CASE STUDY – I

 

The Global Recession

 

Beginning in the United States in December 2007 (and with much greater intensity since September 2008,

according to the National Bureau of Economic Research), the industrialized world has been undergoing a

Recession, a pronounced deceleration of economic activity. This global recession has been taking place in an

economic environment characterized by various imbalances and was sparked by the outbreak of the

financial crisis of 2007-2009. Although the late-2000s recession has at times been referred to as "the Great

Depression," this same phrase has been used to refer to every recession of the several preceding decades.

 

The financial crisis has been linked to reckless and unsustainable lending practices resulting from the

deregulation and securitization of real estate mortgages in the United States. The US mortgage-backed

securities, which had risks that were hard to assess, were marketed around the world. A more broad based

credit boom fed a global speculative bubble in real estate and equities, which served to reinforce the risky

lending practices. The precarious financial situation was made more difficult by a sharp increase in oil and

food prices. The emergence of Sub-prime loan losses in 2007 began the crisis and exposed other risky loans

and over-inflated asset prices. With loan losses mounting and the fall of Leman Brothers on September 15,

2008, a major panic broke out on the inter-bank loan market. As share and housing prices declined many

large and well established Investment and Commercial banks in the United States and Europe suffered huge

losses and even faced bankruptcy, resulting in massive public financial assistance.

 

A global recession has resulted in a sharp drop in international trade, rising unemployment and slumping

commodity prices. In December 2008, the National Bureau of Economic Research (NBER) declared that the

United States had been in recession since December 2007. Several economists have predicted that recovery

may not appear until 2011 and that the recession will be the worst since the Great Depression of the 1930s.

The conditions leading up to the crisis, characterized by an exorbitant rise in asset prices and associated

boom in economic demand, are considered a result of the extended period of easily available credit,

inadequate regulation and oversight, or increasing inequality.

 

Fiscal and monetary policies have been significantly eased to stem the recession and financial risks. While

this has renewed interest in Keynesian economic ideas, the recent policy consensus is for the stimulus to be

withdrawn as soon as the economies recover to “chart a path to sustainable growth”.

 

Questions

1. What do you understand by Global Recession? How was it triggered?

2. How do you distinguish between Recession, Inflation, Deflation and Stagflation?

3. What has been the adverse impact of the present recession on the world economy and the Indian

Economy?

4. How can Recession be fought? What are the immediate measures and policy changes already undertaken

by India and major countries like USA, Japan and Germany?

 

 

CASE STUDY – II

 

India’s Economic Growth in 2009-10

 

Displaying unmistakable signs of a surge, the country’s economy grew by a robust 7.9 per cent in the second

quarter of the current fiscal (July-September 2009), prompting experts to project a seven per cent growth for

the full fiscal as against 6.5 per cent estimated earlier.

Planning Commission deputy chairman Mr. Montek Singh Ahluwalia described the happy development as

being “above expectations”. “There is also scope to revise the growth projections,” Mr. Ahluwalia said,

alluding to the prospect of an upward fine-tuning of the Plan panel’s earlier estimate.

 

The economy had registered a 6.1 per cent growth in the first quarter of this fiscal and took the cumulative

expansion for the first half of the current fiscal (April-September) to seven per cent, the Central Statistical

Organization (CSO) said in a statement here. The growth registered last fiscal was 6.7 per cent.

 

The bulk of the recovery was led by a 9.2-per cent growth in manufacturing, while mining and construction

activities expanded by 9.5 per cent and 6.5 per cent, respectively. The news also enthused the markets and

helped the Sensitive Index (Sensex) of the Bombay Stock Exchange (BSE) gain.

 

The growth rate is the fastest in 18 months, making experts wonder if it was not time to introduce an

interest rate rise and cut stimulus spending in the face of mounting inflation. “This data could be a green

light for the Reserve Bank of India to hike rates, and there are greater chances of this by the end of the

calendar year,” said Mr. Robert Prior-Wandesforde, senior Asia economist at HSBC in Singapore.

 

Allaying fears about food inflation, Mr. Ahluwalia said: “I don’t believe there are serious worries on inflation,

except food prices. Food prices are a matter of concern, but I don’t think conventional monetary policy will

take care of that problem.” He also reiterated the government stance that stimulus would remain in place.

