Economics Final

Study Material
M.B.A.
For
Based on Latest Syllabus of MBA prescribed By Maharshi Dayanand University, Rohtak (DDE)
1st Semester
(Part-1)
By :
Expert Faculties
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CONTENTS
MANAGERIAL ECONOMICS
UNIT II....................................................................27-77 UNIT III.................................................................78-121 UNIT IV...............................................................122-134 Past Year Question Paper......................................135-139 Worksheet............................................................140-142
ACCOUNTING FOR MANAGERS

Syllabus...............................................................143-143 UNIT I.................................................................144-175 UNIT II................................................................176-202 UNIT III...............................................................203-227 UNI IV................................................................228-246 Past Year Question Paper......................................247-253 Worksheet............................................................254-256
INDIAN ETHOS AND VALUES

Syllabus...............................................................257-257 UNIT I.................................................................258-270 UNIT II................................................................271-283 UNIT III...............................................................284-298 UNI IV................................................................299-304 Past Year Question Paper......................................305-309 Worksheet............................................................310-312 Syllabus......................................................................5-5 UNIT I.......................................................................6-26
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MBA1st SEMESTER, M.D.U., ROHTAK
External Marks : 70 Time : 3 hrs. Internal Marks : 30
SYLLABUS
UNIT-I
Nature of managerial economics; significance in managerial decision making, role and responsibility of managerial economist; objectives of a firm; basic concepts - short and long run, firm and industry, classification of goods and markets, opportunity cost, risk and uncertainty and profit; nature of marginal analysis.
UNIT-II
Nature and types of demand; Law of demand; demand elasticity; elasticity of substitution; consumer's equilibrium utility and indifference curve approaches; techniques of demand estimation.
UNIT-III
Short-ru n and long-ru n production functions ; optimal input combination; short-run and long-run cost curv es and their interrelationship; e ngineering cost curv es; economies of scale; equilibrium of firm and industry under perfect competition, monopoly, monopolistic competition and oligopoly; price discrimination.
UNIT-IV
Baumol's theory of sales revenue maximisation basic techniques of average cost pricing; peak load pricing; limit pricing; multi-product pricing; pricing strategies and tactics; transfer pricing.
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MBA 1st Semester (DDE)
UNIT I
Q. What do you mean by Managerial Economics. Explain its Nature and Scope. Ans. Meaning of Managerial Economics : Managerial economics is the study of economic theories, logic and tools of economic analysis that are used in the process of business decision making. Economic theories and techniques of economic analysis are applied to analyse business problems, evaluate business options and opportunities with a view to arriving at an appropriate business decision. Managerial economics is thus constituted of that part of economic knowledge, logic, theories and analytical tools that are used for rational business decision-making. Managerial economics is that subject which describes how economic analysis is used in taking business decisions. The purpose of Managerial Economics is to show how economic analysis can be used in formulating business policies. Managerial economics is that discipline which uses economic concepts, principles and economic analysis in taking business decision and formulating future plans. It integrates economic theory with business practice for choosing business policies. Managerial economics lies on the borderline between economics and business management and bridges the gap between the two. Definition of Managerial Economics According to McNair and Meriam : Managerial economics is the use of economic modes of thought to analyse business situation. According to Mansfield : Managerial economics is concerned with the application of economic concepts and economics analysis to the problems of formulating rational decision making. Nature or Characteristics of Managerial Economics : 1. Managerial Economics is a Science : Managerial economics is a science because it establishes relationship between causes and effects. It studies the
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effects of a change in price of a commodity factors and forces on the demand of a particular product. It also studies the effects and implications of the plans, policies and programmes of a firm on its sales and profit. 2. Managerial Economics is an Art : Managerial economics may also be called an art. Because it also develops the best way of doing things. It helps management in the best and most efficient utilization of limited economic resources of the firm. Entire study of 3. Managerial Economics is a Micro Economics : economics may be divided into two segments- Macro economics and Micro economics. Managerial economics is mainly micro-economics. Microeconomics is the study of the behaviour and problems of individual economic unit. In managerial economics unit of study is firm or business organization and an individual industry. It is the problem of business firms such as problem of forecasting demand, cost of production, pricing, profit planning, capital, management etc. Managerial Economics is the Economics of firms : Managerial 4. economics largely use that body of economic concepts and principles which is known as Theory of the Firm or Economics of the Firm. 5. Managerial Economics uses Macro-economic Analysis : Managerial economics also uses macro-economics to analysis and understand the general business environment in which the business firm must operate. Business management must have the adequate knowledge of external forces that affect the business of the firm. The important macro-factors that affect the firm are trends in national income and expenditure, business cycles, economic policies of the government, trends in foreign trade etc. Managerial Economics is Progmatic : It is concerned with practical 6. problems and results. It has nothing to do with abstract economic theory which has no practical application to solve the problems faced by business firms. 7. Managerial Economics is Normative Science : There are two types of
science-Normative Science and Positive Science. Positive science studies what is being done. Normative science studies what should be done. From this point of view, it can be concluded that managerial economics is normative science because it suggests what should be done under particular circumstances. Scope of Managerial Economics
economic theories in the process of decision-making and formulation of future plans. The management will have to analyse the business problems that are faced by the firm. Thus, the principles relating to following topics constitute the Demand Analysis : A business firm is in an economic organization which is engaged in subject matter of resources into goods that are to be sold scope of transforming productive managerial economics: 1 7
: Managerial economics is the application of
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in the market. A major part of managerial decision-making depends on accurate estimates of demand. A forecast of future sales serves as a guide to management for preparing production schedules and employing resources. It will help management to maintain or strengthen its market position and profitbase. Demand analysis also identifies a number of other factors influencing the demandAnalysis product. Demandare most useful for management occupies a strategic for a : analysis and forecasting Cost Cost estimates decisions. The different factors that cause variations in cost estimates should place in Managerial Economics. be given due consideration for planning purpose. There is the element of 2 uncertainty of cost as other factor influencing cost are either uncontrollable or not Pricing Practices and Policies : always known. As price gives income to the firm, it constitutes as the most important field of Managerial Economics. The success 3 of a business firm depends very much on the correctness of the price decision taken by it. The various aspects that are deal under it cover the price determination in various market forms, pricing policies, pricing method, Profit pricing, : The chief purpose is to earn the differentManagementproductive pricing of a business firmuncertainty about profits maximum profit. There is always an and priceof element forecasting. 4 because of variation in cost and revenue. If knowledge about the future were perfect, profit analysis would have been very easy task. But in this world of uncertainty expectations are not always realized. Hence profit planning and its measurement constitute the most difficult area of managerial economics. Under profit management we study nature and management of profit, profit Capital Management : The problems relating to firms capital investments are perhapsof profit planning like Break Even Analysis. the most complex and the troublesome. Capital policies and techniques management implies planning and control of capital expenditure. The main 5 topics deal with under capital management are cost of capital, rate of return andAnalysis of Business Environment : selection of projects. The environmental factors influence the working and performance of a business undertaking. Therefore, 6
the managers will have to consider the environmental factors in the process of decision-making. The factors which constitute economic environment of a country include the following factors:
Economic System of the Country Business Cycles Fluctuations in National Income and National Production
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Industrial Policy of the Government Fiscal Trade andPolicy Policy of the Government Taxation Policy etc. LicensingEnvironment Political Factors Social in labour and capital markets. Trend Q. What do you mean by Managerial Economics? Explain its significance in Managerial Decision Making. Ans. Meaning of Managerial Economics : Managerial economics is the study of economic theories, logic and tools of economic analysis that are used in the process of business decision making. Economic theories and techniques of
economic analysis are applied to analyse business problems, evaluate business options and opportunities with a view to arriving at an appropriate business decision. Managerial economics is thus constituted of that part of economic knowledge, logic, theories and analytical tools that are used for rational business decision-making. Managerial economics is that subject which describes how economic analysis is used in taking business decisions. The purpose of Managerial Economics is to show how economic analysis can be used in formulating business policies. Managerial economics is that discipline which uses economic concepts, principles and economic analysis in taking business decision and formulating future plans. It integrates economic theory with business practice for choosing business policies. Managerial economics lies on the borderline between economics and business management and bridges the gap between the two. Definition of Managerial Economics According to McNair and Meriam : Managerial economics is the use of economic modes of thought to analyse business situation. According to Mansfield : Managerial economics is concerned with the application of economic concepts and economics analysis to the problems of formulating rational decision making. Significance of Managerial Economics in Managerial Decision Making The most important function of management of a business firms is decision making and future planning. Business decision-making is essentially a process of selecting the best out of alternative opportunities open to the firm. The process of decision-making comprises following phases : (i) Determining and defining the objective to be achieved
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(ii) Developing and analyzing possible course of action; and (iii) Selecting a particular course of action. Economic analysis helps the management in following ways:(1) Reconciling Theoretical Concepts of economics to the Actual Business Behaviour and Conditions : Managerial economics attempts to
policies for future can be formulated on the basis of economic quantities. Managerial economics helps the management in predicting various economic quantities such as:
reconcile the tools, techniques, models and theories of economics with actual business practices and with the environment in which a firm has to operate. Analytical techniques of economic theory builds models by which we arrive at certain assumptions and conclusions are reached thereon in relation to certain firms. There is need to reconcile the theoretical principles based on simplified assumptions with actual business practice and develop the economic theory, if necessary. Managerial economics plays an (2) Estimating Economic Relationship : important role in business planning and decision making by estimating economic relationship between different business factors- income, elasticity of demand like price elasticity, income elasticity, cross elasticity and cost volume profit analysis etc. The estimates of this economic relationship can be used for purpose of business forecasts. Sound business plans and (3) Predicting Relevant Economic Quantities :
Cost Profit Demand Capital Production Price etc. manager has to work in an environment of uncertainty, Since a business future should be well predicted in the light of these quantities. (4) Understanding Significant External Forces : The management has to identify all the important factors that influence firm. These factors broadly
divided into two parts- Internal Factors and External Factors. External factors are the factors over which a firm cannot have any control. Therefore, the plans, policies and programmes of the firm should be adjusted in the light of these factors. Important external factors affecting decision-making process of a firm are: Economic System of the Country Business Cycles Fluctuations in National Income and National Production Industrial Policy of the Government
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a number of tools and methods which increases the analytical capabilities of the business analysis. Q. Who is Managerial Economist? Discuss the Role and Responsibility of Managerial Economist.
in understanding these factors. (5) Basis of Business Policies : Managerial economics is the foundation of all business policies. All the business policies are prepared on the basis of studies and findings of managerial economics. It warns the management against all the turning points in national as well as international economy. (6) Clear Understanding of Economic Concepts : It gives clear understanding of various economic concepts (i.e, cost, price, demand etc.) used in business analysis. For example , the concept of cost includes total, average, marginal, fixed, variable, actual cost, and opportunity cost. Economics clarifies which cost concepts are relevant and in what context. (7) Increases the Analytical Capabilities : Managerial Economics provides
Trade and Fiscal Policy of the Government Taxation Policy etc. Licensing Policy Managerial economics plays an important role by assisting management
Ans. : Managerial Economist is an expert who counsels business management in economic matters and problems faced by a business organization. Taking business decision and formulating forward plans are two important jobs of business management. Specialized skills are needed to perform these jobs efficiently. The managerial economist can assist the management in using the specialized skill to solve the problems of business to formulate business policies. Role of Managerial Economist
management is to determine the key factor which influences the business over a period of time. This function is performed by a Managerial Economist. In general, the factors which influence the business over a period to come fall under two categories: (A) External Factors : The external factors are beyond the control of management. (B) Internal Factors : The internal factors are well within the control of
: One of the main functions of any
management. Thus, the role of Managerial Economist are : (A) Analysis of The external factors operateFactors the External outside firm and firm has no control over these. Such factors constitute business Managerial Economist
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environment and include prices, national income and output, business cycle, government policies, international trends, etc. These factors are of great importance to the firm. Managerial economists by studying and analyzing these factors can contribute effectively in determining business policies. Certain relevant question relating to these factors are:(i) What are the present trends in nations and international economics? (ii) What phase of business cycle lies immediately ahead? (iii) Where are the market and customer opportunities likely to expand or contract most rapidly? (iv) What are the possibilities of demand and prices of finished products? (v) Is competition likely to increase or decrease? (vi) What changes are expected in government policies and control? (vii) What are the demand prospects in new and the established markets? (B) Analysis of Internal Factors : Internal factors are known as business operations. In other words internal activities of a firm are called business operations. A managerial economists can also help the management to solve problems re lating the bus iness operation such as price determination, use of installed capacity, investment decision, expansion and diversification of business etc. Relevant questions in this context are as follows:(i) What will be the reasonable sales and profit targets for the next year? (ii) What will be the most appropriate production schedules and the inventory policy for the next five or six months? (iii) What changes in wage and price policies should be made now? (iv) How much cash will be available in the coming months and how it should be invested? (C) Specific Functions : These Specific functions are as under : (i) Sales Forecasting (ii) Market Research (iii) Economic Analysis of competing firms. (iv) Pricing problem of the industry (v) Evaluation of Capital Projects. (vi) Advice on foreign exchange. (vii) Advice on trade and public relations (viii) Environmental forecasting. (ix) Investment analysis and forecasts (x) Production and inventory schedule (xi) Marketing function. (xii) Analysis of underdeveloped economics Responsibilities of a Managerial Economist 1.
: He must have
To make reasonable profits on capital employed :

