Assignment

Business Economics
Course: EPGDM

Answer the following questions. ( 4*10 marks= 40 marks)

1. You have been asked to produce a forecast for your company’s new product, electric car. Discuss the
kind of information you would look for in order to make this forecast and also bring out the
significance of demand forecasting in your decision making process.

I would consider the following information to forecast my company’s new product.

 What is the current demand of cars?

First thing to consider is the demand for cars in the current market. Is the car market booming
or is it in a slump? If my company makes a successful product, will it be profitable, etc.

 How much does it cost to make an electric car?

The next analysis will be on how much it costs to make an electric car. How expensive are the
components in the current market. Can it be competitively priced compared with a
conventional car with similar specifications? If the car is sold at a premium compared to a
conventional car, would there be a demand for it?

 How does the electric car produced by my company perform against a conventional car?
I will have to analyze how the electric car, produced by my company, performs against a
conventional car. What is the rage of an average conventional car compared to the electric car.
How does it perform compared to a conventional car? Like how fast does it go, what’s the top
speed, how safe is it, etc.

 How much demand will there be for an electric car.

Given that electric cars are fairly new to the market, will the customers accept the product.
How many consumers would be willing to invest in a piece of technology that’s fairly new to the
market?

 How easy is it to obtain parts and components to manufacture an electric car?

Since the technology is new and is not mass produced, how easy and feasible is it to obtain
parts and components to mass produce this technology. Will my company be able to still price
the car competitively?

 After Sales Service.

This is another important aspect to be analyzed. How many service centers does my company
need to open to cater the customers? How many charging stations need to be setup across the
 country so customers are not stranded anywhere. What will be the maintenance cost for the
car, etc.

Demand Forecasting plays a vital role in the decision making process. It helps me make crucial business
decisions to plan the following.

a) Formulating production policy: This 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.
The company sets prices of its products according to market demand. For example, if an
economy enters into depression or recession phase, the demand for the electric car falls. In
such a case, the organization sets low prices of the electric car.

c) Controlling sales: This helps in setting sales targets, which act as a basis for evaluating sales
performance. The company makes demand forecasts for different regions and fixes sales
targets for each region accordingly.

d) Arranging finance: This 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.

e) Deciding the production capacity: This implies that with the help of demand forecasting, we can
determine the size of the plant required for production. The size of the plant should conform to
the sales requirement of the company.

f) Planning long-term activities: This implies that demand forecasting helps in planning for long
term. For example, if the forecasted demand for the electric car is high, then it may plan to
invest in various expansion and development projects in the long term.
2. Forey, Inc., competes against many other firms in a industry. Over the last decade, several firms have
entered this industry and, as consequences, Forey is earning a return on investment that roughly
equals the interest rates. Furthermore, the four-firm concentration ratio and Herfindahl Hirschman
index are both quite small. Based on this information, which market structure best characterizes the
industry in which Forey competes? Explain the characteristics this market structure and what
happens to the Forey Inc’s profit in the short-run and long-run.

Based on the above information, Monopolistic competition market structure best characterizes the
industry in which Forey Inc. competes in. There are many firms and consumers, just as in perfect
competition. Thus, concentration measures are close to zero. Unlike in perfect competition, however,
each firm produces a product that is slightly different from the products produced by other firms;
Rothschild indexes are greater than zero. A firm in a monopolistically competitive market has some
control over the price charged for the product. By raising the price, some consumers will remain loyal
to the firm due to a preference for the particular characteristics of its product. But some consumers
will switch to other brands. For this reason, firms in monopolistically competitive industries often
spend considerable sums on advertising in an attempt to convince consumers that their brands are
better than other brands. This reduces the number of customers who switch to other brands when a
firm raises the price for its product. Some characteristics of this market structure are:

1. Large Number of Buyers and Sellers: There are large number of firms but not as large as under
perfect competition. That means each firm can control its price-output policy to some extent. It is
assumed that any price-output policy of a firm will not get reaction from other firms that means each
firm follows the independent price policy. If a firm reduces its price, the gains in sales will be slightly
spread over many of its rivals so that the extent to which each of the rival firms suffers will be very
small. Thus these rival firms will have no reason to react.

2. Free Entry and Exit of Firms: Like perfect competition, under monopolistic competition also, the
firms can enter or exit freely. The firms will enter when the existing firms are making super-normal
profits. With the entry of new firms, the supply would increase which would reduce the price and
hence the existing firms will be left only with normal profits. Similarly, if the existing firms are
sustaining losses, some of the marginal firms will exit. It will reduce the supply due to which price
would rise and the existing firms will be left only with normal profit.

