2016 – Solved Question Paper | Managerial Economics | Previous Year – Masters of Commerce (M.Com) | Dibrugarh University

2016

COMMERCE

Paper: 105

(Managerial Economics)

Full Marks – 80

Time – Three Hours

The figures in the margin indicate full marks for the questions.

1(a) Define managerial economics? Discuss the roles and responsibilities of a business analyst.

-> Managerial economics is a stream of management studies which emphasizes solving business problems and decision-making by applying the theories and principles of microeconomics and macroeconomics. It is a specialized stream dealing with the organization’s internal issues by using various economic theories.

Economics is an inevitable part of any business. All the business assumptions, forecasting and investments are based on this one single concept.

Business Analyst analyzes the enterprise and design organizations, ministries as well as non-profit organizations. Business Analysts analyze the business models as well as their association with technology. Business Analysis includes at least four levels. They are as follows:

• Strategic Planning – This level of analysis includes the evaluation of strategic activities of the company must.
• Business / Operation Model Analysis – This level includes the identification as well as evaluation of policies and procedures of the organization to do business.
• Process Definition & Design – This level of analysis includes the business process modelling, which is often the outcome of process design and modelling.
• IT & Technology Business Analysis – This level encompasses the rules as well as needs for technical systems. This analysis is usually encountered in the IT field.

Nature of Managerial Economics:-

Art and Science : Managerial economics requires a lot of logical thinking and creative skills for decision making or problem-solving. It is also considered to be a stream of science by some economist claiming that it involves the application of different economic principles, techniques and methods, to solve business problems.

Micro Economics : In managerial economics, managers generally deal with the problems related to a particular organization instead of the whole economy. Therefore it is considered to be a part of microeconomics.

Macro Economics : A business functions in an external environment, i.e. it serves the market, which is a part of the economy as a whole.

Therefore, it is essential for managers to analyze the different factors of macroeconomics such as market conditions, economic reforms, government policies, etc. and their impact on the organization.

Multi-disciplinary : It uses many tools and principles belonging to various disciplines such as accounting, finance, statistics, mathematics, production, operation research, human resource, marketing, etc.

Prescriptive / Normative Discipline : It aims at goal achievement and deals with practical situations or problems by implementing corrective measures.

Management Oriented : It acts as a tool in the hands of managers to deal with business-related problems and uncertainties appropriately. It also provides for goal establishment, policy formulation and effective decision making.

Pragmatic : It is a practical and logical approach towards the day to day business problems.

Managerial economics is concerned with the following aspects of a business:

1. Nature and objectives of a business firm- The promoter managers are to decide upon what would be the nature of business and also to fix objectives to achieve in the near future and also in the long term.

2. Demand analysis and forecasting- The manager is to analyze the demand for their product not only for the present but also he is required to estimate demand for future.

3. Cost and production analysis is another very important area to look into by managerial economic. As you know the managerial economists are more concerned with the future and in this regard also they will have to foresee about cost and output levels and many more.

4. Some other internal problems, fall under the purview of management within a business organization. Inventory management, profit planning, capital management, pricing policy and practices etc. are important internal operational problems of a business. The managerial economics have to take note of all these and must be able to find out the ways and means to control any crisis like situation.

Roles and responsibilities of a business analyst:-

Business analysis has emerged as a core business practice since the dawn of the 21^st century. Although every business domain has some business analyst jobs; IT especially has witnessed an explosion of career opportunities for business analyst profiles.

Roles:

A Business Analyst can able to work as a core intermediate of the company. The role of a Business Analyst proceeds on several dimensions as well as responsibilities, which all match into the huge domain of the core businesses of the organization. The core businesses of any company are packed with processes and the successful working of these processes is under the responsibility of Business Analyst, nominated for that specific project. The primary role of a Business Analysts includes the generating idea for new processes, developing them and very essentially implementing them to ensure that they’re functioning well.

In addition, Business Analyst requires guaranteeing these processes are organized in a way, which permits those processes to be modified to other portions of the company. He includes a clear understanding on how the processes are functioning currently in the environment of the business; hence, he can able to realize how operative it is and after measuring the worthiness, he can identify the gaps and then find the solutions to plug them. He also ensures to prevent those gaps in the new processes.

Since Business Analyst serves as the core processes of a business in the company, he needs to communicate with several departments of an organization. Communication with the uppermost position or top management of the company is essential roles of a Business Analyst. Moreover, he needs to interact with company’s Sales force, Marketing Department, Finance & Accounting department, the Production department and the human resource department as a part of this role. He/she also requires to aware the customer’s consumer behavior, which is influenced to the organization’s businesses. In addition, the job of Business Analyst isn’t of a static in nature. He requires being dynamic, well in his ideas, action, and words. In order to survive in the constantly changing phase of the corporate market, Business Analysts are demanded to review their processes constantly in their business unit and makes required changes if necessary. This behavior is vital to guarantee maximum customer fulfillment for the consumer of an organization and for business profitability optimization.

Responsibilities:

1. Understand the Requirement of the Businesses

A vital responsibility of the Business Analyst is to function with the project stakeholders to understand their requirements and translate them into details, that developers can able to understand. Moreover, to translate the emerging of question from the developers into details that stakeholders can able to understand. The key skill required for this portion of the process is the ability of the Business Analyst to refine the varying messages as well as the requirements of the project stakeholders or consumers into a consistent, single vision. This task sometimes includes certain political and negotiation maneuvering. Business Analysts often need to spend a certain amount of time in the meetings in order to save the development team from spending their time in understanding the stakeholder’s requirement.

2. Possibilities of the System

At the beginning of the project, the role of Business Analyst may seem as one among the software development team designated for the project. However, they are required to work with key project consumers or stakeholders as well as business people communicate and formulate with the vision of the business for the project. In addition, BA is in need to plot the scope and initial requirement of the project. The fundamental goal of the BA is to obtain the project concentrated early by transforming the initial high-level goal into something realistic.

3. Presentation & Public Speaking

For Business, it is paramount important to value the creating as well as delivering a quality presentation on the topics like project status, application designs as well as business requirements. Generally, people listening to the presentation of the Business Analyst are the senior business and IT management people. The main responsibility of the Business Analyst is to impress the stakeholder and other authority with their presentation, which would have a notable effect on the growth of the business.

4. Elaborate the Details of the Project

The most important responsibility of the Business Analyst is elaborating the details. This is where he gets into evaluating the needs and guarantee the implementation team has the entire details, they require creating or implementing the process. Most probably, this phase includes working with a wide range of stakeholders or consumers across the company to guarantee their needs, as well as knowledge, are combined into a detailed conversation about what they will actually build. In a conventional or a waterfall environment of a business, this phase is integrated with beginning the project and it covers the judgment of whether to fund the project or not. In many cases, this phase has taken a bit later, after the time and trust of the stakeholder is absorbed. Based on the project, BA requires a data model or specification as well. Regardless of how BA chooses to mention, this phase needs to complete when the stakeholder or customer have signed off on the agreement of what will get implemented and the developers have aware what they have to design as well as implement the project.

At several companies today, this project phase is taken in an iterative way. That means that the Business Analyst prepares the functional specifications and other requirements in a phase that are accepted by the organization and then the development team of the company designed as well as implemented. User stories and use cases are more suited to this kind of iterative strategy when compared to single functional specification. As a particular set of needs is preparing for the development to begin, the role of BA typically changes from an active side to a reactive side.

5. Support the Project Implementation

The Business Analysts involved in the implementation support through life cycle end. Business Analyst is not generally involved in the implementation directly unless they are holding extra roles on the designated project. However, they’re naturally brought in, if there are problems come up at the time of implementation, which cause some new additional needs to be addressed. This support could involve enabling a problem-solving meeting to identify how certain business requirements can be met provided newly identified technology constraints.

For instance, when redesigning a website, it is needed to form an assumption regarding how the author outlines would work. Then we found that the Word Press no longer allows the functionality we required. Then we are in need to revise the author outlines page and find a simple as well as an elegant solution.

As the task of implementation is finished, often Business Analysts need to have a more active task. They might be required to support the business to accept the new solution, which is being implemented. This task involves the analyzing how the stakeholder or consumers will utilize the new solutions in order to complete the certain activities and task. This task can also encompass user documentation, training or acceptance testing. It is becoming common for the Business Analyst to proceed to take part in the project via this stage. This phase is over when the project is delivered to the production environment and the stakeholders of the business are capable of accessing it successfully in their jobs. Of course, at this process of solution implementation, new requirements, as well as needs, are discovered and the Business Analyst might receive new projects to start and the entire cycle continues again.

6. Functional Requirements and Non-Functional Requirements

Attaining successful end product is one of the roles as well as responsibilities of a Business Analyst. He should determine what the project should do and how the project should work. In the terms of Business Analysis, these are referred as functional (What the project should do) and the non-functional (how the project should work) requirements. The functional, as well as non-functional requirements, serves a role in mentioning the abilities of the completed service or product. As the categories are matured, the greater importance is provided to the non-functional requirements. The main reason for this is that once the product attains its place in the real environment, you can start developing on what it ensures to raise its value.

7. User Acceptance Testing

The responsibilities of the Business Analysts do not end up with the identification of the needs and requirements of the project. Ensuring that the product is functioning well as it is designed for, in addition to ensuring the product delivered satisfies the user requirements is one among the most vital responsibilities of the Business Analyst. User Acceptance Testing is the only possible and accepted the way to ensure this. While the product in the development as well as deployment stages, Business Analysts should actively function on developing user-testing scenarios via testing approaches. The best indication of the user acceptance is that the product will offer the expected result.

