Managerial Economics

By- Dr G.N.Bag,
Mob:9438029262,7873665292
E.mail- baggunanidhi3@gmail.com

Managerial Economics is concerned with the application of economic

theory and methods of decisions sciences to analyse decision-making
problems faced by business firms.

Problems:- 1. Choice of product

2. Price and output of the product
3. Techniques of production
4. Sales promotion .

Economic Decisions Managerial

Theory Sciences Economics
 A. Economics and Managerial
Economics
Science of economics- Allocation of scarce resources to alternative uses so as to achieve
maximum satisfaction of the people.
L.Robins defines economics as a “Science which studies human behaviour as a relationship between
ends and scarce means which have alternative uses”.
Economic theory;-a. Microeconomic theory- deals with the theory of decision-making by
individual consumers/firm/producer etc.
b. Macroeconomic theory-deals with the economy as a whole and its various
aggregates such as national income, employment, general price level, government policies,
economic environment, aggregate demand conditions,investment, rate of interest, business cycle
etc.

Managerial economics deals with allocation of firm’s scarce resources so as to get maximum profit.
 (A)

Micro Unlimited
Economic wants
Theory

Economic
Theory
Macro Limited
Economic resources
Theory
 B. Decisions sciences and Managerial
Economics
• a. Optimisation techniques-
• (i) Differential calculus – rate of change of output
• (ii) Linear Programming -find the best solution out of many alternatives are used to analyse available or alternative
courses of action and their evaluation so as to select the right technique that helps to achieve its objective.
• b. Methods of statistical estimation
• c. Game theory

• Managerial economics refers to the application of economic theory and methods of decisions sciences to arrive at the
optimal solution to the various problems faced by manangers of business firms.

Business decision-making
• A manager has limited resources and plenty of problems to solve in order to get the set target.
a. To identify alternative course of action
b. Rational choice.
c. Price and output
d. Demand estimation
e. Choice of technique
f. Advertisement decision
g. Production decision for short and long run
h. Investment decision.
 (B)
Optimisation Differential
Techniques Calculus

Linear
Decisions Statistical
Programming
Sciences Estimation

Game Theory
• Economics is a study of the choice-making behaviour of the people. It is a science
of choice only.
• “Managerial Economics is the integration of economic theory with business
practice for the purpose of facilitating decision making and forward planning by
manager”-Spencer and Seigelman.
• Many business decisions are taken under conditions of uncertainty and risk.
• Managerial economics can be compared with medical science. Apparently, the
knowledge of medical science helps in diagnosing the disease and prescribing an
appropriate medicine so also managerial economics helps in analyzing the
business problems and in arriving at an appropriate decision.
• The law of Equi-marginal Utility or law of maximum satisfaction(
Mux=Muy=Mum) helps the manager to take a right decision while allocating
scarce resources in business firm. Equally he must use the concept opportunity
cost(the next best alternative that has been foregone) in his management decision
so as to get the required technique in course of production too.
 Managerial decision making process

• 1. Objective- set an objective to achieve.

• 2. Identification of problem- must define the problem for analysis.
• 3.Identifying alternative solutions- finding out available solutions.
• 4.Evaluating alternative courses of action- select the best technique.
• 5. Implementing the decision– risk taking but rational choice.

• Manager has to take a prudent decision in order to attain his objective i.e. profit for his
firm.
 Demand Analysis

• Meaning of demand-
• It is a desire backed by purchasing power of money. It is the willingness to pay
and ability to pay on the part of the consumer for a commodity or goods.
• In managerial economics we are concerned with the demand for a product facing
a firm. Demand for product plays important role in the determination of a firm’s
profitability.
• Demand has a great influence on the firm.
• 1. Fixation of price.
• 2. Expansion of production
• 3.Investment decision i.e. finance.
• 4. Use of human resources- employment.
• 5. Use of technique- efficiency of technology.
• 6 Size of advertisement and market structure.
 Individual and market demand, Change in demand and change in quantity
demanded.

• Individual demand- the demand for a commodity that is demanded by a

consumer at various prices during a given period of time.
• Market demand for a good is the total sum of the demands of all individual
consumers who purchase the commodity at various prices in the market in a
period.
• Change in quantity demanded and change or shift in demand:
• Change in quantity demanded depends on the price of the commodity in a
given time. Here the quantity of a commodity depending upon the price of
that commodity alone. whereas change in demand or shift in demand refers
to commodity and not the price which depends on income, taste and
preference , price of related goods and advertisement.
Direct demand and derived demand
The goods which is desired(demanded) by the consumer and gives direct
satisfaction is called direct demand. The goods demanded by the consumer
indirectly i.e. demanded other goods to produce the desired goods is called
indirect demand.For instance machine, raw materials etc.
 Law of demand

• Law of demand states that if the price of a commodity falls , the

quantity of it will rise and vice versa , other things being constant( ceteri
paribus). There is an inverse relationship between price and quantity of
commodity demanded. So demand of a commodity is the function of the
price of that commodity alone , other things remaining constant. It is
written as Qx = f(Px)
• Table
• Price(Rs) Quantity demanded(Kg)
• 10 50
• 20 30
• 30 10
 Law of demand, its slopes and limitations

• The demand curve usually slopes downward to the right. In the diagram, it is seen that DD i.e.
demand curve slopes downward to the right.
• In the given diagram OX axis represents Quantity demanded and OY axis represents price of the
commodity.

