 The amount of money that a producer receives in

exchange for the sale proceeds is known as revenue.

 For example, if a firm gets Rs. 20,000 from sale of 100
chairs, then the amount of Rs. 20,000 is known as
revenue.
 Total Revenue: Total Revenue refers to total
receipts from the sale of a given quantity of a
commodity. It is the total income of a firm.
Total Revenue = Quantity × Price
 Average Revenue (AR): Average revenue refers
to revenue per unit of output sold. It is
obtained by dividing the total revenue by the
number of units sold.
Average Revenue = Total Revenue/Quantity
 Marginal Revenue (MR): Marginal revenue is
the additional revenue generated from the
sale of an additional unit of output. It is the
change in TR from sale of one more unit of a
commodity.
MR = Change in Total Revenue/ Change
in number of units
= ∆TR/∆Q
 When you increase price, you increase
revenue on units sold (The Price Effect).
 When you increase price, you sell fewer
units (The Quantity Effect).
 If elastic: % change in quantity
demanded > % change in price.
meaning if we increase price,
our quantity
effect outweighs the price
effect, causing a decrease in
revenue.

If inelastic: % change in quantity

demanded < % change in price. The
price effect outweighs the
quantity effect, meaning if we
increase prices, the revenue
gained from the higher price
will outweigh the revenue lost
from less units sold.
 A systematic approach to pricing requires the decision
that an individual pricing situation be generalized and
codified into a policy coverage of all the principal pricing
problems.
 Policies can and should be tailored to various competitive
situations.
 A policy approach which is becoming normal for sales
activities is comparatively rare in pricing.
I. Achieving a Target Return on Investments
II. Price Stability
III. Achieving Market Share
IV. Achieving target return on Sale
V. Increase Sales Volume
VI. Prevention of Competition
VII. Increased Profits
 According to this method, the price is set to cover
the costs of material, labour, overheads and a
certain percentage of profit. Costs to be included in
the price are normally….
◦ Actual costs- costs actually incurred in the production
period.
◦ Expected costs- based on the forecasts of production and
prices.
◦ Standard costs- based on the forecasts made on the basis
of the assumption that the efficiency, sales, prices, etc., will
be normal.

 Price = Average fixed cost + Average variable cost

+ Certain percentage of profit margin
 This method ignores demand.
 This method is easy to operate; but it ignores the nature
of competition in the market.
 This method assumes that costs can be allocated to
individual products. This assumption, is unrealistic.
 It considers full costs. This is not always logical.
 Cost plus pricing suffers from the fallacy of circular
reasoning.
 Sales depend upon price, production depends upon
sales, costs depend upon production (because costs
change as level of production change) and price is said
to depend upon cost-which completes the circle!
 The firms want to ensure that they are earning profits which
they feel are 'fair'. This can be done by adding the profit
mark-up to the cost; by following the full-cost method.
 In practice, firms are uncertain about the shape of their
demand curve and about the return to capital. Thus cost plus
pricing becomes the best method of pricing.

Role of Cost-plus Pricing

 For Product Tailoring
 For Refusal Pricing
 For Monopsony Pricing
 For Public Utility Pricing
 A firm's equilibrium can be explained by comparing marginal
revenue and marginal cost at each level of output. Where
marginal revenue just covers marginal cost, a firm can
stabilize its production or output.
 The marginal cost pricing appears to suggest that the price
charged should be equal to the marginal cost.

