MICRO ECONOMICS FOR BUSINESS

By rajani

Definition of Economics: Economics can be defined as the study of efficient utilization of scarce resources to satisfy unlimited human wants. Adam Smith the Father of Economics defined as a science of wealth. He titled his book as Enquiry into the Nature and cause of the Wealth of Nations

Economics is a social science and art Economics deals the various aspects of production, distribution, consumption of limited resources in an economy in order to satisfy human wants efficiently. Economics explains the day to day activities of people like spending buying etc.

 The two most important areas in the society today are business and the economics, they act a two pillars in the development of any country. The economics of business growth widened too much in recent years. Resources are limited but human wants are unlimited. Scarcity of Natural resources, scarcity of Human resources and scarcity of Capital resources

Types of economy
Market Economy USA(Firms and consumers decides in free market economy) Command Economy USSR (Gove decides) Mixed Economy Public sector vs. Private Sector ( India )

Economics classified into Micro and Macro Economics

Micro Economics
1. Studies the economic behavior of individual entities such as Individuals, firms, house holds etc. 2. Explains the Inter relationships between Economic Units like consumers, commodities , firms, industries, markets . 3. Analyses the conditions for efficiency in consumption and production. 4. Describes product pricing which explains theories of demand, production and cost. 5. Understanding Micro Economics helps a great deal in individual decision making i.e. Managerial decision making.

Macro Economics
1. Studies Economy as a whole 2. Explains total National income, Aggregate demand and supply, General Price level, Total employment etc. 3. Fluctuations and trends in the overall economic activity in a country or between countries in the world. 4. Describes the theory of income and employment, inflation, Economic growth etc.. 5. Macro economics study vital in the formation and execution of economic policies by Govt.

Micro and Macro Economics both deals with the Economic issues. Scope and Purpose of Micro Economics, Price Theory studies: a) How resources are allocated to the production of goods and services. b) How the goods are distributed. c) How efficiently they are distributed. These problems are determined by relative prices of goods and services. Therefore Micro Economics called as Price Theory or Value Theory. I. A study of interacting units: Interaction between consumers market, Producers market, Resources Owners Market. A study of welfare Economics: Studies how efficiently goods and services are distributed.

II.

Importance of Micro Economics 1. Explain how prices are determined: like wages, interests, profit and rent are determined. 2. Explains the conditions of efficiency in production and distribution. 3. Provide tools for Economics for policies. 4. Helps in the efficient employment of resources. 5. Helps business executives: to attain maximum productivity with resources. 6. In understand the problems of taxation. 7. Helpful in International trade and Foreign exchange. 8. To examine the conditions of economic welfare: Elimination wastages and bring maximum social welfare. As per the above Micro Economics is highly important.

Limitations of Micro Economics 1. Based on unrealistic assumptions 2. Neglects the whole gives an incomplete picture 3. It may be misleading.

 Production Possibility Curve The PPC helps us understand the problem of scarcity better , by showing what can be produced with given resources and technology.

Assumptions in Constructing a PPC a) The economic resources available for the use in the year are fixed. b) These economic resources can be used to produce two broad classed of goods. c) Technology remains unchanged during the year.

PRODUCTION POSSIBILITY SCHEDULE AND CURVE

Production Possibilities Rice (in tons) Cloth (in 000 meters)

A B C D E F

0+ 4 tons 7 tons 10 tons 11 tons 12 tons

15000 meters 14000 meters 12000 meters 9000 meters 5000 meters 0

 To increase the production of one item, we have to forgo the production of some units of the other item. An increase in the production or consumption of one good can be achieved only through the opportunity cost of the other good. Opportunity costs are result of scarcity. Best Example: A child with Rs.10 in hand can purchase a soft drink or a candy bar, both of which each costs Rs.10. He can have a drink or a candy bar. True production decisions made when resources are limited. The PPC helps us find out the combinations of outputs that can be produced with the available resources in an economy.

DEMAND
Demand means the desire for a commodity or service backed by willingness as well as ability to pay. (Mere desire is not demand) When we speak of demand, we must also state the price, the place and time. Demand is always at a price. The quantity demanded differs from market to market. At the same price demand may be more in market A than in market B therefore the place also should be stated. Demand differs from time to time. It may be less today and more tomorrow. It should be expressed as demand per day, per week or per month or per year etc. So price demand means the various quantities of commodity or service that consumers would buy in a market in a given time at a given price.

Demand and Supply Analysis

Based on purchasing power statistics, India is ranked as fourth largest economy in the world and ranked 3rd in terms of GDP (Gross Domestic Product is a measure of countries overall economic output) in Asia (after Japan & China) and the second largest economy (after China) among developing countries with high potential for economic development, inspite of political uncertainty, infrastructural bottlenecks and burocratic hassles. That is why Multinational company such as Mc Donalds entered the Indian market in mid 1990s and offered food products, which were not customarised to the Indian tastes. The company over estimated the demand for its products and almost all its operations ran into losses. Later the company made some changes in its minimum, which were more suited to the tastes and preferences of the Indian customers and captured the good market share in the Indian fast food market.

This example is the significance of analyzing the forces of demand and supply for any product. The demand for its product plays a major role to achieve the object of a firm is to maximize its revenues and profits. Law of Demand: states that an inverse relationship exists between the price of a good and its quantity demanded, keeping other factors constant. Benham, the Economist stated - Usually a larger quantity of a commodity will be demanded at a lower price than at a higher price

CHANGES IN DEMAND CURVE

The demand curve always slopes downwards from left to right to product. indicate that demand for a product increase where
there is decrease in price of particular

Demand Schedule Table

Price of coffee per kilo (in Rs) Quantity Demanded (in kilos)

Rs. 15 Rs.10 Rs.5

Rs.3

10000 30000 40000

80000

The demand Schedule shows that demand is more at the lower price. Demand extends as the price falls and vice versa.

Reasons why demand curve slopes downwards The demand curve sloped downwards from left to right because demand expands at a lower price . The reasons are : 1) Income Effect (old buyers buy more): Eg- A spend 1 rupee on apple if the price of the apple is 1 rupee A can get only one apple. If the price falls to 0.50 paise, A can buy 2 apples for the same rupee. Fall in the price means a saving in the money or increase in real income. This is called income effect. 2) Substition effect: When the price of a commodity falls it becomes cheaper Eg: If tea is very much cheaper than coffee, people may prefer to use tea instead of coffee. Therefore the demand for tea increase when the price falls. It is called Substitution effect.

 3) New Buyers: People who could not buy when the price is high begin to buy the commodity when the price falls. Thus the demand will be more at a lower price because new buyers purchase the commodity. 4) Different Uses: There are certain commodities that can be put to several uses like Wheat can be used as food, for cattle feed, for manufacture of alcohol etc. If the price is high it will be used only as an article of food and if the price falls and it become cheap it will be used for manufacturing alcohol also. Therefore the demand increases as its price falls and will be used for other less important purposes. 5) Diminishing Marginal Utility at the Law of Demand: Demand is more at a lower price because the utility of each additional unit of the commodity falls . 6) Consumer Equilibrium: If the price of commodity falls this equilibrium is disturbed. Therefore to equalize the marginal utility price ratio, he has to buy more of the commodity whose price has fallen. These are the factors why demand curve slopes downwards.

 Individual Demand: Individual demand is the demand of an individual consumer for a product in a given period of time. A consumer purchased a commodity in a market at different places relates to Individual demand.

