Managerial Economics: Concepts, Analysis, and Decision-Making Strategies

When making economic decisions, it's important to consider both explicit costs (direct payments) and implicit costs (opportunity costs). Mr. Rahim's decision to pursue an MBA involves financial costs like tuition fees and forgone salary, as well as economic costs associated with the opportunity forgone.To maximize profit, a firm must equate marginal revenue (MR) and marginal cost (MC). By analyzing the total revenue (TR) and total cost (TC) functions, the profit-maximizing quantity can be determined.Price elasticity of demand measures the responsiveness of quantity demanded to changes in price. Determinants of demand include price, income, tastes and preferences, prices of related goods, number of consumers, and future expectations.  

Running head: MANAGERIAL ECONOMICS
Managerial Economics
Name of the Student
Name of the University
Course ID

1MANAGERIAL ECONOMICS
Table of Contents
Part A.........................................................................................................................................2
Answer 1................................................................................................................................2
Answer 2................................................................................................................................3
Answer 3................................................................................................................................4
Answer 4................................................................................................................................6
Answer 5................................................................................................................................9
Answer 6..............................................................................................................................14
Answer 7..............................................................................................................................17
Part B........................................................................................................................................21
Answer 1..............................................................................................................................21
Answer 2..............................................................................................................................24
Answer 3..............................................................................................................................27
References................................................................................................................................32

2MANAGERIAL ECONOMICS
Part A
Answer 1
In making any economic decision, an individual should consider both the explicit and
implicit cost associated with the decision. An explicit cost refers to the direct payment or
monetary cost associated with a business (Varian, 2014). It includes only the financial costs
during the course of an action. Implicit cost in contrast refers to the imputed cost or
opportunity cost related to the economic decision. Opportunity cost is the cost incurred from
forgoing the next best alternative (Cowen & Tabarrok, 2015). It is the indirect cost associated
with a decision. It is also termed as economic cost.
Mr. Rahim’s decision to pursue MBA involves both financial and economic costs.
The financial cost of pursuing MBA involve the direct costs of pursuing the course. These
include tuition fee, buy books and transport cost. In order to pursue the MBA program Mr.
Rahim has to forgone his current job yielding a salary of RM 2,500 per month.
Therefore, the financial and economic cost of doing MBA can be computed
Financial cost=Tuition fee+Cost of buying books+Transport cost
¿ RM 20,000+RM 2,000+ RM 500
¿ RM 22500
Economic Cost =Forgone salary of the current job
¿ ( RM 2500 ×18 )
¿ RM 45000

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Answer 2
The Total Revenue (TR) function of the firm is given as
TR=60Q−Q2
The Total Cost (TC) function of the firm is given as
TC=1
2 Q2+ 30Q+30
Profit maximization of firm occurs at the point where marginal revenue equals marginal cost
(Baumol & Blinder, 2015). From the given, total revenue function, marginal revenue of the
firm is obtained as
Marginal Revenue ( MR ) = d ( TR )
dQ
¿ d ( 60Q−Q2 )
dQ
¿ 60−2Q
Given the total cost function, marginal cost of the firm is obtained as
Marginal Cost ( MC ) = d ( TC )
dQ
¿
d ( 1
2 Q2+ 30Q+30 )
dQ
¿ Q+30
Profit maximization occurs
MR=MC
¿ , 60−2Q=Q+30

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¿ , 2Q+Q=60−30
¿ , 3 Q=30
¿ , Q= 30
3
¿ , Q=10
The quantity level that maximizes total profit of the firm is obtained as 10.
Answer 3
Price elasticity of demand
The term price elastic of demand in economic measures the percentage change in
quantity demanded of a commodity in response to a percentage change in price (Whitehead,
2014). Price elasticity of demand actually measures the responsiveness of demand for a
change in price.
It is measured by computing the percentage change in quantity demanded with respect to
certain percentage change in price.
Price elasticity of demand= Percentage change∈quantity demanded
Percentage chamge∈ price
Determinants of demand
The first primary determinant of demand is price of the product. Given all the factors,
an increase in price lowers demand and vice-versa. Except price, several factors influence
demand of the product. Some of the factors determining demand of a product are discussed
below.

