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SMU MBA 2010 OCT solved assignment
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Dr.

Shradha Sudin Naik Roll No :541111376

MBA-HCS MB0042—Managerial Economics (Book ID B1131) Set 1

Q.1 What is a business cycle? Describe the different phases of a business cycle.

Ans. The business cycle is the periodic but irregular up-and-down movements in economic activity, measured by fluctuations in real GDP and other macroeconomic variables. Or others define The term business cycle (or economic cycle) refers to economy-wide fluctuations in production or economic activity over several months or years. These fluctuations occur around a long-term growth trend, and typically involve shifts over time between periods of relatively rapid economic growth (an expansion or boom), and periods of relative stagnation or decline (a contraction or recession).[1] Business cycles are usually measured by considering the growth rate of real gross domestic product. Despite being termed cycles, these fluctuations in economic activity do not follow a mechanical or predictable periodic pattern. Cycles or fluctuations? In recent years economic theory has moved towards the study of economic fluctuation rather than a 'business cycle'[17] – though some economists use the phrase 'business cycle' as a convenient shorthand. For Milton Friedman calling the business cycle a "cycle" is a misnomer, because of its non-cyclical nature. Friedman believed that for the most part, excluding very large supply shocks, business declines are more of a monetary phenomenon.[18] Rational expectations theory leads to the efficient-market hypothesis, which states that no deterministic cycle can persist because it would consistently create arbitrage opportunities.[19] Much economic theory also holds that the economy is

Again the business cycle continues similarly with ups and downs.usually at or close to equilibrium. income. employment. the recent research employing spectral analysis has confirmed the presence of business (Juglar) cycles in the world GDP dynamics at an acceptable level of statistical significance. prices and profits. Explanation of Four Phases of Business Cycle The four phases of a business cycle are briefly explained as follows :1. Its timing is random and. there is also a rise in the standard of living. The features of prosperity are :- . After the peak point is reached there is a declining phase of recession followed by a depression. Prosperity Phase When there is an expansion of output. predictable. unpredictable. or repeating phenomenon like the swing of the pendulum of a clock. This period is termed as Prosperity phase. However. to a large degress.[citation needed] These views led to the formulation of the idea that observed economic fluctuations can be modeled as shocks to a system.[15] A business cycle is not a regular. A business cycle is identified as a sequence of four phases: · · · · Contraction: A slowdown in the pace of economic activity The lower turning point of a business cycle. In the tradition of Slutsky. business cycles can be viewed as the result of stochastic shocks that on aggregate form a moving average series. where a contraction turns into an expansion Expansion: A speedup in the pace of economic activity Peak: The upper turning of a business cycle The four phases of business cycles are shown in the following diagram :The business cycle starts from a trough (lower point) and passes through a recovery phase followed by a period of expansion (upper turning point) and prosperity.

4. prices and profits.1. prices and profits. Fall in volume of output and trade. Orders are cancelled and people start losing their jobs. Generally. A high level of MEC (Marginal efficiency of capital) and investment. 6. 3. High level of income and employment. There is a steady decline in the output. High level of output and trade. employment. 3. The businessmen lose confidence and become pessimistic (Negative). Depression Phase When there is a continuous decrease of output. 7. When demand starts falling. Recession Phase The turning point from prosperity to depression is termed as Recession Phase. There is an upswing in the economic activity and economy reaches its Peak. The features of depression are :1. 2. employment. so credit also contracts. Expansion of business stops. Rising interest rates. . income. it causes a rise in prices and profits. the level of production is Maximum and there is a rise in GNP (Gross National Product). the overproduction and future investment plans are also given up. Inflation. recession lasts for a short period. 2. 8. During a recession period. the economic activities slow down. The increase in unemployment causes a sharp decline in income and aggregate demand. 5. Large expansion of bank credit. It reduces investment. This is also called as a Boom Period. there is a fall in the standard of living and depression sets in. Due to a high level of economic activity. The banks and the people try to get greater liquidity. Due to full employment of resources. High level of effective demand. Overall business optimism. income. stock market falls.

