONOMICS

By introducing, a non-price variable into this model, Boumal makes a successful attempt to analyze the behavior of a competitive firm under oligopoly market conditions. Under oligopoly conditions as there are only a few big firms competing with each other either producing similar or differentiated products, would resort to heavy advertisements as an effective means to increase their sales and sales revenue.

ASSIGNMENTS- MBA Sem-I MB0026 – MANAGERIAL ECONOMICS

SET - 2

Q.7 What is pricing policy? What are the internal and external factors of the policy?

Answer:

Pricing Policies:- Pricing Policies refer to the policy of setting the price of the product or product & services by the management after taking into account of various internal and external factors, forces and its own business objectives. The decision of pricing is very important in any business. Price once fixed is never permanent. It needs to be reviewed and revised according to the market conditions.

Internal factors which can affect the pricing decisions of the company include suppliers, employees efficiency, profit margin, production cost and other expenses, brand image and expectations of the company. Suppliers provide the raw materials to the company and good relations with suppliers can make the company to buy quality products at reasonable prices. Employees' efficiency can also reduce the costs of the company and company can charge lower prices. Product cost also determines the prices of the products because all of the companies have to cover up the product costs. Moreover, image of the company also plays an important role in the price decisions of the company because a global brand will usually charge premium prices. On the other hand, the external factors include government policies, competitors' prices, costs of raw materials, consumers expectations and demand and supply of the product. Government sets the price floors to save the interest of the borrowers and the sellers, therefore, government policies should be also take into consideration. Expectations of the consumers or consumer reservation prices are also considered in the price decisions. Costs of raw materials in the market also determine the pricing strategies. Moreover, the prices offered by the competitors can also impact the pricing decisions of the company.

Q.8 Mention three crucial objectives of price policies.

Answer:

Price policy has certain objectives:-

1. To maximize profits:- Every firm tries to maximize their profits. So they should have a price policy, which fetches them maximum revenue. Every firm should have a price policy keeping the long run prospects in mind.

2. Price Stability :- Always fluctuating price is not for the goodwill of the company. A stable price always wins the confidence of customers.

3. Ability to pay :- The price should be fixed according to the ability of consumer to pay; high price for rich customers and low for poor customers. This can be applied in case of services given by doctors, lawyers etc.

ASSIGNMENTS- MBA Sem-I MB0026 – MANAGERIAL ECONOMICS

Q.9 Mention the bases of price discrimination.

Answer:

PRICE DISCRIMINATION - The monopoly seller has the advantage of price discrimination, as he is the only producer in the market. Price discrimination is charging different price to different buyer for the same product.

DEGREES OF PRICE DISCRIMINATION

1. First degree price discrimination – It is also called perfect price discrimination, as it involves maximum exploitation of the consumer in the interest of the seller. It happens when the seller is able to sell each unit separately and at a different price. Each buyer is made to pay the amount he is willing to pay rather going without it. The seller will make different bargain with each buyer. Such type of price discrimination enjoyed by the seller is called first degree price discrimination.

2. Second degree price discrimination – It happens when the monopoly seller will charge separate price in such a way that the buyer is divided into different groups according to the price elasticity of demand for his product.

3. Third degree price discrimination – When the seller will be divided into sub-market and charge different price depending on the output sold in the market and the demand condition of that sub-market. The seller practising price discrimination between the domestic market and international market, the seller will charge higher price in the domestic market, where he enjoys monopoly and charge low price in the international market, where he has to face more competition.

Q.10 What do you mean by the fiscal policy? What are the instruments of fiscal policy? Briefly comment on India’s fiscal policy.

Answer: Fiscal policy is a policy, which affects aggregate output, employment, saving, investment etc. A responsible government would contain its expenditure within its revenue and thus making the budget balanced. The instruments of Fiscal Policy are Automatic Stabilizer and Discretionary Fiscal Policy:

i) Automatic Stabilizer: The tax structure and expenditure are programmed in such a way that there is increase in expenditure and decrease in tax in recession and decrease in expenditure and increase in tax revenue in the period of inflation. It refers to built-in response to the economic condition without any deliberate action on the part of government. It is called built- in- stabilizer to correct and thus restore economic stability. It works in the following manner:-

Tax revenue: Tax revenue increases when the income increases; as those who were not paying tax go into the higher income tax bracket. When there is depression, the income decreases and many people fall in the no-income-tax bracket and the tax revenue decreases.

ii) Discretionary Fiscal Policy: Under this, to stabilize the economy, deliberate attempts are made by the government in taxation and expenditure. It entails definite and conscious actions.