8. Technical Writing, Decision Making & Problem Solving

The main role of Business Analysts is the building of business requirements specification, as well as other phases of documentation. They are in need to develop informative, coherent and usable documents for professional success. When it comes to decision making, there are several formalized techniques are available, including decision matrix, which can support to make business appropriate, quality as well as defendable decisions, which can support to offer the best service for the internal clients and enhance the performance. As similar to decision making, there are several formalized problem-solving techniques like Brainstorming and Five Whys, which can support to identify the root cause of a problem and define powerful solutions.

9. Maintenance of System and Operations

Once the entire requirements have been addressed and the solution offered the role of Business Analysts moves to preventing or correcting defects, making changes, enhancements and maintenance of the system to enhance the value of the system. They also involved in providing maintenance reports, system validation reports, deactivation plans as well as other plans and reports of other documents. The Business Analysts will also involve in evaluating the system to find when the replacement or deactivation is needed.

10. Team Building

It is an inevitable responsibility of a Business Analysts. They are required to lead ad hoc or formalized teams. They are in need to coordinate, structure, and lead these team members to make their role more successfully.

(b) What do you mean by business decision? Briefly mention about the decision making process and also state about the different models of decision making.

-> A large part of conducting any business is making decisions. Some of these are strategic: should we enter a certain market, how should we design our new product, which partners and distribution channels should we choose? Others are more routine, made manually or automatically during everyday business operations. The latter are operational decisions.

Operational decisions are determinations that businesses make on a regular basis, a selection or calculation of an outcome that depends on a number of prevailing circumstances (inputs) and which, ultimately, has an observable impact on the behaviour of an organisation. They include making determinations like:

· Should we extend a line of credit to this customer? On what terms?

· Should we initiate an inquiry into a customer’s insurance claim or just pay it?

· What products should we recommend to a client when they visit our website, given their past behaviour?

· Does this trade fee structure satisfy compliance regulations?

Many operational decisions need to happen many times a second and so they are often automated.

Operational decisions determine the day-to-day profitability of the business, how effectively it retains customers or how well it manages risk. Often the quality and consistency of decision-making determines your client reputation—for some clients their sole perception of your company is obtained from the outcome of these decisions.

Operational decisions may not seem as important as the strategic ones, but they are more voluminous and their significance eventually adds up. Decisions are often of special importance in regulatory compliance applications. Digital transformation is partially about how this decision-making can be made more customers focused.

The logic of some decision-making is intellectual capital: it helps to establish or maintain a competitive advantage for your company—it represents what you do to better your rivals, your unique selling points. You need to identify the important decisions you are making, define the decision-making process transparently, ensure they are made accurately, monitor their performance and manage their evolution and improvement. This process of explicitly managing your decisions is business decision management . The means of transparently representing decisions is decision modeling .

Business Vision Statement

A compelling business vision statement will provide a clear and powerful image of your company’s future.

Competitive Business Analysis

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Segmentation Strategy

Use your segmentation strategy to increase focus on customer needs.

Business decision Analysis

Use our business decision analysis, decision management, and road mapping services to accelerate your business success.

Ethics in Decision Making

Ethics in decision making can be addressed as part of the business decision making process.

Decision making process:-

The following are the seven key steps of the decision making process:-

1. Identify the decision. The first step in making the right decision is recognizing the problem or opportunity and deciding to address it. Determine why this decision will make a difference to your customers or fellow employees.

2. Gather information. Next, it’s time to gather information so that you can make a decision based on facts and data. This requires making a value judgment, determining what information is relevant to the decision at hand, along with how you can get it. Ask yourself what you need to know in order to make the right decision, and then actively seek out anyone who needs to be involved.

3. Identify alternatives. Once you have a clear understanding of the issue, it’s time to identify the various solutions at your disposal. It’s likely that you have many different options when it comes to making your decision, so it is important to come up with a range of options. This helps you determine which course of action is the best way to achieve your objective.

4. Weigh the evidence. In this step, you’ll need to “ evaluate for feasibility, acceptability and desirability ” to know which alternative is best, according to management experts Phil Higson and Anthony Sturgess. Managers need to be able to weigh pros and cons, and then select the option that has the highest chances of success. It may be helpful to seek out a trusted second opinion to gain a new perspective on the issue at hand.

5. Choose among alternatives. When it’s time to make your decision, be sure that you understand the risks involved with your chosen route. You may also choose a combination of alternatives now that you fully grasp all relevant information and potential risks.

6. Take action. Next, you’ll need to create a plan for implementation. This involves identifying what resources are required and gaining support from employees and stakeholders. Getting others onboard with your decision is a key component of executing your plan effectively, so be prepared to address any questions or concerns that may arise.

7. Review your decision. An often-overlooked but important step in the decision making process is evaluating your decision for effectiveness. Ask yourself what you did well and what can be improved next time.

Different Models of Decision making:-

1. The Rational/Classical Model:

The rational model is the first attempt to know the decision-making-process. It is considered by some as the classical approach to understand the decision-making process. The classical model gave various steps in decision-making process which have been discussed earlier.

Features of Classical Model:

1. Problems are clear.

2. Objectives are clear.

3. People agree on criteria and weights.

4. All alternatives are known.

5. All consequences can be anticipated.

6. Decision makes are rational.

i. They are not biased in recognizing problems.

ii. They are capable of processing ail relevant information

iii. They anticipate present and future consequences of decisions.

iv. They search for all alternatives that maximize the desired results.

2. Bounded Rationality Model or Administrative Man Model:

Decision-making involve the achievement of a goal. Rationality demands that the decision-maker should properly understand the alternative courses of action for reaching the goals.

He should also have full information and the ability to analyze properly various alternative courses of action in the light of goals sought. There should also be a desire to select the best solutions by selecting the alternative which will satisfy the goal achievement.

Herbert A. Simon defines rationally in terms of objective and intelligent action. It is characterized by behavioral nexus between ends and means. If appropriate means are chosen to reach desired ends the decision is rational.

Bounded rationally model is based on the concept developed by Herbert Simon. This model does not assume individual rationality in the decision process.

Instead, it assumes that people, while they may seek the best solution, normally settle for much less, because the decisions they confront typically demand greater information, time, processing capabilities than they possess. They settle for “bounded rationality or limited rationality in decisions. This model is based on certain basic concepts.

a. Sequential Attention to alternative solution:

Normally it is the tendency for people to examine possible solution one at a time instead of identifying all possible solutions and stop searching once an acceptable (though not necessarily the best) solution is found.

b. Heuristic:

These are the assumptions that guide the search for alternatives into areas that have a high probability for yielding success.

c. Satisfying:

Herbert Simon called this “satisfying” that is picking a course of action that is satisfactory or “good enough” under the circumstances. It is the tendency for decision makers to accept the first alternative that meets their minimally acceptable requirements rather than pushing them further for an alternative that produces the best results.

Satisfying is preferred for decisions of small significance when time is the major constraint or where most of the alternatives are essentially similar.

Thus, while the rational or classic model indicates how decisions should be made (i.e. it works as a prescriptive model), it falls somewhat short concerning how decisions are actually made (i.e. as a descriptive model).

3. Retrospective decision model (implicit favourite model):

This decision­-making model focuses on how decision-makers attempt to rationalize their choices after they have been made and try to justify their decisions. This model has been developed by Per Solberg. He made an observation regarding the job choice processes of graduating business students and noted that, in many cases, the students identified implicit favorites (i.e. the alternative they wanted) very early in the recruiting and choice process. However, students continued their search for additional alternatives and quickly selected the best alternative.

The total process is designed to justify, through the guise of scientific rigor, a decision that has already been made intuitively. By this means, the individual becomes convinced that he or she is acting rationally and taking a logical, reasoned decision on an important topic.

Some Common Errors in Decision-Making:

Since the importance of the right decision cannot be overestimated enough for the quality of the decisions can make the difference between success and failure. Therefore, it is imperative that all factors affecting the decision be properly looked into and fully investigated.

In addition to technical and operational factors which can be quantified and analyzed, other factors such as personal values, personality traits, psychological assessment, perception of the environment, intuitional and judgmental capabilities and emotional interference must also be understood and credited.

Some researchers have pinpointed certain areas where managerial thinking needs to be re-assessed and where some common mistakes are made. These affect the decision-making process as well as the efficiency of the decision, and must be avoided.

Some of the errors re:

a. Indecisiveness:

Decision-making is full of responsibility. The fear of its outcome can make some people timid about taking a decision. This timidity may result in taking a long time for making a decision and the opportunity may be lost. This trait is a personality trait and must be looked into seriously. The managers must be very quick in deciding.

b. Postponing the decision until the last moment:

This is a common feature which results in decision-making under pressure of time which generally eliminates the possibility of thorough analysis of the problem which is time consuming as well as the establishment and comparison of all alternatives. Many students, who postpone studying until near their final exams, usually do not do well in the exams.

Even though some managers work better under pressures, most often an adequate time period is required to look objectively at the problem and make an intelligent decision. Accordingly, a decision plan must be formulated; time limits must be set for information gathering, analysis and selection of a course of action.

c. A failure to isolate the root cause of the problem:

It is a common practice to cure the symptoms rather than the causes. For example, a headache may be on account of some deep-rooted emotional problem. A medicine for the headache would not cure the problem. It is necessary to separate the symptoms and their causes.

d. A failure to assess the reliability of informational sources:

Very often, we take it for granted that the other person’s opinion is very reliable and trustworthy and we do not check for the accuracy of the information ourselves.

Many a time, the opinion of the other person is taken, so that if the decision fails to bring the desired results, the blame for the failure can be shifted to the person who had provided the information. However, this is a poor reflection on the manager’s ability and integrity and the manager must be held responsible for the outcome of the decision.

e. The method for analysing the information may not be the sound one:

Since most decisions and especially the non-programmed ones have to be based upon a lot of information and factors, the procedure to identify, isolate and select the useful information must be sound and dependable. Usually, it is not operationally feasible to objectively analyse more than five or six pieces of information at a time.