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2.
strong conviction that profits are essential and his main obligation is to assist the management in earning reasonable profits on capital invested by the firm. He should always help the management to enhance the capacity of the firm to earn profits. If he fails to discharge this responsibility then his academic knowledge, experience and business skill will be of no use to the firm. Successful Forecasts : It is necessary for the managerial economist to make successful forecasts by making in depth study of internal and external factors that may have influence over the profitability or the working of the firm. A managerial economist is supposed to forecast the trends in the activities of importance to the firm such as sales, profit, demand, costs etc. Knowledge of Sources of Economic Informations : A managerial economist should establish and maintain close contacts with specialists and data sources in order to collect quickly the relevant and valuable information in the field. For this purpose he should develop personal relation with those having specialized knowledge of the field. He should also join professional associations and take active part in their activities. His Status in the Firm : A managerial economist must earn full status in the business ream because only then he can be really helpful to the management in formulating successful business policies.
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Q. What are the objectives of Business Firms? Ans. Introduction : Conv entional theory of firm ass umes profit maximization, as the sole objective of business firms. Recent researchers on this issue reveal that the objectives that business firms pursue are more than one. Some important objectives, other than profit maximization, are:(i) Maximization of Sales Revenue (ii) Maximization of Firms growth rate (iii) Maximization of managers utility function (iv) Long-run survival of the firm Therefore the objectives of the Business firms are Objectives of Business Firms Main Objective Alternative Objectives Profit Maximization Maximization of Sales Revenue Maximization of Firms growth rate Maximization of managers utility function Long-run survival of the firm
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(A) Main Objectives 1. Profit Maximization Goal of a Business Firm : According to traditional
economic theory profit maximization is the sole objective of business firms. The traditional theory suggests a number of reasons as to why does a firm want to maximize profits. All these reasons essentially fall into the following categories: (i) Traditional economic theory assumes that the firm is ownermanaged, and therefore maximizing profit would imply maximizing the income of the owner; Owner would like to have adequate return for his activity as n entrepreneur. (ii) Firm may pursue goals other than profit-maximization, but they can achieve these subsidiary goals much easier if they aim for profit maximization. Under perfect competition individual firms have to maximize their profits at price determined by industry. Under imperfect competition firms search their profit maximizing price output as they are price makers. The profit can be defined as the difference between total revenue and total cost. Profit = Total Revenue - Total Cost. A firm will maximize its profit at that level of output at which the difference between total revenue and total cost is maximum. Generally conventional price theory determines profit maximizing price-output in terms of marginal cost and marginal revenue. Marginal Revenue : Marginal revenue is the addition to total revenue from the sale of an additional unit of a commodity. Marginal Cost : Marginal cost is the addition to total cost from the production of an additional unit of a commodity. The two profit maximizing conditions 1. We take first condition MC = MR : (i) If MC<MR total profits are not maximized because firm will earn more profits by increasing output. (ii) If MC>MR the level of total profit is being reduced and firm can increase profit by decreasing production. (iii) If MC = MR the profits could not increase either by increasing or decreasing output and hence profits are maximized. (b) MC cuts MR from below : Now we take the second condition. The second condition of profit maximization requires that MC be rising at the point of its intersection with the MR curve
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Y P A E MC AR=MR
OM OUTPUT Criticism of profit Maximization Approach :
QX
At point E both the conditions are satisfied. a) The real world business environment is more complex than what convention theory of firm thought. The modern business firms face lot of risk and uncertainty. Long-run survival is more important than short-run profit. b) The other objectives such as sales maximization, growth rate maximization etc. describe real business behavior more accurately. c) Profit maximization objective cannot be realized without the exact measurement of marginal cost and marginal revenue. d) Profits are not only measure of firms efficiency. e) Profit maximization assumption may require expansion of business which means more risks. But firms may prefer less profit instead of bearing additional uncertainties. (B) Alternative Objectives of Business Firms : There are the following objectives: (1) Baumols Hypothesis of Sales Revenue Maximization :
(2)
Baumols theory of sales maximization is an alternative theory of firms behaviour. The basic premise of his theory is that sales maximization, rather than profit maximization, is the plausible goal of the business firms. He argues that there is no reason to believe that all firms seek to maximize their profits. Business firms, in fact, pursue a number of objectives and it is not easy to single out one as the most common objective pursued by the firms. However, from his experience as a consultant to many big business houses, Baumol finds that most managers seek to maximize sales revenue rather than profits. Maximization of firms growth rate : According to Robin Marris managers maximize firms balanced growth rate. He defines firms balanced growth rate (G) as
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G = G =CG D Where G = DGrowth rate of demand for firms product GC= Growth rate of capital supply to the firm 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. (3) Maximization of Managerial Utility Function : According to this concept managers seek to maximize their own utility function subject to a minimum level of profit. Long-Run Survival of the firm : According to this concept, the primary goal of the firm is long-run survival. The managers, therefore, seek to secure their market share and long-run survival. The firms may seek to maximize their profit in the long-run though it is not certain. (A) Short-Run (B) Long-Run (C) Firm (D) Industry (E) Classification of Goods (F) Classification of Markets (G) Opportunity Cost (H) Risk (I) Uncertainty (J) Profit (K) Nature of Marginal Analysis. Ans. (A) :Short-Run Short-Run refers to that time period in which supply of a commodity can be increased only up to its existing production capacity. If demand has increased, there is not enough time for a firm to install new machines nor for the new firms to enter the industry. The main features of short-run are (1) In the short-run there are two types of factors of production:-
(4)
Q. Write a short note on the following :
(2) In the short-run supply can be changed only by varying variable factors. (3) The fixed factors cannot be changed. (4) In short-run demand plays greater role than supply in the determination of price.
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Fixed Factors Variable Factors
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(5) The price that is determined in the short period is called Sub-normal price. (6) There are two types of cost in the short-run: Fixed Cost : The costs of fixed inputs are called fixed costs. Fixed costs are costs which do not change with changes in the quantity of output. Variable Cost : Variable costs are those costs which are incurred on the use of variable factors of production.
Example : Supposing you have a carpet manufacturing factory. If you run your factory for full 24 hours, you can produce 10 carpets at the most. Supposing demand for carpets increases to 20 carpets per day for two days only. You will be unable to meet this additional demand. Your maximum production capacity is limited to 10 carpets only. You do not have time to install new looms to increase your production. (B) :Long-Run Long-Run refers to that time period in which supply of a commodity can be increased or decreased according to the changed conditions of demand. The increased demand can be met with increasing the supply by installing machines. Or new firms can enter the industry. On the contrary, if demand has gone down, some firms will discontinue their production. Price, in the long-run is therefore, more influence by supply than demand. Price that comes to prevail in the long-run is called Normal Price. The main features of long-run are:(1) In the long-run all factors are variable. (2) In the long-run supply can be changed by varying all factors of production. (3) In long-run demand and supply both plays equal role in the determination of price. (4) The price that is determined in the long period is called Normal Price. (5) In the long-run supply can be increased or decreased according to the demand. (6) In the long-run new firms can enter the industry and old firms can leave it. (C) :Firm A firm is a unit engaged in the production for sale at a profit and with the objective of maximizing the profit. A firm is in equilibrium when it is satisfied with its existing amount of output. A firm is in equilibrium has no tendency either to increase or to decrease its output. The objectives of a firm are:17
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Objectives of Business Firms Main Objective Alternative Objectives Profit Maximization Maximization of Sales Revenue Maximization of Firms growth rate Maximization of managers utility function Long-run survival of the firm (D) :Industry The group of firms producing homogenous products is called industry. Homogeneous products are those products in which it is not possible to make any distinction between the units of the commodity being sold by different sellers. Such firms are found only under perfect competition. Perfect competition is that situation of the market in which there are large number of buyers and sellers of homogeneous product. Under perfect competition, price of the commodity is determined by the industry. In perfect competition market firm is a price-taker and not a price-maker. Equilibrium of Industry : An industry is in equilibrium when it has no
tendency to change its size. There are two conditions of an industrys equilibrium: (1) Constant Number of Firms : An industry will be in equilibrium
when the number of its firms remains constant. In this situation, no new firm will enter and no old firm will leave the industry. Equilibrium of Firms : Another condition of an Industrys equilibrium is that all firms operating in it are in equilibrium and have no tendency either to increase or to decrease their output. Conditions of equilibrium of firm are:
(2)
(i) MC=MR (ii) MC curve cuts MR curve from below Y P A E MC AR=MR
OM OUTPUT
QX
At point E both the conditions are satisfied.
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(E) 1.
Classification of Goods
: There are basically three types of goods :
Consumers Goods : Those goods which are directly put to use are called consumers goods. These goods are used in our daily life. For example:Bread, Cloth, Medicines etc. Shopping Goods :
2.
items. Shopping goods purchase are characterized by Pre-Planning, information search & price comparisons. It is divided into: (i) Homogeneous Goods : Homogeneous products are those goods in
which it is not possible to make any distinction between the units of the commodity being sold by different sellers.
This classification includes durable or semi-durable
(ii)
Heterogeneous Goods : Heterogeneous goods mean that goods are close substitutes but are not homogeneous. They differ in colour, name, packing, shape, size, quality etc.
3.
Producer or Capital Goods : Those goods which are used in production by other industries are capital goods. Huge amount is invested in these goods. For Example:- Machinery, Plant, etc. Intermediate Goods : Some industries manufacture such goods as are processed in some other industry to produce some need goods. Such goods are called intermediate goods. For example : Plastic, rubber, aluminum etc. Specialty Goods : The purchase of specialty goods is characterized by extensive search to accept substitutes once the purchase choice has been made. The market for such goods is small but price & profits are high. Normal Goods : Normal goods are those goods the demand for which tends to increase following increase in consumers income, and tends to decrease following decrease in his income. So, there is a positive relationship between consumers income and quantity demanded. Inferior Goods : Inferior goods are those goods the demand for which tends to decline following a rise in consumers income, and tends to increase following a fall in his income. So there is an inverse relationship between income of the consumer and demand for a commodity. Necessaries of Life and Inexpensive Goods : In case of necessaries of life and inexpensive goods, the demand remains almost constant irrespective of the level of income. Luxury Good : A luxury good means an increase in income causes a bigger % increase in demand. Classification of Market : In economics the term market refers not necessarily to a particular place but to the mechanism by which buyers and sellers are brought together. The classification of markets are:19
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9. (F)
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Classification of Market
Perfect Competition Imperfect Competition Monopoly
Monopolistic Competition Oligopoly 1. Perfect Competition : Perfect competition refers to a market situation where there is a large number of buyers and seller. The sellers sell homogeneous product at a uniform price. The price is determined not by the firm but by the industry. Features of Perfect Competition (i) Large Number of Buyers and Sellers (ii) Homogeneous Products (iii) Free entry and exit of firms (iv) Perfect Knowledge (v) Absence of Selling costs (vi) Price Taker. Imperfect Competition :
market
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competition : (a) Monopolistic Competition :
There are two types of market under imperfect
Monopolistic competition is a market structure in which there are many sellers of a commodity, but the product of each seller differs from that of the other sellers on one respect or the other. Thus product differentiation is the main feature of monopolistic competition. The main feature of this (i) Large Number of Buyers and Sellers (ii) Product Differentiation. (iii) Freedom of Entry and Exit of firms (iv) Higher Selling Costs (v) Price Control. (vi) Imperfect Knowledge. (vii) Non-Price Competition
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(b) oligopoly is a: Oligopoly market structure in which there are few sellers selling a homogenous or differentiated products and large number of buyers. The main features (i) Small number of sellers (ii) Interdependence of decision-making. (iii) Barriers to Entry
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3. Monopoly is a : Monopoly market situation in which there is a single seller, there are no close substitutes for commodity it produces, there are barriers to entry. The main features of this market are:(i) One Seller and Large Number of Buyers (ii) Monopoly is also an Industry (iii) Restriction on the entry of the new firms (iv) Price Maker (v) Price Discrimination (G) Opportunity Cost : The concept of opportunity cost is extremely important in economic analysis. We know that the cost is the value of inputs in the process of production. An input has got value because it is scarce or limited. If we use the input to produce one good, it is not available to produce something else. The cost of producing one thing is measured in terms of what was given up in terms of next best alternative that is sacrificed. If several opportunities are given up for producing a particular commodity, it is the value of the next best foregone opportunity that constitutes cost. Thus it is called opportunity cost. The opportunity cost is the cost of next best alternative foregone. It is also called alternative cost. Example : Supposing a farmer can grow both wheat and gram on a farm. If on a farm measuring one-hectare land he grows only wheat, he foregoes the production of gram. If the price of quantity of gram that he foregoes is Rs. 1,000, then the opportunity cost of growing wheat will be Rs. 1,000. Thus, the price of gram which the farmer has to forgo in order to produce wheat is called opportunity cost of wheat. Definition of Opportunity Cost : According to Leftwitch Opportunity cost of a particular product is the value of the foregone alternative product that resources used in its production, could have produce Diagram of Opportunity Cost : Y P
12 10 8 6 4 2O
X-Commodity
PX 2 4 6 8 10 12
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Explanation : In this figure the production line PP shows that if a given quantity of resources is employed to produce both X and Y, it can produce
OR (a) 12 units of Y and nothing of X (b) 6 units of X and nothing of Y OR (c) Any combination of X and Y long the line. This line shows that to produce X, we must forego the opportunity of
producing some of Y. This is called the opportunity cost of X in terms of Y. In this figure the opportunity cost of one unit of X is 12Y/6 = 2Y. This means that the same amount of factors of production that can produce 1 unit of X can produce 2 units of Y. Likewise, the opportunity cost of producing one unit of Y in term of X is 6X/12= 0.5 X. The same amount of factors of production employed in the production of 1 unit of Y can produce 0.5 units of X. The opportunity cost of Y interns of X is 0.5. (H) :Risk In common practice, risk means a low profitability of an expected outcome. From business decision-making point of view, risk refers to a situation in which business decision is expected to yield more than one outcome and the profitability of each outcome is known to the decision makers or can be reliably estimated. Example : If a company doubles its advertisement expenditure, there are three probable outcomes:(i) Its sales may more than double (ii) It may just double (iii) It may less than double. The company has the knowledge of these probabilities of the three outcomes on the basis of its past experience as (i) more than double- 10% (ii) almost double- 40% (iii) Less than double-50% It means that there is 90 % risk in more than doubling the sales and in doubling the sale, the risk is 60% and so on. There are two approaches to estimate probabilities of outcomes of a business decision, viz. (i) (ii) (I) A priori This approach based on intuition. approach This approach is based on past data. Posteriori approach : :
Uncertainty : Uncertainty refers to a situation in which there is more than one outcome of a business decision and the probability of outcome is not known or not meaningful. The unpredictability of outcome may be due to :
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Lack of Reliable market information
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Inadequate past experience
Some Examples of Uncertainties : (i) Life of new plant and future maintenance are unpredictable. (ii) Technological changes are highly unpredictable. (iii) The size of the market may not turn out to be as anticipated due to a number of reasons like, changes in the pattern or fashions, tastes of the people, etc. (iv) It is not possible to base scientific judgments about the following factors which affect the extent of prospective yields in the distant future:
The extent of new competition The prices which may fluctuate from year to year The size of export market during the years to come. Change in fiscal policies particularly in individual taxation and corporate taxation, and policies with regard to labour and wages. Conditions in the labour market, changes in labour legislation, level of wages, the possibilities of lockouts and strikes etc. Political, climate etc.
The long term investment involves a great deal of uncertainty with unpredictable outcome. But, in really investment decisions involving uncertainty have to be taken on the basis of whatever information can be collected, generated. For the purpose of decision-making, the uncertainty is classified as Complete Ignorance : In case of complete ignorance, investment (i)
decisions are taken by the investors using their own judgment. Partial Ignorance : In case of partial ignorance, on the other hand, there is some knowledge about the future market conditions, some information can be obtained from the experts in the field and some probability estimates can be made. The available information can be incomplete and unreliable. (J) Profit means different things to different people. The word profit Profit : has different meaning to businessmen, accountants, tax collectors, workers and economists. In a general sense, profit is regarded as income accruing to the equity holders, in the same sense as wages accrue to the labour, rent accrues to the owners of rentable assets and interest accrues to the money lenders. Concepts of Profit : The two important concepts of profit in business decisions are economic profit and accounting profit. It will be useful to understand the difference between the two concepts of profit.
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(ii)
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(1)
Accounting Profit : Accounting profit is surplus of revenue over and above all paid-out costs, including both manufacturing and overhead expenses. Accounting profit may be calculated as follows: Accounting Profit = TR (W +R + I + M) Where TR= Total Revenue W= Wages and Salaries I=Interest R= Rent M=Cost of materials
Obvious, while calculating accounting profit, only explicit or book costs, i.e., the cost recorded in the books of accounts, are considered. (2) Economic Profit or Pure Profit : The concept of economic profit differs
from that of accounting profit. Economic profit takes into account also the implicit or imputed costs. The implicit cost is opportunity cost. Opportunity cost is the income foregone which a businessman could expect from the second best alternative use of his resources. There are the following examples of opportunity cost: (i) If an entrepreneur uses his capital in his own business, he foregoes interest which he might earn by purchasing debentures of other companies or by depositing his money with joint stock companies for a period. (ii) Furthermore, if an entrepreneur uses his labour in his own business, he foregoes his income (Salary) which he might earn by working as a manager in another firm. (iii) Similarly, by using productive assets (land and building) in his own business, he sacrifices his market rent. These foregone incomes-interest, salary and rent are called opportunity costs or transfer costs. Accounting profit does not take into account the opportunity cost. Economic Profit = Total Revenue (Explicit Costs Implicit Costs) (K) Nature of Margin Analysis : The concept of marginal is widely used in economic analysis. The nature of marginal analysis : (1) Marginal analysis is related to a unit change in independent variable, say,
increase in cost as a result of a unit change in output, increase in product as a result of a unit change in labour, increase in revenue as a result of a unit change in sale, increase in utility as a result of a unit change in consumption of units. These are explained in the following: (a) Marginal Utility (MU) : The marginal utility can be defined as the
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change in total utility from the consumption of an additional or less unit of a commodity. TU MU= DQ MU= Marginal Utility TU = Change in Total Utility D DQ = Change in Quantity (b) Marginal Cost (MC) : Marginal cost can be defined as the change in to total cost as result of producing one more or less unit of a commodity. D TC MC= DQ MC= Marginal Cost TC = Change in Total Cost D DQ = Change in Quantity (c) Marginal Product (MP) : Marginal Product can be defined as the change in total product as result of increasing or decreasing one more unit of labour. MR D TP = MP DL MP= Marginal Product TP = Change inD Total Product DL = Change in Labour (d) Marginal Revenue (MR) : Marginal product can be defined as the change in total revenue due to the sale of one additional unit of a product. D TR MR= DQ MR= Marginal Revenue TR = Change in D Total Revenue DQ = Change in Quantity (2) There are certain cases where marginal analysis is superior to any other analysis. These include the (a) best product-mix, in cases where substitution between products occurs at a decreasing rate., selection of :
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(b) least cost input-mix where inputs are substitutable at a decreasing rate. (c) Optimum input-level where input-output relationship faces diminishing returns, and (d) Optimum maturity of assets, having value decreasing over time. (3) Whenever the cost and revenue functions are curvilinear, it is more appropriate to use marginal analysis. Marginal analysis calls for unit-tounit comparison and would, therefore be able to capture the impact of all points. (4) In case of those functions which are linear, in such a case only the end points of a range are to be compared, and marginal analysis would not give any different results. (5) In case of those alternatives, which are discrete, marginal analysis cannot be used. If a producer wants to produce a particular level of output and wants to make a choice between different technologies for the purpose, it is not possible to compare these processes in terms of marginal cost of moving from one process to another.
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UNIT II
Q. Explain Demand and its various types. Also Explain the Determinants of Demand. Ans. Meaning of Demand : Demand is defined as the quantities of a product which a consumer is not only desiring to purchase and able to purchase but is also ready to purchase at given prices at a given point of time. Definition of Demand According to Ferguson Demand refers to the quantities of a commodity that the consumers are able and willing to but at each possible price during a given period of time, other things being equal. Constituents of Demand : (i) Desire for a thing. (ii) Money to satisfy the desire. (iii) Willingness to spend the money. (iv) Relationship of the price and the quantity of the commodity demanded. (v) Relationship of time and the quantity of the commodity demanded. Types of Demand : There are various types of demand: :
1. Demand for Consumers Goods and Producers Goods : i) Goods and services for final consumption are called consumers goods. These include those consumed by human beings such as food items, clothes, medicines etc. Demand for consumers goods is direct. ii) Producers goods refer to the ones used for the production of other goods such as plant and machines, factory buildings, raw materials etc. Demand for producers goods is derived. 2. Demand for Perishable Goods and Durable Goods : i) Perishable Goods are those goods which can be consumed only once. For example:- bread, milk and vegetables etc.
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ii) Durable Goods are those goods the utility from which accrues over a period of time. For example refrigerator, car, furniture etc. 3. Direct and Indirect Demand : (i) (ii) Direct Demand : direct demand. Goods that are demanded for their own sake have
