(17e00103) Managerial Economics

MANAGERIAL ECONOMICS
Unit 1-Introduction to Managerial Economics

Introduction:
Economics is a study of human activity both at individual and national level. Every person aimed
at earning money and spending this money to satisfy our wants such as food, clothing, shelter
etc., such activities of earning and spending money is called “Economics activities”.
Managerial economics is a discipline that deals with the application of economic concepts,
theories tools and methodologies to the practical problems in a business. It facilitates the
manager in decision making and acts as a link between theory and practice.
Managerial Economics is a combination of management and economics. As management is the
process of planning, organizing, leading and controlling the effort of the organizational members
and of using all the available organizational resources to reach the stated organizational goals.”
Economics is mainly concerned with analyzing and providing solutions to the various economic
problems”.
Managerial Economics is also called as “Business economics”. The origin of the term”
economics lays in the “Greek words” “Oikon and nomos”; which means laws at house holds.
Definition:
“Managerial Economics is the integration of economic theory with business practice for the
purpose of facilitating decision-making and forward planning by management”.
Spencer & Siegelman
“Managerial Economics is the use of economic models of thought to analyze business situation.
Mc Nair &Meriam
“Managerial Economics is the application of theory and methodology to business administration
practice”.
Brigham & Pappab.
Nature of Managerial Economics:-
The following steps or points specify the nature of managerial economics.
1. Managerial Economics is confined only to a part of business management:-
But it is not directly concerned with the managerial problems involving control implementation
conflict resolution and other management strategies.
2. Managerial Economics mainly relies on the sound frame work of traditional
economics and decision sciences:-
In analyzing the problems in a business. It mainly relies on the application of economic
principles and methodologies for business decision making.
3. Managerial Economics is mainly micro economic in nature:-
Micro economics is that branch of economics which deals with the individual units or sections (a
person, a firm or a group of persons or firms) of an economy. As managerial Economics
is mainly concerned with analyzing and finding optimal solutions to the problems of
decision making in a business firm it is essentially micro economic in nature.
4. Managerial economics is pragmatic:-
i.e., it is a practical subject. It prevents the abstract issues of economic theory and incorporates
complications that are not covered by the economic theory in order to analyze the
situation in which managers take decisions.
5. Managerial economics utilizes some of the theories of macro economics:-
An organization affects and is affected by many different factors of the environment in which it
works. Most factors related to this environment come under the subject matter of macro
SUMOURYA INSTITUTE OF MANAGEMENT (SIMK) Page 1

economics. In order to overcome these problems an organization takes the help at some
of the theories of macro economics.
6. Managerial economics is goal-oriented & problem solving in nature:-
It uses the economic theory and decision sciences for solving business oriented problems.
Scope of Managerial Economics:-
The scope of managerial economics includes all the economic concepts, theories; ideas;
principles, tools and techniques that can be used to analyze the business problems.
The following business areas can be considered as the scope of managerial economics.
1. Objectives of a business firm or organization:-Managerial Economics provides a
sound framework by facilitating a business firm to frame its objectives both in the
short-run and long run.
2. Resource Allocation:-managerial Economics provide the methods of effective
resource allocation. It mainly aims at achieving high output through low and proper
allocation of resources.
3. Demand Analysis and Demand Forecasting: - less quality and more buyers. If it is
able to the demand for its product at the right time, with in the right quantity.
Understanding the basic concepts of demand is essential for demand forecasting.
Demand Analysis should be a basic activity of the firms depends upon the outcome of
the demand forecast.
4. Competitive Analysis: - the techniques provided by managerial economics facilitate
a firm to with stand in a competitive situation.
5. Strategic planning:-managerial economics guides a business manager in making
strategic decision.
6. Production management: - managerial economics plays a important role in
production management. This effective tool helps to plan the business schedule,
regulate the production process and effectively place the output in the market.
7. Cost Analysis: - managerial economics provide various cost concepts and cost curves
that facilitates in determining cost out put relationship both in short run and long run.
8. Pricing strategies:-managerial economics provides certain pricing strategies that are
used in analyzing the price of a product and in determining or setting the price of a
product.
9. Market structure analysis:-the techniques and concepts of managerial economics
analyze the market structure and guide in taking necessary decisions that are required
for a firm to exist in the market.
10. Investment and capital budgeting decisions: - the concept of opportunity cost
provided by managerial economics facilitates in making appropriate investment
decisions and choose the best alternative that fits the organizational requirements.
11. Marketing strategies:-
a. Product
b. Price
c. Place
d. Promotion
I. Product Policy
II. Sales promotion
III. Segmentation

12. Economies of scale: - managerial economies in the long run help a firm to enjoy
economies and diseconomies of scale.
13. Profit management: - managerial economics mainly concentrates on the primary
goal of a firm i.e., profit maximization. It deals with the activities like profit
estimation and profit planning.
14. Input and out analysis:-the concept of production function managerial economics
depicts the input and out put relationship.
15. Inventory control: - effective control techniques of managerial economics readily
meet the organizational requirements.
Managerial Economics and its relationship with other disciplines: or Managerial Economics
relationship with other disciplines:-
Managerial Economics is particularly a study of the application of economic theory, tools,
techniques and principals for the economic analysis of business related problems. In
addition to economics, managerial economics draws its tools and techniques from
other disciplines like economics; management theory and accounting. Managerial
Economics and mathematics; Managerial Economics and production management;
Managerial Economics and operations research; Managerial Economics and the
theories of decision making; Managerial Economics and personnel management.
I. Relationship with Economics: The relationship between Managerial
Economics and economics theory may be viewed from the point of view of
the 2 approaches to the subject.
Economics
Micro economics Macro economics
Micro economics:-is the study of the economic behavior of individuals, firms and other such
micro organizations. Managerial Economics is rooted in micro economic theory.
Managerial Economics makes use to several Managerial Economics concepts such as
marginal cost, marginal revenue elasticity of demand as well as price theory and
theories of market structure to name only a few.
Macro economics:-macro economics or theory on the other hand is the study of the
economy as a whole. It deals with the analysis of national income the level of
employment general price level consumption and investment in the economy and
even matters related to international trade,money;public finance etc.,
II. Managerial Economics and management theory and accounting:-
Management theory and accounting also have a great influence on managerial
economic.Managerial Economics has been influenced by the developments in
management theory and accounting techniques.
Accounting is concerned with recording financial transactions of an organization. Accounting
provides the cost and revenue data that forms the basis for all the analysis and
computations in Managerial Economics.

The focus of accounting within the firm is fast changing from the concepts of store keeping
to that if managerial decision making this has resulted in a new specialized area of
study called “Managerial Accounting”.
III. Managerial Economics and Mathematics: - provides various set of tools
which help in the derivation and exposition of economic analysis. The
concepts of mathematics that are used by managerial economics are geometry,
matrices, algebra,logarithms,determinations,input out put tables etc.,
IV. Managerial Economics and production management:-production is defined
as the creation of utility by transforming input into out put. It usually refers to
manufacturing activity and the term operations is used to denote a wider
meaning encompassing all economic activity which creates economy utility.
a. Supply of qualities
b. Maintenance of time-bound deliveries
c. Fulfillment of quality requirement
d. Economizing production operations.
V. Managerial Economics and the theory of decision making: - mainly deals
with the problems of selection of alternatives in decision making under the
uncertainty conditions. It facilitates the manager in taking quick decisions
under the conditions of multiple goals. Thus the theories of decision making
are practical in nature and are goal-oriented.
VI. Managerial Economics and operations research: - depends upon many
models and tools of operations research and quantitative techniques for
business decision making. Managerial Economics aims at problems of
decision making and operation research aims at solving managerial problems.
Managerial Economics utilizes the tools of operations research like: model
building linear programming models inventory game theory optimization
techniques transportation queuing replacement models etc. operations research
is a scientific approach to problems solving for executive management.
VII. Managerial Economics and personnel management:- an HR Manager has
conceder two types of problems
a. An effective utilization of HR in terms of costs and productivity.
b. Improvement in terms and conditions of employment as an adjunct to
employee satisfaction.
Managerial Economics can help personnel management by analyzing the
economic and financial aspects of personnel problems both in relation tot
the economic welfare of the firm.
Role of managerial economist:-
Managerial Economics helps in finding solutions to various business problems. It acts as a tool
for manager in decision making process. With all its tools, techniques, methodologies principles
guide the business and economic decisions. It facilitates the manger to become a proactive
decision maker in dealing with dynamic business situations. It provides various tools like
demand analysis and forecasting short run and long run costs opportunity costs etc for business
decision making.
Objectives of the firm
Allocation of resources

Demand analysis and demand forecasting

Competitive analysis
Strategic planning
Production planning
Cost analysis
Price analysis
Market structure analysis
Investment and capital budgeting decisions
Marketing strategies
Achieving economics of scale
Profit management
Input-out put analysis
Inventory control.
Thus the Managerial Economics plays a vital role in business decision making.
Differences between Managerial Economics and Traditional Economics:-

ional Economics gerial Economics
h micro and macro economics in nature.
Is only micro economic in nature
wide scope. It deals with each and every
aspect of the firm. Has a limited scope. It is concerned with decision
making and economic theories that guide the
managerial decision making.
Is a normative science
h normative and positive science
cerned with theoretical aspects of the firm. Deals with practical aspects of the firm.
ders only the economic aspects of problem Considers both economic and non economic
while decision making. aspects.
with both micro and macro problems of a firm Concerned with decision making of the firm.
Questions:
1. Discuss the nature and scope of Managerial Economics?
2. Point out the importance of Managerial Economics in decision making?
3. Explain the role and responsibility of Managerial Economics?

Unit 2-Objectives of the firm

Meaning of the firm:-
A firm is an organization that combines and organizes resources for the purpose of producing
goods and or services for sale. Firms can be classified on the basis of investment limit number of
owners and government participation in business.
Firms
Investment limit Number of owners Government participation in business
Small Proprietorships Public Sector

(Individually)
Medium
Partnership Private Sector
(Owned by 2 or more
Individuals)
Large Corporations Joint Sector
(Owned by Stockholders)
Firms
Business or Profit Non- Business or not for profit
Firms exist for profit firms not exist for profit
For Ex; - Universities; Hospitals; etc

Functions of the firm:
Purchased Goods Supply of Goods
Supply of Resources Hire Inputs
Demand for Resources Factor Payments
Circular flow of Economic Activity:

The function of a firm is to purchase resources or inputs or factors af production namely 4M’s
*material *men *machine *money in order to transform them into good and service for sale.
The interdependence between the individuals or consumers and firms or producers.
Production techniques and input cost of firms influence the supply of a good or service and
consumer preference the supply of a good or service and consumer preferences and income
determine the demand. Interaction of demand and supply determines the price and quality sold.
The firm’s interdependence between individuals, product market; factor market.
Hire inputs includes: - share holders; stockiest; stake holders.
Factor payments: - P -------------- Political Environment
E ------------- Economical Environment
S ------------ Social Environment
T ----------- Technological Environment

Objectives of the firm
Economic Objectives Non-Economic Objectives
Maximum Growth Rate Burvival
Building up public
Desire for Liquidity confidence for the product
Welfare
Sound business practices
Progressive management
I. Economic Objective:-
a) Maximum Growth rate:- or Product life Cycle:-
The various stages include in the life cycle of a firm. It consists of 5 stages
1. Introduction
2. Growth stage
3. Maturity stage
4. Decline stage
5. Acquit ion or merger or takeover
Stage III
Stage II
Sales Stage I Stage IV

O Time
1. Introduction stage: - in this stage a new company to introduce a new product in the
market. At this time the company to pay high expenses and not getting the minimum
profits. In this situation the firm to produce high quality goods.
2. Growth stage: - it is the second stage of a particular product. In this time the firm get
minimum profits and to pay high expenses.
3. Maturity stage: - it is peek stage of a particular firm or product. In this stage the firm get
maximum profit and to pay nil or less expenses. In this stage the firm achieves their
goals.
4. Declan stage: - in this stage the firm or product go to fall down. The firm to introduce
new product or modification of a product.
5. Merger or take over: - in this case or stage the firm to purchase or combined in to other
company and create new firm to produce new product.
Ex:-maruthi and Suzuki; Satyam and Mahindra; Rin and surf excel.
b). Desire for liquidity:-it is the conversion of assets in to cash. The firm to face financial
crisis that situation the firm to converged assets in to cash.
II. Non- economic objectives:-

a). survival: - peter F. Drunker says that survival is the main goal of any firm. This is a long
term goal of course profitability is required for survival. But it need not be maximum profits but
reasonable profits. It can survive only if it wins the goodwill of the people by producing goods
and service of good quality. A good name earned would help the firm to enjoy a bigger share of
the market and this will unable it in its aspirations of survival over a long period.
b). building up public confidence for the product:-The aim of some firms may be to build the
customer confidence for its product and service. It may also adopt vigorous advertising
techniques.
c). welfare: - The business firm has to keep welfare of different groups of people as its
objectives. First and welfare of the workers has to be considered. They should be provided good
working conditions, fair wages and other benefits to increase their involment in the firm. Labor
welfare goal is very important as it can improve labor efficiency and productivity.
d). sound business practices: - a firm may give more important to business ethics. This will
make it adopt only sound business practices like providing price lists, replacement or refund for
defective products, which again will go a long way in building up the goodwill for the company.

e). progressive management: - it is very essential for dynamic growth of the firm. Hence as a
part of this goal the firm may implement suitable like worker’s participation in management,
workers training programmes, etc
Managerial Theories of Firm:
The managerial theories separate ownership from management. The ownership are share holders, whose
power lies in appointing the board of directors, which in turn appoints top management. A firm’s
managers are agents who work for the firm’s owners, who are the principals. The divorce of
ownership from management permits top management to deviate from profit maximization and
pursue goals which maximize their own utility. The managers may pursue their own objectives
even though this may decrease the profit of the owners. this is referred as principal agent
problem.
Major theories
Optimizing theories non optimizing theories
(Behavioral Theories)
1) Profit maximization theory
2) Managerial theory
Profit Maximization
The monopolist's profit maximizing level of output is found by equating its marginal revenue
with its marginal cost, which is the same profit maximizing condition that a perfectly competitive
firm uses to determine its equilibrium level of output. Indeed, the condition that marginal
revenue equal marginal cost is used to determine the profit maximizing level of output of every
firm, regardless of the market structure in which the firm is operating.
In order to determine the profit maximizing level of output, the monopolist will need to
supplement its information about market demand and prices with data on its costs of production
for different levels of output. As an example of the costs that a monopolist might face, consider
the data in Table 1 . The first two columns of Table 1 represent the market demand schedule that
the monopolist faces. As the price falls, the market's demand for output increases. The third
column reports the total revenue that the monopolist receives from each different level of output.
The fourth column reports the monopolist's marginal revenue that is just the change in total
revenue per 1 unit change of output. The fifth column reports the monopolist's total cost of
providing 0 to 5 units of output. The sixth and seventh columns report the monopolist's average
total costs and marginal costs per unit of output. The eighth column reports the monopolist's
profits, which is the difference between total revenue and total cost at each level of output.
TABLE Monopoly Output, Revenues, Costs, and Profits

1
Outpu Price Total Marginal Total Average Marginal Monopoly

t revenue revenue cost total cost cost profits

0 $14 $0 — $2 — — −2
1 12 12 $12 6 $6 $4 6
2 10 20 8 8 4 2 12
3 8 24 4 12 4 4 12
4 6 24 0 20 5 8 4
5 4 20 −4 35 7 15 −15
The monopolist will choose to produce 3 units of output because the marginal revenue that it
receives from the third unit of output, $4, is equal to the marginal cost of producing the third unit
of output, $4. The monopolist will earn $12 in profits from producing 3 units of output, the
maximum possible.
Graphical illustration of monopoly profit maximization. Figure 1 illustrates the monopolist's
profit maximizing decision using the data given in Table 1 . Note that the market demand
curve, which represents the price the monopolist can expect to receive at every level of output,
lies above the marginal revenue curve.
Figure 1 The monopolist's profit-maximizing decision
The result of the monopolist's price searching is a price of $8 per unit. This equilibrium price is
determined by finding the profit maximizing level of output—where marginal revenue equals

marginal cost (point c)—and then looking at the demand curve to find the price at which the
profit maximizing level of output will be demanded.
Monopoly profits and losses. The monopoly in the preceding example made profits of $12.
These profits are illustrated in Figure 1 as the shaded rectangle labeled abcd. While you usually
think of monopolists as earning positive economic profits, this is not always the case.
Monopolists, like perfectly competitive firms, can also incur losses in the short-run. Monopolists
will experience short-run losses
Managerial Theories of Firm Marris and Williamson's Models
Marris’ Managerial Thesis of Firm
Marris has put forth a significant thesis of firm as per which the managers do not optimize
profits but in its place as per him, they look for to optimize profits balanced rate of increase of
the firm.
Optimization of balanced rate of increase of the firm entails optimization of the rate of
increase of demand for the commodities of the firm and rate of increase of capital supply.
If I symbolize balanced increase, Id for the increased rate of demand for the commodity, Ic
for the rate of increased of the capital supply, and then the aim of the manager is:
Optimize I = Id = Ic
In looking for to optimizing the balanced increased rate, a manager countenances the
subsequent two restraints:
1. Marginal Restraint
2. Financial Restraint
Managerial restraint denotes to the strength of the managerial team and their skills. Financial
restraint denotes to the subsequent three financial proportions:
1. Debt to Total Assets Ratio, which is merely termed as Debt Ration or D/A
2. Liquid Assets of the firm to Total Assets, is termed as Liquidity Ratio L/A
3. Ratio of Retained Earnings to the Total Profits or Retention Ratio (πr / π)
It is significant to note that these financial variables ascertain the job security of the
managers. If these financial ratios set by the manager intersects the cautious line, they reveal the
firm to the jeopardy of being taken over by other or the managers can be suspended which can
imperil their job security.
Thus, financial restraints are related with the job security. Managers consider job security
while considering business plans.
Rationale for Optimizing Balanced Increased of the Firm
A significant query arises that the manager looks for to optimize the balanced increase rate of
the firm, which is why do they mutually optimize the rate of increase of demand for firm’s
commodities and the increased rate of capital supply.
This is for the reason that by doing so they optimize their own utility function and the
utility function of their owners. Before Marris, it was usually conversed by the management
theorists that the aims of managers and aims of the entrepreneurs frequently cash for the reason
that the utility operations which they try to optimize greatly vary.
The utility operation which managers look for to optimize integrate variables such as profits,
capital supply, dimension of the productivity, market share and picture or goodwill in the
community.