The aggregate economic activity is at the lowest. Contraction of bank credit. there are expansions and rise in economic activities. and the business cycle is repeated. causing a decline in prices and profits until the economy reaches its Trough (low point). Recovery Phase The turning point from depression to expansion is termed as Recovery or Revival Phase. 6. often targeting a rate of interest for the purpose of . This increases investments. Monetary policy is the process by which the monetary authority of a country controls the supply of money. income. income and aggregate demand. 3. employment. production. 4. there is a deflation Q. Decline in consumption and demand. 5. Revival slowly emerges into prosperity. The stimulation of investment brings about the revival or recovery of the economy. production increases and this causes an increase in investment. 4. During the period of revival or recovery. The banks expand credit. Fall in MEC (Marginal efficiency of capital) and investment. there is under-utilization of resources and fall in GNP (Gross National Product). Thus we see that. When demand starts rising.2. In depression. Overall business pessimism. and business expands. 7. Fall in interest rate. There is a steady rise in output. Deflation. prices and profits start rising. There is an increase in employment. prices and profits. business expansion takes place and stock markets are activated. 8.2 What is the monetary policy ? Explain the general objectives and instruments of monetary policy? Ans. Fall in income and rise in unemployment. there is inflation and during the contraction or depression phase. The businessmen gain confidence and become optimistic (Positive). during the expansionary or prosperity phase.

which refers to taxation. Monetary theory provides insight into how to craft optimal monetary policy. where an expansionary policy increases the total supply of money in the economy more rapidly than usual. 1. Let us now see objectives of monetary policy in detail :- . 5.[3] General objectives of monetary policy.[1] [2] The official goals usually include relatively stable prices and low unemployment. stability and social justice. 7. Expansionary policy is traditionally used to try to combat unemployment in a recession by lowering interest rates in the hope that easy credit will entice businesses into expanding.promoting economic growth and stability. Contractionary policy is intended to slow inflation in hopes of avoiding the resulting distortions and deterioration of asset values. 6. Rapid Economic Growth Price Stability Exchange Rate Stability Balance of Payments (BOP) Equilibrium Full Employment Neutrality of Money Equal Income Distribution These are the general objectives which every central bank of a nation tries to attain by employing certain tools (Instruments) of a monetary policy. with special attention to the seasonal needs of a credit. 2. In India. and contractionary policy expands the money supply more slowly than usual or even shrinks it. Monetary policy differs from fiscal policy. 3. and associated borrowing. many people accepted significance of monetary policy in attaining following objectives. It is referred to as either being expansionary or contractionary. 4. Objectives of Monetary Policy The objectives of a monetary policy in India are similar to the objectives of its five year plans. In a nutshell planning in India aims at growth. government spending. the RBI has always aimed at the controlled expansion of bank credit and money supply. After the Keynesian revolution in economics.

4. the international community might lose confidence in our economy. Neutrality of Money : Economist such as Wicksted. 5. This increased investment can speed up economic growth. Exchange Rate Stability : Exchange rate is the price of a home currency expressed in terms of any foreign currency. Therefore. In simple words 'Full Employment' stands for a situation in which everybody who wants jobs get jobs. The RBI by altering the foreign exchange reserves tries to influence the demand for foreign exchange and tries to maintain the exchange rate stability. Thus monetary policy has to regulate the supply of money and neutralize 2. 6. The change in money supply creates monetary disequilibrium. In that senses the full employment is never full. Balance of Payments (BOP) Equilibrium : Many developing countries like India suffers from the Disequilibrium in the BOP. Price Stability : All the economics suffer from inflation and deflation. 3. If this exchange rate is very volatile leading to frequent ups and downs in the exchange rate. It refers to absence of involuntary unemployment. Robertson have always considered money as a passive factor. If the RBI opts for a cheap or easy credit policy by reducing interest rates. According to them. It can also be called as Price Instability. If the monetary policy succeeds in maintaining monetary equilibrium. Monetary policy can be used for achieving full employment. . the monetary policy having an objective of price stability tries to keep the value of money stable. If the monetary policy is expansionary then credit supply can be encouraged. The monetary policy can influence economic growth by controlling real interest rate and its resultant impact on the investment. The former reflects an excess money supply in the domestic economy. the monetary policy should regulate the supply of money. then the BOP equilibrium can be achieved. When the economy suffers from recession the monetary policy should be an 'easy money policy' but when there is inflationary situation there should be a 'dear money policy'.e. Full Employment : The concept of full employment was much discussed after Keynes's publication of the "General Theory" in 1936.1. Faster economic growth is possible if the monetary policy succeeds in maintaining income and price stability. money should play only a role of medium of exchange and not more than that. The Reserve Bank of India through its monetary policy tries to maintain equilibrium in the balance of payments. Rapid Economic Growth : It is the most important objective of a monetary policy. The monetary policy aims at maintaining the relative stability in the exchange rate. the 'BOP Surplus' and the 'BOP Deficit'. Both inflation are harmful to the economy. while the later stands for stringency of money. Thus. However it does not mean that there is a Zero unemployment. It could help in creating more jobs in different sector of the economy. The BOP has two aspects i. It helps in reducing the income and wealth inequalities. the investment level in the economy can be encouraged.