Hence, a model must be built which incorporates and handles many variables in order to aid the decision makers. Also, it will be desirable to define the objectives, criteria and constraints as early in the decision-making process as possible.

This would assist in making the process more formal so that no conditions or alternatives would be overlooked. Following established procedures would eliminate the efforts of emotions which may cloud the process and rationality.

f. Do implement the decision and follow through:

Making a decision is not the end of the process, rather it is a beginning. Implementation of the decision and the results obtained are the true barometer of the quality of the decision. Duties must be assigned, deadlines must be set, evaluation process must be established and contingency plans must be prepared in advance. The decisions must be implemented whole heartedly to get the best results.

2(a) What are the different types of elasticity of demand? Discuss about the importance of elasticity of demand for a consumer, a producer and the government.

-> Demand extends or contracts respectively with a fall or rise in price. This quality of demand by virtue of which it changes (increases or decreases) when price changes (decreases or increases) is called Elasticity of Demand.

“The elasticity (or responsiveness) of demand in a market is great or small according as the amount demanded increases much or little for a given fall in price, and diminishes much or little for a given rise in price”. – Dr. Marshall.

Elasticity means sensitiveness or responsiveness of demand to the change in price.

This change, sensitiveness or responsiveness, may be small or great. Take the case of salt. Even a big fall in its price may not induce an appreciable ex appreciable extension in its demand. On the other hand, a slight fall in the price of oranges may cause a considerable extension in their demand. That is why we say that the demand in the former case is ‘inelastic’ and in the latter case it is ‘elastic’.

The demand is elastic when with a small change in price there is a great change in demand; it is inelastic or less elastic when even a big change in price induces only a slight change in demand. In the words of Dr. Marshall, “The elasticity (or responsiveness) of demand in a market is great or small according as the amount demanded increases much or little for a given fall in price, and diminishes much or little for a given rise in price.”But the demand cannot be perfectly ‘elastic’ or ‘inelastic’.

Completely elastic demand will mean that a slight fall (or rise) in the price of the commodity concerned induces an infinite extension (or contraction) in its demand. Completely inelastic demand will mean that any amount of fall (or rise) in the price of the commodity would not induce any extension (or contraction) in its demand. Both these conditions are unrealistic. That is why we say that elasticity of demand may be ‘more or less’, but it is seldom perfectly elastic or absolutely inelastic.

Types of Elasticity:

Distinction may be made between Price Elasticity, Income Elasticity and Cross Elasticity. Price Elasticity is the responsiveness of demand to change in price; income elasticity means a change in demand in response to a change in the consumer’s income; and cross elasticity means a change in the demand for a commodity owing to change in the price of another commodity.

Degrees of Elasticity of Demand:

We have seen above that some commodities have very elastic demand, while others have less elastic demand. Let us now try to understand the different degrees of elasticity of demand with the help of curves.

(a) Infinite or Perfect Elasticity of Demand:

Let as first take one extreme case of elasticity of demand, viz., when it is infinite or perfect. Elasticity of demand is infinity when even a negligible fall in the price of the commodity leads to an infinite extension in the demand for it. Even when the price remains the same, the demand goes on changing.

(b) Perfectly Inelastic Demand:

The other extreme limit is when demand is perfectly inelastic. It means that howsoever great the rise or fall in the price of the commodity in question, its demand remains absolutely unchanged. In other words, in this case elasticity of demand is zero. No amount of change in price induces a change in demand.

In the real world, there is no commodity the demand for which may be absolutely inelastic, i.e., changes in its price will fail to bring about any change at all in the demand for it. Some extension/contraction is bound to occur that is why economists say that elasticity of demand is a matter of degree only. In the same manner, there are few commodities in whose case the demand is perfectly elastic. Thus, in real life, the elasticity of demand of most goods and services lies between the two limits given above, viz., infinity and zero. Some have highly elastic demand while others have less elastic demand.

(c) Very Elastic Demand:

Demand is said to be very elastic when even a small change in the price of a commodity leads to a considerable extension/con­traction of the amount demanded of it.

(d) Less Elastic Demand:

When even a substantial change in price brings only a small extension/contraction in demand, it is said to be less elastic.

Importance of elasticity of demand for a consumer, a producer and the government:-

1. In the Determination of Output Level:

For making production profitable, it is essential that the quantity of goods and services should be produced corresponding to the demand for that product. Since the changes in demand is due to the change in price, the knowledge of elasticity of demand is necessary for determining the output level.

2. In the Determination of Price:

The elasticity of demand for a product is the basis of its price determination. The ratio in which the demand for a product will fall with the rise in its price and vice versa can be known with the knowledge of elasticity of demand.

3. In Price Determination of Factors of Production:

The concept of elasticity for demand is of great importance for determining prices of various factors of production. Factors of production are paid according to their elasticity of demand. In other words, if the demand of a factor is inelastic, its price will be high and if it is elastic, its price will be low.

4. In Demand Forecasting:

The elasticity of demand is the basis of demand forecasting. The knowledge of income elasticity is essential for demand forecasting of producible goods in future. Long- term production planning and management depend more on the income elasticity because management can know the effect of changing income levels on the demand for his product.

5. In Dumping:

A firm enters foreign markets for dumping his product on the basis of elasticity of demand to face foreign completion.

In the Determination of Government Policies:

The knowledge of elasticity of demand is also helpful for the government in determining its policies. Before imposing statutory price control on a product, the government must consider the elasticity of demand for that product.

The government decision to declare public utilities those industries whose products have inelastic demand and are in danger of being controlled by monopolist interests depends upon the elasticity of demand for their products.

6. Helpful in Adopting the Policy of Protection:

The government considers the elasticity of demand of the products of those industries which apply for the grant of a subsidy or protection. Subsidy or protection is given to only those industries whose products have an elastic demand. As a consequence, they are unable to face foreign competition unless their prices are lowered through sub­sidy or by raising the prices of imported goods by imposing heavy duties on them.

7. In the Determination of Gains from International Trade:

The gains from international trade depend, among others, on the elasticity of demand. A country will gain from international trade if it exports goods with less elasticity of demand and import those goods for which its demand is elastic.

In the first case, it will be in a position to charge a high price for its products and in the latter case it will be paying less for the goods obtained from the other country. Thus, it gains both ways and shall be able to increase the volume of its exports and imports.

(b) What do you mean by increase and decrease in demand? Explain it with the help of a graph and a table. Also discuss about the factors that determine elasticity of demand.

-> The change means an increase or decrease in the volume of demand and supply from its equilibrium. There exist some determinants other than the price of the commodity which affects the quantity of demand, like the income of consumers, the taste of consumers, preference of consumers, population, technology, etc. Due to the effects of these determinants , demand or supply of a product changes and demand and supply curve shifts. Such shifts affect the equilibrium price and quantity. Here now we are going to discuss changes in demand.

Changes in demand include an increase or decrease in demand. Due to the change in the price of related goods, the income of consumers, and the preferences of consumers, etc. the demand for a product or service changes.

So there are two possible changes in demand:

· Increase (shift to the right) in demand

· Decrease (shift to the left) in demand

I) Increase in demand (Shift to the Right)

Suppose, the income of the consumer increases. The price of the product and supply of the product remain the same. Due to an increase in income of the consumer, the purchasing power of consumption increases.

So the demand for the product in the market will also increase. Resultantly demand will change even if the price and supply of the product remain the same. This is called an increase in demand.

Since supplies are short, the price of the product will increase. Now due to the higher price, manufacturers of the product also increase their supply to cover extra demand in the market. Ultimately new equilibrium between demand and supply will be established.

Now we can conclude, due to an increase in demand, there is an increase in the equilibrium price. Resultantly quantity supplied also rises because quantity sold and purchases have increased. The Demand curve will shift rightward. Keep in mind the following points:

· No change in the price of the product

· No change in the supply of product

· Income of Consumer is increasing

· Demand is increasing

II) The Decrease in Demand (Shift to the Left)

Now, let’s think of the opposite of the above situation. Suppose the Income of the consumer decreases. But, the price of the product and the supply of the product remains the same. Due to the decrease in income of the consumer, the purchasing power of the consumer will also decrease.

So the demand for the product in the market will also decrease. Resultantly demand will change even if the price and supply of the product remain the same. This is called a decrease in demand.

Since supplies are excess in comparison to demand, the price of the product will decrease to OP₁. Now due to the lower price, manufacturers of the product also decrease their supply to align with demand in the market. Ultimately new equilibrium between demand and supply will be E ₁. At new equilibrium E₁, OP₁ is the price and OQ₁ is the quantity which is demanded and supplied.

Now we can say that due to the decrease in demand, there is also a decrease in the equilibrium price . Resultantly quantity supplied also decreases because the quantity sold and purchases have decreased. The demand curve will shift leftward. Keep in mind the following points:

· No change in the price of the product

· No change in the supply of product

· Income of Consumer is decreasing

· So demand for product decreasing.

Factors that determine elasticity of demand:-

1. Nature of commodity:

Elasticity of demand of a commodity is influenced by its nature. A commodity for a person may be a necessity, a comfort or a luxury.

i. When a commodity is a necessity like food grains, vegetables, medicines, etc., its demand is generally inelastic as it is required for human survival and its demand does not fluctuate much with change in price.

ii. When a commodity is a comfort like fan, refrigerator, etc., its demand is generally elastic as consumer can postpone its consumption.

iii. When a commodity is a luxury like AC, DVD player, etc., its demand is generally more elastic as compared to demand for comforts.

iii. The term ‘luxury’ is a relative term as any item (like AC), may be a luxury for a poor person but a necessity for a rich person.

