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Anna University , Chennai


DEPARTMENT OF COMPUTER SCIENCE & ENGINEERING

QUESTION BANK

SUBJECT CODE

: MG2452

SUBJECT NAME

: ENGINEERING ECONOMICS & FINANCIAL ACCOUNTING

SEM ESTER

: VII

YEAR

: IV

REGULATION

: 2008

Prepared By
D.Vinod. M.E
Asst.Prof/CSE. A.C.T.C.E.T

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UNIT I INTRODUCTION
PART A(2 MARKS)
1. Define Managerial Economics
By combining the basic definition of the two terms Manager and Economics you get the definition of
managerial economics. Managerial Economics is the study of directing resources in a way that it most
efficiently achieves the managerial goals. Managerial Economics is also the application of the tools of economics
analysis in decision making in actual business situations.

2. What is meant by Micro economic analysis?


Micro economic analysis deals with the problems of an individual firm, industry or consumer etc. It helps in dealing
with issues which go on within the firm such as putting the resources available with the firm to its best use,
allocating resources within various activities of the firm to its best use, allocating resources within various activities
of the firm and also deals with being technically and economically efficient.

3. What is meant by Prescriptive approach?


Prescriptive or normative approach tells How things ought to be done.

4. What is meant by descriptive approach?


Descriptive approach tells how things are done.

5. Scope of Managerial Economics:


The following aspects constitute the scope of managerial economics:
1. Objectives of a business firm
2. Demand analysis and forecasting
3. Cost analysis
4. Production management
5. Supply analysis
6. Pricing decisions, policies and practices
7. Profit management
8. Capital budgeting and investment decisions
9. Decision theory under uncertainty
10. Competition

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6. Give the Objectives of a business firm
The objectives of a business firm may be varied. Apart from generating profits a firm has many other objectives like
being a market leader, being a cost leader, achieving superior efficiency, achieving superior quality, achieving
superior customer responsiveness etc.

7. What is meant by Supply Analysis?


Supply analysis deals with the various aspects of supply of a commodity. Certain important aspects of supply analysis
are supply schedule, curves and function, elasticity of supply, law of supply and its limitations and factors
influencing supply.

8. What is meant by Capital Budgeting?


Capital budget is the planning of expenditure on assets.

9. Use of Engineering Economics:


Engineering economics accomplishes several objectives. It presents the aspects of traditional economics that are
relevant for business and engineering decision making in real life.

10. Define Logistics:


It is the movement of goods from one place to the other.

11. Define Inbound Logistics:


It is the movement of raw materials to the factory premises.

12. Define outbound logistics:


It is the movement of finished goods to wholesale or retail outlets and to the final consumers.

13. Define Statistics:


Statistics provide the basis for empirical testing of theory. Generalizations or theory cannot be accepted for practice
unless these theories are checked against the data from the reality. This way, theories become more practical and
useful in real life business situation.

14. Define Economics and define the divisions of Economics:


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Economics has two divisions namely micro economics and macroeconomics. Micro economics is the branch of
economics where the unit of study is an individual or a firm while macroeconomics is branch of economics where
the unit of study is aggregative in character and considers the entire economy.

15. Define Accounting:


Accounting can be defined as the recording of financial operations of an organization. Managerial decisions on profits
and sales etc. derive input largely from the accounting statement of a firm.

16. Define Managerial Economics and Mathematics:


Many of the theories in mathematics will find use in economics. Concepts such as calculus, vectors, logarithms
and exponentials, determinants and matrix, algebra etc. are some to name a few. Managerial economics is metrical
in character. It estimates various economic relationships prediction relevant economic quantities and uses them in
decision making and planning for the future. So mathematics becomes an important tool in managerial economics.

17. Define Operations research:


Operations research was developed as science during the Second World War to solve the complex operations problems
of planning and resource allocation in defense and in basic industries which specifically supplied military equipments.
These theories find high usage in various field of management to solve problems pertaining to logistics, both inbound
and outbound and also the movement of material within the factory premises etc.

18. Define a competitor.


The competitors of the firm are also likely to react or even pro-act to any decisions made by the firm. Competitors
always try to navigate the competitive advantage gained by the firm. Thus managers will have to make wise
investments
in projects that will be hard to be imitated by the competition.

19. Define Decision theory under uncertainty:


Most of the business decisions taken by the managers are done under uncertainty. Uncertainties pertaining to demand,
cost, price, profit, capital etc. prevail most of the time when decisions are made. This makes the whole decision
making process difficult and complex. The tools used in economic analysis have been modified and refined so as
to take into account the uncertainty and thus help decisions making in logical and scientific manner.

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20. Define Profit Management:
All business firms are motivated and committed to produce profits. Profits are one of the tangible yardsticks to measure
the performance of the firm and the managers concerned. It also signifies the health of the firm. Profits are influenced
by various factors such as cost of production, revenues and other factors both internal and external to the firm. Profits
are hard to predict.

21. Define Pricing Decisions


A firms profitability and success greatly depend on the pricing decisions and the pricing policies of the firm.
The patronization of the firms products by the customers, the competition faced by the product along with the profits
of the firm, largely depends on the price of the product. Pricing also depends on the environment in which the firm
operates, competitions, customers etc.

22. Define Production Management:


When a manager organizes and plans the firms production functions i.e. when he tries to convert the raw materials
to finished product, he faces a number of economic problems. The study of production function describes the input
output relationship.

23. Define Cost Analysis:


One way to earn higher profits is by controlling the cost involved in producing the product. Study of cost is necessary
for making efficient and effective managerial decisions. If a detailed cost analysis and estimation is done, the firm can
move upon effective profit management and sound pricing practices.

24. What are the Macro economic Conditions?


(a) The economy in which firms operate is predominantly a free enterprise economy.
(b) The present day economy is undergoing rapid technological and economic changes and,
(c) The government intervening in the economic affairs has increased in the recent times and is likely to go up further.

25. What are the Common points in Managerial Economics?


1. Managerial economics deals with the decision making by managers, executives and engineers of economic nature.
2. Managerial economics is goal oriented.
3. Managerial Economics is both conceptual and metrical.
4. Managerial economics is pragmatic.

PART B (16 MARKS)


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1. Explain the nature and scope of managerial economics.
CHIEF CHARACTERISTICS
1. Managerial Economics is micro-economic in character. This is because the unit of study is a firm; it is the problems
of a business firm which are studied in it. Managerial Economics does not deal with the entire economy as a unit of
study.
2. Managerial Economics largely uses that body of economic concepts and principles which is known as Theory of
the Firm or Economics of the Firm. In addition, it also seeks to apply Profit Theory which forms part of
Distribution Theories in Economics.
3. Managerial Economics is pragmatic. It avoids difficult abstract issues of economic theory but involves complications
ignored in economic theory to face the overall situation in which decisions are made. Economic theory appropriately
ignores the variety of backgrounds and training found in individual firms but Managerial Economics considers the
particular environment of decision-making.
4. Managerial Economics belongs to normative economics rather than positive economics (also sometimes
known as descriptive economics). In other words, it is prescriptive rather than descriptive. The main body of
economic theory confines itself to descriptive hypothesis, attempting to generalize about the relations among different
variables without judgment about what is desirable or undesirable.
5. Macro-economics is also useful to Managerial Economics since it provides an intelligent understanding of
the environment in which the business must operate. This understanding enables a business executive to adjust in the
best possible manner with external forces over which he has no control but which play a crucial role in the well-being
of his concern.

SCOPE OF MANAGERIAL ECONOMICS


1. Demand Analysis and Forecasting: A major part of managerial decision-making depends on accurate estimates of
demand. Before production schedules can be prepared and resources employed, a forecast of future sales is essential.
2. Cost Analysis: A study of economic costs, combined with the data drawn from the firms accounting
records, can yield significant cost estimates that are useful for management decisions.
3. Production and Supply Analysis: Production analysis mainly deals with different production function and their
managerial uses. Supply analysis deals with various aspects of supply of a commodity. Certain important
aspects of supply analysis are: Supply schedule, curves and function. Law of supply and its limitations, Elasticity of
supply and Factors influencing supply.
4. Pricing Decisions, Policies and Practices: The important aspects dealt with under this area are: Price Determination
in various Market Forms, Pricing Methods, Differential Pricing, Product-line Pricing and Price Forecasting.
5. Profit Management: Business firms are generally organized for the purpose of making profits and, in the long run,
profits provide the chief measure of success. In this connection, an important point worth considering is the element
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of uncertainty existing about profits because of variations in costs and revenues which, in turn, are caused by factors
both internal and external to the firm.
6. Capital Management: Capital management implies planning and control of capital expenditure. The topics dealt
with are: Cost of Capital, Rate of Return and Selection of projects.

2. Discuss the relationship between managerial economics and other disciplines.


RELATIONSHIP OF MANAGERIAL ECONOMICS WITH OTHER DISCIPLINES
1. Managerial Economics and Economics: Managerial Economics has been described as economics applied to
decision-making. It may be viewed as a special branch of economics bridging the gulf between pure economic theory
and managerial practice. Economics has two main divisions: micro-economics and macro-economics. Microeconomics has been defined as that branch where the unit of study is an individual or a firm. Macro-economics, on
the other hand, is aggregative in character and has the entire economy as a unity of study.

2. Managerial Economics and statistics: Managerial Economics employs statistical methods for empirical testing of
economic generalizations. These generalizations can be accepted in practice oly when they are checked against the
data from the world of reality and are found valid.

3. Managerial Economics and Mathematics: Mathematics is yet another important tool-subject closely related to
Managerial Economics. This is because Managerial Economics is metrical in character, estimating various economics
relationships, predicting relevant economic quantities and using them in decision-making and forward planning.

4. Managerial Economics and Accounting: Managerial Economics is also closely related to accounting which is
concerned with recording the financial operations of a business firms. Indeed, accounting information is one of the
principal sources of data required by a managerial economist for his decision-making purpose.

5. Managerial Economics and Operations Research: The significant relationship between managerial economics
and operations research can be highlighted with reference to certain important problems of managerial economics
which are solved with the help of or techniques. The problems are: allocation problems, competitive problems,
waiting line problems and inventory problems.

3. List the basic economic tools in managerial economics.

Opportunity Cost Principle:

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By the opportunity cost of a decision is meant the sacrifice of alternatives required by that decision. Thus, it
should be clear that opportunity costs require ascertainment of sacrifices. If a decision involves no sacrifice, its
opportunity cost is nil. For decision-making, opportunity costs are the only relevant costs. The opportunity cost
principle may be stated as under:

The cost involved in any decision consists of the sacrifices of alternatives

required by that decision. If there are no sacrifices, there is no cost.

Incremental Principle:

Incremental concept involves estimating the impact of decision alternatives on costs and revenues, emphasizing
the changes in total cost and total revenue resulting from changes in prices, products, procedures, investments or
whatever may be at stake in the decision.

The

two

basic

components

of

incremental

reasoning

are:

Incremental cost and incremental revenue. Incremental cost may be defined as the change in total cost resulting
from a particular decision. Incremental revenue is the change in total revenue resulting from a particular decision.

Principle of Time Perspective:

The economic concepts of the long run and the short run have become part of everyday language. Managerial
economics are also concerned with the short-run and long-run effects of decisions on revenues as well as costs. The
really important problem in decision- making is to maintain the right balance between the long-run and the shortrun considerations. A decision may be made on the basis of short-run considerations, but may as time elapses have
long- run repercussions which make it more or less profitable than it at first appeared.

Discounting Principle:

One of the fundamental ideas in economics is that a rupee tomorrow is worth less than a rupee today. This seems
similar to saying that a bird in hand is worth two in the bush. If a decision affects costs and revenues at future
dates, it is necessary to discount those costs and revenues to present values before a valid comparison of alternatives
is possible.

Equi-marginal Principle:

This principle deals with the allocation of the available resources among the alternative activities. According
to this principle, an input should be so allocated that the value added by the last unit is the same in all cases. This
generalization is called the equi-marginal principle.

4. Explain the objectives of firms and analyze different theories governing the same.
Baumols Theory of Sales Revenue Maximization
Prof. J. Baumol has postulated seller revenue maximization approach as an alternative to profit maximization
objective. The factors which explain the pursuance of this objective are following:

1. Financial institutions evaluate the success and strength of the firm in terms of rate of growth of its sales revenue.

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2. Empirical evidence shows that the stock earnings and salaries of top management are correlated more closely
with sales than with profits.
3. Increasing sales revenue over a period of time gives prestige to the top management, but profits are enjoyed only
by the shareholders.
4. Growing sales means higher salaries and better terms. Hence sales revenue maximizations results in a healthy
personnel policy.
5. It is seen that managers prefer a steady performance with satisfactory profits than spectacular profits year after
year. They will be criticized if spectacular profits decline. Hence they may prefer a safe and steady performance
with satisfactory profits but good sales.
6. Large and increasing sales help the firm to obtain a bigger market share which gives it a greater competitive
power.
ASSUMPTIONS OF BAUMOLS SALE MAXIMIZATION MODEL
i. Sales maximization goal is subject to a minimum profit constrain.
ii. Advertisement is a major instrument of sales maximization i.e., advertisement will shift the demand curve to the
right.
iii. Advertisement costs are independent of production costs.
iv. Price of the product is assumed to be constant.
IMPLICATIONS OF BAUMOLS THEORY
i. His theory is more consistent with observed behavior. In the traditional theory changes in fixed costs do not
influence output or prices except for fixing the breakeven point. But according to Baumol a firm which experiences
any increase in fixed costs will try to reduce them or pass them on to the consumer in the form of higher prices,
through large scales.
ii. This theory also establishes that businessmen may consider non-price competition through sales maximization to
be the more advantageous alternative.
iii. However, Baumols theory does not explain how the firms maximize their sales volume within a profit
constraint. Further it explains business behavior, without elaborating the mechanism by which they try to find new
alternative.
MARRIS THEORY OF MAXIMISATION OF FIRMS GROWTH RATE
According to Robin Marris, managers maximize firms balanced growth rate subject to managerial and financial
constraints. He defines firms balanced growth rate (G) as, G= GD=GC
Where GD=growth rate of demand for firms product and GC=growth rate of capital supply to the firm.

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In simple words, a firms growth rate is balance when demand for its product and supply of capital to the firm
increase at the same rate. The two growth rates are according to Marris, translated into utility functions:
(i) Managers utility function: The managers utility function (Um) and owners utility(Uo) may be satisfied as
follows. Um=f(salary, power, job security, prestige, status).
(ii) Owners utility function Owners utility function (Uo): Uo=f (output, capital, market-share, profit, public
esteem), implies growth of demand for firms product and supply of capital.
Therefore, maximization of Uo means maximization of demand for firms product or growth of capital supply.
According to Marris, by maximizing these variables, managers maximize both their own utility function and that of
the owners. The managers can do so because most of the variables (e.g., salaries, status, job security, power, etc)
appearing in their own utility function and those appearing in the utility function of the owners (e.g., profit, capital
market, share, etc) are positively and strongly correlated with a single variable, i.e., size of the firm. Maximization
of these variables depends on the maximization of the growth rate of the firms. The managers, therefore, seek to
maximize a steady growth rate.
Marriss theory, though more rigorous and sophisticated than Baumols sales revenue maximization, has its own
weaknesses. It fails to deal to deal satisfactorily with oligopolistic interdependence & it ignores price determination
which is the main concern of profit maximization hypothesis
WILLIAMSONS THEORY OF MAXIMIZATION OF MANAGERIAL UTILITY FUNCTION
Like Baumol and Marris, Willamson argues that managers have discretion to pursue objectives other than profit
maximization. The managers seek to maximize their own utility function subject to a minimum level of profit.
Managers utility function (U) is expresses as: U = f(S, M, ID)
Where S= additional expenditure on staff, M= managerial emoluments, ID= discretionary investments.
According to Williamsons theory managers maximize their utility function subject to a satisfactory profit. A
minimum profit is necessary to satisfy the shareholders or else managers job security is endangered. The

utility

functions which managers seek to maximize include both quantifiable variables like salary and slack earnings, and
non-quantitative variable such as prestige power, status, job security, professional excellence, etc. The nonquantifiable variables are expresses, in order to make them operational, in terms of expense preference defined as
satisfaction derived out of certain types of expenditures (such as slack payments), and ready availability of funds
for discretionary investments.
Williamsons theory suffers from certain weakness. His model fails to deal with problem of oligopolistic
interdependence. Williamsons theory is said to hold only where rivalry between firms is not strong. In case of
strong rivalry, profit maximization is claimed to be a more appropriate hypothesis. Thus, Williamsons managerial
utility function too does not offer a more satisfactory hypothesis than profit maximization.

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CYERT-MARCH THEORY OF SATISFICING BEHAVIOUR
Cyert-March theory is an extension of Simons theory or firms. Satisfying behaviour or satisfying behaviour.
Simon had argued that the real business world is full of uncertainly; accurate and adequate data are not readily
available; where data are available managers have little time and ability to process them; and managers work under
a number of terms of rationality postulated under profit maximization hypothesis. Nor do the firms seek to
maximize sales, growth or anything else. Instead they seek to achieve a satisfactory profit a satisfactory growth,
and so on. This behaviour of firms is termed as Satisfaction Behaviour.

Cyert and March added that, apart from dealing with an uncertain business world, managers have to satisfy a variety
of groups of people-managerial staff, labour, shareholders, customers, financiers, input suppliers, accountants,
lawyers, authorities etc.

All these groups have their interest in the firms-often conflicting. The managers

responsibility is to satisfy them all. Thus, according to the Cyert-March,

firms

behaviour is satisfying

behaviour. The satisfying behaviour implies satisfying various interest groups by sacrificing firms interest
or objective. The underlying assumption of Satisfying Behaviour is that a firm is a coalition of different groups
connected with various activities of the firms, e.g., shareholders, managers, workers, input supplier, customers,
bankers, tax authorities, and so on. All these groups have some kind of expectations-high and low- from the firm,
and the firm seeks to satisfy all of them in one way or another in sacrificing some of its interest.

In order to reconcile between the conflicting interests and goals, managers form an aspiration level of the firm
combining the following goals: (a) Production goal, (b) Sales and market share goals, (c) Inventory goal, and (d)
Profit goal. These goals and aspiration level are set on the basis of the managers past experience and their
assessment of the future market conditions. The aspiration levels are modified and revised on the basis of
achievements and changing business environment.

