05 MBA 12 Managerial economics No. of Lecture Hrs / Week : 04 Total No.

of Lecture Hrs : 56 MODULE 1 IA Marks : 50 Exam Hours : 3 Hours Exam Marks : 100 7 HOURS

Introduction of Economics: Managerial Economics Nature, Scope & Significance, Role of Managerial Economist in decision-making Relationship of Managerial Economics with functional areas of business MODULE 2 7 HOURS

Fundamental Principles/Concepts of Managerial Economics: Opportunity Costs, Incremental, Time perspective, and Discounting and Equimarginal principles. MODULE 3 7 HOURS

Concepts, Objectives of the firm, alternate objectives of firm, firm & industry. Theories of firm, Managerial theories: Baumols model, Marriss Theory, Williamsons theory. Behavioural theories : Satisfying Behaviour, Simple model of Behaviourism. MODULE 4 7 HOURS

Demand analysis, Law of Demand, Exceptions of law of demand, Elasticity of demand Price, Income & Cross elasticity, Uses of elasticity of demand for Managerial decision making. Measurement of elasticity of demand. Advertising and promotional elasticity of demand. Demand forecasting: Meaning & Significance. MODULE 5 7 HOURS

Production analysis: Concepts, Production function: Single Variable & Two Variable function. Total, Average, & marginal Product. Law of diminishing returns, returns to scale.

MODULE 6

7 HOURS

Costs & Revenue functions, short run and long run cost curves, combination, and expansion path. Economics and diseconomics of scale. Law of supply, Elasticity of Supply. MODULE 7 7 HOURS

Market Structure: Perfect Competition, Features. Determination of pricing under perfect competition. Monopoly: Features, Types of monopoly, monopoly power, Pricing under monopoly, Pric discrimination. Oligopoly : Features, Kincked demand curve, cartels, Price Leadership. Monopolistic Competition: Features, Pricing under monopolistc competition, Product difeferentiation. Descriptive Pricing Approaches: Full Cost Pricing, Product Line Pricing, Pricing, Pricing Strategis: Price Skimming, Penetration Pricing, Loss leader pricing. MODULE 8 Profits Nature, Measurement, Break-even analysis. RECOMMENDED BOOKS: 1. Dominick Salvotore: Managerial Economics in Global economy 4 th edition Thomson Publication, 2004. 2. Dr D. M Mithani: Managerial Economics Theory and Application Himalayan Publication, 2/e, 2005 3. Craig Petrerson & Cris Lewis Managerial Economics 4th Edition Pearson Education / PHI 2003. 4. D N Dwivedi Managerial Economics, 6th editin, Vikas Publication, 2005. 5. Managerial Economics Varshney & Maheshwari Sultanchand, 2003 Reference Text : 1. Managerial Economics M. L. Trivedi TMH 2. Managerial Economics, Yogesh Maheshwari, Prentice Hall, 2 nd edition 3. Economics for Management texts and cases Misra and Puri, HPH 4. Micro Economics Theory and Aplication G S Maddala, TMH, 2nd edition 5. Micro Economics, Dominick Salvotore, Oxford Publishers, 4/e, 2004 7 HOURS

6. The New Managerial Economics William Boyes Biztantra, 2005 7. Managerial Economics Keating & Wilson Biztantra, 2003-2004

MANGERIAL ECONOMICS 05 MBA 12

MODULE 1 A. INTRODUCTION TO ECONOMICS B. NATURE, SCOPE & SIGNIFICANCE OF MANGERIAL ECONOMICS. C. ROLE OF MANAGERIAL ECONOMIST D. RELATIONSHIP OF MANAGERIAL ECONOMICS WITHFUNCTIONAL AREAS OF BUSINESS.

