Imt 20 managerial economics m1

IMT-20: MANAGERIAL ECONOMICS
PART – A
Q1. Distinguish between the principles of marginalism and
incrementalism with the help of examples.
Ans. Marginalism is the study of marginal theories and relationships
within economics, and its key focus is how much extra use is gained from
incremental increases in the quantity of goods created, sold, etc. and how
those measures relate to consumer choice and demand.
The principles of marginalism relies on the assumption of (near) perfect
markets, which do not exist in the practical world, but still the core ideas
of marginalism are generally accepted by most economic schools of
thought, and are still used by businesses and consumers to make choices
and substitute goods.
The distinction between marginalism and incrementalism are stated
through the following:
• Marginal concepts are always defined in' terms of unit changes, but
incremental' concepts are defined in terms of chunk changes.
• Incremental concepts are more flexible than marginal concepts. In
marginalism, the reference is to one independent variable, but in
incrementalism, more than one independent variable can be
considered at a time. Marginal revenue is the increase in revenue
due to one-unit increase in level of output. But revenue may
increase due to a change in not only output, but also price and
production process.
• Under special circumstances, incremental and marginal revenue
(cost) may be the same.
Incremental revenue and incremental cost are two basic concepts for
making optimum economic decisions, and a decision is optimum if it
increases revenue more than cost or if it reduces costs more than
revenue, like if the net incremental revenue is positive which may be
termed as the incremental principle to be followed by management in
making decisions.
In economic theory, the concept of margin is very useful because it
renders the determination/derivation of an equilibrium solution quite
simple and easy. However, in the real world of business management,
marginalism should better be replaced by incrementalism because in
making economic decision, management is interested in knowing the
impact of a chuck-change rather than a unit-change.
Incremental reasoning involves a measurement of the impact of decision
alternatives on economic variables like revenue and costs which refer to
the total magnitude of changes in total revenues (or costs) that result
from a set of factors like change in prices, products, processes and
patterns.
IMT 20 Managerial Economics - Assignment Page 1 of 21 22/06/2012

Q2. How is the price elasticity of demand measured? Explain the
relationship between price elasticity, average revenue and
marginal revenue.
Ans. Price elasticity of demand (PED or Ed) is a measure used in
economics to show the responsiveness, or elasticity, of the quantity
demanded of a good or service to a change in its price.
In general, the demand for a good is said to be inelastic (or relatively
inelastic) when the price elasticity demand is less than one, in absolute
value, which is, changes in price have a relatively small effect on the
quantity of the good demanded. While the demand for a good is said to be
elastic or relatively elastic when its PED is greater than one, in absolute
value, that is, changes in price have a relatively large effect on the
quantity of a good demanded.
There are four methods of approaching price elasticity of demand, which
are as follows.
1. The Percentage Method:
It is determined by thee co-efficient of price elasticity (Ep), and this
co-efficient determines the percentage change in the quantity
demanded of an article from a specified percentage price change.
2. The Point Method:
This method has been formulated by Prof. Marshall for measuring
elasticity at a point on the demand curve.
In the diagram, shows AB being straight line demand curve, if the
price falls from PG(=OC) to FH(=OE), the quantity demanded is
augmented from OG to OH. Elasticity at Point P on the AB demand
curve as per the formulae is Ep = (∆q / ∆p) x p / q, where ∆q
represents change in quantity demanded, ∆p change in price level
whereas p and q are prime price and quantity levels.
3. The Arc Method:
Any two points in the demand curve is an arc which measures
elasticity over a definite array of the price and quantity demanded.

4. The Total Outlay Method:
The total outlay method of ascertaining the elasticity of demand is
denoted as price proliferated with the quantity of an article
purchased that is denoted as below.
Total outlay = Price x Quantity Demanded
Q3. Critically examine the law of diminishing marginal utility.
Ans. The law of diminishing marginal utility describes a familiar and
fundamental tendency of human behaviour, which states that as a
consumer consumes more and more units of a specific commodity, the
utility from the successive units goes on diminishing. Thus, the additional
benefit which a person derives from an increase of his stock of a thing
diminishes with every increase in the stock that already has.
The law of diminishing marginal utility is based upon three facts:
1) Total wants of a man are unlimited, but each single want can be
satisfied, and as a man gets more and more units of a commodity,
the desire of his for that good goes on falling, by which a point is
reached when the consumer no longer wants any more units of that
good.
2) Different goods are not perfect substitutes for each other in the
satisfaction of various particular wants, and the marginal utility will
decline as the consumer gets additional units of a specific good.
3) The marginal utility of money is constant, given the consumer’s
wealth.
The basis of the Law of Diminishing Marginal Utility is a fundamental
feature of wants which states that when people go to the market for the
purchase of commodities, they do not attach equal importance to all the
commodities which they buy.
In case of some of commodities, they are willing to pay more and in some
less. There are two main reasons for this difference in demand:
1) The linking of the consumer for the commodity
2) The quantity of the commodity which the consumer has with
himself, by which the marginal utility of a commodity diminishing as
the consumer gets larger quantities of it.
In given span of time, the more of a specific product a consumer obtains,
the less anxious he is to get more units of that product or that as more
units of a good are consumed, additional units will provide less additional
satisfaction than previous units.