The behavioural theory has, however, been criticized on the following grounds. First, though the behavioural theory
deals realistically with the firms activity, it does not explain the firms behaviour under dynamic conditions in the
long run. Secondly, it cannot be used to predict exactly the future course of firms activities; thirdly, this theory
does not deal with the equilibrium of the industry. Fourthly, like other alternative hypotheses, this theory too fails to
deal with interdependence of the firms and its impact on firms behaviour.

5. What are the sources of business risk?


1. Risk of Market Fluctuation: General economic conditions are rarely stable. Firms face booms and depressions.
Though with the help of certain forecasting techniques the firm can somewhat hedge itself against cyclical

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fluctuation, but there is no way the firm can generally know with certainty the timing and volatility of changes. The
firm is, therefore, unstable to completely prepare itself for these changes.

2. Risk of Industry Fluctuations: There may be fluctuations specific to the industry, which are least as uncertain and
may not always coincide with those of the overall market.

3. Competition risks: These are the risk arising from the policy changes of the rivals, which include things like
changes in prices, product line, advertisement expenditure, etc.

4. Risk of technological change: This is also called the risk of obsolescence, which grows with advancement of an
economy. These risks arise from the possibility of newly installed machinery becoming obsolete with the discovery
of new and more economical process of production.

5. Risk of taste fluctuation: In many cases, vagaries of consumer demand create uncertain conditions.
Successful product of one season may become discarded in the next season. These risks are most common in fashion
and entertainment industries.

6. Risk of cost fluctuation: Unless contractually agreed upon, the future prices of labour, material etc. may change.
Thus estimates of future expenditure are subject to uncertainty.

7. Risk of public policy: Government policy regarding business undergoes a change over time, some of which
cannot be precisely predicted. These relate to price control, foreign trade policy, corporate taxation etc.

6. Explain the features and steps in Decision-making process.


FEATURES OF DECISION MAKING
1. Selection process: Decision making is a selection process. The best alternative is selected out of many available
alternatives.
2. Goal-oriented process: Decision making is goal-oriented process. Decisions are made to achieve some goal or
objective.
3. End process: Decision making is the end process. It is preceded by detailed discussion and selection of
alternatives.
4. Human and Rational process: Decision making is a human and rational process involving the application of
intellectual abilities. It involves deep thinking and foreseeing things.

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5. Dynamic process: Decision making is a dynamic process. An individual takes a number of decisions each day.
6. Situational: Decision making is situational. A particular problem may have different decisions at different times,
depending upon the situation.
7. Continues or Ongoing process: Decision making is a continuous or ongoing process. Managers have to take a
series of decisions on particular problems.
8. Freedom to the decision makers: Decision making implies freedom to the decision makers regarding the final
choice. It also involves the using of resources in specified ways.
9. Positive or Negative: Decision may be positive or negative. A decision may direct others to do or not to do.
10. Gives happiness to an Endeavour: Decision making gives happiness to an Endeavour who takes various steps
to collect all the information which is likely to affect decisions.

STEPS IN DECISION MAKING PROCESS IN AN ORGANIZATION


1. Identification of problem: Decision making process begins with the identification of problem that means
recognition of a problem. The managers have to use imagination, experience, and judgment in order to
identify the real nature of the problem.

2. Diagnosis and analysis of the problem: In order to diagnose the problem correctly, a manager must obtain all
pertinent facts and analyze them correctly. The most important part of the diagnosing problem is to find out the real
cause or source of the problem. After analyzing the problem next phase of the decision making is to analyze
problem. This process involves classifying the problem and gathering information.

3. Search for alternatives: A problem can be solved in many ways. All possible ways cannot be equally satisfying.
Managers are advice to limit him to the discovery of the alternatives which are strategic or critical to the problem.
The principle of limiting factor is given as By recognizing and overcoming that factor that stand critically in the
way of a goal, the best alternative course of action can be selected. Creative thinking is necessary to develop
alternatives such as decision makers past experience, practices followed by others, and using creative techniques.

4. Evaluation of alternatives: Evaluation is the process of measuring the positive and negative consequences of
each alternative. Some alternatives offer maximum benefit than others. An alternative is compared with the
others. Management must set some criteria against which the alternatives can be evaluated. Criteria to weigh the
alternative courses of action includes Risk- Degree of risk involved in each alternative, Economy of effort- Cost,
time and effort involved in each alternative, Timing or Situation- Whether the problem is urgent & Limitation of
resources- Physical, financial and human resources available with the organization.

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5. Selecting an alternative: In this stage, decision makers can select the best alternatives. Optimum alternative is
one which maximizes the results under given conditions.

6. Implementation and follow-up: Once an alternative is selected, it is put into action in systematic way. The
future course of action is scheduled on the basis of selected alternatives. When a decision is put into action, it may
yield certain results. These results provide the indication whether decision making and its implementation is proper.
The follow-up action should be in the light of feedback received from the results.

7. Explain the rational decision making and explain it's types.


RATIONAL DECISION MAKING
Decision making is the process of selection from a set of alternative courses of action which is thought to fulfil the
objective of the decision problem more satisfactorily than other. The concept of rationality is defined in terms of
objective and intelligent action.
TYPES OF DECISION MAKING DEPENDING UPON RATIONALITY
1. Major and supplementary decisions: Major decisions refer to the decisions with regard to the quality of the
product, price of the product, developing a new product etc.These decisions have direct bearing on the achievement
of the goals of the concern and so these decisions should be made very carefully. Minor or supplementary decisions,
on the other hand, are made in the course of conversion of major decisions into action.
2. Organizational and personal decision: Organizational decisions are made by the executive in his capacity as
manager in order to achieve the best interests of the organization. These decisions can be delegated to the other
members in the organization. Personal decisions, on the other hand, are made by the manager in his personal
capacity and not in his capacity as a member of the organization. These decisions are not delegated. These
decisions relate to the executives personal work.
3. Basic and routine decisions: Basic decisions involve long range commitment and large funds. Decisions with
regard to selection of a location, selection of a product line, merger of the business are known as basic decisions. As
these decisions affect the entire organization, they are considered as basic decisions. They are also now as vital
decisions. Decisions that are taken to carry out the day-today activities are called routine decisions. These
decisions are repetitive in nature. They have only a minor impact on the business.

These decisions are made at

middle and lower levels of management. For eg., purchase of sundry materials.
4. Group and individual decisions: If the decision is taken by one person, it is called individual decision. Group
decisions are taken by a group of persons.
5. Policy and operating decisions: Policy decisions are made at top management levels. These decisions are taken
to determine the basic policies and goals of the organization. Operating decisions are taken to execute the policy

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decisions. These decisions are taken at the middle and lower management levels and are related to routine
activities of business.
6. Programmed decision: Programmed decision is otherwise called routine decision or structured decision. The
reason is that these types of decision are taken frequently and they are repetitive in nature. Such decision is
generally taken by middle or lower level managers, and has a short term impact. This decision is taken within the
preview of the policy of the organization.
7. Non-Programmed decision: Non programmed structures are otherwise called strategic decisions or

basic

decision or policy decision or unstructured decisions. This decision is taken by top management people
whenever the need arises. This decision deals with unique or unusual or non- routine problems. Such problems
cannot be tackled in a predetermined manner. There are no established methods or readymade answers for
such problems.
8. Organizational decisions: Organizational decisions are decisions taken by an individual in his official capacity to
further the interest of the organization known as organizational decision. These decisions are based on rationality,
judgment and experience.
9. Personal decisions: Personal decisions are decisions taken by an individual based on his personal interest. it is
oriented to the individuals goals. These decisions are based on self ego, self prestige etc.
10. Objectively rational decision: If the decision is really the correct behavior for maximizing given values in a
given situation, then it is called objectively rational decision.
11. Subjectively rational decision: If a decision maximizes attainment relative to the actual knowledge of the
subject, then it is called subjectively rational decision.
12. Consciously rational decision: A decision is consciously rational to extend that he adjustment of means to ends
is a conscious process.
13. Economic model: Economic rationality implies that decision making tries to maximize the values in a given
situation by choosing the most suitable course of action. A rational business decision is one which effectively and
efficiently assures the attainment of aims for which the means are selected.

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UNIT II DEMAND AND SUPPLY ANALYSIS
PART A (2 MARKS)
1. Define Demand.
Demand indicates the quantities of products (goods service) which the firm is willing and financially able to purchase
at various prices, holding other factors constant.

2. Define Determinants of Demand:


An individuals demand for a commodity depends on his desire and capability to purchase it. Apart from the desire
to purchase, there are many other factors which influence the purchase of a product (demand). These are known as
demand determinants.

3. What is meant by Tastes and preferences of Consumers?


The change of tastes and preferences of consumers in favour of a commodity will result in a greater demand for
the commodity. The opposite also holds good i.e. if the tastes and preferences of consumer change against the
commodity, the demand will suffer.

4. What are the two kinds of Consumers expectations?


Consumers have two kinds of expectations one pertains to their future income and the second is related to the future
prices of the goods and its related goods.

5. Define Advertising
Advertisements provide information about the presence of quality products in the market and induce customers to buy
more. It also promotes the latest preferences of the general public to masses.

6. Define the Law of Demand:


The relation of price to quantity demanded / sales is known as the law of demand. Law of demand states that the higher
the price is the lower the demand is and vice versa, holding other factors as constant.

7. Define the price quantity relation.


This price quantity relation can be expressed as demand being a function of priceD=f (p).

8. What Highlights of the law of demand:


1. The relationship between price and quantity demanded is inverse.
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2. Price is the independent variable and demands the dependent variable.
3. Law of demand assumes that except for price and demand, other factors remain constant.

9. What is Demand Shift: (Change in demand?)


Factors shift the demand for a particular product either on the right side of the demand curve or to the left side of the
demand curve based on the changes in price. These factors, other than the price of a good that influence demand are
known as demand shifters. The shift in the demand either to the left or right is called the demand shift.

10. What are the Exceptions to law of demand?


1. In share markets on would have noticed that the rise in price of the shares increases, the sales of the shares while
decrease in the price of the shares results in decrease of sale of the shares.
2. Some goods which act as status symbol and have a snob appeal fall under this category. Here when the price
of the product raises then the appeal of the product also rises and thus the demand. Some example is diamonds and
antiques.
3. Finally, ignorance on the part of the consumer may cause the consumer to buy at a higher price, especially when the
rise in price is taken to mean an improvement in quality and a reduction in price as deterioration in quality.

11. Define Individual demand:


The quantity of a product demanded by an individual purchaser at a given price is known as individual demand.

12. Define Market demand:


The total quantity demanded by all the purchasers together is known as the market demand.

13. What are the types of Demand Function?


1. Consumption function
2. Product consumption function
3. Differences in regional incomes
4. Income expectation and demand

14. What are the Characteristics of demand function?


1. The long run relationship between consumption and income is somewhat stable, and expenditure on consumption
is usually about 85 to 90% of the income.
2. The consumption function is highly unstable in short runs and the relationship between income and consumption
cannot be predicted by any mathematical formula.
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3. During the periods of economic prosperity, there is an absolute increase in the expenditure on consumption, but
decrease as a percentage of income during periods of depression, the consumption declines absolutely but the
expenditure on the consumption increases as a percentage of income.
4. In the periods of economic recovery, the rate of increase in consumption is higher than the rate of the decline
in consumption in times of recession.

15. Define Product consumption function:


This function can be defined as the relationship between the total income of the consumer and sales of particular
products. It means that when there is a change in income there is a change in the demand for particular products.

16. Define Income expectations and Demand:


Expectations are related to peoples estimates of the level and durability of the future economic conditions. The
demand for many consumer durables (household appliances like TV, Washing machine, etc) is often sensitive to
general expectations regarding income level.

17. What are the features of advertising demand relationship?


1. Even when there is no advertising effort done, there will be a certain amount of sales possible for a particular
product
by virtue of its presence in the market.
2. There is a direct relationship between advertising and sales. Thus when there is an increased spending on
advertisements. It will bring in more sales.
3. Increase in advertisements will lead to more than proportionate increase in sales only to a point. After that any
increase in advertisement will have only less than proportionate effect on sales.

18. Define Elasticity of Demand?


Elasticity of demand is defined as the percentage change in quantity demanded caused by one percent change in the
demand determinant under consideration, while other determinants are held constant.

19. Define demand determinant


It is the degree of change in demand to the degree of change in any of the demand determinants.
20. What are the Various Elasticitys?
1. Price elasticity of demand
2. Income elasticity of demand
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3. Cross elasticity of demand
4. Promotional elasticity
5. Exportations elasticity of demand

21. Define Price Elasticity of Demand


Price elasticity of demand can be defined as the degree of responsiveness of quantity demanded to a change in price.

22. What are the Types of price elasticity?


1. Perfectly elastic demand
2. Absolutely inelastic demand or perfectly inelastic demand
3. Unit elasticity of demand
4. Relatively elastic demand
5. Relatively inelastic demand

23. Define absolutely inelastic demand or perfectly inelastic demand.


Absolutely inelastic demand is where a change in price howsoever large, causes no change in the quantity demanded
of a product. Here, the shape of the demand curve is vertical.

24. Define Relatively elastic demand (ep>1):


It is where a reduction in price leads to more than proportionate change in demand. Here the shapes of the demand
curve in flat.

25. What are the Factors determining price elasticity of Demand?


The elasticity of demand depends on the following factors namely
1. Nature of the product
2. Extent of usage
3. Availability of substitutes
4. Income level of people
5. Proportion of the income spent of the product
6. Urgency of demand and
7. Durability of a product.

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PART - B (16 MARKS)
1. What is demand? Explain the various types of demand.
The demand for a commodity is its quantity which consumers are able and willing to buy at various prices during a
given period of time. Demand is a function of Price (P), Income (Y), Prices of related goods(PR) and tastes (T) and
expressed as D=f(P,Y,PR,T). When income, prices of related goods and tastes are given, the demand function is
D=f (P). It shows quantities of a commodity purchased at given prices.
THE VARIOUS TYPES OF DEMAND
i.

Price demand: Price demand refers to various quantities of a commodity or service that a consumer would

purchase at a given time in a market at various hypothetical prices. It is assumed that other things, such as consumers
income, his tastes and prices of inter- related goods, remain unchanged. The demand of the individual consumer is
called individual demand and the total demand of the entire consumer combined for the commodity or service is
called industry demand. The total demand for the product of an individual firm at various prices is known as firms
demand or individual sellers demand.
ii. Income demand: Income demand indicates the relationship between income and the quantity of commodity
demanded. It relates to the various quantities of a commodity or service that will be bought by the consumer at
various level o f income in a given period of time, other things equal. The income demand function for a commodity
increases with the rises in income and decreases with fall income. The income demand curve has a positive slope. But
this slope is in the case of normal goods. In the case of inferior goods the demand curve id is backward sloping.
iii. Cross demand: In case of related goods the change in the price of one affects the demand of the other this
known as cross demand and its written as d=f(pr). Related goods are of two types, substitutes and complementary.
In the case of the substitutes or competitive goods, a rise in the price of one good a raises the demand, arise in the
price of one good a raises the demand for the other good b, the price of remaining the same the opposite holds in the
case of a fall in the price of a when demand for b falls.

2. Explain the determinants of demand.


THE VARIOUS DETERMINATS OF MARKET DEMAND
i.

Price of the product: The law of demand states that the quantity demanded of a product which its consumers

users would like to buy per unit of time, increases when its price falls and decreases when its price increases other
factors remaining constant.
ii. Price of the related goods: The demand for a commodity is also affected by the changes in the price of its
related goods. Related goods may be substitutes or complementary goods

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iii. Consumer income: Income is the basic determinant of quantity of a product demanded since it determines the
purchasing power of the consumer. That is why higher current disposable incomes spend a larger amount on
consumer goods and services than those with lower income.
iv. Consumer taste and preferences: Taste and preferences generally depend on the life style social customs
religious value attached to a commodity, habit of the people, the general levels of living of the society and age and
sex of the consumers taste and preferences. As a result, consumers reduce or give up the consumption of the some
goods and add new ones to their consumption pattern
v. Advertisement expenditure: Advertisement costs are incurred with the objective of promoting sale of the
product. Advertisement helps in increasing demand for the product.
vi. Consumers exceptions: Consumers exceptions regarding the future prices incomes and supply position of
goods, etc play an important role in determining the demand for goods and services in the short run.
vii. Demonstration effect: When new commodities or new models of existing one appear in the market rich people
buy them first.
viii. Consumer credit facility: Availability of credit to the consumers from to the seller banks relation and friends,
or from other source encourages the consumer to buy more that what they is why consumers who can borrow more
can consume more than those who cannot borrow. Credit facility mostly affects the demand for durable goods,
particularly those which requires bulk payment at the time of purchase.
ix. Population of the country: The total domestic demand for a product of mass consumption depends also on the
size of the population. Give n the price, per capita income taste and preference etc, the larger the population the
larger and demand for a product. With an increase (or decrease) in the size of population and with the employment
percentage remaining the same demand for the product tends to increase (or decrease).
x. Distribution of National Income: The level of national income is the basic determinant of the market demands
for a productthe higher the national income, the higher the demand for all normal goods and services. A past from
its level the distribution pattern of national income is also an important determinant of a product.

3. What is elasticity of demand? Explain also it's types.


ELASTICITY OF DEMAND
Elasticity of demand may be defined as the ratio of the percentage change in demand to the percentage change in
price. Ep= Percentage change in amount demanded / Percentage change in price
TYPES OF ELASTICITY DEMAND
i. Price elasticity of demand: Elasticity of demand may be defined as the ratio of the percentage change in price.
Ep = percentage change in quantity demanded / percentage change in price

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ii. Income elasticity of demand: The income elasticity of demand (Ey) express the responsiveness of a consumer
demand or expenditure or consumption) for any good to the change in his income .it may be defined as the ratio of
percentage change in the quantity demanded of a commodity to the percentage in income. Thus
Ey = percentage change in quantity demanded / percentage change in income
iii. Cross elasticity of demand: The cross elasticity of demand is the relation between percentage change in the
quantity demanded of a good to the percentage change in the price of a related good. The cross elasticity good A and
good B is
Eba= percentage change in the quantity demanded of B/ percentage change in price of A
TYPES OF PRICE ELASTICITY OF DEMAND
i. Perfectly elastic demand: Where no reduction in price is needed to cause an increase in quantity demanded. This
is explained with the help of a diagram.

