Assessment 1 (Managerial Economics)

- Submitted by
Aviral Tiwari

Question 1. Companies often change colour, package, design, and

advertisements for their products. Is it because the companies wish to
counter the impact of diminishing marginal utility. Explain with suitable
examples that you may have witnessed, heard, or read. Explain the
law of diminishing Marginal Utility.

Ans -
The law of diminishing Marginal Utility states that the utility of the product decreases as
the customer keeps consuming the product. For every marginal consumption of the
product, the decrease in utility of the product is observed.

The perfect example could be the consumption of chocolates, the utility may increase
but upto a certain point, post which, the utility decreases, which indicates, after a certain
point, an individual may not enjoy the chocolate. The same can be seen from the table
given below

To counter such a situation, companies often incorporate variations in their product to

keep the customers engaged/interested and in turn maintain their profit.

One of the best examples to showcase how the companies often change colour
packaging and design of their products to overcome diminishing marginal utility could be
the Redmi Note pro series.
When Redmi launched Redmi Note 8, they focused on the features of the phone such
as battery power, camera quality, RAM, build etc.

However, after a certain point, to keep themselves more relevant to the market, they
also added more variations to it, in terms of colour, design and upgrades.

They also changed designs and added more upgrades to the phone and positioned it as
Redmi Note 8 pro in the market with better specifications compared to the base model
with a little extra price.

And since then we have also seen more upgrades and the variation in the product
where the company is positioning the product as newer version with slightly better
specifications, designing, structure and colours. Ex - Redmi Note 9 pro, Redmi Note 9
pro max.

Question 2. Any change in product price done by the company will require
the company to assess the impact on its quantity demanded. Competitor
price changes can also influence the demand of the product of the
respondent company. This is because of cross-price elasticity. A change in
our income tends to make us less price sensitive. Explain the concept of
Elasticity - own price elasticity, cross-price elasticity, and Income
elasticity with help of suitable examples.

Price Elasticity of Demand basically means the change in quality of the product with
respect to the price. It explains how the quantity demanded by the customers gets
affected by the change in price of the company, change in price of the competitor’s
product or change in the income of the customers.

Own Price Elasticity

The Own Price Elasticity means how the quantity demanded of the product is affected
by the change in the price of that product.

It is given by the formula - %change in quantity/%change in price

For example, if the price of Pizza decreases from Rs 500 to Rs 300, the demand of the
pizza may increase from 4 per day to 6 per day

% change in price = [(300 - 500)/500]% = - 40%

% change in quantity = [(6-4)/4]% = 50%

Own price elasticity = 50%/40% = 1.25

Cross Price Elasticity

The cross Price Elasticity means how the quantity demanded of the product is affected
by the change in the price of its complement/substitute product.

Let’s assume, we have two products A and B, so the formula for the cross price
elasticity will be
= %change in quantity of A/% change in price of B

If the elasticity is negative, it explains that the two products are complements, which
means, the decrease in price of one product will lead to increase in demand of other
products and vice versa.

For example, if the price of pizza increases, that means the demand for cheese may
decrease as less people will be willing to buy Pizza, hence less cheese will be used in
order to make the product.

Let’s assume, the price of Pizza increases from Rs 300 to Rs 500, which in turns leads
to less people buying the pizza and hence less cheese to be used, which leads to
decrease in quantity of cheese from 10 packs to 6 packs.

% change in price of Pizza = [(500 - 300)/300]% = 67%

% change in quantity of cheese = [(6-10)/10]% = - 40%

Cross price elasticity = (67%)/(-40%) = - 1.675

The negative sign indicates how increase in price of one product leads to decrease in
quantity of the other product and vice versa, hence indicating that the two products are
complements.
If the elasticity is positive, it explains that the two products are substitutes, which
means, the decrease in price of one product will lead to decrease in demand of other
products and vice versa.