Indirect Demand : Goods that are needed in order to obtain some other goods possess indirect demand. Short Run Demand : Short-run demand represents the existing demand which is based on immediate reaction to price changes, income fluctuations and other explanatory variables. Long Run Demand : Long-run demand on the other hand, is that demand which emerges after the influence of price changes, product improvement, promotional efforts and other factors over time is allowed to adjust the market to the new situation. In the long run, new customers may start purchasing the product. Some products may not be demanded any more. Joint Demand : When two goods are demanded in conjunction with one another at the same time to satisfy a single want, they are said to be joint demand. For Example:- Pens and ink, camera and film, Car and petrol etc. Composite Demand : A commodity is said to be in composite demand when it is wanted for several different uses. Individual Demand : Individual demand schedule is defined as the table which shows quantities of a given commodity which an individual consumer will buy at all possible prices at a given time. Market Demand : Market demand schedule is defined as the quantities of a given commodity which all consumers will buy at all possible prices at a given moment of time. Price Demand : Price demand refers to the various quantities of a product purchased by the consumer at alternative prices. D= f (P)
4. Short-Run Demand and Long-Run Demand : (i)
(ii)
5. Joint Demand and Composite Demand : (i)
(ii)
6. Individual Demand and Market Demand : (i)
(ii)
7. Price Demand, Income Demand and Cross Demand : (i)
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(ii)
Income Demand : Income demand refers to the various quantities of a commodity demanded by the consumer at alternative levels of his changing money income. D= f (Y)
(iii) Cross Demand : Cross demand refers to the various quantities of commodity (say coffee) purchased by the consumer in relation to change in the price of a related commodity (say tea) which may either be a substitute or a complementary product. D b= f (P ) a Determinants of Demand : Demand of a consumer for a particular
commodity is determined by the following factors: (1) Price of Commodity : There is an inverse relationship between price and
demand for a commodity. When Price increases, then demand decreases and when price decreases, then demand increases. It is also explained with the help of following diagram :
Y
P1
P D
O Q1 Q X
Quantity
(2)
Price of Related Goods :
its own price, but also upon the prices of related goods. Related goods are broadly classified into two categories (i) Substitute Goods : Substitutes goods are those goods which can be
substituted for each other, such as tea and coffee. Demand of tea is related to the price of coffee. If price of coffee is raised people may shift to tea, and vice-versa. In other words, in case of substitute the demand of one good is positively related to the price of the other good.
Y
P1
Demand for a commodity depends not only on
P D X
O Q Q1
Quantity of Tea 29
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(ii)
Complementary Goods : Complementary goods are those goods which complete the demand for each other, such as car and petrol. There is an inverse relationship between the demand for first good and the price of the second good.
Y
P1
P D
Quantity of Petrol
O Q1 Q X
(3)
Income of the Consumer :
the consumer and his demand for a good in case of normal goods. But there is a negative relation between income of the consumer and demand for a good in case of inferior goods. (i) Normal Goods : There is a positive relation between income of the
consumer and his demand for a good in case of normal goods.
Y
Y1
There is a positive relation between income of
Y D
O Q Q1
Quantity
(ii)
Inferior Goods : There is a negative relation between income of the consumer and demand for a good in case of inferior goods.
D
Y1
Y D
Quantity of Inferior Goods
O Q1 Q X
(4)
Tastes and Preferences : The demand for any goods and service depends on individuals tastes and preferences. Demand for those goods increases for which consumers develop tastes and preferences.
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(5)
Expectations : If the consumer expects that price will rise in future, he will buy more goods in the present even when price is high. In case, he expects that prices will fall in future, he will either buy less in the present. Climate and Weather Conditions : Demand for certain products is determined by climate or weather conditions. For example, in summer, there is a greater demand for cold drinks, fans, coolers, etc. Size of Population : Market demand is influenced by change in size of population. Increase in population leads to more demand and decrease in population means less demand for them.
(6)
(7)
Q. Explain the difference between Increase in Demand and Extension of Demand and Decrease in Demand and Contraction of demand. OR Q. Explain the Change in Demand. Ans . (A) : Change in demand of two types : : Other things remaining the same, when the quantity demanded changes consequent upon the change in price only, then this change is shown by different points along the same demand curve. Fall in price is followed by extension of demand and rise in price is followed by contraction of demand. Change in Price alone Change in Quantity Demanded Movement along the Demand Curve (1) Extension of Demand : Extension of demand refers to a rise in quantity demanded as a result of fall in price, other things remaining the same. This can be explained with the help of following table and diagram: Extension of Demand Price (Rs.) Quantity Demanded Description Change in Demand 5 1Kg Movement Along Demand Curve 1 5 Kg
Fall in Price Extension of Demand
As shown in the above table, when price of apples is Rs.5 per Kg demand is for 1 Kg of apples, when it falls to Re. 1 per Kg demand extends to 5 Kg of apples.
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A 5 4 Extension of Demand
3 2
1 O12345 Quantity
In this figure AB is the demand curve of apples. When price of apples is Rs.5 per Kg demand is for 1 Kg of apples. The consumer is at point A of the demand curve. As the price of apples falls to Re. 1 per Kg demand extends to 5 Kg and the consumer moves to point B of the demand curve. Movement along the demand curve from higher point (A) to lower point (B) is called extension of demand. (2) Contraction of Demand : Contraction of demand refers to a fall in quantity demanded as a result of rise in price, other things remaining the same. This can be explained with the help of following table and diagram: Extension of Demand Price (Rs.) Quantity Demanded Description 1 5 5Kg 1 Kg Rise in Price Contraction of Demand
As shown in the above table, when price of apples is Rs.1 per Kg demand is for 5 Kg of apples, when it rises to Re. 5 per Kg demand contracts to 1 Kg of apples.
A 5
4 3 2 1
O12345 Quantity
Contraction of Demand
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In this figure AB is the demand curve of apples. When price of apples is Rs.1 per Kg demand is for 5 Kg of apples. The consumer is at point B of the demand curve. As the price of apples rises to Re. 5 per Kg demand contracts to 1 Kg and the consumer moves to point A of the demand curve. Movement along the demand curve from lower point (B) to higher point (A) is called contraction of demand. (B) Shift in Demand Curve : A change in any determinants of the demand other than price will shift the entire demand curve to the right or to the left. An increase in demand is shown as rightward shift. A decrease in demand is a leftward shift of the entire demand curve. Change in Income, Tastes or Price of other goods Change in Demand Shift of Demand Curve (1) Increase in Demand :
response to change in determinants of demand other than price of the product. Increase in demand refers to rightward shift in demand curve. Thus, demand may increase in two ways: (i) Same Price more Demand : When price of ice cream is Rs. 3 per
unit, demand is for 3 units. If price remains the same, i.e., Rs. 3 per unit but demand goes up to 4 units, then it will be an instance of increase in demand. More Price same Demand : When price of ice cream is Rs. 3 per unit, demand is for 3 units. If price rises to Rs. 4 per unit but demand remains the same, that is, 3 units, then it will also be an instance of increase in demand.
Increase in demand means rise in demand in
(ii)
This can be explained with the help of following Table and Diagram : Price of Ice Cream (Rs.) Same Price 3 3 More Price 3 4 Quantity Purchased More Purchase 3 4 Same Purchase 3 3
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C 5 A Increase of Demand
4 3 2 1
O12345 Quantity
D B
Causes of Increase in Demand : (i) Increase in Income (ii) Rise in Price of Substitute Good (iii) Fall in the price of complementary good (iv) Favourable changes in tastes and preferences (v) Expectation of rise in price (vi) Increase in population. (2) Decrease in Demand : Decrease in demand means fall in demand in
response to change in determinants of demand other than price of the product. Decrease in demand refers to leftward shift in demand curve. Thus, demand may increase in two ways: (i) Same Price Less Demand : When price of ice cream is Rs. 3 per
unit, demand is for 3 units. If price remains the same, i.e., Rs. 3 per unit but demand goes down to 2 units, then it will be an instance of decrease in demand.
Less Price same Demand : When price of ice cream is Rs. 3 per unit, demand is for 3 units. If price falls to Rs. 2 per unit but demand remains the same, that is, 3 units, then it will also be an instance of decrease in demand. This can be explained with the help of following Table and Diagram : Price of Ice Quantity Cream (Rs.) Purchased Same Price Less Purchase 3 3 Less Price Same Purchase 3 2
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(ii)
3 2 3 3
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A
5 4 3 2
1
Decrease of Demand
B D O12345 Quantity
Causes of Increase in Demand : (i) Decrease in Income (ii) Fall in Price of Substitute Good (iii) Rise in the price of complementary good (iv) UnFavourable changes in tastes and preferences (v) Expectation of Fall in price (vi) Decrease in population. Difference between Extension and Increase in Demand
Extension of Demand : Extension of demand means rise in demand response to fall in the price of a commodity, other things being equal. It is expressed by the movement from a higher point to a lower point along the same demand curve. Increase in Demand : On the other hand, increase in demand refers to rise in demand response to change in the determinants of demand other than the price. It is expressed by the upward shift of the entire demand curve. This difference can be explained with the help of following diagram :
D1
P P1
A
Ex t e ns io n i n De ma n d
Increase of Demand C B
D1
D O
Q Q1
Quantity
This figure shows the distinction between extension and increase in demand. DD is the initial Demand Curve. This figure shows that from the point A of the demand curve DD two quite different rise in demand are possible. One
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is a rise in the quantity demanded from OQ to OQ , moving along the same 1 curve from point A to B. Such a rise in quantity demanded results from consumers adjustment to a reduction in price from OP to OP . It is called 1 extension of demand. The second is the shift in the entire demand curve from DD to D D . At the initial price OP the consumer used to purchase OQ, as shown by point A but now purchases OQ as shown by point C. This change in demand is the 1 response to change in any determinant of demand, other than the price. This change is called increase in demand. Difference between Contraction and Decrease in Demand : Contraction of demand : Contraction in demand means fall in demand in response to a rise in the price of a commodity, other things being equal. It is expressed by the movement from a lower point to a higher point on the same demand curve. Decrease in Demand : On the other hand, decrease in demand refers to fall in demand response to change in the determinants of demand other than the price. It is expressed by the downward shift of the entire demand curve. This difference can be explained with the help of following diagram :
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D
D1
P1 P
Decrease in Demand
B C
Contraction of Demand A D
D1
Q 1Q Quantity
This figure shows the distinction between Contraction and decrease in demand. DD is the initial Demand Curve. This figure shows that from the point A of the demand curve DD two quite different reduction in demand are possible. One is a fall in the quantity demanded from OQ to OQ , moving along the same 1 curve from point A to B. Such a fall in quantity demanded results from consumers adjustment to a rise in price from OP to OP . It is called contraction 1 of demand. The second is the shift in the entire demand curve from DD to D D . At the initial price OP the consumer used to purchase OQ. But now purchases OQ . This change in demand is the response to change in any determinant of demand, other than the price. This change is called decrease in demand.
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Q. Explain the Law of Demand. OR Q. Why does the demand curve slope downwards to the right? Ans. Meaning of Demand : Demand is defined as the quantities of a product which a consumer is not only desiring to purchase and able to purchase but is also ready to purchase at given prices at a given point of time. Law of Demand : Meaning : Law of demand states that, other things being equal, the demand for a good extends with a fall in price and contracts with a rise in price. According to law of demand there is an inverse relationship between price and demand for a commodity. Definition : According to Marshall The law of demand states that amount demanded increases with a fall in price and diminishes when price increases, other things being equal. Assumption : Assumptions of the law of demand are that all the determinants of demand other than the price of good remain unchanged. There are the following assumptions:(1) There should be no change in the price of related goods (2) There should be no change in the income of the consumer (3) There should be no change in the tastes and preference of consumer (4) The consumer does not expect any change in the price of the commodity in the near future. (5) There is no change in weather conditions. Explanation of Law of Demand
help of schedule and diagram : (A) Demand Schedule : Demand schedule is a table that shows different
prices of a good and the quantity of that good demanded at each of these prices. It has two aspects:-
:Law of demand can be explained with the
(1)
Individual Demand Schedule : Individual demand schedule is defined as the table which shows quantities of a given commodity which an individual consumer will buy at all possible prices at a given time. The following table shows Individual demand schedule: Price Per Unit (in Rs.) Quantity Demanded (Units) 1 2 3 4 4 3 2 1
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demand tends to contract. (2) Market Demand Schedule :
Above schedule indicates that as the price of Ice cream increases, its Market demand schedule is defined as the quantities of a given commodity which all consumers will buy at all possible prices at a given moment of time. The following table show market demand schedule. The schedule is based on the assumption that there are, in all two consumers A and B. Price of Demand Demand Market Commodity of A of B 1 2 3 4 4 5 4+5=9 3 4 3+4=7 2 3 2+3=5 1 2 1+2=3 Demand (A+B)
Above schedule indicates that as the price of Ice Cream increases, its market demand tends to contract. (B) Demand Curve : The demand curve is a graphic presentation of a
demand schedule. The curve which shows the relation between the price of a commodity and the amount of the commodity that the consumer wishes to purchase, is called demand curve. It has two aspects:-
(1)
Individual Demand Curve : Individual demand curve is a curve which shows quantities of a given commodity which an individual consumer will buy at all possible prices at a given time. The following figure shows Individual demand curve:
Y 4 3 2 1 D O 1 2 3 Quantity 4 X Individual Demand D
Quantity demanded is shown on OX-axis. And the price is shown on OY-axis. DD is the demand curve. Each point on the demand curve expresses the
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relation between price and demand. At a price of Rs. 1 per unit, demand is for 4 units and at a price of Rs. 4 per unit, demand is for 1 unit. (2) Market Demand Curve : Market demand curve is defined as the
quantities of a given commodity which all consumers will buy at all possible prices at a given moment of time. The following curve shows market demand. The curve is based on the assumption that there are, in all two consumers A and B.
Y 4 3 2 1 D O 2 4 6 Quantity 8 10 X Market Demand D
Quantity demanded is shown on OX-axis. And the price is shown on OY-axis. DD is the demand curve. Each point on the demand curve expresses the relation between price and demand. At a price of Rs. 1 per unit, market demand is for 9 units and at a price of Rs. 4 per unit, demand is for 3 units. Causes of Law of Demand OR Why does Demand Curve slope downward : 1. Law of Diminishing Marginal Utility : A consumer demands a commodity because it has utility. As he consumes more and more units of a commodity, in a given time, the utility derived from each successive unit goes on diminishing. Obviously, a consumer will buy an additional unit of a commodity only if he has to pay less price for it compared to the previous unit. Income Effect : Income effect is the effect that a change in a persons real income caused by change in the price of a commodity has on the quantity of that commodity. When the relative price of a good decrease, less of a persons income would need to be spent to purchase exactly the same amount of the good; therefore it is possible to purchase more because of this rise in purchasing power. For Example : Suppose your income is Rs. 15 per day. You want to buy apples whose price is Rs. 5 per Kg. It means with your fixed income of Rs. 15 you can buy three Kg. In case, the price of apples comes down to Rs. 3
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2.
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per Kg then after buying 3Kg of apples you will be left with Rs.6. This increased income may be spent on buying two more Kg of apples. Thus fall in price causes increase in real income and so extension in demand. On the contrary, rise in price causes decrease in real income and so contraction in demand. 3. Substitution Effect : The substitution effect is the effect that a change in relative prices of substitute goods has on the quantity demanded. Substitutes are goods that can be used in place of each other. For example, tea and coffee, coca cola and Pepsi cola are substitutes. In order to get maximum satisfaction with a fixed income, a consumer will substitute a lower priced goods for higher priced one. For Example : Tea and coffee are substitutes of each other. If price of tea goes down, the consumers may substitute tea for coffee, although price of coffee remains the same.
4.
Different Uses : Some goods have more than one use. Milk, for example, may be used for drinking and for making curd and cheese. At its very high price, an individual consumer may buy milk only for drinking; but at the reduced price more milk may be bought for making curd and cheese as well. 5. Size of Consumer Group : When the price of a commodity falls, then many consumers, who are unable to buy that commodity at its previous price, come forward to but it. Consequently, the total number of consumers goes up. On the contrary, if the price of commodity rises many consumers will withdraw from the market and in this way total demand for apples will go down. Exception of Law of Demand : There are some exceptions of law of demand. Demand curve of such commodities slopes upwards from left to right.
Y D
D O Quantity X
(1)
Articles of Distinction : Veblen goods are articles of distinction or luxury goods like jewellery, original works of art by great artists. Articles of distinction according to Veblen, command more demand when their prices are high.
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(2) Many a time, : Ignorance consumer out of poor judgment consider a commodity to be of low quality of its price is low and of high quality if its price is high. (3) Giffen Goods : Giffen goods are those inferior goods whose demand falls even when their price falls, so that the law of demand does not hold good.
Q. Define Elasticity of Demand. What are the degrees of Price Elasticity of Demand? Ans . : Law of demand tells us about the direction of change in demand for a commodity as a result of change in its price. Thus this law a qualitative statement. It simply states that when price falls demand extends and when price rises demand contracts. It does not explain how much the demand will change. It is the concept of price elasticity of demand which measurers how much the quantity demanded of a good changes when its price changes. Elasticity of demand is a ratio between a cause and an effect, always in percentage terms. Elasticity of demand is a quantitative statement. Types of Elasticity of Demand : Demand for a good depends upon its price, commodity of the consumer and price of related goods. Therefore, elasticity of demand is of three types:(1) Price Elasticity of Demand (2) Income Elasticity of Demand (3) Cross Elasticity of Demand Price Elasticity of Demand : The price elasticity of demand is equal to the ratio of the percentage change in the quantity demanded to a percentage change in the price, other things being equal. It measures how much the quantity demanded of a good changes when its price changes. Price elasticity of demand denotes the ratio at which the demand contracts with a rise in price and extends with a fall in price. There is an inverse relationship between price and quantity demanded of a good. Accordingly, elasticity of demand is expressed by minus(-) sign. Degrees of Price Elasticity of Demand : There are five degrees of elasticity of
demand:(1) Perfectly
Elastic A perfectly elastic demand is one in which any quantity Elasticity of Demand will be bought at the prevailing price. In this case, a very little rise in price causes the demand to fall to zero and a very little fall in price cause the demand to extend to infinity. In this case Elasticity of demand will be infinity. In this diagram DD represents perfectly elastic demand curve. It is parallel to OX-axis.
Y Demand D D Ed= P
Quantity
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(2)
Perfectly Inelastic Demand : A perfectly inelastic demand is one in which a change in price produces no change in the quantity demanded. In this case price elasticity of demand will be zero. Y
P1
P
P2
Ed =0 D
Quantity
to OY-axis. (3) Unitary Elastic Demand :
In this diagram DD represents the perfectly inelastic demand. It is parallel Unitary Elastic demand is one in which a percentage change in price produces an equal percentage in quantity demanded. If 5 percent fall in price is followed by 5 percent extension in demand, then it will be a case of unitary elastic demand i.e. 5%/5% = 1 Y P E =1 d
P1
D X Quantity
O Q Q1
PP (change in price) is equal to OQ (change in quantity). In this case Elasticity of demand will be one. (4) Greater than Unitary Elastic Demand : Greater than unitary elastic
1 1
In this diagram DD represents the unitary elastic demand. In this diagram
demand is one which a given percentage change in price produces relatively more percentage change in quantity demanded. If 5 percent fall in price causes 20 percent extension in demand, then it will be an example of greater than unitary demand i.e. 20% / 5%= 4
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Y P
P1
D E >1 d D
O Q Q1
X Quantity
this diagram OQ (change in price) is more than to PP (change in quantity). In this case Elasticity of demand will be greater than one. (5) Less than Unitary Elastic Demand : Less than unitary elastic demand
1 1
In this diagram DD represents greater than unitary elastic demand. In
is one in which a given percentage change in price produces relatively less percentage change in demand. When fall in price by 4 percent is followed by 2 percent extension in demand then elasticity of demand will be 2% / 4% = i.e. less than unitary
Y P
E <1 d
P1
D
O Q Q1
X Quantity
In this diagram DD represents less than unitary elastic demand. In this diagram OQ (change in price) is less than to PP (change in quantity). In this 1 1 case Elasticity of demand will be less than one.
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Sr. Value of Degrees of Description No. Elasticity Elasticity 1. E = Perfectly Elastic Little Change in price causes d Demand an infinite change in demand. 2. E =0 Perfectly Inelastic Change in price causes no d Demand change in quantity demanded 3. E =1 Unitary Elastic Percentage change in price is d Demand equal to percentage change in demand 4. E >1 Greater than Percentage change in price is d Unitary Elastic less than percentage change in Demand demand 5. E <1 Less than Unitary Percentage change in price is d Elastic Demand more than percentage change in demand Q. How can Price Elasticity of Demand be measured ? Ans. Price Elasticity of Demand : The price elasticity of demand is equal to the ratio of the percentage change in the quantity demanded to a percentage change in the price, other things being equal. It measures how much the quantity demanded of a good changes when its price changes. Measurement of Price Elasticity of Demand : Whether price elasticity of demand is unitary, greater than unitary or less than unitary is know by its measurement. There are five methods of measuring price elasticity of demand:1. Total Outlay or Total Expenditure Method 2. Percentage Or Proportionate Method 3. Point Elasticity Method 4. Arc Elasticity Method 5. Revenue Method Total Outlay Or Total Expenditure Method : Total Expenditure method was evolved by Marshall. According to this method, in order to measure the elasticity of demand it is essential to know how much and in what direction the total expenditure has changed as a result of change in the price of a good. Total Expenditure = Price X Quantity
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1.
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There may be three situations : (i) Unitary Elasticity of Demand : Elasticity of demand is unitary when due to rise or fall in the price of a good, total expenditure remains unchanged. Greater than Unitary Elasticity of demand : Elasticity of demand is greater than unitary when due to fall in price total expenditure goes up and due to rise in price total expenditure goes down.
(ii)
(iii) Less than unitary elasticity of demand : Elasticity of demand is less than unitary when due to fall in price total expenditure goes down and due to rise in price total expenditure goes up. This relationship can also be reflected with the help of following table:Sr. Vale of Degrees of No. Elasticity Elasticity Description
1 E = 1 Unitary Elastic Price Increases..........No d Demand changes in Total Expenditure Price Decreases.......No Change in Total Expenditure 2 E > 1 Greater than Price Increases.............Total d Unitary Elastic Expenditure Decreases Demand Price Decreases ...........Total Eexpenditure Increases 3 E < 1 Less than Unitary Price Increases.............Total d Elastic Demand Expenditure Increases Price Decreases ............Total Expenditure Decreases
2.
Proportionate Or Percentage Method : The second method of measuring price elasticity of demand is called percentage method. According to this method, the price elasticity of demand is equal to the ratio of the percentage change in the quantity demanded to a percentage change in the price. Its formula is as under:-
Percentage change in Quantity Demanded of Commodity E = (-) ----------------------------------------------------------------------d Percentage Change in Price of Commodity
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100 X Change in Quantity Demanded Initial Demand E = (-) -d 100 X Change in Price Initial Price 100 (Q -Q) 1 Q E = (-) d 100 (P -P) 1 P 100 QD Q E = (-) d 100 P D P DQ P E = (-) X
d
QP
Q = Initial Demand Q = New Demand 1 DQ = Change in Demand (Q -Q) P = Initial Price 1 P = New Price DP = Change in Price (P -P)
1 1
3.
Point Elasticity of Demand : Point elasticity refers to price elasticity of demand at any point on the demand curve. Its formula is: Lower Segment E = d Upper Segment
Price elasticity at different points of a straight line shown in the following figure :
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Y M
Ed= A Ed >1 P E =1 d B E <1 d E =0 d
O Quantity
NX
At point P, lower segment = PN & Upper Segment = PM Lower Segment PN E = = = 1 d Upper Segment PM
At point A, lower segment = AN & Upper Segment = AM Lower Segment AN E = = >1 d Upper Segment AM
At point B, lower segment = BN& Upper Segment = BM Lower Segment BN E = = < 1 d Upper Segment BM

