Managerial Economics

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Managerial Economics Theory and Practice
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Managerial Economics
Theory & Practice
First Edition
Author
Dr. Vinith H P
INSC International Publishers

Title of the Book: Managerial Economics – Theory & Practice
Edition: First – 2022
Copyright 2022 © Dr. Vinith H P
No part of this book may be reproduced or transmitted in any form by any

means, electronic or mechanical, including photocopy, recording or any
information storage and retrieval system, without permission in writing
from the copyright owners.
Disclaimer
The author is solely responsible for the contents published in this book. The
publishers or editors don’t take any responsibility for the same in any
manner. Errors, if any, are purely unintentional and readers are requested to
communicate such errors to the editors or publishers to avoid discrepancies
in future.
ISBN: 978-1-68576-271-1
MRP: 250/-
PUBLISHER & PRINTER: INSC International Publishers

Pushpagiri Complex, Beside SBI
Housing Board, K.M. Road
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E-mail:info@iiponline.org
IMPRINT: I I P
ii
Dedicated to
My Beloved Nation
And
The readers of the
book
iii
Preface
It is increasingly being recognized that teaching principles of economics

helps business administration students better understand the economic forces
that helps in taking effective decisions in the real time business practices and
also helps in developing and strengthening the overall analytical talent of
students to solve present and future business problems.
Managerial economics, It is the integration or application of economic

principles in business practices or business administration in order to solve
the problems of the business. It has been receiving more attention in
business as managers become more aware of its potential as an aid to
decision-making, and problem solving.
This Book on Managerial Economics mainly introduces topics in

microeconomics and macroeconomics to students to enable them to apply
the same to business decisions. The purpose of this book is to simplify the
process of understanding Managerial Economics. The Book covers a narrow
range of topics. The readers can make their choice as per the need of study
course.
The Book is initiated as a reference book for PG and UG students in

faculties of Commerce & Management, especially in consideration with
MBA students.
iv
Acknowledgement
One of the most pleasant aspects of writing Book on Managerial Economics

is the opportunity to thank those who have contributed to it. Unfortunately,
the list of expressions of thanks – no matter how extensive is always
incomplete and inadequate. These acknowledgements are, therefore, no
exception. From the depth of my heart I express my deep sincere gratitude to
the Almighty for the Blessings, who had bestowed upon me to do this work.
My sincere gratitude to his divine soul Padmabhushana Sri Sri Sri
Dr. Balagangadhranatha Maha Swamiji, a great visionary and
philanthropist, and I extend my sincere gratitude to His Holiness Sri Sri Sri
Dr. Nirmalanandanatha Maha Swamiji, Pontiff Sri Adichunchanagiri
Mahasamsthana Math.
I wish to place on record my deep sense of gratitude to Dr. C K Subbaraya.

Registrar, Adichunchanagiri University B.G. Nagar and Director,
Adichunchanagiri Institute of Technology, Chikkamgaluru for being a
beacon of light and directing me to the path of academic achievement.
I am thankful to Dr. C T Jayadeva,. Principal, Adichunchanagiri Institute of

Technology, Chikkamgaluru for his encouragement and support for
completing this work.
I express my profound thanks to Dr. Prakash Rao K S, Head, P.G

Department of Management Studies, Adichunchanagiri Institute of
Technology, Chikkamgaluru for his constant encouragement and support for
completing this work.
I owe my debt of gratitude to my beloved former and present colleague’s

Dr. Santosh Kumar G, Dr. Jagadeesha G.T, Dr. Devananda H M,
Mr. Ravi I A, Mr. Lakshmikanth D.R ,Mr. Bharath M and Mr. Sudir
for their fruitful and valuable suggestions in executing this work by
enlightened me and kept ablaze my flames of confidence.
I extend my thanks to the Management and Staff of Adichunchanagiri

Institute of Technology Chikkamgaluru for providing support in completion
of work.
v
I extend my thanks to the Management and Staff of InSc International
Publishers (IIP) for providing support in completion of work.
It is with immense sense of happiness and joy to express my deep sense of

thanks to my brother Mr Ajith H P, my Sister-in- law Mrs. Mahima T and
to their angels Avani & Tapasya.
I express my deep sense of gratitude to my grand Parents Late Chanamma

Nanjegowda and Deviramma Puttappashetty
I owe my deepest gratitude towards my better half for her eternal support
and understanding of my goals and aspirations. Her infallible love and
support has always been my strength. Her patience and sacrifice will remain
my inspiration throughout my life. It would be ungrateful on my part if I
thank Mrs. Poshitha B in these few words. I am thankful to my little angel
Reha V Driti for giving me happiness bearing my demands throughout the
work, which made the journey more remarkable and easy in completing the
thesis.
I express my deep sense of gratitude to my parents Mr. Panchaksharappa

H N and Mrs. Meenakshamma for their forbearance, support and
encouragement. I dedicate to them this humble endeavor of mine. Finally, I
express my gratitude to all those who have either directly or indirectly
helped me in completing my first book Managerial Economics – Theory &
Practice.
Dr.Vinith H P
vi
Contents
Chapter 1 Introduction to Managerial Economics 1- 14
1.1 Meaning of economics 1
1.2 Nature of managerial economics 2
1.3 Scope of managerial economics 2
1.4 Significance or uses of managerial 3
economics
1.5 Role and responsibilities of managerial 4
economist
1.6 Theory of firm and industry 4
1.7 Managerial theories 7
1.8 Decision Making 13
Chapter 2 Demand Analysis 15 -38

2.1 Demand analysis 15
2.2 Law of demand 18
2.3 Exceptions to the law of demand 22
2.4 Elasticity of demand 26
2.5 Income elasticity of demand 27
2.6 Cross elasticity of demand 27
2.7 Measurement of elasticity of demand 28
2.8 Uses or importance of elasticity of demand 31
2.9 Demand forecasting 32
2.10 Supply 35
Chapter 3 Cost and Production Analysis 39 - 64
3.1 Production analysis or concepts of 39
production
3.2 Production function 39
3.3 Laws of Production 40
3.4 Production Function with Two Variable 43
Inputs (I S O Quant’s)
3.5 Optimum Input Combination or Least Cost 47
Combination or Producer’s Equilibrium
3.6 I SO cost curve 47
3.7 Selection of Optimum or Least Cost 48
Combination or Producers Equilibrium
3.8 Diseconomies of scale 49
vii
3.9 Diseconomies of Scale 51
3.10 Introduction to Cost 52
3.11 Types of Production Cost 55
3.12 Behavior of Cost under Short Run 57
Production or Short Run Total Cost
Schedule of a Firm
3.13 Behavior of Cost under Long Run 59
Production or Long Run Cost Curves
3.14 Breakeven Analysis 61
Chapter 4 Market Structures and Pricing Practices 65 - 80
4.1 Market structures 65
4.2 Perfect Competition 65
4.3 Monopoly 67
4.4 Oligopoly market structure 71
4.5 Monopolistic market 74
4.6 Descriptive pricing approaches 77
Chapter 5 Indian Business Environment 81 - 93

5.1 Introduction to business environment 81
5.2 Economic & non-economic environment 84
5.3 Basic macroeconomic concepts 87
5.4 Contribution of Primary, Secondary and 88
Tertiary Sectors to Indian Economy
5.5 SWOT analysis of Indian Economy 89
5.6 Measuring Economy 91
Chapter 6 Indian Industrial Policy 94 - 111
6.1 The new industrial policy of 1991 94
6.2 Private sector 96
6.3 Introduction to MSME’s 99
6.4 Fiscal Policy 100
6.5 Monetary policy 107
Case Study 112 - 114
Market Structures Summary 115
References 116
VTU Question Papers 117 - 131
viii
Chapter-1
Introduction to
1.1. Meaning of Economics
It is an art of household management or it is the process of optimum

utilization of scarce resources. Economics is a study of human activity
both at individual and national level. The economists of early age treated
economics merely as the science of wealth. The reason for this is clear.
Every one of us in involved in efforts aimed at earning money and
spending this money to satisfy our wants such as food, Clothing, shelter,
and others. Such activities of earning and spending money are called
“Economic activities”. It was only during the eighteenth century that
Adam Smith, the Father of Economics, defined economics as the study of
nature and uses of national wealth’.
Dr. Alfred Marshall, one of the greatest economists of the nineteenth

century, writes “Economics is a study of man’s actions in the ordinary
business of life: it enquires how he gets his income and how he uses it”.
Thus, it is one side, a study of wealth; and on the other, and more
important side; it is the study of man. As Marshall observed, the chief aim
of economics is to promote ‘human welfare’, but not wealth.
1.1.1. Meaning of Managerial Economics
It is the integration or application of economic principles in business

practices or business administration in order to solve the problems of the
business.
Managerial Economics can be defined as amalgamation of economic

theory with business practices so as to ease decision making and future
planning by management. Managerial Economics assists the managers of a
firm in a rational solution of obstacles faced in the firm’s activities. It
1
Introduction to Managerial Economics
makes use of economic theory and concepts. It helps in formulating logical

managerial decisions.
1.1.2. Definition of Managerial Economics
According to French Economist Spencer “Managerial Economics is an

integration of economic theory, with business practices for purpose of
facilitating, decision making and forward planning by the management.”
According to D.C. Hague “A fundamental academic subject which seeks

to understand and analyze the problems of business decision making”.
1.2. Nature of Managerial Economics
1. Micro in nature- scope of Managerial Economics is limited, it is a

branch of economics
2. Separate branch of economics
3. Managerial economics covers both macroeconomics as well as
microeconomics, as both are equally important for decision making
and business analysis
4. New discipline
5. Problems and solutions- Helps in identifying business problems and
also provides solution
6. Both Normative and Positive Science
7. Science of Decision Making- Identifying Business problem,
analyzing and solving it.
8. Study of allocation of Resources- Optimum utilization of scarce
resource results in increased profits.
9. Multi Disciplinary- The contents, tools and techniques of managerial
economics are drawn from different subjects such as economics,
management, mathematics, statistics, accountancy, psychology,
organizational behavior, sociology and etc.
1.3. Scope of Managerial Economics
Managerial Economics is a developing subject. The scope of managerial

economics refers to its area of study. Managerial economics has its roots in
economic theory. The empirical nature of managerial economics makes its
scope wider. Managerial economics provides management with strategic
planning tools that can be used to get a clear perspective of the way the
2
business world works and what can be done to maintain profitability in an

ever changing environment. Managerial economics refers to those aspects
of economic theory and application which are directly relevant to the
practice of management and the decision making process within the
enterprise. Its scope does not extend to macroeconomic theory and the
economics of public policy which will also be of interest to the manager.
It covers.
1. Demand function and estimation

2. Elasticity of Demand
3. Demand forecasting- Estimating for future demand for a product or
service
4. Production function and laws of Production
5. Cost analysis & Production costs
6. Price and output determination in different market structures
7. Pricing policies
8. Profit planning
9. Breakeven analysis
1.4. Significance or uses of Managerial Economics
1. Assist in decision making what, how, when ,where, and for whom to
produce
2. Optimum utilization of Resources
3. Deciding the product and quantity to be produced
4. Deciding to buy or manufacture of product.
5. Deciding on level of Inventory- Keeping inventory in excess is a
loss
6. Helping in charting out business Policies
7. Help in business planning
8. Helpful in cost control
9. Useful in demand forecasting
10. Helpful in profit Planning and controlled reduction
11. Helpful in price determination
12. Maintain of costs
13. Measurement of the overall efficiency of the firm
3
1.5. Role and responsibilities of Managerial Economist
1. Demand estimation ( or demand forecasting)

2. Preparation of business or sales forecasting
3. Analysis of the market to determine the nature and extent of
competition
4. Assisting business planning process of firm
5. Advising on pricing & its polices
6. Briefing management on current and global economic scenario
7. Preparation of financial budget
8. Discovering new and possible fields of business Endeavour and its
cost benefit analysis
9. Analysis of the issues and problem of the concerned industry
10. Production and inventory planning
1.6. Theory of Firm and Industry
1.6.1. Introduction
Firm is an economic unit producing the particular product or a service; it is

the part of an industry. Basically, the firm is a unit is involved in the
economic activity for the purpose of gathering the income. Therefore, the
firm is called as an economic unit.
1.6.2. Meaning of Firm
Firm is an center of control where the decisions about what to produce,

how to produce, where to produce, when to produce and for whom to be
produced are taken, In simple terms, firm is understood as an organization
which converts inputs into outputs, the inputs are plant, machinery, human
resource, capital, building, technology, equipment etc and the outputs are
goods and services.
1. Primary Objective of firm – To make profit or Earn profit
2. Alternate objectives of firm – sales maximization ,revenue
maximization, cost minimization, qualitative production, customer
satisfaction, employee retention or satisfaction, and social welfare
etc,
4
1.6.3. Objectives and Alternative Objectives of the Firm
Every firm is having an objective or goal, there are considered to be the

basic foundation of the firms. Following are name of the common
objectives of the firm-
1. Economic objectives – refers to those activities which are

undertaken to increase the profits.
a. Profit learning
b. Creation of customers and retaining them
c. Regular innovations and inventions
d. Optimum utilization of the resources
e. Sales maximization
f. Cost minimization
2. Social Objectives: Since the business operates in the society by

using the resources of society, it is the responsibility of the business
to return for the welfare of the society. Therefore, the business
should have certain obligations and objectives towards the society
like:
a. Production and supply of quality goods.
b. Adaptation of fair pricing practices.
c. Contribution to the society in an general manner (CSR)
3. Human Objectives: These objectives are aimed at well being and

fulfilling the expectation of employees and their families.
a. Economic well being of the employees.
b. Social and psychological satisfaction of employees and their
families.
c. Development of human resources.
4. National Objectives: Being an important part of the country it is

the obligation of every business to fulfill the national objectives
directly/ indirectly.
a. Creation of employment.
b. Promotion of social justice.
c. Producing according to the standards set by the govt.
d. Contributing towards the revenue of the country (taxes).
e. Expert promotion etc.
5
5. Organizational Objectives
a. Growth of the business.
b. Long term sustainability.
c. Wealth maximization.
d. Gaining the industrial leadership….etc.
1.6.4. Meaning of Industry

Group of firms involved in similar kind of production or service activity or
business activity in total.
Example- Telecommunication Industry, IT Industry, Banking Industry etc
1.6.5. Profit Maximization V/S Wealth Maximization
Profit Maximization
It is the process where the company focuses on maximization of the

profits. Here, the company just maximizes the profits without contracting
over any other alternative objectives. Sometimes the company may also
increase the price to maximize the profit.
Features
1. Ultimate goal of the company is to increase the profit.

2. Profit is the parameter of measuring efficiency of the organization.
3. It helps in decreasing the market risk.
4. It leads to the exploration of workers and consumers.
5. It leads to unfair trade practices.
Advantages
1. Maximization of business operations

2. Helps in reducing the risk.
3. It slows the entire position of the business.
4. Can be achieved in short run.
5. Reduces the frustration level of management.
Disadvantages
1. Leads to the exploration of workers and consumers.

2. It does not consider level of management.
6
Wealth maximization
It is the process of that increases the current net value of the business, with
the objectives of bringing the highest possible returns. The wealth
maximizations theory or strategy is a sound financial investments decision
which takes into the consideration of those factors which maximizes the
wealth of the organization rather than the profits.
Features
1. Protection of interest of share holders.

2. Security to the financial of employees.
3. Survival of the company.
4. Interest of society to be served.
Advantages
1. It considers the concept of time value of money.

2. It reduces the risk of business.
3. It also secures the interest of share holders.
4. The concept is universally accepted.
5. The benefits can be clearly measured.
Disadvantages
1. It is a kind of profit maximization.

2. The wealth maximization creates the conflicts between owners
(investors) and mangers.
3. It reduces the return on investment.
4. It can be adopted only when the firms profit position is high.
1.7. Managerial Theories
1.7.1. Sales Maximization Theory or Sales Maximization Model or

Boumal’s Model.
It is an alternative model of profit maximization theory, developed by

professor Boumal, an American economist for oligopolistic markets. It
states that goal of every firm is maximization of sales revenue subjected to
minimum profit constraint.
7
“The primary objective of firm, here is to maximize the sales rather than
profits”
Here minimum profit constraints means expectations of share holder this is

because company has to satisfy the share holder by giving minimum
profits for their investment. It is noted that maximization of sales means
not the physical sales but maximization of sales revenue. Here the
managers are most interested in maximizing the sales revenue rather than
the profits. It has two benefits
a. Increase in Sales Revenue

b. Increase in Margin of Profits.
Rationalization of Boumal’s theory
1. Firm attaches great importance to magnitude of sales.

2. If the firm sales are decreasing means banks, creditor may not show
interest in providing finance, are more willing to finance firms with large
and growing sales.
3. Its own dealers and distributors might stop taking interest with
decreasing sales.
4. Consumer may not buy its products because of its unpopularity.
5. Firm reduce its managerial and other staff with fall in sales.
6. Salaries of workers are tied up with sales even job security and
bonus.
7. If sales are large there is benefit of minimum profit through
economy of scale.
Space for practicing graph
Figure 1.1 Graphical Representation of Boumal’s Model
8
MP – Minimum Profit
TP - Total Profit curve
OQ- Sales with highest profit (BQ highest profit)
OK – Sales with highest sales revenue (LK highest sales revenue)
‘OK’ is greater than ‘OQ’ which is means maximization of output, but the
theory has minimum profit constraint. If firm is going to sell ‘OK ‘units
for Maximum sales revenue ‘KS’ will be the profit which may not help the
firm to get minimum profit (MP). Therefore the firm decides to sell up to
‘OD’ quantities in order to increase Sales revenue up to ‘ED’, and will
also attain minimum profit at ‘DC’.
1.7.2. Williamson’s Managerial-Utility-Maximization Theory
Williamson has developed managerial-utility-maximization theory as

against profit maximization. It is also known as the ‘managerial discretion
theory’. In large modern firms, shareholders and managers are two
separate groups. The shareholders want the maximum return on their
investment and hence the maximization of profits. The managers, on the
other hand, have consideration other than profit maximization in their
utility functions. Thus the managers are interested not only in their own
emoluments but also in the size of their staff and expenditure on them.
Thus Williamson’s theory is related to the maximization of the manager’s

utility which is a function of the expenditure on staff and emoluments and
discretionary funds.
The managers derive utility from a wide range of variables. For this
Williamson introduces the concept of expense preferences. It means “that
managers get satisfaction from using some of the firm’s potential profits
for unnecessary spending on items from which they personally benefit.”
To pursue his goal of utility maximization, the manager directs the firm’s
resources in three ways:
1. The manager desires to expand his staff and to increase their

salaries. “More staff is valued because they lead to the manager
getting more salary, more prestige and more security.” Such staff
expenditures by managers are denoted
9
2. To maximize his utility, the manager indulges in “featherbedding”

such as pretty secretaries, company cars, too many company phones,
‘perks’ for employees, etc. Such expenditures are characterized as
‘management slack’, M by Williamson.
3. The manager likes to set up “discretionary funds” for making
investments to advance or promote company projects that are close
to his heart. Discretionary profits or investments are what remain
with the manager after paying taxes and dividends to shareholders in
order to retain an effective control of the firm.
Thus the manager’s utility function is U = f (S, M, D)
Where U is the utility function, S is the staff expenditure, M is the

management slack and D the discretionary investments. These
decision variables (S, M, D) yield positive utility and the firm will
always choose their values subject to the constraint, Williamson
assumes that the law of diminishing marginal utility applies so that
when additions are made to each of S, M and D, they yield smaller
increments of utility to the manager.
Further, Williamson regards price (P) as a function of output (X),

expenditure on staff (S), and the state of environment which he calls
‘a demand shift parameter’ (E), so that P = f (X, S, E).
This relationship is subject to the following constraints
a. The demand function is assumed to be negatively sloping

b. Staff expenditures help increase the demand for the firms product
and
c. Increases in the demand shift parameter E, tend to raise demand.
These relationships reveal that the demand for X is negatively

related to P, but is positively related to S and E. When the demand
increases, the output and expenditure on staff will also increase
which will push the costs of the firm, and consequently the price will
rise, and vice versa.
10
1.7.3 Marris Growth Maximization Model
Working on the principle of segregation of managers from owners, Marris

proposed that owners (shareholders) aim at profits and market share,
whereas managers aim at better salary, job security and growth. These two
sets of goals can be achieved by maximizing balanced growth of the firm
(G), which is dependent on the growth rate of demand for the firm's
products (GD) and growth rate of capital supply to the firm (GC). Hence
growth rate of the firm is balanced when the demand for its product and
the capital supply to the firm grow at the same rate.
Marris further said that firms face two constraints in the objective of
maximization of balanced growth, which are explained below:
i. Managerial Constraint
Among managerial constraints, Marris stressed on the importance of

the role of human resource in achieving organizational objectives.
According to him, skills, expertise, efficiency and sincerity of team
managers are vital to the growth of the firm. Non availability of
managerial skill sets in required size creates constraints for growth:
organizations on their high levels of growth may face constraint of
skill ceiling among the existing employees. New recruitments may be
used to increase the size of the managerial pool with desired skills;
however new recruits lack experience to make quick decisions, which
may pose as another constraint.
ii. Financial Constraint
This constraint is related to the prudence needed in managing

financial resources. Marris proposed that a sound financial policy will
be based on at least three financial ratios, which set the limit for the
firm's growth. These are debt-equity ratio, liquidity ratio, and retained
profit ratio.
1. Debt equity ratio - This is the ratio between borrowed capital and
owners’ capital. This ratio indicates the financial strength of a firm.
High value of debt-equity ratio may cause insolvency. Therefore, a
low value of this ratio is usually preferred by managers to avoid
insolvency. A lower ratio shows greater security available to the
11
creditors. A low value of this may create a constraint to the growth

of the firm in terms of dependence on equity.
2. Liquidity ratio - This is the ratio between current assets and
current liabilities. Liquidity ratio indicates the coverage of current
assets by current liabilities. It represents the ability of a firm to
meet its short-term obligations, and reflect its short term financial
strength or solvency. According to Marris, a manager try to
achieve sufficient liquidity.
3. Retention ratio - It is the ratio between retained profits and total
profits. The retained profits are that portion of the net profit, that is
not distributed as dividend among shareholders. A high retention
implies that more funds are available to the firm. A higher
retention ratio means lower earning( dividend) to shareholders.
Hence, higher retention ratio is not good from the shareholder's
point of view. Therefore, managers avoid keeping a very high
value of retention ratio.
What is Growth Maximization?