2. Availability of substitutes:

Demand for a commodity with large number of substitutes will be more elastic. The reason is that even a small rise in its prices will induce the buyers to go for its substitutes. For example, a rise in the price of Pepsi encourages buyers to buy Coke and vice-versa.

Thus, availability of close substitutes makes the demand sensitive to change in the prices. On the other hand, commodities with few or no substitutes like wheat and salt have less price elasticity of demand.

3. Income Level:

Elasticity of demand for any commodity is generally less for higher income level groups in comparison to people with low incomes. It happens because rich people are not influenced much by changes in the price of goods. But, poor people are highly affected by increase or decrease in the price of goods. As a result, demand for lower income group is highly elastic.

4. Level of price:

Level of price also affects the price elasticity of demand. Costly goods like laptop, Plasma TV, etc. have highly elastic demand as their demand is very sensitive to changes in their prices. However, demand for inexpensive goods like needle, match box, etc. is inelastic as change in prices of such goods do not change their demand by a considerable amount.

5. Postponement of Consumption:

Commodities like biscuits, soft drinks, etc. whose demand is not urgent, have highly elastic demand as their consumption can be postponed in case of an increase in their prices. However, commodities with urgent demand like life saving drugs have inelastic demand because of their immediate requirement.

6. Share in Total Expenditure:

Proportion of consumer’s income that is spent on a particular commodity also influences the elasticity of demand for it. Greater the proportion of income spent on the commodity, more is the elasticity of demand for it and vice-versa.

Demand for goods like salt, needle, soap, match box, etc. tends to be inelastic as consumers spend a small proportion of their income on such goods. When prices of such goods change, consumers continue to purchase almost the same quantity of these goods. However, if the proportion of income spent on a commodity is large, and then demand for such a commodity will be elastic.

7. Time Period:

Price elasticity of demand is always related to a period of time. It can be a day, a week, a month, a year or a period of several years. Elasticity of demand varies directly with the time period. Demand is generally inelastic in the short period.

It happens because consumers find it difficult to change their habits, in the short period, in order to respond to a change in the price of the given commodity. However, demand is more elastic in long rim as it is comparatively easier to shift to other substitutes, if the price of the given commodity rises.

8. Habits:

Commodities, which have become habitual necessities for the consumers, have less elastic demand. It happens because such a commodity becomes a necessity for the consumer and he continues to purchase it even if its price rises. Alcohol, tobacco, cigarettes, etc. are some examples of habit forming commodities.

Finally it can be concluded that elasticity of demand for a commodity is affected by number of factors. However, it is difficult to say, which particular factor or combination of factors determines the elasticity. It all depends upon circumstances of each case.

3(a) Define demand forecasting with its main features. What are the uses of demand forecasting?

-> Demand forecasting is absolutely essential within supply chain management. Without adequate demand forecasting or planning, you will find that your inventory and stock falls short and could cost you a substantial amount of money over time. The entire concept behind demand forecasting is to ensure that you are fulfilling orders on time in the most efficient method/way possible.

This is why you need to ensure that you understand the characteristics and methods associated with proper demand forecasting and locate a method that enables your company to meet demand in an efficient and on-time manner. Therefore, within this blog, we are going to discuss the characteristics of demand forecasting in supply chain management and how it may pertain to your manufacturing operation.

Characteristics of Demand Forecasting:-

· Demand Forecasting is Always Wrong – It is important to understand that demand forecasts are always wrong. Even if the demand forecast is generated from demand forecasting software, you should expect to see some level of error within the forecasts. This is because year-to-year there will always be a variation in demand forecasts, no matter what company that you are. You have to take into account seasonality, macroeconomic factors, if you are running marketing campaigns, etc. All of these factors and more will greatly affect your demand and therefore leave you unable to accurately forecast what your demand will be.

· Long-Term Demand Forecast are Less Accurate – In correlation with demand forecasting being always wrong, long-term demand forecast are even less accurate than short-term forecast. This is because as you stretch your demand forecast further and further, the harder it is to accurately predict what it could be. Once again this is because of all of the factors associated with demand forecasting and any unforeseen events that may occur. Therefore, it is a must to attempt to only utilize short-term demand forecast and develop an idea of what demand may be.

· Aggregate Demand Forecast is More Accurate – Aggregate demand forecast take the cake when it pertains to accuracy. This is because aggregate demand planning tends to have a smaller standard deviation of error relative to the mean. Many large manufacturing facilities utilize aggregate demand forecasting and have seen a tremendous amount of efficiency improvement within their manufacturing operation. This form of software may be a bit more expensive than the others but is well worth the cost.

If you find that you are unable to purchase an expensive forecasting software, utilizing excel spreadsheets can be a great alternative option. If you find yourself utilizing ERP or MRP software, you may be seeking to locate another software that can fill in the gaps where these software’s lack in terms of efficiency. This is where many companies have found themselves utilizing Advanced Planning and Scheduling (APS) Software. Advanced Planning and Scheduling (APS) Software has become a necessity for manufacturing operations that are seeking to improve operational efficiency and overall reduce costs and waste within the production process. Advanced Planning and Scheduling (APS) Software is a must for manufacturers that want to maintain a competitive edge and improve their operation as a whole.

Uses of demand forecasting:-

i. Fulfilling objectives:

Implies that every business unit starts with certain pre-decided objectives. Demand forecasting helps in fulfilling these objectives. An organization estimates the current demand for its products and services in the market and move forward to achieve the set goals.

For example, an organization has set a target of selling 50, 000 units of its products. In such a case, the organization would perform demand forecasting for its products. If the demand for the organization’s products is low, the organization would take corrective actions, so that the set objective can be achieved.

ii. Preparing the budget:

Plays a crucial role in making budget by estimating costs and expected revenues. For instance, an organization has forecasted that the demand for its product, which is priced at Rs. 10, would be 10, 00, 00 units. In such a case, the total expected revenue would be 10* 100000 = Rs. 10, 00, 000. In this way, demand forecasting enables organizations to prepare their budget.

iii. Stabilizing employment and production:

Helps an organization to control its production and recruitment activities. Producing according to the forecasted demand of products helps in avoiding the wastage of the resources of an organization. This further helps an organization to hire human resource according to requirement. For example, if an organization expects a rise in the demand for its products, it may opt for extra labor to fulfill the increased demand.

iv. Expanding organizations:

Implies that demand forecasting helps in deciding about the expansion of the business of the organization. If the expected demand for products is higher, then the organization may plan to expand further. On the other hand, if the demand for products is expected to fall, the organization may cut down the investment in the business.

v. Taking Management Decisions:

Helps in making critical decisions, such as deciding the plant capacity, determining the requirement of raw material, and ensuring the availability of labor and capital.

vi. Evaluating Performance:

Helps in making corrections. For example, if the demand for an organization’s products is less, it may take corrective actions and improve the level of demand by enhancing the quality of its products or spending more on advertisements.

vii. Helping Government:

Enables the government to coordinate import and export activities and plan international trade.

The objectives of demand forecasting (as shown in Figure-1) are discussed as follows:

i. Short-term Objectives:

Include the following:

a. Formulating production policy:

Helps in covering the gap between the demand and supply of the product. The demand forecasting helps in estimating the requirement of raw material in future, so that the regular supply of raw material can be maintained. It further helps in maximum utilization of resources as operations are planned according to forecasts. Similarly, human resource requirements are easily met with the help of demand forecasting.

b. Formulating price policy:

Refers to one of the most important objectives of demand forecasting. An organization sets prices of its products according to their demand. For example, if an economy enters into depression or recession phase, the demand for products fall. In such a case, the organization sets low prices of its products.

c. Controlling sales:

Helps in setting sales targets, which act as a basis for evaluating sales performance. An organization makes demand forecasts for different regions and fixes sales targets for each region accordingly.

d. Arranging finance:

Implies that the financial requirements of the enterprise are estimated with the help of demand forecasting. This helps in ensuring proper liquidity within the organization.

ii. Long-term Objectives:

Include the following:

a. Deciding the production capacity:

Implies that with the help of demand forecasting, an organization can determine the size of the plant required for production. The size of the plant should conform to the sales requirement of the organization.

b. Planning long-term activities:

Implies that demand forecasting helps in planning for long term. For example, if the forecasted demand for the organization’s products is high, then it may plan to invest in various expansion and development projects in the long term.

(b) What method would you suggest to forecast the demand for a new product? Also explain the criteria of a good forecasting method.

-> Demand forecasting for the new products requires special skill and techniques as they are new products and no previous data will be available about their sales.

The method or techniques should be carefully tailored for the product. Joel Dean makes six possible approaches towards forecasting of new products. They are as follows:

1. The Evolutionary approach in forecasting demand

The principle behind this approach is that the demand for a new product is only an outgrowth and evolution of the existing product. It means that the demand conditions of the existing product should be taken into account while accessing the demand for the product.

Examples: Color TV sets from black and white TV sets; Left-side steering cars from right-side steering cars, etc. But this approach is useful only when the new product is very close to the old existing product.

2. Substitute approach in forecasting demand

By this the new product is analyzed as a substitute for the old existing product or service.

3. Growth curve approach in forecasting demand

The estimates of rate of growth and ultimate level of demand for the new product will be established on the basis of some growth patterns of an already established product.

For example, the average sales of Talcum powder will give an idea as to how a new cosmetic will be received in the market.

4. Opinion Poll approach in forecasting demand

Under this, the demand for the new product will be estimated by making direct enquiries from the ultimate consumers. This is done by sample survey method. But, this is a very complicated process as there will be problems of sampling, probing the real intentions of the consumers, etc..