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Income
In case of a normal good, income has a positive relation with demand. That is as
income increases, ceteris paribus demand for a good or service increases and vice-versa
(Kreps, 2019). Goods for which this does not hold, that is demand reduces with increase in
income are termed as inferior good.
Taste and preferences
Tastes and preferences capture personal like or dislike of buyers of various goods and
services. Tastes and preferences are again influenced by religious belief, advertising, culture,
government reports, promotions, campaign and such other factors. Increasing preference for a
good increases demand and vice-versa.
Price of related good
Related goods of particular goods referred as either substitutes or complements of the
good. When price of a substitute good increases, demand for the concerned good increases as
consumers look for relatively cheaper substitutes (Bade & Parkin, 2015). For example, tea
and coffee. When price of a complementary good increases, demand for the particular good
decreases as consumers to reduce demand for the good along with its complementary good.
For example car and petrol.
Number of consumers/population
The effect of number of buyers on demand for a product varies depending on interest
of changing demographics and associated tastes and preferences.
Future expectation
Buyers’ expectation that price of a good or service will increase in future; encourage
buyers to increase their current demand (McKenzie & Lee, 2016).

6MANAGERIAL ECONOMICS
Optimal Price ( P )= Marginal Cost ( MC )
(1+ 1
Ed )
¿ 200
1− 1
3
¿ 200
2
3
¿ 200 × 3
2
¿ RM 300
Answer 4
Price Discrimination:
Price discrimination refers to the producers’ practices of charging different prices to
different consumers for the same good or service. Under free market, total surplus is divided
between consumers and producers. When producers have sufficient market power then they
try to increase their surplus by practicing price discrimination (Paczkowski, 2019). There are
three types of price discrimination: first degree price discrimination, second degree price
discrimination and third degree price discrimination.
First degree price discrimination: Seller charges highest possible price for each unit of
good. In this case, there is no consumer surplus for the buyers. There is no deadweight loss in
the case of first-degree price discrimination. Social welfare is increased in this case even after
complete extraction of consumers’ surplus. (Pepall, Richards & Norman, 2014)
Second Degree price discrimination: Under second degree price discrimination, firm knows
that different consumers in the market has different demand functions however the demand

7MANAGERIAL ECONOMICS
function of a particular consumer is not known. Firm here offers a menu price for different
packages. Options are designed in such a way consumers can self-select by choosing suitable
package for themselves. Unlike first-degree price discrimination, firms by practicing second-
degree price discrimination cannot capture all consumer surplus.
Third Degree price discrimination: In this case, seller charges according to the elasticity of
demand among different group of buyers. Price discriminator will separate buyers in different
groups having different elasticity of demand (Waldman & Jensen, 2016). Now, the seller will
charge lower price for highly demand elastic market and higher price for lower demand
elastic market. Third degree price discrimination cannot increase the social welfare.
Conditions for Effective price discrimination:
To discriminate price effectively, seller need to identify the demands of the buyers or the
group of the buyers. Conditions for effective price discrimination are the following:
Immovability of buyers: In order the make price discrimination effective, sellers should
ensure that the buyers are not able to switch from one market to another market. That means
buyers cannot move from high price market to low price market (Gillespie, 2016). Markets
could be separated depending on the following factors:
Time: Different prices are charged in different times of a day or week or month.
Age: Prices are different for different age group. Example, due to reservation for old- age
people, they pay less than other people do.
Region: Transportation cost changes the price of same good. Where the transportation cost is
high, prices are higher in that place and vice versa.
Status: Prices can vary for the status or designation of the buyer. For an example, entry fee or
the charges in a club is different for the club members and non-members.

8MANAGERIAL ECONOMICS
Different elasticity of demand: Price elasticity of demand should be different for different
markets. Price inelastic demand one market enables the market to charge more price in the
market and less in other market (Currie, Peel & Peters, 2016). Different demand enables the
market to charge different price. In the inelastic demand market price is higher than the
elastic market.
Except the above two conditions there are some conditions which are also important
in the process of price discrimination. To discriminate price, firms need market power to
charge above marginal cost. Consumers need to be heterogeneous and resealing of products
needs to be banned or costly.
Price discrimination in the airline industry
In the airline industry, price discrimination is a common phenomenon. Passengers
pays different prices for the same flight and same services in the airline industry. Ticket fare
varies depending on time of booking the tickets, facilities associated with seat, seasons and
other attributes (Cattaneo et al., 2016). The conditions that make the price dissemination
possible in the airline industry are explained below.
1. In the airline industry, the source of market power is the barriers that have been
raised by the scale of economies and sunk cost to discriminate price.
2. They occupy the different schedules of flight. To do so, they offer different routes.
This helps them to differentiate among customers. For example, carriers, which
have too many connections to offer for west coast, make itself different from other
carrier, which flies to the east coast only (Bergantino & Capozza, 2015). Both of
them offer their ticket for sale for Boston-Miami route.
3. Different consumers have different elasticity of demand.

