TABLE OF CONTENTS

Session 1: Chapter 1 and 2 ..................................................................................................... 4

Managerial Economics ....................................................................................................................4
Demand Function (Determinants of demand) ..................................................................................4
Demand Curve ................................................................................................................................4
Law of Demand ..............................................................................................................................5
Shift in demand curve and movement along the demand curve .......................................................5
Supply ............................................................................................................................................6
Determinants of Supply (Supply function) .......................................................................................6
Supply Curve ..................................................................................................................................6
Law of Supply .................................................................................................................................6
Shift in supply curve and movement along the supply curve ............................................................7
Market equilibrium.........................................................................................................................7
Shift in demand/supply and equilibrium..........................................................................................8
Complex cases of shift in equilibrium ..............................................................................................8
Session 2: Chapter 2 and 3 ..................................................................................................... 8
Elasticity of demand .......................................................................................................................8
price elasticity of demand – Meaning and Types ..............................................................................9
Calculation of price elasticity of demand ....................................................................................... 10
Factors affecting price elasticity of demand ................................................................................... 10
Practical applications of elasticity of demand ................................................................................ 11
Income elasticity of demand ......................................................................................................... 11
Income elasticity types ................................................................................................................. 11
Cross elasticity of demand ............................................................................................................ 12
Cross elasticity types .................................................................................................................... 12
Elasticity of demand and revenue ................................................................................................. 13
Session 3: Chapter 3 and 4 ................................................................................................... 13
Demand forecasting...................................................................................................................... 13
Risks in business ........................................................................................................................... 13
Concept of Demand Forecasting .................................................................................................... 14
Need for DF .................................................................................................................................. 15
Factors influencing DF ................................................................................................................... 15
Techniques of Demand Forecasting ............................................................................................... 16
Limitations of DF .......................................................................................................................... 18
Session 4: Chapter 4............................................................................................................. 19
Introduction ................................................................................................................................. 19
Concept of Utility.......................................................................................................................... 19
Marginal utility approach.............................................................................................................. 19
Law of Diminishing MU ................................................................................................................. 19
Ordinal Approach to Utility ........................................................................................................... 20
Indifference Curve ........................................................................................................................ 20
Typical Indifference Curve............................................................................................................. 20
Indifference/Preference Map ........................................................................................................ 20
Properties of IC ............................................................................................................................. 21
Marginal Rate of Substitution ....................................................................................................... 21
Types of Indifference curves ......................................................................................................... 22
Consumer’s Budget Line................................................................................................................ 22
 Typical Budget Line ....................................................................................................................... 22
Utility Maximization ..................................................................................................................... 23
Income effect on consumer’s equilibrium ...................................................................................... 24
Price effect on consumer’s equilibrium.......................................................................................... 24
Managerial implications................................................................................................................ 24
Session 5: Chapter 5............................................................................................................. 25
Important concepts ...................................................................................................................... 25
Fixed and Variable inputs .............................................................................................................. 25
Short-run and long-run period ...................................................................................................... 25
Production Possibility Curve.......................................................................................................... 25
Production Function ..................................................................................................................... 26
Production function (short run) – one variable input ..................................................................... 27
Concepts of TP, MP, AP ................................................................................................................. 27
Observations from the table ......................................................................................................... 27
Law of diminishing marginal returns ............................................................................................. 28
Production function (long run) – two variable inputs ..................................................................... 28
Returns to Scale............................................................................................................................ 28
Returns to scale in US industries ................................................................................................... 29
Role of innovations ....................................................................................................................... 29
Types of innovations..................................................................................................................... 29
Session 6: Chapter 6............................................................................................................. 30
Importance of cost in Managerial Decisions................................................................................... 30
Types of costs ............................................................................................................................... 30
Short Run Costs of Production....................................................................................................... 31
Short run costs ............................................................................................................................. 31
Cost calculation ............................................................................................................................ 32
Long-run costs .............................................................................................................................. 32
Long run total cost curve............................................................................................................... 32
Long run average cost curve .......................................................................................................... 32
Explanation of U-shaped cost curve............................................................................................... 33
Returns to scale ............................................................................................................................ 33
Learning Curve ............................................................................................................................. 33
Session 7: Chapter 7 and 8 ................................................................................................... 34
Ownership of firms ....................................................................................................................... 34
Types of Private ownership ........................................................................................................... 34
Objectives of the firm ................................................................................................................... 34
Types of Markets .......................................................................................................................... 34
Concept of Revenue ...................................................................................................................... 35
Revenue of Competitive firm ........................................................................................................ 35
Revenue conditions under monopoly ............................................................................................ 35
Perfect Competition ..................................................................................................................... 36
MR-MC Approach to Profit maximization ...................................................................................... 36
Equilibrium under perfect competition.......................................................................................... 37
Short run equilibrium under perfect competition .......................................................................... 38
Shut Down point........................................................................................................................... 39
Long-run equilibrium .................................................................................................................... 39
Long-run outcome ........................................................................................................................ 39
Session 8: Chapter 9 and 10 ................................................................................................. 40
Features of Monopoly................................................................................................................... 40
Advantages of monopoly .............................................................................................................. 41
Sources of monopoly .................................................................................................................... 41
Revenue conditions under monopoly ............................................................................................ 42
Conditions of Equilibrium.............................................................................................................. 42
Supernormal profit monopoly ....................................................................................................... 43
Equilibrium of monopolist ............................................................................................................ 43
Losses in the short run .................................................................................................................. 43
Long-run equilibrium .................................................................................................................... 44
Price Discrimination ...................................................................................................................... 45
Conditions for PD.......................................................................................................................... 45
Concept of consumer surplus ........................................................................................................ 46
Degrees of Price discrimination ..................................................................................................... 47
International price discrimination ................................................................................................. 47
Session 9: Chapter 11 ........................................................................................................... 48
Monopolistic Competition ............................................................................................................ 48
Product Differentiation ................................................................................................................. 49
Selling cost ................................................................................................................................... 49
Equilibrium of firm under monopolistic competition...................................................................... 49
Short-run equilibrium of the firm under monopolistic competition ................................................ 50
Long-run equilibrium of the firm under monopolistic competition ................................................. 50
Long run equilibrium of the firm under perfect and monopolistic competition ............................... 50
Wastes under monopolistic competition ....................................................................................... 51
Oligopoly...................................................................................................................................... 51
Kinked demand curve ................................................................................................................... 52
Sources of oligopoly...................................................................................................................... 52
Cartel ........................................................................................................................................... 53
Session 10: Chapter 16 ......................................................................................................... 54
Introduction ................................................................................................................................. 54
Why intervention? ........................................................................................................................ 54
Causes of intervention .................................................................................................................. 55
Example of Market failures ........................................................................................................... 55
Causes of market failure ............................................................................................................... 56
Tools of intervention .................................................................................................................... 57
Price regulations ........................................................................................................................... 58
Price ceiling .................................................................................................................................. 58
Price Floor .................................................................................................................................... 58
 MANAGERIAL ECONOMICS
SESSION 1: CHAPTER 1 AND 2
MANAGERIAL ECONOMICS

• Application of economic concepts, theories and

tools to business problems to take sound business
decisions
• How managers make economic decisions by
allocating the scarce resources (limited skilled
workers, machinery and equipment, limited
financial capital for entrepreneur) at their
disposal
• Manager must understand the behaviour of other
decision makers in the process of production –
workers, consumers, producers, government, etc.

DEMAND FUNCTION (DETERMINANTS OF DE MAND)

A functional relationship is generally between dependent (demand) and independent (other) variables.

• Dx (Demand for commodity x) = f (Px, Ps, Pc, Y, T, A, Pe)

• Px = Price of commodity x. Has a negative relation (inverse relation) with Dx under the assumption of
other things remaining the same
• Ps = Price of substitutes. If price of substitute increases, Dx increases. So positive relation. (Price of coffee
increases, the demand for tea goes up)
• Pc = Price of complementary goods. When commodity X and C are jointly demanded, they are
complementary goods. So when Pc rises, Dx falls. (Cameras and film, coffee and sugar)
• Y = Income. Dx is positively related to Y i.e. if increase in income causes the demand for a commodity also
to increase, it is a normal good. But if an increase in income leads to a fall in the demand for a commodity,
it is called an inferior good (low quality).
• A = Advertising expenditure. Positive relation between Dx & A.
• T = Tastes and preferences. A change in T is not directly measurable. But if a good becomes more
fashionable, more healthful people will buy more of it. E.g. Peer pressure
• Pe = Price expected in future. If consumer expects the future price to rise, the Dx is high and vice versa

DEMAND CURVE

• The relationship between price and quantity demanded , holding the

other factors that influence demand, constant, we get the demand
curve.
• There is a negative relationship between price and quantity.
• Demand curve is negatively/downwardly sloped – price increases,
demand falls. At Pa, demand is Qa and at Pb, demand is Qb.
LAW OF DEMAND

Other things remaining the same, fall in price of a commodity leads to increase in demand and vice versa.

Some of the Assumptions of the law

• The income of the consumer remains constant.

• Consumer tastes and preferences remain constant.
• Price of related goods remains unchanged.
• Population size remains constant.
• Consumer expectations do not change.

Exceptions to the law of demand

• It is a condition where law of demand is not applicable. That is, with increase in price, the demand for that
commodity does not fall.
• Giffen goods – inferior goods (low quality commodity that consumes don’t buy when income increases)
• Veblen goods – superior goods (consumers believe that high price = high quality)
• Conspicuous necessities – TV, mobile, etc
• Consumer’s ignorance – belief about high price high quality.
• Situation of crisis/future expectations (cases like floods)

SHIFT IN DEMAND CURVE AND MOVEMENT ALONG THE DEMAND CURVE

Shift in demand curve

• Shift in demand curve is also known as increase or

decrease in demand. It occurs due to change in the
factors other than price (Px) of a commodity.
• These factors are income of a consumer, taste and
preferences, change in the price of related goods, etc.
(i.e. if Ps, Pc, Y, T, etc. change)
• Change in quantity -> change in demand curve

Movement along demand curve

• It is an expansion or contraction in demand

• It is also called as increase or decrease in quantity
demanded (as against the increase and decrease in
demand in the earlier slide)
• It occurs because of change in the price (Px) of a
commodity under consideration.
• Change in quantity demanded -> movement on same
demand curve
SUPPLY

• Quantity supplied is the amount of good that firms want to sell at a given price holding other factors
constant.
• There is a positive relationship between the price and supply of a commodity.

DETERMINANTS OF SUPPLY (SUPPLY FUNCTION)

• Qs = f (Px, Pc, T, G)
• Qs – Quantity supplied of a good
• Px – Price of that good: positive relation
• Pc – Price of factor input: cost of production - inverse relation (because high cost will bring down profit
margin)
• T – Technology used for production – obsolete technique, less production. Technological advancement –
more supply, so positive relation
• G – Government rules and regulations (govt encouraging environmentally friendly (green) goods like solar
panels may impose heavy taxes on goods that harm the environment, like chemicals)

SUPPLY CURVE

• A supply curve shows the quantity supplied at each

possible price, holding other factors (even demand) that
influence firm’s supply decisions.
• It shows a positive relationship between supply and the
price of a commodity.

LAW OF SUPPLY

• The law of supply explains the relationship between price and supply of a product.
• According to the law, the quantity supplied increases with a rise in the price of a product and vice versa
while other factors are constant.
• The other factors may include customer preferences, size of the market, size of population, etc.
• According to the law, both price and supply move in the same direction
SHIFT IN SUPPLY CURVE AND MOVEMENT ALONG THE SUPPLY C URVE

Change in supply due to factors other than change in price (such

as change in technology, govt rules, increase in cost of production,
etc.)

Movement = expansion or contraction in supply.

Supply changes along the same supply curve solely due to

change in price.

Ceteris Paribus = Other factors remaining the same.

MARKET EQUILIBRIUM

• Market is a place in which the buyers buy Other things remaining the same, at price 40 demand
and sellers sell goods, services and resources and supply are equal so this is equilibrium point.
• Demand and supply are in equilibrium when
the demand curve intersects with the supply
curve for a commodity.

Buyers want price to be low, sellers want it to be high. The price which
both agree with is called equilibrium price.
SHIFT IN DEMAND/SUPPL Y AND EQUILIBRIUM

Market equilibrium will shift if either the demand or the

supply shifts.

In the first diagram, supply remains the same but demand has
increased. For e.g. when tastes and preferences change.
Demand changes immediately but supply change may take
time. Equilibrium point changes from P to M and stays at M
until supply changes.

