Business Economics

BBA- 107
Unit-1
Economics
• “Production, distribution and consumption of
goods and services”

• Economic Activities
• Non Economic Activities
“Science of Choice”

• Resources
▫ Land
▫ Labour
▫ Capital
▫ Entrepreneurship
• Scarcity
▫ Diff. between wants& needs and available
resources
• Choices- What, How, Who
• Prof. Samuelson- 3 basic problems of society
▫ What commodities shall be produced in what
quantities and when?
▫ How shall goods be produced?
▫ For whom shall goods be produced?
• 3 economic systems
▫ Primitive/ Traditional system
▫ Command economy
▫ Capitalist economy

• Mixed Economy
 7 general questions- Prof. Lipsey
1. What commodities are being produced and in what
quantities?
2. By what method are these commodities produced?
3. How is the society’s output of goods and services
divided among its members?
4. How efficient is society’s production and distribution?
5. Are the country’s resources being fully utilised or are
some of them lying idle?
6. Is the purchasing power of money constant or is it
being eroded with inflation?
7. Is the economy’s capacity to produce goods and
services growing from year to year or is it remaining
static?
• Ques-1: Theory of Price
Microeconomics
• Ques-2: Theory of Production
• Ques-3: Theory of distribution
• Ques-4: Welfare economics
• Ques-5: Trade Cycle Theory
Macroeconomics
• Ques-6: Theory of inflation
• Ques-7: Theory of Economic growth
Microeconomics and Macroeconomics

Microeconomics Macro Economics

Greek Word ‘Mikros’ Greek Word ‘Makros’

meaning small meaning large

Deals with analysis of Deals with the analysis of

individual economic units economy’s large agrregates
and small aggregates
e.g. Consumers, Firms, National Income, Total
industry Consumption, Aggregate
Investment
• Microeconomics and Macroeconomics are
interdependent in nature
• Not competitive but complimentary
Nature of Economics
• Both an art and a science
• Positive and Normative Science
• Used for decision making and judgement
Business Economics
• Business: An economic activity transforming
inputs into outputs.
• Creation of Surplus- essence of economic
activity/ business [Output> Input]
• What determines output: Efficiency and
Sufficiency of 4 Ms of inputs
▫ Men
▫ Machines
▫ Material
▫ Management
 Output

Goods Services

Ex. Education,
Consumer
Capital Goods Health,
Goods
hospitality, etc.

Ownership

Single use
Durables Private Goods Public Goods
goods
Definitions of Business Economics
• “Managerial Economics is the integration of
economic theory with business practice for the
purpose of facilitating decision making and
forward planning by management”- Spencer and
Seigelmen
• “Managerial economics refers to the application
of economic theory and the tools of analysis of
decision science to examine how an organization
can achieve its aim or objective most efficiently”-
Salvatore
Basic Characteristics of BE
Decision
Making of
economic
nature
Multidisci Goal
plinary oriented

science &
BE prescriptiv
art e

Conceptual
and Pragmatic
metrical
 Contribution of BE to business
Product Price and Output
Make or Buy
Production Technique
Advertising Media and Intensity
Investment and Financing

Framework for Decisions Tools and Techniques of Analysis

•Theory of consumer behavior •Statistical analysis
•Theory of the firm •Forecasting
•Theory of the market structure and •Game Theory
pricing

•Use of Economic Concepts and

•Decision Science Methodology
•to solve Managerial Decision Problems
Scope of BE
• Deals with four problems in decision making
and forward planning
▫ Resource Allocation for optimal results
▫ Pricing problems
▫ Investment problems
▫ Inventory and queuing problems
Scope can be summarised as
• Theory of Demand Analysis and forecasting
• Theory of production and production decisions
• Analysis of market structure and pricing theory
• Cost analysis
• Profit analysis and profit management
• Inventory management
 Roles & responsibilities of Managerial
Economists

Specific
General Tasks
Decisions

1. Production Scheduling
2. Demand Forecasting
3. Economic Analysis of Industry External
Factors Internal Factors
4. Investment Appraisal (Pricing &
(General
5. Security management analysis Economics) Investment)
6. Advice on Foreign Exchange Mgt.
7. Advice on Trade
8. Pricing & related decisions
9. Analysing and forecasting envt.
factors
Relationship between BE & Traditional
Economics
• Contribution of Economics to business
economics
▫ To help in understanding the market conditions
and the general economic environment within
which the firm operates
▫ To provide a platform for understanding and
analysing resource allocation problems
 Business Efficiency

Technical Economic
Efficiency Efficiency

Choice of Best Maximum

Technology output at
minimum cost

Business Economics
Difference between B.E. and
Economics
BE Eco

Application of Economics Body of principles itself

Mainly normative + Micro-economic Both micro and macro

principles

Narrower scope Wider scope

Multidisciplinary Foundation of BE
OPPORTUNITY COST
• Unlimited human wants, limited
means to fulfil demands
• Problem of choice
• Every choice involves measurement of
cost in terms of forgone opportunities
• Cost of forgone opportunities is
the opportunity cost of the
decision.
• Alternative which is sacrificed or next
best alternative
Examples
• Machine can produce either A or B products.
Opportunity cost for producing a given quantity
of A is the quantity of which could be produced
otherwise.
• A farmer who is producing wheat can also
produce potatoes with same factor inputs.
• O.C. of Funds employed in one’s own business is
the interest that could be earned on those funds,
had these funds been employed in other
ventures
• OC of Studying full time is the amount forgone
per month being in job
HOW TO EVALUATE OPPORTUNITIES
 Look at the opportunities for given period of time.
 Evaluate the first opportunity by what would be
gained if you choose to do the second opportunity.
 Add up the cost of first opportunity that would not
be incurred if you opt for second opportunity.
 Evaluate the second opportunity in the light of first
one.
 Choose the option whose opportunity cost is higher.
Production Possibility Frontier/ Curve
• Also Called Transformation Curve
• Explains the concept of OC
• Graphical representation of various
combinations of two commodities which a
society can produce with given resources and
state of technology
• Assumptions
▫ Two commodities Model
▫ Resources Given
▫ Technology Given
• Decision principle should be minimisation of OC
given the objectives and Constraints
 Concave to the origin- Law of Increasing