9MANAGERIAL ECONOMICS
The airline industry does some common price discrimination, which are described as
below:
Versions of Ticket: Different versions of tickets are available in the airline industry. Such as,
expensive and flexible tickets enable the customer to reschedule the flight and cheap tickets,
which have restrictions.
Discounts to Large Customers: in the national and international level, some large customers
are likely to sign a contract with the airline companies to get discount (Chakrabarty & Kutlu,
2014). Such as, a firm’s employees get discounts on tickets. In this case, different groups of
customers pay different prices.
Frequent Flyers: in this programme, the flyers, which take the flights frequently, get
member points for every confirmed flights. Further, these points are used to get a free flight
as a discount.
Answer 5
Law of Diminishing Returns and Short-Run Cost Curve:
The law of diminishing returns states that increase in the quantity of an input other
things remaining same, the total productivity will increase at decreasing rate. In other words,
increase in the quantity of input other things remaining same; the marginal physical
productivity of the input will fall (Allen et al., 2013). There are certain assumptions, which
are described as follows:
 The state of technology remains constant.
 Only one input can be changed and other inputs will remain same.
 The law is not applicable in case of the production where the inputs are proportionally
required (Shepherd, 2015).
 Only physical inputs and outputs are considered.

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Cost
Quantity
Fixed Cost
Variable Cost
Total Cost
Cost
Quantity
Marginal Cost
Average Total Cost
Average Variable Cost
Average Fixed
Cost
Short Run Cost Curve:
The cost function is determined by the cost of production and the other
determinants. The short-run is a period where the supply of factor of production is fixed.
Short-run total cost is determined by the addition of total fixed cost and variable cost. Total
Fixed Cost is the cost at the initial time of production and does not vary with the level of
production. That means there will be a fixed cost even if production is zero. For an example,
machines purchased at the initial time. Total Variable Cost is the cost of inputs, which
changes with the level of production (Nicholson & Snyder, 2014). That means variable cost is
zero at the initial time when production is zero and as production rises variable cost rises.
Figure 1: Different Short Run Cost Curves
Marginal Cost is measured as the change in cost due to change in output. In other way, the
rise in cost due to producing 1-unit extra output. Average Cost is calculated by addition of

11MANAGERIAL ECONOMICS
average fixed cost and average variable cost. Average Fixed Cost is calculated by dividing
the fixed cost with the quantity of output. As output increases, average fixed cost decreases.
Average Variable Cost is measured in the same way by dividing the variable cost with the
quantity of output.
In the short-run, according to law of diminishing returns, an increase in variable input
increases the output at initial time and then decreases. That means the marginal productivity
is negative for the variable input (Mankiw, 2014). The marginal cost of extra units of output
supply is connected with the productivity of input. The law of diminishing returns means the
cost will increase the average total cost.
Economies of Scale and the Long Run Cost Curve
Economies of scale means the cost advantage that arises because of the negative
impact of quantity produced on average fixed cost. A rise in the quantity of output reduces
the average fixed cost. Operational efficiency relates the economies of scale and average
variable cost. Firms can introduce it at any stage of production.
Effects of Economies of Scale
It reduces the average fixed cost, average variable cost and average cost of
production. This happens because of increase in production, which absorb the fixed cost and
expanded scale of production raises the efficiency of production, which helps the economic
scale to reduce the variable cost (Carlton & Perloff, 2015).
Types of Economies of Scale
Internal Economies of Scale: This means the unique economies of a firm. For an example, a
patent over a quality production machine which enables the firm to produce more qualitative
products, which also reduces the cost of production to compete the firms in the industry.

12MANAGERIAL ECONOMICS
External Economies of Scale: This means industry’s economies of scale. For an example, to
increase the production of aluminium, government gives a tax break to the employees of
aluminium producing firms with 5000 workers (Jackson, 2018). Now the firms with less than
5000 workers will employee more workers to reduce average cost of production.
Long Run Cost Curve:
In the short run, operations of a firm are limited to a single cost curve corresponding
to the level of fixed cost. In the long run however as all inputs are variable, firms can choose
any of the average cost curves. The long run average cost curve thus is the envelop of short
run average cost curves associated with a particular level of fixed cost. The long run marginal
cost curve indicates additional cost for each unit of added output (Stiglitz & Rosengard,
2015). The concept of long run marginal cost is explained by return to scale instead of law of
diminishing return. The economies of scale curve actually imply long run average cost curve
as it allows changes in all factors of production. In the presence of economies of scale long
run average cost decreases. The figure below shows long run cost curve and its association
with economies of scale (Pindyck & Rubinfeld, 2014). The falling part of LAC indicates
presence of economies of scale while the rising portion of LAC indicates diseconomies of
scale.

