Search for notes by fellow students, in your own course and all over the country.
Browse our notes for titles which look like what you need, you can preview any of the notes via a sample of the contents. After you're happy these are the notes you're after simply pop them into your shopping cart.
Title: Business Economics
Description: These are the best notes for India's Top University
Description: These are the best notes for India's Top University
Document Preview
Extracts from the notes are below, to see the PDF you'll receive please use the links above
Section I : E-Module Outline plan
Maharaja Surajmal Institute
(Affiliated to GGSIPU, Delhi)
Course: Bachelor of Business Administration
Subject Module
On
Business Economics (BBA/BBA (B&I) ) 17107 & 18107
Semester I
(Credit: 4)
Module Contributor(s): Dr
...
Suhasini Parashar
July, 2021
1
SYLLABUS
Syllabus of Business Economics, Paper Code 17107& 18107
Unit-I
Introduction to Business Economics and Fundamental concepts, Definitions of Business Economics, Nature,
of Business Economics, Scope, of Business Economics, Difference between Business Economics and
Economics, Contribution and Application of Business Economics to Business, Micro vs
...
Opportunity Costs, , Time Value of Money, Marginalism,&
Incrementalism, Market Forces and
Equilibrium, Risk, Return and Profits
...
Shift in Demand Curve, Concept of Measurement of Elasticity of Demand, Factors Affecting
Elasticity of Demand, Income Elasticity of Demand, Cross Elasticity of Demand, Advertising Elasticity of
Demand, Demand Forecasting: Need Objectives of Demand Forecasting, Methods of Demand Forecasting
...
Modern Theory of Cost, Pricing Under Perfect Competition, Pricing Under Monopoly:
Equilibrium in Short & Long Run, Control of Monopoly, Price Discrimination, Pricing Under Monopolistic
Competition: Pricing Under Oligopoly: Kournot’s Duopoly model, Bertrand Duopoly Model, Edgeworth
Model, Collusive & Non- Collusive model, Kink Demand Curve, Price leadership: Low Cost, Dominant
Firm & Barometric Price Leadership
2
TABLE OF CONTENT
Contents
Unit-1- Introduction to Business Economics & Fundamental Concept
Page-Number
5-23
Introduction
Chapter1
...
Difference between Business Economics and Economics/Micro VS Macro 9-10
Economics Positivistic /Normative Approach
Chapter 3
...
Opportunity Cost, Time Value of Money,
13-14
Chapter 5
...
Market Forces and Equilibrium
18-18
Chapter 7
...
Cardinal Utility Approach- Diminishing MU
24-29
Chapter 2
...
Ordinal Utility Approach-Indifference Curve, MRS, Budget Line and 32-37
Consumer Equilibrium
Chapter 4
...
Elasticity and Measurement of Elasticity of Demand, Nature of Goods and
Elasticity of Demand
44-55
Chapter6
...
56-60
Unit 3
...
Factor of Production and production Function
61-75
Chapter 2
...
76-82
Chapter 3
...
83-85
-Isoquants and producer equlibrium
Chapter 4
...
86-91
Unit 4
...
Types of Costs-Short and Long Term
...
Pricing under Perfect Competition
101-109
Chapter 3
...
Pricing under Monopolistic Competition
...
Pricing under Oligopoly Competition
125-130
MCQ (Multiple Choice Question)
131-151
Glossory and Key Words
References and Further Readings
1
...
D (19th ed
...
2
...
N
...
Thomas,CR(10th edition ,2014) Managerial Economics, Mcgraw Hill Education
4
...
(2nd edition 2010),Micro Economics for Managers, Viva Books Pvt
...
5
...
G
...
Petersons
...
Chaturvedi,D
...
(Latest Edition), Business Economics,
4
UNIT-I CHAPTER -1
NATURE AND SCOPE OF BUSINESS ECONOMICS
Nature of Economics
WHAT IS ECONOMICS?
(i) Economics is a social science that studies man’s activities concerning with the maximum
Satisfaction of wants or with the promotion of welfare and economic growth by the efficient
consumption, production and exchange of scarce means having alternative uses
...
LIMITATIONS:
(I)
Study of human activities only
(II)
Study of economic activities
(III)
Study of social man
(IV) Study of average or normal man
(IV)
Measuring rod of money
SIGNIFICANCE:
THEORETICAL IMPORTANCE
PRACTICAL IMPORTANCE
1
It inculcates the logical faculty
Advantage to consumer
2
Increase in knowledge
Advantage to the producer
3
Development of reasoning power
Advantage to the laborers
4
Advantage to the society
BUSINESS ECONOMICS: MEANING
(i) Business or managerial economics is that part of economic theory which deals with the application
of economic tools and concepts to the solution of business problem or the problem of resource
allocation among the competing ends
...
(iii)Business economics is concerned with decision making of economic nature
...
It deals with how decisions should be made
by the managers to achieve the organisational goals
...
5
(vi) It is pragmatic
...
(vii) Business economics is both science and art
...
As it studies factual situations so it is a real science, and at the
same time, as it determines ideals for the future success and therefore, it is a normative science too
...
NATURE OF BUSINESS ECONOMICS
ECONOMIC THEORY –
(i) Macro Economics: The business economics operates mainly in a free resource market
...
(ii) The modern economies are characterized by rapid technological and economic changes
...
(iv) Micro Economic analysis: The micro economic analysis deals with the problem of individual
firm,
industry, consumer etc
...
Some of the concepts are elasticity
of demand, marginal cost, dis-economies of scale, opportunity cost etc
...
Positive economics both micro and
macro is of two types: (a) Descriptive, (b) Theoretical
...
The normative economics is concerned with problems like what the
objectives and policies of business ought to be and how about them
...
To the extent a firm deviates from the
assumption of profit maximization and to the extent its decisions are taken under conditions of
various degree of uncertainty about market environment and technical conditions of production
...
are all necessary for the purpose of
forecasting by the firm
...
is needed for
decision- making
...
(IV) The managers cannot ignore the environment within they operate
(a)They must understand and adjust to the external factors, like government intervention in business,
business cycle fluctuations, etc
...
SCOPE OF BUINESS ECONOMICS:
The scope of business economics is very wide as it involves the application of economic concepts
...
Demand theory explains the
consumer’s behaviour
...
(ii) THEORY OF PRODUCTION AND PRODUCTION DECISIONS- Production theory also
called “theory of firm” explains the relationship between input and outputs
...
It thus helps in
determining the size of the firm , size of the total output and the amount of capital and labour to be
employed
...
Thus it will be helpful in determining the price policy of the firm
...
For instance
the determination of costs the methods or estimating costs the relationship between cost and output ,
the forecast of cost and profit – these are vital to the firm
...
But making a satisfactory profit is not always guaranteed
7
because a firm has out its activities under condition regard to uncertainty (i) demand of the product
(ii) input prices in the factor market (iii) nature and degree of competition the product market (iv)
price behaviour under changing conditions in the product market etc
...
(vi)THEORY OF CAPITAL AND INVESTMENT DECISIONS-Capital like all the others inputs,
is a scarce and expensive factor
...
Its efficient utilisation is the
most important tasks of managers
...
(vii)INVENTORY MANAGEMENT – It refers to the stock of raw materials or finished goods
which a firm keeps
...
On the other hand, if the level of
inventory is low production will be hampered
...
Thus, business economics tries to find out whatever is likely to be the best for the firm under a given
set of conditions
...
It is a branch of economics applied to analyse almost all business decisions
...
(A)What is 'Business Economics'?
(I)Business Economics is a field of applied Economics that studies the financial, organizational,
market-related and environmental issues faced by corporations
...
(II)Business economics is the discipline which deals with the application of economic theory to
business management
(III)Business Economics analyses subjects such as business organization, management, expansion and
strategy
...
)
(B)What is Economics?
(I) Economics is a social science concerned with production and distribution and consumption of
goods and services
...
(II) The social science Economics concerns the use of scarce resources to maximize satisfaction of
unlimited wants
...
But Micro-Economics as a branch of Economics deals with
both Economics of the individual as well as Economics of the firm
...
Thus, the scope of Economics is wider than of Business
Economics
...
Thus, Economics gives the simplified
model, whereas Business Economics modifies and enlarges it
...
Legal constraints, constraints on resource availability, etc
...
Nature
of Economics deals with both micro and It basically deals with application of normative
Economic
macro-economic principles-normative as micro-economic principles and involves value
Principles
well as positive
judgments
...
Scope
of Micro economics as a multi-facet branch of Though business economics is micro in
Study
economics
...
Thus, Economics has a wider scope of
study
Focus
of Under micro economics as a branch of The main focus of study pf business economics
Study
Economics, distribution theories like rent, is profit theory
...
theory of profit
...
Methodology
Economic theory avoids many complexities Business economics is pragmatic in the sense
and makes simplified assumptions to solve that it introduces some realistic aspects such as
complicated theoretical issues
...
And attempts to
solve
some
real-life
complex
business
problems
...
These business problems can be related to
demand and supply prospects of an organisation, level of production, pricing, market structure, and
degree of competition
...
Demand analysis is a process of identifying potential consumers, the amount of goods they want to
purchase, and the price they are willing to pay for it
...
In business economics, demand
forecasting occupies an important place by helping organisations in business planning and deciding
on strategic issues
...
Cost analysis helps firms in determining hidden and uncontrollable costs and taking measures for
effective cost control
...
In a nutshell, CBA is a process of comparing the costs and benefits of a particular project or activity
...
(iii)Analysis of market-structure and pricing theory:
Pricing is one of the key areas of business economics
...
The profit of an
organisation depends a great deal on its pricing strategies and policies
...
(iv)Profit analysis and profit management:
Profit making and maximisation is the main aim of every organisation (except for non-profit
organisations)
...
(v)Capital and investment decisions:
Organisations often find it difficult to make decisions related to capital investment
...
To make sound capital
investment decisions, an organisation needs to determine various aspects, such as cost of capital and
rate of return
...
It also explains under what conditions cost increase or decrease, how total output increases when units
of one factor (input) are increased keeping other factors constant or when all factors are
simultaneously increased , how canoutput be maximised from a given quantity of resources and how
can optimum size of output be determined? Production theory thus helps in determining the size of the
firm, size of the total output and the amount of capital and labour to be employed
...
If it is high,
capital is unproductively tied up, which might, if the stock of the inventory is reduced, be useful for
other productive purposes
...
Thus, business economics will use such methods which are helpful in minimising the inventory cost
...
Decision making
is a process of selecting the best course of action from the available alternatives
...
These concepts support managers in identifying and
analysing problems and finding solutions
...
(iii)
Economics helps managers in framing various policies, such as pricing policies and cost
policies, on the basis of economic study and findings
...
(iv)
Business economics helps in establishing relationships between different economic factors,
such as income, profits, losses, and market structure
...
CHAPTER-4
CONCEPTS OF BUSINESS ECONOMICS
Opportunity costs (Alternative Cost, Transfer cost)
(i) Opportunity costs represent the benefits, an individual investor or business not availed, when
choosing one alternative over another
...
(ii)The term “opportunity cost” concept used in subject, finance and economics when trying to choose
one investment, either financial or capital, over another
...
For example, there is an opportunity cost of choosing to finance a
company with debt over issuing stock
...
Instead,
the person making the decision can only roughly estimate the outcomes of various alternatives, which
mean imperfect knowledge, can lead to an opportunity cost that will only become obvious in
retrospect
...
(iv) The concept of opportunity cost does not always work, since it can be too difficult to make a
quantitative comparison of two alternatives
...
(v) Opportunity cost is not an accounting concept, and so does not appear in the financial records of
13
an entity
...
(vi) Investment in business or deposits the money in banks, opening the school or coaching centre
good example of opportunity cost , next best alternative use of resources
...
(viii) Opportunity avail to gain from alternatives available and maximizing the satisfaction
...
A
A=P(1+r)n
NPV(P) =
-------(1+r)n
r : Discount rate
n: Number of periods
When presented with mutually exclusive options, the decision-making rule is to choose the project
with the highest NPV
...
Thus ,the decision rule then changes from
choosing the project with the highest NPV into undertaking the project if NPV is greater than
zero
...
Borrowing at the rate of 5% and invested ,return more than 5%,in any alternative deal ,
opportunity availed for higher return
...
A land surveyor determines that the
land can be sold at a price of $40 billion
...
The accounting profit would be to invest the $30 billion to receive $80 billion, hence leading to
an accounting profit of $50 billion
...
Time Value of Money (TVM) (Present Discounted Value)
(i)The time value of money (TVM) is the concept that money available at the present time is worth
more than the identical sum in the future due to its potential earning capacity
...
14
(ii)The time value of money draws from the idea that rational investors prefer to receive money today
rather than the same amount of money in the future because of money’s potential to grow in value
over a given period of time
...
(ii)Further illustrating the rational investor’s preference; assume we have the option to choose
between receiving $10,000 now versus $10,000 in two years
...
Despite the equal value at time of disbursement, receiving the $10,000
today has more value and utility to the beneficiary than receiving it in the future due to the
opportunity costs associated with the wait
...
Basic TVM Formula
In general, the most fundamental TVM formula takes into account the following variables:
FV = PV x [ 1 + (i / n) ] (n x t)
FV = Future value of money
PV = Present value of money
i = interest rate
n = number of compounding periods per year
t = number of years
CHAPTER 5MARGINALISM
(i)Marginalism generally includes the study of marginal theories and relationships within economics
...
and how these measures relate to consumer choice and demand
...
These areas can all be thought of as popular schools of thought surrounding financial
and economic incentives
...
(iv)Marginalism is sometimes criticized as one of the “fuzzier” areas of economics, as much of what
15
is proposed is hard to accurately measure, such as an individual consumers’ marginal utility
...
Still, the core ideas of marginalism are generally accepted by most economic schools of
thought and are still used by businesses and consumers to make choices and substitute goods
...
It may help to mentally substitute extra or additional whenever the word
marginally is used
...
(vi)Modern marginalism approaches now include the effects of psychology or those areas that now
encompass behavioral economics
...
Concepts of Marginalism
MC-Marginal Cost, MU-Marginal Utility, MR-Marginal Revenue, MPP-Marginal Physical
Productivity, MRS-Marginal Rate of Substitution, MRTS-Marginal Rate of Technical Substitution
...
Logical incrementalism implies that the
steps in the process are sensible
...
In public policy, incrementalism
is the method of change by which many small policy changes are enacted over time in order to create
a larger broad based policy change
...
These actions
normally don’t require extensive planning and problems can be dealt with one at a time as they arise
...
For example, one might plan a route for a driving trip
on a map, but one would not typically plan in advance where to change lanes or how long to stop at
each streetlight
...
Lindblom developed Incrementalism in the mid 1950s
...
The goal
16
for the new perspective of Incrementalism was for policy makers to avoid making changes before
they really engaged and rationally thought through the issue
...
(i) Politically expedient
Since it does not involve any radical and complete changes, it is easily accepted and therefore the
process is expedient
...
Compared to some of the other budgeting methods used in business, it
is one of the easiest to put in practice one does not have to be an accountant or have much experience
in business to use this form of budgeting
...
Many managers are intimidated by large budget increases from one period to the next
...