As per Marris, in spite of dissimilarity in the variables in the utility functions of managers
and entrepreneurs, the most of the variables incorporated in both of them are positively related
with a single variable, namely, the dimension of the firm.
Moreover, as per to him, the dimension may be measured by the level of productivity, capital
supply, sales revenue or market share. Nevertheless, Marris considers stable balanced increase
over time as the aim of the managers for the reason that most of the variables such as sales,
productivity, capital supply, incorporated in their utility operation besides enhancement at the
same time so that optimizing long tern increase of any variable amounts to optimizing long term
increase of others.
It is note worthy as per Marris, mangers do not optimize the complete dimension of the firm
however its rate of increase and the rate of increase of the firm is not the same thing as its
complete dimension from the point of view of managerial utility operation.
Marris converse that since increase of the firm is well-matched with the interests of investors
who are entrepreneurs of the firm, there is no need to diversify the rate of increase of capital
supply Ic which entrepreneurs Id which managers want to optimize and rate of increase of capital
supply Ic which entrepreneurs needs to optimize for the reason that in the state of symmetry both
the rates are equal.
It is unambiguous from the above that in Marris’ model some variables in the manager’s
utility operation such as remuneration, status, and power are strongly related with the rate of
increase of demand for the commodities and thus managers’ salaries will be higher and they will
have more power and esteem the faster the rate of increase of the firms. Apart firm the higher
increase of a firm also makes sure good job security to the managers.
Thus, utility operation of managers can be represented as follows:
UM = f (ID, S)
UM = Utility of managers
ID = Rate of Increase of demand for productivity of the firm.
S = Measure of job security of managers
Alternatively, as seen above, utility of entrepreneurs is based on the increase of capital supply
which is positively associated with the increase of profits. Therefore, entrepreneurs’ utility
operation can be given as:
U entrepreneurs = f (Ic) where Ic = Rate of increase of capital supply
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Other topics under Pricing Exercises and Policies:
● Ascertaining Productivity for estimating costing margin
● Average Cost Pricing
● Behavioral Model of the Firm - Satisfying Theory of Firm
● Cost-Plus Pricing
● Joint Commodities in Fixed Rations
● Price Discrimination
● Pricing of Multiple Products
● Pricing in Non-Profit Organizations, Ramsey Pricing, Peak Load Pricing
● Price and Productivity ascertainment in the Behavioral Thesis
● Sales - Optimization Model Pricing and Variations in Fixed Costs
● Sales Optimization Model under Oligopoly Firm
● Theory of Games Behavior
● Theory of Strategic Behavior
● Transfer Pricing
Optimization:
In this section we are going to look at optimization problems. In optimization problems we are
looking for the largest value or the smallest value that a function can take. We saw how to solve
one kind of optimization problem in the Absolute Extreme section where we found the largest
and smallest value that a function would take on an interval.
In this section we are going to look at another type of optimization problem. Here we will be
looking for the largest or smallest value of a function subject to some kind of constraint. The
constraint will be some condition (that can usually be described by some equation) that must
absolutely, positively be true no matter what our solution is. On occasion, the constraint will not
be easily described by an equation, but in these problems it will be easy to deal with as we’ll see.
This section is generally one of the more difficult for students taking a Calculus course. One of
the main reasons for this is that a subtle change of wording can completely change the problem.
There is also the problem of identifying the quantity that we’ll be optimizing and the quantity
that is the constraint and writing down equations for each.
The first step in all of these problems should be to very carefully read the problem. Once
you’ve done that the next step is to identify the quantity to be optimized and the constraint.
In identifying the constraint remember that the constraint is the quantity that must true
regardless of the solution. In almost every one of the problems we’ll be looking at here one
quantity will be clearly indicated as having a fixed value and so must be the constraint. Once
you’ve got that identified the quantity to be optimized should be fairly simple to get. It is
however easy to confuse the two if you just skim the problem so make sure you carefully read
the problem first!
Example 1 We need to enclose a field with a fence. We have 500 feet of fencing material and a
building is on one side of the field and so won’t need any fencing. Determine the dimensions of
the field that will enclose the largest area.
Solution

In all of these problems we will have two functions. The first is the function that we are actually
trying to optimize and the second will be the constraint. Sketching the situation will often help
us to arrive at these equations so let’s do that.
In this problem we want to maximize the area of a field and we know that will use 500 ft of
fencing material. So, the area will be the function we are trying to optimize and the amount of
fencing is the constraint. The two equations for these are,

The largest or smallest value of a function provided it’s only got a single variable. The area
function (as well as the constraint) has two variables in it and so what we know about finding
absolute extreme won’t work. However, if we solve the constraint for one of the two variables
we can substitute this into the area and we will then have a function of a single variable.
So, let’s solve the constraint for x. Note that we could have just as easily solved for y but that
would have led to fractions and so, in this case, solving for x will probably be best.

Substituting this into the area function gives a function of y.

The largest value this will have on the interval [0,250]. Note that the interval corresponds to
taking (i.e. no sides to the fence) and
(I.e. only two sides and no width, also if there are two sides each must be 250 ft to use
the whole 500ft).
So, recall that the maximum value of a continuous function (which we’ve got here) on a closed
interval (which we also have here) will occur at critical points and/or end points. As we’ve
already pointed out the end points in this case will give zero area and so don’t make any sense.
That means our only option will be the critical points.
So let’s get the derivative and find the critical points.

Setting this equal to zero and solving gives a lone critical point of . Plugging this into
2
the area gives an area of 31250 ft . So according to the method from Absolute Extreme section
this must be the largest possible area, since the area at either endpoint is zero.
Finally, let’s not forget to get the value of x and then we’ll have the dimensions since this is what
the problem statement asked for. We can get the x by plugging in our y into the constraint.


The dimensions of the field that will give the largest area, subject to the fact that we used exactly
500 ft of fencing material, are 250 x 125.
Don’t forget to actually read the problem and give the answer that was asked for. These types of
problems can take a fair amount of time/effort to solve and it’s not hard to sometimes forget what
the problem was actually asking for.
NEW MANAGERIAL TOOLS FOR OPTIMIZATION:
They are some of new managerial tools for optimization which are as follows:
Bench marking
Reengineering New managerial Total Quality Management
Learning Organization
Bench marking: It is an approach that which includes one may examine both internal and external
excellent performance for both understanding and improvement of a process and/or the entire
organization.
Best practices for organization internally:
a) Comparison of own practices with company’s best internal practices
b) Evaluate those practices.
c) Implement best practices.
Best practices for organization externally:

a) Comparison of own practices with best practices
b) Evaluate those practices.
c) Implement best practices.
Bench marking is a process for identifying and learning from the best practices in the world. It
includes search for and application of significantly better practices that lead to superior
competitive performance. Its also a process of comparing the business of one organization
against another to gain information about “best practices” that when creatively adapted, can lead
to superior performance.
Total Quality Management (TQM): Total Quality Management is a philosophy gradually
evolved from the management theories such a management by objectives quality circles,
strategic planning etc.

According to Professor Leopald S.Vasin, “TQM is the control of all transformation processes of
an organization to best satisfy customer’s needs in the most economical manner”.
A) Main activity areas of TQM system:
a) Pre-production quality evaluation
b) Quality planning
c) Quality evaluation of product and process
d) Quality information system
e) Quality training and orientation
f) Post production quality services
Re-Engineering:
According to Hammer and champy, “Re-engineering is the fundamental rethinking and radical
redesign of business processes to achieve dramatic improvements in critical, contemporary
measures of performance”.
Re-engineering is a process which is confusing and frustrating to some managers. Thus
reengineering implies changes of various types and depth to a system, from a slight renovation to
a total overhaul, in order to reinvent their companies, managers need to abandon the organization
and operational principles and processors they are now using and create entirely new ones. These
new ones combined in to an emerging idea called business re-engineering.
Learning organization: The Learning Organization is a concept that is becoming an
increasingly widespread philosophy in modern companies, from the largest multinationals to the
smallest ventures. What is achieved by this philosophy depends considerably on one's
interpretation of it and commitment to it. The quote below gives a simple definition that we felt
was the true ideology behind the Learning Organization.
"A Learning Organization is one in which people at all levels, individuals and collectively, is
continually increasing their capacity to produce results they really care about."
Questions:
1. Discuss the relevance of Baumol’s Model of sales revenue maximization in the

present context.
2. Compare and contrast and Behavioral Theory with the Economic Theory of a firm.
3. Explain the managerial theories of the firm?
4. Discuss the different theories of the profit?
5. What are the new management tools for optimization?
Unit 3-Basic Economic Principles

There are various Economic Principles which are as follows:-
a. Opportunity cost principle
b. Incremental principle
c. Scarcity principle
d. Principle of marginalize
e. Equi-marginal principle
f. Principle of time perspective
g. Discounting principle
Opportunity cost:-The cost of production of any unit of a commodity ‘A’ is the value of the
factors of production used in producing the unit. The value of these factors of production is

measured by the best alternative use to which they might have been put had a unit of’ A’ not
been produced. This concept of cost has been popularized by the American writers. “Opportunity
cost s” are also known as “alternative costs”.
❖ The opportunity cost at the time an entrepreneur devotes to his own.
❖ The opportunity cost of using a machine to produce one produce is the
earnings forgone which would have been possible from other products.
❖ Business is the salary he could earn in other occupations.
❖ The opportunity cost of the funds employed in one’s own business is
the interest that could be earned on those funds had they been
employed in other ventures.
Incremental principles: - In economic theory this is related to the marginal costs and marginal
revenues. It impact on estimating decision alternative and cost & revenues such as change I total
cost and total revenue resulting from changes in the prices, product, procedures. Investments or
what ever may be at state in decision.
They are two components of incremental reasoning are .
⮚ It decreases costs more than it decreases revenues.
⮚ It reduces some cost more than it increases others.
⮚ It increases some resources more than it decreases others.
⮚ It increases revenue more than it increases cost.
Scarcity principle:-This concept expressed as resource allocation problem of business
enterprise. The essence of any economic problem, micro & macro is the scarcity of resources.
The managers who decide on behalf of the corporate unit or the national economy always face
the economic problem of scarcity of one kind or the other.
For example: - As a production manager, he may be facing scarcity of good quality of
material or skilled technicians.
Principle of marginalize:-Most of the managers refer to this principle of marginal concepts in
economic theory. It relates in associated with arguments concerning changes in the quality used
of a good or of a service. If the sources are look at the disposal of manager he has to careful
about the utilization of each and every additional unit of resources. In that kind of situation
manger has to decide on the use of an additional man-hour. He needs to know what the additional
output is expected there form. Same as a decision about additional investment has to be taken in
view of the additional return from that investment.
⮚ In this economic theory nature of relationship between the various is to
be clearly stated.
⮚ Independent variable is to be changed by just one unit at a time to
work the impact on the dependent variable.
Equi-Marginal Principle:- According to Marshall” if a person has a thing which he can put to
several uses. He will distribute it among these uses in such away that it has the same marginal
utility in all”.
Assumption:
⮚ Utility can be measured in cardinal numbers.
⮚ Consumer is rational:- he wants maximum satisfaction from his
income. He is not influenced by fashion and habits.
⮚ Constant income
⮚ Constant price

⮚ Constant marginal utility

⮚ Divisible goods
⮚ Knowledge of utility
⮚ Independent of utility
⮚ Constant budget period.
Principle of time perspective:-Marginal economics are also concerned with the short run and
long run efforts of decision on revenues as well as costs. The main important problem in
decision-making is to maintain the right balance between the long run and short run
considerations. A decision may be made on the basis of short run consideration. But may as time
elapses have long run repercussions which make it more or less profitable than it at first
appeared.
Example: - suppose there is excess production capacity in a firm. An order of 2000
units comes to management notice. The customer is willing to pay Rs. 5/- Rs
1000/- for the whole lot but no more. Suppose the short run incremental is Rs.
4/-. Therefore contribution to overhead and profit is Rs 1/- per unit. But there
may be long run repercussions and there must be kept in mind.
Discounting principle:In this case the interest rate used in present value problem is some times
referred to as a discount rate. This concept is highly useful in managerial economics in making
invest decisions. Many transactions involve making or receiving cash payments at various future
dates.
Economics of risk and uncertainty:-
Future is uncertain and involves risk. The uncertainty is due to unpredictable changes
in the business cycle, structure the economy and government policies. This
means that the management must assume the risk of making decision for their
institution in uncertain and unknown economic conditions in the future.
Firms may be uncertain about production. Market prices, strategies of rivals etc.
Economic theory generally assumes that the firm has perfect knowledge of its
cost and demand relationships and of its environment. Uncertainty is not
allowed to affect the decisions.
Dynamic changes are external to the firm; they are beyond the control of the firm.
The result is that the risk from unexpected changes in a firm’s cost and
revenue data can’t be estimated and therefore the risks from such changes
can’t be insured.
The managerial economists have tried to take account of uncertainty with the help
of subjective probability. The probabilistic treatment of uncertainty requires
formulation of definite subjective expectations about cost, revenue and the
environment. The probabilities of future events are influenced by the time
horizon, the risk attitude and the rate of change of the environment.
Questions:-
1. Explain the concept of basic economic principles?
2. Describe the risk and uncertainty principle?
3. What is opportunity cost principle?
4. How incremental principle beneficiary for organizations in present
trend?

Unit 4-Theory of Demand

Meaning of Demand:-
The concept demand refers to the quality of a good or service that consumers are willing and
able to purchase at various prices dealing a period of time. The demand in Economics is
something more then desire to purchase through desire is one element of it. It is defined as the
amount of the commodity which an individual consumer will purchase or is willing to purchase
at a given price in a period of time. Form Economics point of view demand for a commodity
refers to both the desire to purchase the commodity and the ability to pay for it.
Types of Demand:

1. Individual Demand:-
When the demand arises from an individual consumer, it is called as “individual
demand”. “Individual consumer” usually demand for the products like clothes,
foot ware etc.
2. House hold Demand:-
When the demand for a product arises from a household, it is called as “household
demand”. “Households” generally demand for the products like refrigerator, A.C,
T.V etc.
3. Market demand:-
When the demand of all the individuals and households for a product in a given market is
considered, it is called as “Market Demand” or “Aggregate Demand”.
Factors which affect demand:-
1. Price:-
Price increases the demand of the product will decreases or if the price of the product
decreases the price of product will be increases.
2. Changes in tastes and fashion.
3. Change in population
4. Climate or weather changes
5. Changes in real income
6. Level of income
7. Change in savings
Demand Analysis:-
Demand Analysis means the study of the factors which influence the demand for a
commodity or goods and how to measure the effects of these influences.
Demand Function:-
Definition:-
A demand function is a mathematical relationship between the quality demanded of
the commodity and its determinants .
A demand function can be represented as
Q=f (demand determinants)
Where
Q=Quality demanded of a commodity
Types of demand function:
Demand Functions

Individual demand Market /Aggregate demand

Function Function
1. Individual Demand Function:-
Individual demand function is a mathematical relationship between the demand by an individual
consumer and the determinants of individual demand. Mathematically, it can be expressed as,
Qx= f (Px, I; P1………….Pn; T, A, EP , E1, U)
Where
Qx =Quality demanded of the commodity x
Px =Price of the commodity it self
I = Consumers income
P1………….Pn = Prices of the related goods
T= consumer tastes and preferences
A= Advertisement
EP =Consumer’s Expectation about future prices
E1 =Consumer’s expectation about his/her future income
U= Other determinants.
An individual demand function can also be defined as the functional relationship of quality
demanded by an individual and its determinants.
2. Market / Aggregate Demand Function:-
Is the functional relationship between the market demand for a commodity and the determinants
of market demand. Mathematically it can be expressed as
Qx = f(Px,I,P1…………….Pn, T,A,EP,E1,P,D,U)
Where
Qx = Quality demanded of the commodity x
Px = Price of the commodity itself
I = Consumer’s income
P1……..Pn = Prices of the related goods.
T= Consumer tastes and preferences
A=Advertisement
EP=consumer’s Expectation about Future Prices.
E1= consumer’s expected about his/her future income
P= Population or market size
D=Distribution of consumers in the market according to Income, Age, Gender etc.
U= Other determinants.
The major deference between the individual demand function and market demand function is
that in market demand function the size and the nature of the consumers in a given
market are also considered.

