Role of Government in Economy: An Economist’s Perspective

The question of government interference in economic activities has been debated for a very long time by the economists. While the early economists considered economics as a handmaid of politics, the modem view is that politics is the handmaid of economics. With the growing importance of the role of government in economic welfare, the modem economists firmly believe that the sphere of government in economic development has no boundary. However, there is no unanimity among the economists about the extent and mode of government intervention in the economic sphere. Hence, we can identify the following political ideologies regarding the government intervention in an economy.

  • The earliest opinion was that the government has nothing to do in an economy as the society will regulate itself. This opinion also stated that the government will wither away over a period of time. These ideologists are called Anarchists.
  • Opposing the anarchists view is the Communists view. According to them, the individuals cannot do anything on their own and there is a need for government to supervise and regulate individuals. The state will own everything and it is the fundamental duty of the government to organize and direct all economic activities.  Hence, government becomes the custodian of the society and it has a very wide role to perform.

In between the above two views, there are two more views about the extent of government intervention in an economy. While one view highlights the individuals, the other lays emphasis on the need for the government.… Read the rest

Product Line Pricing

Since almost every firm has several items in its product line, product line pricing becomes an important phase of pricing policy. The problem of product line pricing is to find the proper relationship among the prices of numbers of a product group. Product line pricing may refer to product group. Product line pricing may refer to products physically the same but sold under different conditions. This gives the seller an opportunity to charge different prices. Thus use differentials (e.g. hot coffee versus cold/iced coffee), seasonal differentials (e.g. night fights or night telephone calls), and style cycles differentials are all phases of product line pricing. The rationale for this heterodox approach to pricing is that the essential economic features of the product line is the cross-elasticity of demand that exist among parts of the seller’s output.

General Approach to Product Line Pricing

The underlying principle in product-line pricing is that demand elasticities and competitive situations rather than cost should form bases for determining the patterns of relative prices of the firm’s products, and the role of cost should be confined to set lower limits for price and to help select the price for the output combination that is most profitable. But in reality this principle is not widely employed in product-line pricing. Instead, firms fix prices in such a way that they are proportional to full cost (i.e. that produce the same percentage net profit margin for all products) or incremental cost (i.e. that produce the same percentage contribution – margin over incremental costs for all products) or with profit margins that are proportional to conversion cost.… Read the rest

Econometric Forecasting Models

Econometric model building holds considerable promise as a method of forecasting demand. The best starting point towards an understanding of the basis of econometric forecasting is regression analysis. But the difficulty with regression analysis is that it is used to forecast a single dependent variable based on the value and the relations between one or more independent variables and each of these independent variables is assumed to be exogenous or outside the influence of the dependent variable. This may be true in many situations. But unfortunately, in most broad economic situations an assumption that each of the variable, is independent is unrealistic.

For example, let us assume that demand is a function of Gross National Product (GNP), price and advertising. In regression terms we would assume that all three independent variables are exogenous to the system and hence are not influenced by the level of demand itself or by one another. This is fairly correct assumption so far as GNP is concerned. If, however, we consider price and advertising, the same assumption may not hold good, for instance, of the per unit cost is of some quadratic form, a different level of cost. Again, advertising expenditures will often influence the price of the product, since the production and selling cost influence the per-unit price. The price, in turn, is influenced by the magnitude of demand, which can also influenced by the magnitude of demand, which can also influence the level of advertising or promotional expenditure. All of these point to the independence of all four of the valuables in our equation.… Read the rest

Profit Maximization Methods in Managerial Economics

The profit maximization theory states that firms (companies or corporations) will establish factories where they see the potential to achieve the highest total profit. The company will select a location based upon comparative advantage (where the product can be produced the cheapest). The theory draws from the characteristics of the location site, land price, labor costs, transportation costs and access, environmental restrictions, worker unions, population etc. The company will then elect the best location for the factory to maximize profits. This is anathema to the idea of social responsibility because firms will place their factory to achieve profit maximization. They are nonchalant to environment conservation, fair wage policies and exploit the country. The only objective is to earn more profits. In economics, profit maximization is the process by which a firm determines the price and output level that returns the greatest profit. There are several approaches to profit maximization.

1. Total Cost-Total Revenue Method

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

There are two graphical ways of determining that Q is optimal. Firstly, we see that the profit curve is at its maximum at this point (A).… Read the rest

Duality between Production Function and Cost Function

Production functions and cost functions are the cornerstones of business and managerial economics. A production function is a mathematical relationship that captures the essential features of the technology by means of which an organisation metamorphoses resources such as land, labour and capital into goods or services such as steel or cement. It is the economist’s distillation of the salient information contained in the engineer’s blueprints. Mathematically, let Y denote the quantity of a single output produced by the quantities of inputs denoted (x1,…, xn). Then the production function f(x1,…,xn) describes how a given output can be produced by an infinite combinations of inputs (x1,.., xn), given the technology in use. Several important features of the structure of the technology are captured by the shape of the production function. Relationships among inputs include the degree of substitutability or complementarily among pairs of inputs, as well as the ability to aggregate groups of inputs into a shorter list of input aggregates. Relationships between output and the inputs include economies of scale and the technical efficiency with which inputs are utilized to produce a given output.

Each of these features has implications for the shape of the cost function, which is intimately related to the production function. A cost function is also a mathematical relationship, one that relates the expenses an organisation incurs on the quantity of output it produces and to the unit prices it pays. Mathematically, let E denote the expense an organisation incurs in the production of output quantity Y when it pays unit prices (p1,…, pn) for the inputs it employs.… Read the rest

Economic Tools for Management Decision Making

Managerial decision-making draws on economic concepts as well as tools and techniques of analysis provided by decision sciences. The major categories of these tools and techniques are optimization, statistical estimation and forecasting. Most of these methodologies are technical. These methods are briefly explained below to illustrate how tools of decision sciences are used in managerial decision making.

1. Optimization

Optimization techniques are probably the most crucial to managerial decision making. Given that alternative courses of action are available, the manager attempts to produce the most optimal decision, consistent with stated managerial objectives. Thus, an optimization problem can be stated as maximizing an objective (called the objective function by mathematicians) subject to specified constraints. In determining the output level consistent with the maximum profit, the firm maximizes profits, constrained by cost and capacity considerations. While a manager does not resolve the optimization problem, he or she may make use of the results of mathematical analysis. In the profit maximization example, the profit maximizing condition requires that the firm select the production level at which marginal revenue equals marginal cost. This condition is obtained from an optimization model/technique. The techniques of optimization employed depend on the problem a manager is trying to solve.

2. Statistical Estimation

A number of statistical techniques are used to estimate economic variables of interest to a manager. In some cases, statistical estimation techniques employed are simple. In other cases, they are much more complex and advanced. Thus, manager may want to know the average price received by his competitors in the industry, as well as the standard deviation (a measure of variation across units) of the product price under consideration.… Read the rest