if the RBI reduces the bank rate. borrowing for commercial banks will be easy and cheaper. There are two types of instruments of the monetary policy as shown below.e RBI) rediscounts bills and prepares of commercial banks or provides advance to commercial banks against approved securities. However this objective of a monetary policy is always criticized on the ground that if money supply is kept constant then it would be difficult to attain price stability. On the other hand. It is "the standard rate at which the bank is prepared to buy or rediscount bills of exchange or other commercial paper eligible for purchase under the RBI Act". monetary policy can help in reducing economic inequalities among different sections of society. These tools are indirect in nature and are employed for influencing the quantity of credit in the country. The Bank Rate affects the actual availability and the cost of the credit. This will boost the credit creation. 1. Even with increased bank rate the actual interest rates for a short term lending go up checking the credit expansion. Any change in the bank rate necessarily brings out a resultant change in the cost of credit available to commercial banks. If the RBI increases the bank rate than it reduce the volume of commercial banks borrowing from the RBI. (A) Quantitative Instruments or General Tools ↓ The Quantitative Instruments are also known as the General Tools of monetary policy. small-scale industries. Thus any change in the . village industries. and provide them with cheaper credit for longer term. Equal Income Distribution : Many economists used to justify the role of the fiscal policy is maintaining economic equality. It deters banks from further credit expansion as it becomes a more costly affair.the effect of money expansion. Bank Rate Policy (BRP) The Bank Rate Policy (BRP) is a very important technique used in the monetary policy for influencing the volume or the quantity of the credit in a country. monetary policy can make special provisions for the neglect supply such as agriculture. 7. Thus in recent period. The bank rate refers to rate at which the central bank (i. The general tool of credit control comprises of following instruments. However in resent years economists have given the opinion that the monetary policy can help and play a supplementary role in attainting an economic equality. This can prove fruitful for these sectors to come up. Instruments of monetary policy The instrument of monetary policy are tools or devise which are used by the monetary authority in order to attain some predetermined objectives. They are designed to regulate or control the total volume of bank credit in the economy. etc. The Quantitative Tools of credit control are also called as General Tools for credit control. These tools are related to the Quantity or Volume of the money.