Market Demand : It is the sum of demand of all individual consumers in the market for a product in a given period of time. Market demand indicates the sum total of the individual demand at a given price level. Total individuals/Consumers demands in market demand.

 1) 2) 3) 4) 5) 6) 7)

Determinants of Demand

The demand for a commodity depends on several factors: Price of the commodity Population Income Tastes and preferences Weather conditions Price of substitutes (Tea / coffee) Discovery of substitutes ( discovery of paper bags reduced demand of jute bags) 8) Changes in the distribution of income 9) Changes in the real income 10) Changes in money supply 11) Changes in savings 12) Conditions of trade( boom/economic downtrend) 13) Changes in the liquidity preference (people prefer to keep more cash, demand for goods decrease) 14) Expectations: (People think shortage of petrol or increase of petrol. When prices are lower they buy more, thereby demand increase)

Change in Quantity Demanded vs Change in Demand

Quantity demanded changes when the price of the good changes. If the price of the good increases quantity demanded decreases. So demand curve is not shifting. A change in demand occurs when one or more of the determinants of demand changes. Determinants of demand include consumer preferences, Income, and the price of substitute goods.

 A change in demand, due to factors other than price is classified as shift in demand.

Elasticity of Demand
Elasticity is a measurement of the rate of change in demand for a given change in the price. Prof. Marshall defined: The elasticity of demand in a market is great or small according to the amount demanded increases much or little for a given fall in the price and PRICE Quantity Demand Total Expenditure diminishes much or little for a given Nature rise of inElasticity (P) (Q) (P x Q) price. Rs. 4 1000 units Rs. 4000 Elastic Demand
Rs. 3 Rs. 2 Rs. 1 4000 units 6000 units 8000 units Rs. 12000 Rs. 12000 Rs. 8000 Unit Elasticity Inelastic Demand

Income Elasticity of Demand

Income Elasticity demand changes due to change in income also. Income Elasticity is the rate of change in the demand for a given change in the income. An increase in real income increases the demand for product, other factors remaining the same. If the percentage change in demand is greater than the percentage change in income it is high income elasticity of demand. If the percentage change in demand is less than the percentage change in income it is low elasticity demand. If there is no change in demand the income elasticity is Zero. For luxuries have high income elasticity for necessaries income elasticity is low. while measuring income elasticity, other things like population, prices etc are supposed to remain constant.

Price Elasticity of Demand

Defined as the percentage change in quantity demanded of a product due to the percentage change in its price, other things remain constant. Ep= Percentage change in Quantity demanded Percentage change in price If demand for petrol reduces by 2% as a result of an increase in petrol price by 10%. The price elasticity of demand for petrol is -2% 10% = - 0.20.

 Usually the Govt. tries to raise income through indirect taxes such a excise duty or sales tax, which raises the price of the product sold in the market. Here the analysis of price elasticity plays crucial role. For Eg: If the Govt. increases the tax on plastic goods, its price will increase. The raise in price reduces the demand for that commodity. Cross Price Elasticity of Demand: is the ratio of percentage change in the quantity demanded for product to a percentage change in price of another related product other factors remain constant.

 Cross Price elasticity can be positive or negative based on the change in the price of a substitute or complementary products. If two products are good substitutes, the value of cross elasticity is positive. For Ex: Close substitute products : Pepsi and coke. If the price of Pepsi increases, its customers may switch to coke. The change in the price of Pepsi and demand for coke are moving in the same direction hence the cross elasticity is positive. For complementary products like Tea and Sugar have negative cross elasticity. If the price of sugar increases the demand of sugar as well as tea would come down. They move in opposite direction, their cross elasticity negative. Firms selling multiple products use cross elasticity of demand to analyze the effect of change in the price of one product to the demand of others. Ex: Hindustan Lever Ltd ( multiple soaps)

 Revenue Concepts: Total revenue means total profits received by a firm from the sale of product. Additional revenue received result from the sale of extra unit of product is called Marginal Revenue. Total revenue per unit of a product sold is Average Revenue. A clear understanding of cost demand price in micro level helps us the revenue of the particular firm to analyze future demand forecasting and profit ratio.

 SUPPLY: In economics the supply of product refers to the various quantities of the product, which a seller is willing and able to sell at different prices in a given period of time.
LAW OF SUPPLY: states that other factors remaining constant, higher the price, greater the quantity supplied and lower the price, lower the quantity supplied. Price and qualities supplied are positively related.

Supply Schedule of Chocolates

Situation Price ( Rs. Per box) Quantity Supplied (Million boxes per year)

A
B

50
40

22
15

C
D E

30
20 10

9
4 0

In situation E, when the price per box is Rs.10, No firm is willing to produce and sell chocolates. Hence the quantity supplied is Zero. As the price increases he manufacturers are willing to produce and supply large quantities of chocolates.

 The Supply Curve: At a very low price, the chocolates manufacturers might want to use their factories for producing other types of related products. But as the price of the chocolates increases the manufacturers find it more profitable to shift to chocolates. Higher the price of chocolates the greater the amount of chocolates supplied (upward raising curve). Higher the price, the larger is the supply.

 Exceptions: 1) Price Changes: If sellers think that the price in the future going to fall, they sell more at lower price. More supply at the price is contrary to the Law. 2) Labor supply: Some laborers may be satisfied with a certain minimum income. Until they get that minimum income they work more as wages raise. After that they work less. Determinants of Supply: 1) Cost of production: If cost of production rise supply will fall. If cost falls supply will increase. 2) Change in Technology: If new techniques that reduce costs are introduced supply will increase. 3) Number of related firms or sellers increase, supply increase. 4) Price of related goods: If the price of related goods raise, firm may move to those industries because it is more profitable.

5) Govt. Policy Taxation: If taxes increase supply will fall. If taxes are reduced supply may increase. 6) In the case of Agricultural Commodities, failure of rains, droughts, floods, fires, etc. will reduce supply. 7) Means of communication and Transport: Improvement in the means of communication and transport increase supply. 8) Labor Troubles: Strikes, Lockouts, labor troubles may reduce supply. 9) Political Disturbances : Wars and other political disturbances reduces supply. Hence quantity supplied depends on several other factors in addition to the price of the commodity.

 Elasticity of Supply: The law of supply states that supply increase as the price raises and falls as the price falls. But the change in supply in response to the change in price will not be the same for all commodities. Elasticity of supply is the measurement of the change. Formula: Es= % change in the quantity supplied of a product % change in its price Factors that determine elasticity of supply: whether the elasticity of supply is more or less depends on several factors: 1) Availability of suitable factors of production to increase the output. 2) Possibilities of changing the technique of production. 3) Availability of Markets. 4) Entry of New Firms: If slight increase in price attracts new firms to the industry, supply will be elastic. 5) Time Element: It takes sometime for new firms to enter the industry, to erect new plant and machinery etc. Therefore Elasticity of supply will be more in the long period than in the short period.

 Market Equilibrium in economics means situation where the supply of an item is exactly equal to its demand. Since neither there is surplus nor shortage in the market, there is no tendency for the price of the item to change. It is the point at which quantity demanded and quantity supplied are equal.

In this supply and demand curves, the quantity demanded and supplied at price P are equal.