Law of Demand:-
This law is also known as first law of purchase. The law of demand states that quantity of a
product demand varies inversely with price. Other things remaining constant.
‘Marshall’ defined “law of demand as the amount demanded increase with a fall in price and
diminishes with a rise in price.”
This law is applicable only when other things remain constant.
Assumption:-
The law of demand is based on the following assumptions.
1. There should be no change in tasted preference of consumer.
2. Incoming of consumer should remain constant.
3. There should not be any change in price of related goods.
4. There should not be any substitute for commodity.
5. There should not be any change in quality of product.
6. The law assumes that commodity is not prestigious goods.
7. People don’t have expectations of future changes in price of the commodity.
Demand Schedule:-
It shows relationship between quality demanded and price. There are two types of demand
schedule named
1. Individual Demand Schedule
2. Market Demand Schedule.
1. Individual Demand Schedule:-
It shows the quality of goods and services demanded at different prices by individuals.
2. Market Demand Schedule:-
It represents demand of all the individuals in market at different prices. It can be shown with help
of a chart and diagram.
Demand schedule can be represented with help of table and graph.
f mangoes dual Demand Schedule et Demand Schedule
10 2 2000
8 4 4000
6 6 6000
4 8 8000
2 10 10000

OY
10 A Demand curve
8 B
Price 6 C
4 D
2 D
O 2 4 6 8 10 X
Quantity Demanded
In the above figure ‘OX’ axis shows quality ‘demanded’ and OY axis shows ‘price’.
In the above figure when the price of a commodity is Rs.8/- the quantity demanded is 4kgs.
When price falls to Rs. 4/- and quantity demanded increases to 8kgs. Thus the demand curve
slopes downwards from left to right which shows the inverse relationship between price and
quantity demanded.
Reasons for demand curve sloping downwards from left to right:-
1. Income Effect:-
When the price of a commodity falls the real income of consumers increase i.e. he can buy more
of commodity with same amount. When the price rises more money is needed for
purchasing same quantity i.e. real income decreases. Hence, demand decreases and
increases because of income effect.
2. Diminishing Marginal Utility:-
This is basis law of demand. Since, the consumer compares the price and utility. He will be
willing to pay a lesser price for additional units as their utility is diminishing. Therefore,
consumers buy more only at a lower prices.
3. Differences in Income:-
When the price of a commodity falls not only the existing consumer for the products but people
with less income groups may also come to purchase commodity. As a result demand
expands at a less price.
4. Substitute Effect:-

Suppose the price of the commodity falls while the price of other commodity remains same. This
commodity appears to be cheaper than others. There fore demand for that commodity
appears. Thus the consumer would like to substitute the cheaper commodity in place of
other costly substitutes. This is called as “Substitute Effect”.
Elasticity of Demand and Degrees of Elasticity of Demand:-
Introduction:-
Alfred Marshall was first Economist’s who introduced concept of Elasticity of demand in to the
theory.
The law of demand shows inverse relationship between price and quantity demanded. But it
does tell us by how much the demand changes. In fact for a given change in price demand
for a commodity changer differently for different persons. The concept of demand to
change with slitest change price is called the ‘Elasticity of demand’.
A small change in price may lead to greater change in demand. In that case we may say that
demand is ‘Elastic’. But even with a change in price may lead to a small change in
demand and sometimes demand may also remain constant. In that case demand is in
elastic. Thus, elasticity is the measurement of changes in demand for given change in
price.
Definition:-
According to K.E.Boulding “Elasticity of demand measures the degree of responsiveness of
demand to change in its price.”
Generally Ed refers to price Ed. Thus, price elasticity of demand may be written as
Ed= Proportionate change in Demand
-----------------------------------------------
Proportionate change in Price
Kinds of price elasticity of demand or Degree of elasticity of demand:-
There is various price elasticity of demand which are divided in to five. They are
1. Perfectly in elastic demand
2. Perfectly elastic demand
3. Relative in elastic demand
4. Relative elastic demand
5. Unitary elastic demand
1. Perfectly In Elastic Demand:-
In this case whether price increases or decreases but there is no change in demand. Hence Ed= 0.
This can be explained with the help of table and graph.
Price uantity Demanded
8 1000
4 1000

2 1000
Y D
P1
Ed=0
P
Price
● D
M
Quantity Demanded
In the above graph ‘DD’ curve is a vertical line parallel to ‘Y Axis’. When price is ‘OP’ quantity
demanded to ‘OM’. When price has increased to ‘OP’, the quantity demanded the same
(i.e.)’OM’.
Suppose the percentage change in price is ‘25%’ and percentage change in demand is ‘0’
percentage.
Ed= Proportionate change in Demand/proportionate change in price
Ed=0/25 . Ed=0
2. Perfectly Elastic Demand :-
In this case even a small reduction in price leads to an unlimited extent in demand which can’t be
measured. This can be explained with the help of a graph.
Y
Price D D
O X
Quantity Demanded

In this graph DD is horizontal line parallel to OX axis. Even a small change in price brings about
a change in demand that is not possible to measure. Hence, elasticity is infinite.
3. Relatively Elastic Demand:-
In this case even a small change in price brings about a greater change in demand. Hence,
elasticity will be greater than one.
Example:- if the price falls for 10% and quantity demanded increases to 30% then elasticity of
demand would be 3 as followed=3 so Ed>1
Ed=percentage change in demand/percentage change in price = 30/10 = >1
P1 D
P Ed>1
Price Q D
O M1 M
Quantity Demanded
In the above graph when price is ‘OP’ the demanded is ‘M’. when price increases for ‘OP to
OP1”, the demand decreased from ‘OM to OM1’. Here in the above graph the percentage change
in demand is more than percentage change in price.
4. Relatively in-elastic demand:-
Quantity demanded changes less than proportional to a change in price. A large change in price
leads to small change in amount demanded. Here Ed < 1. Demanded carve will be steeper.
When price increases from ‘OP’ to ‘OP1 amount demanded decreases from OQ to OQ1, which is
smaller than the change in price. ( Q< P)

5. Unit elasticity of demand:-

The change in demand is exactly equal to the change in price. When both are equal Ed=1 and
elasticity if said to be unitary.
When price increases from ‘OP’ to ‘OP1’ quantity demanded decreases from ‘OQ’ to ‘OQ1’,
quantity demanded increases from ‘OQ’ to ‘OQ1’. Thus a change in price has resulted in an
equal change in quantity demanded so price elasticity of demand is equal to unity. ( Q= P)
Factors influencing Ed or Determinants of Elasticity of Demand:-

Price Elasticity of demand depends upon a number of factors. For some commodities demand is
elastic while others have inelastic demand. The following are the factors determining degree of
elasticity.
1. Nature of commodity: - depending upon nature of a commodity they can be classified in
to 2 categories (i.e.) necessary and luxuries.
a. Necessary: - Generally demand for necessary will be inelastic i.e. the demand for
necessaries does not change very much with change in price.
b. Luxuries:-The demand for these goods is elastic in nature as they are not essential
goods. People will buy less when the price rises and buy more when price falls.
2. Number of uses: - If the commodity can be put to several uses. Every fall in its price
includes people to use it to less urgent needs.
3. Durable goods: - like TV Refrigerators etc in such cases demand will be highly elastic
i.e. when price of durable goods rises demand will fall down.
4. Period of time:-demand will be elastic in short period and will be inelastic in the long
run period.

5. Habit of consumer:-some commodities are habit forming ex: - tabbacco, alcohol etc. the
demand for such goods will tend to be inelastic i.e what ever may be the prices the
consumer wants to buy the product.
6. Range of price: - demand will be in elastic at the higher range of prices and elastic at the
lower range of prices.
Various methods of measuring ED:-
Introduction:-
The law of demand states that demand will change when price of commodity changes. But
change in demand will not be same in all commodities. For a given change in price the
demand for same commodity. Changes very much while demand for some commodities
changes very little.
Elasticity is measured of rate of change for a given change in price. 4 methods are
developed to measure Ed.
1. Total Expenditure method:-
This method was defined by Marshall Ed can be measured on basis of change in total
expenditure followed by change in price of commodity.
Ex: - Total Expenditure (TE) =price*Quantity demanded
If price rises or fall when total expenditure remain same elasticity = 1. This can be explained
by following table.
Price Quantity Total expenditure lasticity
5 200 1000 E=1

4 250 1000
5 200 1000 E>1

4 300 1200
5 200 1000 E<1

4 150 600
a. Unitary elastic:-
When the price falls to Rs. 5 to Rs. 6. Total expenditure remain un change. There fore
demand is unitary elastic.
b. Greater than:-
When the price falls from Rs.5 to Rs. 4. Demand increased to 300 units. Total
expenditure increased from 1000 to 1200. Therefore demand is elastic in nature.
c. Less than:-

When price falls from Rs. 5 to Rs. 4 total expenditure decreases from 1000 to 600.
Therefore demand is inelastic in nature.
Y
P3 D
E>1
P2 C
E=1
P1 B
P E<1
Price
M M2 M1 X
O
Out put
When the price is ‘OP’, then the total expenditure is ‘OM’. When price rises to OP, the total
expenditure rises to OM;
There fore ED between A & B is less than 1. When price increases from OP1 to OP2 the total
expenditure remain at same level OM1;
ED between B & C is equal to 1. When price rises to from OP2 to OP3 the total expenditure
declines from OM1 to OM2. Ed between C & D is Greater than 1.
2. Percentage method:-
In this method the percentage change in price and percentage in demand are compared.
Ed = Q/Q / P/P
= Q/Q *P / P
= Q/ P *P/Q
By applying above formula we can estimate the ratio of change in price and change in
quantity demanded
Ex: - price Q.D
10 1000
8 1500
∆Q/^P *P/Q
500/2*10/100 = 5000/2000 = 5/2 = 2.5>1
There fore
Ed>1

Ex:-
Price Q. D
5 400
2 500
∆Q/^P*P/Q = 100/3*5/4000 = 5000/12000 = 5/12 = 0.4<1
Ed<1
3. Point Method:-
Measurement of elasticity at a point demand curve is called point method. In general middle
point of demand curve is taken as basis and formula given below is applied to know
degree of elasticity
So Ed= lowest segment/upper segment
Y
D
E=&
P3
E>1
P1
E=1
P
P2 E<1
P4 E=0 D
O B X
In the above graph at point P elasticity will be equal to 1. At point P1 elasticity will be
greater than 1. At P2 elasticity is less than 1 at P3 elasticity is infinite and at P4
elasticity is 0. If we apply above formula the degree of elasticity is measured in
following manners.
P=PB/PA
P1 = P1B/p1A
P2 = P2B/P2A etc
4. Arc Method:-

It is useful when the change in price of demand is very large. Arc represents the distance
between two points of demand curve. The following formula is applied to measure
elasticity.
Change in quantity demanded/original quantity +new quantity after change /change in
price/original price + new price after change.
P1 A∆
P B
D
O
M1 M X
In the above graph DD is demand curve. The distance between point A & B can be
measured by applying above formula.
Equation:-
∆Q/OM+OM1/^P/OP+OP1
∆Q/OM+OM1*OP+OP1/^P
∆Q/^P*OP+OP1/OM+OM1
Importance of elasticity of demand:-
Elasticity of demand is having importance in all the fields of economy.
1. Monopoly price:-
The single seller has to examine the degree of elasticity before change in price level.
2. Production:-
Producers generally decide their production level on the basis of demand for the product.
Hence elasticity of demand helps the producers to take correct decision.
3. Government policy:-
Elasticity of demand helps the government in formulating tax policies. For example: - for
imposing tax on a commodity, the finance minister has to take into account the
elasticity of demand.
4. International trade:-
The degree of elasticity is examined in determining quantity of exports and imports.
5. Budget:-
The government has to examine the nature of goods and degree of elasticity in allocation
of the resources through budget.

Demand forecasting:-
Forecasting product demand is crucial to any suppliers,manufacturer or retailer. Forecasts
of future demand will determine the quantities that should be purchased, produced
and shipped. Demand forecasts are necessary since the basic operation process,
moving from the suppliers, raw materials to finished goods in the customer’s
hands, takes time.
Types of demand forecasting:-
Demand foresting
Short term demand forecasting Long term demand forecasting

1. Short term demand forecasting:-
It is limited to short periods; usually for 1 year. It relates to policies regarding sales,
purchase, price and finances. It refers to existing production capacity of the firm.
If the business people expect of rise in the prices of raw materials of shortages, they may
buy early. This price forecasting helps in sale policy formulation. Production may
be undertaken based on expected sales and not on actual sales. Further, demand
forecasting assists in financial forecasting also.
2. Long term forecasting:-
The business men should know about the long-term demand for the product. Planning of
new plant or expansion of an existing unit depends on long term demand.
Similarly a multi product firm must take into account the demand for different
items. When forecast are made covering long periods, the probability of errors is
high. It is vary difficult to fore cast the production, the trend of prices and the
nature of competition.
Methods of forecasting:
Several methods are employed for forecasting demand. All these methods can be grouped under
survey method and statistical method. Survey methods and statistical methods are further
subdivided in to different categories.
1. Survey Method:
Under this method, information about the desires of the consumer and opinion of exports are
collected by interviewing them. Survey method can be divided into four type’s viz., Option
survey method; expert opinion; Delphi method and consumers interview methods.
A. Opinion survey method:

This method is also known as sales-force composite method (or) collective opinion method.
Under this method, the company asks its salesman to submit estimate of future sales in their
respective territories. Since the forecasts of the salesmen are biased due to their optimistic or
pessimistic attitude ignorance about economic developments etc. these estimates are
consolidated, reviewed and adjusted by the top executives. In case of wide differences, an
average is struck to make the forecasts realistic.
This method is more useful and appropriate because the salesmen are more knowledge. They can
be important source of information. They are cooperative. The implementation within unbiased
or their basic can be corrected.
B. Expert opinion method:
Apart from salesmen and consumers, distributors or outside experts may also used for
forecasting. In the United States of America, the automobile companies get sales estimates
directly from their dealers. Firms in advanced countries make use of outside experts for
estimating future demand. Various public and private agencies all periodic forecasts of short or
long term business conditions.
C. Delphi Method:
A variant of the survey method is Delphi method. It is a sophisticated method to arrive at a
consensus. Under this method, a panel is selected to give suggestions to solve the problems in
hand. Both internal and external experts can be the members of the panel. Panel members one
kept apart from each other and express their views in an anonymous manner. There is also a
coordinator who acts as an intermediary among the panelists. He prepares the questionnaire and
sends it to the panelist. At the end of each round, he prepares a summary report. On the basis of
the summary report the panel members have to give suggestions. This method has been used in
the area of technological forecasting. It has proved more popular in forecasting. It has provided
more popular in forecasting non-economic rather than economic variables.
D. Consumers interview method:
In this method the consumers are contacted personally to know about their plans and preference
regarding the consumption of the product. A list of all potential buyers would be drawn and each
buyer will be approached and asked how much he plans to buy the listed product in future. He
would be asked the proportion in which he intends to buy. This method seems to be the most
ideal method for forecasting demand.
2. Statistical Methods:

Statistical method is used for long run forecasting. In this method, statistical and mathematical
techniques are used to forecast demand. This method relies on post data.
a. Time series analysis or trend projection methods:
A well-established firm would have accumulated data. These data are analyzed to determine the
nature of existing trend. Then, this trend is projected in to the future and the results are used as
the basis for forecast. This is called as time series analysis. This data can be presented either in a
tabular form or a graph. In the time series post data of sales are used to forecast future.
b. Barometric Technique:
Simple trend projections are not capable of forecasting turning paints. Under Barometric method,
present events are used to predict the directions of change in future. This is done with the help of
economics and statistical indicators. Those are (1) Construction Contracts awarded for building
materials (2) Personal income (3) Agricultural Income. (4) Employment (5) Gross national
income (6) Industrial Production (7) Bank Deposits (8) Willingness etc.
c. Regression and correlation method:
Regression and correlation are used for forecasting demand. Based on post data the future data
trend is forecasted. If the functional relationship is analyzed with the independent variable it is
simple correction. When there are several independent variables it is multiple correlation. In
correlation we analyze the nature of relation between the variables while in regression; the extent
of relation between the variables is analyzed. The results are expressed in mathematical form.
Therefore, it is called as econometric model building. The main advantage of this method is that
it provides the values of the independent variables from within the model itself.
Demand estimation through Marketing Research Approach:
In this concept we will discuss demand estimation though marketing research. Production of a
good or supplying of product to the market depends on correct estimation of demand in
case of incorrect estimation of demand firm would decrease the profit.Similarly excess
supply of product to the market tends to fall the price of good, and profit margin of a firm
would decline. We can estimate demand through the following techniques.
• Consumer surveys and observational Research.
• Market Experiments.
• The survey conducted at big shopping centers by trained interviewers with sophisticated
questions.
• Consumer clinics.
• Consumer’s questionnaires provide useful information to the firm.
We have a sample of questionnaires:
o Do you know how much your monthly consumption of beer would change if price of
beer rose by 10%
o If your income increase by 20%

o If beer producer doubled its advertising expenditures

o If alcoholic content of beer were reduced by 1% point
o If price of competitor product (beer) reduced by 2%
Observational research:
⮚ This refers to the gathering of information on consumer preferences by watching them
buying and using goods.
⮚ However consumer survey is useful and is the only way to obtain information about
possible consumer response.
⮚ Especially if a firm is thinking of introducing a new product or changing the quality of an
existing one.
⮚ The only way that the firm can test consumer reaction is to directly ask them, since no
other data are available.
Need of Demand forecasting:
1. A. Need of short-term forecasting:
I. Appropriate production scheduling: appropriate production scheduling so s to
avoid the problem of over-production and the problem of short supply. For this
purpose, production schedules have to the geared to expected sales.
B. Helping the firm in reducing cots: it helps the firm in reducing costs of raw materials
and controlling inventory by determining its future resource requirements.
C. Determining appropriate price policy.
D. Setting sales targets and establishing controls and incentives.
E. Forecasting short-term and establishing controls and incentives.
F. Evolving a suitable advertising and promotion program.
2. B. Need for Long-Term forecasting:
C. Planning of a new unit or expansion of an Existing Unit.
C. Planning Long-term Financial Requirements.
D. Planning Man power Requirements.
'Law of Supply'
Introduction:-
In economic supply during a given period of this means the quantities of goods which are offered
for sale at a particular price. Thus, supply of a commodity may be defined as amount of that
commodity which sellers are able and willing to after for sale at a particular price during certain
period of time.
In short supply always means supply at a given price; at different prices the supply may
be different. Normally higher the price the greater the supply.
Supply Schedules:-
The supply schedules refer to a table showing quantity of a commodity supplied at various prices
during a given period. There are 2 types of supply schedule they are.
1. The individual seller supply schedule
2. The market supply schedule
1. The individual seller supply schedule:-
An individual supply schedule refers to a table representing different quantities of a
commodity offered for supply by an individual seller at alternative prices. This can be
represented withy help of table.
An individual seller supply schedule:
of a commodity ity of a commodity x(Units supplied per

. per unit) month)
10 200
12 300
15 500
18 700
20 10000
By growing through supply schedule we observe that at a higher price a greater amount is
offered for a sale than at a lower price.
2. Market supply schedule:-
A market supply schedule is aggregate supply schedule of all sells in market. It refers to total
quantities of a given commodity which sellers in market are willing to offer for sale at
various prices. This can be represented with help of a table
Market supply schedule
(Rs) ommodity x supplied per month by of market supply(1+2+3)
Pro B Pro C
10 3 3 2 8
12 7 5 4 16
14 10 8 6 24
16 14 10 8 32
18 19 11 10 40
It is assured that market consists at only 3 sellers so that total market supply is measured by
aggregating individual supply of these 3 sellers.
The behavior of market supply in terms of price quantity relationship thus correspond
with individual behavior supply schedule i.e. supply tends to rise with rise in price4.

