Introduction To Managerial Economics

• Economics a science 
• Economics a social science which study human behavior when its comes to satisfying wants
with the help  of scarce resource.
• In classical days economics was just one whole body.
• How ever it has now branched out in to various areas.
• We now have a branch of economics every area for ex. Monitory economics, industrial
economics, agriculture economics, infrastructural economics etc., that analyze  the
respective fields. Like wise we have managerial economics which studies the skills of a
manager to bring together certain elements and carry on a successful business .
• We may therefore define managerial economics as the discipline which deals with the
application of economics theory to business management.
• It serves as a bridge between the two disciplines.
• It involves bringing together  co- equal elements and going ahead in business.
• This elements such as innovation, production, promotion, pricing, distribution,rnd
• The Scope of Managerial economics that we will be studying is as follow
1) Demand analysis
2) Supply analysis
3) Cost analysis
4) Market Condition
5) Production analysis and factor of productions
• Economic theory offers various analytical tools which can be of assistance to the manager in decision
making the tools are one
1) Opportunity cost principal means cost involved in any decision consists of sacrifices of alternatives required
by that decision, if there are no sarifices there are no costs.
2) Incremental Principal -  Incremental concept involves estimating the impact of decision of cost and
revenue, resulting from changes in price product procedure, investment eg if a firm decides to go for
computerisation of market info, the additional revenue it earns will be termed as incremental revenue
whereas the cost of setting up the computer facilities will be incremental cost.
3) Principal of Time Perspective – Managerial economies are also concerned with short run and long run
effects of decision of revenue as well as cost
4) Discounting Principal :- so fundamentally a rupee tomorrow is worth less than a rupee today , so principal
involved states if a decision affects at a future date it is necessary to present values before a valid
comparison of alternatives  if possible .eg rs 100 today will not be equivalent to rs 100 after a year. but at
an interest rate of 8% he will get 108rs
• Role of a Managerial economist Involves :-

• Environmental Study

• Business operation

• Specific function

• A managerial economist a best only if he always keep his mind the main
objective of business that is to make a profit on its invested capital to conculed a
managerial economist has a very important roll to play by helping management
in successful decision making and forward planning.
Demand Analysis
• Demand is a basically a desire to buy a good backed by the willingness
to buy it and ability pay for it at a particular price at a point of time.
• Factor affecting demand would be
1) Price of the good
2) Size of population
3) Composition of Population, when its comes to age, sex.
4) Distribution of income
5) Sociological factor
6) Weather condition
• Law of Demand:-
• The law of demand explains a functional relationship between price
of a commodity and qty demanded.
• Other things being constant when the price of the commodity
increases the qty demanded of that commodity decreases. And when
price of a commodity decreases the qty demanded of that
commodity increases.
• Price and demand are inversely related.
• Demand schedule:-
The Demand schedule is a tabular form of expressing the relationship
between the price of a commodity and qty demanded.
• Assumptions to the law:-
1) Price of related goods should remain constant.
substitute goods be complementary goods.

2) Tastes and preferences should remain constant.

3) Size of population and composition of population should remain constant.

4) Distribution of income should remain constant.

5) Sociological Factor should remain constant.

6) Weather condition should remain constant.

Price Of The Commodity Qty Demanded
4 0
3 1
2 2
1 3
0 4
• Demand Curve:-

X
D

Price

Demand Y
The Above Demand Curve D D is seen to be downward sloping from
left to right this indicate a negative relationship between qty demanded
and its price.
• Exceptions to the Law :-
1) Speculation
2) Snob effect
3) Band wagon effect
4) Preference
5) Emergencies
6) Giffen good

Changes in demand and shifts in demand

Changes in demand is when price changes and shifts in demand is
when other factors like taste and preference change.
Elasticity of Demand
• Elasticity of demand is the degree of responsiveness of demand to a
change in price of commodity, change in income of the consumer, or
change in price of related good.
• Hence we have:-
1) Price elasticity.
2) Income elasticity.
3) Cross elasticity.
• Determinants of elasticity
1) Nature of the commodity
2) Availability of substitutes 
3) Share in total expenditure
4) Possibility of postponing consumption
5) Several users of the commodity
6) Consumer habit

• Price elasticity of demand is the degree of responsible of demand to a change in price of

commodity concerned. It is denoted by ed( elasticity of demand)
• Ed= Proportionate change in demand
Proportionate change in Price

= New demand – Old Demand

Old Demand
New Price – Old Price
OLD Price
• Income Elasticity of demand is the degree of responsiveness to a
change in income of the consumer

• Ey=Proportionate change in demand

Proportionate change in Income

• Cross Elasticity of demand is the degree of responsiveness of a

demand for commodity X due to change in price of commodity Y

• Ec= Proportionate change in QTY of X

Proportionate change in Price of Y
Q
Q
P
P

Q P
Q X P

Degrees of price elasticity of demand

1) Perfectly inelastic demand
2) Relatively inelastic demand
3) Unitary Elastic demand
4) Relatively Elastic demand
5) Perfectly Elastic demand
• Perfectly Inelastic Demand:-
When the degree of responsiveness of demand is zero to a change in
price of the commodity concerned.
• e= 0

d
Qty

Price
• Relatively inelastic Demand
It is when a change in price of the commodity is proportionately more
than the change in qty demanded.