Example
Opportunity Cost

Possibilities Guns Butter

(000’) (000’
Kgs)
A 0 15

B 1 14

C 2 12

D 3 9

E 4 5

F 5 0
• A and F are two extremes, in between there lie
many other possibilities
• Not physical transformation, takes place through
diversion of economy’s resources from one use
to another
• Point inside the graph- attainable, outside-
unattainable
▫ Inside point- inefficient production possibility
▫ Outside Point- attainable with tech improvement
or new invention
• All decisions involving choice invariably involve
the calculation of OC
• Either Explicit or Implicit, Quantifiable or Non-
Quantifiable
Examples of OC in Business
• Make or Buy decisions
• Breakdown or Preventive maintenance of
machines
• Recruitment from outside or promotion from
inside
Time Perspective to Decision Making
• Decision Making is a task of coordination along
the time scale
• Analyse the present problem w.r.t. past
experience contemplating clearly its future
implications
• In terms of:
▫ Temporary run (fixed o/p)
▫ Short run or immediate future (o/p slightly
changed)
▫ Long run or distant future (o/p adjusted freely)
• Mustn’t be too short or too long
Examples: Importance of Time
perspective in decision making

• High price of product today, declining sales later

• Overlooking labour welfare today, deteriorating
productivity and image later
• Advertisement expenditure today, increased
revenue flow later
 Marginalism
The term marginal refers to the change (increase/decrease) in the
total quantity or value due to the one unit change in it’s
determinants. Marginalism includes two important components.
They are:-

1) MARGINAL COST- Marginal cost can be defined as the

change in total cost as a result of producing one more unit of
commodity.

Formula of Marginal Cost (MC) = TCn – TC(n-1)

Where,
TCn= Total cost of producing ‘n’ units
TC(n-1)= Total cost of producing ‘n-1’ units
 Marginalism
For Example:
Total Cost of producing 100 units= INR 2500
Total Cost of producing 101 units= INR 2550
Here,
TCn = 2550 and TC(n-1) =2500
So,MC= 2550-2500= 50

2) MARGINAL REVENUE- Marginal revenue is a benefit which get by producing

one more or next unit of commodity.
Formula of Marginal Revenue (MR) = TRn – TR(n-1)
Where,
TRn= Total revenue of producing ‘n’ units
TR(n-1)= Total revenue of producing ‘n-1’ units
 Marginalism
Decision Rule:
MR<MC- Condition of Loss.
MR=MC- No profit No Loss.
MR>MC- Condition of Profit.

This concept of marginality assumes special significance where

maximization and minimization problem can be solved. This is
used in business analysis where businessman has to see the affect
adding or subtracting one variable factor on the total output.
 Incrementalism
Chunk change or Bulk change

The marginal concept is applied only to Marginal Revenue and

Marginal Cost which is sometime difficult to estimate because
businessman sell or produce their product in bulk. So, that’s why
INCREMENTAL PRINCIPLE is applied.

Incrementalism consider two major aspects:-

A. INCREMENTAL COST- It includes the fixed cost and

variable cost. But it doesn't include the sunk cost, cost already
incurred on the excess capacity or cost on unused material.
 Incrementalism
The three major components related to incremental cost are:-
 Present Explicit Cost- Fixed and Variable Cost
 Opportunity Cost
 Future Cost- Advertising cost, depreciation

B. INCREMENTAL REVENUE- The increase in the total

revenue resulting from a business decision is called as
Incremental revenue.

The difference between IC and IR is known as Contribution. It

is useful in taking the decision like:-
 Whether or not accept a project.
 Whether or not introduce a new product.
 Incrementalism
 Whether or not accept the new order.
 Whether or not add an additional plant, etc.

Decision Rule:
TR<TC-Reject
TR=TC- No profit No Loss.
TR>TC- Accept.

The concept of Incrementalism is helpful in taking the business

decision that whether to accept or reject the business proposition
or option.
 Marginal concepts Incremental concepts
Marginal concepts are always Incremental' concepts are defined
defined in' terms of unit changes in terms of chunk changes

Marginal concepts are more Incremental -concepts are more

specific general than marginal concepts
Here the reference is to one But here, more than one
independent variable. independent variable can be
considered at a time.

All Marginal changes are All incremental changes are not

incremental in nature marginal
Time value for money
The time value of money theory states that a rupee that you have
in the bank today is worth more than a reliable promise or
expectation of receiving the rupee at some future date. We can
invest that money today and can earn return on investment such
as interest, dividend etc.

In simple words “ The difference in the value of money today

and tomorrow is referred as TIME VALUE OF MONEY.

REASONS FOR TIME VALUE OF MONEY

• Risk and Uncertainty
• Inflation
• Investment Opportunities
• Individual prefer Current Consumption
 Time value for money
TECHIQUES FOR CALCULATING TIME
VALUE OF MONEY

A) COMPOUNDING TECHNIQUE/ FUTURE

VALUE TECHNIQUE:-
In this technique interest earned on principal amount
becomes a part of principal amount at the end of
compounding period.

Formula FVn = PV(1+r)n

Where,
FVn= Future Value of money for n period
(1+r)n= Future value Interest factor
r= Rate of Interest
PV= Present Value of Money
Time value for money
TECHIQUES FOR CALCULATING TIME
VALUE OF MONEY

B) DISCOUNTING TECHNIQUE/ PRESENT

VALUE TECHNIQUE:-
The process of determining present value of future
payment or receipt is known as Discounting. It is
based on the concept that rupee earned today is more
worth than a rupee received tomorrow.
Formula V= R1/(1+i) +
R2/(1+i)2………Rn/(1+i)n
OR

Where, R= Principal Amount, i= Interest Rate & t=

number of years investment is to be made
Market Forces & Equilibrium
Meaning of Market:
A market is a group of buyers and sellers of a
particular good or service. The buyers as a group
determine the demand for the product, and the
sellers as a group determine the supply of the
product.
In market there are two most important deciding
forces. They are:
• Demand: Quantity demanded of any good, which is the
amount of the good that buyers are willing and able to
purchase.
• Supply: The quantity supplied of any good or service is
the amount that sellers are willing and able to sell.
Market Forces & Equilibrium
Market Equilibrium:
Equilibrium means a state of equality or a state of
balance between market demand and supply. This
point is usually denoted as ‘E’. The price at which these
two curves cross is called the equilibrium price, and the
quantity is called the equilibrium quantity.
• Theoretical construct only because actual
conditions are dynamic & uncertain.
• Entrepreneurs try and make educated guesses to
reach equilibrium by best combinations of
goods, prices, quantities, etc.
• Monkey & dartboard
 Risk, RETURN & PROFIT

• Risk is defined as “The probability that an actual return

on an investment will be lower than the expected”.

• Measured by calculating Standard deviation on average

returns

• Higher the SD, greater the risk. Higher the risk, higher the
returns
Risk is broadly classified into two categories:
 Meaning of Uncertainty

Situation where the current state of knowledge is such that :

the order or nature of things is unknown.

the consequences, extent, or magnitude of circumstances,

conditions, or events is unpredictable.

credible probabilities to possible outcomes cannot be assigned.

Return
• Money made or lost on an investment over some
period of time
• Positive return= profit, Negative return= Loss
• Real Return Vs. Nominal Return
 Meaning of Profit

Profit is the reward gained by risk taking entrepreneurs when the

revenue earned from selling a given amount of output exceeds the
total costs of producing that output.