In this method of pricing, fixed costs are ignored, because the

marginal cost represents an addition to the total cost. When
fixed costs are high, full-cost pricing is likely to make the
price uncompetitive. Marginal cost pricing avoids this
possibility.
 Many businesses do not possess the knowledge of
finding out the marginal cost and the marginal
revenue.
 Pricing has to take into account the future costs and
prices. Due to uncertainties involved on both sides,
there always arises a discrepancy between planned
profits and actual profits.
 Skimming Price
 For a new product, the demand initially is not
likely to be price-elastic. A firm can decide to skim
the cream of the market by charging a high price.
Subsequently, the price can be reduced to reach the
lower income customers.
 Penetration Price
 A firm can begin by charging a very low price to
penetrate the market. In the short-run the firm may
make losses; but in the long-run a profit can be
earned.
 Cyclical pricing:
Cyclical pricing refers to the pricing by a firm depending
on an assessment of general economic environment i.e.
boom or depression.
During the period of depression prices of manufactured
articles, share and stock fall more steeply, while during
boom period, prices of all commodities rise very
significantly.
Transfer pricing :
Transfer pricing is the setting of the price for goods and
services sold between controlled (or related) legal entities
within an enterprise.
For example, if a subsidiary company sells goods to a
parent company, the cost of those goods paid by the
parent to the subsidiary is the transfer price.
 Price leadership:
Price Leadership is a situation in which one company,
usually the dominant one in its industry, sets prices
which are closely followed by its competitors. Price
leadership is commonly used as a strategy among large
corporations.
 Policies
◦ Profit as the basis of price policy
◦ No profit basis
◦ Import-parity price
 Guidelines on Pricing Policy: The Government of India has issued
three guidelines on Pricing Policies for the public sector enterprises,
viz.,
◦ Public enterprises should be economically viable units and an all
out effort should be made to increase their efficiency and to
establish their profitability at the earliest;
◦ Public enterprises which produce goods and services in
competition with the domestic producers, the normal market
forces of demand and supply will operate and their productivity
will be governed by the prices prevailing in the market;
◦ Public enterprises which operate under monopolistic and semi-
monopolistic conditions, the pricing of their products should be
on the basis of the landed cost of comparable imported goods
which would be the normal ceiling.
In the traditional sense, the market is a place where buyers and sellers
meet each other to effect a business transaction.

It is a place, a street or a building where a number of shops dealing in a

particular commodity are located.

◦ National Markets

◦ International Markets

19
Modern View

The meaning of the term market, as understood in the above sense

is, however, traditional; and is not acceptable to the economists.

According to Jevons, an eminent English economist, it is not

necessary for the sellers to exhibit their products at a particular
place or a building.

The same view has been expressed by Cournot, the renowned

French economist.
According to him, the buyers and sellers may be away form each
other; but they may be able to establish contacts through
communication, so as to finalize the transactions.

20
It is not necessary that the market for a commodity should always
be located on a particular street or in a building.

The buyers and sellers may be away from each other and yet they
may constitute a market over the telephone or through the
internet.

When buyers and sellers are in close contact with each other, the
prices prevailing in different parts of a country would tend to
equality.

21
 Market structure refers to the number of firms in an industry and
the degree of competition among the firms. The categorization of
market structure is based on the following factors.
 Number of firms—the sellers
 Degree and nature of competition
 Level of product differentiation
 Possibility of entry and exit of the firms
 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 market structure is broadly classified as :
23
 Types of Market Competitions & its
Features
Criteria Perfect Monopolistic Oligopoly Monopoly
Competition Competition

Nature of the Homogenous Differentiated Quite Unique

product Differentiated

Number of Many Sellers Many Sellers Few Seller One Seller

Sellers
Freedom of Complete Complete Barriers to entry Barriers to entry
entry and exit freedom freedom
Pricing Price Taker somewhat Price interdependence Absolute Price
Maker of Seller Maker

Long Run Profit Normal Normal Positive High

Demand Curve Perfectly Elastic Inelastic

Elastic
Under perfect competition, the number of firms in the industry is very large.
Each firm is very small in size. A single firm action does not affect the market
supply.
Thus, each firm is a price-taker under perfect competition.
The price is determined in the market and every firm has to accept this price.

25
1. General Rule of Price Determination
◦ Under Perfect Competition, generally, demand and supply play
an equally important role in determining the price. They act
and react upon each other and determine the price at the
equilibrium point.
◦ This is called Equilibrium Price. Determination of equilibrium
price can be explained with the help of the following demand
and supply schedule and demand and supply curves.

26
27
 Concept of Firm and Industry –

Any business unit organized under one ownership and

management is called a firm.