Statement of law:-
“Other thing remaining unchanged, supply of commodity expands with a rise in its price and
contracts with a fall in its price”.
The law thus suggests that supply varies differently with change in price.
Explanation of law:-
The law can be explained and illustrated with help of market supply curve.
Market supply curve:
1 S X
In above graph supply curve slopes upward from left to right in directing that there is a directly
relationship between quantity supplied and price.
The bases of law of supply:-
The seller’s reservation price is basis of law of supply. A seller fixes maximum price called as
reservation price. Below which he refuses to sell product.
When market price is low, it would be close to sellers reservation price leaving a small margin
of profit. So he may be willing to after only a smaller part of his given stock for sale. But with
rise in price, other thing being constant the difference the market price and reservation price
tends to be large implying a higher profitability which may in due him to after more and more
stock for sale.
Assumptions:-
1. Cost of production is unchanged
2. No change in techniques of production
3. Fixed scale of operation(production)
4. Government policies are unchanged.
5. No change in transport cost
6. No specialization
7. The price of other goods is held constant.
Determinants of supply:-

The law of supply expresses a relationship prices and quality supplied of a commodity on the
assumption that conditions of supply remains constant. The determinants of supply other
than price are as follows
1. Cost of factors of production:-
The cost of production of a commodity depends on price of various factors of production. If
price of factors of production rises the production cost would be higher for some level
of output. On other hand, a fall in price of a factor would reduce cost of production.
In both cases supply will be affected if cost of production reduces supply will be
more and vise versa.
2. State of technology:-
The supply of a commodity depends upon the methods of production. Most of innovations in
chemistry, electronic etc have greatly contributed to increase supply of a commodity
at lower cost.
3. Tax and Subsidiary:-
A tax on a commodity or a factory production results in rise in a cost of production
consequently production is reduced. A subsidiary on the other hand provides an
incentive to production and arrgements suppliers.
Supply functions:-
In supply function determinents of supply can be summarized as
Sx = (Px;Pf;Py…………………….Pz;O’T’t’S)
Where Sx = Supply of Commodity ‘x”
Px = Price of ‘x’
Pf = Price of factors of production
Py………Pz = The prices of related goods
O = factors outside the economic sphere
T = Technology.
t = commodity taxation
S= Subsidiary
Elasticity of Supply:-
Introduction:-
Supply changes due to a change in price. The extent of change in supply in accordance with
change in price is called “Elasticity of supply”.
When, with the little change in price there is a considerable change in supply the supply
is said to be elastic. When with considerable change in price, there is a little change in
price, the supply is said to be in elastic.
Elasticity of supply may be defined as the ‘Ratio of percentage change in quality supplied
to percentage change in price”.
Es=percentage change in supply/percentage change in price = Q/ P
Elasticity of supply is 5 types. They are

1. Perfectly Elastic Supply

2. Perfectly in elastic supply
3. Relative elastic supply
4. Relatively in elastic supply
5. Unitary elastic supply
1. Perfectly elastic supply:-
A small change in price may bring about un measurable change in supply by which
curve will be horizontal straight line to ox-axis and E is infinite (&)
E=∞
P S S
Price E=∞
O X
Supply
2. Perfectly Inelastic supply:-

The change in price will not have any impact on supply by which curve will be
vertical straight line to oy- axis and E is ‘0’
Y S
E=0
O S X
3. Relatively Elastic supply:-

Straight change in price will increase supply to a greater extent by which
elasticity will be greater.
S

P1
P Es>1
Price S
O M M1 X
Out put
The distance MM1 will be greater than the distance between PP1. SS is the supply curve.
4. Relatively inelastic supply:-

The change in price will be greater than the change in supply. Elasticity will be less than1.
E<1
Y S
P1
P Es<1
Price S
O M M1
Out put
The distance between PP1 will be greater than distance between MM1.
5. Unitary elastic supply:-

The change in supply will be equal to the change in price.
Y S
P1

Price P
O M M1 X
Out put
The distance between PP1 is equal to distance between MM1 i.e. ES=1
Questions:-
1. Define cross elasticity of demand.
2. Explain the types and significance of elasticity of demand?
3. What are the forecasting techniques? Explain them?
4. Define the law of supply and elasticity of supply?
UNIT 5-Production Analysis

Introduction: The production function expresses a functional relationship between physical
inputs and physical outputs of a firm at any particular time period. The output is thus a function
of inputs. Mathematically production function can be written as
Q= f (L, L1, C, T)
Where “Q” stands for the quantity of output and A, B, C, D are various input factors such as
land, labor, capital and technology. Here output is the function of inputs. Hence output becomes
the dependent variable and inputs are the independent variables.
The above function does not state by how much the output of “Q” changes as a consequence of
change of variable inputs. In order to express the quantitative relationship between inputs and
output, Production function has been expressed in a precise mathematical equation i.e.
Y= a+b(x)
Which shows that there is a constant relationship between applications of input (the only factor
input ‘X’ in this case) and the amount of output (y) produced.
Importance:
1. When inputs are specified in physical units, production function helps to estimate the
level of production.
2. It becomes is equates when different combinations of inputs yield the same level of
output.

3. It indicates the manner in which the firm can substitute on input for another without
altering the total output.
4. When price is taken into consideration, the production function helps to select the least
combination of inputs for the desired output.
5. It considers two types’ input-output relationships namely ‘law of variable proportions’
and ‘law of returns to scale’. Law of variable propositions explains the pattern of output
in the short-run as the units of variable inputs are increased to increase the output. On the
other hand law of returns to scale explains the pattern of output in the long run as all the
units of inputs are increased.
6. Production function can be fitted the particular firm or industry or for the economy as
whole. Production function will change with an improvement in technology.
Assumptions:
Production function has the following assumptions.
1. The production function is related to a particular period of time.
2. There is no change in technology.
3. The producer is using the best techniques available.
4. The factors of production are divisible.
Cobb-Douglas production function:
Production function of the linear homogenous type is invested by Junt wicksell and first tested
by C. W. Cobb and P. H. Douglas in 1928. This famous statistical production function is known
as Cobb-Douglas production function. Originally the function is applied on the empirical study
of the American manufacturing industry. Cabb – Douglas production function takes the
following mathematical form.
Y= (AKX L1-x)
Where Y=output
K=Capital
L=Labor
A, ∞=positive constant
Assumptions:
It has the following assumptions
1. The function assumes that output is the function of two factors viz. capital and labor.
2. It is a linear homogenous production function of the first degree
3. The function assumes that the logarithm of the total output of the economy is a linear
function of the logarithms of the labor force and capital stock.

4. There are constant returns to scale

5. All inputs are homogenous
6. There is perfect competition
7. There is no change in technology
ISOQUANTS
The term Isoquants is derived from the words ‘iso’ and ‘quant’ – ‘Iso’ means equal and ‘quant’
implies quantity. Isoquant therefore, means equal quantity. A family of iso-product curves or
isoquants or production difference curves can represent a production function with two variable
inputs, which are substitutable for one another within limits.
Isoquants are the curves, which represent the different combinations of inputs producing a
particular quantity of output. Any combination on the asquint represents the some level of
output.
For a given output level firm’s production become,
Q= f (L, K)
Where ‘Q’, the units of output is a function of the quantity of two inputs ‘L’ and ‘K’.
Thus an isoquant shows all possible combinations of two inputs, which are capable of producing
equal or a given level of output. Since each combination yields same output, the producer
becomes indifferent towards these combinations.
Assumptions:
1. There are only two factors of production, viz.
labor and capital.
2. The two factors can substitute each other up to
certain limit
3. The shape of the isoquant depends upon the
extent of substitutability of the two inputs.
4. The technology is given over a period.
An isoquant may be explained with the help of an arithmetical example.

Combination Labor Capita Output
s (units) l (quintals
(Units )
)

A 1 10 50
B 2 7 50
C 3 4 50
D 4 3 50
E 5 1 50
Combination ‘A’ represent 1 unit of labor and 10 units of capital and produces ‘50’ quintals of a
product all other combinations in the table are assumed to yield the same given output of a
product say ‘50’ quintals by employing any one of the alternative combinations of the two
factors labor and capital. If we plot all these combinations on a paper and join them, we will get
continues and smooth curve called Iso-product curve as shown below.
Labor is on the X-axis and capital is on the Y-axis. IQ is the ISO-Product curve which shows all
the alternative combinations A, B, C, D, E which can produce 50 quintals of a product.
Isocost:
In economics an isocost line shows all combinations of inputs which cost the same total amount.
Although similar to the budget constraint in consumer theory, the use of the isocost line pertains
to cost-minimization in production, as opposed to utility-maximization. For the two production
inputs labor and capital,
Now suppose that a producer has a total budget of Rs 120 and for producing a certain level of
output, he has to spend this amount on 2 factors A and B. Price of factors A and B are Rs 15 and
Rs. 10 respectively.
Combinations Units of Units of Labor Total
Capital expenditure
Price = 150Rs Price = 100 Rs ( in Rupees)
A 8 0 120
B 6 3 120
C 4 6 120
D 2 9 120

E 0 12 120
The isocost line shows all the possible combinations of two factors Labor and capital.
Producer’s Equilibrium:
The tem producer’s equilibrium is the counter part of consumer’s equilibrium. Just as the
consumer is in equilibrium when be secures maximum satisfaction, in the same manner, the
producer is in equilibrium when he secures maximum output, with the least cost combination of
factors of production.
The optimum position of the producer can be found with the help of iso-product curve. The
Iso-product curve or equal product curve or production indifference curve shows different
combinations of two factors of production, which yield the same output. This is illustrated as
follows.
Let us suppose. The producer can produce the given output of paddy say 100 quintals by
employing any one of the following alternative combinations of the two factors labor and capital
computation of least cost combination of two inputs.
L K Q L&LP (3Rs.) KXKP(4Rs.) Total cost
Units Units Output Cost of labor cost of

capital
10 45 100 30 180 210
20 28 100 60 112 172
30 16 100 90 64 154
40 12 100 120 48 168
50 8 100 150 32 182
It is clear from the above that 10 units of ‘L’ combined with 45 units of ‘K’ would cost the
producer Rs. 20/-. But if 17 units reduce ‘K’ and 10 units increase ‘L’, the resulting cost would
be Rs. 172/-. Substituting 10 more units of ‘L’ for 12 units of ‘K’ further reduces cost pf Rs.
154/-/ However, it will not be profitable to continue this substitution process further at the
existing prices since the rate of substitution is diminishing rapidly. In the above table the least
cost combination is 30 units of ‘L’ used with 16 units of ‘K’ when the cost would be minimum at
Rs. 154/-. So this is they stage “the producer is in equilibrium”.

Law of Production:
Production analysis in economics theory considers two types of input-output relationships.
1. When quantities of certain inputs, are fixed and others are variable and
2. When all inputs are variable.
These two types of relationships have been explained in the form of laws.
i) Law of variable proportions
ii) Law of returns to scale
Law of variable proportions:

The law of variable proportions which is a new name given to old classical concept of “Law of
diminishing returns has played a vital role in the modern economics theory. Assume that a firms
production function consists of fixed quantities of all inputs (land, equipment, etc.) except labour
which is a variable input when the firm expands output by employing more and more labour it
alters the proportion between fixed and the variable inputs. The law can be stated as follows:
“When total output or production of a commodity is increased by adding units of a variable input
while the quantities of other inputs are held constant, the increase in total production becomes
after some point, smaller and smaller”.
“If equal increments of one input are added, the inputs of other production services being held
constant, beyond a certain point the resulting increments of product will decrease i.e. the
marginal product will diminish”. (G. Stigler)
“As the proportion of one factor in a combination of factors is increased, after a point, first the
marginal and then the average product of that factor will diminish”. (F. Benham)
The law of variable proportions refers to the behavior of output as the quantity of one Factor is
increased Keeping the quantity of other factors fixed and further it states that the marginal
product and average product will eventually do cline. This law states three types of productivity
an input factor – Total, average and marginal physical productivity.
Assumptions of the Law: The law is based upon the following assumptions:
i) The state of technology remains constant. If there is any improvement in technology,
the average and marginal output will not decrease but increase.
ii) Only one factor of input is made variable and other factors are kept constant. This law
does not apply to those cases where the factors must be used in rigidly fixed
proportions.
iii) All units of the variable factors are homogenous.

Three stages of law:

The behaviors of the Output when the varying quantity of one factor is combines with a fixed
quantity of the other can be divided in to three district
stages. The three stages can be better understood by
following the table.
Variable Total Average Marginal

factor Product Product
(Labor)
Fixe produc
d t
facto
r
1 1 100 100 - Stage I
1 2 220 110 12
0
1 3 270 90 50
1 4 300 75 30 Stage II
1 5 320 64 20
1 6 330 55 10
1 7 330 47 0 Stage III
1 8 320 40 -10

Above table reveals that both average product and marginal product increase in the beginning
and then decline of the two marginal products drops of faster than average product. Total product
is maximum when the farmer employs 6th worker, nothing is produced by the 7th worker and its
marginal productivity is zero, whereas marginal product of 8th worker is ‘-10’, by just creating
credits 8th worker not only fails to make a positive contribution but leads to a fall in the total
output.
From the above graph the law of variable proportions operates in three stages. In the first stage,
total product increases at an increasing rate. The marginal product in this stage increases at an
increasing rate resulting in a greater increase in total product. The average product also increases.
This stage continues up to the point where average product is equal to marginal product. The law
of increasing returns is in operation at this stage. The law of diminishing returns starts operating
from the second stage awards. At the second stage total product increases only at a diminishing
rate. The average product also declines. The second stage comes to an end where total product
becomes maximum and marginal product becomes zero. The marginal product becomes negative
in the third stage. So the total product also declines. The average product continues to decline.
We can sum up the above relationship thus when ‘A.P.’ is rising, “M. P.’ rises more than “ A. P;
When ‘A. P.” is maximum and constant, ‘M. P.’ becomes equal to ‘A. P.’ when ‘A. P.’ starts
falling, ‘M. P.’ falls faster than ‘ A. P.’.
Thus, the total product, marginal product and average product pass through three phases, viz.,
increasing diminishing and negative returns stage. The law of variable proportion is nothing but
the combination of the law of increasing and demising returns.
II. Law of Returns of Scale:
The law of returns to scale explains the behavior of the total output in response to change in the
scale of the firm, i.e., in response to a simultaneous to changes in the scale of the firm, i.e., in
response to a simultaneous and proportional increase in all the inputs. More precisely, the Law of
returns to scale explains how a simultaneous and proportionate increase in all the inputs affects
the total output at its various levels.
The concept of variable proportions is a short-run phenomenon as in these period fixed factors
cannot be changed and all factors cannot be changed. On the other hand in the long-term all

factors can be changed as made variable. When we study the changes in output when all factors
or inputs are changed, we study returns to scale. An increase in the scale means that all inputs or
factors are increased in the same proportion. In variable proportions, the cooperating factors may
be increased or decreased and one faster (Ex. Land in agriculture (or) machinery in industry)
remains constant so that the changes in proportion among the factors result in certain changes in
output. In returns to scale all the necessary factors or production are increased or decreased to the
same extent so that whatever the scale of production, the proportion among the factors remains
the same.
When a firm expands, its scale increases all its inputs proportionally, then technically there are
three possibilities. (i) The total output may increase proportionately (ii) The total output may
increase more than proportionately and (iii) The total output may increase less than
proportionately. If increase in the total output is proportional to the increase in input, it means
constant returns to scale. If increase in the output is greater than the proportional increase in the
inputs, it means increasing return to scale. If increase in the output is less than proportional
increase in the inputs, it means diminishing returns to scale.
Let us now explain the laws of returns to scale with the help of isoquants for a two-input and
single output production system.
Economies of Scale
Production may be carried on a small scale or o a large scale by a firm. When a firm expands its
size of production by increasing all the factors, it secures certain advantages known as
economies of production. Marshall has classified these economies of large-scale production into
internal economies and external economies.
Internal Economies:
Internal economies are those, which are opened to a single factory or a single firm independently
of the action of other firms. They result from an increase in the scale of output of a firm and
cannot be achieved unless output increases. Hence internal economies depend solely upon the
size of the firm and are different for different firms.
Internal economies may be of the following types.
A). Technical Economies.
Technical economies arise to a firm from the use of better machines and superior techniques of
production. As a result, production increases and per unit cost of production falls. A large firm,
which employs costly and superior plant and equipment, enjoys a technical superiority over a
small firm. Another technical economy lies in the mechanical advantage of using large machines.

The cost of operating large machines is less than that of operating mall machine. More over a
larger firm is able to reduce it’s per unit cost of production by linking the various processes of
production. Technical economies may also be associated when the large firm is able to utilize all
its waste materials for the development of by-products industry. Scope for specialization is also
available in a large firm. This increases the productive capacity of the firm and reduces the unit
cost of production.
B). Managerial Economies:
These economies arise due to better and more elaborate management, which only the large size
firms can afford. There may be a separate head for manufacturing, assembling, packing,
marketing, general administration etc. Each department is under the charge of an expert. Hence
the appointment of experts, division of administration into several departments, functional
specialization and scientific co-ordination of various works make the management of the firm
most efficient.
C). Marketing Economies:
The large firm reaps marketing or commercial economies in buying its requirements and in
selling its final products. The large firm generally has a separate marketing department. It can
buy and sell on behalf of the firm, when the market trends are more favorable. In the matter of
buying they could enjoy advantages like preferential treatment, transport concessions, cheap
credit, prompt delivery and fine relation with dealers. Similarly it sells its products more
effectively for a higher margin of profit.
D). Financial Economies:
The large firm is able to secure the necessary finances either for block capital purposes or for
working capital needs more easily and cheaply. It can barrow from the public, banks and other
financial institutions at relatively cheaper rates. It is in this way that a large firm reaps financial
economies.
E). Risk bearing Economies:
The large firm produces many commodities and serves wider areas. It is, therefore, able to
absorb any shock for its existence. For example, during business depression, the prices fall for
every firm. There is also a possibility for market fluctuations in a particular product of the firm.
Under such circumstances the risk-bearing economies or survival economies help the bigger firm
to survive business crisis.
F). Economies of Research:

A large firm possesses larger resources and can establish it’s own research laboratory and
employ trained research workers. The firm may even invent new production techniques for
increasing its output and reducing cost.
G). Economies of welfare:
A large firm can provide better working conditions in-and out-side the factory. Facilities like
subsidized canteens, crèches for the infants, recreation room, cheap houses, educational and
medical facilities tend to increase the productive efficiency of the workers, which helps in raising
production and reducing costs.
External Economies.
External economies are those benefits, which are shared in by a number of firms or industries
when the scale of production in an industry or groups of industries increases. Hence external
economies benefit all firms within the industry as the size of the industry expands.
Business firm enjoys a number of external economies, which are discussed below:
A). Economies of Concentration:
When an industry is concentrated in a particular area, all the member firms reap some common
economies like skilled labor, improved means of transport and communications, banking and
financial services, supply of power and benefits from subsidiaries. All these facilities tend to
lower the unit cost of production of all the firms in the industry.
B). Economies of Information

The industry can set up an information centre which may publish a journal and pass on
information regarding the availability of raw materials, modern machines, export potentialities
and provide other information needed by the firms. It will benefit all firms and reduction in their
costs.
C). Economies of Welfare:
An industry is in a better position to provide welfare facilities to the workers. It may get land at
concessional rates and procure special facilities from the local bodies for setting up housing
colonies for the workers. It may also establish public health care units, educational institutions
both general and technical so that a continuous supply of skilled labor is available to the industry.
This will help the efficiency of the workers.
D). Economies of Disintegration:
The firms in an industry may also reap the economies of specialization. When an industry
expands, it becomes possible to spilt up some of the processes which are taken over by specialist
firms. For example, in the cotton textile industry, some firms may specialize in manufacturing

thread, others in printing, still others in dyeing, some in long cloth, some in dhotis, some in
shirting etc. As a result the efficiency of the firms specializing in different fields increases and
the unit cost of production falls.
Thus internal economies depend upon the size of the firm and external economies depend upon
the size of the industry.
DISECONOMIES OF LARGE SCALE PRODUCTION
Internal and external diseconomies are the limits to large-scale production. It is possible that
expansion of a firm’s output may lead to rise in costs and thus result diseconomies instead of
economies. When a firm expands beyond proper limits, it is beyond the capacity of the manager
to manage it efficiently. This is an example of an internal diseconomy. In the same manner, the
expansion of an industry may result in diseconomies, which may be called external
diseconomies. Employment of additional factors of production becomes less efficient and they
are obtained at a higher cost. It is in this way that external diseconomies result as an industry
expands.
The major diseconomies of large-scale production are discussed below:
Internal Diseconomies:
A). Financial Diseconomies:
For expanding business, the entrepreneur needs finance. But finance may not be easily available
in the required amount at the appropriate time. Lack of finance retards the production plans
thereby increasing costs of the firm.
B). Managerial diseconomies:
There are difficulties of large-scale management. Supervision becomes a difficult job. Workers
do not work efficiently, wastages arise, decision-making becomes difficult, coordination between
workers and management disappears and production costs increase.
C). Marketing Diseconomies:

As business is expanded, prices of the factors of production will rise. The cost will therefore rise.
Raw materials may not be available in sufficient quantities due to their scarcities. Additional
output may depress the price in the market. The demand for the products may fall as a result of
changes in tastes and preferences of the people. Hence cost will exceed the revenue.
D). Technical Diseconomies:

There is a limit to the division of labor and splitting down of production p0rocesses. The firm
may fail to operate its plant to its maximum capacity. As a result cost per unit increases. Internal
diseconomies follow.
E). Diseconomies of Risk-taking:
As the scale of production of a firm expands risks also increase with it. Wrong decision by the
management may adversely affect production. In large firms are affected by any disaster, natural
or human, the economy will be put to strains.
External Diseconomies:
When many firm get located at a particular place, the costs of transportation increases due to
congestion. The firms have to face considerable delays in getting raw materials and sending
finished products to the marketing centers. The localization of industries may lead to scarcity of
raw material, shortage of various factors of production like labor and capital, shortage of power,
finance and equipments. All such external diseconomies tend to raise cost per unit.
Returns to factors: Basic principle of economic research, especially development economics, is
that the factors of production receive income that is equal to their productive contribution. Yet a
careful application of orthodox economic theory suggests something quite different. The section
below explains how market dominance can prevent a market from reaching full-employment
equilibrium.
Questions:
1) What is production function?
2) Explain Is costs and Iso quants?
3) Discuss Cobb-Douglas production function?
4) Explain economies of scale-innovation and global competitiveness?
UNIT 6-COST ANALYSIS

Profit is the ultimate aim of any business and the long-run prosperity of a firm depends upon its
ability to earn sustained profits. Profits are the difference between selling price and cost of
production. In general the selling price is not within the control of a firm but many costs are
under its control. The firm should therefore aim at controlling and minimizing cost. Since every
business decision involves cost consideration, it is necessary to understand the meaning of
various concepts for clear business thinking and application of right kind of costs.
Cost Concepts:
A managerial economist must have a clear understanding of the different cost concepts for clear
business thinking and proper application. The several alternative bases of classifying cost and the
relevance of each for different kinds of problems are to be studied. The various relevant concepts
of cost are:
1. Opportunity costs and outlay costs:
Out lay cost also known as actual costs obsolete costs are those expends which are actually
incurred by the firm these are the payments made for labor, material, plant, building, machinery
traveling, transporting etc., These are all those expense item appearing in the books of account,
hence based on accounting cost concept.
The opportunity cost concept is made use for long-run decisions. This concept is very important
in capital expenditure budgeting. This concept is very important in capital expenditure
budgeting. The concept is also useful for taking short-run decisions opportunity cost is the cost
concept to use when the supply of inputs is strictly limited and when there is an alternative. If
there is no alternative, Opportunity cost is zero. The opportunity cost of any action is therefore
measured by the value of the most favorable alternative course, which had to be foregoing if that
action is taken.
2. Explicit and implicit costs:
Explicit costs are those expenses that involve cash payments. These are the actual or business
costs that appear in the books of accounts. These costs include payment of wages and salaries,
payment for raw-materials, interest on borrowed capital funds, rent on hired land, Taxes paid etc.
Implicit costs are the costs of the factor units that are owned by the employer himself. These
costs are not actually incurred but would have been incurred in the absence of employment of
self – owned factors. The two normal implicit costs are depreciation, interest on capital etc. A
decision maker must consider implicit costs too to find out appropriate profitability of
alternatives.
3. Historical and Replacement costs:

Historical cost is the original cost of an asset. Historical cost valuation shows the cost of an asset
as the original price paid for the asset acquired in the past. Historical valuation is the basis for
financial accounts.
A replacement cost is the price that would have to be paid currently to replace the same asset.
During periods of substantial change in the price level, historical valuation gives a poor
projection of the future cost intended for managerial decision. A replacement cost is a relevant
cost concept when financial statements have to be adjusted for inflation.
4. Short – run and long – run costs:
Short-run is a period during which the physical capacity of the firm remains fixed. Any increase
in output during this period is possible only by using the existing physical capacity more
extensively. So short run cost is that which varies with output when the plant and capital
equipment in constant.
Long run costs are those, which vary with output when all inputs are variable including plant and
capital equipment. Long-run cost analysis helps to take investment decisions.
5. Out-of pocket and books costs:
Out-of pocket costs also known as explicit costs are those costs that involve current cash
payment. Book costs also called implicit costs do not require current cash payments.
Depreciation, unpaid interest, salary of the owner is examples of back costs.
But the book costs are taken into account in determining the level dividend payable during a
period. Both book costs and out-of-pocket costs are considered for all decisions. Book cost is the
cost of self-owned factors of production.
6. Fixed and variable costs:
Fixed cost is that cost which remains constant for a certain level to output. It is not affected by
the changes in the volume of production. But fixed cost per unit decrease, when the production is
increased. Fixed cost includes salaries, Rent, Administrative expenses depreciations etc.
Variable is that which varies directly with the variation is output. An increase in total output
results in an increase in total variable costs and decrease in total output results in a proportionate
decline in the total variables costs. The variable cost per unit will be constant. Ex: Raw materials,
labor, direct expenses, etc.
7. Post and Future costs:
Post costs also called historical costs are the actual cost incurred and recorded in the book of
account these costs are useful only for valuation and not for decision making.

Future costs are costs that are expected to be incurred in the futures. They are not actual costs.
They are the costs forecasted or estimated with rational methods. Future cost estimate is useful
for decision making because decision are meant for future.
8. Traceable and common costs:
Traceable costs otherwise called direct cost, is one, which can be identified with a products
process or product. Raw material, labor involved in production is examples of traceable cost.
Common costs are the ones that common are attributed to a particular process or product. They
are incurred collectively for different processes or different types of products. It cannot be
directly identified with any particular process or type of product.
9. Avoidable and unavoidable costs:
Avoidable costs are the costs, which can be reduced if the business activities of a concern are
curtailed. For example, if some workers can be retrenched with a drop in a product – line, or
volume or production the wages of the retrenched workers are escapable costs.
The unavoidable costs are otherwise called sunk costs. There will not be any reduction in this
cost even if reduction in business activity is made. For example cost of the ideal machine
capacity is unavoidable cost.
10. Controllable and uncontrollable costs:
Controllable costs are ones, which can be regulated by the executive who is in charge of it. The
concept of controllability of cost varies with levels of management. Direct expenses like
material, labor etc. are controllable costs.
Some costs are not directly identifiable with a process of product. They are appointed to various
processes or products in some proportion. This cost varies with the variation in the basis of
allocation and is independent of the actions of the executive of that department. These
apportioned costs are called uncontrollable costs.
11. Incremental and sunk costs:
Incremental cost also known as different cost is the additional cost due to a change in the level or
nature of business activity. The change may be caused by adding a new product, adding new
machinery, replacing a machine by a better one etc.
Sunk costs are those which are not altered by any change – They are the costs incurred in the
past. This cost is the result of past decision, and cannot be changed by future decisions.
Investments in fixed assets are examples of sunk costs.
12. Total, average and marginal costs:

Total cost is the total cash payment made for the input needed for production. It may be explicit
or implicit. It is the sum total of the fixed and variable costs. Average cost is the cost per unit of
output. If is obtained by dividing the total cost (TC) by the total quantity produced (Q)
TC
Average cost = ------
Q
Marginal cost is the additional cost incurred to produce and additional unit of output or it is the
cost of the marginal unit produced.
13. Accounting and Economics costs:
Accounting costs are the costs recorded for the purpose of preparing the balance sheet and profit
and ton statements to meet the legal, financial and tax purpose of the company. The accounting
concept is a historical concept and records what has happened in the post.
Economics concept considers future costs and future revenues, which help future planning, and
choice, while the accountant describes what has happened, the economics aims at projecting
what will happen.
Determinants of costs:
The following are the determinants of cost behavior:
1. Law of returns operating: An important determinant of cost is the law of returns
operating. In case the law of diminishing returns the cost will show a tendency to ris;
the reverse will be the case when the law of increasing returns operates.
2. Size of the plant: - Cost is also influenced by the size of the plant. With a bigger size,
although, the initial fixed costs are high, variable costs tend to be low compared with
a small sized plant.
3. Period: Cost behavior is affected by the period under consideration. If we consider
the short period, then cost curve will rise speedily but in case of long period cost that
would not increase that speedily. In fact, a long run cost curve is an envelope curve of
several short run cost curves.
4. Capacity utilization: cost is also affected by the level of capacity utilization.
Especially this is the per unit fixed cost which makes a big difference; with higher
capacity utilization fixed cost per unit of output is bound to be low.
5. Prices of factors of production: the cost of the product is affected by prices of
factors of production but the impact of the price of a given factor would depend upon

the contribution which that factor of production makes to the total product;in other
words, the relationship of the value of a given input to the total cost of the product.
6. Technology: Technology has also a big influence on cost of a product. Technological
progress is conductive to increased production while technological stagbation may
impede production.
7. Efficiency in the use of inputs: Cost is also affected by efficiency in the use of
inputs as well as choice of relatively. Cheaper inputs which are equally efficient so far
as the product quality is concerned.
8. Lot size of the product: Cost is also affected by the lot size of the product. If it is
possible to process a bigger lot at one time the total cost of operatio and thereby the
unit cost will be lower compared with a process in which only smaller lot sizes are
produced.
9. Level of out put: The larger the output, the greater will be the production cost. For
there will be larger use of various factors of production who shall get larger
payments. Thus, total cost varies directly with output.
10. Geographical location: costs may be affected by geographical location when factor
prices, tax regimes and government incentives vary from place to place.
11. Institutional factors: institutional factors like unionization, local
content/indigenization rules and tariffs also affect costs.
12. Firm’s discretionary policies: costs also depend upon a wide range of firm’s
discretionary policies. The examples are:
1. Nature and design of the product being manufactured;
2. Level of service provided to customers;
3. Package of human resources policies adopted regarding pay, incentive schemes,
employee benefits, training, etc.
Cost-Output Relationship
A proper understanding of the nature and behavior of costs is a must for regulation and control of
cost of production. The cost of production depends on money forces and an understanding of the
functional relationship of cost to various forces will help us to take various decisions. Output is
an important factor, which influences the cost. The cost-output relationship plays an important
role in determining the optimum level of production. Knowledge of the cost-output relation helps
the manager in cost control, profit prediction, pricing, promotion etc. The relation between cost
and its determinants is technically described as the cost function.

C= f (S, O, P, T ….)
Where;
C= Cost (Unit or total cost)
S= Size of plant/scale of production
O= Output level
P= Prices of inputs
T= Technology
Considering the period the cost function can be classified as (a) short-run cost function and (b)
long-run cost function. In economics theory, the short-run is defined as that period during which
the physical capacity of the firm is fixed and the output can be increased only by using the
existing capacity allows to bring changes in output by physical capacity of the firm.
(a) Cost-Output Relation in the short-run:
The cost concepts made use of in the cost behavior are total cost, Average cost, and marginal
cost. Total cost is the actual money spent to produce a particular quantity of output. Total cost is
the summation of fixed and variable costs.
TC=TFC+TVC
Up to a certain level of production total fixed cost i.e., the cost of plant, building, equipment etc,
remains fixed. But the total variable cost i.e., the cost of labor, raw materials etc., Vary with the
variation in output. Average cost is the total cost per unit. It can be found out as follows.
AC=
Q
The total of average fixed cost (TFC/Q) keep coming down as the production is increased and
average variable cost (TVC/Q) will remain constant at any level of output.
Marginal cost is the addition to the total cost due to the production of an additional unit of
product. It can be arrived at by dividing the change in total cost by the change in total output.
In the short-run there will not be any change in total fixed cost. Hence change in total cost
implies change in total variable cost only.

Cost – output relations
Units of Total Total Total Average Average Average Marginal

Output Q fixed variable cost variable fixed cost cost
cost TFC cost (TFC + cost cost (TC/Q) MC
TVC TVC) (TVC / (TFC / AC
TC Q) AVC Q) AFC
0 60 - 60 - - - -
1 60 20 80 20 60 80 20
2 60 36 96 18 30 48 16
3 60 48 108 16 20 36 12
4 60 64 124 16 15 31 16
5 60 90 150 18 12 30 26
6 60 132 192 22 10 32 42
The above table represents the cost-output relation. The table is prepared on the basis of the law
of diminishing marginal returns. The fixed cost Rs. 60 May include rent of factory building,
interest on capital, salaries of permanently employed staff, insurance etc. The table shows that
fixed cost is same at all levels of output but the average fixed cost, i.e., the fixed cost per unit,
falls continuously as the output increases. The expenditure on the variable factors (TVC) is at
different rate. If more and more units are produced with a given physical capacity the AVC will
fall initially, as per the table declining up to 3rd unit, and being constant up to 4th unit and then
rising. It implies that variable factors produce more efficiently near a firm’s optimum capacity
than at any other levels of output.

And later rises. But the rise in AC is felt only after the start rising. In the table ‘AVC’ starts rising
from the 5th unit onwards whereas the ‘AC’ starts rising from the 6th unit only so long as ‘AVC’
declines ‘AC’ also will decline. ‘AFC’ continues to fall with an increase in Output. When the
rise in ‘AVC’ is more than the decline in ‘AFC’, the total cost again begin to rise. Thus there will
be a stage where the ‘AVC’, the total cost again begin to rise thus there will be a stage where the
‘AVC’ may have started rising, yet the ‘AC’ is still declining because the rise in ‘AVC’ is less
than the drop in ‘AFC’.
Thus the table shows an increasing returns or diminishing cost in the first stage and diminishing
returns or diminishing cost in the second stage and followed by diminishing returns or increasing
cost in the third stage.
The short-run cost-output relationship can be shown graphically as follows.
In the above graph the “AFC’ curve continues to fall as output rises an account of its spread over
more and more units Output. But AVC curve (i.e. variable cost per unit) first falls and then rises
due to the operation of the law of variable proportions. The behavior of “ATC’ curve depends
upon the behavior of ‘AVC’ curve and ‘AFC’ curve. In the initial stage of production both ‘AVC’
and ‘AFC’ decline and hence ‘ATC’ also decline. But after a certain point ‘AVC’ starts rising. If

the rise in variable cost is less than the decline in fixed cost, ATC will still continue to decline
otherwise AC begins to rise. Thus the lower end of ‘ATC’ curve thus turns up and gives it a
U-shape. That is why ‘ATC’ curve are U-shaped. The lowest point in ‘ATC’ curve indicates the
least-cost combination of inputs. Where the total average cost is the minimum and where the
“MC’ curve intersects ‘AC’ curve, It is not be the maximum output level rather it is the point
where per unit cost of production will be at its lowest.
The relationship between ‘AVC’, ‘AFC’ and ‘ATC’ can be summarized up as follows:
1. If both AFC and ‘AVC’ fall, ‘ATC’ will also fall.
2. When ‘AFC’ falls and ‘AVC’ rises
a. ‘ATC’ will fall where the drop in ‘AFC’ is more than the raise in ‘AVC’.
b. ‘ATC’ remains constant is the drop in ‘AFC’ = rise in ‘AVC’
c. ‘ATC’ will rise where the drop in ‘AFC’ is less than the rise in ‘AVC’
b. Cost-output Relationship in the long-run:
Long run is a period, during which all inputs are variable including the one, which are fixes in
the short-run. In the long run a firm can change its output according to its demand. Over a long
period, the size of the plant can be changed, unwanted buildings can be sold staff can be
increased or reduced. The long run enables the firms to expand and scale of their operation by
bringing or purchasing larger quantities of all the inputs. Thus in the long run all factors become
variable.The long-run cost-output relations therefore imply the relationship between the total cost
and the total output. In the long-run cost-output relationship is influenced by the law of returns to
scale.In the long run a firm has a number of alternatives in regards to the scale of operations. For
each scale of production or plant size, the firm has an appropriate short-run average cost curves.
The short-run average cost (SAC) curve applies to only one plant whereas the long-run average
cost (LAC) curve takes in to consideration many plants.
The long-run cost-output relationship is shown graphically with the help of “LCA’ curve.

To draw on ‘LAC’ curve we have to start with a number of ‘SAC’ curves. In the above figure it
is assumed that technologically there are only three sizes of plants – small, medium and large,
‘SAC’, for the small size, ‘SAC2’ for the medium size plant and ‘SAC3’ for the large size plant.
If the firm wants to produce ‘OP’ units of output, it will choose the smallest plant. For an output
beyond ‘OQ’ the firm wills optimum for medium size plant. It does not mean that the OQ
production is not possible with small plant. Rather it implies that cost of production will be more
with small plant compared to the medium plant. For an output ‘OR’ the firm will choose the
largest plant as the cost of production will be more with medium plant. Thus the firm has a series
of ‘SAC’ curves. The ‘LCA’ curve drawn will be tangential to the entire family of ‘SAC’ curves
i.e. the ‘LAC’ curve touches each ‘SAC’ curve at one point, and thus it is known as envelope
curve. It is also known as planning curve as it serves as guide to the entrepreneur in his planning
to expand the production in future. With the help of ‘LAC’ the firm determines the size of plant
which yields the lowest average cost of producing a given volume of output it anticipates.
Average cost curves:

In the case of SRTC and LRTC curves, each SRTC curves are related to a corresponding SRAC
curve, i.e., for each plant size there is one SRAC curve. Lower the plant size lower is the fixed
cost. So, the plant produces capacity output at a lower volume, and therefore, the SRAC curve
reaches its lowest point at a lower level of output. As in case of derivation of LRTC curve from
SRTC curve, we consider 3 plants represented by SRAC1, SRAC2 and SRAC3.
Up to Q1, output SRAC1<SRAC2<SRAC3. So, the producer produces at plant1 on
SRAC1. Similarly, between output levels Q1 and Q2 SRAC2 is the lowest. So, the relevant
SRAC is SRAC3.after Q2, SRAC3 becomes relevant. Thus LRAC is ABCDE.it may be noted
that LRAC may not consider the lowest point of an SRAC curve. It considers the lowest average
cost for each level of output. For example, at Q output SRAC1 reaches its lowest,but for that
output SRAC1 is not relevant became at the output SRAC2<SRAC1. So, LRAC is made up of
SRAC2 for that level of output.