In the second diagram, it is exactly opposite. Supply increases

from S to S1 because of factors like govt policies or decrease
in cost of production. Demand remains the same. Price comes
down from P to M.

COMPLEX CASES OF SHI FT IN EQUILIBRIUM

• Simultaneous shift in demand and supply curves may

take place.
• If shift in supply is more than the shift in demand,
equilibrium price falls (Which of the two is stronger will
decided whether price will increase or decrease. E.g. if supply
increases faster than the demand, price will fall, and vice
versa)
• If shift in demand is more than the shift in supply,
the price increases.

SESSION 2: CHAPTER 2 AND 3

ELASTICITY OF DEMAND

Introduction

• We have learnt how different factors qualitatively affect the demand for a particular commodity and the
direction (neg/inverse or pos/direct) of change in quantity demanded with respect to other factors.
• But many times a knowledge about only the direction of change is not sufficient. The measurement or
quantity of change also should be known.
• Elasticity of demand helps in quantitative measurement (by how much?) of a change in demand due to
change in any of the factors influencing (determinants of) the demand such as price, income of consumer
or a price of related good.
PRICE ELASTICITY OF DEMAND – MEANING AND TYPES

Meaning: degree of change in demand for a commodity due to change in –

• Price of that commodity – Price elasticity of demand

• Income of a consumer – income elasticity of demand
• Price of an other commodity (substitute or complementary good) – cross elasticity of demand.

Types

• Perfectly elastic demand: Price increases or decreases, demand

will become 0. Only theoretical, not practical. E.g. price of pen falls
from Rs. 5 to Rs. 3 (something must be wrong) or price increases
from Rs. 5 to Rs. 7 (not worth it). Diag: Demand is infinite at a
single price, so demand curve is a horizontal straight line. If price
moves above or below the demand curve, demand become zero.

• Perfectly inelastic demand:

Demand doesn't change no matter the price. E.g. 1 kg of salt per month. Sale
has no close substitute, so demand is inflexible. We won't eat more salt even
if price falls. Diag: Whether price is OP1 (high price) or OP2 (low price),
demand will remain at OQ1. Demand curve is vertically straight line.

• Relatively elastic demand: Price increases by 10%, demand falls by

20% E.g. luxury, comfort goods – pair of extra shoes for fashion or
variety. We won’t buy if price increases. We will buy more if there is
a sale. Diag: Demand curve is flat. P:P1 is less than Q:Q1, meaning
demand change is more than proportionately.

• Relatively inelastic demand:

Price increases by 10%, demand falls by 5% E.g. demand for essential,
necessary goods like wheat won’t change much if price rises. If price
rises, we may reduce the intake but not stop it completely. Similarly, we
will not eat more even if price falls. Diag: P:P1 is greater than Q:Q1.
Demand changes less than proportionately.

• Unitary elastic demand: Price increases by 10%, demand falls by 10% Hyperbola
curve
(exactly proportionate, unitary value = 1). (Infinite demand only at one
given price (OD). Demand becomes 0 if price changes even a little.) Diag:
Q:Q1 is exactly equal to P:P1. Change in price = Change in quantity.
CALCULATION OF PRICE ELASTICITY OF DEMAND

Ep (Price elasticity of demand) = (change in Q / change in P) x P/Q

Suppose P (old) = 450, P1 (new) = 350, Q = 25,000, Q1= 35,000
Then change in P = 100 and change in Q = 10000
Ep = (10000/100) x 450/25000 = 1.8

EXERCISE

FACTORS AFFECTING PRICE ELASTICITY OF DEMAND

• Availability of substitutes: If close substitutes are not available, a consumer is likely to be too much
dependent on the product and hence the elasticity will be low. E.g. Sugar has more substitutes than salt.
• Proportion of total expenditure spent on product (impact of income): If the proportion is large, demand
will be sensitive to price change and elasticity will be high
• Time period of adjustment: Greater the time span, higher is the elasticity for the same product. A
substitute can be explored in the long run. Oil price rise of 1970s is the best example. The demand for oil
was highly inelastic at that time. But over time other forms of energy were explored.
• Individual’s habits: A product may be essential for someone but not so for the others. E.g. Brown bread,
jogging shoes.
PRACTICAL APPLICATIONS OF ELASTICITY OF DEMAND

• To businessmen – for pricing policy (because a businessman should know what kind of commodity his firm
is producing and if it has an elastic or inelastic demand and if its price should be increased or decreased.)
• To government and finance minister – for selecting commodities for taxation (tax revenue) E.g. If tax
revenue is the objective and tax is imposed on luxury goods, its price will go up, demand will drastically
come down, and government’s tax revenue collection will be less. So generally tax is imposed on essential
goods with relatively inelastic demand. In India, a large amount of tax revenue comes from sugar, tobacco
and tea. Tax will be very small in denomination, but since a large number of our population is consuming
these goods, tax revenue is high.
• International trade – export import policies: Subsidies for exports and heavy taxation on imports in order
to regulate balance of payments, i.e. difference in imports and exports when exports are higher
• Agricultural policy makers – relation between a bumper crop and farmer’s condition: Bumper crop >
supply is very high and price comes down. But elasticity is low because they are essential goods. So
farmers are in a loss if the government doesn’t support them with MSP (minimum support price)
• For trade unions – dearness allowance: income elasticity of demand is important for trade unions

INCOME ELASTICITY OF DEMAND

Meaning: degree of responsiveness of demand for a commodity for change in income of a consumer is called
income elasticity of demand.

Ey = (change in Q / change in Y) x Y/Q

where Y stands for income
Income elasticity may be positive or negative depending upon the nature of commodity.

INCOME ELASTICITY TYPES

• Normal goods: Income up -> demand up.

E.g. fruits, cake
• Inferior goods: Income up -> demand down.
E.g. cheap, low quality bicycle
• Answers in calculation will be either
positive or negative depending on whether the
goods are normal or inferior

CALCULATION

Income elasticity from A to B: (100/2000) x (4000/100) = 2 (normal) Calculate income elasticity of

Income elasticity from G to H: (-100/2000) x (16000/350) = -2.29 (inferior) demand for movement of
Income elasticity from B to C: (100/2000) x (6000/200) = 1.5 (normal) income from A to B, B to C, C to
Income elasticity from C to D: (50/2000) x (8000/300) = 0.67 (normal) D, D to E, E to F, F to G, G to H
CROSS ELASTICITY OF DEMAND

Meaning: degree of responsiveness of demand for a commodity to a given change in the price of some related
commodity.

Ec = (change in Qx / change in Py) x (Py/Qx)

It can be either positive or negative depending upon whether a related commodity is a substitute or a
complementary good.

CROSS ELASTICITY TYPES

3 types: Positive, negative, zero

“or” means substitute, e.g. tea or coffee. Tea price up ->

coffee demand up, hence positive relation and value

“and” means complementary, e.g. car and petrol. Car

price up -> petrol demand down, hence negative relation
and value

Some independent, unrelated goods, e.g. pen and fridge.

Change in price of pen will not affect demand for fridge.

CALCULATION

Bread and Butter

(10/-1) x (7/80) = - 0.88 (complementary)

Tea and Coffee

(10/1) x (4/50) = 0.8 (substitutes)

CASE STUDY
ELASTICITY OF DEMAND AND REVENUE

Impact on Total Revenue

SESSION 3: CHAPTER 3 AND 4

DEMAND FORECASTING

• Risks and uncertainties in dynamic world of business (has become global and complex today)
• Need to mitigate them to avoid huge losses
• Process of predicting demand for the products or services of a firm in a specified time in future is called DF.
E.g. Demand prediction for the products of a business for the next 10 years
• Required by both new and existing firm
o New firm for deciding/expanding scale (firm should be small, medium or large size and which
product/area is going to be in demand in the future and where investment should be done)
o Exiting firm to avoid under/over production

RISKS IN BUSINESS

• Failures of technology (new mobiles, laptops are introduced and they fail (no demand) after a short period
of success), change in government policies (many firms are still not used to GST), natural disasters (risks
 that are out of our control but need to be considered to plan business strategy), economic fluctuations
(India became global after 1991 and LPG i.e. liberalization, privatization and globalization policy was
introduced. Liberalization: Strategically important firms earlier in the hands of the govt were liberated and
investment in them by private domestic or foreign firms was allowed. Privatization: Public sector
industries were allowed in the private sector as well. Globalization: Foreign companies were allowed to
invest in India and Indian companies in foreign countries, collaborations were encouraged to connect with
the global economy. So economic fluctuations throughout the world affect Indian companies as well.)
• By having the knowledge of future demand for the product, through demand forecasting, these risks can
be minimized (If we can predict recession in the near future, we will know that we shouldn’t expand the
business right now. If we know things are fine, we don’t have to wait for expansion)
• Such a knowledge helps the firms to take various business decisions more efficiently such as planning
production process, purchasing raw materials (and keeping them in the inventory), managing funds (for
expansion) and deciding prices

CONCEPT OF DEMAND FO RECASTING

Demand forecasting can be defined as a

process of predicting the future demand for an
organisation’s goods or services. There are
three bases for performing demand
forecasting:

Demand forecasting is classified based on

certain factors such as level, time period and
nature of products.

• Levels of forecasting
o Firm Level (single unit, e.g. Ambuja cement, Narmada cement) – to estimate demand for a firm
o Industry Level (group of units producing a single commodity, e.g. cement industry) – to estimate
demand for an industry through Industry Association (association for each industry which looks
after the demand/supply forces and future of that particular industry, meetings to discuss
problems and solutions, laws, etc.)
o Economy Level (different industries in secondary sector, macro concept) – predicting aggregate
demand for industrial production for a nation as a whole. Macro level demand forecasting is
based on propensity to consume of the society. (Economic activities in a country are divided into
3 major activities: primary, secondary, tertiary. Primary: directly dependent on nature, e.g.
fishing, agriculture, mining. Secondary: indirectly dependent on nature, we take something from
nature and convert it through the process of production, e.g. cotton to cloth. Tertiary: services,
for which we don’t depend on raw materials from nature, e.g. sales, commerce, defence,
construction, manufacturing)
• Time period involved
o Short term, not exceeding one year (seasonal changes in demand, sales targets, promotional
policies, advertisement) – in case of demand for inputs, arranging finance, formulating
production policy, promotional policy, price policy, fixation of sales targets, etc. (E.g. Demand for
greeting cards will be high in the festive season, so the firm will have to decide much earlier to
buy inputs or raw materials for them well in advance since their price will also be high when
greeting card demand is high)
 o Long term, over 5 years. – firm’s scale of operations may change during this period - it is useful
for making decisions like setting up of R&D infrastructure for the introduction of a new product or
for setting up new major plant.
• Nature of products
o Consumer goods – meant for final consumption. They have direct demand. (E.g. bicycle)
o Producers/capital goods (demand for machinery, equipment, raw material, intermediate
products depend on consumer demand) – required for production of consumer goods. They have
derived demand. (E.g. demand for cement depends on demand for housing or demand for
intermediate goods like tires, car accessories depend on demand for bicycles, cars)

NEED FOR DF

• Producing the desired output, predetermined – so that desired quantity of factors of production can be
managed (for better planning, scheduling and efficiency)
• Assessing probable demand
• Forecasting sales figures – historical sales data and current market trends are useful (what is growth rate
of sales, which months sales are high, which season sales are increasing)
• Better control – control over business through understanding of cost, profit, etc.
• Inventory control – raw material, semi-finished goods, spare parts (keep stock to be prepared for changes
in the market, when demand is high)
• Manpower planning – to avoid under/over employment (over-employment – some people will be idle)

FACTORS INFLUENCING DF

• Prevailing economic conditions – NI (National Income), PCI (Per Capita Income), growth rates, savings and
investment affect DF (E.g. Indian saving rate is relatively very high, about 20-25% of the country’s income
is saved, which is a very high ratio. This can be extracted by introducing them to different financial assets)
• Existing conditions of industry – degree of competition in industry (monopoly related trends or too many
firms producing a product, which are the dominant firms, how are they growing, their profit conditions)
• Existing conditions of organisation – plant capacity, advertising expenditure, etc. of a firm (in a family
business – vision of the family, traditional vs modern family)
• Sociological conditions – population size, age group, family income, educational level, etc. (demographic
dividend, which India has because of largest young population, helps in demand forecasting because
young people spend more, not worried much about savings, market widens)
• Psychological conditions – consumers’ attitude, habits, beliefs (what kind of food, clothes, etc. are
preferred)
• Export-import policies
TECHNIQUES OF DEMAND FORECASTING

QUALITATIVE METHODS
First hand data, data collected on the spot. Not based on past data.