The firm may be organized as a sole proprietorship, partnership or a

joint stock company. The form of organization can be anything. It is
necessary that the business should be owned and managed by one
management.

An industry is a group of firms dealing in the same line of business.

The ownership and management of each firm may be different; but
since all such firms are engaged in the production of the same
commodity, they are collectively called an industry. The firms in the
industry are in equilibrium.

28
 Concept of Equilibrium –

When consumer maximizes his satisfaction he is said to be in

equilibrium.

In the case of a firm, equilibrium is reached when the firm’s profits

are maximized. The ultimate aim of every firm is to maximize its
profits and that of every consumer is to maximize his satisfaction.

Like a firm, an industry can also achieve its equilibrium when all the
firms in the industry are in equilibrium.

29
 Equilibrium of Firm –
◦ There are two methods to study the equilibrium of a firm.
 Total Cost and Total Revenue method
 Marginal Cost and Marginal Revenue method

◦ Assumptions –

1. It is presumed that a firm is managed as a sole proprietary

concern.
2. Every individual proprietor aims at profit maximization.
3. The firm is producing only one commodity.

30
 The total cost incurred to
produce a given quantity is
called the Total Cost (TC).
◦ Now, the addition made to
the total cost on account of
production of one more
unit of output is called the
Marginal Cost (MC).
◦ Now, the additional
revenue received by selling
extra unit is MR.

31
The conditions of equilibrium of a firm are applicable to all the
types
of markets. i.e. they are applicable to perfect competition,
monopoly,
monopolistic competition etc. These conditions are i) MR = MC
and ii)
MC Curve must cut MR curve from below.
32
How a firm achieves equilibrium under following conditions –

1. When the firm earns supernormal profits.

2. When the firm earns only normal profits.

3. When the firm begins to incur losses.

4. When the firm is obliged to stop production.

33
 Long run equilibrium –

 Sufficient time to adjust its out put in relation to the demand.

 In this also, MC=MR

 Equilibrium of Industry –

 Equilibrium for industry is established by total supply and total

demand in the industry.
 Price is also decide by industry on the basis of demand and supply
of industry not on the basis of firm.

34
The extreme type of market, is the one where there is absence of any
competition. This is a situation, where there is only one producer, it is
called Monopoly.
Pure and Perfect Monopoly
◦ For pure monopoly to exist, the following conditions must be
satisfied :
 One firm producing in the market,
 The commodity produced should have no substitute.
Impure Monopoly
 Impure or simple monopoly exists in the market of a
commodity, where there is only one producer of the
commodity; and the commodity has no close substitute
 Since there is only one producer, the distinction between the
firm and the industry does not exist under monopoly
 The following features are
seen under simple or limited
monopoly
◦ Single Producer
◦ No Close Substitutes
◦ Barriers to entry of firms
◦ Demand Curve under
Monopoly
 Monopoly differs from perfect competition in the following important
respects.
◦ Under perfect competition, there are many buyers and many sellers. No
individual seller or buyer is able to fix or change the market price.
◦ The price under perfect competition is fixed by the interaction of total
demand and total supply in the market. It is beyond the scope of an
individual seller (firm) to influence the price by his own action. On the
other hand, under monopoly there is only one seller who is free to fix the
price, or change it, whenever he likes.
 Under perfect competition there are many firms in an industry; and all
of them are selling homogeneous products; but under monopoly the
distinction between firm and industry recedes in the background.
Since there is only one seller, firm and industry is the same under
monopoly.
 Under perfect competition there is a free entry and a free exit of
firms. There are no hindrances to the new producers who desire to
enter the industry. But under monopoly entry of new firms is
prohibited. For example, in India no new firm can be started to deal in
railways; because the monopoly of railways has been entrusted to the
Indian Railways.
 Under perfect competition, every seller is charging the same price in
the long run and is making normal profits. If a particular firm charges a
slightly higher price the customers would turn to other sellers. But
under monopoly, there is only one seller, and he can raise the price
any time; and the customers have no other alternative than to buy
from the same monopolist.
 Under perfect competition a firm attains its equilibrium when
marginal cost is equal to marginal revenue, average revenue and price.
But under monopoly, average cost is much lower than the price.