Total profits = Total revenue (TR) – Total costs (TC)

Where TR = Total Revenue = Unit price (P) x Quantity (Q) =

PQ,
and,
TC = Total cost = Variable Cost (VC) + Fixed Cost (FC).
Introduction to Behavioural Economics
• Traditional and Neo Classical Economics
assume Rationality in decision making
• i.e. maximisation of personal benefit (utility) or
Maximisation of Profit
• Behavioural economics attempts to understand
the effect of individual psychological processes,
including emotions, norms, and habits on
individual decision-making in a variety of
economic contexts.
3 questionable assumptions contained
in traditional theory.
• That individuals make decisions based on
‘unbounded (unlimited) rationality’ accurately
processing all the information at their disposal.
• They the use ‘unbounded willpower’ to convert
wants into actions and consumption (or
production), and have absolute self-control
when confronted with choices. In other words,
they can resist making ‘poor’ choices.
• They are driven by ‘unbound selfishness’ to
achieve maximum benefit for themselves.
Nudge Theory
• Nudge theory is a flexible and modern concept
for:
• Understanding of how people think,
make decisions, and behave,
• Helping people improve
their thinking and decisions,
• Managing change of all sorts, and
• Identifying and modifying existing
unhelpful influences on people.
• Nudge theory was named and popularised by the
2008 book, 'Nudge: Improving Decisions About
Health, Wealth, and Happiness', written by
American academics Richard H Thaler and Cass
R Sunstein.
• The book is based strongly on the Nobel prize-
winning work of the Israeli-American
psychologists Daniel Kahneman and Amos
Tversky.
• Nudge theory is mainly concerned with
the design of choices, which influences the
decisions we make. Nudge theory proposes that
the designing of choices should be based on how
people actually think and decide (instinctively
and rather irrationally), rather than how leaders
and authorities traditionally (and typically
incorrectly) believe people think and decide
(logically and rationally).
 Enforced Change Nudge Techniques

Instructing a small child to tidy Playing a 'room-tidying' game with the

his/her room. child.

Erecting signs saying 'no littering' and Improving the availability and
warning of fines. visibility of litter bins.

Joining a gym. Using the stairs.

Counting calories. Smaller plate.

Weekly food shop budgeting. Use a basket instead of a trolley.

End of UNIT-1
UNIT-II
• Consumer Behavior and Demand Analysis
• Cardinal Utility Approach: Diminishing Marginal
Utility, Law of Equi-Marginal Utility. Ordinal
Utility Approach: Indifference Curves, Marginal
Rate of Substitution, Budget Line and Consumer
Equilibrium Theory of demand, Law of Demand,
Movement Vs. 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 and Methods (Brief)
Meaning of Demand
Demand refers to quantity of a commodity that a
consumer is willing to buy at different prices
within a given period of time.
Ex: A consumer demands 1kg apple at Rs 50
today.
Characteristics
• Desire of Commodity
• Capacity to buy
• Willingness to buy
• Demand is w.r.t. time
Meaning of utility
• Utility is want satisfying property of a
commodity. From consumer’s angle , utility is
psychological feeling of satisfaction , pleasure ,
happiness or well being , which a consumer
derives from the consumption , possession or
the use of a commodity.
• Utility Vs. Satisfaction: expected satisfaction and
derived utility
• Consumption & demand
▫ Rationality
▫ Consumer behaviour
Types of Demand
• Individual and Market Demand
• Market segment and Total Market Demand
• Composite Demand
• Joint Demand
• Direct Demand and Indirect Demand
• Price Demand, Income Demand and Cross
Demand
 Factors affecting Demand
1. Price of commodity itself
2. Price of related goods – substitutes and
complements.
3. Income of a consumer
4. Taste and preferences
5. Advertisement expenditure
6. Demonstration effect- bandwagon effect ,
snob effect
7. Consumer credit facility
8. Population of the country
9. Consumer expectations
10. Distribution of national income
Cardinal Utility
• Cardinal utility is the idea that economic welfare
can be directly observable and be given a value
• Utility Function
Cardinal Measurement of Utility
• Measured in Unit- Utils
• In terms of Total Utility and Marginal Utility
• Marginal utility(MU)- it is utility derived
from marginal or one additional unit
consumed. It is addition to TU resulting from
additional unit consumed.

• Total utility(TU)- it is the sum of utility

derived by a consumer from the various units
of goods or service he consumes at a point or
over a period of time.
Example
Units of TU MU
Commodity
1 20 20
2 32 32-20=12
3 38 38-32=6
4 38 38-38=0
5 36 36-38= -2
Assumptions of Utility Analysis
• Rationality
• Cardinal utility
• Constant MU of Money
• Diminishing Marginal Utility
• TU Depends on Quantities
Law of diminishing marginal utility
• This law state that as quantity consumed of a
commodity goes on increasing the utility derived from
each successive unit goes on diminishing ,
consumption of all other commodities remaining the
same.
• Successive increase in consumption- MU will fall, TU
will rise till the point MU=0 (Point of Satiety)

• In other words when a consumer consumes more and

more units of a commodity per unit of time e.g. ice-
cream , keeping the consumption of all other
commodities constant , the utility which he derives
from each successive cup of ice-cream goes on
diminishing.
Assumptions
• Consumption in proper units
• Unchanged Quality
• Continuous Process
• Rationality
• Time period
• Constant Price of Commodity
Units of TU(X) MU(X)
commodity X
1 30 30
2 50 20
3 60 10
4 65 5
5 60 -5
6 45 -15
Why MU decrease
• When consumer consumes successive units of a
commodity , his need is satisfied and intensity of
his need goes on decreasing.
Exceptions to Law
• Miser
• Collector of rare articles
• Aesthetics
Price determination and Utility
• Price is determined by MU and not by TU
• Diamond Vs. Water
Law of Equi-Marginal Utility
• Law of DMU in consumer behaviour
▫ In what way should a person allocate his limited
resources among different uses so as to maximise
the total utility derived from consumption
• Concerned with consumer’s equilibrium
• EMU- Classical Version and Modern Version
• Classical Version of EMU
▫ A consumer will reach the stage of equilibrium
when the MU of various commodities that he
consumes are equal
▫ Optimum combination of commodities in limited
resources to give maximum total Utility
▫ Assumption: Limited Resources and Same prices
of all commodities
Example
Units MUx Muy MUz
1 10 14 18
2 8 12 15
3 7 10 12
4 4 8 8
5 2 6 5
6 0 4 3

MUx=MUy=MUz
• Modern Version of Theory- Law of Proportional
Marginal Utility
▫ Criticism of Classical Version: Impractical
Assumption- Same Prices of all commodities
▫ 2 factors influence consumer behaviour-
▫ A)MU of goods
▫ B) Prices of goods

• “The consumer will spend his money-income

on different goods in such a way that
marginal utility of each good is
proportional to its price”
• MUx/Px=MU per Unit of Money Income
• Mux/Px=MUy/Py= MUz/Pz
• (Px X Qx) + (Py X Qy) + …. = Income
Limitations
• Rationality of consumers
• Consumers’ ignorance
• Habits, customs and fashions
• Indivisibility of goods
• Different life spans of goods
• Utility- Ordinal, not Cardinal
• Constant utility of money- impractical
Limitations of Utility Approach
• Cardinal Approach
• Additive assumption of utility
• Utility is independent
• Unrealistic assumptions
Derivation of Demand Curve
• As the consumer purchases more and more
units of the commodity, the marginal utility
derived from that commodity steadily decreases.