5. Sales Experience approach in forecasting demand

According to Sales experience approach method, samples of new products shall be offered in a sample market to forecast demand. This is done through distributive channels like departmental stores or cooperative society, etc., or by direct mailing. Total demand is predicted on the basis of the sample market. But, the difficulty in this lies in determining the allowance to make for the immaturity of the sample market and full-fledged market.

6. Vicarious approach in forecasting demand

Through vicarious approach method, the reaction of the customer towards new product can be found out indirectly through the specialized dealers who are able to judge the needs, tastes and preferences of customers.

The dealers being the link between the producer and the ultimate consumers will be able to know how the customers will receive the new product.

The criteria of a good forecasting method:-

Forecasting demand and revenues for new variants of existing products is difficult enough. But forecasting for radically innovative products in emerging new categories is an entirely different ball game. There are no past trends to reassuringly extrapolate into the future, just a ton of uncertainty about whether the latent demand that the marketing folk suggested to secure the R&D funding is real or not. And after so much investment, the board is sure that this is the product that is going to become the next cash cow. Sure, you could manage their expectations by reminding them that something like 80% of new products fail and name drop a few of the spectacular flops of Fortune 500 companies. But that would be career limiting. A better alternative is to take control of the situation and adopt some of the forecasting best practices approaches that others have found to work.

Step 1: Make it a collaborative effort

Identify a handful of key people from marketing, sales, operations, and relevant technical departments and form a working group. This core team will be responsible for developing and managing the reforecasting process through the launch period until demand planning becomes more predictable.

Step 2: Identify and agree upon the assumptions

Collectively review all the available qualitative and quantitative data from market research, market testing, and buyer surveys. Use the data to identify a set of assumptions that can form the basis of a forecasting model. Ideally this will include assumptions about:

· Number of consumers in the target market

· Proportion expected to buy the product

· Anticipated timing of their purchase

· Patterns of repeat purchasing and replacement purchasing

Be prepared to commission additional research or consult external industry experts to fill any important data gaps. And always let the working group use their collective judgment to identify a realistic range of values for each assumption.

Step 3: Build granular models

Not all consumers will purchase a new product at the same rate. Some may be prepared to queue all night around the block to get their hands on it, but others will want to wait for subsequent versions when any unforeseen bugs are fixed and prices are typically lower. So it is important to build a forecasting model that is sufficiently granular to reflect how and when different market segments in different geographies might purchase the product and at what price.

Step 4: Use flexible time periods

Sales over the first few days and weeks in the life of any new product need to be carefully monitored as they will quickly show how demand is likely to grow in the future. So although the sales and finance function may only be interested in monthly data, it pays to develop detailed daily forecasts for the first quarter against which to track actual sales.

Step 5: Generate a range of forecasts

Run through a number of iterations, changing various assumptions and probabilities in the model to generate a range of forecasts. This is easily done if a modeling solution that can be recalculated in real-time is deployed as internal experts and business leaders can generate and test alternative scenarios on the fly.

Step 6: Deliver the outputs that users need quickly

In new product launch planning , agreements may have been reached with a number of suppliers to deliver rapid replenishment designed to prevent stock outs in the most uncertain period immediately after the launch. However if reforecasting the exact replenishment needs of every distribution point in the supply chain involves multiple steps, much of that precious time will evaporate.

Building a fully integrated forecasting model that compares existing stock level and automatically generates a detailed replenishment report for every location as soon as any high level assumptions change precludes such delays and shortens the replenishment cycle.

Step 7: Combine different techniques

Bottom up modeling based on purchasing intentions is not the only method available for forecasting demand for new products. In some markets, such as technology and consumer electronics, products can go through an entire life cycle in a matter of months. Such narrow windows of opportunity make it vitally important to assess demand as accurately as possible. The most damaging situation is having a stock shortage while the product is still hot, leading disappointed consumers to purchase a competitor’s product.

These sectors make use of sophisticated modeling techniques developed by academics that use substitution and diffusion rates to forecast how rapidly new technologies replace older ones. Such methodologies might not be appropriate to many businesses, but the message is the same; combining different forecasting techniques gives more accurate results.

Step 8: Reality check the forecast

Whenever reliable data exists, always check the forecast against the sales evolution of comparable products to see if it is realistic. Similarly you should also estimate how your market share might evolve as new competitors came into this emerging category and how the total market might grow. Unless this macro overview is credible, be prepared to rework the assumptions behind the model.

Step 9: Reforecast, reforecast and reforecast some more

Diligently monitor sales and qualitative feedback such as product reviews, media mentions, and customer feedback, and agree with the members of the working group how the assumptions in the model might need to change. If it’s appropriate, reforecast daily.

Step 10: Be prepared to cut your losses

Finally, always have a contingency plan. A high proportion of new products fail and it is better to pull the plug on an ailing new product that is unlikely to achieve a viable level of profitability at the earliest opportunity. So quantify and agree what level of sales penetration constitutes failure well before the product launch. That way, the decision will be swift and the existing stock can be quickly and cost-efficiently depleted.

Forecasting demand for new products is not an exact science and relies on judgment rather than statistical techniques. Key to success are collaboration, using all the quantitative and qualitative data that is available and having a modeling solution that can quickly and easily be updated to generate detailed forecasts for all users across the business. The benefits can be impressive both in terms of reduced inventory costs and improved customer satisfaction, something that is vital for a new product to flourish.

4(a) What is discriminating monopoly? How is it different from normal monopoly? Explain both the concepts with appropriate diagrams.

-> A discriminating monopoly is a single entity that charges different prices—typically, those that are not associated with the cost to provide the product or service—for its products or services for different consumers. Non-discriminating monopolies, on the other hand, do not engage in such a practice.

A company that operates as a discriminating monopoly by using its market-controlling position can do this as long as there are differences in price elasticity of demand between consumers or markets and barriers to prevent consumers from making an arbitrage profit by selling among themselves. By catering to each type of customer, the monopoly makes more profit.

A discriminating monopoly can operate in a variety of ways. A retailer, for example, might set different prices for products it sells based on the demographics and location of its customer base. For instance, a store that operates in an affluent neighborhood might charge a higher rate compared with selling the product in a lower income area.

The variances in pricing may also be found at the city, state, or regional level. The cost of a slice of pizza at a major metropolitan location might be set to scale with the expected income levels within that city.

Pricing for some service companies may change based on external events such as holidays or the hosting of concerts or major sporting events. For example, car services and hotels may raise their rates on dates when conferences are being held in town because of the increased demand with the influx of visitors.

Housing and rental prices can also fall under the effects of a discriminating monopoly. Apartments with the same square footage and comparable amenities may come with drastically different pricing based on where they are located. The property owner, who may maintain a portfolio of several properties, could set a higher rental price for units that are closer to popular downtown areas or near companies that pay substantial salaries to their employees. The expectation is that renters with higher income will be willing to pay larger rental fees compared with less desirable locations.

‘Discriminating monopoly’ or ‘price discrimination’ occurs when a monop­olist charges the same buyer different prices for the different units of a commodity, even though these units are in fact homogeneous. Such a situation is described as “perfectly discriminating monopoly”. It is more usual, however, to find that a monopolist sells identical products to different buyers at different prices.

Discrimination between buyers is more usual than discrimination between units of a homogeneous commodity. In general, it can be said that price discrimination occurs when a producer sells a com­modity to different buyers at two or more different prices for reasons not associated with differences in costs. It may be either systematic (i.e., dis­crimination systematically and persistently) or unsystematic (i.e., discrimi­nation frequently or casually).

In the simplest case, there is one identical good going to two buyers (or groups of buyers).

Then:

Price of buyer 1/Cost ≠ Price of buyer 2/Cost

For example, buyer 1 might be retail purchasers of a medical drug (low elasticity of demand), while buyer 2 is a group of large hospitals (high elasticity). Cost might be Re 1 per bottle.

The ratios might then be:

Rs10/Re1 ≠ Rs 2/Re 1 so that P₁/P₂ = 5

That is fairly steep discrimination. Actual discrimination is usually milder, but it can go even steeper if the conditions are right. The firm gets profits from both parts of the market, but one part is much more attractive than the other. Consumers pay partly by their ability to pay, rather than by cost levels.

Degrees of Discrimination:

Price discrimination is of various types: Here we draw a distinction among three types of price discrimination.

First Degree:

The limit is defined in the concept of discrimination of the first degree, a concept introduced by A.C. Pigou. In discrimination of the first degree, the monopolist knows the maximum amount of money each consumer will pay for any quantity. He then fixes up prices accordingly and takes from each consumer the entire amount of his consumer’s surplus.

This type of situation occurs when the monopolist sells each unit of his product at a different price. This means that he changes the maximum price a consumer is ready to pay for each unit, i.e., as much as the traffic will bear. This type of situation is illustrated in Fig.1. Mrs. Joan Robinson calls this phenomenon perfect discrimination, which is perfect, however, only from the point of view of the monopolist.

The simplest kind of discrimination of the first degree is one where, for some reason, each of his customers buys only one unit from the monopolist. When consumers buy more than one unit of the monopolist’s product, they are willing to buy more units at lower prices. The monopolist must then adjust his units of sale.

This kind of discrimination is the limiting, or extreme, case. Obviously, it could occur only rarely where a monopolist has only a few buyers.

Second Degree:

In discrimination of the second degree, the monopolist captures parts of his buyers’, consumers’, surplus, but not all. This is frequently found in public utility pricing. The different of rates charged by public utilities like the CESC is an obvious example.

If the demand curve of any customer is known, the public utility can divide that demand curve into small segments, so that, in effect, it becomes many customers. For each seg­ment, from the highest portion of the demand curve to the low­est, the utility can charge a differ­ent price, one which reflects the willingness of the customer to buy a given amount, of say, electricity at that price.