“Personally, I don’t think the second quarter numbers suggest any change in the (fiscal) policy in the current

year,” he said. However, RBI Deputy Governor, Mr. Subir Gokarn said he would not be surprised if growth

slowed in the December quarter. “While it is a recovery and it seems to be gaining strength, we should not

ignore the fact that it is still being driven substantially by public spending,” he said.

 

Mr. Rajeev Malik, economist at Macquarie in Singapore, said that the central bank would use liquidity

management rather than rate rises in December and January as farming output was likely to fall. “I don’t

think they are going to be swung by what agriculture has done,” he said. However, the farm sector grew less

than one per cent in the second quarter of this fiscal from 2.7 per cent a year earlier, mainly due to the twin

impact of drought and subsequent floods. The growth in agriculture, forestry and fishing is estimated at 0.9

per cent in the July-September quarter, the Central Statistical Organization (CSO) data said.

 

The finance minister, Mr. Pranab Mukherjee, is all smiles at the nation posting a robust growth. “I’m happy

about the figures released by CSO. If you compare it with the earlier two quarters, it’s a very heartening

progress,” he told reporters outside Parliament.

 

However, Mr. Mukherjee hastened to caution, “even then, I will keep my fingers crossed till the third quarter

result comes in.” “The results that have come out today show that the stimulus package we provided has

started paying dividends... The negative trend in exports is coming down. I’m happy. We will wait for the

next quarter,” Mr. Mukherjee said.

 

Questions

1. What are the projections made above for India’s future growth? Why were the policy-makers optimistic

about it?

2. How is the growth of the economy measured and calculated? Why it is not measured in terms of National

Income or Net National Product?

3. What are the reasons for a very low growth in the Agricultural Sector? What was the future prospect for

Indian Agriculture?

DEMAND FORECASTING FOR M/s BENGAL CABLE COMPANY

The market research department of M/s. Bangal Cable Company, Kolkota was entrusted with forecasting the

demand for cables of the company. It was felt that the demand for cables is considerably influenced by the

pace of industrialization, power development and building activity. Cables are used for different purpose

such as power transmission and industrial and house wiring. Bengal Cable Company was exclusively

engaged in the manufacturing of cable required by industry and housing. While many factors such as the

rate of building activity purchasing power, etc. are important in determining the demand for cables, it was

felt that most of the demand for cables can be explained in terms of the growth of power consumption in the

country. As cables are a must for industry and building the price factor was not considered as significant

variable in determining the demand for cables. After all this products has no substitute.

The market research department of M/s Bengal Cable Company, Kolkata, developed a model relating all India

cable sales (industrial and housing cables) to the peak demand for power in the country. The analysis based

on time series data had shown a strong positive correlation between all India cable sales and the peak

demand for the corresponding year. The estimating equation was as follows:-

Yt. = 1173 + 28.5 Xt.

Where Yt. = annual cable sales (in thousand coils) for all India in year t

Xt. = peak demand in million K.W. in year t

r2 = 0.94

The Central Electricity Authority of the Government of India has estimated the peak demand for the year

2004 as 98.5 million K.W., taking into account likely industrial and building growth and the availability of

power on an all India basis. As there were no marked seasonal fluctuation, it was considered proper to

assume uniform monthly cable sales throughout the year. It was estimated that Bengal Cables market share

in 2004 will be about 20 per cent.

Question 1. Find out the all India cable demand for the year 2004 and monthly estimated sales of Bengal

Cable Company.

Question 2. The Price factor was not considered important in forecasting all India demand for cables. Will the

same be true in estimating demand for the company's cables?

Question 3. Suppose the market share of the company during the previous two years was 10 and 15 percent

respectively, was the company justified in assuming the market share as 20 percent?

Mc Donalds holds nearly 30 percent share of $65 billion US restaurant business and 46 percent of its $2.6

billion burger business. It serves more than 22 million customers per day and with sales of nearly $15 billion

it dwarfs its competitors. After nearly three decades of double digit gains, however, domestic sales at Mc

Donalds have been growing slowly since 1986 as a result of higher prices, changing tastes, slow growth of

the domestic economy, demographic changes, and increased competition from other fast food chains and

other forms of delivering fast foods.