13MANAGERIAL ECONOMICS
Figure 2: Long Run Average Cost Curve and Marginal Cost Curve
New Economies of Globalisation
The rising trade and flow of capital across countries explains the economic
globalisation as rising interdependence of world economies. This shows the continuous
expansion of and incorporation of markets. Economic globalisation is an irreversible trend.
Cross-border trade and marketization of international enterprises are the forces that worked to
make the economic globalisation happen. The additional factor, which plays a major role in
economic globalisation, is technology. Advance technology and science has introduced the
advance level of transport and communication system, which supported the economic
globalisation by reducing the cost and time (Cronin, 2013). GATT and WTO framework have
helped the countries to reduce the cost of trade by removing the tariff and non-tariff barriers.
The trade across the countries, advance technology, reforms aiming market and removal of
trade barriers promoted the development of investment and integration market for which the
economies integrated into a whole. The MNCs, international organisations, globally
producing and allocating resources, forming the operation mechanism at macroeconomic
level, are the bearers of economic globalisation. The process of restructuring and upgrading

14MANAGERIAL ECONOMICS
industry is taking place across the countries (Pradella, 2014). The economic globalisation is
dominated by the developed countries, which can be explained by the fact that these countries
make the rule of economic exchange.
Answer 6
Perfect Competition
Perfectly competitive market has certain features. The features are as follows:
 There is many buyers and sellers in the market.
 Firms always try to maximize their profit.
 The supply curve cannot be affected by the contribution of the production level of
producers.
 Producers are price taker. Firms cannot influence the market price.
 Firms produce homogeneous products. Products do not vary among suppliers.
 Free exit and entry exists in the market (Devine et al., 2018).
 Buyers and producers have perfect information about product quality, price and
utility.
 In perfect competition, there is no transport cost.
 In the long-run, producers profit is zero.
Price Determination:
The large number of firms producing homogeneous products are the price takers. Hence,
firms cannot change the market price and follows the price, determined by the market. Under
perfect competition, market price is fixed by the interaction of market’s demand and supply
and firm accept the price. Hence, the demand curve of a firm in perfect competition is
horizontal line at the price level set by the market (Cowell, 2018). Now firms choose the level
of output at which they can maximizes their profit.

15MANAGERIAL ECONOMICS
S
Output Output
P P=AR=MR
S
D
Q
Price
D
E T R
MC
Q1 Q2
Cost
Revenue
O
P
O
The Equilibrium Condition of a Firm:
A firm must satisfy the below mentioned condition to reach the equilibrium:
1. Firms ensure the marginal revenue is equal to the marginal cost (MR=MC).
 In case, MR>MC, the firm will expand or increase the output.
 In case, MR<MC, the firm will decrease the output as the cost will increase for
addition outputs.
 MR=MC is the only condition where firms will be in equilibrium (Jain &
Ohri, 2015)
2. The slope of MC curve must be positive. The MC curve must cut the MR curve from
below.
Figure 3: Long run equilibrium under perfect condition
In the above figure, demand curve is DD and the supply curve is SS. They intersect
each other at point E. E is the equilibrium point which shows that the equilibrium price is

16MANAGERIAL ECONOMICS
OP. The firms accepted the price at OP and the considered the price line as demand curve
which is horizontal and perfectly price inelastic at P. As the price of all units are same,
marginal revenue is equal to the average revenue (Farm, 2017) The MC cuts the MR at T
and R point. The MC curve cuts the MR curve from above at point T. but the condition is
MC must cut the MT curve from below. At point R, MR curve is cut by MC curve from
below. Therefore, the equilibrium point is R and the equilibrium output is OQ2.
Oligopoly:
Oligopoly market has certain features. The features are as follows:
 There are a few numbers of sellers.
 Products are homogeneous and differentiated.
 There is interdependency among firms.
 Advertising and selling cost plays a vital role.
 There exists price rigidity.
 Firms are price maker.
Except these all, in oligopoly market, firms do not try to raise or reduce the prices. This is
because the demand is elastic for higher prices and the demand is inelastic for lower prices
(Haraguchi & Matsumura, 2016). Therefore, if they reduce or raise the prices, they will end
up by losing revenue.
Price Determination:
There are four ways to determine the price in oligopoly market. They are discussed
below:

17MANAGERIAL ECONOMICS
Interdependent Pricing: The firms in oligopolistic market notices each movement of
other firms of the industry. Firms often compete each other in oligopoly market as they
influence each other by their strategic decisions.
Price War: Oligopolistic firms predict the moves of their competitors and take
strategic decisions to set the price and output. They engage in price wars to capture the
maximum part of the sales (Delbono & Lambertini, 2016). Their objective is to increase the
monopoly power in the market. They often engage in price war to threaten the competitor to
make them their follower under their leadership.
Price Leadership: In the oligopoly market, there exist some firm, which dominates
the firm by their low cost production and large production covering the maximum part of the
total output in the market. In this oligopolistic competition, that firm is considered as the
leader and others follow the firm to set the price (Nava, 2015). Three kinds of price
leadership exist:
1. Dominant firm plays the role of leader.
2. Barometric price leadership
3. Aggressive leadership.
Formal Agreement: Collusion of firms to set a limit in market by setting a price and
market share. This is also known as cartel. There are two types of cartel:
1. Joint-profit Maximizing Cartels (Belleflamme & Peitz, 2015).
2. Market-sharing Cartels.
Answer 7
Oil is internationally traded commodity. Demand, supply and expectation and speculation
of shift in current balance in demand and supply defines the oil price. Trend of balance in

18MANAGERIAL ECONOMICS
demand and supply, estimated by speculators and traders for future prices determine the
current oil price (Baumeister & Kilian, 2016)
Supply Side
United States has become the largest crude oil producer in the world. Oil production
of America has increased by 2 times more in past decade. The reason behind this is
introduction of advance technology in drilling. This improvement in technology enables to
unlock the oil and natural gas trapped in underground. This reduces the total cost of drilling.
OPEC announced a price war to recapture the market share. The market share which has been
lost to America (Baffes et al., 2015). US oil production falls at a small level which was less
than the expected fall. As the cost was low and technology has improved, America started to
increase the production after 2 years. After the removal of 40-year ban on international export
of crude oil by congress. United States export the oil to South America, china and Europe.
United States is less dependent on foreign oil, including Middle East.
The production of oil will increase, as the cost of production has been reduced due to
technological advancement. This will shift the supply curve to the right. The excess supply
will reduce the price and increase the quantity supplied (Baumeister & Kilian, 2016) This
incident can be explained graphically.

19MANAGERIAL ECONOMICS
Figure 4: Excess supply and decline in oil price
In the above diagram, it is shown that the initial supply curve is S1S1 and the demand
curve is DD. The initial price and quantity is P1 and Q1 respectively. Now as the cost of
production falls, firm produces more, which shifts the supply curve rightward. Therefore, the
final supply curve is S2S2. The excess supply reduces the price of the oil and oil products
(Bridge & Dodds, 2018). The price will fall until demand equals to supply. The final price
and quantity is P2 and Q2. Final price is lower than the initial price and the final quantity is
higher than the initial quantity.
Demand Side
The reduced demand of oil in China is one import factor explaining a fall in oil price
in recent years. China is considered as one of the largest oil importers. The economic growth
of China has slowed down in recent years due to the creation of uncertainties by the
deterioration of trade relation between US and China. US started imposing tariffs on the
goods of China (Khan, 2017). US provided the waiver for short time which allows the eight
countries including China and Japan to buy oil from Iran.
Fall in demand of oil in under developing countries will reduce the price of oil.
Similarly, price of oil products will fall if the demand for the oil products fall. The producer

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Price
Quantity
P1
P2
Q2 Q1
O
D2
D2
S
S
D1
D1
reacts on fall in demand of oil by reducing the price (Taghizadeh-Hesary, Rasoulinezhad &
Kobayashi, 2016). The reason behind the reduction in oil price is to sell excess supply of the
oil and oil products, which is caused by the reduction in demand. It can be explained by the
graphical representation.
Figure 5: Decline in demand and fall in oil price
In the figure above, initial demand curve is D1D1 and after the fall of demand, it
shifts left to the D2D2. Due to the fall in demand, there is an excess supply. To sell this
excess amount, producer will charge a lower price and the price starts to fall until the demand
equals to the supply (Friedman, 2017). Finally, when the market reaches at equilibrium, price
becomes P2 and the quantity becomes Q2. Price and quantity has fallen.
Other Factors
In addition to demand and supply side factors, there are other factors explaining a fall in
oil price. In the global market, Saudi Arabia now has to decide whether it is going to reduce
its oil price or cut down its supply. However, it decided to recapture and regain the market