Marris defines the balanced growth (G) of the firm:
G = GD = GC
GD = f(d, k)
GC = f(r, p)
where,
GD= growth rate of demand for firms product
GC = growth rate of capital supply to the firm.
d = diversification;
k = success rate;
r = financial security ratio derived from weighted average of three financial

ratios
p = a constant rate at which profit increases.
In simple words, a firm's growth rate is balanced when demand for its
product and supply of capital to the firm increase at the same rate.
12
The two growth rates are according to Marris, translated into two utility
functions:
1. Manager's utility function, and
2. Owner's utility function.
The manager's utility function (Um) and Owner's utility function (Uo) may
be specified as follows.
Um=f (salary, power, job, security, prestige, status),
Uo= f (output, capital, market-share, profit, public esteem, brand image)
1.8 Decision Making
The word decisions is derived from Latin word ‘de – also’ which means
cutting of or come to a conclusion. Decisions are usually made to achieve
the goals through the suitable follow actions. It is a process of concluding
something. In other words, decisions making is process of selecting the
best out of any alternatives.
Decisions making plays a vital role in any business. The success of

business widely depends upon the kind of the decisions taken and the
alternative selected. Therefore, decisions making is a one of the important
challenges faced by the management.
Process or steps of Decisions Making
1. Identifying the managerial problem.

2. Analyzing the problem.
3. Developing the alternative solutions.
4. Selecting the best solution out of the available alternatives.
5. Converting the decisions into action.
6. Ensuring the feedback and follow up.
Decisions under Market Uncertainty
Uncertainty refers to situation where the events can’t be enumerated and it

is also not possible to attach probability to them. The process of making
decisions under uncertainty is the biggest task.
13
As we say the future of business is uncertainly the decisions whatever we

take to make the future of business as certain is called as decisions under
uncertainty.
While taking decisions in a business we have to deal with various external

environment factors – social, political, legal, technological, geographical,
demographical factors…etc which are uncertain. In this case we have to go
with tactical and strategic decisions.
Tactical Decisions
Tactical decisions are medium term decisions. They support in

implementation of strategic decisions that are made by top level at most.
Example
• The kind of marketing activity to be undertaken
• The price to be fixed.
• No of employees to be recruited …etc
The primary goal of tactical decisions is to make the organization to run

successfully.
Strategic Decisions
Strategy is an unfiled, comprehensive, integrated plan which makes the

organization to run successfully by gaining the competitive advantage
over the competitors and by fulfilling the long term objectives of the
business.
The strategic decisions are concerned with the whole environment of the
business.
Example-
• Increasing the sales.
• Adaptations of new technology…etc
14
Chapter-2
Demand Analysis
2.1. Demand Analysis
2.1.1. Demand
Ordinarily demand means desire or wants for something. However, in

Economics demand is much more than a desire or a want, in Economics
demand refers
1. Willingness to pay and

2. Ability to Buy
According to Professor J. Harvey, “Demand in economics is desire to

possess and the willingness and also the ability to pay a certain price in
order to posses it.”
2.1.2. Mathematical Derivation of the Demand
Demand = Desire + Willingness to Buy + Ability to Pay.
Demand is also related with price and time. Demand is not an absolute
term but it is a relative concept, therefore, a demand for a commodity
should always be referred with price and time, most importantly demand is
not a constant one [it fluctuates]
2.1.3. Factors Influencing Demand
1. Price
2. Time
3. Income
4. Age & Sex ratio
5. Future expectations of customers
6. Inventions and innovations
7. Changing fashion
15
Demand Analysis
8. Changing environment and weather conditions

9. Level of taxation
10. Distribution of wealth and income in the society
11. Relative prices of products [complementary and substitute products]
12. Taste, Habits and preference of consumers
13. Advertising effects
14. Number of buyers in the market
15. General standard of living of people
1. Price of the Commodity- The most important factor affecting

amount demanded is the price of the commodity. The amount of a
commodity demanded at a particular price is more properly called
price demand. The relation between price and demand is called the
Law of Demand. It is not only the existing price but also the
expected changes in price which affect demand. In simple price
increases demand decreases and vise versa.
2. Income of the Consumer- The second most important factor

influencing demand is consumer income. In fact, we can establish a
relation between the consumer income and the demand at different
levels of income, price and other things remaining the same. The
demand for a normal commodity goes up when income rises and
falls down when income falls. But in case of Giffen goods the
relationship is the opposite.
3. Prices of related goods. The demand for a commodity is also

affected by the changes in prices of the related goods also. Related
goods can be of two types:
(1) Substitutes which can replace each other in use; for example, tea
and coffee are substitutes. The change in price of a substitute has
effect on a commodity’s demand in the same direction in which
price changes. The rise in price of coffee shall raise the demand
for tea;
(2) Complementary goods are those which are jointly demanded,
such as pen and ink. In such cases complementary goods have
opposite relationship between price of one commodity and the
amount demanded for the other. If the price of pens goes up,
their demand is less as a result of which the demand for ink is
also less. The price and the demand go in opposite direction. The
16
Demand Analysis
effect of changes in price of a commodity on amounts demanded

of related commodities is called Cross Demand.
4. Tastes of the Consumers- The amount demanded also depends on

consumer’s taste. Tastes include fashion, habit, customs, etc. A
consumer’” taste is also affected by advertisement. If the taste for a
commodity goes up” its amount demanded is more even at the same
price. This is called increase in demand. The opposite is called
decrease in demand.
5. Wealth- The amount demanded of a commodity is also affected by

the amount of wealth as well as its distribution. The wealthier are the
people higher are the demand for normal commodities. If wealth is
more equally distributed, the demand for necessaries and comforts is
more. On the other hand, if some people are rich, while the
majorities are poor, the demand for luxuries is generally higher.
6. Population- Increase in population increases demand for necessaries

of life. The composition of population also affects demand.
Composition of population means the proportion of young and old
and children as well as the ratio of men to women. A change in
composition of population has an effect on the nature of demand for
different commodities.
7. Government Policy- Government policy affects the demands for

commodities through taxation. Taxing a commodity increases its
price and the demand goes down. Similarly, financial help from the
government increases the demand for a commodity while lowering
its price.
2.1.4. Demand Schedule
A Tabular Statement of price and quantity demand relationship is

called as demand Schedule. It relates the amount the consumer is willing
to buy, corresponding to each consumable price for given commodity.
There are two types of demands Schedules:
1. Individual demand schedule

2. Market demand schedule
17
Demand Analysis
1. Individual Demand Schedule: A tabular statement showing the

quantities of commodity that will be purchased by an individual
at a given price and time is known as Individual demand
schedule.
2. Market Demand Schedule: It is the sum total of the individual
demand. It represents the change in market demand
corresponding to the varied price and time.
Table 2.1 Tabular representation of Individual and Market

demand schedule
Individual Market
Price for ‘x’
Demand Demand
10 5 5000
20 4 4000
30 3 3000
40 2 2000
50 1 1000
Note: Here the market represents the sum total of thousand customers or
1000 buyers.
Conclusion: The individual and market demand schedule represents the

change in the demand of both individual and market demand due to the
change in the price of the product. Here we can observe that as the price of
product x is increasing, the individual demand and the market demand is
decreasing, vice versa.
2.2. Law of Demand
Law of demand describes the general tendency of consumer’s behavior in

demanding a commodity in relation to the changing prices. The law of
demand was proposed by Alfred Marshall, in order to analyze the market
behavior. Therefore, it is known as behavioral law.
The law explains the critical relationship between price and demand of a
commodity. Generally the price of the commodity increases, the demand
decreases and as the price of the commodity decreases, the demand
increases. This relationship is expressed by the law.
18
Demand Analysis
Statement: Law of demand states that “At higher price lower will be the
quantity demand and at lower prices higher will be the quantity demand,
following when all other factors remain constant/equal”.
In simple words “Whenever the price increases, the demand decreases and
whenever the price decreases, the demand increases, when all other factors
remain constant”
Figure 2.1 graphical representation of law of demand
Note: The demand curve “DD” always slopes downwards from left to
right.
Assumption: The factors which should remain constant.
1. No change in consumer income.

2. The taste and preference of consumer should not change.
3. There should be no change in government policy.
4. No change in weather conditions.
5. The fashion should remain constant.
6. No change in income and wealth of society.
7. No change in price of related products.
8. No change in size of population.
Exceptions to the law of demand
1. Inferior or giffen goods

2. Prestigious products
3. Demand for necessaries
19
Demand Analysis
4. Fear of shortage
5. Price ignorant customers
6. Brand loyalty
7. Commodities out of fashion
8. Lunatic or toxinated persons
9. During the time of festival and marriages
10. Speculations / Artificial hoardings
11. During the time of war and economic emergencies
1. Giffen Goods: Some special varieties of inferior goods are termed

as Giffen goods. Cheaper varieties millets like bajra, cheaper
vegetables like potato etc come under this category. Sir Robert
Giffen of Ireland first observed that people used to spend more of
their income on inferior goods like potato and less of their income
on meat. After purchasing potato the staple food, they did not have
staple food potato surplus to buy meat. So the rise in price of potato
compelled people to buy more potato and thus raised the demand for
potato. This is against the law of demand. This is also known as
Giffen paradox.
2. Conspicuous Consumption or Veblen Effect: This exception to the

law of demand is associated with the doctrine propounded by
Thorsten Veblen. A few goods like diamonds etc are purchased by
the rich and wealthy sections of society. The prices of these goods
are so high that they are beyond the reach of the common man. The
higher the price of the diamond, the higher its prestige value. So
when price of these goods falls, the consumers think that the prestige
value of these goods comes down. So quantity demanded of these
goods falls with fall in their price. So the law of demand does not
hold good here.
3. Conspicuous Necessities: Certain things become the necessities of

modern life. So we have to purchase them despite their high price.
The demand for T.V. sets, automobiles and refrigerators etc. has not
gone down in spite of the increase in their price. These things have
become the symbol of status. So they are purchased despite their
rising price.
4. Ignorance: A consumer’s ignorance is another factor that at times

induces him to purchase more of the commodity at a higher price.
20
Demand Analysis
This is especially true, when the consumer believes that a high-

priced and branded commodity is better in quality than a low-priced
one.
5. Emergencies: During emergencies like war, famine etc, households

behave in an abnormal way. Households accentuate scarcities and
induce further price rise by making increased purchases even at
higher prices because of the apprehension that they may not be
available. On the other hand during depression, , fall in prices is not
a sufficient condition for consumers to demand more if they are
needed.
6. Future Changes in Prices: Households also act as speculators.

When the prices are rising households tend to purchase large
quantities of the commodity out of the apprehension that prices may
still go up. When prices are expected to fall further, they wait to buy
goods in future at still lower prices. So quantity demanded falls
when prices are falling.
7. Change in Fashion: A change in fashion and tastes affects the

market for a commodity. When a digital camera replaces a normal
manual camera, no amount of reduction in the price of the latter is
sufficient to clear the stocks. Digital cameras on the other hand, will
have more customers even though its price may be going up. The
law of demand becomes ineffective.
8. Demonstration Effect: It refers to a tendency of low income groups

to imitate the consumption pattern of high income groups. They will
buy a commodity to imitate the consumption of their neighbours
even if they do not have the purchasing power.
9. Snob Effect” Some buyers have a desire to own unusual or unique

products to show that they are different from others. In this situation
even when the price rises the demand for the commodity will be
more.
10. Speculative Goods or Outdated Goods or Seasonal Goods:

Speculative goods such as shares do not follow the law of demand.
Whenever the prices rise, the traders expect the prices to rise further
so they buy more. Goods that go out of use due to advancement in
21
Demand Analysis
the underlying technology are called outdated goods. The demand

for such goods does not rise even with fall in prices
11. Seasonal Goods: Goods which are not used during the offseason
(seasonal goods) will also be subject to similar demand behavior.
12. Goods in Short Supply: Goods that are available in limited quantity
or whose future availability is uncertain also violate the law of
demand.
2.3. Elasticity of Demand
Law of demand states that the demand for the commodity increases and
decreases. The law of demand tells only the direction of change. It does
not tell the rate at which the change takes place. Thus, law of demand is a
qualitative statement not a quantitative statement.
It was Alfred Marshall who has introduced the elasticity of demand. It is

an upgraded version of law of demand.
Statement: “The degree of responsiveness of change in quantity demand

due to the change in price” is known as elasticity of demand (or) in simple
words “rate of change in quantity demand due to change in price’.
Conclusion: The law of demand is just a qualitative statement it just

shows the direction at which the change takes place, but elasticity of
demand is both qualitative and quantitative statement, which shows the
direction of change and also the rate and the percentage at which the
change takes place.
Types of elasticity of demand
1. Income elasticity of demand

2. Price elasticity of demand
3. Cross elasticity of demand
2.3.1 Income Elasticity of Demand
It measures the change in quantity demand in response to the change in

consumer income.
22
Demand Analysis
Statement: The degree of responsiveness of change in quantity demand

due to the change in income.
𝑃𝑟𝑜𝑝𝑜𝑟𝑡𝑖𝑜𝑛𝑎𝑡𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑

Income elasticity =
𝑝𝑟𝑜𝑝𝑜𝑟𝑡𝑖𝑜𝑛𝑎𝑡𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑖𝑛𝑐𝑜𝑚𝑒
𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑

Where CQD =
𝑂𝑟𝑖𝑔𝑖𝑛𝑎𝑙 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑
𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑖𝑛𝑐𝑜𝑚𝑒
CI =
𝑂𝑟𝑖𝑔𝑖𝑛𝑎𝑙 𝑖𝑛𝑐𝑜𝑚𝑒
Types of income elasticity of demand
1. Positive income elasticity: Here, the income increases in the same

manner the demand also increases.
Example: Prestigious products, luxurious products, necessity
products.
2. Negative income elasticity: Here, the income increases but the
demand for the product services decreases.
Example: Inferior products [products of low quality]
3. Zero income elasticity: The income may increases or decreases, the
demand remains constant.
Example: Medicines, Salt… Etc
2.3.2. Price Elasticity of Demand
It measures the change in quantity demand in response to the change in

price of the product/ service.
Statement: The degree of responsiveness of change in quantity demand

due to the change in price.
In simple words, ‘rate of change in quantity demand due to the change in

price.

Price elasticity =
𝑃𝑟𝑜𝑝𝑜𝑟𝑡𝑖𝑜𝑛𝑎𝑡𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒

Where CQD =
23
Demand Analysis
𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒
CP =
𝑂𝑟𝑖𝑔𝑖𝑛𝑎𝑙 𝑝𝑟𝑖𝑐𝑒
Types of price elasticity of demand
1. Perfectly elastic demand

2. Perfectly inelastic demand
3. Unitary elastic demand
4. Relatively elastic demand
5. Relatively inelastic demand
1. Perfectly elastic demand: When a small change in price leads to a

infinite change in quantity demand or even when the price doesn’t
change, the demand goes on changing. Here, elasticity= [∞] The
demand curve here will be horizontal straight line. It is only the
imaginary demand curve because in real life there are no such
commodities or service having the perfectly elastic demand.
Figure 2.2 graphical representation of perfectly elastic demand
2. Perfectly inelastic demand: When the demand for a commodity

doesn’t not change whatever maybe the change in price is called as
perfectly inelastic demand.
In this case, the price changes in a greater manner which leads to no

change in quantity demand. Here, the elasticity = 0, the demand
curve will be a vertical straight line (It is also imaginary demand
curve).
24
Demand Analysis
Figure 2.3 graphical representation of perfectly inelastic demand
3. Unitary elastic demand: When a given percentage change in price

cause equally proportionate change in demand, it is known as unitary
elasticity of demand. Price and demand change in similar manner.
Example: When 5% increases in price leads to 5% decrease in
quantity demand and vice-versa, here elasticity =1.
When the proportionate change in quantity demand is equal to the

proportionate change in price, it is called unitary elasticity demand.
Figure 2.4 graphical representation of unitary elastic demand
4. Relatively elastic demand: The proportionate change in quantity

demand is greater than that of the price is known as relatively elastic
demand.
Example: 5% increase in price leads to 10% decrease in quantity

demand and vice versa. Here, the elasticity >1 (Demand changes in
grater manner)
25
Demand Analysis
Figure 2.5 graphical representation of relatively elastic demand
5. Relatively inelastic demand: The Proportionate change in quantity

demand is lesser than that of the price [or] proportionate change in
price is greater than that of quantity demand. (Price changes in grater
manner)
Example: 10% increase in price leads to 5% decrease in demand and

vice versa. Here, the elasticity <1
Figure 2.6 graphical representation of relatively inelastic demand
2.4. Cross Elasticity of Demand
This measures the change in demand for a product or commodity

due to the change in price of some other commodity. But, the product
should have complementary or substitute relationship.
26
Demand Analysis
Statement: Degree of responsiveness of change in quantity demand of

“A” product due to the change in price of “B” product. (Here A & B
should be complementary or substitute in nature.)
𝑃𝑟𝑜𝑝𝑜𝑟𝑡𝑖𝑜𝑛𝑎𝑙 𝑐ℎ𝑎𝑛𝑔𝑒 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑 𝑓𝑜𝑟 𝐴 𝑝𝑟𝑜𝑑𝑢𝑐𝑡
Cross elasticity=
𝑃𝑟𝑜𝑝𝑜𝑟𝑡𝑖𝑜𝑛𝑎𝑙 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓𝐵 𝑝𝑟𝑜𝑑𝑢𝑐𝑡
2.5. Advertising and Derived Demand Relationship (Advertising and

Promotional Elasticity of Demand)
In the modern competitive business world, almost all the business

enterprises depend upon advertisement and other promotional activities for
increases in sales. Advertising is one the most important tool for
promoting the sales, there is a direct relationship between advertising and
sales. Nowadays, the business enterprises are spending lot over
advertisement. Hence, the cost of selling the product is increasing.
Therefore, the companies are naturally interested in study of effects of
advertisements over the volume of sales. In order to study the relationship
between advertisement expenses and volume of sales, we make use of
advertising and promotional elasticity of demand.
Statement: “The proportionate change in quantity demand due to the

change in advertisement and promotional expenses”.
Ac D=
𝑃𝑟𝑜𝑝𝑜𝑟𝑡𝑖𝑜𝑛𝑎𝑡𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝐴𝑑𝑣𝑒𝑟𝑡𝑖𝑠𝑚𝑒𝑛𝑡 & 𝑃𝑟𝑜𝑚𝑜𝑡𝑖𝑜𝑛𝑎𝑙 𝑒𝑥𝑝𝑒𝑛𝑐𝑒𝑠𝑠
2.6 Factors Influencing the Elasticity of Demand
1. Nature of commodity
2. Availability of substitute
3. Number of uses
4. Income of consumers
5. Portion of expenditure
6. Durability of commodity
7. Habit of customers
8. Reoccurrence of demand
27
Demand Analysis
2.7. Measurement of Elasticity of Demand
Methods for measurement of elasticity of demand
1. Proportionate or percentage method

2. Expenditure or outlay method
3. Geometric or point method
4. The Arch method
1. Proportionate or Percentage Method: Under this method the

elasticity of demand is measured by the relation between proportionate
change in quantity demand and proportionate change in price.
Price elasticity =

Where CQD =
𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒
CP =
𝑂𝑟𝑖𝑔𝑖𝑛𝑎𝑙 𝑝𝑟𝑖𝑐𝑒
2. Expenditure or outlay method: Marshall suggested the easiest way of

understanding the elasticity or easiest way of measuring elasticity by
observing the change in total expenditure on a commodity before and
after the price change.
TE= P x Q i.e. Total Expenditure = Price x Quantity
Table 2.2 Representing Expenditure or outlay method