• Demand curve slopes downward to the right

• 1. Income Effect
• 2. Substitution Effect
• 3. Law of Diminishing marginal Utility
• 4. Number of consumers
• 5. Various uses of goods
• ……………………….
• Demand of an individual is interdependent ……… fashion………called Bandwagon effect and Snob
effect ( prestige –oriented goods)…
 Exceptions or Limitations of law of Demand, Determinants of Demand

• law of demand fails to operate i.e. law of demand does not hold good because of the
following reasons.
• 1. Giffen goods………… it is pointed out by Sir Robert Giffen.
• 2. Precious goods- Veblen effect………Propounded by Thorstein Veblen
• 3. Expectations of further price rise in future.
• Determinants of demand
• Generally,there are certain factors that determined the demand of a commodity.
• Besides price of the commodity other non-price factors influence the demand of the
commodity which causes demand curve to shifts rightward or leftward .
• A. Income of the consumers (Y)
• B. Tastes and preferences of the consumers (T)
• C. Changes in the price of related goods. (Py)
• D. Population(P)
Demand is a functions of some determinants only , It is expressed as ……………………………
• Qx= f(Px, Y, Py, T, A,P) , where Qx=f (Px)….. Change in quantity demanded
• and Qx= f ( Y, Py, T, A,P)…………..Change in demand or shift in demand.
 Elasticity of Demand

• Apparently ,the of law of demand indicates only the direction of change in quantity demanded of a
commodity in response to a change in its price.
• It does not tell about the about the magnitude that quantity demanded changes due to a change
in its price. It fails to tell how much quantity of a goods varies to a change in its price.
• Whereas elasticity of demand speaks about the amount or quantity of goods that is demanded to
a change in its price. In other words, elasticity of demand of a goods explains the extent the
quantity demanded of a goods will change as a result of a change in its price .
• Elasticity of demand ,therefore, refers to the degree of responsiveness of quantity demanded of a
goods to a change in its price, income of the consumer and prices of related goods.

• Hence, law of demand is a qualitative statement and elasticity of demand is a quantitative

statement.

• Elasticity of demand has three concepts:

• 1. Price Elasticity of demand (ep)
• 2. Income elasticity of demand (ey)

• 3. Cross elasticity of demand (ecr)

 Types of Price elasticity of demand

• Usually, price elasticity of demand is always positive , irrespective of its sign i.e. (-) or (+).
• It is the ratio of the percentage change in quantity demanded of a commodity to a given
percentage change in price.

e p= Percentage change in quantity demanded

Percentage change in price
Demand is said to be elastic when the percentage change in quantity demanded of a commodity
is greater than the percentage change in price.
Demand is said to be inelastic when a given percentage change in price of a commodity brings a
smaller percentage change in quantity demanded of that commodity.
Types of Price elasticity on the basis of its change in its degree of quantity demanded.
1. Perfectly elastic demand
2. Perfectly inelastic demand
3. Unitary elastic demand
4. Lesser than one elastic demand
5. Greater than one elastic demand
 Determinants of Price elasticity of demand

• The following factors determine price elasticity of demand for a commodity.

• 1.Nature of goods- whether it is necessary or luxury goods.
• Necessary goods – inelastic in nature
• Luxury goods- elastic in nature
• 2. Availability of substitute- close substitute goods-elastic
• N o substitute- inelastic
• 3.Proportion of income spent-
• greater portion of income spent on a commodity-elastic
• lesser or neglibible income spent- inelastic
• 4.Various uses of goods-
• more uses- elastic and once used goods-inelastic
• 5.Time period-
• longer the time to use a goods-elastic
• Shorter the time period for a goods- inelastic
•
 Measurement of Price elasticity of demand

• There are basically three methods of measuring price elasticity of demand.

• 1. Total Expenditure method
• 2.Proportionate or percentage method
• 3. Mid-point method

• Q. Maruti Udyog Pvt. Ltd. Sold for an amount of 5000 rupees of Maruti Van @ 500/- per Van in Bhubaneswar city in the
year 2018 whereas due to economic condition of the country the company forced to reduce it s price of the said Van to Rs
300 . However ,the demand for the Van increased very insignificantly brought an amount of Rs 6000/- only . Find out the
elasticity of the Van.

• Q. The elasticity of the mobile phone is greater than one and the price per mobile sold out is 15 rupees a piece and
brought a revenue of Rs 3000 rupees in total in 2018. The total amount of revenue increased to 4500 when price of
mobile reduced to Rs 12/- per piece. Find out the quantity of mobile sold out in the next phase of the Nokia and its exact
elasticity of demand please.