(iv) Flexibility
It is very flexible
...
(v) Avoiding conflict
Companies with many different departments often run into conflict between departments because of
their different budgets
...
Chaptet -6MARKET FORCES AND EQUILIBRIUM
Economic Equilibrium (Market equilibrium)
(I)Economic equilibrium is a condition or state in which economic forces are balanced
...
17
(II)Economic equilibrium is the combination of economic variables (usually price and quantity)
toward which normal economic processes, such as supply and demand, drive the economy
...
The point of equilibrium represents a theoretical state of rest where
all economic transactions that should occur, given the initial state of all relevant economic variables,
have taken place
...
(IV)The incentives faced by buyers and sellers in a market, communicated through current prices and
quantities drive them to offer higher or lower prices and quantities that move the economy toward
equilibrium
...
Economic Equilibrium in the Real World
Market Equlibrium:
Y
DD
SS
D/S
Q
X
Along X-axis , take quantity, along Y-axis ,Demand and Supply, Market mechanism explains
equilibrium with demand and supply forces
...
The state of all relevant economic variables changes constantly
...
Entrepreneurs compete
throughout the economy, using their judgement to make educated guesses as to the best combinations
of goods, prices, and quantities to buy and sell
...
The business and financial media, price circulars and advertising,
18
consumer and market researchers, and the advancement of information technology all make
information about the relevant economic conditions of supply and demand more available to
entrepreneurs over time
...
CHAPTER-7RISK, RETURN AND PROFITS
RISK
(I)Risk takes on many forms but is broadly categorized as the chance an outcome or investment’s
actual return will differ from the expected outcome or return
...
Different versions of risk are usually measured by calculating
the standard deviation of the historical returns or average returns of a specific investment
...
Many companies allocate large amounts of money
and time in developing risk management strategies to help manage risks associated with their business
and investment dealings
...
(II) A fundamental idea in finance is the relationship between risk and return
...
Investors need to be compensated
for taking on additional risk
...
S
...
A
corporation is much more likely to go bankrupt than the U
...
government
...
(III)There are several ways to measure risk, such as downside deviations, Roy’s safety first ratio, and
portfolio standard deviation
...
(IV)Risk takes on many forms but is broadly categorized as the chance an outcome or investment’s
actual return will differ from the expected outcome or return Risk includes the possibility of losing
some or all of the original investment
...
Risk can be reduced using hedging strategies to insure
19
against some losses
...
All investment assets
can be separated by two categories: systematic risk and unsystematic risk
...
(i) Systematic risk
It is the risk of losing investments due to factors, such as political risk and macroeconomic risk that
affect the performance of the overall market
...
Beta is a measure of an investment’s systematic risk relative to the overall
market
...
However, an investor can hedge against
systematic risk
...
For example,
suppose an investor fears a global recession affecting the economy over the next six months due to
weakness in gross domestic product growth
...
(iii) Specific risk, or diversifiable risk
(i)It is the risk of losing an investment due to company or industry-specific hazard
...
An investor uses
diversification to manage risk by investing in a variety of assets
...
For example, suppose an investor has a portfolio of oil stocks with a
beta of 2
...
Therefore, if the market has a 1% move up or down, the portfolio will move up or down
2%
...
If the trend continues, the
portfolio will experience a significant drop in value
...
(ii)The investor can use diversification and allocate his fund into different sectors that are negatively
correlated with the oil sector to mitigate the risk
...
Generally, as the
20
value of the oil sector falls, the values of the airlines and casino gaming sectors rise, and vice versa
...
(iv) Business risk
It refers to the basic viability of a business—the question of whether a company will be able to make
sufficient sales and generate sufficient revenues to cover its operational expenses and turn a profit
...
These expenses include
salaries, production costs, facility rent, and office and administrative expenses
...
(v) Credit or Default Risk
Credit risk is the risk that a borrower will be unable to pay the contractual interest or principal on its
debt obligations
...
Government bonds, especially those issued by the federal government, have the least
amount of default risk and, as such, the lowest returns
...
Bonds with a lower chance of
default are considered investment grade, while bonds with higher chances are considered junk bonds
...
(vi) Country Risk
Country risk refers to the risk that a country won’t be able to honor its financial commitments
...
Country risk applies to stocks, bonds,
mutual funds, options and futures that are issued within a particular country
...
(vii) Foreign-Exchange Risk
When investing in foreign countries, it’s important to consider the fact that currency exchange rates
can change the price of the asset as well
...
As an example, if you
live in the U
...
and invest in a Canadian stock in Canadian dollars, even if the share value appreciates,
21
you may lose money if the Canadian dollar depreciates in relation to the U
...
dollar
...
This type of risk affects the value of bonds more directly than stocks and is a
significant risk to all bondholders
...
Political Risk
Political risk is the risk an investment’s returns could suffer because of political instability or changes
in a country
...
Also known as geopolitical risk, the risk becomes more of a factor
as an investment’s time horizon gets longer
...
Counterparty risk can exist in credit, investment, and trading
transactions, espcially for those occurring in over-the-counter (OTC) markets
...
Bonds are rated by
agencies, such as Moody’s and Standard and Poor’s, from AAA to junk bond status to gauge the level
of counterparty risk
...
RETURN
(I)A return, also known as a financial return, in its simplest terms, is the money made or lost on an
investment over some period of time
...
A
return can also be expressed as a percentage derived from the ratio of profit to investment
...
(III)A return is the change in price on an asset, investment, or project over time, which may be
represented in terms of price change or percentage change
...
(V)Returns are often annualized for comparison purposes, while a holding period return calculates the
gain or loss during the entire period an investment was held
...
Total return for stocks includes price change as well as dividend
and interest payments
...
Nominal Return
A nominal return is the net profit or loss of an investment expressed in nominal terms
...
Distributions received by an investor depend on the type of
investment or venture but may include dividends, interest, rents, rights, benefits or other cash-flows
received by an investor
...
Real Return
A real rate of return is adjusted for changes in prices due to inflation or other external factors
...
Adjusting the nominal return to compensate for factors such
as inflation allows you to determine how much of your nominal return real return is
...
That’s because
inflation can reduce the value as time goes on, just as taxes also chip away at it
...
Any profit that is gained
goes to the business’s owners, who may or may not decide to spend it on the business
...
(II)Profit is the money a business makes after accounting for all expenses
...
As a result, much of business performance is
based on profitability in its various forms
...
(IV)There are three major types of profit that analysts analyze: gross profit, operating profit, and net
23
profit
...
UNIT-II
CHAPTER-1
CARDINAL UTILITY ANALYSIS (Marshallian Utility Analysis-One Commodity case)
The goods satisfy human wants
...
Utility is that
quality in a commodity by virtue of which it is capable of satisfying a human want
...
(economic goods) satisfies people’s wants and hence they possess utility
...
It measures the total satisfaction obtained from consumption of all the units of that good
...
If the 3rd ice-cream generates satisfaction of 10 utils, then TU
from 3 ice-creams will be 20+ 16 + 10 = 46 utils
...
+ Un
Where:
TUn = Total utility from n units of a given commodity
U1, U2, U3,……………
...
It is the utility derived from the last unit of a commodity purchased
...
The additional 10
utils from the 3rd ice-cream is the MU
...
MU can be calculated as: MUn = TUn – TUn-1
Where: MUn = Marginal utility from nth unit; TUn = Total utility from n units;
24
TUn-1 = Total utility from n – 1 units; n = Number of units of consumption
MU of 3rd ice-cream will be: MU3 = TU3 – TU2 = 46 – 36 = 10 utils One More way to Calculate MU
MU is the change in TU when one more unit is consumed
...
Relation between Total Utility and Marginal Utility:
There is a close relationship between Total Utility and Marginal Utility
...
Total Utility goes on increasing up to that extent till the Marginal Utility becomes Zero
...
ASSUMPTIONS
Rationality: It is assumed that the consumers are rational, and they satisfy their wants in the order of
their preference
...
Limited Resources (Money): The consumer has limited money to spend on the purchase of goods
and services and thus this makes the consumer buy those commodities first which is a necessity
...
Utility is cardinally Measurable: It is assumed that the utility is measurable, and the utility derived
from one unit of the commodity is equal to the amount of money, which a consumer is ready to pay
for it, i
...
1 Util = 1 unit of money
...
This law holds true for the theory of
consumer behavior
...
Utility is Additive: The cardinalists believe that not only the utility is measurable but also the utility
derived from the consumption of different commodities are added up to realize the total utility
...
Assume that a consumer consumes 6 apples
one after another
...
When he consumes
the second and third apple, the marginal utility of each additional apple will be lesser
...
Therefore, this example proves the point that every successive unit of a commodity used gives the
utility with the diminishing rate
...
After the saturation point though, the utility starts to fall
...
On the other hand, marginal utility keeps on diminishing with every
additional apple consumed
...
Hence, the
marginal utility is negative and the total utility falls
...
Disutility: If you still consume the product after the saturation point, the total utility starts to fall
...
When the first apple is consumed, the marginal utility is 20
...
Therefore, we have shown that the utility of apples consumed diminishes with
every increase of apple consumed
...
If we consume another
apple, i
...
6th apple, we can see that the marginal utility curve has fallen to below X-axis, which is
also known as ‘disutility’
...
The law of Diminishing Marginal Utility is based on the assumption of
independence of utilities, i
...
, the utility which a consumer derives from a commodity depends on the
quantity of that commodity only
...
It is hardly real to say that the desire to have still more of a particular commodity, as we have more
and more of it, is simply the result of its own influence on satisfactions
...
2
...
One of the pivotal assumptions of the law of Diminishing Marginal
Utility is that utility is measurable
...
Accordingly, a person
can say that he gets utility equal to 15 units from the consumption of the first unit of a commodity and
10 units from the second unit of it, and so on
...
Thus it is a subjective concept and is incapable of
being measured quantitatively
...
Marginal Utility of Money Variable
...
Thus the law assumes that while the
marginal utilities of commodities diminish as more and more of them are consumed, the marginal
utility of money remains constant throughout the process of consumption
...
As more and more is spent on the purchase of a commodity, and less and less of
money is left with the purchase, the marginal utility of money goes on increasing
...
In this context it is fallacious to use money as the measuring rod of
utility
...
The law of Diminishing Marginal Utility is not universally applicable
...
A drunkard gets more satisfaction on taking ‘successive’
cups of wine
...
5
...
For instance, Marshall assumed
that utility derived from a commodity can be measured in cardinal numbers
...
R
...
G
...
Allen had suggested that utility, being a psychological concept, can
never be measured in cardinal numbers
...
MU of Money Can Never be Constant:
Marshall’s assumption of constant marginal utility of money is another unrealistic assumption
...
According to Marshall, utility from a good
can be measured in terms of money
...
No Formal Distinction between Income and Substitution
Because of the constancy in the marginal utility of money, Marshall could not distinguish between
income effect and substitution effect of a price change
...
Marshall considered only the substitution effect and ignored the income effect
...
Basis of Economic Laws:
The Law of Diminishing Marginal Utility is the basic law of consumption
...
2
...
We know that the use of the same good makes us feel bored; its utility
diminishes in our estimation
...
Thus, this law helps in
bringing variety in consumption and production
...
Value Theory:
The law helps to explain the phenomenon in value theory that the price of a commodity falls when its
supply increases
...
4
...
Because of
their relative scarcity, diamonds possess high marginal utility and so a high price
...
That is why water has low price as compared to a diamond though it is more useful than the
latter
...
Progressive Taxation:
The principle of progression in taxation is also based on this law
...
6
...
The marginal utility of
money to the rich is low
...
7
...
The producer reduces the price of the product for the
purpose of increasing sales
...
As they buy more quantities the marginal utility of the last
rupee diminishes
...
CHAPTER-2
LAW OF EQUI-MARGINAL UTILITY
The equi-marginal principle is based on the law of diminishing marginal utility
...
Suppose a man purchases two goods X and Y whose prices are PX and PY, respectively
...
Only at the margin the last unit of money
spent on X has the same utility as the last unit of money spent on Y and the person thereby maximizes
his satisfaction
...
Example:
This equi-marginal principle or the law of substitution can be explained in terms of an arithmetical
example
...
6, we have shown marginal utility schedule of X and Y from the different units
consumed
...
4 and Rs
...
MUX and MUY schedules show diminishing marginal utilities for both goods X and Y from the
different units consumed
...
This has been shown in Table 2
...
30
MUX/PX and MUY/PY are equal to 6 when 5 units of X and 3 units of Y are purchased
...
35 (= Rs
...
5 x 3) and, thus, gets maximum satisfaction [10 + 9 + 8 + 7 + 6] + [11 + 10 + 6] = 67 units
...
Graphical Representation:
The above principle can also be illustrated in terms of a figure
...
12(a) and (b)
...
Marginal utility per rupee spent on good X = MUX/PX, and
that of Y = MUY/PY
...
2
...
2
...
We have not drawn negative portion of the marginal utility curves
...
2
...
2
...
2
...
31
As we move rightwards from ‘O’, amount spent on X increases and, as we move leftwards from ‘O’,
amount spent on Y increases
...
By purchasing this combination, the consumer equalizes marginal utilities per rupee spent on
X and Y at point E (i
...
, MUX/PX = MUY/PY = ED)
...
CHAPTER-3
INDIFFERENCE CURVE ANALYSIS (ORDINAL UTILITY ANALYSIS)
Indifference Curve and its properties
The basic idea behind ordinal utility approach is that a consumer keeps number of pairs of two
commodities in his mind which give him equal level of satisfaction
...
The ordinal utility approach differs from the cardinal utility approach (also called classical theory) in
the sense that the satisfaction derived from various commodities cannot be measured objectively
...
This approach also explains
the consumer’s equilibrium who is confronted with the multiplicity of objectives and scarcity of
money income
...
Rationality
32
It is assumed that the consumer is rational who aims at maximizing his level of satisfaction for given
income and prices of goods and services, which he wish to consume
...
2
...
This means the
consumer can only tell his order of preference for the given goods and services
...
Transitivity and Consistency of Choice
The consumer’s choice is expected to be either transitive or consistent
...
In other words, if X= Y, Y = Z, then he must treat X=Z
...
4
...
5
...
The MRS is denoted as DB/DA
...
Properties of an Indifference Curve or IC
Here are the properties of an indifference curve:
1
...
This is essential for the level of satisfaction to remain the same on an
indifference curve
...
An IC is always convex to the origin
From our discussion above, we understand that as Peter substitutes clothing for food, he is willing to
part with less and less of clothing
...
The rate gives
a convex shape to the indifference curve
...
•
Two goods are perfect complementary goods – An example of such goods would be gasoline
and water in a car
...
3
...
Also, they need not be parallel to each other either
...
Since A and B lie on IC1, the give the same
satisfaction level
...
Therefore,
we can imply that B and C offer the same level of satisfaction, which is logically absurd
...
4
...
5
...
If the curve touches either of the axes, then it means that he
is satisfied with only one commodity and does not want the other, which is contrary to our
assumption
...
Each point on an indifference curve indicates that a consumer is indifferent
between the two and all points give him the same utility
...
So that the consumer is indifferent among the various combinations
offered to him
I
...