SURVEY METHOD
• CS may involve questioning
consumers about how they would
respond to particular changes in
price of commodity, incomes,
price of related goods, advertising
expenses, incentives, etc.
• Consumer surveys may be in the
form of complete enumeration
(E.g. Census survey in India once
in 10 years, collected from each and every consumer of a particular product. It’s a huge task) or sample
survey (E.g. Data collected by NSSO – National Sample Survey Organization, it is more common than
enumeration. Data is collected from a sample group and generalized for all other consumers. In statistics,
it is said that sample survey is a much better method of collecting information as compared to census
survey, only that how we select the sample is very important. Sample should be true representation of
the population.)
• This method is based on the assumption that the consumers' decisions to purchase houses, automobiles,
etc. are made in advance of actual expenditure.
• Problems with this method are: consumer may give socially acceptable answers (e.g. for cigarettes or
liquor), may not reveal accurate information, costly method (there may be rewards in exchange of
answering questions).

OPINION POLLS
Taking opinions of those who possess the knowledge of market trends such as sales representatives, marketing
experts, and consultants. (Usually opinion and survey are combined) Most commonly used opinion polls are:

• Delphi Method
• Sales force polling

Delphi method

• Here the market experts are provided with the estimates and assumptions made by the other experts in
the industry.
• These estimates may be revised or reconsidered by these experts.
• Consensus of these experts is considered for estimating the future demand.

Sales force polling/experts opinion

• In this method, the sales representatives of different organisations in the same industry get in touch with
the consumers.
 • Information is collected about their buying behaviour.
• On the basis of that estimate is made about the probable demand.

MARKET EXPERIMENTS
• These are conducted at actual market places.
• To select several markets with similar socio-economic characteristics (e.g. in the same city) and change the
price in some markets, change the type of promotion in some other markets, change the packages in still
other markets and responses are recorded. (E.g., if the commodity is ketchup, we divide the market into 3
– one where packaging is changed, one where flavor is changed, and one where price is changed. This is
done because consumers are not aware that they are part of this experiment and it takes place in a
smaller market. It is an expensive method but gives more accurate results.)
• Advantage here is that the consumer is not aware that he is a part of experiment. This method is useful in
testing different packages, in introducing new product, determining best pricing strategy.
• Disadvantage – permanently loosing consumer due to experiment of raising price, competitors also may
monitor the experiment, small experiment may not help in generalising for big markets.

QUANTITATIVE METH ODS

Historical (past) data needed for statistical methods

TIME SERIES ANALYSIS

• Value of variable arranged chronologically by days, months, years, etc. (One variable is always be time,
e.g. wheat production for last 25 years, price of shares in the past week, sales of toys over last 10 months)
• Here the attempt is made to forecast future values on the basis of the past observations (by assuming that
the same trends will continue, e.g. Demand for toy car over the past 10-20 years)

Variations in the time series data

• Irregular variations – strikes, natural calamities

• Seasonal variations – for seasonal products (E.g. demand for umbrellas goes up in June/July, then falls)
• Cyclical variations – as per the phases of business cycles (E.g. production of iron goes down every 5 years)
• Trend – long run/secular change in the data (Continuously rising or falling, e.g. use of bullock carts)

OTHER TECHNIQUES
• Trend projection – projecting past trends by fitting a straight line to data either graphically or by
regression analysis
• Smoothing techniques – predicting values of time series on the basis of some average of its past values.
Irregular or random variations are smoothened out.
• Barometric techniques – rise in general economic indicators are used to forecast increase in business
activity

REGRESSION ANALYSIS
Demand estimation by scatter diagram method.
• Linear regression
o Y = a + bX
 o a and b are constants.
o a is intercept coefficient
o b is slope coefficient
• Regression analysis implies the estimation of these two coefficients.
• Y may be quantity demanded and X may be a price of product.

ECONOMETRIC MODELS
• These identify and measure the relative importance or elasticity of the various determinants of demand
• They help the managers to determine the optimum policies for the firm by explaining the relationships
• Single equation models explaining the demand for the product of the firm to multiple equations models
describing hundreds of sectors and industries together

(Econometricians know mathematical (data science) and economic techniques. Raghuram Rajan)

LIMITATIONS OF DF

• Lack of historical data

• Unrealistic assumptions (like “past trends will continue in the future”)
• Cost incurred
• Change in fashion
• Lack of expertise
SESSION 4: CHAPTER 4
INTRODUCTION

• Why would a consumer buy less when a price of commodity rises?

• It depends upon consumer behaviour – certain characteristics of consumer and his budget constraint.
• It based on the premise that the people choose those goods and services that they value most highly.
• There are different approaches to study consumer behaviour – marginal utility approach, indifference
curve, revealed preference approach
• To explain consumer behaviour, it is assumed that the consumer is rational. It means, there are 3
properties of a consumer
o Completeness/decisiveness – consumer can make a choice by ranking the goods. They can make
decision
o Transitivity – their preferences are consistent (during the period of study/analysis)
o More is better – consumer is never completely satisfied (this is imp because without this
characteristic, market mechanism won’t work and business will not grow)

CONCEPT OF UTILITY

• Utility – satisfaction that a consumer gets by consuming a particular commodity.

• Total utility is the sum of utility derived by a consumer from different units of a commodity.
TU=U1+U2+U3+U4 (considering one commodity at a time)
• Marginal Utility – (satisfaction a consumer gets by consuming one additional unit)
change in Tux / Change in Qx

MARGINAL UTILITY APPROACH

• This approach is popularised by Alfred Marshall.

• An individual buys something because it provides him some pleasure or
satisfaction.
• That means, goods are desired because of their ability to satisfy human wants.
This is total utility defined as total satisfaction obtained from consuming a
particular quantity of a good. (Alfred Marshall believed that we can measure this
satisfaction) It is measured in some psychological unit “Utils”
• As consumer consumes more of a good, total utility or satisfaction increases but
their marginal utility diminishes.
• MU is the extra utility derived from consuming extra unit of a product.

LAW OF DIMINISHING MU

• The pattern of marginal utility implies that the MU of consumption goes on falling and becomes negative
after certain level of consumption.
• No matter how much you like something, after consuming a certain amount, the intensity of desire for it
gradually falls. This law implies why the demand curve is downward sloping.
• This law is based on assumptions like – utility is measurable, utility can be added, marginal utility of
money remains constant (satisfaction from more money never goes down), consumers are rational.
https://www.youtube.com/watch?v=-01GuzRWYHo – Law of diminishing marginal utility.

ORDINAL APPROACH TO UTILIT Y

• This is a modern approach to consumer theory. (Put forward by Hicks. Earlier approach was cardinal
approach by Marshall, with cardinal meaning satisfaction can be calculated. Ordinal = ranking)
• It tries to remove the deficiencies of the earlier approach (such as adding utility, measuring it in numbers
(e.g. we can’t measure utility of TV in number of TVs consumed, its utility is dependent on many
characteristics such as screen size, volume, functions, etc. which can’t be divided), indivisibility of goods)
• It takes into account consumers’ preference for various goods consumed together (not single commodity).
• It takes into consideration the budget constraint and the interlink between demand for various goods.
• It also does not measure satisfaction with cardinal units but compares or orders the satisfaction.

INDIFFERENCE CURVE

A tool or technique used for ordinal approach of utility.

• An alternative to MU app. is indifference (doesn’t make any difference to us, okay

with any choice) curve approach
• An indifference curve shows various combinations of two goods that give the
consumer equal utility or satisfaction. A higher IC indicates higher level of satisfaction
and vice versa.
• Table: Person can have 0 kulfi and 15 chocolates or 3 kulfis 7 chocolates

TYPICAL INDIFFERENCE CURVE

• Combination A -> 60 Y and 10 X

• Combination B -> 40 Y and 20 X
• Combination C -> 20 Y and 40 X
• Combination D -> 15 Y and 50 X

All combinations A, B, C, D give equal level of satisfaction to the consumer. It

makes no difference to the consumer whether they go for A or B. This
satisfaction is not counted but felt.

Consumption of X increases -> Consumption of Y falls

INDIFFERENCE/PREFERENCE MAP

• A complete set of ICs that summarise a consumer’s taste.

• Each curve in a map stands for some level of satisfaction.
• Higher and higher levels of satisfaction are represented by 1,2,3 and 4
• If you increase consumption of both commodities equally, you will move to a
higher level curve. E.g. A young person is growing and doing a lot of physical
activity will eat more, will be on 4th indifference curve.
• As we move higher and higher, the level of satisfaction keeps increasing.
PROPERTIES OF IC

• They are negatively sloped (Consumption of one commodity rises, other falls. If it’s a straight line,
preference for one commodity doesn’t change, so there is no indifference). This is because to be on the
same level of satisfaction, consumer will have to consume less of one commodity if he consumes more of
another.
• Higher IC represents higher level of satisfaction because on higher IC, the consumers can get more amount
of both the commodities.
• They cannot intersect. Otherwise the point of intersection will be on the two ICs giving two different levels
of satisfaction which is inconsistent
• They are convex to the origin due to decreasing marginal rate of substitution.

Property 4
• To move from combination A to B, the consumer has to give
up Y for some additional amount of X.
• ΔY represents the amount of Y sacrificed
• ΔX represents the amount of X gained (same amount, 1 unit)
• Initially a lot of Y is sacrificed, but for every additional (same)
amount of X
gained, the
sacrifice of Y
becomes lesser.

Property 3

• Suppose IC 1 has 100 satisfaction and IC 2 has 150

satisfaction. B is the point of intersection, but it can’t be
both 100 and 150. So IC curves can’t intersect each other.

MARGINAL RATE OF SUB STITUTION

• The rate of sacrifice of a good for the other along a given IC is called marginal rate of substitution.
• It is the amount of one good that an individual is willing to give up for an additional unit of another good
while remaining on the same IC or while maintaining the same level of satisfaction
• Calculation: ΔX/ ΔY (To get more of X, how much Y are we sacrificing or vice versa)
TYPES OF INDIFFERENCE CURVES

Two extreme types:

• Perfect substitutes (straight line ICs) – coke and pepsi, so one

glass of coke will be exchanged for one glass of pepsi. Having
only coke or only pepsi will give you the same level of
satisfaction. They are straight because there is no diminishing
marginal rate of substitution. We will get the same value by
adding one unit of pepsi and sacrificing one unit of coke.

• Perfect complements (right angle ICs) – both the commodities

are consumed in the fixed proportion. Example – Right shoe and
left shoe. If we have only one right shoe, it doesn’t matter how
many additional left shoes we get, satisfaction won’t increase.
The only way for value to increase is to get more complete pairs,
e.g. 2 additional left as well as right shoes.

CONSUMER’S BUDGET LINE

• It is a constraint or limitation faced by a consumer in satisfying his wants

• IC represents consumers’ taste and budget line represents their limitations.
• Budget constraint is either due to limited income or due to given prices of goods.
• Changes in income or in the prices of goods will bring about change in the budget line.

TYPICAL BUDGET LINE

Suppose the consumer has Rs.1000. If he spends the entire amount on Y,

he reaches point A. If he spends it on X, he reaches B. Any point on line
AB will be a combination of X and Y and the sum amount spent will be
under 1000. Budget line AB gives us all those points that are within the
budget of the consumer.

Point A = Units of commodity Y that can be afforded = M/Py where M is

the budget and Py is the price of commodity Y

Point B = Units of commodity X that can be afforded = M/Px where M is

the budget and Px is the price of commodity X
UTILITY MAXIMIZATION

• In order to maximize utility, an individual tries

to reach to the highest possible IC with his
budget line. So the consumer should be on the
indifference curve as well as the budget line.
Income curve explains consumer’s willingness
or preference and budget line explains the
individual’s capacity or ability to buy.
• In order to have equilibrium with maximum
utility, both these have to be brought together.
This occurs when IC (MRSxy) is tangent to the
budget line (Px/Py) so that the slope of IC is
equal to slope of budget line. More is better for
the individual but at the same time his budget is a constraint. Given a choice, he would select point D,
because that point would have given him the highest level of satisfaction (both X and Y will be highest).
But since budget is a constraint, the budget line has to be taken into consideration.
• This is called as the consumer’s equilibrium or optimization. Equilibrium is where indifference curve and
budget line meet – Point A, B, C, E.
• But there is a difference in all these intersections. At point E, budget line is tangent to indifference curve.
Also, point E is the equilibrium point giving maximum satisfaction to the consumer within his budget
because it is on the highest possible indifference curve.