Q4. Why is an indifference curve for two normal goods convex to
origin? Why cannot it be a concave curve or a straight line?
Ans. An indifference curve is a graph showing different bundles of goods
between which a consumer is indifferent, that is, at each point on the
curve, the consumer has no preference for one bundle over another.
One can equivalently refer to each point on the indifference curve as
rendering the same level of utility (satisfaction) for the consumer, and
utility is then a device to represent preferences rather than something
from which preferences come.
The main use of indifference curves is in the representation of potentially
observable demand patterns for individual consumers over commodity
bundles, which shows combination of goods between which a person is
indifferent.
An indifference curve for two normal goods is convex in origin, and not
concave curve or a straight line because its main attributes or properties
or characteristics are as follows:
1) Indifference Curves are Negatively Sloped:
The indifference curves must slope down from left to right, which
means that an indifference curve is negatively sloped downward
because as the consumer increases the consumption of X
commodity, one has to give up certain units of Y commodity in
order to maintain the same level of satisfaction. Thus, the higher
indifference curve that lies above and to the right of another
indifference curve represents a higher level of satisfaction and
combination on a lower indifference curve yields a lower
satisfaction.
2) Indifference Curve are Convex to the Origin:
They are convex to the origin (bowed inward), that as the
consumer substitutes commodity X for commodity Y, the marginal
rate of substitution diminishes of X for Y along an indifference
curve. Thus, the indifference curves cannot intersect each other
because at the point of tangency, the higher curve will give as
much as of the two commodities as is given by the lower
indifference curve.
3) Indifference Curves do not Touch the Horizontal or Vertical Axis:
One of the basic assumptions of indifference curves is that the
consumer purchases combinations of different commodities, and
not supposed to purchase only one commodity. Thus, in that case
indifference curve will touch one axis.

Q5. Why is demand forecasting important? Explain the various
types of survey methods of forecasting demand and their
usefulness.
Ans. Demand forecasting is important and crucial to any supplier,
manufacturer, or retailer because it determines the quantities that should
be purchased, produced, and shipped.
Demand forecasts are necessary since the basic operations process,
moving from the suppliers' raw materials to finished goods in the
customers' hands, takes time, by which most firms must anticipate and
plan for future demand so that they can react immediately to customer
orders as they occur.
In other words, most manufacturers make to stock rather than make to
order, and they plan ahead and then deploy inventories of finished goods
into field locations. Thus, once a customer order materializes, it can be
fulfilled immediately, since most customers are not willing to wait the time
it would take to actually process their order throughout the supply chain
and make the product based on their order.
Consequently, companies that offer rapid delivery to their customers will
tend to force all competitors in the market to keep finished goods
inventories in order to provide fast order cycle times. As a result, virtually
every organization involved needs to manufacture or at least order parts
based on a forecast of future demand.
Furthermore, the ability to accurately forecast demand also affords the
firm opportunities to control costs through levelling its production
quantities, rationalizing its transportation, and generally planning for
efficient logistics operations.
In general practice, accurate demand forecasting lead to efficient
operations and high levels of customer service, while inaccurate demand
forecasting will inevitably lead to inefficient, high cost operations and/or
poor levels of customer service.
In many supply chains, the most important action one can take to
improve the efficiency and effectiveness of the logistics process is to
improve the quality of the demand forecasts.
Accordingly, demand forecasting may be used in making pricing decisions,
in assessing future capacity requirements, or in making decisions on
whether to enter a new market, as well as predict future product and
service demands so that we can supply our clients’ orders quickly and
effectively.