21MANAGERIAL ECONOMICS
share which it had lost to America. Moreover, behind lowering the price there was another
motive. The motive was to kick out the new comers from the oil producing industry. It
happened too. In America, few oil diggers left the market due to low oil prices caused by the
price war (Baumeister & Kilian, 2016). Cost of oil production in Saudi Arabia is much lesser
than the western countries. The western countries use the old heavy machineries to refine oil
which consumes a huge amount of oil.
The rise in production of North America and slow growth rate of oil consumption in
china justifies the market situation.
Part B
Answer 1
Firm’s Decision Making
In doing business, firms have to take decision at various level. Firms take decisions to
maximize profit with minimum cost in regards of the inputs such as land, raw materials,
labour and capital. Therefore, they have to find the optimum combination of inputs to
maximize profit.
Effects of Macroeconomic Environment
Macroeconomic environment is major factor that can control the firm’s decision-
making. Macroeconomic environment can be expressed by the factors that have an impact on
macroeconomic level (Mokhova & Zinecker, 2014) Such factors are growth of economy,
inflation and other factors. These factors are discussed below one by one:
Growth of Economy: Firms are dependent on the growth rate of economy. A fall in growth
rate leads the economic environment to create adverse situation to the firm. Aggregate

22MANAGERIAL ECONOMICS
demand falls in case of slow growth then firm have to reduce the output and curtail
operations.
Inflation: Inflation reduced the aggregate demand which also reduces the opportunities for
growth. In this situation demand for the goods which exist in the market, decreases.
Savings and Investment: Potential of firm can be controlled by the economic factor saving
and investment in the economy. Transformation of savings from surplus funds to deficit can
be the positive sign for the firms to invest in the economy.
Balance of Payment: An unfavourable situation for the firm’s is deficit current account in
balance of payment. In this situation, foreign exchange reserve is low which reduces the
import (McGuigan, Moyer & Harris, 2013). Current account needs to be in favour of firms as
they as crucial impact on efficiency of production.
Recession: Recession is an adverse situation for firms as it reduces the demand for capital
equipment.
Financial Market: Money and capital market stimulates capital creation which accelerates
the growth of the firm. So financial market plays an important role in this case. Financial
market transfers the savings to investment through the firms. Transfer process allocates funds
in the deficit savings efficiently among the firms if the financial market is well developed.
Factors That Influence the Business Activity
Dynamic economic conditions affect all national and international businesses. The
factors are interest rate, demand and supply, recession and inflation. The motive of all
business is too maximise their profits. To do so, one needs to take care of demands of
consumers, proper supply and the quality of the goods and services provided to the customer
(Froeb, McCann & Ward, 2015). The list of the factors are as follows:

23MANAGERIAL ECONOMICS
Demand and Supply: Demand is the willingness of customers to purchase the goods and
services offered by the business. Supply is the ability of business to make availability of the
customers need. For an example, an introduction of latest technological improvement in the
mobile phones will increase the demand of the phone. It will be charged a higher price. Now
if the demand is greater than the supply then the price will remain high.
Marginal and Total Utility: Utility is the satisfaction level of the customer by the
consumption of a good. Continuous consumption of a good reduces the utility of the product
to the consumer. This has a long term and short-term effect in the fall of sales (Ward & Begg,
2016). Therefore, the organizations launch the different brand before the collapse of the
utility of consumers. The utility is one of the factors, which controls the business activity.
Money and Banking: Monetary and fiscal policies influence the business activities and the
consumers of business. Money shows the demand of the consumers and the banking shows
the borrowing capacity of the consumer and the business. Banking policies influence the
prices of goods and interest rate by the using factors like assets prices and investments.
Monetary policies can affect the business activities by influencing the inflation.
Economic Growth and Development: The business needs to serve the demand of a society
of the economy. Development and growth is the most crucial factor, which influences the
business activities most. The long-term investment in business and the people of a country
results in economic growth.
Income and Employment: Rate of employment and income of a particular country has a
great impact on the business. The rate of employments dictates the demand of the society. A
rise in income increases the demand by increasing the purchasing power in the country.
Therefore, these are one of the most important factors affecting the business (Freeman, 2013)

24MANAGERIAL ECONOMICS
For an example, at the time of economic upswing, there are available opportunities to
increase the income.
Inflation: Inflation generally take place due to excess supply of the money in the economy.
The prices of goods increases. The cost of raw materials for the production rises. This cost is
transferred to the retailers. Purchasing power of customer falls with constant income. But the
prices go up.