Price increase at Mc Donalds exceeded inflation in each year since 1986 and in 0 of the last 17 years. The

average check at McDonalds is now $4 a far cry from the 15cent hamburger on which Mc Donalds got rich

and sent customers streaming to lower pricing customers. Concern over cholestrol and calories, as well as

slowing down of growth of the economy and in personal incomes have also reduced growth. In addition the

proportion of 15 to 29 year olds (the primary fast food consumers) in the total population has shrunk from

27.5 to 22.5 percent during the past decade. Increased competition from other fast food chains, and other

fast food options (pizza, chicken tacos and so on) frozen fast foods, mobile units and the vending machines

have also slowed the growth of Big Macs.

Mc Donalds did not sit idle and tried to meet its challenges head on by introducing a “value menu” in 1990

with small hamburgers selling for as little as 59 cents(down from 89 cents) and a combination of burger,

French fries, and soft drinks for as much half as off. IN response to the increased public concern about

cholestrol and calories, Mc Donalds began publicizing the nutritional content of its menu offerings,

substituted vegetable oils for beef tallow in frying French fries, replaced ice cream with low fat yoghurt,

introduced bran muffins and cereals in breakfast menu, and even (unsuccessfully) introduced Mac Lean

Deluxe – a new reduced fat, quarter pound hamburger on which Mc Donalds spent from $50 to $70 to

develop and promote. Furthermore, in response to increased competition from frozen foods, mobile units,

and vending machines, an increasing number of Mc Donalds franchises have drive – throughs from which

they now generate almost half their business. Mc Donalds is also expanding very rapidly abroad. When it

faces much less competition and where there is much more room for growth.

Questions

1. How are sales of burgers related to determinants of demand?

2. What is “value Menu” ?

3. Do you think a decrease in price by 30 cents was a step in right direction?

CASE STUDY

Michael Wolfson, a computer programmer had a decent job with the financial powerhouse Bear, Steams &

Co. Now, he refurbishes computers at the basement in his house and sells it through e-bay. He plans to join

as a school teacher. Michael lost his job in 2003. He was told that his job is being outsourced to India. Paul

Schwartz, a mainframe programmer, who was earning $ 80,000 a year was told that his services were no

longer required. He suspects that his job has been outsourced to India.

There is growing dissent among the Americans against the increasing practice of outsourcing. It has become

an electoral issue in the coming presidential elections in the US. The Democratic candidate, John Kerry has

made it an emotive issue, despite economists trying to portray the positive aspects of outsourcing. There are

numerous reasons for the growing apathy towards outsourcing. The prevailing economic situation and the

increasing joblessness in the US have added fuel to the fire. However, many analysts feel that joblessness in

the US is cyclical in nature resulting from the recession of 2001 and hence, a recovery will create job

opportunities.

Moreover, according to the U.S.-India Business Council, the increasing unemployment is also due to

corporate restructuring and just a quarter of the job loss is due to outsourcing. Since, the beginning of 2001,

the real job loss in US is estimated to be 2.3 million. In comparison, the actual job loss due to outsourcing is

estimated to be only 200,000. Thus, it can be said that there are various other reasons for joblessness in the

US. The outcry against outsourcing seems to be driven more by politics rather than economics.

Outsourcing forms a small proportion of the jobs that are regularly churned in the US economy. On an

average, 24 million jobs are churned in the US every month. In the process, resources are allocated, for more

productive purposes. To come out of the recession and raise the standards of living, higher productivity

seems to be the only solution. The debate on outsourcing gathered momentum only in the recent past. A

study by Forrester, a research group, in the year 2002, brought the issue into limelight. The report claims

that by 2015, 3.3 million white-collar jobs in the US would be transferred to countries like India.

The Economics of Outsourcing

But is outsourcing so bad for the US economy? Gregory Mankiw, professor of economics at the Harvard

University and head of President Bush's Council of Economic Advisers, recently told presspersons that

outsourcing of jobs is in better interest of US. According to him, outsourcing lowers the cost for consumers,

making the corporations more efficient. There were a series of articles in The Economist, highlighting the

advantages of outsourcing.

There are many influential groups in the US who are perturbed by the recent outcry against outsourcing.

