MANAGERIAL ECONOMICS

GAME THEORY - The study of situations involving competing interests, modeled in terms of NASH EQUILIBRIUM
the strategies, probabilities, actions, gains, losses of opposing palyers in game. JOHN NASH - MATHEMATICIAN
- the study of games to determine the probability of winning, given various strategies. Nash equilibrium - a concept of game theory where the optimal outcome of a game is one
where no player has an incentive to deviate from his or her chosen strategy after
APPLICATIONS OF GAME THEORY considering an opponents choice.
- game theory aimed at modelling situations with conflicting decision makers - set of strategies or actions in which each firms does the best it can given its
- it has been used primarily in Economics competitors actions.
1. Government properties 4. politics - is a crucial concept that helps to determine an optimal solution in non-
2. Firms 5. etc. cooperative game where all players do not have any incentives to deviate from
3. markets their initial move.
- recently networking and communications APPLICATION
- road congestion - oligopoly
KEYS TO REMEMBER - sports - legal conflicts
Game- Any set of circumstances that has a result dependent on the actions of two or more - climate change
decision-makers (players) DOMINANT STRATEGIES VS. NASH EQUILIBRIUM
Players - A strategic decision-maker within the context of the game Dominant strategies
Strategy - A complete plan of action a player will take given the set of circumstances that - I’m doing the best I can no matter what you do
might arise within the game - You’re doing the best you can no matter what I do.
Payoff - The payout a player receives from arriving at a particular outcome (The payout can Nash equilibrium
be in any quantifiable form, from dollars to utility.) - I’m doing the best I can given what you are doing.
Information set - The information available at a given point in the game (The term - You’re doing the best you can given what I am doing
information set is most usually applied when the game has a sequential
component. COURNOT EQUILIBRIUM
Equilibrium - The point in a game where both players have made their decisions and an - Oligopoly model in which firms produce a homogenous good, each firm treats the
outcome is reached output of its competitors as fixed, and all firms decide simultaneously how much to
produce. Since no firm has an incentive to change it’s output unilaterally as each firm is
KEYS CONCEPTS - GAME THEORY doing the best it can given the decision of its competitors. Thus a Cournot equilibrium is
Cooperative outcomes - An equilibrium where the players agree to cooperate a Nash equilibrium.
Dominant strategy - a dominant strategy is one where a single strategy is best for a player
regardless of what strategy other players in the game decide to use PRISONER’S DILEMMA
Nash equilibrium - any situation where all participants - A game with a dominant strategy equilibrium. In which playing the dominant strategy
Tacit collusion - where firms undertake actions that are likely to minimize a competitive yields lower individual and total payoffs compared to other startegies. Socially outcome is
response not achieve.
Whistle blowing - when one or more agents in a collusive agreement report it to the - Cooperate or Betray
authorities
Zero sum game - an economic transaction in which whatever is gained by one party must MARKET STRUCTURES AND PRICING DECISIONS
be lost by the other. Price determination is one of the most crucial aspects in economics. Business managers are
expected to make perfect decisions based on their knowledge and judgment. Pricing
discusses the rationale and assumptions behind pricing decisions. It analyzes unique market
needs and discusses how business managers reach upon final pricing decisions.
 It explains the equilibrium of a firm and is the interaction of the demand faced by
the firm and its supply curve. The equilibrium condition differs under perfect competition,
monopoly, monopolistic competition, and oligopoly.
Market Structure - A market is the area where buyers and sellers contact each other and
exchange goods and services. Market structure is said to be the characteristics of
the market. Market structures are basically the number of firms in the market that
produce identical goods and services. Market structure influences the behavior of
firms to a great extent.
When the competition is high there is a high supply of commodity as different
companies try to dominate the markets and it also creates barriers to entry for the
companies that intend to join that market.
Perfect Competition - Perfect competition is a situation prevailing in a market in which
buyers and sellers are so numerous and well informed that all elements of
monopoly are absent and the market price of a commodity is beyond the control
of individual buyers and sellers.
With many firms and a homogeneous product under perfect competition no
individual firm is in a position to influence the price of the product that means
price elasticity of demand for a single firm will be infinite.
Pricing Decisions
Determinants of Price Under Perfect Competition - Market price is determined by the
equilibrium between demand and supply in a market period or very short run. The
market period is a period in which the maximum that can be supplied is limited by
the existing stock. The market period is so short that more cannot be produced in
response to increased demand.
Market Price of a Perishable Commodity - In the case of perishable commodity like fish,
the supply is limited by the available quantity on that day. It cannot be stored for
the next market period and therefore the whole of it must be sold away on the
same day whatever the price may be.
Market Price of Non-Perishable and Reproducible Goods - In case of non-perishable but
reproducible goods, some of the goods can be preserved or kept back from the
market and carried over to the next market period. There will then be two critical
price levels.