THEORY OF CONSUMER BEHAVIOUR

Consumer behavior is the study of when, why, how and where people do or do not buy product. Product means thing produced by labor or effort or result of an act or a process is product. Consumer behavior blends elements from economics, psychology, sociology, social anthropology. It attempts to understand the buyer decision making process, both individually and in groups. Consumption means the use of goods and services to satisfy human wants. It is using the utilities that goods and services possess. Therefore in economics the use of goods and services for which we pay a price only come under consumption. In other words consumption is the use of economic goods. There are 3 types of consumption. a) Direct consumption: When a person consumes food or uses clothes, radios, cars etc. We gets direct enjoyment. The use of this consumers goods is known as final or direct consumption

 b) Indirect Consumption: Use of machinery, raw materials etc. is called Indirect Consumption or productive consumption . These goods are used to produce goods which satisfy human wants. C) Wasteful Consumption: The waste of materials through accidents such as fire or flood is called Wasteful consumption. When individual or community use goods that are not very useful, they are suppose to indulge in waste consumption. In economics we are not concerned whether any consumption is good or bad. Choice of Utility Theory: It is important to understand between preference and choice in order to maximize satisfaction, consumers have to choose the alternatives for which the net benefit is more. Utility in economics means the extent of satisfaction obtained from the consumption of products and services by the customers. Utility is the psychological satisfaction that a customer derives by using a particular product.

 TOTAL UTILITY: The amount of utility a person derives from the consumption of a particular product is called Total Utility. In the initial stage of consumption the total utility increases after consumption of certain number of units the total utility becomes constant and beyond that it starts reducing. We can say that at a particular point of consumption, the consumer maximizes his satisfaction which is known as satisfaction quantity. Further consumption of that particular product decreases his satisfaction level.

Quantity of product Consumed 0 1 2 3 4 5 6

Total Utility 0 5 8 10 10 9 7

Marginal Utility 5 3 2 0 -1 -2

When first two units of a product are consumed total utility increases. When the consumer consumes the third unit, total utility reaches its maximum point 10. The utility remains constant even after the consumption of the fourth unit but when the consumer starts consuming the 5th and 6th unit of the product, total utility reduces.

Total Utility Curve

Total utility is the total benefit that a person gets from the consumption of a good or service. Total utility generally increases as the quantity consumed of a good increases.

Marginal Utility Theory

It economics the marginal utility of a good or service is the utility gained( or lost) from an increase (or decrease) in the consumption of that good or service. In the above table, it is clear that every increase in the consumption of a product reduces its marginal utility. Law of Diminishing Marginal Utility: A law of economics states as a person increases consumption of a product while keeping consumption of other products constant, there is a decline in the marginal utility that person derives from consuming each additional unit of total product. For Ex: If we eat a second apple immediately after the first, the satisfaction we get from the second apple will not be as much of the first. Similarly the third apple will give lesser satisfaction than the second. Thus the more and more units of a commodity which person consumes, the less and less is the utility derived from the additional units. This is true of every commodity which a person consumes. It is called the law of Diminishing Marginal Utility.

Marginal Utility Curve

The general tendency for marginal utility to decrease as the quantity of a good consumed increases the principle of diminishing marginal utility

 Assumptions: 1) No time Interval, continuous assumption: The consumption of the commodity should be continuous without and time gap. 2) Identical Units: The unit of the commodity consumed should be of the same quality same size, taste color etc. They must be identical in all respects. 3) Standard Units: The size of the units consumed should not be too small or too large. For Eg: The standard unit of a water is a glass if we begin to drink water in small spoons the utility of the second spoon of water may not diminish. Therefore the consumption must be in standard units. 4) Tastes and Preferences Constant: The law assumes that there is no change in the character of the consumer during the period of consumption. 5) No change in the Income: There should not be no change in income of the consumer during the period of consumption. 6) Normal Persons: The consumer should be an economic person who acts rationally. The law may not operate in the case of abnormal persons. 7) No Change in Price: If prices change the law may not operate 8) No Change in Other Peoples Stocks: The law also supposes that the stock of the commodity with other people does not change. Eg: if number of telephone connections in the town increases the utility of second phone in the house may increase.

9) No change in the Consumers Other Positions: When we can not buy a horse a carriage may be lying useless with us. But when we buy a horse the utility of carriage goes up. Therefore the law assumes that there is no change in the consumers stock of other goods. 10) Goods should be of Ordinary Type: The law may not apply to extraordinary goods like diamonds. 11) Goods should be Divisible: In the case of durable and indivisible consumers goods like cars, televisions, scooters etc. it is not possible to calculate utility because their use is spread over a period of time. Further we do not generally buy a second car or a second television set, immediately one after the other therefore utilities can not be compared.

Indifference Curve Theory and its Application

An indifference curve reveals the various combinations of two products or services to which the customer is indifferent at a particular level of income. Any combination of products or services on an indifference curve will give the same level of utility. Assumptions: Indifference Curves have a Negative Slope: Indifference slopes downwards to the right which reveals that the consumer prefers more of a particular product. Indifference curves can not Intersect each other and higher level indifference shows higher level of utility.

 Combination of two products that yield same level of Utility:

Utility Quantity of Apples consumed Quantity of Oranges consumed

20

11

20

20

20

11

Indifference Curve Diagram

This shows three indifference schedules of the consumer L1, L2 and L3. L2 shows a higher level of satisfaction than L1. Similarly L3 shows higher level of satisfaction than L2. The consumer may have different indifferent schedules each showing a different level of satisfaction. A higher indifference curve shows a higher level of satisfaction and the lower indifference curve shows a lower level of consumer satisfaction. The problem of consumer is how to distribute his limited income over several wants so as to get maximum satisfaction. Therefore the indifference theory was developed to explain consumers behavior.

Consumer Surplus
Consumer surplus is a measure of the welfare that people gain from the consumption of goods and services, or a measure of the benefits they derive from the exchange of goods. Consumer surplus is the difference between the total amount that consumers are willing and able to buy for a good or service(indicated by the demand curve) and the total amount that they actually do pay (i.e. the market price for the product) The level of consumer surplus is shown by the area under the demand curve and above the ruling market price as stated in the below diagram.

CONSUMER SURPLUS IS THE DIFFERENCE BETWEEN THE PRICE THAT A CONSUMER IS PREPARED TO PAY AND THE ACTUAL PRICE PAID.

Consumer Surplus is the difference between price to consumer has to pay and the price the consumer prepared to pay. Eg: He may be prepared to pay of Rs.200 for a ticket of the movie which costs of Rs.120 only. Here he got Rs.80 consumer surplus. Consumer surplus is the above the equilibrium price.

 Applications of Consumer Surplus: Consumer surplus is useful for designing Govt. policies and implementing welfare programmes. The Govt. can use the concept of consumer surplus to fix taxes since the rich or the upper middle class people have more consumer surplus compared to the rest. Consumer surplus also reveals the purchasing pattern of the economy. For Eg: More taxes can be levied on costly or luxury goods since they would be brought by consumers who have more surplus. The consumer surplus concept is also useful in measuring the gains from International Trade. Consumer surplus can also be used to measure the health of an economy. A higher consumer surplus means the economy is stable.

 Consumer Price Index: A CPI measures changes through time in the price level of consumer goods and services purchased by households. CPI in India comprises multiple services classified based on different economic groups therefore a series: The CPI UNME (Urban non- Mannual Employee), CPI AL (Agricultural Labor), CPI RL (Rural Labor) and CPI IW (Industrial Worker). While the CPI UNME series is published by the Central Statistical Organization, the others are published by the Department of Labor. Most developed countries like USA, UK, JAPAN, FRANCE, CANADA and SINGAPORE used the Consumer Price Index to calculate Inflation. The Globalization describes the process by which regional economies, societies and cultures have become integrated through a global network of communication, transportation and trade. Economic globalization comprises the globalization of production, markets competition technology and corporations and industries.

