Managerial Economics

PART- A
Module 1
1. What do you mean by Economics?
Ans: Economics is a science that deals with human wants and their satisfaction. Human beings have
unlimited wants and these wants are satisfied with the help of goods and services. The word economics was
derived from the Greek word ‘Oikonomia’ which means household management, using the limited funds
available in the most economical manner possible.

2. What do you mean by Micro Economics?

Ans: The study of economics is divided into two –micro economics and macroeconomics. The term
microeconomics is derived from the Greek word ‘mikros’ meaning “small”.
❖ microeconomics deals with a small part or a small component of the national economy of a country.
Microeconomics may be defined as that branch of economic analysis which studies the economic behavior
of the individual unit, may be a person, a particular household, or a particular firm. It is a study of one
particular unit rather than all the units combined together.

3. What do you mean by Macro Economics?

The word macro has been derived from the Greek word ‘makros’ which means large. Macroeconomics is the
branch of economics which deals with the economy as a whole. It deals with the behaviour of not one
particular unit but all the units combined together. Macroeconomics is otherwise known as Aggregate
Economics.

4. Define Managerial Economics

Managerial economics is the study of how scarce resources are directed most efficiently to achieve
managerial goals. It is a valuable tool for analyzing business situations to take better decisions.
Prof. Evan J Douglas defines Managerial Economics as “Managerial Economics is concerned with the
application of economic principles and methodologies to the decision-making process within the firm or
organization under the conditions of uncertainty”

5. What is the relevance of Managerial Economics to managers?

Scope of Managerial Economics:
1. Demand Analysis and Forecasting
2. Cost and Production Analysis
3. Pricing Decisions, Policies and Practices
4. Profit Management
5. Capital Management
Recently, managerial economists have started making increased use of Operation Research methods like
Linear programming, inventory models, Games theory, queuing up theory etc., have also come to be regarded
as part of Managerial Economics.

6. List the role of Managerial Economics in organization decision making activities.

Useful in Business Organization.
Helpful in Chalking out Business Policies.
Help in Business Planning.
Helpful in Cost Control.
Useful in Coordination of Business Activities.
Useful In Demand Forecasting.
Helpful in Profit Planning and Control.

7. What is decision making

Decision Making is the process of choosing a particular course of action from among the various alternatives
to accomplish the pre-determined objectives of the management
 8. Differentiate Programmed and Non-Programmed decisions
Programmed decisions relate to those functions that are repetitive in nature. These decisions are dealt with
by following a specific standard procedure. These decisions are usually taken by lower management.
For example, granting leave to employees, purchasing spare parts etc are programmed decisions where a
specific procedure is followed.

Non-programmed decisions arise out of unstructured problems, i.e. these are not routine or daily
occurrences. So there is no standard procedure or process to deal with such issues.
Usually, these decisions are important to the organization. Such decisions are left to upper management. For
example, opening a new branch office will be a non-programmed decision.

9. Differentiate Routine and Strategic decisions

Strategic Decisions and Routine Decisions
As the name suggests, routine decisions are those that the 0 makes in the daily functioning of the
organization, i.e. they are routine.
Such decisions do not require a lot of evaluation, analysis or in-depth study. In fact, high-level managers
usually delegate these decisions to their subordinates.
On the other hand, strategic decisions are the important decisions of the firm. These are usually taken by
upper and middle-level management. They usually relate to the policies of the firm or the strategic plan for
the future.

10. State Opportunity Cost

The concept of opportunity cost is related to the alternative uses of scarce resources. Resources, though
scarce, have alternative uses. The scarcity and the alternative uses of the resources give rise to the concept
of opportunity cost.
Resource available to a business unit-be it an individual firm,a joint stock corporation or a multinational are
limited. But the limited resources available to a firm can be put to alternative uses.

11. Enumerate Incremental Principle

Incremental Principle
The incremental concept measures the impact of each possible decision on cost and revenue. In other words,
it measures the changes in total cost and total revenue when prices are varied, or different products are
manufactured.
Incremental cost may be defined as the change in total cost due to a specific decision. Similarly, incremental
revenue is the change in total revenue caused by a decision. Thus, when incremental revenue exceeds the
incremental cost resulting from a particular decision it is regarded as profitable.
In managerial economics, incremental reasoning in fundamentally used to estimate the impact of
alternatives involved in the process of decision making and then making the best possible choice.

12. What is Discounting Principle?

One rupee received tomorrow is worth less than a rupee received today. Amounts received at different
periods cannot be treated alike. There are two reasons for this.
Firstly, the future is uncertain and so we are not sure whether we will get the amount on a future date.
Secondly, the one rupee received today can be reinvested which will earn additional profit. One rupee to be
received at a future date cannot be invested until it is received. So, it is less valuable than a rupee received
today.
A present gain is valued more than a future gain. Thus, in investment decision making, discounting of future
value with the present one is very essential. The following formula is useful in this regard.
V=A/ (1 +i)
Where, V=present value, A=annuity or returns expected during a year, i=current rate of interest.

Part -B
What are the objectives of Economics?
Managerial economics is pragmatic. It is concerned with analytical tools that are useful for decision-making
in business. In short, business economics essentially implies the application of economic principles and
methodologies to the decision-making process within the firm under the conditions of uncertainty.
Managerial economics is a selection from the tool box of economic priciples, methods and analysis applied
to business management and decision-making. It follows, thus, that economic theories are very useful in
business analysis and practice for decision-making and forward planning by management. Managerial
economics may be useful in the following respects: It makes problem-solving easy in business; It improves
the quality and preciseness of decisions; It helps in arriving at quick and appropriate decisions. 14
Managerial Economics Business economics is applicable to several areas of business and management in
practice, such as production management, inventory management, marketing management, finance
management, human resource and knowledge management.
What is the Scope of Economics?
• Theory of Demand-Microeconomics is a detailed study of demand theory.
• Theory of production and cost- Microeconomics analyses how a typical producer combines different
factors of production to secure maximum possible output at a least cost.
• Theory of product pricing- This is a major part of microeconomic analysis that helps in price
determination of a particular product under different circumstances.
• Theory of factor pricing- It includes determination of wages, rent, interest and profit.
• Theory of economic welfare- Most of the traditional theory of economic welfare is concerned with the
welfare of individual consumer, producer or worker which is an important part of microeconomics.
Discuss the importance of Micro and Macro Economics
IMPORTANCE OF MICROECONOMICS
• Helpful in the efficient employment of resources – microeconomics is helpful in the efficient
employment of the limited, scarce resources of a country.
• Understanding free Economy - Microeconomics is of great importance in understanding the working
of free enterprise economy without any central control. In such an economy there is no agency to plan
and coordinate the working of the economic system.
• Helpful in the development of international trade – It is used to explain the gains from international
trade, balance of payment etc.
• Provides tools for evaluating economic policies
Importance of Macroeconomics
• Knowledge of functioning of an Economy – Macroeconomics explains fully the working of modern
economic system and interdependence of various economic factors.
• Formulation of economic policies – The study of macroeconomics plays an important role in
formulation and execution of economic policies.
• Economic planning – macroeconomics helps the planners to formulate suitable economic plan for the
country.
• Studying economic growth – macroeconomics provides tools to study economic growth.
• Studying Inflation and Deflation – With the help of the analysis of aggregate demand and supply, we
come to know the inflation and deflation rates of the country.
• Estimating Welfare – It provides useful tools for the estimation and measurement of economic welfare
in an economy
Explain the role of Managerial Economics in a Modern Organization
A managerial economist helps the management by using his analytical skills and highly developed techniques
in solving complex issues of successful decision-making and future advanced planning. He assists the
business planning process of a firm. He also carries cost-benefit analysis.
Business economics, in the true sense, is the integration of economic principles with
business practice. The subject-matter of business economics, as such, should pertain to economic
analysis that can be helpful in solving business problems, policy and planning. But, one
cannot make good use of economic theory in business practices unless he masters the basic
contents, principles, and logic of economics. Business economics is pragmatic. It is concerned
with analytical tools that are useful for decision-making in business.
Managerial economics is an evolving science. It is a newly developing subject with the
popularity of management studies. Hence, there is no demarcation or any uniform pattern of
its subject-matter and scope.
Business economics has picked-up relevant concepts, techniques, tools and theories
from micro and macroeconomics applicable to business issues and problems of decisionmaking.
Following are the core topics of managerial economics:
• Demand Function and Estimation
• Demand Elasticity
• Demand Forecasting
• Production Function and Laws
• Cost Analysis
• Pricing and Output Determination in different market structures such as perfect
competition, monopoly, oligopoly and monopolistic competition
• Pricing Policies and Practices in Real Business
• Profit Planning and Management
• Project Planning and Management
• Project Planning
• Capital Budgeting and Management
• Break-even Analysis
• Linear Programming
• Game Theory
• Government and Business.
The scope of business economics is usually restricted to the understanding of the business
behaviour and problems of a firm at a micro level in the context of the prevailing business
environment.
Managerial Economics is the discipline which deals with the application of economic theory to business
management. Elucidate.
Managerial economics is a discipline which deals with the application of economic theory to business
management. ... Managerial Economics is thus constituted of that part of economic knowledge or economic
theories which is used as a tool of analyzing business problems for rational business decisions.
Discuss the nature of Managerial Economics
Nature of Managerial Economics:
• The primary function of business manager in a business organization is decision making and forward
planning.
• Decision making and forward planning go hand in hand with each other. Decision making means the
process of selecting one action from two or more alternative courses of action. Forward planning
means establishing plans for the future to carry out the decision so taken.
• The problem of choice arises because resources at the disposal of a business unit (land, labour, capital,
and managerial capacity) are limited and the firm has to make the most profitable use of these
resources.
• The decision-making function is that of the business manager, he takes the decision which will ensure
the most efficient means of attaining a desired objective, say profit maximization. After taking the
decision about the particular output, pricing, capital, raw-materials and power etc., are prepared.
Forward planning and decision-making thus go on at the same time.
• A business manager’s task is made difficult by the uncertainty which surrounds business decision-
making.
• He prepares the best possible plans for the future depending on past experience and future outlook
and yet he has to go on revising his plans in the light of new experience to minimise the failure.
• In fulfilling the function of decision-making in an uncertainty framework, economic theory can be,
pressed into service with considerable advantage as it deals with a number of concepts and principles
 which can be used to solve or at least throw some light upon the problems of business management.
E.g are profit, demand, cost, pricing, production, competition, business cycles, national income etc.
What is the importance of decision making in an organization?
A decision is an act of selection or choice of one action from several alternatives. Decision-making can be
defined as the process of selecting a right and effective course of action from two or more alternatives for
the purpose of achieving a desired result. Decision-making is the essence of management.
Importance of Decision-Making:
Management is essentially a bundle of decision-making process. The managers of an enterprise are
responsible for making decisions and ascertaining that the decisions made are carried out in accordance with
defined objectives or goals.
Decision-making plays a vital role in management. Decision-making is perhaps the most important
component of a manager’s activities. It plays the most important role in the planning process. When the
managers plan, they decide on many matters as what goals their organisation will pursue, what resources
they will use, and who will perform each required task.
When plans go wrong or out of track, the managers have to decide what to do to correct the deviation.
In fact, the whole planning process involves the managers constantly in a series of decision-making
situations. The quality of managerial decisions largely affects the effectiveness of the plans made by them. In
organising process, the manager is to decide upon the structure, division of work, nature of responsibility
and relationships, the procedure of establishing such responsibility and relationship and so on.
In co-ordination, decision-making is essential for providing unity of action. In control, it will have to decide
how the standard is to be laid down, how the deviations from the standard are to be rectified, how the
principles are to be established how instructions are to be issued, and so on.
The ability to make good decisions is the key to successful managerial performance. The managers of most
profit-seeking firms are always required to take a wide range of important decision in the areas of pricing,
product choice, cost control, advertising, capital investments, dividend policy, personnel matters, etc.
Similarly, the managers of non-profit seeking concerns and public enterprises also face the challenge of
taking vital decisions on many important matters.
Decision-making is also a criterion to determine whether a person is in management or not.

Explain the types of decision making

• Strategic Decisions and Routine Decisions
• As the name suggests, routine decisions are those that the 0 makes in the daily functioning of the
organization, i.e. they are routine.
• Such decisions do not require a lot of evaluation, analysis or in-depth study. In fact, high-level
managers usually delegate these decisions to their subordinates.
• On the other hand, strategic decisions are the important decisions of the firm. These are usually taken
by upper and middle-level management. They usually relate to the policies of the firm or the strategic
plan for the future.
Programmed Decisions and Non-Programmed Decisions
• Programmed decisions relate to those functions that are repetitive in nature. These decisions are
dealt with by following a specific standard procedure. These decisions are usually taken by lower
management.
• For example, granting leave to employees, purchasing spare parts etc are programmed decisions
where a specific procedure is followed.
• Non-programmed decisions arise out of unstructured problems, i.e. these are not routine or daily
occurrences. So there is no standard procedure or process to deal with such issues.
• Usually, these decisions are important to the organization. Such decisions are left to upper
management. For example, opening a new branch office will be a non-programmed decision.
Policy Decisions and Operating Decisions
Tactical decisions pertaining to the policy and planning of the firm are known as policy decisions. Such
decisions are usually reserved for the firm’s top management officials. They have a long term impact on the
firm and require a great deal of analysis.
Operating decisions are the decisions necessary to put the policy decisions into action. These decisions help
implement the plans and policies taken by the high-level managers.
Such decisions are usually taken by middle and lower management. Say the company announces a bonus
issue. This is a policy decision. However, the calculation and implementation of such bonus issue is an
operating decision.
Organizational Decisions and Personal Decisions
When an executive takes a decision in an official capacity, on behalf of the organization, this is an
organizational decision. Such decisions can be delegated to subordinates.
However, if the executive takes a decision in a personal capacity, that does not relate to the organization in
any way this is a personal decision. Obviously, these decisions cannot be delegated.
Individual Decisions and Group Decisions
Any decision taken by an individual in an official capacity it is an individual decision. Organizations that are
smaller and have an autocratic style of management rely on such decisions.
Group decisions are taken by a group or a collective of the firm’s employees and management. For example,
decisions taken by the board of directors are a group decision.

What are the steps in decision making?

Defining the problem

The first step in the process of decision making is to identify and study the real problem. If the problem is
inaccurately defined, the other steps in the process become incorrect. So the manager should take sufficient
time for defining and identifying the problem. Proper identification and study of the problem minimize the
chances of wastage of time and energy.
Analyzing the problem
After defining the problem the next step is its analysis. It involves classifying the problem and gathering
information. The problem should be classified keeping in view the following factors.
The nature of decision – strategic or routine
The impact of decision on other functions
The futurity of the decision
The periodicity of the decision
The limiting or strategic factor relevant to the decision
The problem should be analyzed from all possible angles. So the manager analyze the problem in detail with
all the available data's and information
Developing Alternatives
The success of decision-making process always depends on the ability and quality of the manager. In
developing alternatives, the manager has to use his past experiences, personal judgements and also take the
opinion and judgement of experts. Management must ensure that the best alternatives are considered before
a course of action is selected
Evaluating Alternatives
Each and every alternative solutions may have advantages and disadvantages. While evaluating the
alternatives the solution should have substantial quality, acceptability, anticipation, consideration of risks
and focus on present situations. The element of risk involved in each alternative and the resources available
for its implementation should also be considered.
Selecting the best Alternative
Selection involves choice making. The manager has to select the best suitable one which satisfies the
organizations objectives. The selected alternative should accomplish the pre-determined goals. So he has to
study and compare all the merits and short comings of each alternative to select the best one. The selected
alternative should be the right and appropriate one which helps to achieve the goals.
Implementing the decision
Implementation means conversion of decision into action. For getting the desired results the decision should
be properly implemented in the right time. Everyone involved in it must know what he must do, how to do
it and when. Necessary resources should be allocated and responsibilities for specific tasks should be
assigned to individuals.
The main problem the manager may face at the implementation stage is the resistance by the subordinates
who are affected by the decision. In order to make the decision acceptable the manager should make people
understand what the decision involves, what is expected of them and what they expect from the
management.
Follow-up action
The actual results of the decision should be compared with the expected results to find out the variations.
Feedback is necessary in decision making and it helps the decision maker to see whether the selected
alternative solve the problems and accomplish the targets.

Outline the classification of time from economic perspective with respect to decision-making
The Time Concept
The short run and long run effects on cost and revenue must be taken into consideration when a business
decision is taken.
Short run refers to a period which is not sufficient to change all the factors of production. In the short run
the supply of some factors of production remains fixed and some are variable. Any increase in production in
this period is possible only by increasing the variable factors(raw materials and labour). As the fixed factors
cannot be increased, increase in output is attained by putting the fixed factor to more intense use.
Long run is a period sufficient to vary all the factors of production( fixed cost and variable cost) . So in the
long run all the factors of production are variable. Thus in the long run output can be increased by increasing
the scale of inputs, size of the firm etc.
The effect of policy decisions on cost and revenues in the light of these time distinctions must be considered
when business decisions are taken.
A business manager must take into consideration both the short run and long run effects on revenue and
costs so that a right balance between long run and short run perspectives can be maintained.
A pricing decision taken only with the short run perspective may have some long term consequences that
may make it less profitable than it appeared at first sight
A firm has some idle capacity. It produces and sells a product at Rs.500 per unit. The cost of producing the
product is Rs.420 per unit (Rs.360 per unit variable cost and Rs.60 per unit fixed cost). The firm gets a new
order to supply 500 units at Rs. 380 per unit. If this order is evaluated from the short run perspective, it will
bring in an additional revenue of Rs. 10,000 (500*20). As the fixed cost is ignored here, the contribution
towards profit is Rs.20 per unit (380-360). Before accepting this order, the following long-term effects of this
decision also must be considered.
1. If the firm has to execute similar orders at, he same price, the fixed cost (which are ignored here) will
become variable. The new orders may necessitate an increase in production capacity by adding new
machinery and new supervisory staff.
2. If this order at a lower price is accepted, regular customers who paid higher price for the same product
will feel bad. This will be viewed by them unethical and spoil the company’s image.
3. Accepting a price that does not cover total cost may adversely affect the image of the firm.
An automobile firm adopts a new factory plant to increase its output. This may involve a rise in its total
costs by 20% and rise in total sales revenue by 30% against increase in output by 10%. Calculate
incremental cost and incremental revenue.
Incremental Cost
Incremental Cost is defined as the ratio of change in total cost owing to change in total quantity of output.
Thus:
IC=ATC/AQ
Where IC = Incremental Cost and TC = Total Cost
In decision making, the managerial choice is based on the criterion of incremental revenue is greater than
incremental cost in the given option.
Managerial Rule of Thumb:
IR > IC

IC = 20%/10%
=2%
Incremental Revenue
It is the ratio of change in total revenue owing to the change in the total output level. Thus:
IR = ATR/AQ
Where IR =Incremental Revenue,
TR = Total Revenue,
Q=Total Quantity of Output,
A =Change
Often, incremental revenue is also estimated in relation to total investment, thus
IR = ATR/AI
Where, I refer to total volume of investment.
IR =30%/10%
= 3%
In this case,
IR = 3% and IC = 2%
IR (3%) > IC (2%)
It is profitable decision to undertake the new investment.
Illustrate Opportunity Cost with the help of an example
The concept of opportunity cost is related to the alternative uses of scarce resources. Resources, though
scarce, have alternative uses. The scarcity and the alternative use of the resources give rise to the concept of
opportunity cost.
Resource available to a business unit-be it an individual firm, a joint stock corporation or a multinational are
limited. But the limited resources available to a firm can be put to alternative uses.
For example, suppose a firm has Rs.100 million at its disposal and the firm finds three risk free alternative
uses of the fund available to it: 1)to expand the size of the firm ii) to set up a new production unit in another
city and iii) to buy shares in another firm. Suppose also that the expected annual return from each of the
three alternative uses of finance is given as follows:
Alternative 1: Expansion of the size of the firm
Rs.20million.
Alternative 2: setting up a new production unit
Rs.18 million
Alternative 3: Buying shares in another firm Rs.16 million.