• Consumer is ready to pay higher price for the

initial units and lesser for the additional ones.
Ordinal Approach to Consumer
Behaviour
• Cardinal Approach: Psychological and
restrictive in nature, unrealistic assumptions
• Ordinal Approach: behaviour can be analysed in
terms of preferences and rankings
▫ Consumer is able to rank various combinations of
goods and services in order of his preference
Indifference Curve Approach
• Indifference: equal preference
• When consumer assigns same numerical values
for each commodity bundle
• Preference approach to consumer behaviour or
indifference curve approach
• It doesn’t make use of cardinal numbers but
ordinal numbers
• Also called ordinal utility analysis
Indifference Curve
• IC depicts the various combinations of the goods
which provide same level of satisfaction to the
consumer
• It represents the combinations providing a
single level of satisfaction
Combination Units of Good Units of Good
‘Y’ ‘X’
A 64 1
B 48 2
C 36 3
D 25 4
E 15 5
F 8 6
Indifference Schedule
• Various combinations
of the two goods are
equally acceptable to
the consumer and he
prefers none of them to
any point on the curve
• Also called is iso-
utility curve
• Represents a level of
satisfaction
Indifference Map
• A collection of indifference curves corresponding
to different levels of satisfaction

• IC1= lowest satisfaction, IC4=highest satisfaction

Assumptions of IC Analysis

• Non Satiety
• Transitivity
• Diminishing Marginal rate of substitution
• Two Commodities
• Ordinal Utility
• Positive Marginal Utilities
• Divisibility
• Rationality
Marginal Rate of Substitution
• The rate at which the commodities can be
substituted at the margin in such a manner that
the total satisfaction of the consumer remains
unaltered
• MRSx,y is defined as the amount of Y the
consumer is just willing to give up to get an
additional unit of X.
Diminishing Marginal Rate of
Substitution
• Every time a consumer gives up a unit of good Y,
he does not require the same additional amount
of good X to compensate for the loss of
satisfaction.
• Consumer is willing to part with lesser and
lesser quantities of one commodity as the
quantity of other commodity continuously
increases.
• MRS at a point on the IC can be measured by its
slope at that point.
• MRSx,y= ∆Y/∆X

Combination Biscuits (Y) Tea (X) MRSxy

A 12 1

B 8 2 4:1

C 5 3 3:1

D 3 4 2:1

E 2 5 1:1
• The ratio of ∆Y/ ∆X is different at different
positions on the indifference curve.
• MRS is defined more precisely at point than arc

and
• The numerical value of slope goes on declining,
therefore IC are expected to be convex to the
origin
Properties of IC
• Slopes downward
• Convex to origin
• Two ICs cannot touch each other/ intersect
• Higher IC represents Higher level of satisfaction
• IC need not be parallel to each other
Budget Line
• IC/ Indifference Map gives merely a hypothetical
ranking of various commodity combinations
• Consumer can not decide to buy a particular
combination on this basis
• IC does not tell him which combination will give
him the most of his money
• Budget line shows all the combinations of
the two commodities the consumer cab
buy by spending his entire income for the
given prices of the two commodities
• The line suggests that consumer can not choose
any combination beyond this line
• Below this line, the income not fully spent
• Also called opportunity line, consumption
possibility line
Properties of budget line
• Negative slope
• If price of X and Y are equal, line would be at 45
degrees angle with both the axis
• Two commodities
• Depicts boundary line/ dividing line
• Position as well as slope of the budget line will
change if the price of any one commodity
changes with same income
Change in budget line
• Due to change in price (slope changes)
• Due to change in consumer’s income – shift
(slope remains same)
Changes in budget line
Consumer Equilibrium
• IC- What consumers would like to do
• Budget line- What consumer is able to do
• Consumer Equilibrium- What consumer will
actually do

• Consumer is said to be at equilibrium where he

maximises the satisfaction, subject to his budget
or income constraimt
• First Order
Condition:
Budget line is
tangent to
indifference curve
• Second Order
Condition: IC
should be convex
to the origin
Meaning of Demand
Demand refers to quantity of a commodity that a
consumer is willing to buy at different prices
within a given period of time.
Ex: A consumer demands 1kg apple at Rs 50
today.
Factors affecting Demand
1. Price of commodity itself
2. Price of related goods – substitutes and
complements.
3. Income of a consumer
4. Taste and preferences
5. Demonstration effect- bandwagon effect ,
snob effect
6. Consumer credit facility
7. Population of the country
8. Consumer expectations
9. Distribution of national income
Types of goods
• Normal goods-demand for these goods
increases with increase in income. Ex: clothing
, furniture , automobiles
• Inferior goods -a commodity is deemed to
be inferior if its demand decreases with
increase with increase in consumer’s income
beyond a certain level of income
• Luxury and prestige goods -goods that
add to pleasure and prestige of a consumer
without enhancing his earning.
Cont..
• Essential consumer goods- these are goods
of basic needs and are consumed by all persons
of a society. Ex food grains , vegetables , cooking
fuel , clothing , housing.
Demand Function
It depicts the relationship between quantity
demanded and its determinants.
D=f (P, Pr, Y, T, A, E)
P-price of commodity
Pr-price of related goods
Y-consumer’s income
A-advertising
E-price expectations
Demand Schedule

Price (per Quantity

Demand schedule is kg) demanded
a tabular statement (kg)
showing different
quantities of a 20 2
commodity 16 3
demanded at
different prices 12 4
during a given
period of time. 8 5

4 6
Demand curve

Demand curve is a
graphical
representation of
the demand
schedule. It shows
the relationship
between price and
quantity graphically.
Law of Demand

• Tendency of the consumers to buy more

of a good at a lower price and less of it at a
higher price.
• Inverse relationship between the price
and quantity demanded of a commodity
• Indicates the direction, not the magnitude
of change
• Price- Cause variable, Demand- Effect
variable
Slope of Demand
It slopes downward due to:
1.Diminishing marginal utility
2.Income effect
3.Substitution effect
Assumptions of law of demand
• There should be no change in price of related
goods.
• There should be no change in income of
consumer.
• There should be no change in tastes and
preferences.
• In short factors other than price should remain
constant.
Exceptions to law of demand
• giffen goods
• Rare commodities
• Veblen goods (luxury goods)/ unique goods
• Necessities
• Emergency/war
Change in demand
Price Elasticity of demand
• It is the degree of responsiveness of change in
quantity due to change in price.