e<1

Price D

Demand Y
• Unit Elastic Demand
• It is when change in price of a commodity is equal to change in qty
demanded of the commodity.
• e=1
•X

•
Price

• Demand
• Relativlty Elastic Demand
• When the change in the price of a commodity Is proportionately
lesser than the change in qty demanded of the commodity
•e>1
•x

• D
•
Price

• Y

• Demand
• Perfectly Elastic Demand
• When the Degree of responsiveness of demand is infinitely elastic
with a small change in price it is known as perfectly demand.
• e=
X

Price

Demand Y
• Income Elacticity of Demand
• Ey=Proportionate change in demand
Proportionate change in Income

Ey= Q x Y
Q Q
• Cross Elasticity of Demand
EC= Proportionate Change in qty of X
Proportionate Change in Price of Y

EC= QX x PY
PY QX
Elasticity of Substitution:-
This Concept is base on substitution effect. A consumer who has
choose between combinations of two commodities.
Elasticity of substitution is degree at which one commodity can be
substituted for another.
• Ec= Proportionate Change in combination of ratios of X and Y
Proportionate Change in Price Ratios of X and Y
Method to measure price elasticity demand
1) Total outlay Method
Total outlay refer to total expenditure
TO= P x Q
P- Price
Q- Qty
ED= 1 - Total Outlay
Q1 P
• Point Elasticity Method ( Geometric Method)
In this Method elasticity is not measured over a price range but at a
point on the demand curve.
The elasticity can thus be measured on the straight line
A AB=12 AM=6 DB=4 AD=8
C

M Click to add text

O B
• EC= Lower Segment
Upper Segment

ED at point M = MB = 1
MA

ED at Point C = CB
CA
ED > 1
ED at point D= DB
DA
ED < 1
ED at Point B = B = 0
BA
ED = At point AB =
A
DEMAND FORECASTING
Demand forecasting refers to the prediction of future demand.
Demand is known to be volatile as there are constant changes in the economy,constant changes in
production,demand,tastes of the consumer.
Due to these dynamic conditions,forecasting is essential.
Purpose of forecasting.
a)Time perods:long term forecasting
Short term forecasting
-under short term forecasting,one can plan purchasing raw material, changing pricing strategies,schedule new
production,etc

-Usually purpose of long term forecasting :

Planning of a new project
-expansion
-modernization of an existing unit
-diversifying
-raising financial resources
-changing production techniques
STEPS INVOLVED IN DEMAND
FORCASTING
• Selection of goods
• Consumer goods
• Capital goods
• New goods
• Existing goods

• Setting of objectives
Firm should be clear of the objectives
Setting of objectives
• Size of output
• Fixing price of the commodity
• Upgrading technology…

Selection of the method

Different methods used for forecasting..
These methods should be easy,data should be available in time,trained personnel..

Interpreting results
A good demand forecasting method has
certain criteria
• 1)Accuracy
Degree of deviation between reality and forecast
Extent of succsess in forecasting

2)Economical
3)Easily available
4)Should not be time consuming
5)Simple no complications
DIFFERENT LEVELS OF FORECASTING
• The different levels at which one can forecast are:
• Macro level
• Firm level
• Industry level
• Product line level

METHODS OF FORECASTING
OPINION POLL METHOD
STATISTICAL METHOD

• OPINION POLL METHOD

• 1)consumer survey method
• 2)collective opinion method
• 3)experts opinion method

• STATISTICAL METHOD
• 1)Trend projection method
• 2)Barometric method
• 3)Regession method
Consumer survey method
• Sample survey
• Collective opinion or sellers survey

• Merits of opinion poll method

• It is a simple method.
• Not complicated.
• Based on first hand information of buyers and sellers
• This method may prove useful in forecasting sales of new products
• The method is subjective and usefulness is restricted to short term.
STASTICAL METHODS
A) Trend Projection Method :-
Trend refers to a tendency to either increase or decrease ( treand
Pattern) output and sales of a firm may increase and decrease hence
can be measure showing the rise or fall depending of the data.
Y= A+ BX where Y is the trand A and B are constants. Y is a dependent
variable X is a independent variable. YEARS X Sales Y
1985 20
This can be graphically represented 1986 30
1987 40
1988 50
1989 60
1990 70
1991 80
• 
• Y

