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1] Define Managerial Economics

According to McNair and Meriam, "Managerial Economics consists of the use of economic modes of thought to analyse business situation." Spencer and Siegelman have defined Managerial Economics as "The integration of economic theory with business practice for the purpose of facilitating decision making and forward planning by management." We may, therefore define Managerial Economics as the discipline which deals with the application of economic theory to business management. Managerial Economics thus lies on the borderline between economics and business management and serves as a bridge between economics and business management.

2] Discuss the features/characteristics of managerial economics


It would be useful to point out certain chief characteristics of Managerial Economics, in as much its they throw further light on the nature of the subject matter and help in a clearer understanding thereof. 1. Managerial Economics is micro-economic in character. 2. Managerial Economics largely uses that body of economic concepts and principles, which is known as 'Theory of the firm' or 'Economics of the firm'. In addition, it also seeks to apply Profit Theory, which forms part of Distribution Theories in Economics. 3. Managerial Economics is pragmatic. It avoids difficult abstract issues of economic theory but involves complications ignored in economic theory to face the overall situation in which decisions are made. Economic theory appropriately ignores the variety of backgrounds and training found in individual firms but Managerial Economics considers the particular environment of decision making. 4. Managerial Economics belongs to normative economics rather than positive economics (also sometimes known as Descriptive Economics). In other words, it is prescriptive rather than descriptive. The main body of economic theory confines itself to descriptive hypothesis, attempting to generalize about the relations among different variables without judgment about what is desirable or undesirable. For instance, the law of demand states that as price increases. Demand goes down or vice-versa but this statement does not tell whether the outcome is good or bad. Managerial Economics, however, is concerned with what decisions ought to be made and hence involves value judgments.

What is the scope of managerial economics?


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Managerial Economics deals with allocating the scarce resources in a manner that minimizes the cost. As we have already discussed, Managerial Economics is different from microeconomics and macro-economics. Managerial Economics has a more narrow scope - it is actually solving managerial issues using micro-economics. Wherever there are scarce resources, managerial economics ensures that managers make effective and efficient decisions concerning customers, suppliers, competitors as well as within an organization. The fact of scarcity of resources gives rise to three fundamental questionsa. What to produce? b. How to produce? c. For whom to produce? To answer these questions, a firm makes use of managerial economics principles. The first question relates to what goods and services should be produced and in what amount/quantities. The managers use demand theory for deciding this. The demand theory examines consumer behaviour with respect to the kind of purchases they would like to make currently and in future; the factors influencing purchase and consumption of a specific good or service; the impact of change in these factors on the demand of that specific good or service; and the goods or services which consumers might not purchase and consume in future. In order to decide the amount of goods and services to be produced, the managers use methods of demand forecasting. The second question relates to how to produce goods and services. The firm has now to choose among different alternative techniques of production. It has to make decision regarding purchase of raw materials, capital equipments, manpower, etc. The managers can use various managerial economics tools such as production and cost analysis (for hiring and acquiring of inputs), project appraisal methods( for long term investment decisions),etc for making these crucial decisions. The third question is regarding who should consume and claim the goods and services produced by the firm. The firm, for instance, must decide which is its niche market-domestic or foreign? It must segment the market. It must conduct a thorough analysis of market structure and thus take price and output decisions depending upon the type of market. Managerial economics helps in decision-making as it involves logical thinking. Moreover, by studying simple models, managers can deal with more complex and practical situations. Also, a general approach is implemented. Managerial Economics take a wider picture of firm, i.e., it deals with questions such as what is a firm, what are the firms objectives, and what forces push the firm towards profit and away from profit. In short, managerial economics

emphasizes upon the firm, the decisions relating to individual firms and the environment in which the firm operates. It deals with key issues such as what conditions favour entry and exit of firms in market, why are people paid well in some jobs and not so well in other jobs, etc. Managerial Economics is a great rational and analytical tool. Managerial Economics is not only applicable to profit-making business organizations, but also to non- profit organizations such as hospitals, schools, government agencies, etc.

4] Distinguish between Economics & Managerial Economics?


Managerial Economics can be said as the combination of business practices with economic theory. This is done as to ease future planning and decision-making with the aid of management. Traditional economics can be said as the economic system where the allotment of available resources is done on the base of inheritance. Managerial Economics Managerial economics is a course of the MBA program. The main objective of this course is to make the students realize the link of economics within business management. Many of the Indian universities provide courses in managerial economics. The qualification needed by a student to pursue the course in managerial economics is a graduate degree in any discipline. Students who are going to sit for their finals are eligible to apply too. It is possible for students of managerial economics to get jobs in the teaching sector or with leading corporates. Some of the areas where Managerial Economics is employed are:

Capital Budgeting Determination of Demand Price Analysis Production Analysis Risk Analysis

Traditional economics Almost all the colleges in India offer students with course in traditional economics. It is available at both the graduate as well as postgraduate levels. The basic eligibility criterion that is needed for students to study the graduate course is a pass in standard 12. After the completion of this program, students can either go for advanced studies or get jobs with some leading firms. If they opt for higher studies, they can then go for further specialism in the form of a Ph.D. Some of the areas where it is possible for students can get good jobs are with:

Banks Business Journals And Newspapers Finance And Investment Firms Government Enterprises Private Sector Public Undertakings

Key differentiators between Managerial Economics and Traditional Economics The main differences between Managerial Economics &Traditional Economics are:

The norms of Traditional economies are stated by religion, tradition and customs. The science of the effective use of scarce resources can be called as Managerial Economics. Traditional Economy generally employs prehistoric techniques and instruments. Managerial Economics employs analytical as well as statistical tools to examine economic theories as to solve practical business problems.

Traditional economics and managerial economics have their own roles in the running of out present day society. However, in todays world, the usage of traditional economics is not much. Conversely, Managerial economics is more used and it considered as most useful.

5] State & explain the law of demand. What are the exceptions to the law of demand?
Understanding Demand - Definition of Demand In economic terminology the term demand conveys a wider and definite meaning than in the ordinary usage. Ordinarily demand means a desire, whereas in economic sense it is something more than a mere desire. It is interpreted as a want backed up by the - purchasing power. Further demand is per unit of time such as per day, per week etc. moreover it is meaningless to mention demand without reference to price. Considering all these aspects the term demand can be defined in the following words, Demand for anything means the quantity of that commodity, which is bought, at a given price, per unit of time. Law Of Demand - Demand Price Relationship This law explains the functional relationship between price of a commodity and the quantity demanded of the same. It is observed that the price and the demand are inversely related which means that the two move in the opposite direction. An increase in the price leads to a fall in the demand and vice versa. This relationship can be stated as

Other things being equal, the demand for a commodity varies inversely as the price or The demand for a commodity at a given price is more than what it would be at a higher price and less than what it would be at a lower price

Exceptions of the 'Law of Demand'


In case of major bulk of the commodities the validity of the law is experienced. However there are certain situations and commodities which do not follow the law. These are termed as the exceptions to the law; these can be expressed as follows: 1. Continuous changes in the price lead to the exceptional behavior. If the price shows a rising trend a buyer is likely to buy more at a high price for protecting himself against a further rise. As against it when the price starts falling continuously, a consumer buys less at a low price and awaits a further in price. 2. Giffenss Paradox describes a peculiar experience in case of inferior goods. When the price of an inferior commodity declines, the consumer, instead of purchasing more, buys less of that commodity and switches on to a superior commodity. Hence the exception. 3. Conspicuous Consumption refers to the consumption of those commodities which are bought as a matter of prestige. Naturally with a fall in the price of such goods, there is no distinction in buying the same. As a result the demand declines with a fall in the price of such prestige goods. 4. Ignorance Effect implies a situation in which a consumer buys more of a commodity at a higher price only due to ignorance. In the exceptional situations quoted above, the demand curve becomes an upwards rising one as shown in the alongside diagram. In the alongside figure, the demand curve is positively sloping one due to which more is demanded at a high price and less at a low price

6] Enumerate various factors that influence demand.