Ed= % change in quantity demanded

% change in price
• Explains the magnitude
• A ratio between cause and effect
• Negative
• Elastic and inelastic demand
Measurement of Elasticity of demand
• A ratio between effect and cause
▫ Percentage method
▫ Total outlay method
▫ Point method
▫ Arc method
Percentage Method
Degree of price of elasticity

• Perfectly inelastic
demand (Ed=0)
• Perfectly elastic
demand (Ed=infinity)
• Unitary elastic demand
(Ed=1)
• Highly elastic demand
(Ed >1)
• Inelastic demand
(Ed<1)
Total Outlay Method

• Study of elasticity of • e=1; Unit elastic

demand in relation • e>1; More than Unit
to change in total elastic
outlay as a result of • e<1; Less than unit
change in price and elastic
consequent change
in demand
 Point Method
• Measurement of
elasticity of demand
at a point on
straight line demand
curve
Arc Method

• Useful when the

changes in price and
demand are very
large.
Factors affecting elasticity

• Availability of substitutes.
• Nature of commodity.
• Alternative uses
• Time factor in adjustment of consumption
pattern/ postponement of demanddx
• Price Range of a commodity
• Joint demand
• Durability of goods
Income elasticity
• It is used to measure responsiveness of demand
to change in income. It is percentage change in
demand associated with one percent change in
income.
• EI= % change in quantity
%change in income
Cont..
• Income elasticity is greater than one for luxury
goods
• It is less than one for essential goods
• It is almost equal to one for comforts
Cross elasticity
• The responsiveness of quantity demanded due to
change in price of other goods.
• EC= % CHANGE IN QX
% CHANGE IN PY
• Cross elasticity is positive for substitutes and
negative for complements
Advertising elasticity
• It is the change in sales due tom change in
advertising.
Ea= % change in sales
% change in advertising
• If EA=0 it means sales do not respond to
advertisement expenditure
• If EA>0 BUT<1 increase in total sales is less
than proportionate to increase in advertisement
expenditure
• Ea=1 increase in total sales is proportionate to
increase in advertisement expenditure
• Ea>1 increase in total sales is more than
proportionate to increase in advertisement
expenditure
Factors determining advertising
elasticity
• Level of total sales
• Advertising by rival firms
• Cumulative effect of past advertisement
• Other factors-change in product price ,
consumer’s income , growth of substitutes and
their prices
 Demand forecasting
• Demand forecasting is predicting the future
demand for firm’s product .
• Different from guessing
 • It helps in following areas of business decision
making-
1) Planning and scheduling production
2) Acquiring inputs
3) Making provision for finances
4) Formulating pricing strategies
5) Planning advertisement
Steps in demand forecasting
1. Specifying the objective
2. Determining the time perspective
3. Making choice of method for demand
forecasting
4. Collection of data and data adjustment
5. Estimation and interpretation of results
 Methods in demand forecasting
Consumer survey method
1.Direct interview-
a)complete enumeration
b)sample survey
c)end-use method
2.Opinion poll methods
a) Expert opinion method
b) Delphi method
c) Market studies and experiments
 Methods in demand forecasting
Statistical Methods
1.Historical Observation
2. Smoothing Techniques
3. Trend Projections
4. Barometric Method
5. Econometric Methods
Unit 3
Theory of production
• Meaning and Concept of Production, Factors of
Production, production function, ISO
Quants. Fixed and Variable Factors. Law of
Variable Proportion (Short Run Production
Analysis), Law of Returns to a Scale (Long Run
Production Analysis) through the use of
ISOQUANTS.
Important Concepts
• Land: Primary factor, includes physical
territory and all natural resources
• Labour: Any physical or mental exertion
undertaken to create or produce goods and
services
• Efficiency: Productivity during a given time
period
• Capital: Man Made goods used for further
production of wealth
Meaning of production
• Production means process by which resources
are transformed into a more useful commodity
or service.
• ‘Production is used for creation of those goods
and services which have an exchange value.’
• Creation of economic utilities which can be:
form utility, time utility and place utility
• It means transforming inputs into output

• Production is the physical relationship between

inputs used and resulting output or conversion
of inputs or factors of production into outputs
Production does not include
• Domestic Work done by a family member out of
affection
• Voluntary services done for patriotic feeling or
society welfare
• Goods for self consumption, not to be sold in
market to earn income
Meaning of input and output
• Input: the input is a good or service that goes
into the process of production. “An input is
simply anything which the firm buys for use in
its production or other processes”.
• Economist classified inputs as labour, capital,
land, raw materials, entrepreneurship.
Technology and time are also treated as inputs
in the modern concept of production.
• Output: an output is any good or service that
comes out of production process.
Short run and long run
• Short run refers to the period of time in which the
supply of certain inputs is fixed or is inelastic. In
short run production of a commodity can be
increased by increasing the use of only variable
inputs like labour and raw materials
• Long run refers to a period of time in which the
supply of all inputs is elastic. That is, in long run all
inputs are variable. Therefore, in the long run
production can be increased by employing more of
both fixed and variable factors.
Fixed and variable inputs
• In economic sense a fixed input is one whose
supply is inelastic in the short run.
• A variable input is defined as one whose supply
in the short run is elastic, e.g. labour and raw
material etc.
Factors of Production
• Land
▫ Fixed in supply
▫ Natural/ can not be produced
▫ Imperishable
▫ Immobile
▫ Passive factor- can not produce anything by itself
▫ Heterogeneity- different situational advantages/
disadvantages
• Labour
▫ Perishable
▫ Active Factor
▫ Inseparable from labourer
▫ Labourer sells his service, not himself
▫ Difficult to calculate cost of labour
▫ Different efficiencies
▫ Mobility of labour- Horizontal/ vertical
▫ Division of Labour- product/process/territorial
• Capital
▫ Capital vs. Capital Formation
▫ Classifications
 Real vs. human capital
 Individual vs. social capital
 Fixed vs. circulating capital
 Tangible vs. intangible capital
 Sunk vs. floating capital
 Internal vs. external capital
 Production vs. consumption capital
Production function
• Production function is the mathematical presentation of
input-output relationship.
• It includes only technically efficient combinations of
inputs. The general production function can be
expressed as :
• X=f(L,K,R,E,S)
Where,
X= output
L=labor
K= capital
R= raw materials
E=efficiency
S= land
Production in the short run
• It is also known as production with one variable
input.
• In the short run production can be changed by
changing variable inputs since the quantity of
fixed inputs cannot be varied.
Three concepts of product
• Total product(TP):TP is defined as the total
quantity of goods produced by a firm during a
specific period of time.TP can be increased by
employing more units of variable factor.
• Marginal product(MP):MP is defined as the
change in TP resulting from the employment of
an additional unit of a variable factor.
• Average product(AP): AP is defined as the
amount of output per unit of variable factor
employed.
LAW OF VARIABLE PROPORTIONS
• This law is also known as law of diminishing
returns
• This law states that when more and more units
of a variable input are used with a given quantity
of fixed inputs, the total output initially increase
at an increasing rate and then at a constant rate,
but it will eventually increase at diminishing
rates.
Assumptions of the law
• Labor is the only variable input, capital
remaining constant
• Labor is homogenous
• The state of technology is given(constant)
• Input prices are given(constant)
THREE STAGES OF PRODUCTION
No. of workers Total product – Marginal Average Stage of
(N) TPL (tonnes) Product (MPL) Product (APL) production
(1) (2) (3) (4) (5)
1 24 24 24
2 72 48 36 I
INCREASING
3 138 66 46
AND
4 216 78 54 CONSTANT
5 300 84 60 RETURNS