The first, if price is very high the seller will be prepared to sell the whole stock. The
second level is set by a low price at which the seller would not sell any amount in
the present market period, but will hold back the whole stock for some better
time. The price below which the seller will refuse to sell is called the Reserve Price.
Monopolistic Competition - Monopolistic competition is a form of market structure in
which a large number of independent firms are supplying products that are slightly
differentiated from the point of view of buyers.
In other words, product differentiation is the only characteristic that distinguishes
monopolistic competition from perfect competition.
Monopoly - Monopoly is said to exist when one firm is the sole producer or seller of a
product which has no close substitutes.. According to this definition, there must be
a single producer or seller of a product. If there are many producers producing a
product, either perfect competition or monopolistic competition will prevail
depending upon whether the product is homogeneous or differentiated.
Monopolist is a price maker. He tries to take the best of whatever demand and cost
conditions exist without the fear of new firms entering to compete away his profits
Oligopoly - In an oligopolistic market there are small number of firms so that sellers are
conscious of their interdependence. Oligopoly is a situation in which only a few
firms are competing in the market for a particular commodity. The distinguishing
characteristics of oligopoly are such that neither the theory of monopolistic
competition nor the theory of monopoly can explain the behavior of an
oligopolistic firm.
Two of the main characteristics of Oligopoly are briefly explained below
1. Under oligopoly the number of competing firms being small, each firm controls an
important proportion of the total supply.
2. Under oligopoly new entry is difficult. It is neither free nor barred. Hence the condition of
entry becomes an important factor determining the price or output decisions of
oligopolistic firms and preventing or limiting entry of an important objective.
MANAGERIAL ECONOMICS- PRICING STRATEGIES
Pricing is the process of determining what a company will receive in exchange for its
product or service. A business can use a variety of pricing strategies when selling a product
or service.
Pricing a New Product - Most companies do not consider pricing strategies in a major way,
on a day-today basis. The marketing of a new product poses a problem because
new products have no past information. Fixing the first price of the product is a
major decision. The future of the company depends on the soundness of the
initial pricing decision of the product
Skimming Price - Skimming price is known as short period device for pricing. Here,
companies tend to charge higher price in initial stages. Initial high helps to “Skim
the Cream” of the market as the demand for new product is likely to be less price
elastic in the early stages.
Penetration Price - Penetration price is also referred as stay out price policy since it
prevents competition to a great extent. In penetration pricing lowest price for the
new product is charged.
Multiple Products - As the name indicates multiple products signifies production of more
than one product. The traditional theory of price determination assumes that a
firm produces a single homogenous product. But firms in reality usually produce
more than one product and then there exists interrelationships between those
products.
Full Cost Pricing Method- Full cost plus pricing is a price-setting method under which you
add together the direct material cost, direct labor cost, selling and administrative
cost, and overhead costs for a product and add to it a markup percentage in order
to derive the price of the product.
Pricing formula = Total production costs − Selling and administration costs − Markup
Number of units expected to sell
This method is most commonly used in situations where products and services are
provided based on the specific requirements of the customer.
Marginal Cost Pricing Method - the practice of setting the price of a product to equal the
extra cost of producing an extra unit of output is called marginal pricing in
economics. By this policy, a producer charges for each product unit sold, only the
addition to total cost resulting from materials and direct labor.
Transfer Pricing - Transfer Pricing relates to international transactions performed between
related parties and covers all sorts of transactions. The most common being
distributorship, R&D, marketing, manufacturing, loans, management fees, and IP
licensing.
Dual Pricing - in simple words, different prices offered for the same product in different
markets is dual pricing. Different prices for same product are basically known as
dual pricing. The objective of dual pricing is to enter different markets or a new
market with one product offering lower prices in foreign county.
Price Effect - price effect is the change in demand in accordance to the change in price,
other things remaining constant. Other things include − Taste and preference of
the consumer, income of the consumer, price of other goods which are assumed to
be constant
Price Effect = Proportionate change in quantity demanded of X  - A second kind of market failure is failure by incentive. In the production and
Proportionate change in price of X
Price effect is the summation of two effects, substitution effect and income effect
Price effect = Substitution effect − Income effect
Substitution Effect - In this effect the consumer is compelled to choose a product that is
less expensive so that his satisfaction is maximized, as the normal income of the
consumer is fixed. It can be explained with the below examples −
- Consumers will buy less expensive foods such as vegetables over meat.
- Consumers could buy less amount of meat to keep expenses in control.
Income Effect - Change in demand of goods based on the change in consumer’s
discretionary income. Income effect comprises of two types of commodities or
products
Normal goods − If there is a price fall, demand increases as real income increases and vice
versa.
Inferior goods − In case of inferior goods, demand increases due to an increase in the real
income.
ROLE OF THE GOVERNMENT IN A MARKET ECONOMY
COMPETITION AND THE ROLE OF GOVERNMENT - MANAGERIAL ECONOMICS
- When considering the role of government in the market economy, it has been
traditional to focus on how government influences economic activity through tax policies,
law enforcement, and infrastructure investments in highways, water treatment facilities,
and the like.