Says Charles E Morrison, President, East West Center, a US based think tank, "Off-shoring is not an economic

problem, but an economic opportunity". Many analysts in the US feel that anti off-shoring bills in the US

would prove to be ineffective. Similar views were echoed by Michael T Clark of US-India business council. He

says that, "Jobs lost to off-shoring were less than a quarter of all jobs lost in the US in 2002. The rest were

lost due to corporate restructuring. The current debate in the US on off-shoring is informed by lack of facts".

In an article, "Why Your Job Isn't Moving to Bangalore" in the New York Times, Jagdish Bhagwati, a senior

fellow at the Council on Foreign Relations and professor at Columbia University writes that the panic and

furor over outsourcing is completely unwarranted. He further says that no jobs are being taken away from

America. He says that the affect of changes in technology is being felt in the labor intensive industries.

According to him, the loss of jobs in the US is due to technological changes.

Professor Bhagwati is also critical about politicizing the whole issue. He says that outsourcing will strengthen

the competitiveness of the US companies. Firms ignoring the cheaper supplies would lose out. Professor

Bhagwati further says that outsourcing service jobs is nothing different from importing of labor-intensive

textiles and other goods. According to him, all empirical studies in the US over the last two decades suggest

that wage stagnation in the manufacturing industry is more due to automation of the processes, not the

cheaper imports. The same is applicable to service industry as well. Jane Linder of Accenture's Institute for

Strategic Change says that companies outsourcing the traditional back-office work have more control and

discipline over their operations. Moreover, employees of the company can concentrate on framing strategies.

Further, outsourcing also results in greater efficiency and lowering costs. This allows companies to offer

better services to customers. A study done by McKinsey Global Institute reveals that for every dollar of work

outsourced by the US, it gets back $1.14 as income, and the countries to which the work is being outsourced

gains 35 cents. This shows that outsourcing is a win-win situation for both the countries.

Benefits for US Benefits for India

Savings to US investors or customers 0.58 Labor 0.1

Imports of US goods and services by providers in India 0.05 Profits retained in India 0.1

Transfer of profits by US based providers in India back to US

0.04 Suppliers 0.09

       

Net direct benefit retained in US 0.67 Central government taxes 0.03

       

Value for US labor reemployed 0.45-0.47State government taxes 0.01

       

Potential net benefit for US 1.12-1.14 Net benefit to India 0.33

Source: Mckinsey Global Institute

There is a definite cost advantage in off-shoring work to India. These advantages are a result of lower wages

in the developing countries along with the development of telecommunications in these countries. A report

published by HSBC, which has off-shored more than 4,000 jobs to India, says that the telephone costs from

India to America and Britain has decreased by almost 80%, since January 2001. The wage difference

between these countries is also a factor that forces the companies to outsource their business processes to

India. A study done by NASSCOM, says that the average salary of an IT professional in UK is $96,000, in US it

is $75,000, whereas in India it is just $26,000. The wage difference between the low end call center jobs of

both the countries is also very wide. An average call center employee in UK earns $20,000 on the average.

Whereas, a call center professional in India barely manages to earn one tenth of the earnings of their British

counterparts.

Offshoring allows companies to work round the clock. It gives ample time to the companies to think about

their IT problems. Recently, American Express paid $5,000 to a group of software programmers in India, to

develop a package for them. The same would have cost them several million dollars in US.

The benefits of outsourcing go much beyond the cost advantage. An article in Mckinsey quarterly suggests

that the companies need to look beyond cost savings. The article says that "Companies are merely

replicating what they do at home, where labor is expensive and capital is relatively cheap, in countries in

which the reverse is true."

Alan Greenspan, US Federal Reserve Chairman, is a staunch supporter of outsourcing. He is of the opinion

that any move to curb outsourcing of work to countries like India and China, might give just a temporary

relief. Reacting to the proposed legislations in the US banning outsourcing, Greenspan said, "A new round of

protectionist steps is being proposed against outsourcing. These alleged cures will make matters worse".

Greenspan feels that any effort to protect US jobs through legislation would backfire.

Not all companies have taken full advantage of outsourcing. According to Harris Miller, president of the

Information Technology Association of America (ITAA), a lobby group, so far only 3-4 % of all American

companies outsource their processes. The remaining still rests with American firms. A report published by

Forrester, in December 2003, says that 60% of the Fortune 1000 companies have a negligible or near nil

presence in off-shoring. Report also suggests that 40% of the work of these companies could be outsourced.