PART – B
Q1. Diagramatically explain the three stages of the law of
diminishing marginal returns.
Ans. The law of diminishing marginal returns states that an increase in
the capital and labour applied to the cultivation of land causes in general a
loss than the proportionate increase in the amount of produce raised
unless, it happens to coincide with an improvement in the art of
agriculture.
This law also pertains to physical returns simply stating that with an
increase in variable inputs applied, the production initially increases with
increasing rate, then at constant rate and eventually it declines. However,
this law will not hold true (limitation) when there is:
• An improvement in technology,
• Efficient management and
• Residual effect
There are three stages of the law of diminishing returns, and they are:
Stage – I
1) This stage starts from origin and ends where AP & MP curves
intersect each other.
2) The TP is increasing at increasing rate at first then at decreasing
rate.
3) PP and MP both increase but MP is grater than IP.
4) The EP is greater than 1 (one)
Stage – II
1) It starts where PP & MP intersect each other and EP = l. It ends
when MP = 0
2) TP increases but at decreasing rate.
3) MP Starts to decline continuously and AP also start to decline but it
is greater than MP
4) The elasticity of production (EP) is greater than zero but less than
1.
Stage – III
1) This stage starts when MP is zero and TP is at maximum.
2) TP starts to decline and it declines continuously.
3) MP becomes negative, remains positive.
4) EP is always less than zero.
The law of diminishing returns states that a point will be reached when
further additions of a variable input will yield diminishing marginal returns
per unit of that variable, which is one of the most fundamental principles
in economics.

Q2. What are isoquants and isocost lines? Explain graphically
Ans. In economics an isocost line shows all combinations of inputs which
cost the same total amount, and although similar to the budget constraint
in consumer theory, its use pertains to cost-minimization in production, as
opposed to utility-maximization.
The isocost line is combined with the isoquant map to determine the
optimal production point at any given level of output, and specifically, the
point of tangency between any isoquant and an isocost line gives the
lowest-cost combination of inputs that can produce the level of output
associated with that isoquant.
The absolute value of the slope of the isocost line, with capital plotted
vertically and labour plotted horizontally, equals the ratio of unit costs of
labour and capital.
An isoquant is a contour line drawn through the set of points at which the
same quantity of output is produced while changing the quantities of two
or more inputs, and are typically drawn on capital-labour graphs, showing
the technological trade-off between capital and labour in the production
function, and the decreasing marginal returns of both inputs. Thus, 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 an isoquant map, a graph
combining a number of isoquants, each representing a different quantity
of output, also called equal product curves.
An isoquant graph can also indicate decreasing or increasing returns to
scale based on increasing or decreasing distances between the isoquant
pairs of fixed output increment, as output increases.

Conversely, if the distance is decreasing as output increases, the firm is
experiencing increasing returns to scale; doubling both inputs results in
placement on an isoquant with more than twice the output of the original
isoquant.
An isoquant map where Q3 > Q2 > Q1, which is a typical choice of inputs
would be labour for input X and capital for input Y, and more of input X,
input Y, or both is required to move from isoquant Q1 to Q2, or from Q2
to Q3.
Q3. Distinguish between implicit cost and explicit cost with the
help of example.
Ans. Implicit cost and explicit cost are terms used in accounting, which
are usually called relative cost to each transaction. However as these
costs are measured, the most common types being mentioned are implicit
and explicit cost.
Implicit cost is considered as the cost that has occurred on an enterprise
but is not initially reflected and reported as a direct expenditure which is
usually referred to as the deficit from a potential revenue, a result when
the person renounces his capacity to gain higher profitability, or when a
company forgoes the satisfaction and benefits that a specific project might
generate.
Explicit cost is the cost that is solidly reported based on numbers and
statistics, very detailed in terms of the figures that were generated which
provides a clear and continuous cash flow from expenses that do not
necessarily proved to be obvious about it and establish the right from the
thought of profitability.
Difference between implicit cost and explicit cost can be attributed this
way, implicit cost is an anticipated loss of revenue even before the whole
transaction pushed through, and these are not in reflected in cash but
rather this is based on benefits that a certain investment seems very
promising. While explicit cost on the other hand, is measured by its
monetary value or any of its equivalent which can be counted and verified
in a report, and definite in nature and very exact.