• INCOME ELASTICITY OF DEMAND

• The degree of responsiveness of quantity demanded of a good to a small change in

income of the consumer is called income elasticity of demand. It is the ratio of the
proportionate change in the quantity purchased of a good to the proportionate
change in income.
 Income Elasticity and Cross Elasticity of demand

• ey= Proportionate change in purchase of a goods

• Pproportionate change in income
• It is the ratio of the proportionate change in the quantity purchased of a
goods to the proportionate change in income which induces the
consumer.
• Normal goods=positive income elasticity of demand
• Inferior goods= negative income elasticity of demand
• Luxury goods= greater than one income elasticity of demand
• Necessaries goods= less than one income elasticity of demand

• ec=Proportionate change in the quantity demanded of X

• Proportionate change in the price of goods Y
 Cross Elasticity of demand

• The degree of responsiveness of change in the demand for one goods in response to change
in the price of another goods represents the cross elasticity of demand of one goods for the
other.

• Demand Estimation
• Adequate information regarding price and output of the product and its data from the
empirical relationship between the changes in factors affecting demand and the quantity
demanded of a product require immensely. Thus estimation of demand is more important by
Manager of a firm to achieve his goal i.e. to get maximum profit with growth too. From the
estimation of demand function it is very easy to predict the price ,income and other factors
of a product.
• For estimation of demand , there are certain methods to be followed such as:-
• 1. Consumer Surveys
• 2. Consumer Clinics
• 3.Market Experiments
• 4.Statistical Technique of Regression Analysis.
 ESTIMATION OF DEMAND

• 1. Consumer surveys- The technique of consumer surveys involves

• (a) through direct interaction(interview with the consumer
• (b) through a suitable questionnaire
• Consumer surveys provide useful information and data about demand relationships to the
firms for formulating price , output and advertising strategies. Some parameters of the
demand function can be predicted for further estimation of demand. Of course, consumer
surveys is unable to provide correct and reliable information.
• 2.Consumer Clinics:-It is similar to laboratory experiments where some selected individuals
are given some amounts of money and asked to spend on certain goods kept in a particular
store(( termed as clinic).
• Consumer clinic is more realistic than consumer surveys but to set up such clinic is very
expensive and the participants may not reveals their true character in respect to goods they
wanted . They are not free to express their desire under such artificial market condition.
• 3.Market experiments:-Under this, firm may vary price or some other determinants of the
product and estimate effect on quantity demanded. This method is very good to assess the
effect of demand but it has some shortcomings too. It is very risky on the cost aspect of the
firm as some consumer may leave for other firm because of changes in the price or other
determinants.
 Demand estimation

• 4.Regression analysis:-
• Regression analysis is statistical technique to estimate demand for a product. This method
helps to estimate unknown variable(dependent) by observing known
variable(independent).Quantity of goods can be estimated by observing the changes in the
determinants of the demand for a goods. It involves following steps:-
• 1. Identification of variables
• 2. Data collection
• 3. Choice of functional form- linear and multiplicative demand model
• 4.Estimating the parameters of the demand equation
• 5. Interpretation of estimated demand function.
• To estimate the regression line or estimation line , there are two normal equations:-
• Regression Equation of Y on X is Yc=a+bX , Regression Equation of X on Y is Xc=a+bY
• and two parameters i.e. a and b are constants. It determines the position of the line. So
these constants are called the parameters of the line. The parameter ‘a’ determines the level
of the fitted line. The parameter ‘b’ determines the slope of the line.
 Regression analysis

• Normal equations are: 1. Regression of Y on X

• EY=Na+bEX
• EXY=aEX+bEX2……………………………..(I)
•

• 2. Regression of X on Y
• EX= Na+bEY
• EXY=aEY+bEY2…………………………(II)

• Where b=EXY
• EX2 or b=EXY
• EY2
 Demand forecasting

• Forecasting demand means prediction of future demand for firm’s product. Forecasting of future demand one of
the most important functions of managers of firms. It reduces uncertainty of environment in which business
decisions are made. It also important for calculating rate of return on capital investment. Demand forecasting is
needed not only by established firms but also by the new firms who are planning to enter an industry.
• The knowledge about the future demand for the product helps a great deal in the following areas of business
decision-making.
• 1. Plamnning and scheduling production
• ,2. Acquiring inputs
• ,3.Making provison for finances
• .,4.formulating pricing strategy
• ,5. Planning advertisement.