4.
At point M, Elasticity of Demand will be infinity. At point N. Elasticity of Demand will be Zero.
Arc Elasticity : Arc Elasticity is a measure of the average responsiveness to price change shown by the demand curve over some definite portion between two points on a demand curve. An arc is the portion between two points on a demand curve. The portion between two points A and C on the demand curve DD as shown in the given figure is called Arc. Change in Quantity Change in Price
E = (-) d (Sum of Quantities) (Sum of Prices)

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(Q -Q) (P -P)
E = (-) d (Q +Q) (P +P)

1 1 1
Y
P1
D A C D X
(Q -Q) (P +P) E = (-) X d (Q +Q) (P -P)

11 11
(Q -Q) (P +P) 1 1 E = (-) X d (Q +Q) (P -P)

1 1
OQ
Q1
Q = Initial Demand Q = New Demand 1 P = Initial Price P = New Price 5. Revenue Method :
products is called its revenue. Supposing by selling 10 meters of cloth, a firm gets Rs. 50 then this amount of Rs. 50 will be called the total revenue of the firm. There are three types of revenue:(i) Total Sale proceeds of a firm is called total revenue. Revenue :
Sales proceeds that a firm is obtained by selling its
Average Revenue : When total revenue is divided by the number of units sold we get average revenue. (iii) Marginal Revenue : Addition made to the total revenue by the sale of one more unit of the commodity is called marginal revenue. According to Revenue Method Elasticity of Demand can be measured from the following formula : (ii) A E = d A-M A = Average Revenue M = Marginal Revenue Ed = Elasticity of Demand Q. Write a short note on the following (A) Income Elasticity of Demand. (B) Cross Elasticity Or Elasticity of Substitution.
Ans. (A) Income Elasticity of Demand
: The income elasticity of demand is equal to the ratio of the percentage change in the quantity demanded to a percentage change in the income, other things being equal. It measures
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how much the quantity demanded of a good changes when consumers income changes. Definition of Income Elasticity of Demand According to Watson Income Elasticity of demand means the ratio of the percentage change in the quantity demanded to the percentage change in income. Measurement of Income Elasticity : Income Elasticity can be measured by the following formula:Percentage Change in Quantity Demanded Ey = Percentage Change in Income :
100 Q D Q Ed = 100 Y D Y
DQ Y Ed = X QY D
Q = Initial Demand Q = New Demand 1 DQ = Change in Demand (Q -Q) Y = Initial Income 1 Y = New Income DP = Change in Income (P -P) 1 Degrees of Income Elasticity of Demand
is of three types: (1) Positive Income Elasticity of Demand :
:Income Elasticity of demand
Income Elasticity of demand for a good is positive when with an increase in the income of a consumer his demand for the good increases and with a decrease in the income of a consumer his demand for the good decreases. Income elasticity of demand is positive in case of normal goods.
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Y A B
Dy
Dy
O Q Q1
X Quantity
In this figure DY DY curve represents positive income elasticity of demand. It shows that when income increased form OB to OA then demand also increase from OQ to OQ . It slopes upward from left to right i.e. positive 1 slope. (2) Negative Income Elasticity of Demand : Income Elasticity of demand for a good is Negative when with an increase in the income of a consumer his demand for the good decreases and with a decrease in the income of a consumer his demand for the good increases. Income elasticity of demand is positive in case of inferior goods Y
Dy
A B
Dy
Q1 X
Quantity In this figure Dy Dy curve represents negative income elasticity of demand. It shows that when income increased form OB to OA then demand decrease from OQ to OQ . It slopes downward right to left i.e. 1 negative slope. (3) Zero Income Elasticity of Demand : Income elasticity of demand is zero, when change in the income of consumer evokes no change in his demand
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Y A B
Dy
Dy
OQ Quantity
In this figure Dy, Dy curve represents zero income elasticity of demand. It shows that when income increased form OB to OA then demand constant at point OQ. In this case demand curve will be parallel to OY-axis. (B) Cross Elasticity of Demand OR Elasticity of Substitution : There is a mutual relationship between change in price and quantity demanded of two related goods. Change in the price of one good can cause change in the demand for the related good. For example, change in the price of tea ordinarily causes change in demand for coffee. The cross elasticity of demand is the proportional change in the quantity demanded of good X divided by the proportional change in the price of the related good Y. Measurement of Cross Elasticity of Demand : Cross elasticity of demand is measure by the following formula:Percentage Change in Quantity Demanded of good X Ec = Percentage Change in the Price of good Y 100 X Change in Quantity Demanded of X Initial Demand of X E = c 100 X Change in Price of Y Initial Price of Y 100 QD x Qx E = c 100 Py D Py
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DQx Py E = X c Q x Py D DQx = Change in the quantity of good X Qx = Initial demand of good X DPy = Change in price of good Y Py = Initial price of good Y Ec = Cross Elasticity of Demand
be of three types: 1. Positive Cross Elasticity of Demand :
Degrees of Cross Elasticity of Demand :
Cross elasticity of demand can
Cross Elasticity of demand is positive in case of substitutes. In other words when goods are substitutes of each other, then a given percentage rise in the price of a good will lead to a given percentage increase in the demand for the substitute good. For example, rise in the price of coffee will lead to increase in demand for tea, because the two are close substitute of each other. Y A B
Ds
Ds
O Q Q1
Quantity fo Tea
2.
In this figure DS DS curves represents cross elasticity of demand. In this diagram quantity of tea is shown on OX-axis and price of coffee on OYaxis. When price of coffee is OB, demand for tea is OQ. When price of coffee rises to OA, demand for tea increases to OQ1. This curve slopes upward from left to right. Negative Cross Elasticity of Demand : Price Elasticity of demand is negative in case of complementary goods. In case of complementary goods. Percentage rise in the price of one good leads to percentage fall in the demand for the other.
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Y
Dc
A B
Dc
O Q Q1 X
Quantity of Butter In this figure Dc, Dc curve represents the negative cross elasticity demand. In this diagram quantity of butter is shown on OX-axis and price of bread on OY-axis. When price of bread is OB, demand for butter OQ1. When the price of bread rises to OA, demand for butter decreases to OQ. It slopes downward from left to right. Zero Elasticity of Demand : Cross elasticity of demand is zero when two goods are not related to each other. For example, rise in the price of wheat will have no effect on the demand for books. Their cross elasticity of demand will be called zero.
3.
Q. Discuss factors which influence the Price Elasticity of demand.
Ans. : (1) Nature of the Commodity : In economics all goods are divided into three categories: (i) Necessaries : Demand for necessaries like salt, kerosene oil, match
boxes etc. is less than unitary elastic or inelastic. Comfort Goods : etc. is unitary (ii) Price elasticity of comfort goods ,i.e. cooler, fan
(iii) Price elasticity of luxuries goods is greater than unitary Luxuries : elastic. Change in the price of these goods has a great impact on the demand. (2) Availability of Substitutes : (i) There are two possibilities:When Substitutes are available : The greater the number of substitutes available for the product the greater will be its elasticity of demand. When Substitutes are not available : have any substitutes have inelastic demand. Commodities that do not :
(ii) (3)
Goods with Goods that can be put to different uses have uses Different Factors Determining the Price Elasticity of Demand
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elastic demand. For instance, electricity has many uses. It can be used for heating, lighting, cooling etc. When electricity charges are high, it is used for lighting purpose only and so its demand for other less urgent uses will fall considerably. (4) Postponement of the Use : Goods whose demand can be postponed to a future period have elastic demand. On the other hand, goods whose demand cannot be postponed have inelastic demand. Income of the Consumer : People having very high or very low income have inelastic demand. On the other hand demand of middle-income people is elastic. Habit of the Consumer : Demand for those goods is inelastic to which consumers become habituated e.g. cigarette, coffee, etc.
(5)
(6)
(7) Elasticity of demand tends to be more elastic in long period than Time : in short period. The longer the time, the more elastic will be the demand. (8) Complementary Goods : Goods demanded jointly or complementary goods, have relatively inelastic demand, e.g. car and petrol, pen and ink. Rise in the price of petrol may not contract its demand if there is no fall in the demand for cars. :
Q. What is the Importance of Price Elasticity of Demand?
Ans. (1) Determination of Price under Monopoly :
A monopolist always takes into consideration the price elasticity of demand of his product while determining its price. There are two (i) If demand is elastic, he will fix low price per unit. (ii) If demand is inelastic, he will fix high price per unit. Price Discrimination : When a monopolist sells the same product at different prices, it is called price discrimination. A monopolist can practice price discrimination when price elasticity of demand for his product for different uses and for different consumers is different. There are two possibilities (i) He will charge more price from those consumers whose demand is inelastic (ii) He will charge less price form those consumers whose demand is elastic.
possibilities
(2)
(3)
Price Determination of Goods which are produced Joint Importance of in the same act of production are called joint-supply Price Elasticity of Demand simultaneously goods. Elasticity of demand of such goods is taken into consideration while fixing their price.
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(4)
Advantage to Finance Minister : While planning new taxes, a finance minister takes into consideration elasticity of demand: (i) Taxes on goods having elastic demand will be low (ii) Taxes on goods having inelastic demand will be high. International Trade : The concept of elasticity of demand is also important in the field of international trade. A country will gain by increasing the price of exports if their demand in the importing country is inelastic. If their demand in the importing country is elastic then the exporting country will reduce the price. Wage Determination : If the demand of their service of the labourers is elastic, the possibility of getting their wages raised is less. If, on the other hand, demand for their services is inelastic then labour unions succeed in getting their wages increased
(5)
(6)
Q. What do you mean by consumers equilibrium? Explain it with the help of utility analysis? Ans. : Consumers equilibrium refers to a situation wherein a consumer gets maximum satisfaction out of his limited income and he has no tendency to make any change in his existing expenditure. Assumptions
the following assumptions: 1. Rational Consumer :
: Consumers equilibrium through utility analysis is based on
Consumer is assumed to be rational. A rational consumer is one who is keen to get maximum satisfaction out of his limited income. Cardinal Utility : Utilit of every commodity can be measured in terms of cardinal numbers, such as, 1,2,3,4 etc. Independent Utility : It is assumed that the utility derived from one good is not depend on the utility derived from other goods.
2. 3.
4. Marginal Utility of money is constant 5. Fixed Income and Price : It is assumed that the income of the consumer
and the price of the commodity remain fixed. 6. 7. Tastes are Tastes of the consumer also remain unchanged. Constant : Perfect Knowledge : The consumer knows the different goods on which he can spend his income.
Determination of Consumers Equilibrium : Consumers equilibrium through utility analysis can be ascertained under tow different situations : (1) A Single Consumers Equilibrium Commodity First of all we shall study the with One
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Use
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equilibrium situation of a consumer who gets maximum satisfaction by consuming a single commodity with one use. For each unit of commodity he makes a sacrifice in terms of price. In return he gets some utility from each unit. Obviously, a rational consumer will consume the commodity upto a point where the marginal utility of the final unit of the commodity is equal to the marginal utility of money paid for it. Marginal Utility of good X = Price of good X Explanation : diagram : It can also be explained with the help of following table and :
Consumers Equilibrium in case of One Commodity with One Use
Unit of X Marginal Utility Price of X Surplus Commodity of X Commodity Commodity Or OR MU of Deficit Money 1 50 2 40 3 30 4 20 5 10 20 30 20 20 20 10 20 0 20 -10
Supposing the price of commodity X is Rs. 1 per unit which in terms of marginal utility is taken as equal to 20 utils. When the consumer buys 4 units of the commodity then the marginal utility of commodity and marginal utility of money is equal to each other. The consumer will be in equilibrium in this situation.
50 40 30 20 P E P 10
M MU=P
U 12 345 Quantity
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In this figure Quantity is shown on OX-axis and Utility/Price is shown on OYaxis. MU is the Marginal Utility curve. PP is the price line. E is the equilibrium point. The consumer is in equilibrium at point E both where marginal utility of 4 unit of commodity is equal to its price. (2) Several Commodities : When a consumer spends his fixed income on
th
more than one commodity, he compares the marginal utilities of different commodities with a view to getting maximum satisfaction. Consumer arrives at a situation where the last unit of money spent on different commodities yields him equal marginal utility. This will be the position of his equilibrium.The position of consumers equilibrium is also explained with the help of following table and diagram : : Supposing a consumer has Rs. 5 to be spent on two commodities, X and Y. Price of each commodity is Re. 1 per unit. Quantity MU of X MU of Y Commodity Commodity 1 2 3 4 5 12 10 8 6 4 10 8 6 4 2
The table indicates that to be in equilibrium the consumer will spend Rs. 3 on X-commodity and Rs. 2 on Y-Commodity as he gets equal marginal utility (8) from the last unit of money so spen MU of X = MU of Y = 8 utils 12 Consumers Equilibrium Several Commodities
MUx MUy E 12 10 10
8 6 4
O 5
8 6
4 2
2 1 2 3 4 Quantity of X 4 3 2 1 Quantity of Y 5 0
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In this figure Quantity is shown on OX-axis and Utility is shown on OY-axis. MUx is the marginal utility curve of X commodity and MUy is the marginal utility curve of Y commodity. Consumers equilibrium is at point E where the consumer consumes 3 units of commodity X and 2 units of commodity Y and the marginal utility (8) of both the commodities is equal. Q. What is an Indifference Curve? Discuss the main Properties or Characteristics of an Indifference Curve. Ans. Meaning of Indifference Curve : An indifference curve is a curve which shows different combinations of two commodities yielding equal satisfaction to the consumer. It means all the points located on an indifference curve represent such combinations of two commodities as yield equal satisfaction to the consumer. Since the combination represented by each point on the indifference curve yields equal satisfaction, a consumer becomes indifferent about their choice. In other words, he gives equal importance to all the combinations on a given indifference curve. Definition : According to H.L. Varian An indifference curve represents all combinations of two commodities that provided the same level of satisfaction to a person. That person is therefore indifference among the combinations represented by the points on the curve. Indifference Schedule : An indifference schedule refers to a schedule that indicates different combinations of two commodities which yield equal satisfaction. A consumer, therefore, gives equal importance to each of the combinations. In other words, he becomes indifferent towards them. The following indifference schedule indicates different combinations of apples and oranges yielding equal satisfaction. Indifference Schedule Combination of Apples Apples Oranges & Oranges A B C D 1 10 27 35 44
The above schedule shows that the consumer gets equal satisfaction from all the four combinations, namely A, B, C and D of apples and oranges.
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Indifference Curve : Indifference curve is a diagrammatic presentation of indifference schedule. Indifference curve is shown in the following figure : Y A
9 B 8 CD 7 6 IC 5 4 O12 34X Apples 3 In this diagram, Quantity of apples is shown on OX-axis and that of oranges on 2 OY-axis. IC is an indifference curve. Different points A, B, C and D on it indicate those combinations of apples and oranges which yield equal satisfaction to the 1 consumer. This curve is also known as Iso-Utility curve.
10
Indifference Map : An indifference map is that graph which represents a group of indifference curves each of which expresses a given level of satisfaction. Indifference map is shown in the following figure :
Indifference Map
Apples
Properties of Indifference Curves
indifference curves : (1) An indifference Curve Slopes Downwards from Left to the Right :
:The following are the main properties of An
indifference curve slopes downwards from left to right, or that, its slope is negative. This property is based on the assumption that if a consumer uses more quantity of one good he will use less quantity of the other, then only he will have equal satisfaction from their different combinations. This property can be explained with the help of following diagram:
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(2)
9 8 7 6 IC 5 4 O1234X Apples 3 Convex to the Point of Origin : An indifference curve will ordinarily be convex (bowed inward) to2 point of origin. Convexity of the curve means the that it bows inward to the origin. The slope of the indifference curve is called the marginal rate of1 substitution because it indicates the rate at
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which the consumer is willing to substitute one good for the other. This property can be explained with the help of following diagram :
(3)
9 8 7 IC 6 5 4 O12 34X Apples 3 Two Indifference Curves Never Touch or Intersect each other : 2 indifference curve represents different levels of satisfaction, so they do not intersect or touch each other. This property can be explained with the help 1 of following diagram
10
Y A B
IC2
Each
C
IC1
O1234X
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(4)
In this figure two indifference curve IC and IC have been shown 12 intersecting each other at point A, but it is not possible. Point A and C on indifference curve IC represent combinations yielding equal satisfaction, 1 that is, satisfaction from A combination = satisfaction from C Likewise, point A and B on indifference curve IC represents combinations yielding 2 equal satisfaction, that is, satisfaction from A combination = satisfaction from B combination. It implies that satisfaction from B combination is equal to satisfaction from C combination; but it is not possible because in B combination quantity of oranges is more than C combination, although quantity of apples in both combinations is equal. Higher Indifference Curve Indicates Higher Satisfaction : indiff erence map, high er indifferenc e c urv e repre se nts those combinations which yield more satisfaction than the combinations on the lower indifference curve. This property is illustrated in the following figure:
Y
In
AB
IC2 IC1
Apples
in the indifference curve analysis that a consumer buys combinations of different quantities of two goods. Hence an indifference curve touches neither OX-axis nor OY-axis. In case an Y indifference curve touches either axis it means that the consumer wants only one commodity and his demand for the second commodity is zero. An indifference curve may touch OY-axis if it represents money instead of a commodity, as shown in the following IC In the above figure, IC touches OY-axis at point M. It OX Q means the consumer has in his possession OM Apples quantity of money and does not want any unit of
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In this figure IC2 is higher and IC1 is lower indifference curve. Point B on IC2 represents more units of apples than point A on IC1 curve, although in both combinations quantity of oranges is the same. Hence point B on IC2 will give more satisfaction than point A on IC1. It is assumed (5) Indifference Curve touches neither X-axis nor Y-axis :
figure
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apples. At point N consumer likes to have a combination of OQ quantity of apples and OP units of money. This combination will yield him same satisfaction as by keeping OM units of money.
Y
IC3 IC2 IC1
X Apples
(6)
Indifference Curves need not be parallel to each other : Indifference curves may or may not be parallel to each other. It all depends on the marginal rate of substitution of two curves shown in the indifference map. If marginal rate of substitution as indicated by two curves diminishes at the same rate, then these curves(IC and IC ) will be parallel to each other, 12 otherwise they will not be parallel as IC and IC 23 Q. Explain the Income Effect, Substitution Effect and Price Effect with the help of Indifference Curves. Ans. Introduction : Consumers equilibrium is affected by change in his income, change in the price of substitutes and change in the price of good consumed. The effect of changes in consumers income, the price of substitutes or the price of the good consumed on consumers equilibrium are known as:
(A) Income Effect (B) Substitution Effect (C) Price Effect

(A) Income Effect : The income effect may be defined as the effect on the purchases of the consumer or consumers equilibrium caused by change in his income, if relative prices remain constant. The income effect can be studied under the following two types of goods: (1) Income Effect in Case of Normal Goods : Income effect of normal goods is positive. It implies that the quantity demanded increases with an increase in income and decrease with decrease in income. In other words, income effect indicates that, in case of normal goods, other things being equal increase in income increases the satisfaction of the consumer. As a result, equilibrium point shifts upwards to the right. On the contrary, decrease in income decreases the satisfaction of the consumer and his equilibrium point shifts downwards to the left.
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Assumptions : (i) Both the goods are normal goods. (ii) The prices of both the goods remain constant. (a) Income effect of a rise in income : Income effect of an increase in income shows that increase in income increases the satisfaction of the consumer. As a result, consumers equilibrium point shifts upwards to the right. It is because when the income of the consumer increase it enables him to buy more units of the commodities at given prices. This can be explained with the help of following figure: Y C A
P1
ICC
E1 E B
IC1
D IC
O Q Q1 X
Apples In this figure, AB is the initial budget line and IC is the initial indifference curve. Point E refers to consumers equilibrium at which the budget line AB is tangent to indifference curve IC. At this point consumer buys OP units of oranges and OQ units of apples. Suppose the income of the consumer increases enabling him to buy more units of apples and oranges. Consequently his budget line shifts upwards to the right as shown by CD budget line. The consumer moves to a higher indifference curve IC and his equilibrium point shifts to the right to E . At this point, consumer1 will purchase more units of both the goods i.e. OP units of 1 oranges and OQ units of apples.
1
(b)
Income Effect of fall in Income : Income effect of decrease in income shows that a decrease in income decreases the satisfaction of the consumer. As a result equilibrium point shifts downwards to the left. In is because when the income of the consumer decreases, he has to buy less units of the commodities at given prices. This can be explained with the help of following figure:
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Y A C P
P1
ICC
E E1 D
IC1
IC B
OQ
Q1 X
Apples In this figure, AB is the initial budget line and IC is the initial indifference curve. Point E refers to consumers equilibrium at which the budget line AB is tangent to indifference curve IC. At this point consumer buys OP units of oranges and OQ units of apples. Suppose the income of the consumer decreases forcing him to buy less units of apples and oranges. Consequently his budget line shifts downward to the left as shown by CD budget line. The consumer moves to a lower indifference curve IC and his 1 equilibrium point shifts to the right to E1. At this point, consumer will purchase less units of both the goods i.e. OP units of oranges and OQ 1 units of apples. Income Effect in Case of Inferior Goods : Income effect in case of inferior good is negative. It implies that quantity demanded decreases as income increases and quantity demanded increases as income increases. Assumptions : (i) Commodity X is inferior good while commodity Y is a normal good (ii) The prices of both the goods remain constant. Income effect in case of inferior goods can be explained with the help of following diagram : Y ICC C A