It is known as Marginal Rate of Substitution
(MRS), denoted as,
MRS (Marginal Rate of Substitution)
The rate at which an individual will substitute one commodity for another
...
Indifference Set It is a set of those combinations of two goods which offer the consumer the same
level of satisfaction
...
III
...
A consumer may
Consumer’s Equilibrium
By now, you are clear about indifference curves and the budget line
...
A consumer is in equilibrium when he derives maximum satisfaction from the goods
and is in no position to rearrange his purchases
...
(i)The consumer has a fixed money income and wants to spend it completely on the goods X and Y
...
(iii)The goods are homogenous and divisible
...
Consumers Equilibrium
In order to display the combination of two goods X and Y, that the consumer buys to be in equilibrium,
let’s bring his indifference curves and budget line together
...
The combination R , From Fig
...
Even if he chooses the combination H, the argument
is similar since H lies on the curve IC1 too
...
One can reach a higher level of satisfaction within his budget
by choosing the combination Q lying on IC3 – higher indifference curve level
...
(i)Indifference Map – shows the consumer’s preference scale between various combinations of two
goods
(ii)Budget Line – depicts various combinations that he can afford to buy with his money income and
prices of both the goods
...
From the figure, we can see that the combinations R, S, Q, T, and H cost the same to the consumer
...
Since we have assumed a budget constraint, he will be forced to remain on the budget line
...
Demand theory forms the basis for the demand curve, which relates
consumer desire to the amount of goods available
...
Demand is the quantity of a good or service that consumers are willing and able to buy at a given
price in a given time period
...
The demand for a product at a certain
price reflects the satisfaction that an individual expects from consuming the product
...
The demand for a good
or service depends on two factors:
(1) Its utility to satisfy a want or need, and
(2) The consumer’s ability to pay for the good or service
...
Built into demand are factors such as consumer preferences, tastes, choices, etc
...
The market system is governed by the
laws of supply and demand, which determine the prices of goods and services
...
When demand is higher than supply, prices
increase to reflect scarcity
...
The law of demand introduces an inverse relationship between price and demand for a good or
service
...
Also, as the price decreases, demand increases
...
The demand curve has a negative slope as it charts downward from left to right to reflect the inverse
relationship between the price of an item and the quantity demanded over a period of time
...
When the price of a commodity falls, an individual can get the same level of satisfaction for less
expenditure, provided it’s a normal good
...
This is the income effect
...
As more people buy the good
with the lower price, demand increases
...
This is
referred to as a change in demand
...
For example, a
consumer who receives an income raise at work will have more disposable income to spend on goods
in the markets, regardless of whether prices fall, leading to a shift to the right of the demand curve
...
Giffen goods are inferior
goods that people consume more of as prices rise, and vice versa
...
Demand theory is one of the core theories of microeconomics
...
Based on the perceived utility of goods and services by consumers, companies adjust the
39
supply available and the prices charged
...
It works with the law of
supply to explain how market economies allocate resources and determine the prices of goods and
services that we observe in everyday transactions
...
In other words, the higher the price, the lower the quantity demanded
...
That is, consumers use the first units of an
economic good they purchase to serve their most urgent needs first, and use each additional unit of the
good to serve successively lower valued ends
...
Demand is derived from the law of diminishing
marginal utility, the fact that consumers use economic goods to satisfy their most urgent needs first
...
Changes in price can be reflected in movement along a demand curve, but do not by
themselves increase or decrease demand
...
Understanding the Law of Demand
Economics involves the study of how people use limited means to satisfy unlimited wants
...
Naturally, people prioritize more urgent wants and needs
40
over less urgent ones in their economic behavior, and this carries over into how people choose among
the limited means available to them
...
For example, consider a castaway on a desert island who obtains a six pack of bottled, fresh water
washed up on shore
...
The second bottle might be used for bathing to
stave off disease, an urgent but less immediate need
...
In our example, because each additional bottle of water is used for a successively less highly valued
want or need by our castaway, we can say that the castaway values each additional bottle less than the
one before
...
Because they value each additional unit of the good
less, they are willing to pay less for it
...
By adding up all the units of a good that consumers are willing to buy at any given price we can
describe a market demand curve, which is always downward-sloping, like the one shown in the chart
below
...
At
point A, for example, the quantity demanded is low (Q1) and the price is high (P1)
...
Factors Affecting Demand
So what does change demand? The shape and position of the demand curve can be impacted by
several factors
...
The availability of close substitute products that compete with a given
economic good will tend to reduce demand for that good, since they can satisfy the same kinds of
consumer wants and needs
...
Other factors such as
future expectations, changes in background environmental conditions, or change in the actual or
41
perceived quality of a good can change the demand curve, because they alter the pattern of consumer
preferences for how the good can be used and how urgently it is needed
...
In
this article, we will look at ways by which you can understand the difference between a movement
along a demand curve and shift of the demand curve
...
There are many factors that affect
the demand and these effects can be seen by observing the changes in the demand curve
...
The important aspect to remember is that other factors like the consumer’s income and tastes along
with the prices of other goods, etc
...
In such a scenario, the change in price affects the quantity demanded but the demand follows the same
curve as before the price changes
...
The movement can occur
either in an upward or downward direction along the demand curve
...
Also, a decrease in the price increases the demand
...
1 above, we can see that when the price of a commodity is OP, its demand is OM (provided
other factors are constant)
...
Also, the demand curve
moves UPWARD
...
Also, the demand
curve moves DOWNWARD
...
The shift of the Demand Curve
When there is a change in the quantity demanded of a particular commodity, at each possible price,
due to a change in one or more other factors, the demand curve shifts
...
, which was expected to remain constant, changed
...
Therefore, the demand
follows a different curve for every price change
...
The demand
curve can shift either to the left or the right, depending on the factors affecting it
...
),
Definition: The Elasticity of Demand is a measure of change in the quantity demanded in response to
the change in the price of the commodity
...
Ec=
Proportionate change in Demand of X
---------------------------------------------------------------------Proportionate change in Price of X
Marshall, a renowned economist suggested mathematical method to measure the elasticity of demand
...
Types of Elasticity of Demand
(I)PRICE ELASTICITY OF DEMAND
The change in quantity demanded of a product due to change in its price is known as price elasticity
44
of demand
...
KINDS OF PRICE ELASTICITY OF DEMAND
1
...
More elastic demand (Ed=e>1
3
...
less inelastic demand (Ed=e<1
5
...
When the proportionate change in demand is equal to proportionate change in price, it is known as
unitary elastic demand
(iv)RELATIVELY INELASTIC DEMAND
When the proportionate change in demand is less than the proportionate change in its price, it is
known as relatively inelastic demand
...
(Habits-Cigarette, Movies, Luxury)
FACTORS AFFECTING PRICE ELASTICITY OF DEMAND
(i)Nature of the commodity- the elasticity of demand for any commodity depends upon the category
to which it belongs, i
...
whether it is necessity, comfort or luxury
...
(ii)Availability of substitutes- commodities having
substitutes have more elastic demand
...
(iii)Variety of uses of commodity- the demand for goods, having variety of uses such as mil coal
45
electricity, is more elastic
...
(v)Proportion of income spent of commodity- goods on which a consumer spends a very small
proportion of his income have inelastic demand
(vi)Ranges of price- elasticity of demand depends upon the range of prices
...
on the other hand , at middle range of prices demand
tends to be elastic because a rise or fall in demand will affect the demand of a large number of
persons
...
Despite rise in their prices, people demand such goods in more or less same quantity
...
The shorter the time the lesser will be elasticity of demand, the longer the time,
the higher will be the elasticity of demand
...
e
...
car and petrol, camera and
film, bread and jam etc
...
When
goods are durable like scooter, T
...
set etc
...
(xi)Fashion – the elasticity demands for a commodity which is in fashion will be elastic, because it
becomes more or less necessary for a costumer to purchase it
...
Importance of Elasticity of Demand:
(i)The concept of Ed helps in price determination by the monopolist
...
The demand for product high, higher the
price consumers will buy the product even when the price rises
...
The determination of the price depends on demand for and supply of commodity
...
(ii) It helps to understand other types of price such as exchange rate , terms of trade that is currency
exchange and export and import
...
Income Elasticity of Demand
Definition:-In economics, income elasticity of demand measures the responsiveness of the quantity
demanded for a good or service to a change in the income of the people demanding the good
...
Ec=
Proportionate change in Demand of X
---------------------------------------------------------------------Proportionate change in Income(Y)
For example, if in response to a 10% increase in income, the quantity demanded for a good increased
by 20%, the income elasticity of demand would be 20%/10% = 2
...
For example, the "selected income elasticity"
below suggest that an increasing portion of consumer's budgets will be devoted to purchasing
automobiles and restaurant meals and a smaller share to tobacco and margarine
...
Specifically when a buyer in a
certain income bracket experiences an income increase, their purchase of a product changes to match
that of individuals in their new income bracket
...
When the income distribution is
described by a gamma distribution, the income elasticity is proportional to the percentage difference
between the average income of the product's buyers and the average income of the population
...
The income elasticity of demand is different for different products
...
Positive Income Elasticity of Demand:
Refers to a situation when the demand for a product increases with increase in consumer’s income and
decreases with decrease in consumer’s income
...
It is explained with the help of Figure-12:
In Figure-12, the slope of the curve is upward from left to right, which indicates that the increase in
income causes increase in demand and vice versa
...
The positive income elasticity of demand can be of three types, which are discussed as follows:
a
...
For example, if income increases
by 50% and demand also rises by 50%, then the demand would be called as unitary income elasticity
of demand
...
b
...
For example, if the
income increases by 50% and demand rises by 100%
...
c
...
For example, if the
income increases by 50% and demand increases only by 25%
...
ii
...
The income elasticity of demand is negative for inferior goods, also
known as Giffen goods
...
In such a case, the millet would be inferior to wheat for the
customer
...
10, then the demand for goods is 4 units
...
20, then the demand is 2 units
...
Therefore, in such a case, the elasticity of demand is negative
...
Zero Income Elasticity of Demand:
Refers to the income elasticity of demand whose numerical value is zero
...
The income elasticity of demand
is zero (ey= 0) in case of essential goods
...
Figure-14 shows the zero income elasticity of demand:
49
Figure-14 shows that when income increases from Rs
...
20, then the demand for goods is
remain same, 4 units
...
Therefore, in such a case, the
elasticity of demand is zero
...
Therefore, it helps in estimating the required
production level of different commodities at a certain point of time in the future
...
Useful for classification of normal & inferior goods: The concept of income elasticity of demand
can also be used to define the normal and inferior goods
...
On the other hand, the goods for whose
income elasticity is negative beyond a certain level of income are termed as inferior goods
...
For example, firm producing luxury items should concentrate its
marketing efforts on media that reach the high-income group of the people
...
Simply, goods whose demand rises with rise in income and whose demand
falls with fall in income is known as normal goods e
...
The coefficient of income elasticity of
these goods is always positive
...
In other words, inferior goods are such goods whose demand falls with rise
in income and vice versa e
...
budget smartphones
...
50
Applications and Measurements of Income Elasticity of Demand
Income elasticity of demand helps us to measure the health of an industry, future consumption
patterns and economic reasoning behind investment decisions
...
When to increase or decrease your production?
The income elasticity of demand provides an answer to this question
...
If we can catch
up with economic cycles of a country and change in average income of the people, we can plan and
make business decisions well in time to stay ahead of our competitors
...
However, in
case of luxury products the rise in the income calls for an increase in our products to meet the rising
demand
...
In a study,
Atakhanova and Howie (2007) calculated that income-elasticity of demand for electricity in the
residential sector is very low in comparison to demand in industrial and service sectors in Kazakhstan
...
They concluded that there would be no socio-political problem on electricity production if no further
investment is made in the business
...
Real World Income Elasticity (In United States, products with different income elasticity
Product
Income Elasticity
Elasticity Level
Oversea Travels
3
...
41
Elastic
Housing Services
2
...
94
Elastic
Restaurant Food
1
...
38
Elastic
Petrol and Gasoline
1
...
36
Elastic
Cars
1
...
00
Unitary Elastic
Shoes and other footwear
0
...
86
inelastic
Alcohol
0
...
53
inelastic
Clothing
0
...
38
inelastic
Phone
0
...
14
inelastic
CROSS ELASTICITY OF DEMAND
Ec=
Proportionate change in Demand of Y
---------------------------------------------------------------------Proportionate change in Price of X
The measure of responsiveness of the demand for a good towards the change in the price of a related
good is called cross price elasticity demand
...
The
consumption behavior being related, the change in the price of a related good leads to a change in the
demand of another good (Price of X to demand of Y)
...
MEASUREMENT OF CROSS ELASTICITY OF DEMAND:
Cross Elasticity of demand can be measured with the help of the following formula:
KINDS OF CROSS ELASTICITY OF DEMAND:
52
Positive Cross Elasticity (in case of substitutes goods-which can be used in place of one another for
satisfaction of particular want, increase in the demand for a given commodity and vice-versa
...
Demand for a given commodity is directly affected by change in
price of the substitute goods)
...
Advertising Elasticity of Demand
Advertising elasticity of demand (AED) is a measure of a market’s sensitivity to increases or
decreases in advertising saturation
...
It is calculated by dividing the percentage change in the
quantity demanded by the percentage change in advertising expenditures
...
The impact that an increase in advertising expenditures has on sales varies by industry
...
Advertising elasticity of demand is
valuable in that it quantifies the change in demand (expressed as a percentage) by spending on
advertising in a given sector
...
For example, a commercial for a fairly inexpensive good, such as a hamburger, may result in a quick
bump in sales
...
Because a number of outside factors, such as the state of the economy and consumer tastes, may also
result in a change in the quantity of a good demanded, the advertising elasticity of demand is not the
most accurate predictor of advertising’s effect on sales
...
A good
example of this is when a specific beer company advertises their product, which compels a consumer
to buy beer, but not simply the specific brand they saw advertised
...
0, which means that advertising has little influence on profits
...
Advertising Elasticity of Demand Applied
The primary use for advertising elasticity of demand is making sure advertising expenses are justified
by their returns
...
PED applied alongside AED can help
determine what impact pricing changes may have on demand
...
If a company finds that their AED is high, or if their PED is low, they
should advertise heavily
...
These might include:
•
The purpose of a lot of advertising may not be to directly boost demand, but to help with building a brand
image or brand loyalty – the AED value cannot show the effectiveness of this strategy
•
If dealing with a family of brands, it may be difficult to isolate the effect of the advertising spending on a
single product or service and this may distort the apparent effectiveness of the expenditure
•
It may be difficult to isolate the impact of advertising expenditure to a specific time period – some
campaigns are ongoing over a considerable period and other factors may also influence demand over an
extended period
...
5(Less elastic)
Proportionate change in Price of X(20)
(II)TOTAL OUTLAY METHOD OR TOTAL EXPENDITURE METHOD
TE= Total Expenditure,
P=Price of X commodity, Q= Quantity, TE-Increasing, Constant, or
Decreasing
•
(III)GEOMETRIC METHOD OR POINT METHOD
54
Ed=
Lower segment of Demand Curve (4cm
...
)
*If variation then, Ed is different degree
...