• There are two types of demand forecasting:-

• 1. Short-term forecasts:- period up to one year ………it is made in order to know the effect of present policies of
the firm relating to relative price, advertising outlay, product model etc. on the demand for the product and also
due to changes in government’s fiscal and monetary policies.
2. Long-term forecasts:- more than one year or so. It relates to those forecasts which are made for a period of
five, ten or even twenty years. Long term forecasts of demand are made when a new product has to be launched.
More sophisticated techniques such as econometric or statistical methods are used to make long term forecasts.
 Demand forecasting- methods

• Methods :-
• 1. Consumer surveys:- (i) Complete enumeration (ii) Sample survey
• 2. Expert opinion:- (i) Delphi Technique (ii) Sales force
• 3. Market Experiments:- (i) test marketing (ii) Controlled experiments.
• 4. Time series:- Statistical data which are collected, observed or recorded at successive
intervals of time is generally referred to as time series. When we observe numerical
data at different points of time the set of observations is known as time series.

• a= EY b =EXY
• N EX2 EY=Na+bEX
• EXY=aEX+bEX2 Where EX=0

• Component of time series:-1. Secular Trend,2. Seasonal Trend,3. Cyclical trend,4.

Irregular trend.
• Y=T x S x C x I in a multiplicative model.Y=T+S+C+I is an additive model.
• Methods of determining trend:- 1. Free hand graphic 2. Semi-average 3. Moving
average.4. Method of least square.
 Time series

• .
5 Econometric method:- Econometric is use statistical methods and economic
theory to estimate the casual relationship between economic variables.
Econometric model is that it not only forecast an economic phenomenon but also
explains the magnitude of change in it.
• SUPPLY ANALYSIS
• Supply refers to the schedule of the quantities of a goods that the firms are able
and willing to offer for sale at various prices.
• Basically , production of goods on the part of the firm depends on the ;-(i)
resources available and (ii)the technology that firm adopts during a period of
time of course.
• But the magnitude of goods of the firms will be willing to offer for sale depends
on the profit they expect to make on producing and selling the goods.
• Profits in turn depends on the price of the goods on the one hand and unit cost of
production on the other.
 Supply and quantity supplied

• Supply refers to the offer of goods for sale by the firm at different prices during a given
period of time. Quantity supplied refers to the quantity of a goods offer for sale at a
particular price at a given time.

• Supply is a flow concept and not a stock .Production of goods by firm is not the same with
the goods actually sold. Sometimes the quantity which the firms are willing to produce and
sell at a price is greater than the quantity demanded, so the quantity actually bought and
sold is less than the quantity supplied.
• Factors determining supply of a goods are:-
• 1. Price of the commodity
• 2. Prices of inputs
• 3. The state of technology
• 4. The number of firms producing and selling the commodity
• 5. The prices of related goods produced
• 6. Future expectations regarding prices.
• Q= f( Px….F1, F2……..Fn, T)
 Law of supply

• Supply of a commodity functionally related to its price positively. The law of supply depicts
the functional relationship between goods supplied and its price. The law of supply explains a
direct relationship between price and quantity supplied.
• According to the law of supply , when the price of a commodity rises, the quantity supplied
of it in the market increases, and when the price of the commodity falls, its quantity supplied
decreases, other factors determining supply remaining the same.
• Price Qty supplied(kg of X)
• 10 150
• 20 200
• 25 300
• 30 350
 Increase and decrease of supply

• Shifting of supply curve rightward or leftward depends upon the following reasons:-
• Change of technology, prices of related goods, price of inputs, monsoon, future expectations
of prices, taxes and subsidies , other than price of the goods supplied in fact influences the
shift in supply curve rightward or leftward respectively.

•
• Elasticity of supply.
• The degree of responsiveness of supply to changes in price of a good. The percentage change
in quantity supplied of a good in response to a given percentage change in price of the goods.

• es=
• Mid-point method is more accurate to measure supply elasticity of demand.
 Supply function and elasticity of supply

• The linear supply function for a commodity is of the following form:-

• Q=c+dP
• Where Q is quantity supplied of a commodity, P is its price and c and d are constants.The
constant coefficent d represents the slope of the supply function and indicates how quantity
supplied changes in response to a change in price.
• That is ,d= Change in Q
• Change in P
• d is positive and it shows supplied changes due to the change in its price only.

• es= d P
• Q
• Supply function is to estimate elasticity of supply
• Q= 100+20P if price is 10
• es= 20 x 10
• 100 = 2
•
 Factors determining Elasticity of supply

• Determining price of a goods depends upon the elasticity of supply. The greater the elasticity
of supply of a product , the less the rise in its price when demand for it increases.