In addition, implicit cost and explicit cost are also distinguished through:
Implicit cost is considered as the cost that has occurred on an
enterprise, but is not initially reflected and reported as a direct
expenditure.
Explicit cost is the cost that is solidly reported based on numbers
and statistics. This actual cost is very detailed in terms of the
figures that were generated.
Implicit cost is an anticipated loss of revenue even before the whole
transaction pushed through.
Explicit cost on the other hand is the black and white accountability
of all the profit.
Q4. Graphically explain the relationship between change in
output and AVC, AC and MC.
Ans. Average Variable Cost (AVC) is found by dividing total variable cost
(TVC) by the corresponding output which declines initially, reaches a
minimum, and then increases again. While the Average Cost (AC) can be
found by dividing total cost (TC) by total output (Q) or, by adding AFC and
AVC for each level of output.
On the other hand, Marginal Cost (MC) is defined as the extra, or
additional, cost of producing one more unit of output which can be
determined for each additional unit of output simply by noting the change
in total cost which that unit’s production entails: Change in TC ∆TCMC =
Change in Q ∆Q.
It is notable that the relationship between change in output and that
marginal cost cuts through AVC, AC and MC at their minimum, and when
both the marginal and average variable costs are falling, average will fall
at a slower rate. Thus, when MC and AVC are both rising, MC will rise at a
faster rate.
As a result, MC will attain its minimum before the AVC, and when MC is
less than AVC, the AVC will fall, and when MC exceeds AVC, AVC will
increase, which means that so long as MC lies below AVC, the latter will
fall and where MC is above AVC, AVC will rise. Therefore, at the point of
intersection where MC=AVC, AVC has just ceased to fall and attained its
minimum, but has not yet begun to rise.
Similarly, the marginal cost curve cuts the average total cost curve at the
latter’s minimum point, since MC can be defined as the addition either to
total cost or to total cost or to total variable cost resulting from one more
unit of output. However, no such relationship exists between MC and the
average fixed cost, because the two are not related, and by definition,
marginal cost includes only those costs which change with output and
fixed costs by definition are independent of output.

Q5. Describe the long run average cost (LAC) curve according to
the modern cost theory.
Ans. The Long-run Average Cost (LAC) curves are derived from the long-
run production functions in which all inputs are variable, but in the long
run none of the factors are variable and all can be varied to increase the
level of output.
The long run average cost of production is the least possible average cost
of production of producing any given level of output when all inputs are
variable, including of course the size of the plant, and in the long run
there is only the variable cost as total cost, by which there is no
dichotomy of total cost into fixed and variable costs. Thus we study the
shape and relationship of long run average cost curve and long run
marginal cost curve.
Long run is a planning horizon, and it is only a perspective view for the
future course of action which comprises all possible short run situations
from which a choice is made for the actual course of operation.
The features of Long Run Average Cost (LAC) Curve are:
• Tangent curve:
By joining the loci of various plant curves relating to different
operational short run phases, the LAC curve is drawn as a tangent
curve.
• Envelope curve:
It is also referred to as the envelope curve because it is the
envelope of a group of short run curves.
• Planning curve:
It denotes the least unit cost of producing each possible level of
output and the size of the plant in relation to LAC curve.
• Minimum cost combination:
It is derived as a tangent to various SAC’s curve under
consideration, so the cost level presented by LAC curve for different
level of output reflect minimum cost combination at each long run
level of output.
• Flatter U-shaped:
It is less shaped or rather dish shaped. It gradually slopes
downward and then after reaching a certain level, gradually begins
to slope upwards

PART – C
Q1. Explain the Cyert-March Hypothesis of satisficng behaviour.
Ans. Cyert and March Hypothesis of satisfying behaviour explicitly stated
that they developed their framework for dealing with the large, multi-
product firm, and in discovering how BTF can be applied to the
development of a BTEF, it needs to boil down Cyert and March’s ideas to
key elements, then examined in greater detail.
The Behavioural Theory of Cyert-March is a theory that is built around a
political conception of organizational goals, a bounded rationality
conception of expectations, an adaptive conception of rules and
aspirations, and a set of ideas about how the interactions among these
factors affect decisions in a firm.
Modern perspectives often rely, implicitly or explicitly, on the behavioural
ideas from Cyert and March’s hypothesis, and their ideas about goal
conflict, behavioural conceptions of information search and expectation
formulation, and the adaptive adjustment of choice variables provided the
supporting architecture of firm decision-making essential to strategic
theories of firms.
Cyert-March Hypothesis’ also helped to extend the understanding of
competitive interaction and the performance of individual firms as well as
industries, and served to propagate modern research on individual
behaviour in firms and markets.
Central to Cyert and March’s hypothesis is the idea that decision making
consists in finding a satisfactory solution (satisficing) rather than in
evaluating the best possible alternative (optimization). Thus, making
management the art of dealing effectively with the reality of bounded
rationality in a changing environment, by which these themes remain as
fresh and relevant today as they were when Cyert and March launched
upon their endeavour in the early 1960s. However, with very few
exceptions, very little has been said by researchers in the tradition of
Cyert and March about the behaviour of entrepreneurial firms, whether
they are conceptualized as small firms, young firms, or pre-firms.
There are three ideas that parallel key concepts in the Cyert and March’s
hypothesis:
1. Accumulating stakeholder commitments under goal ambiguity
2. Achieving control through non-predictive strategies
3. Having a predominately exaptive orientation in the entrepreneurial
firm.
Together, all these ideas can be collated into a model of entrepreneurial
firm behaviour that emphasizes transforming current realities to fabricate
new environments rather than acting within extant environments.