= ----------------------------AR--MR
• AR—Average Revenue
•
MR-Marginal Revenue
55
CHAPTER-6
DEMAND FORECASTING: NEED, OBJECTIVES AND METHODS
According to Evan J
...
” In the words of Cundiff and Still, “Demand
forecasting is an estimate of sales during a specified future period based on proposed marketing plan
and a set of particular uncontrollable and competitive forces
...
An organization can forecast demand by making own estimates called guess estimate or taking the
help of specialized consultants or market research agencies
...
Forecasting of demand for Trendy (Fashion Product)
...
Forecasting of demand for Automobiles
...
Forecasting of demand of services-telecommunication , transport ,Teacher’s in educational
institution ,Doctors in Hospitals, Lawyers in Court ,
Need of Demand Forecasting
Demand plays a crucial role in the management of every business
...
Apart from this, demand
forecasting provides an insight into the organization’s capital investment and expansion decisions
...
Demand forecasting helps
in fulfilling these objectives
...
For example, an organization has set a target of selling 50, 000 units of its products
...
If the demand for the
organization’s products is low, the organization would take corrective actions, so that the set objective
can be achieved
...
For instance, an
organization has forecasted that the demand for its product, which is priced at Rs
...
In such a case, the total expected revenue would be 10* 100000 = Rs
...
In this
way, demand forecasting enables organizations to prepare their budget
...
Producing according to the
forecasted demand of products helps in avoiding the wastage of the resources of an organization
...
For example, if an
organization expects a rise in the demand for its products, it may opt for extra labor to fulfill the
increased demand
...
If the expected demand for products is higher, then the organization may plan to expand
further
...
(v) Taking Management Decisions
Helps in making critical decisions, such as deciding the plant capacity, determining the requirement of
raw material, and ensuring the availability of labor and capital
...
For example, if the demand for an organization’s products is less, it may
take corrective actions and improve the level of demand by enhancing the quality of its products or
spending more on advertisements
...
Objectives of short-term demand forecasting
Production policy: Short-term demand forecasting is used to evolve a suitable production policy
which can avoid the problems of over production and short supply
...
Knowledge of near future economic conditions
help the firm in reducing costs of purchasing raw materials and controlling inventory
...
Price policy: Sales forecasting is useful in determining pricing policy
...
Sales targets, controls and incentives: Short term demand forecasting is used to set sales targets and
for establishing controls and incentives
...
Cash
57
requirement depends on production and sales levels
...
Objectives of long term demand forecasting
New unit or expansion: Long term demand forecasting helps in planning of a new unit or expansion
of an existing unit of a business organization
...
Long-term sales forecast is
necessary to estimate long term financial requirements
...
Demand forecasting is also useful to the Government in
determining import and export policies
...
The objectives of short-term demand
forecasting are different from those of long term demand forecasting
...
Proper judgment along with the scientific
formula is needed to correctly predict the future demand for a product or service
...
Survey of Buyer’s Choice
When the demand needs to be forecasted in the short run, say a year, then the most feasible method is
to ask the customers directly that what are they intending to buy in the forthcoming time period
...
This survey can be done in any of
the following ways:
(a) Complete Enumeration Method: Under this method, nearly all the potential buyers are asked about
their future purchase plans
...
End-use Method: It is especially used for forecasting the demand of the inputs
...
e
...
The desirable norms of
consumption of the product are fixed, the targeted output levels are estimated and these norms are
applied to forecast the future demand of the inputs
...
58
However, the judgments of the buyers are not completely reliable and so the seller should take
decisions in the light of his judgment also
...
This method is suitable when goods are supplied in bulk to industries
but not in the case of household customers
...
Collective Opinion Method
Under this method, the salesperson of a firm predicts the estimated future sales in their region
...
These estimates are
reviewed in the light of factors like future changes in the selling price, product designs, changes in
competition, advertisement campaigns, the purchasing power of the consumers, employment
opportunities, population, etc
...
They can also easily find out the
reasons behind the change in their tastes
...
Hence, this method is also known as Sales force opinion or Grassroots approach method
...
3
...
The economic indicators are used to predict the future trends of the business
...
An index of economic indicators is formed
...
leading indicators, lagging indicators, and coincidental
indicators
...
The lagging
indicators are those that follow a change after some time lag
...
4
...
Under this
method, the demand is forecasted by conducting market studies and experiments on consumer
behavior under actual but controlled, market conditions
...
However, this method is very expensive and time-consuming
...
Expert Opinion Method
Usually, the market experts have explicit knowledge about the factors affecting the demand
...
The Delphi technique, developed by Olaf Helmer is one such
method
...
They are also required to give the suitable reasons
...
This is a fast and cheap technique
...
Statistical Methods
The statistical method is one of the important methods of demand forecasting
...
The major statistical methods used for demand forecasting
are:
Trend Projection Method: This method is useful where the organization has sufficient amount of
accumulated past data of the sales
...
Thus,
the time series depicts the past trend and on the basis of it, the future market trend can be predicted
...
Thus, on the basis of the predicted future trend,
the demand for a product or service is forecasted
...
In our case, the quantity demanded is the dependent variable and income, the
price of goods, price of related goods, the price of substitute goods, etc
...
The regression equation is derived assuming the relationship to be linear
...
Where Y is the forecasted demand for a product or service
...
According to traditional
economic theory, there are four main factors of production: land, labor, capital, and entrepreneurship
...
They are the inputs that we use to
produce goods and services so that we can make an economic profit
...
All the inputs are classified into two groups—primary inputs and
secondary inputs
...
Factors of production include any resource needed for the creation of a good or service
...
Land represents all natural resources, such as timber and gold, used in the production of a
good
...
The entrepreneur is the individual who takes an idea and
attempts to make an economic profit from it by combining all other factors of production
...
Capital is made up of all of the
tools and machinery used to produce a good or service
...
Land
This factor includes land plus anything that comes from the land
...
Forests, coal, natural gas, copper, oil, and water, for
example, belong to the category common land or natural resources
...
It can also be a renewable resource, such as timber
...
For example, oil is a
natural resource, but gasoline is a capital good
...
Land plays an important part in production because land itself and the resources on it are usually
limited
...
Also, many of the natural resources are
nonrenewable, meaning that their amount is fixed, and they can't be used indefinitely
...
From Land we get rent
...
A lease is a contract outlining the terms under which
one party agrees to rent property owned by another party
...
Both the lessee and the lessor face
consequences if they fail to uphold the terms of the contract
...
If
a person wishes to rent an apartment or other residential property, for example, the lease prepared by
the landlord describes the monthly rent amount, when it is due each month, what happens if the lessee
fails to pay his rent, how much of a security deposit is required, the duration of the lease, whether the
lessee is allowed to keep pets on the premises, how many occupants can live in the unit and any other
essential information
...
Leases for commercial properties, on the other hand, are usually
negotiated in accordance with the specific lessee and typically run from one to 10 years, with larger
tenants often having longer, and more complex, lease agreement
In the figure given here OR is the equilibrium rate of Interest which is determined at the point at
which the supply of savings curve intersects the investment demand curve, so that OQ amount of
savings is supplied as well as invested
...
Indeed, the demand for capital is influenced by the productivity of capital and the supply of capital
...
Thus, the classical theory of
Interest implies that the real factor, thrift and productivity in the economy are the fundamental
determinants of the rate of Interest
...
Therefore, that we
have to accept is as it is
...
(iii)Land is limited in area: Land surface of the world is remaining unchanged
...
But these efforts have produced a negligible result as compared with
the total area already in existence
(iv)Land is permanent: Land as factor of production is not easy to destroy
...
(v)Land lacks mobility: Land cannot move bodily from one place to another
...
(vi)Land is of infinite variety: Land is not man-made
...
For example, soil
may be of different types, climate elements like temperature, rains received in different part is always
varying
...
The
productivity depends upon following factors
...
The
sandy soil with low rainfall always yield less but it is not so in cause of black cotton soil
...
(b) Human factor: Man is always trying his best how maximum output can be obtained from land
...
This human effort is very important to increase the
productivity
...
The fertile land
in remote corner of the country perhaps may not be cultivated but the land having less fertility but
located nearby marked can give a good yield
...
Labour
63
(a)Labor refers to the effort that humans contribute to the production of goods and services
...
(b)Resources include,
the work that the engineer who designed a bridge did
...
Labor represents
all of the people that are available to transform resources into goods or services that can be purchased
...
Nobody has to produce everything themselves
...
It's also important that a
labor force is well educated and well trained to ensure that they can produce goods at peak efficiency
and quality
...
We refer to labor resource income as wages
...
(d)How the wage rate is determined by demand for and supply of labour is shown above where DD
represents the demand curve for labour and SS represents its supply curve
...
This means that at wage rate OW, quantity demanded of labour is equal to quantity supplied
of it
...
All those who are willing to work at the wage rate OW get employment
...
64
Peculiarities of Labour: The important peculiarities of labour are as under
...
g
...
Therefore, the labour’s work has to be delivered
in person
...
Thus labourer is only selling his
services not himself
...
Therefore a day lost which out work means the day’s work gone forever
...
Labourer has not the same power
of bargaining as their employers
...
(d)Man, not a machine: A labourer differs from machine
...
After all labourer is man and he has feelings and likings
...
(e)Less mobile: Generally labourer does not want to leave his home
...
(f)Supply Independent of its demand: The supply of labour is always independent of its demand and
cannot be easily and quickly increased or decreased
...
But when sudden increase demand for labour, as
during war, wages will rise but supply cannot be quickly increased
...
3
...
Specifically, it includes those elements that we use
to produce goods and services
...
Capital is an important factor of production because it's what allows labor and land to be purchased
...
Examples include
computers, delivery vehicles, conveyor belts, forklift trucks, hammers, etc
...
For example, a teacher uses desks, a
65
whiteboard, and textbooks to deliver education services
...
When consumers become more future oriented and decide to save more, then the supply curve shifts
to the rights thus leading to an increase in the savings and investment rate
...
2) Supply of appliances and equipment: The fixed capital goods
...
Supposes only 5 to 6 goats maintain by a poor person it will give him sizeable
income to survive his family
...
Importance of capital
(a)In modern economy capital is very important factor of production which is essential to undertake
production
...
On the
contrary, if apple supply-capital is made the production and productivity can be increased
substantially
...
(e)The under-developed countries remained, under-developed due to lack of capital
...
(g)When more production is there, more economic activities can he initiated and as a result, more
employment opportunities can be created
...
4
...
The
earliest definition of entrepreneurship, dating from the eighteenth century, used it as an economic
term describing the process of bearing the risk of buying at certain prices and selling at uncertain
prices
...
The
concept of innovation was added to the definition of entrepreneur-ship
...
Entrepreneurship as involving the creation of new enterprises and that the entrepreneur is
the founder
...
Entrepreneurs thrive in economies
where they have the freedom to start businesses and buy resources freely
...
Functions of Entrepreneur:
1) Initiation: Taking the review of situation and availability of resources organizer initiates a business
or production
...
2) Organization: Organizer now combines the land, labour and capital resources and starts the
business or production
...
Thus, organize executes the business in a proper way
...
Because of changes in situation in
respect of marketing, Govt
...
will hamper the business
...
67
5) Risk taking: Risk means uncertainty
...
The business cannot be
always in profit
...
Risk taking is therefore becomes an
important function of an organizer
...
He can introduce new method or
commodity in the production process or in business
...
Therefore, a firm which aims to maximize profits will produce output level of OQ, and will
charge a price of its product which buyers are prepared to pay depending on the demand conditions
...
In the real world, it is not so easy to know exactly your marginal revenue and the marginal cost of last
goods sold
...
It also depends on how other firms react
...
But, if they are the only firm to increase the price, demand will be elastic
However, firms can make a best estimation
...
e
...
if they see increasing price leads to a smaller % fall in demand they will
68
try increase price as much as they can before demand becomes elastic
It is difficult to isolate the effect of changing the price on demand
...
Firms may also have other objectives and considerations
...
Firms may also have other social objectives such as running the firm like a cooperative – to maximize
the welfare of stakeholders (consumers, workers, suppliers) and not just profit of owners
...
because
it is not a productive resource
...
Money merely facilitates
trade, but it is not in itself a productive resource
...
It is used
in the theory of production in which the various combinations of factors of production help in
producing output when a firm operates under increasing or decreasing costs in the short-run, and
when the returns to scale increase or decrease in the long-run
...
From the point of view of the theory of costs of production,
factors of production are divided as fixed factors and variable factors
...
The concept of factor of production is used in explaining the theory of factor-pricing
...
A factor of production which
is specific in use earns a higher reward than a non-specific factor
...
Production and Analysis
Since the primary purpose of economic activity is to produce utility for individuals, we count as
production during a time period all activity which either creates utility during the period or which
increases ability of the society to create utility in the future
...
69
According to Bates and Parkinson “Production is the organized activity of transforming resources into
finished products in the form of goods and services; the objective of production is to satisfy the
demand for such transformed resources”
...
R
...
This definition makes it clear that, in economics, we do not treat the mere
making of things as production
...
The making or doing of things which are not wanted or are made just for the fun of it does not qualify
as production
...
Those who provide services Such as hair-dressers, solicitors, bus drivers, postmen, and clerks are as
much a part of the process of satisfying wants as are farmers, miners, factory workers and bakers
...
If
we will buy something we must want it; if we are not willing to buy it then, in economic terms, we do
not want it
...
Three Types of Production
For general purposes, it is necessary to classify production into three main groups:
1
...
These industries are engaged in such activities as extracting the gifts of Nature
from the earth’s surface, from beneath the earth’s surface and from the oceans
...
Secondary Production
This includes production in manufacturing industry, viz
...
They are generally described as manufacturing and construction industries, such as the
manufacture of cars, furnishing, clothing and chemicals, as also engineering and building
...
Tertiary Production
70
Industries in the tertiary sector produce all those services which enable the finished goods to be put in
the hands of consumers
...
Examples cover distributive traders, banking, insurance, transport and
communications
...
Output
Any activity connected with money earning and money-spending is called an economic activity
...
It results in the output (creation) of an enormous variety
of economic goods and services
...
These include any resource needed for the creation of a
good or service
...
These production factors are also construed by organizations as management, machines, materials and
labor, technology and knowledge
...
The Basics of Factors of Production
The modern definition of factors of production is primarily derived from a neoclassical view of
economics
...
Land, labor, and capital as factors of production were originally identified by the early political
economists such as Adam Smith, David Ricardo, and Karl Marx
...
1
...
Natural
resources, such as oil and gold, can be extracted and refined for human consumption from the land
...
For a group of early French
economists called the physiocrats, who pre-dated the classical political economists, the land was
responsible for generating economic value
...
For example, a technology company can easily begin operations with zero
investment in land
...
2
...
Again,
it can take on various forms
...
Within the software
industry, labor refers to the work done by project managers and developers in building the final
product
...
For the early political economists, labor was the primary driver of economic value
...
Labor by an uneducated and untrained worker is typically paid at low prices
...
For example, an accountant’s job requires synthesis and analysis of
financial data for a company
...
The difference in skill levels and terminology also helps companies and
entrepreneurs arbitrage corresponding disparities in pay scales
...