1. What is Economics? - Economics Is A Social Science. - What is Science? Natural / Physical Sciences. - Types of Sciences Social Sciences 2. Kautilys Arthashastra 3. Adam Smith (1776) - An Inquiry into the Nature and Causes of Wealth of Nations - Economics Is A Study of Wealth, It Studies how wealth is produced, distributed and consumed. - Focus was on Wealth Creation - Philosophers like Aristotle; Carlyle condemned it as Dismal Science, Mundane Science. 4. Alfred Marshall (1890) - Principles of Political Economy. - Economics is Study of Welfare. - Not a study of Wealth Creation but use of wealth for the welfare of human society. 5. Prof. Lionel Robbins (1934)

- An Essay on the Nature and Significance of Economics Science - Economics is a study of human behavior as relationship between ends and scarce means which have alternative uses.
ECONOMICS

Wealth Creation Use of Wealth for welfare Scarcity and Choice Allocation of limited resources among different purposes by a business unit.

MANAGEMENT
- Management is concerned with making decisions, solving problems and managing men, material, money and operations. - Decision-making is an uncertainty framework - Risk and Uncertainty. - Individual and Collective Decisions. Two Characteristics of a Decision 1. How to get best out of expensive resources, which are scarce and have alternative uses? 2. Uncertainty In Business. - A Decision means making or not making a choice out of the alternatives available - Any problem faced by manager is known as Decision Problem.

- How to Solve a Decision Problem?

1. 2. 3. 4. 5. 6. 7. 8. State the Problem clearly. Define objectives. Collect Information facts / figures. Classify Information Identify Issues & Elements Establish relationship between different elements Find out alternatives. Select Best alternatives apply cost - benefit principle 9. Implement the Decision. 10. Seek Feedback 11. Take Corrective action. - A Decision should be taken considering 1. Internal Environment 2. External Environment 3. Goals of Business / Firm 4. Resources available 5. Organizational Structure

- Management Revolution is taking place Its major component are: 1. Globalisation. 2. Spread of Information Technology 3. Computers replacing Middle Level Management 4. Knowledge and Communication revolutions. - Managerial Economics is an integration of economic theory and managerial practice. - It is application of economic principles to business practices. - Managerial economics lies on the border line of economics and business management. - Micro and Macro Economics - Micro Economics is a study of particular decision-making unit. It is an individualistic study - Macro Economics is concerned with whole economy. It is an aggregative study.

- Managerial economics is economics applied to decisionmaking - It is a special branch created to bridge the gap between economic theory and management practice. - Application of economic theory to business practice. - Managerial economics is the study of the allocation of resources available to the firm among its activities.Use of economic modes of thought to analyse business situations. MC Nair and Mariam Molton Spencer and Louis Siegelman Managerial economics is the integration of economic theory with business practice for the purpose of facilitating decision-making and forward planning by management.

- Deals with classifying decision problems, organising and evaluating information and comparing alternative courses of action. - Economics provides a number of concepts and analytical tools which are useful for Decision-making in an uncertainly framework. - Develop skills and competencies. Characteristics of Managerial Economics 1. Micro economic in character. 2. A study of Firm / Business unit. 3. Pragmatic in nature. 4. Normative Science. 5. Macroeconomics is also useful. 6. Provides tools & Techniques to Managers. Scope of Managerial Economics 1. Normative or Positive Science. 2. Area of Study Subject Matter. 2.a. Demand Analysis and Forecasting 2.b. Cost and Production Analysis 2.c. Pricing Decisions, Policies and Practices. 2.d. Profit Management. 2.e. Capital Management 2.f. Linear Programming & Theory of Games 2.h Queuing Theory. 3. Profit A central concept - Profit Maximising - Accounting & economic Profits. 4. Optimisation 5. Managerial Economics & Other Disciplines. - Theory of Decision-making - Operations Research - Mathematics and statistics. - Management Theory & Accounting

- Plays a useful role in the process of decision-making at the firm level. 1. Consultant. 2. Analyst. 3. Model Builder. 4. Economic Intelligence / Espionage. 5. Environmental Forecaster. 6. Corporate Planner 7. Risk Analyst. 8. Profit and Production Planning. 9. Adviser. 10. Budget- Making. 11. Member of the Team of Decision-makers. Qualities require by a Managerial Economist 1. Alertness 2. Inquisitiveness 3. Hard work 4. Knowledgeable 5. Analytical Mind 6. Communication Skill 7. Self-Confidence 8. Quick Group 9. Intellectual Honesty 10. Public Relations 11. Responsible.