For example, if Papa John’s Pizza, increases the price of their pizza from Rs 500 to Rs
750, this leads to customers not buying Papa John’s pizza and switching to Dominos
instead, which leads to the increase in demand of Dominos pizza from 30 per day to 40
per day

% change in price of Papa John’s Pizza = [(750 - 500)/5000]% = 50%

% change in quantity of Dominos Pizza = [(40 - 30)/30]% = 33%

Cross price elasticity = (50%)/(33%) = 1.51

The positive sign indicates how an increase in price of one product leads to an increase
in quantity of the other product and vice versa, hence indicating that the two products
are substitutes.

Income Price Elasticity

The cross Price Elasticity means how the quantity demanded of the product is affected
by the change in the income of the customers.

It is given by the formula - %change in quantity/%change in income

When the rise in income leads to rise in the quantity demanded of the product, it is
called as normal goods, as the demand is directly proportional to the income of the
customers
Let’s assume if the income rises for an individual from Rs 30,000 to Rs 50,000, the
individual may buy the pizza from 4 per month to 6 per month post increment.

% change in income = [(50000 - 30000)/30000]% = 67%

% change in quantity of Dominos Pizza = [(6 - 4)/4]% = 50%

Income price elasticity = (50%)/(67%) = 0.74

The positive sign indicates how an increase in income leads to an increase in quantity
of the product and vice versa, hence indicating that the product comes under Normal
goods.

When the rise in income leads to decline in the quantity demanded of the product, it is
called Inferior goods, as the demand is inversely proportional to the income of the
customers.

For example, If an individual was more into burgers but later preferred Pizza due to the
change of his/her income from Rs 40000 to Rs 60000. Let’s assume the monthly
demand of that individual’s burger decreased from 6 per month to 4 per month.

% change in income = [(60000 - 40000)/40000]% = 50%

% change in quantity of burger = [(4 - 6)/6]% = - 33%
Income price elasticity = (- 33%)/(50%) = - 0.66

The negative sign indicates how an increase in income leads to an decrease in quantity
of the product and vice versa, hence indicating that the product comes under inferior
goods.

Question 3. Let’s assume you are planning to buy a new car. Explain the
demand determinants. Which of the demand determinants will have higher
weightage and why?

The demand determinants that may be present when an individual is planning to buy a
car is given below.

Car finance/Affordability -

Unlike other investments which may bring fruitful returns, investing in a car is like
investing in something which is like a depreciating asset or sometimes a liability
depending on the usage. This also means that the amount invested in the car, if
invested elsewhere may bring better returns.

Hence one of the major economic factors are if an individual is compatible enough to
pay for the car, and other factors should be considered as well like, the availability,
affordability and capability of paying back the loans (if implied), the future/sudden
expenses of the family, the change in income or any other change in situations such as
shifting of location etc.

Daily Usage/Need and Presence of substitutes

The other important determinant is the daily usage or the need of owning a car. Due to
the rise of heavy traffic and pollution in tier 1 and tier 2 cities and the availability of
certain commute services such as Ola and Uber also plays a factor in buying a new car.

The daily usage may differ from individual to individual. Owning a car may not benefit a
person who has his business closer to his accommodation but it may be beneficial for
someone who offers his services as a driver, transportation of goods etc or someone
who is a frequent commuter. An individual also considers if the existence of any
substitute is fulfilling the need, such as local transport, OLA or Uber. The status symbol
plays a role too, as someone who is a top executive in a company may not prefer to use
local transports and other commute services to work.

Prices of substitutes (Petrol, diesel, monthly servicing etc)

As of today, petrol price in Delhi is at Rs 101.84 per litre and almost Rs 108 in Mumbai
due to the recent rise of petrol prices all over India. Such factors contribute to the
demand of the car as one begins to think if the monthly expenses in maintaining and
paying for the substitutes of a car is logical enough in terms of managing the finance,
using the substitutes such as local transport or cab services.