IC1
(2)
E OQ
Q1
IC BD
X-Commodity
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In this figure AB is initial budget line and IC is the initial indifference curve. Point E refers to consumer equilibrium. Point E indicates that consumer buys OQ units of X-commodity. Suppose the income of the consumer increases. Consequently the budget line shifts upwards to the rights as shown by CD. The consumer moves to indifference curve IC and his equilibrium point shifts to E . The equilibrium point E1 shows that consumer will purchase less units of Xcommodity i.e. OQ which is an inferior good. It becomes clear that when income increases, the consumption of inferior good decreases. Similarly it can be shown that when income decreases the consumption of inferior good increases. Substitution Effect : The substitution effect may be defined as the (B) change in the purchase of consumer or consumers equilibrium caused by
1 1
(1)
changes in relative prices if real income remains constants. If change in relative prices of the goods is followed by change in the monetary income of the consumer in such a way that his real income remains constant, then the consumer will substitute cheaper good for the dearer good. Consequently it will affect the quantity purchased of both the goods. This effect is known as substitution effect. Two well known measures of substitution effect are: Slutskys Measure : According to Slutskys measure real income is constant if the consumer is left with an income which would enable him to buy his original combination of goods at the new price, if he wanted to do so. The consumer may move to a higher indifference curve due to fall in the price of a commodity or to a lower indifference curve due to a rise in the price of the commodity, other things being equal. This can be explained with the help of following diagram : Y A T
E IC F
K
IC2
IC1
OQ
X BC T X-Commodity Substitution Effect M
In this figure, point E indicates initial equilibrium of the consumer where price line AB and indifference curve IC are tangent to each other. The consumer buys OM quantity of commodity X. When price of X reduces, the price line stretches to become AC. The consumer is now in equilibrium at point K where IC1 and
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new price line AC are tangent to each other. Now we take away just enough income (AT) to allow the consumer to purchase the original quantity of commodity X and Y as indicated by point E. The new budget line TT is drawn which is parallel to new price line AC and cuts across point E, the old point of equilibrium. This line indicates that AT amount of money income is withdrawn from the consumer, allowing him the original combination of both the commodities. The consumer will trace his new equilibrium some where on the line TT. Let it be point F where TT and IC2 are tangent to each other. Being in equilibrium at point F the consumer is buying OQ quantity of X. The change in the purchase of commodity X which is equal to MQ is Slutskys substitution effect. The consumer will move to a higher indifference curve IC2 and his satisfactionMeasure : Hicks will increase. According to J.R. Hicks constant real income means (2) that the consumer stays on the same indifference curve as before the
change in price. In other words, due to substitution effect, there will neither be increase nor decrease in the satisfaction of the consumer. He will only substitute the relatively cheaper goods for relatively expensive goods. Hicks substitution effect is discussed in detail as follows : Y A
N G P
OQ
E F
IC1
D
IC2
X BC H X-Commodity
Substitution Effect In this figure AB is the original price line and IC1 is the original indifference curve. Consumer is in equilibrium at point E. He is getting ON units of commodity Y and OM units of commodity-X. Supposing commodity A becomes cheaper. Consequently, AB price line will shift outwards to the right on OX-axis as AC and be tangent to higher indifference curve IC2 at point D which will be new equilibrium point of the consumer. If we want that real income of the consumer should remain the same as before then we will have to take away some of his monetary income, which should be equal to AG in this figure. Line GH is drawn parallel to AC so that the new price ratio is not disturbed. Also, GH is drawn tangent to IC1 as the consumer is to be brought back to the old
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indifference curve offering him the same level of satisfaction. The new price line GH is tangent to indifference curve IC1 at point F which will be the new point of equilibrium, with constant real income of the consumer. Being in equilibrium at point F, the consumer will buy OQ quantity of commodity X. The change in the purchase of commodity X which is equal to MQ is Hicks substitution effect. The consumer is substituting MQ quantity of relatively cheaper good X for NP quantity of relatively expensive good Y. It proves that substitution effect is always negative. Price Effect : The price effect may be defined as the change in the (C)
consumption of goods when the price of either of the two goods changes while the price of the other goods and the income of the consumer remain constant. :
Definition
According to Lipsey : The price effect shows how much satisfaction of the consumer varies due to the change in the consumption of two goods as the price of one changes the price of the other and money income remains constant. Price effect can be explained with the help of following diagram
Y A PCC S R P F C M E E1
IC2
G
IC1
IC
ON
TB Apples
In this figure IC is the original indifference curve and AB the original budgetline and consumer is in equilibrium at point E. When the income of the consumer and the price of oranges remain constant but the price of apples falls, then new budget line assumes the shape of AD which touches higher indifference curve IC1 at point G, the new equilibrium point. In other words, demand for apples will increase from ON to OT i.e. by NT which is what we call Price effect of a fall in price. On the other hand if the price of apples increases, other things remaining constant, the budget line will move inwards to AC. It touches indifference curve IC2 at new equilibrium point F. It shows that demand for apples will decrease from ON to OM i.e. by MN which represents
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price effect of a rise in price. By joining together different equilibrium points Like E, F, G one gets price consumption curve (PCC). Q. How Income Effect and Substitution Effect is separated from Price Effect? Ans. : We know when the price of a commodity changes, it has two effects: (1) There is a change in the real income of the consumer leading to change in the consumption of the consumer. It is called income effect. (2) Secondly, due to change in relative price, the consumer substitutes relatively cheaper good for relatively expensive good. It is called substitution effect. The combination of this income and substitution effect is called price effect. Thus: Price Effect = Income Effect + Substitution Effect
There are two different approaches relating to the separation of substitution effect and income effect given the price effect. These are: (A) The Hicksian Approach : Hicksian approach for separation of
substitution effect and income effect is discussed considering following cases. It may be noted here that substitution effect is always negative because of the negative slope of the indifference curve, quantity demanded always increases as the price falls and always decreases as the price rises. In contrast, income effect is positive or negative depending in whether the goods are normal or inferior. Separation of Substitution Effect and Income Effect for Normal Normal goods are those goods whose substitution effect is Goods negative but income effect is positive. Indeed, substitution Separation of Substitution Effect and Income Effect effect is always negative. (a) Separation of Substitution and Income Effects for a Normal Good in case of Price Rise : The separation of substitution and income effect for a normal good in case of price rise may be explained with the help of following figure:
R L A IC C B
IC1
(i)
Price Effect=SQ Substitution Effect=TQ Income Effect=ST
OSTQNPMX Apples 68
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This figure shows that the LM is the original budget line. The consumer is in equilibrium at point B on indifference curve IC. He purchases OQ units of apples. When the price of apples rises, the budget line shifts inwards to LN. The consumer moves to a new equilibrium position at point A on indifference curve IC1. At this point he purchases OS units of apples. The price effect is indicated by the movement from B to A or by the reduction in quantity demanded from OQ to OS. In other words price effect = OQ-Os= SQ. An increase in price of apples results in a decline in real income of the consumer as indicated by the shifting of indifference curve IC to IC1. If the monetary income of the consumer is increased to such an extent that he remains on his original indifference curve IC or that his real income remains constant, the new budget line will be RP. It is tangent to indifference curve IC at point C. It is parallel to the budget line LN conforming to the new price ratio as indicated by LN after the price of apples rises. Substitution Effect is represented by the movement from the original equilibrium point B to C, both points being situated on the same indifference curve. The substitution effect is the reduction in the quantity demanded of apples from OQ to OT. In other words Substitution effect = OQ- OT = TQ Income Effect is represented by the movement from point C to A. In other words it will be ST Price Effect = SQ Substitution Effect = TQ Income Effect = ST Thus SQ(Price Effect) = TQ (Substitution effect) + ST (Income Effect) (b) Separation of Substitution Effect and Income Effect in case of a Normal Good for a Price Fall : Y A
N G P
ON
F
E2 E1 IC1 IC2
X BL T X-Commodity
Substitution Effect
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In this figure AB is the original budget line and IC the original indifference curve. Consumer is in equilibrium at point E. When price of apples falls while the price of oranges and the income of the consumer remains constant then the new budget line shifts from AB to AC. The new budget line touches higher indifference curve IC1 at point E1 which is the new equilibrium of the consumer. Movement from equilibrium point E to new equilibrium point E1 signifies the effect of changes in the price of apples. Thus price effect is MT. Fall in the price of apples means increase in the real income of the consumer. If the monetary income of the consumer is reduced to such an extent that he remains on his original indifference curve IC, new budget line will be PH and new equilibrium point E2. Substitution Effect: It is represented by the movement from E to E2. Income Effect is represented by the NT Price Effect = MT Substitution Effect = MN Income Effect = NT MT (Price Effect) = MN (Substitution effect) + NT (Income Effect) (B) The Slutskys Approach : The following figure explained with the help of following figure : Y A S Q T
IC2
R IC
IC1
OLMX NB C S Apples In this figure, initially the consumer is in equilibrium at point Q where budget line AB and indifference curve IC are tangent to each other. Owing to the fall in the price of Apples, price line shifts to the right to become AC. The consumer is now in equilibrium at point R where IC1 and budget line AC are tangent to each other. Movement from Q to R shows the change in quantity demanded of apples from OL to OM, which is price effect (LM). Slutsky isolates the substitution effect by withdrawing from the consumer AS amount of money income. So that the real income of the consumer remains constant in terms of the original combination of apples and oranges indicated by point Q. Thus, a new budget line SS is drawn Parallel to AC but passing
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through Q. New budget line SS is tangent to IC2 at point T which emerges as the new point of equilibrium corresponding to reduced money income, but constant real income of the consumer. At T the consumer demands ON amount of apples compared to the OL amount at equilibrium Q. The difference is substitution effect (LN) Substitution Effect = LN Income Effect = NM Price Effect (LM) = Substitution Effect (LN) + Income Effect (NM) Q. What do you mean by consumers equilibrium? Explain it with the help of Indifference Curve Analysis? Ans. Consumers Equilibrium : Consumers equilibrium refers to a situation wherein a consumer gets maximum satisfaction out of his limited income and he has no tendency to make any change in his existing expenditure. A consumer may find out with the help of indifference curve analysis as to how he should spend his limited income on the combination of different goods so that he gets maximum satisfaction. Assumptions : Consumers equilibrium through indifference curve analysis is based on the following assumptions : (i) Consumers income is constant (ii) Consumer knows the price of all things. (iii) Consumer can spend his income in small quantities (iv) Consumer is rational and so maximizes his satisfaction from the purchase of the two goods (v) Consumer is fully aware of the indifference map. (vi) Goods are divisible. Conditions of Consumers Equilibrium : There are two conditions of consumers equilibrium with the help of indifference curve analysis:(1) Budget Line Or Price Line should be Tangent to Indifference Curve. (i) Indifference Curve : An indifference curve is a curve which shows ifferent combination of two commodities yielding equal satisfaction to the consumer. Supposing a consumer consumes two goods, namely apples and oranges. The following table and diagram indicates different combination of apples and oranges yielding equal satisfaction. Combination of Apples Apples Oranges & Oranges A B C D 1 2 3 4 10 7 5 4
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9 8 7 6 IC 5 4 O1234X Apples 3 (ii) Budget Line : The budget 2 is that line which shows all the different line combinations of the two commodities that a consumer can purchase given 1 his money income and the price of two commodities.
10
Explanation : Supposing a consumer has an income of Rs. 4 to be spent on apples and oranges. Price of orange is Rs. 0.50 per orange and that of apple Rs. 1 per apple. With his given income and given prices of apples and oranges, the different combinations that a consumer can get of these two goods are shown in the following table and diagram:Income Apples = Rs. 1.00 Oranges = Rs. 0.50 Four Four Four Four Four
Y 8 6 4 2 O B 45 X A
0 1 2 3 4
8 6 4 2 0
3 Apples
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(2) Indifference curve must be convex to the origin. Consumers Equilibrium help of following diagram : Y 8 6 4 2 O 1 2 D
IC2 IC1
: Consumers equilibrium can be explained with the
A C Consumer's Equilibrium
E 3 Apples
IC B 45
In this figure AB is the budget or price line. IC, IC ,IC are the indifference 12 curves. A consumer can buy any of the combinations, A, B,C,D and E of apples and oranges shown on the price line AB. Out of A, B,C,D and E combinations, the consumer will be in equilibrium at combination D (4 oranges and 2 apples) because at this point price line is tangent to the indifference curve and indifference curve is convex to the point of the origin. Q. Discuss critically the different methods of Demand Forecasting. Ans. Meaning of Demand Forecasting : Demand forecasting is predicting future demand for a product. The information regarding future demand is essential for planning and scheduling production, purchase of raw materials, acquisition of finance and advertising. This problem may not be of a serious nature for small firms which supply a very small fraction of the total demand, and whose product caters to the shortterm, seasonal demand or to demand of a routine nature. But, firms working on a large scale find it extremely difficult to obtain fairly accurate information regarding the future market demand. In some situations, it is very difficult to obtain information needed to make even short-term demand forecasts and extremely difficult to make long-term forecasts. Methods of Demand Forecasting OR Demand Estimation : There are various methods of estimating and forecasting demand. The techniques of forecasting are many, but the choice of a suitable method is a matter of purpose, experience and expertise. Demand forecasting techniques are :
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Techniques of Demand Forecasting
Survey Methods
Statistical Methods
Trend Projection Barometric Econometric Consumer Survey Opinion Poll Direct Interview Methods Complete Expert Graphical Regression Simultaneous Enumeration Opinion Methods Methods Equations
Sample Market Least Survey Studies Square Method & Experiments End-Use Method
(A) Survey Methods : Survey methods are generally used where the purpose is to make short-run forecast of demand. Under this method, consumer surveys are conducted to collect information about their intentions and future purchase plans. This method includes: (1) Consumer Survey Methods-Direct Interviews : The consumer survey
method of demand forecasting involves direct interview of the potential consumers. It may be in the form (a) Complete Enumeration : In this method, almost all potential users
of the product are contacted and asked about their future plan of purchasing the product in question. The quantities indicated by the consumers are added together to obtain the probable demand for the product.
of
Limitations : (i) Consumers themselves may not know their actual demand in future and hence may be unable or unwilling to answer the query. (ii) Even if, they answer, their answer to hypothetical questions may be only hypothetical and not real, (iii) Consumers response may be biased according to their own expectations about the market conditions (iv) Their plans may change with a change in the factors not included in the questionnaire.
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(b)
Sample Survey : Under this method, only a few potential consumers and users selected from the relevant market through a sampling method are surveyed. Method of survey may be direct interview or mailed questionnaire to the sample-consumers.
Merits : (i) This method is simpler (ii) This method is less costly (iii) This method is less time-consuming (iv) This method is generally used to estimate short-term demand. Limitations :
demand. This method, however has some limitations similar to those of complete enumerations method. (c) End-Use Method : The end-use method of demand forecasting has a
considerable theoretical and practical value, especially in forecasting demand for inputs. Making forecasts by this method requires building up a schedule of probable aggregate future demand for inputs by consuming industries and various other sectors. In this method, technological, structural and other changes which might influence the demand are taken into account in the very process of estimation.
The sample survey method is widely used to forecast
(2)
Opinion Poll Methods :
opinions of those who are supposed to possess knowledge of the market, e.g., sales representatives, sales executives, professional marketing experts and consultants. The opinion poll methods include: (a) Expert-Opinion Method : Firms having a good network of sales
representatives can put them to the work of assessing the demand for the product in the areas, regions or cities that they represent. Sales representatives, being in close touch with the consumers or users of goods, are supposed to know the future purchase plans of their customers, their reaction to the market changes their response to the introduction of a new product, and the demand for competing products.
The opinion poll methods aim at collecting
(b)
Market Studies and Experiments : An alternative method of collecting necessary information regarding demand is to carry out market studies and experiments on consumers behaviour under actual, though controlled, market conditions. Under this method, firms first select some areas if the representatives market. Them they carry out market experiments by changing prices, advertisement expenditure and other controllable variables in the demand function under the assumption that other things remain the same.
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Limitations : (i) This method is very expensive. (ii) This method is based on short term and controlled conditions which may not exist in an uncontrolled market. (B) Statistical Methods (1) : Statistical methods include : Trend Projection Methods : Trend projection method is a classical method of business forecasting. This method is essentially concerned with the study of movement of variable through time. The use of this method requires a long and reliable time-series data. There are two techniques of trend projection based on time-series data: (a) Graphical Method (b) Fitting Trend Equation or Least Square Method Barometric Method of Forecasting : The barometric method of forecasting follow the method meteorologists use in weather forecasting. Meteorologists use the barometer to forecast weather conditions on the basis of movements of mercury in the barometers. Following the logic of this method, many economists use economic indicators as a barometer to forecast trends in business activities. This method was first developed and used in the 1920s by the Harvard Economic Service. The basic approach of barometric technique is to construct an index of relevant economic indicators and to forecast future trends on the basis of movements in the index of economic indicators. The indicators used in this method are classified as: (i) Leading Indicators (ii) Coincidental Indicators (iii) Lagging Indicators. Econometric Methods :
(2)
(3)
tools with economic theories to estimate economic variables and to forecast the intended economic variables. The forecasts made through econometric methods are much more reliable than those made through any other method. The econometric methods are therefore most widely used to forecast demand for a product for a group of products and for the economy as a whole. The econometric methods are briefly described under two basic methods: Regression analysis is the most popular (a) Regression Method :
method of demand estimation. This method combines economic theory and statistical techniques of estimation In regression technique of demand forecasting, the analysts estimate the demand function for a product. In the demand function, the quantity to be forecast is a dependent variable and the variables that affect or determine the demand are called independent variables.
The econometric methods combine statistical
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(i)
Simple Regression Technique : In simple regression technique a single independent variable is used to estimate a statistical value of the dependent variable. Multi-Variate Regression : The multi-variate regression equation is used where demand for a commodity is deemed to be the function of many variables or in cases in which the number of explanatory variables is greater than one.
(ii)
(b)
Simultaneous Equation Model : In explaining this model, it will be helpful to begin with a comparison of simultaneous equation method with regression method. Regression technique of demand forecasting consists of a single equation. In contrast, the simultaneous equations mode l of fore casting inv olves es timating several simultaneous equations. These equations are, generally: (i) Behavioural Equations (ii) Mathematical Identities (iii) Market-Clearing Equations
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UNIT III
Q. Explain Law of Returns to Factors and Law of Returns to Scale. Ans. Law of Production : The law of production describe the ways which are technically possible to increase the level of production. The output can be increased in various ways: Law of Production Or Returns
Law of Return ot Factors: Law of Returns ot Scale: A single variable factor All Factors are variable in the same proportion
Other Factors Constant Always Long Run Analysis Generally Short Run Analysis
(A) Law of Return to a Factor : Laws of Returns mainly divided in three parts (i) Law of Increasing Returns to a Factor. (i) Law of Constant Returns to a Factor. (ii) Law of Diminishing Returns to a Factor. 1. Law of Increasing Returns : According to the Increasing returns to a factor, as more and more units of the variable factor are combined with the fixed factor total output increases at a increased rate and marginal product also increases. This tendency is also called Law of Diminishing Costs. Explanations : and diagram:78
This law can be explained with the help of following table
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Units of Units of Total Marginal Labour Capital Production Production 1 2 3 4 5