Finance 1. Marketing 2. Production / Operations 3. Human Resources 4. Information technology. BOOKS FOR REFERENCE 1. Milton H. Spencer & Louis Siegelman Managerial Economics. 2. D. N. Dwivedi Managerial Economics.

QUESTIONS Question 1 1.1 What is economics? 1.2 Who is the father of economics? 1.3 Who is the author of Arthashastra? 1.4 What is Managerial Economics? 1.5 Is economics a normative science? 1.6 What is a positive science? 1.7 Mention the characteristics of managerial economics? 1.8 Mention the process of decision-making? 1.9 What is a decision? 1.10 Distinguish between programmed and non-programmed decisions. 1.11 What is a collective decision? 1.12 Mention the factors influencing a decision. 1.13 Who is a managerial economist? 1.14 Mention any three qualities required by a managerial economist. 1.15 What is Micro Economics? 1.16 Define Macro Economics. 1.17 What is the main objective of a firm> 1.18 What is Profit? 1.19 Define Uncertainty. 1.20 Define economic profit.

Question 2 1.1 Economics is a science of a. Wealth b. Welfare c. Scarcity and choice d. Money. 1.2 The first book on economics was written by a. Adam Smith b. Alfred Marshall c. Kautilya d. Keynes J.M 1.3 Managerial economics is a. Economics applied to decision making b. Management used in economics. c. Economics of environment d. Economics managed by people. 1.4 Programmed decision are a. Routine decisions b. Non-routine decisions c. Computer-based decisions d. Planned decisions 1.5 Managerial economics is a. Positive science b. Descriptive science c. Normative science d. Pure science. 1.6 Economics is a a. Natural science b. Social Science c. Physical Science d. Art 1.7 The objective of any business unit is e. Maximisation of consumer satisfaction. f. Maximisation of Profits. g. Maximisation of sales h. Minimsation of costs 1.8 Accounting profit considers only i. Implicit costs j. Explicit costs k. Fixed costs

l. Variable costs 1.9 According to Professor Samuelson, economics is a. The queen of social sciences b. An unimportant social science. c. Important science d. A science of wealth 1.10 Adam Smith considered economics as e. a science of wealth f. a science of welfare g. a science of scarcity h. a science of choice. QUESTION 3 State whether the following statements are True or False. 3.1 3.2 3.3 3.4 3.5 3.6 3.7 3.8 3.9 Economics is a social science.-T Managerial Economics is a positive science.-F Business houses create wealth.-T Modern business faces many uncertainties.-T Micro economics is an aggregative economics.-F Macro economics is a study of individual.-F Accounting profit is the true profit of business.-F Profit measures the success or failure of business.T Managerial economics is an integration of economics and business management.-T 3.10 Managerial economist assists the process of decision-making- T QUESTION 4 A 1. Adam Smith 2. Economics costs-4. 3. Lionel Robbins 4. Profit 5. Kautilya 6. Micro Economics 7. Macro Economics 8. Positive Science Match the following B Scarcity & Choice-3 Difference between Revenue and Father of Economics -1 Arthashastra-5 Queen of social sciences.-2 Quality of Managerial economist-10. Descriptive-8 Prescriptive-9

9. Normative Science 10 Alertness

Study of individual unit-6 Study of aggregative & averages.-7

MODULE 2
FUNDAMENTAL PRINCIPLES (CONCEPTS) IN MANAGERIAL ECONOMICS There are five important concepts that are basic in the study of managerial economics. They are: 1) The incremental concept, 2) The concept of time perspective, 3) The discounting concept, 4) The concept of opportunity cost, 5) The equi-marginal principle. 1) The Incrememental Concept: Two important incremental concepts (i) Incremental revenue (ii) Incremental costs Incremental revenue simply measures the difference between the old and new total revenues. It is not restricted to the effects of a change in price. It measures the impact of decision alternatives in the total revenue. The formula for incremental revenue is:

IR = R2 - R1 = R
Where IR stands for incremental revenue, R2 indicates new total revenue, R1 denotes old total revenue, Delta means, change in. Incremental revenue concept is akin to the marginal revenue concept of economic theory. But there exists some difference between the incremental revenue and the marginal revenue. Marginal revenue means the addition made to the total revenue by selling an additional or extra unit of output. It shows the change in total revenue when one more or one less unit is sold. In other words, marginal revenue is the addition to the total revenue per unit of output change. It is derived by employing the following formula:

R2 - R1
MR =
=

R
=

dR Dq

Q2 - Q1

Where MR stands for marginal revenue, R2 represents new total revenue, R1 indicates old total revenue, Q2 measures new quantity of output sold, Q1 shows old quantity of output sold d or delta indicates change in. R-revenue, Q-output. The difference between the incremental revenue and the marginal revenue will be clear from the following illustration. Suppose the price of a commodity fall from Rs. 5 per unit to Rs. 4 per unit. As a result, sales increases from 1000 units to 1500 units.

Incremental cost are additional costs incurred due to a change in the nature of activity. These costs refer to any type of change: adding a new product, changing distribution channels, installing a new a machine, expanding the market area, and so on. Incremental costs are not the same as marginal costs. Incremental costs simply measure the difference between the old and new total costs. In fact, it measures the impact of decision alternatives on the total costs. Marginal cost has a limited meaning. It refers to the cost of an added unit of output. It is the per unit cost of the added units.

Incremental costs are more flexible than the marginal costs because incremental costs refer to any kind of change, while marginal costs are calculated for unit changes in output. Incremental costs appear to be more relevant in decision making at the firm level. The incremental costs may be computed by employing the formula.

IC = C2 - C1 = C
Where IC stands for the incremental costs, C2 represents new total costs, C1 denoted old total costs Similarly, marginal costs may be computed by using the following formula.

C2 - C1
MC =
=

C
=

dC dQ

Q2 - Q1

Where MC denoted marginal cost, C2 indicates new total costs, C1 shows old total costs, Q2 represents new total output, Q1 implies old total output. 1. Marginal costs and revenues are always defined in terms of unit changes in output. But incremental costs and revenues are not necessarily restricted to unit changes. 2. Generally, marginal cost and marginal revenue are restricted to the effects of changes in output. But in managerial economics, decision-making may not be confined to changed output at all. 2.The Concept of Time Perspective Time element has played a decisive role in economic theory, particularly in the field of pricing. It was Professor Marshall who first introduced the element of time in the value theory. He conceived four market forms based on time period-very short period, short period, long period and the secular period.

Haynes, Mote and Paul A decision should take into account both the short-run and long-run effects on revenues and costs, giving appropriate weight to the most relevant time period.

3. The Discounting Principle. The discounting principle is another fundamental concept used in managerial economics. It is our common experience that a rupee tomorrow is worth less than a rupee today. Whenever we make a comparison between the present and the future values of money, we always discount future value to make it comparable with the present value. According to the discounting principle, it is necessary to discount costs and revenues at future dates. 4. The Concept of Opportunity Cost. Opportunity costs are the costs of displaced alternatives. represent only sacrificed alternatives. sacrifices made in taking a particular decision. 5. The Equi-marginal Principle. The equi-marginal principle is one of the popular concepts of economics. It states that the inputs available to the firm should be allocated in such a manner as to equate the value added by each unit in all uses. Let us consider:

They

They involve the measurement of

VMPLK = VMPLL = VMPLM = VMPLN = VMPLO

MODULE 3 THEORY OF FIRM

- Useful in managerial decisions. Concepts 1. Firm 2. Group 3. Industry. - A firm is a business unit that combines and organizes recourses for producing goods and services for sale. - Ownership Pattern 1. Proprietary 2. Partnership 3. Company 4. Co-operative Society - A firm exists to save TRANSANCTION COSTS. - Internalising transaction by performing many functions by the firm Saves on Sales Tax, avoids price control and other regulations. - Cannot continue to grow indefinitely and independently. OUT SOURCING: OBJECTIVES OF FIRM 1. Profit Maximisation. (a) What is profit? (b) Accounting / Business Profit (c) Economic Profit Risk Theory (d) Profit Theories Uncertainty Wages Fund Innovation 2. Wealth Maximisation. - Maximum value of the firm - Present value of all expected future profit.

