Managerial Economics

Q. 1) Explain briefly the features of Public Sector Enterprises?

Point out its merits and demerits?

Ans. 1) Public Sector Enterprise is the Enterprise, which are owned,

managed and controlled by the government. They are also called as State
Enterprise or Public Undertakings. Eg: Railway transport, road transport, water,
electricity, gas etc.

Features of Public Sector Enterprises:

 State Control: They are owned, managed and controlled by the

concerned government departments.

 Management: professionals may manage some of them.

 Accountability: They are accountable to the public.

 Legal Status: Each public enterprise is a separate legal entity and

established by law. They are influenced by the state policy.

 Profit: Profit making is not the main motive of such organizations, but to
promote social welfare.

Three forms of Organization of Public Sector Enterprises:

1.) Departmental Management: The government departments run these. Such

as posts and telegraphs, railways, electricity, gas etc. Enterprises that provide
the steady income to the government are generally departmentally managed.

Main Features of departmentally managed undertakings are:

 Managed by various departments of government.

 Civil servants run these services.
 Concerned ministries exercise control over such departments.
 Accountable to public through govt.
 They are financed by the govt. annually.

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Some of the Defects departmentally managed undertakings:

 Lack of initiative
 Ignorance,
 Delay in taking decisions,
 Red-tapism,
 Rigidity in operations,
 Politically motivated, etc.

2.) Joint stock company form of Management: These are the enterprises,
which are owned by the government but operated as private limited companies.
eg: Bharat Heavy Electricals Ltd. (BHEL),Steel Authority of India Ltd. (SAIL),
Hindustan Antibiotics Ltd. (HAL).

Main Features of Joint stock company form of Management:

 Owned by the government.

 Commercial in nature with profit motive
 Quick decision making
 Registered as private limited company
 Financial operations are subjected to close scrutiny by the govt.
 Efficient than departmentally managed enterprises

3.) Public Corporations: These are the organizations, which are created by the
special acts of legislature to run the newly setup public undertaking. eg: Life
Insurance co-operation of India (LIC), Oil and Natural Gas Commission (ONGC),
Reserve bank of India(RBI).

Main Features of Public Corporations:

 Created by the special acts of parliament.

 Commercial in nature with profit motive.
 Efficient than departmentally managed enterprises.
 Powers and functions are clearly laid down by the act of parliament.
 Financially independent and free to take day to day decisions without
intervention of the parliament.

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Merits of Public Enterprise:

1. Use of Profit: Profits earned from such enterprises is used to promote

social welfare or further expansion of the company. Eg: HMT, which is
commercial in nature with profit motive.

2. Sufficient Capital: It is in a position to raise more capital then private

sector as fund can be raised from various sources.

3. Economies of Scale: On account of large-scale production it is able to

take advantage of Economies of Scale

4. Public Welfare: They are formed with the aim of public welfare and
provide the facilities like electricity, water, rail transport, posts and
telegraphs etc at a appropriate rate which otherwise would have if they
were given to the private sectors.

5. Nature of Investment: There are certain fields where the private sectors
cant invest because they are either too risky or rate of return on
investment is very low. Such types of projects are undertaken by the
public enterprise for common welfare. Eg: construction of river project.

6. Labour Relation: Workers are likely to be contended due to security and

justice in the service hence the chance of conflict is very less.

7. Industrial Development: It can hire best technical and managerial talent

by paying high salaries, thus leading to the development.

8. Balanced Development: This can be achieved by locating the public

enterprise in the less developed areas and thereby reducing the regional
income inequalities.

9. Ultimate control by the people: As the control is ultimately in the hands

of people any wrong doings is set right.

10. No Wastes: Expenses like Advertising etc can be avoided, as there is no

need for it in the public enterprise.

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De-Merits of Public Enterprise:

1. Inefficient Management: Decision-making is a very slow process in this

case and hence making the management inefficient.

2. No personal interest: There is no personal interest of any individual in

the progress of such firm hence making it inefficient.

3. Political Interference: Such enterprise may be exposed to political

corruption and bribery. Political consideration may determine the transfers
and appointments of person.