From limited SRAC Curves we move on to infinite number of SRAC curves. LRAC curve is
made up of those SRAC curves which result in lowest possible costs for different levels for
different levels of output. LRAC curve is made up of least cost combination of resources for all
levels of output. For each level of output, that SRAC is chosen which is the lowest among all
available SRACs.
There are seven such SRAC3, SRAC1, and SRAC2… SRAC7. Producer chooses point A on
SRAC1, points B, C, D, E, F, and G on SRAC2, SRAC3, SRAC4, SRAC5, SRAC6 and SRAC7
respectively. Because, for QA output SRAC1 is the least cost SRAC, for QB output SRAC2
gives the lowest cost of production, and so on.
It is observed that, LRAC curve touches all SRACs from below. No portion of any SRAC curve
can be below the LRAC curve. In that case, there arises some output level for which LRAC does
not consider the lowest cost giving SRAC.
Secondly, LSRC curve is not made up of the lowest points of the SRAC curves. For example,
SRAC1 reaches the lowest point QB output but SRAC2 is relevant for LRAC curve at that
output because SRAC2<SRAC1. As such, for smooth LRAC curve, lowest points of no SRAC
curve belong to the LRAC curve apart from one SRAC curve.

Long run marginal cost curve (LRMC): It has been observed that for each level output one
SRTC and one SRAC exist. Correspondingly, for each output level a particular short run
marginal cost is there if we chose a particular SRTC or a particular SRAC.When an LRTC curve
or an LRAC curve is constructed, a particular point on a particular level of output. For that level
of output, corresponding to that SRTC or SRAC curve a point on an SRMC curve exists. So, for
all levels of output there are points on different and related SRMC curves. Locus of all those
points is the LRMC curve.
For example: SRMC1 is the short run marginal cost (SRMC1) corresponding to SRAC1.
Similarly we get SRMC2, SRMC3, and SRMC7. As point A or SRMC1 is chosen for output
level Q1,SRMC corresponding to that output level is given by point A on SRMC1. Similarly, we
may get points B,C,D,F,G on SRMC2,SRMC3………….SRMC7 respectively. Locus of A, B, C,
LRAC7……..G is LRMC.

Explanation of the “U” shape of the long run average cost curve: LAC curve is a”U” shape
curve. This shape of LAC curve depends upon the returns to scale. As the firm expands, returns
to scale increase. After a range of constant returns to scale, the returns to scale finally decrease.
On the same line, the long run average cost of production. How ever, a firm cannot go on
receiving economies of scale. A time comes when diseconomies start operating and the average
cost of production goes on increasing. Thus, according to the traditional economic theory, the
long run average cost curve will be a ‘U’ shaped curve’.
Over-all cost leadership:-
In an industry is achieves through a set of functional policies. It requires aggressive
construction of efficient scale facilities, vigorous pursuit of cost reductions from experience,
tight cost and overhead control, avoidance of marginal customer accounts, and cost minimization
in areas like service, sales force, research and development, advertising etc. a great deal of
managerial attention to cost control is necessary to achieve these aims. Low overall cost relative
to competitors becomes the theme running through the entire strategy, through quality, service,
and other areas cannot be ignored.
Low cost enables the leader to price its products lower than its competitors in order to
win a large market share. Firms with a large share of the market are usually able to achieve costs
through economies of scale, and the experience effect.
Scale Effect:-
Economies of scale are achieved primarily through the size of operations. Large businesses have
the potential to operate at lower unit costs. Large-scale plants, for example, are cheaper to build,
and they yield lower operating costs per unit of output. Although the most substantial gains are
usually seen in manufacturing, benefits of scale can be achieved in marketing, sales, distribution,

administration, R&D, and services. The cost of raw materials and shipping can also be reduced
through economies of scale.
Experience Effect:-
The experience effect, or “experience curve”, refers to the cumulative number of units produced
by a company to date. The cost of production declines 10-30 percentages each time the firm
doubles its experience, and consequently, lower costs.
The benefits of the experience effect arise primarily from human ingenuity, dexterity and skill. A
variety of sources, such as the following, contribute to the experience effect:
1. Labor efficiency
2. Work specialization
3. New production processes.
4. Enhanced performance
5. Changes in resource mix
6. Product standardization
7. Product redesign.
Questions
1. Explain cost concepts? Determinants of cost?
2. Explain long run- short run?
3. Discuss average cost curves?
4. Describe the over all cost leadership?

Unit-7
INTRODUCTION TO MARKET AND PRICING STRATEGIES
Pricing
Introduction
Pricing is an important, if not the most important function of all enterprises. Since every
enterprise is engaged in the production of some goods or/and service. Incurring some
expenditure, it must set a price for the same to sell it in the market. It is only in extreme cases
that the firm has no say in pricing its product; because there is severe or rather perfect
competition in the market of the good happens to be of such public significance that its price is
decided by the government. In an overwhelmingly large number of cases, the individual producer
plays the role in pricing its product.
It is said that if a firm were good in setting its product price it would certainly flourish in the
market. This is because the price is such a parameter that it exerts a direct influence on the
products demand as well as on its supply, leading to firm’s turnover (sales) and profit. Every
manager endeavors to find the price, which would best meet with his firm’s objective. If the price
is set too high the seller may not find enough customers to buy his product. On the other hand, if
the price is set too low the seller may not be able to recover his costs. There is a need for the
right price further, since demand and supply conditions are variable over time what is a right
price today may not be so tomorrow hence, pricing decision must be reviewed and reformulated
from time to time.
Price:- Price denotes the exchange value of a unit of good expressed in terms of money. Thus the
current price of a maruti car around Rs. 2, 00,000, the price of a hair cut is Rs. 25 the price of an
economics book is Rs. 150 and so on. Nevertheless, if one gives a little, if one gives a little
thought to this subject, one would realize that there is nothing like a unique price for any good.
Instead, there are multiple prices.
Price concepts:-Price of a well-defined product varies over the types of the buyers, place it is
received, credit sale or cash sale, time taken between final production and sale, etc.
It should be obvious to the readers, that the price difference on account of the above four factors
are more significant. The multiple prices is more serious in the case of items like cars
refrigerators, coal, furniture and bricks and is of little significance for items like shaving blade,
soaps, tooth pastes, creams and stationeries. Differences in various prices of any good are due to
differences in transport cost, storage cost accessories, interest cost, intermediaries’ profits etc.
Once can still conceive of a basic price, which would be exclusive of all these items of cost and
then rationalize other prices by adding the cost of special items attached to the particular
transaction, in what follows we shall explain the determination of this basis price alone and thus
resolve the problem of multiple prices.
Price determinants – Demand and supply: - The price of a product is determined by the
demand for and supply of that product. According to Marshall the role of these two determinants
is like that of a pair of scissors in cutting cloth. It is possible that at times, while one pair is held
fixed, the other is moving to cut the cloth. Similarly, it is conceivable that there could be
situations under which either demand or supply is playing a passive role, and the other, which is
active, alone appear to be determining the price. However, just as one pair of scissors alone can
never cut a cloth, demand or supply alone is insufficient to determine the price.

Equilibrium Price: - The price at which demand and supply of a commodity is equal known as
equilibrium price. The demand and supply schedules of a good are shown in the table below.
Demand supply schedule
Price Demand Supply
50 100 200
40 120 180
30 150 150
20 200 110
10 300 50
Of the five possible prices in the above example, price Rs.30 would be the market-clearing price.
No other price could prevail in the market. If price is Rs. 50 supply would exceed demand and
consequently the producers of this good would not find enough customers for their demand,
thereby they would accumulate unwanted inventories of output, which, in turn, would lead to
competition among the producers, forcing price to Rs.30. Similarly if price were Rs.10, there
would be excess demand, which would give rise to competition among the buyers of good,
forcing price to Rs.30. At price Rs.30, demand equals supply and thus both producers and
consumers are satisfied. The economist calls such a price as equilibrium price.
It was seen that the demand for a good depends on, a number of factors and thus, every factor,
which influences either demand or supply is in fact a determinant of price. Accordingly, a change
in demand or/and supply causes price change.

MARKET:-Market is a place where buyer and seller meet, goods and services are offered for
the sale and transfer of ownership occurs. A market may be also defined as the demand made by
a certain group of potential buyers for a good or service. The former one is a narrow concept and
later one, a broader concept. Economists describe a market as a collection of buyers and sellers
who transact over a particular product or product class (the housing market, the clothing market,
the grain market etc.). For business purpose we define a market as people or organizations with
wants (needs) to satisfy, money to spend, and the willingness to spend it. Broadly, market
represents the structure and nature of buyers and sellers for a commodity/service and the process
by which the price of the commodity or service is established. In this sense, we are referring to
the structure of competition and the process of price determination for a commodity or service.
The determination of price for a commodity or service depends upon the structure of the market
for that commodity or service (i.e., competitive structure of the market). Hence the
understanding on the market structure and the nature of competition are a pre-requisite in price
determination.
Different Market Structures:-Market structure describes the competitive environment in the
market for any good or service. A market consists of all firms and individuals who are willing
and able to buy or sell a particular product. This includes firms and individuals currently engaged
in buying and selling a particular product, as well as potential entrants. The determination of
price is affected by the competitive structure of the market. This is because the firm operates in a
market and not in isolation. In making decisions concerning economic variables it is affected, as
are all institutions in society by its environment.
Perfect
Competition:-Perfect competition refers to a market structure where competition among the

sellers and buyers prevails in its most perfect form. In a perfectly competitive market, a single
market price prevails for the commodity, which is determined by the forces of total demand and
total supply in the market.
Characteristics of Perfect Competition
The following features characterize a perfectly competitive market:
1. A large number of buyers and sellers: The number of buyers and sellers is large and
the share of each one of them in the market is so small that none has any influence on the
market price.
2. Homogeneous product: The product of each seller is totally undifferentiated from those
of the others.
3. Free entry and exit: Any buyer and seller are free to enter or leave the market of the
commodity.
4. Perfect knowledge: All buyers and sellers have perfect knowledge about the market for
the commodity.

5. Indifference: No buyer has a preference to buy from a particular seller and no seller to
sell to a particular buyer.
6. Non-existence of transport costs: Perfectly competitive market also assumes the
non-existence of transport costs.
7. Perfect mobility of factors of production: Factors of production must be in a position to
move freely into or out of industry and from one firm to the other.
Under such a market no single buyer or seller plays a significant role in price determination. One
the other hand all of them jointly determine the price. The price is determined in the industry,
which is composed of all the buyers and seller for the commodity. The demand curve facing the
industry is the sum of all consumers’ demands at various prices. The industry supply curve is the
sum of all sellers’ supplies at various prices.
Pure competition and perfect competition:-The term perfect competition is used in a wider
sense. Pure competition has only limited assumptions. When the assumptions, that large number
of buyers and sellers, homogeneous products, free entry and exit are satisfied, there exists pure
competition. Competition becomes perfect only when all the assumptions (features) are satisfied.
Generally pure competition can be seen in agricultural products.
Equilibrium of a firm and industry under perfect competition:-Equilibrium is a position
where the firm has no incentive either to expand or contrast its output. The firm is said to be in
equilibrium when it earn maximum profit. There are two conditions for attaining equilibrium by
a firm. They are: Marginal cost is an additional cost incurred by a firm for producing and
additional unit of output. Marginal revenue is the additional revenue accrued to a firm when it
sells one additional unit of output. A firm increases its output so long as its marginal cost
becomes equal to marginal revenue. When marginal cost is more than marginal revenue, the firm
reduces output as its costs exceed the revenue. It is only at the point where marginal cost is equal
to marginal revenue, and then the firm attains equilibrium. Secondly, the marginal cost curve
must cut the marginal revenue curve from below. If marginal cost curve cuts the marginal
revenue curve from above, the firm is having the scope to increase its output as the marginal cost
curve slopes downwards. It is only with the upward sloping marginal cost curve, there the firm
attains equilibrium. The reason is that the marginal cost curve when rising cuts the marginal
revenue curve from below.
The equilibrium of a perfectly competitive firm may be explained with the help of the fig. 6.2. In
the given fig. PL and MC represent the Price line and Marginal cost curve. PL also represents

Marginal revenue, Average revenue and demand. As Marginal revenue, Average revenue and
demand are the same in perfect competition, all are equal to the price line. Marginal cost curve is
U- shaped curve cutting MR curve at R and T. At point R marginal cost becomes equal to
marginal revenue. But MC curve cuts the MR curve from above. So this is not the equilibrium
position. The downward sloping marginal cost curve indicates that the firm can reduce its cost of
production by increasing output. As the firm expands its output, it will reach equilibrium at point
T. At this point, on price line PL; the two conditions of equilibrium are satisfied. Here the
marginal cost and marginal revenue of the firm remain equal. The firm is producing maximum
output and is in equilibrium at this stage. If the firm continues its output beyond this stage, its
marginal cost exceeds marginal revenue resulting in losses. As the firm has no idea of expanding
or contracting its size of out, the firm is said to be in equilibrium at point T.
Pricing under perfect competition
The price or value of a commodity under perfect competition is determined by the demand for
and the supply of that commodity.
Under perfect competition there is large number of sellers trading in a homogeneous product.
Each firm supplies only very small portion of the market demand. No single buyer or seller is
powerful enough to influence the price. The demand of all consumers and the supply of all firms
together determine the price. The individual seller is only a price taker and not a price maker. An
individual firm has no price policy of its own. Thus, the main problem of a firm in a perfectly
competitive market is not to determine the price of its product but to adjust its output to the given
price, So that the profit is maximum. Marshall however gives great importance to the time
element for the determination of price. He divided the time periods on the basis of supply and
ignored the forces of demand. He classified the time into four periods to determine the price as
follows.
1. Very short period or Market period
2. Short period
3. Long period
4. Very long period or secular period
Very short period: It is the period in which the supply is more or less fixed because the time
available to the firm to adjust the supply of the commodity to its changed demand is extremely
short; say a single day or a few days. The price determined in this period is known as Market
Price.
Short Period: In this period, the time available to firms to adjust the supply of the commodity to
its changed demand is, of course, greater than that in the market period. In this period altering the
variable factors like raw materials, labor, etc can change supply. During this period new firms
cannot enter into the industry.
Long period: In this period, a sufficiently long time is available to the firms to adjust the supply
of the commodity fully to the changed demand. In this period not only variable factors of
production but also fixed factors of production can be changed. In this period new firms can also
enter the industry. The price determined in this period is known as long run normal price.
Monopoly
The word monopoly is made up of two syllables, Mono and poly. Mono means single while poly
implies selling. Thus monopoly is a form of market organization in which there is only one seller
of the commodity. There are no close substitutes for the commodity sold by the seller. Pure

monopoly is a market situation in which a single firm sells a product for which there is no good
substitute.
Features of monopoly
The following are the features of monopoly.
1. Single person or a firm: A single person or a firm controls the total supply of the
commodity. There will be no competition for monopoly firm. The monopolist firm is the
only firm in the whole industry.
2. No close substitute: The goods sold by the monopolist shall not have closely
competition substitutes. Even if price of monopoly product increase people will not go in
far substitute. For example: If the price of electric bulb increase slightly, consumer will
not go in for kerosene lamp.
3. Large number of Buyers: Under monopoly, there may be a large number of buyers in
the market who compete among themselves.
4. Price Maker: Since the monopolist controls the whole supply of a commodity, he is a
price-maker, and then he can alter the price.
5. Supply and Price: The monopolist can fix either the supply or the price. He cannot fix
both. If he charges a very high price, he can sell a small amount. If he wants to sell more,
he has to charge a low price. He cannot sell as much as he wishes for any price he
pleases.
6. Downward Sloping Demand Curve: The demand curve (average revenue curve) of
monopolist slopes downward from left to right. It means that he can sell more only by
lowering price.
Pricing under Monopoly:-Monopoly refers to a market situation where there is only one seller.
He has complete control over the supply of a commodity. He is therefore in a position to fix any
price. Under monopoly there is no distinction between a firm and an industry. This is because the
entire industry consists of a single firm.
Being the sole producer, the monopolist has complete control over the supply of the commodity.
He has also the power to influence the market price. He can raise the price by reducing his output
and lower the price by increasing his output. Thus he is a price-maker. He can fix the price to his
maximum advantages. But he cannot fix both the supply and the price, simultaneously. He can
do one thing at a time. If the fixes the price, his output will be determined by the market demand
for his commodity. On the other hand, if he fixes the output to be sold, its market will determine

the price for the commodity. Thus his decision to fix either the price or the output is determined
by the market demand.
The market demand curve of the monopolist (the average revenue curve) is downward sloping.
Its corresponding marginal revenue curve is also downward sloping. But the marginal revenue
curve lies below the average revenue curve as shown in the figure. The monopolist faces the
down-sloping demand curve because to sell more output, he must reduce the price of his product.
The firm’s demand curve and industry’s demand curve are one and the same. The average cost
and marginal cost curve are U shaped curve. Marginal cost falls and rises steeply when compared
to average cost.
Price output determination (Equilibrium Point)
The monopolistic firm attains equilibrium when its marginal cost becomes equal to the marginal
revenue. The monopolist always desires to make maximum profits. He makes maximum profits
when MC=MR. He does not increasing his output if his revenue exceeds his costs. But when the
costs exceed the revenue, the monopolist firm incurs losses. Hence the monopolist curtails his
production. He produces up to that point where additional cost is equal to the additional revenue
(MR=MC). Thus point is called equilibrium point. The price output determination under
monopoly may be explained with the help of a diagram.
In the diagram 6.12 the quantity supplied or demanded is shown along X-axis. The cost or
revenue is shown along Y-axis. AC and MC are the average cost and marginal cost curves
respectively. AR and MR curves slope downwards from left to right. AC and MC and U shaped
curves. The monopolistic firm attains equilibrium when its marginal cost is equal to marginal
revenue (MC=MR). Under monopoly, the MC curve may cut the MR curve from below or from
a side. In the diagram, the above condition is satisfied at point E. At point E, MC=MR. The firm
is in equilibrium. The equilibrium output is OM.
The above diagram (Average revenue) = MQ or OP
Average cost = MR
Profit per unit = Average Revenue-Average cost=MQ-MR=QR
Total Profit = QRXSR=PQRS
The area PQRS resents the maximum profit earned by the monopoly firm.
But it is not always possible for a monopolist to earn super-normal profits. If the demand and
cost situations are not favorable, the monopolist may realize short run losses.