PV =

1 + 2 ------------------ n
(1+ r)1 (1+ r)2
n

(1+ r)n

t-1 (l+r)
3. Sales Maximisation Baumol Profit is a constraint Limiting Profits a) Competition C) Customer b) Public standards d) Labour 4. M. Reader - sacrifice Profit for Financial Control 5. William Fellner Safety Margin 6. K. Rothschild - Long-run Survival 7. Scitovsky Trade Off between Profit and Leisure 8. Satisfying Objective. 9. Extending Market Share 10. Maximising Growth - Multple Objectives of the Firm - Firm is deliberative than Maximising. Modern Firms has FIVE objectives 1. Production 2. Sales 3. Inventory 4. Market Share 5. Profit optimization. There is no universally acceptable objective for business policy. Each business must define its own objectives which may have to satisfy the needs of those groups whose co-operation makes continued existence of the firm . - Christopher Savage & John Small. - Profit Maximisation a traditional objective. - Limiting Profits. (a) Competition (b) Public Image (c) Labour (d) Customer

(e) Maintaining Control (f) Non-financial amenities. Fix Profit Standards. II. Managerial Approach - A firm is a co-operative venture of management, workers and stockholders. - Each stakeholder has own objective and a firm has to reconcile for survival. - Important feature divorce between owners and management. - Shareholders are owners spread over a wide area - Management Board of Directors - Widening distance between the two - Professional Managers play a significant role - Prof. Samuelson Giant Firms are the outcome of managerial revolution. - Prof. Henry Simon makes a distinction between organizational Goals and managerial Goals. Organisational Goals (Shareholders Goals) 1. Production Goal 2. Inventory 3. Sales 4.Market Share 5. Profit optimisation. Management Goals (Operational Goals) 1. Good Rate of Return on Investment 2. Maximising Growth of a company 3. Responsible corporate citizen.

THEORIES OF FIRM 1. JDownie The competitive Process has developed theory of firm growth Firm is essentially a specialist organization having technical and marketing experience Activities are broadly determined by technology. It is market structure and conventions that determine firms behaviour Conventions are Rules of the Game

 Rules of the Game affect dispersion of efficiency between firms and technical progress. Some firms more efficient less efficient Unit costs technology superior due to innovation patented and skills and experience Firm in a competitive market aim at. Maximization of Growth Objectives: More efficient firms encroach upon market share of less efficient firms. Downie uses concept of Transfer Mechanism Efficiency determine Growth Efficient firm at competitive price to take market share easy access to financial and other facilities for expanding production capacity. Rate of Profit co-related to rate of growth. - This theory does not consider non-price competition - Beyond a price less production less profit Optimum Growth Rate Capacity Growth Curve Market Growth Curve Rate of Growth e Capacity growth curve Market Growth Curve

O Growth Rate

e Equilibrium where market growth and capacity growth rate are same Less efficient firms have to innovate 2 E. Penrose The Theory of Growth of the Firm . - A firm is a pool of productive resources organized within an administrative framework. - Every firm tries to increase its profits in the long-run.

She considers Long Run Profit as the goal . A firm makes Investment so long as it is able to get Positive Returns used concept of Productive Opportunity . A firm continues to grow till its productive opportunity allows it to grow Each firm has a unique productive opportunity. Physical quantities of recourses same Potential services differ Service is a function of activity The process of growth of firm is not automatic but deliberative. - Management provides plan for expansion. Provides administrative structure, experience and expertise determine the extent of productive opportunity. - Growth of the firm depends on effective management. - A firm can sustain higher rate of growth only if management has entrepreneurial; and managerial abilities. - Efficiency & Growth management abilities External factors - D, Innovations in Techonology, Supply of inputs, entry barries, competition. Internal Factors unused productive services and other potentials of the firm Managerial capabilities & effective Competition Greatly determine growth - Firm uses productive opportunity through process diversification, production diversification, merger and acquisition - Management effectiveness as a determinate of growth Penrose effect