How Government Influences Business
- Government affects what and how firms produce, influences conditions of entry and
exit, dictates marketing practices, prescribes hiring and personnel policies, and imposes
a host of other requirements on private enterprise. Government regulation of the market
economy is a controversial topic because the power to tax or compel has direct economic
consequences
Economic Considerations - Economic regulation began and continues in part because of the
public’s perception of market imperfections. It is sometimes believed that unregulated
market activity can lead to inefficiency and waste or to market failure. Market failure is
the inability of a system of market institutions to sustain socially desirable activities or to
eliminate undesirable ones.
- First cause of market failure is failure by market structure. For a market to
realize the beneficial effects of competition, it must have many producers (sellers) and
consumers (buyers), or at least the ready potential for many to enter. Some markets do
not meet this condition.
consumption of goods and services, social values and costs often differ from the private
costs and values of producers and consumers. Differences between private and social
costs or benefits are called externalities.
A Negative externality is a cost of producing, marketing, or consuming a product that is
not borne by the product’s producers or consumers.
A Positive externality is a benefit of production, marketing, or consumption that is not
reflected in the product pricing structure and, hence, does not accrue to the product’s
producers or consumers.
Social Considerations - Competition promotes efficiency by giving firms incentives to
produce the types and quantities of products that consumers want. Competitive
pressures force each firm to use resources wisely to earn at least a normal profit. The
market-based resource allocation system is efficient when it responds quickly and
accurately to consumer preferences. Not only are these features of competitive markets
attractive on an economic basis, but they are also consistent with basic democratic
principles.
 Regulatory policy can be a valuable tool with which to control monopolies, restoring
control over price and quantity decisions to the public.
A second social purpose of regulatory intervention is to limit concentration of economic
and political power
Adam Smith - introduced the concept of the invisible hand, which refers to the free
functioning of the price (market) system in the absence of government
intervention
As Paul Samuel- son has put it, “An ideal market economy is one where all goods and
services are voluntarily exchanged for money at market prices. Such a system
squeezes the maximum benefits out a society’s available resources without
government intervention”.
The doctrine of laissez faire, which means ‘leave us alone’ held that government should
interfere as little as possible in economic affairs and leave economic decisions to the
interplay of supply and demand in the marketplace.
And, in 1936, J.M. Keynes suggested in his revolutionary book: The General Theory that
the visible hand of the government should replace, at least partly, the invisible hand of the
market.
To quote Samuelson again, “in the real world, no economy actually conforms totally to the
idealised world of the smoothly functioning invisible hand. Rather, every market economy
suffers from imperfections which lead to such ills as excessive pollution, unemployment and
extremes of wealth and poverty”.
Four Main Functions of Government in a Market Economy:
1. Efficiency - First, the government should attempt to correct market failures like
monopoly and excessive pollution to ensure efficient functioning of the economic
system.
2. Infrastructure - Secondly, the government should provide an integrated infrastructure.
Infrastructure (or social overhead capital) refers to those activities that enhance,
directly or indirectly, output levels or efficiency in production.
3. Equity - Markets do not necessarily produce a distribution of income that is regarded as
socially fair or equitable. As market economy may produce unacceptably high
levels of inequality of income and weather. Government programmes to promote
equity use taxes and spending to redistribute income toward particular groups.
4. Economic Growth or Stability - Fourthly, governments rely upon taxes, expenditures and
monetary regulation to foster macroeconomic growth and stability to reduce
unemployment and inflation while encouraging economic growth.
Countries with low state capability need to focus first on basic functions: the
provision of pure public goods such as property rights, macroeconomic stability,control of
infectious diseases, safe water, roads and protection of the destitute. Recent reforms have
emphasised economic fundamentals. But social and institutional (including legal)
fundamentals are equally important to avoid social disruption and ensure sustained
development.
Going beyond these basic services are the intermediate functions, such as
management of externalities (pollution, for example), regulation of monopolies, and the
provision of social insurance (pensions, unemployment benefits).
States with strong capability can take on more-activities functions, dealing with the
problem of missing markets by helping coordination.
Matching role to capability involves not only what the state does but also how it
does it. Rethinking the state also means exploring alternative instruments, existing or new,
that can enhance state effectiveness.
For example:
In most modern economies the state’s regulatory role is now broader and more
complex than ever before, covering such areas as the environment and the financial sector,
as well as more traditional areas such as monopolies.
Although the state still has a central role in ensuring the provision of basic services
— education, health, infrastructure — it is not obvious that the state must be the only
provider, or a provider at all.
In protecting the vulnerable, countries need to distinguish more clearly between
insurance and assistance. Insurance, against cyclical unemployment for example, aims to
help smooth households’ income and consumption through a market economy’s inevitable
ups and downs. Assistance, such as food-for-work programs or bread subsidies, seeks to
provide some minimum level of support to the poorest in society.