These reserve ratios are named as Cash Reserve Ratio (CRR) and a Statutory Liquidity Ratio (SLR). etc. This way when the RBI enters in the OMO transactions. Any change in the VRR (i.e. However there are certain limitations that affect OMO viz. In India the CRR by law remains in between 3-15 percent while the SLR remains in between 25-40 percent of bank reserves. Contrary to this when the RBI buys the securities from commercial banks in the open market. CRR + SLR) brings out a change in commercial banks reserves positions. Changes in the VRR helps in bringing changes in the cash reserves of commercial banks and thus it can affect the banks credit creation multiplier. Thus by varying VRR commercial banks lending capacity can be affected. However. This reduces the existing money supply as money gets transferred from commercial banks to the RBI. size and strength of the money market. If the RBI sells securities in an open market. indebtedness of commercial banks. underdeveloped securities market. Normally during the inflation period in order to reduce the purchasing power. RBI increases VRR during the . excess reserves with commercial banks. The CRR refers to some percentage of commercial bank's net demand and time liabilities which commercial banks have to maintain with the central bank and SLR refers to some percent of reserves to be maintained in the form of gold or foreign securities. the efficiency of the bank rate as a tool of monetary policy depends on existing banking network. Obviously the stock of money in the economy increases. 3. interest elasticity of investment demand. Open Market Operation (OMO) The open market operation refers to the purchase and/or sale of short term and long term securities by the RBI in the open market. Variation in the Reserve Ratios (VRR) The Commercial Banks have to keep a certain proportion of their total assets in the form of Cash Reserves.bank rate is normally associated with the resulting changes in the lending rate and in the market rate of interest. commercial banks sell it and get back the money they had invested in them. etc. It is important to understand the working of the OMO. Thus under OMO there is continuous buying and selling of securities taking place leading to changes in the availability of credit in an economy. Apart of these cash reserves are also to be kept with the RBI for the purpose of maintaining liquidity and controlling credit in an economy. This is very effective and popular instrument of the monetary policy. to influence the term and structure of the interest rate and to stabilize the market for government securities. 2. the actual stock of money gets changed. international flow of funds. the RBI sells securities and during the recession or depression phase she buys securities and makes more money available in the economy through the banking system. The OMO is used to wipe out shortage of money in the money market. commercial banks and private individuals buy it. Some part of these cash reserves are their total assets in the form of cash. etc.

Under this method the down payment. This method is used to encourage credit supply for the needy sector and discourage it for other non-necessary sectors. Fixing Margin Requirements The margin refers to the "proportion of the loan amount which is not financed by the bank". etc is fixed in advance. A change in a margin implies a change in the loan size. Credit Rationing . Example:. This can help in checking the credit use and then inflation in a country.If the RBI feels that more credit supply should be allocated to agriculture sector. Or in other words. The Selective Tools of credit control comprises of following instruments. This published information can help commercial banks to direct credit supply in the desired sectors. Through its weekly and monthly bulletins. the information is made public and banks can use it for attaining goals of monetary policy. consumer credit supply is regulated through hire-purchase and installment sale of consumer goods. Publicity This is yet another method of selective credit control. This method can have influence over the lender and borrower of the credit. installment amount. They are used for discriminating between different uses of credit. 4. It can be discrimination favoring export over import or essential over non-essential credit supply. Consumer Credit Regulation Under this method. then it will reduce the margin and even 85-90 percent loan can be given. Through it Central Bank (RBI) publishes various reports stating what is good and what is bad in the system. (B) Qualitative Instruments or Selective Tools ↓ The Qualitative Instruments are also known as the Selective Tools of monetary policy. loan duration. 2. But during the recession or depression it lowers the VRR making more cash reserves available for credit expansion. 3. These tools are not directed towards the quality of credit or the use of the credit. it is that part of a loan which a borrower has to raise in order to get finance for his purpose. This can be done by increasing margin for the non-necessary sectors and by reducing it for other needy sectors. 1.inflation to reduce the purchasing power and credit creation.