Total
Quantity
Price Expenditure Elasticity
(UTS)
(TE)
Original 2 10 20 -
4 5 20
Change-1 Elasticity =1
1 20 20
4 4 16
Change-2 Elasticity >1
1 24 24
4 6 24 Elasticity <1
Change-3
1 16 16
28
Demand Analysis
• When with the change in price (P↑↓) the total revenue remains
unchanged is called as unitary elasticity of demand (e=1)
• When with the increase in price (P↑) the total revenue decreases
(TR↓), decrease in price (P↓) total revenue increases (TR↑) the
elasticity > 1. Therefore, it is relatively elastic demand.
• When the increase in price (P↑) leads to increase in TR and the
decreases in price (P↓) leads to decreases in total revenue (TR↓) the
elasticity < 1. Therefore, it is relatively inelastic demand.
Figure 2.7 Graphical representation of Expenditure/outlay method
3. Geometric or Point Method: This method is also proposed by Alfred

Marshall.
This is used as a measure of change in quantity demand due to the very
small change in price.
Statement: Under this method we can measure the elasticity of demand
at any point of straight line demand curve by using the formula.
𝐿𝑜𝑤𝑒𝑟 𝑠𝑒𝑐𝑡𝑖𝑜𝑛 𝑜𝑓 𝑑𝑒𝑚𝑎𝑛𝑑 𝑐𝑢𝑟𝑣𝑒

Elasticity=
𝑈𝑝𝑝𝑒𝑟 𝑠𝑒𝑐𝑡𝑖𝑜𝑛 𝑜𝑓 𝑑𝑒𝑚𝑎𝑛𝑑 𝑐𝑢𝑟𝑣𝑒
29
Demand Analysis
Figure 2.7 Graphical representation of Geometric or Point Method

Figure 2.8 Graphical representation of Geometric or Point Method

𝐿𝑜𝑤𝑒𝑟 𝑠𝑒𝑐𝑡𝑖𝑜𝑛 𝑜𝑓 𝑑𝑒𝑚𝑎𝑛𝑑 𝑐𝑢𝑟𝑣𝑒
Elasticity for point P; E p =
𝑢𝑝𝑝𝑒𝑟 𝑠𝑒𝑐𝑡𝑖𝑜𝑛 𝑜𝑓 𝑑𝑒𝑚𝑎𝑛𝑑 𝑐𝑢𝑟𝑣𝑒
3
Ep= =1
3
E = 1 [Unitary Elasticity]
If elasticity = 1, then it is called as unitary elasticity of demand.
𝐿𝑆𝐷𝐶
Elasticity of point B; EB =
𝑈𝑆𝐷𝐶
2
EB = = 0.5
4
E<1
If E < 1, then it is relatively inelastic demand
𝐿𝑆𝐷𝐶
Elasticity for point A; EA =
𝑈𝑆𝐷𝐶
4
EA = =2
2
E>1
If E > 1, then it is relatively elastic demand
30
Demand Analysis
4. Arc Method: Point method is applicable for the finite change between
price and quantity demand. We cannot make use of point method when
there is an infinite change between price and quantity demand in this
case we make use of the arc method in order to measure elasticity of
demand.
Arc elasticity of demand measures the proportionate change in quantity
demand and price with an infinite change.
Arc elasticity = x P1 + P2
𝑝𝑟𝑜𝑝𝑜𝑟𝑡𝑖𝑛𝑎𝑡𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒
Q1 + Q2
Where P1 = original price

P2 = change in price
Q1 = Original quantity of demand
Q2 = change in quantity of demand
Figure 2.9 Graphical representation of Arc Method
2.8. Uses or Importance of Elasticity of Demand
The concept of elasticity of demand is of much practical importance.
1. Price fixation: Each seller under monopoly and imperfect

competition has to take into account elasticity of demand while
fixing the price for his product. If the demand for the product is
inelastic, he can fix a higher price.
31
Demand Analysis
2. Production: Producers generally decide their production level on

the basis of demand for the product. Hence elasticity of demand
helps the producers to take correct decision regarding the level of cut
put to be produced.
3. Distribution: Elasticity of demand also helps in the determination of
rewards for factors of production. For example, if the demand for
labour is inelastic, trade unions will be successful in raising wages. It
is applicable to other factors of production.
4. International Trade: Elasticity of demand helps in finding out the
terms of trade between two countries. Terms of trade refers to the
rate at which domestic commodity is exchanged for foreign
commodities. Terms of trade depends upon the elasticity of demand
of the two countries for each other goods.
5. Public Finance: Elasticity of demand helps the government in
formulating tax policies. For example, for imposing tax on a
commodity, the Finance Minister has to take into account the
elasticity of demand.
6. Nationalization: The concept of elasticity of demand enables the
government to decide about nationalization of industries
2.9. Demand Forecasting
Future is dark and always uncertain. In modern business world the firms
are required to estimate the future demand for their products and services,
otherwise their functioning may get handicapped.
“A forecast is tomorrow’s expectation based on yesterday’s achievements

and today’s plan”.
Meaning: ‘Demand forecasting is the process of estimating a future

demand for product or service with the help of past data and present
circumstances’.
2.9.1. Levels of Demand Forecasting
1. Micro level - firm level, forecasts are done to estimate the demand
of those products whose sales depends on the specific policy of a
particular firm.
32
Demand Analysis
2. Macro level - macro level, forecasts are undertaken for general

economic conditions, such as industrial production and allocation of
national income.
3. Industrial level - Industry level, forecasts deal with products whose
sales are dependent on the specific policy of a particular industry.
2.9.2. Features of Demand Forecasting
1. Based on past data and present circumstances

2. Done for a fixed period of time
3. It is the basis for future plan
4. Associated with sales and sales revenue
5. It should be given in terms of specific quantities(Numbers)
6. It is basically a guess work, not 100% precise.
2.9.3. Objectives of Demand Forecasting
1. It helps in preparing suitable production policy.

2. Helps in increasing regular supply of raw materials.
3. Sales forecasting.
4. Investment planning.
5. Fixation of price.
6. To solve the problems faced by the business.
7. To maintain the stability of the business.
2.9.4. Criteria for Good Demand Forecasting
1. Accuracy
2. Simplicity
3. Quickness
4. Economy
5. Flexibility [Dynamic]
2.9.5 Methods of Good Demand Forecasting for Existing Products
1. Survey Method
a. Consumer Interview Method: Under this method sampled
consumers are directly interviewed and the quantity what they
wish to buy will be estimated; with the help of results of the
interview [formal, informal interview or questionnaires are used].
33
Demand Analysis
b. Collective Opinion Method: The salesmen are the nearest

persons to consumers and they are able to judge the minds of
consumers. Under this method the demand forecasting is done by
interviewing the salesmen and by collecting their opinion.
c. Expert or Delphi Method: Here the demand forecasting is done
on the basis of opinions of experts [wholesales, retailers,
distributers… etc]
2. Market studies and experiment method

a. Market Method: Under this method the whole market is sub-
divided into smaller parts and one of the small divided market is
taken in order to conduct test marketing, here the demand
forecasting is done based on the test marketing results.
b. Controlled Laboratory Experiment Method: Under this
method the consumers are given some money to buy specific
products in an artificially created market, the products with the
various prices and packages are kept in the market. The
customers are free to purchase within the given amount. Here, the
response of the customers is recorded, based on their response the
demand is estimated.
3. Statistical Method: Statistical method uses the part data as guide

for knowing the level of future demand. This is generally used for
long run forecasting.
a. Trend Projection Method: Future sales are dependent on past
sales, because future is the grand child of past and child of
present.
Under this method the demand is estimated on the basic of
analyzing the past data. It makes use of time series [independent
variables]. The following methods are used –
i) Least squares method [problems]
ii) Moving average method
iii)Simple average method
b. Regression and Correlation - This method combines both
economic and statistical theory of estimation of future demand.
Regression and correlation are used for forecasting demand.
Based on past data the future data trend is forecasted. If the
functional relationship is analyzed with the independent variable
it is simple correction. When there are several independent
variables it is multiple correlation. In correlation we analyze the
34
Demand Analysis
nature of relation between the variables while in regression; the

extent of relation between the variables is analyzed. The results
are expressed in mathematical form. Therefore, it is called as
econometric model building. The main advantage of this method
is that it provides the values of the independent variables from
within the model itself.
c. Barometric Method - It is the improved version of trend
projection method. Simple trend projections are not capable of
forecasting turning paints. Under Barometric method, present
events are used to predict the directions of change in future. This
is done with the help of economics and statistical indicators.
Those are (1) Construction Contracts awarded for building
materials (2) Personal income (3) Agricultural Income. (4)
Employment (5) Gross national income (6) Industrial Production
(7) Bank Deposits etc.
2.9.6. Demand Forecasting for New Products (Methods)
1. Evolutionary Approach - Based on the assumption that every new

product is evolution from some old product by looking into the sales
of old product demand forecasting for new product is done
2. Substitute Approach- Here, the new product is treated as the
substitute of existing product. Thus, the demand for the new product
is estimated by looking into the demand for substitute products.
3. Growth Curve Approach- Under this method the growth rate of
new products is estimated on the basis of growth rate of existing
product in the product line.
Example: If HUL is going to release a new product (soap), the
demand for the new soap is estimated by looking into the sales of
existing soap brands of HUL.
4. Opinion Pole Method- Here the demand forecasting is done on the
basis of opinions of experts (wholesales, retailers, distributers… etc)
2.10. Supply
In economics, supply during a given period of time means the quantities of

goods which are offered for sale at particular amount of the commodity
which the seller or producer are able and willing to offer for sale at a
particular price during the given period of time.
35
Demand Analysis
Determinates of supply
1. Cost of production
2. Profit margins
3. State of technology
4. Weather conditions
5. Tax rates
6. Subsidy rates
7. Economic conditions
2.10.1. Law of Supply
Statement: The law of supply refers to the general tendency of seller in

offering this stock of commodity with relation to the varying prices.
“When all the factors remain constant or unchanged, the supply of the
commodity increases as the price increases and the supply of the
commodity decrease as the price decreases”. (Or)
In simple words, “Whenever the price increases the supply of goods and
services increases, whenever the price decreases the supply of goods and
services decreases, when all other factors remain constant”.
Table 2.3 Tabular Representation of Law of supply
Price of Pen Units of Supply
10 100
20 200
30 300
40 400
Figure 2.6 Graphical representation of Law of supply
36
Demand Analysis
Assumptions: (factors that should remain constant)
1. The cost of production should be unchanged.

2. No technique of production should be changed.
3. Fixed scale of production(quantities)
4. Government policy should remain unchanged.
5. No speculation (artificial holding).
6. Prices of others goods should remain constant.(Complementary and
Substitute Product)
2.10.2 Elasticity of Supply
The price elasticity of supply is a measure of the degree of responsiveness

of change in quantity supplied due to the change in the price of a given
commodity. It is an important parameter in determining how the supply of
a particular product is affected by fluctuations in its market price. It also
gives an idea about the profit that could be made by selling that product at
its price difference.
Price elasticity of supply formula

𝑃𝑟𝑜𝑝𝑜𝑟𝑡𝑖𝑜𝑛𝑎𝑡𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑆𝑢𝑝𝑝𝑙𝑦
Price elasticity =
Five types of elasticity of supply
1. Perfectly Elastic Supply: A commodity becomes perfectly elastic

when its elasticity of supply is infinite. This means that even for a
slight increase in price, the supply becomes infinite. For a perfectly
elastic supply, the percentage change in the price is zero for any
change in the quantity supplied.
2. More than Unit Elastic Supply: When the percentage change in the
supply is greater than the percentage change in price, then the
commodity has the price elasticity of supply greater than 1.
3. Unit Elastic Supply: A product is said to have a unit elastic supply

when the change in its quantity supplied is proportionate or equal to
the change in its price. The elasticity of supply, in this case, is equal
to 1.
37
Demand Analysis
4. Less than Unit Elastic Supply: When the change in the supply of a
commodity is lesser as compared to the change in its price, we can
say that it has a relatively less elastic supply. In such a case, the
price elasticity of supply is less than 1.
5. Perfectly Inelastic Supply: Product supply is said to be perfectly

inelastic when the percentage change in the quantity supplied is zero
irrespective of the change in its price. This type of price elasticity of
supply applies to exclusive items. For example, a designer gown
styled by a famous personality.
38
Chapter-3
Cost and
Production Analysis
3.1. Production Analysis or Concepts of Production
Human wants are satisfied by the means of production of goods and

services, production is the process of transforming factors of production
into goods and services the factors like capital, land, labors, machine,
technology, and Entrepreneurship collectively known as input.
Production implies the provision of goods and services often described as

output.
production and consumption
Definition: According to Hick-“production is an activity directed to the

satisfaction of other people wants through exchange”.
• The concept of the economic well-being of a unit (or "economic status" or "well-offness") refers to its ability
to demand goods and services, in relation to its needs.
3.2. Production Function
The functional relationship between input and output is known as the

production function. The production function states the maximum quantity
of output which can be produced from any selected combination of input.
In other words it states the minimum quantity of input that is necessary to

produce a given quantity of output. The rate of output of commodity
functionally depends on the quantity of inputs used with per unit of time.
Definition: “A Production function refers to functional relationship

between the input and the output under given technology” with per unit of
time (Technological and physical relations between input and outputs).
39
Cost and Production Analysis
Algebraic Statement
Q = f (L,C,T,M……...n T)
Q = f (A, B, C,D ……n T)
Where ` L or A = Labour
C or B = Capital
T or C = Technology
M or D= Machinery
T = Time
f = sum of
Attributes or features of Production Function
1. Flow concept
2. Physical Concept
3. State of Technology and inputs
4. Some inputs are complementary in nature
5. Some inputs are substitute to another
6. Some inputs may be specific
7. Factors combination for maximum output
8. Long run and short run production function.
3.3. Laws of Production
The production function involves transformation of all inputs into outputs.

In production function, we are going to study the various combinations of
factor inputs giving maximum output
1. The output can is produced by keeping one factor as fixed while all
other factors are varied- Law of Diminishing Marginal Returns.
(One fixed factor and rest all are variable factors).
2. The production function where one factor is variable and rest all
other factors are kept constant or fixed – Law of Variable
Propositions. (One variable factor and rest all are fixed factors.)
3. Another type of production function, where quantities of every input
combinations can be varied to produce the different quantities of
output – Law of Constant Returns to Scale – Every factor is
variable.
4. Least cost Combination- ISO Quant’s & ISO Cost’s
40
3.3.1. Law of Diminishing Marginal Returns
It was originally explained by classical economist with reference to

agriculture. It was studied in relation to land which was kept constant
(fixed factor) while all other factors were increased (as they were
variable), the output did not increased proportionately. It is the experience
of every farmer that output of the land cannot be doubled by doubling the
labour, capital etc on the given piece of land.
In simple words though you are going to increase the capital, labour,
fertilizers, insecticides, pesticides, seeds etc which are variable factors to
fixed factor land the output may not increase proportionately, finally it
decreases or diminishes. Although the law was originally explained in
connection with land and agriculture, it can be applied to the field of
mining, fishing and house construction etc.
3.3.2. Law of Variable Proportion
This is the modern version of law of diminishing marginal returns under

this law it is assumed that “One factor of production will be variable factor
while all other production factors will be fixed”. As we increase the
quantity of variable factor keeping other factors constant, the output of
variable factor may increase more than proportionately in the initial stages
but finally it will not increase proportionately.
Conditions
1. Only one factor is variable factor , rest are fixed factors

2. The scale of production is unchanged
3. The technique of production does not change
4. All units of factor inputs are Homogeneous in nature
Statement of Law of Variable Proportions
During the short run production under the given state of technology and
while keeping other conditions unchanged with the given fixed factors and
with only one variable factor if you keep on increasing one variable factor
by keeping all others factor fixed the total product may increase in early
stage and diminishes in the later stages (because the marginal product may
find to raise initially, later on it is going to diminish).
41
Table 3.1Representing law of variable proportions

Variable Total Average Marginal Product
Factor Product Product MP= Tcn- Tcn-1
1 20 20 20
2 50 25 30 Ist Stage
3 120 30 40
4 120 30 30
5 135 27 15
6 144 24 09 II st Stage
7 141 21 03
8 148 18.5 01
9 148 16.4 00
IIIrd Stage
10 145 14.5 -3
Stage 1: Increasing returns
Here, the total product increases at increasing rate and this continuous till
the end of this stage, the average product also increases and reaches its
highest point at the end of this stage (later on it diminishes) the marginal
product increases at an increasing rate. Here Total Product (TP) Average
Product (AP) and Marginal Product (MP) all are increasing so the stage is
known as increasing returns.
Stage 2: Diminishing returns
The total product continuous to increase but in a decreasing rate until it

reaches its maximum point at the end of this stage, But both the Average
product and Marginal product diminishes but still they remain in the
positive axis, till the end of this stage. As both Average Product and
Marginal Product decline and even the Total Product increases in a
decreasing rate this stage is known as Diminishing returns.
Stage 3: Negative returns
In this stage the Total Product declines and the Average Product also
declines but never enters into zero, the Marginal Product enters into the
zero in the beginning of this stage and it moves towards the negativity i.e
below the ‘X’ axis, hence the third stage is known as negative returns. If
the production is further continued both Total Product and the Average
Product enters into negative zone.
42
Figure 3.1 Graphical representation of law of variable proportions
3.3.3. Laws of Returns to Scale
Adjustment among different factors can be brought about in a long run

production. Thus all factors become variable in the long run that means in
the long run production the size of the firm can be expanded as the scale of
productions is enhanced. The economists used the phrase “Returns to
scales” to describe the output behaviors in the long run in relation to the
variations in the factor input. Here all the factors are variable factors in
long run production; here under the long run production every fixed factor
will be converted into the variable factor. Thus law of returns to scale is an
long run analysis.
Statement: “As the firm in the long run increases the quantities of all
factors employed while other things being equal or unchanged the output
may raise initially at a rapid rate than the rate of increase in the input, then
output may increase in the same proportion to the input, and ultimately
output increases less proportionately when compared with input”
Assumptions
1. The technique of production is unchanged

2. All units of inputs are Homogenous in nature
3. Returns are measured in physical quantities
43
There are three phases of returns in long run which may be separately
described as
1. The law of increasing returns to scale
2. The law of constant returns to scale
3. The law of decreasing or diminishing returns to scale
1. Law of increasing Returns to scale: When input increases in given

proportionate, and the output increases in greater proportionate than
the input, said to be increasing returns to scale
Example: Input increased by 40% and output increased by 60%
2. Law of Constant Returns to Scale: The process of increasing

returns to scale however cannot go on forever. It may be followed
by the next stage i.e Constant Returns, to scale, as the firm here
continuous to expand its scale of operation, it gradually exhaust and
the proportionate increase in the input and the proportionate increase
in the output will be equal. When the inputs are increased in given
proportionate and the output are also increased in the same
proportionate the stage is known as constant returns to scale
Example: Input increased by 40% and output also increased by 40%
3. The Law of Decreasing or Diminishing Returns to Scale: It is

also known as Diminishing returns to scale if the firm continues to
expand the production beyond the stage of constant returns to scale,
the production enters into the stage of diminishing and decreasing
returns to scale. Here “The proportionate increase in the input leads
to Proportionate decrease in the output”
Example: Input increases by 40% output increase by 20%
Figure 3.2 Graphical representation of The Laws of returns to scale
44
3.4. Production Function with Two Variable Inputs

(I S O Quant’s)
So for we have discussed the firm is going to increase the output by using.
1. One fixed factor and all other variable factors
2. One variable factor and rest all others as fixed factor
3. With all the variable factors
Let us now consider the case where the firm is expanding its output by
using combinations of two variable factors and rest all other factors as
fixed. This kind of production function with two variable factor inputs can
be represented with the help of I S O quant’s.
I S O Quant’s (In difference Curve)
I S O Quant’s is the combination of two words, Where I S O means Equal

and Quant’s means quantities. I S O Quant’s mean equal quantities (Equal
Quantity of output).
I S O Quant’s are the curve which represents the different combination of

two variable factor of inputs in producing the particular quantity of output
or same level of output. Thus ISO Quant’s shows all possible
combinations of two variable factors input capable of producing given
level of output or equal output.
I S O Quant’s are also known as I S O Product curve. I S O Quant’s can

be better explained with the help of statistical table and graph where we
have two variable factors
1. Labour represented with ‘L’ and
2. Capital represented with K or machinery represented by ‘M’
Table 3.2 Representing I S O Quant’s
Combination Units of Units of Total output

Labour (L) capital (x)
A 5 9 1000
B 10 6 1000
C 15 4 1000
D 20 3 1000
45
Figure 3.3 Graphical representation of I S O Quant Curve
Figure 3.4 Graphical representations of I S O Quant’s Curves
Features of Properties of I S O Quant’s
1. I SO Quant’s have negative slope

2. I SO Quant’s Are convex in origin
3. I SO Quant’s Do not intersect each other
4. I SO Quant’s need not to be parallel to each other
5. Higher the I SO Quant’s represents larger the output
6. I SO Quant’s always flow from left to the right
7. No I SO Quant’s touch either the axis
46
3.5. Optimum Input Combination or Least Cost Combination or