All other things being the same, a rational decision for the firm would be to invest the money in alternative
1. This implies that the manager would have to sacrifice the annual return from the second alternative, i.e, a
return of Rs. 18 million expected from alternative 2.
In economic jargon, Rs.18 million is called an annual opportunity cost of an annual income of Rs.20 million.
Thus, the opportunity cost of availing an opportunity is the foregone income expected from the second-best
opportunity of using the resources.
Opportunity cost arises only when there is an alternative. The opportunity cost of the funds employed in
one’s own business is the income that could be earned on that fund if it was used in another way.
The opportunity cost of the time one puts into his own business is the salary he could earn in some other
occupation.

Economics is the science of choice when faced with unlimited ends and scarce resources having
alternative uses – Comment
Economics is the scientific study of how people and institutions make decisions about producing and
consuming goods and services and how they face the problem of scarcity. It is essentially a study of the ways
in which human kind provides for its well-being.
Economists are concerned with the ways in which people apply their knowledge, skills and efforts to the gifts
of nature in order to satisfy their material wants. Economics limits itself to the study of material aspects of
life.
Human wants are unlimited, but human capacity to satisfy the wants is limited. This is the ‘economic
problem’ – unlimited wants, very limited means.
And we cannot overcome this problem completely. All we can do is to make the most of what we have, by
exercising our choice. In other words we seek to overcome the problem of scarcity by exercising our choice.
We economise, make a careful use of our resources (means) or cut our unnecessary expenditure.
The choice problem has to be faced by an individual or by a family firm or even by a government. A household
has to decide what to buy with limited income in order to satisfy the needs of its members. A business firm
having limited resources, has to decide what to do to produce and how much of each commodity to produce.
A government has to decide whether to build schools, roads or hospitals with its limited revenue All these
activities are competing for the limited revenue it can raise by taxation Extra houses power plants, stadiums
and new roads – all are claiming a share of the limited land available. In these and many other instances, the
government has to face the task of making the most of the nation’s resources.

What is the application of economics theories in business decisions?

1. Demand Analysis and Forecasting
2. Cost and Production Analysis
3. Pricing Decisions, Policies and Practices
4. Profit Management
5. Capital Management
Recently, managerial economists have started making increased use of Operation Research methods like
Linear programming, inventory models, Games theory, queuing up theory etc., have also come to be regarded
as part of Managerial Economics.
1.Demand Analysis and Forecasting:
A business firm is an economic organisation which is engaged in transforming productive resources into
goods that are to be sold in the market. A major part of managerial decision making depends on accurate
estimates of demand.
A forecast of future sales serves as a guide to management for preparing production schedules and
employing resources.
Demand analysis also identifies a number of other factors influencing the demand for a product. Demand
analysis and forecasting occupies a strategic place in Managerial Economics.
2.Cost and production analysis:
A firm’s profitability depends much on its cost of production. A wise manager would prepare cost estimates
of a range of output, identify the factors causing are cause variations in cost estimates and choose the cost-
minimising output level, taking also into consideration the degree of uncertainty in production and cost
calculations.
Production processes are under the charge of engineers but the business manager is supposed to carry out
the production function analysis in order to avoid wastages of materials and time. Sound pricing practices
depend much on cost control.
3.Pricing decisions, policies and practices
Pricing is a very important area of Managerial Economics. In fact, price is the genesis of the revenue of a firm
and the success of a business firm largely depends on the correctness of the price decisions taken by it.
The important aspects dealt with this area are: Price determination in various market forms, pricing
methods, differential pricing, product-line pricing and price forecasting.
4.Profit management
Business firms are generally organized for earning profit and in the long period, it is profit which provides
the chief measure of success of a firm. Economics tells us that profits are the reward for uncertainty bearing
and risk taking.
A successful business manager is one who can form more or less correct estimates of costs and revenues
likely to accrue to the firm at different levels of output. The more successful a manager is in reducing
uncertainty, the higher are the profits earned by him.
5.Capital management:
The problems relating to firm’s capital investments are perhaps the most complex and troublesome.
Capital management implies planning and control of capital expenditure because it involves a large sum and
moreover the problems in disposing the capital assets off are so complex that they require considerable time
and labour.

Managerial economics is a part of normative economics. It is pragmatic and conceptual in nature

Economics studies economic activities of mankind without reference to their ethical significance. Economic
activities may be good or bad but so long as they involve the use of limited resources to satisfy many wants,
they constitute a part and parcel of economics. This raises a further question, viz., does economics study
activities, as they ought to? It involves saying whether economics is a positive science, which studies things
as they are. For example, Physics, Chemistry and other positive sciences do not suggest how things should
work, but study things as they actually work or behave. Normative sciences study things, as they ought to.
Ethics, for example, is a normative science. It tells us how we should behave. As a matter of fact, the positive
sciences simply describe, while the normative sciences simply prescribe.
Positive Economics explains the economic phenomenon as: What is, what was and what will be. Normative
Economics prescribes what it ought to be. Whether economics is a positive science or a normative science is
a controversial question. According to economists like Professors Marshall and Pigou, the ultimate object of
the study of any science is to contribute to human welfare. According to these economists, economics should
be a normative science. It should be able to suggest policy measure to the politicians. It should be able to
prescribe guidelines for the conduct of economic activities. Economists have to be both tool makers and tool
users. It means that not only economists should build up the economic theory but also, at the same time, they
should provide policy measures.
According to Prof. Robbins, however, economics is a positive science. Science is, after all, a search for truth
and, therefore, economics should study the truth as it is and not as it ought to be. This is because when we
say that this ought to be like this, we presume that our point of view is correct. When we express opinions,
our own value enters into our consideration.
In the study of a problem at a given point of time, not only economic considerations but also many other
considerations, such as ethical, political, etc., must be considered. It is after weighing the relative importance
of these various factors that a policy decision is to be taken. There are, therefore, bound to be differences in
respect of policy prescription and it is, therefore, better to keep away from areas which are controversial and
study the facts as they are
Explain the scope of Managerial Economics. What are its uses?
1. Demand Analysis and Forecasting
2. Cost and Production Analysis
3. Pricing Decisions, Policies and Practices
4. Profit Management
5. Capital Management
Recently, managerial economists have started making increased use of Operation Research methods like
Linear programming, inventory models, Games theory, queuing up theory etc., have also come to be regarded
as part of Managerial Economics.
1.Demand Analysis and Forecasting:
A business firm is an economic organisation which is engaged in transforming productive resources into
goods that are to be sold in the market. A major part of managerial decision making depends on accurate
estimates of demand.
A forecast of future sales serves as a guide to management for preparing production schedules and
employing resources.
Demand analysis also identifies a number of other factors influencing the demand for a product. Demand
analysis and forecasting occupies a strategic place in Managerial Economics.
2.Cost and production analysis:
A firm’s profitability depends much on its cost of production. A wise manager would prepare cost estimates
of a range of output, identify the factors causing are cause variations in cost estimates and choose the cost-
minimising output level, taking also into consideration the degree of uncertainty in production and cost
calculations.
Production processes are under the charge of engineers but the business manager is supposed to carry out
the production function analysis in order to avoid wastages of materials and time. Sound pricing practices
depend much on cost control.
3.Pricing decisions, policies and practices
Pricing is a very important area of Managerial Economics. In fact, price is the genesis of the revenue of a firm
and the success of a business firm largely depends on the correctness of the price decisions taken by it.
The important aspects dealt with this area are: Price determination in various market forms, pricing
methods, differential pricing, product-line pricing and price forecasting.
4.Profit management
Business firms are generally organized for earning profit and in the long period, it is profit which provides
the chief measure of success of a firm. Economics tells us that profits are the reward for uncertainty bearing
and risk taking.
A successful business manager is one who can form more or less correct estimates of costs and revenues
likely to accrue to the firm at different levels of output. The more successful a manager is in reducing
uncertainty, the higher are the profits earned by him.
5.Capital management:
The problems relating to firm’s capital investments are perhaps the most complex and troublesome.
Capital management implies planning and control of capital expenditure because it involves a large sum and
moreover the problems in disposing the capital assets off are so complex that they require considerable time
and labour.
What are the major areas of business decision making?
Generally, the six functional areas of business management involve strategy, marketing, finance, human
resources, technology and equipment, and operations. Therefore, all business planners should concentrate
on researching and thoroughly understanding these areas as they relate to the individual business.

Similarly, what are the 4 types of decision making? Every leader prefers a different way to contemplate a
decision. The four styles of decision making are directive, analytical, conceptual and behavioral.
How does economic theory contribute to managerial decision making?
Economics through ,variously defined is essentially the study of logic, tools and techniques of making
optimum use of the available resources to achieve the given ends. Economics thus provides analytical tool
and technique that managers need to achieve the goals of the organization they manage.
Baumaol has pointed out there main contributions of economic theory to business.
First one of the most important! Unexpected End of Formula things which the economic theories can
contribute to the management science is building analytical models which help to recognize the structure of
managerial problems, eliminate the minor details which might obstruct decision making and help to
concentrate on the main issue.
Secondly, Economic theory contributes to the business analysis & set of analytical methods which may not
be applied directly to specific business problems, but they do entrance the analytical capabilities of the
business analyst.
Thirdly, Economic theories offer clarity to the various concepts used in business analysis, which enables the
the managers to avoid conceptual pitfalls.
The areas of business issues to which economics theories can be directly applied may be broadly divided
into two categories :-
1. Operational or internal issues and
2. Environmental or external issues
Operational problems are of internal nature. They include all those problems which arise within the
business organization and fall within the preview and control of the management. Some of the basic internal
issues are
1. choice of business and the nature of product i.e. what to produce;
2. choice of size of the firm i.e.. how much to produce
3. choice of technology i.e. choosing the factor contribution ;
4. choice of price i.e. how to price the common;
5. how to promote sales;
6. How to face price competition
7. How to decide on new investment;
8. How to manage profit and capital;
9. How to manage inventory i.e. stock of both finished goods and material.
The Microeconomic Theories which deals most of these questions include:-
1. Theory of demand.
2. Theory of production and production decisions.
3. Analysis of market structure and pricing theory.
4. Profit analysis and profit management.
5. Theory of capital and investment decision.
Environmental issues pertain to the general business environment in which a business operates. They are
related to the overall economic, social and political atmosphere of the country. The factors which constitute
economic environment of a country include the following factors:-
1. The type of economic system of the country
2. General trend in production, employment, income, price, savings and investment etc
3. Structure of the trends in the working of financial institutes e.g. banks, financial co-operations,
insurance companies
4. Magnitudes of trends in foreign trend
5. Trends in labor and capital markets
6. Government’s economic policies e.g.. industrial policy, monetary policy, fiscal policy, price policy etc.
7. Social factors like the value system of the society, property rights, customs and habits
8. Social organizations like trade unions, customer’s co-operatives and producers union
9. The degree of openness of the economy and the influence MNCs

Explain the various fundamental concepts in Managerial economics that aid decision making
Fundamental concepts in Managerial economics that aid decision making
1. Incremental Principle
The incremental concept measures the impact of each possible decision on cost and revenue. In other
words, it measures the changes in total cost and total revenue when prices are varied, or different products
are manufactured.
Incremental cost may be defined as the change in total cost due to a specific decision. Similarly,
incremental revenue is the change in total revenue caused by a decision. Thus when incremental revenue
exceeds the incremental cost resulting from a particular decision it is regarded as profitable.
In managerial economics, incremental reasoning in fundamentally used to estimate the impact of
alternatives involved in the process of decision making and then making the best possible choice.
Incremental Revenue
It is the ratio of change in total revenue owing to the change in the total output level. Thus :
IR = ATR/AQ
Where IR =Incremental Revenue,
TR = Total Revenue,
Q=Total Quantity of Output,
A =Change
Often, incremental revenue is also estimated in relation to total investment, thus
IR = ATR/AI
Where, I refers to total volume of investment.

Incremental Cost
Incremental Cost is defined as the ratio of change in total cost owing to change in total quantity of output.
Thus:
IC=ATC/AQ
Where IC = Incremental Cost and TC = Total Cost
In decision making, the managerial choice is based on the criterion of incremental revenue is greater than
incremental cost in the given option.
Managerial Rule of Thumb:
IR > IC

Explain Discounting Principle, Time Concept and Equi-Marginal Principle with the help of an
Illustration
The Discounting Principle
One rupee received tomorrow is worth less than a rupee received today. Amounts received at different
periods cannot be treated alike. There are two reasons for this.
Firstly, the future is uncertain and so we are not sure whether we will get the amount on a future date.
Secondly, the one rupee received today can be reinvested which will earn additional profit. One rupee to be
received at a future date cannot be invested until it is received. So it is less valuable than a rupee received
today.
So when we speak of a rupee receivable tomorrow, we speak of it now only at a discounted value. Where
there is a time lag there is a discounting problem. The mathematical technique for adjusting the time value
of money and computing present value is called discounting.
This concept is useful in taking investment decisions. Different investment opportunities are compared by
converting their costs and revenues into present values at appropriate discounting rate.
A present gain is valued more than a future gain. Thus, in investment decision making, discounting of future
value with the present one is very essential. The following formula is useful in this regard.
V=A/(1 +i)
Where, V=present value, A=annuity or returns expected during a year, i=current rate of interest.
To illustrate the formula, suppose A=110 and i=10% or 1/10, we can ascertain the present value of Rs.110
one year after as:
V=110/1+0.1=110/1.1=100
In business decision making process, thus, the discounting principle may be stated as “ if a decision affects
costs and revenue at future dates, it is necessary to discount those costs and revenues to present values
before a valid comparison of alternatives is possible.
Let us assume that a firm is involved in the production of three products viz, A,B,C. the firm has a maximum
of 600 labour hours per week. The firm can increase production of any one of these products by adding more
labour hours. But this can be done only at the cost of other products. So as per the equi marginal principle
the firm can maximize its profit when the labour hours are allocated to the production of all the three
products in such a way that the Marginal product of Labour(MPL) is equal in all the three products. That is,
MPLa = MPLb = MPLc
MPLa, MPLb, MPLc are the MPL of products A,B and C)
Marginal product of Labour is the amount of output a firm gets by employing one more unit of Labour.
 .The Time Concept
The short run and long run effects on cost and revenue must be taken into consideration when a business
decision is taken.
Short run refers to a period which is not sufficient to change all the factors of production. In the short run
the supply of some factors of production remains fixed and some are variable. Any increase in production in
this period is possible only by increasing the variable factors(raw materials and labour). As the fixed factors
cannot be increased, increase in output is attained by putting the fixed factor to more intense use.

Long run is a period sufficient to vary all the factors of production( fixed cost and variable cost) . So in the
long run all the factors of production are variable. Thus in the long run output can be increased by increasing
the scale of inputs, size of the firm etc.
The effect of policy decisions on cost and revenues in the light of these time distinctions must be considered
when business decisions are taken.
A business manager must take into consideration both the short run and long run effects on revenue and
costs so that a right balance between long run and short run perspectives can be maintained.
A pricing decisions taken only with the short run perspective may have some long term consequences that
may make it less profitable than it appeared at first sight

A firm has some idle capacity. It produces and sells a product at Rs.500 per unit. The cost of producing the
product is Rs.420 per unit (Rs.360 per unit variable cost and Rs.60 per unit fixed cost). The firm gets a new
order to supply 500 units at Rs. 380 per unit. If this order is evaluated from the short run perspective, it will
bring in an additional revenue of Rs. 10,000 (500*20). As the fixed cost is ignored here, the contribution
towards profit is Rs.20 per unit (380-360). Before accepting this order the following long-term effects of this
decision also must be considered.
1. If the firm has to execute similar orders at he same price, the fixed cost (which are ignored here) will
become variable. The new orders may necessitate an increase in production capacity by adding new
machinery and new supervisory staff.
2. If this order at a lower price is accepted, regular customers who paid higher price for the same product
will feel bad. This will be viewed by them unethical and spoil the company’s image.
3. Accepting a price that does not cover total cost may adversely affect the image of the firm
MODULE 2
Q1. What is Bandwagon Effect?
This is the most common type of exception to the law of demand wherein the consumer tries to purchase
those commodities which are bought by his friends, relatives or neighbors. Here, the person tries to imitate
the buying behavior and patterns of the group to which he belongs irrespective of the price of the commodity.
For example, if the majority of group members have smart phones then the consumer will also demand for
the smartphone even if the prices are high.
Q2. What do you mean by Giffen's Paradox?
Sir Robert Giffen observed that when price of certain commodity increases, demand also increases and vice
versa. These are special kinds of inferior goods, often referred as ‘Giffen goods’.
Inferior goods must possess the following characteristics.
1. It must be consumed mainly by the people with low income
2. Major part of the poor man’s income must be spent on that commodity
3. It must not have any substitute or near substitute

Q3. What is Demand Function?