X axis-quantity demanded
Y axis- price
DD1- demand curve
Explanation: Price elasticity of demand is infinity when a small change in price leads to an infinitely large change in
the amount demanded. It is perfectly elastic demand. [E=]
ii. Perfectly in elastic demand: Here a large change in price causes no change in quantity demanded. It is zero
elastic demand [E=0]. This is explained with the help of a diagram.

X axis-quantity demanded
Y axis- price
DD1- demand curve
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Explanation: The figure shows that even if the price decrease from p to p1 there is no change in the quantity
demand. This happens in case of necessities like salt.
iii. Unitary elastic: Where a given proportionate change in price causes an equally proportionate change in
quantity demand. This is explained with the help of a diagram.

X axis-quantity demanded
Y axis- price
DD1- demand curve
Explanation: Price elasticity of demand is unity when the change in demand is exactly proportionate to the change in
price. [E=1].
iv. Relatively elastic: Where a small change in price causes a more than proportionate change in quantity
demanded. The price elasticity of demand is greater than unity [E >1]. This is explained with the help of a diagram.

X axis-quantity demanded
Y axis- price
DD1- demand curve

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Explanation: The figure shows that there is a small decrease in price from P to P1, but it has resulted in a large
increase in quantity demanded from Q to Q1. It is also known as relatively elastic demand.
v. Relatively inelastic demand: Where a change in price causes a less than proportionate change in quantity
demanded. The price elasticity of demand is lesser than unity [E <1]. This is explained with the help of a diagram.

X axis-quantity demanded
Y axis- price
DD1- demand curve
Explanation: The figure shows that there is a large decrease in price from P to P1, but it has resulted in only a small
increase in quantity demanded from Q to Q1. It is also known as relatively elastic demand.
TYPES OF INCOME ELASTICITY OF DEMAND
i. Positive and elastic income demanded: The value of the coefficient E is greater than unity , which means that
quantity demanded of good X increases by a larger percentage than the income of the consumer. This is explained
with the help of a diagram.

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X axis quantity demanded
Y axis Income
DD- demand curve
Explanation: The curve Ey shows a positive and elastic income demanded. In the case of necessities, the coefficient
of income of income elasticity is positive but low, Ey=1. Income elasticity of demanded is low when the demand for
a commodity rises less than proportionate to the rise in the income.
ii. Positive but inelastic income demand: It is low if the relative change in quantity demanded is less than the
relative change in money income. Ey<1. This is explained with the help of a diagram.

Explanation: The curve Ey shows a positive but in elastic income demand. In the case of necessities, the coefficient
of income elasticity is positive but low, Ey<1. Income elasticity of demand is low when the demand for a
commodity rises less than proportionate to the rises less than proportionate to the rise income.
iii. Unitary income elasticity of demand: The percentage change in quantity demanded is equal to the percentage
change in money income. This is explained with the help of a diagram.

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X axis quantity demanded
Y axis Income
DD- demand curve
Explanation: The curve Ey shows unitary income elasticity of demand. In the case of comforts, the coefficient of
income elasticity is unity (Ey=1) when the demand for a commodity rises in the same proportions as the increases in
income.
iv. Zero income elasticity: A change in income will have no effect on the quantity demanded. The value of the
coefficient Ey is equal to zero. This is explained with the help of a diagram.

X axis quantity demanded


Y axis Income
DD- demand curve
Explanation: The curve shows a vertical income, elasticity demand curve Ey with zero elasticity. If with the
increases in income, the quantity demanded remains unchanged the coefficient of income elasticity, Ey=0.
v. Inferior goods: Inferior goods have negative income elasticity of demand. It explains that less is bought at higher
incomes and more is bought at lower incomes. The value of the coefficient Ey is less than zero or negative in this
case. This is explained with the help of a diagram.

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Explanation: The coefficient of income elasticity of demand in the case of inferior goods is negative. In the case of
an inferior good, the consumer will reduce his purchases of it, when his income increases.
DIFFERENT TYPES OF CROSS ELASTICITY OF DEMAND
A. CROSS ELASTICITY OF SUBSTITUTES: In case of substitutes, as the price of one good increases the
demand for the other good also increase at the same time.
i.

Relatively elastic: Where a small change in price of good A causes a large change in quantity demanded of

good B. The elasticity of substitutes is greater than unity [E >1].This is explained with the help of a diagram.

X axis quantity demanded of B


Y axis price of A
DD demand curve
Explanation: The figure shows that there is a small increase in price of good A from a to a1, but it has resulted in a
large increase in quantity demanded of B from b to b1. It is also known as relatively elastic demand.
ii. Relatively inelastic demand: Where a large change in price of good A causes a small change in quantity
demanded of good B. The elasticity of substitutes is lesser than unity [E <1]. This is explained with the help of a
diagram.

X axis quantity demanded of good B, Y axis price of good A


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Explanation: The figure shows that there is a large increase in price of good A from a to a1, but it has resulted in
only a small increase in quantity demanded of good B from b to b1. It is also known as relatively in elastic demand.
iii. Unitary elastic: Here a given proportionate change in price causes an equally proportionate change in quantity
demand. This is explained with the help of a diagram.

X axis-quantity demanded of good B


Y axis- price of good A
DD- demand curve
Explanation: Price elasticity of demand is unity when the change in demand is exactly proportionate to the change in
price. [E=1].
iv. Perfectly in elastic demand: Here a large change in price causes no change in quantity demanded. It is zero
elastic demand [E=0]. This is explained with the help of a diagram.

X axis-quantity demanded of good B.


Y axis- price of good A.
DD- demand curve
Explanation: The figure shows that even if the price increases from a to a1 there is no change in the quantity
demand. This happens in case of necessities like salt.

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v. Unrelated goods: If two goods are not at all related then they have negative elasticity of demand. This is
explained with the help of a diagram.

X axis-quantity demanded of good B.


Y axis- price of good A.
DD- demand curve
Explanation: The figure shows that even if the price increases from a to a1 there is no change in the quantity
demand. This happens in case of necessities like salt.
v. Unrelated goods: If two goods are not at all related then they have negative elasticity of demand. This is
explained with the help of a diagram.

X axis quantity demanded of good B.


Y axis Price of good A.
DD- demand curve
Explanation: The figure shows that in case on unrelated goods if the price of good A increase from a to a1, then the
demand for good B will decrease from b to b1.

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B. CROSS ELASTICITY OF COMPLIMENTARY GOODS:
In case of complimentary goods, as the price of one good increases the demand for the other good decreases at the
same time.
(i) Perfectly elastic demand: Where no reduction in price is needed to cause an increase in quantity demanded.
This is explained with the help of a diagram.

X axis-quantity demanded of good B


Y axis- price of good A
DD- demand curve
Explanation: Price elasticity of demand is infinity when a small change or no change in price of good A leads to an
infinitely large change in the amount demanded of good B. It is perfectly elastic demand. [E=]
ii. Perfectly in elastic demand: Here a large change in price of good B causes no change in quantity demanded of
good B. It is zero elastic demand [E=0]. This is explained with the help of a diagram.

X axis-quantity demanded of good B


Y axis- price of good A
DD- demand curve

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Explanation: The figure shows that even if the price of good B decreases from a to a1 there is no change in the
quantity demand of good A. This happens in case of necessities like salt.
iii. Unitary elastic: Where a given proportionate change in price causes an equally proportionate change in
quantity demand. This is explained with the help of a diagram.

X axis-quantity demanded of good B


Y axis- price of good A
DD- demand curve
Explanation: Price elasticity of demand is unity when the change in demand is exactly proportionate to the change in
price. [E=1].
iv. Relatively elastic: Where a small change in price of good B causes a more than proportionate change in
quantity demanded of good A. The price elasticity of demand is greater than unity [E >1].This is explained with the
help of a diagram.

X axis quantity demanded of good B


Y axis price of good A
DD demand curve

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Explanation: The figure shows that there is a small decrease in price from a to a1, but it has resulted in a large
increase in quantity demanded from b to b1. It is also known as relatively elastic demand.
v. Relatively inelastic demand: Where a change in price causes a less than proportionate change in quantity
demanded. The price elasticity of demand is lesser than unity [E <1]. This is explained with the help of a diagram

X axis quantity demanded of good B


Y axis price of good A
DD- demand curve
Explanation: The figure shows that there is a large decrease in price from a to a1, but it has resulted in only a small
increase in quantity demanded from b to b1. It is also known as relatively elastic demand.

4. Explain the importance and factors determining price elasticity of demand.


THE FACTORS DETERMING PRICE ELASTICITY OF DEMAND
i. Necessaries and conventional necessaries: people buy fixed quantities of such commodity whatever is the price.
The change in the price of wheat may be immaterial for upper classes, but its consumption will certainly increase
among the poor when the price falls. It may be noted that demand for a necessity life as a whole may be inelastic,
but in a competitive market, demand for the output of any particular firm is highly elastic. If it raises the price a bit,
it may lose the entire market.
ii. Demand for luxuries is elastic: It stands to reason that lowering of the price of things like radio will lead to more
bring bought i.e. the demand is elastic. Thus for the same article the demand may be elastic for some people and
inelastic for others elastic in one country and inelastic in another and elastic at one time and inelastic at another.
iii. Proportion of total expenditure: It a consumption good absorbs only a small proportion of total expenditure,
eg, salt the demand will not be much affected by a change in price hence, it will be inelastic.

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iv. Substitutes: The main cause of difference in the responsiveness of the demand for that there are more
completing substitutes for some goods than for others. When the price of tea rises, we may curtail its purchase and
take of coffee, and vice versa. In a case like this a change in price will lead to expansion or contraction in demand.
v. Goods having several uses: Coal is such a commodity when it will be used for several purposes e.g, cooking
heating and industrial purposes; and its demand will increase. But , when the price goes up, it use will be restricted
only to very urgent uses and consequently less will be purchased when the prices rises the demand will thus contract
when wheat becomes very cheap it can be used even as cattle feed hence demand for a commodity having several
uses is elastic
vi. Joint demand: If for instance, carriages become cheap but the prices of horses continue to rule high, demand
for carriage will not extend much. In other words the demand for jointly demanded goods is less elastic.
vii. Goods the use of which can be postponed: Most of us during the war postponed our purchases where we could
e.g. building a house, buying furniture or having a number of warm suits. We go in for such things in a large
measure when they are cheap demand for such goods is elastic.
viii. Level of prices: If a thing is either very experience or very cheap, the demand will be in elastic. If the price is
too high, a fall in it will not increase the demand much. If on the other hand , it is too low, people will have already
purchased as much as they wanted: any further fall will not increase the demand.
ix. Market imperfections: Owing to ignorance about market trends the demand for a good may not increase hen
its price falls for the simple reasons that consumers may not be aware of the fall in price.
x. Technological factors: Low price elasticity may be due o some technical reasons. For example lowering of
elasticity may be electricity rates may not increase consumption because the consumers are unable to buy the
necessary electric appliances.
xi. Time period: The elasticity of demand is greater in the long run than in the short run for the simple reasons that
the consumer has more time to make adjustment in his scheme of consumption. In other word he is able to increase
or decrease his demand for a commodity

IMPORTANCE (OR) SIGNIFICANCE OF ELASTICITY OF DEMAND


i.

Taxation: The tax will no doubt raises the prices but the demand being in elastic, people must continue to buy

the same quantity of the commodity. Thus the demand will not decrease.
ii. Monopoly prices: In the same manner, the businessman, especially if he is a monopolist, will have to consider
the nature of demand while fixing his price. In case I is in elastic, it will pay him to him to change a higher price and
sell a smaller quantity. If, on the other hand, the demand is elastic he will lower the prices, stimulate demand and
thus maximize his monopoly net revenue

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iii. Joint products: In such cases separate costs are not ascertainable the producers will be guided mostly by
demand and its nature fixing his price. The transport authorities fix their rates according to this principle when we
say that they charge what the traffic will bear
iv. Increasing returns: When an industry is subject to increasing returns the manufacturer lowers the price4 to
develop the market so that he may be able to produce more and take full advantage of the economies of large scale
production.
v. Output: Elasticity of demand affects industrial output reduction in price will certainly increases the sale in
the market as a whole.
vi. Wages: Elasticity of demand also exerts its influence on wages. If demand for a particular type of labour is
relatively inelastic, it is easy to raise wages, but not otherwise.
vii. Poverty in plenty: The concept of elasticity explains the paradox of poverty in the midst of plenty. This is
specially so if produce is perishable. A rich harvest may actually fetch less money a poor one.
viii. Effect on the economy: The working of the economy in general is affected by the nature of consumer demand.
It affects the total volume of goods and services produced in the country. It also affects producers demand for
different factors of production their allocation and remuneration.
ix. Economies policies: Modern governments regulate output and prices. The government can create public utilities
where demand is inelastic and monopoly element is present.
x. International trade: The nature of demand for the internationally traded goods is helpful in determining the
quantum of again of gain accruing to the respective countries. Thus is how it determines the terms of trade.
xi. Price determination: The concept of elasticity of demand is used in explaining the determination of price under
various market conditions.
xii. Rate of foreign exchange: With fixing the rate of exchange, the government has to consider the elasticity or
otherwise of its imports and exports.
xiii. Relation between price elasticity average revenue and marginal revenue: This relationship enables us to
understand and compare the conditions of equilibrium under different market conditions.
xiv. Price determination: Price determination is forced to be profitable if elasticity of demand in another. The
monopolist can charge a higher price in the market where elasticity of demand is less and a lower price where
elasticity of demand is greater
xv. Measuring degree of monopoly power: The less is the elasticity of demand higher will be the price and wider
the difference between the marginal cost and greater the monopoly power, and vice versa.
xvi. Classification of goods as substitutes and complements: Goods are classified as substitutes on the basis of cross
elasticity. Two commodities may be considered as substitutes if cross elasticity is positive and complements when
elasticity is negative.

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xvii. Boundary between industries: Cross elasticity of demand is also useful in indicating boundaries between
industries. Goods with high cross elasticitys constitute one industry, where as goods with lower elasticity constitute
different industries.
xviii. Market forms: The concept of cross elasticity help[s to understand different market forms infinite cross
elasticity indicates perfect market forms infinite cross elasticity indicates perfect competitions, where as zero or hear
zero elasticity indicates pure monopoly and high elasticity indicates imperfect competition
xix. Incidence of taxes: The concept of elasticity of demand is used in explaining the incidence of indirect taxes like
sales tax and excise duty. less is the elasticity of demand higher the incidence, and vice versa. In case of inelastic
demand the consumer have to buy the commodity and must bear the tax.
xx. Theory of distribution: Elasticity of demand is useful in the determination of relative shares of the various
factors determination of relative shares of the various factors of production is loss elastic, its share in the national
dividend is higher, and vice versa. If elasticity of substitution is high the share will be low.

5. Define Supply. Explain the determinants of supply.


The supply of a commodity means the amount of that commodity which producers are able and willing to offer for
sale at a given price. The supply curve is explained with the help of a diagram.

X axis-----Quantity Supplied
Y axis------Price
Explanation: The figure shows that as the price of a commodity increases from P to P1, the supply also increases
from Q to Q1. It means that price & supply are directly related.

Reserve Price
If the price falls too much, supply may dry up altogether. The price below which the seller will refuse to sell is
called Reserve Price. At this price, the seller is said to buy his own stock.

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DETERMINANTS OF SUPPLY
i.

Goals of firms: The supply of a commodity depends upon the goals of firms.

ii. Price of the commodity: The supply of a commodity depends upon the price of that commodity. Ceteris
paribus the higher the price of the commodity the more profitable it will be to make that commodity. One expects,
therefore, that the higher the price, the greater will be the supply.
iii. Prices of all other commodities: The supply of a commodity depends upon the prices of all other commodities.
Generally, an increase in the price of other commodities will make production of the commodity whose price does
not rise relatively less attractive than it was previously. We thus expect that ceteris paribus, the supply of one
commodity would fall as the price of other commodities rises.
iv. Prices of factors of production: The supply of a commodity depends upon the prices of factors of production. A
rise in the price of one factor of production will cause a large increase in the costs of making those goods which use
a great deal of that factor, and only a small increase in the cost of producing those commodities which use a small
amount of the factor.
v. State of technology: The supply of a commodity depends upon the state of technology.
vi. Time factor: Time factor can also determine elasticity of supply. Time can be broadly classified into three
categories: Market period is the one where supply is fixed as no factor of production can be altered.
vii. Short period is the time period when it is possible to adjust supply only by changing the variable factors like
raw- material, labor, etc., and Long period where supply can be changed at will because all the factors can be
changed.
viii. Agreement among the producers: Supply may be consciously decreased by agreement among the producers.
ix. To raise price: Supply may also be destroyed to raise price.
x. Taxation on output or imports: Supply may also be affected by taxation on output or imports. Government
may also restrict production of certain commodities on grounds of health (e.g., opium in India).
xi. Political disturbances or war may also create scarcity of certain goods.

6. What is the concept of elasticity of supply? Explain the types of elasticity of supply.

ELASTICITY OF SUPPLY
It can be defined as the degree of responsiveness of supply to a given change in price. The formula to
find out the elasticity of supply is:
Es = percentage change in quantity supplied / percentage change in price

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TYPES OF ELASTICITY OF SUPPLY
i. Perfectly elastic supply: Where no change in price is needed to cause an increase in quantity supplied. This is
explained with the help of a diagram.

X axis-quantity supplied
Y axis- price
SS- supply curve
Explanation: The elasticity of supply is infinity when a small change in price leads to an infinitely large change in
the quantity supplied. It is perfectly elastic supply. [E=]
ii. Perfectly in elastic supply: Here a large change in price causes no change in quantity supplied. It is zero elastic
supply [E=0]. This is explained with the help of a diagram.

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X axis-quantity supplied
Y axis- price
SS- supply curve
Explanation: The figure shows that even if the price increases from p to p1 there is no change in the quantity
supplied.

iii. Unitary elastic: Where a given proportionate change in price causes an equally proportionate change in
quantity supplied. This is explained with the help of a diagram.

X axis-quantity supplied, Y axis- price, SS- supply curve


Explanation: Elasticity of supply is unity when the change in supply is exactly proportionate to the change in price.
[E=1].
iv. Relatively elastic: Where a small change in price causes a more than proportionate change in quantity supplied.
The price elasticity of supply is greater than unity [E >1].This is explained with the help of a diagram.