4. Rigid: They are rigid in their operation, rules and regulations

5. Extravagance: The officials in charge of managing the enterprise may

spend in the extravagant way causing loss to the enterprise.

6. Lack of Incentive: Because of lack of incentive there is lack of initiative

and responsibility. They may not work enthusiastically and efficiently.

7. Transfers: Transfer of officers is quite common phenomenon in such

enterprises thus reducing the efficiency of the organization.

8. Unfair Competition: Public enterprise may offer unfair competition to the

Private enterprise in the same field.

9. Helplessness of Consumer: Consumers have to depend for goods and

services on public sector even if they are not up to the mark. Also the
officers may not treat consumers properly.

10. Prices: Prices may go on increasing and will no longer be of a public

welfare enterprise.

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Q. 2) Briefly review the various theories of profit?

Ans. 2) Various theories of profit are as follows:

a.) Risk Taking Theory:

According to Hawley, profit arises because considerable amount of

risk is involved in the business. But his was criticized for several
reasons. Firstly the types of risks involved in the business are not
classified. Also Cawer pointed out that profit is not the reward for
risk taking but instead it is a reward for risk avoiding. Successful
entrepreneur is the one who earns a good profit by avoiding the
risks, while mediocre businessman is not able to earn profit as he
is unable to avoid risks.

b.) Uncertainty-Bearing Theory:

In this theory the risks are classified into 2 types:

 Insurable Risks: These are the risks covered by the

insurance company. Eg: risk of fire, accidents, risk of
theft etc. Owner takes the insurance policy by paying the
premium for the same.

 Non-Insurable Risks: The insurance company does

not cover these risks. They may occur due to sudden
increase in the price of raw material, introduction of new
substitutes, raw material supply may be reduced. When
the demand for the products suddenly falls large stock
remains in the inventory. Also there can be sudden
change in the fashion. All these factors are uncertain and
cannot be insured.

Losses arising of such uncertainty cannot be estimated with

precision; hence profit can be considered as reward for uncertainty.

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 c.) Innovation Theory:

According to this theory suggested by Schumpeter, profit is the

reward for Innovation. It is up to the entrepreneur how he exploits
the invention made by the scientist into innovation. But this theory
of Schumpeter has been criticized on several grounds. He
neglected the fact that profit is reward for risk and uncertainty
bearing. Innovative characteristics of the producer may help him to
earn super normal profits in the short run, but in the long run they
will disappear, as it will further attract the new firms into the market.
Thus it is said that profits caused by innovation are disappeared by
imitation.

d.) Dynamic theory of profit:

The renowned economist J.B Clark developed this theory. He

pointed out that whole world is dynamic and required of changes.

He pointed out the following type of changes:

 Changes in the quality and quantity of human needs.

 Changes in the techniques of production
 Changes in the supply of capital
 Changes in the organization of business
 Changes in population

Techniques of production can be changed and improved machinery

may be introduced. This may reduce the cost of production and
improve the profit and output. Purchasing of improved machinery
would involve lot of capital to be raised. Adding partners or
converting the partnership firm into Joint Stock Company can solve
this purpose. For this purpose producer has to keep on adjusting
himself or he would lag behind in this dynamic ever-changing
world.

Thus profit is the reward paid for dynamism.

This theory was criticized for several reasons. He classified the

changes under 5 categories but has failed to look at many other
important changes like change in the government policy, monetary
policy of Central Bank can lead to expansion and contraction of
supply of money. These factors may drastically affect the smooth
working of the business.
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Q. 3) What is Demand Forecasting?
Briefly review the methods of Demand Forecasting?

Ans. 3) Demand Forecasting is the method of predicting the future demand

for the firm’s product. It is guess or anticipation or prediction of what is likely to
happen in the future. Forecast can be done for several things. It is based on the
experience.

Techniques or methods of Demand Forecasting: Method of Demand

Forecasting is based on whether the good is Established Good or new good.

