SPECIAL ASSIGNMENT OF CRITICAL THINKING ESSAY (SACE)

Repeat-2 Examination, December-2021

SUBJECT :- Principles of Economics

SEMESTER :- I

NAME :- Lucky Tandon

BATCH :- XIV
I.D no. :- 14/2014/1032
Roll no. :- 75
Section : ‘C’

HIDAYATULLAH NATIONAL LAW UNIVERSITY, RAIPUR (C.G.)

“Question 1. “The problem before a firm, under the condition of profit-maximizing perfectly
competitive market, is to determine its output only. Whereas, a firm under the monopoly market
and the monopolistic competitive market does not have to face this problem. Critically explain
with the help of appropriate diagrams.”

Answer 1.

A perfectly competitive company just has to execute one fundamental decision: how much to
produce. A perfectly competitive company can't select price it charges because the price for its
output is decided by the product's market demands and supplies,this is already determined by the
profit calculation, thus the perfectly competitive business could sell any amount of things at the
same price. It signifies that the demand curve for the firm's product is entirely elastic, meaning
that customers are prepared to pay the market price for whatever quantity of production
generated. When a completely competitive firm selects how much to produce, the amount, along
with market pricing for output and inputs, determines total income, total costs, and, eventually,
profit margins.

The primary objective of any firm is profit maximization which can either be achieved through a
spike in total revenue(TR) or decrease in the total cost (TC) The difference between revenue and
expense is characterized as profit. To increase revenue, it is desirable to either increase the
quantity produced or the cost. Thereby , boosting revenues or reducing costs of production
through time with accompanying economy of scale will increase the profit difference. The firm's
Marginal cost, Average cost, Average revenue, and Marginal revenue are all equal to the
commodity price in a perfect market. The price is computed by summing the average and
marginal costs together. The marginal cost is the cost of the last manufactured product, or the
cost of the final manufactured product, when the firm is in equilibrium. By dividing the total cost
by the number of items produced, the average cost is obtained

The maximisation of profits is a basic premise in classical economics.

Total Revenue (TR) – Total Costs = Profit (TC).

As a result, profit maximisation happens when the difference between total income and overall
cost is the greatest. If a company produces at a quantity wherein marginal revenue (MR) equals
marginal cost, it may maximise profits (MC)
The following properties are expected to exist in a Perfect competitive market:

1) Because there are so many buyers and sellers in the market, no single agent has the ability to
influence the market price. As a result, both companies are price takers. And Every manufacturer
makes a minor contribution to the market. The supply curve is unaffected by their own output
levels.

2) All of the products available are the same.

3) Both consumers and sellers have complete knowledge about a product's price, usefulness,
quality, and manufacturing techniques.

4) Any company can enter the business without facing cost i.e free for entry. Commodities can
also travel freely across sectors. To put it another way, there is no barrier to entrance. Producers
have complete freedom to enter and quit the market.

5) Every manufacturer takes a price. They don't have any influence over the market. Customers
will buy from a competitor who has a lower price if a firm tries to raise its pricing. All of the
goods are identical. The characteristics of a good or service are consistent among sources.

6) In the long term, producers make no economic profit.

This model's firms are all profit maximizers. Because the enterprises are market price takers,
their decision variable is carried out through output. They face an indefinitely elastic market
demand curve as price takers and can sell an unlimited amount of output at that price.

Revenues of a Firm.
In a competitive market, a company, like any other, strives to maximise earnings. Profit is
defined as the difference between a company's total revenue and total costs. The revenue of a
company functioning in a completely competitive market is computed as follows:

Total Revenue = Price * Quantity

AR (Average Revenue) = Total Revenue / Quantity
MR (Marginal Revenue) = Change in Total Revenue / Change in Quantity
“ The amount of money a business obtains for each unit of output is known as the average revenue
(AR). The difference in total income from an additional unit of production sold is known as
marginal revenue (MR). In a competitive market, both AR and MR will be equal to the price for
all enterprises. ’

Maximizing Profit.
Firms set marginal revenue equal to marginal cost (MR=MC) to maximise profits in a
completely competitive market. The slope of the revenue curve, which is equally equal to the
demand curve (D) and the pricing curve (P), is called MR (P). It is conceivable for economic
earnings to be positive, zero, or negative in the short term. When the price exceeds the average
total cost, the company is profitable. When a firm's pricing is less than its average overall cost, it
is losing money in the market.