ASSIGNMENTS- MBA Sem-I MB0026 – MANAGERIAL ECONOMICS

Instruments of Fiscal Policy: Some important instruments of fiscal policy are:-

1. TAXATION: Taxation is always a very important source of revenue for both developed and developing countries. Tax comes under two heading –Tax on individual (direct tax) and tax on commodity (indirect tax or commodity tax).Direct tax includes income tax, corporate tax, taxes on property and wealth. Indirect tax is tax on the consumptions. It includes sales tax, excise duty and custom duties. Direct tax structure can be divided into three bases-

a. Progressive tax b. Regressive tax c. Proportional tax

Progressive tax: Progressive tax says that higher the level of income, greater the volume of tax burden you have to bear. This means as income increases, the tax contribution should also increase. Low income group people pay low tax, whereas the high income group people pay higher tax.

Regressive tax: It is theoretically possible, though no government implements such tax structure, because that leads to unequal distribution of income. As your income increases the contribution through tax decreases. Low income people will pay more and high income people will pay less.

Proportional tax: When the tax imposed is irrespective of the income you earn, every income group, high or low pay the same amount of tax.

2. INDIRECT TAX OR CONSUMPTION TAX: Indirect tax differs from direct tax. Tax which is imposed on every unit of product is known as lump sum tax. E.g. excise tax and sales tax. Taxes depending on the value of particular product are called ‘ad valorem tax’ e.g. tax on airline tickets. A good tax structure has to control and bring stability in economic system. There are few requirement of a good tax structure. They are –

a. The revenue earned through tax structure should be adequate. b. The distribution of tax burden should be equal. c. Administration cost should not be more than revenue earned. d. Tax burden should be borne by the person who is taxed.

Q.11 Comment on the consequences of environmental degradation on the economy of a community.

Ans: Environmental Degradation For sustainable economic growth, the environment should be properly preserved and improved. The stocks may remain constant or it can even rise but the environment resources are the base of the country and the quality of air, water and land represents the heritage of a nation. The environment damages in the developing countries are the main concern nowadays. Environmental damages can be in these categories-

Water pollution – the water quality is continuously deteriorating due to contamination from the industrial waste, by throwing out chemical waste and heavy metal in the river. It is difficult to remove the pollutants form the water to make it good for drinking purpose. The capacity of the water to preserve the aquatic life is becoming more and more difficult. The under ground water is also getting affected by the industrial waste, as they some times get discharged directly into underground water.

ASSIGNMENTS- MBA Sem-I MB0026 – MANAGERIAL ECONOMICS

Air pollution- Air pollution can be contributed to the three man made sources, industrial production, vehicles and the energy. Human suffering increases due to the air pollution. Respiratory disorders and cancers are due to inhalation of polluted air. The vehicle increases the sulpur dioxide concentration in the air creating breathing problems for the children and affects their neurological developments.

Deforestation- Forest is the most important source to protect environment. They protect soil erosion and regulate the ecological balance of the nature. They i affect the nature and the climatic condition of the region. The blind increase in the industrial growth is leading to cutting down of many forest leading to many serious problems for the human being.

Q.12 Write short notes on the following:

a) Philips curve

Ans: Philips Curve describes the relationship between inflation and unemployment in an economy. New Zealand-born economist A.W Philips first put this theory forward in 1958 gathered the data of unemployment and changes in wage levels in the UK from 1861 to 1957. He observed that one stable curve represents the trade-off between inflation and unemployment and they are inversely/negatively related. In other words, if unemployment decreases, inflation will increase, and vice versa.

For example, after the economy has just been in recession, the unemployment level will be fairly high. This will mean that there is a labor surplus.

As the economy has just started growing, the aggregate demand (AD) will increase and therefore leading to an increase in employment. In the beginning, there will be little pressure for a raise in wages. However, as the economy grows faster and more people are employed, wages will start rising slowly.

B) Stagflation

Ans: Stagnation + Inflation = Stagflation Stagnation = Slow or no growth. Inflation = Rises in price. Stagflation is an economic trend in which inflation and unemployment rise while general growth of the economy is slow. It can be difficult to correct stagflation, because focusing on one aspect of the problem can exacerbate other aspects. Many governments try to avoid stagflation through fiscal policy, by

ASSIGNMENTS- MBA Sem-I MB0026 – MANAGERIAL ECONOMICS

promoting even and healthy growth and attempting to prevent inflation. If stagflation continues long enough, it will trigger an economic recession and an ultimate self-correction.

Stagflation is when the economy experiences slow GDP growth (stagnation) with high inflation and high level of unemployment. This occurred in the 1970's in many countries. When the economy is working normally, slow economic growth reduces demand, which keeps prices low, preventing inflation. Stagflation can only occur when fiscal or monetary policy sustains high prices, and inflation, despite slow growth. Stabilization policies to control stagflation.

i. The money supply should be tightened to check inflation. ii. We can control inflationary wage and price increases with direct controls. Government can limit

increases by law or constrain them through tax policies. iii. Protect people against the effects of inflation. All wages, including the minimum wage, could be

increased automatically when the Consumer Price Index increases. Government bonds could pay a fixed real interest rate by adjusting the actual interest rate for inflation.

Stagflation is difficult to control without government controls. Therefore, political will is necessary for formulating the measures to stop stagflation.