TP 40 30 20 10 O12345 12 8 4 O 12345 X
244 2 10 6 2 18 8 2 28 10 2 40 12
Y MP
Units of Labour Diagram : Increasing Returns to a Factor 2. Law of Constant Returns to a Factor : According to the constant returns to a factor, as more and more units of the variable factor are combined with the fixed factor total output increases at a constant rate and marginal product remain constant. Explanations : This law can be explained with the help of following table and diagram Units of Units of Total Marginal Labour Capital Production Production 1 2 3 4 5 255 2 10 5 2 15 5 2 20 5 2 25 5
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Y 25 20 TP 15 10 5 O12345 Units of labour
TP
Y 5 4 MP 3 2 1 X O 12345 Units of labour
MP
Diagram : Constant Returns to a factor
3.
Law of Decreasing Return to a Factor : According to the Decreasing returns to a factor, as more and more units of the variable factor are combined with the fixed factor total output increases at a decreasing rate and marginal product will decrease. Explanations : and diagram : This law can be explained with the help of following table
Units of Units of Total Marginal Labour Capital Production Production 1 2 3 4

Y 12 10 8 TP 6 4 2 O1234 Units of Labour 80 X MP TP
255 283 2 10 2 2 11 1
Y 5 4 3 2 1 O 1234 Units of Labour MP X
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(B) Law of Returns to Scale : It is a Long run concept. All factors of production are variable in the long period. No factor is a fixed factor. Accordingly, scale of production can be changed by changing the quantity of all factors. According to Koutsoyiannis The term returns to scale refers to the changes in output as all factors change by the same proportion. Aspects of Returns to Scale : There are three aspects : (1) Increasing Return to Scale (2) Constant Returns to Scale. (3) Diminishing Returns to Scale. 1. Increasing Returns to Scale : Increasing returns to scale refers to the production situation where if all factors are increased in a given proportion, output increases in a greater proportion. Thus, if by 100 per cent increase in factors of production, output increases by 120 percent or more, it will be an instance of increasing returns to scale. Increasing Returns to Scale
Y 25 20 % Increaase in Output 15 10 5 O 5 10 15 20 25 30 X
% Increase in all Factor Inputs 2. Constant Returns to Scale : It refers to that production situation where of all factors of production are increased ion a given proportion, the output produced increases in exactly the same proportion. If 25 percent increase in factors of production is followed by 25 percent increase in output, then it is an instance of constant returns to scale.
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Constant Returns to Scale

% Increaseina 3.
lll Factor Input
Diminishing Returns to Scale : It refers to that production situation where if all the factors of production are increased in a given proportion, the output increases in a smaller proportion. If 20 percent increase if factor of production is followed by 10 percent increase in output, then it is an instance of diminishing returns to scale. Decreasing Returns to Scale
% Increase in all Factor Inputs Q. Explain Law of Variable Proportion. Ans . Meaning of Law of Variable Proportions : In short-period when the output of a good is sought to be increased by way of additional application of the variable factor, law of variable proportions comes into operation. When the number of one factor is increased while all other factors remain constant, then the proportion between the factors is altered. On account of change in the proportion of factors there will also be a change in total output at different
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rates. In economics, this tendency is called Law of Variable Proportions. The law states that as the proportion of factors is changed, the total production at first increases more than proportionately, then equi-proportionately and finally less than proportionately. Definition : According to Samuelson The law states that an increase in some inputs relative to other fixed input will, in a given state of technology, cause total output to increase; but after a point the extra output resulting from the same addition of extra inputs is likely to become less and less. Assumptions :The law has following assumptions : 1. One of the factors is variable while all other factors are fixed. 2. All units of the variable factor are homogeneous. 3. There is no change in the technique of production 4. Factors of production can be used in different proportions. Explanation of the Law : Law of variable proportion can be explained with the help of following table and diagram: Units of Units of Total Marginal Average Land Labour Product Product Product 11222 1 2 5 3 2.5 13943 1 4 12 3 3 End of the First Stage Beginning of the Second Stage 1 5 14 2 2.8 1 6 15 1 2.5 1 7 15 0 2.1 End of the Second Stage Beginning of the Third Stage 1 8 14 -1 1.7
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s ndrd 1t Stage 2 Stage 3 Stage
Y FG TP E
O Y
MN
ABJ AP O -ve MP No. of Labourers X
Explanation : From the above Table and Diagrams drawn on the assumption that production obeys the law of variable proportions, one can easily discern three stages of production. These are elucidated in the following table: Three Stages of Production
Stages Total Product Marginal Product Average Product 1s tStage Initially it increases Initially increases and Increases and at an increasing rate. reaches the maximum reaches its Later at diminishing point. The starts maximum point. rate decreasing 2n Stage Increases at Decreases and becomes After reaching its d diminishing rate and zero reaches its maximum point 3rdStage Begins to fall Becomes Negative Continues to maximum begins to dcrease
diminish
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Causes of Applicability
law of variable proportions are as follows: (1) Under utilization of Fixed Factor :
: Main causes accounting for the application of the
(2)
In the initial stage of production, fixed factor of production like land or machine, is under-utilized. More units of variable factor, like labour are needed for its proper utilization. Thus, as a result of employment of additional units of variable factor there is proper utilization of fixed factor. Consequently, total production begins to increase. Fixed Factors of production : The principal cause of the operation of this law is that some of the factors of production are fixed during the short period. When the fixed factor is used with variable factor, then its ratio if compared to variable factor falls. Production is the result of the cooperation of all factors. Consequently, marginal return of the variable factor begins to diminish. Optimum Production : After making the optimum use of a fixed factor if it is combined with increasing units of variable factor, then the marginal return of such variable factor begins to diminish.
(3)
(4)
Imperfect Substitute : It is the imperfect substitution of factors that is mainly responsible for the operation of the law of diminishing returns. One factor cannot be used in place of the other factor. Consequently, when fixed and variable factors are not combined in an appropriate ratio, the marginal return of the variable factors begins to diminish. Postponement of the Law : Postponement of the law of variable proportion is
possible under the following conditions: (1) Improvement in Technique of Production :
Operation of the law can be postponed if alongwith the increase in variable factors technique of production is improved. Perfect Substitute : The law can also be postponed if factors of production are made perfect substitutes, i.e., when one factor can be substituted for the other.
(2)
Q. Explain Internal Economies and External Economies. Ans. Economies of the Scale : When scale of production is increased, upto a point, one gets economies of scale. Marshall has divided economies of scale into two parts : Economies of Scale
Internal Economies
External Economies
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Real Pecuniary Economies Economies 1.Economies of Concentration 2. Economies of Information 3. Economies of Disintegration 1. Labour Economies 2. Technical Economies 3. Inventory Economies 4. Selling or Marketing Economies 5. Managerial Economies 6. Transport and Storage Economies (B) Internal Economies : When a firm increases its scale of production it enjoys several economies. These economies are called internal economies. Types of Internal Economies : economies: (a) There are two types of internal
Real Economies : Real economies are those which are associated with a reduction in the physical quantity of inputs, raw materials, various types of labour and various types of capital. Real economies can be of six types : Labour Economies or Specialization : Specialization means to perform just one task repeatedly which ,makes the labour highly efficient in its performance. This adds to the productivity and efficiency of the labour. Technical Economies : Technical economies are those economies which are related with the fixed capital that includes all types of machines & plants. Tecnhical economies are of three types:(i) Economies of Increased Dimension (ii) Economies of Linked Processes (iii) Economies of the use of By-Product. Inventory Economies : A large size firm can enjoy several types of inventory economies, a big firm possess large stocks of raw material. Selling Or Marketing Economies : A firm producing a large scale also enjoy several marketing economies in respect of sale of this large output. Managerial Economies : A firm producing on large scale can engage efficient & talented managers.
(1)
(2)
(3) (4)
(5)
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(6) (b)
Transport and Storage Economies : scale enjoys economies of transport & storage.
A firm producing on large
Pecuniary Economies : Pecuniary economies are economies realized from playing lower prices for the factors used in the production and distribution of the product due to bulk-buying by the firm as its size increases.
(B) External Economies : External economies refer to all those benefits and facilities which are available to all the firms of a given industry. (1) Economies of Concentration : When several firms of an industry establish themselves at one place, then they enjoy many benefits together, e.g., availability of developed means of communications and transport, trained labour, by products, development of new inventions pertaining to that industry etc. Economies of Information : When the number of firms in an industry increase, then it becomes possible for them to have concerted efforts and collective activities.
(2)
(3)
Economies of Disintegration : When an industry develops, the firms engaged in its mutually agree to divide the production process among themselves. Q. What is Producers Equilibrium? How optimum factor combination can be achieved. OR Q. Explain Optimum Input combination. Ans. Producers Equilibrium : The producers equilibrium refers to the situation in which a producer maximizes his profits. In other words the producer is producing given amount of output with least cost combination of factors. The least cost combination of factor s also called optimum combination of the factor or input. Optimum combination is that combination at which either (i) The output derived from a given level of inputs is maximum OR (ii) The cost of producing a given output is minimum. Conditions of Producers Equilibrium producers equilibrium:: There are two conditions of
(1) At the point of equilibrium the Isocost line must be tangent to Isoquant curve. i) Isoquant Curve:The isoquant curve is a technical relation showing how inputs are converted into output. In other words, isoquant curve is that curve which shows the different possible combination of two factors inputs yielding the same amount of output.
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Explanation : An isoquant curve can be explained with the help of the following isoquant schedule and curve showing different possible combination of two factors (labour and capital) for a given level of output. Combinations Capital Labour Output (watches) A 90 10 100 B 60 20 100 C 40 30 100 D 30 40 100
100 90 80 70 60 50 40 30 20 10 O 10 20 30 40 Labour IQ
The table and curve shows 100 watches can be produced by combining
90 units of capital and 10 units of labour 60 units of capital and 20 units of labour 40 units of capital and 30 units of labour units of of labour 30Line : capital and 40 units is that line which shows the various ii) Isocost An isocost line combination of factors that will result in the same level of total cost. It refers to
those different combinations of two factors that a firm can obtain at the same cost.
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Explanation Isocost line can be explained with the help of table and diagram. Suppose the producers budget for the purchase of labour and capital is fixed at Rs. 100. Further suppose that a unit of labour cost the producer Rs. 10 while a unit of capital Rs. 20. Total Expenditure Labour = Rs. 10 Capital = Rs. 20 100 100 100 100
Y A 5 4 3 2 1 0 1 2 3 4 5 6 7 8 9 10 Labour B
10 0 4 2
0 5 3 4
(2) At the point of tangency the Isoquant curve is convex to the origin. Explanation of Optimum Input Combination Or Producers Equilibrium : There are two conditions of producers equilibrium : (1) At the point of equilibrium the Isocost line must be tangent to Isoquant curve. (2) At the point of tangency the Isoquant curve is convex to the origin. Producers equilibrium can be explained with the help of following diagram :
K Y
C AM R E N S IQ
IQ1
LB Labour
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In this figure AB is the isocost line. IQ, IQ are the isoquant curves. A producer 1 can buy any of the combinations, A, B,C,D and E of Labour and Capital shown on the isocost line AB. Out of A, B,C,D and E combinations, the producer will be in equilibrium at combination D (OL units of Labour and OK units of Capital) because at this point isocost line is tangent to the isoquant curve and isoquant curve is convex to the point of the origin. Q. What is the Cost of Production? Also Explain the Concepts of Cost. Ans . Cost of Production : In order to produce a good, every firm, makes use of factors of production. The amount spent on the use of factors of production is called cost of production. Cost of production mainly depends on the quantity of production. Therefore: C = f(Q) It will be read as cost is a function of quantity Concepts of Cost (1) : Explicit Cost : Many inputs are bought or hired by the firm. The monetary payments which a firm makes to those outsiders who supply inputs are called explicit costs. For Example :
Wages to Labourers Cost of Raw Material Interest on loans etc. Types of Explicit Costs
according to the time.
: Explicit costs may be classified into two types