Even though the focus in economics is on the relationship between the price of a product and how much consumers are willing and able to buy, it is important to examine all of the factors that affect the demand for a good or service. These factors include: Price of the Product There is an inverse (negative) relationship between the price of a product and the amount of that product consumers are willing and able to buy. Consumers want to buy more of a

product at a low price and less of a product at a high price. This inverse relationship between price and the amount consumers are willing and able to buy is often referred to as The Law of Demand. The Consumer's Income The effect that income has on the amount of a product that consumers are willing and able to buy depends on the type of good we're talking about. For most goods, there is a positive (direct) relationship between a consumer's income and the amount of the good that one is willing and able to buy. In other words, for these goods when income rises the demand for the product will increase; when income falls, the demand for the product will decrease. We call these types of goods normal goods. However, for some goods the effect of a change in income is the reverse. For example, think about a low-quality (high fat-content) ground beef. You might buy this while you are a student, because it is inexpensive relative to other types of meat. But if your income increases enough, you might decide to stop buying this type of meat and instead buy leaner cuts of ground beef, or even give up ground beef entirely in favor of beef tenderloin. If this were the case (that as your income went up, you were willing to buy less high-fat ground beef), there would be an inverse relationship between your income and your demand for this type of meat. We call this type of good an inferior good. There are two important things to keep in mind about inferior goods. They are not necessarily low-quality goods. The term inferior (as we use it in economics) just means that there is an inverse relationship between one's income and the demand for that good. Also, whether a good is normal or inferior may be different from person to person. A product may be a normal good for you, but an inferior good for another person. The Price of Related Goods As with income, the effect that this has on the amount that one is willing and able to buy depends on the type of good we're talking about. Think about two goods that are typically consumed together. For example, bagels and cream cheese. We call these types of goods compliments. If the price of a bagel goes up, the Law of Demand tells us that we will be willing/able to buy fewer bagels. But if we want fewer bagels, we will also want to use less cream cheese (since we typically use them together). Therefore, an increase in the price of bagels means we want to purchase less cream cheese. We can summarize this by saying that when two goods are complements, there is an inverse relationship between the price of one good and the demand for the other good.

On the other hand, some goods are considered to be substitutes for one another: you don't consume both of them together, but instead choose to consume one or the other. For example, for some people Coke and Pepsi are substitutes (as with inferior goods, what is a substitute good for one person may not be a substitute for another person). If the price of Coke increases, this may make Pepsi relatively more attractive. The Law of Demand tells us that fewer people will buy Coke; some of these people may decide to switch to Pepsi instead, therefore increasing the amount of Pepsi that people are willing and able to buy. We summarize this by saying that when two goods are substitutes, there is a positive relationship between the price of one good and the demand for the other good. The Tastes and Preferences of Consumers This is a less tangible item that still can have a big impact on demand. There are all kinds of things that can change one's tastes or preferences that cause people to want to buy more or less of a product. For example, if a celebrity endorses a new product, this may increase the demand for a product. On the other hand, if a new health study comes out saying something is bad for your health, this may decrease the demand for the product. Another example is that a person may have a higher demand for an umbrella on a rainy day than on a sunny day. The Consumer's Expectations It doesn't just matter what is currently going on - one's expectations for the future can also affect how much of a product one is willing and able to buy. For example, if you hear that Apple will soon introduce a new iPod that has more memory and longer battery life, you (and other consumers) may decide to wait to buy an iPod until the new product comes out. When people decide to wait, they are decreasing the current demand for iPods because of what they expect to happen in the future. Similarly, if you expect the price of gasoline to go up tomorrow, you may fill up your car with gas now. So your demand for gas today increased because of what you expect to happen tomorrow. This is similar to what happened after Huricane Katrina hit in the fall of 2005. Rumors started that gas stations would run out of gas. As a result, many consumers decided to fill up their cars (and gas cans), leading to long lines and a big increase in the demand for gas. This was all based on the expectation of what would happen. The Number of Consumers in the Market As more or fewer consumers enter the market this has a direct effect on the amount of a product that consumers (in general) are willing and able to buy. For example, a pizza shop located near a University will have more demand and thus higher sales during the fall

and spring semesters. In the summers, when less students are taking classes, the demand for their product will decrease because the number of consumers in the area has significantly decreased.

7] What is the importance of ceteris paribus in the statement of the law of demand?
Defintion of Ceteris Paribus Ceteris Paribus is a latin phrase meaning 'all other things remaining equal' The concept of ceteris paribus is important in economics because in the real world it is usually hard to isolate all the different variables. Example of Ceteris Paribus in Economics An increase in interest rates will 'ceteris paribus' cause demand for loans to fall. Higher interest rates increase the cost of borrowing so there will be less demand for loans. However, if confidence was high, people might still want to borrow more. Ceteris paribus assumes things like confidence remain the same

8] What do you understand by the concept of price elasticity of demand


Defining elasticity of demand Ped measures the responsiveness of demand for a product following a change in its own price. The formula for calculating the co-efficient of elasticity of demand is: Percentage change in quantity demanded divided by the percentage change in price Since changes in price and quantity nearly always move in opposite directions, economists usually do not bother to put in the minus sign. We are concerned with the co-efficient of elasticity of demand. Understanding values for price elasticity of demand If Ped = 0 then demand is said to be perfectly inelastic. This means that demand does not change at all when the price changes the demand curve will be vertical

If Ped is between 0 and 1 (i.e. the percentage change in demand from A to B is smaller than the percentage change in price), then demand is inelastic. Producers know that the change in demand will be proportionately smaller than the percentage change in price If Ped = 1 (i.e. the percentage change in demand is exactly the same as the percentage change in price), then demand is said to unit elastic. A 15% rise in price would lead to a 15% contraction in demand leaving total spending by the same at each price level. If Ped > 1, then demand responds more than proportionately to a change in price i.e. demand is elastic. For example a 20% increase in the price of a good might lead to a 30% drop in demand. The price elasticity of demand for this price change is 1.5

9] Discuss different methods of measuring price elasticity of demand


There are three methods of measuring price elasticity of demand: (1) Total Expenditure Method. (2) Geometrical Method or Point Elasticity Method. (3) Arc Method.

These three methods are now discussed in brief:


(1) Total Expenditure Method/Total Revenue Method:


Definition, Schedule and Diagram: The price elasticity can be measured by noting the changes in total expenditure brought about by changes in price and quantity demanded. (i) When with a percentage fall in price, the quantity demanded increases so much that it results in the increase in total expenditure, the demand is said to be elastic (Ed > 1). For Example: Price Per Unit ($) 20 10 Quantity Demanded 10 Pens 30 Pens Total Expenditure ($) 200.0 300.0

The figure (6.6) shows that at price of $20 per pen, the quantity demanded is ten pens, the total expenditure OABC ($200). When the price falls down to $10, the quantity demanded of pens is thirty. The total expenditure is OEFG ($300). Since OEFG is greater than OABC, it implies that change in quantity demanded is proportionately more than the change in price. Hence the demand is elastic (more than one) Ed > 1. (ii) When a percentage fall in price raises the quantity demanded so much as to leave the total expenditure unchanged, the elasticity of demand is said to be unitary (Ed = 1). For Example: Price Per Pen ($) 10 5 Quantity Demanded 30 60 Total Expenditure ($) 300 300

The figure (6.7) shows that at price of $10 per pen, the total expenditure is OABC ($300). At a lower price of $5, the total expenditure is OEFG ($300). Since OABC = OEFG, it implies that the change in quantity demanded is proportionately equal to change in price. So the price elasticity of demand is equal to one, i.e., Ed = 1. (iii) When a percentage fall in price raises the quantity demanded of a good so as to cause the total expenditure to decrease, the demand is said to be inelastic or less than one, i.e., Ed < 1. For Example: Price Per Pen ($) 5 2 Quantity Demanded 60 100 Total Expenditure ($) 300 200

In the fig (6.8) at a price of $5 per pen the quantity demanded is 50 pens. The total expenditure is OABC ($300). At a lower price of $2, the quantity demanded is 100 pens. The total expenditure is OEFG ($200). Since OEFG is smaller than OABC, this implies that the change in quantity demanded is proportionately less than the change in price. Hence price elasticity of demand is less than one or inelastic. Note: As the demand curve slopes downward, therefore, the coefficient of price elasticity of demand is always negative. The economists for convenience sake, omit the negative sign and express the price elasticity of demand by positive number. (2) Geometric Method/Point Elasticity Method: "The measurement of elasticity at a point of the demand curve is called point elasticity". The point elasticity of demand method is used as a measure of the change in the quantity demanded in response to a very small changes in price. The point elasticity of demand is defined as: "The proportionate change in the quantity demanded resulting from a very small proportionate change in price". Measurement of Geometric/Point Elasticity Method: (i) Measurement of Elasticity on a Linear Demand Curve: The price elasticity of demand can also be measured at any point on the demand curve. If the demand curve is linear (straight line), it has a unitary elasticity at the mid point. The total revenue is maximum at this point.