THEORY OF PRODUCTION AND COST

Production: Production refers to the output of goods and services produced by businesses within a market. This production creates the supply that allows our needs and wants to be satisfied. 1) Short run Production: The short run is a period of time when there is at least one fixed factor input. This is usually the capital input such as plant and machinery and the stock of buildings and technology. In the short run the output of a business expands when more variable factors of production (i.e. labor, raw materials and components) are employed. 2) Long run Production: In the long run all the factors of production can change giving a business the opportunity to increase the scale of its operations. For eg: A business may grow by adding extra labor and capital to the production process and introduction new technology into their operations.

 What is Production Function: Production function deals with the maximum output that can be produced with a limited and given quantity of inputs.

 The meaning of Productivity: When economists and Govt. Ministers talk about productivity they are referring to how productive labor is. But productivity is also about other inputs. For ex: A company could increase productivity by investing in new machinery with latest technological progress, which reduces the number of workers required to produce the same amount of output. The Govt. objective is to improve labor and capital productivity. Production with One Variable Input: In the short run one of the inputs is fixed and other input is variable. Usually, firms plan and consider changes in operations involve in changes in all inputs. Therefore, while firms plan for a long run, they operate in the short run. Production refers to the economic process of converting of inputs into outputs. Production uses resources to create a good or service that is suitable for exchange. Some economists production broadly as all economic activity other than consumption. Inputs are Land, Labor (the ability to work) and capital goods (factories, tools, equipment) Raw material , Machinery applied to production.

 The material produced, manufactured, yielded (or) the final product is output. The most common example of a variable input is labor, to control short run production. The Law of Variable Proportions: The law of variable proportion is the new name given to the famous law of diminishing returns. The law states the marginal product of each unit of input will decline as the amount of input increases holding all other inputs constant. It is one of the important laws of economics. This law shows the short run input relation. According to C.E. Ferguson- As the amount of variable input is increase the amount of other inputs held constant, a point is reached beyond which marginal product declines. The clear example of this law can be found in agriculture production. In agriculture, if we keep the quantity of land fixed and go on increasing the quantity of labor, eventually the marginal product decline. This law is of greater importance in understanding the problems of under developed countries because agriculture is the main occupation in such countries.

 Law of Return to Scale: As we know that law of variable of proportion such law is concerned with short run. But we have long run situation also where both labor and capital are variable. In this situation when firms changes both labor and capital the effects of production will be analyzed within the name of return to scale. There will be the operation of the increasing return of scale, constant return to scale and decreasing return to scale. Increasing Returns to Scale: When an increase in all inputs leads to more than proportional increase in output it is called increasing returns to scale. In a small scale chemical plant, let us assume that labor, material, capital- all factors of production- are increased by10%. Output will increase more than 10% in use of increasing returns to scale. Constant Returns to Scale: When an increase in all inputs leads to proportional increase in output it is called constant returns to scale. For Ex: There are two factors of production- land , labor and they are doubled, the output will also double in case of constant returns of scale.

 Decreasing Returns to Scale: It occurs when an increase in all inputs leads to less than proportional increase in output. When processes are scaled up, they reach a point beyond which inefficiencies set in. It may happen due to either cost of management or in effective control. For eg: It has been found that in electric generation plants, when the plant grows too large risks of plant failure increase disproportionately. Internal and external diseconomics lead to diminishing returns.

1) 2) 3) 4)

Assumptions: All the factors are variable There are no technological changes There is a perfect competition The output is measured in physical units.

 Graphical Representation: OX axis shows scale of production. OY axis output. As the scale of production increases up to the point C we get increasing returns. From C to D we get constant returns. From D onwards we get diminishing returns.

 COST CONCEPTS: Broadly 3 types of costs for producing a commodity by the firm. 1) Money cost of production: The producer has to pay prices to the factors of production he has employed, wages, interest, rent etc. He has to pay prices for the raw material, fuel etc. Money costs refers to the money payments made by the producer for producing goods or services. These money costs are divided into fixed costs and variable costs. Fixed Costs (Supplementary or Overhead Costs): Fixed costs remain same whether the outputs increased or decreased. Equipment, machinery, buildings, salaries of permanent staff, insurance premia, taxes on property, interests on capital or some of the fixed costs. Even production is nil these costs have to be incurred. Variable Costs: Variable costs are those that vary or change with changes in the output. If production increases variable costs increases. If production decreased, variable cost also decreased. Expenditure on raw materials, power, fuel, wages for labor are some examples of variable costs. If there is no production variable costs will be nil. Variable costs vary with the outputs.

 2) Real Cost of Production: Real costs refer to the effort, trouble and sacrifices involved in producing a commodity. It is a subjective concept. The work done by laborers is painful, disagreeable, wages paid to them may not be equal to the efforts, troubles and sacrifice involved in labor. Capital comes out of savings. Savings involve reduction of consumption. The classical Economists said that the real costs of production are the efforts, sacrifices and disutilities involved in production. Efforts, trouble, sacrifices etc are mental and psychological feelings. They are subjective. They can not be measured. But the concept is useful to know that money costs may not reflect the pain and sacrifice. 3) Opportunity Cost (or) Alternative Cost (or) Transfer cost: The concept is based on the fundamental fact that resources are scare while the ends are unlimited. When resources are scare, if we want to produce more of a commodity we have to produce less of another commodity.

 For eg: If we want to produce more sugar cane, we may have to divert land from paddy production. To produce motor cars we may have to reduce the production of military equipment. Thus one commodity can be produced at the cost of another. The cost of producing more sugar cane is the output of paddy foregone. If for producing 100 tones of sugar cane, 140 tones of paddy is foregone, then the cost of producing 100 tones of sugar cane is 140 tones of paddy foregone. The opportunity cost of anything is the next best alternative commodity foregone. The concept of opportunity are Alternative cost is useful and important to management in taking decisions among alternatives.

 Theory of Costs in Short run and Long run: The nature and behavior of costs depends on the time factor also. There are differences between short period costs and long period costs. In the short period the number of firms in the industry and the size of firms remain constant. In the shorter period output can be changed with the variable factors only, plant and machinery being the same but long period is the period when a firm increases production by increasing its size by changing the size of plants and machinery etc. Diagram Representation of Short and Long Period Costs: With plant size 1, SRAC is the short period average cost curve. It is a small size. With plant size 2, SRAC 2 is the short period average cost curve. This second plant is bigger than the first. With plant size 3, SRAC 3 is the short period average cost curve. This plant is bigger than the second.

 If we draw a curve connecting the three short period average cost curves we get the long period average cost curve, LRAC. LRMC is the long period marginal cost curve corresponding to LRAC. LRAC shows that long period costs will be lower than the short period costs. In this for producing R1 output short period cost is K while the long period cost is E. E is lower than K. When the output is N, short period and long period costs are equal. It is the lowest point. The firm should try to reach that output in the long period. At the outset N, LRAC and LRMC are also equal. The firm has to workout the long period costs with different sizes of plant and equipment so as to know the best size of plant and machinery with it can be produced at the lowest average cost.