A mathematical expression of the relationship between quantity demanded for the commodity and its
determinants is known as the demand function.
When this relationship relates to the demand by an individual consumer it is known as individual’s demand
function, while if it relates to the market it is called market demand function.
Q4. What is Elasticity of Demand?
Elasticity of a demand refers to the rate of change in demand for a commodity in response to the change in
its demand determinants.
Q5. What is Price Floor Elasticity of Demand?
Price Elasticity of demand shows the extent of change in the quantity of a commodity to change in the price
of that commodity. The price elasticity of demand is defined as the percentage change in quantity demanded
due to certain percentage change in price.
Q6. What do you mean by Income Elasticity?
Income elasticity of demand is the degree of responsiveness of quantity demanded of a commodity due to
change in consumer’s income, other things remaining constant. In other words, it measures by how much
the quantity demanded changes with respect to the change in income.The income elasticity of demand is
defined as the percentage change in quantity demanded due to certain percent change in consumer’s income.
Q7. What do you mean by demand forecasting?
Demand forecasting may be defined as “the process of making objective assessment of demand for the
product during a given future period in order to evolve an effective production plan for the period’’. Demand
Forecasting refers to the process of predicting the future demand for the firm’s product.
Q8. What do you mean by Delphi method of demand forecasting?
Under this method forecast is made on the basis of consensus among experts. Here a team of experts are
asked to give their opinion and after evaluation of the opinions each one is asked to comment on the opinion
of others supported by reasons. When the process is repeated, often a consensus among them emerges. It is
suitable for long term forecasting.
Q9. What are the different levels at which demand forecasting is undertaken?
Demand forecasting may be undertaken at the following levels:
1. Micro level: It refers to the demand forecasting by the individual business firm for estimating the
demand for its product.
2. Industry level: It refers to the demand estimate for the product of the industry as a whole. It relates
to the market demand as a whole.
3. Macro level: It refers to the aggregate demand for the industrial output by the nation as a whole. It is
based on national income or aggregate expenditure of the country. With the growth of national
income, consumption expenditure increases, as such, overall demand for goods and services in
general may tend to rise.
Q10. Define Indifference curve?
An indifference curve may be defined as the locus of various combinations of two goods which yield same
total satisfaction to the consumer. Each point on the curve represents each combination of two goods. All
these combinations yield same level of total satisfaction. Therefore, the consumer is indifferent so as to the
different combinations on the same curve.
Q11. What do you mean by marginal utility?
Marginal utility means additional utility from the consumption of an additional unit of a commodity. For
example, a consumer gets a total utility of 10 utils from one unit and 18 utils from two units, he gets 8 utils
extra from the consumption of the second unit. Then the marginal utility from the second unit of good is 18-
10=8units. If the total utility from 3 units of the good is 24 units, then the marginal utility of the third unit is
24-18=6 units.
Q12. Define Indifference map?
A set of indifference curve is referred to as the indifference map. A consumer can have any number of
indifference curves representing different levels of satisfaction. Each indifference curve shows a particular
level of satisfaction. Naturally, a consumer prefers combinations on higher indifference curve.
B PART
Q1. Describe the determinants of Demand
The demand for a product is influenced by many factors. These factors are known as ‘determinants of
demand’. They are
1. Price of the product
Price has a dominant role in shaping the demand for a product. There is an inverse relationship between
the price and the quantity demanded. i.e decrease in price extends demand and increase in price contracts
demand. A fall in price of a commodity encourages more consumption by the existing customers and also
brings new customers, while an increase in the price of a commodity may induce the existing customers to
go for substitutes.
2. Income of the consumer
Purchasing power of the consumer depends upon his income. It is the income that decides the type and
quantity of the goods to be purchased. When the income of a person rises he may go for quality goods and
buy more. On the other hand if the income falls, he may buy inferior goods. The demand for normal goods
increases with increase in income, whereas their demand decreases with decrease in income.
3. Price of related goods
Related goods are substitute goods and complimentary goods. E.g Tea and coffee, rice and wheat, fish and
meat etc. are examples of substitute goods. When the price of a commodity increases, the demand for its
substitute commodity goes up. Similarly price reduction causes decline in the demand for its substitute.
Complimentary goods are those which are jointly used. For example, coffee and sugar, bread and butter, pen
and ink, car and petrol etc. In the case of complimentary goods, increase in price of one commodity reduces
the demand for the other.
4. Advertisement Effect
Advertisement has a major role in influencing demand. Advertisement attracts new customers to the product
in addition to encouraging more consumption by the existing customers
5. Taste and preferences of the consumers
Fashion, habit and customs create taste and preference for the product. Advertisements helps to change and
shape the taste and preferences of the customer for the product

Q2. Discuss the exceptions of the Law of Demand

There are certain situations where the law of demand does not apply or becomes ineffective, i.e. with a fall
in the price the demand falls and with the rise in price the demand rises are called as the exceptions to the
law of demand.
 1. Inferior goods or Giffen goods
The law of demand does not operate in the case of certain goods. Sir Robert Giffen observed that when
price of certain commodity increases, demand also increases and vice versa. These are special kinds of
inferior goods, often referred as ‘Giffen goods’.
Inferior goods must possess the following characteristics.
1. It must be consumed mainly by the people with low income
2. Major part of the poor man’s income must be spent on that commodity
3. It must not have any substitute or near substitute.

2. Status or Prestige goods

Another exception to the law of demand is given by the economist Thorstein Veblen, who proposed the
concept of “Conspicuous Consumption.” According to Veblen, there are a certain group of people who
measure the utility of the commodity purely by its price, which means, they think that higher priced goods
and services derive more utility than the lesser priced commodities.Possession of goods like diamond, gold,
rare paintings etc. enhances social status. People buy them because of their high value. The demand for these
goods increases when the price rises. This phenomenon is known as Veblen Effect.

3. Anticipation regarding changes in price

When price rises, consumers may expect further rise and start buying more and when price falls that
postpone buying expecting further fall.
4. Ignorance
Often people are misconceived as high-priced commodities are better than the low-priced commodities and
rest their purchase decision on such a notion. They buy those commodities whose price are relatively higher
than the substitutes.
5. Emergencies
During emergencies such as war, natural calamity- flood, drought, earthquake, etc., the law of demand
becomes ineffective. In such situations, people often fear the shortage of the essentials and hence demand
more goods and services even at higher prices.
6. Change in fashion and Tastes & Preferences
The change in fashion trend and tastes and preferences of the consumers negates the effect of law of demand.
The consumer tends to buy those commodities which are very much ‘in’ in the market even at higher prices.

7. Conspicuous Necessities
There are certain commodities which have become essentials of the modern life. These are the goods which
consumer buys irrespective of an increase in the price. For example TV, refrigerator, automobiles, washing
machines, air conditioners, etc.
8. Bandwagon Effect
This is the most common type of exception to the law of demand wherein the consumer tries to purchase
those commodities which are bought by his friends, relatives or neighbors. Here, the person tries to imitate
the buying behavior and patterns of the group to which he belongs irrespective of the price of the commodity.
For example, if the majority of group members have smart phones then the consumer will also demand for
the smartphone even if the prices are high.
Q3. Explain change in demand, increase and decrease in demand with the help of a diagram
✓ Change in Demand
Demand for a commodity is determined by many factors. The change in demand may due to change in price
or due to factors other than price of the commodity.
1. Extension and Contraction of demand
The change in demand due to changes in price alone are called extension and contraction of demand. Rise in
demand due to fall in price is called extension of demand and fall in demand due to rise in price is called
contraction of demand.

✓ Increase and Decrease in Demand

Change in demand due to factors other than price is called increase and decrease in demand.it may be due to
change in income, taste and preference, fashion etc.
Rise in demand due to changes in factors other than price is called increase in demand. That is more is
demanded at same price or same quantity is demanded at a higher price.
Fall in demand due to factors other than price is called decrease in demand. That means, less is demanded at
the same price or same quantity is demanded at a lower price.
Q4. Factors Determining Price Elasticity of Demand
1. Nature of the product
The necessities of life like rice, wheat, salt,sugar etc.have inelastic demand, people usually buy the same
quantity even if their price increases. The demand for luxury items are elastic. The luxury goods are
demanded more at lower price and less at higher price.
2. Range of substitutes
The demand for products which have close substitutes is elastic. On the other hand the demand for products
like salt ,which have no close substitutes is inelastic.
3. Range of prices
The demand for very costly as well as very low priced articles is inelastic. It is because the costly articles are
generally bought by the rich and the price increases do not affect them. Demand for very low cost items like
pin and clip is inelastic for change in the price of these items is often ignored.
4.Extent of use
Products like coal, diesel and electricity have varied uses. Demand for these goods goes up when their price
is reduced. On the other hand if the price of these goods increases, they are used only for some unavoidable
purposes and the demand contracts.
5. Level of Income
People with higher income will continue to use the same quantity irrespective of price change and hence the
demand for goods consumed by the rich is inelastic. Since people with low income level are forced to reduce
consumption when the price increases the demand for goods meant for such people is usually elastic.
6. Influence of habit
Goods consumed as a matter of habit will have inelastic demand. For instance, the demand for cigarettes, and
pan remains unchanged even if their price increases.
Q5. What are the different kinds of income elasticity?
1. Positive income elasticity of demand (EY>0)
If there is direct relationship between income of the consumer and demand for the commodity, then income
elasticity will be positive.That is, if the quantity demanded for a commodity increases with the rise in income
of the consumer and vice versa, it is said to be positive income elasticity of demand.
For example: as the income of consumer increases, they consume more of superior (luxurious) goods. On the
contrary, as the income of consumer, decreases, they consume less of luxurious goods.
Positive income elasticity can be further classified into three types:
• Income Elasticity Greater than Unity E>1
• Income Elasticity Equal to Unity E=1
• Income Elasticity Less than Unity E<1

(A) Income elasticity greater than unity (EY > 1)

If the percentage change in quantity demanded for a commodity is greater than percentage change in
income of the consumer, it is said to be income greater than unity.
For example: When the consumer’s income rises by 3% and the demand rises by 7%, it is the case of income
elasticity greater than unity.
In the given figure, quantity demanded and consumer’s income is measured along X-axis and Y-axis
respectively. The small rise in income from OY to OY1has caused greater rise in the quantity demanded from
OQ to OQ1 and vice versa. Thus, the demand curve DD shows income elasticity greater than unity.

(B) Income elasticity equal to unity (EY = 1)

If the percentage change in quantity demanded for a commodity is equal to percentage change in income of
the consumer, it is said to be income elasticity equal to unity.
For example: When the consumer’s income rises by 5% and the demand rises by 5%, it is the case of income
elasticity equal to unity.
In the given figure, quantity demanded and consumer’s income is measured along X-axis and Y-axis
respectively. The small rise in income from OY to OY1 has caused equal rise in the quantity demanded from
OQ to OQ1 and vice versa. Thus, the demand curve DD shows income elasticity equal to unity.

(C) Income elasticity less than unity (EY < 1)

If the percentage change in quantity demanded for a commodity is less than percentage change in income of
the consumer, it is said to be income greater than unity. For example: When the consumer’s income rises by
5% and the demand rises by 3%, it is the case of income elasticity less than unity.
In the given figure, quantity demanded and consumer’s income is measured along X-axis and Y-axis
respectively. The greater rise in income from OY to OY1has caused small rise in the quantity demanded from
OQ to OQ1 and vice versa. Thus, the demand curve DD shows income elasticity less than unity.

2. Negative income elasticity of demand ( EY<0)

If there is inverse relationship between income of the consumer and demand for the commodity, then
income elasticity will be negative. That is, if the quantity demanded for a commodity decreases with
the rise in income of the consumer and vice versa, it is said to be negative income elasticity of demand.
For example: As the income of consumer increases, they either stop or consume less of inferior goods.

In the given figure, quantity demanded and consumer’s income is measured along X-axis and Y-axis
respectively. When the consumer’s income rises from OY to OY1 the quantity demanded of inferior
goods falls from OQ to OQ1 and vice versa. Thus, the demand curve DD shows negative income
elasticity of demand.

3. Zero income elasticity of demand ( EY=0)

If the quantity demanded for a commodity remains constant with any rise or fall in income of the consumer
and, it is said to be zero income elasticity of demand.
For example: In case of basic necessary goods such as salt, kerosene, electricity, etc. there is zero income
elasticity of demand.

In the given figure, quantity demanded and consumer’s income is measured along X-axis and Y-axis
respectively. The consumer’s income may fall to OY1 or rise to OY2 from OY, the quantity demanded remains
the same at OQ. Thus, the demand curve DD, which is vertical straight line parallel to Y-axis shows zero
income elasticity of demand

Q6. Explain the different methods of measuring elasticity of demand

Q7. Explain the Process of Demand Forecasting
1. Identification of objective
It is necessary to be clear about what does one want to get from the forecast. The purpose of the exercise
may be the estimation of one or more than one aspect, like quantity and composition of demand, price to be
quoted, sales planning, inventory control etc.
2. Determining the nature of goods under consideration
Different category of goods have their own distinctive demand patterns. It is therefore, necessary to
determine the class in which the good falls. These being broadly, the capital goods, consumer durables and
non durables. This will help us in identifying the approach of the forecasting exercise and in determining the
variables to be considered for forecasting.
3. selecting a proper method of forecasting
The selection of an appropriate method of forecasting is related to the objective of forecasting, type of data
available, period for which the forecast is to be made, etc. Ex. If the data shows cyclical fluctuations, the use
of linear trend will not be suitable. Similarly, general trend may be more useful for long term forecasting,
while seasonal patterns will be more important for the short term forecasts
4. Interpretation of results
Mere preparation of forecasts does not lead the management anywhere. Interpretation of results is of equal
importance. Efficiency of a forecast depends, to a large extent, upon the efficiency in the interpretation of its
results. Further, we need to frequently revise the forecasts in the light of changing circumstances because
forecasts are, in the first instance, made on the assumption.
Q8. Discuss the importance of demand forecasting
1. Production planning
Demand forecasting is a prerequisite for the production planning of a business firm. Expansion of output of
the firm should be based on the estimates of likely demand.
2. Sales forecast
Sales forecasting is based on demand forecasting. Promotional efforts of the firm should be based on sales
forecasting
3. Inventory control
A satisfactory control of business inventories such as raw materials, intermediate goods, semi-finished
product, finished product, spare parts etc. requires satisfactory estimates of the future requirements which
can be traced through demand forecasting.
4. Growth and long – term investment programme
Demand forecasting is necessary for determining the growth rate of the firm and its long term investment
programmes and planning.
5. Stability
Stability in production and employment over a period of time can be made effective by the management in
the light of the suitable forecasting about market demand.
6. Economic planning and policy making
Demand forecasting at macro level for the nation as a whole is of great help to the planners and policy makers
for a better planning and rational allocation of the country’s productional resources. The Government can
determine its import and export policies in view of the long term demand forecasting for various goods in
the country
Q9. What are the prerequisites of a good forecast? Discuss them in detail
Q10. Compare and contrast Cardinal utility approach and Ordinal utility approach
✓ Cardinal utility approach
According to Marshall, utility can be measured and quantified. This approach is based upon certain
assumptions like:
Utility can be measured: This approach assumes that utility can be measured in terms of units called as utils,
which are measurable and quantifiable. Eg. In util terms, the consumer can compare the utility of two
products say mineral water and soft drinks.
Independent variables- this approach also assumes that the utility derived from a particular product is
independent by itself.
Law of diminishing marginal utility and law of equimarginal utility are derived from the cardinal utility
theory.
✓ Ordinal Utility Approach
The proponents of the ordinal approach opine that utility cannot be measured, but can only be ranked in
order of preferences. Thus it explains that the consumer is able to compare different levels of satisfaction.
Hence, if a customer prefers commodity X to commodity Y, he will not be in a position to compare the
quantitative differences between the two satisfaction levels, but he can do qualitative comparison. This
theory is based on two assumptions:
• Customer is consistent in ranking
• The preference of the customer is based on the choice of products available.

Q11. Write a note on properties of indifference curve. Illustrate your answer with proper diagrams.
Explain the uses and applications of Indifference Curve.
1) Indifference Curves are Negatively Sloped
The indifference curves must slope downward from left to right. As the consumer increases the consumption
of X commodity, he has to give up certain units of Y commodity in order to maintain the same level of
satisfaction.
Indifference Curves are Negatively Sloped

2) Higher Indifference Curve Represents Higher Level of Satisfaction

Indifference curve that lies above and to the right of another indifference curve represents a higher level of
satisfaction. The combination of goods which lies on a higher indifference curve will be preferred by a
consumer to the combination which lies on a lower indifference curve.
In this diagram, there are three indifference curves, IC1, IC2 and IC3 which represents different levels of
satisfaction. The indifference curve IC3 shows greater amount of satisfaction and it contains more of both
goods than IC2 and IC1. IC3 > IC2> IC1.
 3) Indifference Curves are Convex to the Origin
This is an important property of indifference curves. They are convex to the origin. As the consumer
substitutes commodity X for commodity Y, the marginal rate of substitution diminishes as X for Y along an
indifference curve.
The Slope of the curve is referred as the Marginal Rate of Substitution. The Marginal Rate of Substitution is
the rate at which the consumer must sacrifice units of one commodity to obtain one more unit of another
commodity

4) Indifference Curves cannot Intersect Each Other

The indifference curves cannot intersect each other. It is because at the point of tangency, the higher curve
will give as much as of the two commodities as is given by the lower indifference curve.
 5) Indifference Curves do not Touch the Horizontal or Vertical Axis
One of the basic assumptions of indifference curves is that the consumer purchases combinations of different
commodities. He is not supposed to purchase only one commodity. In that case indifference curve will touch
one axis. This violates the basic assumption of indifference curves.

6) Indifference curves are not necessarily parallel to each other

Though they are falling, negatively inclined to the right, yet the rate of fall will not be same for all indifference
curves. In other words, the diminishing marginal rate of substitution between the two goods is essentially
not the same in the case of all indifference schedules. The two curves I1and I2shown in figure 11 are not
parallel to each other.

PART C
Q1. Why does demand curve slope downward?
Demand curve slopes downward from left to right indicating that more will be demanded at lower price and
less at higher price.
Following are the main causes which are responsible for downward sloping of demand curve.
1. Income Effect
A change in price of a commodity affects consumers real income. When price falls, real income of the
consumer increases. This will induce him to buy more of the commodity. This is called income effect
2. Substitution Effect
When the price of a commodity falls, it becomes cheaper in comparison to other commodities. Then the
consumer starts to substitute the costly commodities with cheaper commodities. This is called substitution
effect.
3. Price Effect
Remaining the price of other goods constant, when the price of a particular commodity falls, some new
customers are attracted towards the commodity and some old customers start to purchase more of the
commodity. When the price increases, new customers withdraw and old customers start consuming lesser
commodity.
4. Different uses of the commodity
Most of the commodities can be put to several uses. Due to which the demand curve slopes downward from
left to right. When price of a such commodity is high, its uses will be restricted to that purpose which is
considered to be most important by the consumer. But if the price falls the commodity can be put to less
important uses. Hence, quantity demanded increase with fall in price and vice-versa
5. Change in number of consumers
When the price of a commodity falls, its consumption spreads to more and more consumers. There fore, the
number of its consumers and also its demand increases. Similarly when price increases the commodity gets
out of the reach of some consumers. Hence its demand falls.
6. Effect of law of diminishing marginal utility
We know that the satisfaction derived from the consumption of successive units goes on falling. That is, when
a consumer buys more and more units of a commodity, the marginal utility is progressively declines.
Therefore, a consumer will buy additional units of a the commodity, only when its price falls.
Q2. Describe the types of Demand
Demand is generally classified on the basis of various factors, such as nature of a product, usage of a product,
number of consumers of a product, and suppliers of a product.
The demand for a particular product would be different in different situations.
1. Individual and Market Demand
Refers to the classification of demand of a product based on the number of consumers in the market.
Individual demand can be defined as a quantity demanded by an individual for a product at a particular price
and within the specific period of time.
In simple terms, market demand is the aggregate of individual demands of all the consumers of a product
over a period of time at a specific price, while other factors are constant.