CASE STUDY
• In a study, an economist Goldberg examined data on purchase of large passenger cars in the US between
1984 and 1987. Her study shows that the a typical new car buyer shows preference for two characteristics
– horsepower and fuel economy. She also found that the buyer is willing to sacrifice some power and
acceleration for greater fuel efficiency.
• What are the implications for:
o Manufacturers
o Policy makers

ANSWER KEY
• Understanding consumers’ willingness to trade horsepower for fuel efficiency is important for both the
automobile manufacturers and public policy makers.
• The manufacturers can use this information for designing of a car to appeal the consumers. Consumers
consider fuel efficiency as the most important feature and not acceleration. So cars that are more fuel
efficient will be projected by manufacturers.
• Policymakers can use it to evaluate the likely success of policies that encourage consumers to purchase
fuel-efficient cars. Fuel efficiency or environmental sustainability may be the objective of the government,
so they may tax cars that are not fuel efficient and price of those cars will go up. Govt may give tax
concessions to fuel efficient cars. If consumers prefer cars with better acceleration over fuel efficiency,
then the government’s objective will not be achieved.
INCOME EFFECT ON CONS UMER’S EQUILIBRIUM

• When the income of the consumer changes, there is a parallel shift in

the budget line and it is equal to the increase in income.
• Suppose income is 1000, number of apples that can be purchased will
be on line B1 and indifference curve I1.
• If income increases to 1500, number of applies that can be purchased
will now be on line B2 and indifference curve I2.

PRICE EFFECT ON CONSUMER’S EQUILIBRIUM

• Point A represents number of oranges that can be purchased

with Budget line 1 and indifference curve U1.
• If the price of oranges goes up, it brings a change in the slope
of the budget line (as less oranges but same number of apples can
be purchased with given income now) and point C is now the point
of equilibrium. Earlier budget line was flatter, new one is steeper.
• So the purchasing power (real income) of the consumer has
reduced.
• Individuals satisfaction level has come down. And the new
combination has more of apples and less of oranges.

MANAGERIAL IMPLICATIONS

• Simplifying consumer’s choices – Too many choice before the consumers. For example – Cable tv channels.
To avoid making decisions, in such a case, consumers prefer not to buy.
• To avoid this problem, a good manager makes a decision-making easier for consumers. They may offer
default bundles/options/packages. Sports package, movie package.
SESSION 5: CHAPTER 5
IMPORTANT CONCEPTS

• Production – transformation of resources or inputs into output. Creation of goods and services from inputs
or resources, such as labour machinery and other capital equipment (technology), land, raw material and
so on.
• Output of a firm can either be a final commodity such as a personal computer or an intermediate product
such as semi-conductors. The output can be a service like education, medicine, banking, communication or
transport
• Inputs are the resources used in the production of goods and services. They are grouped into three broad
categories:
o Capital – long-lived inputs like land, buildings, equipment
o Labour – human services like managers, skilled workers, less skilled workers
o Materials – natural resources and raw goods like oil, wheat and processed goods like plastic,
paper, steel

FIXED AND VARIABLE INPUTS

• Fixed factors (constant, not easily available inputs like land, labor, capital and organization) of production
are those that cannot be readily changed during the time period under consideration. Such as firm’s
plants, and specialised equipment (machinery is huge and expensive).
• Variable factors (easily available) of production/inputs are those that can be varied easily and on a very
short notice. Such as raw materials and unskilled labour (skilled labor cannot be changed easily.

SHORT-RUN AND LONG-RUN PERIOD

• Short Run
o Period of time in which quantities of one or more production factors cannot be changed (Some
factors are fixed, some variable. Supply doesn't change.)
o These inputs are called fixed inputs
• Long Run
o Amount of time needed to make all production inputs variable (Can increase the supply of all its
inputs)
• Short run and long run are not time specific. For example, for setting up or expansion of a dry-cleaning
business, long run will be only a few months (Dry-cleaning shop can hire more employees, open more
shops within 6 months). For the construction of a new electricity-generating plant, it may be many years.

PRODUCTION POSSIBILITY CURVE

(Originally a macro concept)

• At any given point of time, the resources available to an economy – size of working population, land,
building, machinery – are all given.
• So if more resources are used for one sector, less will be available for the other sectors.
• So a combination of goods and services has to be decided for an economy.
Production Possibility Curve

• It is based on the famous gun-butter paradox (Dividing the

economy into two major goods: Gun - military goods, Butter
- civilian goods)
• Concepts of scarcity, choice and efficiency can be well
understood with the help of PPC
• In PPC, guns represent military goods and butter represents
civilian goods.
• PPC slopes downwards which reflects scarcity of resources.
To get more guns, society has to sacrifice butter
• PPC is concave (Curve indicates that earlier resources were
used for one use (military goods) and now they're being used
for another use (civilian goods)) to the origin indicating the
increasing relative cost of transferring resources from one sector
to another. Shift towards the origin indicates
negative economic growth
• The curved line represents all the possible combinations of guns
and butter that could be produced under the assumptions of the
model
• With given resources, country can produce either more of guns or
of butter.(B or C)
• Pt. F indicates inefficiency
• Pt. E is unattainable with the given resources
• Movement from one PPC to other indicates expansion of resources
• (PPC helps explain 4 issues in the economy: Scarcity, alternative
uses, efficiency/inefficiency, economic growth)

EXAMPLES
• Pt. A: Total resources worth 100 crores. All used only to produce guns: Point A. All used only for butter:
Point D.
• Pt. B: More military goods or 50-50 military-civilian. Those who want political power.
• Pt C: More civilian goods. Peace-loving countries.
• Pt F: Underutilized (not utilizing all 100 crores) of resources or wastage of resources
• Pt E: Not accessible or unreachable with 100 crores by this country. Needs shift in PPC -> economic growth

PRODUCTION FUNCTION

• Meaning of production function

• Production function is a technological relationship between physical inputs and physical output of the firm.
• Q = f (LB, L,K, M, T, t)
• Quantity of output is a function of or depends on the Land and building, labour, capital, raw material,
technology and time used up in production.
PRODUCTION FUNCTION (SHORT RUN) – ONE VARIABLE INPUT

• The short run production function is given as

• Q f(L, ǩ ) where
o L – labour which is variable
o ǩ - Capital which is constant
• In the short run, the law of variable proportions or the law of diminishing marginal return is applicable. For
this, following concepts need to be understood.

EXAMPLE
• A firm - XYZ assembles computers for a manufacturing firm that supplies XYZ with the necessary parts
such as computer chips and disk drives. If the assembly firm wants to increase the output in the short run,
it cannot do so by increasing capital (workstations fully equipped with tools, equipment for testing). But it
can do so by hiring extra workers or paying current workers extra to work overtime.

CONCEPTS OF TP, MP, AP

• TP is the total output

• AP is TP/L assuming that L is a variable factor
• MP is increase in total output due to a one-unit increase in labour. (change in TP/ change in L )

• Change in quantity due to change in labour

units employed

• Wages are same for everyone regardless of

average production. This may result in
inefficient working of the firm after some
time.

• Too much crowding, some workers will have

no work or not sufficient work to do.
Additional workers' production will be zero.
They go for lunch and spend more time,
influence other workers

OBSERVATIONS FROM TH E TABLE

• Initially MP is rising implying that an additional labour unit will lead to specialisation and more efficient
production.
• Then MP starts declining even if TP increases. This is law of diminishing returns. Holding other inputs
constant and technology same, an increase in variable input will lead to fall in the MP after a certain point.
• If still labour is employed, MP will become negative
• In brief:-
 • If MP > 0, TP rises as L rises (Additional L adds to output)
• If MP = 0, TP remains constant (Additional L does not affect output)
• If MP < 0, TP falls (additional L reduces output)

LAW OF DIMINISHING MARG INAL RETURNS

• This diagram shows a graphical relationship between the TP,AP and MP.
• Stage I : TP, AP, MP rise
• Stage II : AP, MP decline, TP rises at diminishing rate
• Stage III: TP falls, MP negative
• Production with two variable inputs (Long run)

PRODUCTION FUNCTION (LONG RUN) – TWO VARIABLE INPUTS

• Firm can produce output by combining different amounts of labor and capital
• In the long run, capital and labor are both variable
• We can look at the output we can achieve with different combinations of capital and labor.

RETURNS TO SCALE

When firm expands its scale i.e. it increases both inputs, there are 3 possibilities :-

• Increasing returns to scale

• Constant returns to scale
• Diminishing returns to scale

(100 L + 100 K = 1000 Q

200 L + 200 K = ? Q

1. Output will more than double

2. Output will double

3. Output will less than double)

INCREASING RETURNS TO SCALE

Increasing r/s : output increases in a greater proportion as compared to the increase in the amounts of factors of
production. If factors are doubled, output is more than doubled. This is due to:-

• indivisibility of inputs(mechanical equipments and managerial skills) 1/3rd part of a tractor cannot be
used, half a production manager can not be employed.
• specialisation.
CONSTANT RETURNS TO SCALE
Constant r/s : output increases in the same proportion as compared to increase in factors of production. Quantity
of factors is doubled, output also doubles.

• This stage is for a long time. This is mainly because of overcoming of the inefficiencies and also due to the
fact that the economies of scale have their own limits.

DIMINISHING RETURNS TO SCALE

Diminishing r/s: output increases in the smaller proportion as compared to increase in factors of production. If
quantity of factors is doubled, the output is less than doubled. Mainly due to managerial problems.

RETURNS TO SCALE IN US INDUST RIES

ROLE OF INNOVATIONS

• Innovation – new idea, device or method which affects the markets in many ways
• Antibiotics, TV, aircraft, PC, internet devices, etc are the outcomes of innovation

TYPES OF INNOVATIONS

• Process innovations – improve method of production for existing goods. These are more frequent
• Organisational innovations – new ways of organising firm. E.g. holacracy – workers are arranged in a
circles without top-down approach
• More output is to be produced with the same level of inputs – it is also called as technical progress
• Technical progress may either be neutral or non-neutral
• Neutral – more output with same ratio of inputs
• Non-neutral – same output with different ratio of inputs – labour/capital saving

CASE STUDY ANALYSIS

Refer to Bajaj Auto case study and answer the following questions.

• Explain the factors responsible for decreasing returns to scale as experienced by the Bajaj Auto. (Global
competition, change in taste and preferences)
• What were the steps taken by Bajaj to increase productivity? (To increase productivity and recapture the
market 1. Change in philisophy/vision of the company "Small is better" 2. Headcount declined, but
 company survived because they must have given proper compensation to workers 3. R&D: New facility
created in a remote area so cost reduced 4. Entry level: cost reduction 5. (Add own opinion))
• Explain the economic theory behind this case. (Long-term strategy - Returns to scale (briefly elaborate all 3
points) Reduced labour as well as size of firm - this case study relates to diminishing returns to scale)

SESSION 6: CHAPTER 6
IMPORTANCE OF COST IN MANAGERIAL DECISIO NS

• Decade 1990 – cost cutting through restructuring, downsizing, right sizing etc. which meant reduce the
number of people on a company’s payroll.
• New dimension added to this is “shared services” which refers to the consolidation of support functions as
finance and accounting, IT and HR. – onshore, offshore, etc.
• Also to merge, consolidate and then reduce headcount. Eg. Jet Airways acquiring Air Sahara and merging
into a new entity called JetLite operating as a low-cost airlines.
• Behind all these is the economic analysis of cost and production function showing the relationship between
cost and production

TYPES OF COSTS

• Opportunity cost – value of next best alternative use of the resource.

• Explicit – actual expenditure of firm to hire, rent or purchase the inputs required in production
• Implicit – value of inputs owned and used by the firm
in its own production activity – highest salary that an
entrepreneur would get in alternative employment.
• Business costs – all expenditures to carry out business.
All payments and contractual obligations made by a
business
• Incremental costs – change in the total costs from
implementing a particular management decision –
new product line, ad campaign
• Fixed cost – costs borne by the firm that do not change
with the changes in output. Eg – depreciation,
administrative cost, rend on land, building, taxes, etc
• Variable costs – directly depend on the production. Raw material, labour expenses, transport cost, etc.
 FC: Straight horizonal curve

VC: Starts from origin and goes upwards

TC: Starts from a positive number and goes upwards,

parallel to VC curve

MC: U-shaped curve

AFC: Falls downward

AVC: U-shaped curve

ATC: U-shaped curve

SHORT RUN COSTS OF P RODUCTION

• Short-run Total Cost: The Short-Run Total Cost (SRTC) of an organisation consists of two main elements:
o Total Fixed Cost (TFC): These costs do not change with the change in output. TFC remains
constant even when the output is zero. TFC is represented by a straight line horizontal to the x-
axis (output).
o Total Variable Cost (TVC): These costs are directly proportional to the output of a firm. This
implies that when the output increases, TVC also increases and when the output decreases, TVC
decreases as well.
• SRTC = TFC + TVC

SHORT RUN COSTS

• Short run average cost

• Short run variable cost
• Short run marginal cost

• ATC- Short run Average cost – is calculated by dividing

total cost by output. It is U shaped in nature. Initially
with increase in output the AC falls and then with
increase in output, the AC increases
• MC – Short-run Marginal cost curve. It refers to the
change in the total cost due to change in the firm’s
output.
COST CALCULATION

Some companies start calculating MC only

from the 2nd unit, so here 10 under MC can
be 0.