6 384 84 64

7 462 78 66
8 528 66 66 II
DIMINISHING
9 576 48 64
RETURNS
10 600 24 60

11 594 -6 54 III
12 552 -42 46 -VE RETURNS
 BEHAVIOUR OF TPP,MPP AND APP DURING
THE THREE STAGES OF PRODUCTION

TOTAL PHYSICAL MARGINAL PHYSICAL AVERAGE

PRODUCT PRODUCT PHYSICAL
PRODUCT

STAGE I
INCREASES AT AN INCREASES, REACHES ITS INCREASES &
INCREASING RATE MAXIMUM & THEN DECLINES REACHES ITS
TILL MP = AP MAXIMUM
STAGE II
INCREASES AT A IS DIMINISHING AND STARTS
DIMINISHING RATE BECOMES EQUAL TO ZERO DIMINISHING
TILL IT REACHES
MAXIMUM
STAGE III
STARTS DECLINING BECOMES NEGATIVE CONTINUES TO
DECLINE
Reasons for increasing returns
• Full utilization of fixed resources
• Specialization
• Realization of optimum combination of factors
Reasons for diminishing returns
• Use beyond optimum capacity
• Lack of perfect substitution between factors
• Fall in quantity of fixed inputs per unit of
variable factors
Reasons for negative returns
• Excessive variable factors relative to fixed
factors.
• Too much variable factors leads to inefficiency of
fixed factors
Stage of operation of a rational firm
• A rational firm will always operate on second stage.
Firm will not stay in first stage as it is moving
towards achievement of ideal combination of factors
in which AP increases at every level of output. So
firm will apply additional labor instead of stopping
production
• Firm will not operate on third phase where MP is
negative and TP is decling.
• First and third are stages of economic absurdity. So
a rational firm will always operate on second stage.
Long Run Production Function
• Laws of returns to scale
• Explained through production function and
isoquant curve technique
Production in long run
• It can be defined as production with two variable
inputs.
• In the long run all factors of production becomes
variable.
• Long run production function is of type
X=f(L,K)
• The long run production function can be
represented graphically by isoquants or Iso-
product curves.
ISOQUANT

An isoquant or iso product curve or equal product curve or

a production indifference curve show the various
combinations of two variable inputs resulting in the same
level of output.

It is defined as a curve passing through the plotted points

representing all the combinations of the two factors of
production which will produce a given output.
• For example from the following table we can see
that different pairs of labour and capital result in
the same output.

Labour Capital Output

(Units) (Units) (Units)
1 5 10
2 3 10
3 2 10
4 1 10
5 0 10
 For each level of output there will be a different
isoquant. When the whole array of isoquants are
represented on a graph, it is called an isoquant map.

Important assumptions

1. only two inputs

2. The two inputs can substitute each other to produce
a commodity
3. Technology of production is given
 PROPERTIES OF ISOQUANTS
1. An isoquant is downward sloping to the right. I.E
NEGATIVELY INCLINED. This implies that for
the same level of output, the quantity of one
variable will have to be reduced in order to
increase the quantity of other variable.
 PROPERTIES OF ISOQUANTS
2. A higher isoquant represents larger output. That is
with the same quantity of 0ne input and larger
quantity of the other input, larger output will be
produced.
 PROPERTIES OF ISOQUANTS

3. No two isoquants intersect or touch each other. If

the two isoquants do touch or intersect that means
that a same amount of two inputs can produce two
different levels of output which is absurd.
 PROPERTIES OF ISOQUANTS
4. Isoquant is convex to the origin. This means that
the slope declines from left to right along the
curve. That is when we go on increasing the
quantity of one input say labour by reducing the
quantity of other input say capital, we see less
units of capital are sacrificed for the additional
units of labour.
 SLOPE OF ISOQUANT

The slope of an isoquant has a technical name called

the marginal rate of technical substitution (mrts) or
the marginal rate of substitution in production.
Thus in terms of capital services K and labour L
MRTS = Dk/DL
Isoquant Map and Economic Region of
Production
• Isoquant Map: set of isoquants presented on a
two-dimensional plane
• Various combinations of two inputs that can be used
to produce a given level of output.
• Economic Region: every point at isoquant curve
is not technically efficient. MRTS decreases along
isoquant curve, limit to zero. I.e. there is a limit to
which one input can substitute another.
• Beyond this point, additional employment of one
input will necessitate employing additional units of
other inputs.
• Upper ridge line &
Lower ridge line
• Any production
technique outside this
region is technically
inefficient since it
requires more of both
inputs to produce same
quantity
Ridge lines
• Ridge lines are the loci of points on the
isoquants where the marginal product of the
factors are zero.
• Along the upper ridge line MPk=0
• Along the lower ridge line, MPl=0
TYPES OF ISOQUANTS

1. CONVEX ISOQUANT
2. LINEAR ISOQUANT
3. RIGHT-ANGLE ISOQUANT
4. KINKED ISOQUANT
 CONVEX ISOQUANT
IN CONVEX ISOQUANTS THERE IS SUBSTIUTABILTY
BETWEEN INPUTS BUT IT IS NOT PERFECT.