Sales Y= A+BX

Years Y
The above show an upper Trend

B) Least Squares Method

it is a mathematical procedure for fitting a line. This technique is called the least square method as
the sum of square deviations is calculated and the errors are minimize by squaring them and
minimizing their sum here we find trend line which best fit the data
Trend Line Y= a+bX
I
II
Year (n) Year number (x) Sales (Y)
1987 1 20 1 20
1988
1988 2
2 30
30 4
4 60
60
1989
1989 3
3 35
35 9
9 105
105
1990
1990 4
4 40
40 16
16 160
160
1991 5 38 25 190
1991 5 38 25 190
1992 6 47 36 282
1992 6 47 36 282
N=6
N=6
1. 210=6a+21b Solve Simultaneously
2. 817=21a+91b
b=4.68
By substituting value of b in above equation you get value of a
a=18.60
y=a+bx

When x = 1
Y = 18.60 + 4.68 x 1
= 23.28
When x= 2
Y=18.60+4.68 x2
Y= 27.96
• Hence we can see values of x and y even for the 7th year when we
have values of unknown constants a and b.
• Method of measuring price elasticity of demand
1) Total outlay method
2) Proportionate method
3) Point elasticity method

Importance of elasticity of Demand

4) Importance to a monopolist
5) Importance to the Government
6) Importance in international trade
7) Paradox of poverty amidst plenty
• SUPPLY ANALYSIS
• Supply refers to the quantity offered by a seller for sale,at a particular
price at a a point of time,supported by the ability to sell and the
willingness to sell.
• Supply is a relative concept.
• Like demand supply is also part of an important mechanism in the
economy.(market forces)
• Supply can be offered by a single seller or the market.
• There are different types of supply:
• The different types of supply are as follows:
• 1)Joint supply-when two or more commodities are supplied with one source.
• 2)Composite supply-when one commodity has different sources of supply.

• Factors influencing supply:

• Price
• Natural factors
• Technological factors
• Transport conditions
• Availability of factors of production
• Government policies
• The supply function is as follows:

• Qs=f(P,O)
• Where ouantity supplied is a function of,or depends on price of the
commodity and other factors.
• Concepts of changes in supply and variations in supply.
• Changes in supply refers to change in supply pattern due to all the non
price factors.
• Variations in supply refer to increase or decrease in supply due to price.
LAW OF SUPPLY
• Statement of the law:
• Other things being equal,when the price of a commodity increases,the supply for that commodity rises,when the
price of a commodity falls,the supply for that commodity falls.
• This explains a functional relationship between quantity supplied and price of that commodity,
• It indicates a direct relationship between the two.

• ASSUMPTIONS TO THE LAW OF SUPPLY

• No change in transport cost.
• No variations in cost of production.
• No change in technique of production.
• No change in scale of production.
• No change in government policies.
• No change in price of related goods
• No speculations
• Supply depends on STOCK
• Stock happens to be the source of supply.
• SUPPLY SCHEDULE

PRICE Q SUPPLIED
1 10
2 20
3 30
4 40
5 50
• In the supply schedule we can see how the price rises and
subsequently the supply also rises with the price.
• This shows a direct relationship between price and the quantity
supplied.

• SUPPLY CURVE

Price SS

QTY
• In the given diagram,we can see how the supply curve SS goes
upward from left to right.
• This indicates how supply and price go in one direction.

• Exceptions to the law

• 1)antiques
• 2)supply of savings
• 3)backward bending supply curve of labour
• Backward bending supply curve of labour shows how supply of labour
rises with a rise in wages.
• However, as the wages tend to go higher,beyond a point,supply of
labour begins to drop,
• This is because the labourer may want to start investing in leisure.

SS
Price

QTY
• We
  can note in the given diagram,that the curve SS first rises with rise in
wages,further the same curve bends,showing,higher wages but a fall in
supply of labour to match with it.

• ELASTICITY OF SUPPLY:
• Elasticity of supply is thr degree of responsiveness of supply to a change
in price of the commodity or change in price of related commodity.
• Es=
•
• The two main types of elasticities of supply:
• Price elasticity
• Cross elasticity
• Price elasticity refers to the degree of responsiveness of supply to a
change in price of the commodity concerned.
• Cross elasticity refers to change in supply of a commodity due to a
change in price of another commodity.
DIFFERENT DEGREES OF PRICE
ELASTICITY OF SUPPLY
• Perfectly inelastic supply

SS
Price

QTY
• Indicates complete shortage
• Relatively inelastic supply
SS
Price

Qty

• This indicates a small shortage of supply

• UNITARY ELASTIC SUPPLY

SS
Price

Qty

• This indicates supply change proportionately equal to price change.

• Relatively elastic supply

Price SS

Qty

• This indicates large supply with a small change in price

• Perfectly elastic supply

• This indicates infinite supply at a small change in price.(dumping)

Price SS

QTY
COST ANALYSIS
• Cost of production of a firm is extremely crucial.
• It is very important that a manager analyses the cost as,every increase
in cost reduces profit.
• The total cost of a firm is the complete cost of production borne by a
producer.
• This includes every single cost from the smallest variable cost to the
biggest fixed cost involved in the process of producing a commodity.
• A cost function is what determines what cost depends on.
• Cost functions differs from short run to long run.
DIFFERENT TYPES OF COSTS

• The cost order or the cost ladder:

• TOTAL COST-the aggregate expenditute incurred by a firm on producing a given

level of output
• -Total fixed cost +Total variable cost =Total cost

• AVERAGE COST-it is a fixed cost per unit of output

• AFC=TFC
• Q
• Ie total fixed cost divided by total units of output
Types of cost continued

• AVERAGE TOTAL COST=Average variable cost +Average fixed cost

• Average variable cost is the variable cost per unit of output
• AVC=TVC
Q
Like wise AVERAGE FIXED COST = TOTAL FIXED COST
TOTAL UNITS OF OUTPUT
• Marginal Cost ( MC)
Marginal cost is cost of producing and additional unit of output.