Q2. Explain the profit maximizing conditions of a firm with the
help of marginal revenue and marginal cost.
Ans. The profit maximizing conditions of a firm with the help of marginal
revenue is shown in the amount by which a firm's revenue increases when
it expands output by one unit, taking into account that to sell one more
unit it may need to reduce price on all units, and such benefits can be
seen in terms of utility/satisfaction/or dollar amounts.
In addition, the maximizing benefit of marginal revenue is the extra
revenue that an additional unit of product will bring a firm which can also
be described as the change in total revenue/change in number of units
sold.
Relatively, marginal revenue is equal to the change in total revenue over
the change in quantity when the change in quantity is equal to one unit
(or the change in output in the bracket where the change in revenue has
occurred).
For a firm facing perfectly competitive markets, price does not change
with quantity sold, so marginal revenue is equal to price, and for a
monopoly, the price received will decline with the quantity sold, so
marginal revenue is less than price which means that the profit-
maximizing quantity, for which marginal revenue is equal to marginal
cost, will be lower for a monopoly than for a competitive firm, while the
profit-maximizing price will be higher.
While marginal cost is the increase in cost that accompanies a unit
increase in output, by which the partial derivative of the cost function with
respect to output.
Moreover, marginal cost is also known as incremental cost or differential
cost. A simple definition of marginal cost (MC) would be, "The change in
total costs arising from a change in the managerial control variable"
(Baye, 2006). According to the Blackwell Encyclopedic Dictionary of
Managerial Economics "The marginal cost is the change in total costs due
to a unit (or incremental) change in output.
Basically, marginal cost is the change in total cost that arises when the
quantity produced changes by one unit, and mathematically, the function
is expressed as the derivative of the total cost (TC) function with respect
to quantity (Q), which may change with volume, and so at each level of
production, the marginal cost is the cost of the next unit produced.
Q3. Explain why does a perfectly competitive firm reaps normal
profits in the long run.
Ans. A perfectly competitive firm reaps normal profits in the long run
because ease of entry and exit in monopolistically competitive markets
forces firms into a slightly more competitive mode, in which many
potential suppliers compete vigorously with makers of close, but not
perfect, substitutes for their “brand-name” products.

Competitors do not base decisions on the anticipated individual reactions
of their many competitors, so they are not mutually interdependent in the
way others are, by which product differentiation (e.g., packaging,
advertising, or styling), however, gives them some control over prices.
Pure competition allows easy entry or exit, but differs because each firm
produces a differentiated good, and have:
1. Large numbers of potential buyers and suppliers.
2. Differentiated products that are close substitutes.
3. Easy entry or exit in the long run.
Successful product differentiation creates market power by expanding the
demand curve the firm faces and decreasing its price elasticity which can
allow a competitor to act a little like a monopolist that has some control
over price, but like normal competitors, monopolistic competitors earn
only normal profit in the long run because entry by potential competitors
is easy.
Regardless of market structure, all firms maximize profit by producing
where marginal revenue equals marginal cost, and in the short run, this
successful firm's economic profit equals the shaded area.
A perfectly competitive firm may also suffer short-run losses, and profits
would be impossible if a firm's average cost curve were always above the
demand curve, but like all firms, a competitor would minimize losses by
selling that output where marginal revenue equals marginal cost, as long
as the price it could set (average revenue) exceeded average variable
costs.
A competitive firm differentiate products to exploit short-run profit
opportunities, and would like their profits to persist, and these hopes are
usually frustrated because typical competitors earn only normal profits in
the long run; the long-run industry adjustments parallel those for pure
competition. Thus, wntry of new firms seeking profits cannot be
prevented, which may increase production costs, by which profits are also
dissipated because prices fall when new competitors expand output and
take customers from existing firms.
4. What is price discrimination? How does a discriminating
monopolist allocate his output in different markets to charge
different price.
Ans. Most businesses charge different prices to different groups of
consumers, for what is more or less the same good or service, normally
known as price discrimination which has become widespread in nearly
every market.