Any point above the midpoint has an elasticity greater than 1, (Ed > 1). Here, price reduction leads to an increase in the total revenue (expenditure). Below the midpoint elasticity is less than 1. (Ed < 1). Price reduction leads to reduction in the total revenue of the firm. Graph/Diagram:

The formula applied for measuring the elasticity at any point on the straight line demand curve is:

Ed =

%q %p

p q

The elasticity at each point on the demand curve can be traced with the help of point method as:

Ed = Lower Segment Upper Segment

In the figure (6.9) AG is the linear demand curve (1). Elasticity of demand at its mid point D is equal to unity. At any point to the right of D, the elasticity is less than unity (Ed < 1) and to the left of D, the elasticity is greater than unity (Ed > 1). (1) Elasticity of demand at point D = DG = 400 = 1 (Unity). DA 400 (2) Elasticity of demand at point E = GE = 200 = 0.33 (<1). EA 600

(3) Elasticity of Demand at point C = GC = 600 = 3 (>1). CA 200 (4) Elasticity of Demand at point C is infinity. (5) At point G, the elasticity of demand is zero. Summing up, the elasticity of demand is different at each point along a linear demand curve. At high prices, demand is elastic. At low prices, it is inelastic. At the midpoint, it is unit elastic. (ii) Measurement of Elasticity on a Non Linear Demand Curve: If the demand curve is non linear, then elasticity at a point can be measured by drawing a tangent at the particular point. This is explained with the help of a figure given below:

In figure 6.10, the elasticity on DD/ demand curve is measured at point C by drawing a tangent. At point C: Ed = BM = BC = 400 = 2 (>1). MO CA 200 Here elasticity is greater than unity. Point C lies above the midpoint of the demand curve DD/. In case the demand curve is a rectangular hyperbola, the change in price will have no effect on the total amount spent on the product. As such, the demand curve will have a unitary elasticity at all points. (3) Arc Elasticity:

Normally the elasticity varies along the length of the demand curve. If we are to measure elasticity between any two points on the demand curve, then the Arc Elasticity Method, is used. Arc elasticity is a measure of average elasticity between any two points on the demand curve. It is defined as: "The average elasticity of a range of points on a demand curve". Formula: Arc elasticity is calculated by using the following formula: 1 2 Ed = q X P + P p q1 + q2 Here: q denotes change in quantity. p denotes change in price. q1 signifies initial quantity. q2 denotes new quantity. P1 stands for initial price. P2 denotes new price. Graphic Presentation of Measuring Elasticity Using the Arc Method:

In this fig. (6.11), it is shown that at a price of $10, the quantity of demanded of apples is 5 kg. per day. When its price falls from $10 to $5, the quantity demanded increases to 12 Kgs of apples per day. The arc elasticity of AB part of demand curve DD/ can be calculated as under:

Ed = q X P1 + P2 p q1 + q2

Ed = 7 X 10 + 5 = 7 X 15 = 7 X 15 = 21 = 1.23 5 5 + 12 5 17 5 17 17 The arc elasticity is more than unity.

10] What are the different types of elasticity of demand?


The quantity of a commodity demanded per unit of time depends upon various factors such as the price of a commodity, the money income of the prices of related goods, the tastes of the people, etc., etc. Whenever there is a change in any of the variables stated above, it brings about a change in the quantity of the commodity purchased over a specified period of time. The elasticity of demand measures the responsiveness of quantity demanded to a change in any one of the above factors by keeping other factors constant. When the relative responsiveness or sensitiveness of the quantity demanded is measured to changes, in its price, the elasticity is said be price elasticity of demand. When the change in demand is the result of the given change in income, it is named as income elasticity of demand. Sometimes, a change in the price of one good causes a change in the demand for the other. The elasticity here is called cross electricity of demand. The three main types of elasticity of demand are now discussed in brief. (1) Price Elasticity of Demand: Definition and Explanation: The concept of price elasticity of demand is commonly used in economic literature. Price elasticity of demand is the degree of responsiveness of quantity demanded of a good to a change in its price. Precisely, it is defined as: "The ratio of proportionate change in the quantity demanded of a good caused by a given proportionate change in price". Formula:

The formula for measuring price elasticity of demand is: Price Elasticity of Demand = Percentage in Quantity Demand Percentage Change in Price Ed = q X P p Q Example: Let us suppose that price of a good falls from $10 per unit to $9 per unit in a day. The decline in price causes the quantity of the good demanded to increase from 125 units to 150 units per day. The price elasticity using the simplified formula will be: Ed = q X P p Q q = 150 - 125 = 25 p = 10 - 9 = 1 Original Quantity = 125 Original Price = 10 Ed = 25 / 1 x 10 / 125 = 2 The elasticity coefficient is greater than one. Therefore the demand for the good is elastic. Types: The concept of price elasticity of demand can be used to divide the goods in to three groups. (i) Elastic. When the percent change in quantity of a good is greater than the percent change in its price, the demand is said to be elastic. When elasticity of demand is greater than one, a fall in price increases the total revenue (expenditure) and a rise in price lowers the total revenue (expenditure). (ii) Unitary Elasticity. When the percentage change in the quantity of a good demanded equals percentage in its price, the price elasticity of demand is said to have unitary elasticity. When elasticity of demand is equal to one or unitary, a rise or fall in price leaves total revenue unchanged. (iii) Inelastic. When the percent change in quantity of a good demanded is less than the percentage change in its price, the demand is called inelastic. When elasticity of demand is inelastic or less than one, a fall in price decreases total revenue and a rise in its price increases total revenue. (2) Income Elasticity of Demand:

Definition and Explanation: Income is an important variable affecting the demand for a good. When there is a change in the level of income of a consumer, there is a change in the quantity demanded of a good, other factors remaining the same. The degree of change or responsiveness of quantity demanded of a good to a change in the income of a consumer is called income elasticity of demand. Income elasticity of demand can be defined as: "The ratio of percentage change in the quantity of a good purchased, per unit of time to a percentage change in the income of a consumer". Formula: The formula for measuring the income elasticity of demand is the percentage change in demand for a good divided by the percentage change in income. Putting this in symbol gives.