Short and Long run cost curves

 Differences between Short period and Long period costs LRAC represents costs for different plant size, while SRAC represents cost for only one particular plant size. In the long period the firm can move from one plant size to another. Long period cost can not be higher than the Short period average cost at a given output. LRAC curve can not cut any short period cost curve. LRAC shows that it is not possible to produce a given output in the cheapest way in the short period. It can be done only in the long period. LRAC shows the optimum size of the firm. It shows what output it can produce at the lowest average cost. LRAC will be equal to SRAC which has the lowest average cost. LRAC curve will be flatter than the SRAC curve.

 Break Even Analysis: Break Even analysis is important practical application of the cost function. In business planning many decisions are taken on the basis of an anticipated level of output. Break Even analysis studies the inter-relationships between the firms revenues , costs and operating profit at various levels of production. It is very useful for managerial decision making. The break even point can be defined as a situation where a firm makes no profit and no loss. The break even point depends upon the revenue output and cost output functions. It is a inexpensive method where it helps in forecasting the required level of unknown variables.

MARKETING ORGANISATION
Marketing is the process by which companies create customer interest in goods and services. It is an integrated process through which companies build strong customer relationships and create value for their customers and for themselves. Marketing is used to identify the customer. Satisfy the customer and to keep the customer. With the customer as the focus of its activities it can be concluded that marketing management is one of the major components of business management. The term marketing concept holds that achieving organizational goals depends on knowing the needs and wants of target markets and delivering their desired satisfactions. Marketing is defined by the American Market Association (AMA) as The activity, set of institutions, and processes for creating, communicating, delivering and exchanging offerings that have value of customers, clients, partners and society at large. The Charted Institute of Marketing defines Marketing as the management process responsible for identifying, anticipating and satisfying customer requirements profitably.

 In economics, it refers to a place or locality where a commodity or commodities are bought and sold. In economics the term Market implies in 5 ways: 1. There should be buyers and sellers of the product. 2. Contact between buyers and sellers. 3. Same commodity. 4. There should be a price 5. Market promotion. Classification of Markets: There are 3 types : 1. Local Market: When buying and selling is confined to a particular locality or village or town, it is called local market. The demand and supply are influenced by local conditions only. Generally, perishable goods like milk, flowers, vegetables etc have a local market.

 National Market: If a commodity is demanded and supplied over the entire country, it is a National market. For eg: rice, wheat etc have a National market. International/Global Market: If the commodity is demanded and supplied over the entire world, it is International Market. For eg: Gold, Silver, cotton, petrol etc.. The size of a market is influenced by several factors. In 21st century, the extent of market for almost al commodities and services are widen world wide.

Marketing Communication Channels

Newspapers Direct Mail Radio Television Telephone Posters Personal Selling Flyers Individual Referral E-mail Internet

Marketing
Different Categories
Print Voice/Pictures Electronic

Print
Brochures Flyers

Advertisements
Articles

Voice/Pictures
Radio Television Telemarketing Video Tapes

Electronic
Web Pages E-mail

Internet ads

How tightly can it focus in on the market?

How economical is it?

Each category has advantages and How effective is it? disadvantages:

 Factors that determine the extent or the size of Markets: These can be divided into qualities of the product and general factors. Qualities of the Product: 1) Nature of Demand: If the commodity is demanded through out the country it will have national market. If it has demand through out the world it will have International market. Cotton, wheat, gold have National and International market. If the demand is local it will have local markets only. 2) Durability: If the commodity is durable it will have National and International markets. If the commodity is perishable like milk, fruits etc. it will have local markets. 3) Portability: If commodity can be easily transported it will have wide market. Goods

 4) Grading and Sampling: If a commodity can be graded according to quality size etc. it will have National and International markets also. 5) Adequate Supply: To have large markets the supply of the commodity should be sufficient to meet the large demand. If the supply of the commodity is small and can not be increased it will have only a small market. General Factors: 6) Transport and Communications: Speedy transportation and quick communication expand the size of the market. Efficient and quick transport and communications enable traders to buy and sell even in distant markets 7) Efficient Banking System: Trade requires credit. It involves payments and transfers of money. Efficient banking system provides such financial facilities required by trade and industry. Therefore growth of commercial banking system and stable currency

 8) Scientific Methods of Business: Adoption of scientific methods of business also increases the size of the market. Up to date and scientific salesman ship advertisements and market by samples extend the size of the market. 9) Peace and Political Stability: Stability in political conditions and maintenance of law and order are very essential for the growth of trade and industry. 10) Government Policy: The Govt. trade policy plays a very important part in making the market narrow or wide. If the Govt. places restrictions on the movement of goods the size of the market will

Pricing under Perfect Competition

Features of the Perfect Competition: 1. There will be large number of buyers and sellers. No single buyer or seller can change the market price by his action. 2. The buyers and sellers will have perfect knowledge of the commodity sold and the price prevailing in the market. 3. The commodity sold is identical in all respects. 4. The firm can freely enter or leave the industry. 5. There is a perfect mobility of factors of production. 6. There are no transport costs. 7. Transactions takes place on the basis of price only. No personal or other considerations enter sale or purchase.

 Equilibrium Price: Price is determined by demand and supply forces. Demand for a commodity is a schedule of various quantities purchased in given market in a given period of time at different prices. Demand and supply are opposite forces. When the price falls demand extends but supply falls. Similarly when price rises, demand falls but supply increases. The price that brings into equality the quantity supplied and the quantity demanded is called Equilibrium Price. It is the equilibrium price that will settle down in the market making demand and supply equal.

Price
(Rs)

Quantity Demanded (in Kilos)

Quantity Supplied (in Kilos)

3
2

10000
20000

40000
20000 Equilibrium price 10000

40000

At the price of Rs.2 the quantity demanded is 20,000 kilos and the quantity offered for sale is also 20,000 kilos. Supply and demand are equal at the Equilibrium price. Therefore price has no tendency either to raise or to fall. It is the Equilibrium Price. At the point E supply and demand curves intersect when the price is OP. At the price OP demand and supply are equal. OP is the Equilibrium Price. OM is the quantity sold and bought.

Changes in equilibrium price with changes in Demand and Supply: If there is a change in demand or in the supply, the equilibrium price will also change. When the demand increases (supply being constant) the price will increase and where the demand decreases price will fall. Similarly when the supply increases (demand being constant) price will fall and when the supply decreases price will rise.

 In the diagram A SS is the supply curve and DD is the demand curve. OP is the first equilibrium. When demand has increased to DD1 the new equilibrium price is OP1. When demand has decreased DD2 the new equilibrium is OP2. In the diagram B when supply has increased from SS to SS2 the new equilibrium has decreased from OP to OP2. When supply has decreased from SS to SS1 the new equilibrium price has increased from OP to OP1. The equilibrium price is determined both by demand and supply. Although perfect competition does not exist in the real economy it is very helpful for managers and business persons to take decisions regarding an ideal combination of output pricing for an industry or a firm. It also helps in analyzing the role of demand and

IMPERFECT COMPETITION
Competition becomes imperfect if any one of the conditions of perfect competition is not satisfied. When there is a imperfect competition in a market it is called Imperfect market. Imperfect competition is very common. In this kind of market there are few sellers and product differentiation and price wars are common. Features: 1) The number of sellers in the market are small. Therefore each seller may be in a position to influence the price by his action. 2) Competition becomes imperfect when the buyers are few in number. Each buyer may be in a position to influence the price by his action. 3) The product is not homogeneous. There is a product differentiation for eg: In tooth pastes we have several varieties like Colgate, Pepsodent etc. when there is such product differentiation it is called Monopolistic Competition which is one form of Imperfect Competition.