Producer’s Equilibrium
I S O Quant’s show the different combinations of two factors input
producing same level of output. However the producer will accept the best
combination which brings him maximum profits with minimum cost (He
selects one out of all the combinations)
This is possible only by maximizing the output with minimum cost
therefore he will select the optimum input combination which involves the
least cost
“The optimum input combination or least cost combination” is that

combination which produces maximum output with minimum cost this is
called as producers equilibrium. This can be identified by combining the
firm’s production function and cost function.
1. The firm production function is represented with I SO Quant’s

2. The firm cost function is represented with I SO COST.
The principles or Assumptions of least cost combination

1. Labor and capital are two factors involved [two variable factors)
2. All units of both the factors are homogeneous in nature
3. The prices of factor input are given
4. Total money outlay (Total cost) is also pre determined or given.
3.6. ISO Cost Curve
In order to select the optimum quantity of two factor inputs the firm has to
consider the quantities and their respective prices. Therefore the prices
and the amount of money which the firm wants to spend have to be taken
into the consideration.
ISO Cost Curve represents the different combination of two factor inputs
which the firm can buy at given prices with a given amount of money.
ISO Cost Curve:
47
Figure 3.5 Graphical representation of ISO cost curves
3.7. Selection of Optimum or Least Cost Combination or

Producers Equilibrium
The producer’s equilibrium can be identified with the help of ISO

QUANTS and I SO COST CURVES. A firm equilibrium will be attained
at a point where the ISO QUANT and ISO COST CURVES touch or
intersect each other. The point where ISO QUANT CURVE touches the
ISO COST CURVE is called as point of producer’s equilibrium or least
cost combination.
Figure 3.6 Graphical representation of least cost combination or

producers equilibrium
48
3.8. Economies of the Scale
Large scale production leads to low cost production
It is the general tendency of the part of every business to enhance the scale
of productions so as to get some advantages. The advantage which the
business man enjoys when he expand his operation of production is know
as Economies of scale.
Meaning: “Large scale production which leads to the low cost production
is called as Economies of Scale”
“Large scale productions is economical in the sense the cost of production

is low. The low cost is a result what is called as Economies of Scale.
Definition: Anything which serves to minimize average cost production in
the long run as the scale of output increases is referred as Economies of
scale; it is measured in monitory terms.
3.8.1. Types of Economics of Scale
1. Internal Economies: In Internal economies, the individual

organization increases the scale of production and reduces the cost of
production. Internal Economies means increase in returns to scale
which arises within a firm as a result of its own expansion (expansion
in operations, business or in production)
Types of in Internal Economics

Technical Economies of Scale: Companies achieve technical
economies of scale by lowering the unit cost using the improvements in
their production process. These economies can be achieved by using
efficient equipment, improving quality control, using improved
processes, etc.
Managerial Economies of Scale: Managerial economies of scale

happen based on the improvements of the management team of the
company. The company will have a greater opportunity to attract more
expert talent when the company is scaling up. When the company is
growing, the current management will gain experience more and more.
49
The performance of management increases because of greater

knowledge in managerial staff with their experience gained.
Marketing Economies of Scale: When the company’s scale of
production increases, the spread of the fixed marketing expenses will be
distributed among a large number of units, which results in lower per-
unit costs. Larger established companies have a strong brand reputation
which increases their chance of having the same level of advertising
impact at a lower cost than the small companies. Also, large companies
are benefited from better-experienced sales staff resulting in increased
sales volume.
Financial Economies of Scale: Larger and established companies are
considered more creditworthy than relatively smaller companies. Banks
usually consider larger established companies as low risk, which results
in obtaining debt (loans) with a much lower interest rate. Also, larger
companies have different ways to gain capital, rather than not
depending on debt/bank loans. Listed companies can also raise capital
from the stock market by issuing bonds.
Labor Economies of Scale: Large companies usually have a bigger
number of employees. People tend to work in globally established,
well-reputed large companies more. These large companies have the
distinct advantage of attracting skillful talent to their company. Also,
the employees have the chance to be employed in the job where they
are most suited.
Risk Bearing Economies of Scale: Larger companies spread their risk
by producing different products or services as a contingency plan if
one/few products are failed. This will reduce the overall risk of the
company and its investors.
2. External Economies
Those which are available to the industry as a whole. When the
entire industry expands the scale of production they will get adequate
resources at less cost, machineries at cheaper rates, raw materials at less
cost and even the technology etc, which leads to low cost production.
50
3.9. Diseconomies of Scale
The Economies of Scale will not continue for a long time, after certain
level, too much expansion will create Diseconomies in production instead
of Economies. The existing machinery will be over strained, the
technology will be outdated, coordination and control may be difficult etc.
The combined of all these things shifts the cost of production from low to
high that means as the level of production is increased after a certain level
the cost of the production increase i.e. “ large scale production which leads
to the high cost production is called as Diseconomies of the scale”.
Types of Diseconomies
1. Financial diseconomies: For expanding business, the entrepreneur

needs finance. But finance may not be easily available in the
required amount at the appropriate time. Lack of finance retards the
production plans thereby increasing costs of the firm.
2. Managerial diseconomies: There are difficulties of large-scale

management. Supervision becomes a difficult job. Workers do not
work efficiently, wastages arise, decision-making becomes difficult,
coordination between workers and management disappears and
production costs increase.
3. Marketing Diseconomies: As business is expanded, prices of the

factors of production will rise. The cost will therefore rise. Raw
materials may not be available in sufficient quantities due to their
scarcities. Additional output may depress the price in the market.
The demand for the products may fall as a result of changes in tastes
and preferences of the people. Hence cost will exceed the revenue.
4. Technical diseconomies: There is a limit to the division of labour
and splitting down of production p0rocesses. The firm may fail to
operate its plant to its maximum capacity. As a result cost per unit
increases. Internal diseconomies follow.
5. Diseconomies of risk-taking: As the scale of production of a firm
expands risks also increase with it. Wrong decision by the
management may adversely affect production. In large firms are
affected by any disaster, natural or human, the economy will be put
to strains.
51
3.10. Introduction to Cost
In Managerial economics the cost is normally considered from the

producers or the firm’s point of view.
In producing a commodity or service the firm has to employ the various,

materials and most importantly ownership or entrepreneurship. These
factors are compensated by firm for their efforts in producing a product or
service. Their compensation is usually cost to a producer and it is
compensated in terms of money.
Meaning: “Cost is the aggregate amount or price spent by a producer over

various factors of production to produce a product or service”
3.10.1. Concepts of Cost
Real cost: The terms real cost refers to the physical quantity of various
factors is producing a commodity or service is considered including
minute of minute cost. The real cost is just imaginary based and it is
difficult to calculate cost in terms of real cost.
Example: Real cost of an table composed by a manufacture includes
carpenter labor, 2 cubic foot of wood, dozens of nails, half a bottle of
varnish, depreciation of tools, electricity charges, lunch or any kind of
food for carpenter during the process of production, transportation
charges… etc
Opportunity cost: It is the foregone benefit which is missed due to the

selection of one alternative by sacrificing next best alternative course of
action. So, the opportunity cost means scarification of next best alternative
course of action.
Example: A businessman invests his own capital in business. Here, the

opportunity cost is measured in terms of interest which he would earn by
lending the money. Similarly when he devotes his time in organizing the
business, the opportunity cost is measured in terms of salary he could have
earned from employment elsewhere.
Money cost: The cost of production which is measured in terms of money

and it is called as money cost.
52
“ Money cost is the monetary expenditure made over various factors of

production like land, labor , raw materials , machines, ownership,
money… etc required for the output”. (Or) It is the money spent over
purchasing the different factors of production for producing a product or
service.
Money cost= Explicit cost + Implicit cost
1. Explicit cost [ the cost incurred with the direct market transaction]
Explicit costs are direct money payments incurred through market
transaction.
“Explicit cost refers to actual money outlay or out of pocket
expenditure of the firm to buy or hire production resources which is
required for process of production “.
Example: Cost of raw material, wages, power charges, rent of
building, insurance premium, paid on capital.
2. Implicit cost: Implicit cost is the opportunity cost of the use of
factors which a firm does not buy or hire, but already own.
“Implicit cost are not directly incurred by the firm through market
transactions, these are estimated on the basis of opportunity cost
(hidden cost)”.
Example: Wages or salary of entrepreneur or owner himself, interest
on capital invested by the owner himself which is used for business
purpose.
Fixed cost: Fixed costs are the amount spent by the firm on fixed inputs or
the fixed factors of production in short run production function. Thus fixed
cost remains constant irrespective of level of output. The cost of the
production remains unchanged when the output is increased or decreased
or even the output is nil (0).
“Fixed costs are those costs which are incurred as a result of use of fixed
factors of production and remain fixed at any level of output (even when
it is 0) Under the short run production function”.
Example: Investments over building, plant, machineries, rent, salary… etc
Variable cost: Variable cost is those which are incurred as the investment
over variable factors of production. These costs vary directly with the
output (or)
53
“The variable costs are those which increases as the output increases,
decreases as the output decreases, it will be nil (zero) when the output is
nil or zero.
Example: Investments or expenditure over raw materials, fuel charges,

electricity, and laborers (wages)… etc
Note: Short run production function is something which is done in a

shorter period of 4 to 6 months, in the short run production function we
can find and make use of both the fixed and variable factor. Therefore, in
this function we are going to include both fixed and variable cost.
The formula
Total cost = Total Fixed cost + Total variable cost
TC = TFC +TVC
Long run production function is done for a longer period. In the long run
production function every factor is converted into variable factor, that
means there is an absence of fixed cost or fixed factor in the long run
production function
The formula
Total cost = Total variable cost
TC =TVC
Incremental cost: Incremental refers to change in total. Incremental cost

maybe defined as “change in total cost due to the specific decisions”
Example: original sale of manufacturing of 10 pens is as follows, where

TFC is 50 Rs and TVC is 50 RS
Therefore, TC = TFC + TVC

= 50+50
TC= 100 Rs
Here the producer has taken the decision to increase the scale of
production from 10 pens to 20 pens, where the TFC of manufacturing 20
pens remains constant at the rate of 50 Rs, but the variables cost increases
to 100 Rs from 50 Rs.
54
TC = TFC + TVC
= 50+ 100
TC = 150
The total cost of producing 10 pens was 100 Rs which was increased to
150 Rs because of specific decision. I.e. to increase the scale of production
from 10 pens to 20 pens, Here, the incremental cost is changed total cost -
original cost 150 – 100 = 50 Rs
3.11. Types of Production Cost
Total cost: Total cost is aggregate amount or the expenditure incurred by

the firm in producing the given level of output.
Conceptually total cost includes all the trends of money cost.
a. Total cost = Total fixed cost + Total variable cost
b. Total cost = Total revenue – profit (TR = P x Q)
Total Fixed Cost: The total fixed cost is correspondence to the fixed input
in the short run production function. It is obtained by summing up of the
aggregate value of amount spent over fixed factors of production. The total
fixed cost remains constant irrespective of output.
TFC = f (a, b, c…, n), where “a” may be salary, “b” may be investment on
machinery, “c” may be insurance paid ,….n represents the various fixed
factors and f represents the sum of
TFC = TC – TVC
Or
TFC = AFC x Q
Total Variable Cost: It is obtained by summing up of aggregate money

value of all the variable factors of production.
TVC = f (a, b, c, d, …..,n) where “a”, may be wages paid to labours , “b”
may be cost of raw materials, “c” maybe cost of electricity , fuel ,
transportation charges etc.
TVC = TC – TFC
Or
TVC = AVC x Q
55
Average Fixed Cost:

𝑇𝐹𝐶
AFC = 𝑜𝑟 𝐴𝐹𝐶 = 𝐴𝑇𝐶 − 𝐴𝑉𝐶
𝑄
Where, TFC is total fixed cost and Q represents total quantity of output.
Average Variable Cost:

𝑇𝑉𝐶
AVC = 𝑜𝑟 𝐴𝑉𝐶 = 𝐴𝑇𝐶 − 𝐴𝐹𝐶
𝑄
Where, TVC = total variable cost and Q represent total quantity of output.
Average total Cost:

𝑇𝐶
ATC = AFC + AVC or ATC =
𝑄
Where, AFC = Average Fixed Cost and AVC represent Average Variable
Cost.
Marginal Cost: It is also known as per unit cost. It is an addition made to

the total cost by producing an extra unit.
MC n = TC n – TCn-1
Here, marginal cost of n units = Total cost of n units – Total cost of n-1
unit.
“Marginal cost means cost of producing an extra unit or output”.
Example: Suppose total cost of producing 4 chairs is 1000Rs, while that

for 3 chairs is 8000 Rs. Then the marginal cost for fourth chair can be
calculated as follows-
MCn = TCn – TCn-1

MC4 = TC4 – TC4-1
=10,000 – 8000
MC4 = 2000
The marginal cost of producing 4th chair is 2000 Rs
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3.12. Behavior of Cost under Short Run Production or Short Run

Total Cost Schedule of a Firm
Short run cost function states the relationship between cost and the output
or it studies the behavior of the costs under given scale of output under the
short run production function.
The cost function of a firm can be expressed statistically with the help of
cost schedule or graphically with the help of cost curves. A cost schedule
is a statement which shows the variation in the costs resulting from the
variation in the level of output. It shows the response of the cost to the
changing output.
Short run costs
To examine the cost behavior in the short run production we may begin the
analysis with the help of following major four cost concepts.
1. Total cost
2. Total Fixed Cost
3. Total variable cost
4. Marginal cost
5. Average Fixed Cost
6. Average Variable Cost
7. Average Total Cost
Assumptions
1. Labour and capital are two factor input

2. Labour is an variable factor
3. Capital is a fixed factor
4. Price of each labour is 10 Rs per unit
5. Price of capital is 25 Rs per unit
Since we are going to make use of 4 units of capital, the total fixed cost
remains constant at 100 Rs. The total variable cost varies as the variable
factors are going to vary.
57
Table 3.3 Representing Cost Schedule

Fixed Variable MC
Total
Factor Factor TFC TVC TC AFC AVC ATC [TCn –
Product
[capital] [labour] TCn-1]
4 0 0 100 0 100 0 0 0 -
4 1 2 100 10 110 50 5 55 10
4 3 5 100 30 130 20 6 26 20
4 3 10 100 30 130 10 3 13 0
4 4 15 100 40 140 6.6 2.6 9.2 10
4 5 18 100 50 150 5.5 2.7 8.2 10
4 8 20 100 80 180 5 4 9 30
4 12 21 100 120 220 4.7 5.7 10.4 40
Figure 3.7 Behavior of cost under short run production

Figure 3.8 Behavior of Short run Average and Marginal Cost

Curves under short run production
58
1. Total Fixed Cost (TFC): It remains constant at all the level of

output. It is same even when the output is nil. Thus, it is independent
of output.
2. Total Variables Cost (TVC): It varies with the output, it is nil
when there is no output, it increases as the output increases and
decreases as the output decreases. The TVC does not change in the
same proportion, initially it increases at decreasing rate later on it
increases in an increasing rate.
3. Total cost (TC): It varies in the same proportion as TVC. Thus, in
short run production function TC changes entirely due to the
influence of TVC. The TC increases as the output increases and
decreases as the output, there will be certain amount of TC when the
output is nil. This is due to the influence of TFC.
4. Marginal cost [MC]: MC is assumed to be u- shaped curve, the MC

initially decreases as the output increases, it enters into the stage of
zero and remains constant for a while and later on it increases as the
output increases.
5. Behavior of average cost curves: The average fixed cost, average

variable cost and the average total cost will be nil when the output is
nil. As the output increases all the average costs gradually decreases
later on it increases.
3.13. Behavior of Cost under Long Run Production or Long Run

Cost Curves
Long run period is sufficient enough to enable a firm to vary all its factors
which are included in the process of production. Therefore, in the long run
production function every factor will be a variable factor. Thus, there will
be the absence of fixed factor.
59
Figure 3.9 long run Average cost curve
As there are no fixed factors in the long run production there will be also
the absence of fixed cost. Therefore, here under the long run production
function we are going to study the behavior of variable cost, total cost and
marginal cost with the varying output [long run production function].
Hence, we have only to study the relationship of long run average cost
curves; the long run average cost curve is the envelope of the various short
run average cost curves. The tendency for the long-run average costs to fall
as the firm expands its operation scale is a reflection of cost economies
available with the increase in size, while the ultimate size in the long-run
curve is due largely to the eventual setting in of diseconomies of scale.
Features of Long Run Cost Curve
1. Tangent curve- By joining the SAC’s of various years we can draw

the LAC, of hence it is called as tangent curves.
2. Envelope curve- Holds various SAC’S, It is drawn to cover them
and is often known as Envelope curve as no point on SAC curve can
ever be below the LAC curve.
3. Planning curve- A long run average cost curve is known as a
planning curve. This is because a firm plans to produce an output
in the long run by choosing a plant on the long run average cost
curve corresponding to the output. It helps the firm decide the size of
the plant for producing the desired output at the least possible cost.
4. Flatter U shaped curve- This U-shape of the LAC curve implies
lower and lower average costs in the beginning until the optimum
scale of the enterprise is reached and successively higher average
costs thereafter i.e. with plants larger than that of the optimum scale.
60
5. There will be no similarity between the SAC.

6. As the SAC increases, the LAC increases and vice-versa.
3.14. Breakeven Analysis
BEA has considerable significance in economic research, business

decisions, company management, investment decisions etc BEA is an
important technique used to trace the relationship between cost, revenue
and the profit on one side with the varying output on the other side. In
simple, the BEA studies the relationship between cost, revenue and profits
with the varying output. This relationship can be better understood with
the help of break even chart.
Breakeven Chart
Break even chart is the graphical representation of short run relationship

between total cost, total revenue and profits with the varying output. Break
even chart graphically shows cost, profit and revenue relationship with the
varying output break even chart also determines the breakeven point.
Breakeven Point
BEP is the point where (TC =TR) total cost is equal to total revenue. This
is the point where the companies enjoy no profit or no loss. The zone
below the BEP is called as loss zone. The zone above the BEP is called as
profit zone. The break even point is determined when the total cost and
total revenue curve intersect each other.
Figure 3.10 Breakeven chart
61
Assumptions
1. Cost and revenue functions are linear in nature [increasing]

2. Total cost includes both fixed and variable cost.
3. Selling price remains constant
4. Volume of sales and production are identical
5. Production mix is stable
Limitations of BEP
1. It is static ( less flexible)

2. It is unrealistic
3. The scope is limited to short run production only
Usefulness or importance of BEP
1. It provides microscopic view of profit structure

2. It helps in cost decisions
3. It helps in revenue decisions
4. It helps in determine the volume of sales
5. It helps in determining the margin of safety
1. Manages the size of units to be sold: With the help of break-even

analysis, the company or the owner comes to know how many units
need to be sold to cover the cost. The variable cost and the selling
price of an individual product and the total cost are required to
evaluate the break-even analysis.
2. Budgeting and setting targets: Since the company or the owner
knows at which point a company can break-even, it is easy for them
to fix a goal and set a budget for the firm accordingly. This analysis
can also be practised in establishing a realistic target for a company.
3. Manage the margin of safety: In a financial breakdown, the sales
of a company tend to decrease. The break-even analysis helps the
company to decide the least number of sales required to make
profits. With the margin of safety reports, the management can
execute a high business decision.
4. Monitors and controls cost: Companies’ profit margin can be
affected by the fixed and variable cost. Therefore, with break-even
analysis, the management can detect if any effects are changing the
cost.
62
5. Helps to design pricing strategy: The break-even point can be

affected if there is any change in the pricing of a product. For
example, if the selling price is raised, then the quantity of the
product to be sold to break-even will be reduced. Similarly, if the
selling price is reduced, then a company needs to sell extra to break-
even.
6. New business: For a new venture, a break-even analysis is essential.
It guides the management with pricing strategy and is practical about
the cost. This analysis also gives an idea if the new business is
productive.
7. Manufacture new products: If an existing company is going to
launch a new product, then they still have to focus on a break-even
analysis before starting and see if the product adds necessary
expenditure to the company.
Formula for BEP, PV Ratio, Contribution Ratio and Margin of Safety
1. BEP:
𝑇𝐹𝐶
BEP =
𝑃𝑟𝑖𝑐𝑒−𝐴𝑉𝐶
𝑇𝐹𝐶
BEP = (in units)
𝐶
𝑇𝐹𝐶
BEP = ( in sales)
𝑃𝑉 𝑟𝑎𝑡𝑖𝑜
2. Contribution Ratio:
a. Contribution = TR – TVC (sales)
b. Contribution = Selling price – variable cost per unit
3. Profit Volume Ratio:

𝐶
PVR = 𝑥 100
𝑠𝑎𝑙𝑒𝑠
𝑆𝑎𝑙𝑒𝑠−𝑣𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑐𝑜𝑠𝑡
PV/R = 𝑥 100
𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑜𝑓𝑖𝑡
PV/R = 𝑥 100
𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑠𝑎𝑙𝑒𝑠
𝐹𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡+𝑝𝑟𝑜𝑓𝑖𝑡
PV/R = 𝑥100
4. Margin of safety:
𝑠𝑎𝑙𝑒𝑠−𝐵𝐸𝑃
Margin of safety = 𝑥 100
𝑝𝑟𝑜𝑓𝑖𝑡
Margin of safety =
𝑃𝑉/𝑅
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Note: to identify the difference between TVC and AVC
1. If quantity is given it is TVC