LONG-RUN COSTS

• Long run is a period of time during which the firm can vary all its inputs.
• It is a period sufficiently long to permit changes in the plant, capital equipment, machinery, land, etc to
expand or contract the output.
• The long-run cost of production is the least cost of producing any given level of output.
• This is because of economies of scale and diseconomies of scale.
• Firm may incur fixed cost but it is avoidable unlike in short run
o Eg. – rent that a restaurant pays in the long run is fixed cost as it does not change with the
number of meals served. In the short run this cost is sunk cost. Firm may have to pay it even if the
restaurant is not doing well
• But not so in the long run. Shut down is possible.

LONG RUN TOTAL COST CURVE

LONG RUN AVERAGE COST CURVE

Features:

1. It is u shaped

2. It is known as an envelope curve that includes all short run

costs
EXPLANATION OF U-SHAPED COST CURVE

• LRAC curve first declines as the output increases, then remains constant and then rises.
• U-shape of the curve is due to Economies of Scale and Returns to Scale.
• Returns to Scale initially increase, then remain constant and then they decrease. LRAC changes in
accordance with that.
• A major reason why short run average cost curve is U-shaped is the falling average fixed cost.
• But in the long run, fixed costs are not so important
• In the long-run, returns to scale play a major role in determining

RETURNS TO SCALE

LEARNING CURVE

• Average cost over years may fall due to three reasons

o Increasing returns to scale
o Technological progress
o Learning by doing – productive skills and knowledge
that the workers and managers gain from experience.
• Workers – speed of new task increases with practice
• Managers – learn how to organise production more efficiently,
which worker should be assigned which task, where more
inventories are required and where to be reduced
• Engineers – optimise product designs after experimenting on many
o All this results in fall in average cost.
• Learning curve is the relationship between average costs and cumulative output.
o For example, it may take 1000 hours to assemble the 100th aircraft but only 700 hours for 200th
aircraft.
• Learning curves are documented in many manufacturing and service sectors ranging from manufacturing
of aircrafts to appliances, ship building, refined petroleum products to power plants.
• Learning curves also are used to forecast the need for personnel, machinery and raw materials and for
scheduling production and determining price.
SESSION 7: CHAPTER 7 AND 8
OWNERSHIP OF FIRMS

Firms may differ by the types of ownership, how they are managed and whether they seek to maximise their profit.
On the basis of ownership of firm, there are three types of firm:

• Private – owned by individuals or non-governmental entities who earn profits

• Public – owned by the government or govt agencies (their objectives could be profit, social welfare, supply
of essential goods and services, to not have a monopoly, e.g. railways)
• Non-profit – charitable organisations, neither owned by govt not earning profits (aim for no profit no loss)

TYPES OF PRIVATE OWNERSHIP

• Sole proprietorship – owned and controlled by single individual (owner or manager)

• Partnerships – owned and controlled by two or more people under partnership agreement
• Corporations – owned by shareholders (in proportion of the number of shares held). Shareholders elect the
Board of Directors and the managers are hired.

OBJECTIVES OF THE FIRM

• Profit maximisation – profit is a difference between revenue and cost

• Sales maximisation – large organisations are managed by not the owners but the managers. Managers
aim at sales maximisation. (enjoys reaching to a large number of people and enjoying a larger market
share, e.g. Tata, who have entered into many different markets and now achieved brand recognition in
many homes)
• Growth maximisation – long term, sustainability of business
• Good business reputation
• Larger market share
• Social responsibility

TYPES OF MARKETS

• Perfect competition – sellers selling homogenous product

• Imperfect competition – selling heterogenous product (use is same but other characteristics can be
different)
• Imperfect market may be sub-divided into – Monopolistic competition, oligopoly and monopoly

The pricing and output decision will be answered within the framework of four basic types of markets: -

• Perfect Competition
• Monopoly
• Monopolistic Competition
• Oligopoly
CONCEPT OF REVENUE

• Revenue is the total amount of

money received by an
organisation in return of the
goods sold or services provided
during a given time period.
• Revenue of a firm refers to the
amount received by the firm from
the sale of a given quantity of a commodity in the market.

The concept of revenue consists of three important types of revenues:

• Total Revenue (TR) of a firm refers to total receipts from the sale of a given quantity of a commodity. Total
revenue is calculated by multiplying the quantity of the commodity sold with the price of the commodity.
o Symbolically, Total Revenue = Quantity × Price
• Average Revenue (AR) of a firm refers to the revenue earned per unit of output sold. It is calculated by
dividing the total revenue of the firm by the total number of units sold.
o Symbolically, Average Revenue = Total Revenue / Total number of units sold
• Marginal Revenue (MR) of a firm refers to the revenue earned by selling an additional unit of the
commodity.
o Symbolically, MRn = TRn – TRn-1, where MRn = marginal revenue of the nth unit
(additional unit), TRn = total revenue from n units, TRn-1 = total revenue from (n-1) units and n =
number of units sold
o MR can also be computed using the following method:
MR = Change in Total Revenue / Change in number of units or MR = ΔT / ΔQ

REVENUE OF COMPETITIVE FIRM

In percom, the seller is the price taker and has no

control over the price of the product. Features of
revenue in a percom firm:

• Price = AR = MR = Demand
• Demand curve will be a horizontal straight
line

REVENUE CONDITIONS UNDER MONOPOLY

Monopolistic firms can sell more only if the price goes

down. Features of the revenue are:

• Price = AR = Demand
• MR is always less than (below) AR
• Demand curve is downward sloping
PERFECT COMPETITION

Features

• Large number of buyers and sellers – no individual seller or buyer can influence price because each one is
very small. So neither a firm is able to affect market price nor a buyer will be able to extract discounts or
special credit terms.
• Free entry and exit for a firm
• Homogenous product – identical so no consumer preference, e.g. a particular grade of Basmati rice
(minute features are identical)
• Sellers are price takers – have to accept the market price
• Perfect mobility of factors of production – workers can easily move from one job to another. So in the long
run, a firm can leave the market very easily. No patents or copyrights. (capital can also move freely
between industries)
• Perfect information available to buyers and sellers (both know about the market price) – consumer will
not pay higher price than necessary, the differences in the price will be quickly eliminated and single price
will prevail in the market

Examples of perfect competition:

Percom is a rare phenomenon, exact examples cannot be seen. The examples below are closest to percom:

• Financial markets – stock exchange, currency markets, bond markets

• Agriculture (best example of percom)
• Natural gas industry and trucking industry in US also approach PC

Advantages of perfect competition:

• High degree of competition helps allocate resources to most efficient use (because it’s highly competitive,
you have to perform, if you are inefficient you will be out of the market)
• Price = marginal costs (buyer pays lowest possible price)
• Normal profit made in the long run
• Firms operate at maximum efficiency
• Consumers benefit

MR-MC APPROACH TO PR OFIT MAXIMIZATION

Two conditions of equilibrium for a profit maximizing firm are:

• Marginal Cost should be equal to Marginal Revenue (necessary condition)

• MC curve must cut the MR curve from below (sufficient condition) i.e. after this point of intersection the
cost curve should be rising
Profit Maximisation

• Price = AR = MR (horizontal line) in perfectly competitive firm

• MC = MR is at two points: X and Y
• For X, MC curve is cutting MR from above
• In case of Y, MC is cutting MR from below
• X is not an efficient point of equilibrium because cost is further falling
after X
• Efficiency is at point Y because cost is rising after that

Firm as a price taker

• Industry has downward sloping demand

curve and upward sloping supply curve
• Once price Pe is fixed in the industry,
the firm has to accept that price Pe and
then it will be able to sell as many units
as its capacity allows.
• Hence demand curve is a horizontal
straight line (price remains same
despite change in quantity)
• If demand curve in industry changes,
firm will accept the new price

EQUILIBRIUM UNDER PERFECT COMPETITION

Under percom, there are many types of equilibrium conditions possible, different in the short and long run

• Short run (period during which some factors of production are constant and not too many adjustments
are possible)
o Excess Profit
o Normal Profit
o Losses
o Shut down situation
• Long Run (period during which all adjustments are possible)
o Normal Profit
SHORT RUN EQUILIBRIUM UNDER PERFECT COMPE TITION

Equilibrium with supernormal or excess profit

• D = AR = MR
• Supernormal or excess profit
• U-shaped cost curve AC and MC
• Equilibrium point is where MC cuts MR
from below = K
• Draw a perpendicular line from K to the x-
axis and cut all the curves
• OQe = equilibrium quantity (it is profit
maximizing for this firm)
• Profit = TR – TC
• TR = Price x Quantity = OP x OQe = OPKQe
• Equilibrium line is cutting AC curve = M
• Draw a perpendicular line from M to y-axis
and you get point C
• AC = OC
• TC = AC x Quantity = OC x OQe = OCMQe
• Profit = TR – TC = CPKM (yellow rectangle)
• Profit = excess profit because it is over and above the AC, which includes the cost of all the factors of
production, land’s rent, laborers’ wages, capitalists’ interest and entrepreneur’s minimum profit

Equilibrium with normal profit

• Equilibrium point = G
• TR = Price x Quantity = OP* x OQ* = OP*GQ*
• Equilibrium line is cutting AC curve = G
• AC = OP*
• TC = AC x Quantity = OP* x OQ* = OP*GQ*
• Profit = TR = TC = normal profit

Equilibrium with losses

• Equilibrium point = M
• TR = Price x Quantity = OP x OQ = OPMQ
• Equilibrium line is cutting AC curve = K P
SAC

• AC = OB R
I
• TC = AC x Quantity = OB x OQ = OBKQ C
• Loss = TC - TR = PBKM E
B

• In short run there are certain costs that are fixed, so even if the M
MR=AR
firm is making losses and closes down, they have to bear the fixed
costs
quantity
SHUT DOWN POINT

• ATC = AVC + AFC

• This firm is incurring losses, because it’s revenue curve is
below the cost curve
• Instead of shutting down, the firm should see if it’s able to
cover at least variable cost (raw material, unskilled labor,
transportation, electricity)
• If the firm can sell enough to get revenue equal to variable
cost, then it should continue
• If the firm is not even able to cover variable costs, then it
closes down (shut down point), where P = minimum (lowest) AVC
• Shut down is different from exit, it is not a good condition

LONG-RUN EQUILIBRIUM

• PC firms always enjoy normal profits in the long run

• If supernormal profit, new firms enter the market (supply increases, prices come down)
• If subnormal profit existing firms leave (shut down, supply will fall, prices will increase and go back to
supernormal profit prices)
• So long run equilibrium is with normal profit

LONG-RUN OUTCOME

• Initially in the Personal Computer industry, computer manufacturers like Apple and Compaq made big
profits. But the PC industry turned out to have low barriers to entry and numerous small firms entered the
market. Today there are many firms with small share of the market.

Most important for this long run outcome is to have competitiveness in the market. E.g. 1991 economic reforms in
India to inject competitiveness in the Indian industry as there were many restrictions on foreign goods. It was
decided that we will open up our economy for the foreign and private sectors so that there will be competitiveness
in the market, which will benefit both buyers and sellers/producers. Producers will produce at the most efficient
point, with minimum wastage and resources will be properly utilized, and buyers will get the lowest possible price
even if the seller gets minimum profit. All other markets apart from percom are making buyers pay a higher price.

QUIZ 3
• A certain car manufacturer regards his business as highly competitive because he is keenly aware of his
rivalry with the other few car manufacturers in the market. Like the other car manufacturers, he
undertakes vigorous advertising campaigns seeking to convince the potential buyers of the superior quality
and better style of his cars. Is this a perfect competition. Explain.