X axis-quantity supplied, Y axis- price, SS- supply curve

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Explanation: The figure shows that there is a small increase in price from P to P1, but it has resulted in a large
increase in quantity supplied from Q to Q1. It is also known as relatively elastic supply.

v. Relatively inelastic Supply: Where a large change in price causes a less than proportionate change in quantity
supplied. The elasticity of supply is lesser than unity [E <1]. This is explained with the help of a diagram.

X axis-quantity supplied
Y axis- price
SS- supply curve
Explanation: The figure shows that there is a large increase in price from P to P1, but it has resulted in only a small
increase in quantity supplied from Q to Q1. It is also known as relatively inelastic supply.

7. What is demand forecasting? Explain the types, methods and limitations of forecasting techniques.
FORECASTING
Forecasting is the process of estimating the future, based on the analysis of their past and present behaviour. A
forecast tries to define wheat one believers will happen in the future. Its aim is to provide information for planning
and decision making.
FEATURES OF FORECASTING
i. Relates to future events: Forecasting relates to future events which are needed for planning process.
ii. Best use of available data: Forecasting uses the best available data and makes the best informed guess. There
will be errors involved, so that all forecasts should state a plus or minus margin of error.

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iii. Take account of discontinuities: The further away the forecast the less accurate it is likely to be. In all forecasts,
it is important to take account of discontinuities, which can affect the data trend.
iv. Statistical tools and techniques: The analysis of various factors may require the use of various statistical tools and
techniques.
v. Feedback mechanism: All forecasting system should include a feedback mechanism where the actual results are
compared with the forecast values and the forecasting system is modified to make it more accurate in future.
NEED OF FORECASTING OR APPLICATIONS OF FORECASTING WITHIN INDUSTRY
i. Inventory control/production planning: forecasting the demand for a product enables us to control the stock of raw
materials and finished goods, plan the production schedule, etc
ii. Investment policy: forecasting financial information such as interest rates, exchange rates, share prices, the price
of gold, etc. This is an area in which no one has yet developed a reliable (consistently accurate) forecasting
technique (at least if they have or they havent told anybody)
iii. Economic policy: forecasting economic information such as the growth in economy, unemployment, the
inflation rate, etc is vital both to government and business in planning for the future.
iv. Compel to think ahead: The process of making forecast and their review by authorities compel them to think
ahead, looking to the future, and providing for it.
v. Disclose the areas where necessary control is lacking: Preparation of the forecast may disclose the areas where
necessary control is lacking in the organization for its future course of action.
vi. Helps to unity and coordinate plans: Forecasting, especially when there is participation throughout the
organization, helps to unity and coordinate plans.
vii. Helps in promotion of organization: Forecasting certainly helps in promotion of organization by achieving its
objectives in best possible way, since forecasting of future events is of direct relevance in achieving an objective.
viii. Key to planning process: Forecasting is the essential step in planning process. So, it is a key to planning process.
Planning decides the future course of action but forecasting to decide it. Therefore, forecasting generates the
planning process.
LIMITATIONS OF FORECASTING
i. Based on wrong assumptions: Forecasting is based on some assumptions. It assumes that events do not change
rapidly or haphazardly but change on a regular pattern. These assumptions may not hold good for all conditions or
situations.
ii. Indicate the trend of future happening: they are not always true: Forecasts merely indicate the trend of future
happening: they are not always true. This is so because of the factors taken into account for making the forecast.
These factors are affected by human who are highly unpredictable. Period of forecasting is also one of the factors
affecting the forecast. Degree of error increases with increases in period of forecast.

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iii. Time and cost factor: Another important of forecasting is time and cost factor, forecasting requires past data and
information. The collection and proper arrangement of such information and data requires lot of time and money.
Moreover, it requires lot of calculations and selection of proper calculation method which requires lot of manpower
and money. Therefore, most of the smaller organization does not go for formal system forecasting.
VARIOUS TYPES OF FORECASTING
i. Long-range and is used research and forecast: The long-range forecast usually covers a period of three to more
years in areas such as planning for new products, facility location or expectation, development, and capital
expenditures.
ii. Short- range forecast: The short- range forecast covers a time span of up to one year, but often it is less than
three months. It is used in areas such as purchasing, planning, job assignments and scheduling, and levels of work
force.
iii. Medium-range forecast: The medium- range forecast usually covers a time period from three months to three
years and finds applications in many areas including sales planning, budgeting, and production planning.
VARIOUS STEPS IN FORECASTING
i. Determine the objective: Determine the forecast applications and objective.
ii. Choose the items: Choose with care the items to be forecasted.
iii. Time horizon: Determine the forecast time horizon (i.e., long, short, or medium)
iv. Forecasting models: Chose appropriate forecasting models.
v. Collect data: Collect the appropriate data required to make the forecasting under consideration.
vi. Validate forecasting model: Validate the forecasting model with care.
vii. Relevant forecasts: Make all relevant forecasts.
viii. Implement results: Implement the appropriate results.
VARIOUS METHODS OF FORECASTING
A. Qualitative Method: The qualitative methods provide forecasts that incorporate factors such as the decision
makers emotions, personal experiences, and intuition. Some examples of the qualitative methods are jury of
executive opinions, Delphi method, consumer market survey, and sales force opinion composite
i. Jury of Executive Opinion: This is the simplest method, in that the executive of the organization each provides an
estimate of future volume, and the president provides a considered average of these estimates.
ii. Delphi Method: The Delphi method makes use of a panel of experts, selected based on the areas of expertise
required. The Delphi method is an exercise in group communication among a panel of geographically dispersed
experts. The technique allows experts to deal systematically with a complex problem or task.

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iii. Consumer Market Survey: This method is mainly useful for predicting the sales forecast when it is introduced in
the market. For a new product, there will be no historic or past data available to forecast. In this method, field
surveys are conducted to gather information on the intentions of the concerned people.
iv. Sales Force Opinion Composite: In this method, members of the sales force estimate sales in their own territory,
regional sales managers adjust these estimates for their opinion or permission of individual sales people, and the
general sales mangers massages the figures to account for new products or factors of which individual salesman
are unaware.
v. Scenario Building: In this method, the parameters of importance to the company are first recorded. A number of
assumptions are then followed through on how these parameters may change. Several scenarios are developed based
on the assumptions.
vi. Judgment Decomposition: The idea behind judgmental decomposition is to divide the forecasting problem into
parts that are easier to forecast than the whole. One then forecasts the parts individually, using methods appropriate
to each part. Finally, the parts are combined to obtain a forecast.
B. Quantitative Method: The quantitative methods provide forecasts that were obtained by employing various
mathematical models that use past data or causal variables to forecast demand.
i. Time series Methods/Analysis: Methods of this type are concerned with variable that changes with time and which
can be said to depend only upon the current time and the previous values that it took.
ii. Simple Moving Average: This method uses the average of the previous N periods to estimate the demand in
any future period.
iii. Weighted Moving Average: In the weighted moving average method, for computing the average of the most
recent N periods, the recent observations are typically given more weight than older observations.
iv. Exponential Smoothing: This is frequently used and sophisticated weighted moving-average forecasting method.
The method is fairly easy to use and requires very little record keeping of past data.
C. Econometric Forecasting: In this method of forecasting, the analyst finds the cause-and-effect relationship
between the demand and some other phenomena that are related to the demand. There are many dependent variables
that interact with each other via series of equations, the form of which is given by economic theory. Economic
theory gives some insight into the basic structural relationship between variables. The precise numeric relationship
between variables must often be deduced by examining data. This process is called economic forecasting.
Econometric analysis utilizes correlation and regression techniques.
i. Correlation Analysis: In this method, correlation coefficient is measures of the extension to which variables (e.g.
number of trucks sold and clutch plates sold) are associated.
ii. Regression Analysis: Regression models assume that a linear relationship exists between a variable designated
the dependent (unknown) variable and one or more dependent (known) variable.

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D. Technological forecasting: Technological forecasting may be defined as the forecasting the future technology
may affect the operations of the enterprise. It is a prediction, based on confidence that certain developments can
occur within a specified time period with a given level or resource allocation. Two types of technological
forecasting should be considered: normative and exploratory.
i. Normative forecasting: In normative forecasting, some desired future goal is selected, and a process is developed,
working backward from the future to the present, designed to achieve this goal.
ii. Exploratory forecast: An exploratory forecast begins with the present stage of technology and explicates into the
future assuming some expected rate of technical progress. Delphi method is one such a technique which is already
discussed elaborately in topic Delphi Method.
iii. Technology S-curve: Another useful model for technological forecasting is the technology S-curve. The
performance gained from a new technology tends to start slowly, and then raise almost exponentially as many
scientists and engineers begin applying themselves to product improvement. Ultimately, as the technology becomes
mature, performance gains become more and more difficult to attain, and performance approaches some natural
limit.
iv. Internet: Another tool for forecasting is the internet, which has become a powerful tool at a companys disposal
for evaluating the composition, predicting the market, and establishing trend, one method is that company web
pages may be equipped with counters to keep track of visitors and even set feedback forms to gather additional
information. This information allows a company to evaluate their customers habits and determine the most
appropriate and beneficial way to deal with each one. This activity also provides database information for trending
and predicting future responses.

8. What is Consumer Surplus? Explain in detail about the effects of consumer equilibrium curve.
CONSUMER SURPLUS
The excess of the price which he would be willing to pay rather than go without thing, over that which he actually
does pay, is the economic measure of this surplus satisfaction. It may be the called consumers surplus. This is
explained with the help of a diagram.

Explanation:
The figure shows that at OA price OM units of commodity is sold, but sometimes the consumer is also willing to
buy even less commodity i.e. OM1 at a high price of OA1 rather than going without buying that commodity & this
is called as consumer surplus.

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THE EFFECT OF PRICES ON CONSUMER EQUILIBRIUM


Price consumption curve: Now we shall describe how a consumers equilibrium shifts as a result of a change in the
price of one of the goods, while his income and the price of the other good remain the same (i.e., the price effect).
This can be explained with the help of a diagram.

X axis-Good X
Y axis- Money
PCC---Price Consumption curve
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Explanation:
i. With a certain fixed income and given market prices of the two goods X and Y represented by the price-income
line ML1, the consumer is in equilibrium at point P1.
ii. Suppose the price of X falls, income and price of Y remaining unchanged, so that new price-income line becomes
ML2, the consumer will be in equilibrium a point P2 on the higher indifference curve C2. In this position, he will be
buying OH2 of commodity X.
iii. If the price of X falls further, so that the relevant price line is ML3, the consumer will be in equilibrium at point
P3 and will be buying OH3 of commodity X.
iv. When all the points such as P1,P2,P3,P4 are joined together we have the price consumption curve shows how
the consumption of commodity X changes as its price changes, the consumers income and price of Y remaining the
same.
THE SUBSTITUTION EFFECT ON CONSUMERS EQUILIBRIUM
Substitution effect: Substitution effect means he changes in the quantity of a good purchased which is due only to
the change in relative prices, money income remaining constant. This is be explained with the help of diagram.

X axis-Good X
Y axis- Good Y
Explanation:
i.

The consumer is in equilibrium at point Q where the given price line PL is tangent to indifference curve C1.

ii. When the price of X falls while the price of Y remains the same, the price line will shift to PH (because now
more of X is purchased) and the consumer will be in equilibrium at R, where the new price line PH touches the
indifference curve C2.

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iii. To find out the substitution effect, we draw a hypothetical price line AB parallel to the price line PH so that it
(i.e., AB) should touch the indifference curve C1.
iv. With price line AB, the consumer is in equilibrium at T on indifference curve C1.
v. At the point T, he gets the same satisfaction as at Q, because both Q and T are situated as on the same
indifference curve C1.
vi. Movement from Q to T on the same indifference curve C1 is due only to the relative fall in the price of X.
vii. At the point T, the consumer buys MK more (at q he bought OM but at T h b uys OK) of X than at Q as X is
now relatively cheaper.
viii. This MK is the substitution effect which involves movement from Q to T.
THE EFFECT OF INCOME ON CONSUMERS EQUILIBRIUM
Income Consumption curve: Income effect is the effect on the quantity demanded exclusively as a result of change
in money income, all prices remaining constant. This is be explained with the help of diagram.

X axis-Good X
Y axis- Money
ICC---Income Consumption curve
Explanation:
i. With price- income line L1M1, the consumer is in equilibrium at point P1.
ii. Now suppose the income of the consumer increases so that his new price- income line is L2M2. As a result of
this increase in income, the consumer will move to a new equilibrium position, at the point P2, on a higher
indifference curve C2 and will be buying OH2 of commodity X and OQ2 of commodity Y.

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iii. Thus we get various points of equilibrium such as P1, P2, P3 for different levels of income, prices of the
commodities remaining the same. If the points P1, P2, P3, P4, etc., are joined together by a line passing from the
origin, we get, what is called Income consumption curve (ICC).
TWO CONDITIONS OF EQUILIBRIUM:
i.

The price line should be tangent to an indifference curve or MRS of one commodity for another should be equal

to their relative prices.


ii. At the point of equilibrium an indifference curve must be convex to the origin.
This can be explained by the diagram

X axis Good x
Y axis Good y
IC1,IC2,IC3,IC4, - Indifference curve
Explanation:

i.

The consumer will be in equilibrium at the point p. the consumer will maximize his satisfaction and be in

equilibrium at a point where the price line touches (or its tangent to) an indifference curve.

ii. Any combination other than p on the given price line can be shown to give less satisfaction to the consumer, for
all other points on the price line must lie on indifference curves of a lower order than that on which p lies.

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UNIT III PRODUCTION AND COST ANALYSIS


PART A (2 MARKS)
1.Say some of the main cost concepts.
1) Actual costs and opportunity costs
2) Incremental costs and sunk costs
3) Explicit costs and implicit costs
4) Past costs and future costs
5) Accounting costs and economic costs
6) Direct cost and indirect cost
7) Private costs and social costs
8) Controllable costs and non-controllable costs
9) Replacement costs and original costs
10) Shutdown costs and abandonment costs
11) Urgent costs and postponable costs
12) Business costs and full costs
13) Fixed costs and variable costs
14) Short run and long run costs
15) Incremental costs and marginal costs

2.What are actual costs and opportunity costs?


Actual costs which a firm incurs for producing or acquiring a product or a service. As example for this is the cost on
raw materials, labour, rent, interest.

3.What are incremental costs and sunk costs?


Incremental cost is the additional cost due to change in the level of nature or business activity. Sunk costs are the costs
that are not altered by a change in quantity produced and cannot be recovered.

4.What are explicit costs and implicit costs?


Explicit or paid out costs are those expenses which are actually paid by the firm. Implicit costs are the theoretical costs
in the sense that they go unrecognized by the accounting system.
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5.What are past costs and future costs?


Past costs are the actual costs incurred in the past are generally contained in the financial accounts. Future costs are
costs that are expected to occur in some future period or periods.

6.What are accounting costs and economic costs?


Accounting costs are the actual outlay costs. Economic cost relate to the future.

7.What is direct and indirect cost?


Direct cost are traceable cost or assignable cost are the ones that have direct relationship with a unit of operation like
a product, a process or a product, or a department of the firm. On the other hand, indirect costs or non-traceable costs
or common or non-assignable costs are the costs whose course cannot be easily and definitely traced to the plant.

8.What are private costs and social costs?


Private costs are those which are actually incurred or provided for the business activity by an individual or the
business firm. Social costs on the other hand are the total costs to the society on account of production of a good.

9.What are controllable and non-controllablecosts?


Controllable costs are those which are capable of being controlled or regulated by the managers ant = d it can be used
to assess the managerial efficiency in controlling the cost in his department. Non controllable costs are those which
cannot be subjected to administrative controls and supervision.

10.What are replacement costs and original costs?


Original costs or the historical costs are the costs paid for assets such as land, building, and cost of plant, equipment
and materials. Replacement costs are the costs that the firm incurs if it wants to replace or acquire the same assets now.

11.What is shut down cost and abandonment cost?


Shutdown costs are costs in which the firm incurs if it temporarily stop its operation. Abandonment costs are the costs
of retiring altogether a fixed asset from use.

12. What are incremental cost and marginal cost?


Incremental cost is important when dealing with decisions where discrete alternatives are to be compared. Marginal
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cost deals with unity unit output.

13. What are the determinants of cost?


1) Level of output
2) Price of inputs.
3) Size of plant
4) Output stability
5) Production lot size
6) Level of capability utilization
7) Technology
8) Learning effect
9) Breadth of product range.
10) Geographical location

14. What are the two aspects in cost output relationships?


1) Cost output relationship in short run.
2) Cost output relationship in long run.

15. What are the terms involved in cost output relationship?


1) Average fixed cost.
2) Average variable cost.
3) Average total cost.

16. What is level of capacity utilization?


The higher the capacity utilization fixed cost per unit of output in bound to be low.

17. What is output stability?


Stability of output leads to savings in various kinds of hidden cost interruption and learning.

18. What is size of plants?


Production costs are usually lower in bigger plants than smaller plants.

19. What is cost?


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Cost is the money spent on producing and selling a product to the customers. The cost of a product starts from the
raw materials through production costs till selling costs include the cost in maintaining outlets.

20. What is the significance of cost in managerial decision making?


Study of costs is essential for making a choice from among the competing production plans. Production decisions are
not possible without their respective cost considerations.

21. What is price of input?


If the price of the raw materials labour, power increases then naturally the cost of production goes up. This cost
of productions varies directly with the prices of inputs.

PART-B (16 MARKS)


1. Explain the product possibility curve.
The Production Possibility curve is the laws of output combinations which can be obtained from given quantities of factors
or inputs. This curve not only shows production possibilities but also the rate of transfor mation of one product into the
other when the economy moves from one possibility point to the other.
Assumptions:
i. Only two goods X (Consumer goods) and Y (Capital goods) are produced in different proportions in the
economy.
ii. The same resources can be used to produce either or both of the two goods and can be shifted freely between them.
iii. The supplies of factors are fixed. But they can be re-allocated for the production of the tow goods within limits.
iv. The production techniques are given and constant.
v. The economy's resources are fully employed and technically efficient.
vi. The time period is short.
This is explained with the help of a diagram.