Thus, the potential for growth in outsourcing is still immense.

Advancement in the technology can give a further push to the off-shoring activity. The inflexible architecture

of the current technologies is acting as a hindrance in off-shoring, says Simon Heap of Bain & Co, a

consultancy firm. The advancement in software and hardware would enable the companies to off-shore even

small activities. Firms would be able to off-shore the activities of the entire department, say billing of

customers.

However, not everyone seems to agree with the supporters of outsourcing. Stephen Roach, the chief

economist at Morgan Stanley, says that it is only the wage difference that is encouraging companies to

outsource work to India or any other developing country. He further says that joblessness is taking away the

charm of recovery in the US.

Many analysts also feel that companies should take some concrete steps to minimize the affects of

outsourcing. Companies should make the process of job transfers to offshore destinations more smooth.

British Telecom exhibited a process of outsourcing that can be used as a model by other companies.

In 2003, when BT announced that it is planning to open two call centers in India, with a capacity of 2200

people, it was criticized from all corners. It was said that BT was not acting in a socially responsible manner.

Realizing the gravity of the situation, BT approached Sustainability, an international consultancy, specializing

in business strategy and sustainable development. The consultancy firm was asked to find whether or not

outsourcing and corporate social responsibility (CSR) co-exist.

Sustainability noted that the immediate impact of outsourcing would be job loss for the employees, and the

resulting affect on the society. The consultancy firm was of the opinion that before outsourcing, companies

should address the negative impact of outsourcing. In order to check the negative impact of off-shoring,

firms should consult with employees, trade unions, communities and other key stakeholders. Employees

should be involved in the process of any such decision making. Sustainability also suggested that firms

should be transparent and make the employees know the services that are being outsourced.

Firms should also make an attempt to redeploy the employees in some other departments. This would

minimize layoffs. An attempt should be made to retrain the redundant workers. A part of the savings from

off-shoring should be invested for this purpose. As per the suggestion made by McKinsey Global Institute, 4-

5% of the resulting savings from off-shoring should be used for insurance policy for employees to cover the

lost wages.

US was one of the prime supporters of free trade. US was least bothered about the concerns of many other

developing countries when they raised their voices against job losses as a result of the cheap exports. But,

this aggressiveness seems to have mellowed down in recent days. It always propagated that inefficient

industries should be closed. One of the primary tasks of the U.S. Trade Representative's office was to keep a

check on the world markets. It assesses the markets which are opening up and which are getting closed as a

result of high tariffs and other quantitative restrictions. Now, with the growing efficiency of developing

countries in the service sectors, many jobs in these sectors are being transferred to developing countries (of

which a major chunk is coming to India). US is worried about the increasing joblessness but that seems

paradoxical. It hails globalization but when it comes to the developing countries trying to reap the benefits of

globalization, it raises all sorts of issues.

Recently the US government has tightened the visa norms. The number of H-1B visas issued to Indian

software programmers fell to 65,000 from 1,95,000 in 2003. Analysts feel that this would increase

outsourcing of jobs further, particularly to India. According to Craig Barrett, the chief executive of Intel,

granting of fewer visas would force the companies to shift their jobs to countries like India, where there is no

dearth of qualified engineers.

Despite no ban from the federal authorities on outsourcing, many States have initiated the process of putting

restrictions on outsourcing government work to foreign countries. The lawmakers in the state of New Jersey

have proposed a bill that stops firms to outsource any government related work to a foreign country.

Succumbing to the public pressure, the government was forced to bring back a helpline for welfare recipients

that was being outsourced to India. Similarly, the state of Indiana withdrew a $ 15 million contract from an

American subsidiary of an Indian IT firm. Commenting on the move, the Indiana governor said that contract

was not in tune with Indiana's vision of providing better and more job opportunities to local companies and

workers. However, analysts feel that these decisions have been influenced by political pressure in the

backdrop of coming presidential elections in the US.