An example of this is the change in production processes in
the Information Technology (IT) industry after jobs were outsourced to countries with a trained
workforce and significantly lower salaries
...
Capital as a Factor
In economics, capital typically refers to money
...
Instead, it facilitates the processes used in
production by enabling entrepreneurs and company owners to purchase capital goods or land or pay
72
wages
...
As a factor of production, capital refers to the purchase of goods made with money in production
...
Along the same lines, desks and chairs used in an
office are also capital
...
A personal vehicle
used to transport family is not considered a capital good
...
During an economic contraction or when they
suffer losses, companies cut back on capital expenditure to ensure profits
...
An illustration of the above is the difference in markets for robots in China versus the United States
after the financial crisis
...
As a result, the country became the biggest market for robots
...
4
...
An example of entrepreneurship is the evolution of social media
behemoth Facebook Inc
...
Mark Zuckerberg assumed the risk for the success or failure of his
social media network when he began allocating time from his daily schedule towards that activity
...
After Facebook became popular and spread across campuses, Zuckerberg realized that he needed help
to build the product and, along with co-founder Eduardo Saverin recruited additional employees
...
The
continued popularity of the product meant that Zuckerberg also had to scale technology and
operations
...
At first, there was no need for land
...
Each of these requires significant real estate and capital investments
...
The retail coffee chain needs
all four factors of production: land (prime real estate in big cities for its coffee chain), capital (large
machinery to produce and dispense coffee), and labor (employees at its retail outposts for service)
...
While large companies make for excellent examples, a majority of companies within the United
States are small businesses started by entrepreneurs
...
5
...
But that is a theoretical
construct and is rarely the case in practice
...
For example, a firm operating in the real
estate industry typically owns significant parcels of land
...
Capital also follows a similar model in that it can be owned or leased
from another party
...
Labor’s transaction
with firms is based on wages
...
For example,
private enterprise and individuals own most of the factors of production in capitalism
...
As such, factors of production, such as
land and capital, is owned by workers
...
“The production function is purely a technical relation which connects factor inputs and output
...
Koutsoyiannis
Defined production function as “the relation between a firm’s physical production (output) and the
material factors of production (inputs)
...
Watson
In this way, production function reflects how much output we can expect if we have so much of
labour and so much of capital as well as of labour etc
...
The reason behind physical relationship is that money prices do not appear in it
...
It shows the flow of inputs resulting into a flow of output during some time
...
With every development in technology the production
function of the firm undergoes a change
...
Sometimes a new production function of the firm may be
adverse as it takes more inputs to produce the same output
...
Fixed and Variable Factors
Fixed Factors
Fixed factors are those which remain unchanged as out output of the firm changes in the shout-run
...
They are independent of output in the short-run
...
are the examples of fixed factors
...
It is not possible in the short-run
...
Raw materials, labour, fuel, power etc
...
If a firm wants
to expand output in the short-run, then it can employ more labourers, purchase more raw materials
and can use more power
...
This shows that as production increases, variable factors
also increase and as production falls the quantities of variable factors also fall
...
So important
75
in the short-run vanishes in the long-run
...
Distinction between Fixed and Variable Factors
FIXED FACTORS
VARIABLE FACTORS
1
...
2
...
3
...
are the examples
of fixed
...
It exists even in the zero level of
output
...
Variable factors exist both in the short-run and longrun
...
It changes with the change of output in the short-run
3
...
are the examples of variable
factors
...
When output is zero, quantities of variable factors are
reduced to zero
...
This law is also known
as Law of Proportionality
...
In the
short run when output of a commodity is sought to be increased, the law of variable proportions
comes into operation
...
For instance, there are two factors of production viz
...
“As the proportion of the factor in a combination of factors is increased after a point, first the
marginal and then the average product of that factor will diminish
...
” Samuelson
Assumptions
Law of variable proportions is based on following assumptions:
76
(i) Constant Technology
The state of technology is assumed to be given and constant
...
(ii) Factor Proportions are Variable
The law assumes that factor proportions are variable
...
(iii) Homogeneous Factor Units
The units of variable factor are homogeneous
...
Short Run Production Analysis
The short run is a period of time in which at least one input used for production and under the control
of the producer is variable and at least one input is fixed
...
This functional relationship (of
dependence) between the variable input quantities and the output quantity is called the short run
production function
...
Therefore, in this case, the firm’s short-run production function may be written as:
q = f(x, y̅)
The short run production function is one in which at least is one factor of production is thought to be
fixed in supply, i
...
it cannot be increased or decreased, and the rest of the factors are variable in
nature
...
Therefore, it is
quite difficult for the firm to change the capital equipment, to increase the output produced, among all
factors of production
...
In
short run, increasing returns are due to the indivisibility of factors and specialisation, whereas
diminishing returns are due to the perfect elasticity of substitution of factors
...
g
...
e
...
Consider pizza making
...
Similarly, the pizzaiolo may take
tomatoes, spices, and water to make pizza sauce
...
The pizzaiolo uses a peel—the shovel-like wooden tool–
to put the pizza into the oven to cook
...
What are the inputs (or factors of production) in the production
process for this pizza?
Economists divide factors of production into several categories:
•
Natural Resources (Land and Raw Materials) – The ingredients for the pizza are raw
materials
...
If the pizza place uses a wood-burning oven, we would
include the wood as a raw material
...
Don’t forget electricity for lights
...
•
Labor – When we talk about production, labor means human effort, both physical and mental
...
He or she needs to be strong enough to roll out
the dough and to insert and retrieve the pizza from the oven, but he or she also needs to know how to
make the pizza, how long it cooks in the oven and a myriad of other aspects of pizza-making
...
•
Capital – When economists uses the term capital, they do not mean financial capital (money);
rather, they mean physical capital, the machines, equipment, and buildings that one uses to produce
the product
...
•
Technology – Technology refers to the process or processes for producing the product
...
Who makes those decisions? Ultimately, it is the entrepreneur, the
person who creates the business, whose idea it is to combine the inputs to produce the outputs
...
Let’s explore these ideas in
more detail
...
Different products
have different production functions
...
Firms in the same industry may have
somewhat different production functions, since each firm may produce a little differently
...
A sit-down
pizza restaurant probably uses more labor (to handle table service) than a purely take-out restaurant
...
Fixed inputs are those that can’t easily be increased or decreased in a short period of time
...
Once the entrepreneur signs the lease, he or she is stuck in the
building until the lease expires
...
This is
analogous to the potential real GDP shown by society’s production possibilities curve, i
...
the
maximum quantities of outputs a society can produce at a given time with its available resources
...
The
pizzaiolo can order more ingredients with a phone call, so ingredients would be variable inputs
...
Economists often use a short-hand form for the production function:
Q=f[L,K],Q=f[L,K],
where L represents all the variable inputs, and K represents all the fixed inputs
...
The short run is the period of time during which at least some factors of production are fixed
...
The long run is the period of time during which all factors are variable
...
79
Let’s explore production in the short run using a specific example: tree cutting (for lumber) with a
two-person crosscut saw
...
(Credit: Wknight94/Wikimedia Commons)
Since by definition capital is fixed in the short run, our production function becomes
Q=f[L,−K]orQ=f[L]Q=f[L,K−]orQ=f[L]
This equation simply indicates that since capital is fixed, the amount of output (e
...
trees cut down per
day) depends only on the amount of labor employed (e
...
number of lumberjacks working)
...
Short Run Production Function for Trees
# Lumberjacks
1
2
3
4
5
# Trees (TP)
4
10
12
13
13
MP
4
6
2
1
0
Note that we have introduced some new language
...
In
this example, one lumberjack using a two-person saw can cut down four trees in an hour
...
We should also introduce a critical concept: marginal product
...
Mathematically, Marginal Product is the change in total product divided
by the change in labor: MP=ΔTP/ΔLMP=ΔTP/ΔL
...
Why might that be the case? It’s because of the nature of the
capital the workers are using
...
Suppose we add a third lumberjack to the story
...
What you see in the table is a
critically important conclusion about production in the short run: It may be that as we add workers,
the marginal product increases at first, but sooner or later additional workers will have decreasing
marginal product
...
This is
80
called the Law of Diminishing Marginal Product and it’s a characteristic of production in the short
run
...
Both concepts are examples of the more
general concept of diminishing marginal returns
...
We will see this more clearly when we discuss production in the long
run
...
(Figure) graphically
shows the data from (Figure)
...
81
Production is the process a firm uses to transform inputs (e
...
labor, capital, raw materials, etc
...
It is not possible to vary fixed inputs (e
...
capital) in a short period of time
...
g
...
Marginal product is the
additional output a firm obtains by employing more labor in production
...
Mathematically, marginal product is the slope of the
total product curve
...
The laws of
returns to scale refer to the effects of a change in the scale of factors (inputs) upon output in the longrun when the combinations of factors are changed in some proportion
...
If in order to secure equal increases in output, both factors are increased in larger proportionate units,
there are decreasing returns to scale
...
The returns to scale can be shown diagrammatically on an expansion path “by the distance between
successive ‘multiple-level-of-output’ isoquants, that is, isoquants that show levels of output which are
multiples of some base level of output, e
...
, 100, 200, 300, etc
...
Increasing Returns to Scale
Figure shows the case of increasing returns to scale where to get equal increases in output, lesser
proportionate increases in factors, labour and capital, are required
...
There may be indivisibilities in machines, management, labour, finance, etc
...
When a
business unit expands, the returns to scale increase because the indivisible factors are employed to
their full capacity
...
Increasing returns to scale also result from specialisation and division of labour
...
Work can be
83
divided into small tasks and workers can be concentrated to narrower range of processes
...
Thus with specialization, efficiency increases and increasing
returns to scale follow
...
As the firm expands, it enjoys internal economies of production
...
All these economies help in increasing the returns to scale more than
proportionately
...
A firm also enjoys increasing returns to scale due to external economies
...
When a large number of firms are concentrated at one place, skilled labour, credit and transport
facilities are easily available
...
Trade journals,
research and training centres appear which help in increasing the productive efficiency of the firms
...
100 units of output require 3C + 3L
200 units of output require 5C + 5L
300 units of output require 6C + 6L
so that along the expansion path OR, OA > AB > BC
...
2
...
It follows that
100 units of output require 2C + 2L
200 units of output require 5C + 5L 300 units of output require 9C + 9L so that along the expansion
path OR, OG < GH < HK
...
Returns to scale may start diminishing due to the following factors:
1
...
2
...
Business may become unwieldy and produce
problems of supervision and coordination
...
3
...
These arise from
higher factor prices or from diminishing productivities of the factors
...
rises
...
Prices of raw
materials also go up
...
All these factors tend to raise costs
and the expansion of the firms leads to diminishing returns to scale so that doubling the scale would
not lead to doubling the output
...
Constant Returns to Scale
Figure shows the case of constant returns to scale
...
e
...
To treble output, units of both factors
are trebled
...
The returns to scale are constant when internal economies enjoyed by a firm are neutralized by
internal diseconomies so that output increases in the same proportion
...
Another reason is the balancing of external economies and external diseconomies
...
Constant returns to scale also result when factors of production are perfectly divisible,
substitutable, and homogeneous and their supplies are perfectly elastic at given prices
...
CHAPTER-4
ECONOMIES OF SCALE & DISECONOMIES OF SCALE
Economies of scale are when the cost per unit of production (Average cost) decreases because the
output (sales) increases
...
(i)Growth brings both advantages and disadvantages to a business
...
(ii)This is the area of economies and diseconomies of scale
...
This competitive cost advantage allows large firms to have larger profit
86
margins and have more options in pricing policy
...
Therefore since costs per unit (Average Costs) are
calculated by dividing the cost by the number of units of output
(ii)AC=Costs/quantity
(iii)Then any average involving Fixed Costs (Numerator) must decrease as quantity produced
(Denominator) increases (make sure you follow this ok)
...
Managerial - managers are on a fixed salary
2
...
Technical - machinery, buildings etc are paid for as a fixed amount
Purchasing economies of scale:
Large firms are able to negotiate more favourable terms when buying raw materials etc
...
Bulk buying - remember it is the cost per unit of buying in bulk not the total cost (Great example is
supermarkets and local shop)
...
Financial - similar in principle to buying in bulk but this time interest rates a more favorable
Reasons:
1
...
Coordination - between departments
3
...
Principle agent problem - delegating to employees who are not as committed as the owner
...
Types of Internal Economies of Scale
87
(i)Administrative or Managerial Economies
(ii)Technical Economies
(iii)Marketing Economies or Commercial Economies
(iv)Indivisibility
(v)Financial Economies
Administrative or Managerial Economies
When a firm expands its output or enlarges the scale of production it follows the principle of division
of labour and creates special departments e
...
marketing, production, cost, processing cost accountant,
marketing manager etc
...
The entrepreneur gives
attention to more important jobs e
...
import and export problems, credit from banks and concessions
from the government etc
...
(i)Technical Economies
Technical economies arise due to the large scale production because there is a mechanical advantage
in the use of large machines
...
Specialised
persons can only be employed with large machinery and plant
...
(ii)Marketing Economies or Commercial Economies
These economies arise from the purchase of raw material and sale of finished goods
...
g
...
(iii)Indivisibility
We can get total benefit from most of the factors of production when they are being used at full
capacity
...
This may be due to indivisibility of factors of production
...
e
...
Firstly, skilled and trained labor becomes available to all the firms
...
Thirdly, the transport and communication facilities may get improved
considerably
...
Lastly,
supplementary industries may emerge to assist the main industry
...
Firstly,
an individual firm may not be in a position to spend enormous amounts on research
...
The fruits of the invention can be
shared by all the member firms
...
(iii)Economies of Disintegration
When the industry grows, it becomes possible to split up production into several processes and leave
some of the processes to be carried out more efficiently by specialised firms
...
For example, in the cotton textile industry, some firms may
specialise in manufacturing thread, some others in producing vests, some in knitting briefs, some in
weaving t-shirts etc
...
Both will help the industry in
avoiding duplication, and in saving time materials
...
(i)Internal Diseconomies
Internal diseconomies implies to all those factors which raise the cost of production of a particular
firm when its output increases beyond the certain limit
...
When a
firm expands beyond a certain limit, it becomes difficult for the manager to manage it efficiently or to
co-ordinate the process of production
...
(b) Technical Difficulties:
Another major reason for the onset of internal diseconomies is the emergence of technical difficulties
...
If a firm operates beyond these limits
technical diseconomies will emerge out
...
Beyond, this optimum point, technical economies will stop and technical
diseconomies will result
...
It may be due to the use of inferior or less efficient factors as the
efficient factors are in scarcity
...
(d) Marketing Diseconomies:
After an optimum scale, the further rise in the scale of production is accompanied by selling
diseconomies
...
Firstly, the advertisement expenditure is bound to increase
more than proportionately with scale
...
(e) Financial Diseconomies:
If the scale of production increases beyond the optimum scale, the cost of financial capital rises
...
To conclude, diseconomies emerge
beyond an optimum scale
...
External Diseconomies
External diseconomies are not suffered by a single firm but by the firms operating in a given industry
...
Localisation leads to increased demand for transport and, therefore, transport costs rise
...