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i. The curve production possibility (PP1) depicts the various possible combinations of the two goods, P,B,C,D
and P1. This is also known as the transformation curve or production possibility frontier.
ii. The production possibility curve further shows that when the socie ty moves from the possibility point
B to C or to D, it transfers resources from the production of good X. It is concern as the optimum product =
mix of a society.
iii. Again, all possibility curve combinations lying on the production possibility curve (such as B, C and D) show
the combinations of the tow goods that can be produced by existing resources and technology of the society. S uch
combinations are said to be technologically efficient.
iv. Any combination lying inside the production possibility curve, such as R implies that the society is not
using its existing resources fully. S uch a combination is said to be technologically inefficient.
v. Any combination lying outside the production possibility frontier, such as K, implies that the economy does not
possess sufficient resources to produce this combination. It is said to be technologically infeasible or
unobtainable.
THE US ES OR APPLICATIONS OF THE PRODUCTION POSS IBILITY CURVE
i. Unemployment: The production possibility curve helps in knowing the level of unemployment of resources in the
economy.
ii. Technological Progress: The production possibility curve helps in showing technical progress enables
an economy to get more output from the same quantities of resources.
iii. Economic growth: The production possibility curve helps in explaining how an economy grows.
iv. Present goods vs. Future goods : An economy that allocates more resources in the present to the production of
capital goods than to consumer goods will have more of both kinds of goods in the future. It will there,
experience higher economic growth. This is because consumer goods satisfy the present wants while capital
goods satisfy future wants.
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v. Economic efficiency : The production possibility curve is also used to explain the three efficiencies namely
efficient selection of the goods to be produced, efficient allocation of resources in the production of these
goods and efficient choice of methods of production, efficient allotment of the goods produced among
consumers
vi. Basic fact of human life : The production possibility curve tells us about the basic fact of human life that
the resources available to mankind in terms of factors, goods, money or time are scarce in relation to wants, and the
solution lies in economizing these resources.

2. Explain in detail about isoquants.


ISOQUANT OR EQUAL PRODUCT CURVE
An iso product curve also shows all possible combinations of the two inputs physically capable of producing
a given level of output. S ince an iso product curve represents those combinations which will allow the
production of an equal quantity of output, the producer would be indifferent between them. Iso product
curve are therefore, called product indifference curves. They are also known as Iso quants or equal product
curve. This is explained with the help of a diagram.

X axis

Units of labor

Units of capital

IP

Iso quant curve (or) Equal product curve

Explanation:
IP represents all those combinations with which the units of the product can be produced. The shape of the
isoquants shows the degree of substitutability between the two factors used in production.

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EQUAL PRODUCT MAP (OR) IS O PRODUCT MAP
An iso product map showing various iso product curves, it is possible to say by how much production is greater
or less on one iso product curve than on another. This is explained with the help of a diagram.

Explanation:
An iso product map showing various iso-product curves, it is possible to say by how much production is greater
or less on one iso product curve than on another. Higher the iso product curve higher is the level of production &
vice versa.

3. Explain the nature and managerial uses of production function.


MANAGERIAL USES OF PRODUCTION FUNCTION
1. Calculate the least cost input combination: It can be used to calculate the least cost input combination for a
given output.
2. Calculate the maximum-input-output combination: It can be used to calculate the maximum- inputoutput combination for a given cost.
3. Deciding on the value of employing a variable input factor: Knowledge of production function is useful in
deciding on the value of e employing a variable input factor in the production process. As long as the
marginal revenue productivity of a variable input factor exceeds its price, it is worthwhile to increase its
usage. When the marginal revenue productivity just equals the price of input factors then the additional use of
input factors must be stopped.
4. Aid in long run decision making: Production functions also aid in long run decision making. If the return
to scale is increasing, one can increase production through a proportionate increase in all the input factors
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of production. The opposite is true if there is decreasing returns to scale. The producer will be indifferent about
increasing or decreasing the production in case of constant returns to scale provided the demand is of no constraint
ISO COST LINE
The combination of factors with which a firm produces the product also depends on the prices of the factors
and the amount of money which a firm wants to spend; Iso cost line represents these two things. The prices of
productive factors and the amount of money which a firm wants to spend, Each iso cost line will show various
combinations of tow factors which can be purchased with a given amount of total money. The iso cost line is also
known as price line (or) outlay line. This can be explained with the help of a figure below:

Explanation
The slope of the iso cost line represents the ratio of the price of a unit of input X to the price of a unit of input
Y. In case the price of any one o f them changes, there would be a corresponding change in the slope of the
iso cost curve and the equilibrium would shift too.

THE CHOICE OF OPTIMAL FACTOR COMBINATION (OR) LEAS T COST COMBINATION OF


FACTORS (OR) PRODUCER EQUILIBRIUM
The choice of optimal expansion path refers to the Combinations of factors of production that enable the firm to
produce various levels of outputs at the least cost while relative factor prices remain constant. Its analysis is done
in relation to the short run and the long run.
Assumptions:
i. There are two factors, labor and capital
ii. All units of labor and capital are homogeneous
iii. The prices of units of labor (W) and that of capital
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(iv) are given and constant.
v. The cost outlay is given
vi. The firm produces a single product.
vii. The price of the product is given and constant.
viii. The firm aims at profit maximization.
ix. There is perfect competition in the factor market.

Explanation
(i) In order to maximize its profits or to have the least cost combination, the firm combines labor and capital in
such a way that the ratio of their MP is equal to the ratio of their prices, i.e. MPL/MPC = w/r. This equality
occurs at the point of tangency between an iso cost line and an iso quant curve.
(ii) The line C2L2 shows higher total outlay than the line C1L1 and C3L3 still higher total outlay than the line
C2L2. They are shown parallel to each other there by reflecting constant factor prices.
(iii) The firm Is in equilibrium at point P where the isoquant IQ1 is tangent to its corresponding iso cost line
C1L1 and similarly the other tow iso quants IQ2 and IQ3 are tangent to isocost lines C2L3 and C3L3 respectively
at points Q and R.
(iv) Each point of tangency implies optimal combination o f labor and capital that produces an optimal output
level. The line OS joining these equilibrium point P,Q and R through the origin is the expansion path of the firm
PRODUCTION FUNCTION
The Production function expresses a functional relationship between quantities of inputs and outputs. It shows
how and to what extent output changes with variations inputs during a specified period of time.
ECONOMIES AND DISECONOMIES OF SCALE OR OF LARGE SCALE PRODUCTION
Economies of Scale: An economy of scale exists when larger output is associated with lower per unit cost.
Diseconomies of Scale: A diseconomy of scale exists when larger output leads to higher per unit cost.
ECONOMIES (OR) ADVANTAGES OF LARGE SCALE PRODUCTION
i. Efficient use of capital equipment: There is a large scope for the use of machinery which results in lower
costs
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ii. Economy of specialized labour: Specialized labour produces a large amount of output and of better quality.
iii. Better utilization and greater s pecialization in management: When the scale of production is
enlarged, there is fuller use of the manager's time and ability.

Also, he is able to delegate some of his less

important functions to his assistants and increasingly specialize in the jobs where his ability is most fruitful.
iv. Economics of buying and selling: While purchasing raw material and others accessories, a big business can
secure specially favorable terms on account of its large custom.
v. Economics of the overhead charges: The expenses of administration and distribution per unit of output in a
big business are much less.
vi. Economy in Rent: A large-scale producer makes a savings in rent too.
vii. Experiments and Research: A large concern can afford to spent liberally on research and experiments.
viii. Advertisement and Salesmanship:

A big concern can afford to spend large amounts of money on

advertisement and salesmanship.


ix. Utilization of By-products: A big business will not have to throw away any of its by- products or waste
products.
x. Meeting Adversity: A big business can secure credit facilities at cheap rates.

4. Explain the types of economies and diseconomies in scale.


TYPES OF ECONOMIES AND DISECONOMIES OF SCALE TYPES OF ECONOMIES
A. Real Internal Economies: Real internal economies are associated with a reduction in the physical quantity of inputs,
raw materials, various types of capital (fixed or circulating) used by a large firm.
i. Labour economies: When a firm expands in size this necessitates division of

labour whereby each worker is

assigned one particular job, and the splitting of processes into sub- processes for greater efficiency and productivity.
ii. Technical Economies: Technical economies are associated with all types of machines and equipments used by a large
firm. They arise from the use of better machines and techniques of production which increase output and reduce per
unit cost of production. It includes, economies of indivisibility, economies of increased dimensions, economies of
linked processes, economies of the use of By-products, economies in power consumption.
iii. Marketing Economies: A large firm also reaps the economies of buying and selling. It buy its requirements of
various inputs in bulk and is, therefore, able to secure them at favorable terms in the form of better quality inputs,
prompt delivery, transport concessions, etc.
iv. Managerial Economies: A large firm can afford to put specialists to supervise and manage the various departments.
There may be a separate head for manufacturing, assembling, packing, marketing, general administration, etc.
v. Risk-Bearing Economies: A large firm is in a better position than a small firm in spreading its risks. It can produce a
variety of products, and sell them in different areas.

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vi. Economies of Research: A large firm possesses larger resources than a small firm and can establish its own research
laboratory and employ trained research workers.
vii. Economies of welfare: All firms have to provide welfare facilities to their workers. But a large firm, with its large
resources, can provide better working conditions in and outside the factory. It may run subsidized canteens, provide
crches for the infants of women workers and recreation rooms for the workers within the factory premises.
B.

Pecuniary Internal Economies: Pecuniary or monetary internal economies accrue to a large firm solely through

reductions in the market prices of its inputs.


i. It purchases raw materials in bulk at lower prices from its suppliers.
ii. It gets loans from banks and other financial institutions at low interest rates because it possesses large assets and
good reputation.
iii. It raises capital by floating shares at a premium and debentures at low interest rates in the capital market.
iv. It advertises at concessional rates on a large scale in different media
v. It transports large quantities of its commodity at concessional transport rates. Thus pecuniary economics are
realized from paying lower prices for the factors used in the production and distribution of the product, due to bulkbuying by the firm as its size increases.
C. Real External Economies: Real external economies accrue to a firm in an industry due to technological influences
on its output which reduce its real cost of production.
i. Technical Economies: Technical external economies arise from specialization.

When an industry expands in

size, firms start specializing in different processes and the industry benefits on the whole.
ii. Economies of Information: As an industry expands, it specializes in collecting and disseminating market
information, in marketing the industry's product and in supplying the firms with consultant services.
iii. Economies of By-products: When an industry is localized, it turns out large quantities of waste materials, such as
molasses in sugar industry and iron scrap in steel industry.
D. Pecuniary External Economies: Pecuniary external economies arise to firms in an industry from reductions in
factor prices.
TYPES OF DISECONOMIES
A. Real Internal Diseconomy: When a firm expands beyond an optimum level, a number of problems arise such as
factor shortages, lack of coordination and management, marketing and technological difficulties, etc.
i. Managerial Diseconomy: There is a limit beyond which a firm becomes unwidely and hence unmanageable. S
upervision becomes less. Workers do not work efficiently, wastages arise, decision- making
co-ordination between workers and

becomes

difficult,

management disappears and per unit cost increases.

ii. Marketing Diseconomy: The expansion of a firm beyond a certain limit may also involve marketing problems.
Raw materials may not be available in sufficient quantities due to their scarcities. The demand for the products of the

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firm may fall as a result of changes in tastes of the people and the firm may not be in a position to change accordingly
in the short period.
iii. Technical Diseconomy: A large scale firm often operates heavy capital equipment which is indivisible.

As the

firm expands its size beyond the optimum level, there are repeated breakdowns in plants and equipments and the
firm may fail to operate its plant to its maximum capacity. It may have excess capacity or idle capacity. As a
result, per unit cost increases.
iv. Diseconomy of Risk-taking: As the scale of production of a firm expands, risks also increase with it. An
error of judgment on the part of the sales manager or the production manager may adversely affect sales or production
which may lead to a great loss.
B. Pecuniary Internal Diseconomy: Pecuniary internal diseconomy arises when the prices of factors used in the
production and distribution of the commodity increase.
C. Pecuniary External Diseconomy: Pecuniary external diseconomy arises solely through increases in the market
prices of inputs of an industry.

5. Discuss briefly about the cost concepts relevant to managerial decisions of planning and control.
COST CONCEPT
i. Money Cost: The cost may be nominal cost or real cost.
ii. Nominal Cost: Nominal Cost is the money cost of production. It is also called expenses of production. These
expenses are important from the point of view of the producer. He must make sure that the price of the product, in
the long run, covers these expenses including normal profit, otherwise he cannot afford to carry on the business.
iii. Real Cost: Attempts have been made to pierce the monetary veil and to establish cost on a real basis. The real
cost of production has been variously interpreted. Adam smith regarded pains and sacrifices of labour as real cost.
Marshall includes under it real cost of efforts of various qualities and real cost of waiting. This is called the
social cost by Marshall.
iv. Opportunity Cost: The Austrian school of economists and their followers gave a new concept of real costs.
According to them, the real cost of production of a given commodity is the next best alternative sacrificed in order
to obtain that commodity. It is also called opportunity cost or displacement cost.
v. Economic Cost:

By economic costs is meant those payments which must be received by resource owners in

order to ensure that they will continue to supply them in the process of production.

This definition is based on the

fact that resources are scarce and they have alternative uses. To use them in one process is to deny their use
in other processes. Economic Cost includes normal profit.

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vi. Implicit Cost: Implicit costs are costs of self-owned and self-employed resources such as salary of the proprietor
or return on the entrepreneur's own investment. These costs are frequently ignored in calculating the expenses of
production.
vii. Explicit Cost: Explicit costs are the paid-out costs, i.e., payments made for productive resources purchased or
hired by the firm. They consist of the salaries and wages paid to the employees, prices of raw and semi- finished
materials, overhead costs and payments into depreciation and sinking fund accounts. These are firm's accounting
expenses.
viii. Full Cost: If we add to the money expenses two item, viz., alternative or opportunity costs and normal profits,
we get the full costs.
ix. Business Cost: Business costs are synonymous with firm's total money expenses as computed by ordinary
accounting methods. The entrepreneur must be sure of normal pro fit if he is to continue in business. In this sense
normal profit too is a cost.
x. Social Cost: It is the amount of cost the society bears due to industrialization. Industrialization has certain
economic and social merits, but along with the merits, they bring about certain demerits also. They are like,
development of slums, air-pollution, noise pollution, land pollution, social inequalities, and so on. The amount of
cost the society bears due to industrialization is referred as Social Cost.
xi. Entrepreneurs Cost: In what follows, we shall use the term cost of production in the sense of money cost or
expenses of production. This is entrepreneur's cost. The entrepreneur's cost of production includes the following
element: (i) Wages of labour; (ii) Interest on capital; (iii) Rent or royalties paid to the owners of land or other
property used; (iv) Cost of raw materials; (v) Replacement and repairing charges of machinery; (vi)
Depreciation of capital goods; and (vii) Profits if the manufacturer sufficient to induce him to carry on the
production of the commodity.
xii. Classification of Entrepreneurs Cost: Entrepreneur's costs may

be

classified

as: Production costs,

including material costs, wage costs, interest costs, etc., both direct and indirect costs. Selling costs, including
costs of advertising and salesmanship, Managerial costs, Other costs, including insurance charges, rates, taxes, etc.
xiii. Short run: Short run is a period of time within which the firms can its output by varying only the amount of
variable factors, such as labour and raw materials. In the short run, fixed factors, such as capital equipment, top
management personnel, etc., cannot be varied.
xiv. Long run: Long run is a period of time during which the quantities of all factors, variable as well as fixed, can
be adjusted.
xv. Prime Cost & Overhead Cost:

Some costs vary more or less proportionately with the output, while others are

fixed and do not vary with the output in the same way. The former are known as prime costs and the latter as
supplementary costs of production or overhead costs.

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xvi. Total Cost: Total Cost is the sum of Fixed cost (Factory land, building and machinery) plus the total variable
cost (raw material charges, electricity)
xvii. Average Cost: Average Cost per unit is the total cost divided by the number of units produced. It is the sum of
average fixed cost and the average variable cost.
xviii. Marginal Cost: Marginal cost is the addition to total cost caused by a small increment in output. Marginal cost
may be defined as the change in total cost resulting from the unit change in the quantity produced. Thus, it can be
expressed by the formula:
MC=Change in Q Change in TC
COST-OUTPUT FUNCTION
Cost function express the relationship between cost and determinants, like the size of plant, level of output, input
prices, technology, etc. in ma mathematical form it can be expressed as, c=f(S, O,P,T,...), Where
C=refers to cost(unit cost or total cost) S=refers to size of plant
O=means level of output
P=denotes the price of inputs used in production
T=refers to the nature of technology

6. Explain the method and problem involved in estimating the cost analysis.
METHODS OF ESTIMATING COST FUNCTIONS
1. Accounting method: this method is used by the cost accountants. Essentially, in this method the data is
classified into various cost categories. Observations of cast are then taken at the extreme and the various
intermediate levels of output. By plotting the output levels and the corresponding costs on a graph and joining
them by a line the cost functions are estimated. The cost functions, thus found, may be linear or non- linear. It
must be noted that while finding cost functions from basic data in this what, no attention is generally paid to build
up a hypothesis or to find out the changes in conditions which influence cost.
2. Statistical or econometric method: this method uses statistical techniques on economic data to find the nature of
cost-output relationship. The economic data may relate to past records of the firm or to the different firms in the
same business at a point of time. If we use the series data we generally get a short-run cost function, while if we take
resources to the cross section data we derive a long-run cost function.
3. Survivorship Method: this method is based on the rationale that overtime competition tends to eliminate firms of
inefficient size and that only the firms with efficient size will survive as these will have lower average cost. The
size-group whose share in the industry grows the most during the specified time period is considered the most
efficient size- group. For example, if the share of small firms in the industry increases at the cost of the share of
large firms, it implies that the optimum size of a firm in the present case is the small one.