• Factors determing elasticity of supply:

• 1. Changes in MC of production.
• 2. Response of the Producers
• 3. Availability of Inputs for Expanding Output.
• 4. Possibilities of substitution of one Product for the Others.
• 5. The Length of time.
• Market period- perfectly inelastic supply curve
• short period- less elastic supply curve
• Long period- more elastic supply curve.
• ……………………………………………………
 Concepts of cost
• Supply of goods not only depends on price but it also equally depends on the cost of
production. Hence cost of production is very important to determine the level of output
and the amount of profit and the growth process of the firms. Generally cost means the
amount of expenditure incurred by the firm in the process of producing goods and services
in a given period of time.
• Types of cost
• 1. Opportunity cost;-The opportunity cost of product is the value of the next best
alternative product that is forgone so as to release resources for greater production of the
former.
• 2.Explicit Cost;- The accounting cost is called explicit cost because the entrepreneur
incurred some expenditure for which he paid to the outsiders for acquiring their services
and goods as raw materials for his production of goods.
• 3.Implicit cost;-The expenditure that would have incurred but not incurred in the
accounting sense is called implicit cost. The manager or entrepreneur must have used his
money as capital and used his skill to manage firm for which he is not paid . Had he
worked somewhere else or use his capital, he would have earn some . So the amount he
would have earned had he used it somewhere else constitutes implicit cost.
• Economic costs=Accounting (explicit) costs+ Implicit costs.
• Economic Profits=Total Revenue-Economic costs
 Cost functions

• Time is very important which influences greatly in the determination of cost of production.
• Hence, there are two time periods such as – (i)Short Run cost and (ii)Long Run cost
• Short-run Costs are those costs which are incurred by the firm on the purchases of labour,
raw materials, chemicals, fuels etc.which vary with the changes in the level of output.
• Long –run Costs are those costs incurred during a period which is sufficiently long to allow
the variation in all factors of production including capital equipment, land and management
staff to produce output.
• Basically there are two factors such as Fixed factor and Variable factor in short period.
During short period the level of out put varies with the variation of the variable factor only,
keeping the fixed factor fixed .In the short-run costs , it is total cost that comprises of total
fixed cost anf total variable cost.
• TC=FC+VC or TC= TFC+TVC
• AFC= TFC
• Q
• AVC=TVC
• Q
 Costs function

• ATC= AFC+AVC or ATC=TC

• Q
• MC= The additional cost added to total cost because of the changes in the unit of goods
produced. Mc= d(TC)
• dQ
In the short-run, the cost curve usually U-shaped.
• In the long run there is no fixed cost and variable costs. The time is long enough for changing
the fixed factor so all costs are variable cost. And costs curve take less pronounced u –
shaped.
• The act of production involves the transformation of inputs into outputs. Theory of
production helps managers of firms in deciding how to combine various factors or inputs
most efficiently to produce desired output. the relation between inputs and output of a firm
has been called production function.
• The time period in which at ;least one factor or input is fixed and production is incresed by
varying other factors is called the short-period.The study of short-run production function
when at least one factor is kept fixed forms the subject of Law of variable proportions
 Law of variable proportions

• This law is also called law of returns.(diminishing, increasing ).

• Assumptions.
• 1.Technology is unchanged
• 2.One factor i.e. capital is fixed
• 3.It does apply where a fixed proportions of factors are used.
 Law of variable proportions

• 1 and end of stage1st stage-(increasing return)Total product increases at a increasing rate to

a point( inflection point).The marginal product is maximum, after which it stats diminishing.
The average product curve reaches its highest point and stage-I ends here.
• 2nd stage-The total product continues to increase at a diminishing rate until it reaches a
point where the Marginal product is zero and the stage-2 ends here.
• 3rd stage-the total product declines and marginal product is negative
• A rational producer produces in between the end of stage-2.
Law of returns to scale
• In the long-period when all factors of production are variable this law is applicable.
 Long-run production functions

• In the long-run factor proportions are altered when factors or inputs are variable with the
changes of output. The proportionate changes in both the factors bring about a change in the
scale. Thus an increase in the scale means that all inputs or factors used in a production
process are increased in the same proportion.
• The term returns to scale refers to the degree by which output changes as a result of a
given proportionate change in the amount of all factors(inputs) used in production.

• Q=f(L,K)
• Increasing Returns to scale ( or D.C.)-This occurs because of the following:-
• 1.Indivisibility of the factors-some factors are available in large unit and can be utilised
efficiently at a large level only.
• 2. Specialisation of labour and machinery:-In a large scale specialization is cost effective.
• 3. Economies of scale-
• Increasing returns to scale means output increases in a greater proportion than the increase
in inputs.
• Equal increases in out put are obtained by successively smaller and smaller increments in
inputs.
 Returns to scale

• Constant Returns to scale( or constant cost)-:When all factors increase in a given proportion
and the output increases in the same proportion, return to scale are called constant returns
to scale. In mathematics the case of constant returns to scale is called Linear homogeneous
production function or homogeneous production function of the first degree.

• Decreasing Returns to scale (or Increasing Cost:)- When out put increases in a smaller
proportion than the increase in all inputs, it is called decreasing returns to scale.
 Economies of scale

• Under long-run a firm enjoys increasing returns to scale because of the economies of scale
in the following manner-(Internal economies and external economies0
• 1. Use of technically efficient machines-
• 2. Division of labour-
• 3.Indivisibility of factors-
• 4.Financial Economies-
• 5.Economies of scope- other product, market,advertisement,transport and storage etc.