Ey = Percentage Change in Demand Percentage Change in Income Simplified formula: Ey = q X P p Q Example: A simple example will show how income elasticity of demand can be calculated. Let us assume that the income of a person is $4000 per month and he purchases six CD's per month. Let us assume that the monthly income of the consumer increase to $6000 and the quantity demanded of CD's per month rises to eight. The elasticity of demand for CD's will be calculated as under: q = 8 - 6 = 2 p = $6000 - $4000 = $2000 Original quantity demanded = 6 Original income = $4000 Ey = q / p x P / Q = 2 / 200 x 4000 / 6 = 0.66 The income elasticity is 0.66 which is less than one. Types: When the income of a person increases, his demand for goods also changes depending upon whether the good is a normal good or an inferior good. For normal goods, the value of

elasticity is greater than zero but less than one. Goods with an income elasticity of less than 1 are called inferior goods. For example, people buy more food as their income rises but the % increase in its demand is less than the % increase in income. (3) Cross Elasticity of Demand: Definition and Explanation: The concept of cross elasticity of demand is used for measuring the responsiveness of quantity demanded of a good to changes in the price of related goods. Cross elasticity of demand is defined as: "The percentage change in the demand of one good as a result of the percentage change in the price of another good". Formula: The formula for measuring, cross, elasticity of demand is: Exy = % Change in Quantity Demanded of Good X % Change in Price of Good Y The numerical value of cross elasticity depends on whether the two goods in question are substitutes, complements or unrelated. Types and Example: (i) Substitute Goods. When two goods are substitute of each other, such as coke and Pepsi, an increase in the price of one good will lead to an increase in demand for the other good. The numerical value of goods is positive. For example there are two goods. Coke and Pepsi which are close substitutes. If there is increase in the price of Pepsi called good y by 10% and it increases the demand for Coke called good X by 5%, the cross elasticity of demand would be: Exy = %qx / %py = 0.2 Since Exy is positive (E > 0), therefore, Coke and Pepsi are close substitutes. (ii) Complementary Goods. However, in case of complementary goods such as car and petrol, cricket bat and ball, a rise in the price of one good say cricket bat by 7% will bring a fall in the demand for the balls (say by 6%). The cross elasticity of demand which are complementary to each other is, therefore, 6% / 7% = 0.85 (negative). (iii) Unrelated Goods. The two goods which a re unrelated to each other, say apples and pens, if the price of apple rises in the market, it is unlikely to result in a change in quantity demanded of pens. The elasticity is zero of unrelated goods.

12] Discuss various factors that determine price elasticity of demand for any commodity
Demand for rail services At peak times, the demand for rail transport becomes inelastic and higher prices are charged by rail companies who can then achieve higher revenues and profits

The number of close substitutes for a good / uniqueness of the product the more close substitutes in the market, the more elastic is the demand for a product because consumers can more easily switch their demand if the price of one product changes relative to others in the market. The huge range of package holiday tours and destinations make this a highly competitive market in terms of pricing many holiday makers are price sensitive The cost of switching between different products there may be significant transactions costs involved in switching between different goods and services. In this case, demand tends to be relatively inelastic. For example, mobile phone service providers may include penalty clauses in contracts or insist on 12-month contracts being taken out The degree of necessity or whether the good is a luxury goods and services deemed by consumers to be necessities tend to have an inelastic demand whereas luxuries will tend to have a more elastic demand because consumers can make do without luxuries when their budgets are stretched. I.e. in an economic recession we can cut back on discretionary items of spending The % of a consumers income allocated to spending on the good goods and services that take up a high proportion of a households income will tend to have a more elastic demand than products where large price changes makes little or no difference to someones ability to purchase the product. The time period allowed following a price change demand tends to be more price elastic, the longer that we allow consumers to respond to a price change by varying their purchasing decisions. In the short run, the demand may be inelastic, because it takes time for consumers both to notice and then to respond to price fluctuations Whether the good is subject to habitual consumption when this occurs, the consumer becomes much less sensitive to the price of the good in question. Examples such as cigarettes and alcohol and other drugs come into this category Peak and off-peak demand - demand tends to be price inelastic at peak times a feature that suppliers can take advantage of when setting higher prices. Demand is more elastic at off-peak times, leading to lower prices for consumers. Consider for example the charges made by car rental firms during the course of a week, or the cheaper deals available at hotels at weekends and away from the high-season. Train fares are also higher on Fridays (a peak day for travelling between cities) and also at peak times during the day The breadth of definition of a good or service if a good is broadly defined, i.e. the demand for petrol or meat, demand is often fairly inelastic. But specific brands of petrol or beef are likely to be more elastic following a price change

Q14]What is meant by production function? Describe its important features


In micro-economics, a production function is a function that specifies the output of a firm for all combinations of inputs. A meta-production function (sometimes metaproduction function) compares the practice of the existing entities converting inputs into output to determine the most efficient practice production function of the existing entities, whether the most efficient feasible practice production or the most efficient actual practice production.[3]clarification needed In either case, the maximum output of a technologicallydetermined production process is a mathematical function of one or more inputs. Put another way, given the set of all technically feasible combinations of output and inputs, only the combinations encompassing a maximum output for a specified set of inputs would constitute the production function. Alternatively, a production function can be defined as the specification of the minimum input requirements needed to produce designated quantities of output, given available technology. It is usually presumed that unique production functions can be constructed for every production technology. By assuming that the maximum output technologically possible from a given set of inputs is achieved, economists using a production function in analysis are abstracting from the engineering and managerial problems inherently associated with a particular production process. The engineering and managerial problems of technical efficiency are assumed to be solved, so that analysis can focus on the problems of allocative efficiency. The firm is assumed to be making allocative choices concerning how much of each input factor to use and how much output to produce, given the cost (purchase price) of each factor, the selling price of the output, and the technological determinants represented by the production function. A decision frame in which one or more inputs are held constant may be used; for example, (physical) capital may be assumed to be fixed (constant) in the short run, and labour and possibly other inputs such as raw materials variable, while in the long run, the quantities of both capital and the other factors that may be chosen by the firm are variable. In the long run, the firm may even have a choice of technologies, represented by various possible production functions. The relationship of output to inputs is non-monetary; that is, a production function relates physical inputs to physical outputs, and prices and costs are not reflected in the function. But the production function is not a full model of the production process: it deliberately abstracts from inherent aspects of physical production processes that some would argue are essential, including error, entropy or waste. Moreover, production functions do not ordinarily model the business processes, either, ignoring the role of management. (For a primer on the fundamental elements of microeconomic production theory, see production theory basics). The primary purpose of the production function is to address allocative efficiency in the use of factor inputs in production and the resulting distribution of income to those factors. Under certain assumptions, the production function can be used to derive a marginal product for each factor, which implies an ideal division of the income generated from output into an income due to each input factor of production.

Q15]The Law of Variable Proportion .


Law of variable proportion INTRODUCTION: The law of variable proportion describes the behavior of output as the quantity of one factor is increased keeping the quantity of other factors fixed.

FUNCTION: A relationship between dependent and independent variables is called function.

PRODUCTION FUNCTION: The fundamental relationship between physical inputs and physical outputs of a firm is called production function. GENERAL PRODUCTION FUNCTION: X =f(Lb,K,Ld,Tech)...

Where; X: Lb: K: Ld: Output Labor Capital Land

Tech: Technology DEFINITION: The law of variable proportion can be started as, In a given state of technology, when the units of variable factors of production (labor) are increased with the units of other fixed factors, the marginal productivity increases at increasing rate up to a point after that point it will become less and less.

EXPLANATION OF THE LAW: The law of variable proportion can be explained with the help of table and graph.

SCHEDULE: Land 10 10 10 10 10 10 10 Labour 1 2 3 4 5 6 7 TP AP 10 10 30 15 60 20 80 20 90 18 90 15 80 11.5 MP 10 20 30 20 10 0 -10 Stages First First First Second Second Third Third TP, AP & MP decrease Relationship TP increase MP increase MP>AP MP & AP decrease TP increase

EXPLANATION: In the above schedule units of variable factors (labor) are employed with the other fixed factors of production. The marginal productivity of labor goes on increase up to 3rd worker. After the 3rd worker the marginal productivity goes on falling on wards till it drops down to zero at the 6th unit of labor. The 7th worker is responsible in making the making the marginal productivity negative. The marginal productivity (MPL) and average productivity (APL) equalize at the 4th worker then MPL falls more sharply.