 Since under monopoly, average cost is much lower than the price, the
monopolist can earn supernormal profits in the long run. Under
perfect competition, however, a firm can earn only the Normal profits
in the long run. If it earns supernormal profits, there will be entry of
new firms and this profit would be shared by all the firms. Ultimately,
the firm would earn only the normal profit. Under monopoly, the
entry of new firms being prohibited, the monopolist can earn
supernormal profits in the long run.

 Since there are many firms operating under perfect competition, total
output in the society is larger and the price charged is also reasonable.
But under monopoly, total output is smaller and the price charged is
unreasonable.
 Marginal Cost and Marginal
Revenue
◦ Under monopoly, the firm is a
price-marker, a firm can
therefore fix the price of its
product, given the output. The
demand curve (AR curve) is
therefore, downward sloping
under monopoly, and so the
MR curve is below the AR
curve.
◦ The conditions of equilibrium
are the same as under perfect
competition, i.e.
 MR = MC and MC curve cuts
MR curve from below
 A monopolist can make either
normal profits or supernormal profits
in the short-run. A monopolist
making sub-normal profits will
remain in production in the short-run
so long as its AVC is covered.
 Thus, in the short-run under
monopoly, there are three
possibilities as shown below.
 In the figure, E1 is the point of
equilibrium, Q1 is the equilibrium
output and P1 is the equilibrium
price.
AC = A1Q1
AR = A1Q1
AC = AR, the firm makes normal
profits.
 In the figure, E2 is the point
of equilibrium, OQ2 is the
equilibrium output, OP2 is
the equilibrium price.
AC = A2 Q2
AR = R2 Q2
AR > AC, the firm makes
Super- Normal profits
equal to the area given by
P2R2A2C2
 In the figure, E3 is the point
of equilibrium, OQ3 is the
equilibrium output, OP3 is
the equilibrium price.
 AC = A3Q3
 AR = R3
 Q3, AVC = R3Q3
 AR < AC, the firm makes sub-
normal profits equal to
C3A3R3P3. Even though the
firm makes losses, it
continues to produce in the
short-run because AVC is
covered.
 Long - run equilibrium under
Monopoly
◦ A firm under monopoly may
make normal profits in the
long-run; however, it tries to
make super-normal (abnormal)
profits in the long-run. The
LRAC is flatter than the short-
run average cost curve, but the
conditions of equilibrium are
the same as in the short-run.
◦ E0 is the point of equilibrium,
OQ0 the equilibrium output,
OP0 equilibrium price.
AR = R0Q0. AC = C0Q0, AR > AC
so the firm makes super -
normal profits equal to P0R0C0P.
 By following trial and error method, a monopolist fixes the price of his
product so as to maximize his profit. There is a second alternative open
to the monopolist. He can discriminate between buyers and charge
different prices to different customers. This is called Price
Discrimination or Discriminating Monopoly.

 What is Price Discrimination?