The Indian Response

The Indian BPO industry is not taking the outcry against outsourcing in the US seriously. Indian BPO firms are

no longer just call centers. Their activities now cover marketing and knowledge based services. These

companies are now aspiring to become strategic partners for US companies. There is a sudden spurt in the

number of venture capitalists willing to invest in different areas. Though, some software companies can't

hide their concern over the legislations banning government related off-shoring in the long-run but, for now

they are clear that, these legislature will have negligible effect on the current contracts with the private

companies. Reacting to the whole issue, Narayana Murthy, Chairman and Chief Mentor of Infosys said that

there is no issue to worry about. He termed the outcry as normal. He suggested that rather than getting

worried and agitated, Indians should put forward their point of view and explain the advantages of off-

shoring. He said that the present uncertain economic situation is responsible for the concern over the job

losses in the US.

Many analysts feel that the opposition to outsourcing may not end with the US presidential elections. With

many of the American States, coming out with legislations banning government contracts to other countries,

the issue of off-shoring is going to be alive. Conditions for off-shoring may become favorable with the

improvement in the performance of the US economy.

Question for discussion:

Que. Give your opinion on outsourcing and its impact on the prospects of growth of the economy

of home Nation and host nation.

Guidelines for the answer: Discuss the issue in the perspective of opportunity and threats faced by

developing and developed nations.

Case Study

Electron Control, Inc., sells voltage regulators to other manufacturers, who then customize and distribute the

products to quality assurance labs for their sensitive test equipment. The yearly volume of output is 15,000

units. The selling price and cost per unit are shown below:

Selling price $200

Costs:

     Direct material $35

     Direct labor 50

     Variable overhead 25

     Variable selling expenses 25

     Fixed selling expenses 15 150

     Unit profit before tax $ 50

Management is evaluating the alternative of performing the necessary customizing to allow Electron Control

to sell its output directly to Q/A labs for $275 per unit. Although no added investment is required in

productive facilities, additional processing costs are estimated as:

     Direct labor $25 per unit

     Variable overhead $15 per unit

     Variable selling expenses $10 per unit

     Fixed selling expenses $100,000 per year

Question A. Calculate the incremental profit Electron Control would earn by customizing its instruments and

marketing directly to end users.

CASE STUDY - 1

 

In 1997, over $700 billion purchases were charged on credit cards, and this total is increasing at a rate of

over 10 per cent a year. At first glance, the credit card market would seem to be a rather concentrated

industry. Visa, MasterCard and American Express are the most familiar names, and over 60 per cent of all

charges are made using one of these three cards. But on closer examination, the industry seems to exhibit

most characteristics of perfect competition. Consider first the size and distribution of buyers and sellers.

Although Visa, Mastercard and American Express are the choices of the majority of consumers, these cards

do not originate from just three firms. In fact, there are over six thousand enterprises (primarily banks and

credit unions) in the US that offer charge cards to over 90 million credit card holders. One person's Visa card

may have been issued by his company's credit union in Los Angeles, while a next door neighbour may have

acquired hers from a Miami Bank when she was living in Florida.

Creditcards are a relatively homogenous product. Most Visa cards are similar in appearance, and they can all

be used for the same purposes. When the charge is made, the merchant is unlikely to notice who it was that

actually issued the card. Entry into and exit from the credit card market is easy as evidenced by the 6000

institutions that currently offer cards. Although a new firm might find it difficult to enter the market, a

financially sound bank, even one of modest size, could obtain the right to offer a MasterCard or a Visa card

from the present companies with little difficulty. If the bank wanted to leave the field, there would be a ready

market to sell its accounts to other credit card suppliers. Thus, it would seem that the credit card industry

meets most of the characteristics for a perfectly competitive market.

 

 

Questions:

1. What are the characteristics of perfect competition that are exhibited by the credit card industry?

 

2. Discuss the price and output condition of a perfect competition.

 

3. Do you think the same competitive state is applicable to the Indian scenario?

CASE STUDY - 2

The past fifteen years have seen numerous mergers of banks in every part of the US. Invariably, bank

managers point to significant cost reduction (increasing returns to scale) associated with consolidation of

computer systems, combining neighbouring branch outlets and reduction of corporate overhead expenses as

justification. Many of these mergers involved multibillion dollar banks, which appeared to be inconsistent

with existing empirical research on bank costs that showed significant diseconomies of scale for banks with

more than $25-50 million in deposits. Unfortunately, these studies used data only for banks with less than $1

billion in deposits. In a more recent study, Sherrill Shaffer and Edmond David used data for large banks

( those with $2.5 to $121 billion in deposits) and found increasing returns to scale (i.e., declining per unit

costs) up to a bank size of $15 to $37 billion. Clearly, the owners and managers of the merged banks knew

more about their actual cost functions than did the earlier economic analysts. The consistent pattern of

mergers of banks much larger than $24 to $50 million in deposits was strong evidence that the existing

research was incorrect.