A) Methods of Demand Forecasting for established goods: Information of

the established good is available so the forecast can be based on this
information. 2 Basic methods of Demand Forecasting for the established goods
are:

(1) Interview and Survey Approach: (for short period forecast):

Interview and Survey Approach collects information in the different
way. Depending upon how the information is collected, we have
different sub methods as follows:

(a) Opinion-Polling Method:

This method tries to collect information from the customer
directly or indirectly through market research department of
the firm or through the whole sellers or the retailers.
Consumers are contacted through mails or phones or
Internet and information regarding their expected
expenditure is collected. This method is useful when
consumers are small in number.

Limitations:

a) It is difficult and costly to contact all the customers

b) It is suitable only for short period

c) Consumers are not sure of their purchase plans

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(b)Collective Opinion Method:

Large firms have organized sales department. The
salesman has the technical training as how to collect the
information from the buyers. This information is further used
for forecasting the demand.

Limitations:

a) It is difficult and costly to contact all the customers

b) It is suitable only for short period

c) This is based on judgment & has no scientific

basis.

(c)Sample Survey Method:

The total number of consumers for the firm’s product is very
large called as population. It is practically not possible to
contact all the consumers. Only few of them are contacted
and this forms the sample. The sample forecasts are then
generalized for the whole population through advanced
statistical methods available.

Limitations:

a) Information collected may not be accurate.

b) Sample is not a random sample.

c) Consumers do not have the correct idea of their

purchases in future.

(d)Panel of experts:
Panel of experts consists of persons either from within the
firm or from outside the firm. These experts come together
and forecast the demand for their product that is purely
based on the judgment of these experts so they are less
accurate. But if based on the scientific method the forecast
would be accurate.

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(e)Composite management opinion:

The opinions of the experienced person within the firm are
collected and manger analyses this information. This
method is quick, easy and saves time, but is not based on
the scientific analysis and thus may not give very accurate
results.

(2) Projection Approach: (for long period forecast)

In this method past experience is projected into the future. This can be done with
the help of statistical methods.

(a)Correlation and Regression analysis:

Past data regarding the factors affecting the demand can be
collected. It is possible to express this on the graph. This is
a scatter diagram.
Eg: If we collect the past data about the sales and
advertising expenditure of the firm, it is possible to express
in the form of scatter diagram as shown below:

Y
A
.
.
. .
Sales . .
.
A .

O X
Advertisement
Expenditure

In the above diagram we get the functional relationship as

line AA. Here Advertisement Expenditure is the independent
variable and Sales is the dependent variable. The
relationship between these variables is correlation and the
technique of establishing this relationship is regression. In
simple correlation we establish relationship between 2
variables and more than 2 variables in multiple correlation.

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Limitation:

a) Assumption made is that correlation between 2

variables will continue in future also, this might not
happen.

(b)Time Series analysis

Demand forecasts for a period of 2-3 years are based on
time series analysis. It is similar to the correlation analysis. It
is based on the assumption that the relationship between
the dependent and the independent variable continues to
hold in the future.

B) Methods of Demand Forecasting for new products:

Indirect methods of forecasting are used to estimate demand for new products.
Following are the methods suggested:

(1)Evolutionary Method:
Some new goods evolve from already established goods. Demand
forecast for such new good is based on already established good
from which they are evolved. Eg: Demand for the color TV can be
calculated from Demand for the black and white TV, from which it is
actually evolved.

Limitation:

a) The product should have been evolved from the existing

product.

b) It ignores the problem of how the new product differs from

the old product.

(2)Substitution Method
Some new goods are substituted of already established goods. Eg:
VCR substituted with VCD player.

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Limitation:

a) New product may have many uses and each use has
different substitutability

b) When the substitute is added is added into market

existing firm may react by changing the prices.

(3)Opinion Polling Method

Expected buyers and the consumers are directly contacted and
opinion about the product is directly taken from them. If the
population is large then sample is selected and results are
generalized for the population.

Limitation:

a) It is difficult and costly to contact all the customers

b) It is suitable only for short period

c) Consumers are not sure of their purchase plans

(4)Sample Survey Method:

New product are first introduced in the sample market and the
results seen in the sample market are generalized for the total
market.

Limitations:

a) Information collected may not be accurate

b) Tastes and the preferences may differ from market to market

(5)Indirect Opinion Polling Method:

Opinion of the consumers is indirectly collected through the dealers
who are aware of the needs of the customers.