25MANAGERIAL ECONOMICS
Answer 2
Components of Aggregate Demand:
Aggregate demand is overall demand for the goods and services available in the
market. This depicts the relationship between the price and the purchased or produced goods
or services in the economy. There are four components of aggregate demand. They are
consumption, investment, government expenditure and net export. AD=C+I+G+(X-M)
explains how the aggregate demand is related to its components. Any change in this four
components can lead to a change or shift in aggregate demand.
1. Consumption
Every individual existing in the economy makes consumption. Consumption often
accounts for the greatest proportion of aggregate demand (Goodwin et al., 2015). The factors
that affect the consumption are described below:
 Consumer Confidence:
The confidence of consumers about their job, income can increase the spending in a
stable and growing economy. Uncertain income or job threat can decrease the spending.
The increase in confidence of consumer shifts the aggregate demand rightward.
 Interest rate:
Interest rate have a great impact on consumption pattern. If there is a fall in interest rate,
then consumers will purchase more. They can buy house car or properties as they can borrow
at low interest rate. Lower interest rate increases the aggregate demand.
 Consumer debt:

26MANAGERIAL ECONOMICS
Consumer debt has a negative impact on consumption. As individual with debt have to
pay his debt, his consumption will be relatively less. Consumer debt can reduce consumption
and aggregate demand.
 Wealth:
Wealth is nothing but the property or stocks held by households. An increase in property
means increase to consumption.
2. Investment:
The firms make investment on capital. Investment is the most volatile component of
aggregate demand. In the short run, a rise in investment shifts the aggregate demand to the
right (Uribe & Schmitt-Grohe, 2017) The description of factors that affect the consumption
are as follows:
 Interest Rates:
Decrease in interest rate makes borrowing cheaper. Therefore, a fall in interest rate
increases large investments and firms get incentive to take risk.
 Business Confidence:
In a stable and growing economy, confident firms are more likely to invest in new
projects and making new business.
 Investment Policy:
Incentives like subsidies, loans and tax break can raise the investment. On the other hand,
corruption can decrease the investment.
 National Income:

27MANAGERIAL ECONOMICS
The firm need new machines if they want to increase the output. In other way, if firms
need to produce more, they have to purchase machines. This is called the Accelerator
relationship.
3. Government Spending:
A rise in government expenditure can shift the aggregate demand curve to the right.
Transfer payments are pensions and unemployment benefits. Capital spending is like
spending on roads, bridges, hospital and schools. Government spending means capital
spending and transfer payments. Factors affecting government spending include state of
economic growth, power of political parties and fiscal policy objectives.
4. Net Export
Net export is the difference between export and import. Exports are domestic goods
sold abroad and imports are foreign goods bought by domestic customers. Exchange rate is
an important determinant of trade flow within the nation (Heijdra, 2017) Exchange rate,
which reflects the price of domestic currency relative to foreign currency, influences the
extent of import and export demand.
Volatility of component
There are four components of aggregate demand. Among them the least volatile
component is government spending as it is imposed by the government according to the
economic situation. Policies imposed by government have specific impact on aggregate
demand. After government, spending the next volatile component is net export. Net export is
calculated by subtracting the import from export. Import and export depends on the currency
exchange rate. This is controlled by the demand of foreign economy and the domestic
economy. Human expectation is one of the most volatile factor, which affects consumption
and investment (Argy, 2013) Consumption and investment depend on expectation or

28MANAGERIAL ECONOMICS
confidence of consumer and firm respectively. Investment presents a smaller proportion of
output compared to consumption. However, the consumers always try to smooth out and the
consumption over time and they are successful to do so. Economic conditions can change the
investments more dramatically compared to consumption. Hence, compared to consumption,
investment is more volatile. According to Keynes, the most variable component is aggregate
demand. As, investment also depends on expectation of future profits. When a growth is
expected to take place in an economy, then new business will be encouraged towards new
investment.
Answer 3
The Foreign Exchange Rate
Currency of a country is exchanged for the currency of other country at a specific rate
determined by the demand and supply of both countries. This specific rate is called foreign
exchange rate (Uribe & Schmitt-Grohe, 2017). This is calculated by the ratio of prices of a
standard in two countries. In other way, foreign exchange rate shows the price of domestic
currency relative to foreign currency.
Determination of Foreign Exchange Rate:
Two methods of foreign exchange rate determination are gold standard mechanism
and paper currency system. In paper currency system, balance of payments theory operates.
The following discussion is about the determination of foreign exchange rate by balance of
payment theory:
Balance of Payment Theory of Foreign Exchange Rate Determination:
Foreign exchange rate can be determined by the supply-demand concept or BOP theory.
There are two countries say A and B and the domestic country is A. The value of country A’s