• Diseconomies of scale
• 1. Mis-management-machine, unskilled labour,taxation, wastage
• 2. Trade Union-wages, sanitation, environment,
 Market structure-: Perfect Competition, Monopoly, Monopolistic Competition

• In economics, market is a system by which buyers and sellers bargain for the price of a
product. It is a self- ordain organization of buyers and sellers in which price of a product is
settled .Hence, market does not necessarily mean a place.
• The determination of price of a commodity depends on the number of buyers and sellers.
The number of sellers of a product in a market determines the nature and degree of
competition in the market. The nature and degree of competition make the structure of the
market.
• Depending on the number of sellers and the degree of competition, the structure in broadly
classified as follows-:
• 1. Perfect competition
• 2.Imperfect competition- (i) Monopoly (ii) Monopolistic competition (iii) Oligopoly

• The market structure determines a firm’s power to fix the price of its product and the degree
of competition determines a firm’s degree of freedom in determining price of its product. In
fact, higher the degree of competition, the lower firm’s degree of freedom in pricing
decision and control over the price of its own product and vice versa.
 Perfect competition

• Under Perfect competition market structure the following characteristics are seen generally
such as –
• 1. A large number of buyers and sellers
• 2. Homogeneous product
• 3. Perfect mobility of factors of production
• 4. Free entry and free exit of firms
• 5. Perfect knowledge about the market
• 6. No government intervention
• 7. Absence of collusion or artificial restraint.
• Price and output determination- Time plays a greater role in fixing the price goods and
position of supply too of a product.
• Market period is too short to change the supply so it takes a vertical shape and demand
curve shift forward or backward depending upon the demand condition. Price will be xied
according to the demand and supply curves.
• Short period is one in which firms can increase the variable inputs to adjust with the
demand curve and fix the price.
 Perfect competition, Monopoly

• During short period firms may make losses. But firms try to cover at least MC of the product and stay in production.
• In short-run Firms may get(i) Supernormal profit(ii) Normal profit(iii) Sub-normal profit.
• Long period is one in which firms get enough time to adjust with the changing demand and therby earn profit only.
• In long run firms earn supernormal profit and normal profit only.

• MONOPOLY
• Monopoly market is one in which there is only one seller of a product having no close substitute. Monopolized industry is
a single-firm industry. Such a monopoly has hardly ever existed.
• Characteristics of Monopoly-(i) Single seller (ii) No Close substitute (iii0 No entry and exit of firm.

AC and MC curves , in a competitive and monopoly market are generally identical but revenue conditions differ. Monopoly
firm faces a downward sloping demand curve.
Short run- Profit only
Long run– More profit but no loss

Price discrimination means selling the same product to different sections of consumers at different prices. It is possible under
monopoly only……..(i) Time(ii) Quantity (iii) Social and economic status(iv)Age and sex,colour etc.

Conditions for price discrimination:- (i) Market must be separated(ii) elasticity of demand for the product must be different.

•
 Monopolistic Competition

– Monopolistic competition is defined as market setting in which a large number of sellers

sell differentiated products .
– Characteristics-
– 1.Large number of sellers but limited
– 2.Free entry and free exit
– 3. Perfect mobility of factors of production
– 4.Complete dissemination of market information
– 5. Differentiated product but close substitute

– In short run- Firms may earn Super normal profit , normal profit and even loss.
– Long run- firms earn super normal profit but it turns to normal profit only later on.
– OLIGOPOLY
– Oligopoly market is one in which there are a few sellers selling homogeneous or
differentiated products. When it sells homogeneous product it is called pure oligopoly.
– When it sells differentiated product it is called heterogeneous oligopoly.
 Features of oligopoly

• 1. Small number of sellers

• 2. Interdependence of decision-making
• 3.Barrier to entry
• 4.Indeterminate price and output
• 5. Group Behaviour
• 6.Importance of Advertising and Selling costs.
• Factors responsible for the existence of Oligopoly
• 1. Economies of scale
• 2. Huge capital Investment
• 3. Patent rights
• 4. Control over certain raw materials
• 5. Merger and takeover
• 6. Product differentiation
 Price-output determination under Oligopoly

• Because of the interdependence of firms in oligopoly and the uncertainty about the reaction
patterns of the rivals , the easy and determinate solution to the oligopoly problem is not
possible. There are various approaches to determine price-output under oligopoly market.
• The solution to determination of price-output depends upon its assumptions only. Hence
there is no single determinate solution is accepted without any fault of course.
• Oligopoly firms are more strategic oriented while dealing with the price-output. The
strategic behavior means that the oligopolistic firms must take into account he effect of
their price-output decisions on their rival firms and on the reactions they expect from
them.