Limitation:

a) It is based on the judgment

b) Limited Scope

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Q. 4) What is meant by economies of scale?

Explain with illustration the Internal and External economies of scale?

Ans. 4) Initially when a new firm is starts its operations there are diseconomies
of scale, but with the passage of time it is fairly established in the market. Its
products are constantly in demand. Workers also acquire proficiency in
producing high quality goods. As a result firm decides to increase the scale of
production. Economies of the scale are classified as Internal and External
economies.

Internal Economies:

1. Technical Economies:
A firm that produces on the large scale can install improved
and the up to date machinery. New machinery reduces the
cost of production. Also the quality of goods produced by
such firm will be superior.

2. Commercial Economies:
A firm that produces on the large scale is required to buy the
raw material on the large scale. Bulk buying enables the firm
to procure the material at the lower cost. A firm making the
purchase is in a good position for bargaining. Also it can
negotiate with the transport operators and can secure
concessional freight charges. Big firm enjoys the good
reputation in the market and its good are in constant
demand in the market.

3. Managerial Economies:
A firm that produces on the large scale can hire the services
of the experts in the various fields such as purchase,
production, marketing and finance. These experts utilize
their knowledge and experience towards maximization of
the profit.

4. Financial Economies:
A firm that produces on the large scale can avail the benefit
of cheaper finance. A firm that has acquired reputation and
high credit rating can raise the capital quickly and easily.

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5. Risk and Uncertainty:

A firm that produces on the large scale can earn large
profits. It can build up huge reserves out of undistributed
profits. Capacity of such firm to sustain losses is therefore
big.

External Economies:

Benefits of the large firms are passed on to all small firms in that area. If
in any particular area many such firms are located then they may promote
common activities. These common activities may bring several benefits to
all the firms in an industry. For example in such a region facilities of
transport, banking, post-office etc may be developed and the firm can
benefit of these services. Number of new firms dealing with the ancillary
product is developed in this region. These firms may manufacture spare
parts on a large scale. The big firm may buy the spare parts at lower cost
which otherwise would have cost if they had manufactured themselves. It
is therefore profitable for the big firms to buy from small firms. Similarly
various firms concentrated in such region can start the research institute.
Benefits of this passed to all the firms. Such economies are called as the
external economies.
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Q. 5) Write Short Notes On:

e) Fiscal Policy:

It is one of the important economic policies to achieve economic stability.

Fiscal Policy refers to variation in taxation and public expenditure
programs by the government to achieve predetermined objectives.
Taxation is transferring of funds from private purses to public
(Government) coffers. It is the withdrawal of funds from private use.
Public expenditure on the other hand increases the flow of funds into the
private economy.

Since the tax-revenue and public expenditure form two sides of the
government budget, the taxation and public expenditure policies are also
jointly called the ‘Budgetary Policy’.

Fiscal or Budgetary Policy is regarded as powerful instrument of

economic stabilization. The importance of fiscal policy as an instrument of
economic stabilization rests on the fact that government activities in the
modern economies are greatly enlarged, and government tax-revenue
and expenditure account for a considerable proportion of GNP, ranging
from 10-25 per cent. Therefore the government may affect the private
economic activities to same extent through variation in taxation and public
expenditure.

Besides fiscal policy is considered to be more effective than

monetary policy because the former directly affects the private
decisions while later does so indirectly. If the fiscal policy is
formulated that it is during the period of expansion, it is known as
‘counter-cyclical fiscal policy’.

f) Monetary Policy:

Monetary Policy refers to the program of Central Bank’s variations, in the

total supply of money and cost of money to achieve certain predetermined
objectives. One of the primary objectives of monetary policy is to achieve
economic stability.

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 The traditional instrument through which Central Bank carries out the
Monetary Policies are:

Quantitative Credit Control measures such as open market operations,

changes in bank rates (or discount rates), and changes in the statutory
reserve ratios. Briefly speaking, open market operations by the Central
Bank are the sale and purchase of government bonds, treasure bills,
securities, etc., to and from public. Bank rate is the rate at which Central
Bank discounts the commercial banks bills of exchange or first class bill.
The statutory reserve ratio is the proportion of commercial banks time and
demand deposit, which they are required to deposit with Central Bank or
keep cash-in-vault. All these instruments when operated by the Central
Bank reduce (or enhance) directly and indirectly the credit creation
capacity of the commercial banks and thereby reduce (or increase) the
flow of funds from the banks to the public.