◦ Instead of charging a uniform price to all the consumers a monopolist
may divide the market into different classes of people. One market
segment may consist of poor, whereas another market segment may
be inhabited by the rich. The monopolist may charge a lower price to
the poor and middle class people whereas he may charge a higher
price to the rich customers. Charging different prices to different
customers for the same product is called Price Discrimination.
 When is Price Discrimination Possible?
◦ Charging different prices to different customers is rendered
possible in the following circumstances
 Legal Sanction
 Nature of Commodity
 Geographical Barriers
 Ignorance of Buyers
 For price discrimination to be successful the following conditions
should be fulfilled :
◦ The different markets in which the product is sold should be
separated. i.e. there should be no contact between buyers in the
two markets. If buyers in one market know that the price charged
in another market is lower, they would buy the product in another
market and sell it in their own market. This will lead to equality of
price in both the markets and price discrimination would no more
be possible. No possibility of resale of the product.
◦ The elasticity of demand in different markets should be different.
Price discrimination may not be possible if elasticity of demand is
the same in both the markets.
◦ Market must be imperfect.
 When is it Profitable?
◦ Having known the conditions of price discrimination, it is
worthwhile to know when it is profitable to the monopolist. In
other words, it is necessary to study the position of equilibrium
when the monopolist maximizes his profit.
◦ The principles which apply to the equilibrium of a firm are also
applicable in this case. An additional assumption to be made here
is that the monopolist is selling his product in two different
markets.
 Fairly Large Number of Firms
◦ There may be (20-25) sellers engaged in the same
line of business producing commodities which are
close substitutes for each other.
 Product Differentiation
 Elastic Demand
 Price War
 Gift Articles
 Unfair Methods
 Short-run Equilibrium under Monopolistic Competition
 Long-run equilibrium under monopolistic competition
 Oligopoly is a type of imperfect market. It has few
firms capable of influencing the total supply in the
market. When there are more than two firms and not
many, selling homogenous or differentiated products
then oligopoly market is said to exist.
 Duopoly market comprises of two firms. Both the firms
are interdependent on each other regarding prices and
output. If one decides to reduce the price the other will
follow the same.
 Government dictated ceiling on the prices of essential
consumer goods, to keep cost of living within a
manageable range. Price control was quite common in
developing countries until 1990s.
 Government-mandated minimum or maximum prices set
for specific goods and are typically put in place to
manage the affordability of the goods.

 Minimum Support Price is the price at which government

purchases crops from the farmers, whatever may be the
price for the crops.
The need for government intervention with the functioning
of the free market mechanism has arisen out of the failure
of the free market economy expected to ensure:
◦ that all those who are willing to work at prevailing
wage rate get employment;
◦ that all those who are employed get their living in
accordance with their contribution to the total output,
(i.e., their productivity);
◦ that factors of production are optimally allocated
between the various industries
◦ production and distribution pattern of national product
is such that all get sufficient income to meet their basic
needs - food, clothing, shelter, education, medical
care, etc.

55
 Why the Government regulates monopolies
 Prevent excess prices.
 Quality of service
 Monopsony power
 Promote competition
 Natural Monopolies
 Price capping by regulators RPI-X
 Regulation of quality of service
 Merger policy
 Breaking up a monopoly
 Yardstick or ‘Rate of Return’ Regulation
Cost-volume-profit (CVP) analysis is used to
determine how changes in costs and volume
affect a company's operating income and net
income. In performing this analysis, there are
several assumptions made
 Fixed cost remain static & marginal costs are
completely variable at all levels of output.
 Selling prices are constant at all sales volume.
 Factor prices are constant at all sales volume .
 Efficiency and productivity remain unchanged. In a
multi product situation ,there is constant sales mix at
all level of sales.
 Turnover level is only relevant factor affecting cost &
revenue.
The breakeven point (BEP) is where total revenue
equal total costs.
 COST CONTROL.
 PROFIT PLANNING.
 EVALUTION OF PERFORMANCE.
 DECISION MAKING.
 FIXATION OF SELLING PRICE.
 KEY LIMITING FACTOR.
 SUITABLE PRODUCT MIX.
 Make or buy decision:
 Production planning
 Price determination
 Cost control
 Profit Planning
 Financial structure
 Conditions of uncertainty
 Many costs and their components do not fall into neatly
compartmentalized fixed or variable cost categories as they possess the
characteristics of both types.
 If company sells several products, the financial manager has to prepare
and evaluate a number of profit-graphs covering integrated segments of
independent activities.
 A break-even chart represents a short-run static relationship of costs
and output and become obsolete very quickly.
 The relations indicated in the break-even chart do not help for all levels
of operations. Costs tend to be higher than shown on the static break-
even chart when the plant’s operation approaches 100 percent of its
capacity.
 The frequent changes happening in the selling price of the product
affect the reliability of the break even analysis.
 The cost of securing funds to expand is disregarded in break-even
chart.