INDUSTRIAL

ECONOMICS
 ECONOMICS
 Economics is the study of how human beings make
choice to allocate scarce resources to satisfy their
unlimited wants in such a manner that consumers
can maximize their satisfaction, producers can
maximize their profits and the society can maximize
its objectives.
Classification of Economics
 Micro Economics- is the economics of individual
economic unit like a firm, an industry, a producer and
the factors of production.
 Macro Economics- relates to the growth of national
income, aggregate demand, aggregate supply,
aggregate investment level and economy as a
whole.
INDUSTRIAL ECONOMICS

 It is a distinctive branch of economics which

deals with the economic problems of the
firms and the industries and their relationship
with the society.

 It has both micro aspect and macro aspect.

Role of General Economics in
Industrial Economics
 The problem of decision making

 The problem of uncertainty and risk

Imperfect market conditions, government policies, import and
export

 The problem of forecasting

Position of raw materials, the prices of factors of production etc.
OBJECTIVES

 Achieving industrial development

 Information related to the natural resources,
industrial climate, supplies of factors of
production etc.
 SCOPE OF INDUSTRIAL ECONOMICS

 Industrial Efficiency- Determined by

production function
 Diversification
 Industrial Finance-
Two Dimensions- Source of finance & its effective utilization
 Industrial location
 The determinants of profitability-
Government policies, Advertisement, Size of a firm, market
concentration etc.
 The organizational form and its motives
 Theory of demand- Consumer behavior
 Theory of production- Producer’s behavior
 Cost Analysis- Relation between cost and
quantity of output.
 Profit Analysis- Most common objective
 Analysis of pricing theory- Different market
conditions, price discrimination.
PRODUCTION FUNCTION
Production Function

 It is the functional relationship between the

quantity of product and the quantities of the
factors of production required to produce.
Types of production function
 Short run production function- It is that time period in
which production of a commodity is increased by
increasing the use of only variable inputs like labour
and raw material while the fixed input remains
constant.

 Long run production function- It refers to that time

period in which production of a commodity can be
increased by employing both the variable and the
fixed inputs.
CONCEPTS OF PRODUCTION
 Total Production- Total amount of goods and
services produced in a given period.

 Marginal Production- Change in total production due

to application of one more or one less unit of variable
factor.

 Average Production- Per unit production of variable

factor.
LEAST COST COMBINATION
Least cost combination
 Least cost combination is the optimum
combination of the factors of production at
which a producer has to pay minimum cost of
producing a certain quantity of output.
 2concepts-
 Iso Quant curve
 Iso Cost line
Iso Quant Curve

 It represents all the factor inputs which yield

a given quantity of product.
 Iso Product Map- A family or a group of equal
product curves is called an Iso Product Map.
Properties of Iso Quant Curves
 It is convex to the origin- Diminishing
marginal rate of technical substitution.

 An Iso Quant Curve slopes downwards from

left to right.

 Two Iso Quant curves never intersect each

other.
ISO-COST LINE

 Iso cost line represents the various

combination of two factors that will incur the
same level of total cost.

 Suppose total finance available with a firm-

Rs. 10,000. Per unit price of labour- Rs.100,
Per unit price of Capital- Rs. 1000.
 3 Alternatives-
 Spend all its finance on Capital
 Spend all its finance on Labour
 Partly on Capital and partly on Labour.
 Determination of Optimum
Combination

 Firms attain equilibrium at a point where Iso-

Cost line is tangent to Isoquant Curve.

 MRTSLK= dK/dL = PL/PK

LAW OF VARIABLE PROPORTIONS
Law of Variable Proportions
 It predicts the consequences of varying the
proportions in which the fixed and variable factors of
production are used.