Through a directive the central bank can influence credit structures. Ans : . 5. It helps in restraining credit during inflationary periods. But a right mix of both the general and selective tools of monetary policy can give the desired results. RBI may refuse credit supply to those banks whose borrowings are in excess to their capital. Under moral suasion central banks can issue directives. guidelines and suggestions for commercial banks regarding reducing credit supply for speculative purposes 6.10 . upper limit of credit can be fixed and banks are told to stick to this limit. For certain purpose. Q. 7. The RBI issues directives to commercial banks for not lending loans to speculative sector such as securities.Central Bank fixes credit amount to be granted. Central bank can penalize a bank by changing some rates. Find the elasticity of the supply of pens.3 A firm supplied 3000 pens at the rate of Rs. Commercial banks are informed about the expectations of the central bank through a monetary policy. It is a suggestion to banks. These directives guide commercial banks in framing their lending policy. working of the Non-Banking Financial Institutions (NBFIs). Secondly. profit motive of commercial banks and undemocratic nature off these tools. etc beyond a certain limit. Credit is rationed by limiting the amount available for each commercial bank. At last it can even put a ban on a particular bank if it dose not follow its directives and work against the objectives of the monetary policy. Moral Suasion It implies to pressure exerted by the RBI on the indian banking system without any strict action for compliance of the rules. This method controls even bill rediscounting. the RBI may refuse to rediscount their bills and securities. However the success of these tools is limited by the availability of alternative sources of credit in economy. If certain banks are not adhering to the RBI's directives. Control Through Directives Under this method the central bank issue frequent directives to commercial banks. next month due to the rise of in the price to 22 rs per pen the supple firm increases to 5000 pens. This can help in lowering banks credit expoursure to unwanted sectors. Direct Action Under this method the RBI can impose an action against a bank. These are various selective instruments of the monetary policy. supply of credit to certain limit for a specific purpose.

Opportunity cost is a key concept in economics. Explicit costs are taken into account along with implicit ones when considering economic profit. it will always be less than or equal to accounting profit. as opposed to implicit costs. which are those where no actual payment is made. Give a brief description of 1) Implicit and explicit cost. or group.= . The term also applies to forgone income from choosing not to work. however: for example. Implicit costs also represent the divergence between economic profit (total revenues minus total costs.555 22-10/10 Inelastic supply. 2) Actual and oppurtunity cost.[1] In other words. An explicit cost is a direct payment made to others in the course of running a business. Accounting profit only takes explicit costs into account. implied cost.[2] The notion of .[1] The opportunity cost is also the cost of the foregone products after making a choice. also called an imputed cost. It is the sacrifice related to the second best choice available to someone.EDy= 5000-3000/3000 ----------------------. or notional cost. In economics. where total costs are the sum of implicit and explicit costs) and accounting profit (total revenues minus only explicit costs). Since economic profit includes these extra opportunity costs. pension contributions and other "perks" must be taken into account when considering the cost of labour. rent and materials. an implicit cost is any cost that results from using an asset instead of renting. Opportunity cost is the cost of any activity measured in terms of the value of the next best alternative foregone (that is not chosen). which is borne directly. is the opportunity cost equal to what a firm must give up in order to use factors which it neither purchases nor hires. selling. or lending it. who has picked among several mutually exclusive choices. It is the opposite of an explicit cost. It is possible still to underestimate these costs. and has been described as expressing "the basic relationship between scarcity and choice". such as wage. an implicit cost.

From an external point of view. Marginal Revenue MR – In addition to total revenue as a result of a small hike in the sale of a firm. it is difficult to ascertain which are the alternative considered. TR = P x Q. If a firm sells 3 units of an article at $ 24. Algebraically it is the total revenue earned by selling N units of the commodity instead of N-1 i. This is since under ideal rivalry the number of firms selling an identical product is very huge. its total revenue is 3 x 24.AR and MR under different market condition. 3. Under Ideal Rivalry – The average revenue curve is a horizontal straight line parallel to X axis and the marginal revenue curve coincides with it. Total Revenue – It is the total sale proceeds of a firm by selling a commodity at a given price. pleasure or any other benefit that provides utility should also be considered opportunity costs. opportunity costs are not restricted to monetary or financial costs: the real cost of output foregone.e. The revenue concept relates to total revenue. It is obtained by dividing the total revenue by the number of units sold.opportunity cost plays a crucial part in ensuring that scarce resources are used efficiently. The term revenue denotes to the receipts obtained by a firm from the scale of definite quantities of a commodity at various prices.e. Thus. AR = TR / Q = P x Q / Q = P. Thus total revenue is price per unit proliferated by the number of nits sold.5 Explain in brief the relationship between TR. 1. Now let us discuss the concepts of revenue. The . Actual costs refer to real transactions. therefore. average revenue and marginal revenue. Total Average and Marginal Revenue The revenue of a firm jointly with its costs ascertains profits. Ans. 2. lost time. The average revenue of a firm is in fact the price of the commodity at each level of output since TR = P x Q. where TR is the total revenue. Q. i. Relation Between AR and MR Curves 1.. whereas opportunity costs refer to the alternative taken into consideration by decision makers who might want to choose the line of activity which minimise the costs. Average Revenue – It is the average receipts from the sale of certain units of the commodity. MRn = TRn – TRn-1. P the price and Q the quantity.