FOR EXAMPLE

(1) A SHIRT CAN BE MADE WITH LARGE AMOUNT OF

LABOUR AND A SMALL AMOUNT MACHINERY.
(2) THE SAME SHIRT CAN BE WITH LESS LABOURERS, BY
INCREASING MACHINERY.
(3) THE SAME SHIRT CAN BE MADE WITH STILL LESS
LABOURERS BUT WITH A LARGER INCREASE IN
MACHINERY.
Linear Isoquant
• Implies perfect substitutability
• MRTS between K and L remains constant
throughout
• Possible only when K and L are perfect
substitutes
 LINEAR ISOQUANT
In linear isoquants there is perfect substiutabilty of
inputs.

For example in a power plant equiped to burn oil or

gas. Various amounts of electricity could be produced
by burning gas, oil or a combination. I.E OIL AND
GAS ARE PERFECT SUBSITUTES. Hence the
isoquant would be a straight line.
Right angled Isoquant
• Also called Fixed factor proportion or L-shaped
isoquant
• Assumes a fixed proportion between K and L
• Zero substitutability between K and L
• Perfect complementarity assumption
• Also called Leontief function
• Very realistic and applicable in many areas
• Example: Taxi and Taxi driver
 RIGHT-ANGLE ISOQUANT
In right-angle isoquants there is complete non-
substiutabilty between inputs.

For example two wheels and a frame are required to

produce a bycycle these cannot be interchanged.

This is also known as leontief isoquant or input-

output isoquant.
Kinked or Linear Programming Isoquant
• Unlike fixed factor, there may have multiple
techniques or ways to do a task
• Each technique having a different fixed
proportion of inputs
• Example: 10 passengers, 10 taxis and 10 taxi
drivers
Or
1 bus, 10 passengers ad 1 driver
 RETURNS TO SCALE
• Diminishing returns refer to response of output to an
increase of a single input while other inputs are held
constant.
• We have to see the effect by increasing all inputs.
• What would happen if the production of wheat if land,
labour, fertilisers, water etc,. Are all doubled. This refers to
the returns to scale or effect of scale increases of inpurts on
the quantity produced.
CONSTANT RETURNS TO SCALE

• This denotes a case where a change in all inputs

leads to a proportional change in output.
• For example if labour, land capital and other
inputs doubled, then under constant returns to
scale output would also double.
INCREASING RETURNS TO SCALE
• This is also called economies of scale. This arises when an
increase in all inputs leads to a more-than-proportional
increase in the level of output.
• For example an engineer planning a small scale chemical
plant will generally find that by increasing inputs of labour,
capital and materials by 10% will increase the total output
by more than 10%.
DECREASING RETURNS TO SCALE
• This occurs when a balanced increase of all inputs leads to
a less than porportional increase in total output.
• In many process, scaling up may eventually reach a point
beyond whih inefficiencies set in. These might arise
because the costs of management or control become large.
• This was very evident in electricity generation when plants
grew too large, risk of plant failure increased.
IMPORTANCE OF RETURNS TO SCALE
CONCEPT
If an industry is characterized by increasing returns to
scale, there will be a tendency for expanding the size of the
firm and thus the industry will be dominated by large
firms.
The opposite will be true in industries where decreasing
returns to scale prevail.
In case of industries with constant returns to scale, firms of
all sizes would survive equally well.
Reasons for economies of
scale/increasing returns
• Specialization of management
• Economies of superior techniques
• Financial economies
• Dimensional relations
Reasons of diseconomies/decreasing
returns
• Risk bearing diseconomies
• Financial diseconomies
• External diseconomies
• Technical diseconomies
Budget Line/ Isocost
• It represents the alternative combinations of K
and L that can be purchased out of the total cost
Producer’s equilibrium
Cobb-Douglas production function
Elasticity of substitution between
labor and capital
Unit 4
Cost analysis & Price output
decisions
Concept of Cost, Cost Function, Short Run Cost, Long Run
Cost, Economics and Diseconomies of Scale. Explicit Cost
and Implicit Cost, Private and Social Cost. Pricing Under
Perfect Competition, Pricing Under Monopoly, Control of
Monopoly, Price Discrimination, Pricing Under
Monopolistic Competition, Pricing Under Oligopoly.
Introduction
• Business decisions and Money values
• Cost of Production
• Decisions related to cost:
▫ Production Management
▫ Minimizing the cost
▫ Optimum level of output
▫ Pricing decisions
▫ Profit margins
▫ Estimating the business costs, etc.
Meaning of cost
• Cost denotes the amount of money that a
company spends on the creation or production
of goods or services.
• From a seller’s point of view, cost is the amount
of money that is spent to produce a good or
product
• From a buyer’s point of view the cost of a
product is also known as the price.
Cost Concept
• Accounting Concept
• Analytical Concept

Overlapping Categories
Types of cost
• Opportunity cost : it is the cost of next best
alternative foregone.
• Actual Cost: Actually incurred by the firm
• Explicit cost : Explicit costs, also called
accounting costs, are out-of-pocket costs, such
as expenses on labor, raw materials, and rent.
• Implicit cost : Implicit costs are costs a
business incurs without actually spending
money.
Types of cost
• Fixed cost : cost which is incurred irrespective
of the level of output.
• Variable cost : which changes with change in
level of output.
• Short run cost : costs which vary with
variation in output, the size of the firm
remaining the same
• Long run cost : costs which are incurred on
fixed assets (sans depreciation)
Types of cost
• Incremental Cost: total additional cost
associated with chunk changes
• Sunk cost : it is the cost which is already
incurred but cannot be recovered.
• Private cost : cost which is incurred by the
producer in production of goods and services.
• Social cost : Social costs is a category that is
not incurred by the producer/ firm but by the
society/ nation.
• Total Cost: Total expenditure incurred on the
production of goods and services
• Marginal cost : Marginal cost is the cost of the
next unit or one additional unit of volume or
output
• Average Cost: Statistical not actual in nature;
obtained by dividing Total Cost by Total Output
The Theory of Cost: Cost-Output
Relations
• Behaviour of cost in relation to change in output
• Basic Principle: TC increases with increase in
output
• Observed fact but little theoretical and practical
relevance
• More important: Direction of change in AC
and MC- Nature of Cost Function
Short run Cost functions and Cost
curves
Types of Cost Curves

• A total cost curve is the graph of a firm’s total

cost function.
• A variable cost curve is the graph of a firm’s
variable cost function.
• An average total cost curve is the graph of a
firm’s average total cost function.
Types of Cost Curves

• An average variable cost curve is the graph of a

firm’s average variable cost function.
• An average fixed cost curve is the graph of a
firm’s average fixed cost function.
• A marginal cost curve is the graph of a firm’s
marginal cost function.
Types of Cost Curves

• How are these cost curves related to each other?