2. If quantity is absent then it is AVC
3. If per unit is given then it is AVC
4. If per unit is absent it is TVC
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Chapter-4
Market Structures and
Pricing Practices
4.1. Market structures
In economics, Markets are classified in two types

1. Perfect competition
2. Imperfect competition
a. Monopoly
b. Oligopoly
c. Monopolistic
4.2. Perfect Competition
The classical economists have developed theory of perfect competition it

is coined by Adam Smith in his book Wealth of Nations.
Meaning: It is a market situation where there are large number of buyers

and sellers. Here the competition means, competition between sellers, this
kind of market is called as ‘Price Takers Market’
Definition: According to Benham- “ Market is said to be perfect when all

sellers and buyers are promptly aware of the price at which transaction
takes place and all of the offers made by other sellers and buyers can
purchase from any sellers and vice-versa”
Under the perfect competition only single price is resulting for the product.
Characteristics
1. A large number of buyers and sellers: The number of buyers and

sellers is large and the share of each one of them in the market is so
small that none has any influence on the market price.
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Market Structures and Pricing Practices
2. Homogeneous product: The product of each seller is totally

undifferentiated from those of the others.
3. Single price: no seller can increase or decrease the price. It remains
same.
4. Free entry and exit: Any buyer and seller is free to enter or leave
the market of the commodity.
5. Perfect knowledge: All buyers and sellers have perfect knowledge
about the market for the commodity.
6. Indifference: No buyer has a preference to buy from a particular
seller and no seller to sell to a particular buyer.
7. Non-existence of transport costs: Perfectly competitive market also
assumes the non-existence of transport costs.
8. Perfect mobility of factors of production: Factors of production
must be in a position to move freely into or out of industry and from
one firm to the other.
Price determination in perfect competition under SRPF
Under perfect competition Price is fixed by industry. Here under perfect
competition there are large number of producers who produce identical or
homogenous product as there are large number of firms no individual firm
has control over price.
Under the perfect competition the price is determined by demand and
supply and this was coined by Alfred Marshall. Here the price of
commodity is fixed at a point where both demand and supply curves
intersect each other which are called as ‘EQUILLIBRIUM POINT’ where
Demand is equal to Supply. With the help of EQUILLIBRIUM POINT’
we can decide the equilibrium price and we can determine equilibrium
quantity.
Figure 4.1 Price Determination under Perfect Competition
66
In the figure 4.1 D-D represents demand curve And S-S represents supply
curve. Both demand and supply curve has intersected at point E which is
called as equilibrium point, with the help of equilibrium point the industry
fixes price at ‘P’ suppose the seller is going to increase the price ‘P’ to ‘M’
the demand will be between ‘M’ To ‘A’, but the supply will be between
‘M’ To ‘B’, which leads to excess supply of ‘AB’, which is an loss to
organization.
In the second case if the seller decreases price from ‘P’ to ‘L’ the demand
will be between ‘L’ to ‘H’ and the supply is between ‘L’ to ‘T’, which
leads to excess demand of ‘TH’ which is a loss to organization.
Therefore under perfect competition the seller can neither increase nor
decrease the price and has to follow the price fixed by industry.
4.3. Monopoly
It is derived from two Greek words MONO and POLY, where MONO
means Single, POLY means Seller. Thus Monopoly is the market where
there is a single seller or producer of a product or service with no close
substitute, with large number of buyers.
Under the Monopoly one person controls entire market, he also has full
control over price. Here under the monopoly market the price is
determined by seller hence it is called as “PRICE MAKERS MARKET”
The Monopoly marketer or producer tries to fix the price at point which
maximizes his profit.
Definition according to Lancer- “Monopoly is a seller, one who is a soul

seller of the product or service”
Features of Monopoly
1. One seller and large number of buyers

2. There is no close to substitute for product or service
3. Full control over supply of the commodity
4. Price is fixed by seller
5. Restricted entry and exit
6. Firm and industry are same.
7. Downward sloping demand curve
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1. Single person or a firm: A single person or a firm controls the total

supply of the commodity. There will be no competition for
monopoly firm. The monopolist firm is the only firm in the whole
industry.
2. No close substitute: The goods sold by the monopolist shall not
have closely competition substitutes. Even if price of monopoly
product increase people will not go in far substitute. For example: If
the price of electric bulb increase slightly, consumer will not go in
for kerosene lamp.
3. Large number of Buyers: Under monopoly, there may be a large
number of buyers in the market who compete among themselves.
4. Price Maker: Since the monopolist controls the whole supply of a
commodity, he is a price-maker, and then he can alter the price.
5. Supply and Price: The monopolist can fix either the supply or the
price. He cannot fix both. If he charges a very high price, he can sell
a small amount. If he wants to sell more, he has to charge a low
price. He cannot sell as much as he wishes for any price he pleases.
6. Downward Sloping Demand Curve: The demand curve (average
revenue curve) of monopolist slopes downward from left to right. It
means that he can sell more only by lowering price.
Types of Monopoly
1. Natural Monopoly- When a Monopoly is established due to natural

causes then it is called natural monopoly. To-day India has got
Monopoly in mica production and Canada has got Monopoly in
nickel production. These Monopoly natures has provided to these
countries.
2. Legal Monopoly- When anybody receives or acquires Monopoly
due to legal provisions in the country. For Example: When legal
monopolies emerge on account of legal provisions like patents,
trade-marks, copyrights etc.
3. Simple Monopoly- A simple monopoly firm charges a uniform
price for its output sold to all the buyers. While a discriminating
monopoly firm charges different prices for the same product to
different buyers. A simple monopoly operates in a single market a
discriminating monopoly operates in more than one market.
4. Social Monopoly-When the government controls the production for
public welfare, it is said to be a social monopoly.
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5. Discriminating Monopoly- It discriminates amongst the buyers for

selling similar products, different prices are charged on divergent
buyers such as lawyer charges different fees from his every client.
Price Discrimination in Monopoly
Meaning: It can be done only under monopoly market. Price

discrimination means charging different price for different customers for
same product or service. [This is because of single seller in marker]
Definition: According to John Robinson, “The act of selling same article

produced under single control at different prices to different buyers is
known as price discrimination”
Types of Price Discrimination
1. Personal discrimination: It occurs when different charges are

changed for different persons for the same product by a single seller
or producer.
2. Location discrimination: Charging low price at one location and
charging high price at some other location by the same seller for a
same commodity or service.
3. Trade Discrimination: Charging different prices to different users
by the same seller for the same product or service based or quantity
of the goods or services traded.
4. Time Discrimination: Here the discrimination of prices is done for
the product or services rendered by the same seller at different time.
5. Age Discrimination: Here the discrimination of prices is done for
the product or services rendered by the same seller based on
different age group of customers.
6. Size Discrimination: Discrimination done on the volume of
transaction for the same product or service by a same seller
Price determination in monopoly under SRPF for super normal

profit
To examine and determine equilibrium price and output the monopoly

producer has to consider two important factors and these two factors are
interdependent to each other.
69
1. Determine the price of product (equilibrium price)

2. Determine the output (equilibrium output)
However if monopoly firm decides any one other is just implied. Thus,
monopoly firm cannot determine output and price separately
In the monopoly market the price and output are determined at point where
Marginal Cost= Marginal Revenue (MC=MR). This is the point where
firm enjoys maximum profit or Super Normal Profit.
Here under the monopoly market the point MC=MR is determined as
equilibrium point.
Table 4.1Marginal Cost and Marginal Revenue Relationship at

different level of prices
Marginal Cost Marginal Revenue

Price
(MC) (MR)
100 200 400 MC<MR
200 300 500 MC<MR
300 400 400 MC=MR
400 500 300 MC>MR
Figure 4.2 Monopoly Equilibrium for Super Normal Profit
In Figure-4.2, if output is increased beyond OQ, MR will be less than MC.

Thus, if additional units are produced, the organization will incur loss. At
equilibrium point, total profits earned are equal to shaded area ABEC. E is
the equilibrium point at which MR=MC with quantity as OQ.
70
Note: the marginal cost curve should cut the marginal revenue curve from
Bottom
4.4. Oligopoly Market Structure
It is an imperfect market; it lies between monopoly and monopolistic

situation. The term oligopoly is derived from two Greek words OLIGO
means few, POLY means seller. Thus it is the market situation where
there will be few sellers and large number of buyers. Here the competition
will be among few sellers, the sellers produce both identical and
differentiated products
Definition: According to Elongner, “oligopoly is a market situation in

which there is small number of sellers and activity of every seller is very
important to other, with large number of the buyers”
Features of Oligopoly
1. Few seller and large number of buyers

2. Homogenous and distinctive product
3. Blocked entry and exit
4. Lack of information among the customers
5. Interdependence among the competitors
6. Huge investments over advertisement
7. Constant struggle for sustainability
8. Lack of certainty among customers
9. Price rigidity.
1. Few Firms: There are only a few firms in the industry. Each firm
contributes a sizeable share of the total market. Any decision taken by
one firm influence the actions of other firms in the industry. The
various firms in the industry compete with each other.
2. Interdependence: As there are only very few firms, any steps taken by
one firm to increase sales, by reducing price or by changing product
design or by increasing advertisement expenditure will naturally affect
the sales of other firms in the industry. An immediate retaliatory action
can be anticipated from the other firms in the industry every time when
one firm takes such a decision. He has to take this into account when he
takes decisions. So the decisions of all the firms in the industry are
interdependent.
71
3. Indeterminate Demand Curve: The interdependence of the firms

makes their demand curve indeterminate. When one firm reduces price
other firms also will make a cut in their prices. So he firm cannot be
certain about the demand for its product. Thus the demand curve facing
an oligopolistic firm loses its definiteness and thus is indeterminate as it
constantly changes due to the reactions of the rival firms.
4. Advertising and selling costs: Advertising plays a greater role in the
oligopoly market when compared to other market systems. According
to Prof. William J. Banumol “it is only oligopoly that advertising comes
fully into its own”. A huge expenditure on advertising and sales
promotion techniques is needed both to retain the present market share
and to increase it. So Baumol concludes “under oligopoly, advertising
can become a life-and-death matter where a firm which fails to keep up
with the advertising budget of its competitors may find its customers
drifting off to rival products.”
5. Price Rigidity: In the oligopoly market price remain rigid. If one firm
reduce price with the intention of attracting the customers of other firms
in the industry. In order to retain their consumers they will also reduce
price. Thus the pricing decision of one firm results in a loss to all the
firms in the industry. If one firm increases price. Other firms will
remain silent there by allowing that firm to lose its customers. Hence,
no firm will be ready to change the prevailing price. It causes price
rigidity in the oligopoly market.
Price Determination Models of Oligopoly under SRPF
1. Kinked demand curve Model

Figure 4.3 Kinked demand curve
72
According to Professor Paul M C-“Kinked demand curve, or a firm

in oligopoly market has a kink in the demand curve. The demand
curve or average revenue curve here made up of two segments one is
relatively elastic demand and other is relatively inelastic demand.
Corresponding to given point KP, there is kink at a point K of

demand Curve DD, DK is relatively elastic segment and KD is
relatively inelastic segment. Thus under oligopoly market if the firm
increases the price the firm will enter into relatively elastic demand
segment, if the firm decreases the price the firm will enter into
relatively inelastic demand segment. Here, the firm can’t either
increase or decrease the price. Thus firm thinks it is worthwhile to
follow the prevailing prices. Here the price tends to be more elastic,
there is also fear of losing the buyers to other sellers in case of rise in
price, on the other hand lowering the price will have an effect over
net profit.
2. Price Leadership Model: Under price leadership, one firm assumes

the role of a price leader and fixes the price of the product for the
entire industry. The other firms in the industry simply follow the
price leader and accept the price fixed by him and adjust their output
to this price. The price leader is generally a very large or dominant
firm or a firm with the lowest cost of production. It often happens
that price leadership is established as a result of price war in which
one firm emerges as the winner.
Types of Price Leadership
There are several types of price leadership. The following are the principal
types:
1. Price leadership of a dominant firm, i.e., the firm which produces

the bulk of the product of the industry. It sets the price and rest of
the firms simply accepts this price.
2. Barometric price leadership, i.e., the price leadership of an old,
experienced and the largest firm assumes the role of a leader, but
undertakes also to protect the interest of all firms instead of
promoting its own interests as in the case of price leadership of a
dominant firm.
73
3. Exploitative or Aggressive price leadership, i.e., one big firm built

its supremacy in the market by following aggressive price
leadership. It compels other firms to follow it and accept the price
fixed by it. In case the other firms show any independence, this firm
threatens them and coerces them to follow its leadership.
4.5. Monopolistic Market
The term monopolistic market is first coined by Professor E L Chamberlin.

It refers to market situation where competition is imperfect. It is the
market situation where there are many producers producing goods and
services which are identical but differentiated.
“Monopolistic market situation is where large number of small producers

or sellers having some degree of monopoly because of their differentiated
products with large number of buyers”
Definition: According to Professor A.L. Merry-“A situation where there

may be many sellers with differentiated products with large number of
buyers, sellers having some level of monopoly and price here is
determined based on the level of competition”
Features
1. Large number of small sellers and large buyers

2. Identical but differentiated products- based on brand, quality,
packaging, services etc
3. Free entry and exit
4. Presence of selling cost
5. Some degree of monopoly enjoyed by the sellers.
1. Existence of Many firms: Industry consists of a large number of

sellers, each one of whom does not feel dependent upon others.
Every firm acts independently without bothering about the reactions
of its rivals. The size is so large that an individual firm has only a
relatively small part in the total market, so that each firm has very
limited control over the price of the product. As the number is
relatively large it is difficult for these firms to determine its price-
output policies without considering the possible reactions of the rival
74
forms. A monopolistically competitive firm follows an independent

price policy.
2. Product Differentiation: Product differentiation means that

products are different in some ways, but not altogether so. The
products are not identical but the same time they will not be entirely
different from each other. It really means that there are various
monopolist firms competing with each other. An example of
monopolistic competition and product differentiation is the
toothpaste produced by various firms. The product of each firm is
different from that of its rivals in one or more respects. Different
toothpastes like Colgate, Close-up, Cibaca, etc., provide an example
of monopolistic competition. These products are relatively close
substitute for each other but not perfect substitutes. Consumers have
definite preferences for the particular verities or brands of products
offered for sale by various sellers. Advertisement, packing,
trademarks, brand names etc. help differentiation of products even if
they are physically identical.
3. Large Number of Buyers: There are large number buyers in the

market. But the buyers have their own brand preferences. So the
sellers are able to exercise a certain degree of monopoly over them.
Each seller has to plan various incentive schemes to retain the
customers who patronize his products.
4. Free Entry and Exist of Firms: As in the perfect competition, in

the monopolistic competition too, there is freedom of entry and exit.
That is, there is no barrier as found under monopoly.
5. Selling costs: Since the products are close substitute much effort is
needed to retain the existing consumers and to create new demand.
So each firm has to spend a lot on selling cost, which includes cost
on advertising and other sale promotion activities.
6. Imperfect Knowledge: Imperfect knowledge about the product

leads to monopolistic competition. If the buyers are fully aware of
the quality of the product they cannot be influenced much by
advertisement or other sales promotion techniques. But in the
business world we can see that thought the quality of certain
products is the same, effective advertisement and sales promotion
75
techniques make certain brands monopolistic. For examples,

effective dealer service backed by advertisement-helped
popularization of some brands through the quality of almost all the
cement available in the market remains the same.
7. The Group: Under perfect competition the term industry refers to

all collection of firms producing a homogenous product. But under
monopolistic competition the products of various firms are not
identical through they are close substitutes. Prof. Chamberlin called
the collection of firms producing close substitute products as a
group.
Price determination in Monopolistic Market under SRPF
Under the monopolistic market it is impossible to analyze the price in

terms of graphical representation. Reasons for this are:
1. Product differentiation
2. Multiple pricing
Here under the monopolistic competition the price is determined on the

basis of the principle of both the Perfect competition and Monopoly. In
other words under the monopolistic competition the price is determined at
the point where MC= MR (Marginal Cost equals to Marginal revenue)
Note- Refer Figure 4.2 Monopoly Equilibrium for Super Normal Profit
Product differentiation
1. Based on features of product more or large features Example: Smart

Phones
2. Conditions relating to sale of product or Service
3. Brand differentiation
4. Quality
5. Differentiation based on additional and after sales services.
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4.6. Descriptive Pricing Approaches
Price
Price is very important both for a buyer and seller, buyer always wants to
buy at less price and the seller wants to sell at high price. Only when both
of them agree at some point the price will be fixed. The exchange of goods
and services takes place. Price is the money value or the monetary value of
goods and services or it is the exchange value of products or services
which is done in terms of money.
To a seller the price is revenue which includes both cost and profit,
whereas for a buyer the price is a amount spent by a customer to buy the
product [cost].
Price = Total cost + Profit
Objectives of pricing policy
1. Profit maximization- Maximization of profits is one of the main

objectives of a business enterprise. A firm can adopt such a price
policy which ensures larger profits.
2. Increase of market share- Market share refers to the share of the
company in the total sales of the product in the market. Some of the
concerns when introduce their product in the competitive market
want to achieve a certain share in the market in the initial stages. In
the long run the concern may aim at achieving a sizeable portion of
the market by selling its products at lower prices.
3. Target return on investment - This is the most important objective
which every concern wants to achieve. The objective is to achieve a
certain rate of return on investments and frame the pricing policy in
order to achieve that rate.
4. Meet or prevent competition - Modern industrial set up is
confronted with cut throat competition. Pricing can be used as one of
the effective means to fight against the competition and business
rivalries.
5. Survival and growth of company- Finally, pricing is aimed at
survival and growth of company’s business activities and operations.
It is a fundamental pricing objective. Pricing policies are set in a way
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that company’s existence is not threatened by keeping f low of

regular income to the organizations.
6. Running the business stably.
Factors influencing pricing policy
1. Cost
2. Demand and consumer psychology
3. Competition / Level of competition
4. Margin of profits
5. Government policy
6. Organizational factors
7. Distribution channel
8. General economic condition
9. Product differentiation
10. Marketing mix of a company
11. Characteristics or features of a product
12. Reactions of the customers
13. Objections of the organization
14. Stages of product life cycle
Pricing Methods
1. Cost based pricing

a. Cost + Pricing: The theory of cost = pricing or full cost pricing
has been developed by Hall and Hitch, according to them, the
company can fix their price by calculating their total cost and
adding the margin of profit to the total cost to determine price .
This is the cost common method used by the producers or sellers,
the other names are mark up pricing and full cost pricing.
b. Target Pricing: This is the by variant of full cost pricing, Here,
the firm is going to pre-determine target return on investment and
they fix the price.
Example: 10%, 20%, or 30% returns based on expected sales.
c. Marginal Cost Pricing: Under both the cost – pricing and target
pricing the price is fixed on the basis of total cost .But under the
marginal cost pricing the price is always fixed with marginal cost
i.e. the cost of producing the extra unit.
d. Break even pricing: Here break even analysis technique is used
to fix the price. The firm here first determines breakeven point
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and then with the help of breakeven point the firm fixes the price
by knowing the expected sales is into profit or loss zone.
2. Skimming pricing strategy: This is done with the basic idea of

gaining premium customers. Under this method product is initially
charged with very high price, later on the seller may decrease the
price.
3. Penetration pricing: Under this method the seller is going to charge

very less price at the initial stages. His intension is to penetrate the
market; later on he may increase the price.
4. Dual pricing: Charging different prices to different customers for

same product or service in different markets by a same seller.
5. Transfer pricing: It is associated with multinational companies

corporation. It is also referred as intra firm pricing, the price of the
product in one country is transferred to other country.
6. Geographical pricing: It is the practice of charging different price

in different geographical locations.
7. Psychological pricing: It is one of the special kind of pricing

practices where the price of a product is fixed by playing a game of
psychological mindset with the prices are low but in reality they are
not.
8. Competitive bidding pricing: This is the kind of pricing strategy

where price of a product or service is fixed by looking into the price
of competitors.
9. Administered pricing: It means the prices which are fixed and

enforced by government or administrative authority.
10. Product line pricing: It refers to group of product which has similar
physical feature and similar function within a product line. There
may be variety of products with differences in quantity, size, shape,
color, features… etc
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11. Loss leader Pricing: Pricing strategy where a product is sold at a

price below its market cost a loss leader pricing strategy, a term
common in marketing, refers to an aggressive pricing strategy.
12. Peak load pricing: The pricing strategy wherein the high price is
charged for the goods and services during times when their demand
is at peak.
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Chapter-5
Indian Business
Environment
5.1. Introduction to Business Environment
5.1.1. Meaning of Business Environment
Environment is the set of Internal & external factors which affect the
operation of business firms.
Examples for Internal factors are Labor, method of production etc. and
examples for external factors are Governmental regulation, competition
etc.
5.1.2. Nature of Indian Business Environment