29MANAGERIAL ECONOMICS
currency in terms of country B’s currency represents the foreign exchange rate. Demand and
Supply of foreign exchange influence the foreign exchange rate.
Demand for Foreign Exchange: demand for foreign exchange is created when the country
A’s people needs to pay in country B for the purchased goods and services. That means,
country A demand for the foreign currency by paying the domestic currency in the foreign
exchange market. Therefore, the country releases its foreign currency to meet the demand.
This is how; the demand source of foreign exchange is seen in the debit side of the BOP
account. Large amount of import shows the higher demand for foreign exchange. A fall in the
price of foreign exchange in terms of domestic currency makes the foreign good cheaper.
Therefore, domestic consumers will demand for foreign goods and imports from foreign will
rise. Thus, demand for foreign exchange rises (Gabaix & Maggiori, 2015) Which means the
demand curve of foreign exchange is downward slopping. If there is a rise in the price of
foreign exchange, foreign goods will become expensive which will reduce the demand for
foreign exchange.
In the figure below, foreign exchange rate is measured on the vertical axis and foreign
exchange on the horizontal axis. The DD curve represents the demand for foreign exchange.
Supply of Foreign Exchange:
Receipts of exports determines the supply of exchange. The supply of foreign
exchange is generated when foreign country purchases goods and services from domestic
country. Simply, the amount of import from the domestic country is the source of foreign
exchange. More specifically, credit side of the balance of payment shows the supply of
foreign exchange. A rise in foreign exchange rate implies that the goods in domestic country
are cheaper in terms of the foreign currency. This influence the domestic country to export
and attracts the foreign investment (Heijdra, 2017). Therefore, low exchange rate shows the

30MANAGERIAL ECONOMICS
Foreign Exchanges
D
D
S
S
a b
E
c d
P1
P
P2
M
O
Exchange
Rate
higher supply of foreign exchange and vice versa. In the figure below, upward rising SS
curve is the supply curve of foreign exchange.
Figure 6: Demand, Supply, and equilibrium in foreign exchange market
Equilibrium exchange rate can be determined by the supply and demand curve of
foreign exchange. The intersection point of demand and supply curve of foreign exchange
shows the equilibrium exchange rate. In the above figure, the intersection point is E where
demand and supply of foreign exchange is equal. At point E, the equilibrium foreign
exchange rate is OP and the equilibrium demand and supply is OM. Now, if the foreign
exchange rate exceeds the equilibrium exchange rate say at P1, there is excess supply equals
to the amount of ‘ab’. Due to excess supply foreign exchange rate will fall up to point E
where demand equals to supply driven by market force (Rossi, 2013). Similarly, below the
exchange rate OP, there is excess demand. At the exchange rate OP2, the excess demand
equals o the amount of ‘cd’. Then the banks will have a shortage of foreign exchange, which
will raise the exchange rate until demand equals to supply.

31MANAGERIAL ECONOMICS

32MANAGERIAL ECONOMICS
Depreciation of the Malaysian Ringgit
A number of factors are there which are responsible for the depreciation of the
Malaysian Ringgit. Among them, the most crucial factors are global economy, investors’
expectations and internal factors.
Global Economy: Economic blocks clash between US and China has hanged the
global economy. US has raised the dollar value to strengthen and stabilise the currency of
US. On the other hand, China has devalued its currency to increase the export to recover
BOP. The clash between china and US influenced the disturbance of developing countries’
economic conditions. Malaysia is one of the developing countries, which were affected by the
clash (Yeo, 2015). The value of ringgit was fluctuating due to inability of competing with
yuan and dollar. Fall in yuan and rise in dollar made the ringgit low and weak.
Oil Price: Falling oil prices devaluated the ringgit. Fall in oil prices reduces the foreign
reserve of Malaysia. This also helped in depreciation of ringgit.
Investor Expectation: This has a great impact on the ringgit value. FDI in Malaysia is
greatly influenced by the investment. FDI has major contribution to the GNP of Malaysia.
MNC that were operating in Malaysia moved to other countries like Indonesia and Vietnam.
MNCs always look for the cheap labour and the cheaper cost of production. This factors leads
to move the MNCs from Malaysia as they got Vietnam and Indonesia. Expectation of
investors that a rise in cost of production may occur they started moving (Thestar.com.my,
2017) To attract and give opportunities Malaysia devalued their currency and used foreign
reserve. This lowers the value of ringgit.
Internal Factors: National debt was the crucial internal factor in devaluation of ringgit. The
pay back of the debt was high, so, it was unable to protect from the economic crisis.
Government needs funds to finance their expenditures and investments and deficit budgeting

33MANAGERIAL ECONOMICS
of Malaysia. The public debt was high due to high rate of deficit budget. This incident forced
the value of ringgit to fall.

34MANAGERIAL ECONOMICS
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