 It states that as the proportion of factors is changed,

the total production at first increases more than
proportionately, then equi-proportionately and finally
less than proportionately.
ASSUMPTIONS
 One of the factors is variable, while all other
factors are fixed.
 All units of variable factors are homogenous
or equally efficient.
 There is no change in technique of
production.
 Factors of production can be used in different
proportions.
STAGES

 I Stage- From origin to point where the

average output is the maximum.
 II Stage- From the point where average
output is maximum to where marginal output
is zero.
 III Stage- Range over which marginal output
is negative.
Causes of Application
 Indivisibility of Factors
 Change in Factor Ratio
 Imperfect Substitutes

 STAGE OF RATIONAL DECISION-

 The rational decision of the purely
competitive firm will be to operate in stage II
LAW OF RETURNS
Returns- 2 types

 Returns to Factor
 Returns to Scale
Law of Returns to Factor

 Laws of return to factor describe increase in

production by taking only the one variable
factor along with the other fixed factors.
3 parts-

 Increasing returns to a factor

 Constant returns to a factor
 Decreasing returns to a factor
Increasing Returns to a Factor

 As the proportion of one factor in a combination of

factors is increased, upto a point, the marginal
productivity of the factors will increase.

 Reasons
 Fuller utilization of fixed resources
 Indivisibility of factors
 Division of Labour
Constant Returns to a Factor

 Constant returns to a factor occur when

additional application of the variable factor
increases output only at a constant rate.

 Reason-
 Optimum use of fixed factor
Diminishing Returns to a Factor

 As we increase the quantity of any one input which is

combined with fixed quantity of other inputs, the
marginal physical productivity of the variable input
must eventually decline.

 Causes-
 Imperfect Substitutes
 Fixed Factors of Production
LAW OF RETURNS TO SCALE
 The term returns to scale refers to the
changes in output as all factors change by
the same proportion.

 3 parts-
 Increasing
 Constant
 Diminishing
Increasing Returns to Scale
 It is a situation when proportionate increase
in all the factors of production results in more
than proportionate increase in output.

 Cause-
 Economies of Scale> Diseconomies of Scale
Constant Returns to Scale
 It refers to a situation when a proportionate
increase in all the factors of production
results in equal proportionate increase in
output.

 Cause
 Economies of Scale= Economies of Scale
Diminishing Returns to Scale

 It refers to a situation when a proportionate

increase in all the factors of production
results in less than proportionate increase in
output.

 Cause-
 Diseconomies> Economies
THEORY OF COSTS
Ordinarily, the term ‘cost of production’ refers to
money expenses incurred in production of a
commodity.

But a little reflection would make it clear that

money expenses are not the only expenses
that are incurred on the production of a
commodity.
 COSTS

PRIVATE,
INCREMENTAL
OPPORTUNITY EXTERNAL
MONEY COSTS AND
COST AND
SUNK COST
SOCIAL COSTS

EXPLICIT COST IMPLICIT COST

OPPORTUNITY COSTS

 The opportunity cost of anything is the next

best alternative that could be produced
instead by the same factors or by an
equivalent group of factors, costing the same
amount of money.

 This concept was first developed by the

Austrian School of Economics.
 COST FUNCTION
 A cost function expresses the relationship between
cost and its determinants.

 Several factors influence cost. When their

relationship to cost is expressed in a functional or
mathematical form, it is called cost function.
C=f (S, O, P, T)

S-size of plant, O- level of output,

P- price of inputs, T-technology
SHORT-RUN COST FUNCTION

 2 TYPES OF COSTS-
 FIXED COSTS
 Salary and other expenses of administrative staff.
 Salary of staff involved directly in the production, but on a fixed
term basis.
 Wear and tear of machinery.
 The expenses for the maintenance of buildings.

 VARIABLE COSTS
 Direct labour which varies with output.
 Raw material.
 Running expenses of machinery.
 SHORT
RUN
COSTS

AVERAGE MARGINAL
TOTAL COSTS
COSTS COSTS

TOTAL TOTAL AVERAGE AVGERAGE

FIXED VARIABLE FIXED VARIABLE
COSTS COSTS COSTS COSTS
Total Costs of Production

 It refers to the aggregate of expenses on

fixed and variable factors of production.

 TC= TFC+TVC
 TC=AC*Q
 Total Fixed Costs- It refers to the sum of all the
expenses on the fixed factors like land, insurance
etc.

 Total Variable Costs- It represents the cost of all

variable resources, such as labour, raw material, etc.

 Total Cost- Sum total of total fixed costs and variable

costs.
 AVERAGE COSTS

 It is the per unit cost of production.