1. Co-Existence of Public and Private Sector: Indian business
environment is characterized by the co-existence of both public and
private sector in respect of its participation in various economic
activities in the country. Accordingly, the various economic policies
of the country can promote the development of both the sectors in
different spheres of activities.
2. Low Income Level: Another feature of Indian business environment

is that it has to face low income level of the people in general as an
important economic parameter for determining its economic
activities.
3. Poor Rate of Capital Formation: Capital deficiency is one of the

important features of the Indian business environment. Both the
amount of capital available per head and the present rate of capital
formation in India is very low. Moreover, this low level of capital
formation in India is also due to weakness of the inducement to
invest and also due to low propensity and capacity to save. Thus
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Indian Business Environment
under this present feature, the business environment of the country

never faces adequate incentive towards faster development of the
country.
4. Low Level of Technology: Prevalence of low level of technology is

another important feature of Indian business environment. The
business environment of the country is thus suffering from
technological backwardness. Obsolete techniques of production are
largely being applied in both agriculture and industrial sector of the
country.
Sophisticated modern technology is being applied in production

units at a very limited scale as it is very much expensive. Moreover,
the huge unskilled and untrained labour force is also an important
impediment towards technological modernization of the country.
5. Under-Utilization of Capacity: Under-utilization of productive

capacity of Indian industries is another important feature of Indian
business environment. As a result of this under utilization, the
industries in India are suffering from higher unit costs and low
profitability syndrome.
6. Lack of Diversification: The business environment of the country is

also subjected to the problem of lack of diversification in its
industry, trade and other related activities.
7. Financial Market: Indian business environment is also supported

by under developed financial market. Financial market is suffering
from lack of buoyancy and there is also the problem of lack of
adequate and free uninterrupted flow of institutional credit towards
industrial and other business units.
8. Industrial Dispute and Slow Pace of Labour Reforms: Another

important feature of business environment is the growing industrial
dispute leading to strikes and lock-outs in growing number of units
as a result of irrational trade union activities. Moreover, the slow
pace of labour reforms introduced by the Government has affected
the business environment of the country.
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9. Government Interference: Business environment in the country is

also affected by unwanted government interference in various
spheres of business and industrial activities. There is lack of single
window clearance and lack of administration efficiency in respect of
industrial licensing. Thus the business enterprises have to face the
problem of red-tapism, harassment, corruption, undue delay etc.
which ultimately interrupts the promotion of smooth business
environment in the country.
10. Extent of Market: Another feature of business environment of India

is the poor extent of market in the after math of globalization and
international competition faced by the country. The business
enterprises of the country are also suffering from lack of
diversification of its export market.
However, considering the natural advantage available in the country,

the country would be able to diversify its export market particularly
in respect of its agro-processed industries, services sector,
information technology sectors etc.
11. Transportation Bottle Neck: Another important feature of

business, environment of the country is that it is subjected to
frequent transport bottle-neck. Although the country has developed a
wide network of transportation system throughout the country but its
frequent interruption as a result of natural calamities like flood,
landslides etc. and insurgency has been resulting a serious blow to
the business environment of the country.
12. Slow Flow of Foreign Investment: Promotion of business

environment also depends on the smooth flow of foreign investment
in various sectors. But the country is suffering from delayed or slow
flow of foreign investment, which goes against the promotion of
business environment in the country.
13. Disturbed Law and Order Conditions: Another important feature

of business environment in India is its disturbed law and order
conditions in some particular regions leading unbalanced growth
where smooth flow of business is interrupted. Thus the business
environment in a vast country like India is subjected to its diversified
features.
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Figure 5.1Structure of Business Environment
5.2. Economic and Non-Economic Environment
Economic Environment
National
• Country’s economic system (Price situation, levels of savings,
balance of payment situation and overall growth activity)
• Phase of business cycle
• Organization of financial systems
• Economic policies of government (?)
Global
• Globalization
• WTO policies
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Non-Economic Environment
• Country’s history
• Culture
• Sociology
• Geography
• Policy & government
• Legal
Economic Environment
Interest rates, inflation rates, changes in disposable income of people,

stock market indices and the value of rupee are some of the economic
factors that can affect management practices in a business enterprise. Short
and long term interest rates significantly affect the demand for product and
services. For example, in case of construction companies and automobile
manufacturers, low longer-term rates are beneficial because they result in
increased spending by consumers for buying homes and cars on borrowed
money. Similarly, a rise in the disposable income of people due to increase
in the gross domestic product of a country creates increasing demand for
products. High inflation rates generally result in constraints on business
enterprises as they increase the various costs of business such as the
purchase of raw materials or machinery and payment of wages and salaries
to employees
Social Environment
The social environment of business include the social forces like customs
and traditions, values, social trends, society’s expectations from business,
etc. Traditions define social practices that have lasted for decades or even
centuries. For example, the celebration of Diwali, Id, Christmas, and Guru
Parv in India provides significant financial opportunities for greetings card
companies, sweets or confectionery manufacturers, tailoring outlets and
many other related business. Values refer to concepts that a society holds
in high esteem. In India, individual freedom, social justice, equality of
opportunity and national integration are examples of major values
cherished by all of us. In business terms, these values translate into
freedom of choice in the market, business’s responsibility towards the
society and non-discriminatory employment practices. Social trends
present various opportunities and threats to business enterprises. For
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example, the health-andfitness trend has become popular among large

number of urban dwellers. This has created a demand for products like
organic food, diet soft drinks, gyms, bottled (mineral) water and food
supplements. This trend has, however, harmed business in other industries
like dairy processing, tobacco and liquor.
Technological Environment
Technological environment includes forces relating to scientific

improvements and innovations which provide new ways of producing
goods and services and new methods and techniques of operating a
business. For example, recent technological, advances in computers and
electronics have modified the ways in which companies advertise their
products. It is common now to see CD-ROM’s, computerized information
kiosks, and Internet/ World Wide Web multimedia pages highlighting the
virtues of products. Similarly, retailers have direct links with suppliers
who replenish stocks when needed. Manufacturers have flexible
manufacturing systems. Airline companies have Internet and World Wide
Web pages where customers can look for flight times, destinations and
fares and book their tickets online. In addition, continuing innovations in
different scientific and engineering fields such as lasers, robotics,
biotechnology, food preservatives, medicine, telecommunication and
synthetic fuels have provided numerous opportunities and threats for many
different enterprises. Shifts in demand from vaccum tubes to transistors,
from steam locomotives to dieseland electric engines, from fountain pens
to ballpoint, from propeller airplanes to jets, and from typewriters to
computer based word processors, have all been responsible and creating
new business.
Political Environment
Political environment includes political conditions such as general stability

and peace in the country and specific attitudes that elected government
representatives hold towards business. The significance of political
conditions in business success lies in the predictability of business
activities under stable political conditions. On the other hand, there may be
uncertainty of business activities due to political unrest and threats to law
and order. Political stability, thus, builds up confidence among business
people to invest in the long term projects for the growth of the economy.
Political instability can shake that confidence. Similarly, the attitudes of
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government officials towards business may have either positive or

negative impact upon business. For example, even after opening up of our
economy in 1991, foreign companies found it extremely difficult to cut
through the bureaucratic red tape to get permits for doing business in
India. Sometimes, it took months to process even their application for the
purpose. As a result these companies were discouraged from investing in
our country. The situation has improved over time.
Legal Environment
Legal environment includes various legislations passed by the Government

administrative orders issued by government authorities, court judgments as
well as the decisions rendered by various commissions and agencies at
every level of the government— centre, state or local. It is imperative for
the management of every enterprise to obey the law of the land. Therefore,
an adequate knowledge of rules and regulations framed by the
Government is a pre-requisite for better business performance. Non-
compliance of laws can land the business enterprise into legal problems. In
India, a working knowledge of Companies Act 1956; Industries
(Development and Regulations) Act 1951; Foreign Exchange Management
Act and the Imports and Exports (Control) Act 1947; Factories Act, 1948;
Trade Union Act; 1926; Workmen’s Compensation Act, 1923; Industrial
Disputes Act, 1947, Consumer Protection Act, 1986, Competition Act,
2002 and host of such other legal enactments as amended from time to
time by the Parliament, is important for doing business. Impact of legal
environment can be illustrated with the help of government regulations to
protect consumer’s interests. For example, the advertisement of alcoholic
beverages is prohibited. Advertisements, including packets of cigarettes
carry the statutory warning ‘Cigarette smoking is injurious to health’.
Similarly, advertisements of baby food must necessarily inform the
potential buyer that mother’s milk is the best. All these regulations are
required to be followed by advertisers.
5.3. Basic Macroeconomic Concepts
Open Economy- An open economy is one that interacts freely with other
economies around the world. An open economy interacts with other
countries in two ways.
1. It buys and sells goods and services in world markets.
2. It buys and sells capital assets in world financial markets.
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Closed Economy: A closed economy is one that does not interact with
other economies in the world. There are no exports, no imports, and no
capital flows.
5.4. Contribution of Primary, Secondary and Tertiary Sectors to

Indian Economy
Contribution of Primary Sector towards Economy
It includes agriculture, fishing, mining, forestry, horticulture etc.,

Agriculture has always been back bone of Indian economy. Despite of
lack of concentration over agriculture sector from past seven decades,
Agriculture always plays a prime role in economy when compared with
other sectors. It provides indirect or direct employment to 51% of the total
population. (It was around 73% in 1950-51).Contribution towards GDP
during 1950 -51-81%, 1990-91-31%, 2020-21-12%
Note: Above contribution includes fishing, mining, and horticulture.
Indian agriculture has been major source of supply to both large and small
scale industries. Around 18% of income generated by manufacturing
sector is by the agricultural based industries.
1. Sector directly and indirectly provides, about 50% of exports.

2. The contribution towards service sector is also high. It is estimated
that more than 55% if the transportation industry directly or
indirectly depends on primary sector.
3. As per the ‘Fourth Advance Estimate’ of principal crops, food grain
production in India is estimated at 308.65 million tonnes in FY21, an
increase of 11.14 million tonnes as compared with FY20.
4. In November 2021, monthly sales of fertilizers stood at 66.2 Lakh
LMT, closely equivalent to previous year levels.
Contribution of Secondary Sector towards Economy
It includes those industries who are directly and indirectly involved in

activity of manufacturing goods semi finished goods and also ancillary
items. It includes large medium and small scale industry. Contribution
towards GDP is 28% in 2020-21 [14.16% in 1950-51], Contribution
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towards employment is 22% in 20-20-21 (9% in 1950-51), It has the

annual growth rate of 23% it provides 25% towards the exports.
In October 2021, the overall IIP (Index of Industrial Production) registered

a 3.2% growth Year over year. Textiles, food, base metals, non-metallic
minerals, and computer electronics all showed signs of recovery within the
manufacturing sector.
Contribution of Tertiary Sector towards Economy
It is also known as service sector. Indian service industry is 8th largest in

whole world. Contribution towards GDP is 60% in 2020-21 (33.25%-
1950-51), Contribution towards employment is 27%in 2020-21 (18% -
1950-51), it is the fastest growing sector having growth rate of 40%
premium. It contributes around 25% over exports. It provides support to
all other sectors. In November 2021, air cargo traffic increased by 6.15%,
year of year indicating that the increase in air freight and traffic activity
has maintained.
5.5. SWOT analysis of Indian Economy
Strengths
1. India has a great workforce

2. There is a high percentage of cultivable land
3. Diversified nature of the economy
4. There is a large English-speaking population and the availability of
skilled labor
5. A stable economy is not affected by external changes
6. The extensive higher education policy, is the third largest reservoir
of engineers
7. High growth rate of the economy
8. The IT and BPO sector, which provides valuable foreign exchange,
is booming
9. Abundance of natural resources
Weakness
1. The labor force involved in agriculture is very high, representing less

towards GDP
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2. A quarter of the population below the poverty line

3. High unemployment rate
4. Inequality in the current socio-economic conditions
5. Poor infrastructure
6. Low productivity
7. Massive population that leads to resource shortages
8. Low-level automation
9. Red tapeism, bureaucracy, Corruption
10. Low literacy rates
11. Unequal distribution of wealth
12. The rural-urban division leads to disparities in living standards
13. High fiscal deficit
Opportunities
1. The scope of the entry of private companies in various sectors for

business.
2. Foreign direct investment flows are likely to increase in many
sectors.
3. It is possible to earn large currencies in the IT and ITES sector.
4. Invest in R&D and engineering design.
5. The biotechnology area.
6. Large population of Indians in abroad (NRI).
7. Infrastructural area
8. Large domestic market: an opportunity for the sale of multinationals
9. There are huge reserves of natural gas in India
10. A vast forest area and diverse wildlife
11. Huge agricultural resources, fisheries, plantations, crops and
livestock.
Threats
1. Depression in the global economy post pandemic effect

2. Volatility in crude oil prices worldwide
3. Increase in import invoice
4. Population explosion, the population growth rate is even higher
5. The uneven Monsoon.
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5.6. Measuring Economy
5.6.1. Gross Domestic Production
The GDP of a country gives a basic measurement for the growth of

economy.
There are four ways of measuring economy of a nation-
1. Gross Domestic Production- Aggregate value of goods and

services produce in a nation during a period of time which doesn’t
include the income arrived from exports and the imported product.
But the value of exported product produced in a nation is always
considered.
2. Gross National Production: It is the aggregate value of goods and
services produced during the period with in a nation including
exports and excluding import.
3. Net Domestic Production: Net domestic product (NDP) is an
annual measure of the economic output of a nation that is calculated
by subtracting depreciation from gross domestic product (GDP).
4. Net National Product: Net national product (NNP) is the monetary
value of finished goods and services produced by a country's
citizens, overseas and domestically, in a given period. It is the
equivalent of gross national product (GNP), the total value of a
nation's annual output, minus the amount of GNP required to
purchase new goods to maintain existing stock, otherwise known as
depreciation.
Formula for GDP
GDP=GNP-NFIA [Net Factor Income from Abroad]

GDP= C+ I+G-[X_M]
C → total consumption
I → Investment
G → Govt purchase and govt investments
(X-M) → net income from exports.
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5.6.2. National Income
National Income is monetary value of all the goods and services produced
with in a country during a specific period or sum of total of various
incomes earned with in a national boundary like total of wage, profit, rent,
interest, pension and any other sources of payment done to a resident of a
particular country.
Each sector of economy employs natural, material, human resource,

financial resource etc., during a year. This aggregate flow of money over
factors of production represents the aggregate income earned sum total of
such income over a period of one year is called as national income
Estimation on National Income India
1. Product method or value added method: Under this method we

calculate money value of all final goods and services produced in a
country during a year it is calculated based on the market prices.
2. Income method: Here we are going to estimate the income earned

by various factors of production engaged in process of production of
goods and services. The sum of total income helps to calculate
National Income.
National Income = Wage + Salary +Rent + Interest+ Dividend+
Profit+ Taxes etc.,
3. Expenditure method: Here we are going to sum up all the

expenditure which is incurred with in an economy. If we add value
of all the expenses done in producing the goods and services within
the nation for a specific period of time give us a gross national
expenditure in reverse we can call it as gross national income.
Methodology of National Income Estimation in India
In India estimation of NI is done by combining the entire three methods

Product, Income, Expenditure method
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Table 5.1 National Income Estimation in India
Method of Estimation Sector

Agriculture, Fishing, Forestry Mining,
Registered Manufacturing Companies,
1. Product method
House Construction in Urban Areas,
Organized Manufacturing
Electricity Production, Railways, Airport,
Air Transportation, Organized Road
2. Income method
Transportation, Banking, Insurance, Real
Estate, Public Administration and Defense
Unregistered Mining, Gas Refinery,
Unorganized Road and Water
3. Estimated income
Transportation, Unorganized House
method
Construction, Unorganized Trades
Services Petroleum Industry Etc,
4. Expenditure
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Chapter-6
Indian Industrial
Policy
6.1. The New Industrial Policy of 1991
The New Industrial Policy of 1991 comes at the center of economic

reforms that launched during the early 1990s. All the later reform
measures were derived out of the new industrial policy. The Policy has
brought comprehensive changes in economic regulation in the country. As
the name suggests, these reform measures were made in different areas
related to the industrial sector.
As part of the policy, the role of public sector has been redefined. A
dedicated reform policy for the public sector including the disinvestment
programme were launched under the NIP 1991. Private sector has given
welcome in major industries that were previously reserved for the public
sector.
Similarly, foreign investment has given welcome under the policy. But the
most important reform measure of the new industrial policy was that it
ended the practice of industrial licensing in India. Industrial licensing
represented red tapism. Because of the large scale changes, the Industrial
Policy of 1991 or the new industrial policy represents a major change from
the early policy of 1956.
The new policy contained policy directions for reforms and thus for LPG
(Liberalisation, Privatisation and Globalisation). It enlarged the scope of
private sector participation to almost all industrial sectors except three
(modified). Simultaneously, the policy has given welcome to foreign
investment and foreign technology. Since 1991, the country’s policy on
foreign investment is gradually evolving through the introduction of
liberalization measures in a phase wise manner.
94
Indian Industrial Policy
Perhaps, the most welcome change under the new industrial policy was the
abolition of the practice of industrial licensing. The1991 policy has limited
industrial licensing to less than fifteen sectors. It means that to start an
industry, one has to go for license and waiting only in the case of these
few selected industries. This has ended the era of license raj or red tapism
in the country. The 1991 industrial policy contained the root of the
liberalization, privatization and globalization drive made in the country in
the later period. The policy has brought changes in the following aspects
of industrial regulation:
1. Industrial delicensing
2. Deregulation of the industrial sector
3. Public sector policy (dereservation and reform of PSEs)
4. Abolition of MRTP Act
5. Foreign investment policy and foreign technology policy.
1. Industrial delicensing policy or the end of red tapism: the most
important part of the new industrial policy of 1991 was the end of
the industrial licensing or the license raj or red tapism. Under the
industrial licensing policies, private sector firms have to secure
licenses to start an industry. This has created long delays in the start
up of industries. The industrial policy of 1991 has almost abandoned
the industrial licensing system. It has reduced industrial licensing to
fifteen sectors. Now only 13 sector need license for starting an
industrial operation.
2. Dereservation of the industrial sector– Previously, the public
sector has given reservation especially in the capital goods and key
industries. Under industrial deregulation, most of the industrial
sectors was opened to the private sector as well. Previously, most of
the industrial sectors were reserved to the public sector. Under the
new industrial policy, only three sectors- atomic energy, mining and
railways will continue as reserved for public sector. All other sectors
have been opened for private sector participation.
3. Reforms related to the public sector enterprises: reforms in the
public sector were aimed at enhancing efficiency and
competitiveness of the sector. The government identified strategic
and priority areas for the public sector to concentrate. Similarly, loss
making PSUs were sold to the private sector. The government has
adopted disinvestment policy for the restructuring of the public
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sector in the country. At the same time autonomy has been given to
PSU boards for efficient functioning.
4. Foreign investment policy: another major feature of the economic
reform measure was it has given welcome to foreign investment and
foreign technology. This measure has enhanced the industrial
competition and improved business environment in the country.
Foreign investment including FDI and FPI were allowed. Similarly,
loan capital has also introduced in the country to attract foreign
capital.
5. Abolition of MRTP Act: The New Industrial Policy of 1991 has

abolished the Monopoly and Restricted Trade Practice Act. In 2010,
the Competition Commission has emerged as the watchdog in
monitoring competitive practices in the economy.
The industrial policy of 1991 is the big reform introduced in Indian

economy since independence. The policy caused big changes including
emergence of a strong and competitive private sector and a sizable number
of foreign companies in India.
6.2. Private Sector
Meaning of private sector undertaking
An industrial undertaking owned and managed by private people or private

player.
Process of privatization in India
1. Transfer of state ownership and productive assets to private sector

2. Entry of private sector in those areas which are exclusively meant
for public sector
3. Transfer of ownership and control of public sector undertaking
Reasons
1. To reduce Financial burden over government

2. Decreasing Performance of public sector undertaking
3. To Increase Revenue of government
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4. Overall development of secondary sector

5. To Improve efficiency and performance
6. Helps in capital formation
7. Increase competition
8. Reduce government intervention
Problems faced by private sector industries in India
1. Unnecessary control
2. Lack of financial availability & support
3. Tax structure
4. Declining Return on Investment
5. Increase in labour cost
6. Lack of infrastructure
Prospects of private sector in India
Normally, the government assigned a secondary role to the private sector

for a long time but the Sixth Five-Year Plan (1980-85) gave greater
importance to the private sector and nearly 47 percent of the total
investment was to be in the private sector.
The private sector too has shown sufficient buoyancy and has registered a
fast rate of growth by raising increasing funds in the capital market and
setting up a series of joint ventures in other countries.
However, as the Sixth Five-Year Plan itself expressed clearly, “in a large
number of areas, our capabilities are almost 20 years behind those in the
advanced nations and as of behind those established recently in developing
countries.” Special facilities for the setting up of export-oriented units,
exemption from Monopolies and Restrictive Trade Practices (MRTP)
restrictions on industries producing for export, easy industrial licences for
new units located in “Zero industry” districts, quick and sympathetic
processing of licence applications, liberalization of import and pricing
policies, etc.
These measures were in operation during the Sixth Plan period and the
government has further liberalized and strengthened these measures during
the Seventh Plan period.
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The Industrial Policy of 1991 has further liberalized the economy in favour
of the private sector, as follows:
1. Industrial licensing has been abolished for all projects except for a
short list of industries related to security and strategic concerns,
social reasons, hazardous chemicals and overriding environmental
concerns.
2. Exception from licensing will apply to all substantial expansion of
existing units.
3. Approvals will be given for direct foreign investment upto 51
percent foreign equity in high priority industries.
4. Automatic permission will be given for foreign technology in high
priority industries
5. No permission will be required from the MRTP commission for
expansion, new undertakings, mergers, amalgamations and take
over’s and appointment of directors.
In short, a greater role for the private sector is envisaged in the new
industrial policy by removing the barriers and controls and following a
more liberalised approach.
The importance of private sector in Indian economy
The importance of private sector in Indian economy has been very

commendable in generating employment and thus eliminating poverty.
Further, it also affected the following
1. Increased quality of life