Types of Explicit Costs
Cost in Short-Run
Cost in Long-Run
Total Cost Average Cost Marginal Cost Total Fixed Cost Average Fixed Cost Total Variable Cost Average Variable Cost
Long-Run Long-Run Long-Run Total Cost Average Cost Marginal Cost
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(2)
Implicit Costs : Many inputs are self owned and self employed by the firm. The firm does not have to make any payment for them to anyone, but it foregoes the opportunity to receive payments from someone else to whom it could sell or lease out self owned resources. The cost of using resources owned by the firm or contributed by its owners is called implicit cost. Opportunity Costs : The concept of opportunity cost is extremely important in economic analysis. We know that the cost is the value of inputs in the process of production. An input has got value because it s scarce or limited. If we use the input to produce one good, it is not available to produce something else. The cost of producing one thing is measured in terms of what was given up in terms of next best alternative that is sacrificed. If several opportunities are given up for producing a particular commodity, it is the value of the next best foregone opportunity that constitutes cost. Thus it is called opportunity cost. The opportunity cost is the cost of next best alternative foregone. It is also called alternative cost.
(3)
Q. Define Short Run Total Cost. Also explain the relationship between Total Cost, Variable Cost and Fixed Cost. Total Cost : T Ans. otal cost is the cost of all resources necessary to produce any particular level of output. Since in the short run we classify factors into fixed and variable categories, we break up the firms total cost of production in the same way. TC= TFC+TVC TC = Total Cost TFC = Total Fixed Cost TVC = Total Variable Cost
There are three aspects of Total Cost : (1) Total Fixed Cost : The cost of fixed inputs are called fixed costs. Fixed
costs are costs which do not change with changes in the quantity of output. Production may be maximum or zero unit, fixed cost remain the same. The fixed cost is calculated by the following formula: TFC = Units of Fixed Factors X Price of the Factor Example : Rent, Depreciation etc. Total Fixed Cost is also explained with the help of following table a diagram:
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Quantity of Fixed Cost Output (Rs.)
Fixed Costs
Y F 10 8 6 4 2 0 1 2 3 4 5 6 7 8 9 10 Units of Output X C
0 10 1 10 2 10 3 10 4 10 5 10 6 10 7 10 8 10
In this figure units of output are shown on OX-axis and costs of production on OY-axis. FC line represents fixed costs. It is parallel to OX-axis, signifying that cost remains fixed whether output is more or less. FC line touches OY-axis at point F, it means even when output is zero, fixed cost remains Rs. 10. (2) Total Variable Costs : Variable costs are those costs which are incurred
on the use of variable factors of production. Variable costs vary with the level of output. If output falls these costs also fall and if output rises these costs also rise. If the output is zero, variable cost will be zero. Some example of variable costs are : (i) Expenses on Raw Materials (ii) Wages of Labour (iii) Electricity charges etc. Variable cost can also be explained with the help of table and diagram : Quantity of Fixed Cost Output (Rs.)
00 1 10 2 18 3 24 4 28 5 32 6 38 7 46 8 62
Y 50 40 30 20 10
VC
0 1 2 3 4 5 6 7 8 9 10
Output
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In this figure units of output are shown on OX-axis and costs of production on OY-axis. VC line represents Variable cost. When output is zero, variable costs are zero. Upward sloping VC curve signifies that output increases, variable costs also increase. (3) Short run total: is the sum of total fixed cost and total Total Cost cost variable cost. Quantity of Fixed Variable Total Output Cost (Rs.) Cost(Rs.) Cost (Rs.) 0 1 2 3 4 5 6 7 8 10 0 10 10 10 18 10 24 10 28 10 32 10 38 10 46 10 62 0 20 28 34 38 42 48 56 72
Q. Define Short-Run Average Cost OR Average Cost.
Ans. Average : is the cost per unit of output. It is also called unit Average cost cost of production. There are three aspects of (1) Average Fixed Cost : Average fixed cost is per unit fixed cost. It is total
fixed cost divided by output. TFC AFC= Q AFC = Average Fixed Cost TFC = Total Fixed Cost Q = Quantity of output
average
cost
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Quantity of Fixed Average Fixed Output Cost (Rs.) Cost(Rs.) 1 2 3 4 5 6 7 8 (2) 10 10 10 10 10 10 10 10 10 5 3.3 2.5 2 1.7 1.4 1.2
Average Variable Cost : Average variable cost is per unit variable cost. It is total variable cost divided by output. TVC AVC = Q AVC = Average Variable Cost TVC = Total Variable Cost Q = Quantity of output Quantity of Variable Average Variable Output Cost (Rs.) Cost (Rs.) 1 2 3 4 5 6 7 8 10 18 24 28 32 38 46 62 10 9 8 7 6.4 6.3 6.6 7.8
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(3) Average Total Cost : The average total cost is the total cost per unit of output. We can also define it as the sum of average fixed cost and average variable cost. TC AC= = AFC + AVC Q AC = Average Cost TC = Total Cost Q = Quantity of output AFC = Average Fixed Cost AVC = Average Variable Cost.
Quantity of Average Fixed Average Average Total Output Cost (Rs.) Variable Cost (Rs.) Cost (Rs.) 1 10 10 259 3 3.3 8 4 2.5 7 5 2 6.4 6 1.7 6.3 7 1.4 6.6 8 1.2 7.8 20 14 11.3 9.5 8.4 8 8 9
Q. Define Marginal Cost. Ans. Marginal Cost : Marginal Cost is the increase in total cost when output is increase by one unit. Marginal Cost is determining by dividing change in total cost by change in output. DTC MC = D Q
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DTC = Change in Total Cost Q = Change inD Output For Example : Total cost of 5 units of commodity is Rs. 135. When 6 units are produced, total cost of production goes upto Rs. 180. Thus, Marginal Cost: DTC MC = DQ 45 MC = = 45 1 Quantity of Total Cost Marginal Cost Output (Rs.) (Rs.) 1 2 3 4 5 6 7 8 20 28 34 38 42 48 56 72 20-0=20 28-20=8 34-28=6 38-34=4 42-38=4 48-42=6 56-48=8 72-56=16
Q. Define Long Run Cost Curves. Ans .Cost in Long Run :
are variable. There are three concepts of costs in the long run, namely (1) Long Run Total Cost : Since all inputs are variable in the long run, there
is only one long run total cost curve. The long run total cost is the minimum cost at which each level of output can be produced. In the long run firm can produce a given level of output at the minimum cost since it has sufficient time
The long run is the period of time in which all inputs
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(i) To select the optimum plant size. (ii) To select the least cost factor proportion. This means that the long run total cost is always less than or equal to short run total cost, but it is never more than short run total cost. It can be explained with the help of the following formula: LTC STC < Long run total cost is less than or equal to short run total cost.
Y LTC
Output
In this figure LTC represents long run total cost. The following are the main features (i) Long run total cost curve begins from the point of origin O while short run total cost begins from any point on OY-axis. (ii) Long run total cost curve has a positive slope. It costs more to produce more. (2) Long Run Average Cost OR Envelope Curve : Long run average cost refers to minimum possible per unit cost of producing different quantities of output in the long period. LTC LAC = Q LAC = Long run average cost LTC = Long run total cost Q = Quantity
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SAC1
LAC
In this figure long run average cost curve has been shown. Long run average cost curve is tangent to each short run average cost curve at some point. This cost curve is also called Envelope Curve. (3) Long Run Marginal Cost : In the long run change in the total cost due to
production of one-more or one-less unit of a commodity, is called long run marginal cost.
Y
Output
LMC
Output
In this figure LMC is long run marginal cost curve. It first reaches a minimum and then rises. Q. Define Perfect Competition Market. Also explain the equilibrium of the firm in the short run and long run under perfect competition. Ans. Perfect Competition Market : Perfect competition is that situation of the market in which there are large number of buyers and sellers of homogeneous product. Under perfect competition, price of the commodity is determined by the industry. In perfect competition market firm is a price-taker and not a price-maker.
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Assumptions or Features of Perfect Competition :
features of perfect competition are as (1) Large number but small size of Buyers and Sellers :
under
Main assumptions or
The number of buyers and sellers of a commodity is very large under perfect competition, but each buyer and each seller is so small in comparison with the entire market of the product, that by changing the quantity of the product bought and sold by him, he cannot influence its price. Homogeneous Products : The other features of perfect competition is that all sellers sell homogeneous units of a given product. It is not possible to make any distinction between the units of the commodity being sold by different sellers. Perfect Knowledge : Buyers and Sellers are fully aware of the price of the product. Buyers have perfect knowledge about the price being charged by the sellers for a given product. Sellers also know well, where and from which buyer, they can charge more price. Because of this knowledge and awareness, all sellers will charge one price for one product from all buyers without any distinction. Free Entry and Exit of Firms : Under perfect competition, in the longrun, any new firm can enter any industry and any old firm can withdraw from any industry. There is no legal restriction on the entry of new firms into any industry. Lack of Selling Cost : Under perfect competition, a seller does not spend on advertisement and publicity etc. It is so because all firms sell homogeneous product.
(2)
(3)
(4)
(5)
(6) Under Perfect competition market, each seller charges the Same Price : same price for the same product. Price is determined by the industry. All firms have to sell their products at this price. (7) Average Revenue and Marginal Revenue Curve : competition, average revenue curve is equal to marginal revenue curve(AR=MR). Therefore both curves are parallel to OX-axis.
Y
Under perfect
AR=MR
Output
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Meaning of Firms Equilibrium : A firm is in equilibrium when it is satisfied with its existing amount of output. A firm in equilibrium has no tendency either to increase or to decrease its output. Equilibrium of the Firm approaches: : Equilibrium of the firm can be studied by two
(1) Total Revenue and Total Cost Approach (2) Marginal Cost and Marginal Revenue Approach (1) Total Revenue and Total Cost Approach : According to this approach, profit is the difference between total revenue and total cost. This approach can be explained with the help of following diagram:
TC
Break-Even Point Y
TR B
M1 M M2
X Output TP
(2)
Marginal Revenue and Marginal Cost Approach : According to this approach, a firm is in equilibrium when two conditions are fulfilled: (i) Marginal Cost should be equal to Marginal Revenue (MC=MR) (ii) MC curve cuts MR curve from below
Equilibrium Y P A MC=MR MC E AR=MR MC=MR
These conditions are also explained with the help of following diagram :
N M Output
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Both the conditions of firms equilibrium are explained with the help of this figure. In this figure PP is the average revenue as well as marginal revenue curve. It is clear from this figure that MC curve is cutting MR curve PP at two points A and E. MC curve represents marginal cost. But both conditions of equilibrium are satisfied at point E. Determination of Equilibrium of the Firm : into two sections : (A) Short-Run Equilibrium of the Firm (B) Long-Run Equilibrium of the Firm. (A) Short Run Equilibrium of the Firm : may face any of the three situations : (1) A firm in short run equilibrium Firms equilibrium are studied
Super Normal Profits(AR>AC) : A firm is in equilibrium when its marginal cost is equal to marginal revenue and marginal cost curve cuts marginal revenue from below. A firm is in equilibrium earns super normal profit, when average revenue is more than its average cost. It can also be explained with the help of following diagram
Super-Normal Profit (AR>AC) Y MC E A AC P AR=MR
P B
Super-Normal Profit O N M Output X
In this figure, output of the firm is shown on OX-axis and cost/revenue on OYaxis. MC is the marginal cost and AC is average cost curve. PP is the average revenue and marginal revenue curve (MR=AR). Supposing OP is the price determined by the industry. At this price, firms equilibrium will be at point E, where marginal cost is equal to marginal revenue and marginal cost curve cuts marginal revenue curve from below. Equilibrium output is OM. At this output AR (price) = EM and AC= AM. Since AR (EM) > AC (AM), firm is earning EA super normal profit per unit of output. Per Unit super normal profit = EA Total Super- Normal Profit = EABP
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(2)
Normal Profits (AR=AC) : Normal profits cover just the reward for entrepreneurial services and are included in the cost of production. So that, a firm in equilibrium earns normal profits when its average cost is equal to the average revenue i.e. AC=AR
MC Y E AC AR=MR Normal Profit
O Output
In this figure, output of the firm is shown on OX-axis and cost/revenue on OYaxis. MC is the marginal cost and AC is average cost curve. PP is the average revenue and marginal revenue curve (MR=AR). Supposing OP is the price determined by the industry. At this price, firms equilibrium will be at point E, where marginal cost is equal to marginal revenue and marginal cost curve cuts marginal revenue curve from below. The firm earns normal profits at equilibrium output because its average cost and average revenue are equal. Normal Profits = MC = MR= AC= AR. (3) Minimum Loss (AR<AC) : A firm in equilibrium may incurr minimum loss when the average cost is more than the average revenue and average revenue is equal to average variable cost. Even if, the firm discontinues its production, in the short run, it will have to bear the loss of fixed costs. Loss of fixed costs is the minimum loss of the firm.
Y
Loss A
MC AC
P B
O Output
AR=MR E
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In this figure, output of the firm is shown on OX-axis and cost/revenue on OYaxis. MC is the marginal cost and AC is average cost curve. PP is the average revenue and marginal revenue curve (MR=AR). Supposing OP is the price determined by the industry. At this price, firms equilibrium will be at point E, where marginal cost is equal to marginal revenue and marginal cost curve cuts marginal revenue curve from below. At equilibrium point AN (AC) is more than EN(AR). In other words, average cost is more than average revenue by AE which represents per unit loss. As such firms total loss is AEPB. Per Unit Loss = AE Total Loss = AEPB (B) Long-Run Equilibrium of the Firm : be in equilibrium when: (i) LMC=MR (ii) LMC cuts MR from below. In the long-run also, the firm will
In the long run, ordinarily all firms in equilibrium will be earning only normal profits. Normal Profit
LMC Y E LAC AR=MR
Output
In this figure LAC is the long run average cost curve and LMC is the Long run marginal cost curve. At op price determined by the industry, the firm will be in equilibrium at point E and OM will be equilibrium output and OP equilibrium price. At this point AR=LAC i.e. normal profits. Q. Explain the short-run and long-run equilibrium of the Industry in Perfect Competition Market. Ans. Meaning of Industry : the group of firms producing homogenous products is called industry. Such firms are found only under perfect
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competition. An industry is in equilibrium when it has no tendency to change its size. Conditions of an Industrys Equilibrium industrys equilibrium: (i) : There are two conditions of an
Constant number of firms : An industry will be in equilibrium when the number of its firms remains constant. In this situation, no new firm will enter and no old firm will leave the industry. Equilibrium of firms : Another condition of an Industrys equilibrium is that all firms operating in it are in equilibrium and have no tendency either to increase or to decrease their output. Conditions of equilibrium of firm are: MC=MR MC curve cuts MR curve from below : Equilibrium of industry are studied into two
(ii)
Equilibrium of Industry sections:
(A) Short Run Equilibrium of the Industry : The industry is in equilibrium at that price at which quantity demanded is equal to quantity supplied. But for industry to be in full equilibrium, in the short run, is very rare. Full equilibrium position is possible only when all firms earn just normal profit. But in the short run, some firms may be earning super-normal profit and others may be incurring losses. Short-run equilibrium is explained with the help of following diagram
(A)
Y D E SD O Q Output X Y S
(B)
Profit SAC E MC Y Loss AR=MR
(C)
MC SAC R T E AR=MR
A P
O Output
T P
O Output
In this figure, DD is the demand curve and SS the supply curve of industry. They both intersect at point E. So point E, indicates equilibrium of industry. In this case OP is the equilibrium price and OQ is the equilibrium output. But it will not be full equilibrium of industry, if some firms are getting super normal profit and others are incurring losses. In Figure(B) the firm is getting super normal profit at the prevailing price OP as shown by ABEP shaded area. Figure(C) firm is incurring losses at the prevailing price OP as shown by PERT shaded area.
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In short, the industry is in equilibrium at that price at which the demand for and supply of its production are equal. But in the position of equilibrium of industry, the firms may earn super normal profit or incur losses. As such, industry is ordinarily not in full equilibrium in short period. (B) Long-run Equilibrium of the Industry : In the long run, an industry is
in equilibrium when its firms are earning normal profit. Long run equilibrium of the industry means that no new firm has a tendency to enter it nor any old firm has a tendency to leave it. Long run equilibrium is explained with the help of following diagram:
Y D E SD O Q Output X O Output Q X Y S P E AR=MR LMC LAC
In this figure, DD is demand and SS is supply curve of the industry. Both intersect each other at point E. Thus E is the equilibrium point of the industry, that determines OP as the equilibrium price. It indicates that firms are getting only normal profits. Q. What do you mean by Monopoly? How are the price and output determined under it? Ans. Monopoly is the market structure in which a single firm is Monopoly : the sole producer of a product for which there are no close substitutes. Since the monopoly is the only seller in the market, it has no competitors. The monopolist is the price maker. Its demand curve slopes downward to the right. Example : For example, you get your electricity supply from one agency, that is, State Electricity Board; you travel by railway train owned and run by government of India. All these are examples of Monopoly. Definition : According to Koutsoyiannis : Monopoly is a market situation in which there is a single seller, there are no close substitutes for commodity it produces, there are barriers to entry. Features or Assumptions of Monopoly :
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(1)
One seller and large number of buyers : Under monopoly there should be a single producer of the commodity. He may be a sole-proprietor or there may be a group of partners or a joint-stock company or a state. Monopoly is also an Industry : Under monopoly situation, there is only one firm. There is no difference between the study of a firm and industry. Restrictions on the entry of the new firms : Under monopoly, there are some restrictions on the entry of new firms into monopoly industry. These barriers may take several forms as:
(2) (3)
(4) (5)
No Close Substitutes : no close substitute.
Patent rights Government Laws etc. The commodity produced by the firm should have
Price Maker : A monopolist is a price maker. A price maker is one who has got control over the supply of the product. A monopolist has full control over the supply of the commodity. Price Discrimination : A monopolist may be able to charge different prices for the same product from different customers. Average Revenue and Marginal Revenue : Under monopoly, average revenue and marginal revenue curves are separate from one other. Both slope downwards. It can also be explained with the help of following diagram
Y
(6) (7)
AR O Output MR X
Determination of Price and Equilibrium under Monopoly monopoly, price and equilibrium are determined by two different approaches: (1) Total Revenue and Total Cost Approach (2) Marginal Revenue and Marginal Cost Approach (1)
: Under
Total Revenue and Total Cost Approach : Monopolist can earn maximum profit by selling that amount of output at which difference
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between total revenue and total cost is maximum. Profit = Total Revenue Total Cost This approach can be explained with the help of following diagram
Y C TC TR TC
O P
Output
TP
(2)
Marginal revenue and Marginal Cost Approach : According to this approach, a monopolist will be in equilibrium when two conditions are fulfilled: (i) MC=MR (ii) MC curve cuts MR curve from below. This approach can also be explained with the help of following diagram:
E MR AR
OQX Y
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(A) Price determination under short-period or Short-Run Equilibrium : Short run refers to that period in which time is so short that a monopolist cannot change fixed factors, like machinery, plant etc. Monopolist can increase his output in response to increase in demand by changing his variable factors. A monopolist may face three situations in short period : (1) Super-Normal Profits : If the price fixed by the monopolist in equilibrium is more than his average cost, then he will get super normal profits
Y Super- Normal Profit MC AC
C D
A B E
AR MR O M Output X
In this figure, the monopolist is in equilibrium at point E, because at this point marginal cost is equal to marginal revenue and MC cuts MR from below. The monopolist will produce OM units of output and sell it at AM price, which is more than average cost BM by AB per unit. AB is the super normal profit per unit. Average Revenue Per Unit= AM Average Cost Per Unit= BM Super-Normal Profit per unit= AM-BM = AB Total Super Profit = ABDC (2) Normal Profit : If the price fixed by the monopolist in equilibrium is equal to his average cost, then he will earn only normal profits.
Y Normal Profit MC P A E AR O MR M Output X AC
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In this figure, the monopolist is in equilibrium at point E, because at this point marginal cost is equal to marginal revenue and MC cuts MR from below. The monopolist will produce OM units of output and sell it at AM price, which is equal to average cost AM. Monopoly firm, therefore, earns only normal profit in equilibrium situation. Average Revenue Per Unit= AM Average Cost Per Unit= AM Normal Profit AR=AC (3) Minimum Loss : In short run, the monopolist may incurr loss also. If in the short run price falls due to depression or fall in demand, the monopolist may continue his production so long as the low price covers his average variable cost (AVC). In case the monopolist is obliged to fix a price which is less than average variable cost, then he will prefer to stop production. Thus Minimum loss = AC-AVC. This can be explained with the help of following diagram:
Y MC P P1 E O M Output X N A AC AVC
In this figure, the monopolist is in equilibrium at point E, because at this point marginal cost is equal to marginal revenue and MC cuts MR from below. The monopolist will produce OM units of output and sell it at AM price, which is less than his average cost NM. Monopoly firm, therefore, incurs minimum loss in equilibrium situation. Average Revenue Per Unit= AM Average Cost Per Unit= NM Minimum Loss = NM-AM = AN OR Minimum Loss = AC-AVC= NM AM = AN (B) Price determination under long-period or Long-run Equilibrium : In the long run, the monopolist will be in equilibrium at a point where his long run marginal cost is equal to marginal revenue. In long run price is more than the long run average cost. If price is less than long run average cost, the monopolist would like to close down the unit rather than suffer the loss. In the long run a monopolist earns super normal profit.
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Super- Normal Profit LMC LAC
C D
A B E MR AR Output
In this figure, point E indicates the equilibrium of the monopolist. At point E, MR = LMC, hence OM is the equilibrium output and AM is the equilibrium price. BM is the long run average cost. Price AM being more than long run average cost BM, the monopolist will get super normal profit. Average Revenue Per Unit= AM Average Cost Per Unit= BM Super-Normal Profit per unit= AM-BM = AB Total Super Profit = ABDC Q. Explain Price Discrimination. Ans. : A monopolist often charges different prices of the same product from different customers. This price policy of the monopolist is called price discrimination. The monopolist practicing it is c alled discriminating monopolist. Definition : According to Koutsoyiannis Price discrimination exists when the same product is sold at different prices to different buyers. Kinds of Discriminating Monopoly
types: (1) Personal Price Discrimination :
: Price discrimination is mainly of three
When a monopolist charges different price from different customers for the same product, then it is called personal price discrimination. Personal price discrimination becomes possible because of the ignorance of the customer, little difference in price etc. Geographical Price When a monopolist charges Discrimination Price Discrimination different price in different areas for the same product, then it is called geographical price discrimination. Places where demand is elastic, he charges low price and where demand is inelastic he charges high price. :
(2)
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(3)
as harmful effects on the society. Its effects are therefore studies under two parts: (1) Beneficial Effects : Its main beneficial effects are as under :
(i)
Price Discrimination according to Use : When a monopolist charges different prices for different uses of a product, then it is called price discrimination according to use. For example, rate of electricity charge per unit for domestic use and commercial purpose are different. : Price discrimination has beneficial as well
(2)
Beneficial to the Poor : If the price of a commodity is fixed low as to benefit the poor and the loss thus suffered is recovered by charging high price from well-to-do customers, then such a discrimination will be beneficial to the society as a whole. (ii) Public Utility Services : There are many ordinary services which cannot be made available without resorting to price discrimination, e.g., the service of railway department. If there is no price discrimination, then every section of the society may not be able to avail of these services according to its need. Harmful Effects : Main harmful effects are as under : (i) No Proper use of factors of production : Proper use of factors of production is not possible. Monopolists are more inclined to produce luxury goods because of greater scope of price discrimination in their production. Consequently, production of necessaries falls causing great hardship to the weaker sections of the society. Less Production : Price discrimination also proves harmful when monopolists deliberately restrict production and enhance the price in order to maximize their profits.
(ii)
Q. What is Monopolistic Competition? How price and output are determined under it? Ans . Monopolistic Competition : Monopolistic competition is a market structure in which there are many sellers of a commodity, but the product of each seller differs from that of the other sellers in one respect or the other. Thus product differentiation is the characte ristic feature of monopolistic competition. Example : Firms producing variety of tooth pastes, such as, forhans, colgate, cibaca, etc. are examples of monopolistic competition. Definition : According to J.S.Bains Effects Monopolistic competition is market structure where there is a large of Price Discrimination number of small sellers, selling differentiated but close substitute products.
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Assumptions or Features of Monopolistic Competition : (1) Large Number of Buyers and Sellers : Under monopolistic competition there are large number of firms producing differentiated product and also large number of buyers. Product Differentiation : Product differentiation is a salient feature of monopolistic competition. Product differentiation refers to that situation wherein the buyer can distinguish one product from the other in one way or the other. Freedom of Entry and Exit of Firms : As in case of perfect competition, there is no restriction on the entry and exit of firms. Selling Costs : Each firm spends a lot of funds on advertisement and publicity of its products. With a view to selling more and more units of the product it gives wide publicity of its products in: (5) Newspapers Cinemas Journals Radio T.V. etc.
(2)
(3) (4)
(6)
Price Control : Each firm has limited control on the price of its product. Average and marginal curves of a firm under monopolistic competition slope downwards as in case of monopoly. It means if a firm wants to sell more units of its product it will have to lower the price per unit. Imperfect Knowledge : Buyers and sellers lack perfect knowledge about the price of the product. Because it is not possible to compare the products of different firms due to product differentiation.
(7)
Non-Price Competition : Under monopolistic competition different firms may compete with one another without changing the price of the product. Under non-price competition, firms compete with each other in offering free gifts and other services to attract more and more customers. Such a competition is called non-price competition. (8) Under monopolistic competition , there are many firms Group : producing a commodity. The aggregate of such firms is known as Group. (9) Marginal Revenue and Average Revenue Curves : Under monopolistic competition marginal revenue and average revenue curve are as under:
Y
MR O Output
AR X
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Price and Equilibrium under Monopolistic Competition monopolistic competition, there are many firms producing a commodity. The aggregate of such firms is known as Group. In case of monopolistic competition, price and equilibrium of the firm and the group will be studied in two parts: (1) Firms Equilibrium (2) Groups Equilibrium (1)
: Under
Firms Equilibrium : Even under monopolistic competition aim of each firm is to get maximum profit. Profit is maximum when: (i) MC=MR (ii) MC curve cuts MR from below. Study of firms equilibrium under monopolistic competition is made under two different time period:
(A) Short Run Equilibrium : Short run refers to that time period in which production can be changed by changing variable factors of production. There is no time available either to increase or decrease the fixed factors of production lime machines, plants, etc. In the short period, the firms may face three situations: (1) Super Normal Profit : If the average revenue is greater than average cost, then it is called super normal profit.
Super- Normal Profit MC AC
C DA
O
B E MR M Output AR X
AR per Unit = AM AC per Unit = BM Super-Normal Profit = AB Total Super Normal Profit = ABCD
This figure shows that firm is in equilibrium at point E, because at this point MC=MR. Point E indicates that the firms equilibrium output is OM. AR of equilibrium output is AM. This equilibrium average revenue is greater than average cost BM. Hence the firm earns super normal profit equivalent to the different between AM and BM , .i.e. AB per unit. (2) Normal Profit : If the price fixed by the firm in equilibrium is equal to his
average cost, then he will earn only normal profits.
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Normal Profit MC AC
PA AR MR O M Output X
In this figure, the firm is in equilibrium at point E, because at this point marginal cost is equal to marginal revenue and MC cuts MR from below. The firm will produce OM units of output and sell it at AM price, which is equal to average cost AM. Firm, therefore, earns only normal profit in equilibrium situation. Average Revenue Per Unit= AM Average Cost Per Unit= AM Normal Profit AR=AC (3) Minimum Loss : In short run, the firm may incurr loss also. It is the minimum loss of the firm. If in the short run price falls due to depression or fall in demand, the firm may continue his production so long as the low price covers his average variable cost (AVC). In case the firm is obliged to fix a price which is less than average variable cost, then he will prefer to stop production. Thus Minimum loss = AC-AVC. This can be explained with the help of following diagram:
Y Loss MC B AC AVC
C DA
E
AR O M
MR X
Output
In this figure, the firm is in equilibrium at point E, because at this point marginal cost is equal to marginal revenue and MC cuts MR from below. The firm will produce OM units of output and sell it at AM price, which is less than his average cost BM. Firm, therefore, incurs minimum loss in equilibrium situation.
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Average Revenue Per Unit= AM Average Cost Per Unit= BM Minimum Loss = BM-AM = AB Total Minimum Losses = BADC (B) Long Run Equilibrium : Long period is that time period in which every firm can change its production capacity in response to change in demand. In the long run firms earn normal profit only
Y Normal Profit LMC LAC PA AR MR O M Output X
(2)
: Under perfect competition there are large numbers of firms producing homogeneous products. Collectively, these firms are called industry. Under monopoly, there is only one firm. There is no question of industry, Firm is the industry. Under monopolistic competition there are many firms producing close substitutes. Chamberlin has used the term group instead of industry, for the group of such firms as produce differentiated products. Determination of Group sake of simplicity, we For the Equilibrium study group equilibrium on the basis of two assumptions: Group Equilibrium (i) Demand and costs of all firms of a group are the same. (ii) Number of firms in the group is so large that no individual firm by its own decision can influence the price and output of other firms. Equilibrium can be explained with the help of following diagram :
Y DC
D1
A B
O
R EG
D1
C D X
M1 M
Output
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In this figure, DD is demand curve and CC is cost curve. Each producer would like to fix price equal to OA because at this price, difference between revenue and cost is the maximum. Such a price will yield super normal profits equivalent to BARG. This super normal profit will attempt many new firms to join the group. Consequently, the total market demand will be distributed among several sellers. This will make the demand curve shift to the left as D D . The number of producers will go on increasing until D D curve becomes 11 tangent to cost curve CC. This will happen at point E. No firm will now earn super normal profits. Each firm of the group will, in this situation, be in equilibrium. OB will be the equilibrium price of the group and OM will be the 1 equilibrium output. Q. What do you mean by oligopoly? Give main features. Ans . : oligopoly is a market in which there are few producers of a An product. For example, there are only five firms in India, manufacturing Cars. Hence car-market will be called oligopoly. In this case also each firm has to take into account the price being charged by the other. To that extent, firms are inter-dependent. If they enter into some sort of agreement they can charge high price. On the contrary, if they do not conclude any agreement among themselves, then they suffer losses. There is no set principle to determine price under oligopoly. Features of Oligopolistic Market : (1) Few Sellers : In case of oligopoly, the number of sellers is very small but that of the buyers is very large. The number of sellers being small, each seller has a control over a very large part of the total supply. Hence, he can influence the market price. (2) Inter-dependence : Each firm sells a substantial part of production of a commodity. If one firm reduces the price, the other firms also bring down their price. On the other hand, if one firm raises the price, it is quite possible the other firms may not like to raise their price. Thus, the sales of the former will be adversely affected. It means that there exists an interdependence among the firms. Selling Costs : Each firm under oligopoly incurs lot of expenditure on different modes of advertisement in order to push the sale of its products. Group Behaviour : Under oligopoly there is inter-dependence as well as competition among the firms. Each firm intends to maximize its profit. To achieve this objective either the firms decide independently the price and output of their product or they enter into a mutual agreement, as a group, in this respect. Uncertainty of Demand Demand curve is uncertain under Curve : oligopoly. Oligopoly Under oligopoly, the firm face Kinked demand curve.
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MANAGERIAL ECONOMICS Y D K AR P R O Quantity M X