Diagram:

EXPLANATION OF DIAGRAM: We can explain diagram into three stages. Stage 1:

This stage starts from 1st unit to 3rd unit of labor. In this stage TP, AP and MP curves are increasing. Stage 2: This stage starts from 4th unit to 5th unit of labor. In this stage TP curve increasing while MP and AP curves are decreasing. Stage 3: This stage starts from 6th to 7th unit of labor. In this stage TP curve first reaches to its top point and then began to decrease. AP curve also decreases. MP curve first reaches to zero then becomes negative.

ASSUMPTIONS OF THE LAW: The law holds good only under the following assumptions Short Run Technique of production Fix Factor Variable Factor

Homogeneous Agricultural Commodities Demand, Supply, Wages & Rent

Short Run: The law operates only in short run. Technique of Production: The technique of production remains unchanged. Fix Factor: Land assumes as a fix factor. Variable Factors: Labor is the variable factor.

Homogeneous: All the units of labor are homogeneous. Agricultural Commodities: We are producing agricultural commodities. Demand, Supply, Wages and Rent: There is no change in demand, supply, wages and rent.

LIMITATIONS OF THE LAW: Following are the limitations of the law. Labor Long Run Equally Efficient Wrong Division New Soil (Earth)

16] Discuss various economies of scale.


When more units of a good or a service can be produced on a larger scale, yet with (on average) less input costs, economies of scale (ES) are said to be achieved. Alternatively, this means that as a company grows and production units increase, a company will have a better chance to decrease its costs. According to theory, economic growth may be achieved when economies of scale are realized. Adam Smith identified the division of labor and specialization as the two key means to achieve a larger return on production. Through these two techniques, employees would not only be able to concentrate on a specific task, but with time, improve the skills necessary to perform their jobs. The tasks could then be performed better and faster. Hence, through such efficiency, time and money could be saved while production levels increased. Just like there are economies of scale, diseconomies of scale (DS) also exist. This occurs when production is less than in proportion to inputs. What this means is that there are inefficiencies within the firm or industry resulting in rising average costs. Internal and External Economies of Scale

Alfred Marshall made a distinction between internal and external economies of scale. When a company reduces costs and increases production, internal economies of scale have been achieved. External economies of scale occur outside of a firm, within an industry. Thus, when an industry's scope of operations expands due to, for example, the creation of a better transportation network, resulting in a subsequent decrease in cost for a company working within that industry, external economies of scale are said to have been achieved. With external ES, all firms within the industry will benefit. Where Are Economies of Scale? In addition to specialization and the division of labor, within any company there are various inputs that may result in the production of a good and/or service.

Lower input costs: When a company buys inputs in bulk - for example, potatoes used to make French fries at a fast food chain - it can take advantage of volume discounts. (In turn, the farmer who sold the potatoes could also be achieving ES if the farm has lowered its average input costs through, for example, buying fertilizer in bulk at a volume discount.)

Costly inputs: Some inputs, such as research and development, advertising, managerial expertise and skilled labor are expensive, but because of the possibility of increased efficiency with such inputs, they can lead to a decrease in the average cost of production and selling. If a company is able to spread the cost of such inputs over an increase in its production units, ES can be realized. Thus, if the fast food chain chooses to spend more money on technology to eventually increase efficiency by lowering the average cost of hamburger assembly, it would also have to increase the number of hamburgers it produces a year in order to cover the increased technology expenditure.

Specialized inputs: As the scale of production of a company increases, a company can employ the use of specialized labor and machinery resulting in greater efficiency. This is because workers would be better qualified for a specific job - for example, someone who only makes French fries - and would no longer be spending extra time learning to do work not within their specialization (making hamburgers or taking a customer's order). Machinery, such as a dedicated French fry maker, would also have a longer life as it would not have to be over and/or improperly used. Techniques and Organizational inputs: With a larger scale of production, a company may also apply better organizational skills to its resources, such as a clear-cut chain of command, while improving its techniques for production and distribution. Thus, behind the counter employees at the fast food chain may be organized according to those taking in-house orders and those dedicated to drive-thru customers. Learning inputs: Similar to improved organization and technique, with time, the learning processes related to production, selling and distribution can result in improved efficiency - practice makes perfect!

External economies of scale can also be realized from the above-mentioned inputs as a result of the company's geographical location. Thus all fast food chains located in the same area of a certain city could benefit from lower transportation costs and a skilled labor force. Moreover, support industries may then begin to develop, such as dedicated fast food potato and/or cattle breeding farms. External economies of scale can also be reaped if the industry lessens the burdens of costly inputs, by sharing technology or managerial expertise, for example. This spillover effect can lead to the creation of standards within an industry. But Diseconomies Can Also Occur As we mentioned before, diseconomies may also occur. They could stem from inefficient managerial or labor policies, over-hiring or deteriorating transportation networks (external DS). Furthermore, as a company's scope increases, it may have to distribute its goods and services in progressively more dispersed areas. This can actually increase average costs resulting in diseconomies of scale. Some efficiencies and inefficiencies are more location specific, while others are not affected by area. If a company has many plants throughout the country, they can all benefit from costly inputs such as advertising. However, efficiencies and inefficiencies can alternatively stem from a particular location, such as a good or bad climate for farming. When ES or DS are location specific, trade is used in order to gain access to the efficiencies. Is Bigger Really Better? There is a worldwide debate about the effects of expanded business seeking economies of scale, and consequently, international trade and the globalization of the economy. Those who oppose this globalization, as seen in the demonstrations held outside World Trade Organization (WTO) meetings, have claimed that not only will small business become extinct with the advent of the transnational corporation, the environment will be negatively affected, developing nations will not grow and the consumer and workforce will become increasingly less visible. As businesses get bigger, the balance of power between demand and supply could become weaker, thus putting the company out of touch with the needs of its consumers. Moreover, it is feared that competition could virtually disappear as large companies begin to integrate and the monopolies created focus on making a buck rather than thinking of the consumer when determining price. The debate and protests continue. Conclusion The key to understanding ES and DS is that the sources vary. A company needs to determine the net effect of its decisions affecting its efficiency, and not just focus on one particular source. Thus, while a decision to increase its scale of operations may result in decreasing the average cost of inputs (volume discounts), it could also give rise to diseconomies of scale if its subsequently widened distribution network is inefficient because not enough transport trucks were invested in as well. Thus, when making a strategic decision to expand, companies need to balance the effects of different sources of ES and DS so that the average cost of all

decisions made is lower, resulting in greater efficiency all around.

18] What is meant by the term cost? Discuss different types of cost.
An amount that has to be paid or given up in order to get something. In business, cost is usually a monetary valuation of (1) effort, (2) material, (3) resources, (4) time and utilities consumed, (5) risks incurred, and (6) opportunity forgone in production and delivery of a good or service. All expenses are costs, but not all costs (such as those incurred in acquisition of an income-generating asset) are expenses.

Types of Costs Fixed cost Fixed cost involves all the expenditure done on fixed factors of production. However, the fixed costs remain constant i.e. they do not vary with the level of output. For instance, interest, insurance premium, rent and wages of permanent employees are categorized as fixed costs. Variable cost Variable cost can be defined as the cost that does remain constant i.e. it varies with the level of output. For example, salaries of employees appointed on day to day basis and expenditure made on fuel, power and raw material. Opportunity cost It is quite true that the resources are limited; therefore the production of one commodity can only be made possible at the cost of other. The good that is given up is the opportunity cost of the commodity manufactured. Accounting cost The accounting cost outlines actual expenditure incurred during the production. Economic cost Aggregate of implicit cost, normal profits and explicit cost. Explicit cost Explicit cost embraces all the money payments done to the suppliers who provide the company with raw materials or many other equipments used in production etc. Implicit cost Implicit cost is the aggregate cost of self owned resources. Total cost curves in short run Total Fixed Cost (TFC)

Total Fixed Cost (TFC) is a straight line curve that does not change with the level of output, even in the situation when output is zero unit or one hundred units it remains same all through the course. For example, interest on bonds, insurance premium etc is considered as total fixed cost. Total Variable Cost (TVC) Total Variable cost is the cost that is directly proportional to output which implies that TVC increases when output increases and decreases when output decreases. Total Cost (TC) Total Cost (TC) is derived by adding Total fixed cost (TFC) and Total variable cost (TVC). All the changes occurring in TC are due to changes in TVC due to the fact that TFC remains constant. TC = TFC + TVC Where, TC = Total Cost TFC = Total Fixed Cost TVC = Total Variable Cost

The table below highlights the relation between TFC, TVC and TC.