• There are two types of strategies open to the Oligopolis:

• 1. Compete with their rivals to promote their individual interests
• 2.Co-operate with the rivals to promote their mutual interests to maximize joint profits.
• Ways to find the price-output solution:
• 1. Ignoring interdependence
• 2. Predicting reaction pattern and counter –moves of rivals
 Assumptions to oligopoly

• .
3 Co-operative behaviour: forming Collusion
• 4. Game theory approach to Oligopoly

• Non-cooperative Behaviour-
• ( A ) Augustin Cournot’s approach to oligopoly
• In 1838, this model called Duopoly was developed. He assumed two firms . Cournot has
concluded that each firm ultimately supplies one-third of the market and both firms charge
the same price. And one-third of the market remains unsupplied.
• Assumptions:
• 1. Two firms
• 2. MC is Zero
• 3. Demand curves slope downward 4.Each firm reacts believing that other firm will not react
to his decisions.
• (B) Paul M. Sweezy’s Kinked Demand curve model to oligopoly
 Kinked demand curve

• Developed in 1939, the kinked demand curve analysis does not deal with price and output
determination directly . Rather ,it seeks to establish that once a price-quantity combination is
determined, an oligopoly firm does not find it profitable to change its price even if there is a
considerable change in cost of production.
• There are three ways in which rival firms may react:
• 1. The rival firms follow changes ,both cut and hike.
• 2. The rival firms do not follow the price change.
• 3. the rival firms follow the price cuts but not the price hikes.
Each oligopolistic will adhere to the prevailing price seeing no gain in changing it.

• (C) Price Leadership : (i) Low-Cost (ii) Dominant firm (iii) Barometric –better knowledge
• (D) Collusion- (i)Cartel works through a Board of Control
• (ii) Tacit
• (E) Game Theory- A dominant strategy is one that gives optimum pay-off,no matter what
the opponent does.
 Pricing strategies

– In a complex business world, business firms follow a variety of pricing rules and methods
depending on the conditions faced by them.
– Important pricing strategies and pricing practices are as follows:-
– 1. Cost-plus pricing or Mark-up pricing or average-cost pricing or Full cost pricing-
The cost –plus pricing is the most common method of pricing used by the manufacturing
firms. Generally, under this method a fair percentage of profit margin is added to
average variable cost( AVC). The formula for setting the price is as follows:-
P= AVC+ AVC(m)
AVC= average variable cost, m= mark-up percentage, Avc(m)= gross profit margin(GPM).
The mark-up percentage i(m) is fixed so as to cover AFC(average fixed cost) and a net profit
margin(NPM).
AVC(m)=AFC+NPM
2. Skimming price policy:- This pricing policy is adopted where close substitute of a new
products are not available. It intended to skim the cream off the market i.e. consumer’s
surplus, by setting a high initial price followed by a series of reduction of
price(especially in durable consumer goods).
 Pricing policy

• 3.Penetration price policy:-This policy is generally adopted in the case of new product
where substitutes are available. The firms pursuing the penetration price policy set a low
price of the product in the initial stage and intended to maximize the profits in the long-run.
As the product catches the market, price is gradually raised up.
• 4.Input Pricing-This is usually seen in the agricultural sector. Input pricing refers to subsidies
on seeds,fertilisers,pesticides,machinery,water,electricity fuels and farm credit.

• CONSUMPTION FUNCTION
• Generally, consumption refers to the destruction of utility of a commodity in the process of
deriving satisfaction out of it.
• Consumption occupies a central position in the determination of income, employment in
an economy says J.M.Keynes.
• To determine equilibrium level of national income and employment, aggregate demand
aggregate supply is needed. According to Keynes, in the short period, aggregate supply is
more or less remain constant, it is the aggregate demand which is volatile for which it is
necessary to know the role of consumption and investment . It is a matter of fact that
consumption and investment or saving constitute aggregate demand in an economy.
• Y= C+I or Y=C+S therefore I=S
 Consumption Function

• Consumption depends upon the level of income. In other words consumption is a function of
income. C= f(Y) where C= a+ bY
• Where a and b are constants While a is intercept term of the consumption function, b
stands for the slope of the consumption function and therefore represents marginal
propensity to consume.
• MPC= b

• The consumption function relates the amount of consumption to the level of income.
Keynes said that:-
• (i) when income increases consumption also increases.
• (ii) consumption increases less than proportionate.
• How much consumption increases due to increase in income depends upon the marginal
propensity to consume(MPC).
• MPC= Change in Consumption
• Change in Income
• where MPC+ MPS=1 or MPC=1- MPS MPC is less than 1 but more than 0
 Consumption function

• However, in Keynesian theory, APC (average propensity to consume) falls whereas MPC
remains constant .
• APC= C/Y
• APC is the ratio of the amount of consumption to total Income.
• APC=1-APS or APS=1-APC therefore APC+APS= 1
Keynes put forward a psychological law of consumption,according to which,as the income
increases , the consumption also increases but the gap between income and consumption
is widening because consumption increases less than proportionate. The difference
between consumption and income represents savings or investment.
The assumption of diminishing average propensity to consume is a significant part of
Keynesian theory of income and employment. This implies that as income increases, a
progressively larger proportion of national income would be saved.
Determinants of consumption functions. 1. Changes in the general price level; Real balance effect:-
2. Fiscal policy
3. Stock of wealth
4. Rate of Interest
5. Credit conditions and consumer Indebtedness
6. Income Distribution
7. Windfall Gains and Losses
8. Change in Expectations.
•
 Investment function