ANSWER KEY
• 1. Products are not homogenous 2. No need for advertising in perfect competition because consumers
don't buy based on taste and preference in such market 3. Not easy to enter a market with vigorous
advertising, not so in perfect competition
SESSION 8: CHAPTER 9 AND 10
FEATURES OF MONOPOLY

• Single seller: Perfect competition > Large number of sellers, monopoly > single seller. The entire market is
supplied by only one seller
• Barriers to entry: Perfect competition > Free entry, monopoly > barriers to entry
o By the very nature of the market, because if another seller enters it will no longer remain a
monopoly. Two sellers > Duopoly. To maintain monopoly market and its features, no entry
should be allowed
o Single seller or monopolist is established in the market. Consumers know and are used to the
seller. Seller has achieved a larger size and is enjoying benefits of economies of scale. Giving
competition to a firm already established in the market and entering such a market becomes a
difficult task.
• No close substitute for product: Perfect competition > homogeneous products, monopoly > firm sells
unique products. So naturally, seller becomes monopolist with monopoly power.
• Firm and industry same: No distinction between concept of firm and industry because there is only one
firm in the entire industry.
• Downward sloping demand curve: So monopolist can Downward sloping demand curve
control either price or quantity and not both. If a person • If he wants to sell more he has to keep
is a single seller, if there are no close substitutes, if the price low
• If he wants to keep the price high, he
there are no competitors, they can exploit the market
has to accept fall in the sales
the way they want then why do we say that the
Downward sloping demand curve
monopolist has some limitations? Because the market
itself has put some kind of a control over the monopoly
D
power of the monopolist and the monopolist has to
face a download sloping demand curve. If the price is
high, quantity sold is low and vice versa. He has to P-2

accept one of these two powers, whether he wants to

P-1
keep the price high or sell more. He can’t do both
D
simultaneously. He can’t say that he wants to keep
price as P2 and sell OT. Although he’s a monopolist,
there’s no substitute and no competitor, no one can O Q T

force the consumer to purchase.

EXAMPLES
• There’s a unique, excellent painter with many fans > He wants to earn 20 crores year by selling his
paintings. Two options: Keep the price as 50 lakhs per painting and paint about 40 paintings a year. These
paintings will go to 40 houses and he will earn the revenue. Suppose he wants to sell to more people, he
can keep the price reasonable like as 50k or 1 lakh per painting and paint more. He has to decide if he
wants to control the price or the quantity, he cannot control both at the same time.
• So monopolist can be very powerful but there are natural restrictions on his power. He can have excess
profit but not unlimited profit
• Indian Railways in an example of monopoly but not a good example of true monopoly because its
objective is not profit maximization.
• BCCI has monopoly rights to telecast so it has become a monopoly over a period of time.
 • DBS is a good example of monopoly

ADVANTAGES OF MONOPOLY

• May be appropriate if natural monopoly (due to increasing returns to scale)

• Encourages R&D
• Encourages innovation
• Development of some products not likely without some guarantee of monopoly in production
• Economies of scale can be gained – consumer may benefit

EXAMPLES
• Natural monopoly:
o Amitabh Bachchan – he’s old but is going to come back in Kaun Banega Crorepati. We can’t
complain about TV channels taking only him and not giving others a chance. His own expertise,
intelligence and qualities have brought him to this level.
o In manufacturing, natural monopoly can come from increasing returns to scale. A particular firm
is functioning efficiently, it is able to double or more than double its output then that firm slowly
may have a monopoly and we have to consider that natural monopoly as appropriate.
• Encourages R&D: It is not so easy to remain a monopolist in the market. You may gain monopoly for some
time, but in order to sustain as a monopolist, we have to improve the product continuously and keep the
consumers happy. We have to keep the product unique. Perfect competition doesn't allow any kind of
R&D because their prices and qualities are the same and there are a large number of competitors, so R&D
may not be allowed because the prices cannot change or are not allowed to move greatly.
• Encourages innovation: Unless the products are innovative, people will not stick to them. Companies like
Colgate and Xerox had monopoly but over a period of time it changed. So in order to maintain monopoly
and the position in the market. innovations have to be done.
• Development of product have guarantee of monopoly: Money is spent on R&D and innovation to get
some guarantee like in the form of a patent, like for the next 5 years your product is protected and no one
will imitate it. Innovation is difficult but imitation is very easy, so the one who is innovating should be
given some kind of a monopoly and legally in the form of patents.
• Economies of scale can be gained: Some of the followers/advocates of monopoly say that the monopolist
may grow big in size and start enjoying economics of scale and give advantage of this to the consumers.
This is what is happening with social media like Whatsapp or Facebook. In order to retain the customers
they give a lots of facilities, something free or some new features are introduced at small intervals.

SOURCES OF MONOPOLY

• Patents and copyrights granted by the govt for certain no. of years: Legal kind of monopoly. If the product
is patented, nobody else can imitate it.
• Natural monopoly due to economies of scale and efficiency: Economies of scale and efficiency may give a
firm power, which is called natural monopoly
• Government regulations or franchise. Here a firm is set up as the sole producer and distributor of a
product but under govt control: Example is IRCTC or parking lots are allocated to a particular group or
person so that person is a sole provider of that service. But under govt control, there might be restrictions
on the prices charged or conditions for the consumers. So consumers may not be that greatly exploited.
 • Exclusive possession of technical knowledge: No one has been able to imitate the chemical combination
used by Coke. Pepsi and Coke are part of a duopoly market.
• Economies of large scale production: Monopoly power may be obtained through this.

REVENUE CONDITIONS UNDER MON OPOLY

Firm under monopoly can sell more only if price of the product is
less. Price and AR is the same but AR and MR is not the same.

In perfect competition, we had a horizontal demand curve where P

= MR = AR. But today the average revenue curve is downward
sloping and marginal revenue curve is below the average revenue
curve.

CONDITIONS OF EQUILI BRIUM

• Short run
o Excess profit
o Losses
• Long run
o Excess profit

In the short run period, the monopolist has to face two kinds of situations – a monopolist may enjoy excess profit
or they may incur losses (please notice: a monopolist can incur losses, contrary to our initial impression that they
won’t) But in the long run, the monopolist always enjoys excess profit. Perfect competition > long run always
normal profit, monopoly > long run excess profit. Excess profit means price is higher than the cost, which is part of
the increase in price meaning the consumer has to pay a higher price and the producer gets a profit over and
above the minimum profit expected. So excess profit is like an exploitation of the consumer since the consumer
has to pay unnecessarily extra price. So in monopoly the long run equilibrium is always with excess profit.

Another feature of monopoly is that it always has a steep downward sloping demand curve, where demand is
inelastic in nature. What this means is that there are only two choices for the buyer – either from this firm or leave
without the commodity. So the consumer has to buy even if the price is high for a long time until it gets
unbearable because there are no substitutes and only one seller.

EXAMPLE
Apple enjoys excess profit in the long run
SUPERNORMAL PROFIT MONOPOLY

Price or revenue or cost on the y-axis and quantity on the x-

axis.

Two conditions for equilibrium: equilibrium is at a point

where MC = MR and MC should cut MR from below. So in
P
this diagram, F is the point of equilibrium. Once you get an R
equilibrium point, you draw a straight line cutting all the I
curves in the diagram. You draw a straight line downwards C
E
to connect it to the to the x-axis so that you know the
equilibrium quantity.

What will be the equilibrium price? Here the firm is not the
price taker. In perfect competition, the price was given but
quantity
here the price has to be found out with the help of an
equilibrium line. So what is the equilibrium price in this case? Rule to find out the equilibrium price is to see where
the equilibrium line (TQ) is cutting the AR curve, because AR curve is equal to the demand curve. In all the markets,
AR = demand and in order to understand the equilibrium price should know the demand. Then just draw a
perpendicular line on y-axis to find out the equilibrium price. Therefore, in this diagram, P is the equilibrium point
and OP is the equilibrium price.

EQUILIBRIUM OF MONOPOLIST

• Equilibrium with excess profit

• Equilibrium at MC = MR
• TR = OPTQ
• TC = OKGQ (equilibrium line cutting AC, then perpendicular line on y-axis, because price, cost, revenue all
fall on the y-axis, then OK x GQ)
• TR > TC ((From the diagram, you come to know that the revenue is greater than the cost, so there’s an
excess profit)
• Excess Profit = KPTG

In all the markets, these basic conditions remain the same. Excess profit means TR > TC. These are the principles of
finding out the profit-maximizing output.

LOSSES IN THE SHORT RUN

In most of the cases, a monopolist enjoys excess profit. But

sometimes they incur losses.

• N = equilibrium point (Where MC cuts MR from below) P

R
• OP = equilibrium price I
• TR = OPTQ (OP x TQ) C
E
• TC = OKGQ (OK x GQ)
• TR < TC (hence there are losses)
• Loss = PKGT
quantity
Monopolist may have to bear losses in the short run. This may be due to

• Cost and revenue conditions: Cost of production may be very high, input or raw material may not be
available or be very expensive, or market may be down, and because of changing market conditions, low
approachability or no information about that product, the demand for that product may come down and
so revenue may not rise or may go down.
• Threat from potential competitors: Suppose a new firm is entering the market, the barriers put up are not
physical barrier, the existing firm cannot physically drive the firm out, so they deliberately keep their
prices low, which is not legal. Since the monopolist has already been in the market for a long time and
enjoyed excess profit, they may have the capacity to incur losses for some time. So the new entrant may
not be able to lower their prices this much and have to leave the market, after which the prices are
increased again.
• Government policy: Monopoly profit can comes under taxation. There are some countries where
monopoly is not allowed because it restricts competition and restriction on competition is not allowed, so
if it is found that a particular firm is not following the business ethics and following anti-competitive
policies, then heavy taxes can be imposed on them.

LONG-RUN EQUILIBRIUM

• In the long run all inputs and costs of production are variable and the monopolist can construct the
optimal scale of plant to produce the best level of output.
• Since the entrance in the market is blocked, a monopolist can earn supernormal profit in the long run:
threat of competitors is there only in the short run but in the long run, everything will be according to the
monopolist. They can settle down, trial and error is over, the plant size has become optimal, optimal scale
is achieved, as a result of which the monopolist enjoys excess/supernormal profit in the long run

Questions in TEE: Monopolist always enjoys excess profit. Do you agree?

CASE STUDY
De Beers- The Diamond Monopoly

• De Beers is the sole seller of diamonds with no close substitutes (as perceived by the market). As a
company, it did all that a monopolist does- it manipulated output, fixed prices, and even chose the sellers.
• De Beers Consolidated Mines Limited was established in 1888 and by 1890, controlled 95 per cent of the
world’s diamond production. This company stood on the monopoly principle. ‘The only way to increase the
value of diamonds is to make them scarce by reducing production.’
• De Beers indulged in many monopolistic practices: It created the diamond cartel and formed a single
channel monopoly; it flooded the market with diamonds similar to those of producers who did not join the
cartel; it purchased and stockpiled diamonds produced by other manufacturers in order to control supply
and thereby the price.
• In 2004, De Beers paid $10 million as fine for price fixation.

This case tells you how De Beers have maintained their monopoly, doing which is not that easy. All the firms
engaging in diamond came together and formal a single channel of monopoly. These are all the practices which are
under the control of the anti-trust legislation (US). In India we call it unfair practices under the control of Industry
Associations or Industry Act. Stockpiling = Holding. Artificial scarcity is created so that the price always remains
high. They were taken to court and had to pay a fine.

PRICE DISCRIMINATION

• PD occurs when the same product is sold to different consumers for different prices.
• NOT because of cost differences (despite cost being the same)
• PD can’t happen in perfect competition because there the firms are price takers. It happens only in
monopoly.