Unit cost curves in short run Average Fixed Cost (AFC) There exist an inverse association between AFC and output which implies that AFC decreases with increase in output and vice-versa. AFC = TFC/ Q Where, AFC = Average Fixed Cost TFC= Total Fixed Cost Q= Units of output Average Variable Cost (AVC) Average Variable cost can be easily calculated by dividing Total Variable Cost by output. AVC = TVC/Q Where, AVC = Average Variable Cost TVC = Total Variable Cost Q = Units of output Average Total cost (ATC) or Average cost (AC) Average Total cost or Average cost can be estimated by any of the two methods mentioned below: First method;

ATC = TC/Q Where, ATC = Average Total Cost TC = Total Cost Q = Units of output Second method; ATC = AFC + AVC Where, ATC = Average Total Cost AFC = Average Fixed Cost AVC = Average Variable Cost Marginal Cost (MC) MC can be defined as the increase in total cost resulting from to one unit increase in the level of output. MC = TC /Q Where, MC = Marginal Cost TC = Change in Total Cost Q = Change in Quantity

The table below highlights the relation between TC, AC and MC:

20] What is meant by Monopoly? What are its main features?


A situation in which a single company or group owns all or nearly all of the market for a given type of product or service. By definition, monopoly is characterized by an absence of competition, which often results in high prices and inferior products. According to a strict academic definition, a monopoly is a market containing a single firm. In such instances where a single firm holds monopoly power, the company will typically be forced to divest its assets. Antimonopoly regulation protects free markets from being dominated by a single entity. These four characteristics mean that a monopoly has extensive (boarding on complete) market control. Monopoly controls the selling side of the market. If anyone seeks to acquire the production sold by the monopoly, then they must buy from the monopoly. This means that the demand curve facing the monopoly is the market demand curve. They are one and the same.

The characteristics of monopoly are in direct contrast to those of perfect competition. A perfectly competitive industry has a large number of relatively small firms, each producing identical products. Firms can freely move into and out of the industry and share the same information about prices and production techniques. A monopolized industry, however, tends to fall far short of each perfectly competitive characteristic. There is one firm, not a lot of small firms. There is only one firm in the market because there are no close substitutes, let alone identical products produced by other firms. A monopoly often owes its monopoly status to the fact that other potential producers are prevented from entering the market. No freedom of entry here. Neither is there perfect information. A monopoly firm often has specialized information, such as patents or copyrights, that are not available to other potential producers. Single Supplier The essence of a monopoly is a market controlled by a single seller. The "mono" part of monopoly means single. This "mono" term is also the source of such words as monarch--a single ruler; monochrome--a single color; monk--a solitary religious figure; monocle--an eyeglass for one eye; and monolith--a single large stone. The "poly" part of monopoly means to sell. So the word itself, monopoly, means a single seller. The single seller, of course, is a direct contrast to perfect competition, which has a large number of sellers. In fact, perfect competition could be renamed multipoly or manypoly, to contrast it with monopoly. The most important aspect of being a single seller is that the monopoly seller IS the market. The market demand for a good IS the demand for the output produced by the monopoly. This makes monopoly a price maker, rather than a price taker. A hypothetical example that can be used to illustrate the features of a monopoly is Feet-First Pharmaceutical. This firm owns the patent to Amblathan-Plus, the only cure for the deadly (but hypothetical) foot ailment known as amblathanitis. As the only producer of AmblathanPlus, Feet-First Pharmaceutical is a monopoly with extensive market control. The market demand for Amblathan-Plus is THE demand for Amblathan-Plus sold by Feet-First Pharmaceutical. Unique Product To be the only seller of a product, however, a monopoly must have a unique product. Phil the zucchini grower is the only producer of Phil's zucchinis. The problem for Phil, however, is that gadzillions of other firms sell zucchinis that are indistinguishable from those sold by Phil. Amblathan-Plus, in contrast, is a unique product. There are no close substitutes. Feet-First Pharmaceutical holds the exclusive patent on Amblathan-Plus. No other firm has the legal authority to produced Amblathan-Plus. And even if they had the legal authority, the secret formula for producing Amblathan-Plus is sealed away in an airtight vault deep inside the fortified Feet-First Pharmaceutical headquarters. Of course, other medications exist that might alleviate some of the symptoms of amblathanitis. One ointment temporarily reduces the swelling. Another powder relieves the redness. But nothing else exists to cure amblathanitis completely. A few highly imperfect

substitutes exists. But there are no close substitutes for Amblathan-Plus. Feet-First Pharmaceutical has a monopoly because it is the ONLY seller of a UNIQUE product. Barriers to Entry and Exit A monopoly is generally assured of being the ONLY firm in a market because of assorted barriers to entry. Some of the key barriers to entry are: (1) government license or franchise, (2) resource ownership, (3) patents and copyrights, (4) high start-up cost, and (5) decreasing average total cost. Feet-First Pharmaceutical has a few these barriers working in its favor. It has, for example, an exclusive patent on Amblathan-Plus. The government has decreed that Feet-First Pharmaceutical, and only Feet-First Pharmaceutical, has the legal authority to produce and sell Amblathan-Plus. Moreover, the secret ingredient used to produce Amblathan-Plus is obtained from a rare, genetically enhanced, eucalyptus tree grown only on a Brazilian plantation owned by FeetFirst Pharmaceutical. Even if another firm knew how to produce Amblathan and had the legal authority to do so, they would lack access to this essential ingredient. A monopoly might also face barriers to exiting a market. If government deems that the product provided by the monopoly is essential for well-being of the public, then the monopoly might be prevented from leaving the market. Feet-First Pharmaceutical, for example, cannot simply cease the production of Amblathan-Plus. It is essential to the health and welfare of the public. This barrier to exit is most often applied to public utilities, such as electricity companies, natural gas distribution companies, local telephone companies, and garbage collection companies. These are often deemed essential services that cannot be discontinued without permission from a government regulation authority. Specialized Information Monopoly is commonly characterized by control of information or production technology not available to others. This specialized information often comes in the form of legallyestablished patents, copyrights, or trademarks. While these create legal barriers to entry they also indicate that information is not perfectly shared by all. The AT&T telephone monopoly of the late 1800s and early 1900s was largely due to the telephone patent. Pharmaceutical companies, like the hypothetical Feet-First Pharmaceutical, regularly monopolize the market for a specific drug by virtue of a patent. In addition, a monopoly firm might know something or have a piece of information that is not available to others. This "something" may or may not be patented or copyrighted. It could be a secret recipe or formula. Perhaps it is a unique method of production. One example of specialized information is the special, secret formula for producing Amblathan-Plus that is sealed away in an airtight vault deep inside the fortified Feet-First Pharmaceutical headquarters. No one else has this information.

21] Discuss different types of monopolies.

A monopoly occurs when only one company sells a particular product on the market. A product can be a good, such as jewelry, computers or energy, or it can be a service, such as garbage disposal or sewage removal. Economists differentiate between different types of monopolies based on why the monopoly exists, such as where the barrier to entry for new companies comes from, which could be high entry costs or legal restrictions.

Natural Monopoly

A natural monopoly occurs when the type of industry makes it financially impractical, if not impossible, for multiple companies to engage in the business. For example, if you had multiple companies attempting to offer sewage services, that would require multiply sewer lines running to homes which is financially--and likely spatially-impossible. This makes the sewage industry a natural monopoly.