• MC = TC
Q
Relationship Between average cost and marginal cost
MC

AC
aaa
• Cost

Output
ECONOMIES AND DISECONOMIES TO
SCALE
• Economies to scale are basically advantages to a Firm due to production
which could be internal or external Eg. Internal would be productivity of
labour, technology, expansion of output ( Large scale economies which
reduced cost.
• External economies would be when a rival firm faces production problems
• Diseconomies could also be internal or external ( disadvantages to a firm).
• Internal diseconomies would be when overcrowding starts due to
expansions of output beyond a reasonable level or labour problems,
technological problems that arise.
• External diseconomies is when there are disadvantages due to external
factor
TYPES OF COST
• EXPLICIT COST
• IMPLICIT COST
• PAST COST OR HISTORICAL COST
• REPLACEMENT COST
• OPPORTUNITY COST
LONG RUN AVERAGE COST CURVE
• The long run is a period during which the firm can vary all its inputs.
• The long run average cost depicts the least possible average cost for producing
all levels of output.
• This curve has various names.
• It is called the planning curve.
• It is also called the envelope curve.

• CSAC

Cost

.
SAC
LAC

output
• MARKET STRUCTURES
• A market is not necessarily a place but a set of conditions to which both buyers and sellers
abide,for the purpose of buying and selling at a particular price at a point of time.
• The modern version of market is merely these conditions.Transactions can happen
anywhere eg online transctions have been a trend for several years now.
• Markets are now dynamic and see constant changes in transaction norms.
• These are classified on various basis:
• 1)TIME PERIODS:
• Short period
• Long period

• 2)CLASSIFICATION ON BASIS OF AREA

• Local
• Domestic
• international
On basis of number of sellers
• Markets can be classified on the basis of number of sellers
• Depending on that we have various types of market conditions
• And competition on basis of number of sellers in that market type.
TYPES OF COMPETETION
• Perfect competition (large nos of buyers and sellers)

• Imperfect competition
• Monopoly (single seller)
• Duopoly (2 sellers)
• Oligopoly (8 but few sellers)
• Monopolistic (perfect competition +monopoly)
• The above does have large nos of buyers and sellers but with
characteristics of monopoly.
PERFECT COMPETETION
FEATURES OF PERFECT COMPETETION
1)Large numbers of buyers and sellers,infinite numbers of buyers and sellers in the market.
2)Free entry and exit to the firm.no restrictions on entry and exit for any firm.
3)Every firm is a price taker.it cannot decide the the price in the market.
4)Homogeneous products,identical commodities in every way.
5)Perfect mobility of factors of production.
6)Perfect knowledge of market to both buyers and sellers.
7)Absence of transport costs.
We can see that this is a classical concept and it accrues to only certain goods.
PRICE AND OUTPUT DETERMINATION
UNDER PERFECT COMPETETION
• Since both sellers and buyers are price takers,the price and output
under perfect competition is determined by market forces of demand
and supply,which are also known as market forces or invisible hands.
SS

Price AR=MR

DD
Output, Cost, Revenue
AR=MR=AC=MC
• As we can see in the earlier diagram,under perfect competition,the
forces of demand and supply give the market price,hence the
intersection of demand and supply give the price under perfect
competition which becomes the market price under perfect
competition which is carried forward by all the firms as equilibrium
price and output.
• Also under perfect competition,AVERAGE REVENUE of a firm equals
the MARGINAL REVENUE which equals the price.
EQUILIBRIUM OUTPUT UNDER
PERFECT COMPETETION
• Under perfect competition,equilibrium output and price are
determined by MC and MR ie marginal cost and marginal revenue.
• It is determined at a point where the MC coincincides with the MR
also at this point the level of output obtained is optimum.
• Hence for the equilibrium 2 conditions have to be fulfilled:

• 1)MC=MR at the point of equilibrium

• 2)MC should cut MR at that point.

Equilibrium output under Pc

• MC
•

• P e AR=MR
•e

•
•

• O Q Q1
•
Equilibrium output under perfect competition
is as follows:
• For equilibrium ouitput under pc,
• 1)MC=MR at the point of equilibrium
• 2)MC cuts MR from below at the point of equilibrium

• In the given diagram,at point e, MC =MR also MC cuts MR from

below.Hence point e is the point of equilibrium and oq1 is equilibrium
output.
PROFIT AND LOSS CONDITIONS UNDER PERFECT
COMPETETION
• Super normal profits:
• Under perfect competition,supernormal profits are short
term.herein,AC<AR .However this happens for a short period as
eventually this kind of profit does not exist under PC.