 

 

Questions:

1. How can mergers in the banking industry result in economies of scale (cost reduction)?

 

2. Do you think the same factors can lead to economies of scale in the banking sector in India?

 

3. What are the other factors that can lead to economies of scale in the banking sector?

CASE STUDY – I

 

Estimation of the Demand for Oranges by Market Experiment

 

Researchers at the University of Florida conducted a market experiment in Grand Rapids, Michigan, to

determine the price elasticity and the cross-price elasticity of demand for three types of Valencia oranges:

those from the Indian River district of Florida, those from the interior district of Florida, and those from

California. Grand Rapids was chosen as the site for the market experiment because its size, demographic

characteristics, and economic base were representative of other midwestern markets for oranges.

 

Nine supermarkets participated in the experiment, which involved changing the price of the three types of

oranges, each day, for 31 consecutive days and recording the quantity sold of each variety. The price

changes ranged within ±16 cents in 4-cent increments, around the price of oranges that prevailed in the

market at the time of the study. More than 9,250 dozen oranges were sold in the nine supermarkets during

the 31 days of the experiment. Each of the participatin supermarkets was provided with an adequate supply

of each type of orange so that supply effects could be ignored. The length of the experiment was also

sufficiently short so as to ensure no change in tastes, incomes, population, the rate of inflation, and

determinants of demand other than price.

 

The results, summarized in the following table indicate that the price elasticity of demand for all three types

of oranges was fairly high (the boldface numbers in the main diagonal of the table). For example, the price

elasticity of demand for the Indian River oranges of -3.07 indicates that a 1 percent increase in their price

leads to a 3.07 percent decline in their quantity demanded. More interestingly, the off-diagonal entries in the

table, show that while the crossprice elasticities of demand between the two types of Florida oranges were

larger than 1, they were close to zero with respect to the California oranges. In other words, while consumers

regarded the two types of Florida oranges as close substitutes, they did not view the California oranges as

such. In pricing their oranges, therefore, producers of each of the two Florida varieties would have to

carefully consider the price of the other (as consumers switch readily among them as a result of price

changes) but need not be much concerned about the price of California oranges.

 

Price Elasticity and Cross-Price Elasticity of Demand for Florida Indian River, Florida

Interior, and California Oranges

  Price Elasticities and Cross-Price Elasticities

Type of OrangeFlorida Indian

Florida Interior CaliforniaRiver

Florida Indian River -3.07 +1.56 +0.01

Florida Interior +1.16 -3.01 +0.14

California +0.18 +0.09 -2.76

 

Questions

(a) In light of the case define a test market? When should a firm take help of market experiments to forecast

demand?

 

(b) Suggest a suitable price policy for the three types of oranges.

 

 

CASE STUDY – II

 

A deodorant company manufactures and sells several types of deodorants which are branded as ‘Smell

Fresh’. The company introduced five years ago, a new type of deodorant and its sales increased rapidly.

However, over the past two years, sales have been declining steadily even though the market for deodorants

has been expanding. Worried by the declining sales the company conducted a survey of the market, which

yielded the following information:

 

(i) Several new rivals have come up during the past five years, which manufacture and sell almost similar

deodorants.

 

(ii) Other companies have set prices lower than the prices of this company.

 

(iii) This company had initially set the price of its new brand at Rs 40, for which retailer pays Rs 30, which

was never changed.

 

(iv) The rival firms have set their prices at Rs 37.50, retailers paying Rs 25.

 

In view of these facts, the company decided to review the cost structure to find out whether the margin to

the retailers could be reduced to the level of the rival firms. The company finds that the variable costs

(including raw materials and labour) stands at Rs 15 per deodorant. At present the company sells 4, 00,000

deodorants. As to the market prospects, if the price is reduced to Rs 35, the demand would increase by

1,50,000 and if the price is reduced to Rs. 32.50, demand would increase to 6,50,000 units. With such an

increase in production, the firm could use its resources more fully. The bulk of purchase of raw materials and

more efficient use of labour would both help to reduce the unit variable cost to Rs. 12.50.