2. Increased access to essential items
3. Increased production opportunities
4. Lowered prices of essential items
5. Increased value of human capital
6. Improved social life of the middle class Indian
7. Decreased the percentage of people living below the poverty line in
India
8. Changed the age old perception of poor agriculture based country to
a rising manufacturing based country
9. Effected increased research and development activity and spending
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10. Effected better higher education facilities especially in technical

fields
11. Ensured fair competition amongst market players
12. Dissolved the concept of monopoly and thus neutralized market
manipulation practice
6.3. Introduction to MSME’s
Role of MSMEs in the Indian economy

SMEs employ around 40% of India’s workforce, which is an estimated 80
million people, who are given an opportunity for livelihood and
employment via low-skilled jobs. Around 1.3 million SMEs contribute
45% to India’s manufacturing output and 40% of India’s total export. In a
way, they form the backbone of the Indian economy. At 48 million, India
has the second largest number of SMEs in the world, edging close to
China which has around 50 million SMEs.
Table 6.1: MSME’s Definition in India
Revised Classification applicable w.e.f 1st July 2020

Composite Criteria: Investment in Plant & Machinery/equipment and
Annual Turnover
Classification Micro Small Medium
Manufacturing Investment in Investment in Investment in
Enterprises and Plant and Plant and Plant and
Enterprises Machinery or Machinery or Machinery or
rendering Services Equipment: Equipment: Equipment:
Not more than Not more than Not more than
Rs.1 crore and Rs.10 crore and Rs.50 crore and
Annual Annual Annual
Turnover ; not Turnover ; not Turnover ; not
more than Rs. 5 more than Rs. more than Rs.
crore 50 crore 250 crore
Source- Ministry of MSME’s Website, Government of India
There are around 6000 products manufactured by 31.7% SMEs while the
remaining 68.2% are engaged in delivering various services. This sector, if
99
extended the right support, has the potential to spread industrial growth
throughout the country.
Despite employing 40% of India’s workforce, SMEs are also the bane of
India’s economic problems. Though the volume numbers work in their
favor, they currently contribute to about 17% of India’s GDP.
Problems of MSME’s
MSME face number of problems such as inadequate and timely banking
finance, skilled manpower, limited capital and knowledge, non-availability
of suitable technology, low production capacity, ineffective marketing
strategy, identification of new markets, constraints on modernization and
expansion, non-availability of high skilled labour at affordable cost, and
follow-up with various government agencies to resolve various
problems.etc
6.4. Fiscal Policy
Meaning of Fiscal Policy
The fiscal policy is concerned with the raising of government revenue and
incurring of government expenditure. To generate revenue and to incur
expenditure, the government frames a policy called budgetary policy or
fiscal policy. So, the fiscal policy is concerned with government
expenditure and government revenue.
Fiscal policy has to decide on the size and pattern of flow of expenditure
from the government to the economy and from the economy back to the
government. So, in broad term fiscal policy refers to "that segment of
national economic policy which is primarily concerned with the receipts
and expenditure of central government." In other words, fiscal policy
refers to the policy of the government with regard to taxation, public
expenditure and public borrowings.
The importance of fiscal policy is high in underdeveloped countries. The

state has to play active and important role. In a democratic society direct
methods are not approved. So, the government has to depend on indirect
methods of regulations. In this way, fiscal policy is a powerful weapon in
100
the hands of government by means of which it can achieve the objectives

of development.
Main objectives of Fiscal Policy in India
1. Development by effective mobilization of resources
The principal objective of fiscal policy is to ensure rapid economic

growth and development. This objective of economic growth and
development can be achieved by Mobilization of Financial
Resources. The central and the state governments in India have used
fiscal policy to mobilize resources. The financial resources can be
mobilised by:
• Taxation: Through effective fiscal policies, the government aims
to mobilise resources by way of direct taxes as well as indirect
taxes because most important source of resource mobilisation in
India is taxation.
• Public Savings: The resources can be mobilised through public
savings by reducing government expenditure and increasing
surpluses of public sector enterprises.
• Private Savings: Through effective fiscal measures such as tax
benefits, the government can raise resources from private sector
and households. Resources can be mobilised through government
borrowings by ways of treasury bills, issue of government bonds,
etc., loans from domestic and foreign parties and by deficit
financing.
2. Efficient allocation of financial resources

The central and state governments have tried to make efficient
allocation of financial resources. These resources are allocated for
Development Activities which includes expenditure on railways,
infrastructure, etc. While Non-development Activities includes
expenditure on defence, interest payments, subsidies, etc.
But generally the fiscal policy should ensure that the resources are
allocated for generation of goods and services which are socially
desirable. Therefore, India's fiscal policy is designed in such a
manner so as to encourage production of desirable goods and
discourage those goods which are socially undesirable.
101
3. Reduction in inequalities of Income and Wealth

Fiscal policy aims at achieving equity or social justice by reducing
income inequalities among different sections of the society. The
direct taxes such as income tax are charged more on the rich people
as compared to lower income groups. Indirect taxes are also more in
the case of semi-luxury and luxury items, which are mostly
consumed by the upper middle class and the upper class. The
government invests a significant proportion of its tax revenue in the
implementation of Poverty Alleviation Programmes to improve the
conditions of poor people in society.
4. Price stability and control of inflation
One of the main objectives of fiscal policy is to control inflation and

stabilize price. Therefore, the government always aims to control the
inflation by reducing fiscal deficits, introducing tax savings
schemes, Productive use of financial resources, etc.
5. Employment generation
The government is making every possible effort to increase

employment in the country through effective fiscal measure.
Investment in infrastructure has resulted in direct and indirect
employment. Lower taxes and duties on small-scale industrial (SSI)
units encourage more investment and consequently generates more
employment. Various rural employment programmes have been
undertaken by the Government of India to solve problems in rural
areas. Similarly, self employment scheme is taken to provide
employment to technically qualified persons in the urban areas.
6. Balanced regional development
Another main objective of the fiscal policy is to bring about a

balanced regional development. There are various incentives from
the government for setting up projects in backward areas such as
Cash subsidy, Concession in taxes and duties in the form of tax
holidays, Finance at concessional interest rates, etc.
102
7. Reducing the deficit in the balance of payment
Fiscal policy attempts to encourage more exports by way of fiscal

measures like Exemption of income tax on export earnings,
Exemption of central excise duties and customs, Exemption of sales
tax, etc. The foreign exchange is also conserved by Providing fiscal
benefits to import substitute industries, Imposing customs duties on
imports, etc. The foreign exchange earned by way of exports and
saved by way of import substitutes helps to solve balance of
payments problem. In this way adverse balance of payment can be
corrected either by imposing duties on imports or by giving
subsidies to export.
8. Capital formation
The objective of fiscal policy in India is also to increase the rate of

capital formation so as to accelerate the rate of economic growth. An
underdeveloped country is trapped in vicious (danger) circle of
poverty mainly on account of capital deficiency. In order to increase
the rate of capital formation, the fiscal policy must be efficiently
designed to encourage savings and discourage and reduce spending.
9. Increasing national income
The fiscal policy aims to increase the national income of a country.

This is because fiscal policy facilitates the capital formation. This
results in economic growth, which in turn increases the GDP, per
capita income and national income of the country.
10. Development of infrastructure
Government has placed emphasis on the infrastructure development

for the purpose of achieving economic growth. The fiscal policy
measure such as taxation generates revenue to the government. A
part of the government's revenue is invested in the infrastructure
development. Due to this, all sectors of the economy get a boost.
11. Foreign exchange earnings
Fiscal policy attempts to encourage more exports by way of Fiscal

Measures like, exemption of income tax on export earnings,
103
exemption of sales tax and octroi, etc. Foreign exchange provides

fiscal benefits to import substitute industries. The foreign exchange
earned by way of exports and saved by way of import substitutes
helps to solve balance of payments problem.
Conclusion on Fiscal Policy
The objectives of fiscal policy such as economic development, price

stability, social justice, etc. can be achieved only if the tools of policy like
Public Expenditure, Taxation, Borrowing and deficit financing are
effectively used. Though there are gaps in India's fiscal policy, there is
also an urgent need for making India's fiscal policy a rationalised and
growth oriented one. The success of fiscal policy depends upon taking
timely measures and their effective administration during implementation.
6.4.1. Budget 2021-22 at Glance (Fiscal Policy)
Rupee Comes from
Figure 6.1Revenue accumulation Sources out of every One Rupee,

Budjet-2022
Source- Ministry of Finance Website, Government of India
104
Rupee Goes Out
Figure 6.2 Sources of Expenditure out of every One Rupee,

Budjet-2022
105
Table 6.2 Budjet 2022 at Glance
Key Highlights
1. Formulation of Master Plan for expressways. Completing 25000 km

national highways in 2022-23 Unified Logistics Interface Platform
allowing data exchange among all mode operators.
2. Open Source Mobility Stack for seamless travel of passengers
3. 4 Multimodal Logistics parks through PPP to be awarded in 2022-
23
4. Integration of Postal and Railways Network facilitating parcel
movement.
5. One station one product
106
6. Extending coverage under Kavach

7. 400 new generation Vande Bharat Trains
8. Multimodal connectivity between mass urban transport and railway
stations
9. National Ropeways Development Plan as sustainable alternative to
conventional roads
10. Capacity building for infrastructure Projects
11. Promoting chemical free natural farming starting with farmers’
lands close to river Ganga
12. Promoting post harvest value addition, consumption and branding
of millet product
13. Delivery of Digital and Hi-Tech services to farmers in PPP mode
14. Use of Kisan Drones to aid farmers.
15. Launching fund with blended capital to finance agriculture start ups
16. Implementation of Ken Betwa Link Project benefitting 9.1 lakh
hectare farm land, providing drinking water to 62 lakh people and
generating 130MW power.
17. Har Ghar, Nal Se Jal: 3.8 crore households to be covered in 2022-23
18. PM Awas Yojana: 80 lakh houses to be completed in 2022-23
19. PM-DevINE: To fund infrastructure and social development based
on felt needs of the North East
20. Vibrant Villages Programme: Targeting development of villages on
the Northern Border left out from the development gains
21. Digital Banking by Post Offices: 100% of post offices to come on
the core banking system
22. Digital Payments: Scheduled Commercial Banks to set up 75
Digital Banking Units in 75 districts
23. Introduction of Digital Rupee by RBI starting 2022-23
24. Public investment to continue to pump prime private investment
and demand in 2022-23
25. Tax relief to persons with disability
6.5. Monetary policy
Definition: Monetary policy is the macroeconomic policy laid down by

the central bank. It involves management of money supply and interest
rate and is the demand side economic policy used by the government of a
country to achieve macroeconomic objectives like inflation, consumption,
growth and liquidity.
107
Note: It is usually defined as Central Bank Policy
In India Monetary Policy is developed and regulated by Reserve Bank of

India which is the Central bank of India.
The monetary policy states the use of financial instruments under the
control of the Reserve Bank of India to standardise magnitudes such as
availability of credit, interest rates, and money supply to achieve the
ultimate objective of economic policy mentioned in the Reserve Bank of
India Act, 1934.
Objectives
1. The main aim of the financial policy is to retain price stability while
considering the goal of growth. Stability in price is a necessary
prerequisite to sustainable growth.(inflation & Deflation)
2. To promote savings and tap potential savings
3. To mobilize the savings for capital formation
4. To provide extensive credit to the growing need of agriculture,
industry , trade and commerce
5. Promoting overall growth of economy
6. To promote incentive for savings by paying interest to increase
capital formation
Instruments of monetary policy

1. Repo Rate: The (fixed) interest rate at which the Reserve Bank
provides overnight liquidity to banks against the collateral of
government and other approved securities under the liquidity
adjustment facility (LAF).
2. Reverse Repo Rate: The (fixed) interest rate at which the Reserve
Bank absorbs liquidity, on an overnight basis, from banks against the
collateral of eligible government securities under the LAF.
3. Bank Rate: It is the rate at which the Reserve Bank is ready to buy
or rediscount bills of exchange or other commercial papers. The
Bank Rate is published under Section 49 of the Reserve Bank of
India Act, 1934. This rate has been aligned to the MSF rate and,
therefore, changes automatically as and when the MSF rate changes
alongside policy repo rate changes.
4. Cash Reserve Ratio (CRR): The average daily balance that a bank
is required to maintain with the Reserve Bank as a share of such per
108
cent of its Net demand and time liabilities (NDTL) that the Reserve
Bank may notify from time to time in the Gazette of India.
5. Statutory Liquidity Ratio (SLR): The share of NDTL that a bank
is required to maintain in safe and liquid assets, such as,
unencumbered government securities, cash and gold. Changes in
SLR often influence the availability of resources in the banking
system for lending to the private sector.
6. Open Market Operations (OMOs): These include both, outright
purchase and sale of government securities, for injection and
absorption of durable liquidity, respectively.
7. Credit Ceiling: Ceilings are upper limits which can be applied to
various aspects of a financial transaction. They are commonly
applied to factors such as interest rates, amortization periods, or the
principal balance of loans. Ceilings are used to control risks. From
the perspective of lenders, for instance, they can be used to control
the risk of default by debtors.
8. Base rate policy: Base rate is the minimum rate set by the Reserve
Bank of India below which banks are not allowed to lend to its
customers.
Table 6.3 Monitory Policy key Indicators

Indicator Current Rate Space to Wright
Changed Rate
CRR 3.00%
(till March 21,2021)
SLR 18.00%
Repo Rate 4.00%
Reverse Repo Rate 3.35%
Marginal Standing 4.25%
Facility Rate
Bank Rate 4.25%
6.6. EXIM Policy

• Comprehensive Foreign Trade Policy to make India a global trade
player - focus on employment generation, along with massive push
to exports.
109
• Target plus scheme to achieve quantum increase in exports. Special

package for agriculture - new scheme “Vishesh Krishi Upaj Yojana”
to boost exports.
• All goods and services exported exempt from service tax, all
exporters with minimum turnover of Rs 5 crore exempt from bank
guarantee requirement, major procedural simplification and
rationalisation measures.
• Improvements and additional flexibilities in EPCG scheme, DEPB
to continue till replaced by suitable alternative.
• Free trade warehousing zone to make India a global trading hub.
EOUs exempted from service tax.
• New rationalized scheme of status holder categorization introduced.
Special focus initiatives introduced in five areas.
• Bio-technology parks to be set up.
• Major thrust to service exports - “served from India” scheme -
Export Promotion Council for Services.
• New mechanism for grievance redressal.
• Board of Trade to be revamped and given dynamic role.
1. Agricultural Export Zones: With a view to providing remunerative

returns to the farming community in a sustained manner, efforts will
be made to provide improved access to the produce/ products of the
Agriculture and Allied sectors in the international market.
2. Market Access Initiative (MAI): The Government would assist the

industry in research & development, market research, specific
market and product studies, warehousing and retail marketing
infrastructure in select countries and direct market promotion
activities through media advertising and buyer seller meets. A plan
scheme has been evolved for this purpose.
3. Special Economic Zones: A new Chapter on Special Economic

Zones introduced. Special Economic Zones developers are allowed
duty free import/ procurement from DTA for development of SEZ to
give a boost for development of integrated infrastructure for exports.
4. Removal of QRs: The process of removal of import restrictions,

which began in 1991, has been completed in a phased manner this
year with removal of restrictions on 715 items. Out of these 715, 342
110
are textile products, 147 are agricultural products including alcoholic

beverages and 226 are other manufactured products including
automobiles.
5. Export Promotion Capital Goods Schem: Zero duty

EPCG scheme allows import of capital goods for pre-production,
production and post production at zero Customs duty, subject to an
export obligation equivalent to 6 times of duty saved on capital
goods imported under EPCG scheme,
111
Case Study
ASE – 1 Dabur India Limited: Growing Big and Global
Dabur is among the top five FMCG companies in India and is positioned
successfully on the specialist herbal platform. Dabur has proven its
expertise in the fields of health care, personal care, homecare and foods.
The company was founded by Dr. S. K. Burman in 1884 as small
pharmacy in Calcutta (now Kolkata), India. And is now led by his great
grandson Vivek C. Burman, who is the Chairman of Dabur India Limited
and the senior most representative of the Burman family in the company.
The company headquarters are in Ghaziabad, India, near the Indian capital
New Delhi, where it is registered. The company has over 12
manufacturing units in India and abroad. The international facilities are
located in Nepal, Dubai, Bangladesh, Egypt and Nigeria. S.K. Burman, the
founder of Dabur, was trained as a physician. His mission was to provide
effective and affordable cure for ordinary people in far-flung villages.
Soon, he started preparing natural remedies based on Ayurved for diseases
such as Cholera, Plague and Malaria. Due to his cheap and effective
remedies, he became to be known as ‘Daktar’ (Indianised version of
‘doctor’). And that is how his venture Dabur got its name—derived from
Daktar Burman. The company faces stiff competition from many multi
national and domestic companies. In the Branded and Packaged Food and
Beverages segment major companies that are active include Hindustan
Lever, Nestle, Cadbury and Dabur. In case of Ayurvedic medicines and
products, the major competitors are Baidyanath, Vicco, Jhandu, Himani
and other pharmaceutical companies.
Vision, mission and objectives
Vision statement of Dabur says that the company is “dedicated to the

health and well being of every household”.
• The objective is to “significantly accelerate profitable growth by
providing comfort to others”. For achieving this objective Dabur
aims to:
• Focus on growing core brands across categories, reaching out to new
geographies, within and outside India, and improve operational
efficiencies by leveraging technology.
112
Case Study
• Be the preferred company to meet the health and personal grooming

needs of target consumers with safe, efficacious, natural solutions by
synthesizing deep knowledge of ayurveda and herbs with modern
science.
• Be a professionally managed employer of choice, attracting,
developing and retaining quality personnel.
• Be responsible citizens with a commitment to environmental
protection.
• Provide superior returns, relative to our peer group, to our
shareholders.
Chairman of the company
Vivek C. Burman joined Dabur in 1954 after completing his graduation in

Business Administration from the USA. In 1986 he was appointed
Managing Director of Dabur and in 1998 he took over as Chairman of the
Company. Under Vivek Burman’s leadership, Dabur has grown and
evolved as a multi-crore business house with a diverse product portfolio
and a marketing network that traverses the whole of India and more than
50 countries across the world. As a strong and positive leader, Vivek C.
Burman has motivated employees of Dabur to “do better than their best”—
a credo that gives Dabur its status as India’s most trusted nature-based
products company.
Leading Brands
More than 300 diverse products in the FMCG, Healthcare and Ayurveda
segments are in the product line of Dabur. List of products of the company
include very successful brands like Vatika, Anmol, Hajmola, Dabur Amla
Chyawanprash, Dabur Honey and Lal Dant Manjan with turnover of
Rs.100 crores each.
Strategic positioning of Dabur Honey as food product, lead to market

leadership with over 40% market share in branded honey market; Dabur
Chyawanprash is the largest selling Ayurvedic medicine with over 65%
market share. Dabur is a leader in herbal digestives with 90% market
share. Hajmola tablets are in command with 75% market share of digestive
tablets category. Dabur Lal Tail tops baby massage oil market with 35% of
total share.
113
Case Study
CHD (Consumer Health Division), dealing with classical Ayurvedic

medicines has more than 250 products sold through prescription as well as
over the counter. Proprietary Ayurvedic medicines developed by Dabur
include Nature Care Isabgol, Madhuvaani and Trifgol. However, some of
the subsidiary units of Dabur have proved to be low margin business; like
Dabur Finance Limited. The international units are also operating on low
profit margin. The company also produces several “me – too” products. At
the same time the company is very popular in the rural segment.
Questions
1. What is the objective of Dabur? Is it profit maximisation or growth

maximisation? Discuss.
2. Do you think the growth of Dabur from a small pharmacy to a large
multinational company is an indicator of the advantages of joint
stock company against proprietorship form? Elaborate
114
Market Structures
Summary Chart
Perfect Monopoly Oligopoly Monopolistic
Competition Competition
# of firms Many One 2 or more Many
Average size of Small Very large Large Small to

firms medium
Nature of product Same Unique Identical/ Differentiated
differentiated
Barriers to entry None Significant Significant Few
Government No Yes Some No

intervention
Output decisions No output Most output Output Output
restriction restriction restricted restricted
Interdependence Each firm is No Interdependent Each firm is
independent competitors decisions independent
Profit making Low High High Medium
possibility
Price and P = MC P > MC P > MC P > MC
Marginal Cost
Implication for Horizontal Downward Kinked/Downw Downward
Demand Curve slopping; ard slopping; slopping;
inelastic inelastic elastic
Pricing decisions MC = MR = P MC = MR Strategic MC = MR
pricing
115
References
[1]. Managerial Economics Theory & Applications- by Dr. D.M. Mithani, 4th
Edition, Himalaya Publishing House
[2]. Economic Environment of Business- by S.K. Mishra & V.K. Puri, 5th Edition,
Himalaya Publishing House
[3]. Web source: www.indianeconony.net
116
Question Papers
(Source: VTU E-Resources)
117
CBCS Scheme
First Semester MBA Degree Examination June / July 2019
Time: 3hrs Max Marks: 100
N ote: 1. Answer any Four Full Questions from Q1 to Q7.