 4) Ignorance of market prices and conditions also leads to imperfect markets. If the buyers do not know the different prices in the market the price at which one buyer buys will be different from the other. 5) Advantages of location also sometimes leads to imperfect competition. Some buyers may prefer to buy from a shop located nearer to them even though the price is bit high. Therefore different prices may exist in the market for the same commodity. 6) Discrimination, Personal likes and dislikes also lead to imperfect competition. If the seller sells at a lower price to some customer or if the buyers buy from some sellers only even though the price is high it become imperfect market. 7) The existence of transport costs makes the market imperfect. There will be different prices for the same commodity due to differences in the transport costs. 8) Absence of free mobility of factors and restriction on freedom of entry or exit of firms also lead to Imperfect markets.

 In an imperfect market there will be different prices for the same product. Monopoly and monopolistic competition are two forms of imperfect competition. When there is only single producer or seller and there are no close substitutes for his product, we called monopoly. When there are few sellers with product differentiation it is called Monopolistic competition. In perfect competition when firm reaches equilibrium normally all its resources are put to optimum use. On the contrary in imperfect competition when firm reaches its equilibrium all its resources are not put to optimum use. Markets with imperfect competition are 3 types. Monopoly, Monopolistic competition or Oligopoly.

PRICING UNDER MONOPOLY

In Monopoly there is only one seller of the product in the market and there are no close substitutes for the product. Monopoly is the exact opposite of the market situation prevailing in perfect competition. The firm operation in the monopoly can either fix the price or control the supply of products. There is no competition in monopoly but there will be many buyers. Under Monopoly there is no distinction between firm and industry since there is only one firm, firm and industry are same. Eg: Indian Railways may be termed a monopoly. The state owned electricity boards might be termed as .monopolis

 Characteristics of Monopoly: There is only one firm which supply the entire market and many buyers and consumers. The firm sells a unique product which has no close substitutes. The firm has market power (that it can control its price). Profit maximiser Entry into the market is restricted. Eg: Due to high costs and some special barriers to entry.

 Foundations of Monopoly Power: 1. Legal Monopolies: They arise due to copyright, patent right etc. 2. Artificial Monopolies: They arise due to combination of firms, agreements etc. 3. Natural Monopolies: They arise due to exclusive position of some commodities given by nature. Eg: Diamonds in Africa. 4. Social or State Monopolies: They arise when the Govt. takes over public utility industries or other industries . 5. Heavy Investment: When the industry requires heavy investment only one or few firms may undertake it. It may give raise to monopoly. Eg: Doordarshan, Indian Airlines and BSNL etc. 6. Control over supply of raw materials: When a firm owns all the sources of raw material supply new firms cannot enter industry. Monopoly arises. 7. Goodwill: Due to goodwill earned by a firm it may get monopoly power.

 Price Determination under Monopoly: The aim of the monopolist is to get maximum net monopoly revenue or maximum monopoly profit. The monopolist chooses that price and quantity which gives maximum profits. Monopoly:
Output (Units) Price (Rs) Total Revenue (Rs) Marginal Revenue MR (Rs) 2 Average Revenue AR (Rs) 2 (2/1)

2 (1x2)

1.90

3.80 (1.90x2)

1.80 (3.80-2.00)

1.90 (3.80/2)

 MC is the marginal cost curve and AC is the average cost curve. AR is the average revenue curve and MR is the marginal revenue curve. Both AR and MR slopes downwards as the price falls when output is increased. MR curves lies below AR because MR will be less than AR. The monopolists stops output at OM because at the output MC and MR are equal. MC cuts MR at point S therefore at OM, MC=MR. He sells the output OM at the price P1 on the demand curve AR. AR is the demand curve also at the output OM average cost is L on AC curve, price P1 is above AC. The shaded area PP1 LT are the super normal profits of the monopolist. It is the maximum profit position. No other price and output will give such maximum profits.

 Limitations on Monopoly Power: 1) Government may interfere and fix price if the monopoly price is very high. 2) Consumers may boycott his product if the price is very high. 3) Substitutes for his product may be found out if the price is very high. 4) Imports may be made. 5) Govt. may abolish monopoly. These limitations prevent monopoly price to be very high.

 Price Discrimination by the Monopolist: The monopolist may not charge the same price in all the markets. He may fix a lower price in the market where demand is elastic and a higher price in the market where demand is inelastic. Such price discrimination brings him maximum net monopoly revenue.

 Difference between Monopoly and Perfect Competition: 1. Demand curve monopoly, slopes downwards Perfect competition, perfectly elastic: Under perfect competition a single seller cannot change the market price by his output decisions whether he increases output or reduces output the market price does not change . The seller under perfect competition is a price taker. In the case of monopolist it is not so as he is only seller and there is no other seller changes in his output influences the price. The seller under monopoly is a price maker. 2. Size of Profits: Perfect competition Normal profit, Monopoly, permanent abnormal profits. 3. Costs and Equilibrium: Perfect competition equilibrium only when costs are rising. Monopoly equilibrium, costs may be falling or raising. 4. Price Discrimination: The monopolists can change different prices. It is not possible under Perfect competition. 5. Price higher, output lower under Monopoly: Price under monopoly will be higher than competitive price and output is lower in perfect competition. 6. Loss of Consumer Surplus: Since monopoly price is higher

 It was Prof. Chamberlin who was mainly responsible for the development of Monopolistic competition theory. He developed theory in his famous book in Theory of Monopolistic Competition in 1933. In this each firm will be in a monopoly position but at the same time it will have to face competition from similar Monopoly firms, which produce close substitute products. For eg Toothpaste. We have different varieties in the market Colgate, Close up, Peopsodent etc. Similarly, in soaps we have several varieties like Hamam, Lux, Rexona, Cinthol etc. Under Monopolistic competition the firm produce goods that satisfy the same want, but each firm produces a different variety of the same product. These different varieties are close substitutes. This market structure is a combination of elements from Perfect Competition and Monopoly. Firms in the service industry also try to differentiate themselves through their logos. Service companies such as Banks, Financial service companies, Insurance companies, Consultancies, Courier companies etc. they try to create quality of identity in

Features and Pricing under Monopolistic Competition

Features:
1) Large number of Sellers: There will be large number of sellers under monopolistic competition but no one controls a major portion of the total output. Every firm acts independently regarding its price and output policies without considering the reactions of the rival firms. 2) Product Differentiation : Product differentiation is the most important feature of monopolistic competition. All the firms produce a product that satisfies the same demand but product produced by each firm is in some way different from the other. These differences may be real or imaginary. Each firm creates an impression that its product is superior to others and attracts a group of customers to its products who always like to purchase it. The products are close substitutes but not perfect substitutes. Such product differentiations is created by changing the quality of product, by advertisement and propaganda by patent rights and trade mark etc. 3) Freedom of Entry and Exit: Under Monopolistic

 Price and Output Determination under Monopolistic Competition: Can be divided into short and long period equilibrium. A. Short Period Equilibrium: Each firm under monopolistic competition has a group of customers for itself who like to purchase its product even if the price is little high. Each firm has its own market therefore each firm has monopoly power. The demand facing a firm under monopolistic competition is highly elastic. If a firm increase its price it may loose its customers because they may prefer to buy other varieties of product which are cheaper. Similarly if it reduces the price it can attract some more customers. Therefore the demand curve facing the firm slopes downwards from left to right. Efficiency, cost condition, elasticity of demand may differ from firm to firm therefore some firms may be getting abnormal profits and some firms normal profits and some firms losses also. Firms which have been in the field for long time and earned good name may be earning abnormal profits. New firms may prefer to fix lower price and be satisfied with normal profits. Some firms may be working under losses also because cost and demand conditions are not favorable to them.