AC MC

P e AR=MR
K F

O Q
• In the given diagram we can see that the AC average cost is lesser
than the average revenue we can also see that equilibrium e has given
us be output OQ on which we have the profit PEFK
• LOSS UNDER PERFECT COMPETETION
AC MC
p1 g
p e AR=MR

O Q
• In the given diagram we can see that the AC is higher than the AR
which shows that the firm is suffering losses on the out put OQ sold.

• LONG RUN NORMAL PROFIT

AC MC

P e AR=MR

O Q
• In the given a diagram we can see that AC = AR at point E where the
firm is at a no profit, no loss situation at this point AC = AR = MC = MR
and this is truly the long term equilibrium under perfect competition
• SHUT DOWN POINT
In a firm when the revenue earned by a firm is less than the total
variable cost the firm will shut down to avoid unnecessary losses.
A firm has to recover variable cost for survival that is ie the current
expenditure in business.
If a firm price is less than average variable cost it will not cover any
cost.
Than the firm wil have to minimize losses by not producer.
AC MC

AVC
e AR=MR=P

e1 AR=MR1=P
Shut down point
• Long Run Equilibrium of a firm under perfect competion
Illustration
MONOPLY
• The term monopoly is derived from the words “mono” which mean
single and poly which selling it means single control over supply
monopoly is that market firm in which a single producer control the
entire supply of a commodity which has no substitutes. (or Negligible)
• There must be producer or seller which may be and individual or joint
stock.
• This single firm constitute the whole industries.
• This firm price maker and can detect price however he can not detect
the price as well as the qty sold at the same time.
• Causes of Monopoly:-
1) Natural monopoly
2) Control over Raw Material
3) Legal restriction for eg. Copyright, patent,
4) Business reputation
5) Economies of Large scale
• TYPES OF MONOPOLY
1) Simple Monopoly ( Such a firm charges a uniform price to all the buyer and also operate in single market).
2) Discriminating Monopoly ( the firm charges different prices to different buyer and operates in one more than market.
• There are various forms of discrimination.
A) Personal discrimination
B) Age discrimination
C) Size discrimination
D) Geographical discrimination
E) Quality Variation discrimination
F) Used discrimination
G) Time discrimination
H) Condition necessary for price discrimination
I) Separate market
J) Apparent product differentiation
K) Buyers illusion
L) Legal sanction
Determination of Output Equilibrium Under
Monopoly
• Under Monopoly the AR is relatively elastic in nature and seans the MR
always follows the AR we will see how the MR lies the under the AR curve

Price
MC
Revenue
Cost e
0 MR AR
Output
• In the given diagram equilibrium out put is shown where MC cuts MR
From below.
• Super normal profit ( this can be enjoyed as long run profits under monopoly)
AC < AR
AC MC
P
R t
C e
MR AR

O Q
Output
We can see that a Part of The AC lies below the AR indicating super normal or
abnormal profits in Red. This kind of a profit is possible in the long run under
monopoly.
Normal Profits Under Monopoly
• Under monopoly a no profit no loss situation is rare but possible as
the monopolist will always struggle to obtain a margin.
AR=AC
AC
MC
P,R,C
AR
MR
O Q
Output
Diagram for normal profit
• As we can see in the given diagram,the AC=AR.
• The output can be seen at oq.

• LOSS UNDER MONOPOLY(short run)

•

•
• AC MC
• P,R,
•C

MR AR

•
•
MONOPOLISTIC COMPETETION
• Monopolistic competition is a combination of monopoly and perfect
competition.
• Some of its features resemble those of monopoly and some thode of perfect
competition.
• Like perfect competition there are alarge number of buyers and sellers.
• There is no restrictions on the number of sellers and buyers entering or exiting
the market.
• However unlike perfect competition,the commodities are similar,not
homogeneous.the commodities may be similar not identical.
• This is because the main feature of monopolistic competition is PRODUCT
DIFFERETIATION.
PRODUCT DIFFERENTIATION
• Product differentiation is the most crucial feature under monopolistic
competition.
• Product differentiatation refers to making the products look different from
each other by various means.
• For the above,the seller would need to incur SELLING COSTS.
• Selling costs refer to the cost incurred by a seller on trying to sell his product.
• The expenditure incurred on advertising,publicity,salesmanship and other
forms of sales promotion is called selling cost.
• Under perfect competition,the need for selling cost is absent as all units of the
commodity look homogeneous.
PRICE AND NON PRICE COMPETETION
• Price competition is where firms compete with each other on the
basis of price.
• Non pricecompetetion is where firms compete with each other,but
here there is no price war.(there could be variations in selling costs)
• Therefore a momopolistic seller does enjoy super normal profit
margins in the long run.
• This is possible as the demand curve or the AR is relatively inelastic in
nature.(this also indicates that a small change in price does not bring
about a drastic change in demand)
EQUILIBRIUM OUTPUT UNDER
MONOPOLISTIC COMPETETION
• In the diagram we see how the MC cuts MR and gives us an equilibrium output