2. Organization and Industry Demand

Refers to the classification of demand on the basis of market. The demand for the products of an organization
at given price over a point of time is known as organization demand. For example, the demand for Toyota
cars is organization demand. The sum total of demand for products of all organizations in a particular
industry is known as industry demand.
For example, the demand for cars of various brands, such as Toyota, Maruti Suzuki, Tata, and Hyundai, in
India constitutes the industry’ demand.
3. Autonomous and Derived Demand
Refers to the classification of demand on the basis of dependency on other products. The demand for a
product that is not associated with the demand of other products is known as autonomous or direct demand.
For example, the demand for food, shelter, clothes, and vehicles is autonomous as it arises due to biological,
physical, and other personal needs of consumers. On the other hand, derived demand refers to the demand
for a product that arises due to the demand for other products.
For example, the demand for petrol, diesel, and other lubricants depends on the demand of vehicles. Apart
from this, the demand for raw materials is also derived demand as it is dependent on the production of other
products. Moreover, the demand for substitutes and complementary goods is also derived demand.
4. Demand for Perishable and Durable Goods
Refers to the classification of demand on the basis of usage of goods. The goods are divided into two
categories, perishable goods and durable goods. Perishable or non-durable goods refer to the goods that
have a single use. For example, cement, coal, fuel, and eatables. On the other hand, durable goods refer to
goods that can be used repeatedly.
For example, clothes, shoes, machines, and buildings. Perishable goods satisfy the present demand of
individuals. However, durable goods satisfy both present as well as future demand of individuals. Therefore,
consumers purchase durable items by considering its durability.
5. Short –run demand and long –run demand
Short run refers to a period in which only minor changes are possible with regard to quantity, price, income
etc. Therefore, short run demand relates to the existing demand with its immediate reaction to changes in
price, income etc.
Long run refers to a sufficiently long period when major changes takes place in the quantity of the product,
methods of production, availability of substitutes etc.
Q3. Uses of Elasticity of Demand for Managerial Decision Making
1. Determination of Price
The primary objective of any firm is to earn profit or increase revenue. Therefore, increasing price of its
products to maximize profit is one of the primary concerns of producers.
However, during the course of increasing price, the producers must not forget that demand and price share
inverse relationship. They must be aware that demand falls with rise in price. And thus, they must increase
price of their commodity to that level where their desired or optimal profit is still achievable
For example: In the table given below are shown three cases (I, II & III) of a restaurant that sells burger.

In the above table, we can see that when price of the burger was $10 per unit, its demand in the market were
100 units per day, causing the firm profit of $300.
When the firm increased the price to $10.2, its demand fell by 10 units per day.
As a result, the firm gained profit of $288, causing reduction of $12 in initial profit. In the same way, when
the price is increased to $11 per unit, there is once again decrease in demand. The new demand in market is
85 units per day and the new profit is $340.
From the example, it is clear that producers must always analyze elasticity of their product and must
evaluate the impact of changes in price on the total revenue and profit of their firm.
2. Wage Determination
The concept of elasticity of demand is important in the determination of wages of a particular type of labor.
If a commodity is of inelastic nature, the labor can force the employer to increase their wage through extreme
ways like strike. As a result, the company will have to consider the demands of labor in order to meet the
demand of consumers for the inelastic goods.
However, if the commodity is of elastic nature, labor unions and other associations cannot force the
employers to raise wage as the producers can alter the demand of their products
3. Importance in International Trade
We have already known that change in price cannot bring drastic change in demand of the product in case
of inelastic commodity. But even a slight change in price can cause huge effect on demand of elastic
commodity.
We have also known that higher price can be charged for inelastic goods and lowest possible price must be
set for elastic goods.
Taking into account the above information, a country may fix higher prices for goods of inelastic nature.
However, if the country wants to export its products, the nature (elasticity/inelasticity) of the commodity
in the importing country should also be considered.
4. Importance to Finance Minister
Price elasticity of demand can also be used in the taxation policy in order to gain high tax revenue from the
citizens. One of the ways would be for the government to raise tax revenue in commodities which are price
inelastic.
For example: Government could increase the tax amount in goods like cigarettes and alcohol. Given how
these are the commodities people choose to purchase regardless of the price tag, the tax revenue would
significantly rise.
On the other hand, in case of a commodity with elastic demand high tax rates may fail to bring in the required
revenue for the government.
5. Price Discrimination
The situation where a single group or company controls all or almost all of market for a particular good or
service is called monopoly. The monopolistic market lacks competition. Thus, the goods or services are often
charged high prices in such market.
If the product is inelastic (less or no effect on demand with change in price), the producer can earn profit by
setting high price. However, if the product is elastic (highly affected by even slightest change in price), the
producer must set low or at least reasonable price so that the consumers are attracted to buy the goods.
For example: Fuel is necessity of consumers. Therefore, monopolist who runs the market of fuel can
generate profit even by setting high price of fuel
6. Price Determination of Joint Products
Joint products are various products generated by a single production procedure at a single time. Sheep and
wool, cotton and cotton seeds, wheat and hay, etc. are some examples of joint products.
However, since they are two different products, we cannot sell them at the same price in the market. Price
elasticity of demand plays important role in determining the prices of these joint products.
Let us suppose, there has been bumper production of cotton this season. As a result, huge amount of cotton
as well as cotton seeds have been produced.
Cotton has wide scope in the market as it can be used for different purposes. The producers of cotton can
gain maximum profit by setting high price of cotton, as demand of cotton in market is not easily altered. But
cotton seeds have limited scope, so it is an elastic product. If the business does not decrease the price, then
demand will be less.
By setting a high price for cotton (inelastic product) and low price for cotton seeds (elastic product), the
business can maximize its revenue.
7. Helps in Granting Protection:
The government considers the elasticity of demand of the products of those industries which apply for the
grant of a subsidy or protection.

8. In fixing minimum prices for farm products

Government policies of guaranteeing minimum prices for farm products, price support programmes etc are
done by identifying the nature and degree of demand.
Q4. Discuss briefly the different degrees of price elasticity?
The rate of change in demand to the change in price is not uniform for all products. The effect of change in
price on demand is more in some products and less in others. i.e, the degree of price elasticity is different
for different products. The following are the main types of price elasticity of demand:
1. Perfectly elastic demand
2. Perfectly inelastic demand
3. Unit Elasticity
4. Relatively elastic demand
5. Relatively inelastic demand

1. Perfectly elastic demand (ep=∞)

When the demand for a product changes infinitely due to small change in price, the demand is termed as
perfectly elastic. Here the seller is unable to satisfy the demand at the reduced price. At the same time a
marginal increase in price reduces the demand to zero. The demand curve in this case will be a straight line
horizontal to OX axis as in the following diagram.
 2. Perfectly inelastic demand (ep=0)
When the quantity demanded of a product remains unaffected by the change in price, the demand is perfectly
inelastic. In the case of perfectly inelastic demand, the demand curve will be a vertical straight line parallel
to the oy axis.
The figure shows that the quantity demanded remains OQ units in spite of price variations from OP to OP1
or OP2

3. Unit elasticity (ep=1)

The demand is unitary elastic when the proportionate change in the price of a product results in the same
change in the quantity demanded. The percentage change in quantity is just equal to the percentage change
in price. The elasticity is equal to one .
At OP price the quantity demanded is OQ and the total outlay is OPRQ, when the price is reduced to OP1 the
quantity demanded increases to OQ1 and the total outlay is OP1R1Q1. since the areas in these two rectangles
are same, the demand curve is known in mathematics as a rectangular hyperbola.
 4. Relatively elastic demand (ep>1)
If the elasticity of demand for a product is more than one, the product is said to have relatively elastic
demand. In this case the change in demand is more than proportionate to the change in price.
When the price is OP, demand is OQ units and the total outlay is OPRQ. When the price is reduced to OP1
the demand increases to OQ1 and the total outlay becomes OP1R1Q1. Since the area of the rectangle
OP1R1Q1 is more than that of OPRQ, the elasticity is more than one and hence the product is relatively elastic.

5. Relatively Inelastic demand (ep<1)

The demand is relatively inelastic when the quantity demanded changes less than proportionate to the
change in price. In this case the elasticity of demand is less than one and the total outlay becomes less than
the outlay at the original price.
At price OP the quantity demanded is OQ units, the total outlay is OPRQ, When the price is reduced from OP
to OP1 the quantity demanded increased to OQ1. The new outlay is OP1R1Q1. The total area of the rectangle
OPRQ is more than the area in the rectangle OP1R1Q1. thus the demand for the product is relatively inelastic
Q5. Discuss the methods of Demand Forecasting

Methods of demand forecasting refer to devices of estimating demand. The different forecasting techniques
are
1. Survey Method
2. Market studies and experiment method
3. Statistical method

1. Survey Method
Survey Methods denote the collection of data relating to future demand either form the customers directly
or from sales experts. These methods are very extensively employed for short term forecasting and for
forecasting demand for consumer products.
According to the source of information, survey methods are classified into a) Direct interview method b)
Opinion Survey Method and c) Delphi Method
A) Direct Interview Method
This method implies collection of information relating to future demand for the product directly from the
prospective customers. Here the information may be collected either from all the potential customers or
from a selected group.
The method of collecting details of demand from all the potential customers is known as census or complete
enumeration method of demand forecasting.
On the other hand, if the forecast is made on the basis of details collected from a selected group of potential
customers, is known as sample survey method.
Complete enumeration method is suitable for those products that are purchased by a limited number of
customers in bulk quantities.
Sample survey method is advised for forecasting the demand for the products whose customers are very
large in number and scattered over a large area
Limitations of Direct Interview Method
1. The buyers are likely to exaggerate their requirements if they anticipate shortage.
2. Consumers may not stick to a particular brand. Hence, their buying intentions may not be steady.
B) Opinion Survey Method
In this method, the demand forecasting is made by analyzing the opinion of dealers, salesmen and other sales
experts. Since these people are very close to the customers, they can give reliable information relating to the
future demand for the product in their respective areas.
The salesmen can realize the reactions of the consumers to the changing market situations and also towards
new product and the demand for competing products. Their estimates are put together to find out the total
demand of the firms product.

Advantages of Opinion Survey Method

1. It involves minimum statistical work
2. It is economical when compared to direct interview method
3. It is reliable as the estimate is based on the opinion of salesmen
Limitations
1. It is informed by the personal prejudices of the salesmen
2. It is often based on simple guess work or vague modification of certain data
3. It is useful mainly for short term forecasting

C) Delphi Method
Under this method forecast is made on the basis of consensus among experts. Here a team of experts are
asked to give their opinion and after evaluation of the opinions each one is asked to comment on the opinion
of others supported by reasons. When the process is repeated, often a consensus among them emerges. It is
suitable for long term forecasting.

Features of Delphi Method

1. A panel of experts is selected to find a solution to the problem
2. The identity of each experts is not revealed to the other. This help to reduce the bias or ego of each
expert when they react to others opinion
3. There must be a coordinator to prepare the questionnaire and circulate it and collect the opinions.

2. Market Studies and Experiment Method

This method tried to find out the reactions of the customers under different market conditions and helps to
estimate elasticity coefficients of some important demand determinants like price, advertisement etc. The
elasticity coefficient are determined by altering the relevant demand determinants in different markets
having similar characteristics.
The markets in which experiments are conducted may be actual or simulated. The simulated market is an
artificial market consisting of some selected customers.
Here the customers are provided with necessary cash and asked to spend it on competing products. Often
the price of the product and packing and other promotional techniques are changed to study the change in
the demand for the products.

Benefits of Market Studies and Experiment Method

1. It helps to know the buyers response to change in the price and promotional techniques.
 2. Unproductive heavy advertisements canbe avoided by studying the customers reactions towards the
products in the selected markets.
Limitations Market Studies and Experiment Method
1. It is very expensive and time consuming
2. Since the experiment is conducted over a short period, the result obtained may not be reliable. It only
reflects buyers initial emotional reaction.
3. Simulated markets suffer from the fact that the participants often behave differently when they buy
things with their own money.
Q6. What is demand forecasting? What are the benefits of demand forecasting of a new product?
Demand forecasting may be defined as “the process of making objective assessment of demand for the
product during a given future period in order to evolve an effective production plan for the period’’.
Demand Forecasting refers to the process of predicting the future demand for the firm’s product

Q7. Describe briefly the law of diminishing marginal utility

Gossen, a German economist, is the first to explain the law of diminishing marginal utility based on general
observations of human behavior. Because of this reason, the law is further termed as ‘Gossen’s first law’.
The law has later developed by the classical economist, Prof.Alfred Marshal. The law states that if a consumer
goes on consuming more units of a particular product at a given point of time, his total utility increases but
only at a diminishing rate. The law says that more a consumer consumes a product, the less is the utility he
derives from the consumption of the same product.
According to Alfred Marshall, the law of diminishing marginal utility is, “ The additional benefit which a
person derives from a given increase of his stock diminishes with every increase in the stock that he already
has.

The table shows that when the consumer consumes one unit of the commodity (Apple), his marginal utility
is 20 units, for the second unit it is 18, for the third unit it is 15 and so on. When consumer increases his
consumption to 6 units his marginal utility becomes zero and when he consumes the seventh unit, his
marginal utility is -8.
The negative sign of the marginal utility indicates that, it do not derive any satisfaction, but dissatisfaction,
which may occur in situations like over eating.
Assumptions
1. All units of the commodity should be of normal and homogeneous in size and quality
2. There should not be any time lag in the consumption of successive units of the commodity
3. The habits, tastes, income and fashion of the consumer should remain the same
4. There should not be any change in price of the commodity and related goods.
Q8. Prepare an indifference curve by using an indifference schedule.
An indifference curve may be defined as the locus of various combinations of two goods which yield same
total satisfaction to the consumer.
Each point on the curve represents each combination of two goods. All these combinations yield same level
of total satisfaction. Therefore, the consumer is indifferent so as to the different combinations on the same
curve.

Indifference Schedule

Indifference curve can be better understood with the help of indifferent schedules. An indifferent schedule
is a table showing the different combinations of two goods giving the same level of satisfaction. In the table
Schedule 1 represents five combinations, a, b,c,d,e. all these combinations are equally preferable as they give
the same level of satisfaction to the consumer. In other words he will be indifferent between these
combinations.
Combinations a consists of 1 unit of commodity X and 12 units of commodity Y. Where as combination b
consists of 2 units of commodity X and 8 units of commodity Y. For one unit of X, the consumer give away 4
units of Y. the loss in utility of Y is matched by the gain in utility of X. so the total utility from both
combinations a and b remains unchanged.
Now consider schedule II. It also has five combinations marked as a,b,c,d,e. all the combinations give these
same levels of satisfaction to the consumer.
All the combinations in schedule II have more amount of either X or Y or both X and Y compared to schedule
I. Therefore, all the combination in schedule II will be preferred to all the combinations in schedule I

In the diagram the schedule I is represented by the indifference curve ICI. If we represent the schedule II on
the same graph the curve would have been on the right of ICI. A higher level of satisfaction can be shown
only on higher indifference curve. The points a,b,c,d,e are the different combinations of X and Y which give
the same level of satisfaction between which the consumer is in indifferent.
MODULE 3

What is production function?

State the Laws of Production

Law of production deal with the production function in the short run and long run. The law of production in the
short run is known as Law of Diminishing Returns or Law of Variable Proportions. The Law of production in the
long run is known as Law of Returns to Scale.
Distinguish between fixed input and variable input

What are isoquants?

• Iso-product or Iso-quant curve is that curve which shows the different combinations of two factors
yielding the same total product.
• “’An Iso-quant curve may be defined as a curve showing the possible combinations of two variable
factors that can be used to produce the same total product.”
What is Iso product map?
An Iso-product map shows a set of iso-product curves. The graph showing a set of iso product curves for
different levels of output is called an iso product map. A higher iso-product curve represents a higher level
of output.
Differentiate Isoquant curve and Isocost curve
• Iso-product or Iso-quant curve is that curve which shows the different combinations of two factors
yielding the same total product.
• “’An Iso-quant curve may be defined as a curve showing the possible combinations of two variable
factors that can be used to produce the same total product.”
• Like, indifference curves, Iso- quant curves also slope downward from left to right. The slope of an
Iso-quant curve expresses the marginal rate of technical substitution (MRTS).

What do you mean by economies of scale?

Economies of scale are cost advantages reaped by companies when production becomes efficient. Companies
can achieve economies of scale by increasing production and lowering costs. This happens because costs are
spread over a larger number of goods. Costs can be both fixed and variable.
What do you mean by diseconomies of scale?
Diseconomies of Scale is an economic term that defines the trend for average costs to increase alongside
output. At a specific point in production, the process starts to become less efficient. In other words, it starts
to cost more to produce an additional unit of output.
Differentiate economies of scale and diseconomies of scale
Economies of scale and diseconomies of scale are related concepts and are the exact opposites of one another.
Economies of scale arise when the cost per unit reduces as more units are produced, and diseconomies of
scale arise, when the cost per unit increases as more units are produced. A firm constantly aims to obtain
economies of scale, and must find the production level at which economies of scale turns to diseconomies of
scale.
What is Explicit Cost and Implicit Cost
Explicit costs are the same as actual costs. They refer to all monetary expenses incurred by a firm for
production of a commodity.
Implicit costs or imputed costs refer to non-monetary expenses incurred by the firm for the purpose of
production.
Define Sunk cost
It is the cost incurred in the past and has no effect on future decision making. For example, when replacement
of an asset is under consideration, the undepreciated value of the existing asset is the sunk cost.

What is Fixed cost and variable cost

Fixed costs are those costs which do not change with changes in the volume or level of activity within the
limits of a plant capacity. Fixed cost depends upon the passage of time and does not vary directly with the
volume of output.
Variable cost is one which tends to vary directly with variation in the volume of output. It varies in direct
proportion to the volume of production.
Part b
Describe in detail the factors of production

What are the characteristics of a production function

➢ Production function specifies the maximum quantity of output that can be obtained from a given
quantity of inputs.
➢ It explains how inputs get turned into output
➢ It permits the evaluation of the efficiency of the technology
➢ It describes the intensity with which any particular technology employs inputs
➢ It projects the economies of scale i.e. the benefits of large scale operation
➢ It describes how one input is substituted by another.
Managerial use of Production Function
 • A systematic understanding of production function helps the manager very much in business decision
making and efficient management of production in the firm.
• It helps to find out the least cost combination to produce a certain quantity of output.
• It also helps him to decide whether he can increase the production by increasing all the inputs.
It helps him to substitute costly input with less costly one.