In the diagram 2. . This is since products are close substitutes under monopolistic competition. But there is an exclusion that the AR curve is more elastic and it is represented in the diagram 6. Thus the demand for the firm’s product becomes infinitely elastic. Monopolistic Competition – The relationship between AR and MR is the same as under monopoly. each firm can sell as much it wishes at the market price OP. MR passes to the left of the mid point B on the CA. 2. In is AR the the the horizontal AR curve of the firm. if the AR curve is concave to the origin. The marginal revenue is lower than the average revenue. Given the demand for his product the monopolist can increase his sales by lowering the price. the shape of curve is horizontal to the X axis at price OP and MR curve coincides with it. Alternatively. the MR curve will cut any perpendicular from a point on the AR curve at more than half –way to he Y axis. in the diagram 5. Any change in the demand and supply circumstances will change market price of the product and consequently Under Monopoly or Imperfect Competition. MR will cut the perpendicular at less than half way towards y axis. In the diagram 3. This relation will always exist amidst straight line downward sloping AR and MR curves. the diagram 1. the MR curve falls below the AR curve and lie half a way on the perpendicular drawn from AR to Y axis. marginal revenue also falls but the rate of fall in marginal revenue is greater than that in average revenue.price is determined the market forces of supply and demand so that only one price tends to prevail for the whole industry. the average revenue curve is the downward inclining industry demand curve and its related marginal revenue curve lies below it. since the demand curve the firm’s average revenue curve. AR curve is convex to the origin. 3. In diagram 4. MR passes to the right of the mid point B on the CA. The firm can hikes sales by a reduction in its price.

the firm incurs losses. the firm earns normal profits. output. His average revenue curve is represented in the diagram 7 becomes elastic after K and its consequent MR curve rises discontinuously from a to b and then persists its course at the new higher level. AR curve is below the AC curve at the equilibrium point. By relating the AR curve to the AC curve of a firm. . They acquire kinks. his rival also follows him in reducing the prices of their products so that he is not able to enhance his sales.  Determination of Full capacity – It can also be known from their relationship whether the firm is producing at is full capacity or under capacity. Under Oligopoly – The average and marginal revenue cures do not have a smooth downward slope under oligopoly. it makes super normal profits. If the AR curve is tangent to the AC curve at the point of equilibrium. under perfect rivalry. if the oligopolistic seller reduces the price of his product. it can ascertain whether it is earning supernormal or normal profits or incurring losses. the firm produces its full capacity. the firm posses idle capacity.  Equilibrium Determination – The MR curve when intersected by the MC curve determines the equilibrium position of the firm under all market conditions. If the AR curve is tangent to the AC curve at its minimum point. under monopolistic competition. His AR curve becomes less elastic from K onwards and it is represented in the diagram 8. If a seller raises the price of his product. The consequent MR curve falls vertically from a to b and then slopes at a lower level. Alternatively. Importance of Revenue Costs The AR and MR curves form significant tool for economic analysis. Where it is not so. As the number of sellers under oligopoly is small. and profit and loss of a firm.4. If the AR curve is above AC curve. the effect a price cut or price hikes on the par of one seller will be followed by some changes in the behaviour of the other firms. In case.  Profit Determinants – The A curve is the price line for the producer in all market situations. the other seller will experience a fall in demand for his product. Their point of intersection in fact determines price.

