A-AS Level (CIE) Business Studies Paper-3: Specimen Questions with Answers 13 - 13 of 20


Case Study-2

Adam, the owner of Ever-Joy Ice-Cream Center, near University Campus, was also a part time student of management studies in a Commerce College. After having studied the theory of price elasticity of demand, he thought that the demand for ice-cream should be price elastic. For an experiment ho announced special-reduced price for the Ever Joy Ice-Cream cone in the second week of August 2001 under the 54th Independence Anniversary Week. He observed the following sales outcome.

He Observed the Following Sales Outcome
AugustPriceTotal Sales
I week$ 51000
II Week$ 41500

Finding demand elasticity to be much above unity, he inferred that the price reduction led the total sales revenue to increase. This outcome encouraged him to reduce the price in October on permanent basis to ₹ 4.50. To his utter surprise he found that his average weekly sales revenue rather declined to ₹ 4,770.

What happened? Though the average weekly demand had risen to 1060 with the price reduction the sales revenue declined. Because, this time the degree of price elasticity is demand suddenly become price inelastic? Why? What went wrong?

Adam՚s approach to price policy was purely theoretical, assuming all other things being equal. He did not care to look at other factors influencing the demand for ice-cream, such as possibilities like winter, climate adverse effects, similar price-war by the rivals shops in the area. Besides, Adam offered a 20 % price reduction temporarily in August only for a week, so most buyers responded to take the advantage and probably the rival did not retaliate knowing it was a short-term phenomenon at that time. Furthermore, now when the buyers realized that price- reduction in October is permanent, they did not react much on the buying-spree. In the previous case of price reduction, the buyers expected that in future - after the celebration work is over- price will go back to the original level, therefore, they purchased more. This phenomenon of further expectations was also not taken into accounting determining the later price-reduction policy. In short, the business excision of Adam was misled by overestimation of price elasticity from the very short-term data in a special situation rather than resorting to demand estimation based on the long-term sales data under normal circumstances.

From Adam՚s experience, we should learn one important lesson that any judgement based on an aerial view may not always be good. Besides, reality widely differs from theory. Real life is never simple as depicted in theory. Managerial decision making in practice is, therefore, more of an art than science.

Question 13 (3 of 10 Based on Passage)


Describe in Detail


What is the significance of Managerial economics in Decision Making?


  • Managers constantly face the major problem of choice among alternatives of producing goods and allied business policies. Managerial economics help them in making a rational choice. In the decision-making process, a manager measures a few micro and macro variables forecasting is a fundamental activity of a business manager He deals with the business problems in sharp manner with a deep probing through economic analysis.
  • A managerial economist in a business firm may carry on a wide range of Demand estimation and forecasting. Functions, such as Preparation of business/sales forecasts. To provide forecasts of changes in costs and business conditions based on market research and policy analysis.
    • Analysis of the market survey to determine the nature and extent of competition.
    • Analyzing the issues and problems of the concerned industry.
    • Assisting the business planning process of the firm.
    • Discovering new and possible fields of business endeavor and its cost-benefit analysis as well as feasibility studies.
    • Advising on pricing, investment, and capital budgeting policies.
    • Evaluation of capital budgets.
    • Building micro and macroeconomic models of aspects of the firm՚s activities that are useful in solving specific business problems. Most models may be prediction-oriented.

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