Price discrimination or yield management occurs when a firm charges a
different price to different groups of consumers for an identical good or
service, for reasons not associated with costs, which makes it important to
stress that charging different prices for similar goods is not pure price
discrimination.
One must be careful to distinguish between price discrimination and
product differentiation, which is when differentiation of the product gives
the supplier greater control over price and the potential to charge
consumers a premium price because of actual or perceived differences in
the quality / performance of a good or service.
Price discrimination is an extremely common type of pricing strategy
operated by virtually every business with some discretionary pricing
power which is a classic part of price competition between firms seeking a
market advantage or to protect an established market position, as well as
a discriminating monopolist firm allocates its output in different markets
to charge different price required for discriminatory pricing:
a) Perfect Price Discrimination:
Charging whatever the market will bear, also sometimes known as
optimal pricing, and with perfect price discrimination, the firm
separates the whole market into each individual consumer and
charges them the price they are willing and able to pay.
b) Second Degree Price Discrimination
This type of price discrimination involves businesses selling off
packages of a product deemed to be surplus capacity at lower
prices than the previously published/advertised price, and in these
types of industry, the fixed costs of production are high, at the
same time the marginal or variable costs are small and predictable.
c) Third Degree (Multi-Market) Price Discrimination
This is the most frequently found form of price discrimination and
involves charging different prices for the same product in different
segments of the market, where the key is that third degree
discrimination is linked directly to consumers’ willingness and ability
to pay for a good or service which means that the prices charged
may bear little or no relation to the cost of production.
Q5. Explain how price is determined under oligopoly under
conditions of price leadership.
Ans. An oligopoly is a market dominated by a few large suppliers, by
which the degree of market concentration is very high, such as a large
percentage of the market is taken up by the leading firms.

As such, firms within an oligopoly produce branded products (advertising
and marketing is an important feature of competition within such
markets) and there are also barriers to entry.
Another important characteristic of an oligopoly is interdependence
between companies which means that each company must take into
account the likely reactions of other businesses in the market when
making pricing and investment decisions, creating uncertainty in such
markets, which economists seek to model through the use of game
theory.
Game theory may be applied in situations in which decision makers must
take into account the reasoning of other decision makers, and it has been
used, for example, to determine the formation of political coalitions or
business conglomerates, the optimum price at which to sell products or
services, the best site for a manufacturing plant, and even the behaviour
of certain species in the struggle for survival.
In oligopoly:
• A few firms selling similar product;
• Each firm produces branded products;
• Likely to be significant entry barriers into the market in the long run
which allows firms to make supernormal profits;
• Interdependence between competing firms, where businesses have
to take into account likely reactions of rivals to any change in price
and output
Price is determined under oligopoly under conditions of price leadership,
through:
1) Oligopoly firms collaborate to charge the monopoly price and get
monopoly profits;
2) Oligopoly firms compete on price so that price and profits will be
the same as a competitive industry;
3) Oligopoly price and profits will be between the monopoly and
competitive ends of the scale;
4) Oligopoly prices and profits are "indeterminate" because of the
difficulties in modelling interdependent price and output decisions.

CASE STUDY – I
Estimation of the Demand for Oranges by Market Experiment
Researchers at the University of Florida conducted a market experiment in
Grand Rapids, Michigan, to determine the price elasticity and the cross-
price elasticity of demand for three types of Valencia oranges: those from
the Indian River district of Florida, those from the interior district of
Florida, and those from California.
Grand Rapids was chosen as the site for the market experiment because
its size, demographic characteristics, and economic base were
representative of other midwestern markets for oranges.
Nine supermarkets participated in the experiment, which involved
changing the price of the three types of oranges, each day, for 31
consecutive days and recording the quantity sold of each variety.
The price changes ranged within ±16 cents in 4-cent increments, around
the price of oranges that prevailed in the market at the time of the study.
More than 9,250 dozen oranges were sold in the nine supermarkets during
the 31 days of the experiment. Each of the participating supermarkets
was provided with an adequate supply of each type of orange so that
supply effects could be ignored.
The length of the experiment was also sufficiently short so as to ensure no
change in tastes, incomes, population, the rate of inflation, and
determinants of demand other than price.
The results, summarized in the following table indicate that the price
elasticity of demand for all three types of oranges was fairly high (the
boldface numbers in the main diagonal of the table).
For example, the price elasticity of demand for the Indian River oranges of
-3.07 indicates that a 1 percent increase in their price leads to a 3.07
percent decline in their quantity demanded.
More interestingly, the off-diagonal entries in the table, show that while
the crossprice elasticities of demand between the two types of Florida
oranges were larger than 1, they were close to zero with respect to the
California oranges.
In other words, while consumers regarded the two types of Florida
oranges as close substitutes, they did not view the California oranges as
such.
In pricing their oranges, therefore, producers of each of the two Florida
varieties would have to carefully consider the price of the other (as
consumers switch readily among them as a result of price changes) but
need not be much concerned about the price of California oranges.