Geographic Monopolies

Geographic monopolies occur when there is only one company that offers a particular good or service in an area. For example, in a small town there may only one general store, which has a monopoly on the goods it sells. Because of the small size of the town, it may not be financially feasible for another company to come in--if the profits were split neither business would make money.

Technological Monopolies

Technological monopolies occur when the good or service the company provides is has legal protection in the form of a patent or copyright. For example, if a company develops and patents a drug to cure brain cancer, that company has a legal monopoly over that drug.

Government Monopolies

Sometimes a government will pass laws reserving a specific trade, product or service for government agencies. For example, many times a government agency will be in charge of running water. The legal barriers that are put up prevent other companies from competing with the government.

22] What are the different barriers to entry in the market?


Barriers to market entry include a number of different factors that restrict the ability of new competitors to enter and begin operating in a given industry. For example, an industry may require new entrants to make large investments in capital equipment, or existing firms may

have earned strong customer loyalties that may be difficult for new entrants to overcome. The ease of entry into an industry in just one aspect of an industry analysis; the others include the power held by suppliers and buyers, the existing competitors and the nature of competition, and the degree to which similar products or services can act as substitutes for those provided by the industry. It is important for small business owners to understand all of these critical industry factors in order to compete effectively and make good strategic decisions. "Understanding your industry and anticipating its future trends and directions gives you the knowledge you need to react and control your portion of that industry," Kenneth J. Cook explained in his book The AMA Complete Guide to Strategic Planning for Small Business. "Since both you and your competitors are in the same industry, the key is in finding the differing abilities between you and the competition in dealing with the industry forces that impact you. If you can identify abilities you have that are superior to competitors, you can use that ability to establish a competitive advantage." The ease of entry into an industry is important because it determines the likelihood that a company will face new competitors. In industries that are easy to enter, sources of competitive advantage tend to wane quickly. On the other hand, in industries that are difficult to enter, sources of competitive advantage last longer, and firms also tend to develop greater operational efficiencies because of the pressure of competition. The ease of entry into an industry depends upon two factors: the reaction of existing competitors to new entrants; and the barriers to market entry that prevail in the industry. Existing competitors are most likely to react strongly against new entrants when there is a history of such behavior, when the competitors have invested substantial resources in the industry, and when the industry is characterized by slow growth. In his landmark book Competitive Strategy: Techniques for Analyzing Industries and Competitors, Michael E. Porter identified six major sources of barriers to market entry: 1. Economies of scale. Economies of scale occur when the unit cost of a product declines as production volume increases. When existing competitors in an industry have achieved economies of scale, it acts as a barrier by forcing new entrants to either compete on a large scale or accept a cost disadvantage in order to compete on a small scale. There are also a number of other cost advantages held by existing competitors that act as barriers to market entry when they cannot be duplicated by new entrants such as proprietary technology, favorable locations, government subsidies, good access to raw materials, and experience and learning curves. 2. Product differentiation. In many markets and industries, established competitors have gained customer loyalty and brand identification through their long-standing advertising and customer service efforts. This creates a barrier to market entry by forcing new entrants to spend time and money to differentiate their products in the marketplace and overcome these loyalties. 3. Capital requirements. Another type of barrier to market entry occurs when new entrants are required to invest large financial resources in order to compete in an industry. For example, certain industries may require capital investments in inventories or production facilities. Capital requirements form a particularly strong barrier when the capital is required for risky investments like research and development. 4. Switching costs. A switching cost refers to a one-time cost that is incurred by a buyer as a result of switching from one supplier's product to another's. Some examples of

switching costs include retraining employees, purchasing support equipment, enlisting technical assistance, and redesigning products. High switching costs form an effective entry barrier by forcing new entrants to provide potential customers with incentives to adopt their products. 5. Access to channels of distribution. In many industries, established competitors control the logical channels of distribution through long-standing relationships. In order to persuade distribution channels to accept a new product, new entrants often must provide incentives in the form of price discounts, promotions, and cooperative advertising. Such expenditures act as a barrier by reducing the profitability of new entrants. 6. Government policy. Government policies can limit or prevent new competitors from entering industries through licensing requirements, limits on access to raw materials, pollution standards, product testing regulations, etc. It is important to note that barriers to market entry can change over time, as an industry matures, or as a result of strategic decisions made by existing competitors. In addition, entry barriers should never be considered insurmountable obstacles. Some small businesses are likely to possess the resources and skills that will allow them to overcome entry barriers more easily and cheaply than others. "Low entry and exit barriers reduce the risk in entering a new market, and may make the opportunity more attractive financially," Glen L. Urban and Steven H. Star explained in their book Advanced Marketing Strategy. But "in many cases, we would be better off selecting market opportunities with high entry barriers (despite the greater risk and investment required) so that we can enjoy the advantage of fewer potential entrants."

23] Explain, with the help of diagram, the equilibrium of a monopoly firm.
Monopoly Diagram Short Run and Long Run
Readers Question Explain with the help of diagrams the equilibrium of a firm having monopoly power in the market in the short-run and long-run?

The diagram for a monopoly is generally considered to be the same in the short run as well as the long run. Profit Maximisation occurs where MR=MC. Therefore equilibrium is at Qm, Pm. Features of this diagram

There are barriers to entry in Monopoly. Firms are price makers. The industry demand curve is the same as the firms demand curve. Profits are maximised at output where MR=MC. This means they set a price greater than MC which is allocatively inefficient. In this diagram the firms makes supernormal profits because AR is greater than AC.

Long Run Average Costs

It is assumed monopolies have a degree of economies of scale, which enables them to benefit from lower long run average costs. Note: In monopolistic competition the short run equilibrium is different to the long run equilibrium

24] What do you understand by the term price discrimination?


Price discrimination or price differentiation[1] 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. Otherwise, the moment the seller tries to sell the same good at different prices, the buyer at the lower price can arbitrage by selling to the consumer buying at the higher price but with a tiny discount. However, product heterogeneity, market frictions or high fixed costs (which make marginal-cost pricing unsustainable in the long run) can allow for some degree of differential pricing to different consumers, even in fully competitive retail or industrial markets. Price discrimination also occurs when the same price is charged to customers which have different supply costs. The effects of price discrimination on social efficiency are unclear; typically such behavior leads to lower prices for some consumers and higher prices for others. Output can be expanded when price discrimination is very efficient, but output can also decline when

discrimination is more effective at extracting surplus from high-valued users than expanding sales to low valued users. Even if output remains constant, price discrimination can reduce efficiency by misallocating output among consumers. 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 are 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. Price discrimination in intellectual property is also enforced by law and by technology. In the market for DVDs, DVD players are designed - by law - with chips to prevent an inexpensive copy of the DVD (for example legally purchased in India) from being used in a higher price market (like the US). 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) 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.

25] How does a monopoly firm allocate its total output in different market segments under price discrimination? 26] What are the conditions of perfect competition? Explain their significance.
When economists analyze the production decisions of a firm, they take into account the structure of the market in which the firm is operating. The structure of the market is determined by four different market characteristics: the number and size of the firms in the market, the ease with which firms may enter and exit the market, the degree to which firms' products are differentiated, and the amount of information available to both buyers and sellers regarding prices, product characteristics, and production techniques. Four characteristics or conditions must be present for a perfectly competitive market structure to exist. First, there must be many firms in the market, none of which is large in terms of its sales. Second, firms should be able to enter and exit the market easily. Third, each firm in the market produces and sells a nondifferentiated or homogeneous product. Fourth, all firms and

consumers in the market have complete information about prices, product quality, and production techniques. Price-taking behavior. A firm that is operating in a perfectly competitive market will be a price-taker. A price-taker cannot control the price of the good it sells; it simply takes the market price as given. The conditions that cause a market to be perfectly competitive also cause the firms in that market to be price-takers. When there are many firms, all producing and selling the same product using the same inputs and technology, competition forces each firm to charge the same market price for its good. Because each firm in the market sells the same, homogeneous product, no single firm can increase the price that it charges above the price charged by the other firms in the market without losing business. It is also impossible for a single firm to affect the market price by changing the quantity of output it supplies because, by assumption, there are many firms and each firm is small in size.