MC

Price

MR AR
0 O, Q, R
SUPERNORMAL PROFITS UNDER
MONOPOLISTIC COMPETETION
• We can see in the given diagram,that AC lies below AR which indicates
there is a supernormal profit margin.hence the equilibrium output OQ
and the profit margin is PKSD.

p S
t ac
mc
MR AR
O Q
NORMAL PROFITS UNDER
MONOPOLISTIC COMPETETION
• UNDER MONOPOLISTIC COMPETETION NO SELLER WOULD WANT TO
SUFFER LOSSES.HOWEVER IN THE LONG RUN,UTMOST COMPETETION
MAY BRING NORMAL PROFITS.

mc
p ac

mr ar
O Q
EQUILIBRIUM OF A FIRM INCURRING
SELLING COSTS
• We will now observe in the following diagram,how a firm which is
already earning profits,now starts earning higher margins,after it
starts to incur advertising costs.
MC ASC

ar1

ac mr1

ar
mr
• In the given diagram we can see that the firm is initially operating at price op
and output oq.here the monopolistic firm is already earning a profit box of
PSTF.
• However when the firm incurs ASC ie average selling costs,the price of the
firm is raised to op1,also the output rises to oq1,thirdly the profit box is now
a bigger one,indicating higher profit margins.
• Another unusual point here is that the firm`s demand curve which was
initially AR is now AR1 which is inelastic (steeper) compared to the earlier
demand curve,
• This shows that by incurring selling costs,the firm is going towards
uniqueness.
OLIGOPOLY AND ITS FEATURES
• Oligopoly is an important form of imperfect competition.
• It is characterized by few sellers.(8 to 9)
• There is extreme competetion between these sellers.
• Here too there may be similar products which are differentiated.
• Hence the concept of product differentiation is crucial to this form.
• The most important feature of oligopoly is INTERDEPENDANCE.
• Here the few firms comprise the industry and there is extreme interdependence between these
few firms.
• As the number of firms is less,any change in price or output of a firm will have a direct effect on
the others.
• The other firms may retaliate by changing their own prices and output.
• Due to this cut throat price war,the price under oligopoly is sticky.
• This sticky price gives rise to PRICE RIGIDITY under oligopoly.
• None of the sellers would like to budge from the sticky price,else there is a possibility of a price or non
price war.
• So either there is retaliation by price cutting or non price war by way of advertising and other means.

• Hence there are two types of oligopoly;

• COLLUSIVE OLIGOPOLY
• NON COLLUSIVE OLIGOPOLY
• Collusive oligopoly is when the sellers are aware of the rival firms moves
• This is possible as CARTELS are formed between the competing firms,hence price and output are pre
decided by all.
• Another collusive type is PRICE LEADERSHIP.
• Price leadership is when the firms follow the price and output of a DOMINANT FIRM or a LOW COST firm.
• In both cases the other firms take the comman price and output.
• Whereas in a NON COLLUSIVE oligopoly,there is price cutting and
price war,no one really benefits.

• Hence under oligopoly,the demand curve is rather peculiar,where

price is sticky at a bend on the curve.it is therefore called the KINKY
DEMAND CURVE.
•

p mc
mr ar
0 q
• We can see in the given diagram, that the demand curve AR is a
broken one.it has a bend in it.
• This point at which it is bent,is called the kink,where the equilibrium
output is determined.
• The broken AR is made up of two elasticities,hence it is matched with
two MRs.
• The MC passes through the gap between the MC.that is where the
output is determined.
DUMPING
• The practice of discriminating monopoly pricing in the area of foreign trade is
described as dumping.
• It implies different prices for the same good in domestic and foreign markets.
• Haberler defines dumping as:The sale of a good abroad,at a prce which is lower
than selling price of the same good at the same timein the same circumstance.
• Under this practice a producer possessing monopoly in home market,charger
lower price in foreign market,thus wanting to compete and capture the foreign
market.
• At times the producer ends up charging even lower than the cost,to make up
for deficient revenues from sales by charging high price at home.
• DIAGRAM FOR DUMPING