Second degree price discrimi­nation “is necessarily practiced in markets where there are many buyers, sometimes hundreds of thousands of them.” One rate or price schedule must apply to all buyers. Because tastes and incomes differ, the monopolist can seize only a small part of the consumers’ surpluses of those buyers whose desires for his service are stronger, and whose incomes are higher. Second degree discrimination is furthermore limited to services sold in blocks of small units — cubic feet of gas, kilowatt hours of electricity, minutes of telephoning — that can be easily metered, recorded and billed.

Third Degree:

Allocation of a given amount. Third degree price discrimination refers to the fact that the monopolist divides his customers into two or more classes or groups, charging a different price to each class of customer. Each class is a separate market, e.g., the D.C. seats in cinema halls, the reserved seats in a cultural programmed and so on.

This is the commonest kind of price discrimination. Here, the monopolist sells the same commodity is two separate markets at two separate prices at the same time. Thus, he applies the equi-marginal principle: the last unit sold in each of the two markets makes the same addition to total revenue. Third-degree discrimination is that situation where in each of several mar­kets there is a separate demand function.

(b) Compare and contrast between monopoly and monopolistic competition.

-> Monopoly competition- A market structure characterized by a single seller, selling a unique product in the market. In a monopoly market, the seller faces no competition, as he is the sole seller of goods with no close substitute.

In a monopoly market, factors like government license, ownership of resources, copyright and patent and high starting cost make an entity a single seller of goods. All these factors restrict the entry of other sellers in the market. Monopolies also possess some information that is not known to other sellers.

Characteristics associated with a monopoly market make the single seller the market controller as well as the price maker. He enjoys the power of setting the price for his goods.

Monopolistic competition is a type of imperfect competition such that many producers sell products that are differentiated from one another (e.g. by branding or quality) and hence are not perfect substitutes . In monopolistic competition, a firm takes the prices charged by its rivals as given and ignores the impact of its own prices on the prices of other firms. ^{[1] [2]} In the presence of coercive government, monopolistic competition will fall into government-granted monopoly . Unlike perfect competition , the firm maintains spare capacity. Models of monopolistic competition are often used to model industries. Textbook examples of industries with market structures similar to monopolistic competition include restaurants , cereal, clothing , shoes, and service industries in large cities. The “founding father” of the theory of monopolistic competition is Edward Hastings Chamberlin , who wrote a pioneering book on the subject, Theory of Monopolistic Competition (1933). ^[3] Joan Robinson published a book The Economics of Imperfect Competition with a comparable theme of distinguishing perfect from imperfect competition.

Monopolistically competitive markets have the following characteristics:

· There are many producers and many consumers in the market, and no business has total control over the market price.

· Consumers perceive that there are non-price differences among the competitors’ products.

• There are few barriers to entry and exit.

· Producers have a degree of control over price.

· The principal goal of the firm is to maximize its profits.

• Factor prices and technology are given.

· A firm is assumed to behave as if it knew its demand and cost curves with certainty.

· The decision regarding price and output of any firm does not affect the behaviour of other firms in a group i.e., impact of the decision made by a single firm is spread sufficiently evenly across the entire group. Thus, there is no conscious rivalry among the firms.

· Each firm earns only normal profit in the long run.

· Each firm spends substantial amount on advertisement. The publicity and advertisement costs are known as selling costs.

The long-run characteristics of a monopolistically competitive market are almost the same as a perfectly competitive market. Two differences between the two are that monopolistic competition produces heterogeneous products and that monopolistic competition involves a great deal of non-price competition, which is based on subtle product differentiation. A firm making profits in the short run will nonetheless only break even in the long run because demand will decrease and average total cost will increase. This means in the long run, a monopolistically competitive firm will make zero economic profit . This illustrates the amount of influence the firm has over the market; because of brand loyalty, it can raise its prices without losing all of its customers. This means that an individual firm’s demand curve is downward sloping, in contrast to perfect competition, which has a perfectly elastic demand schedule.

5(a) Briefly discuss about the different theories of business cycle .

-> The six theories are:-

Theory 1: Sun-Spot Theory:

This is perhaps the oldest theory of business cycles. Sun-spot theory was developed in 1875 by Stanley Jevons. Sun-spots are storms on the surface of the sun caused by violent nuclear explosions there. Jevons argued that sun-spots affected weather on the earth.

Since economies in the olden world were heavily dependent on agriculture, changes in climatic conditions due to sun-spots produced fluctuations in agricultural output. Changes in agricultural output through its demand and input- output relations affect industry. Thus, swings in agricultural output spread throughout the economy.

Other earlier economists also focused on changes in climatic or weather conditions in addition to those caused by sun-spots. According to them, weather cycles cause fluctuations in agricultural output which in turn cause instability in the whole economy. Even today weather is considered important in a country like India where agriculture is still important.

In the years when due to lack of monsoon there are drought in the Indian agriculture, it affects the income of farmers and therefore reduces demand for the products of industries. This causes industrial recession. Even in USA in the year 1988 a severe drought in the farm belt drove up the food prices around the world. It may be further noted that higher food prices reduce income available to be spent on industrial goods.

Critical Appraisal:

Though the theories of business cycles which emphasize climatic conditions for business cycles contain an element of truth about fluctuations in economic activity, especially in the developing counties like India where agriculture still remains important, they do not offer an adequate explanation of business cycles.

Therefore, much reliance is not placed on these theories by modern economists. Nobody can say with certainty about the nature of these sun-spots and the degree to which they affect rain. There is no doubt that climate affects agricultural production. But the climate theory does not adequately explain periodicity of the trade cycle.

If there was truth in the climatic theories, the trade cycles may be pronounced in agricultural countries and almost disappear when the country becomes completely industrialised. But this is not the case. Highly industrialised countries are much more subject to business cycles than agricultural countries which are affected more by famines rather than business cycles. Hence variations in climate do not offer complete explanation of business cycles.

Theory 2: Haw trey’s Monetary Theory of Business Cycles:

An old monetary theory of business cycles was put forward by Haw trey. His monetary theory of business cycles relates to the economy which is under gold standard. It will be remembered that economy is said be under gold standard when either money in circulation consists of gold coins or when paper notes are fully backed by gold reserves in the banking system.

According to Haw trey, increases in the quantity of money raises the availability of bank credit for investment. Thus, increasing the supply of credit expansion in money supply causes rate of interest to fall. The lower rate of interest induces businessmen to borrow more for investment in capital goods and also for investment in keeping more inventories of goods.

Thus, Haw trey argues that lower rate of interest will lead to the expansion of goods and services as a result of more investment in capital goods and inventories. Higher output, income and employment caused by more investment induce more spending on consumer goods. Thus, as a result of more investment made possible by increased supply of bank credit economy moves into the expansion phase.

The process of expansion continues for some time. Increases in aggregate demand brought about by more investment also cause prices to rise. Rising prices lead to the increase in output in two ways. First, when prices begin to rise, businessmen think they would raise further which induces them to invest more and produce more because prospects of making profits increase with the rise in prices.

Secondly, the rising prices reduce the real value of idle money balances with the people who induce them to spend more on goods and services. In this way rising prices sustain expansion for some time.

However, according to Haw trey, the expansion process must end. He argued that rise in incomes during the expansion phase induces more expenditure on domestically produced goods as well as on imports of foreign goods. He further assumes that domestic output and income expand faster than foreign output.

As a result, imports of a country increase more than its exports causing trade deficit with other countries. If exchange rate remains fixed, trade deficit means there will be outflow of gold to settle its balance of payments deficit. Since the country is on gold standard, outflow of gold will cause reduction in money supply in the economy.

The decrease in money supply will reduce the availability of bank credit. Reduction in the supply of bank credit will cause the rate of interest to rise. Rising interest rate will reduce investment in physical capital goods. Reduction in investment will cause the process of contraction to set in.

As a result of reduced order for inventories, producers will cut production which will lower income and consumption of goods and services. In this state of reduced demand for goods and services, prices of goods will fall. Once the prices begin to fall businessmen begin to expect that they will fall further.

In response to it traders will cut order of goods still causing further fall in output. The fall in prices also causes real value of money balances to rise which induces people to hold larger money holdings with them. In this way contraction process gathers momentum as demand for goods starts declining faster and with this economy plunges into depression.

But after a lapse of sometime depression will also come to an end and the economy will start to recover. This happens because in the contraction process imports fall drastically due to decrease in income and consumption of households, whereas exports do not fall much. As a result, trade surplus emerges which causes inflow of gold.

The inflow of gold would lead to the expansion of money supply and consequently availability of bank credit for investment will increase. With this, the economy will recover from depression and move into the expansion phase. Thus, the cycle is complete. The process, according to Haw trey, will go on being repeated regularly.

Critical Appraisal:

Haw trey maintains that the economy under gold standard and fixed exchange rate system makes his model of business cycles self-generating as there is built-in tendency for the money supply to change with the emergence of trade deficit and trade surplus which cause movements of gold between countries and affect money supply in them. Changes in money supply influence economic activity in a cyclical fashion.

However, Haw trey’s monetary theory does not apply to the present-day economies which have abandoned gold standard in 1930s. However, Haw trey’s theory still retains its importance because it shows how changes in money supply affect economic activity through changes in price level and rate of interest. In modem monetary theories of trade cycles this relation between money supply and rate of interest plays an important role in determining the level of economic activity.

Theory 3: Under-Consumption Theory:

Under-consumption theory of business cycles is a very old one which dates back to the 1930s. Malthus and Sismondi criticised Say’s Law which states ‘supply creates its own demand and argued that consumption of goods and services could be too small to generate sufficient demand for goods and services produced. They attribute over-production of goods to lack of consumption demand for them. This over-production causes piling up of inventories of goods which results in recession.