Price Elasticity and Cross-Price Elasticity of Demand for Florida Indian
River, Florida
Interior, and California Oranges
Price Elasticities and Cross-Price Elasticities
Type of Orange
Florida Indian
Florida Interior California
River
Florida Indian River -3.07 +1.56 +0.01
Florida Interior +1.16 -3.01 +0.14
California +0.18 +0.09 -2.76
Questions:
1) In light of the case define a test market? When should a firm
take help of market experiments to forecast demand?
Ans. A test market, in the field of business and marketing, is a
geographic region or demographic group used to gauge the viability of a
product or service in the mass market prior to a wide scale roll-out, where
the criteria used to judge the acceptability of a test market region or
group include:
o A population that is demographically similar to the proposed target
market; and
o Relative isolation from densely populated media markets so that
advertising to the test audience can be efficient and economical.
In addition, the test market ideally aims to duplicate everything,
promotion and distribution as well as product, on a smaller scale, by
which the technique replicates, typically in one area, what is planned to
occur in a national launch, and the results are very carefully monitored, so
that they can be extrapolated to projected national results.
A firm take help of market experiments to forecast demand sales since it
helps business managers determine how many units to create and
distribute, as well as vital for determining sales quotas.
Also known as the buyer's intentions method, the user expectations
method is also a market experiment in demand forecasting which relies on
answers from customers regarding their intent to purchase the product
during the forecasting time period, and works best when attempting to
estimate current market potential as well as to forecast demand, because
it does not take into account the company's marketing and advertising
efforts which may affect consumers' intent to buy.
While the sales force composite method is a forecasting experiment which
starts with the forecaster asking for opinions about future sales from
every member of the sales staff currently working in the field, where each
sales force member states how many sales she thinks she'll make during
the given forecasting period.

2) Suggest a suitable price policy for the three types of
oranges.
Ans. The concepts of comparative advantage and competitiveness are
important foundations for understanding the importance of international
trade which illuminate the underlying factors responsible for current trade
patterns.
Accordingly, comparative advantage and competitiveness are related, but
are often mistakenly exchanged for one another, which explain how trade
benefits nations through more efficient use of the world's resource base
when that trade is totally unrestricted. While competitive advantage
defines trading patterns as they exist in the real world including all the
barriers to free trade ignored by comparative advantage.
The concepts of comparative advantage and competitiveness are
important foundations for understanding the importance of international
trade, and said concepts illuminate the underlying factors responsible for
current trade patterns.
The most suitable price policy for the three types of oranges is the
California Orange, given that prices of the same commodity under self-
sufficient conditions vary substantially among countries even if consumer
demand was the same in each of those countries.
Such price variation is due to the variable quantity and quality of
productive factors such as land and climate, and the presence of skilled
labour more suitable for production of certain products than others. And
due to these resource variations some goods may be produced only at
very high cost, or perhaps not at all, in some nations.
Classic example of which is that the production of oranges in Canada
could only be accomplished under greenhouse conditions resulting in
extremely high unit production costs while oranges are produced in
California at relatively low cost due to the immovable factors of climate,
water and land favourable for orange production.
Considering a world where trade among nations is possible while
maintaining the previous assumption of immovable productive resources,
consumers will compare prices of locally produced oranges with the prices
of the same commodity produced in other nations.
Subsequently, consumers will choose to purchase identical type of
oranges at the lowest price regardless of where produced, as trade
proceeds among nations, commodity prices rise in those nations which
had relatively low prices in the absence of trade while prices fall in nations
with relatively high pre-trade prices.