Explain Production function with one variable input.

The table shows that up to the 3rd worker the total

product increases at an increasing rate and beyond that the output increases at a diminishing rate up to the
9th worker. At this level the output is the maximum and the marginal product is zero. When the 10 th worker
is introduced the total output decreases and the marginal product becomes negative.
The average product, which is the total product divided by the number of input factors also increases initially
and becomes maximum when the marginal product is equal to the average product. From the 5th worker
it decreases gradually.

Describe Isocost curve with the help of a diagram.

Isocost curves describes the cost function by showing different combinations of inputs which a firm can buy,
given a certain amount of money.
Suppose a firm has Rs.1,000 to spend for capital and labour inputs and each unit of capital costs Rs.50 and
labour Rs.20. It can spend the amount either for 20 units of capital or for 50 units of labour or partly on
capital and partly on labour. The isocost curve shows all possible ways of spending the amount among two
different inputs. The following diagram depicts isocost curve for Rs.1000.

The figure shows that the firm may spend Rs. 1,000 for 10 units of capital and 25 units of labour or 14 units
of capital and 15 units of labour or 6 units of capital and 35 units of labour and so on. Hence an isocost curve
is the one which gives different combinations of two inputs where the cost of each combinations is the same.

What are the properties of isoquants?

• 1. Iso-Product Curves Slope Downward from Left to Right:
• They slope downward because MTRS of labour for capital diminishes. When we increase labour, we
have to decrease capital to produce a given level of output.
 • The Fig. 3 shows that when the amount of labour is increased from OL to OL 1, the amount of capital
has to be decreased from OK to OK1, The iso-product curve (IQ) is falling as shown in the figure.

2. Isoquants are Convex to the Origin

• Like indifference curves, isoquants are convex to the origin. In order to understand this fact, we have
to understand the concept of diminishing marginal rate of technical substitution (MRTS), because
convexity of an isoquant implies that the MRTS diminishes along the isoquant.
• This fact can be explained in Fig. 5. As we move from point A to B, from B to C and from C to D along
an isoquant, the marginal rate of technical substitution (MRTS) of capital for labour diminishes.
Everytime labour units are increasing by an equal amount (AL) but the corresponding decrease in the
units of capital (AK) decreases.
• Thus it may be observed that due to falling MRTS, the isoquant is always convex to the origin.

3.Isoquants are Convex to the Origin

• Like indifference curves, isoquants are convex to the origin. In order to understand this fact, we have
to understand the concept of diminishing marginal rate of technical substitution (MRTS), because
convexity of an isoquant implies that the MRTS diminishes along the isoquant.
• This fact can be explained in Fig. 5. As we move from point A to B, from B to C and from C to D along
an isoquant, the marginal rate of technical substitution (MRTS) of capital for labour diminishes.
Everytime labour units are increasing by an equal amount (AL) but the corresponding decrease in the
units of capital (AK) decreases.
• Thus it may be observed that due to falling MRTS, the isoquant is always convex to the origin.

Higher Iso-Product Curves Represent Higher Level of Output:

A higher iso-product curve represents a higher level of output as shown in the figure 7 given below:
In the Fig. 7, units of labour have been taken on OX axis while on OY, units of capital. IQ1 represents an output
level of 100 units whereas IQ2 represents 200 units of output.
Isoquants Need Not be Parallel to Each Other
 • Isoquants Need Not be Parallel to Each Other:
• It so happens because the rate of substitution in different isoquant schedules need not be necessarily
equal. Usually they are found different and, therefore, isoquants may not be parallel as shown in Fig.
8. We may note that the isoquants Iq1 and Iq2 are parallel but the isoquants Iq3 and Iq4 are not parallel
to each other.
No Isoquant can Touch Either Axis:

• If an isoquant touches X-axis, it would mean that the product is being produced with the help of labour
alone without using capital at all. These logical absurdities for OL units of labour alone are unable to
produce anything. Similarly, OC units of capital alone cannot produce anything without the use of
labour. Therefore as seen in figure 9, IQ and IQ1 cannot be isoquants

What do you mean by optimum combination of inputs? How it is determined?

A certain quantity of output can be produced with different input combinations. The cost of each combination
varies and only one of the combinations gives the minimum. The combination which is most economical or
which bears the least cost is the ‘optimum input combination’.
The optimum combination is found out with the help of isoquant and isocost curves. The optimum input
combination to produce a given output level is given by the point of tangency of the isoquant to isocost line.
This is shown in the following figure.

In the figure, IQ represents isoquant curve. Isocost lines AB,CD and EF represent three levels of cost-highest,
lower and the lowest cost on various combinations of inputs. There are two feasible combination of inputs
OK1 and OL1 and OK2 and OL2, with the cost represented by AB. There is one feasible combination of inputs
OK and OL with the cost represented by CD. Input combinations represented by AB (i.e. R and S) are not
optimal for producing a given output.
It is obvious that, of the three feasible combinations, the one of the isocost line CD(i.e. Z) is the least cost
input combination.
Thus we conclude that the least cost input combination lies at the point of tangency between the isoquant
curve and isocost curve.
What are the sources of internal and external economies?
Sources of Internal Economies
• Marginal Economies
• Financial Economies
• By-Products
• Better Utilization of Inputs
• Economies of Inventory
• Marketing Economies
• Advertising
• Risk Economies
Sources of External Economies of Scale
Marginal Economies
They arise because of the scope of employing well skilled, qualified, trained, and better employees. They help
the organization to have a greater financial advantage.
They help the firm by taking quicker and better decisions. Also, they use new techniques and methods to
improve management and to reduce the cost of operations.
Financial Economies
Financial economies make it cheaper to raise money. The lenders of the money decide the rate of interest.
They give importance to the bigger firms. One believes that bigger firms are more creditworthy.
By-Products
A firm does not only produce the needed products or services. By-products are generated in the process.
The smaller firms are not able to use these products for additional profit. A firm can sometimes sell these
products or wastes to other firms to have an upper hand in earning.
Better Utilization of Inputs
Having a lot of workers and machines don’t help the firm to achieve the goal. One needs the proper
knowledge to handle the machine and the techniques of their operation.
A machine can go out of order. They need maintenance and servicing. A small firm has to bear some damage
when the machines go out of order. On the other hand, a bigger firm can adjust and can skip the intake of
loss.
Economies of Inventory
Inventories are generally the stocks of finished goods. A bigger firm can adjust the stock of products.
Marketing Economies
These are the economies of buying and selling. A bigger firm has the advantage of buying and selling in bulk.
Business in bulk reduces the cost of buying cost. The marketing departments of a firm use the professional
approach for the marketing job.
Advertising
The success of a firm also depends on its promotion. A company can make a financial advantage by effective
use of Ads or promotion.
A smaller firm cannot afford to advertise. An advertisement all-round the year is the key to success.
Risk Economies
A big firm has better command over its resources. The risk faced by it is averaged out. The firm can
compensate for the loss through the profit of another service. This is not an option for smaller firms.

Sources of External Economies of Scale

1. Economies of concentration
When firms within the same industry cluster together, they can take advantage of the existing infrastructure
and supply networks. Moreover, skilled workers tend to shift close to such clusters for work, thereby giving
firms easy availability to labor.

2. Economies of information
When several firms are located close to each other, they can access perfect information on the prices of
inputs. Since all firms purchase inputs from the same suppliers, the latter cannot charge different prices from
different firms. The elimination of discriminatory pricing ensures that no firm pays a higher amount for
inputs, and it reduces the overall average cost.

3. Economies of innovation
Many firms prefer to set up their premises close to centers engaged in research and development of efficient
production methods. Firms can then quickly adapt to all innovations developed by these centers in order to
achieve greater efficiency in production and, therefore, lower their costs.

4. Tax breaks
When the government of a country offers tax concessions on the production of a certain product or subsidies
on the purchase of certain raw materials, it reduces the cost of production of all firms in that particular
industry. It is another source of external economies of scale.
Consider a new firm, X, which faces the option of setting up premises in isolation or in a cluster. Its cost of
production includes the following components: raw materials, labor, machinery, and transportation.

What are the economies and diseconomies of scale?

Economies of scale may be defined as the cost advantages that can be achieved by an organisation by the
expansion of their production in the long run. Therefore, the advantages of large scale expansion are known
as Economies of Scale. The lower average cost per unit achieves the advantage in cost.
Diseconomies of scale happen when a company or business grows so large that the costs per unit increase.
It takes place when economies of scale no longer function for a firm. With this principle, rather than
experiencing continued decreasing costs and increasing output, a firm sees an increase in costs when output
is increased.
Discuss the types of economies of scale

Determination of cost function (costbehaviour)

The following factors influence cost function
1. size of the plant –the size of the plant has a bearing on cost. There is an inverse relationship between
size and cost. As the size increases, unit cost decreases and vice versa.
2. Level of output – it is obvious that total cost increases with increase in output. But the average cost
and marginal cost behave in a different manner. They first show decreasing trend and then increase
with increase in output.
3. Price of input – change in the price of inputs affects cost. If the prices of inputs increase the cost will
increase and if the price decrease cost will decrease.
 4. State of technology – the state of technology influences cost. Modern and more efficient technology
would reduce cost where as old technology would increase cost.
5. Managerial efficiency – managerial efficiency has its influence on cost, but it is difficult to quantify the
impact of efficiency on cost.

Actual Cost, Business Cost and Full Cost

Actual cost is also known as absolute cost, out of pocket cost, money cost etc. Actual cost are those costs
which involve financial expenditure at some point of time or other and which are recorded in the books of
accounts. Expenses on raw materials, labour, fuel, lighting, rent, taxes, insurance, advertisement etc. are
examples of expenses of this category.
Business cost or accounting cost includes all cash payments made for the use of inputs for production and
depreciation on plant, equipment's and other fixed assets. That mean business cost is composed of actual
cost plus depreciation.
Full cost or economic cost is the total of business cost, implicit cost, and normal profit. Implicit cost includes
the opportunity cost of self owned resources used in the business, for example, salary foregone by the
proprietor working in the firm, interest on capital employed, rent on land and building etc.
Normal profit is the minimum expected profit to keep the entrepreneur engaged in the same business.
Explicit Cost and Implicit Cost
Explicit costs are the same as actual costs. They refer to all monetary expenses incurred by a firm for
production of a commodity.
Implicit costs or imputed costs refer to non-monetary expenses incurred by the firm for the purpose of
production. They refer to costs of self owned resources employed in the firm. Examples of implicit cost are
opportunity cost of service of the owner, opportunity cost of land and capital belonging to the owner
employed in the business, depreciation on fixed assets etc. these expenses, except depreciation are not
normally recorded in the books of accounts.
Opportunity Cost and Outlay Cost
Opportunity cost or alternative cost is the return from the next best opportunity of a resource, had it not
been put to the present use. It means that the cost of using something in a particular venture is the benefit
foregone(or opportunity lost) by not using it in its next best alternative use.
Suppose the land used in the business is owned by the entrepreneur himself. If it were not used in the
business, it could have been let out to somebody else and earned a rent on it. The rent lost by putting the
land to business use is the opportunity cost of land.
Outlay costs are those expenses which are actually incurred by the firm. These are the actual payments made
for labour, machinery, advertisement etc. it is also called absolute cost or actual cost.
Sunk cost and Differential Cost
It is the cost incurred in the past and has no effect on future decision making. For example, when replacement
of an asset is under consideration, the undepreciated value of the existing asset is the sunk cost.
Sometimes a plant may be closed down permanently. In such a case the total capital invested minus the
salvage amount is lost. The amount so lost also is the sunk cost or irrecoverable cost. Just like the name
implies, sunk costs are gone and can’t be recovered.
Differential cost is the change in total cost due to change in the level of activity, change in the product mix,
alternative method of production etc. it is the result of the alternative course of action. For example, when
labour is replaced by machinery there will be change in total cost. If the change results in increase in total
cost it is called incremental cost. If it results in decrease in cost, it is called decremental cost.
Incremental cost and marginal cost
Incremental cost represents the increase in total cost as a result of decision to expand the level activity or
employment of a new technology. It may include both variable cost and fixed cost. In the short run
incremental may consist of variable cost only. i.e cost of additional raw materials, labour, fuel, power etc. In
the long run additions may have to be made to the fixed factors of production as well as variable factors of
production. Therefore incremental cost in the long run may consist of both variable and fixed costs.
Marginal cost is the increase in total cost as a result of increase in output by one unit. In otherwords marginal
cost is the cost of producing an additional unit of the product.
Fixed cost and variable cost
Fixed costs are those costs which do not change with changes in the volume or level of activity within the
limits of a plant capacity. Fixed cost depends upon the passage of time and does not vary directly with the
volume of output.
Example, Rent on business premises, insurance, depreciation, taxes, salary of executives, like general
manager, MD etc.
Variable cost is one which tends to vary directly with variation in the volume of output. It varies in direct
proportion to the volume of production. Such cost increases in aggregate as the production goes up and it
correspondingly decreases when production comes down.
Historical Cost and Replacement cost
The cost which are ascertained after their incurrence are called historical cost. Such cost are available only
when the production of a particular thing has already been done.
Replacement cost is the cost of replacement of a worn out asset at the current price. Replacement cost is
relevant for decision making.
Out of pocket Costs and Book Costs
Out of pocket costs refers to cost that involve cash payments to the suppliers of resources, e.g payments to
suppliers of raw materials, wages to workers, etc. all explicit costs belong to out of pocket costs.
There are certain business expenses which do not involve cash payments, such as depreciation on allowance
on assets, interest on owned funds etc. These are imputed cost.
Past cost and future cost
Past cost or historical cost represents value of goods and services exchanged and which find their place in
the financial accounting records. It may be divided into expired cost and unexpired cost. Expired costs are
losses and cannot contribute anything towards future revenue. E.g salary paid for services already rendered.
Unexpired costs are assets and they contribute towards revenue in the future. e.g advance salary paid.
Future costs are costs that are likely to be incurred in the future.
Short run Cost and Long run Cost
• Short run cost is defined as the cost which varies with the changes in the level of output by changing
the variable factors of production. In the short run variable costs change with changes in the output,
while fixed cost remains constant.
• Long period is a period of time long enough for the firm to make changes in the fixed factors also, in
addition to variable factors. That is in long run all factors are variable. There is no fixed cost, all costs
are variable.
Total cost, Average cost and Marginal Cost
Total cost is the total of all implicit and explicit costs incurred for producing a certain product. It includes
fixed cost and variable cost.
Average cost is the cost per unit of output. It is obtained by dividing the total cost by the total number of units
produced.
Marginal Cost is the extra cost incurred for producing an extra unit of output. It is the cost of marginal unit
produced.

Show by means of diagram the nature of the following cost curves in the short run. a)TFC b)TVC c)TC
Total Fixed Cost:
These are costs of production that do not change (vary) with the level of output, and they are incurred
whether the firm is producing or not.
They are independent of the level of output and it is the sum of all costs incurred by the firm for fixed inputs,
and it is always the same at any level of output. It includes; (a) salaries of administrative staff (b) depreciation
(wear and tear) of machinery (c) expenses for building depreciation and repairs (d) expenses for land
maintenance and depreciation (if any).
Total Fixed Cost (TFC) is graphically denoted by a straight line parallel to the output axis.
Total Variable Cost:
These are costs of production that change directly with output. They rise when output increases and fall
when output declines. They include (a) the raw materials (b) the cost of direct labour (c) the running
expenses of fixed capital, such as fuel, ordinary repairs and routine maintenance. It is the total cost incurred
by the firm for variable inputs.
TVC = f (Q)
Total Cost
The firm's short run total cost is the sum of the total fixed cost (TFC) and total variable cost (TVC) at any
given level of output. Total cost also varies with the level of the firm's output.
TC = TFC + TVC
TC = f(Q)
TFC = TC - TVC
TVC = TC - TFC

In the graph x axis measures output and y axis measures cost. TFC is parallel to x axis indicating that TFC
remains the same for any volume of output.
TVC is upward rising from the origin at the left bottom to the right top. It shows that TVC is zero when there
is no production and it increases when output increases. Since TC = TFC+TVC, the vertical distance between
the TC curves and TFC curve also measures TVC. The shape of TVC curve depends upon the productivity of
the variable factors. The TVC curve above assumes the law of variable proportions, which operates in the
short run.
The TC curve is parallel to the TVC curve, as TC is the vertical summation of TVC and TFC. The vertical
distance between TVC curve and TC curve represents TFC.

Lon-run average cost curve is also known as envelope curve. Why

Long run Smooth Envelope Curve
• LAC curve is sometimes called the planning curve of a firm as it helps the firm to decide what plant to
set up in order to produce any level of output at the minimum cost in the long run. It is a guide to the
entrepreneur in his decision to plan the future expansion of output.