mc

p ar = mr
f f
mrh arh
o q q1
• In the given diagram we can note that both the home market and
foreign market are shown in the same graph.
• In the home market,since there is a monopoly,the AR and MR are
inelastic,and the output is oq.
• However in the foreign market,since there is a perfect
competition,the output is oq1.
• We are now looking at a joint MR and MC cuts MR of home country
plus MR of foreign country,this is where output is determined.,so the
extra output is the dumped output.
THEORY OF CONSUMER BEHAVIOUR
• This theory seeks to explain the behaviour of a consumer when he
wants to:
• 1)satisfy his wants
• 2)maximise his satisfaction.
• A consumer will always strive towards spending his income in such a
way so as to derive maximum satisfaction from the consumption.
• There are two ways in which he an reach maximum satisfaction
• 1)Marginal utilty analysis or Cardinal approach
• 2)Indifference curve analysis or ordinal approach
• Marginal utility approach is based on the concept of utility.
• Utility is the power of a commodity to satisfy a persons wants.
• It is the capacity of a commodity to satisfy a persons wants.
• This approach states that utility is measurable in cardinal numbers such as 1,2,3 and so
on
• CHARACTERISTICS OF UTILITY
• Utility is a reative concept
• It is measurable in cardinal numbers
• The concept is not concerned with moral values.
• Utility function is:
• Ux=f(qx) utiity of x depends on quantity of x consumed.
• The marginal utility analysis makes use of two laws to see how a
consumer reaches maximium satisfaction in the process of
consumption.
• 1)Law of diminishing marginal utility
• 2)law of equimarginal utility

• The ordinal approach in general does have a lot of shortcomings and

is heavily criticized for it.
THE ORDINAL APPROACH OR
INDIFFERENCE APPROACH
• In the ordinal approach,we consider the scale of preference of the consumer.
• The consumers preference of a commodity over the other can be seen.
• We will also see the satisfaction levels which he derives out of these goods.
• There are certain assumptions of this approach:
• The consumer ranks his preference hence his level of satisfaction can be seen.
• Consumer behaviour is constant
• Combinations of two goods can be ranked differently
• The scale of preference is finally shown by an indifference curve.
• THE INDIFFERENCE CURVE
• The indifference curve is a set of points,each or every point on which
shows us a different combination of goods giving the same level of
satisfaction.
• It means any point on one indifference curve will give us the same
level of satisfaction.however,a higher curve will indicate higher
satisfaction and a lower curve will indicate a lwer level of satisfaction.
• INDIFFERENCE SCHEDULE

• combi 1 goodA goodB

• 1st 1 20
• 2nd 2 14
• 3rd 3 9
• 4th 4 5
• 5th 5 3
• 6th 6 2
• INDIFFERENCE CURVE

• COM Y

• IC
•
•
• 0 COM X
• In the given diagram we can see that every combination on the curve
IC shows that the consumer is consuming more of one commodity
and less of another.
• This indicates a trade off between the two commodities.
• Hence an IC slopes downwards from left to right,has a negative slope.

• PROPERTIES OF IC
• An indifference curve slopes downwards from left to right,indicating
that one commodity is preferred over the other.
• The slope of the ic is negative,also showing the MARGINAL RATE OF
SUBSTITUTION between the two goods,the rate at which one good
can be substituted for another.
• IC never intersect each other.
• Every point on the indifference curve shows a different combination
of goods giving the same level of satisfaction.
• Every indifference curve indicates a unique level of satisfaction.
• IC are always convex to the origin(based on the principle of
diminishing marginal rate of substitution.
BUDGET LINE OR PRICE LINE
• The budget line is a line that shows maximum possible expenditure that can be
incurred by a consumer on the two goods.
• Beyond this there can be no expenditure.

• com y
• A

• B com x
• In the given diagram we can see that there are two commodities X
and Y.
• The budget line is AB that indicates that the consumer has spent
maximum possible on the two goods and that is truly the outer
limit,beyond which he cannot spend anymore.

• Let us now see how the consumer equilibrium is reached.

CONSUMER EQUILIBRIUM
• In order to derive the consumer equilibrium,we will now have to
make use of the budget line and the indifference curves.

• good a IC2

IC1
IC

Good B
• In the given diagram we can see that points R and T are on IC.
• Since any point on below budget line AB,are within the reach of the
consumer,these combinations are feasible.
• Points S and F are on IC2 which are way above the budget line.
• Points M and N are on the indifference cure IC,since these are on the
same IC as R and T,the satisfaction on these points is also the same.
• The equilibrium is therefore on IC1,
• Herein the equilibrium point is where the budget line is tangent to IC1 at
the point e.at this point,the slopes of the indifference curve and budget
line are equal.
INCOME EFFECT
• REAL INCOME
• NOMINAL INCOME

• In this effect we will see the effect of change in income of the consumer.
• Here the prices of goods A and B are said to be constant.
• Certain assumptions will have to be made in order to see the effects.

•
•

•
• In this effect, we have assumed that the prices of goods A and B are
constant, but income changes.
• When income rises, the budget line moves from AB to A1B1
This indicates that the equilibrium is at a higher level.

A2
A IC2
A1 IC
IC1
B1 B B2
So the satisfaction coming from both the goods also rises.
Likewise, the real income, in terms of purchasing power to buy goods A
and B also rises.
PRICE EFFECT
• In case of the of the price effect,
• The assumptions are,that the income of the consumer fremains
constant.
• We also assume here that the price of good A remains constant,but
that of good B falls.
•
A
IC1
ic

B B1
• In the given diagram,the budget line AB slides out to AB1 as according
to the assumptions,income is constant but prive of good B has fallen
• Hence AB shifts out to show that affordability to purchase good B
goes up.
• Therefore AB shifs out to AB1.