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4. Engineering method: In the engineering approach, the cost functions are estimated with the help of physical
relationships, such as weight of supplies and materials used in a process, rated capacity of equipment, etc. emphasis
is placed primarily on the physical relationship of production and these are then converted into money terms to
arrive at an estimate of costs. This method may be useful if good historical data is difficult to obtain. But this
method requires a sound understanding of engineering and a detailed sampling of the different process under
controlled conditions, which may not always be possible.
PROBLEMS IN THE ESTIMATION OF COST
i. Time Period: We must choose an appropriate time period for the analysis of cost. The choice of such a time period
involves the following important considerations:
a. Normality : The time period of study should be normal. A period during which the changes in technology, plant
size, efficiency, other dynamic events are non-existent or are at their minimum.
b. Variety: the length of period should be such that it includes sufficiently wide variation in output, so that enough
observation is available for getting a reliable cost function.
c. Recent period: since the results of the cost function are to be used as a guide for future planning, the period
chosen should be recent enough to include data which will be relevant for the future.
d. Units of observation: The value-and-effect relationship between cost and output would be more useful if the data
pertains to a shorter length of time. For example, by taking weekly or monthly data we average out smaller changes
in cost and output than by talking yearly data.
ii. Technical Homogeneity: To eliminate or minimize the impact of technical differences on cost, the plants chosen
for the study of the cost-output relationship should be characterized by homogenous input and output structures.
Homogeneity of inputs will ensure that the variations in cost due to different machines and equipment used in
production at different output levels are eliminated. Homogeneity in output reduces the problem of additively that
exists in case of heterogeneous product measurement.
iii. Cost Adjustment
a. The choice of a proper data for cost measurement is obviously necessary: Generally, the cost data is not available in
the form which can be readily used it needs certain adjustment and precautions, which are the following:
b. Selection of cost data: In order to find cost output relationship, one must select only those elements of cost that
vary with output. Overhead costs and allocated expenses that do not bear any relation to changes in output must be
excluded. Further , it is always better to use date on total cost rather than unit cost because(1) the unit cost being a
ratio of cost to output, the impact of the output on cost will not be very revealing and there may be basic problems in
interpretation of results. And (2) average and marginal cost functions can be derived from the total cost functions.
No additional purpose is, therefore, served in using unit cost data.

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c. Cost deflation: since prices change over time, any money value cost would therefore relate partly to output
changes and partly to price changes. In order to estimate the cost-output relationship, the impact of price change on
cost needs to be eliminated by deflating the cost data by price indices. Wages and equipment price indices are
readily available and frequently used to deflate the money cost.
iv. Economic Versus Accounting Cost Data: Accounting data is relatively more easily available and is therefore,
used in most of the empirical studies. This data records the actual expenses on historical basis.
v. Changes in Accounting Practices : In case we are using time series of accounting data is necessary that we find
out whether accounting methods and procedures have changed or not during that period. These changes may be
related to say depreciation method, timing of recording expenses, etc. if there are any such changes they merit
proper adjustment before being used for cost analysis.

7. Define Pricing. Explain the objectives and determinants of it.


PRICING
Price is defined as the exchange value of product or a service quantified in monetary terms.
OBJECTIVES OF PRICING
i. Satisfactory return on investment.
ii. Maintaining the market share.
iii. Meeting a specified profit goal.
iv. Attaining largest possible market share.
v. Profit maximization. vi. Meeting competition.
vii. Discouraging entry of the new firms.
viii. Flexibility to vary prices to meet change in economic conditions.
ix. Prices set at a high level and then lowered after a certain period has elapsed.
x. The ultimate objective of the firm is to maximize profits.

Hence the firm should strive to blend the different

objectives mentioned above to achieve this.


DETERMINANTS OF PRICE
A. Internal Factors
i. Organizational factors: Pricing decisions occur on two level in the organization. Overall price strategy is dealt
with by top executives and the actual mechanics of pricing a re dealt with the lower levels in the firm.

Usually

some combination of production and marketing specialists are involved in choosing the price.
ii. Marketing mix factors:

Marketing experts view price as only one of the many important elements of the

marketing mix. (product, price, place and promotion). A shift in any one of the elements has an immediate effect on
the otherthree. Thus, all pricing decisions must be viewed in the context of a total marketing strategy and must be
coordinated with elements of production, promotions and distribution
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iii. Product differentiation: Generally, the more differentiated a product is from competitive offerings, the more
leeway a firm has in setting prices.
iv. Costs: Price are determined solely by costs in that the firm wishes to take its relevant costs that goes in it.
However, in deciding the price of a new product, the firm should think what prices are realistic, considering current
demand and competition in the market.
v. Objectives: The variety of possible pricing objectives was discussed earlier in this chapter. A firm should define
its objectives as specifically as possible so that they can be acted upon.
B. External Factors
i. Demand: The market of demand for a product or service obviously has a big impact on pricing. Demand in turn
in affected by the number and size of competitors. What they are charging for similar products. The most likely
buyers.

How much they are willing to pay, and what their particular preferences are in deciding upon a price,

marketers must study all of these factors and then gauge the total effect
ii. Competition: Before a firm cam make pricing decisions. It must have a sense of not on the price of a product.
The fluctuations in price of their supplies to firm may have an impact on the prices of finished goods.
iii. Suppliers: Suppliers of raw materials and other goods can have a significant effect on the price of a product.
The fluctuations in prices of their supplies to the firm may an impact on the prices of finished goods.
iv. Buyers: The various buyers that buy a firm's products and service may have an influence in the pricing decision.
v. Economic conditions: Inflation, recession, shortage and stagflation all have an impact on prices in most decision.
vi. Government:

The government keeps a close watch on pricing in the private sector.

Regulatory pressure effectively discourages private companies from winning too large a share of the market and
controlling prices. Also, in many case, special committees or
commissions were appointed by the government to recommend fair selling prices.

Tariff

commission(abolished

with effect from august 1, 1976), bureau of industrial costs and prices, essential commodities act, are some of the
few instances were a government can intervene in price fixation.
PRICING UNDER DIFFERENT OBJECTIVES
i. Need based Pricing: Not much managerial thinking has been devoted to this kind of pricing.
However, in a system where economic policy is activity used to promote social goals, need - based pricing is quite
important. Four different approaches are available to arrive at a need- based price:
ii. Ability to pay: The price may be determined according to the ability of consumer to pay.
This method of pricing is used in the pricing of state health service, some of the schooling services, housing
provided by government or public sector companies, etc.

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iii. Comparative reasonable price: In some case, price is determined by using a comparative and reasonable open
market, price as
iv. Pricing by norm: A norm may be developed. For example, food in an institutional cafeteria may be priced on the
basis of a price per caloric norm.
v. Poorest can afford: Sometimes pricing of an essential commodity or service is done on the basis that the poorest
section of society should be able to afford the product. Rationed sugar or grain and controlled cloth are priced based
on such consideration.
vi. Cost-based Pricing: Cost consideration is the fundamental driving force in setting the price.
When other factor which influences pricing, such as government regulations, competitors
pricing strategies, market demand, technology are not dominant, the sole criteria on which the price is set may be
costs.
vii. Market-based Pricing: Any pricing policy which takes demand factors into consideration and seeks to maximize
revenues or profits is called market-based pricing. Most consumer packaged goods and many industrial products
have market-based prices. S ince market-based prices is fraught with uncertainties of demand estimation and market
response, the problem is often divided into small, structured manageable steps, each of which the executive into
small, structured manageable steps, each of which the executive can hope to tackle with judgment.

8. Explain about the various pricing policies and strategies.


PRICING POLICIES
Pricing policies are the decisions by a company determining prices to be charged for its products.

There are a

number of different pricing policies or strategies which a firm may adopt in order to achieve its pricing objectives.
i. Skim pricing: uses high prices to obtain a high profit and quick recovery of the development costs in the early
stages of a product's life before competition intensities.
ii. Penetration pricing: Is the use of lower than normal prices to increase market share. It is also used to establish a
new product in a market which is expected to have a long-life and potential for growth.
iii. Mixed pricing: is a policy which initially uses skim pricing and then, as competition increases, price
cutting, sometimes even below cost, to penetrate the market, increases market share and eliminate competition.
iv. Destructive pricing: involves reducing the price of an existing product or selling a new
product at an artificially low price in order to destroy competitor's sales.
v. Differential or discrimination pricing: is the use of different prices for the same product when it is sold in
different locations or market segments. Large buyers for example. O ften receive quantity discounts. Whilst small
buyers or those located in remote areas may be charged a higher price to cover the additional distribution costs.
Electricity, gas is sold at different prices to domestic and industrial consumers.

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vi. Absorption pricing: involves the use of lower than normal prices ether to launch a new product or to
periodically boost the sales of existing products.

Regular special offers by traders and businesses use loss

leaders where everyday goods are sold at less than cost to attract customers.
vii. Marginal cost pricing: is something used when a firm has some spare capacity which it wishes to use without
diverting a way from its regular business.
operating at full capacity.

Essentially, a firm incurs fixed costs such as rent, whether or not it is

These costs are covered by the firm's regular products. Therefore, sometimes a firm is

prepared to accept additional business provided that the marginal (i.e., additional) revenue covers the marginal costs
(i.e. materials and labour) involved and makes at least some contribution to the fixed cost which represents the
profit.
viii. Negotiable pricing: is common in industrial markers. The price is individually calculated to take account of
costs, demand and any specific customer requirement.
ix. Single pricing: involves a policy of charging one price to everyone. Examples include standard bus fares,
prices of books etc.
x. Market pricing: is determined by the interaction of demand and supply. The seller has little control over the price
in this situation which is likely to fluctuate daily. Examples include commodity markets such as gold, silver, wheat
and wool and stock exchange.
xi. Sealed-bid pricing: is widely used in government, public sector and other private sector markets whereby
suppliers are invited to tender(offer a fixed price) for the supply of specified goods or services. Tenders must
normally be submitted by a specified date in a sealed envelope.

The contract is than usually awarded to the

lowest bidder. A business will calculate a tender price based on its own costs and analysis from knowledge and
experience of competitor's likely bids.
I. COST-ORIENTED PRICING
a. Cost-plus Pricing: In this method the price is determined by adding a fixed mark- up to the cost of acquiring or
producing the product.
b. Marginal cost (or direct cost) pricing: The marginal cost pricing implies that the price of the product is based on
the incremental cost of production. Unlike the full-cost pricing which is based on average cost, the incremental or
marginal cost pricing is based on variable cost only- the difference between the two being fixed cost only.

This

makes it apply clear that whereas the full-cost pricing is a long period phenomenon; the incremental-cost pricing is
a short period phenomenon.
c. Rate of Return (or Target) Pricing : It is a refined version of cost-plus pricing. When, due to certain reasons, the
firm has to revise its prices it needs to ensure that the prices so revised would allow it to maintain either a fixed
percentage mark-up over cost; Profit as a fixed percentage of total sales; or a fixed return on existing investments.

II. COMPETITION-ORIENTED PRICING


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a. Going-rate pricing: The going-rate pricing is, in a sense, opposite to full-cost pricing. In case of the latter the
emphasis is on cost of production, while in case of the former it is on the market situation. The simplest form of the
going- rate pricing is where the firm simply examines the general pricing structure in the industry and fixes the price
of its own product accordingly.
b. Loss leaders:A loss leader is an item which produces a less than customary contribution or a negative
contribution to overhead but which is expected to create profits on increased future sales or sales of other items.
c. Trade association pricing: To avoid un certainties of pricing decisions and the downward pressure on prices which
competition exerts, firms frequently come to the express or implied agreements to maintain prices at a similar level.
Though express (or, overt) agreements are generally declared as illegal, the firms can easily and safely enter into an
implied (or, tacit) collusion.
d. Customary pricing: In case of some commodities the prices get fixed because they have prevailed over a long
period of time. Any change in costs for such products gets reflected in quality or quantity of the product rather than
its price.
e. Price leadership: It often happens that in an industry there is one or many big firms whose cost of production is
low and they dominate the industry. In such a situation, the small firms will not like to enter into price war with
these big firms. The former may, therefore, follow the price fixed by the leader.
f. Cyclical pricing : We are aware of various methods of pricing employed in various kinds of market structures like
perfect and imperfect competition. However, there are considerations other than market structure that operate to
influence the pricing decisions, viz., seasonal and cyclical fluctuations in economic activity.

Whereas seasonal

factors operate on short-term basis, the cyclical factors influence the economic activity for a long run (up to 3 or
more years).
g. Imitative pricing and suggested prices : This approach is often used in retail business. In oligopolistic market
conditions, the firms often follow a price-leader. But in non-oligopoly situations also, it is many a time considered
useful to imitate the price set by other firms. This approach makes decision- making quite easy, as the decisionmaker does not have to undertake the demand and cost analysis.
PRICING BASED ON OTHER ECONOMIC CONSIDERATIONS
i. Administered prices: These are those prices which are statutorily fixed by the government, taking into account the
cost and the stipulated profit per unit.

The purpose of introducing administered prices is to control prices of

essential goods and inputs as well as to provide them at economic prices to weaker sections of consumers and
producers. The public distribution system, whereby fair price shops sell essential goods to public, is based on
administered prices. Prices of certain goods like steel, fertilizer, coal, etc., are generally statutorily fixed.

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ii. Dual pricing: A market, where a commodity is covered simultaneously under the administered price as
well as market price, is said to have dual prices. Here, part of the output of a firm is subjected to administered price,
while the rest of its output is sold in the free market.
iii. Price Discrimination or Differential Pricing: In an open price discrimination situation the market is sub-divided
on some systematic basis, such that it is almost impossible for the group of buyers to whom a high price is quoted to
take advantage by shifting and joining the group to which a lower price is quoted.

There are many bases on

which the open price discrimination is practiced. These are discussed below.
a. Time Price Differentials: It is a general practice to use the expression the demand for a product or service, but
it is important to note t hat demand also has a time dimension. The demand may shift in fairly short-time intervals.
b. Clock-time price differentials: When demand elasticity's of buyers undergo a change within 24-hour period, the
seller can discriminate between the buyers demanding services at different points of time within the 24- hour time
period. These price differentials are called clock-time differentials and its object is to charge higher price for the
product or service during the period of relatively inelastic demand and lower price during the period of
relatively elastic demand. The oft quoted example of clock-time differentials is the differences between day
and night rates of long-distance telephone calls.
c. Calendar-time price differentials: When price differentials are not based on demand elasticity differences but
simply on time differences like days, weeks, months, etc., we call them calendar-time differentials.

These

differences are often found in recreational activities.


d. Use-price Differential: Different buyers have different uses of a product or a service. For example, Electricity
can, similarly, be used for industrial or residential purposes. Charges for these different segments according to
demand elasticity based on buyers use of the product or service, and then he charges different prices from these
different segments.
e. Quality Price Differentials: If the product caters to that group of consumers who are concerned about its quality,
then the quality becomes a significant determinant of demand elasticity.
differences in quality to sell his product.

The seller has, therefore, to create

It must be emphasized here that the differences in quality basically

depend upon the buyer's understanding of the quality. Sellers use many decides to create quality appearance of the
product, by restricting a particular type of the product to a region or to a sale channel, etc. It is also found that
consumers judge quality by the price of the product.
PRICING STRATEGIES
a. Stay-out Pricing: When a firm is not certain about the price at which it will be able to sell its product, it starts with
a very high price. If at this high price quotation it is not able to sell, it then lowers the price of its product. It will
keep on lowering the price till it is able to sell the targeted amount of the product. This approach helps the firm to
ascertain the maximum possible price it can charge from its customers.

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b. Price lining: Here, price of one product in the total range of the products is fixed. Price of rest of the
commodities is automatically determined by the relationship between the commodity whose price has been
fixed and the rest of the commodities in the range. For example, if a firm producing shoes or shirts fixes up the
price for a particular size, price of rest of the sizes is then fixed simultaneously on the basis of the differences in
their sizes. Also, when price of one size of shoes or shirts changes, prices of rest in the line of the product get
automatically adjusted.
c. Psychological Pricing(or, Odd number and round number pricing): This is not truly a method of pricing but of
price-tagging. Here a firm fixes the price of its product in a manner which gives the impression of being low. For
example, if the price of a product is fixed at Rs. 89.90 rather than Rs. 90, it may have the psychological impact on
consumers that price is in 80s rather than in 90s. This may have some impact on sales.

For example, the shoe

companies have been following this price policy with some success. O n the other hand, some firms round their
prices to the next higher rupee so that accounts can be kept easily.
d. Limit Pricing: A firm (or firms) may also try to establish a price that reduces or eliminates the threat of entry of
new firms into the industry.

This is called limit pricing. For limit price to be effective some of collusion is

necessary among existing firms.


e. Resale Price Maintenance : Resale price maintenance is common in cases of popular or branded products. The
manufacturers of such products fix and stipulate the price of the products at which the product is to be resold by the
individual retailer. This is done to maintain a uniform selling price of the branded produces at all the outlets of
their sale. S ince such a price is handed down from the manufacturer to the retailer, it is kind of vertical price
control.
f. Peak-load pricing: A firm that uses the same facility to supply many markets at different points of time can
increase its profits by the use of peak-load pricing.

Peak-load pricing essentially involves charging higher price

from consumers wanting to consume the service during the peak demand period and lower price from those who
consume during off-peak period.
g. Multi-product Pricing:

Pricing that reflects the inter-relationship among multiple products of a firm that are

complements or substitute of each other.


h. Public Utility Rate Regulation: The method of pricing a service owned and operated by the State.

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UNIT IV PRICING
PART A (2 MARKS)
1. What are the two factors in pricing strategies?
-> External factors
->Internal factors

2. What are the external factors in pricing strategies?


i. The competition in the market
ii. The elasticity of supply and demand
iii. Trends of the market
iv. Purchasing power of buyers.
V. Government policies towards prices.

3. What are the two factors in pricing strategies?


->The costs
->Management policy towards the gross margin and the sales turnover

4. What are the determinants?


i. Objectives of business
ii. Competition
iii. Product and promotional strategies
iv. Nature of price sensitivity
v. Influence of middle men
vi. Routinisation of pricing
vii. Government regulation

5. What is objectives of business?


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The fundamental objective of a firm is to survive in the business and then thrive. The pricing strategy adopted by a firm
is very much by these factors.

6. What is competition in pricing strategy?


To come out with a pricing policy that will be advantages to the firm, managers require a perfect understanding of
the competitive environment in which the firm is placed.

7. What are product and promotional strategies?


i. product itself
ii. Pricing
iii. Promotion activities
iv. Distribution of products through the channel to the consumer.

8. What is nature of price sensitivity?


We know that many factors contribute to the increase of price sensitivity, but managers should not ignore the factors
that minimize price sensitivity .when designing pricing strategies.

9. What is influence of middlemen?


Middlemen are the ones who stock the finished product of the manufacturer to sell it to the customers. These are also
called the channel for distribution.

10. What is Routinisation of price?


This strategy of pricing relies on the tried and trusted pricing strategies which the organization has followed all along.
This pricing practice is often routinized but the extend varies from company to company and from product to product.

11. What is the government regulation in pricing?


In order to safeguard the interests of the public the government acts on their behalf to prevent the abuse of the
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monopolistic power and collusion among business.

12. Say some of the objectives of the pricing policy?


i. Profit maximization.
ii. Long term welfare of the firm.
iii. Facing competition.
iv. Flexibility to economic changes.
v. Satisfying rate of returns.