Fig.1

achievable for an enterprise to generate a profits in the short term. In Fig.1, the price or average
income, represented by P, is more than the average cost, given by C.

In case of Perfect Competition in the long run.

More firms will enter the market if enterprises in a perfectly competitive market earn long-term
positive economic gains, pushing the supply curve to the right. When the supply curve shifts to
the right, the equilibrium price falls. As the price declines, economic profits will dwindle until
they hit zero. When a company's pricing is less than its average overall cost, it loses money.
More firms will leave the market if enterprises in a fully competitive market make negative
economic profits over time, pushing the supply curve to the left. When the supply curve shifts to
the left, the price will climb. As the price rises, economic profits will climb until they hit
zero.Thus, effectively completing the loop.

To summarise, enterprises operating in a completely competitive market gain no economic

profits in the long run. In a perfectly competitive market, the long-run equilibrium point is where
“

the demand curve (price) crosses the marginal cost (MC) curve and the minimum point of the
average cost (AC) curve. ’

Fig.2

As more firms enter the market, the demand curves of each company shift downward, decreasing
the price, average revenue, and marginal revenue curves. In the long term, the firm will not make
any money. Its horizontal demand curve will connect with its average total cost curve at its
lowest point.
In a totally competitive market, the market demand curve is a downward sloping line, indicating
that as the price of an average item rises, so does the amount wanted of that good. In perfect
competition, the confluence of market demand and supply determines price; individual
businesses have no influence on market pricing.When market supply and demand dynamics
determine the market price, individual businesses become price takers. Individual businesses
must charge the market's equilibrium price, or consumers would purchase the goods from one of
the many other businesses that offer a lower price (keep in mind the key conditions of perfect
competition). As a result, the demand curve for a particular enterprise represents the market's
equilibrium pricing.

Monopolistic market
Monopolistic competition is a market structure in which a large number of independent
businesses compete to offer items that are just marginally unique in the eyes of purchasers. As a
result, the rival enterprises' products are similar but visibly poor options since purchasers do not
consider them comparable. This occurs when a comparable product is sold under several various
brand , each of which differs in some way from the others. For example, Pepsodent, Colgate,
Close up, and so on.  Consequently, each firm is the sole producer of a particular brand or
"products." It is monopolistic in terms of a certain brand. Since most of the brands are nearly
identical, a large number of "monopoly" producers of these brands battle aggressively with each
other. Monopolistic competition is a market system in which a high number of "monopolists"
compete against each other.
Other feature include,
 Large Number of Buyers and Sellers.
“ ”

 Free Entry and Exit of Firms.

“ ”

 Product Differentiation .
“ ”

 Selling Costs.
“ ”

 Lack of Perfect Knowledge.

“ ”

 Less Mobility.
“ ”

 More Elastic Demand.

“ ”

Firms control the pricing of items and services in a monopolistic market, hence they
are price makers. Because businesses have entire control over the market, product
and service costs in this type of market are frequently exorbitant. Firms control a
large portion of the market, making entry and exit points difficult. Because of the
high barriers to entry in a monopolistic market, businesses that do succeed in
breaking in are usually dominated by a single bigger organisation. Customers
have limited choice about where they get their goods or services in a monopolistic
market since there is generally just one vendor. Pure monopolistic markets are
 extremely rare, if not impossible, in the absence of substantial barriers to entry,
such as a restriction on competition or sole control of all natural resources.

Monopolistic Competition in the short run.

In the short run, the diagram for monopolistic competition is the same as for a monopoly.

The firm maximises profit where MR=MC. This is at output Q1 and price P1, leading to
supernormal profit .A monopolistically competitive company maximises profit or avoids losses
in the short run by producing the quantity where marginal revenue equals marginal cost. If the
average total cost is less than the market price, the company will make a profit.
Monopolistic Competition in the long run.

Demand curve shifts to the left due to new firms entering the market. Supernormal profit
promotes new enterprises to enter the market in the long run. This lowers demand for current
businesses, resulting in typical profit.

“Allocative inefficient. The above diagrams show a price set above marginal cost

Productive inefficiency. The above diagram shows a firm not producing on the lowest point of
AC curve

Dynamic efficiency. This is possible as firms have profit to invest in research and development.