CASE STUDY – II
A deodorant company manufactures and sells several types of deodorants
which are branded as ‘Smell Fresh’. The company introduced five years
ago, a new type of deodorant and its sales increased rapidly. However,
over the past two years, sales have been declining steadily even though
the market for deodorants has been expanding. Worried by the declining
sales the company conducted a survey of the market, which yielded the
following information:
(i) Several new rivals have come up during the past five years, which
manufacture and sell almost similar deodorants.
(ii) Other companies have set prices lower than the prices of this
company.
(iii) This company had initially set the price of its new brand at Rs 40, for
which retailer pays Rs 30, which was never changed.
(iv) The rival firms have set their prices at Rs 37.50, retailers paying Rs
25.
In view of these facts, the company decided to review the cost structure
to find out whether the margin to the retailers could be reduced to the
level of the rival firms. The company finds that the variable costs
(including raw materials and labour) stands at Rs 15 per deodorant. At
present the company sells 4, 00,000 deodorants. As to the market
prospects, if the price is reduced to Rs 35, the demand would increase by
1,50,000 and if the price is reduced to Rs. 32.50, demand would increase
to 6,50,000 units. With such an increase in production, the firm could use
its resources more fully. The bulk of purchase of raw materials and more
efficient use of labour would both help to reduce the unit variable cost to
Rs. 12.50.
Questions:
1) What price should the company charge to recapture market
lost to rival firms?
Ans. In order for the deodorant company to charge and recapture
market lost to rival firms, predatory pricing may be the solution for the
firm deliberately setting prices to incur losses for a sufficiently long period
of time to eliminate, discipline, or deter entry by a competitor, in the
expectation that they will subsequently be able to recoup its losses by
charging prices above the level that would have prevailed in the absence
of the impugned conduct, with the effect that competition would be
substantially lessened or prevented.
Competition delivers many economic benefits, including competitive prices
and product choices, where low prices are usually a good indication of
vigorous competition.

However, while competitive prices are beneficial to consumers, certain
anti-competitive pricing behaviour, such as predatory pricing, can harm
the economy, making predatory pricing to have short-term benefits for
consumers, but it can ultimately lead to higher prices or other anti-
competitive effects in the long run.
Relatively, in today’s fast-paced, global economy, markets are constantly
changing, demanding flexible and innovative responses to competitive
challenges.
Asset position of the deodorant company impacts the competitive
strategies, and in order to cope up with the resource constraints and earn
for livelihoods, small and medium sized firms like this case rely upon own
labour and target the medium and low-price segments.
In order to be able to recapture market lost to rival firms, the company’s
product mixes should comprise of single varieties and medium qualities of
the fast moving product lines, mixed lot sizes, negotiate for prices and
offer periodic price discounts since overhead costs are nearly negligible for
them, and manage their product purchases from several sources to keep
the cost prices low.
Consequently, due to the company’s financial and physical constraints, it
then attempts to minimize the risks, and content with their businesses
that provide a stable flow of income. However, in contrast, large sized
firms target the upper and medium price segments.
2) Suggest alternative strategies that the company can adopt
to counteract competition.
Ans. There are alternative strategies that the deodorant company can
adopt to counteract competition, where they tailor their competitive
strategies to the demographics features, purchase, capacity and taste
preferences of the target markets.
Accordingly, they design the merchandise mixes, depth and breadth of
product lines, product quality, lot sizes, fix prices, advertise product
promotion, add services, operate for suitable business hours, and manage
for logistic, etc.
The alternative strategies that the company in this case, can adopt to
counteract competition, is presented below, namely:
1) PRODUCT DIFFERENTIATION
Product differentiation along a single/multiple attributes takes a
comparatively longer time to change than price that could be
changed at a very short notice and plays merely a tactical role.
Thus, the company should focus on single varieties of the seasonal
products mainly of medium qualities with an average size of 2.43
products.

2) MARKET DEVELOPMENT
The deodorant company must also focus high on the low and
medium and low on the high price segments, and medium sized
companies are high on the medium and moderate on the low and
high price segments. Thus, quite often all sized firms influence
customer purchase decisions through salesmanship, and depending
upon the sizes and characteristics of the target markets they adapt
the marketing mixes, by which within each market segment,
customers comprise of two groups, regular and floating.
3) PRODUCT PRICING
Difficulty of controlling the product quality and volume, intra and
inter seasonality, proper temperature throughout the distribution
system limits the evolution of true consumer franchises for specific
brands that makes the dynamics of fresh produce markets largely
commodity like and most firms act as price-takers. However, the
company’s purchase choices, lot sizes and the product supply
positions at any point of time impact theirs' offer prices for the
seasonal products in the wholesale markets, where they use the
principle of "cost plus" and "competitive" pricing for pricing
products. Said costs set the price floor while customers' and
competitors' characteristics impact the actual price fixation.

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