Through the monopolist is a price marker, due to weak demand and high costs; he suffers a loss
equal to PABC.
If AR > AC -> Abnormal or super normal profits.
If AR = AC -> Normal Profit
If AR < AC -> Loss
In the long run the firm has time to adjust his plant size or to use existing plant so as to maximize
profits.
Monopolistic competition:-Perfect competition and pure monopoly are rate phenomena in the
real world. Instead, almost every market seems to exhibit characteristics of both perfect
competition and monopoly. Hence in the real world it is the state of imperfect competition lying
between these two extreme limits that work. Edward. H. Chamberlain developed the theory of
monopolistic competition, which presents a more realistic picture of the actual market structure
and the nature of competition.
Characteristics of Monopolistic Competition
The important characteristics of monopolistic competition are:
1. Existence of Many firms: Industry consists of a large number of sellers, each one of
whom does not feel dependent upon others. Every firm acts independently without
bothering about the reactions of its rivals. The size is so large that an individual firm has
only a relatively small part in the total market, so that each firm has very limited control
over the price of the product. As the number is relatively large it is difficult for these
firms to determine its price- output policies without considering the possible reactions of
the rival forms. A monopolistically competitive firm follows an independent price policy.
2. Product Differentiation: Product differentiation means that products are different in
some ways, but not altogether so. The products are not identical but the same time they
will not be entirely different from each other. IT really means that there are various
monopolist firms competing with each other. An example of monopolistic competition
and product differentiation is the toothpaste produced by various firms. The product of
each firm is different from that of its rivals in one or more respects. Different toothpastes
like Colgate, Close-up, Forehans, Cibaca, etc., provide an example of monopolistic
competition. These products are relatively close substitute for each other but not perfect
substitutes. Consumers have definite preferences for the particular verities or brands of
products offered for sale by various sellers. Advertisement, packing, trademarks, brand
names etc. help differentiation of products even if they are physically identical.
3. Large Number of Buyers: There are large number buyers in the market. But the buyers
have their own brand preferences. So the sellers are able to exercise a certain degree of
monopoly over them. Each seller has to plan various incentive schemes to retain the
customers who patronize his products.
4. Free Entry and Exist of Firms: As in the perfect competition, in the monopolistic
competition too, there is freedom of entry and exit. That is, there is no barrier as found
under monopoly.
5. Selling costs: Since the products are close substitute much effort is needed to retain the
existing consumers and to create new demand. So each firm has to spend a lot on selling
cost, which includes cost on advertising and other sale promotion activities.
6. Imperfect Knowledge: Imperfect knowledge about the product leads to monopolistic
competition. If the buyers are fully aware of the quality of the product they cannot be

influenced much by advertisement or other sales promotion techniques. But in the

business world we can see that thought the quality of certain products is the same,
effective advertisement and sales promotion techniques make certain brands
monopolistic. For examples, effective dealer service backed by advertisement-helped
popularization of some brands through the quality of almost all the cement available in
the market remains the same.
Price – Output Determination under Monopolistic Competition:-Since under monopolistic
competition different firms produce different varieties of products, different prices for them will
be determined in the market depending upon the demand and cost conditions. Each firm will set
the price and output of its own product. Here also the profit will be maximized when marginal
revenue is equal to marginal cost.
Short-run equilibrium of the firm:-In the short-run the firm is in equilibrium when marginal
Revenue = Marginal Cost. In Fig 6.15 AR is the average revenue curve. NMR marginal revenue
curve, SMC short-run marginal cost curve, SAC short-run average cost curve, MR and SMC
interest at point E where output in OM and price MQ (i.e. OP). Thus the equilibrium output or
the maximum profit output is OM and the price MQ or OP. When the price (average revenue) is
above average cost a firm will be making supernormal profit. From the figure it can be seen that
AR is above AC in the equilibrium point. As AR is above AC, this firm is making abnormal
profits in the short-run. The abnormal profit per unit is QR, i.e., the difference between AR and
AC at equilibrium point and the total supernormal profit is OR X OM. This total abnormal
profits is represented by the rectangle PQRS. As the demand curve here is highly elastic, the
excess price over marginal cost is rather low. But in monopoly the demand curve is inelastic. So
the gap between price and marginal cost will be rather large.
If the demand and cost conditions are less favorable the monopolistically competitive firm may
incur loss in the short-run fig 6.16 Illustrates this. A firm incurs loss when the price is less than
the average cost of production. MQ is the average cost and OS (i.e. MR) is the price per unit at
equilibrium output OM. QR is the loss per unit. The total loss at an output OM is OR X OM. The
rectangle PQRS represents the total loses in the short run.

Long – Run Equilibrium of the Firm:

A monopolistically competitive firm will be long – run equilibrium at the output level where
marginal cost equal to marginal revenue. Monopolistically competitive firm in the long run
attains equilibrium where MC=MR and AC=AR Fig 6.17 shows this trend.
Oligopoly
The term oligopoly is derived from two Greek words, oligos meaning a few, and pollen meaning
to sell. Oligopoly is the form of imperfect competition where there are a few firms in the market,
producing either a homogeneous product or producing products, which are close but not perfect
substitute of each other.
Characteristics of Oligopoly
The main features of oligopoly are:
1. Few Firms: There are only a few firms in the industry. Each firm contributes a sizeable
share of the total market. Any decision taken by one firm influence the actions of other
firms in the industry. The various firms in the industry compete with each other.
2. Interdependence: As there are only very few firms, any steps taken by one firm to
increase sales, by reducing price or by changing product design or by increasing
advertisement expenditure will naturally affect the sales of other firms in the industry. An
immediate retaliatory action can be anticipated from the other firms in the industry every
time when one firm takes such a decision. He has to take this into account when he takes
decisions. So the decisions of all the firms in the industry are interdependent.
3. Indeterminate Demand Curve: The interdependence of the firms makes their demand
curve indeterminate. When one firm reduces price other firms also will make a cut in
their prices. So he firm cannot be certain about the demand for its product. Thus the

demand curve facing an oligopolistic firm loses its definiteness and thus is indeterminate
as it constantly changes due to the reactions of the rival firms.
4. Advertising and selling costs: Advertising plays a greater role in the oligopoly market
when compared to other market systems. According to Prof. William J. Banumol “it is
only oligopoly that advertising comes fully into its own”. A huge expenditure on
advertising and sales promotion techniques is needed both to retain the present market
share and to increase it. So Banumol concludes “under oligopoly, advertising can become
a life-and-death matter where a firm which fails to keep up with the advertising budget of
its competitors may find its customers drifting off to rival products.”
5. Price Rigidity: In the oligopoly market price remain rigid. If one firm reduced price it is
with the intention of attracting the customers of other firms in the industry. In order to
retain their consumers they will also reduce price. Thus the pricing decision of one firm
results in a loss to all the firms in the industry. If one firm increases price. Other firms
will remain silent there by allowing that firm to lose its customers. Hence, no firm will be
ready to change the prevailing price. It causes price rigidity in the oligopoly market.
PRICING METHODS
The micro – economic principle of profit maximization suggests pricing by the marginal
analysis. That is by equating MR to MC. However the pricing methods followed by the firms in
practice around the world rarely follow this procedure. This is for two reasons; uncertainty with
regard to demand and cost function and the deviation from the objective of short run profit
maximization.
It was seen that there is no unique theory of firm behavior. While profit certainly on important
variable for which every firm cares. Maximization of short – run profit is not a popular objective
of a firm today. At the most firms seek maximum profit in the long run. If so the problem is
dynamic and its solution requires accurate knowledge of demand and cost conditions over time.
Which is impossible to come by?
In view of these problems economic prices are a rare phenomenon. Instead, firms set prices for
their products through several alternative means. The important pricing methods followed in
practice are shown in the chart.

Cost Based Pricing:- There are three versions of the cost – based pricing. Full – cost or break
even pricing, cost plus pricing and the marginal cost pricing. Under the first version, price just
equals the average (total) cost. In the second version, some mark-up is added to the average cost
in arriving at the price. In the last version, price is set equal to the marginal cost. While all these
methods appear to be easy and straight forward, they are in fact associated with a number of
difficulties. Even through difficulties are there, the cost- oriented pricing is quite popular today.
The cost – based pricing has several strengths as well as limitations. The advantages are its
simplicity, acceptability and consistency with the target rate of return on investment and the price
stability in general. The limitations are difficulties in getting accurate estimates of cost
(particularly of the future cost rather than the historic cost) Volatile nature of the variable cost
and its ignoring of the demand side of the market etc.
Competition based pricing:- Some commodities are priced according to the competition in their
markets. Thus we have the going rate method of price and the sealed bid pricing technique.
Under the former a firm prices its new product according to the prevailing prices of comparable
products in the market. If the product is new in the country, then its import cost – inclusive of the
costs of certificates, insurance, and freight and customs duty, is used as the basis for pricing,
Incidentally, the price is not necessarily equal to the import cost, but to the firm is either new in
the country, or is a close substitute or complimentary to some other products, the prices of
hitherto existing bands or / and of the related goods are taken in to a account while deciding its
price. Thus, when television was first manufactures in India, its import cost must have been a
guiding force in its price determination. Similarly, when maruti car was first manufactured in
India, it must have taken into account the prices of existing cars, price of petrol, price of car
accessories, etc. Needless to say, the going rate price could be below or above the average cost
and it could even be an economic price.
The sealed bid pricing method is quite popular in the case of construction activities and in the
disposition of used produces. In this method the prospective seller (buyers) are asked to quote
their prices through a sealed cover, all the offers are opened at a preannounce time in the
presence of all the competitors, and the one who quoted the least is awarded the contract
(purchase / sale deed). As it sound, this method is totally competition based and if the

competitors unit by any change, the buyers (seller) may have to pay (receive) an exorbitantly
high (too low) price, thus there is a great degree of risk attached to this method of pricing.
Demand Based Pricing
The demand – based pricing and strategy – based pricing are quite related. The seller knows
rather well that the demand for its product is a decreasing function of the price its sets for
product. Thus if seller wishes to sell more he must reduce the price of his product, and if he
wants a good price for his product, he could sell only a limited quantity of his good. Demand
oriented pricing rules imply establishment of prices in accordance with consumer preference and
perceptions and the intensity of demand.
Two general types demand oriented pricing rules can be identified.
i. Perceived value pricing and
ii. Differential pricing
Perceived value pricing considers the buyer’s perception of the value of the product as the basis
of pricing. Here the pricing rule is that the firm must develop procedures for measuring the
relative value of the product as perceived by consumers. Differential pricing is nothing but price
discrimination. In involves selling a product or service for different prices in different market
segments. Price differentiation depends on geographical location of the consumers, type of
consumer, purchasing quantity, season, time of the service etc. E.g. Telephone charges, APSRTC
charges.
Strategy based pricing (new product pricing)
A firm which products a new product, if it is also new to industry, can earn very good profits it if
handles marketing carefully, because of the uniqueness of the product. The price fixed for the
new product must keep the competitors away. Earn good profits for the firm over the life of the
product and must help to get the product accepted. The company can select either skimming
pricing or penetration pricing.
While there are some firms, which follow the strategy of price penetration, there are some others
who opt for price – skimming. Under the former, firms sell their new product at a low price in
the beginning in order to catch the attention of consumers, once the product image and credibility
is established, the seller slowly starts jacking up the price to reap good profits in future. Under
this strategy, a firm might well sell its product below the cost of production and thus runs into
losses to start with but eventually it recovers all its losses and even makes good overall profits.
The Rin washing soap perhaps falls into this category. This soap was sold at a rather low price in
the beginning and the firm even distributed free samples. Today, it is quite an expensive brand
and yet it is selling very well. Under the price – skimming strategy, the new product is priced
high in the beginning, and its price is reduced gradually as it faces a dearth of buyers such a
strategy may be beneficial for products, which are fancy, but of poor quality and / or of
insignificant use over a period of time.
A prudent producer follows a good mix of the various pricing methods rather than adapting any
one of them. This is because no method is perfect and every method has certain good features
further a firm might adopt one method at one time and another method at some other accession.
Definition of 'Price Discrimination'
A pricing strategy that charges customers different prices for the same product or service.
In pure price discrimination, the seller will charge each customer the maximum price that he or
she is willing to pay. In more common forms of price discrimination, the seller places customers
in groups based on certain attributes and charges each group a different price.

Price discrimination or price differentiation exists when sales of identical goods or

services are transacted at different prices from the same provider.[2] In a theoretical market with
perfect information, perfect substitutes, and no transaction costs or prohibition on secondary
exchange (or re-selling) to prevent arbitrage, price discrimination can only be a feature of
monopolistic and oligopolistic markets,[3] where market power can be exercised.
Price discrimination requires market segmentation and some means to discourage
discount customers from becoming resellers and, by extension, competitors. This usually entails
using one or more means of preventing any resale: keeping the different price groups separate,
making price comparisons difficult, or restricting pricing information. The boundary set up by
the marketer to keep segments separate is referred to as a rate fence. Price discrimination is thus
very common in services where resale is not possible; an example is student discounts at
museums: In theory, students, for their condition as students, may get lower prices than the rest
of the population for a certain product or service, and later will not become resellers, since what
they received, may only be used or consumed by them. Another example of price discrimination
is intellectual property, enforced by law and by technology. In the market for DVDs,
DVD-players are designed and produced- by law- with hardware or software to prevent
inexpensive copying or playing of content purchased legally elsewhere in the world (for example
legally purchased in India) from being used in a higher price market (like in the US or Europe).
The Digital Millennium Copyright Act has provisions to outlaw circumventing of such devices
to protect the enhanced monopoly profits that copyright holders can obtain from price
discrimination against higher price market segments.
Price discrimination can also be seen where the requirement that goods be identical is relaxed.
For example, so-called "premium products" (including relatively simple products, such as
cappuccino compared to regular coffee with cream) have a price differential that is not explained
by the cost of production. Some economists have argued that this is a form of price
discrimination exercised by providing a means for consumers to reveal their willingness to pay.
Definition of 'Penetration Pricing'
A marketing strategy used by firms to attract customers to a new product or service.
Penetration pricing is the practice of offering a low price for a new product or service during its
initial offering in order to attract customers away from competitors. The reasoning behind this
marketing strategy is that customers will buy and become aware of the new product due to its
lower price in the marketplace relative to rivals.
The advantages of penetration pricing to the firm are:
● It can result in fast diffusion and adoption. This can achieve high market penetration rates
quickly. This can take the competitors by surprise, not giving them time to react.
● It can create goodwill among the early adopters segment. This can create more trade
through word of mouth.
● It creates cost control and cost reduction pressures from the start, leading to greater
efficiency.
● It discourages the entry of competitors. Low prices act as a barrier to entry (see Porter's
5-forces analysis).
● It can create high stock turnover throughout the distribution channel. This can create
critically important enthusiasm and support in the channel.
● It can be based on marginal cost pricing, which is economically efficient.

The main disadvantage with penetration pricing is that it establishes long term price expectations
for the product, and image preconceptions for the brand and company
Penetration Pricing Example
Wholesale
Penetration pricing isn't unique to the retail market. Wholesale distributors also use this
technique to break into new markets. For example, a tool manufacturer may want to grow its
customer base, so it offers extremely low wholesale prices to hardware stores to carry its
products for a certain length of time. The hardware stores can sell the tools at a considerable
profit during that time and use that time to determine whether the tools are a good value for their
customers. After the discount period has ended, the wholesaler can begin negotiating a higher
wholesale price with its now-loyal retailers.
Product Line Pricing Definition
Product line pricing is a pricing strategy that uses one product with various class
distinctions. An example would be a car model that has various model types that change with
performance and quality. This pricing process is evaluated through consumer value perception,
production costs of upgrades, and other cost and demand factors.
Product lining is offering several related products for sale individually. Unlike product
bundling, where several products are combined into one group, which is then offered for sale as a
unit, product lining involves offering the products for sale separately. A line can comprise related
products of various sizes, types, colors, qualities, or prices. Line depth refers to the number of
subcategories a category has. Line consistency refers to how closely relate the products that
make up the line are. Line vulnerability refers to the percentage of sales or profits that are
derived from only a few products in the line.
MULTIPLE-PRODUCT PRICING
It is difficult to think of a firm that does not produce a variety of products. Almost all
companies produce multiple models, styles, or sizes of output, and each of these variations can
represent a separate product for pricing purposes. Although multiple-product pricing requires the
same basic analysis as for a single product, the analysis is complicated by demand and
production interrelations.
Almost all the firms have more than one product in their line of production. Even the
most specialized firms’ produce a commodity in multiple models, styles and size, each so much
differentiated from the other that each model or size of the product may be considered a different
products e.g. the various models of television, refrigerators etc produced by the same company
may be treated as different product for at least pricing purpose. The various models are so
differentiated that consumers view them as different products. Hence each model or product has
different average revenue (AR) and Marginal Revenue curves and that one product of the firm
concepts against the other product. The pricing under this condition is known as multi-product
pricing or product line pricing. In multi-product pricing, each product has a separate demand
curve. But, since all of them are produced under one organization by interchangeable production
facilities, they have only one inseparable marginal cost curve. That is, while revenue curves, AR
and MR, are separate for each product, cost curves AC and MC are inseparable
Questions:
1) Discuss the types of competitive situation?

2) Explain the term under the both long-run and short-run?

A) Monopoly
B) Monopolistic competition
C) Oligopoly
3) Explain the pricing methods?
4) Determine Skimming price and Loss leader pricing?
UNIT 8 -PROFIT MANAGEMENT

Introduction:
The concept of profit management dictates all functions and processes within an organization to
and extending from the organization into its suppliers and consumers. Impacts profitability and
continuously needs measurement and review to optimize performance and results. Profit
management includes the strategy and decision making.
Profit management includes cost reduction, working capital improvement accounts receivables
(AR), accounts payables (AP) inventory and margin improvement.
Meaning and Definition of Profit:
Profit means the net income of a businessman. It is calculated by deducting from the total
receipts and total expenditure.
Profit=total receipts-total expenditure
(Or)
Profit=total sales-total expenses
Definition:-
“Perhaps no term or concept in economic discussion is used with a more bewildering variety of
well-established meaning than profit.”

------------ Prof. Knight.