 B. Long Period Equilibrium: In the long period there can not be abnormal profits or losses. The firms will be making normal profits only. Under monopolistic competition new firms can enter or existing firms can leave therefore if there are abnormal profits new firms will enter the field. If prices decline on the other hand costs raise. The entry of new firms and larger production increase the demand for factors of production. Therefore factor prices like wages, raw material cost may rise further the existing firms may have to spend more on advertisement, publicity etc to keep up their sales. Thus with the entry of new firms prices fall while costs of production raise. The process will go on until the firms earn normal profits only in the long period. The old and experienced firms may be earned some abnormal profits in the long period. If there are losses, the firms will leave the field. Production will fall and price will raise until there are no losses and the firms earn normal profits. Therefore in all firms normal profit position may not definitely take place.

 C. Group Equilibrium: The firms under monopolistic competition can not be called an industry because they do not produce identical product. They can be called as Group of firms. When the firms are making normal profits in the long period there will be group equilibrium. Difference between Imperfect Competition and Monopolistic Competition: Imperfect competition is a very wide term that includes all market imperfections. But the term monopolistic competition is restricted to imperfect competition that arise due to product differentiation . Difference between Monopoly and Monopolistic Competition: Under monopoly there is only one producer or firm. There is no close substitute for his product. New firms can not enter the field and abnormal profits will be permanent. But under Monopolistic competition there are many firms. The firms produce very close substitutes. New firms can enter the field. The firms can earn normal profits in the long period.

 Difference between Perfect Competition and Monopolistic Competition: In Monopolistic competition resembles perfect competition in a way because just like perfect competition, under Monopolistic competition also there are many sellers, there is freedom of entry and exit and the firms make normal profits only in the long period. But in other respects it differs completely. The product produced is not identical. Even though the firms under Monopolistic competition earn normal profits, the output is not expanded up to the minimum point on the AC. They are not optimum size. There will be unutilized or excess capacity. Under perfect competition all firms will be of optimum size.

Pricing under Oligopoly

The term Oligopoly has been derived from two Greek words Oligi which means few and Polien means sellers. Oligopoly defined by Feller as Competition among the few. Oligopoly refers to a market situation where there are few sellers in a market selling homogenous are differentiated products. This kind of market structure has a small number of large producers. Pricing decision depends on the demand conditions, the cost conditions and the pricing strategies of competitors. In an Oligopoly market it is difficult to determine the equilibrium price and output because there is interdependence among different firms and it is difficult to specify the particular reaction of the rivals.

 Oligopoly arise due to following reasons: 1) Large capital requirements: Some industries require large amount of capital. Only a few big industrialists can enter such industries. 2) Economies of Scale: In some industries only few firms of sufficiently large size can meet the demand. For eg: Iron and steel industry, automobile industry, cement, petroleum etc. In such industries only large firms can get the economies of large scale production. The number of firms will be few. 3) Aggressive Entrepreneurs: With a desire to make large gains the superior entrepreneurs drive out of the rivals by ruthless competition or by forming mergers and holding companies. 4) Patent Rights: A few firms acquire patent rights for some goods others can not enter the industry. 5) Possession of some Essential Resources: A few firms may possess some essential resources for the production of the commodity. They get absolute advantage in costs and others can not survive in the industry.

 Characteristics of Oligopoly: 1) Interdependence: As a number of firms are very few the price and output decision of one firm effect the other firms. If one firm reduces the price the other firms also may retaliate by reducing their prices. Therefore a firm in Oligopoly cannot independently fix the price and output. It has to consider the reactions of other firms. 2) Indeterminate Demand Curve: A firm under Oligopoly cannot make an accurate estimate of its sales. If it were to reduce the price it is difficult to foresee the reactions of the rival firms. The demand curve or the revenue curve of the firm is indeterminate. 3) Importance of Selling Costs: Due to interdependence each firms has to adopt aggressive advertisement techniques and spend huge amounts on advertisement to make the demand favorable to it.

4) Competitive and Collusion Trends: Sometimes the firms realize the need for mutual cooperation and they collude at other times there will be rivalry and competitive spirit. Thus we find conflicting features of mutual co operation sometimes and competition at other times. 5) Element of Monopoly: If there is product differentiation each firm controls a large share of market and becomes a small monopolist. In such a case it will have more independence. 6) Price Rigidity: It is likely that under Oligopoly price may be kept unchanged for years together for fear of retaliation. Price Determination under Oligopoly: 1) Independent Pricing: A) If there is product differentiation each firms has a monopoly element. Therefore it can fix its price as under monopoly aiming at maximum monopoly profits. B) If there is no product differentiation and all firms produce homogenous product no definite solution can be stated for independent pricing. There may be price-war each firm trying to fix lower price and undersell the other (or) after arriving at a reasonable price they may not change it. But independent pricing does not continue for a long under Oligopoly. Firms

2) Collusive Pricing: The firm may form a cartel (a combination of independent business organizations formed to regulate production, pricing and marketing of goods by the members) to regulate prices and output of all firms and avoid competition. If it is perfect cartel board of control will determine the output and the price to be charged by each firm. If it is loose cartel the firms divide the market among themselves and agree to charge a uniform price. Each firm gets profits on its sales in the market allocated to it. But collusive pricing may not continue for long. 3) Price leadership: The firms agree to sell at a price set by the leader of the industry. a) Barometric Price Leadership: One firm with the wisest entrepreneur announces a price and the other firms follow it. b) Dominant Price Leadership: One big and largest firm in the industry set the profit maximization price and the other firms follow it. c) Aggressive or Exploitative Price leadership: One firm that dominates the market fixes the prices which forces the other

 Effective Price leadership: When there are few firms with same cost conditions and less elastic demand a price may agreed upon by all firms to avoid competition among them. Difficulties of Price Leadership: In the real world price leadership does not work smoothly. 1. Price leader may not be able to assess correctly the reactions of other firms. Therefore other firms may not follow it. 2. The rival firms may secretly charge lower prices and try to increase their sales at the cost of others. 3. The rival firms may resort to non price competition to increase sales. 4. The new entrants into the industry may not follow priceleader. 5. When there are differences in cost of production some firms find it difficult to follow the price-leader.

KINKY DEMAND CURVE THEORY

Prof. Paul Sweezy of Harvard University published Demand under conditions of Oligopoly. Prof. Sweezy argued that an ordinary demand curve does not apply to Oligopoly markets and promoted a Kinked Demand Curve. Definition: Price pattern when supplies are few: the demand curve that prevails in an Oligopoly where competitors will cut prices to match those of rivals but will not increase to match them. To explain Price -Rigidity under Oligopoly Prof. Sweezy used the Kinky Demand Curve model. If the firm under Oligopoly increases its price it believes that other firms will not increase their price. It sales will fall. Therefore it does not like to increase the present price. If it reduces the price the rival firms may also reduce the price. Therefore the firm cannot estimate what its demand would be if price is reduced by it. There will be uncertainty. Therefore it does not like to reduce the price and sticks on to the present price. This uncertainty in demand when its price is reduced is called Discontinuity or Kink in the demand curve.