• Since LAC envelopes (or supports) the SAC curves, it is also known as envelope curve. It is clear from
the Fig. that LAC curve is tangent to the whole set of SAC curves relevant for different plant sizes.
• The point of tangency occurs to the falling portion of the SAC curves for points lying to the left of the
minimum point ‘M’ of the LAC. The point of tangency for outputs larger than OQ occurs to the rising
part of the SAC curves.
• Thus, at the falling part of the LAC, the plants are not worked to full capacity and to the rising part of
the LAC, the plants are overworked. Only at the minimum point ‘M’, the plant is optimally used.
Explain briefly the law of diminishing returns and its relevance to business decisions
Law of Diminishing Returns or Law of Variable Proportion
The law explains the input-output relation when the output is increased by putting more and more units of
one variable input.
‘The law states that when additional units of a variable factors are applied to the fixed factors of production,
after a certain point, each successive unit of the variable factor brings forth a less than proportionate
increase’ in the total output.
It means that addition of each variable input causes an increase in the total output beyond a certain point at
a diminishing rate.
Alfred Marshall defines the law thus: an increase in the amount of a variable factor added to a fixed factor
causes in the end, a less than proportionate increase in the amount of product, under given technical
conditions.
The above definitions clearly show that with the successive addition of a variable input, the total product
increases, while after a certain point, both the average product and marginal product go on decreasing. The
following table illustrates the law

The table shows that up to the 3rd worker the total product increases at an increasing rate and beyond that
the output increases at a diminishing rate up to the 9th worker. At this level the output is the maximum and
the marginal product is zero. When the 10th worker is introduced the total output decreases and the marginal
product becomes negative.
The average product, which is the total product divided by the number of input factors also increases initially
and becomes maximum when the marginal product is equal to the average product. From the 5th worker
it decreases gradually.
The marginal product is the increase in the total product by the addition of one unit of input. It also shows
an initial increase and after that diminishes gradually up to the 9th worker where the marginal product is
zero. When the 10th worker is introduced the marginal product becomes negative. Thus the law shows three
stages in the physical productivity-first it increases, then it diminishes and finally it becomes negative.
It helps to decide
1. How to obtain maximum output from a given set of inputs and
2. How to obtain output from the combination of inputs.
The above stage in the operation of the law can be illustrated diagrammatically as shown below
 OX axis shows the quantity of variable input
(workers) and OY axis the output. TP is the
total product curve. AP is the average product
curve and MP is the marginal product curve.
TP curve rises steeply up to the end of the first
stage, then it has a slanting rise showing
diminishing rate of return and towards the
end it comes down showing decrease in the
total output. At point P marginal product is
zero and the total output is the maximum.
Assumptions to the Law
1. Only one factor is varying while others are
kept constant.
2. All units of the variable factor are homogeneous
3. The product is measured in physical units.
4. There is no change in technology adopted
5. It assumes a short run situation

Explain with examples the law of returns to scale

Law of Returns to Scale: Definition, Explanation and Its Types
In the long run all factors of production are variable. No factor is fixed. Accordingly, the scale of production
can be changed by changing the quantity of all factors of production.
The law of returns to scale explains how a simultaneous and proportionate increase in all inputs affects the
total output.
If the increase in output is more than proportionate to the increase in input, it is increasing returns to scale,
if it is proportionate, then it is constant returns to scale and if it is less than proportionate, it is diminishing
returns to scale.
Types of returns to scale
There are three different cases of returns to scale.
1. Increasing Returns to scale.
2. Constant Returns to Scale
3. Diminishing Returns to Scale
1.Increasing Returns to scale.
Increasing returns to scale or diminishing cost refers to a situation when all factors of production are
increased, output increases at a higher rate.
It means if all inputs are doubled, output will also increase at the faster rate than double. Hence, it is said to
be increasing returns to scale. This increase is due to many reasons like division external economies of scale
2.Constant Returns to Scale:
• Constant returns to scale or constant cost refers to the production situation in which output increases
exactly in the same proportion in which factors of production are increased. In simple terms, if factors
of production are doubled output will also be doubled.
• In this case internal and external economies are exactly equal to internal and external diseconomies.
This situation arises when after reaching a certain level of production, economies of scale are
balanced by diseconomies of scale. This is known as homogeneous production function.
3. Diminishing Returns to Scale
• Diminishing returns or increasing costs refer to that production situation, where if all the factors of
production are increased in a given proportion, output increases in a smaller proportion. It means, if
inputs are doubled, output will be less than doubled. If 20 percent increase in labour and capital is
followed by 10 percent increase in output, then it is an instance of diminishing returns to scale.
• The main cause of the operation of diminishing returns to scale is that internal and external
economies are less than internal and external diseconomies.
Explain how the least cost combination of inputs can be achieved.
Producer’s Eqilibrium (Least Cost Input Combinations)
A producer is confronted with innumerable combinations of inputs for producing a given quantity of output.
The problem before him is to choose that combination of inputs which minimizes the cost of production for
maximising profit.
The producer is said to be in equilibrium regarding combination of inputs when he hits at the least cost
input combination. Least Cost Input Combination can be easily identified with the help of isoquant curve and
isocost curve.
• Iso-product or Iso-quant curve is that curve which shows the different combinations of two factors
yielding the same total product.
• “’An Iso-quant curve may be defined as a curve showing the possible combinations of two variable
factors that can be used to produce the same total product.”
• Like, indifference curves, Iso- quant curves also slope downward from left to right. The slope of an
Iso-quant curve expresses the marginal rate of technical substitution (MRTS).
Isocost curve
Isocost curves describes the cost function by showing different combinations of inputs which a firm can buy,
given a certain amount of money.
Optimum Combination of Inputs
A certain quantity of output can be produced with different input combinations. The cost of each combination
varies and only one of the combinations gives the minimum. The combination which is most economical or
which bears the least cost is the ‘optimum input combination’.
The optimum combination is found out with the help of isoquant and isocost curves. The optimum input
combination to produce a given output level is given by the point of tangency of the isoquant to isocost line.
This is shown in the following figure.
In the figure, IQ represents isoquant curve. Isocost lines AB,CD and EF represent three levels of cost-highest,
lower and the lowest cost on various combinations of inputs. There are two feasible combination of inputs
OK1 and OL1 and OK2 and OL2, with the cost represented by AB. There is one feasible combination of inputs
OK and OL with the cost represented by CD. Input combinations represented by AB (i.e. R and S) are not
optimal for producing a given output.
It is obvious that, of the three feasible combinations, the one of the isocost line CD(i.e. Z) is the least cost
input combination.
Thus we conclude that the least cost input combination lies at the point of tangency between the isoquant
curve and isocost curve.

Explain Production function with two variable input.

Law of Returns to Scale: Definition, Explanation and Its Types
In the long run all factors of production are variable. No factor is fixed. Accordingly, the scale of production
can be changed by changing the quantity of all factors of production.
The law of returns to scale explains how a simultaneous and proportionate increase in all inputs affects the
total output.
If the increase in output is more than proportionate to the increase in input, it is increasing returns to scale,
if it is proportionate, then it is constant returns to scale and if it is less than proportionate, it is diminishing
returns to scale.
Types of returns to scale
There are three different cases of returns to scale.
1. Increasing Returns to scale.
2. Constant Returns to Scale
3. Diminishing Returns to Scale
1.Increasing Returns to scale.
Increasing returns to scale or diminishing cost refers to a situation when all factors of production are
increased, output increases at a higher rate.
It means if all inputs are doubled, output will also increase at the faster rate than double. Hence, it is said to
be increasing returns to scale. This increase is due to many reasons like division external economies of scale
2.Constant Returns to Scale:
• Constant returns to scale or constant cost refers to the production situation in which output increases
exactly in the same proportion in which factors of production are increased. In simple terms, if factors
of production are doubled output will also be doubled.
• In this case internal and external economies are exactly equal to internal and external diseconomies.
This situation arises when after reaching a certain level of production, economies of scale are
balanced by diseconomies of scale. This is known as homogeneous production function.
3. Diminishing Returns to Scale
• Diminishing returns or increasing costs refer to that production situation, where if all the factors of
production are increased in a given proportion, output increases in a smaller proportion. It means, if
inputs are doubled, output will be less than doubled. If 20 percent increase in labour and capital is
followed by 10 percent increase in output, then it is an instance of diminishing returns to scale.
 • The main cause of the operation of diminishing returns to scale is that internal and external
economies are less than internal and external diseconomies.

Law of returns to Scale

Economies of scale are associated with large scale operation.Explain

Discuss the effects of Economies of Scale on Production Costs

1. It reduces the per-unit fixed cost. As a result of increased production, the fixed cost gets spread over
more output than before.
2. It reduces per-unit variable costs. This occurs as the expanded scale of production increases the
efficiency of the production process.
The graph above plots the long-run average costs (LRAC) faced by a firm against its level of output. When
the firm expands its output from Q to Q2, its average cost falls from C to C1. Thus, the firm can be said to
experience economies of scale up to output level Q2. In economics, a key result that emerges from the analysis
of the production process is that a profit-maximizing firm always produces that level of output which results
in the least average cost per unit of output.

➢ Explain how the least cost combination of inputs can be achieved. ( answer is same as 3rd question)
➢ Discuss the production function with two variable input( answer is same as 4th question)
Explain short run cost function with the help of a diagram
Short run cost Function(Short run Cost Output Relationship)
short run costs are divided into Total fixed costs (TFC), total variable costs (TVC).
TC = TFC + TVC
Total Fixed Cost:
These are costs of production that do not change (vary) with the level of output, and they are incurred
whether the firm is producing or not.
They are independent of the level of output and it is the sum of all costs incurred by the firm for fixed inputs,
and it is always the same at any level of output. It includes; (a) salaries of administrative staff (b) depreciation
(wear and tear) of machinery (c) expenses for building depreciation and repairs (d) expenses for land
maintenance and depreciation (if any).
Total Fixed Cost (TFC) is graphically denoted by a straight line parallel to the output axis.
Total Variable Cost:
These are costs of production that change directly with output. They rise when output increases and fall
when output declines. They include (a) the raw materials (b) the cost of direct labour (c) the running
expenses of fixed capital, such as fuel, ordinary repairs and routine maintenance. It is the total cost incurred
by the firm for variable inputs.
TVC = f (Q)
Total Cost
The firm's short run total cost is the sum of the total fixed cost (TFC) and total variable cost (TVC) at any
given level of output. Total cost also varies with the level of the firm's output.
TC = TFC + TVC
TC = f(Q)
TFC = TC - TVC
TVC = TC - TFC

In the graph x axis measures output and y axis measures cost. TFC is parallel to x axis indicating that TFC
remains the same for any volume of output.
TVC is upward rising from the origin at the left bottom to the right top. It shows that TVC is zero when there
is no production and it increases when output increases. Since TC = TFC+TVC, the vertical distance between
the TC curves and TFC curve also measures TVC. The shape of TVC curve depends upon the productivity of
the variable factors. The TVC curve above assumes the law of variable proportions, which operates in the
short run.
The TC curve is parallel to the TVC curve, as TC is the vertical summation of TVC and TFC. The vertical
distance between TVC curve and TC curve represents TFC.
Short run average cost and marginal cost
From the Total-Cost curves we obtain Average-Cost curves.
a. Average Fixed Cost (AFC): The AFC at any given level of output is total fixed cost divided by output.
AFC= TFC/Q
It may also be obtained by the formula AFC=ATC-AVC
Since TFC is constant for any level of activity, fixed cost per unit goes on diminishing as output goes on
increasing. The AFC curve is downward slopping towards the right throughout its length with a sleep fall at
the begining.

b. Average Variable Cost (AVC):

The average variable cost at any given level of output is total variable cost divided by output. In symbol, it
becomes:
AVC=TVC/Q
It can also be obtained by the formula
AVC = ATC-AFC, AVC in the beginning will be high and then it falls gradually with increase in output till a
certain level of output is reached. Thereafter it starts rising upwards with further increase in output. This is
due to the operation of the law of variable proportions. This phenomenon is well reflected in the U shaped
AVC curve.
c. Average Total Cost (ATC):
Average total cost (ATC) or simply average cost is obtained by dividing the total cost by the number of units
produced. Thus
ATC = TC/Q
It nay also be obtained by the formula ATC=AFC+AVC.
In the beginning both AFC and AVC decline and therefore the ATC also declines. The AFC continuous the
trend throughout, though at a diminishing rate. AVC continuous the trend till it reaches a certain level and
thereafter it starts increasing slowly. The ATC continuous to decrease for some more time and reaches the
lowest point which obviously is further than the lowest point of the AVC. Thereafter the rate of increase to
the AVC is greater than the rate of decrease in the AFC and therefore the ATC starts rising. The ATC curve
assunes U shape, as in the case of AVC . The theoretical explanation for the U shape is given by the law of
variable proportions.
Marginal Cost
Marginal Cost (MC) is the additional cost necessitated by increase in output by one unit.in simple terms it is
the additional cost of producing an additional unit of commodity.
MCn = TVCn – TVCn-1
Where
MCn = marginal cost of producing n units
TVCn = TVC of producing n units
TVCn-1 = TVC of producing n-1 units
TFC in the short line remains fixed for any level of activity and a change in the TC takes place on account of
the change in the TVC. Therefore, MC is not influenced by TFC. MC can hence be defined as the increase in
the TVC, when output is increased by one unit. MC curve will be U shaped on account of the operation of the
law of variable proportions
Relationship between AVC and MC
• When the MC is below AVC, AVC falls and when it is above AVC, AVC rises. It follows that MC and AVC
will be equal when AVC is the minimum. Graphically MC curve cuts AVC curve from below at the
lowest point on the AVC.
Relationship between ATC and MC
• When ATC falls MC will be below ATC and when ATC rises MC will be above ATC. When ATC is
minimum ATC =MC. It means that MC curve cuts ATC curve from below, at the lowest point on the
ATC.
• Thus we find that the relationship between AVC and MC is similar to that of the relationship between
ATC and MC.
Tabular presentation of cost Function

Output Decision
We have seen that in the short run the MC curve and Average cost curve are u shaped reflecting the operation
of law of variable proportion. That is in the short run there is a phase of increasing productivity and a phase
of diminishing productivity of variable inputs.
Explain long run cost function with the help of a diagram
Long-run Cost Function
In the long run all factors are variable and the total cost is composed of variable cost only. Therefore cost
function in the longrun implies relationship between average (total) cost and total output.
In the short run plant size is fixed and therefore change in the level of activity is possible only by making
changes in the volume of inputs.ie, by changing the proportion of inputs.
But in the long run,a firm has a number of plant size and corresponding optimal input combinations to
choose, to suit its specific requirements of production.
In the long-run the firm can adjust its scale of operations or size of plant to produce any required output in
the most efficient way. Thus, in the long run fixed factors can be altered.
Management can be restructured to run a firm of a different size. Capital can also be used differently. In short,
all factors are variable in the long run and therefore the scale of operations can be altered.
Thus, in the long-run all costs are variable (i.e. the firm faces no fixed costs). The length of time of the long-
run depends on the industry.
In some service industries, such as dry-cleaning, the period of the long-run may be only a few months or
weeks.
For capital intensive industries, such as electricity generating plant, the construction of a new plant may
take many years and hence long-run may be many years.
The length of time of the long-run depends upon the time required for the firm to be able to vary all inputs
• In the long run, a firm can have a large number of alternative plant sizes. For a certain level of output, a
plant of a particular size will be most suited.

The above figure is drawn on the assumption that there are three plants and they are depicted by the short
run average cost curves SAC1, SAC2, SAC3. A given plant is best suited for a particular level of output.

• OL can be produced at a lower cost with the plant SAC1 than with the plant SAC2.
• The cost of producing OL output on plant SAC1, is AL and it is less than the cost of producing the same
output with plant SAC2.
• The difference in cost is equal to AB.
• If the firm wants to produce ON output it can produce it either by plant SAC1 or plant SAC2.
• The larger output OM can be obtained at the lowest average cost from the plant SAC2 .

• Thus, output larger than ON but less than OQ can be produced at a lower average cost with plant SAC2.
For output larger than OQ, the firm will have to employ plant SAC3.
• For instance, output OP can be produced at average cost of PE with plant SAC3.
 • It is clear from the above analysis that in the long run the firm has a choice regarding the employment
of a plant and it will employ that plant which yields possible minimum average cost for producing a
given output.
Long run Smooth Envelope Curve
• LAC curve is sometimes called the planning curve of a firm as it helps the firm to decide what plant to
set up in order to produce any level of output at the minimum cost in the long run. It is a guide to the
entrepreneur in his decision to plan the future expansion of output.

• Since LAC envelopes (or supports) the SAC curves, it is also known as envelope curve. It is clear from
the Fig. that LAC curve is tangent to the whole set of SAC curves relevant for different plant sizes.
• The point of tangency occurs to the falling portion of the SAC curves for points lying to the left of the
minimum point ‘M’ of the LAC. The point of tangency for outputs larger than OQ occurs to the rising
part of the SAC curves.
• Thus, at the falling part of the LAC, the plants are not worked to full capacity and to the rising part of
the LAC, the plants are overworked. Only at the minimum point ‘M’, the plant is optimally used.
MODULE 4

Module 4
Part A
1. Define Market
In ordinary sense, market means a place where goods are bought and sold. But, to an economist, the term
‘market’ does not refer to a place. In economics, market refers to a group of buyers and sellers dealing in a
particular commodity (e.g., gold market, oil market, car market, fruit market, etc.)
Cournot’s definition – the French economist Cournot defined a market thus “Economists understand by the
‘Market’ not any particular market place in which things are bought and sold but the whole of any region in
which buyers and sellers are in such free intercourse with one another that the prices of the same goods tend
to equality, easily and quickly.”
2. Which are the four popular types of Market Structure?

The four popular types of market structures include

• Perfect competition
• Oligopoly market
• Monopoly market
• Monopolistic competition.

Perfect Competition: It is such a market structure where there are large number of buyers and sellers of a
homogeneous product and the price of the product is determined by the industry. E.g., agricultural market,
street food vendors etc.
MONOPOLY: It is a market structure in which there is only a single seller of the product. Here one firm is
selling the product and has full control over the supply of the product
e.g., the supply of electricity by the State Electricity Board.
Monopolistic competition: Monopolistic competition is a kind of market in which a large number of firms
supply differentiated products. The number of sellers is so large that each firm can act independently of
others.
OLIGOPOLY: An oligopoly is a market structure in which there are a few sellers of a product selling identical
or differentiated products.

3. State the law of supply

It is clear from the supply schedule that higher the price, larger the quantity supplied and lower the price,
smaller the quantity supplied. This relationship stated in the form of a law is called the Law of Supply. The
law states “other things remaining the same, as price of a commodity rises its supply is extended, as the price
falls its supply is contracted.

4. Define reserve price

A seller has two critical price levels during market period. 1) a high price at which he is prepared to dispose
of the whole stock and 2) a low price below which he is not prepared to sell. This low price is called reserve
price. Sellers reserve price is defined as that price below which sellers are not prepared to sell.
5. Differentiate between Perfect and Imperfect Market Structure
 BASIS FOR
PERFECT COMPETITION IMPERFECT COMPETITION
COMPARISON

Meaning Perfect Competition is a type of Imperfect Competition is an

competitive market where there economic structure, which does
are numerous sellers selling not fulfil the conditions of the
homogeneous products or perfect competition.
services to numerous buyers.

Nature of concept Theoretical Practical

Product None Slight to Substantial

Differentiation

Players Many Few to many

Restricted entry No Yes

Firms are Price Takers Price Makers

6. In perfect competition firms are not the price makers; they are price takers. Why?
In perfect market conditions (also called perfect competition) a firm is a price taker because other firms can
enter the market easily and produce a product that is indistinguishable from every other firm's product. This
makes it impossible for any firm to set its own prices.
Under conditions of perfect competition individual firms do not have control over the market. The price is
determined by the interaction of the forces of market demand and supply. Individual firms do not have price
policy of their own. They can just produce as much as they want and sell them in the prevailing price. They
are not ‘price makers’; they are ‘price takers. The problem of firm under perfect competition is not price
determination but output determination for the purpose of maximising profit.
7. Define monopoly
Monopoly is a market structure in which there is only one producer of a commodity with no close substitute
for commodity it produces, there are barriers to entry.".
Thus, the analysis of monopoly begins with two simple assumptions:
(i) First, that an entire industry in supplied by a single seller who is called a monopolist;
(ii) Second by the monopolist sets a single price and supplies all buyers who wish to buy at that price
e.g., the supply of electricity by the State Electricity Board or postage stamps, post cards, envelopes etc. are
supplied by the Postal Dept.