X-efficiency. This is possible as the firm does face competitive pressures to cut cost and provide
better products. ”

Monopolistic rivalry is exemplified by the following examples.

Restauraqnt - restaurants contend on both pricing and meal quality. Differentiation of products
is an important aspect of the business. When it comes to opening a new restaurant, the obstacles
to entry are rather low.
Hairdressers. A service that will help businesses establish a reputation for high-quality hair-
cutting.

Clothing. only product;s brand and  uniqueness matters when it comes to designer label clothing.

TV shows - as a result of globalisation, the variety of television shows available from around the
world has risen. Domestic channels, as well as imports from other nations and innovative
services like as Netflix, are available to consumers.

The monopolistic competition model's limitations.

Some businesses will excel at brand uniqueness and, as a result, will be able to earn above-
average profits in the real world. New businesses will not be recognised as a viable alternative.
There is a lot of crossover with oligopoly, except that monopolistic competition implies no entry
barriers. In the actual world, there are very certainly some entrance restrictions. When a
“

company has significant brand loyalty and product distinctiveness, it becomes a barrier to entry
in and of itself. A new company will find it difficult to gain brand loyalty. Many businesses that
”

we may characterize as monopolistically competitive are extremely successful, thus assuming

normal earnings is overly simple.
Question 2 “Demand Elasticity of goods in a given market is high or low according to the
quantity demanded increases much or little for a given fall in price and decreases much or little
for a given rise in price”. Critically explain the statement with real-life examples and
appropriate diagrams. Also, do you think the degree of necessity, the existence of close
substitutes, habits and income of consumers have any influence on Demand Elasticity?
Explain.”

Answer 2.

In his book Principles of Economics, published in 1890, Alfred Marshall is credited with coining
the term "elasticity of demand."1 Only four years after inventing the notion of elasticity, Alfred
Marshall created price elasticity of demand. To derive the equation for price elasticity of
demand, he employed Cournot's fundamental demand curve creation method. 2He states “And we
may say generally:— the elasticity (or responsiveness) of demand in a market is great or small
according as the amount demanded increases much or little for a given fall in price, and
diminishes much or little for a given rise in price”

The rule of demand describes just the direction of change in quantity demanded, not how much
the quantity demanded changes as a result of price changes. In various instances, the amount
required reacts differently to changes in the commodity's price. The study of price elasticity of
demand is centred on this topic.

“Meaning of Price elasticity of Demand ”

Many variables influence the demand for a product, including its price, the price of comparable
commodities, the buyer's income, tastes and preferences, and so on. The term "elasticity" refers
to the degree of reaction. Demand elasticity refers to how responsive demand is. Changes in
price, the price of similar items, income, and other factors all influence demand for a commodity.
As a result, we have three aspects of demand elasticity:

1
Taylor, John (2006). p. 93.
2
https://en.wikipedia.org/wiki/Price_elasticity_of_demand
Price elasticity of demand: Price elasticity of demand refers to how sensitive a commodity's
demand is to price changes. For example, if demand for a commodity increases by 10% as a
result of a 5% price drop,

Price elasticity of demand Ep

Percentage change inquantity demanded/Percentage change in commodity.= 10/(-5)=(-)2.

Because of the inverse connection between price and quantity requested, ep will always be
negative.

Income elasticity of demand: Income elasticity: of demand refers to the degree of

responsiveness of demand for a commodity to the change in income of its buyer. Suppose,
income of buyer rises by 10% and his demand for a commodity rises by 20%, then,

Income elasticity of demand.= % change in quantity demanded/ % Change in price of

commodity. = 20/10=2.

(Tastes and preferences cannot be expressed numerically. So elasticity of demand cannot be

numerically expressed.)

Determining Factors of Price elasticity.

The most essential factor in determining elasticity is customers' willingness and capacity to
postpone immediate consumption decisions regarding a product and seek for alternatives in the
wake of a price change. As a result, a number of factors might impact the elasticity of demand
for a particular commodity..

1. Availability of substitutes.

The higher the elasticity, the more and closer the alternatives are accessible, since individuals
may quickly transfer from one product to another if the price changes even slightly; there is a
substantial substitution impact. If there are no near replacements, the substitution impact will be
limited, and demand will be inelastic.
2. Definition of goods .