 Average Fixed Cost- It is the per unit cost of the fixed

factors of production.
AFC=TFC/TQ

 Average Variable Cost- It is the per unit cost of the

variable factors of production.
AVC=TVC/TQ
Why AC Curve is a
U-Shaped Curve?
 AC Curve is the sum of AFC and AVC.

 Total fixed costs remains constant at different level of output, it

follows that average fixed cost falls as the level of output is
increased.

 AVC is a dish shaped curve, influenced by law of variable

proportions.

 Hence, as long as average variable costs fall, Average total

costs also falls. Beyond this point , for some time, though the
AVC may be rising, the falling fixed cost overbears it resulting
in declining AC. But ultimately AC must rise.
 MARGINAL COST

 Marginal Cost is the addition to the total cost

as a result of a unit increase in the output.
MCn = TCn – TCn-1
 Relation between Marginal Cost &
Average Cost

 When average cost falls with an increase in output,

marginal cost is less than the average cost.

 MC begins to rise at a lesser level of output than AC.

 The MC curve cuts the average cost curve at its

minimum point.

 With increase in AC, marginal cost rises at a faster

rate.
When MC>AC, it pulls A Upwards.

When MC<AC, it pushes AC downwards.

When MC=AC, A is constant.

Long Run Costs

Long Run Costs

Long run
Long Run Long Run
Average Costs
Total Costs Marginal Costs
Long Run Total Costs

 It is the summation of several short run total

cost curves.

 The long run cost of production is the least

possible cost of producing any given level of
output when all inputs are variable.
Long run Average Cost

 It shows the lowest average cost of

producing output when all inputs can be
varied freely.

 LAC curve is U shaped. Why?

Long Run Marginal Cost

 It is that curve which shows the extra cost

incurred in producing one more unit of output
when all inputs can be changed.
MARKETS
MONOPOLY

 Monopoly is a market situation in which there

is a single seller, there are no close
substitutes for commodity it produces, there
are barriers to entry.
Features of Monopoly

 One seller and large number of Buyers

 Monopoly is also an industry
 Restriction on the entry of the new firms
 No close Substitutes
 Price Maker
 Price Discrimination
Causes or Sources of Monopoly

 Control over raw material or ownership of

Natural resources
 Patents
 Technical Barriers
 Government Policy
 Limiting Pricing Policy
 Price & Output Determination under
Monopoly

 2 Approaches-
1. Total Revenue and Total Cost Analysis
2. Marginal Revenue and Marginal Cost
Analysis
Short Period
Long Period
 Price Determination under Short
Period

 Super Normal Profit

 Normal Profit
 Minimum Loss

Price Determination under Long

Period
 Comparison Between Monopoly and
Perfect Competition

 Goals of the firm

 Assumptions Regarding Production
 Assumption Regarding number of seller and
buyers
 Assumption regarding Entry
 Implication regarding shape of Demand
Curve
 Comparison Regarding Price
contd….
 Comparison Regarding Output
In Perfect Competition- MC=MR=AR=LAC
 Comparison Regarding Profits
 Utilization of Resources
DISCRIMINATING MONOPOLY

 Discriminating monopoly means charging different rates from

different customers for the same good or service.

 It becomes possible where there is no competition in the

market and different buyers show different elasticity of demand
for the product.

Types-
 Personal Price Discrimination
 Geographical Price Discrimination
 Price Discrimination according to Use
Conditions of Price Discrimination

 Existence of Monopoly
 Separate market
 Difference in the elasticity of demand
 Expenditure in dividing and subdividing market to be
minimum
 Production of commodity to Order
 Legal Sanction
 Product Differentiation
 Behavior of the Consumers
 When is Price Discrimination
Profitable?

 It is profitable when the price elasticity of demand is

different in different markets
.
 MR=AR((E-1)/E)

 It is profitable to transfer the commodity from less

marginal revenue market to more marginal revenue
market.
 Price & Output Determination Under
Discriminating Monopoly

 In order to get maximum profit 2 conditions must be

fulfilled-

1. Must get same marginal revenue in both markets-

MR1=MR2
2. Equality between MR & MC-
MR1=MR2=MC
Effects of Price Discrimination

 Beneficial Effects-
1. Beneficial to the Poor
2. Public Utility Services
3. Full Utilization of Resources

 Harmful Effects-
1. No proper Use of Factors of Production
2. Less Production