An individual may believe that renting a car, or using the daily cab services may be
more beneficial and cheap compared to paying monthly EMI, maintenance and
petrol/diesel for the car.

Brand

The brand plays an important role in the decision making process while buying a new
car as it may not just satisfy the needs of the customer but also boost their self esteem
and pride. The brand offers certain parameters to customers like the design, safety,
quality, discounts, add ons etc as per the customers needs which in turn makes them
more decisive about buying the brand’s product.

An individual may trust Hyundai as a brand and hence it will take him very less time to
decide to buy a Hyundai compared to any other brand, given all other criterias are met.
Hence, this proves that Brand plays an important role in

Technical Specifications

A product is as good as the comfort it offers. One of the most significant factors one
considers prior to buying a car is the technical specification of the car which enables a
buyer to decide if the car is worth the price, or if he is getting any additional value at a
given price.
Certain factors like engine, mileage, trunk and cargo capacity, suspension, gear shifting,
steering capacity and several more features play a vital role to understand if the car is
worth buying as per the budget.

The most important factor while buying a car is Car finance/Affordability as if an

individual cannot afford a car or arrange the finance for the car (or to pay for the
arrangement of the finance), there won’t be any question at the first place to buy the car.
Income, ability to pay the loans, affordability to bear expenses after buying of the car etc
are very important factors which are always catered prior to buying of a car.

Question 4. Assume food delivery firms like Swiggy are making huge
profits. Higher profits may attract the entry of new firms into the food
delivery industry. Explain what could be the impact of entry on the firms and
the industry as a whole.

1. The average cost of rendering the delivery service for the existing
players
2. Price/commissions that they charge from their customers
3. Profitability
4. How would the break-even point impact due to entry of new firms?

Ans -

1. The average cost of rendering the delivery service for the existing
players

Food delivery is a market which is easily penetrable as no company has monopoly on

the Indian food delivery market as of now. If the new firms are getting attracted to the
food delivery industry, it will increase the average cost of rendering the delivery services
for existing players as they will need to retain the customers more using various tactics
like discounts, daily or weekly offers, and better services.

The new firms will be offering various new services/offers which may attract most of the
customers if they are cost effective and comfortable and in order to maintain their
market demand, the existing firms will have to do the same, hence leading to an
increase in their average cost of rendering the delivery of the services.
2. Price/commissions that they charge from their customers

The companies in order to acquire more customers offer cheap prices for their products
under a perfect competitive market. Hence, in order to maintain their market
penetration, the existing firms will have to charge less from their customers. Hence the
price and commissions will decrease for the existing firms.

The best example could be swiggy and zomato competing with each other in terms of
price they charge from the customers in terms of change in subscription fee, free
deliveries, various coupon codes and offers. To maintain their customer base, they offer
various types of values to their customers. Entry of new markets will ensure the same,
where the firms will be competing to offer the best price to the customer as well as
maintaining their profits.

3. Profitability

As of now the price and output curve for the existing firm may look like the following

As the new firms enter the market, the demand for the input will also rise to cater to the
customers for these new markets. As the demand for input rises, the cost for input also
rises which leads to increase in the average cost for the company, which in turns forces
the existing firms to attain the zero economic profit, where they are selling their products
at the cost they are incurring, which can be seen from the following figure

Since the average cost is increased, the existing firms will be selling the product at Zero
profit.

4. How would the break-even point impact due to entry of new firms?

Break-even occurs when one organisation achieves a certain position where the total
revenue of the products is equal to the cost incurred to manufacture the product.

Upon the entry of new markets, the cost of the product/services will increase as the
demand of the input rises. The price of the product will decrease as the companies will
charge very less from the customers in order to retain their market share hence leading
to decrease in their revenue, hence the break even point will be achieved within very
less time as compared to usual pace ie - no new entry of any firms in the market.

Hence the break even point will be achieved easily when the new markets enter which
is not beneficial for the companies who are already making huge profits.

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