8. What is discriminating monopoly?

Price discrimination is the act of selling the same article produced under a single control at different prices
to different consumers. The different types of price discrimination are;
Personal discrimination: when the monopolist charges different customers different prices, discrimination
becomes personal.
Place discrimination: when the monopolists sell his commodities in different markets at different prices the
discrimination is called place discrimination.
Trade discrimination/Use discrimination: in this type of discrimination price depends upon the use to which
the product is put to.
9. What are the causes of monopoly?

10. State the meaning of monopolistic competition

Monopolistic competition is a kind of market in which a large number of firms supply differentiated products.
The number of sellers is so large that each firm can act independently of others. "Monopolistic competition
is a market structure found in the industry where there are large number of small sellers, selling
differentiated but close substitute products. "Monopolistic competition is a market situation where there are
many producers but each offers a slightly differentiated product.
11. Define Oligopoly
An oligopoly is a market structure in which there are a few sellers of a product selling identical or
differentiated products. If they are selling identical products, it is a case of pure oligopoly and if they are
selling differentiated products, it is a case of differentiated oligopoly. In this case each firm has to take into
account the price being charged by the others. price rigidity and price war are the common features of
oligopoly.

12. Differentiate monopoly and monopolistic competitive market

BASIS OF DIFFERENCE MONOPOLY MONOPOLISTIC

COMPETITION
MEANING A monopoly is the type of A monopolistic competition is
imperfect competition a type of imperfect
where a seller or competition where many
producer captures the sellers try to capture the
majority of the market market share by
share due to the lack of differentiating their products.
substitutes or
competitors.
Number of players ONE MANY
Degree of competition No competition exists, as A very high competition exists,
only one seller is present as there are many sellers.
in the market.
Barriers to entry HIGH LOW
Demand curve STEEP FLAT
Price control Due to steep demands Some level of price control is
and only one seller, the exercised by buyers, as many
price is controlled by the sellers are available in the
seller. market.

Part B
1. Explain the features of market
Essential characteristics of a market are as follows:
• One commodity: In practical life, a market is understood as a place where commodities are bought
and sold at retail or wholesale price, but in economics “Market” does not refer to a particular place
as such but it refers to a market for a commodity or commodities i.e. , a wheat market, a tea market
or a gold market and so on.
• Area: In economics, market does not refer only to a fixed location. It refers to the whole area or region
of operation of demand and supply
 • Buyers and Sellers: To create a market for a commodity what we need is only a group of potential
sellers and potential buyers. They must be present in the market of course at different places.
• Perfect Competition: In the market there must be the existence of perfect competition between
buyers and sellers. But the opinion of modern economist is that in the market the situation of
imperfect competition also exists, therefore, the existence of both is found.
• Business relationship between Buyers and Sellers: For a market, there must exist perfect business
relationship between buyers and sellers. They may not be physically present in the market, but the
business relationship must be carried on.
• Perfect Knowledge of the Market: Buyers and sellers must have perfect knowledge of the market
regarding the demand of the customers, regarding their habits, tastes, fashions etc.
• One Price: One and only one price be in existence in the market which is possible only through
perfect competition and not otherwise.

2. Discuss the classification of market

A. According to the extent of area covered, a market is classified into local, national, and
international.
• In a local market, perishable goods are transacted. A uniform price prevails over the local
market.
• There are some goods bought and sold almost at the same price (barring taxes) all over
the country the markets for these commodities are national.
• Gold market is international in character in the sense that buyers and sellers all over the
world come in contact with each other.

B. Marshall has classified market in accordance with the time period. He considers four kinds of
market:
• The very short period market
• The short period markets
• The long period markets
• The very long period market.
It is to be remembered that the ‘period’ is not a calendar time. Above all, it depends on the nature of business
and the nature of the commodity.
C. Markets can also be classified according to the nature of the competition among buyers and
sellers.
• In a perfect market quite a large number of firms compete in the supply of a single product.
• But in an imperfect competition, number of sellers may not necessarily be large
Perfect competition
Perfect Competition: It is such a market structure where there are large number of buyers and sellers of a
homogeneous product and the price of the product is determined by the industry. E.g., agricultural market,
street food vendors etc.
IMPERFECT COMPETITION
MONOPOLY: It is a market structure in which there is only a single seller of the product. Here one firm is
selling the product and has full control over the supply of the product
e.g., the supply of electricity by the State Electricity Board.
Monopolistic competition: Monopolistic competition is a kind of market in which a large number of firms
supply differentiated products. The number of sellers is so large that each firm can act independently of
others.
OLIGOPOLY: An oligopoly is a market structure in which there are a few sellers of a product selling identical
or differentiated products.
3. " Markets are classified according to the structure of the industry serving the market" narrate.
Illustrate the main types of market structure with suitable industry examples
4. Examine the conditions under which a firm under perfect competition is shut down

Any firm will shut down its production when the marginal cost is less than average variable cost.

When the price falls further to OP3 the firm attains equilibrium at point A, with OQ3 units. At this point
AVC=AR and AVC is minimum. In short, the firm should recover at least the variable cost. Therefore, the firm
can afford to undertake production of OQ3 units. If price falls below OP3, the firm cannot recover the variable
cost in full and loss increases. Therefore, point A, when AVC=AR and AVC is the minimum indicates the
shutdown point.
5. Examine the conditions of equilibrium and supernormal profit of a firm under perfect
competition
SUPER NORMAL PROFIT
Super normal profit is also known as excess profit/ pure profit/ abnormal profit. Supernormal profit is an
amount of profit that exceeds “normal” profit.

The diagram on the left shows the price determination and the one on the right side shows how the firm
determines its output at the price OP fixed by the industry.
The firm is in equilibrium at point A where MC=MR and MC cuts the MR curve from below. It Produces OQ
units at price OP. AVC and AFC makes ATC, QB which is less than the AR. Therefore, AB represents the
average profit and the shaded area PABD represents the super normal profit. As price increases,
supernormal profit increases and as price decreases supernormal profit declines and finally disappears
6. How price is determined in the market period under perfect competition
Market period is a very short period during which supply is determined by the stock in hand. The period is
too short that additional units of the product cannot be produced by the existing firms. It is impossible for
the new firms to establish themselves and start production. Since the process of production has been
completed supply cannot be curtailed also. In short, the supply is constant, under the assumption that the
entire stock is offered for sale.
The duration of the period depends upon the nature of the product and the gestation period.
Since the market supply is fixed it has a passive role in the matter of price determination. Demand acts as a
powerful factor. If the demand increases a new equilibrium price is fixed above the existing level. If the
demand decreases the equilibrium price is fixed below the existing level. The equilibrium price is thus
obtained by the interaction of the forces of demand and supply during the market period is called the market
price and it will be short lived because supply will soon adjust itself to demand.

• The vertical straight line MPS represents the market period supply curve, and OM the quantum of
supply. The demand curve DD intersects the supply curve at point P and the equilibrium price is OP’.
When the demand increases from DD to D1D1, the supply remains at the original level. The new
demand curve intersects the supply curve at point Q and a temporary equilibrium is established with
price OQ’. The demand decreases from DD to D2D2. then also the supply remains the same. The
demand curve D2D2 intersects the supply curve at point R to establish a new equilibrium price at OR’.
The assumption that supplies in the market period is constant is not always true. In the case of durable goods,
if the price falls below a certain level the seller may hold back the goods. Even in the case of perishable goods
like fish, if the price decreases too much, goods may be held back and preserved by using cold storage
facilities.
Thus, a seller has two critical price levels during market period. 1) a high price at which he is prepared to
dispose of the whole stock and 2) a low price below which he is not prepared to sell. This low price is called
reserve price. Sellers reserve price is defined as that price below which sellers are not prepared to sell.
Under certain conditions (like nature of the commodity, gestation period, storage facilities etc) the supply is
not assumed to be constant, it varies with price. As demand increases and price crosses reserve price and
keeps on increasing, the seller offers more and more for sale. Once the price reaches the ‘high level’, the entire
stock will be offered for sale. Since the supply is limited in the market period, further increase in supply is
not possible in tune with the increase in demand. Therefore, if there is further increase in demand, the price
(market price) will shoot up.
MPS-M represents the market demand supply curve. OM is the reserve price and OR’ the high price. The
portion of the supply curve M-R indicates the various quantities offered for sale at different prices. As
demand increases from DD to D1D1 and D2D2 price and supply increases. The vertical portion of the supply
curve R-MPS represents fixed supply. The supply does not increase in response to demand. Therefore, the
market price increases rapidly
7. What is price discrimination? What are the essential conditions for making price discrimination
successful?
Price discrimination is the act of selling the same article produced under a single control at different prices
to different consumers. The different types of price discrimination are;
Personal discrimination
Place discrimination
Trade discrimination

8. Discuss the degrees of price discrimination under monopoly.

Prof.A.C. Pigou identifies three degrees of price discrimination; -
First degree price discrimination
Second degree price discrimination
Third degree price discrimination
• First degree of price discrimination- in the first degree of price discrimination, the monopolists’
charges different prices for different units of a commodity sold so that the entire consumer surplus is
taken away. The monopolist finds out the maximum price a consumer is willing to pay for each unit
of the commodity and charges accordingly.
• Second degree price discrimination- in the second-degree price discrimination, the monopolists does
not take away the entire amount of consumer surplus, a part is left out the customer. He charges
different charges to different lots.
• Third degree price discrimination- the monopolists divide the market into different groups on the
basis of elasticity of demand for the product. The price is charged on the basis of the conditions of
 demand and supply. Here the consumers surplus is more than that of second-degree price
discrimination
9. "Profit maximization is the main aim of any business" narrate. Explain the pre-conditions of profit
maximization under the market structure.

10. Discuss the characteristics of monopolistic competition

(1) Large number of firms: There is a large number of firms or sellers operating under monopolistic
competition but a relatively small fraction of the total market is shared by each firm or seller.
(2) Product differentiation: The second distinct feature of monopolistic competitive market structure is
product differentiation. The number of firms is large but their products differ from one another in colours,
shape and size, brand, chemical composition, quality, trade mark, packaging, durability etc. For example,
firms produce different kinds of bathing soap e.g. Hamam, Lux, Lifebuoy, Rexona, Liril, Dove, Pears, etc. but
these products are close substitutes.
(3) Freedom of entry and exit: Under monopolistic competition the firms are relatively free to enter the
industry and to exit from the industry, but they have no absolute freedom of entry the industry. New firms
are free to enter into the market with new brands as close substitute of the existing brands.
(4) Non-price competition: Under monopolistic competition firms compete with one another without
changing the price of their products. The firms attract the pot1.
(5) Less Mobility: There is no perfect mobility of factors of production and of goods and services in practical
life. The factors are less mobile because of psychological reasons and disparity among the regions.
(6) No perfect knowledge: Under monopolistic competition the buyers and sellers do not have perfect
knowledge about the market conditions.
(7) Close Substitutes: Under monopolistic competitions the product are not homogeneous products but they
are close substitutes to each other which tends to create competition among the firms regarding their
products.

11. Explain the features of Oligopoly

(1) Relatively small number of sellers: There are relatively small number of sellers under oligopoly market
structure selling identical or differentiated products. Each seller controls a large part of the demand and the
policies of every seller influence the price and output of the industry as a whole.
(2) Interdependence of the firms: Under the oligopoly market structure all the firms are sailing in the same
boat and every tilting position influences each of the firm as well with equal proportion. No firm can be
neutral. They depend on each other while determining the price and output of the firm.
(3) Price rigidity and price war: Price rigidity and price wars are the common features of an oligopoly market
structure. Each firm retaliate and acts according to the actions of the other firms and a tug of war starts
between them which is better known as 'Price War' which further paves way to price rigidity.
(4) Difficulty in entry and exit: Under oligopoly the entry and exit of the firms is banned. The new firms cannot
enter the market as the old firms have complete hold over the market conditions and the firms are also
reluctant to leave because of the huge investment made by them.
(5) Selling costs: Under oligopoly market structure, each firm pursues an aggressive and defensive marketing
strategy to control the market. Advertisement is an important method used by the oligopolists to control the
bigger part of the market

12. Differentiate oligopoly from the monopolistic competition?

 Parameters of
Oligopoly
Comparison
An oligopoly market is a small number of
sellers of large firms tout interlinked
Meaning
homogeneous or differentiated products
to the customers.
Number of sellers There are a few sellers of large firms.
Strict barriers to entry and exit of
oligopoly firms to the market can reflect
the other firm’s actions as actions of one
Entry and Exit firm. Moreover, Government regulation
on the entry of new firms is quite difficult
as the existing firm is already making an
optimized profit.
Oligopoly firms sell homogeneous
products which are similar in size, shape,
Nature of
colour, material and price. Sometimes,
products
they also sell differentiated products to
compete with other firms.
Oligopoly firms are highly
interdependent on other firm’s actions
because there are only a few firms in the
market selling analogous products.
Interdependence
Therefore, the action of one firm makes
an impact on other firms. So setting
prices may reflect the performance of
other firms in an oligopoly market.
The automobile industry of large firms-
Examples like Tata Motors sells homogeneous
products.
Part C
1. Explain with the help of a diagram the general principle of determination of market price.
Examine how changes in supply and demand affect the market price.
2. What do you mean by equilibrium price? With the help of a diagram explain the process of
determination of equilibrium price.
Monopolistic Competition
Monopolistic competition is imperfect
competition, with many firms selling
particular or grouped heterogeneous
products to the customers.
There are many MC firms, where each
firm sells a set of similar products
while competing with other MC firms
who are selling another set of different
products.
The entry and exit of Monopolistic
competition are free, where the new
firm can enter as well as existing firms
sustaining loss can freely leave the
market.
The nature of products under
monopolistic competition is
heterogeneous or differentiated
products. The firms sell products that
are different in size, colour, shape or
price.
Monopolistic competition firms are
independent. A monopoly is termed as
a single firm selling or setting products
at their own decided price.
Monopolistic competition examples
are restaurants like Dominos sells Aloo
Tikka Pizza in India,
whereas pepperoni pizza sells in
American firms.
Price is determined by the interaction of the forces of demand and supply. The impact of demand and supply
will be different under different market conditions and accordingly separate theories of price – output
determination have been evolved to suit different market conditions.
Let us now examine the general principle applicable to all types of market situations.
According to the Law of Demand, large quantity is demanded at low price, and small quantity at high price.
As per the Law of Supply, large quantity is offered at high price, and small quantity at low price.
Thus, demand and supply are two forces working in opposite direction. When the forces of demand and
supply working in opposite direction are balanced, i.e., demand equals supply at a particular price, a state of
equilibrium is said to have been attained. This price is called equilibrium price (market price) and the
quantity, the equilibrium quantity.

The process of determination of price by the interaction of the forces of demand and supply can be presented
graphically.
DD is the demand curve and SS is the supply curve. The equilibrium price and quantity can be identified at
the point of intersection at the two curves at point E. OP is the equilibrium price and OQ the equilibrium
quantity. When price is OP1, quantity demanded is P1F, but quantity supplied is only P1C. When price is OP2,
quantity demanded is P2A, but supplied is P2B. So, when price is OP1, there is excess demand and when price
is OP2, there is excess supply.
3. Examine the process of price and output determination of firm under perfect competition in the
short run
Under conditions of perfect competition there are a large number of firms selling the same product in the
market. The price is determined by the industry demand and supply. A firm may produce as much as it wants
and sell them at the prevailing market price. If the firm tries to increase its price above the market price it
cannot sell anything. If it decreases the price it gains nothing as it can sell any quantity even at the prevailing
market price. Therefore, the problem of the firm is to adjust its output to the prevailing price and earn
maximum profit or incur minimum loss in the short run.
The short run equilibrium price, which is often called short run normal price, is determined by the
interaction of the forces of short run industry demand and industry supply. During this period, firm can vary
the supply of output by varying the volume of variable costs. The price is determined by the industry is
accepted by all the firms in the industry.
If the price covers at least the average variable cost, the firm will decide to produce. If price falls below the
average variable cost, the firm will not produce; it will shut down the plant. So the shut down point is where
AVC = AR(or price).
How much the firm will produce during short run depends upon its marginal revenue and marginal cost. To
a firm price is fixed. So price and average revenue and marginal revenue are equal. Since price is constant
demand curve is a horizontal straight line. Every firm aims at maximizing profit, it will produce output up to
the point where its marginal revenue equals marginal cost i.e. MR=MC.
The figure on the left illustrates the price determination by the industry during short run, and the figure on
the right illustrates the price output adjustment by the firm.
The short run equilibrium price is OP, since the demand curve DD intersects the short run supply curve SRS
at point A. The line is also the demand curve of the firm. At this point firm decides to produce because it is
above its AVC. It produces the quantity OQ because at this quantity its marginal revenue equals marginal
cost(see point E)
The industry demand rises to D1D1 which intersect the short run supply curve SRS at point B. As a result
short run price rises to OP1. At this prices the firm increases its output to OQ1. where its MR=MC at point E1.
The price OP1 is higher than the firms average total cost. Hence the firm begins to earn profit. The profit per
unit of output is E1D. (the difference between price and ATC).
4. Examine the process of price and output determination of firm under perfect competition in the
long run
Long period is a period of time sufficient to make changes in all factors of production. Therefore, in the long
run all factors are variable and total cost means total variable cost. The existing firms can may change the
scale of operation or leave the industry. New firms may enter the industry. Supply gets fully adjusted to
demand. The long run normal price is determined by the interaction of the forces of demand and supply.
• In the long run firms cannot afford to incur loss. Normal price should cover long run average (total)
cost which includes normal profit. The firm will be in equilibrium when;
– MC=MR, MC curve should cut MR curve from below
– AR=AC (MC=MR=AR=AC)
 • The equilibrium quantity of the firm is OQ when the price is OP. At this level MC=MR, MC curve cutting
the MR curve from below and AR=AC. AC is min at this level of output. Thus in the long run a firm is
in equilibrium when LMC=MR=AR=LAC=Price. The firm earns normal profit, it does not earn super
normal profit or incur loss
• If the price is above the minimum long-run average cost, the firms will make super normal profit.
Therefore, in the long run, new firms will enter the industry to compete away there extra profits and
the price will fall to the level where it is equal to the minimum LAC. neither can the price fall below
the minimum Average cost since in that case the firms will be incurring loss. In the long run, if these
loss persist, some of the firms will leave the industry. As a result, the price will rise to the level of
minimum average cost, so that in the long run firms are earning normal profits only.
5. Examine the process of price and output determination of firm under monopoly in the short run

Price output determination under monopoly (equilibrium of the firm)