The lower the elasticity, the broader the definition of a good (or service). For example, if a large
number of alternatives are available, Company X's fish and chips will have a very high elasticity
of demand, whereas food in general will have an extremely low elasticity of demand since no
substitutes exist.

3. Habits. Consumer habits also influence the price elasticity of demand for commodities. A
chain smoker, for example, will not cut back on his smoking even if cigarette prices rise.

4. 4.Consumer income. In comparison to consumers with low incomes, demand for an item is
often less elastic for higher income groups. For example, if the price of a thing rises, a wealthy
customer is unlikely to cut his demand, but a poor buyer may do so.

5. 5.Share in Total Expenditure: "The elasticity of demand for an item increases as the amount
of money spent on it increases. If the share of money spent on that product is relatively tiny,
demand for that commodity is inelastic.". ”s

Price elastic demand Demand is price elastic if a change in price leads to a bigger % change in
demand; therefore the PED will, therefore, be greater than 1.

Elastic items generally have one or more of the characteristics listed below. Sports cars, for
example, are high-end commodities. Sports cars and holidays, for example, are expensive and eat
a considerable percentage of one's income. Goods with a plethora of options and a saturated
market. Because there are so many alternatives frequently purchased, people would be price
sensitive if Amul hiked the price of their milk.

Price inelastic demand.

These are goods where a change in price leads to a smaller % change in demand; therefore PED
<1 e.g. – 0.5

Inelastic goods have one or more of the following characteristics:

For example, there are few or no close substitutes for petroleum and cigarettes. They are
necessities; if you own a car, for example, you must continue to buy fuel even if the price rises.
For example, cigarettes are very addictive. They either cost a little amount of one's salary or are
only bought once in a while. Because it takes time to find alternatives, demand is often more
inelastic in the short term. If the price of chocolate went up, demand would be inelastic since
there are no alternatives; but, if the price of Cadbury went up, there are close counterparts in the
form of other chocolate, therefore demand would be more elastic.

Graphical representation of Demand Elasticity.

Figure Ep is also known as the elasticity co-efficient or the coefficient of price elasticity of
demand, and it is used to determine how sensitive the market is to demand. Due to the downward
dip of the demand curve, either P or Q change must be negative. The outcome is that the ratio
(Ep) is negative. This is why, in order to obtain a positive coefficient value, we must employ a
negative sign. Demand elasticity is always negative in relation to the price of the commodity. As
a result, demand and price are inversely related. When expressing the price elasticity of demand,
the negative sign is almost never used. The minus symbol is recognised.

Conclusion

The concept of demand elasticity is crucial when it comes to pricing and calculating output
levels. It assists businesses, particularly monopolists, in determining product prices. We can
determine the fraction of demand that will decrease in response to a price rise if we know the
elasticity of demand. A provider can charge a high price for a product if demand is particularly
inelastic. If demand is relatively elastic, he may charge a low price. When enacting statutory
price limits and levying taxes on a product, the elasticity of demand also contributes in the
formation of government policy.

The government can levy higher taxes on products with somewhat inelastic demand. The
income elasticity of demand must be known when forecasting future demand for a product.
Because India's general income levels are expected to rise, demand for items purchased with
disposable income would soar. In international commerce, the concept of demand elasticity is
extremely important. If a country sells low-demand-elasticity commodities and buys high-
demand-elasticity ones, it is said to profit from international trade.
The interest rate's value flexibility evaluates its responsiveness to value transformations; it is
determined by isolating the rate change desired by the rate change in cost. Request is cost
inelastic if the outright worth of the value versatility of interest is less than one; request is value
flexible if the outright worth is equal to one; and request is value versatile if the outright worth is
more than one. The upper half of any direct interest bend has value flexible interest, whereas the
bottom half has cost inelastic interest. The unit cost is flexible at the midway point. When a
request is cost inelastic, the total revenue shifts toward a value change. When the request is unit
value flexible, the absolute revenue does not vary in response to a value change.

References

 https://en.wikipedia.org/wiki/Price_elasticity_of_demand#History

 https://www.economicshelp.org/microessays/equilibrium/price-elasticity-demand/

 https://www.analyticssteps.com/blogs/elasticity-demand-and-its-types

 https://www.investopedia.com/ask/answers/040715/which-factors-are-more-important-
determining-demand-elasticity-good-or-service.asp