13. What are the cost oriented pricing method?


i. Cost plus pricing or full cost pricing.
ii. Marginal cost pricing or incremental or direct cost pricing.
Iii.Target pricing or rate pricing.
iv. Program pricing.

14. What are the competition oriented pricing method?


i. Going rate pricing.
ii. Loss reader pricing.
iii. Customary pricing.
iv. Price leadership pricing.
v. Trade association pricing.
vi. Cyclical pricing.
vii. Imitative pricing.
viii. Turnover pricing.

15. What are the praising based methods?


i. Administered pricing.
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ii. Dual pricing.
iii. Price discrimination or differential pricing.

16. What are cost oriented pricing methods?


i) Cost plus.
ii) Marginal cost pricing.
iii) Target pricing.

17. What is going rate pricing method?


In going rate pricing the emphasis is on the market situation unlike the full cost pricing where the emphasis was on costs.

18. What is leadership pricing method?


The pricing strategy is widely used in retailing business. Because the names has the word loss in it this policy may
be confused with the pricing which results in losses.

19. What is customary pricing method?


In case of some products their prices get more or less. This does not happen due to deliberate action on the sellers part
but it happens as the results of the product prevailing in the market for a long period of time.

20. What is price leadership method?


In any industry, out of all the firms operating industry, at least one firm will have its cost of production lower than all
other firms.

21. What is trade association pricing method?


The kind of pricing arises out of an unsaid understanding agreement between the firms operating in the market.

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22. What is the cycling pricing method?
The pricing method which is done to capitalize on the cycles of the season in nature and the cycle in the economy are
known as cyclical pricing.

23. What is imitative pricing method?


It is very similar to the loss leader pricing method. This pricing policy is often used in retail business.

24. What is turnover pricing method?


Turnover is the word which denotes the sales of the product. The higher the turnover means higher the sales.
25. What is dual pricing method?
Usually the firms which produce essential commodities have part of their product under administrating pricing and part
of the product is solid in the free market.

26. What is price?


Price is the source of revenue for the firm and it decides the health of the firm. The customer acceptance or rejection
of a product is most of the time predominantly influenced by price.

27. What are the external factors influencing the prcising decision?
i. The competition in the market.
ii. The elasticity of supply and demand.
iii. Trends of the market.
iv. Purchasing power of buyers.
v. Government policies towards prices.

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PART - B (16 MARKS)
1. Enumerate the features of short run average cost curve and long run average cost curve.
THE EQUILIBRIUM OF THE FIRM DURING SHORT RUN UNDER PERFECT COMPETITION
Equilibrium in short run:
The short run has been has been defined as a period of time sufficient to allow the firm to adjust its output by increasing
or decreasing the amount of variable factors of production cannot be altered. Thus in the short run; the size and kind of
plant cannot be changed, nor can new firms enter the industry.
Assumptions:
i. All firms are working under identical conditions.
ii. The factors of production used by the different firms are homogeneous and are available at
given and constant prices.
This is explained with the help of a diagram.

X axis =O utput
Y axis= Revenue/cost
SAC= Short run average cost curve
SMC = Short run marginal cost curve
L,L1,L2 = AR=MR (Average Revenue = Marginal Revenue)
Explanation:
i. When the firm makes supernormal profits in the short -run: The firm makes supernormal profits in the short-run when
the price is OP1, because only at this price the average cost is less than the price.
ii. The firm just makes normal profit: The firm makes normal profits in the short-run when the price is OP, because only
at this price the average cost is equal to the price.
iii. The firm incurring losses, but does not shut down: The firm incurs loss in the short-run when the price is OP2, because
only at this price the average cost is more than the p rice. Even if the firm is incurring losses but still the firm will not shut
down.

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SHUTDOWN POINT OF THE FIRM
The point at which when the firm is not able to cover even its average variable cost is called the shut down point of a firm.
This is explained with the help of a diagram.

X axis = output
Y axis = revenue/cost
AC = Average cost curve
MC = Marginal cost curve
AVC = Average variable cost curve
L,L1,L2 = AR=MR

i. If price is OP2, the firm is incurring losses, because the price is less than the average cost.
ii. But if the price happens to be OP3, the firm will be in equilibrium at point D. At point D, the firm would be
covering total variable costs but no part of the fixed costs, since price OP3 is equal to average variable cost MD at
the equilibrium output OM.
iii. But if the price is OP4, the firm would shut down, as in this situation the firm is not able to cover even variable
costs, since the price will be less than the average variable cost. Point D
is therefore called shut down point.
THE EQUILIBRIUM OF THE FIRM DURING LONG RUN UNDER PERFECT COMPETITION
Equilibrium in the long run: The long run is a period of time long enough to permit changes in the variable as well as in
the fixed factors. In the long run, accordingly, all factors are the variable and none fixed. Thus, in the long run, firms can
change their output by increasing their fixed equipment.
Conditions of equilibrium:
Price = Marginal cost
Price = Average cost
Thus, the conditions for long-run equilibrium of perfectly competitive firm can be written as: Price = Marginal cost =
Minimum Average Cost.
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This is explained with the help of a diagram.

X axis = O utput
Y axis = revenue/cost
LAC = Long run average cost curve
LMC = Long run marginal cost curve
L,L1,L2= LAR=LMR

Explanation:
i. The firm under perfect competition cannot be in long run equilibrium at price OP1 because it is greater than the average
cost & point the firm will be earning supernormal profits. Hence, there will be incentives for the new firms to enter the
industry. As a result, the price will be forced down to the level OP at which price, the firm is in equilibrium at R and will
produce OM output.
ii. The firm under perfect competition cannot be in long run equilibrium at price OP2 because it is less than the average
cost & point the firm will be incurring loss. To avoid these losses, some of the firms will leave the industry. As a result,
the price will be rise to OP, where again all firms are making normal profits. When the price OP is reached, the firms
would have no further tendency to quit.
iii. Therefore the firm under perfect competition will be in lo ng run equilibrium at price OP. At point R the equilibrium
output is OM, the price is equal to average cost, and hence the firm will be earning only normal profits. Therefore at price
OP, there will be no tendency for the outside firms to enter. Hence, the firm will be in equilibrium at OP price and OM
output.

THE SHORT RUN SUPPLY OF PERFECT COMPETITIVE INDUSTR Y OR DERIVATION


SHORT RUN SUPPLY CURVE OF PER FECTLY COMPETITIVE INDUSTR Y
Short run supply curve:

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The short run is a period in which the capital equipment is fixed and the increased demand is possible only by
the intensive use of the given plant, i.e., by increasing the amount of the variable factors. This is explained
with the help of diagram.

[Both Panels (a) & Panel (b)]


Panel (a) = S hows the production level
Panel (b) = S hows the supply of output at different prices
X axis O utput
Y axis P rice
SMC Short run average cost curve
SAC Short run average cost curve
SAVC S hort run average variable cost curve
SRS Short run supply curve
The short run supply curve for the perfectly competitive industry is derived by adding up
both panel (a) & panel (b).
Explanation for Panel (a):
i. Panel (a) explains about the various equilibrium points & the different levels of output being produced at various prices.
ii. At price OP0, the SMC cuts the price at pt.E0, hence the firm will produce OM0 amount of
output, since only at this output the price OP0 equals marginal cost.
iii. Similarly, at prices OP1, OP2, OP3 & OP4, the SMC cuts the price at points E1, E2, E3 & E4, hence the firm will
produceOM1, OM2, OM3, & OM4 amount of output respectively, since only at these outputs the prices are equal to their
marginal costs.

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Explanation for Panel (b):
i. Panel (b) explains about the supply of output at various prices.
ii. It shows that at price OP0, the firm will supply OM0 amount of output.
iii. As the price increases from OP1 to OP4, the supply of output also increases from OM1 to
OM4 respectively.
iv. It means that as the price increases the supply also increases. Thus, the short run supply curve of the perfectly
competitive industry slopes upwards.
THE LONG RUN SUPPLY AT DIFFERENT COST CONDITIONS
Long run supply curve:
Long run supply is defined as supplies offered at various prices by the existing as well as the potential procedures in the
long run.
(A) Supply curve of the constant cost industry:
An industry is a constant cost industry if its expansion generates neither external economies nor external diseconomies.
This is explained with the help of a diagram.

Panel (a) = S hows the production level


Panel (b) = S hows the supply of output at different prices
X axis O utput
Y axis P rice
LAC long run average cost curve
LMC long run marginal cost curve
LSC - long run supply curve
Explanation:
i. In the case of constant cost industry, the long run supply curve will be a horizontal straight line.
ii. Every firm will be in long run equilibrium at the minimum point of the long run average cost.

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iii. In the long run, new firms will enter the industry without raising or lowering the cost curves of the firms in the
industry so that the industry so that the industry would supply any amount of commodity at the price of OP which is
equal to the minimum long run average cost.
iv. The long run supply curve is horizontal straight line (i.e., perfectly elastic) at price OP, which is equal to the
minimum average cost.
(B) Supply curve of the increasing cost industry: If the industry is of a big size, then sometimes due to the
disadvantages of large scale production the cost of production will rise resulting in increase in prices of the product.
Therefore it will shift both the average and marginal cost curves to upwards towards the left. It means that less
output will be produced at high cost. This is explained with the help of a diagram.

Panel (a) = S hows the production level


Panel (b) = S hows the supply of output at different prices
X axis O utput
Y axis P rice
LAC long run avera ge cost curve
LMC long run marginal cost curve
LSC - long run supply curve

Explanation for Panel (a):

i. Panel (a) explains about the various equilibrium points & the different levels of output being produced at various
prices.
ii. It shows that at OP price, OM level amount of output is produced.
iii. It is seen that when the price is increased to OP1, the output is decreased to OM1 & the LAC
& LMC curves are shifted upwards towards the left side.
iv. It means that both the cost & price have increased & the production of output has decreased.
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Explanation for Panel (b):


i. Panel (b) explains about the supply of output at various prices.
ii. It shows that as the price increases from OP0 to OP1, the supply also increases from ON to
ON1 respectively.
iii. It means that in an increasing cost industry more output will be supplied at higher price.
iv. Thus the long run supply curve (LSC) of the increasing cost industry will slope upwards as shown in panel (b)
of the figure.
(C) Supply curve of the decreasing cost industry: An industry might have decreasing costs due to advantages of
large scale production so that, with the expansion of the industry, the cost of production will be reduced. Therefore
it will shift both the average and marginal cost curves to downwards towards the right. It means that more output
will be produced at less cost. This is explained with the help of a diagram.

Panel (a) = S hows the production level


Panel (b) = S hows the supply of output at different prices
X axis O utput
Y axis P rice
LAC long run average cost curve
LMC long run marginal cost curve
LSC - long run supply curve

Explanation for Panel (a):


i. Panel (a) explains about the various equilibrium points & the different levels of output being produced at various
prices.
ii. It shows that at OP price, OM level amount of output is produced.
iii. It is seen that when the price is decreased to OP1, the output is increased to OM1 & the LAC
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& LMC curves are shifted downwards towards the right side.
iv. It means that both the cost & price have decreased & the production of output has increased.
Explanation for Panel (b):
i. Panel (b) explains about the supply of output at various prices.
ii. It shows that as the price decreases from OP0 to OP1, the supply also increases from ON to
ON1 respectively.
iii. It means that in a decreasing cost industry more output will be supplied at less price.
iv. Thus the long run supply curve (LSC) of the increasing cost industry will slope downwards as shown in panel
(b) of the figure.

2. Explain the price output determination of short run and long run.
THE PRICE-OUTPUT DETERMINATION UNDER PERFECT COMPETITION DURING THE SHORTRUN
Short-run period: This period is sufficient only to make limited output adjustment with the existing equipment by
expanding output along the short-run marginal cost curves. This is explained with the help of a diagram.

Panel (a) = S hows the production level


Panel (b) = S hows the supply of output at different prices
X axis O utput
Y axis P rice
MC Marginal cost curve
AC Average cost curve
AVC Average variable cost curve
SRS Short-run supply curve
MPS Market period supply curve
DD Demand curve
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Explanation for Panel (a):

i. Panel (a) explains about the various equilibrium points & the different levels of output being produced at various
prices.
ii. At price OP, the firm will produces ON amount of output, since only at this output the price
OP equals marginal cost.
iii. Similarly, when the price increases to O R the firm will increase its output to ON' amount of output & when the
price decreases to OT the firm will decrease its output to ON'' amount of output & respectively, since only at these
outputs the prices are equal to their marginal costs.

Explanation for Panel (b):

i. Panel (b) explains about the changes in price & output at different demands during the market period & short
period supply.
ii. It is seen that when the DD curve cuts the MPS curve & SRS curve, the price is OP & the
output is OM.
iii. When the increased demand curve D'D' cuts the MPS curve, the price alone increase to OK, but the output does
not change Again when the decreased demand curve D'' D'' cuts the MPS curve, the price alone decreases to OL, but
the output does not change. It means that during the market period only the price changes & the output remain fixed.
iv. When the increased demand curve D'D' cuts the SRS curve, the price increases to OR & the output increases to
OM'. Again when the decreased demand curve D''D'' cuts the SRS curve, the price decreases to OT & the output
also decreases to OM''. It means during the short run more output will be supplied at a higher price & vice versa.
THE PRICE-OUTPUT DETERMINATION UNDER PERFECT COMPETITION DURING THE LONGRUN
Long-run period: In the long run, the time is long enough for the firms to change the size of their plants or build
new plants. Also, new firms can enter the industry. In the long-run the firms can a band on old plants or build new
ones and when the new firms can enter the industry or old ones can leave it. This is explained with help of a
diagram..

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X axis O utput
Y axis Cost & Revenue
LMC Long-run marginal cost curve
LAC Long-run average cost curve
Explanation:
i. If the price is above the minimum long-run average cost, the firm will be making supernormal profits.
Therefore, in the long-run new firms will enter the industry to compete away their extra profits and the price will fall
to the level where it is equal to the minimum long-run average cost.
ii. Neither can the price will fall below the minimum average cost since in that case the firms will be incurring
losses. In long-run, if these losses 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 only normal profits.
iii. Therefore during the long run the firms will be earning only normal profits & will be in equilibrium at point S,
where the long run average cost is equal to the long run average revenue.

THE PRICE-OUTPUT DETERMINATION UNDER PERFECT COMPETITION DURING THE LONGRUN UNDER DIFFERENT COST CONDITIONS
Long-run normal price in increasing-cost industry: S upply curve of an increasing-cost industry slopes upwards
from left to right. This is so because when a full-sized industry expands as a result of the increased demand for its
product, it experiences certain external economies and diseconomies. But external diseconomies in the case of an
increasing-cost industry outweigh the external economies and this brings about an upward shift in the cost curves
of all firms. This is explained with the help of a diagram.

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Panel (a) = S hows the production level


Panel (b) = S hows the supply of output at different prices
X axis O utput
Y axis P rice/Cost
LMC Long-run marginal cost curve LAC Long-run average cost curve DD Demand curve
MPS Market-period supply curve
SRS Short-run supply curve
LRS Long-run supply curve

Explanation for Panel (a):


i. Panel (a) explains about the cost & output at different levels of prices.
ii. It shows that OP is the basic price. In the increasing cost industry, the cost of production is increased, which
increases the price to OP''', thereby shifting the LAC & LMC curves upwards towards the left side.
Explanation for Panel (b):
i. Panel (b) explains about the changes in price & output at different demands during the market period supply, short
run supply & long run supply.
ii. It is seen that when the DD curve cuts the MPS curve, SRS curve & LRS curve, the basic price is OP & the
output remains the same i.e OM.
iii. When the increased demand curve D'D' cuts the MPS curve, the price alone increase to OP', but the output
remains the same i.e OM. It means that during the market period only the price changes & the output remain fixed.
iv. When the increased demand curve D'D' cuts the S RS curve, the price increases to OP'' & the
output increases to OM'. It means during the short run more output will be supplied at a higher price.
v. When the increased demand curve D'D' cuts the LRS curve, the price increases to OP''' & the output increases to
OM''. It means that in increasing cost industry during the long run more output will be supplied at a higher price.
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3. When is Price Discrimination profitable?
(A) Price discrimination not profitable when the demand curves are iso-elastic:
We shall take the two markets where the demand curves are iso-elastic, i.e., where at every price, elasticity of
demand curve is the same.
When in two markets elasticity of demand is the same, then the marginal revenue will also be the same. Marginal
revenue in the two markets being the same, it will not be profitable from one market to another in order to change a
different price. This is explained with the help of a diagram.

X axis = output
Y axis = Revenue / cost
Markets A & B=Markets having same elasticties
ARa & ARb = Average revenue curve of market A & B MRa & MRb = Marginal Revenue curve of market A & B

Explanation:
i. The demand curves ARa and ARb have the same elasticity at the price OP. At this price, marginal revenue in the
two markets is the same.
ii. Now if the monopolist increases the price in market A from OP to OP' to earn profit, the output will be reduced
from OM toON1. Thus the monopolist incurs loss in market A.
iii. In order to compensate loss the monopolist decreases the price from OP to OP '' in market B
& the output also increases from OM2 to ON2. Thus the monopolist earns profit in market B.
iv. But the profit in Market B is less than the loss in market A.
v. This shows that when the demand curve have the same elasticity then price discrimination
will not be profitable.

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(B) Price discrimination profitable when elasticity's differ:
The monopolist will find it profitable to charge discriminating prices, when the elasticity's of demand in the two
markets are different. Rather, this is the only way for him to maximize profits. If elasticity of demand is different in
the two markets, he would charge higher price in the market where elasticity is low and low price where it is high.
This is explained with the help of a diagram.

X axis = output
Y axis = Revenue / cost
Markets A & B=Markets having different elasticities
ARa & ARb= Average revenue curve of market A & B MRa & MRb = Marginal Revenue curve of market A & B

Explanation:

i. The demand curves ARa and ARb have the different elasticity at the price OP. At this price, marginal revenue in
the two markets is different.
ii. Now if the monopolist increases the price in market A from OP to OP' to earn profit, the output will be reduced
from OM1 toON1. Thus the monopolist incurs loss in market A.
iii. In order to compensate loss the monopolist decreases the price from OP to OP '' in market B
& the output also increases from OM to ON2. Thus the monopolist earns profit in market B. iv. Now the profit in
Market B is greater than the loss in market A.
v. This shows that when the demand curve have different elasticity then price discrimination will be profitable.