D1
In this figure, demand curve has two segments. DD1 demand curve has a kink at point K. Demand curve is also known as average revenue (AR) curve. Upper segment of AR curve from point K is more elastic. It implies that when one firm raises its price, the other firms keep their prices unchanged. Thus, when one firm alone will effect change in price, then there will be considerable change in its sales. Lower segment of AR curve from point K i.e., KD1 represents less elastic demand. It implies that when one firm reduces its price then all other firms in the market also reduce their prices. When all firms reduce prices, then there will be no increase in the sale of any one firm, rather all firms may find a very small increase in their sale. Both these segments of average revenue curve form a kink at point K.
When average revenue curve is kinked then its corresponding marginal revenue curve is DPRM. DP portion of marginal revenue curve which is below the more elastic portion DK of the average revenue curve, is positive. On the contrary, RM portion of marginal revenue curve which is below the inelastic portion KD1 of the average revenue curve is negative. It means that if a firm lowers its price, its total revenue will not increase. PR gap in the marginal revenue curve arises because average revenue curve has suddenly changed from more elastic to inelastic curve.
Difference between Monopolistic Competition and Oligopoly :

Sr. Basis of Monopolistic No. Difference Competition 1. Number of Sellers Under monopolistic Under oligopoly there are competition there are large few sellers. number of sellers 2. Demand Curve Under monopolistic Under oligopoly, there is competition there is kinked demand curve Oligopoly
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downward sloping demand curve 3. Price Under monopolistic Under oligopoly, prices are Determination competition, prices are also determined by the determined by the firm firm but price is influence by other firms 4. Relation of firms Under monopolistic Under oligopoly, firms are competition, firms are largely inter-dependent almost independent
Q. Differentiate between Monopolistic Competition and Perfect Competition. Ans. Monopolistic Competition : Monopolistic competition is a market structure in which there are many sellers of a commodity, but the product of each seller differs from that of the other sellers in one respect or the other. Thus product differentiation is the characte ristic feature of monopolistic competition. Perfect Competition : Perfect competition is that situation of the market in which there are large number of buyers and sellers of homogeneous product. Under perfect competition, price of the commodity is determined by the industry. In perfect competition market firm is a price-taker and not a pricemaker Difference between Monopolistic Competition and Perfect Competition
Sr. Basis of Monopolistic Perfect Competition No. Difference Competition
1. Assumption Under Monopolistic Under perfect regarding competition there are competition there are Buyers and large numbers of large numbers but Sellers buyers and sellers. small size of buyers and sellers. 2. Assumption Under monopolistic Under perfect regarding competition there is competition it is Product product differentiation. assumed that all firms Foods produced by the produce homogeneous firms differ in one way products. or the other. 3. Assumption Under monopolistic Under perfect regarding competition it is competition it is Degree of assumed that buyers assumed that buyers Knowledge and sellers are not fully and sellers have aware of the market perfect knowledge of conditions. the market situations.
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4. Marginal Under monopolistic Under perfect Revenue and competition, marginal competition, marginal Average revenue and average revenue and average Revenue Curve revenue curve are: revenue curve are:
Y AR=MR
5. Comparison Under monopolistic Under perfect regarding Price competition, firm is competition, firm is price-maker, not price- price-taker, not pricemaker. taker. 6. Implications Under monopolistic Under perfect regarding competition, a firm can competition a firm can Decisions determine either the take decision only with output to be produced regard to the quantity or the price to be of output to be charged. produced. 7. Selling Cost Under monopolistic Under perfect competition each firm competition, a seller spends a lot of funds does not spend on on advertisement and advertisement and publicity of its product. publicity etc.
OX Y
MR Output
AR O Output X
Q. Differentiate between Monopolistic Competition and Monopoly. Ans. Monopolistic Competition : Monopolistic competition is a market structure in which there are many sellers of a commodity, but the product of each seller differs from that of the other sellers in one respect or the other. Thus product differentiation is the characteristic feature of monopolistic competition Monopoly : Monopoly is the market structure in which a single firm is the sole producer of a product for which there are no close substitutes. Since the monopoly is the only seller in the market, it has no competitors. The monopolist is the price maker. Its demand curve slopes downward to the right. Difference between Monopolistic Competition and Monopoly :
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Sr. Basis of Monopolistic Monopoly No. Difference Competition 1. Assumptions Under monopolistic In case of monopoly, there regarding Number competition there are large is only one seller and of Buyers and number of buyers and large number of buyers. Sellers sellers. 2. Assumption Under monopolistic Product of a monopolist regarding Product competition there is may or may not be product differentiation. homogeneous. 3. Assumption Under monopolistic Under monopoly there are regarding Entry competition there are no restrictions on the entry restrictions on the new of new firms. firms to enter into and the old ones to leave the group. However, this entry and exit are not so easy in the short -period. It is possible in the long-run only. 4. Assumption Under monopolistic Under monopoly, it is regarding Degree competition, buyers and assumed, that buyers and of Knowledge sellers have imperfect sellers have perfect knowledge of the knowledge regarding market conditions market conditions. 5. Marginal Revenue Under monopolistic Under monopoly marginal and Average competition, marginal revenue and average Revenue revenue and average revenue curve are: revenue curve are:
AR MR MR Output AR
6. Comparison Under monopolistic Under monopoly, a Regarding Profit competition in the long run monopolist earns super firm generally earns normal profit only in normal profits only. long run.
OX Y
Output
OX Y
Q. Differentiate between Monopoly and Perfect Competition. Ans. Monopoly is the market structure in which a single firm is Monopoly : the sole producer of a product for which there are no close substitutes. Since the monopoly is the only seller in the market, it has no competitors. The monopolist is the price maker. Its demand curve slopes downward to the right.
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Perfect Competition : Perfect competition is that situation of the market in which there are large number of buyers and sellers of homogeneous product. Under perfect competition, price of the commodity is determined by the industry. In perfect competition market firm is a price-taker and not a pricemaker Differentiate between Monopoly and Perfect Competition :
Sr. Basis of Monopoly Perfect No. Difference Competition
1. Assumptions In case of monopoly, Under perfect competition regarding Number there is only one seller there are large numbers but of Buyers and and large number of small size of buyers and Sellers buyers. sellers. 2. Assumption Product of a monopolist Under perfect competition it regarding may or may not be is assumed that all firms Product homogeneous. produce homogeneous products. 3. Assumption Under monopoly there Under perfect competition regarding Entry are restrictions on the there are no restriction on entry of new firms. the entry and exit of firms. 4. Marginal Revenue Under monopoly Under perfect competition, and Average marginal revenue and arginal revenue and average Revenue average revenue curve revenue curve are: are: Y Y AR=MR
MR OX
AR X
O Output Output 5 Comparison Under monopoly, a Under perfect competition a Regarding Profit monopolist earns super firm earns normal profits normal profit in only in long run. long run. 6. Implications A monopolist can Under perfect competition, a regarding determine either the firm can take decision only Decisions quantum of output in respect of the quantity to or the price. be produced. 7. Comparison Under monopoly, a firm Under perfect competition, a Regarding Price is price maker, not firm is price taker, not price taker price maker. 8. Selling Cost Under monopoly firm Under perfect competition, a spends a few amount seller does not spend on on advertisement and advertisement and publicity of its product. publicity etc.
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UNIT IV
Q. Explain Baumols Theory of Sales Revenue Maximization. Ans. Baumols theory of sales maximization is an alternative theory Meaning : of firms behaviour. The basic premise of his theory is that sales maximization, rather than profit maximization, is the plausible goal of the business firms. He argues that there is no reason to believe that all firms seek to maximize their profits. Business firms, in fact, pursue a number of objectives and it is not easy to single out one as the most common objective pursued by the firms. However, from his experience as a consultant to many big business houses, Baumol finds that most managers seek to maximize sales revenue rather than profits. He argues that, in modern business, management is separated from ownership, and managers enjoy the discretion to pursue goals other than profit maximization. Their discretion eventually falls in favour of sales maximization. Causes : According to Baumol, business managers pursue the goal of sales maximization for the following (1) First, Financial institutions consider sales as an index of performance of the firm and are willing to finance the firm with growing sales. (2) Second, while profit figures are available only annually, sales figures can be obtained easily. Maximization of sales is more satisfying for the managers than the maximization of profits which go to the pockets of the shareholders. (3) Third, salaries and slack earnings of the top managers are linked more closely to sales than to profit. (4) Fourth, the routine personnel problems are more closely handled with growing sales. Higher payments may be offered to employees if sales figures indicate better performance. (5) Fifth, if profit maximization is the goal and it rises in one period to an unusually high level, this becomes the standard profit target for the shareholders which managers find very difficult to maintain in the long run.
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(6) Finally, sales growing more than proportionately to market expansion indicate growing market share and a greater competitive strength and bargaining power of a firm. Explanation : To formulate his theory of sales maximization Baumol has develop two basic models: 1. Baumols Model Without Advertising 2. Baumols Model with Advertising 1. Baumols Model Without Advertising : Baumols Model without advertising can be explained with the help of following diagram :
Y F
H J
TC
TR
M K E T L
O P
TP
Q1 Q2
Output
Q3
Baumol assumes cost and revenue curves to be given as in conventional theory of pricing. Suppose that the total cost (TC) and the total revenue (TR) curves are given in this figure. The profit curve, TP, is obtained by plotting the difference between the TR and TC curves. Profits are zero where TR = TC. Given the TR and TC curves, there is a unique level of output at which total sales revenue is
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maximum. The total sales revenue is maximum where the slope of the TR curve is equal to zero. Such a point lies at the highest point of the TR curve. In this figure the point H represents the total maximum sales revenue. It implies that a sales revenue maximizing firm will produce output OQ and its price equal to HQ / OQ . We have shown above how price and 2. Baumols Model with Advertising :
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output are determined in a static single period model without advertising. Baumol considers in his model with advertising as the typical form of nonprice competition. (i) Firms objectives are to maximize sales. (ii) Advertising causes a shift in the demand curve and hence the total sales revenue rises with an increase in advertisement expenditure. (iii) Price remains constant. (iv) Production costs are independent of advertising.
TC Y TR
In his analysis of advertising, Baumol makes the following assumptions:-
Total Profit Curve B M
OP
X
Ap Ac
Advertising Qutlay
Explanation : Baumols model with advertising is presented in this figure. The TR and TC are measured on Y-axis and total advertisement outlay on the Xaxis. The TR curve is drawn on the assumption that advertising increases total sales in the same manner as does price reduction. The TC curve includes both production and advertisement costs. The total profit curve is drawn by subtracting TC from TR. As shown in this figure profit maximizing advertisement expenditure is OA which maximizes profit MA . Assuming that p p minimum profit required is OB, the sales maximizing advertisement outlay
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would be OA . This implies that a firm increases its advertisement outlay until it c reaches the profit constraint level which is lower than the maximum profit. Criticism : 1. First, it has been argued that in the long-run, Baumols sales maximization hypothesis and the conventional hypothesis would yield identical results, because the minimum required level of profits would coincide with the normal level of profits. 2. Second, Baumols theory does not distinguish between firms equilibrium and industry equilibrium. Nor does it establish industrys equilibrium when all the firms are sales maximisers. 3. Third, it does not clearly bring out the implications of inter-dependence of the firms price and output decision. Thus, Baumols theory ignores not only actual competition between the firms but also the threat of potential competition in an oligopolistic market. 4. Fourth, Baumols claim that his solution is preferable to the solutions offered by the conventional theory, from a social welfare point of view, is not necessarily valid. Q. Write a note on Average Cost Pricing. Ans. Average Cost Pricing : Average cost pricing is also known as mark-up pricing, cost-plus pricing or full cost pricing. The average cost pricing is the most common method of pricing used by the manufacturing firms. The general practice under this method is to add a fair percentage of profit margin to the average variable cost (AVC). The formula for setting the price is given as:P = AVC + AVC (m) P = Price AVC = Average Variable Cost m = Mark-up percentage AVC(m) = Gross Profit Margin (GPM) The mark-up percentage (m) is fixed so as to cover average fixed cost (AFC) and a net profit margin (NPM). Thus, AVC(m) = AFC + NPM NPM : The fair percentage of profit margin is usually determined on the basis of the firms past experience and the practice of the rival firms. Procedure for arriving at AVC and Price Fixation : The procedure for arriving at AVC and price fixation may be summarized as follows: 1. The first step in price fixation is to estimate the average variable cost. For this, the firm has to ascertain the volume of its output for a given period of time, usually one accounting year. To ascertain the output, the firm uses
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figures of its planned or budgeted output or takes into account its normal level of production. If the firm is in a position to compute its optimum level of output or the capacity output, the same is used as standard output in computing the average cost. 2. The next step if to compute the total variable cost of the standard output. The Total Variable Cost includes direct cost i.e. (a) Cost of Labour (b) Cost of Raw Material (c) Other Variable Costs These costs added together give the total variable cost. The Average Variable Cost (AVC) is then obtained by dividing the total variable cost (TVC) by the standard output (Q), i.e., TVC AVC = Q After AVC is obtained, a mark-up of some percentage of AVC is added to it as profit margin and the price is fixed. While determining the mark-up, firms always take into account what the market will bear and the competition in the market. Average cost Pricing can be recommended for the following reasons (1) In case of a multi-product firm with large common cost, average cost if far easier to calculate than the marginal cost. (2) Since nobody pays more than the actual cost of production of the goods, average cost pricing does not result in exploitation. (3) Average cost pricing ensures that the entire expenditure of the undertaking is covered, thereby ensuring the viability and the autonomy of the production unit. Limitations of Average Cost Pricing : (1) First, average cost pricing assumes that a firms resources are optimally allocated and the standard cost of production is comparable with the average of the industry. In reality, however it may not be so and cost estimates based on these assumptions may be an overestimate or an underestimate. (2) Second, in average cost pricing, generally historical cost rather than current cost data are used. (3) Third, if variable cost fluctuates frequently and significantly, average cost pricing may not be an appropriate method of pricing. (4) Finally, it is also alleged that average cost pricing ignores the demand side of the market and is solely based on supply conditions.
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Q. Write a short note on Peak Load Pricing. Ans. Peak Load Pricing : It is a form of price discrimination where the monopolist charges a higher price for peak use than for a non-peak use. Peak load pricing is more usually practiced by Public Utilities, like electricity companies, telephones etc. Public utilities produce non storable services, their output is consumed the very moment it is produced. These are demanded in varying amounts in day and night times. Consumption of electricity reaches its peak in day time. It is called peak-load time. It reaches it bottom in the night. This is called off-peak time. Electricity consumption peaks in day times because all establishments, offices and factories come into operation. It decreases during nights because most business establishments are closed and household consumption falls to its basic minimum. Also in India demand for electricity peaks during summers due to the use of ACs and coolers and it declines its minimum level during winters. Similarly, consumption of telephone services is at its peak at day time and at its bottom at nights. Another example of peak and off-peak demand is of railway services. During festivals and summer holidays the demand for railway travel service rises to its peak. A technical feature of such products is that they cannot be stored. Therefore, their production has to be increased in order demand and reduced to off-peak level when demand decreases. Had they been storable, the excess production in off-peak period could be stored and supplied during the peak-load period. But this cannot be done. The rational of peak-load pricing by Electricity Company can be presented with the help of following figure :
Y SMC
to
meet
the
peak-load
P3 P2 P1
D B E
Dp DL
O Q1 Q2 Q3 Q4 X
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In this figure, the short-run marginal cost of electricity is shown as SMC. It slopes upwards. We further assume that demand varies between two periods, with the demand curve for the peak period shown as D and the demand curve p for the off-peak period shown as D . The price in each period would be set where L SMC intersects the relevant demand curve. Thus, price would be OP in the off- 1 peak period and OP in 3the peak period. Consumers would purchase OQ in the off-peak period and OQ in 3the peak period. Conclusion : Generally a double price system is adopted. A higher price, called peak-load price is charged during the peak-load period and a lower price is charged during the off-peak period. Q : Write a short note on Limit Pricing. Ans. Meaning of Limit Pricing : A firm may also try to establish a price that reduced or eliminates the threat of entry of new firms into the industry. This is called limit pricing. Limit Pricing is illustrated in the following figure :
Y
SRAC1 P1
LMC
LAC
P2
AR MR
O Q1 Q2
X Units of Output
Suppose that the existing firms in the industry operate at the scale represented by the short-period average cost curve SRAC1 and price their product at P1. If the new firms could be expected to enter the industry even at the scale represented by SRAC1, they could potentially make a profit by producing and competing at the established price P1. Now if the existing firms set the price lower, say at P2 potential entrants would incur economic loss by entering the industry. If the entry appears initially any firm which plans entry must also consider the effect of the entry on price. With entry the total supply and demand for the already existing firms output is going to be affected.
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The price must consequently fall and the new entrant may ultimately find that price has fallen below SRAC1 and he has, therefore made a wrong decision. Thus, if the existing firms set their price closer to average cost there will be less incentive for new entrants, though also lower short-run profits for the existing firms. Q. Explain Multiple Product Pricing Or Product-Line Pricing. Ans . Multiple Product Pricing : The price theory or microeconomics models of price determination are based on the assumption that a firm produces a single, homogenous product. In actual practice, however, production of a single homogenous product by a firm is an exception rather than a rule. Almost all firms have more than one product in their line of production. For example, the various model of refrigerators, TV sets, radio and car models produced by the same company may be treated as different product for at least pricing purposes. The various models are so differentiated that consumers view them as different product and in some cases as perfect substitutes for each other. It is therefore, not surprising that each model or product has different AR and MR curves and that one product of the firm competes against the other product. The pricing under these conditions is known as multi-product pricing or product-line pricing. The major problem in pricing multiple products is that each product has a separate demand curve. But, since all of them are produced under one organization by interchangeable production facilities, they have only one inseparable marginal cost curves. That is, while revenue curves, AR and MR, are separate for each product, cost curves, AC and MC are inseparable. Therefore, the marginal rule of pricing cannot be applied straightway to fix the price of each product separately. The problem, however, has been provided with a solution by E.W. Clemens. The solution is similar to the one employed to illustrate third degree price discrimination. As a discriminating monopoly tries to maximize its revenue in all its market, so does a multi-product firm in respect of each of its products.
YABCD
MC
D1 P1 D2 P2 D3 P3 D4 P4
EMR
MR1 MR2 MR3 MR4
O Q1 Q2 Q3 Q4 Quantities Demanded Per Time Unit
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Explanation : To illustrate the multiple product pricing, let us assume that a firm has four different product:- A, B, C and D in its line of production. The AR and MR curves for the four goods are shown in four segments of above mentioned figure. The marginal cost for all the products taken together is shown by the curve MC, which is the factory marginal cost curves. Let us suppose that when the MRs for the individual products are horizontally summed up, the aggregate MR (not given in the figure) passes through C on the MC curve. If a line parallel to the X-axis, is drawn from point C to the Y-axis through the MRs, the intersecting points will show the points where Mc and MRs are equal for each product, as shown by the line EMR, the Equal Marginal Revenue line. The point of intersection between EMR and MRs determine the output level and price for each product. Outputs of the four products are given as : (i) OQ1 of Product A (ii) O1Q2 of Product B (iii) O2Q3 of Product C (iv) O3Q4 of Product D The prices for the four products are : (i) P1Q1 for Product A (ii) P2Q2 for Product B (iii) P3Q3 for Product C (iv) P4Q4 for Product D These price and output combinations maximize the profit from each product and hence the overall profit of the firm. Q. Write a note on Pricing Strategies and Tactics. Ans. Pricing Strategies and Tactics : Every firm has to take pricing decisions
from time to time depending upon its pricing policies and conditions prevailing in the market. Some of the important pricing strategies are discussed below: (1) Skimming Price Policy : The skimming price policy is adopted where
close substitutes of a new product are not available. In this pricing policy prices are decided high. This policy succeeds for the following reasons:(a) First, in the initial stage of the introduction of product, demand is relatively inelastic. (b) Cross elasticity is usually very low for lack of a close substitute. (c) High initial prices are helpful in recouping the development costs.
(2)
Penetration Price Policy : In contrast to skimming price policy, the penetration price policy involves a reverse strategy. This pricing policy is adopted generally in the case of new products for which substitutes are available. This policy requires fixing a lower initial price designed to penetrate the market as quickly as possible and is intended to maximize
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the profits in the long-rum. This policy succeeds for the following reasons:(a) First, the short run demand for the product should have an elasticity greater than unity. (b) Second, the potential market for the product is fairly large and has a good deal of future prospects. (c) Third, the product should have a high cross-elasticity in relation to rival products for the initial lower price to be effective. (3) Pricing in Relation to Established Products : In pricing a product in relation to its well established substitutes, generally three types of pricing strategies are adopted (i) Pricing below the ongoing price. (ii) Pricing at par with the prevailing market price (iii) Pricing above the existing market price. Pricing at Prevailing Prices : The strategy is followed to stay in the market because a price above the market price would sharply bring down sales while a lower price would not significantly increase sales. The products offered by different producers are substitutes of each other and there is no product differentiation. Pricing at the prevailing price is aimed at avoiding price competition. Stay out Price : 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. Price Lining : Price lining is used extensively by the retailers. The retailers usually offer a good, better and best assortment of merchandise at different price levels. For example, a retailer of readymade shirts may sell shirts at three prices: Rs. 190, Rs. 360 and Rs. 750. The first price stands for the economy choice, the second for the medium quality and the third for the super-fine quality. Psychological Pricing : Under this policy, prices are fixed in such a way that they have some kind of psychological influence on the buyers. Odd pricing is a form of psychological pricing i.e., prices are set at odd amounts such as Rs. 19, Rs. 49, Rs.99 etc. Limit Pricing : A firm 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. Follow the Leader Pricing : The pricing policy is generally used under
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(5)
(6)
(7)
(8)
(9)
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oligopolistic competition where there are a small number of sellers and any on of them operates on such a scale that an increase or decrease in his turnover will appreciably affect the market price. They charge the prices which are charged by the major producer. (10) Discriminatory Or Dual Pricing : Some business enterprises follow the policy of charging different prices from different customers according to their ability to pay. This policy is very popular with the service enterprises. E.g, legal and medical services. Q. Write a note on Transfer Pricing. Ans. Meaning of Transfer Pricing : The large size firms divide their operation very often into product divisions or subsidiaries. Growing firms add new divisions or departments to the existing ones. The firms then transfer some of their activities to other divisions. The goods and services produced by the new division are used by the parent organization. In other words, the parent division buys the product of its subsidiaries. Such firms face the problem of determining an appropriate price for the product transferred from one division or subsidiary to the other. Specially, the problem is of determining the price of a product produced by one division of the same firm. This problem becomes much more difficult when each division has a separate profit function to maximize. Price of intra-firm transfer product is referred to as transfer pricing. One of the most systematic treatments of the transfer pricing technique has been provided by We willHirshlerifer. briefly his discuss here technique of transfer pricing. To begin with, let us suppose that a refrigeration company established a decade ago used to produce and sell refrigerators fitted with compressors bought from a compressor manufacturing company. Now the refrigeration company decides to set up its own subsidiary to manufacture compressors. Assumptions : Let us also assume : (1) Both parent and subsidiary companies have their own profit functions to maximize. (2) The refrigeration company sells its product in a competitive market and its demand is given by a straight horizontal line; and (3) The refrigeration company uses all the compressors produced by its subsidiary. In addition, we assume that there is no external market for the
compressors. We will later drop this assumption and alternatively assume that there is an external market for the compressors and discuss the technique of transfer pricing under both the alternative conditions. (A) Transfer Pricing without External Market : Given the foregoing
assumptions, the refrigeration company has to set an appropriate price
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for the compressors so that the profit of its subsidiary too is maximum. This can be explained with the help of following diagram: (1) Price Determination of the Final Product (Refrigerators) :
Y P ARr r=MR MCc
M
MCb
QX
Number of Refrigerators and Compressors Diagram: Price Determination of the Fina Product (Refrigerators) Since the refrigeration company sells its refrigerators presumably in a
rr
competitive market, the demand for its product is given by a straight horizontal line as shown by the line AR = MR in diagram. The marginal cost of intermediate good i.e., compressor, is shown by MC curve and that of the refrigerator body by MC . The MC and MC added vertically give the combined marginal cost curve, the MC The MCt intersects line AR = MR at point P. An ordinate drawn from point P down to the horizontal axis determined the most profitable outputs of refrigerator body and compressors each at OQ. Now, the question arises is what (2) Determination of Transfer Price :
c bcb t. rr
should be the price of the compressors so that the compressor manufacturing division too maximizes its profit? The answer is to this question can be obtained by applying the marginality principle which requires equalizing MC and MR in respect of compressors. The marginal cost curve for the compressors is given by MC in the following figure. The c marginal revenue of the compressors MR can be cobtained by subtracting the non- compressor marginal cost of the final good from the MR. Thus, r MRc r= cMR (MC -MC ) t
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This can be explained with the help of following figure :

MCc Y
MC c and r MR
O Quantity
Diagram: Determinationof Transfer Price
In this figure, the MC curve intersects MR curve at point P. At point P MRc = MCc and output is OQ. Thus the price of compressors is determined at PQ in above figure. This price enables the compressor division to maximize its own profit. (B) Transfer Pricing with External Competitive Market : We have
c c
discussed above the transfer pricing under the assumption that there is nor external market for the compressors. It implies that the refrigeration company was the sole purchaser of its own compressors and that the compressor division had no external market for its product. Let us now discuss the transfer pricing technique assuming that there is an external market for the compressors. The existence of the external market implies that the compressor division has the opportunity to sell its surplus production to other buyers and the refrigeration company can buy compressors from other sellers if the compressor division fails to meet its total demand. Also assume that the external market is perfectly competitive.
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Past Year Question Papers
JAN 2009
UNITI
1. Define Managerial Economics ? How does it assist managers in decision making ? 2. Profit maximization remains the most important objective of business firms inspite of the multiplicity of alternative business objectives suggested by modern economists ? Comment ?
UNITII
3. Explain various types of demand ? Distinguish between (a) Extension & increase in demand (b) contraction & decrease in demand ? 4. Show the break up of price effect into income effect & substitution effect, of a price of an inferior commodity and a giffen good ?
UNITIII
5. Explain short term cost, their interrelationship and their importance for business managers ? 6. What is meant by price discrimination ? What are its various degrees ? Describe equilibrium of a firm under discrimination monoploy ?
UNITIV
7. Explain Baumols theory of sales revenue maximization ? 8. Write short notes on : a) Peak Load Pricing b) Average Cost Pricing JULY 2008
UNITI
1. What do mean by Managerial Economics ? Explain its significance in Managerial decision making ? 2. Critically examine the profit maximization goal of a business firm ?
UNITII
3. What do you mean by Price Elasticity, Income elasticity and cross elasticity of demand ? Explain the factors affecting elasticity of demand ? 4. Explain consumers equilibrium with the help of indifference curve technique?
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UNITIII
5. What do you mean by fixed cost, variable cost, total cost, average cost and marginal cost ? Explain the relationship between AC and MC ? 6. What is meant by price discrimination ? Discuss the equilibrium of firm under monopoly ?
UNITIV
7. Explain Baumols sales revenue maximization theory of the firm ? 8. Explain Pricing strategies and transfer pricing of a business firm ? JAN 2008
UNITI
1. Discuss the role and responsibility of Managerial Economist ? 2. Write short notes on : a) Short run and long run b) Opportunity cost
UNITII
3. Explain the law of demand ? Why does demand curve slope downward from left to right ? 4. Explain consumers equilibrium with the help of Indifference curve technique ?
UNITIII
5. How does a producer establishes optimum input combination to optimize his behaviour ? 6. What do you mean by monopolistic competition ? How is equilibrium achieved by a firm under monopolistic competition in the short run and long run ?
UNITIV
7. Critically examine Baumols sales maximization theory of the firm ? 8. Explain Average Cost Pricing and Limit Pricing strategy of a business firm ? JULY 2007
UNITI
1. Define Managerial Economics ? Discuss its nature and scope ? 2. Explain and illustrate the following : a) Incremental reasoning b) Opportunity Cost
UNITII
3. What are the conditions for a consumers equilibrium ? Explain and illustrate consumers equilibrium using indifference curve technique ? 4. Define elasticity of demand ? What are the different types of price elasticity ?
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UNITIII
5. Explain the laws of returns to variable proportions and laws of returns of sale ? What are the reasons for the operations of law of the diminishing returns ? 6. Define monopoly ? What are its characteristics ? Discuss the equilibrium of firm under monopoly ?
UNITIV
7. Explain Baumols theory of sales revenue maximization ? What are its assumptions ? 8. Write short notes on : a) Average Cost b) Pricing strategies JAN 2007
UNITI
1. What is Managerial Economics ? Discuss the characteristics and scope of Managerial Economics ? How does Economics theory contribute to managerial decisions ? 2. a) Write detailed notes on Opportunity cost. b) Write detailed notes on Incremental reasoning.
UNITII
3. What are the conditions for a consumers equilibrium ? Explain consumers equilibrium using indifference curve technique ? 4. What are the objectives of demand forecasting ? Explain steps involved in forecasting ? UNITIII 5. Explain laws of returns to variable proportions and laws of return of scale ? Explain the factors, which causes increasing return to scale ? What are the reasons for the operations of law of the diminishing returns ? 6. Compare perfect competition and monopolistic competition ? How are price and output decisions taken under perfect competition ?
UNITIV
7. Write short notes on : a) Peak Load Pricing b) Write short notes on transfer pricing 8. Explain the sales revenue maximization model with advertisement ? JULY 2006
UNITI
1. Define Managerial Economics and briefly discuss its scope ? What are the responsibilities of managerial economics ? 2. Explain and illustrate the following : a) Opportunity Cost b) Incremental reasoning
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UNITII
3. What are the conditions for a consumers equilibrium ? Explain consumers equilibrium using indifference curve technique ? 4. Define and distinguish between : a) Arc elasticity and point elasticity b) Price elasticity and cross elasticity
UNITIII
5. From the data given in table a) Find the AFC, AVC, AC and C b) Why does AFC decline continuously ? c) What is the relation between AC and MC ? Table (a) Quantity (Units) TFC (Rs.) TVC (Rs.) TC (Rs.) 0 1 2 3 4 5 100 0 100 100 100 200 100 150 250 100 250 350 100 400 500 100 600 700
6. Compare perfect competition and monopolistic competition ? How are price and output decisions taken under perfect competitions ?
UNITIV
7. Explain the sales revenue maximization model with advertisement ? 8. Explain the following : a) Average cost pricing b) Pricing strategies JAN 2006
UNITI
1. Explain the importance of Managerial Economics from the point of view of Managerial Decision-making ? What is the role of managerial economist in business organization ? 2. Write short notes on : a) Short-run and long-run b) Risk and uncertainity
UNITII
3. Explain the various poll methods of demand forecasting ? 4. Define income elasticity of demand and define its various types ? Discuss the significance of income elasticity of demand in managerial decisions ?
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MANAGERIAL ECONOMICS UNITIII 5. How is monopoly caused ? Explain price and output determination under monopoly in the short-run and long-run ? 6. Explain the types of isoquant curves ? Show, with the help of an illustration, how will you determine the cost combination ?
UNITIV
7. Briefly explain Baumols theory of sales revenue maximization ? 8. Give and discuss various techniques price formation in actual business situation? JULY 2005
UNITI
1. What is Managerial Economics ? Discuss the characteristics and scope of Managerial Economics ? How does Economic theory contribute to managerial decisions ? 2. Write a short notes on : a) Nature and marginal analysis b) Opportunity cost
UNITII
3. Explain laws of return to variable proportions and laws of return of scale ? Explain the factors, which causes increasing return to scale ? What are the reasons for the operations of law of the diminishing return ? 4. Define price elasticity of demand and define its various types ? Discuss the determinates of price elasticity of demand in managerial decision ?
UNITIII
5. Discuss the meaning and main features of monopolistic market situation ? Draw a diagram to show equilibrium of the firm ? 6. What is price discrimination ? Under what conditions seller resort to it ? Explain?
UNITIV
7. Briefly explain Baumols theory of sales revenue maximization alongwith its assumption ? 8. Write short notes on : a) Average cost pricing b) Limit pricing c) Transfer pricing
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Economics Final

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Study Material

Price : Rs. 400.00

ACCOUNTING FOR MANAGERS

INDIAN ETHOS AND VALUES

: Managerial economics is the application of

: One of the main functions of any

To make reasonable profits on capital employed :

OM OUTPUT Criticism of profit Maximization Approach :

Q. Write a short note on the following :

Fixed Factors Variable Factors

(i) MC=MR (ii) MC curve cuts MR curve from below Y P A E MC AR=MR

At point E both the conditions are satisfied.

: There are basically three types of goods :

This classification includes durable or semi-durable

Perfect Competition Imperfect Competition Monopoly

competition : (a) Monopolistic Competition :

There are two types of market under imperfect

Lack of Reliable market information

Inadequate past experience

4. Short-Run Demand and Long-Run Demand : (i)

5. Joint Demand and Composite Demand : (i)

6. Individual Demand and Market Demand : (i)

7. Price Demand, Income Demand and Cross Demand : (i)

Price of Related Goods :

Demand for a commodity depends not only on

Income of the Consumer :

There is a positive relation between income of

Quantity of Inferior Goods

Fall in Price Extension of Demand

Increase in demand means rise in demand in

:Law of demand can be explained with the

demand tends to contract. (2) Market Demand Schedule :

to OY-axis. (3) Unitary Elastic Demand :

In this diagram DD represents the unitary elastic demand. In this diagram

In this diagram DD represents greater than unitary elastic demand. In

Ed= A Ed >1 P E =1 d B E <1 d E =0 d

E = (-) d (Sum of Quantities) (Sum of Prices)

E = (-) d (Q +Q) (P +P)

(Q -Q) (P +P) E = (-) X d (Q +Q) (P -P)

(Q -Q) (P +P) 1 1 E = (-) X d (Q +Q) (P -P)

Sales proceeds that a firm is obtained by selling its

Ans. (A) Income Elasticity of Demand

is of three types: (1) Positive Income Elasticity of Demand :

:Income Elasticity of demand

be of three types: 1. Positive Cross Elasticity of Demand :

Degrees of Cross Elasticity of Demand :

Cross elasticity of demand can

Q. Discuss factors which influence the Price Elasticity of demand.

Q. What is the Importance of Price Elasticity of Demand?

Ans. (1) Determination of Price under Monopoly :

the following assumptions: 1. Rational Consumer :

: Consumers equilibrium through utility analysis is based on

Consumers Equilibrium in case of One Commodity with One Use

Properties of Indifference Curves

:The following are the main properties of An

IC3 IC2 IC1

(A) Income Effect (B) Substitution Effect (C) Price Effect

X BC T X-Commodity Substitution Effect M

Price Effect=SQ Substitution Effect=TQ Income Effect=ST

: Consumers equilibrium can be explained with the

Techniques of Demand Forecasting

The sample survey method is widely used to forecast

Opinion Poll Methods :