This raises the prices of raw-materials and other factors of production
...
Some of the external diseconomies are as under:
(a)
...
The polluted
environment acts as health hazard for the labourers
...
(b)
...
As a
result of this, the transportation of raw materials and finished goods gets delayed
...
As a result of the strains on infrastructure, monetary as well as
the real costs of production rise
...
Diseconomies of High Factor Prices:
The excessive concentration of an industry in a particular industrial area leads to keener competition
among the firms for the factors of production
...
Hence, the expansion and growth of an industry would lead to rise in costs of
production
...
(II)An organization incurs a number of costs, such as opportunity costs, fixed costs, implicit costs,
explicit costs, social costs, and replacement costs
...
It excludes deductions of tax, interest, and
dividend paid by an organization
...
(III)Cost analysis involves the study of total costs incurred by an organization to acquire various
resources, such as labor, raw materials, machines, land, and technology
...
(IV)Apart from this, it enables an organization to decide whether to opt for the available alternative or
not
...
An organization is said to be profitable if its total revenue is
more than costs incurred by it
...
In other words, cost can be defined as monetary expenses that are incurred by an organization for a
specified tiling or activity
...
” In terms of manufacturing, costs refer to sum total -of monetary value of resources used in
producing or manufacturing a product
...
COST FUNCTION
A cost function is a mathematical formula used to used to chart how production expenses will change
at different output levels
...
Management uses this model to run different production scenarios and help predict what the total cost
92
would be to produce a product at different levels of output
...
Understanding a firm’s cost function is helpful in the budgeting process because it helps management
understand the cost behavior of a product
...
Also, this allows management to evaluate how
efficiently the production process was at the end of the operating period
...
Remember, fixed
costs are incurred whether or not we manufacture, whereas variable costs are incurred per unit of
production
...
Cost function:
C(x) = FC + V(x)
Short-run Cost
The Short-run Cost is the cost which has short-term implications in the production process, i
...
these
are used over a short range of output
...
In a short-run, at least one factor of production is fixed while the other remains variable
...
The shortrun cost includes both the fixed cost (that do not change with the change in the level of output) and
variable cost (that varies with the variations in the level of output)
...
For example, Suppose a company observes a sudden surge in the demand for its goods and in order to
meet the increased demand in the short-run, it can increase its level of output only by varying the
variable factors
...
Thus, all the cost incurred on the variable factors such as labor and raw material constitutes
the short-run cost
...
Thus, the short-run cost is treated as a variable cost
...
1 This curve indicates the firm’s total cost
of production for each level of output when the usage of one or more of the firm’s resources remains
fixed
...
Examples of such costs are rent of land, depreciation charges, license fee, interest on loan, etc
...
Such costs remain contractually fixed and so cannot be
avoided in the short run
...
The total fixed cost (TFC) curve is a
horizontal straight line
...
The total
variable cost curve (TVC) starts from the origin, because such cost varies with the level of output and
hence are avoidable
...
In Fig
...
Clearly, variable cost and, therefore, total cost must increase with an increase in output
...
This cost structure is accounted for by the law of
Variable Proportions
...
e
...
These costs are incurred on the fixed factors, Viz
...
but however, the running cost and the depreciation on plant and machinery
is a variable cost and hence is included in the short-run costs
...
In short-run, all the factors of
production and costs are variable and hence the level of output can be changed by varying all the
factors, the even capital
...
The entrepreneurship, land, labor, capital goods, etc
...
The long-run stage is characterized by planning and implementation wherein the producer decides on
the level of production and take long-run decisions that affect the overall cost of the firm
...
Long Run Total Cost
Long run Total Cost (LTC) refers to the minimum cost at which given level of output can be
produced
...
” LTC represents the least cost of
different quantities of output
...
As shown in Figure, short run total costs curves; STC1, STC2, and STC3 are shown depicting
different plant sizes
...
Therefore, LTC envelopes the STC curves
...
The
derivation of long run average costs is done from the short run average cost curves
...
The long run average costs
curve is also called planning curve or envelope curve as it helps in making organizational plans for
expanding production and achieving minimum cost
...
In short run, the
plant sizes are fixed thus, organization increase or decrease the variable factors
...
From Figure, it can be noted that till OB amount of production, it is beneficial for the organization to
operate on the plant SAC2 as it entails lower costs than SAC1
...
Thus, in the long run, it is clear that the producer
would produce till OB on plant SAC2
...
If an organization wants to exceed output from OC, it will be beneficial to produce at SAC3
than SAC2
...
LAC depicts the lowest possible average cost for producing different levels of output
...
It first falls and then rises, thus it is U- shaped curve
...
Returns to scale implies a change in output of an organization with a change in inputs
...
In case of increasing returns to scale (IRS), organizations can double the output by using less than
twice of inputs
...
In case of constant
returns to scale (CRS), organizations can double the output by using inputs twice
...
On the other hand, in
case of decreasing returns to scale (DRS), organizations can double the output by using inputs more
than twice
...
As a result, LAC increases
...
This is because at this stage IRS is applied
...
After M, LAC slopes upwards implying DRS
...
This cost is derived from short run marginal cost
...
If perpendiculars are drawn from point A, B, and C, respectively; then they would intersect SMC
curves at P, Q, and R respectively
...
It should
be noted that LMC equals to SMC, when LMC is tangent to the LAC
...
These costs are borne by the firm itself
...
For a firm, all the actual
97
costs incurred, both implicit (depreciation, interest, insurance, etc
...
) are private costs
...
All these costs are internal costs of the firm and are
incorporated in the firm’s total cost of production
...
The private
benefit is the reward an individual or a firm gets in return of goods and services
...
Social Cost
The Social Cost is the cost related to the working of the firm but is not explicitly borne by the firm
instead it is the cost to the society due to the production of a commodity
...
The social cost includes both the private cost and the external cost
...
These are the costs borne by the society and therefore is called as the social cost
...
For
example, Mathura Oil Refinery discharging its wastes into river Yamuna is contaminating the water
thereby causing the water pollution
...
The use of public utility services such as roadways, drainage systems, etc
...
It is assumed that the disutility created through pollution is equal to the total private and public
expenditure incurred by the firm to safeguard the public from the health hazards and social tension
created by the production process
...
Noise pollution and accident proneness are some other social costs due to rising traffic in big cities
...
Social cost is the sum of private cost and external cost
...
If social cost is more than
private cost, there is an external cost (or
...
On the other hand, if social cost is less
than private cost, there is an external benefit (or positive externality)
...
Knowledge of social cost and social benefit is extremely
important in the efficient utilisation of limited resources
...
Implicit Cost
In economics, an implicit cost, also called an imputed cost, implied cost, or notional cost, is the
opportunity cost equal to what a firm must give up in order to use a factor of production for which it
already owns and thus does not pay rent
...
[1] In other words, an implicit cost is any cost that results from using an asset instead of
renting it out or selling it
...
Implicit costs also represent the divergence between economic profit (total revenues minus total costs,
where total costs are the sum of implicit and explicit costs) and accounting profit (total revenues
minus only explicit costs)
...
Lipsey (1975) uses the example of a firm sitting on an expensive plot worth $10,000 a month in rent
which it bought for a mere $50 a hundred years before
...
[1] In calculating this figure, the firm ought to ignore the figure
of $50, and remember instead to look at the land's current value
...
It is possible still to underestimate these costs, however: for example, pension contributions and
other "perks" must be taken into account when considering the cost of labour
...
Accounting profit only takes explicit costs into account
...
Explicit Costs show that payment has
been made to outsiders, while business is carried on
...
They show that an amount has been spent
over a business transaction
...
Recording of the explicit cost is
very important because it helps in the calculation of profit as well as it fulfils purposes like decisionmaking, cost control, reporting, etc
...
Suppliers provide commodities based on the market demand, their cost and revenue
functions
...
In this article, we
will look at the features of perfect competition
...
These are the three essential features of perfect competition:
The number of buyers and sellers in the market is very large
...
Due to the large number, no buyer or seller influences the demand or supply in the
market
...
In other words, goods produced by different
firms are identical in nature
...
Additional Features of Perfect Competition
(i) Buyers and Sellers have a perfect knowledge of:
The quantities of stock of goods in the market
The conditions of the market
Prices at which transactions of sale or purchase are happening
...
(iii) Buyers have no preference between different sellers
...
(v) Sellers have no preference between different buyers
...
In other words, all
firms must accept the price determined by the market forces to total demand and supply
...
An individual firm supplies a very small portion of the total output and is not
powerful enough to exert an influence on the market price
...
Market price in a
perfectly competitive market is determined by the interaction of the forces of market demand and
market supply
...
Similarly, market supply is the sum of quantity supplied by the individual firms in the industry
...
Therefore, in a perfectly competitive market, the main
problem for a profit-maximizing firm is not to determine the price of its product but to adjust its
output to the market price so that profit is maximized
...
The total stock of the
commodity in the market is limited
...
For example, in the case of perishable commodities like vegetables, fish, eggs, the period may be a
day
...
Fig
...
Let us suppose that the demand curve for fish is given
by dd
...
If
the demand for fish increases suddenly, shifting the demand curve upwards to d’d’
...
In this situation, price is
102
determined solely by the demand condition that is an active agent
...
If the supply
of the product decreases suddenly from SS to S’S’, the price increases from P to P’
...
In this case supply curve shifts leftward causing increase in price of the reduced supply goods
...
Demand curve remaining
the same, the decrease in supply shifts the supply curve to its left to S’S’
...
The supply curve of non-perishable but reproducible goods will not be a vertical straight line
throughout its length
...
The price below which the seller declines to offer for any amount of his product is known as ‘reserve
price’
...
The amount he offers for sale will vary with price
...
The supply curve of a seller will,
therefore, slope upwards to the right up to the price at which he is ready to sell the whole stock
...
(b) Pricing in the Short Run- Equilibrium of the Firm
Short period is the span of time so short that existing plants cannot be extended and new plants cannot
be erected to meet increased demand
...
In the
short run, therefore, supply curve is elastic
...
Demand curve, in a perfectly competitive market, is also the average revenue curve and the marginal
revenue curve of the firm
...
The Ushape of both the cost curves reflects the law of variable proportions operative in the short run during
which the size of the plant remains fixed
...
The QC is the average cost and the firm earns total profit equal to the
area shown by ABCD
...
Earlier to the point of equilibrium, the firm does
not attain the maximum profit as each additional unit of output brings more revenue that its cost
...
For the equilibrium of a firm the two conditions must be fulfilled:
104
(a) The marginal cost must be equal to the marginal revenue
...
Figure 4 shows that marginal cost
is equal to marginal revenue at point e’, yet the firm is not in equilibrium as Oq output is greater than
Oq’
...
e
...
Thus, a perfectly competitive firm will adjust its output at the point where its marginal cost is equal to
marginal revenue or price, and marginal cost curve cuts the marginal revenue curve from below
...
In
the short-run equilibrium firms may earn supernormal profits, normal profits or may incur losses
...
If the average cost is below the average revenue, the
firm earns supernormal profits
...
If the average cost is above the average revenue the firm makes a loss
...
In this case the firm will continue to produce only if it is able to cover its variable costs
...
The point at which the firm covers its variable costs is called ‘the closing-down point’
...
Figure 7 explains shut- down point
...
106
Figure 8 explains that DD is the industry demand and SS the industry supply
...
OQ is the quantity
demanded and quantity supplied
...
In
the long run the firms may not continue incurring losses
...
Firms that are making supernormal profits will expand their capacity
...
Free movement of firms in and outside the industry and readjustment of
the existing firms in the industry will establish a long run equilibrium in which firms will just be
earning normal profits and there will be no tendency of entry or exit from the industry
...
In the long run, accordingly, all factors are variable and non- fixed
...
They can enlarge the old plants or
replace them by new plants or add new plants
...
On the contrary, if the situation so
demands, in the long run, firms can diminish their fixed equipments by allowing them to wear out
without replacement and the existing firm can leave the industry
...
In the long run, it is the long run average and marginal cost curves,
which are relevant for making output decisions
...
The average total cost is of determining importance, since in the long run all
costs are variable and none fixed
...
This is equally valid in the long run
...
If the price is greater than the average cost, the firms will be making
supernormal profits
...
When the new firms enter the industry, the supply or output of the industry will
increase and hence the price of the output will be forced down
...
On the other hand, if the price happens to be below the average cost, the firms will be incurring loses
...
As a result, the output of the industry will decrease
and the price will rise to equal the average cost so that the firms remaining in the industry are making
normal profits
...
Thus, for a perfectly competitive firm to be in
equilibrium in the long run, price must equal marginal and average cost
...
Hence, marginal cost can be equal to the average cost
only at the point where average cost curve is neither falling nor rising, i
...
at the minimum point of
average cost curve
...
Thus, the conditions for long run equilibrium of perfectly competitive firm can be written as:
Price = Marginal Cost = Minimum Average Cost
...
4
...
The firm under perfect competition cannot be in long run equilibrium at price
OP’, because though the price OP’ equals MC at G (i
...
, at output OQ) but it is greater than the
average cost at this output and, therefore, the firm will be earning supernormal profits
...
Hence, there
will be attraction for the new firms to enter the industry
...
At point F or equilibrium output OQ”, the price is equal to average cost, and hence the firm will be
earning only normal profits
...
Hence, the firm will be in equilibrium at OP price and OQ output
...
Though price OP” is equal to marginal cost at point E, or at output OQ” but price OP” is lower than
the average cost at this point and thus the firm will be incurring losses
...
To avoid these losses, some of the firm will leave the industry
...
When the price OP is reached, the firms would have
no further tendency to quit
...
Thus, at OP price, full equilibrium, i
...
equilibrium of all the individual firms and also of the industry, as a whole, is achieved in the long run
under perfect competition
...
At one extreme is perfect competition
...
This produces a system in which no individual
economic actor can affect the price of a good – in other words, producers are price takers that can
choose how much to produce, but not the price at which they can sell their output
...
For example,
commodity markets (such as coal or copper) typically have many buyers and multiple sellers
...
It is unlikely
that a copper producer could raise their prices above the market rate and still find a buyer for their
product, so sellers are price takers
...
Monopolies are
characterized by a lack of economic competition to produce the good or service and a lack of viable
substitute goods
...
Public utility companies tend to be monopolies
...
There are no good substitutes for electricity delivery so consumers have few options
...
110
Sources of Monopoly Power
Monopoly power comes from markets that have high barriers to entry
...
Perfect Competition
Monopoly and perfect competition mark the two extremes of market structures, but there are some
similarities between firms in a perfectly competitive market and monopoly firms
...
The shutdown decisions are the
same, and both are assumed to have perfectly competitive factors markets
...
In a perfectly competitive market, price equals marginal
cost and firms earn an economic profit of zero
...
Perfect competition produces an equilibrium in which
the price and quantity of a good is economically efficient
...
For this
reason, governments often seek to regulate
...
The Monopolist behaves like a firm
...
The profits are maximised when marginal cost is equal to marginal
revenue
...
A Monopolist being the only producer and seller of that commodity can determine its price and the
quantity of its production or supply
...