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4. Explain the various types and conditions of price discrimination.
THE VARIOUS TYPES OF PRICE DIS CRIMINATION
i. Personal price discrimination based on the income of the customer: For example, doctors and lawyers charge
different fees from different customers on the basis of their incomes. Higher fees are charged to rich persons and
lower to the poor.
ii. Price discrimination based on the nature of the product: Paperback is cheaper than the deluxe edition of the same
book, for the former is bought by the majority of readers, and the latter by libraries. Unbranded products, like open
tea are sold at lower prices than branded products like brooke bond or lipton tea. Economy size tooth pastes are
relatively cheaper than ordinary sized tooth pastes. In the case of services too, such price discrimination is practiced
when off-season rates of holds at hill stations are very low as compared to the peak season. Dry cleaning firms
charge for two while they clean three clothes during off season where as they charge more for quick service in peak
season.
iii. Price discrimination related to the age, gender and status: price discrimination is also related to the age, gender
and status of the customers. Barbers charge less for childrens haircuts. Certain cinema halls admit ladies only at
lower rates. Military personnel in uniform are admitted at concessional rates in all cinema houses.
iv. Discrimination is also based on the time of service: C inema houses at certain places, like new delhi, charge half
the rates in the morning show than in the afternoon shows.
v. Geographical or local discrimination: There is geographical or local discrimination when a monopolist sells in
one market at a higher price than in the other market.
vi. Discrimination based on the use of the product: Railways charge different rates for different compartments
or for different services. Less is charged for the transportation of coal than for bales of cloth on the same route. State
power boards charge low rates for industrial use than for domestic consumption of electricity.

THE VARIOUS CONDITIONS OF PRICE DISCRIMINATION

i. Market imperfection: The individual seller is able to divide and keep his market into separate parts only if it
is imperfect. Customers do not move readily from one market to the other because of ignorance.
ii. Agreement between rival sellers: price discrimination also takes place when the seller of a commodity is a
monopolist or when rivals enter into an agreement for the sale of the product at different prices to different
customers. This is usually possible in the sale of direct services.
iii. Geographical and tariff barriers: The monopolist may discriminate between home and foreign buyers by selling
at a lower price in the foreign market than in the domestic market. This type of discrimination is known as dumping

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iv. Differential products: Discrimination is possible when buyers need the same service

in connection with

differential products.
v. Ignorance of buyers: Discrimination also occurs when small manufacturers sell goods made to order. They charge
different rates to different buyers depending upon the intensity of their demand for the product
vi. Artificial difference between goods: A monopolist may create artificial difference by presenting the same
commodity in different quantities. He may present it under different names and lables, one for rich and snobbish
buyers and the other for the ordinary. Thus he may charge different prices for substantially the same product.
vii. Difference in demand: For price discrimination, the demand in the separate markets must be considerably
different. Different prices can be charged in separate markets based on differences of elasticity of demand,
low price is charged where demand is more elastic and high price in the market with the less elastic demand.

5. Explain the source, types and also the methods for controlling monopoly?

THE VARIOUS SOURCES AND TYPES OF MONOPOLY


i. Grant of a patent right to a firm by the government to make, use or sell its own invention.
ii. Control of a strategic raw material for an exclusive production process
iii. A natural monopoly enjoyed by a firm when it supplies the entire market at a lower unit cost due to
increasing economies of scale just as in the supply of electricity, gas etc.\iv. Government may grant
exclusive right to a private firm to operate under its re gulation. S uch privately owned and government
regulated monopolies are mostly in public utilities and are called legal monopolies such as in transport
communications, etc.
v. There may be government owned and regulated monopoly such as postal services, water, and sever
systems of municipal corporation etc.
vi. Government may grant license to a sole firm and protect it to exclude foreign rivals.
vii. The sole manufacturer of a product may adopt a limit pricing policy in order top prevent the entry of
new firms.
METHODS TO CONTROL AND REGULATE MONOPOLY
(A) Fear that prevent the monopolist from charging a very high price in order to earn large super-normal profits.
i. Fear of potential rivals: The fear of potential competitors may prevent a monopolist to charge a very high price to
his customers. If he sets a very high price he will earn large super normal profits. Attracted by these monopoly
profits new entrants may force themselves into the monopolized industry. The monopolist being averse to the
entry of new firms would prefer to charge a reasonable price and thus earn only a modest pro fit.

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ii. Fear of government regulation: Same consideration applies to potential government regulation. The
monopolist is well aware that charging unusually high price or profits would attracts the attention of the
government. Rather than risk government regulation he may voluntarily fix a low price and earn less monopoly
profits.
iii. Fear of nationalization: The fear of nationalization also prevents the monopolist to wield an absolute monopoly
power. If the products or service which monopolist produces is a public utility service, that is every likelihood of the
state's taking over the monopoly organization in public interest. This consideration may prevent the monopolist
from charging too high a price.
iv. Fear of public reaction: The monopolist is also aware of pub lic reaction he charges a very high price and earns
huge profits. Voices may be raised against the monopoly firm in parliament to press for anti- monopoly
legislation.
v. Fear of boycott: People may even boycott the use of monopolized product or service and start their own service
instead. For instance, if in a big city taxi operators combine to charge high rates, people may boycott taxi services
and even start operating their own services by forming a cooperative society. Naturally such a fear compels
monopoly firms to charge reasonable prices and earn only nominal profits.
vi. Fear of substitutes: Then there is the fear of substitutes. In fact the fear of substitutes is the most potent- factor
which prevents monopoly firms from charging very high prices and thereby earning huge super- normal profits.
It is only under pure monopoly that there are absolutely no substitutes for the product. But pure monopoly like pure
competition being unreal, the monopoly product has some substitute though it is not a close substitutes is always
uppermost in the mind of the monopolist which acts as a restraint on his absolute power.
vii. Difference in elasticity of demand: The difference in the short and long run elasticities of demand for monopoly
product also limit monopoly power. In the short run the monopolist can charge a very high price because customers
take time to adjust their habits tastes, and income to some other substitutes. The demand for the monopoly products
is, therefore less elastic in the short run but in the long run t he fear of public opinion emergence of substitutes,
government regulations etc will force the monopolist to set a low price. He will view his demand curve as elastic
and sell more at a low price.
(B) Control of monopoly through legislation: Government tries to control monopoly by anti- monopoly lows and
restrictive trade practices legislation. These measures tend to:
i. Remove restrictive trade practices and fix high prices. ii. Reduce the incidence of market-sharing agreements.
iii. Remove unfair competition.
iv. Restrict the control of very large share of the market. v. Prevent unfair price discrimination.
vi. Restrict mergers in order to avoid market domination.
vii. Prohibit exclusive agreements between the producer and retailer to the detriment of other
traders.
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(C) Control of monopoly through price regulation and taxation:


i. Regulated monopoly pricing: To regulate monopoly the government imposes price ceiling so that monopoly price
should be near or equal to competitive price. This done when the government appoints a regulating authority or
commission which fixes a prices for the monopoly product below the monopoly price, thereby increasing output
and lowering the price for the consumer.
ii. Taxation: Taxation is another way of controlling monopoly power. The tax may be levied lump sum without any
regard to the output of the monopolist or it may be proportional to the output the amount of tax rising with the
increase in output.
iii. Lump sum tax: By levying a lump sum tax, the government can reduce or even eliminate monopoly profits
without affecting either the price or output of the product.
iv. Specific tax: The government can also reduce monopoly profits by levying a specific or a per
unit tax on the monopolist's product.

6. What is Duopoly? Explain any two models of Duopoly.


DUOPOLY
Duopoly is a special case of the theory of oligopoly in which there are only two sellers. Both the sellers are
completely independent and no agreement exists between them. Even though they are independent, a change in the
price and output of one will affect the other, and may set a chain of reactions. A seller may however, assume that
his rival is unaffected by what he does, in that case he takes only his own direct influence on the price.
COURNOT MODEL OF DUOPOLY
Assumptions:
i. There are two independent sellers. In other words, interdependence of the duopolists is ignored.
ii. They produce and sell a homogenous product- mineral water.
iii. The total output must be sold out, being perishable and non-storable. iv. The number of buyers is large.
v. Each seller knows the market demand curve for the product. vi. The cost of production is assumed to be zero.
vii. Both have identical costs and identical demands
viii. Each seller decides about the q uantity he wants to produce and sell in each period. ix. But each is ignorant
about his rivals plan about output.
x. At the same time, each seller takes the supply output of its rival as constant.
xi. Neither of them fixes the price for its product, but each accepts the market demand price at
which the product can be sold. xii. The entry of firms is blocked.
xiii. Each seller aims at obtaining the maximum net revenue or profit.

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This is explained with the help of a diagram:

X axis = output
Y axis = P rice
Explanation:
i. It shows how A and B producers share the total market and adjust output and how they maximize their profits.
ii. SB is the total demand. Let the unit cost be zero i.e., MC=0. Therefore MR is also zero at A. iii. Before B enters
the market, A produces OA=Half of OB. The price is OC giving maximum
profits OAPC.
iv. Then B enters the market and produces AH = Half of AB, i.e the remaining market.
v. This process will continue till equilibrium output and price are achieved. As more and more
firms enter, they will produce output approaching the competitive output. If the number of firms goes up to N they
will produce N+1 (N) OB.

THE EDGE WORTH MODEL OF DUOPOLY:


This can be explained with the help of diagram.

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X axis = output
Y axis = P rice
Explanation:
i. It is assumed that each producer's capacity is limited to 3/4th of his entire market and each is confronted with his
own demand curve made up of one half of the consumers. The maximum output that A can produce is OB and B can
produce OB.
ii. The demand curves of A and B re respectively are DT and DH.
iii. The A first enters the market and sets his price P1 he sells the total output aP1.Then B enters the market and sells
at price slightly lower than A and thus captures his market.
iv. B then sells the whole output at P2 and snatches fro m Abb of sales. Now A reacts and
captures Bs market to the extent of CC.
v. This process of price-cutting continues until one of them say B fixes his prices at P4.At this
point none can snatch the market from the other by lowering the price.
vi. Then A raises the price back to P1 to maximize his profits from his share of the market knowing that B has
already thrown his entire supply, B then follows suit.
vii. There is thus continual oscillation of price between P1 and P4 i.e., the upper and lower limits.
CHAMBERLIN MODEL OF DUOPOLY: This can be explained with the help of diagram

X axis = output
Y axis = P rice

Explanation:
i. Suppose the producer A enters the market first DB is the demand curve and O L is the total output he chooses to
produce.
ii. It is sold at OA price and the total profit made is OLP A.
iii. Now the producer B enters the market and produces LH quantity. iv. Now the total quantity produced is
OL+LH=OH.
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7. What is Oligopoly? Explain the characteristics, effects and evils of it.


OLIGOPOLY
It is a market situation in which there are a few firms selling homogenous or differentiated products. It is difficult
to pinpoint the number of firms in the oligopolistic market. There may be three, four or five firms. It is also known
as competition among the few.

CHARACTERISTIC FEATURES OF OLIGOPOLY


i. Interdependence: There is a recognized interdependence among the sellers in the oligopolistic market.
ii. Advertisement: One producer's fortunes are dependent on the policies and fortunes of the other producers in the
industry. It is for this reason that oligopolistic firms spend much on advertisement and customer services.
iii. Competition: In oligopolistic market, each seller is always on the alert over the moves of its rivals in order to
have a counter-move.
iv. Barrie rs to Entry of Firms: As there is keen competition in an oligopolistic industry, there are no barriers to
entry into or exit from it.
v. Lack of Uniformity: In oligopoly market, there is a lack of uniformity in the size of firms.
vi. Demand Curve: Under oligopoly, the exact behavior pattern of a producer cannot be ascertained with certainty
his demand curve cannot be drawn accurately.
vii. No Unique Pattern of Pricing Behavior: The rivalry arising from interdependence among the oligopolists leads
to two conflicting motives. So it is not possible to predict any unique pattern of pricing behavior in oligopoly
markets.
THE PRICE-OUTPUT DETERMINATION UNDER OLIGOLOPOLY OR THE SWEEZY MODEL
OF KINKED DEMAND CURVE (RIGID PRICES)
Assumptions
i. There are few firms in the oligopolistic industry.
ii. The product produced by one firm is a close substitute for the other firms. iii. The product is of the same quality.
There is no product differentiation.
iv. There are no advertising expenditures
v. There is an establishment or prevailing market price for the product at which all the sellers are satisfied.
vi. Each sellers attitude depend s on the attitude of his rivals.
vii. Any attempt on the part of a seller to push up his sales by reducing the price of his product will be counteracted
by the other sellers who will follow his move.
viii. If he raises the price others will not follow him, rather the y will stick to the prevailing price and cater to the
customers, leaving the price-raising seller.
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ix. The marginal cost curve passes through the dotted portion of the marginal revenue curve so
that changes in marginal cost do not affect output and price.
This is explained with the help of a diagram.

X axis = output
Y axis = P rice
DD= Demand C urve/ Average revenue
MR = Marginal revenue curve
MC = Marginal cost curve
Explanation:
i. There are two oligopolistic firms, one facing the elastic demand & the other one facing inelastic demand.
ii. The fixing of prices under oligopoly is a very difficult situation as the oligopolists will not
agree for a common price.
iii. Therefore, it is said that under oligopoly price is fixed at the kink, where the MC curve cuts the MR curve from
below.
EFFECTS OF OLIGOPOLY
i. Small output and higher prices: Oligopoly results in the restriction of output and changing of higher prices.
ii. Prices exceed average costs: Owing to restrictions, partial or complete, on the entry of new firms, the prices
fixed, under oligopoly, are higher than the average cost.

The consumers have to pay more than is necessary to

retain the resources in the industry.


iii. Lower efficiency: There is no tendency under oligopoly, for the firms in the industry to build optimum scales of
plant and operate them at the optimum rates of output.

They do

not, therefore attain maximum potential

economic efficiency.
iv. Selling costs: In order to snatch markets form their rivals the oligopolistic firms engage in aggressive and
extensive sales promotion effort by means of advertisement and by changing the design and improving the quality of
their products.

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v. Wide r range of products: Oligopoly places at the consumer's disposal a wider range of
commodities. To this extent, it promotes consumer's welfare.
vi. Welfare effect: Under oligopoly, since output does not generally correspond to the minimum long-run unit cost,
more units of resources per unit of output are utilized than it its necessary.
EVILS OF OILGOPOLY
i. Price war: There is generally a continuous price war which finally results in disastrously low level of prices.
ii. Cut-throat competition: Such cut-throat competition in industries characterized by heavy overheads and
increasing costs proves ruinous to all producers.
iii. Price agreements: There may tacitly or explicitly enter into price agreements, which may results in the
exploitation of the consumers.
iv. Earn a fair return on past investments: A tendency to earn a fair return on past investments, resulting in
the excessive plant capacity, is detrimental to consumer's welfare, because they face scarce output and high prices.
v. Liquidate excess capacity: Hence, cut-throat competition may be, essential to liquidate excess capacity
through losses or sub-normal profits.
vi. Idle plants: oligopoly, prices stay firm and only output varies resulting in idle plants. This is bad for the society
and bad for the government.

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UNIT V FINANCIAL ACCOUNTING (ELEMENTARY TREATMENT)
PART A (2 MARKS)
1. What is balanced sheet?
The balanced sheet provides the financial position of a company at any given point of time.

2. Say some of the important financial statements?


i. Profit and loss account.
ii. Balance sheet.
iii. Fund flow statement.

3. What are the contents of a balance sheet?


i. Assets
ii. Liabilities.

4. Say some of the types of assets?


i. Fixed assets.
ii. Investments.
iii. Current assets.
iv. Loans and advances.
v. Miscellaneous expenditure

5. What is fixed assets?


Their life period is very long, these are purchased for carrying out the operation in a company. Using this the company
can generating revenue.

6. What is investment?
The long term and short term financial securities owned by a company comes under this category. Here long
term investments means buying shares of the other companies.

7. What is current assets?


Any asset that can be converted into cash within one year of time is called as current asset. They would be converted
into cash at the end of the operating cycle of a firm.

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8. What are the items come under this current assets?
i. Cash.
ii. Debtors.
iii. Inventories.

9. What is loans and advances?


It is the amount that a company loans to its employees, advances given to supplies, government contractors and
other agencies it is also include prepaid expenses.

10. What are the types of liabilities?


i. Share capital.
ii. Reserves and surpluses.
iii. Secured loans.
iv. Unsecured loans.
v. Current liabilities.

11. What is meant by share capital?


It includes both equity share capital and preference share capital. Equity share holders are the owners of a company
they take risk and their dividend is not fixed but is case of preference share capital the dividend rate is fixed.

12. What is meant by Reserves and Surpluses?


It is nothing but the profit that is retained by accompany not by not paying it as dividend to the shareholders.

13. What are the types of reserves?


i. Revenue reserve.
ii. Capital reserve.

14. What is meant by secured loans?


Loan amount borrowed by the firm by pledging assets (ie) securities are provided for these loans.

15. What is meant by unsecured loans?


In this case no security is provided examples are fixed deposits, loans and advances.

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16. What is meant by current liabilities?
This consists of amount that is to the suppliers when goods are purchased on a credit basis, advance payments
received accrued expenses, provisions for tax.

17. What is meant by income statement?


The companies act does not any particular way in which the profit and loss account or the income statement has
to be prepared. This statement reflects the performance of a company over a period of time.

18. Who are all the users of financial statement?


i.management.
ii.shareholders, investors, anlyst.
iii.lenders
iv.suppliers.
v.customers.
vi.employees.
vii.government and regularity agencies.
viii.others

19. What is meant by cash flow statement?


A firm would enter into trouble if it spends more cash than it is able to generate. The firm should generate adequate
capital for it survival.

20. How the cash flow of a business can be classified?


a. operating activities
b. investing activities
c. financing activities

21. What is meant by ratio analysis?


It is one of the powerful tool for financial statement analysis. Ratio is nothing but the relationship between two or
more items.

22. What are the different ways of carrying out analysis?


a. past ratio
b. competitors ratio
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c. industrial ratio
d. projected ratio

23. What is meant by past ratio?


The current financial years ratios can be compared with the previous years ratio to find whether the financial position
has improved over the years or not.
24. What is meant by competitors ratio?
The ratio of a company can be compared with the ratio of the competitors and with the market leader.

26. What is meant by industry ratio?


The ratios of a firm can be compared with the ratios of the industry to which the particular firm belongs to.

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