• SUBSTITUTION EFFECT
• The substitution effect can be seen when,we assume that the price of
one commodity is constant and price of the other one falls.
• We also assume that income falls.
• We can note this in the following diagram:

A1
E
E1

B B1

• With a fall in income,the budget line slides down from AB to A1B1

• This is to show that,income falls,but since price of good B falls too
• The consumer now wants to shift his purchase to good B.
• Hence the budget line shifts out towards B
• PRODUCTIVITY
• The concept of productivity is very crucial.
• There are two types:
• Physical productivity
• Revenue productivity
FACTORS OF PRODUCTION AND THEIR
PRICING
• In this segment,we will study the four different factors of production
and analyse their pricing and productivity,
• We will discuss the production function here,which primarily shows a
relationship between input and output.
• The four factors namely land,labour,capital and entrepreneur.
• Each one has peculiar features and the factors affecting their
productivity and availability.
Physical productivity is expressed in physical terms.in terms of physical units of commodity produced
Whereas Revenue productivity is in monetary terms,in terms of revenue earned
Marginal product is a change in total product due to a change in total units of factor
Average product is total product divided by total unit of factor
Relationship between AP and MP
Supply side economics for factors of
production
• Considering that there is a perfect competition in the factor market
• Then the equilibrium price and output will have two conditions:
• 1 mp =mc
• 2mp cuts mc from above

• AP curve is an inverted U to show that on X axis we show units of

factor and Y axis we show ap then as we add more and more units of
factor, the AP initially rises then becomes maximum and then begins
to fall
RENT

• Rent was earlier defined in a narrow sense

• It was defined as a price paid for the use of land and other natural
resources,which are completely fixed in total supply
• We have different theories of rent
• 1 Ricardian theory also known as classical theory
• Here rent is treated as a differential surplus
• Ricardo defines rent as that portion of the produce of the earth which is
paid to the landlord for the use of the indestructible powers of the soil.
• He assumes that land is used to grow corn and there is difference in fertility
MODERN THEORY OF RENT
• This theory was propounded by Joan Robinson
• It is based on 3 propositions
• 1]Rent arises due to scarcity of land
• 2]it is a generalized surplus earned by all the factors
• 3]it is based on transfer earnings[earnings which can be got by next
best alternative use of the factor
WAGES
• The term wages means payment made for the services of labour.it is a price paid for the
use of labour
• Concpt of real wages and nominal wages
• Supply of labour and wages have a direct relationship
• Besides supply of labour depends on
• 1]rate of population growth
• 2]age and distribution of population
• 3]working hours
• 4]labour laws regarding women and children
• 5]attitude of workers towards work and leisure
• 6 ]mobility of labour
WORK LEISURE RATIO
• The work leisure ratio is affected by changes in wage rate
• When wage rate rises it induces worker to work more at the cost of
leisure
• However after a point when the income increases they prefer leisure;

• COLLECTIVE BARGAINING
• Aprocess of negotiations between union and management over
wages and working conditions.
INTEREST
• Interest is a payment made for the use of capital
• According to Marshall,interest is a price paid for the use of capital in
any market.
• It is also expressed as a percentage return on capital invested after
allowing for risks of investment.
• Demand for savings [interest on borrowing]
• Supply of savings[for productive purposes]

• Equilibrium between demand and supply of capital

Lonable fund theory
• As per professor wickshell,interest is earned for loaning funds,it is infact a
reward for loaning funds for productive purposes.hence he called his,the
loanable fund theory.
• Professor Keynes propoundede the liquidity preference theory of interest.
• He spoke of the fact that people had 3 motives for which they needed to
hold money in its liquid form
• 1)transaction motive
• 2)precautionary motive
• 3)speculation motive
The motives
Transaction motive refers to day to day transactions,for whicjh money
was required in its liquid form.
Precautionary motive was when money was needed for any
emergencies or unforeseen events.
In case of speculations,people would hold money to deal in
speculations
Meaning buying and selling of shares.
Liquidity trap
• When interest rate on savings was high,demand for money for
speculative purposes was low.whereas when interest rate on savings
was low,demand for money for speculative purpose was high.
• Keynes did speak of the Liquidity trap
• He said that at a point the interest rate fell so low,and supply of
savings was elastic in the sense that it became interest elastic
• People prefer to hold money as its pointless keeping it in banks
PROFIT THEORIES
• There are several theories of profit
• Risk bearing theory propounded by prof knight
• He said that profit was paid to the emtrepreneur for taking on to risks
and uncertainities in business.
• There were innumerable uncertainities and fluctuations in the
economy.
• Risks could be man made or natural
• External or Internal
• Prof Schumpeter gave the innovation theory of profit
BUISINESS CYCLE
• It refers to the phases in the economy
• The cyclical phases which represent the condition in an economy.
• There are primarily 4 phases
• Namely Recovery,Boom,Recession,trough or depression.