As the single firm constitutes the industry, the equilibrium of the industry is same as equilibrium of the firm.
A monopolist has complete control over the supply. The principle of price determination in the short run and
long run remains the same. The only point is to be remembered is that in the short run monopolist compares
marginal revenue with the short run marginal cost and in the long run marginal cost with the long run
marginal revenue
The aim of the monopolist is to maximise profit. Therefore he goes on producing so long as the additional
units produced contribute more to revenue than cost. He stops production at the point where the cost of
additional units produced is more than the revenue.
The monopoly firm ( and the industry) is said to be in equilibrium at the level of output where MC=MR and
MC curve cuts MR curve from below. At this price - output level, the firm maximises its profit.
The general law of demand, ie,’ higher the price, lower the demand and vice versa’ is applicable to monopolist
also. Therefore the monopoly firm faces a downward slopping demand curve.(AR curve).As price falls with
increase in sales. AR and MR will diminish and the MR will be lower than AR. Thus the MR curve will be below
the AR(demand curve )

The monopoly is in equilibrium at the point N, where MC=MR and MC curve cuts MR curve from below. The
firm produces OQ units of the product and sells them at price OP. The distance between A and Q represents
average revenue and B and Q, average cost. AB represents average profit. Average profit (AB) multiplied by
quantity gives the monopoly profit. Thus the shaded area PABD represents the supernormal profit earned
by the monopoly firm at the equilibrium price-output level.
6. Examine the process of price and output determination of firm under monopoly in the long run
A monopolist may earn super profit in the short run and in the long run. As the monopolist is the single
producer and as new firms cannot enter the industry, the monopolist will continue to earn super profit in
the long run.
Just like the short run ie. Monopolist firm maximises profit in the long run by producing and selling that
output at which Marginal Revenue is equal to Marginal Cost.
The long run equilibrium of the monopolist will be at the output where the long run marginal cost curve MC
intersects the marginal revenue curve MR. the optimum output will be OQ and the price at which the output
can be sold in the market will be QP’ (ie.OP) in the long run equilibrium. The monopolist produce more and
sells at a lower price thus making large monopoly profit. The rectangle PPLT shows the long run monopoly
profit of the monopolist.
If AR>AC - Super normal profit
If AR = AC- Normal Profit
If AR < AC – loss
7. Explain short run equilibrium of a firm under monopolistic competition
Price output determination under monopolistic competition
Price out put determination under monopolistic competition depends upon the conditions of cost and
revenue. The average revenue curve (demand curve) will be downward slopping because more goods will
be demanded at low price and vice versa. For the same reason marginal revenue curve will also be downward
sloping and it will lie below the average revenue curve.
The aim of the firm under monopolistic competition is to maximize profit, the firm is said to be in equilibrium
at the price-output level where the firm maximises its profit. This occurs when MC=MR, as under any other
market situation. In short run the firm may earn super normal profit or incur loss
Equilibrium of the firm when it earns profit

In the diagram AR represents average revenue curve and MR, marginal revenue curve. SAC and SMC
represent short run average cost curve and short run marginal cost curve respectively. The marginal cost
curve cuts marginal revenue curve from below at point D which represents the equilibrium point. The
equilibrium quantity is OQ at price OP. Average revenue QA is greater than average cost QB. BA represents
average profit. Average profit multiplied with quantity OQxBA= CBAP represents profit. Thus the shaded
area PABC represents profit (supernormal) of the firm under monopolistic competition.

Equilibrium of the firm when it earns loss

The equilibrium point occurs at point D, where MC curve cuts MR curve from below. The equilibrium output
is OQ at price OP. At this level of output average cost QB is more than the average revenue QA, AB represents
average loss. The shaded area PBCA represents loss of the firm in the short run.

8. Explain long run equilibrium of a firm under monopolistic competition

Long run equilibrium of the firm
A firm under monopolistic competition can earn , in the short run, super normal profit or incur loss. An
important feature of monopolistic competition is that there is no restriction on the entry of new firms or the
exit of the existing ones.
if in the short run, the existing firms earn super normal profit, new firms will enter the market and supply
increases. This brings down price and average revenue. Super normal profit disappears. If on the other hand
existing firms incur loss, some may quit the field. This will reduce the supply and increases price and average
revenue. In this process of balancing average revenue equals average cost and the firm will be earning only
normal profit, which is included in cost. Thus in the long run, firm under monopolistic competition will be in
equilibrium when MC=MR and AC=AR

The long run marginal cost (LMC) curve cuts marginal revenue(MR) curve from below at point A, which is
the equilibrium point. At equilibrium output is OQ, and price OP. At equilibrium price –output level, long run
average cost and average revenue are equal. The firm earns no profit and incurs no loss. Thus in the long run
the firm will be in equilibrium when MC=MR and AC=AR.
MODULE 5

Part A
UNIT 5

1. What is pricing
Pricing can be defined as a process of determining the value that is received by an organization in exchange
of its products or services. It acts as a crucial element of generating revenue for an organization. Therefore,
the pricing decisions of an organization have a direct impact on its success.

2. What are the objectives of pricing

Objective of pricing:
1. Profit-oriented Objectives: profit-oriented pricing objectives are about making as much money as
possible.
2. Sales-oriented Objectives: Sales-oriented pricing objectives seek to boost volume or market share.
3. Status quo-oriented Objectives: A status quo pricing objective is one that maintains current price levels
or meets the price levels of the competition.

3. Explain the role of pricing in an organization

4. What is cost oriented pricing?

In this pricing method, many firms consider the Cost of Production as a base for calculating the price of the
finished goods. The cost of the product is the total cost spent on the production of the product. Cost-oriented
pricing method covers the following ways of pricing:

1. Cost-Plus Pricing
2. Maginal cost pricing
3. Target-Return pricing

5.What is competition-oriented pricing?

This pricing method is useful when the product is homogeneous and market is highly competitive. Under
this method, the company tries to maintain the price of its products more or less at par with its competitors
price. This pricing method includes :
1. Premium pricing –Pricing above the level adopted by the competitor.
2. Discount pricing – Pricing below the level adopted by the competitor.
3. Going rate pricing –Pricing to match with the competitor .
6.define cost plus pricing
It is one of the simplest pricing method wherein the manufacturer calculates the cost of production incurred
and add a certain percentage of markup to it to realize the selling price. The markup is the percentage of
profit calculated on total cost i.e. fixed and variable cost.
E.g. If the Cost of Production of product-A is Rs 500 with a markup of 25% on total cost, the selling price will
be calculated as
Selling Price= cost of production + Cost of Production x Markup Percentage/100
Selling Price=500+500 x 0.25= 625
Thus, a firm earns a profit of Rs 125 (Profit=Selling price- Cost price)

7. What is the importance of pricing in small business

8. Define Price Skimming

Price skimming involves setting rates high during the initial phase of a product. The company then lowers
prices gradually as competitor goods appear on the market. An example of this is seen with the introduction
of new technology, like an 8K TV, when currently only 4K TVs and HDTVs exist on the market.

9. What is psychological pricing

Psychological pricing refers to techniques that marketers use to encourage customers to respond based on
emotional impulses, rather than logical ones.
For example, setting the price of a watch at $199 is proven to attract more consumers than setting it at $200,
even though the actual difference here is quite small.

10. Identify the objectives of pricing in large enterprises

11. List out ant two methods of pricing in large enterprises

12. What is Kinked Demand Curve

The concept of kinked demand curve was introduced by an American economist Paul M Sweezy. Kinked
demand curve explains the situation of price rigidity under oligopoly. The demand curve of an oligopolist
firm has a kink at the prevailing market price. The kind divides the demand curve into two portions. The
upper portion of the demand curve is more elastic and the lower portion is less elastic.

Part B

1.What are the objectives of pricing process

2. Discuss the steps involved in Pricing Process

1. Selecting the pricing objective: If a company is looking to maximise the profit, it
can set a higher price by considering costs and the competition. On the other hand,
if a company is looking to improve and maximise its market share, it will set a lower
price to generate maximum volume.
2. Determining Demand: What companies must do is plan the demand while
understanding price sensitivity. It is possible to estimate the demand by analysing
historical data or performing price-related tests. That way, a company can gain a
deeper insight into how much the consumers are willing to pay for a specific
product or service.
3. Estimating cost: Companies need to manage their costs so that they are left with a
good profit margin. Therefore, to achieve this, a company needs to establish a
production level at which it will be able to maintain it’s fixed and variable costs.
4. Analyzing competitors price, offers: Every company has to track its competitors
carefully. That especially goes for pricing, costs, and promotional offers. Companies
need to know just how much their competitors’ prices can fluctuate in comparison
to their own. They also need to be ready to adjust to those fluctuations with their
own offers.
5. Selecting the pricing method:
6. Selecting the final priceThe previous steps will help you set a price, but the final
word goes to your consumers. Do market research to make sure that you’re not
under or overcharging for your products or services.

3. Why product pricing is important?

4. Explain the types of pricing strategies?

 5. Explain the types of cost-oriented pricing?
Many firms consider the Cost of Production as a base for calculating the price of the finished goods. Cost-
oriented pricing method covers the following ways of pricing:
1. Cost-Plus Pricing: It is one of the simplest pricing method wherein the manufacturer calculates
the cost of production incurred and add a certain percentage of markup to it to realize the selling
price. The markup is the percentage of profit calculated on total cost i.e. fixed and variable cost.
E.g. If the Cost of Production of product-A is Rs 500 with a markup of 25% on total cost, the selling price will
be calculated as
Selling Price= cost of production + Cost of Production x Markup Percentage/100
Selling Price=500+500 x 0.25= 625
Thus, a firm earns a profit of Rs 125 (Profit=Selling price- Cost price)
2. Maginal cost pricing: Under marginal cost pricing, fixed costs are ignored and prices are
determined on the basis of marginal cost. The firm uses only those costs that are directly
attributable to the output of a specific product.
3. Target-Return pricing: In this kind of pricing method the firm set the price to yield a required
Rate of Return on Investment (ROI) from the sale of goods and services.
E.g. If soap manufacturer invested Rs 1,00,000 in the business and expects 20% ROI i.e. Rs 20,000,
The target return price is given by:
Unit cost =16 and unit sales =5000
Target return price= Unit Cost + (Desired Return x capital invested)/ unit sales
Target Return Price=16 + (0.20 x 100000)/5000Target Return Price= Rs 20

6. Explain the types of competition-oriented pricing?

This pricing method is useful when the product is homogeneous and market is highly competitive. Under
this method, the company tries to maintain the price of its products more or less at par with its competitor’s
price. This pricing method includes:
1. Premium pricing –Pricing above the level adopted by the competitor. Companies use a premium
pricing strategy when they want to charge higher prices than their competitors for their products. The
goal is to create the perception that the products must have a higher value than competing products
because the prices are higher. The company is betting that the consumer will not investigate to find
out if the product is truly a higher-quality item
2. Discount pricing – Pricing below the level adopted by the competitor. In Discount pricing the original
price for a product or service is reduced with the aim of increasing traffic, moving inventory, and
driving sales. People are drawn to lower prices because consumers love feeling as if they are scoring a
good deal.
3. Going rate pricing –Pricing to match with the competitor. With a going-rate pricing method,
companies feel secure as they are sure to get the customers because of the same rates prevailing in the
industry.

7. Explain the different pricing strategies for small business?

The different pricing strategies for small business are as follows:
1. Pricing for market penetration: Penetration pricing aims to attract buyers by
offering lower prices on goods and services than competitors.
2. Economy Pricing: This involves minimizing marketing and production expenses as
much as possible. Economy pricing aims to attract the most price-conscious
consumers. Because of the lower cost of expenses, companies can set a lower sales
price and still turn a slight profit
3. Pricing at a premium: With premium pricing, businesses set costs higher because
they have a unique product or brand that no one can compete with.
An example of premium pricing is seen in the luxury car industry. Companies like Tesla can get away with
higher prices because they’re offering products, like autonomous cars, that are more unique than anything
else on the market.
4. Price skimming: price skimming involves setting rates high during the initial phase
of a product. The company then lowers prices gradually as competitor goods appear
on the market. An example of this is seen with the introduction of new technology,
like an 8K TV, when currently only 4K TVs and HDTVs exist on the market.
5. Psychological pricing: Psychological pricing refers to techniques that marketers
use to encourage customers to respond based on emotional impulses, rather than
logical ones.
For example, setting the price of a watch at $199 is proven to attract more consumers than setting it at $200,
even though the actual difference here is quite small.
6. Bundle pricing: In bundle pricing, small businesses sell multiple products for a
lower rate than consumers would face if they purchased each item individually. A
useful example of this occurs at our local fast food restaurant where it’s cheaper to
buy a meal than it is to buy each item individually.
7. Geographical pricing: Geographical pricing involves setting a price point based on
the location where it’s sold. Factors for the changes in prices include things like
taxes, tariffs, shipping costs, and location-specific rent.
8. Promotional pricing: Promotional pricing is another competitive pricing strategy.
It involves offering discounts on a particular product. Example- vouchers or
coupons.

8. How do you select pricing strategy for the small business?

9. What is the best pricing strategy for small business?

10. Explain the different pricing strategies for large business?

11. How do you select pricing strategy for the large business?

12. What is the best pricing strategy for large business?

PART C

1. Explain the factors affecting Price Determination?

Pricing can be defined as a process of determining the value that is received by an organization in exchange
of its products or services.
It acts as a crucial element of generating revenue for an organization.
Therefore, the pricing decisions of an organization have a direct impact on its success.A company has to keep
in mind various factors while determining the price of a product. Some such important factors are given here:
 1. Cost of the Product:
The most important factor affecting the price of a product is the product cost. The same principle also applies
in case of services. The product cost will be inclusive of the cost of production, the distribution costs and
the selling and promotion costs. This cost will act as a benchmark for setting the price.
The three types of costs of a company
a) Fixed Cost: These costs are fixed. They have no relation to the level of activity or
production of the company. Even if there is no production of goods these costs will
occur. For example, the rent of the factory is a fixed cost.
b) Variable Cost: These are the costs that vary in direct proportion to the production
levels of an entity. Higher the production, higher the cost and vice versa. The raw
material is a classic example of a variable cost
c) Semi-Variable Costs: These costs also vary with the production levels. But they are not
directly proportional. Say for example the salary of a manager is 10,000/- a month fixed
and then 10% of his sales. This is a semi-variable cost.
2. The Demand for the Product:
The cost of the product will only give you a benchmark to determine the price. The upper limit of the price
range will depend on the utility the product has and hence its demand in the market. So the cost of the
product is the seller’s concern. The buyer’s concern is the utility of the product. The demand for the product
will depend on its utility and its price.
3. Price of Competitors:
One factor that affects price termination is the price the competition charges for their product. Not only their
price but their products, its features and other factors like distribution channel, promotions etc. should also
be studied.

4. Government Regulation:
The government has a duty to protect its citizens from unfair practices and pricing. So it may impose certain
laws and regulations with regards to the pricing of a product. It can even regulate the prices of goods that it
considers essential goods.
2. What is the importance of pricing in modern organization?

3. Discuss the various pricing strategies for the organization?

Strategy is a plan of action to adjust with changing condition of the– market place. New and unanticipated
developments such as price cut by rivals, government regulations, economic recession, changes in consumer
demand etc. may take place, and then changes all for special attention and relevant adjustments in the pricing
policies and producers.
1. Cost-Plus Pricing:
It is one of the simplest pricing method wherein the manufacturer calculates the cost of production incurred
and add a certain percentage of markup to it to realize the selling price. The markup is the percentage of
profit calculated on total cost i.e. fixed and variable cost.
E.g. If the Cost of Production of product-A is Rs 500 with a markup of 25% on total cost, the selling price will
be calculated as Selling Price= cost of production + Cost of Production x Markup Percentage/100
Selling Price=500+500 x 0.25= 625
Thus, a firm earns a profit of Rs 125 (Profit=Selling price- Cost price)
2. Maginal cost pricing:
Under marginal cost pricing, fixed costs are ignored and prices are determined on the basis of marginal cost.
The firm uses only those costs that are directly attributable to the output of a specific product.
3. Target-Return pricing:
In this kind of pricing method the firm set the price to yield a required Rate of Return on Investment (ROI)
from the sale of goods and services.
E.g. If soap manufacturer invested Rs 1,00,000 in the business and expects 20% ROI i.e. Rs 20,000, the target
return price is given by:
Unit cost =16 and unit sales =5000
Target return price= Unit Cost + (Desired Return x capital invested)/ unit sales
Target Return Price=16 + (0.20 x 100000)/5000Target Return Price= Rs 20
4. Competition based pricing:
This pricing method is useful when the product is homogeneous and market is highly competitive. Under
this method, the company tries to maintain the price of its products more or less at par with its competitors
price. This pricing method includes :
a. Premium pricing –Pricing above the level adopted by the competitor.
b. Discount pricing – Pricing below the level adopted by the competitor.
c. Going rate pricing –Pricing to match with the competitor.

5. Sealed bid Pricing:

This method of pricing is quite popular in construction activities and disposal of used products. Here the
prospective buyers are asked to quote their prices through a sealed cover. All the offers are opened at a pre-
announced time of a day in the presence of all the bidders. The buyers who quotes the highest is awarded
the contract.
6. Pricing for market penetration:
Penetration pricing aims to attract buyers by offering lower prices on goods and services than competitors.
7. Economy Pricing:
This involves minimizing marketing and production expenses as much as possible. Economy pricing aims to
attract the most price-conscious consumers. Because of the lower cost of expenses, companies can set a
lower sales price and still turn a slight profit.
8. Pricing at a premium:
With premium pricing, businesses set costs higher because they have a unique product or brand that no one
can compete with.
An example of premium pricing is seen in the luxury car industry. Companies like Tesla can get away with
higher prices because they’re offering products, like autonomous cars, that are more unique than anything
else on the market.
9. Price skimming:
Price skimming involves setting rates high during the initial phase of a product. The company then lowers
prices gradually as competitor goods appear on the market. An example of this is seen with the introduction
of new technology, like an 8K TV, when currently only 4K TVs and HDTVs exist on the market.
10. Psychological pricing:
Psychological pricing refers to techniques that marketers use to encourage customers to respond based on
emotional impulses, rather than logical ones.
For example, setting the price of a watch at $199 is proven to attract more consumers than setting it at $200,
even though the actual difference here is quite small.
11. Bundle pricing:
In bundle pricing, small businesses sell multiple products for a lower rate than consumers would face if they
purchased each item individually. A useful example of this occurs at our local fast food restaurant where it’s
cheaper to buy a meal than it is to buy each item individually.
12. Geographical pricing:
Geographical pricing involves setting a price point based on the location where it’s sold. Factors for the
changes in prices include things like taxes, tariffs, shipping costs, and location-specific rent.
13. Promotional pricing:
Promotional pricing is another competitive pricing strategy. It involves offering discounts on a particular
product. Example- vouchers or coupons.

4. Effective pricing strategy is a tool for the success

5. What are the advantages and disadvantage of competing on the basis of price in
small business?
6. Price is a major weapon of competition in large small enterprises. Elucidate
7. Describe the important pricing method in the success of small business.
8. Price is a major weapon of competition in large enterprises. Elucidate
9. What are the importance pricing strategy in large enterprises?