EXAMPLES
• Telephone companies charge a given price per call for a given number of calls and a lower price for
additional batches of call, higher for festival seasons than the normal days.
• Electricity charges different for domestic and industrial use
• Airlines are the masters of PD. They segment the market by pricing tickets differently for those who travel
in peak hours, off-peak hours, for those who are business or pleasure travelers and for those who are
willing to stand by (charge less from those
who are flexible). (Marginal cost of adding
one more customer is zero, so main purpose
for PD is to increase revenue)
• Foreign and domestic market
• Adult and child charged differently for the
same ticket.
• Disneyland charges – less for locals more for
tourists (foreigners won’t bargain)
• PD is not easy, so why do firms choose to
go for it? How does it help? (see table)

CONDITIONS FOR PD

Whether PD is profitable or not depends on certain conditions:

• For PD firm must have control over price – imperfect competition

o So it possible only for monopoly, monopolistic competition or oligopoly firm
o Not possible for perfectly competitive firm
• Markets should be separated. No resale or transfer for the product should be possible (otherwise everyone
will buy at low price and sell for higher price). – preventing resale is easier in some firms
o If plumber charges less from you for fixing a water pipe, you cannot make that deal for your
neighbour
o Even for physical good, resale should be difficult – cement bag (because the bags are heavy, they
will not buy for their neighbours)
• Or some difficult conditions may be applied – student ID card for discount, checking at the entrance of
Disneyland or amusement park
• Limit on the number how many pieces one individual can buy during the sales or offers.
 • The demand curves in the segmented markets (markets differentiated in different sections) must have
different elasticities at given price. (PD will be possible/useful if elasticities are different, as you charge
low price from those whose demand curve will be highly elastic and vice versa)
o Youngster and adult for movie tickets (youngsters may want to watch a movie on the first day,
adults will wait till the price comes down, so high price for youngsters)
o Low price for highly elastic demand and high price for inelastic demand

EXAMPLES
• What is described in Economic theory as PD, by the airlines by charging different fares accelerating to
business and economy class travels or an array of prices for buying air-tickets or different time intervals, in
airline industry it is known as “Yield Management” – where the business goal is to maximise the revenue
(same as purpose of PD) as much as possible from the flights each time.
• This process of pricing strategy adopted by the airlines implies an effective way of extracting the slices of
consumers’ surplus. (PD takes place to extract either part of or the entire surplus. After finding out the
consumer surplus, the firm knows how much consumers are willing to stretch and tries to extract a part or
whole of it.)

CONCEPT OF CONSUMER SURPLUS

The difference between what consumers are willing

to pay and what they actually pay is called consumer
surplus.

Example

What is maximum you will pay for salt rather than

going without salt? Today we pay Rs. 15, and we are
ready to pay up to Rs.250. So the difference between
the two is called consumer’s surplus. Consumer
surplus can be found out for each and every
commodity.

Diagram: Demand curve is extended so that it cuts

the y-axis. Price = highest price a consumer is willing to pay, P1 = actual price the consumer is paying. So the blue
triangle area is consumer surplus.

What will happen if the price falls? Consumer surplus will increase. This is why, when the price falls, consumers
want to buy more and vice versa.

CONSUMER SURPLUS AND FIRST DEGREE PD

Compare the total revenue of a monopolist when he sells 4 units of a commodity and practices first degree PD (at
prices Rs. 65, 55, 45, 35 respectively) with the TR when he continues to sell 4 units but does not practice PD (at price
Rs. 40 each).

• TR for discriminating monopolist = 65 + 55 + 45 + 35 = 200 (40 more than non-discriminating)

• TR for non-discriminating monopolist = 40*4 = 160
DEGREES OF PRICE DISCRIMINATION

FIRST DEGREE PD
• First degree - selling each unit of commodity separately and charging different price for each unit.
• Rare type. Because the producer must know about each consumer’s demand curve and he should be able
to extract the entire consumer surplus. (“depth of the pocket” in simple terms)
• May be applied to personal services like medical or legal where the charge is different for different
individuals. (for commodities like salt, less price will be charged to consumers with a smaller surplus)

SECOND DEGREE PD
• Second degree – charging uniform price per unit for a specific quantity or block sold to the customer and a
lower/higher price for the next block. (E.g. First 50GB data for a price and next some GB for a lower price
so that you use more data and revenue of the seller increases)
• Some part of consumer surplus will be extracted in this kind of price discrimination (not the entire part
because you’re diving the consumers into only 2 or 3 categories/groups)
• It is possible for products/services which are metered (measurable) like electricity, gas and water, number
of copies duplicated (photocopying) (E.g. Zomato gold or similar services on Ola, Uber, Swiggy)
o Without PD price is Rs. 40 per unit. 4 units are sold.
o In second degree PD, the monopolist sets a uniform price per unit for a specific quantity of
commodity, lower per unit for a specific batch and higher for the other batch. The monopolist sets
the price Rs. 65 for first 2 units and Rs. 35 for the other 2 units.

THIRD DEGREE PD
• Charging different prices for the same product in different markets. More common type.
• Higher price where the elasticity of demand is low and lower price where elasticity of demand is high.
o Electricity – higher rate for residential use than commercial use. Because elasticity for electricity
for domestic use is lower than that for the commercial use. The commercial users may have more
substitutes such as generating their own electricity.
o Higher airfares for business people and lower for vacationers
• But if the elasticity is same in both the markets, then no PD

INTERNATIONAL PRICE DISCRIMINATION

• Dumping
o Between domestic country and foreign country
o Charging lower price abroad where competition is more and price elasticity for the product is
higher – substitutes available
o Charging higher price in domestic market where monopoly element is more – price elasticity is
lower where no substitutes are available.
• Predatory dumping – charging price below cost temporarily in the foreign market to gain the position of
monopoly and to drive the competitor away and then raising the price
• Sporadic dumping – occasional sale of commodity at price lower than cost to unload (get rid of) the
temporary surplus of commodity (without changing the domestic price)
EXAMPLES
• China dumping cheaper products in India after trade liberalisation
• India imposed anti-dumping duties on Chinese steel in 2015 and tiles in 2016
• US imposed anti-dumping duties on Indian shrimps in 2013/2016
• Japan is accused of dumping steel, TV sets and computer chips in US

SESSION 9: CHAPTER 11

MONOPOLISTIC COMPETI TION

Chamberlin – monopoly & perfect competition are not mutually exclusive (Before this, it was believed that there is
either perfect competition or monopoly. But Chamberlin was of the opinion that both can coexist, and such a
market was named by him as monopolistic competition). Monocom has characteristic features of both.

Features

• Many firms (Slightly less than percom, relatively small in size. This feature is closer to percom.)
• Product differentiation (Similar in utility but slightly different from competitors, real or imaginary, in
nutritional value, size, color, fragrance. These products are called differentiated products. Each of these
brands will have their own loyal consumers. Adds an element of monopoly.)
• Close substitute goods (this makes the market highly competitive)
• Selling cost
• Highly elastic downward sloping demand curve (because substitutes are available and slight increase in
price will cause fall in demand)

Monopolistic competition is a market structure in which:

o A large number of independent firms compete.

o Each firm produces a differentiated product.
o Firms compete on product quality, price, and marketing.
o Firms are free to enter and exit.

Large number of firms:

o Like perfect competition, the market has a large number of firms. The implications are:
o Small market share
o No market dominance
o This adds the element of competition
PRODUCT DIFFERENTIATION

• Making a product that is slightly different from the products of competing firms.
• Similar but not identical products. But satisfy the same need.
• A differentiated product has close substitutes but it does not have perfect substitutes.
• Differentiation may be real (nutritional values, sugar content may differ) or imaginary (all brands of
Aspirin – same ingredients)
• This adds element of monopoly

SELLING COST

• Percom > every product is identical and once price is fixed, the firm can sell as much as it wants
depending on capacity, so no need for advertising.
• Monopoly > no need to spend on promotional activities as there is a single seller, most they can do is have
informational advertisements
• Monocom > these expenses become a very big part of the cost of production. Rather, cost is divided into
cost of production and selling cost.
• Selling expenses – incurred on advertisement, increase in sales force, provide better servicing for its
product and so on (this expense is necessary because there is a need to show consumers how your
product is different/better than competitors’ product)
• This expenditure is in addition to the cost of production.

EXAMPLES
The amount of monopoly power depends on the degree of differentiation (how different is my product from other
products). (Dove soap has a certain % of consumers who buy it even though the price is higher than other soaps.
So how much monopoly a product has will depend on the difference between characteristics of this firm and
competitor firms) Examples of this very common market structure include (particularly consumer goods):

• Toothpaste
• Soap
• Food and beverages
• Drugs and chemicals

EQUILIBRIUM OF FIRM UNDER MONOPOLISTIC COMPETITION

• Short run
o With excess profit
• Long run
o With normal profit (as seen in perfect competition)
SHORT-RUN EQUILIBRIUM OF THE FI RM UNDER MONOPOLISTIC COMPETITION

Two main features of this demand curve:

• It is downward sloping
• It is highly elastic
• N = equilibrium point
• TR = OMLQ
• TC = OTGQ
• Excess profit = TMLG

In the short run, monopolistically competitive firm enjoys

excess profit due to its feature of product differentiation.
Because it has some degree of monopoly power.

LONG-RUN EQUILIBRIUM OF THE FIRM UNDER MONOPOLISTIC COMPETITION

Normal profit equilibrium

Point of equilibrium is N, where MC = MR, L = Long run

M is on AC as well as AR, so TR = TC and this is a normal

profit (rewards to all factors of production, like rent of
land, wages of workers, interest of capitalist and also the
minimum profit are included in the cost)

TR > TC = supernormal profit

TR < TC = subnormal profit (i.e. loss)

LONG RUN EQUILIBRIUM OF THE FIRM UNDER PERFECT AND MONOPOLISTIC COMPETI TION

• Is there a difference between normal profit equilibrium of

perfcom and monocom? What is it?
• Demand curve is horizontal (perfectly elastic) in PC and
downward sloping (highly elastic) in MC
• Monocom > equilibrium is at the point before AC becomes
lowest, at a higher price
• Percom > equilibrium is at the point where AC becomes
lowest, at the lowest price. Percom is called an ideal market
because it provides lowest possible price to the consumer.

Efficient production (quantity of output) is the one that happens

at the lowest AC. In monocom, equilibrium point is not reaching
lowest AC at all (not possible to reach that point due to downward sloping demand curve). The firm is in
equilibrium much before that.
What are the economic implications of this?

• The consumer has to pay a higher price

• In spite of consumer paying higher price, producer doesn’t get excess profit

So where is the excess price paid by consumer going? It goes to P1P2 = Selling cost (advertising). This may not be
profitable to the producer but the cost is paid by the consumer in the form of increased price.

WASTES UNDER MONOPOLISTIC COMPETITION

• Excess capacity – ideal output is the one which is associated with minimum cost. (almost all monocom
firms have excess capacity as they are unable to use their capacity to the fullest) Excess capacity is the
difference between the output with minimum cost and the output under monopolistic competition. (OQ2-
OQ1 in the previous diagram)
• Advertising cost – consumers have to pay higher price under MC as the cost of production also increases
for the firm.
• (why do some people advocate for monocom when there is wastage?) But the logic behind differentiated
goods and services produced by a modern market economy. The great variety of products fulfils consumer
tastes and preferences. Reducing the number of monopolistically competitive firms may reduce the
consumer welfare because it would reduce the choice available with them.

OLIGOPOLY

This market is still under study. It has features not found in any other market.

• A market where there are a few sellers selling homogenous or differentiated products
o Homogenous products – pure oligopoly
o Differentiated products – differentiated oligopoly

Goods produced in this market are mainly producer goods like iron, steel, equipment, machinery, cement, etc.

Features

• Small number of sellers (ideally 3 to 9 sellers), each with large capacity relative to total market demand.
(there is a mix of competition and monopoly, but comparatively more monopoly)
• In many oligopolies, competition is through advertising and product differentiation (car)
• In some other oligopolies, standardised products (steel)
• Barriers to entry in oligopoly either due to economies of scale or due to strong product/brand name
recognition. E.g. Aircraft manufacturers Boeing and Airbus, investment in power Tata and Adani
(previously Reliance)
• Interdependence or rivalry of firms – Policies of each firm affect the other firms in industry. (If these firms
come together, they can form a monopoly) For example when Ford introduces rebates in sale of its
automobiles, GM also follows the same.
o This is because of a few firms (both interdependence and rivalry)
• Each oligopolist has to consider the possible reaction of his competitors in deciding its pricing policy,
degree of product differentiation, level of advertising to undertake, etc.
o So managerial decision-making is complex.
 • Existence of price rigidity: Under oligopolistic market, organisations do not prefer to change the prices of
their products as this can adversely affect the profits of the organisation.
o For instance, if an organisation reduces its price (to attract consumers), its competitors may
reduce the prices too, which would bring a reduction in the profits of the organisation. (all firms
will have an equilibrium with lesser profit margin)
o On the other hand, the increase in prices by an organisation will lead to loss of buyers. (the same
firm now increases the prices but the other firms keep the lowered price, so this firm loses its
customers)

Fall in price is imitated by other firms but increase in price is not because the other firms want to attract customers
with a lower price

KINKED DEMAND CURVE

• Percom > horizontal demand curve

• Monopoly > inelastic downward sloping demand
curve
• Monocom > elastic downward sloping demand curve
• Oligopoly > kinked demand curve (pP = price rigidity)

Significance: Two different demand curves (PD and Pd)

whose slope is not the same are coming together at
the kink. Above the kink, there is a flat slope (Pd =
elastic demand) and below the kink a steep slope (PD
= inelastic demand).