Under-consumption theory as propounded by Sismondi and Hobson was not a theory of recurring business cycles. They made an attempt to explain how a free enterprise economy could enter a long- run economic slowdown. A crucial aspect of Sismondi and Hobson’s under-consumption theory is the distinction they made between the rich and the poor.

According to them, the rich sections in the society receive a large part of their income from returns on financial assets and real property owned by them. Further, they assume that the rich have a large propensity to save, that is, they save a relatively large proportion of their income and, therefore, consume a relatively smaller proportion of their income.

On the other hand, less well-off people in a society obtain most of their income from work, that is, wages from labor and have a lower propensity to save. Therefore, these less well-off people spend a relatively less proportion of their income on consumer goods and services.

In their theory, they further assume that during the expansion process, the incomes of the rich people increase relatively more than the wage-income. Thus, during the expansion phase, income distribution changes in favor of the rich with the result that average propensity to save falls, that is, in the expansion process saving increases and therefore consumption demand declines.

According to Sismondi and Hobson, increase in saving during the expansion phase leads to more investment expenditure on capital goods and after some time-lag, the greater stock of capital goods enables the economy to produce more consumer goods and services. But since society’s propensity to consume continues to fall, consumption demand is not enough to absorb the increased production of consumer goods.

In this way, lack of demand for consumer goods or what is called under-consumption emerges in the economy which halts the expansion of the economy. Further, since supply or production of goods increases relatively more as compared to the consumption demand for them, the prices fall.

Prices continue falling and go even below the average cost of production bringing losses to the business firms. Thus, when under-consumption appears, production of goods becomes unprofitable. Firms cut their production resulting in recession or contraction in economic activity.

Karl Marx and Under-Consumption:

It is worth mentioning that Karl Marx, the philosopher of scientific socialism, had also predicted the collapse of the capitalist system due to the emergence of under-consumption. He predicted that capitalism would move periodically through expansion and contraction with each peak higher than its previous peak and each crash (i.e., depression) deeper than the last.

Ultimately, according to Marx, in a state of acute depression when the cup of misery of working class is full, they will overthrow the capitalist class which exploits them and in this way the new era of socialism or communism would come into existence.

Like other under-consumption theorists, Marx argues that driving force behind business cycles is ever increasing income inequalities and concentration of wealth and economic power in the hands of the few capitalists who own the means of production. As a result, the poor workers lack income to purchase goods produced by the capitalist class resulting in under-consumption or over­production.

With the capitalist producers lacking market for their goods, capitalist economy plunges into depression. Then the search for ways of opening of new markets is started. Even wars between capitalist countries take place to capture other countries to find new markets for their products. With the discovery of new methods of production of finding new markets, the economy recovers from depression and the ne v upswing starts.

Critical Appraisal:

The view that income inequalities increase with growth or expansion of the economy and further that this causes recession or stagnation is widely accepted. Therefore, even many modern economists suggest that if growth is to be sustained (that is, if recession or stagnation is to be avoided), then consumption demand must be increasing sufficiently to absorb the increasing production of goods.

For this, deliberate efforts should be made to reduce inequalities in income distribution. Further, under-consumption theory rightly states that income redistribution schemes will reduce the amplitude of business cycles.

Besides, the suggested behaviour of average propensity to save and consume of the property owners and wage earners in this theory have been found to be consistent with the observed phenomena. Even in the theory of economic development the difference in average propensity to save (APS) of the property owners and workers has been widely used.

It is clear from above that under-consumption theory contains some important elements, especially the emergence of the lack of consumption demand as the cause of recession but it is regarded as too simple. There are many features other than growing income inequalities which are responsible for causing recession or trade cycles. Although under-consumption theory concentrates on a significant variable, it leaves too much unexplained.

Theory 4: Hayek’s Over-Investment Theory of Business Cycles:

It has been observed that over time investment varies more than that of total output of final goods and services and consumption. This has led economists to investigate the causes of variation in investment and how it is responsible for business cycles.

Two versions of over-investment theory have been put forward. One theory offered by Hayek emphasises monetary forces in causing fluctuations in investment. The second version of over-investment theory has been developed by Knut Wick-shell which emphasises spurts of investment brought about by innovation.

It is worth noting that in both the versions of this theory distinction between natural rate of interest and money rate of interest plays an important role. Natural rate of interest is defined as the rate at which saving equal’s investment and this equilibrium interest rate reflects marginal revenue product of capital or rate of return on capital. On the other hand, money rate of interest is the rate at which banks give loans to the businessmen.

Theory 5: Hayek’s Monetary Version of Over-Investment Theory:

Hayek suggests that it is monetary forces which cause fluctuations in investment which are prime cause of business cycles. In this respect Hayek’s theory is similar to Haw trey’s monetary theory except that it does not involve inflow and outflow of gold causing changes in money supply in the economy.

To begin with, let us assume that the economy is in recession and businessmen’s demand for bank credit is therefore very low. Thus, lower demand for bank credit in times of recession pushes down the money rate of interest below the natural rate. This means that businessmen will be able to borrow funds, that is, bank credit at a rate of interest which is below the expected rate of return in investment projects. This induces them to invest more by undertaking new investment projects.

In this way, investment expenditure on new capital goods increases. This causes investment to exceed saving by the amount of newly created bank credit. With the spurt in investment expenditure, the expansion of the economy begins. Increase in investment causes income and employment to rise which induces more consumption expenditure.

As a result, production of consumer goods increases. According to Hawtrey, the competition between capital goods and consumer goods industries for scarce resources causes their prices to rise which in turn push up the prices of goods and services.

But this process of expansion cannot go on indefinitely because the excess reserves with the banks come to an end which forces the banks not to give further loans for investment, while demand for bank credit goes on increasing.

Thus, the inelastic supply of credit from the banks and mounting demand for it cause the money rate of interest to go above the natural rate of interest. This makes further investment unprofitable. But at this point of time there has been over-investment in the sense that savings fall short of what is required to finance the desired investment.

When no more bank credit is available for investment, there is decline in investment which causes both income and consumption to fall and in this way expansion comes to an end and the economy experiences downswing in economic activity.

However, after a lapse of sometime the fall in demand for bank credit lowers the money rate of interest which goes below the natural rate of interest. This again gives boost to investment activity and as a result recession ends. In this way alternating periods of expansion and contraction occur periodically.

Theory 6: Wicksell’s Over-Investment Theory:

Over-investment theory developed by Wicksell is of non-monetary type. Instead of focusing on monetary factors it attributes cyclical fluctuations to spurts of investment caused by new innovations introduced by entrepreneurs themselves. The introduction of new innovations or opening of new markets makes some investment projects profitable by either reducing cost or raising demand for the products.

The expansion in investment is made possible because of the availability of bank credit at a lower money rate of interest. The expansion in economic activity ceases when investment exceeds saving. Again it may be noted that there is over-investment because the level of saving is insufficient to finance the desired level of investment. The end of investment expenditure causes the economy to go into recession.

However, another set of innovations occurs or more new markets are found which stimulates investment. Thus, when investment picks up as a result of new innovations, the economy revives and moves into the expansion phase once again.

Appraisal:

Though the over-investment theory does not offer an adequate explanation of business cycles, it contains an important element that fluctuations in investment are the prime cause of business cycles. However, it does not offer a valid explanation as to why changes in investment take place quite often.

Many exponents of this theory point to the behaviour of banking system that causes diverges between money rate of interest and natural rate of interest. However, as Keynes later on emphasised, investment fluctuates quite often because of changes in profit expectations of entrepreneurs which depends on several economic and political factors operating in the economy. Thus, the theory fails to offer adequate explanation of business cycles.

(b) Explain the concept of inflation. Explain the various measures that can be used to control inflation.

-> Inflation and unemployment are the two most talked-about words in the contemporary society.

These two are the big problems that plague all the economies.

Almost everyone is sure that he knows what inflation exactly is, but it remains a source of great deal of confu­sion because it is difficult to define it unam­biguously.

Inflation is often defined in terms of its supposed causes. Inflation exists when money supply exceeds available goods and services. Or inflation is attributed to budget deficit financing. A deficit budget may be financed by the additional money creation. But the situation of monetary expansion or budget deficit may not cause price level to rise. Hence the difficulty of defining ‘inflation’.

Inflation may be defined as ‘a sustained upward trend in the general level of prices’ and not the price of only one or two goods. G. Ackley defined inflation as ‘a persistent and appreciable rise in the general level or aver­age of prices’. In other words, inflation is a state of rising prices, but not high prices.

It is not high prices but rising price level that con­stitute inflation. It constitutes, thus, an over­all increase in price level. It can, thus, be viewed as the devaluing of the worth of money. In other words, inflation reduces the purchasing power of money. A unit of money now buys less. Inflation can also be seen as a recurring phenomenon.

While measuring inflation, we take into ac­count a large number of goods and services used by the people of a country and then cal­culate average increase in the prices of those goods and services over a period of time. A small rise in prices or a sudden rise in prices is not inflation since they may reflect the short term workings of the market.

As the nature of inflation is not uniform in an economy for all the time, it is wise to distin­guish between different types of inflation. Such analysis is useful to study the distribu­tional and other effects of inflation as well as to recommend anti-inflationary policies. Infla­tion may be caused by a variety of factors. Its intensity or pace may be different at different times. It may also be classified in accordance with the reactions of the government toward inflation.

Thus, one may observe different types of inflation in the contemporary society:

A. On the Basis of Causes:

(i) Currency inflation:

This type of infla­tion is caused by the printing of cur­rency notes.

(ii) Credit inflation:

Being profit-making institutions, commercial banks sanction more loans and advances to the public than what the economy needs. Such credit expansion leads to a rise in price level.