 

Questions

(i) What price should the company charge to recapture market lost to rival firms?

 

(ii) Suggest alternative strategies that the company can adopt to counteract competition.

stimation of the Demand for Oranges by Market Experiment

 

Researchers at the University of Florida conducted a market experiment in Grand Rapids, Michigan, to

determine the price elasticity and the cross-price elasticity of demand for three types of Valencia oranges:

those from the Indian River district of Florida, those from the interior district of Florida, and those from

California. Grand Rapids was chosen as the site for the market experiment because its size, demographic

characteristics, and economic base were representative of other midwestern markets for oranges.

 

Nine supermarkets participated in the experiment, which involved changing the price of the three types of

oranges, each day, for 31 consecutive days and recording the quantity sold of each variety. The price

changes ranged within ±16 cents in 4-cent increments, around the price of oranges that prevailed in the

market at the time of the study. More than 9,250 dozen oranges were sold in the nine supermarkets during

the 31 days of the experiment. Each of the participatin supermarkets was provided with an adequate supply

of each type of orange so that supply effects could be ignored. The length of the experiment was also

sufficiently short so as to ensure no change in tastes, incomes, population, the rate of inflation, and

determinants of demand other than price.

 

The results, summarized in the following table indicate that the price elasticity of demand for all three types

of oranges was fairly high (the boldface numbers in the main diagonal of the table). For example, the price

elasticity of demand for the Indian River oranges of -3.07 indicates that a 1 percent increase in their price

leads to a 3.07 percent decline in their quantity demanded. More interestingly, the off-diagonal entries in the

table, show that while the crossprice elasticities of demand between the two types of Florida oranges were

larger than 1, they were close to zero with respect to the California oranges. In other words, while consumers

regarded the two types of Florida oranges as close substitutes, they did not view the California oranges as

such. In pricing their oranges, therefore, producers of each of the two Florida varieties would have to

carefully consider the price of the other (as consumers switch readily among them as a result of price

changes) but need not be much concerned about the price of California oranges.

 

Price Elasticity and Cross-Price Elasticity of Demand for Florida Indian River, Florida

Interior, and California Oranges

  Price Elasticities and Cross-Price Elasticities

Type of OrangeFlorida Indian

Florida Interior CaliforniaRiver

Florida Indian River -3.07 +1.56 +0.01

Florida Interior +1.16 -3.01 +0.14

California +0.18 +0.09 -2.76

 

Questions

(a) In light of the case define a test market? When should a firm take help of market experiments to forecast

demand?

 

(b) Suggest a suitable price policy for the three types of oranges.

 

 

CASE STUDY – II

 

A deodorant company manufactures and sells several types of deodorants which are branded as ‘Smell

Fresh’. The company introduced five years ago, a new type of deodorant and its sales increased rapidly.

However, over the past two years, sales have been declining steadily even though the market for deodorants

has been expanding. Worried by the declining sales the company conducted a survey of the market, which

yielded the following information:

 

(i) Several new rivals have come up during the past five years, which manufacture and sell almost similar

deodorants.

 

(ii) Other companies have set prices lower than the prices of this company.

 

(iii) This company had initially set the price of its new brand at Rs 40, for which retailer pays Rs 30, which

was never changed.

 

(iv) The rival firms have set their prices at Rs 37.50, retailers paying Rs 25.

 

In view of these facts, the company decided to review the cost structure to find out whether the margin to

the retailers could be reduced to the level of the rival firms. The company finds that the variable costs

(including raw materials and labour) stands at Rs 15 per deodorant. At present the company sells 4, 00,000

deodorants. As to the market prospects, if the price is reduced to Rs 35, the demand would increase by

1,50,000 and if the price is reduced to Rs. 32.50, demand would increase to 6,50,000 units. With such an

increase in production, the firm could use its resources more fully. The bulk of purchase of raw materials and

more efficient use of labour would both help to reduce the unit variable cost to Rs. 12.50.

 

Questions

(i) What price should the company charge to recapture market lost to rival firms?

 

(ii) Suggest alternative strategies that the company can adopt to counteract competition.