Price is reduced -> demand becomes inelastic ->

everyone reduces the price -> price is increases -> no
other firm increases price -> demand becomes elastic

EXAMPLES
Automobiles, Aluminium, Steel, Electrical equipment, Civil aviation, Cement

SOURCES OF OLIGOPOLY

• Economies of scale (new firms can’t enter)

• Huge capital investment and specialised machinery and inputs (because goods are producers goods)
• Patents (given to 2-3 firms)
• Loyal customers
• Control over the entire raw material supply (oil producing countries)
• Government franchise (right to use particular land or service to a few firms)
CARTEL

It is an outcome of oligopoly

• Existing sellers form an agreement on controlling market supply jointly and determining the price for their
product with creation of monopoly (5 firms divide a country into 5 regions with the agreement that none
will enter another’s region, each becoming a monopolist in their own region)
• OPEC (Organization of Petroleum Exporting Countries) – Example of cartels, they ruled over the world
• Cartels violates competitive spirit and laws
• Detection of cartel is difficult as these are informal

CASE STUDY
• The Organization of Petroleum Exporting Countries (OPEC) was formed in 1960 in response to the low price
that ruled around the late 1950s. Since then, the exporting countries have gained greater and greater
control over the production and revenues. (They decided the quota for each country, e.g. if there is a
demand for 100 barrels, only 80 will be produced. If demand is more than the supply, prices will always be
high. These 80 were divided among 20 countries on the basis of size and export potential)
• OPEC is dominated by Arab countries, particularly Saudi Arabia. How has ‘chiselling’ been taken care of?
In fact, between 1974-8, most of the oil exporting countries were chiselling. However, the two big players,
Saudi Arabia and Kuwait, were willing to cut down on production, while others chiselled and expanded
their production in order to maintain the overall output at the restricted level.
• Saudi Arabia can, if it desires, expand output and force market prices to come down. This credible threat is
probably what is making other OPEC members to refrain from excessive chiselling.

QUIZ 1
Match the following

ANSWER KEY
1. a)
2. c)
3. d)
4. b)

CASE STUDY ANALYSIS (MAGGI)

1. Cross elasticity of demand refers to the fall or rise in the demand of a product because of the fall or rise in
the price of its substitute. Relationship between Dx and Py. Explain positive (substitutes), negative
(complementary goods) and zero (unrelated goods) elasticity.
2. Demand and supply of substitutes will increase because the main player (Maggi) is out of the market
because people were used to fast food like instant noodles. But if both demand and supply increase, the
equilibrium price will remain the same.
3. Price elasticity of demand refers to relationship between the price and quantity of product. For a manager
this is very important information because they will be able to find out the demand and know whether to
 raise or lower the price depending on whether the demand is elastic or inelastic. This is surely a very
important decision for any manager to make. E.g. If commodity X is produced and its demand is inelastic,
raising price will be of no use. Impact on revenue.

SESSION 10: CHAPTER 16

INTRODUCTION

• Government intervention – considerably in business environment and functioning of market

• In general interest of nation
• In India – Up to 1947 – free market economy (India under the british rule had capitalistic economy, free
economy (free trade, no tariffs, anything can be imported/exported). Main motto is let individuals take
their own decisions and do their best (as per classic economists. If supply of labor is high, wages will come
down and laborers’ families will become poor. Number of workers will fall and wages will increase. If
there is too much capital in the market, interest rates will come down, capital will go down and interest
will go up.)
• 1951-1980 – socialist economy with public and private sectors hand in hand but public sector as big
brother (Everything will be decided by the govt or communist party. Means of production will be owned
by govt and everyone will be workers who will be paid wages. No one will be owners. Take from everyone
(contribution) according to their ability and give everyone (payment) acc to their requirement. After
independence, India became a mixed economy where pvt and pub sectors co-exist, but public was
dominant. Any new investment would be made only in the public sector > socialist ideology till 1980.
Trade was controlled, imports were imposed with heavy tariffs. No single foreign company was allowed,
like Tata Suzuki. Indian companies had 51% shares.)
• 1980 onwards – change in the role of government towards economic matters (In between is mix of
economies, capitalism and communism, public and private sector where there is some govt control. In
India it’s 70% private and 30% public. 30 activities were in the control of the govt, now there are only 3.
LPG > liberalization (not control by govt), privatization (sectors were made open), globalization (foreign
policies were also changed))
• Manager needs to recognise the role of govt, understand the dynamics of business environment, functions
of govt, policies towards business.
• Accordingly, demand management and supply management has to be moulded
• Understand the fiscal (fisc = govt’s treasury/account, fiscal/public revenue = taxation, govt/public
expenditure, public debt > bonds, borrowed from foreign banks or institutions) and monetary policy
(related to money and banking, central bank of govt is highest authority who can print the notes,
increase/decrease money supply or change interest rate. To control inflation > raise interest rate >
businessman won’t be able to borrow > investment won’t happen > unemployment) changes, other
macroeconomic policies – deregulation, MRTP – Monopoly and Restrictive Trade Practices Act (encourage
competition instead of controlling monopoly as restrictions on monopoly seems like a rigid method), rural
industrialisation, export promotion, import substitution, etc

WHY INTERVENTION?

• Earlier – Laissez faire policy – no govt control over private business – was advocated
• Govt was “Necessary Evil” (defence – external security, policy – internal security and infrastructure)
 • Govt – not allowed in the free play of market economy
• Price mechanism was to be the key of efficiency of market
• But Great Depression of 1930s showed the limitations of market economy without control (all the variables
started declining – income falls – consumption falls – demand fall – production/supply falls – firms close
down – less jobs – unemployment – less income. Keynes suggested govt should employ people, print new
notes and pay them wages for digging and filling up a hole. They will then demand products and money
will be injected into the economy. Market did not recover on its own as was earlier believed. An external
factor had to intervene. In Keynesian ideology govt is called a welfare state.)
• Shortcomings of market mechanism –
o Economic instability (recession may happen after huge investment)
o Economic inequalities (certain sectors get more money, others don’t get as much compensation,
wealth is distributed unequally)
o Wastage of resources
o Rise of monopolies (because of economies of scale)
o Social cost not considered (in the form of env degradation, evil social effects, not included in the
price of the commodity)
o Shortage of collective consumption goods like defence, infrastructure, social goods (pvt sector is
not interested in investing in these firms)

Therefore it is advised that govt may intervene in a free market

CAUSES OF INTERVENTION

• Counteract cyclical fluctuations (depression, too much prosperity, bumper crops, govt investment is
required to take back the money, to buy crops and store them for ___)
• Prevent economic inequalities and concentration of economic power (only govt can control monopoly
power, like Jio)
• Humanitarian consideration (too many workers > wages will come down > families will starve and next
gen will have fewer children > number of workers will fall > wages will go up)
• Provision of social infrastructure (edu and health facilities, training facilities)
• Licensing, Patents (If company spends on R&D, they need to be taken care of by govt providing them
patents)
• Price regulation
• Quality standards – Bureau of Indian Standards
• Environment standards

EXAMPLE OF MARKET FAILURES

• Agricultural subsidies on fertilisers (fertilizers given at a cheaper rate, make it affordable to farmers >
demand will go up, excessive use of fertilizers > land quality will be affected)
• Reduce the price of fertilisers
• This may lead to excessive use of fertilisers
• Adverse effects
CAUSES OF MARKET FAILURE

• Externalities (benefit or disadvantage by exchange between unrelated two sides)

• Public goods
• Asymmetry of information
• Imperfect competition

EXTERNALITIES
• Spill over or neighbourhood effect – harmful or beneficial side effect which is borne either by firm or
people not directly involved in the process of production or consumption
• Exists both in consumption and production
• Positive externality – Uncompensated benefits conferred on some firms or on people - construction of
Metro/Airport – increase in the value of property around that area or increased expenditure on
maintaining lawn
• Negative externality – uncompensated costs imposed on some individuals by consumption expenditure of
other individuals. Chemical factory, wooden furniture (market failure because of social cost – does not
include cost of env degradation, needs to be resolved by govt intervention only) – overproduction,
smoking (Other examples: Oil spill, mobile tower radiation)
• The effect of externalities is not transmitted through price mechanism in markets – example chemical
factory creating pollution
• Impact of production and consumption of products on the third party – other than buyer or seller needs to
be tackled through govt policy
• Forbidding that activity by law, taxes or subsidies, voluntary payments (say to minimize impact of
pollution) (plastic ban by govt or imposing heavy taxes on wooden furniture or giving incentives for
factory activities to be conducted in the outskirts of the city instead of residential areas)

PUBLIC GOODS
• Goods satisfying collective/social wants
• They are not subject to exclusion principle (road, flyover, public park – even non-taxpayers can use it)
• Non-excludable - Non-excludability means a good that benefits one individual can be used by others too.
• Non-rival in nature – good that benefits one individual, can benefit the other too - Non rivalry means the
enjoyment of using a product does not reduce satisfaction to others. – lighthouse, flyover
• Defence/Police provide security to tax-payers as well as those who do not pay the tax (civilians,
foreigners).
• So the private sector may not be interested in providing these goods. (pvt. sector wants that the one who
buys should use it, so market fails here)
• Free rider – enjoy benefits without compensation
• Investment in social and human capital needs to be done by government (because it is an example of
market failure)

INFORMATION ASYMMETRY
• Either buyer or seller has better information than other. So taking right decision may be difficult. (In
perfect competition, market functions well because everyone has equal information available)
 • Market for second hand cars, insurance policy (If I’m the seller, I know why I’m selling the car. Many
defects or problems, which I will not reveal because the price will come down. So the price which is fixed
is not an equilibrium price because of unequal info. In health insurance, I may not disclose my smoking
habits or operation done in the past so premium for a fit person may be accepted. In first one seller
knows more, in second one buyer knows more)
• Two problems
o Adverse selection – lack of relevant knowledge – health insurance policy without declaring the
smoking habit. (Info is not given so policy selection will not be proper. People will be divided into
low risk, no risk and high risk. High risk will be charged more premium. Market is not considered
fit.)
o Solution for this is to define high risk group compared to general population and charge high
premium to them
• Moral hazards – Lack of incentive to guard against risk where one is protected from its consequences
o Driver with insurance coverage will drive with less care than the one without insurance, because
he is not going to pay for the cost of damage. (this comes in the way of efficient market
functioning)

IMPERFECT MARKET
• When a firm has market power, it may create inefficiency in the market. (monopoly, oligopoly – any
market other than perfect competition)
• Firms may raise the price above cost (supernormal profit is earned with no mechanism to take it away)
• Various barriers to entry may be created
• Organisations may influence price

TOOLS OF INTERVENTION

(Set the child right and the world will automatically be right)

• Legislative measures
• Promotion of competition (to prevent imperfect competition like monopoly by minimizing the barriers e.g.
when foreigners were allowed to enter the Indian market)
• Fiscal measures (tax concessions or subsidies to move into rural areas in case of concentration of
industries in a particular area or tax imposition in case of anti-social goods, subsidy is opposite of tax
imposition)
• Nationalisation (imp sectors like railways and a few banks)
• Provision of public goods (pvt sector is not interested in public goods)
• Economic planning (5-year plan in India by planning commission started in 1951, an activity by which govt
or authority appointed by govt sets the target, like agri should grow by this %, based on forecasting and
requirement of society. Targets are shared even for pvt sectors and rules are made accordingly. )
• Price regulation
PRICE REGULATIONS

These are governmental measures dictating the quantities of a commodity to be sold at specified price both in the
retail market and at other stages in the production process. (Equi price is where demand = supply. In intervention
price may be set higher or lower than equi due to some considerations)

• These regulations act as control measures or emergency economic measures in the case of imperfect
competition to prevent probable market failures.
• The most commonly used price regulations are:
o Price ceilings
o Price floor

PRICE CEILING

• It is the price set by the government below equilibrium price. Example rent control (when rent is
exorbitantly high in a particular area, govt intervenes and keeps the price at highest possible price)
• This results in shortages because price being lower than the equilibrium, demand will rise.
• But shortages can be resolved by various ways like – first come first served, government’s choice (criteria
like near school or workplace), lottery

PRICE FLOOR

• Government regulation to fix the price above equilibrium – not to allow the prices go below certain level
• Eg - Minimum Wages, agricultural prices (During bumper crop, supply is high so price comes down,
farmers will be badly affected so govt will fix the price above the equi, not below subsistence level, MSP)
• This may result in surplus in the market. (Govt purchases and maintains the stock, which may be released
in cases like natural calamities. Or when there is surplus workers when wages are high, govt may provide
employment concessions)