Different Economists:-
The percentage return on investment of capital is known as “Reward of ownership”
Some have refers to the reward for risk-taking is known as “Reward of Entrepreneurship.”
Profit Management Process:-
Profit Management
Profit Formation Management Profit Distribution Management
1. Profit Formation Management:-

It includes the development of policy for managing profits of operational, investment and
financial activities. The basic constituents of these activities are income,expenses, tax
payment, risk management.
2. Profit Distribution Management:-
It includes management of duty payment of taxes and collection of other compulsory
payments related to profit as well as optimization of the proportion between the
capitalization and usable profits.
Types of Profits:
Profits can be classified in to 2 types.
1. Gross Profit
2. Net Profit
1. Gross Profit:-
Gross profit=Total Revenues-Total explicit cost
Total Explicit cost= wages+Interst on loan+rent.
2. Net Profit:-
Net profit=total revenues-total implicit cost
Total implicit cost=Gross profit+wages for his own labour,interest for his own
capital, rent for his own land and business premises, depreciation of machinery,
buildings etc.
Nature of profit:-
“Profit is that minimum payment which must be paid to the entrepreneurs to keep a given
amount of capital invested in the business.”
“The opinion that an entrepreneur gets profit because he undertakes risk.”
Features of Profit:-
1. Residual Income:-
Which accurse to the entrepreneur after all types of payments have been made and all
types of production and sales expenses have been met.
2. More fluctuations in profits:-
Another feature profits is that these are more fluctuations in profits than in the other 3
factors
1. Incomes, rent 2. Interest 3. Wages. There are more ups and downs in the levels of
profit.
3. Profits can be negative:-

Profits are different from the income of land, labour and capital. Because profits can fall
to ‘0’. They can be even negative. It means that an entrepreneur can get losses ever. On the
contrary land, labor and capital always earn positive price for their services and thus rent, wages
and interest can never be negative.
Scope of Profit/Role of Profit:-
1. Measure of performance: - A perfect measure indicates the business is being run
successfully and effectively. To produce quality goods and services and maintain perfect
measures.
2. Ensuring supply of future capital:- profit ensures the supply of future capital for
innovation and expansion either directly, by providing the means of self financing out of
retained earnings or profits or through providing sufficient inducement for new external
capital which will optimize the company’s capital structure and minimize its cost of
capital.
3. Motivating entrepreneur:-the function of profit is that it not only creates a motivation in
the entrepreneur to bear risk and uncertainty but also creates a capability in him to bear
losses. If a firm is receiving continuous profits it can bear losses also some times. A firm
which gets losses only, will have to be closed down.
4. Provide resources: - profits not only motivate an entrepreneur for innovation but also
provide resource for this purpose. In the absence of profits, programmes of technological
improvement, innovation would be adversely affected because without resources,
research and development (R&D) is not possible.
5. Source of revenue: - profits are a big source of revenue to the government. Government
imposes a good amount of income tax on the profits of firms and companies. As the
profits of firm and companies increase, the tax revenue of government also automatically
increases. This revenue is used by government for public purposes.
Different Theories of Profit
Many theories have been put forward by different economists. Some of them are as follows:
1. Dynamic Theory of Profit
The dynamic theory of profit was given by J.B. Clark. According to him profit accrues because
the society is dynamic by nature. Since the dynamic nature of society makes future uncertain and
any act, the result of which has to come in future, involves risk. Thus profit is the price of risk
taking and risk bearing. It arises only in a dynamic society which means in a society where
changes does not occur i.e. it is static by nature the risk element disappears and hence the profit
element does not exist there.
Actually, a society is said to be dynamic when there is a change in its population, change in
trends of the people, change in stock of the capital, change in the supply of entrepreneurs etc.
when all these factors becomes constant, the future also becomes certain and the risk element
disappears from the society.
According to Clark, profit is the result of an adjustment, which is brought about by the
entrepreneurs themselves. They may find new techniques of production by inventing new
machines. Their use reduces the cost of production and reduces the course of time as well and
gives the entrepreneur higher profits. But when the use of machinery and production becomes
common and used by the other entrepreneur operating in the economy. The supply of goods then
increase and the prices fall. Hence the profit margin also goes down. Under this situation the
profit is determined by the demand and supply of enterprise at a point where they are equal.

Criticism,this theory completely ignores the future or uncertainty. According to Prof. Knight
only those changes, which cannot be foreseen, and which cannot be provided in advance will
yield profits and not others. Also this theory often gives a misleading conclusion regarding the
competition.
2. Marginal Productivity Theory of Profit
According to this theory, profit always equals to the marginal productivity of the entrepreneur.
The marginal productivity of the entrepreneur cannot be evaluated in the case of the firm because
there is only one entrepreneur in a firm. It is however can be easily done in an industry where the
number of the firms can be calculated and hence the marginal productivity of various
entrepreneurs can be measured.
According to this theory the profit depends upon the marginal production. Greater the marginal
production greater will be the profit.
3. Wages Theory of Profit
According this theory the services of the entrepreneur are also classified as labour though of a
superior type. These entrepreneurs do a lot of work in organizing the business unit as well. The
entrepreneurs in the shape of profit pay to themselves for service just as managers are paid for
their services. It means that profit is a wage for the entrepreneur for the services rendered by
them.
4. Un-Certainty Breaking Theory of Profit
According to Prof. Knight
“Profit is the reward for uncertainty bearing and not the risk bearing”.
Prof. Knight has regarded uncertainty bearing as a factor of production. Knight’s theory
classifies the position that profit arises because of the joint action of uncertainty bearing and
capital.
5. Risk Bearing Theory of Profit
According to F.B. Hawley, “Profit is reward for risk bearing which is the most important
function of an entrepreneur”. Hawley believes that risks are unpleasant and therefore no one
likes to bear it, until and unless some reward is insured. Profit is a reward for bearing these risks.
Measurement of profit
Introduction: The income statement is one of four financial statements resulting from the
financial reporting process the statement is often known as the profit and loss statement or
statement of financial performance the use of income statement is inconsistent with use of “profit
and loss statement” in the Corporations Act 2001
 Measurement of profit, as a measure of performance, is the overriding goal of business
entities as opposed to not-for-profit organizations The reported profit figure, otherwise known as
periodic profit, usually attracts the most attention Accounting standard-setters have, not
surprising, set out to improve the measurement and reporting of profit, sometimes to the
disadvantage of the balance sheet
 Measurement of profit According to the Framework, “information about the performance of
an entity, in particular its profitability, is required in order to assess potential changes in the
economic resources that is it likely to control in the future “… It is also useful in forming
judgments about the effectiveness with which the entity might employ additional resources”
 . Measurement of profit the elements income and expenses are directly related to the
measurement of profit it is common practice to distinguish between items of income and

expenses that arise from the ordinary activities of the entity and those which do not. “Items that
arise from the ordinary activities of one entity may be unusual in respect of another entity”.
 Measurement of profit Income The definition of income comprises both revenue and gains
“Revenue arises in the course of the ordinary activities of an entity and is referred to by a variety
of different names including sales, fees, interest, dividends, royalties and rent”.
 Measurement of profit “Gains represent other items that meet the definition of income and
may, or may not, arise in the course of the ordinary activities of an entity”. Gains represent
increases in economic benefits and are no different in conceptual terms (i.e. in nature) from
revenue.
 Measurement of profit Gains are usually displayed separately in the income statement
because knowledge of them is regarded as useful for economic decision making “Gains are often
reported net of related expenses”.
 Measurement of profit Expenses The definition of expenses comprises both losses and also
expenses that arise from the ordinary activities of the entity “Expenses that arise in the course of
the ordinary activities of the entity include, for example, cost of sales, wages and depreciation”.
 Measurement of profit “Losses represent other items that meet the definition of expenses and
may, or may not, arise in the course of the ordinary activities of the entity” Losses represent
decreases in economic benefits and are no different in conceptual terms (i.e. in nature) from other
expenses
 Measurement of profit Losses are usually displayed separately in the income statement
because knowledge of them is regarded as useful for economic decision making “Losses are
often reported net of related expenses”.
 Measurement of profit there are three possible approaches to measuring periodic profit: -
Operating-profit approach - All-inclusive approach - Comprehensive income approach.
 Measurement of profit Under the operating-profit approach, periodic profit is measured and
reported as income from operations less expenses from operations When applying this approach,
adjustments (such as corrections or revisions) relating to prior periods, items of an extraordinary
nature and those arising from changes in accounting policy bypass the income statement
 Measurement of profit under the all-inclusive approach, periodic profit is measured and
reported as the result of ordinary operations plus adjustments relating to prior periods and items
of an extraordinary nature and the effects of some accounting policy changes. This approach is
broader than the operating-profit approach
 Measurement of profit Under the comprehensive income approach, profit for the period
includes all income and expenses as defined in the framework In other words, all changes in net
assets (i.e. all recognized changes in the carrying amount of assets and liabilities), other than
transactions with owners, are included in the measurement of profit .
 Measurement of profit “ Total comprehensive income is the change in equity during a period
resulting from transactions and other events, other than those changes resulting from transactions
with owners in their capacity as owners” .Total comprehensive income comprises all components
of: Profit or loss, and Other comprehensive income
 Measurement of profit “Profit or loss is the total income less expenses, excluding the other
components of comprehensive income“Other comprehensive income comprises items of income
and expense (including reclassification adjustments) that are not recognized in profit or loss as
required or permitted by other Australian Accounting Standard”.
Cost–volume–profit Analysis (CVP):

In managerial economics, is a form of cost accounting. It is a simplified model, useful for

elementary instruction and for short-run decisions.
CVP analysis expands the use of information provided by breakeven analysis. A critical part of
CVP analysis is the point where total revenues equal total costs (both fixed and variable costs).
At this break-even point, a company will experience no income or loss. This break-even point
can be an initial examination that precedes more detailed CVP analysis.
CVP analysis employs the same basic assumptions as in breakeven analysis. The assumptions
underlying CVP analysis are:
● The behavior of both costs and revenues is linear throughout the relevant range of
activity. (This assumption precludes the concept of volume discounts on either purchased
materials or sales.)
● Costs can be classified accurately as either fixed or variable.
● Changes in activity are the only factors that affect costs.
● All units produced are sold (there is no ending finished goods inventory).
● When a company sells more than one type of product, the sales mix (the ratio of each
product to total sales) will remain constant.
The components of CVP analysis are:
● Level or volume of activity
● Unit selling prices
● Variable cost per unit
● Total fixed costs
● Sales mix
Model
Basic graph
Basic graph of CVP, demonstrating relation of total costs, sales, and profit and loss
The assumptions of the CVP model yield the following linear equations for total costs and total
revenue (sales):
)
These are linear because of the assumptions of constant costs and prices, and there is no
distinction between units produced and units sold, as these are assumed to be equal. Note that
when such a chart is drawn, the linear CVP model is assumed, often implicitly.
In symbols:

Where
● TC = Total costs
● TFC = Total fixed costs
● V = Unit variable cost (variable cost per unit)
● X = Number of units
● TR = S = Total revenue = Sales
● P = (Unit) sales price
Profit is computed as TR-TC; it is a profit if positive, a loss if negative.
Break down
Costs and sales can be broken down, which provide further insight into operations.
Decomposing total costs as fixed costs plus variable costs.

One can decompose total costs as fixed costs plus variable costs:
Decomposing sales as contribution plus variable costs

Following a matching principle of matching a portion of sales against variable costs, one can
decompose sales as contribution plus variable costs, where contribution is "what's left after
deducting variable costs". One can think of contribution as "the marginal contribution of a unit to
the profit", or "contribution towards offsetting fixed costs".
In symbols:

Where
● C = Unit Contribution (Margin)
Profit and loss as contribution minus fixed costs

Subtracting variable costs from both costs and sales yields the simplified diagram and equation
for profit and loss.
In symbols:
Diagram relating all quantities in CVP.

These diagrams can be related by a rather busy diagram, which demonstrates how if one
subtracts variable costs, the sales and total costs lines shift down to becomes the contribution and
fixed costs lines. Note that the profit and loss for any given number of unit sales is the same, and
in particular the break-even point is the same, whether one computes by sales = total costs or as
contribution = fixed costs. Mathematically, the contribution graph is obtained from the sales
graph by a shear, to be precise , where V are unit variable costs.

Applications
CVP simplifies the computation of breakeven in break-even analysis, and more generally allows
simple computation of target income sales. It simplifies analysis of short run trade-offs in
operational decisions.
Limitations
CVP is a short run, marginal analysis: it assumes that unit variable costs and unit revenues are
constant, which is appropriate for small deviations from current production and sales, and
assumes a neat division between fixed costs and variable costs, though in the long run all costs
are variable. For longer-term analysis that considers the entire life-cycle of a product, one
therefore often prefers activity-based costing or throughput accounting.
Questions:
1. Describe the Different theories of profit?

2. What are the measurement policies taken under profit management?
3. Explain Cost-Volume profit analysis?
All the Best
Managerial Economics (Imp questions)

1. Define Management Economic. Discuss the nature and scope of Managerial economics.
2. What do you mean by discriminating monopoly? Explain the price and output
determination is discriminating monopoly.
3. Write short note on:-Opportunity cost
a. Replacement and Historical cost
b. Incremental costs and Sunk costs
c. Past and Future cost
d. Short run vs. Long run Costs.
4. Distinguish between Accounting Profit and Economic Profit.
5. Write short note on break even analysis.
6. What factors do you think affect Price elasticity of demand?
7. What is oligopoly? Explain price rigidity under oligopoly in terms of kinked demand curve.
8. Explain the pay back Period method of Project appraisal. Describe its merits and
limitations.

9. Define cross elasticity of demand.

10. How does monopolistic competition differs from perfect competition? Illustrate with some
example.
11. Explain the cost-Plus method of pricing. What are its limitations?
12. What are the different classifications of market structure> Discuss their characteristics.
13. How would a monopolist fix his Price and output? Explain with diagrams.
14. Discuss the various managerial uses of estimated Production function.
15. What are the criteria of a good forecasting method?
16. Explain how Managerial Economics is related to Economics, Mathematics, Statistics and
Accounting.
17. Explain important economic theories which are applied to Managerial Economics.
18. What are the limitations of the break-even analysis?
19. Explain the concept of ‘Barriers to entry’. Discuss its relevance taking into consideration the
present economic scenario.
20. Price leadership is an alternative cooperative method used to avoid tough competition’.
Comment.
21. Discuss the relevance of Baumol’s Model of sales revenue maximization in the present
context.
22. What is oligopoly? Explain price rigidity under oligopoly in terms of kinked demand curve?
23. Calculate break-even point from the following data:
Sales: 550 units
Sale Receipt: RS. 28,875
Total Fixed cost: RS. 16, 000.
Total variable costs: RS.11, 000.
24. Discuss the relevance of Bauman’s Model of sales revenue maximization in the present
context.
25. What is oligopoly? Explain price rigidity under oligopoly in terms of kinked demand curve.
26. Briefly explain the concept of returns to scale?
27. Compare and contrast and Behavioral Theory with the Economic Theory of a firm.
28. Calculate break-even point from the following data:
Sales: 550 units
Sale Receipt: RS. 28,875
Total Fixed cost: RS. 16, 000.
Total variable costs: RS.11, 000
29. “Managerial economics is economics applied in decision making” Discuss.
30. Show that the principle of “Egin-marginalism” is an extension of the condition of
equilibrium of a consumer.
31. What is demand forecasting? Techniques of demand-forecasting?
32. Why long run average cost curve is likely to be L-Shaped?
33. Explain in detail the role and functions of managerial economist in firm?
34. What is optimization?
35. What are the optimization techniques available for a firm?
36. What is time perspective in economics?
37. What is incremental concept economics?
38. What is production function?

39. Explain the role of innovations as an economy of scale in production.

40. What are the short run and long run costs?
41. Write a note on over all cost-Leadership?
42. What are the fundamental features of monopolistic competition?
43. Discuss different theories of profit?
44. Explain in detail about cost-volume profit analysis?

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MANAGERIAL ECONOMICS

Unit 1-Introduction to Managerial Economics

SUMOURYA INSTITUTE OF MANAGEMENT (SIMK) Page 1

SUMOURYA INSTITUTE OF MANAGEMENT (SIMK) Page 2

Micro economics Macro economics

SUMOURYA INSTITUTE OF MANAGEMENT (SIMK) Page 3

SUMOURYA INSTITUTE OF MANAGEMENT (SIMK) Page 4

Demand analysis and demand forecasting

Differences between Managerial Economics and Traditional Economics:-

SUMOURYA INSTITUTE OF MANAGEMENT (SIMK) Page 5

Unit 2-Objectives of the firm

Investment limit Number of owners Government participation in business

Small Proprietorships Public Sector

Business or Profit Non- Business or not for profit

Firms exist for profit firms not exist for profit

For Ex; - Universities; Hospitals; etc

SUMOURYA INSTITUTE OF MANAGEMENT (SIMK) Page 6

Functions of the firm:

Purchased Goods Supply of Goods

Supply of Resources Hire Inputs

Demand for Resources Factor Payments

Circular flow of Economic Activity:

SUMOURYA INSTITUTE OF MANAGEMENT (SIMK) Page 7

Objectives of the firm

Economic Objectives Non-Economic Objectives

Maximum Growth Rate Burvival

Sound business practices

Sales Stage I Stage IV

SUMOURYA INSTITUTE OF MANAGEMENT (SIMK) Page 8

II. Non- economic objectives:-

SUMOURYA INSTITUTE OF MANAGEMENT (SIMK) Page 9

Optimizing theories non optimizing theories

TABLE Monopoly Output, Revenues, Costs, and Profits

Outpu Price Total Marginal Total Average Marginal Monopoly

SUMOURYA INSTITUTE OF MANAGEMENT (SIMK) Page 10

Figure 1 The monopolist's profit-maximizing decision

SUMOURYA INSTITUTE OF MANAGEMENT (SIMK) Page 11

SUMOURYA INSTITUTE OF MANAGEMENT (SIMK) Page 12

SUMOURYA INSTITUTE OF MANAGEMENT (SIMK) Page 13

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SUMOURYA INSTITUTE OF MANAGEMENT (SIMK) Page 15

Reengineering New managerial Total Quality Management

Best practices for organization externally:

SUMOURYA INSTITUTE OF MANAGEMENT (SIMK) Page 16

1. Discuss the relevance of Baumol’s Model of sales revenue maximization in the

Unit 3-Basic Economic Principles

SUMOURYA INSTITUTE OF MANAGEMENT (SIMK) Page 17

SUMOURYA INSTITUTE OF MANAGEMENT (SIMK) Page 18

⮚ Constant marginal utility

SUMOURYA INSTITUTE OF MANAGEMENT (SIMK) Page 19

Unit 4-Theory of Demand

SUMOURYA INSTITUTE OF MANAGEMENT (SIMK) Page 20

SUMOURYA INSTITUTE OF MANAGEMENT (SIMK) Page 21

Individual demand Market /Aggregate demand

SUMOURYA INSTITUTE OF MANAGEMENT (SIMK) Page 22

f mangoes dual Demand Schedule et Demand Schedule

SUMOURYA INSTITUTE OF MANAGEMENT (SIMK) Page 23

SUMOURYA INSTITUTE OF MANAGEMENT (SIMK) Page 24

Price uantity Demanded

SUMOURYA INSTITUTE OF MANAGEMENT (SIMK) Page 25

SUMOURYA INSTITUTE OF MANAGEMENT (SIMK) Page 26

SUMOURYA INSTITUTE OF MANAGEMENT (SIMK) Page 27

5. Unit elasticity of demand:-

Factors influencing Ed or Determinants of Elasticity of Demand:-