Either he fixes the
price and leaves the output to be determined by the consumer demand at that price or he can fix the
output to be produced and leave the price to be determined by the consumers’ demand for his product
...
Under no circumstances, he will be ready to bear losses
...
As soon
as the marginal reserve is zero he will not increase its supply
...
The explanation and diagrams of these situations are given below:
On the point E the firm is in equilibrium when MC = MR
...
Under
the condition, OP is the price and OQ is the ‘total production’ of the commodity so determined
...
If AR
> AC, the difference between the two is profit per unit and by multiply it with total number of units
produced we can get total profit
...
Thus, RS =PT is unit for
profit
...
In
the second figure RQ = OP is the determined price and RQ is the average cost
...
In the figure three also price per unit is RQ = OP but cost per unit is SQ
...
As a result TPRS shaded area will be the total loss
...
In the long period, this loss will disappear, under that condition and situation, only
profit will be earned
...
During this period in order to gain excess profit, he will change efficiency and capacity of
his resources according to his need
...
This is clear from the following figure:
113
In this figure LMC and LMR intersect each other at the point E and after that LMC goes on rising
...
But average cost is SQ
...
ADVERTISEMENTS:
Under Price Competition AR =MR, where-as under Monopoly MR
This
price is acceptable to all the firms in the industry
...
So, average revenue
and marginal revenue, at every level of production, will be constant and equal
...
Under Monopoly, to sell every additional unit of the commodity price will have to be lower
...
But the
decrease in average revenue is relatively less sharp than the decrease in marginal revenue, It is
because marginal revenue is limited to one unit, whereas in case of average revenue, the decrease
price is divided by the number of units
...
That is the reason why marginal revenue is less than average revenue
...
In pure price
discrimination, the seller charges each customer the maximum price he or she will pay
...
Price discrimination is most valuable when the profit that is earned as a result of separating the
markets is greater than the profit that is earned as a result of keeping the markets combined
...
Consumers in a
relatively inelastic submarket pay a higher price, while those in a relatively elastic sub-market pay a
lower price
...
]
Procedure:
With price discrimination, the company looking to make the sales identifies different market
segments, such as domestic and industrial users, with different price elasticity
...
For example, Microsoft Office Schools edition is available for a lower price to educational institutions
than to other users
...
The company must
also have monopoly power to make price discrimination more effective
...
Because prices vary among units, the firm captures
all available consumer surplus for itself
...
Second-degree price discrimination occurs when a company charges a different price for different
quantities consumed, such as quantity discounts on bulk purchases
...
For example, a theater may divide moviegoers into seniors, adults, and children,
each paying a different price when seeing the same movie
...
Examples of Price Discrimination
One example of price discrimination can be seen in the airline industry
...
When demand for a particular flight is high, airlines raise ticket prices in response
...
Because many passengers prefer flying home late on Sunday, those
115
flights tend to be more expensive than flights leaving early Sunday morning
...
With price discrimination, a seller charges customers a different fee for the same product or service
...
Second-degree discrimination involves discounts for products or services bought in bulk, while thirddegree discrimination reflects different prices for different consumer groups
...
The monopolist has control over
pricing, demand, and supply decisions, thus, sets prices in a way, so that maximum profit can be
earned
...
This
practice of charging different prices for identical product is called price discrimination
...
”
According to Stigler, “Price discrimination is the sale of various products at prices which are not
proportional to their marginal costs
...
”
According to J
...
Bains, “Price discrimination refers strictly to the practice by a seller to charging
different prices from different buyers for the same good
...
Types of Price Discrimination:
Price discrimination is a common pricing strategy’ used by a monopolist having discretionary pricing
power
...
There are three types of price discrimination, which are shown in Figure-13:
116
The different types of price discrimination (as shown in Figure-13) are explained as follows:
i
...
The
different prices are charged according to the level of income of consumers as well as their willingness
to purchase a product
...
ii
...
This type of discrimination is also called dumping
...
On the basis of use:
Occurs when different prices are charged according to the use of a product
...
Degrees of Price Discrimination:
Price discrimination has become widespread in almost every market
...
The degree of price
discrimination vanes in different markets
...
First-degree Price Discrimination:
117
Refers to a price discrimination in which a monopolist charges the maximum price that each buyer is
willing to pay
...
In this, consumers fail to enjoy any consumer surplus
...
ii
...
Railways and airlines
practice this type of price discrimination
...
Third-degree Price Discrimination:
Refers to a price discrimination in which the monopolist divides the entire market into submarkets
and different prices are charged in each submarket
...
In this type of price discrimination, the monopolist is required to segment market in a manner, so that
products sold in one market cannot be resold in another market
...
The groups are divided according to age, sex, and
location
...
Students get discount in
cinemas, museums, and historical monuments
...
It is possible under the following conditions:
i
...
The degree of the price
discrimination depends upon the degree of monopoly in the market
...
Separate Market:
Implies that there must be two or more markets that can be easily separated for discriminating prices
...
iii
...
A supplier can discriminate
prices if there is no contact between buyers of different markets
...
The monopolists should be able to separate markets and avoid reselling in these
markets
...
Different Elasticity of Demand:
Implies that the elasticity of demand in the markets should differ from each other
...
Price discrimination fails in case of markets having same
elasticity- of demand
...
However, it acts as a loss for the
consumers
...
Helps organizations to earn revenue and stabilize the business
ii
...
Benefits customers, such as senior citizens and students, by providing them discounts
In spite of advantages, there are certain disadvantages of price discrimination
...
Leads to losses as some consumers end up paying higher prices
ii
...
CHAPTER -4
PRICING UNDER MONOPOLISTIC COMPETITION
(i)In monopolistic competition, the market has features of both perfect competition and monopoly
...
(ii) In monopolistic competition, the market for soaps and detergents in India and many well-known
brands like Lux, Rexona, Dettol, Dove, Pears, etc
...
(iii)All manufacturers produce soaps, appears to be an example of perfect competition, but each seller
varies the product slightly to make it different from its competitors
...
Thus, every seller to attract buyers to itself based on some factor other than
price
...
Features
Under, the Monopolistic Competition, there are a large number of firms that produce differentiated
products which are close substitutes for each other
...
Features:
(i)Product Differentiation: This is one of the major features of the firms operating under the
monopolistic competition, that produces the product which is not identical but is slightly different
from each other
...
(ii)Large number of firms: A large number of firms operate under the monopolistic competition, and
there is a stiff competition between the existing firms
...
(iii)Free Entry and Exit: With an intense competition among the firms, the entity incurring the loss
can move out of the industry at any time it wants
...
120
(iv)Some control over price: Since, the products are close substitutes for each other, if a firm lowers
the price of its product, then the customers of other products will switch over to it
...
Thus, under the
monopolistic competition, an individual firm is not a price taker but has some influence over the price
of its product
...
Since the products are different and are close substitutes for each other; the firms need to
undertake the promotional activities to capture a larger market share
...
To meet the needs of the customers, each firm tries to adjust its product accordingly
...
Thus, the amount of product a firm is selling in the market depends on the uniqueness
of its product and the extent to which it differs from the other products
...
These factors include aggressive advertising, product development, better distribution, after sale
services, etc
...
If the firms indulge in price-wars, which is the possibility under perfect competition,
some firms might get thrown out of the market
...
In such a market, all firms determine the price of
their own products
...
Overall, we can say that
the elasticity of demand increases as the differentiation between products decreases
...
In this figure AC is below
the AR curve
...
Cost is equal to the area OQBR and revenue is
equal to the area OQPA
...
121
Loss - The figure shows a situation of loss in monopolistic competition
...
This means that cost is no longer being covered
...
The difference between the two PP’TT’ is the
amount of loss that is being suffered by the firm
...
above depicts a firm facing a downward sloping, but flat demand curve
...
Conditions for the Equilibrium of an individual firm
The conditions for price-output determination and equilibrium of an individual firm are as follows:
(a) MC = MR
(b) The MC curve cuts the MR curve from below
...
, we can see that the MC curve cuts the MR curve at point E
...
122
Total super-normal profit = APCB
The following figure depicts a firm earning losses in the short-run
...
, we can see that the per unit cost is higher than the price of the firm
...
As these firms enter, the profits per firm decrease as the total
demand gets shared between a larger numbers of firms
...
Therefore, in the long-run, firms, in such a market, earn only normal profits
...
This is because new firms will enter into the
market to take advantage of excess profits in the market
...
MC must be equal to MR and AC must also be equal to AR
...
The Firm cost and revenue area are the same OMPP’
...
123
As we can see in Fig
...
This corresponds to quantity Q1 and price P1
...
Therefore, all firms earn zero
super-normal profits or earn only normal profits
...
In simple words, it produces a lower quantity than its full capacity
...
above, we can see that
the firm can increase its output from Q1 to Q2 and reduce average costs
...
Hence, we can conclude that in
monopolistic competition, firms do not operate optimally
...
In case of losses in the short-run, the firms making a loss will exit from the market
...
124
CHAPTER-5
PRICING UNDER OLIGOPOLY
(a)The term ‘Oligopoly’ is coined from two Greek words ‘Oligo meaning ‘a few’ and ‘Polly means
‘to sell’
...
The concentration ratio measures the market share of the
largest firms
...
There
is no precise upper limit to the number of firms in an oligopoly, but the number must be low enough
that the actions of one firm significantly influence the others
...
According to
game theory, the decisions of one firm therefore influence and are influenced by decisions of other
firms
...
Entry barriers include high investment requirements, strong consumer loyalty for existing
brands and economics of scale
...
In India, markets for automobiles, cement, steel, aluminium, etc, are the examples of oligopolistic
market
...
Collusive oligopoly : price determination under cartel
125
(i)In order to avoid uncertainty arising out of interdependence and to avoid price wars and cut throat
competition, firms working under oligopolistic conditions often enter into agreement regard-ing a
uniform price-output policy to be pursued by them
...
But since formal or open agreements
to form monopolies are illegal in most countries, agreements reached between oligopolists are
generally tacit or secret
...
(i)Collusion
There are three main factors which bring collusion between the oligopolistic firms
Collusion reduces the degree of competition between the firms and helps them act monopolistically in
their effort of profit maximisation
Collusion reduces the oligopolistic uncertainty surrounding the market since cartel members are not
supposed to act independently and in the manner that is determined to the interest of other firms
Collusion forms a kind of barrier to the entry of new firms
...
(A) Cartels:
A cartel is an association of independent firms within the same industry
...
Cartels
may be voluntary or compulsory and open or secret depending upon the policy of the govern-ment
with regard to their formation
...
We discuss below the two most
common types of cartels: (1) Joint profit maximisation or perfect cartel; and (2) market-sharing cartel
...
Joint Profit Maximisation Cartel:
The uncertainty to be found in an oligopolistic market provides an incentive to rival firms to form a
perfect cartel
...
In this, firms producing a
homogeneous product form a centralised cartel board in the industry
...
126
The board determines output quotas for its members, the price to be charged and the distribution of
industry profits
...
Assumptions:
The analysis of joint profit maximisation cartel is based on the following assumptions:
1
...
2
...
3
...
4
...
5
...
6
...
7
...
Joint Profit Maximisation Solution:
Given these assumptions, and given the market demand curve and its corresponding MR curve, joint
profits will be maximised when the industry MR equals the industry MC
...
The aggregate marginal cost curve of the industry ΣMС is drawn by the lateral
summation of the MC curves of firms A and В, so that ΣMС = MCa + MCb
...
127
First of all, the cartel will estimate the demand curve of the industry’s product
...
29
...
Cartel’s marginal cost curve (MCc) will be given by the horizontal addition of the marginal cost
curves of the two firms
...
29
...
It should be noted that cartel’s marginal cost curve MCc, obtained as it is by horizontal addition of
marginal cost curves of the two firms, will indicate the minimum possible total cost of producing each
industry output on it; each industry output being distributed among the two firms in such a way that
their marginal costs are equal
Now, the cartel will maximise its profits by fixing the industry’s output at the level at which MR and
MC curves of the cartel intersect each other
...
29
...
It will also be seen from the demand curve DD that the output
OQ will determine price equal to QL or OP
...
This can be known by drawing a
horizontal straight line from point R towards the Y-axis
...
The output quota of firm A will be OQ1 and of firm B will
be OQ1
...
Criticisms of the Model:One main drawback of the cartel model is that the threat to revert to Cournot
behaviour for- ever is not really strong or very realistic
...
A more
realistic model would consider shorter periods of retaliation
...
2) Market -Sharing Cartels:
(I)The formation of perfect cartels, as described above, has been quite rare in the real world even
where their formation is not illegal
...
(II)Non-price competition: the non price competition agreements are usually associated with loose
cartels
...
The only requirement is that firms are not allowed to reduce the price below cartel price
...
While low cost firms press for a low price ,the high cost firms press for a higher
price
...
But the firms are allowed to compete with one another in the market On a price level basis
...
However, as the rivals
gradually loose their customers, the cheating by the low-cost firms will be ultimately discovered and
consequently open price war may commence and cartel breaks down
...
The market-sharing cartel is the agreement
reached between the oligopolistic firms regarding quota of output to be produced and sold by each of
them at the agreed price
...
However, when costs of member-firms are different, the different quotas for various firms will be
fixed and therefore their market shares will differ
...
During the bargaining process, two
criteria are usually adopted to fix the quotas of the firms
...
In this arrange-ment,
price and also style of the product of cartel firms may vary
...
Only two firms can enter into market-sharing agreement on the basis of the quota system
...
Each firm produces and sells a homogeneous product
...
The number of buyers is large
...
The market demand curve for the product is given and known to the cartel
...
Each firm has its own demand curve having the same elasticity as that of the market demand curve
...
Both firms share the market equally
...
Cost curves of the two firms are identical
...
There is no threat of entry by new firms
...
Each sells the product at the agreed uniform price
...
AC and MC are their identical cost curves
...
Since the total output of the industry is OQ which is
equal to 2 x Oq = (OQ = 20q), it is equally shared by the two firms as per the quota agreement
...
The total profit earned
by each firm is RP x Oq and by both is RP x 20q or RP x OQ
...
Moreover, their cost curves are also not identical
...
Each firm will charge an independent price in accordance with its own MC and
MR curves
...
They may be charging a price
slightly above or below the profit maximisation price depending upon its cost conditions
...
This will lead to the breaking up of the market
sharing agreement
...
Most cartels are loose
...
Cartels do not prevent the possibility of entry of new firms
...
They create the
conditions for instability in price and output
...
2
...
4
...
(ii) Agricultural income should be taxed
...
a
...
ii
and
iii
c
...
iii and iv
Micro Economics is a study of
a
...
Output and employment growth in the economy
c
...
d
...
What is the opportunity cost of you doing two MPOB assignments?
a
...
2 Micro Assignment
c
...
4 Micro Assignment
Which of the following statements about opportunity cost is TRUE?
I
...
II
...
III
...
a
...
b
...
III
only
...
I and III only
...
Microeconomics deals with thestudy of
economicentities
...
Aggregate
b
...
Macro
131
d
...
Cross elasticity of demand between two perfect substitutes will be
a
...
high
c
...
infinity
7
...
Own-price
elasticity of demand is equal to:
a
...
6
...
2
d
...
8
...
5
...