• How are a firm’s long-run and short-run cost
curves related?
Fixed, Variable & Total Cost Functions
• F is the total cost to a firm of its short-run fixed
inputs. F, the firm’s fixed cost, does not vary
with the firm’s output level.
• cv(y) is the total cost to a firm of its variable
inputs when producing y output units. cv(y) is
the firm’s variable cost function.
• cv(y) depends upon the levels of the fixed inputs.
 Short Run Average & Marginal Cost
Curves
• Average Cost: Total Cost Per
Unit of Output
▫ ATC= AFC+AVC
• AFC(Average Fixed Cost): TFC
divided by output
▫ Since TFC is constant, AFC
steadily falls as output
increases (hence, downward
sloping)
▫ At very large output, it
approaches zero, but never
touches the axis
 ▫ Pick any point at AFC curve, multiply that AFC
with corresponding quantity of output, it is always
same (Rectangular Hyperbola) because this
product will yield TFC which is constant
• AVC (Average Variable Cost): TVC divided by
number of units produced
▫ Falls initially (because output rises to normal
capacity), then rises (operations at diminishing
returns)
▫ Vertical distance between ATC and AVC
represents AFC
• ATC or AC (Average Total Cost or Average Cost):
Cost Incurred Per Unit of Output
▫ Its nature depends on AVC and AFC
▫ 1. Sharp Fall because AFC and AVC fall
▫ 2. Continues to fall because even AVC begins to
rise but AFC falling steeply
▫ 3. rises when output further increases, making
AVC rise sharply and effects more than falling
AFC.
• MC- Short run Marginal Cost: Addition to TC
caused by producing one more unit of output
▫ Closely related to variable factor and independent
of fixed factor
▫ MC=∆TVC/ ∆Q
• Relationship between MC and AC curves
▫ When AC falls, MC is below AC curve
▫ When AC is lowest, MC=AC
▫ When AC rises, MC is above AC curve
Marginal & Average Cost Functions

• The short-run MC curve intersects the short-run

AVC curve from below at the AVC curve’s
minimum.
• And, similarly, the short-run MC curve
intersects the short-run ATC curve from below at
the ATC curve’s minimum.
Short-Run & Long-Run Average Total
Cost Curves
For any output level y, the long-run total cost
curve always gives the lowest possible total
production cost.
Therefore, the long-run av. total cost curve must
always give the lowest possible av. total
production cost.
The long-run av. total cost curve must be the
lower envelope of all of the firm’s short-run av.
total cost curves.
Short-Run & Long-Run Marginal Cost
Curves

• For any output level y > 0, the long-run marginal

cost is the marginal cost for the short-run
chosen by the firm.
• This is always true, no matter how many and
which short-run circumstances exist for the firm.
Short-Run & Long-Run Marginal Cost
Curves

• For any output level y > 0, the long-run marginal

cost is the marginal cost for the short-run
chosen by the firm.
• So for the continuous case, where x2 can be fixed
at any value of zero or more, the relationship
between the long-run marginal cost and all of
the short-run marginal costs is ...
 Short-Run & Long-Run Marginal Cost
Curves
$/output unit
SRACs

AC(y)

y
Short-Run & Long-Run Marginal Cost
Curves
$/output unit
SRMCs

AC(y)

y
 Short-Run & Long-Run Marginal Cost
Curves
$/output unit
MC(y)
SRMCs

AC(y)

For each y > 0, the long-run MC equals the

MC for the short-run chosen by the firm.
Economies and Diseconomies of Scale
Economies of Scale
• Determine returns to scale
▫ Increasing, decreasing and constant returns to
scale
• Classified as internal and external economies of
scale
• Internal Economies: “Real Economies” arise
from expansion of plant size and are internalized
▫ Economies in production
▫ Economies in Marketing
▫ Managerial Economies
▫ Economies in Transport and Storage
• External Economies: “Pecuniary Economies”
accrue to the advantages arising outside of firm
▫ Discounts and concessions on- inputs, finance
▫ Massive advertisement campaigns
▫ Growth of ancillary industries
Diseconomies of Scale
• Internal Diseconomies:
▫ Managerial inefficiency
▫ Labour inefficiency
• External Diseconomies
Break Even Analysis
• Profit Contribution Analysis
• TR=TC
• Break Even Point: A point of No Profit-No Loss
• Could be linear function or Non linear function
Market structure
• Market structure is determined by the number
and size distribution of firms in a market, entry
conditions, and the extent of product
differentiation.
Forms of market
• Perfect competition
• Imperfect competition
Monopoly- natural and artificially created
Monopolistic
Oligopoly
Meaning of perfect competition
• the situation prevailing in a market in which
buyers and sellers are so numerous and well
informed that all elements of monopoly are
absent and the market price of a commodity is
beyond the control of individual buyers and
sellers.
Features of perfect competition
• Large number of buyers and sellers.
• Homogenous products.
• Free entry and exit
• Firm is the price taker and industry is the price
maker
• Perfect knowledge with no information failure
• No govt. regulation
Imperfect competition
• The situation prevailing in a market in which
elements of monopoly allow individual
producers or consumers to exercise some control
over market prices.
Meaning of monopoly
• “Pure monopoly is represented by a market situation in which
there is a single seller of a product for which there are no
substitutes; this single seller is unaffected by and does not
affect the prices and outputs of other products sold in the
economy.” Bilas
• “Monopoly is a market situation in which there is a single
seller. There are no close substitutes of the commodity it
produces, there are barriers to entry”. -Koutsoyiannis
• “Under pure monopoly there is a single seller in the market.
The monopolist demand is market demand. The monopolist is
a price-maker. Pure monopoly suggests no substitute
situation”. -A. J. Braff
• “A pure monopoly exists when there is only one producer in
the market. There are no dire competitions.” -Ferguson
Features of monopoly
• Single seller
• Unique product
• Barriers to entry
• Price discrimination
• Supernormal profits
• Both price taker and price maker
Price determination under monopoly
Price discrimination
• The practice of charging different price to
different group of consumers is known as price
discrimination.
Third degree price discrimination
• It is the practice of charging different prices
according to the demand elasticity of different
consumers.
• Consumers having inelastic demand are
charged higher prices and those with elastic
demand are charged lower prices.
Meaning of monopolistic competition
• Monopolistic competition as a market structure
was first identified in the 1930s by American
economist Edward Chamberlin, and English
economist Joan Robinson
• A central feature of monopolistic competition is
that products are differentiated. There are four
main types of differentiation: Physical product
differentiation , marketing differentiation ,
human capital differentiation , differentiation
through distribution.
Features of monopolistic competition
• Differentiated product
• Each firm makes independent decisions
about price and output, based on its product, its
market, and its costs of production
• Imperfect information
• Barriers to entry and exit
• Normal profit
Features of oligopoly
• Differentiated product
• Barriers to entry and exit
• Interdepedence of firms in setting price and
output
• Few sellers and large no of buyers
Syllabus Complete