– The real investment means the addition to the stock of physical capital. Thus, in
economics ,investment means the new expenditure incurred on addition of capital
goods such as machines, buildings, equipments, tools ,etc.
– Consumption function is more or less stable in the short run and it is the investment
function which determines the level of income of employment. Greater the investment
greater will be the level of income and employment.
– INVESTMENT:- 1. Autonomous Investment(Ia)……..(independent of income)
– Autonomous investment refers to the investment which does not depend upon
changes in the income level. This autonomous investment depends on population
growth and technical progress than on the level of income. Most of the investment
undertaken by government is of autonomous in nature.
– 2. Induced Investment(Id)………(.depends on income)
– Induce investment is that investment which is affected by the changes in the level of
income.
– Determinants of Investment
– 1. MEC( marginal efficiency of capital)……
 Investment function

• MEC is the expected rate of return from the capital assets.

• Supply price= Discounted prospective yields
• C= R1 + R2 + R3……………Rn
• (1+r) (1+r)2 (1+r)3 (1+r)n

• C= supply price.
• R1,R2, R3 Rn = represent the annual prospective yields from the capital asset.
• R+ is the rate of discount on the capital asset.
• MEC depends upon the supply price.

• 2. Rate of Interest- Higher the rate of interest lower will be the motive for investment.
• 3.Public policy
• 4.Level of economic activity
• 5.Technological change
 Saving Function

• The income not spent on consumption is defined as SAVING. Hence saving is the act of not
consuming all of one’s current income.

• S=f(Y) and Saving is residual income after consumption.

• Y=C+S where S=Y-C
• Determinants of Saving
• 1. Level of income
• 2. Income distribution
• 3. Pattern of consumption-standard of living
• 4. Wealth-
• 5. Habit- power to save and will to save
• 6. Population- age, number and political stability
• 7. Institutional factors- banking and other financial institutions
• 8. Motivational factors- to meet unforeseen situation, expectation of profit
• 9.Rate of Interest
 Business cycle

• The business cycle or trade cycle or economic cycle is the natural rise and fall of economic
growth that occurs over time. The alternating periods of expansion and contraction in
economic activity over a time period is called business cycle.
• There has been a long-run upward trend in Gross national Product(GNP), but periodically
there have been a long-run fluctuations in economic activity, that is, changes in output,
income, employment and prices around this long-trend term.
• The period of high income, output and employment has been called the period of
expansion, upswing or prosperity, and the period of low income, output and employment
has been described as contraction, recession, downswing or depression.
• In fact business cycle means fluctuations in economic activity which occurs and reoccurs
periodically in a more or less regular fashion.
• Actually, there has been no clear evidence of very regular cycles of the same definite
duration. Some business cycles have been very short lasting for only two to three years,
while others have lasted for several years.
• Fluctuations in economic activity creates a lot of uncertainty in the economy which causes
anxiety to the individuals about their future income and employment opportunities and
involve a great risk for long-run investment in projects.
 Phases of business cycle

• Phases of Business cycles:-

• 1. Expansion (boom, upswing or prosperity)
• 2. Peak( upper turning point).
• 3. Contraction ( downswing, recession or depression)
• 4. Trough (lower turning point.
•
 Phases of Business cycle

• 1. Expansion and prosperity-

• In this phase both output and employment increase till it reaches full-employment of resources
and production reaches its highest level.
• There is no involuntary unemployment and whatever unemployment prevails is only of frictional
and structural types.
• Potential GNP=Actual GNP.
• Prices rise during expansion phase.
• High standard of living
• Demand for durable goods rises.
• 2. And the economy reaches it s top called PEAK

• Then something may occur, bank start reducing credit, MEC falls. Businessmen become
pessimistic about future state of the economy. Investment falls , downswing in economic activity.
• 3. The economy reaches the trough
• GNP falls, level employment reduced. Involuntary unemployment appears, investment falls.
• There is a limit to which level of economic activity can fall. The lowest level of economic activity
called trough.
• 3. Contraction and depression-
 Phases of Business cycle

• At times of contraction or depression rate of interest falls . With lower rate of interest
people's demand for money holding increases.
• New technology emergence.
• Labour becomes cheap for hiring for the production.
• Banks offer credit with lowest interest rate
• Stimulation of investment brings about the revival or recovery of the economy. The recovery
is the turning point from depression into expansion.
• As investment rises, employment, production rises consumption increase
• Features of Business cycle
• 1.Occurs periodically.
• 2.Business cycles are synchronic( start in sector it spreads to other sectors).
• 3. Durable consumer goods affected the most due to fluctuations.
• 4.Profit fluctuates more than any other type of income.
• 5.Business cycles are international in character.- moves one country to other easily because
of trade relations.