3. Product Differentiation: Another feature of the monopolistic competition is the product

differentiation. Product differentiation refers to a situation when the buyers of the product
differentiate the product with other. Basically, the products of different firms are not altogether
different; they are slightly different from others. Although each firm producing differentiated product
has the monopoly of its own product, yet he has to face the competition. This product differentiation
may be real or imaginary. Real differences are like design, material used, skill etc. whereas imaginary
differences are through advertising, trade mark and so on.
 4. Selling Cost: Another feature of the monopolistic competition is that every firm tries to promote its
product by different types of expenditures. Advertisement is the most important constituent of the
selling cost which affects demand as well as cost of the product. The main purpose of the monopolist is
to earn maximum profits; therefore, he adjusts this type of expenditure accordingly.

5. Lack of Perfect Knowledge: The buyers and sellers do not have perfect knowledge of the market.
There are innumerable products each being a close substitute of the other. The buyers do not know
about all these products, their qualities and prices. Therefore, so many buyers purchase a product out
of a few varieties which are offered for sale near the home. Sometimes a buyer knows about a
particular commodity where it is available at low price. But he is unable to go there due to lack of time
or he is too lethargic to go or he is unable to find proper conveyance. Likewise, the seller does not
know the exact preference of buyers and is, therefore, unable to get advantage out of the situation.

6. Less Mobility: Under monopolistic competition both the factors of production as well as goods and
services are not perfectly mobile.

7. More Elastic Demand: Under monopolistic competition, demand curve is more elastic. In order to
sell more, the firms must reduce its price.

3. A political campaign manager must decide whether to emphasize television advertisements or

letters to potential voters in a re-election campaign. Describe the production function for campaign
votes. How might information about this function (such as the shape of the isoquants) help the
campaign manager to plan strategy?

The output of concern to the campaign manager is the number of votes. The production function has
two inputs, television advertising and letters. The use of these inputs requires knowledge of the
substitution possibilities between them. If the inputs are perfect substitutes for example, the isoquants
are straight lines, and the campaign manager should use only the less expensive input in this case. If
the inputs are not perfect substitutes, the isoquants will have a convex shape. The campaign manager
should then spend the campaign’s budget on the combination of the two inputs that maximize the
number of votes.
4. A certain town in a country obtains all of its electricity from one company, South Electric. Although
the company is a monopoly, it is owned by the citizens of the town, all of whom split the profits
equally at the end of each year. The CEO of the company claims that because all of the profits will be
given back to the citizens, it makes economic sense to charge a monopoly price for electricity. Do you
agree with the CEO? Why or Why not? If the gains of the producers from monopoly power could be
redistributed to consumer, would the social cost of monopoly power be eliminated? What are the
important measures you suggest to control monopoly power?

I disagree with CEO’s argument because the argument is not rational from the view of the citizens,
because they would charge the higher price for electricity. But from the view of CEO the argument is
rational, because he wants to maximize monopolist’s profits. The decrease of output and increase of
price are the social costs of monopoly power. If the company charges the monopoly price then it will
be producing a smaller quantity than the competitive equilibrium. An important difference between
monopoly and perfect competition is that whereas under perfect competition allocation of resources is
optimum and therefore social welfare is maximum, under monopoly resources are misallocated
causing loss of social welfare. When a product is produced and sold under conditions of monopoly, the
monopolist gains at the expense of consumers, for they have to pay a price higher than marginal cost
of production. This results in loss of consumer’s welfare.

When the firm exploits its monopoly power by charging a price above marginal cost, consumers buy
less at the higher price, and consumer surplus decreases. Some of the lost consumer surplus is not
captured by the seller, however, because the quantity produced and consumed decreases at the higher
price, and this is a deadweight loss to society. Therefore, if the gains to producers were redistributed
to consumers, society would still suffer the deadweight loss.

With monopoly power, the price is lower and the quantity is less than under competitive buying
conditions. Because of the lower price and reduced sales, sellers lose revenue. Only part of this lost
revenue is transferred to the buyer as consumer surplus, and the net loss in total surplus is deadweight
loss. Even if the consumer surplus could be redistributed to sellers, the deadweight loss persists. This
inefficiency will remain because quantity is reduced below the level where price is equal to marginal
cost.

To conclude, the CEO’s claim is false. If the company charges the monopoly price it will produce a
smaller quantity than the competitive equilibrium. Therefore, even though all of the monopoly profits
are given back to the citizens, there is still a deadweight loss associated with the fact that too little
Electricity is produced and consumed.