In addition these instruments, Central Bank use also various selective

credit control measures and moral suasion. The selective credit controls
are intended to control the credit flows to particular sectors without
affecting the total credit, and also to change the composition of credit from
undesirable to desirable pattern. Moral suasion is a persuasive method to
convince the commercial banks to behave in accordance with the demand
of the time and in the interest of the nation.

The fiscal and monetary policies may be alternatively used to

control the business cycles in the economy, though monetary policy
is considered to be more effective to control inflation than to control
depression. It is however, always desirable to adopt a proper mix of
fiscal and monetary policies to check the business cycles.

k) Economic Problem and its universal nature

The same basic economic problem – unlimited wants and relatively

limited resources – arises at all levels of human organization. Thus
whether we are thinking of grampanchayat, or of zilla parishad, or club or
hospital or national government, all have to face the basic economic
problem. Thus whether it is Government of India or the Government of
America, the problem of economy is always there.

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 The government of India with annual revenue of about 1,00,000/- crores
has innumerable demands on its resources such as meeting mounting
defense expenditure, expanding expenditure in respect of development
that is to be brought about in various sectors like agriculture, industries,
transport, education and so on. The government of India therefore
continually faces the basic problem of economy of how to make best use
of its limited resources. In the some way, the federal government of
America, the richest government faces some basic economic problem.
Though in absolute terms, its annual revenues are enormous running into
billions or trillions of dollars, its needs are also unlimited. Expanding and
modernizing the defense forces, establishing military bases all over the
world giving military assistance to the friendly countries, expenditure on
space and military research etc. and therefore even the richest
government of US is always confronted by the same basic economic
problem of limited resources to fulfill unlimited wants. Every nation, poor
or rich, small or great with small or huge population, has to face the basic
economic problem; no nation can escape it.

Thus we can conclude that that there is something universal about

problem of economy. The basic economic arises in the case of an
aboriginal, a villager, a city dweller, in the case of poor as also the rich, in
case of associations like clubs, schools, hospitals and government
organization right from the village level to national level. The problem of
economy – unlimited wants and limited means with alternative uses -has
been forever confronting the mankind. The economic problem is the
universal problem. Economy problem does not recognize boundaries of
caste, creed, colour, religion and culture.

l) Profit maximization goal:

The conventional economic theory assumes profit maximization as the

only objective of the business firms. It forms the basis for the conventional
price theory. Profit maximization is regarded as the most reasonable and
analytically most productive business objective.

Besides, profit maximization assumption has a great predictive power. It

helps in predicting the behavior of business firms in the real world and
also the behavior of the price and output under different market
conditions.

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There are two conditions that must be fulfilled for the profit maximization:

 The necessary condition requires that Marginal

Revenue (MR) must be equal to marginal cost (MC).
Marginal Revenue is obtained from production and
sales of one additional unit of output. Marginal cost is
the cost incurred due to one additional unit of output.

 The secondary condition requires that necessary

condition must be satisfied under the condition of
decreasing MR and increasing MC. The fulfillment of
two condition makes the sufficient condition.

Objections to this approach:

 Profit maximization assumption is too simple to

explain the business phenomenon in the real world.
In fact, businessman themselves are not aware of
this objective attributed to them.

 It is claimed that there are alternative and equally

simple objectives of business firms that explains
better the real world business phenomenon. Eg:
sales maximization, market share.

 Firm do not have the necessary knowledge and priori

data to equalize MR and MC.

In defense of Profit Maximization assumption:

 Only those firms continue to survive in the long run in

a competitive market, which are able to make
reasonable profit.

 This assumption has been accurate in predicting the

firm’s behavior.

 It is time honored objective of firm

 Profit is one of the most efficient and reliable

measures of efficiency of a firm.

The End

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