2. Question No. 8 is compulsory.
1. a. Define 180 – Quant. (3 Marks)

b. Explain Baumol’s model of sales maximization (7 Marks)
c. Describe the nature and scope of managerial economics in (10 Marks)
relation to business and industry.
2. a. What do you by “Envelope Curve”? (3 Marks)

b. There are few exception to the law of demand what are (7 Marks)
they? Explain.
c. Explain five fundamental principles of managerial (10 Marks)
economies.
3. a. Distinguish between substitute and complementary goods (3 Marks)

with example.
b. Explain the concept of law of variable proportion with the (7 Marks)
help of diagram.
c. Describe the types of price elasticity with diagram and (10 Marks)
example.
4. a. Define CARTEL. (3 Marks)

b. Discuss the different methods available for demand fore (7 Marks)
casting.
c. Explain with the help of diagram “kinked demand curve” (10 Marks)
5. a. Different between accounting profit and economic profit. (3 Marks)

b. Briefly explain economics and dis-economics of scale. (7 Marks)
c. Construct a Break even chart and explain its assumptions (10 Marks)
and its managerial significance.
6. a. State the law of supply. (3 Marks)

b. Elaborate Williamson’s theory of maximization of (7 Marks)
118
managerial utility function.
c. What are the features of perfect completion? Explain how (10 Marks)
price is determined under perfect competition in short run.
7. a. Define “Loss leadership” (3 Marks)

b. Describe the least cost combination with example. (7 Marks)
c. “Managerial Economics is the integration of economics (10 Marks)
theory with business practice for the purpose of
facilitating decision making and forward planning by
management.
8. Compulsory: Case Study
Nokia Going the Qwerty Ways
The India mobile handset market is projected to grow by 25% by volume

in2011 to 210 million units as against to 151 million units as on Dec 31st
2009, with smart phones contributing sales of nearly 12 million units in
2011. Nokia is still the most selling brand with a 56% market share but it
is losing its market share due to due emergence and gradual popularity of
Androids and smart phones, availability of local brands like Spice and
Micromax and shift in India consumer preference for more features.
Nokia is all set to uphold itself as a trust worthy brand by adopting
multiple strategies. “It ‘s time we leave range our market position and
brand”. “We will sell several low cost dual SIM handsets with feature like
camera and radio which are much is demand” – says Shivkumar the M.D
and vice president for Nokia India while launching a new series of smart
phones,
QWERTY is one of the fastest growing mobile phone categories in due

world due to the rise in messaging and social networking. In order to cash
in on the growing demand of QWERTY phones. Nokia on Thursday 27 th
2011 launched its new handset. Nokia X2-01 with its low price, colourful
design and optimized messaging ability. The Nokia X2-01 makes it easy
to set up chat and send mail directly and superfast access to Ovi Mail, Ovi
chat and more.. This handset will help in democratizing the use of
QWERTY keypads to Indian consumers. It will be available at Rs 4,459.
Questions
a. What are the altemate objective of the firm? (5 Marks)

b. In your opinion what is the objective of Nokia in (5 Marks)
introducing the new series of phone?
119
c. Elaborate with relevant theory? (5 Marks)
Do you agree that Growth maximization with managerial
discretion in more suitable for public limited companies
like Nokia?
d. ‘Nokia can maximize the sales on the basic of brand (5 Marks)
name’ comment
120
CBCS Scheme
First semester MBA Degree Examination Dec.2019/Jan.2020
N ote: 1. Answer any Four Full Questions from Q1 to Q7.

1. a. Define GDP (3 Marks)

b. Explain income elasticity of demand using suitable examples. (7 Marks)
c. Describe the nature and scope of managerial economic with (10 Marks)
reference to managing businesses.
2. a. Define oligopoly. (3 Marks)

b. List and explain the factors that affect demand in general (7 Marks)
c. An air-conditioner manufacturing company’s sales records (10 Marks)
are as follows:
Year 2015 2016 2017 2018 2019
Sales (in Rs. 25 30 40 50 65
Crorecs
Calculate the demand for air – conditioners for next three
years
3. a. State the Cobb-Douglas production function (3 Marks)
b. Explain the law of demand and state its exception. (7 Marks)
c. Explain the types of price elasticity of demand with diagrams. (10 Marks)
4. a. What is meant by price –discrimination? (3 Marks)

b. Explain the law of diminishing marginal utility (7 Marks)
c. Explain the following pricing approaches: 1) Full cost pricing (10 Marks)
2) Product line pricing 3) Price skimming 4)
Penetration pricing 5) Loss eldership pricing.
5. a. What is meant incremental revenue? (3 Marks)

b. Why the average cost curve is is a U soaped curve? Explain (7 Marks)
c. Explain the concept of “kinked Demand Curve” with a (10 Marks)
suitable diagram
6. a. Define cross-elasticity of demand. (3 Marks)

b. State and explain the law of returns to scale (7 Marks)
121
d. From the following particular, calculate BEP. 1) In terms of (10 Marks)
sales value and in units 2) Number of units to be sold to
carn a profit of Rs 90,000.
Fixed factory overhead cost Rs. 60,000
Fixed selling overhead cost Rs. 12,000
Variable manufacturing cost/unit Rs. 12
Variable sellin cost/unit Rs. 03
Selling price/unit Rs. 24
7. a. Define ISO- quant. (3 Marks)

b. Explain the economies and diseconomies of scale. (7 Marks)
c. Explain the five fundamental principles of managerial (10 Marks)
economics.
8. a. Define the following: 1) Average cost 2) Managerial cost (10 Marks)

3) Variable cost 4) Average fixed cost 5) Average variable
cost.
b. From the following data calculate Average Cost, marginal (10 Marks)
cost, variable cost. Average fixed cost and Average variable
cost.
Output ( in units) 0 1 2 3 4 5 6 7
Total costs (in Rs.) 120 140 180 210 240 300 360 420
122
CBCS Scheme
First semester MBA Degree Examination Aug / Sept. 2020
Note: (1) Answer any FOUR full questions from Q. No 1 to 7

(2) Q. No 8 is Compulsory
1. a. what is Managerial Economics? (3 Marks)

b. Explain the concepts of Macro economics and Micro (7 Marks)
economics.
c. Explain the different survey methods of demand (10Marks)
forecasting
2. a. What is Opportunity cost? Give an example. (3 Marks)

b. Explain Simon’s satisfying Model of Behavioural (7 Marks)
theory
c. Explain Baumol’s Hypothesis of sales maximization, (10Marks)
with a suitable graph.
3. a. What is Income Elasticity of demand? (3 Marks)

b. State ‘Law of Demand’. What are its exceptions? (7 Marks)
c. Explain the different survey methods of demand (10Marks)
forecasting.
4. a. What is ‘Economies of Scale’? (3 Marks)

b. What are different cost concepts? (7 Marks)
c. What is ISO-Quant curve? Briefly explain its (10Marks)
Properties.
5. a. What is Product Life Cycle pricing? (3 Marks)

b. Explain Cross- elasticity of demand. Explain its uses. (7 Marks)
c. Explain ‘Kinked Demand curve’, with a neat diagram. (10Marks)
6. a. What is a Contribution? (3 Marks)

b. What is the use of Break-even analysis in Managerial (7 Marks)
decision making?
c. Explain with graph how to access profits and apply (10Marks)
BEP for decision making using linear revenue and
cost functions.
123
7. a. What is a Cartel? (3 Marks)
b. Explain Cross-elasticity of demand. Explain its uses (7 Marks)
c. ‘A, firm under prefect competition is a price taker and (10Marks)
not price maker’ Explain
8. Jio: the new Samurai in Telecom Battle
RIL chairman Mukesth Ambani’s new venture Reliance Jio launched

its tariff plans on 1st September 2016. It offered free voice and
services for users till 31st December 2016, in order to capture the
maket. Immediately Bharti Airtel Rs 12,000 crore in market
capitalization eroded Ideal Cellular Ltd., lost its market value by Rs
2800 crore.
Reliance Jio had also appealed to TRAI on 10 th April 2017 for

strongest possible action and highest penalty against Bharti Airtel,
Aditya Birla group’s Idea Cellular and UK based Vodafone’s Indian
subsidiary for using unfair means to retain customers using number
portability to exit their networks and join services of Jio.
Lot of analyst now believes that Reliance Jio’s entry with such kind
of offers of free voice calls, roaming and probably world’s cheapest
data plans will kick start the telecom industry consolidation and will
push smaller mobile service providers such as Aircel, Telenor India,
Tata Teleservices and Reliance Communication towards exiting the
Industry Bharti Airtel, the country’s largest mobile operator, along
with Vodafona and Idea reacted in September itself, by launching
unlimited voice plans bundled with data. For example, Airtel
announced a 90-deay free 4G data pre- paid pack through initially
restricting it only to Rs 1,495 plan. Airtel had also introduced free-
voice plans on some of its existing premium plans by then. Even
State-owned BSNL announced a counter – attack by offering free
voice calling beginning in 2017.
The battle further intensified with operators approaching authorities
with allegations and counter allegations. Bharti Airtel moved fair
trade regulator CCI (Competition Commission of India) with the
allegation that Jio is indulging in Predatory pricing’ by way of
providing free services. Airtel also alleged that Reliance Jio is
abusing its dominant position. Jio has in turn, accused Airtel for
misleading consumers through advertising claiming “Airtel is
officially the fastest network in the Country’.
124
The Advertising Council of India has ruled against Airtel and asked
it to modify or withdraw the commercial by 11th April 2017. The
modified advertisement is pitching Airtel as “India’s Fastest
Network”, dropping the work “Officially”.
Questions
a. When companies enter into price war, consumer is (10 Marks)

the ultimate gainer. Discuss in light of telecom
industry.
b. Do you think regulatory authorities should intervene (10 Marks)
in the matter of market? Why? Why not?
125
CBCS Scheme
First semester MBA Degree Examination Jan/Feb. 2021
Note: 1. Answer any Four Full Questions from Q1 to Q7.

1. a. What are Giffen goods? (3 Marks)

b. Differentiate between Fixed cost and variable cost. Give (7 Marks)
example.
c. Explain briefly the objectives of a business firm. (10 Marks)
2. a. Define Managerial Economic. (3 Marks)

b. What is Price elasticity of demand? What are the various (7 Marks)
price elasticities of demand?
c. What are used and Assumptions of BEA? And explain (10 Marks)
break-even chart with diagram.
3. a. Explain features of perfect competition. (3 Marks)

b. What are the exceptions to law of demand? (7 Marks)
c. What is kinked demand curve? What are it assumption? (10 Marks)
4. a. What are different types of costs? (3 Marks)

b. Discuss law of variable proportion with diagram (7 Marks)
c. What is economics of scale? Elaborate the factors (10 Marks)
influencing it.
5. a. What is Accounting profit and economics profit? (3 Marks)

b. Explain different pricing strategies (7 Marks)
c. Describe Baumol’s model with graphical representation (10 Marks)
6. a. Why cost curve average is U-shaped? (3 Marks)

b. Explain the scope of Managerial Economics. (7 Marks)
c. Explain price determination and equilibrium under perfect (10 Marks)
competition.
7. a. What is ISO-quants? (3 Marks)

b. Explain the principles of Managerial Economics. (7 Marks)
c. What are the roles and responsibilities of a Managerial (10 Marks)
126
Economist.
8. Case Study (20 Marks)

Pepsi company produce a single article. Following cost data
is given about its product.
Selling price per unit Rs. 40
Marginal cost per unit Rs. 24
Fixed cost per annum Rs. 16,000
Calculate
a. P/V ration
b. Break even sales
c. Sales to earn a profit of Rs 2000
d. Profit at Rs. 60,000
127
Managerial Economics – 20MBA12
Time: 3 hrs Max. Marks: 100
Note: 1. Answer any FOUR questions from Q. No. 1 to Q. No. 7

2. Question No. 8 is compulsory
1. a. State Three responsibilities of “Managerial Economist” (3Marks)

b. What is Price Elasticity of Demand? Explain different (7 Marks)
types of price Elasticity of Demand .
c. Elaborate Cost –output relationship in shirt run. (10 Marks)
2. a. State three exception to “Law of Demand” (3Marks)

b. Which are the different sectors contributing to Indian (7 Marks)
Economy?
c. Describe the Scope of Managerial Economics in relation (10 Marks)
to Business and Industry
3. a. What is Oligopoly? (3Marks)

b. What are the uses or application of Break-even analysis (7 Marks)
and limitations?
c. What do mean by Economies of scale? Describe the (10 Marks)
various types of internal and external Economies of
scale?
4. a. What is Production Function? (3Marks)

b. Briefly explain the characteristic or features of Perfect (7 Marks)
competitions
c. Explain the Law of Variable Proportions with the help of (10 Marks)
diagrams, indicating the Increasing, diminishing and
negative returns.
5. a. What is GDP? (3Marks)

b. Explain briefly different Method of Demand (7 Marks)
Forecasting.
c. How is Price-Output determined in the short-run in (10 Marks)
monopolistic market? Discuss
6. a. What is Monetary Policy? (3Marks)

b. Explain in detail Baumol sales maximization model. (7 Marks)
c. Critically evaluate 1991 Industrial Policy. (10 Marks)
128
7. a. What is Margin of Safety? (3Marks)
b. Discuss the role of private sector in India and its (7 Marks)
problems
c. ABC Manufacturing ltd incurs fixed expenses (10 Marks)
amounting to Rs 12000 its variable cost of product “x”
is Rs. 5 per units Its selling price Rs.8/- Determine its
break-even quantity and its Margin of safety for the sales
of Rs 5000 units interpret the result
8. Case Study
• ABC Company is an industrial manufacturing unit
specializing in one particular product used in
automobile industry; very few competitors are there in
market. Prices are fairly stable. The company is thinking
of reduction in price in order to enhance its market
share.
1. What type of market is the company in?
(5 Marks)
2. Will a reduction in price enhance the market share
(5 Marks)
as expected by the company?
3. What strategy would you suggest to increase its
(10 Marks)
market share without reducing the price?
9. a. What is managerial economics? (3Marks)
b. Explain the application of economics to business (7 Marks)
decision making
c. Explain Marris’s Hypothesis of Growth Maximization (10 Marks)
10. a. What are Giffen goods? (3Marks)

b. Explain about demand forecasting . (7 Marks)
c. Explain income elasticity and cross elasticity of demand (10 Marks)
11. a. Explain Break even analysis. (3Marks)

b. What are the different properties of ISO-Quant curve? (7 Marks)
c. What do mean by economies of scale? Describe the (10 Marks)
various types of internal and external economics of
scale?
12. a. What are Cartels? (3Marks)

b. Explain different pricing strategies. (7 Marks)
c. Explain price-output determination under monopolistic (10 Marks)
competition.
13. a. What is PESTEL analysis mean? (3Marks)
129
b. Explain the three sector of Indian economy. (7 Marks)
c. What is GDP? Explain the components of GDP (10 Marks)
14. a. What is Monetary Policy? (3Marks)

b. List and explain the features of India’s Industrial policy (7 Marks)
of 1991
c. Explain Fiscal & monetary policy of India. (10 Marks)
15. a. Explain LAC curve? (3Marks)

b. Explain Kinked Demand curve (7 Marks)
c. From the following data, calculate (i) PV Ratio (ii) BEP (10 Marks)
in units
Selling price per unit Rs.50
Variable cost per unit Rs.40
Fixed cost Rs.5,000
Based on the general features and facilities offered, the Ministry of

Tourism Govt. of India classifies hotels into 7 categories: five star
deluxe, five star, four star, three star, two star, one star and heritage
hotels. These apart, there are hotels in the unorganized sector that
have a significant presence across the country and cater primarily to
economy tourists. Encouraged by the boom in tourism and increased
spending on leisure, there has been an influx of globally renowned
groups by way of joint ventures. The premium and luxury segment
(high end 5-star deluxe and 5 star hotels) mainly cater to the business
and up market foreign leisure travelers and offer a high quality and
wide range of services. These constitute about 30 percent of the
hospitality industry in India. The mid-market Segment (3 and 4 star
hotels) offers most of the essential services of luxury hotels without
the high costs, since the tax component of this segment are lower
compared with the premium segment. The budget segment comprises
1 and 2 star hotels, which provide.
Affordable accommodation to the highly price-conscious segment of

travelers. Heritage Hotels are architecturally distinctive properties
such as palaces and forts, built prior to 1950, that have been
converted into hotels.
In the face of stiff competition, hotels in India have come up with

ingenious ways to attract customers. These hotels distinguish
themselves with beds, bathroom, amenities and complementary
breakfast. Other facilities may include innovations in food and
130
beverage products, spa, fitness centre or other lifestyle facilities. The
ongoing revolution in cuisine has been accompanied by innovations
such as free standing, niche restaurants.
Questions
a. Do you think the hotel industry is monopolistically (10 Marks)

competitive? What are the features of industry which
suggest the same?
b. Comment on differentiation offered by the hotels in (10 Marks)
India.
131
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Managerial Economics Theory and Practice

Book · February 2022

The user has requested enhancement of the downloaded file.

INSC International Publishers

Edition: First – 2022

Copyright 2022 © Dr. Vinith H P

No part of this book may be reproduced or transmitted in any form by any

PUBLISHER & PRINTER: INSC International Publishers

It is increasingly being recognized that teaching principles of economics

Managerial economics, It is the integration or application of economic

This Book on Managerial Economics mainly introduces topics in

The Book is initiated as a reference book for PG and UG students in

One of the most pleasant aspects of writing Book on Managerial Economics

I wish to place on record my deep sense of gratitude to Dr. C K Subbaraya.

I am thankful to Dr. C T Jayadeva,. Principal, Adichunchanagiri Institute of

I express my profound thanks to Dr. Prakash Rao K S, Head, P.G

I owe my debt of gratitude to my beloved former and present colleague’s

I extend my thanks to the Management and Staff of Adichunchanagiri

It is with immense sense of happiness and joy to express my deep sense of

I express my deep sense of gratitude to my grand Parents Late Chanamma

I express my deep sense of gratitude to my parents Mr. Panchaksharappa

Chapter 2 Demand Analysis 15 -38

Chapter 5 Indian Business Environment 81 - 93

It is an art of household management or it is the process of optimum

Dr. Alfred Marshall, one of the greatest economists of the nineteenth

1.1.1. Meaning of Managerial Economics

It is the integration or application of economic principles in business

Managerial Economics can be defined as amalgamation of economic

makes use of economic theory and concepts. It helps in formulating logical

1.1.2. Definition of Managerial Economics

According to French Economist Spencer “Managerial Economics is an

According to D.C. Hague “A fundamental academic subject which seeks

1.2. Nature of Managerial Economics

1. Micro in nature- scope of Managerial Economics is limited, it is a

1.3. Scope of Managerial Economics

Managerial Economics is a developing subject. The scope of managerial

business world works and what can be done to maintain profitability in an

1. Demand function and estimation

1.4. Significance or uses of Managerial Economics

1.5. Role and responsibilities of Managerial Economist

1. Demand estimation ( or demand forecasting)

1.6. Theory of Firm and Industry

Firm is an economic unit producing the particular product or a service; it is

1.6.2. Meaning of Firm

Firm is an center of control where the decisions about what to produce,

1.6.3. Objectives and Alternative Objectives of the Firm

Every firm is having an objective or goal, there are considered to be the

1. Economic objectives – refers to those activities which are

2. Social Objectives: Since the business operates in the society by

3. Human Objectives: These objectives are aimed at well being and

4. National Objectives: Being an important part of the country it is

1.6.4. Meaning of Industry

1.6.5. Profit Maximization V/S Wealth Maximization

It is the process where the company focuses on maximization of the

1. Ultimate goal of the company is to increase the profit.

1. Maximization of business operations

1. Leads to the exploration of workers and consumers.

1. Protection of interest of share holders.

1. It considers the concept of time value of money.

1. It is a kind of profit maximization.

1.7. Managerial Theories

1.7.1. Sales Maximization Theory or Sales Maximization Model or

It is an alternative model of profit maximization theory, developed by