Explain, how does a firm operating in perfect competition attain equilibrium In the short-run.
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A perfectly competitive firm maximizes profit by producing the quantity of output that equates marginal revenue and marginal cost. In that price equals marginal revenue for a perfectly competitive firm, price is also equal to marginal cost. In other words, the firm produces by moving up and down along its marginal cost curve. The marginal cost curve is thus the perfectly competitive firm's supply curve. Because the marginal cost curve is positively sloped due to the law of diminishing marginal returns, so too is the firm's supply curve. And because all firm's in a perfectly competitive industry have positively-sloped marginal cost curves, the market supply curve for the entire industry is also positively sloped. This offers a prime explanation for the law of supply. Insight Into Supply The analysis of the short-run production decisions for a perfectly competitive firm has direct implications for the market supply curve and the law of supply. The primary conclusion is that a perfectly competitive firm's short-run supply curve is that segment of its marginal cost curve that lies above the average variable cost curve. A perfectly competitive firm produces the quantity of output that equates marginal revenue, which is equal to price, and marginal cost, as long as price exceeds average variable cost. The profit-maximizing choices of output at alternative prices generates the perfectly competitive firm's short-run supply curve. Consider three key points: 1. A profit-maximizing firm produces the quantity of output that equates marginal revenue and marginal cost (MR = MC).

2. A perfectly competitive firm is characterized by the equality between price and marginal revenue (P = MR). 3. The law of diminishing marginal returns gives the marginal cost curve a positive slope. Combining all three points means that a profit-maximizing perfectly competitive firm produces the quantity of output that equates price and marginal cost (P = MC).

An increase in the price, moves the profit-maximizing quantity to a higher point on the positively-sloped marginal cost curve, and a larger production quantity. A decrease in the price, moves the profit-maximizing quantity to a lower point on the positively-sloped marginal cost curve, and a smaller production quantity.

Working a Graph To illustrate, consider the production and supply decision made by Phil the zucchini grower, a hypothetical firm. Because Phil is one of gadzillions of zucchini producers, each producing identical products and each with a relatively small part of the overall market, he has no market control. As such, Phil is a price taker. He must react to the price determined by the interaction of market demand and market supply, making adjustments in his own production to accommodate higher or lower market prices. This graph displays Phil's U-shaped cost curves representing his zucchini production. Note that all three curves (average total cost, average variable cost, and marginal cost) are U-shaped. The marginal cost curve is U-shaped as a direct consequence of increasing, then decreasing marginal returns. As a profit-maximizing zucchini producer, Phil produces the quantity of zucchinis that equates the going market price with marginal cost. Phil's supply response to changing prices can be observed by... well... by changing prices then noting Phil's supply response. One place to begin is with a price of say $4. A click of the [$4] button reveals that Phil maximizes profit by producing 7 pounds of zucchinis. The quantity supplied by Phil at a $4 price is thus 7 pounds zucchinis. This price/quantity supplied combination is one point on Phil's zucchini supply curve. What might Phil do if he faces different prices. Consider a higher price. A click of the [$6] button reveals that Phil maximizes profit in this case by producing almost 8 pounds of zucchinis. This higher price induces Phil to increase his quantity supplied from 7 to almost 8. How about an $8 price? A click of the [$8] button reveals that Phil maximizes profit by producing about 8.5 pounds of zucchinis. Once again, a higher price motivates Phil to increase his quantity supplied. Bumping the price up to $10, Short-Run Supply

seen with a click of the [$10] button results in an even greater quantity supplied, 9 pounds of zucchinis. Does Phil reduce the quantity supplied if the price declines? Up to a point. That point being the minimum of the average variable cost curve, about $2.75. If the price falls below this level, then Phil shuts down production in the short run, incurring a lost equal to total fixed cost. The conclusion from this analysis is that the marginal cost curve that lies above the average variable cost is Phil's short-run supply curve. A click of the [Short-Run Supply] button highlights Phil's zucchini supply curve. Only Perfect Competition This short-run supply curve explanation relies on Phil being a perfectly competitive price taker. The marginal cost curve is a supply curve only because a perfectly competitive firm equates price with marginal cost. This happens only because price is equal to marginal revenue for a perfectly competitive firm. Should price and marginal revenue NOT be equal, then a profit-maximizing firm does NOT equate price to marginal cost. As such, the marginal cost curve is NOT the firm's supply curve. Because perfect competition does not exist in the real world, most real world firms do not have equality between price and marginal revenue, and thus do not equate price to marginal cost. In fact, real world firms with varying degrees of market power do not have supply curves comparable to that of an idealistic perfectly competitive firm. This recognition is a major stumbling block in the explanation of the law of supply and the role that the law of supply is plays in market analysis.

Explain, with the help of diagram, the shut down point for a firm under perfect competition.
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In the short run, a firm operating at a loss [R < TC (revenue less than total cost) or P < ATC (price less than unit cost)] must decide whether to continue to operate or temporarily shutdown.[14] The shutdown rule states "in the short run a firm should continue to operate if price exceeds average variable costs."[15] Restated, the rule is that for a firm to continue producing in the short run it must earn sufficient revenue to cover its variable costs.[16] The rationale for the rule is straightforward. By shutting down a firm avoids all variable costs.[17] However, the firm must still pay fixed costs.[18] Because fixed cost must be paid regardless of whether a firm operates they should not be considered in deciding whether to produce or shutdown. Thus in determining whether to shut down a firm should compare total revenue to total variable costs (VC) rather than total costs (FC + VC). If the revenue the firm is

receiving is greater than its total variable cost (R > VC) then the firm is covering all variable cost plus there is additional revenue (contribution), which can be applied to fixed costs. (The size of the fixed costs is irrelevant as it is a sunk cost. The same consideration is used whether fixed costs are one dollar or one million dollars.) On the other hand if VC > R then the firm is not even covering its production costs and it should immediately shut down. The rule is conventionally stated in terms of price (average revenue) and average variable costs. The rules are equivalent (If you divide both sides of inequality TR > TVC by Q gives P > AVC). If the firm decides to operate, the firm will continue to produce where marginal revenue equals marginal costs because these conditions insure not only profit maximization (loss minimization) but also maximum contribution. Another way to state the rule is that a firm should compare the profits from operating to those realized if it shutdown and select the option that produces the greater profit.[19][20] A firm that is shutdown is generating zero revenue and incurring no variable costs. However, the firm still has to pay fixed cost. So the firms profit equals fixed costs or (- FC).[21] An operating firm is generating revenue, incurring variable costs and paying fixed costs. The operating firm's profit is R - VC - FC. The firm should continue to operate if R - VC - FC - FC which simplified is R VC.[[22][23] The difference between revenue, R, and variable costs, VC, is the contribution to fixed costs and any contribution is better than none. Thus, if R VC then firm should operate. If R < VC the firm should shut down. A decision to shut down means that the firm is temporarily suspending production. It does not mean that the firm is going out of business (exiting the industry).[24]] If market conditions improve, and prices increase, the firm can resume production. Shutting down is a short-run decision. A firm that has shut down is not producing. The firm still retains its capital assets; however, the firm cannot leave the industry or avoid its fixed costs in the short run. Exit is a long-term decision. A firm that has exited an industry has avoided all commitments and freed all capital for use in more profitable enterprises.[25] However, a firm cannot continue to incur losses indefinitely. In the long run, the firm will have to earn sufficient revenue to cover all its expenses and must decide whether to continue in business or to leave the industry and pursue profits elsewhere. The long-run decision is based on the relationship of the price and long-run average costs. If P AC then the firm will not exit the industry. If P < AC, then the firm will exit the industry. These comparisons will be made after the firm has made the necessary and feasible long-term adjustments. In the long run a firm operates where marginal revenue equals long-run marginal costs