(iii) Deficit-induced inflation:

The budget of the government reflects a deficit when expenditure exceeds revenue. To meet this gap, the government may ask the central bank to print additional money. Since pumping of additional money is required to meet the budget deficit, any price rise may then be called the deficit-induced inflation.

(iv) Demand-pull inflation:

An increase in aggregate demand over the available output leads to a rise in the price level. Such inflation is called demand-pull in­flation (henceforth DPI). But why does aggregate demand rise? Classical economists attribute this rise in aggre­gate demand to money supply. If the supply of money in an economy ex­ceeds the available goods and services, DPI appears. It has been described by Holborn as a situation of “too much money chasing too few goods.”

Keynesians hold a different argu­ment. They argue that there can be an autonomous increase in aggregate de­mand or spending, such as a rise in con­sumption demand or investment or government spending or a tax cut or a net increase in exports (i.e., C + I + G + X – M) with no increase in money sup­ply. This would prompt upward adjust­ment in price. Thus, DPI is caused by monetary factors (classical adjustment) and non-monetary factors (Keynesian argument).

DPI can be explained in terms of Fig. 4.2, where we measure output on the horizontal axis and price level on the vertical axis. In Range 1, total spending is too short of full employment out­put, Y_F. There is little or no rise in the price level. As demand now rises, out­put will rise. The economy enters Range 2, where output approaches towards full employment situation. Note that in this region price level begins to rise. Ul­timately, the economy reaches full em­ployment situation, i.e., Range 3, where output does not rise but price level is pulled upward. This is demand-pull in­flation. The essence of this type of in­flation is that “too much spending chas­ing too few goods.”

(v) Cost-push inflation:

Inflation in an economy may arise from the overall increase in the cost of production. This type of inflation is known as cost-push inflation (henceforth CPI). Cost of pro­duction may rise due to an increase in the prices of raw materials, wages, etc. Often trade unions are blamed for wage rise since wage rate is not completely market-determined. Higher wage means high cost of production. Prices of commodities are thereby increased.

A wage-price spiral comes into opera­tion. But, at the same time, firms are to be blamed also for the price rise since they simply raise prices to expand their profit margins. Thus, we have two im­portant variants of CPI wage-push in­flation and profit-push inflation.

B. On the Basis of Speed or Intensity:

(i) Creeping or Mild Inflation:

If the speed of upward thrust in prices is slow but small then we have creeping inflation. What speed of annual price rise is a creeping one has not been stated by the economists? To some, a creeping or mild inflation is one when annual price rise varies between 2 p.c. and 3 p.c. If a rate of price rise is kept at this level, it is con­sidered to be helpful for economic development. Others argue that if annual price rise goes slightly beyond 3 p.c. mark, still then it is considered to be of no danger.

(ii) Walking Inflation:

If the rate of annual price increase lies between 3 p.c. and 4 p.c., then we have a situation of walking inflation. When mild inflation is allowed to fan out, walking inflation appears. These two types of inflation may be described as ‘moderate inflation’.

Often, one-digit inflation rate is called ‘moder­ate inflation’ which is not only predict­able, but also keeps people’s faith on the monetary system of the country. Peoples’ confidence gets lost once moderately maintained rate of inflation goes out of control and the economy is then caught with the galloping inflation.

(iii) Galloping and Hyperinflation:

Walking inflation may be converted into running inflation. Running inflation is danger­ous. If it is not controlled, it may ulti­mately be converted to galloping or hyperinflation. It is an extreme form of inflation when an economy gets shatter­ed.”Inflation in the double or triple digit range of 20, 100 or 200 p.c. a year is labeled “galloping inflation”.

(iv) Government’s Reaction to Inflation:

In­flationary situation may be open or suppressed. Because of anti-infla­tionary policies pursued by the govern­ment, inflation may not be an embar­rassing one. For instance, increase in income leads to an increase in con­sumption spending which pulls the price level up.

If the consumption spending is countered by the govern­ment via price control and rationing device, the inflationary situation may be called a suppressed one. Once the government curbs are lifted, the sup­pressed inflation becomes open infla­tion. Open inflation may then result in hyperinflation.

The various measures that can be used to control inflation:-

Some of the important measures to control inflation are as follows:

1. Monetary Measures

2. Fiscal Measures

3. Other Measures.

Inflation is caused by the failure of aggregate supply to equal the increase in aggregate demand. Inflation can, therefore, be controlled by increasing the supplies of goods and services and reducing money incomes in order to control aggregate demand.

The various methods are usually grouped under three heads: monetary measures, fiscal measures and other measures.

1. Monetary Measures:

Monetary measures aim at reducing money incomes.

(a) Credit Control:

One of the important monetary measures is monetary policy. The central bank of the country adopts a number of methods to control the quantity and quality of credit. For this purpose, it raises the bank rates, sells securities in the open market, raises the reserve ratio, and adopts a number of selective credit control measures, such as raising margin requirements and regulating consumer credit. Monetary policy may not be effective in controlling inflation, if inflation is due to cost-push factors. Monetary policy can only be helpful in controlling inflation due to demand-pull factors.

(b) Demonetisation of Currency:

However, one of the monetary measures is to demonetize currency of higher denominations. Such a measures is usually adopted when there is abundance of black money in the country.

(c) Issue of New Currency:

The most extreme monetary measure is the issue of new currency in place of the old currency. Under this system, one new note is exchanged for a number of notes of the old currency. The value of bank deposits is also fixed accordingly. Such a measure is adopted when there is an excessive issue of notes and there is hyperinflation in the country. It is a very effective measure. But is inequitable for its hurts the small depositors the most.

2. Fiscal Measures:

Monetary policy alone is incapable of controlling inflation. It should, therefore, be supplemented by fiscal measures. Fiscal measures are highly effective for controlling government expenditure, personal consumption expenditure, and private and public investment.

The principal fiscal measures are the following:

(a) Reduction in Unnecessary Expenditure:

The government should reduce unnecessary expenditure on non-development activities in order to curb inflation. This will also put a check on private expenditure which is dependent upon government demand for goods and services. But it is not easy to cut government expenditure. Though this measure is always welcome but it becomes difficult to distinguish between essential and non-essential expenditure. Therefore, this measure should be supplemented by taxation.

(b) Increase in Taxes:

To cut personal consumption expenditure, the rates of personal, corporate and commodity taxes should be raised and even new taxes should be levied, but the rates of taxes should not be so high as to discourage saving, investment and production. Rather, the tax system should provide larger incentives to those who save, invest and produce more.

Further, to bring more revenue into the tax-net, the government should penalise the tax evaders by imposing heavy fines. Such measures are bound to be effective in controlling inflation. To increase the supply of goods within the country, the government should reduce import duties and increase export duties.

(c) Increase in Savings:

Another measure is to increase savings on the part of the people. This will tend to reduce disposable income with the people, and hence personal consumption expenditure. But due to the rising cost of living, people are not in a position to save much voluntarily.

Keynes, therefore, advocated compulsory savings or what he called ‘deferred payment’ where the saver gets his money back after some years. For this purpose, the government should float public loans carrying high rates of interest, start saving schemes with prize money, or lottery for long periods, etc. It should also introduce compulsory provident fund, provident fund-cum-pension schemes, etc. All such measures increase savings and are likely to be effective in controlling inflation.

(d) Surplus Budgets:

An important measure is to adopt anti-inflationary budgetary policy. For this purpose, the government should give up deficit financing and instead have surplus budgets. It means collecting more in revenues and spending less.

(e) Public Debt:

At the same time, it should stop repayment of public debt and postpone it to some future date till inflationary pressures are controlled within the economy. Instead, the government should borrow more to reduce money supply with the public.

Like monetary measures, fiscal measures alone cannot help in controlling inflation. They should be supplemented by monetary, non-monetary and non-fiscal measures.

3. Other Measures:

The other types of measures are those which aim at increasing aggregate supply and reducing aggregate demand directly.

(a) To Increase Production:

The following measures should be adopted to increase production:

(i) One of the foremost measures to control inflation is to increase the production of essential consumer goods like food, clothing, kerosene oil, sugar, vegetable oils, etc.

(ii) If there is need, raw materials for such products may be imported on preferential basis to increase the production of essential commodities,

(iii) Efforts should also be made to increase productivity. For this purpose, industrial peace should be maintained through agreements with trade unions, binding them not to resort to strikes for some time,

(iv) The policy of rationalization of industries should be adopted as a long-term measure. Rationalization increases productivity and production of industries through the use of brain, brawn and bullion,

(v) All possible help in the form of latest technology, raw materials, financial help, subsidies, etc. should be provided to different consumer goods sectors to increase production.

(b) Rational Wage Policy:

Another important measure is to adopt a rational wage and income policy. Under hyperinflation, there is a wage-price spiral. To control this, the government should freeze wages, incomes, profits, dividends, bonus, etc.

But such a drastic measure can only be adopted for a short period as it is likely to antagonize both workers and industrialists. Therefore, the best course is to link increase in wages to increase in productivity. This will have a dual effect. It will control wages and at the same time increase productivity, and hence raise production of goods in the economy.

(c) Price Control:

Price control and rationing is another measure of direct control to check inflation. Price control means fixing an upper limit for the prices of essential consumer goods. They are the maximum prices fixed by law and anybody charging more than these prices is punished by law. But it is difficult to administer price control.

(d) Rationing:

Rationing aims at distributing consumption of scarce goods so as to make them available to a large number of consumers. It is applied to essential consumer goods such as wheat, rice, sugar, kerosene oil, etc. It is meant to stabilize the prices of necessaries and assure distributive justice. But it is very inconvenient for consumers because it leads to queues, artificial shortages, corruption and black marketing. Keynes did not favor rationing for it “involves a great deal of waste, both of resources and of employment.