YOU

THEM

RESULT

Ignore

Your competitors will ignore your price and keep their price the same so consumers will go to them.(Elastic demand)
Your competitors will match your price decrease so you wont get that many more consumers (In elastic demand)

Match

 The Kinky Demand Curve model is one method of explaining price rigidity in Oligopoly and it can be explained by several other reasons. 1) Price war leads to uncertainty and risk of losses. Therefore after at a price that gives reasonable profits, the firms do not like to change it. 2) The firms prefer to increase the sales by non price competition like variation of product, better services etc. Then adopt price cutting and price war. 3) The customers are accustomed to the present price. Therefore the firm may not like to change it and invite consumer dislike. 4) The firms may come to an understanding to charge a uniform price that prevents new entrants into the industry. They may not like to change.

THOERY OF FACTOR PRICING

Factor pricing means the price paid for the services rendered for the factor of production but not the price of the factor itself. For eg: Rent is the price paid for usage of land, but it is not the price to own the land itself. The theory of Factor Pricing is concerned with the evaluation of the services of the factors of production. It deals with the determination of the share prices of 4 factors of production. Eg: :Land, Labor, Capital and Organization . Pricing of factors of production is Functional not Personal. The rewards of factors of production is income from the factors of production point of view but cost from firms point of view.

 MARGINAL PRODUCTIVITY THEORY OF FACTOR PRICING National Income is distributed to the factors of production land, labor, capital and organization. Land gets rent and labor gets wages. Capital gets interest and organization gets profits. This is called Functional Distribution of income. The marginal productivity theory of distribution explains how these rewards to the factors are determined. This theory was developed by Wicksteed Marshal etc. Essential Points of the Marginal Productivity Theory 1. Factors of production contribute to production. They are paid rewards for their services. 2. The reward paid to each factor will be equal to its Marginal revenue product. Marginal revenue product is its marginal physical product multiplied by the price. 3. The marginal productivity of a factor diminishes when more of its employed keeping other factors constant due to the law of diminishing returns. 4. The Marginal productivity divided by price ratio of all the factors employed will be equal. The employer aims at maximum profits. Therefore he substitutes cheaper factor in the place of costlier factor.

5. Under perfect competition the reward paid to a factor will be equal not only to its marginal product but also to its average product in the long period. 6. No employer who aims at maximum profits will pay rewards which are more than the value of marginal product under Perfect Competition. An example in the case of labor.
Labor Marginal Production (Units ) 10 5 2 Price (Rs) 2 2 2 Marginal Revenue Product (Rs) 20 (10x2) 10 (5x2) 4 (2x2)

1 2 3

In this when 3 laborers are employed the marginal product of the last laborer (marginal laborer) is 2 units. The marginal product is diminishing due to the law of diminishing returns. The price per unit of production is taken as Rs 2. It remains contestant under Perfect competition. Marginal revenue productivity is equal to marginal product x price. Therefore the marginal product of the last laborer employed is Rs. 2x2=4. He will be paid a wage of Rs. 4.

 It is assumed that all the laborers are equally efficient. Therefore what is paid to the last laborer will be paid to others also. Thus wages are determined by marginal productivity of labor. Similarly in the case of all factors of production the reward paid to them is determined by their marginal productivity. Assumptions of The Marginal Productivity Theory 1. There is perfect competition. 2. There is perfect mobility of factors of production. 3. All the units of a factors are homogenous. One is as efficient as the other . 4. There is perfect substitution. One factor can be substituted for the other. 5. The law of diminishing returns operates. 6. Their is full employment. 7. The technique of production remains same. 8. The proportions of the factors are variable, 9. The employer aims at maximum profits. 10. It is applicable to the short period.

Rent. Definition:Rent is that portion of the produce of the earth which is paid to the landlord for the use original and indestructible powers of the soil. Economic rent is the surplus above cost of production. The classical view as stated by Ricardo is that Rent is a surplus above costs. Basic Assumptions: 1. Rent is a payment for the use of land: Land is a free gift of Nature. It has original and indestructible powers in the form of fertility. Rent is a payment made to the landlord for the use of these powers of the soil. 2. Rent arises due to differences in the fertility of land: Fertility differs from land to land. Some lands are more fertile while some lands are less fertile. Suppose there are 3 grades of land in a country, A,B,C. A grade land is most fertile. B grade lands are less fertile and C grade lands are lease fertile. When population is small, enough food can be produced by cultivating, A grade lands only. When population increases B and then C grade lands also will be cultivated to grow enough food for the growing population.

RICARDIAN THEORY OF RENT David Ricardo a British Economist proposed Ricardian Theory of

3. Rent is a differential surplus: Rent according to Ricardo is a differential surplus. It arises due to differences in the fertility of land. 4. Rent in Intensive Cultivation: When the same land is cultivated more intensively, there will be rent on the intra marginal units of production. The cost of production of marginal output increases due to diminishing returns after a point. Price will be equal to the cost of production of the marginal output. Therefore there will be surplus on the output which is not marginal (Intramarginal output). 5. Rent does not enter into Price: According to Ricardo rent, does not enter into price. It is not price determining. Price is equal to the marginal cost which does not contain rent. Rent is a surplus measured after the price is determined. As Ricardo said Corn is high not because rent is high: Rent is high because is high. Price of food grains is high not because high rent is paid. On the other hand rents are high because the price of food grains increased. When market price increase the surplus on superior lands also will increase. Thus rent is price determined not price determining.

6. Rent arises on land only: According to Ricardo rent arises on land only because it is a free gift of nature. It has original and indestructible powers and its supply is fixed. In the below diagram on X axis Grades of Land A,B,C are shown. A is the most fertile land. B is less fertile and C is the lease fertile land. The returns are shown on Y axis. The returns on A and B grade lands are more than on the C grade land which is marginal land. Since the market price is equal to the cost of production of C grade lands, A and B grade lands get a surplus because the returns on these lands are more than the C grade lands. The surplus is rent it is shown by the shaded area. Ricardian theory brings out an important fact that rent is a surplus and that it is an unearned income.

WELFARE ECONOMICS
Welfare Economics is a branch of economics that uses micro economic techniques to evaluate economic well being, especially relative to competitive general equilibrium( the behavior of Supply, Demand and Prices in a whole economy) within an economy as to economic efficiency and the resulting income distribution associated with it. It analyzes Social Welfare however measured, in terms of economic activities of the individuals that comprise the theoretical society considered. As such individuals, with associated economic activities, are the basic units for aggregating to social welfare, whether of a group, a community, or a society, and there is no Social Welfare apart from the Welfare associated with its individual units.

 Concept of Social Welfare refers to the overall welfare of society. With sufficiently strong assumptions, it can be specified as the summation of the welfare of all individuals in the society. Global Solidarity, human rights, poverty elevation with human face, development economics and the economic of peace or the best known works of Dr. Amartya Kumar Sen, our Indian Economist, awarded the 1998 Nobel Prize in Economic Sciences for his contribution to Welfare Economics. At present Dr. Sen working as a professor of Economics at Harvard University is best known for his concept of Social Welfare and Welfare Economics. ---------------------------------------------------------------------