These all operate for the firm Arcadia within the industry of retail. the actual quantity sold and purchased is always equal. Thus the market equilibrium has has two dimensions. Dorothy Perkins. Miss Selfridge. In factor pricing they are inverted U shaped and the average and marginal revenue curves become the average revenue productivity and marginal revenue productivity curves ARP and MRP. or the chain of stores that sells the clothes. Q. also they are useful device in describing the equilibrium of the firm under different market conditions. The difference between this and a firm is that a firm is the company that operates within the industry to create the product. More specialised industries deal with a specific thing. anything in the shops that get sold to the public. This is because one of the advantages of having a firm behind you is that it is a safeguard against possible bankruptcy because the firm can support the chain that it owns Equilibrium of a firm and industry under perfect competition. Please note that the we are talking about quantity actual sold and purchased.6 Distinguish between a firm and an industry . and Evans. Factor Pricing Determination – The use of the average marginal revenue helps in determining factor prices. within its industry. Sometimes. a firm is not necessary within the industry and independent chains and retailers can enter straight into the market without a firm behind them. An industry is the name given to a certain type of manufacturing or retailing environment. A firm is usually a corporate company that controls a number of chains in the industry it is operating within. When we speak of market equilibrium in economics it refers to level of prices at which the quantity demanded by the customers is same as the quantity offered for for supply by the suppliers. For example in retail. The steel industry is a more specialised industry. The firm might be a factory. Explain the equlibrium of a firm and industry under perfect competition. The retail industry is very vast and has many sub divisions. although this is risky. which is where one firm is in charge of the whole industry. Unlike quantities demanded and quantity offered for supply. They create the steel in that firm for the steel industry. For example. Several firms can operate in one industry to ensure that there is always competition to keep prices reasonable and stop the market becoming a monopoly. . the firm Arcadia stores owns the clothing chains Topshop. For example. and (2) quantity sold and purchased. the retail industry is the industry that involves everything from clothes to computers. one firm that makes steel might be Avida steel. such as electrical and cosmetics. dealing with the making of steel and selling it on to buyers. (1) price.

but marginal cost iswhat they need to know. In an oligopoly it is not possible to give a fixed formula for the equilibrium point for individual firms as it is dependent on actions of competitor firms and may change from time to time in response to changing competitive action and the competitive strategy of the firm itself. itis easier for firms to calculate their average costthan their marginal cost. the entire market supply is accounted by one firm. expenditures likeincreased maintenance and repairs should beattributed to the output that creates these costs. Marginal cost pricing is essential in determininghow firms should choose output. In a perfectly competitive market the marginal cost and revenue at this point are also same as the market price. You can’t just sit around. In practice. The firm can supply as much as it wishes. allowing some market power could be beneficial.Zero profits. Profitsare transitory. which is a graph showing AFC on y-axis and production of x-axis.In a monopoly market. but imitatable innovation is not asprofitable as a smaller innovation that cannot be limitated. Process. There is a tension between the invisible handand the incentive to imitate. In the above equation for AFC we see that numerator (fixed cost) is constant. In a dynamic sense.The timing of when the bill must be paid isirrelevant.Marginal cost pricing is useful in setting up“transfer prices” within the firm. Average fixed cost is simply this fixed cost divided by total quantity produced. This is why wehave patent laws. However the quantity supplied by each firm at this equilibrium price depends on the cost structure of the firm. Therefore. Thus same price is applicable to firm level equilibrium. . therefore it supplies a quantity that maximizes its profit. As a result AFC curve. and competition is fierce to be better than the “marginal firm. Product vs.In measuring marginal cost. the combined marginal cost for all the firms in a perfectly competitive market is also same as market equilibrium price.”A big. In a perfectly competitive market. while denominator (total quantity produced) is variable. is a downward sloping curve. Since marginal cost for every firm operating in a perfect competition is same as market price. Example ofAT&T secretarial pool. Thus: Average Fixed Cost = AFC = Fixed cost/Total quantity produced. Average Fixed Cost: Fixed cost refers to the minimum fixed cost that a firm incurs for manufacturing irrespective of the total quantity produced. equilibrium point for the market and for the firm are the same. AFC reduces with increasing production quantity. Therefore. This occurs when the marginal cost of the firm just equals the marginal revenue. individual firms have no influence on the market price as the demand curve for the firm is a horizontal line at the level of the market price.

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