A 1% increase in price will result in a 50% increase in quantity supplied
...
A 1% increase in price will result in a 5% increase in quantity supplied
c
...
d
...
5% increase in quantity supplied
...
Qd = 1200 - 2 P
Qs = 8 P
What is equilibrium quantity and Price?
a
...
P=120, Q=900
c
...
P=120, Q=960
10
...
b) P = $4, Q = 8
...
d) None of the above
...
George consumes only two goods, pizza and compact discs
...
Suppose the price of pizza decreases
...
increase due to the income effect
...
increase due to the substitution effect
...
increase due to a negative income elasticity
...
remain unchanged, since the income elasticity of pizza is greater than 0
...
Which best expresses the law of diminishing marginal utility?
a
...
b
...
c
...
d
...
13
...
a
...
Diminishing
c
...
Zero
14
...
MRSxy>Px/Py
b
...
MRSxy=Px/Py
d
...
Suppose there are two different points on an isoquant for inputs capital (K) and labour (L):
point A (at K=10, L=20), and point B (at K=15, L=10)
...
Producers prefer capital to labour
...
Using 10 units of capital and 20 units of labour costs the same amount as using 15
units of capital and 10 units of labour
...
Using 10 units of capital and 20 units of labour produces the same output as 15 units of
capital and 10 units of labour
...
Capital is cheaper than labour
...
Labour is cheaper than capital
...
Short-run production function shows the functional relation between ………
...
a
...
Materials and matters
c
...
Functions and equations
17
...
of an IQ
a
...
Function
c
...
Price
18
...
a
...
Price lines
c
...
Bridge line
19
...
total revenue is zero
...
average revenue is zero
...
total revenue is at a maximum or a minimum
...
average revenue is at a maximum or a minimum
...
The law of variable proportions depends on the assumption …………
...
Heterogeneity of factor
b
...
Changing technology
d
...
The upper portion of the kinked demand curve is relatively
a
...
More elastic
c
...
Inelastic
22
...
Price taker
b
...
Adjust price
d
...
Efficient allocation of resources is achieved to greatest extent under
a
...
Perfect competition
c
...
Monopolistic competition
24
...
a monopolist
...
an oligopolist
...
a perfect competitor
...
a monopolistic competitor
...
The short-run supply curve of a perfectly competitive firm
a
...
134
b
...
c
...
d
...
26
...
many monopolistically competitive firms
b
...
a former monopoly that has been broken up by the government
d
...
Internal economies of scale are those that
a
...
Increase due to the growth of the industry as a whole
c
...
Reduce production costs in the short run
28
...
a
...
Business, Location
c
...
Business, Size
29
...
price will be higher and output will be lower
...
price will be lower and output will be higher
...
price will be higher and output will be higher
...
It is not possible to predict without further information about the market
30
...
Perfect competition
b
...
Oligopoly
d
...
Economics is a science which deals with
...
matters and substance
b
...
human wants and resources
d
...
Microeconomics deals with the study of
economic entities
...
Aggregate
b
...
Macro
135
d
...
Macroeconomics deals with
economic entities
...
Aggregate
b
...
Micro
d
...
is an example of Microeconomic theory
...
Theory of Consumption
b
...
Theory of Money
d
...
is an example of Macroeconomic theory
...
Theory of Production
b
...
General Theory
d
...
Opportunity costs are
measured in monetary terms
...
Always
b
...
Not
d
...
An exogeneous variable exists
the economic model
...
Within
b
...
Inside
d
...
express functional relationship between two or more variables
...
Functions
b
...
Programs
d
...
Slope of straight line is
at all points
...
Different
b
...
Falling
d
...
Graph is a
tool used to show the relationship between the variables
...
Physical
b
...
Social
d
...
shows the rate at which a variable change
...
Slope
b
...
Function
d
...
Positive Economics is based on
...
Value judgement
b
...
Facts
d
...
Normative Economics is based on
...
Moral values
b
...
Numbers
d
...
Sociology is an example of
science
...
Positive
b
...
Normative
d
...
Physics is an example of
science
...
Positive
b
...
Fiscal
d
...
plays an important role in the market economy
...
Government
b
...
Public sector enterprise
d
...
An equation specifies the relationship between the
variables
...
Positive and normative
b
...
Dependent and independent
d
...
Downward curve or line shows
relation between two variables
...
Positive
b
...
Inverse
d
...
Upward curve or line show
relation between two variables
...
Direct
b
...
Negative
d
...
=∆Y/∆X
a
...
Slope
c
...
Function
137
51
...
53
...
55
...
57
...
59
...
is the point at which the line or the curve crosses the vertical axis
...
Internet
b
...
Equilibrium
d
...
a
...
without
c
...
never in
Exogeneous variable is that which influences
...
Externally
b
...
Excessively
d
...
Unlimited buyers and limited sellers
b
...
Unending wants and limited people
d
...
a
...
Functions
c
...
Slopes
Resources have
uses
...
Limited
b
...
Alternative
d
...
a
...
How to produce
c
...
Full employment of resources
The problem deals with the way in which output is distributed among the members of society
...
What to produce
b
...
For whom to produce
d
...
a
...
How to produce
c
...
Full employment of resources
The problem of
refers to the question of whether all available resources of a society
are fully utilized
...
b
...
d
...
is a universal problem
...
Scarcity
b
...
Lack of investment
d
...
According to Prof
...
a
...
Supply
c
...
Price mechanism
63
...
a
...
Efficiency and marginalism
c
...
Efficiency and production
64
...
Work and leisure
b
...
Work and supply
d
...
Human wants refer to all goods and services individual
a
...
Desire
c
...
Demand
66
...
Profit
b
...
Revenue
d
...
Market economy suffers from
which are responsible for problem like inflation,
unemployment etc
...
Imperfection
b
...
Inefficiency
d
...
Government can improve economic efficiency by correcting
...
Market failure
b
...
Unemployment
d
...
cost is the value of the next best alternative or option
...
70
...
72
...
74
...
Production
b
...
Opportunity
d
...
a
...
Consumption
c
...
Saving
An is something that induces a person to act
...
Investment
b
...
Incentive
d
...
a
...
Revenue
c
...
Income
is a place in which people make exchanges which are governed by prices
...
Market
b
...
Bank
d
...
Alfred Marshall
b
...
David Ricardo
d
...
A country’s
depends on its ability to produce goods and services
...
Marshall’s
d
...
In short run Phillips curve have
slope
...
Negative
b
...
Vertical
d
...
can improve market outcomes
...
Public sector
b
...
Service sector
d
...
allows countries to specialize in goods and services
...
Production
b
...
Trade
d
...
is a state where there is rise in general price level
...
Deflation
b
...
Prosperity
d
...
a
...
c
...
In long run, Phillips curve is
Upward
Downward
Horizontal
Vertical
...
a
...
c
...
d
...
a
...
c
...
People make decision by comparing
Input and output
Demand and Supply
Cost and benefit
Income and expenditure
141
analysis
...
The concept of invisible hand was introduced by
...
Alfred Marshall
b
...
C
...
Lionel Robbins
d
...
The relationship between productivity and
has important implications for
public policy
...
Investment
b
...
Saving
d
...
When money supply increases in economy, value of money decreases and price
...
Increases b
...
Remains constant d
...
Number of sellers
b
...
Control over price
d
...
Degree of
decides the nature of market
...
Competition
b
...
Price discrimination
d
...
There is/are
number of sellers under perfect competition
...
One
b
...
Few
d
...
There is/are
number of sellers under monopoly
...
One
b
...
Few
d
...
There is/are
number of sellers under oligopoly
...
One
b
...
Few
d
...
As per law of demand, demand and price of a good are
...
a
...
Inversely
c
...
Not
142
91
...
related
...
Positively
b
...
Inversely
d
...
Shift and movement in demand are ………
...
Different
b
...
Equal
d
...
Movement in supply is caused by changes in………
...
Non-price factors
b
...
technology
d
...
Shift in demand is caused by changes in the………
...
non-price factors
b
...
cost of production
d
...
The market demand curve slopes
from left to right
...
Downward
b
...
Horizontal
d
...
Market
is derived by adding up all the individual demand
...
Demand
b
...
Price
d
...
Which of the following shows the inverse relationship between the price of a good and the
amount of the good that consumers want at that price?
a
...
Demand curve
c
...
Production possibilities frontier
98
...
a
...
Prevailing price
c
...
None of the above
99
...
a
...
Price of related goods
c
...
Size off population
100
...
a
...
Varies inversely with price
c
...
Various proportionately with price
101
...
The ratio of percentage change in the demand to the percentage change in price
...
The ratio of percentage change in the demand for a given product to the percentage
change in the price of a related other product
...
The ratio percentage change in the demand for product X to the percentage change
in the demand for product Y
...
The ratio of two different elasticities
102
...
Two products are substitutes
b
...
Two products are complementary
d
...
When demand is perfectly elastic, the demand curve is
a
...
Linear
c
...
Vertical
104
...
Horizontal demand curve
b
...
Vertical demand curve
d
...
If cross elasticity of demand is negative, goods are
...
Complementary
b
...
Not related
d
...
A percentage change in quantity demanded divided by a percentage change in price is
called
a
...
Price elasticity of demand
c
...
Elasticity of substitution
107
...
Income elasticity of demand
144
b
...
Price elasticity of supply
d
...
A percentage change in quantity demanded for one commodity divided by a percentage
change in price of another commodity is called
a
...
Price elasticity of demand
c
...
Cross Elasticity of demand
109
...
Income elasticity of demand
b
...
Promotional elasticity of demand
d
...
A demand curve has a
...
a
...
Positive
c
...
Concave
111
...
income elasticity of demand
...
Positive
b
...
Zero
d
...
Inferior goods have
...
a
...
Negative
c
...
High
113
...
it means demand is perfectly elastic
...
Zero
b
...
One
d
...
When the price elasticity of demand is greater than unity; it implies that the demand
is……
...
Perfectly elastic
b
...
relatively elastic
d
...
Income elasticity is negative for
...
a
...
117
...
119
...
Inferior
c
...
Foreign
Cross elasticity of demand is positive for
...
a
...
Complementary
c
...
Inferior
Cross elasticity of demand is
...
a
...
Negative
c
...
Greater than one
Cross elasticity of demand is
...
a
...
Negative
c
...
Greater than one
When demand is perfectly inelastic, demand curve will be
...
Upward
b
...
Vertical
d
...
Alfred Marshall introduced approach of
utility
...
Cardinal
b
...
Form
d
...
is the base of demand
...
Price
b
...
Utility
d
...
of Paul Samuelson makes a distinction between strong ordering and weak
ordering
...
The law of demand
b
...
The law of diminishing marginal utility
d
...
Paul Samuelson’s theory of
is based on strong ordering
...
Demand
b
...
Revealed preference
d
...
analysis is an example of weak ordering
...
Indifference curve
b
...
Demand
d
...
In economic analysis, a consumer is assumed to be rational when he attempts to
maximize
...
Consumption
b
...
Satisfaction
d
...
In economic analysis, a producer is assumed to be rational when he attempts to
maximize
...
Income
b
...
Investment
d
...
An indifference curve measures the same level of
derived from the different
combinations of two commodities say X and Y
...
Production
b
...
Satisfaction
d
...
An Indifference curve analysis is an example of
utility approach
...
Cardinal
b
...
Form
d
...
An indifference curve analysis was developed by
...
Smith and Ricardo
b
...
Allen and Hicks
d
...
An indifference curve analysis is applicable only to
goods
...
Substitute
b
...
Giffen
d
...
Consumer’s equilibrium was explained by
_ through utility analysis
...
Adam Smith
b
...
David Ricardo
d
...
M
...
The concept of scale of preference is basis of consumer’s
a
...
Choices
c
...
Income
133
...
a
...
Downward
c
...
Horizontal
134
...
a
...
Horizontal
c
...
Downward
135
...
Indifference curves
b
...
Supply curves
d
...
An indifference curve must be
to the origin
...
Convex
b
...
Straight
d
...
The necessary condition of consumer’s equilibrium is
a
...
MRS xy < Px/Py
c
...
MRS xy ≠ Px/Py
138
...
a
...
Diminishing
c
...
Zero
139
...
a
...
Consumption
c
...
Investment
140
...
a
...
Prices of commodities
148
c
...
Savings
141
...
a
...
Prices of commodities
c
...
Savings
142
...
Consumer’s surplus
b
...
Consumer demand
d
...
In indifference curve analysis, the necessary condition for consumers’ equilibrium is
...
MRSxy = Px
b
...
MRSxy = Px / Py
d
...
In indifference curve analysis, the sufficient condition for consumers’ equilibrium is, at
the point of tangency indifference curve must be _
to the origin
...
Upward
b
...
Concave
d
...
Income effect refers to a change in consumer’s equilibrium when his
alone
changes and all other things remains constant
...
Price
b
...
Income
d
...
An inferior good is one, the consumption of which
as income increases
...
Increases
b
...
Remains constant
d
...
If a commodity is normal, income effect will be
...
Positive
b
...
Zero
d
...
In case of inferior good, ICC slopes
...
Upward
b
...
Horizontal
149
d
...
When demand for a commodity increases with an increase in income, it’s called
commodity
...
Giffen commodity
b
...
Inferior commodity
d
...
effect refers to the tendency of a consumer to consume more of a one good
when its relative price falls and to consume less of that good when its relative price
increases
...
Income
b
...
Substitution
d
...
An upward sloping PCC indicates
price effect
...
Positive
b
...
Negative
d
...
A backward sloping PCC indicates
price effect
...
Positive
b
...
Negative
d
...
situation arises when both price effect and income effect on commodity are
negative
...
Depression
b
...
Inflation
d
...
Effect = Income Effect + Substitution Effect
a
...
Consumption
c
...
Combine
155
...
Adam smith
b
...
David Ricardo
d
...
The
slope of demand curve gives rise to the concept of consumer’s surplus
...
Negative
b
...
Vertical
150
157
...
159
...
a
...
c
...
d
...
Positive
b
...
Negative
d
...
Total Utility – Price
b
...
Total utility – Marginal Utility
d
...
a
...
Social
c
...
Political
Following are the limitations of the concept of consumer’s surplus except
Unrealistic assumption
Cardinal measurement is not possible
It is not a realistic concept
Inequality between price and marginal utility
151
(Please write your Enrollment No
...
MAHARAJA SURAJMAL INSTITUTE
(MID - TERM EXAMINATION)
FIRST SEMESTER [BBA,BBA (B&I)] February – 2021
Subject Business Economics
Time: 2
...
Question one is compulsory
...
Discuss any four,
a
...
b
...
c
...
d
...
(4x5)= 20
Consumer Surplus
f
...
Q2
...
(10)
Q3
...
(10)
Q4
...
Explain the consumer equilibrium with
indifference curve
...
Q 6
...
(10)
Discuss the forecasting of demand objectives, steps and methods of estimation
...
Multiple Choice Question, (Annexure -1)(1x30)= 30
Q2
...
(15)
Q3
...
(15)
Q 4
...
(15)
Q 5
...
(15)
152
Title: Business Economics
Description: These are the best notes for India's Top University
Description: These are the best notes for India's Top University