Marris Model of Maximisation of Firms Growth Rate Objective is Maximisation of balanced rate of growth Balanced growth rate G determined by two factors i) Growth rate of demand GD ii) Growth rate of Capital supply GC to firm

G = GD = GC Two Constraints 1) Managerial Constraint 2) Financial Constraint Managerial Constraint is set by skill and efficiency available Financial Constraint is set by the desire of mangers t achieve maximization of their own utility function owners utility funds. Goals of Managers and Goals of Owners difference not wide may be areas of common interest. - Utility function of Managers Salary, Power, Status, Job Security - Utility function of Owners Profits, Capital output, Market share, Public Image. Um = m (GD,S) Uo = o ( GS ) Managerial Utility Function Um = m ( GD ) s Marris adopts Penroses theories that there is a definite limit on the rate of managerial expansion such as Managerial Ceiling limits growth Financial Constraint manager become risk avoiders A prudent financial policy required optimum levels of some critical ratios. 1. Leverage / Debt Ratio r1 = Value of Debts Total Assets. 2. Liquidity Ratio r2 = Liquidity Assets Total Assets. 3. Retention Ratio r3 = Retained Profits Total Profits. Three are combined to represents the financial security constraint.
3

t=1 = r
Three Instrumental Variables 1. Financial security coefficient = r 2. Rate pf product diversification d 3. The average profit margin = m Objectives + Constraint + Instrumental Policy 1. Gd = Gs ( Balance Growth equal condition) 2. Gd = D (m.d) Demand growth equation 3. Gs = v {s(m,d)} Supply of capital equation 4. = f (m,d) Profit equation 5. r r security constraint

Profit- endogenously determined

Security exogenously determined Firm is affected by m d II. Williamsons Hypothesis of Maximisation of Managerial Utility Function (Managerial Discretion Model) - Mangers have discretion to pursue objectives other than profit maximization - Manager try to maximize own utilities function with minimum level of profits - Managers own utility functions depends on three components a) Level of staff expenditure b) Amount of discretionary spending available for investment c) Amount of managerial emoluments / perquisites U = f [S, M, Id] S = staff expenditure (excess) M = Managerial emoluments perquisites Id = discretionary Investment To formalize his model,

Williamson introduces four types of profits

(1) Maximum Profits as Profit Maxmimising agent

- MS (2) Actual Profits = Maximum Profit excess staff expenditure

= -M (3) Reported Profits Management slack absorbed
T =t (4) Minimum required profits

= Maximum

Actual Profits =

Reported Profits = - m ( management stock is less ) Utility Maximisation firm has higher staff expenditure and more management slack than profit maximization firm Cyert and March - Satisfying behaviour - Extension of Simons hypothesis Objectives determined by 1) Bargaining between groups and relationship between groups within the firm 2) Method by which objectives are formulated 3) How group and firm react to experiences and make adjustments - Satisfying Various interest groups coalition of different groups. - Study of human beings in terms of their relationship with their environment - Environment may generate shocks to be taken care by slacks - Environment behaviour as a compromise between conflicting interests and views - Satisfycing than maximizing.

- MS ( Staff Expenditure)

MODULE 4 DEMAND ANALYSIS AND FORECASTING

Demand analysis aims at discovering the forces that determine sales. It has two main managerial purposes (i) Forecasting Sales, (ii) Manipulating Demand. Sales forecasting is one of the important requirements of business planning. All activities of the firm such as purchase commitments, production schedules, inventory plans, cash and capital expenditure etc, are determined by the sales forecasting. Demand or sales forecasting is thus crucial in the entire scheme of operations of the firm. DEMAND: Demand, in economics, refers to the desire accompanied by the necessary purchasing power. A person willing or desiring to purchase a commodity should have ability to purchase it. Mere desire does not constitute demand in economics. Demand for a commodity always implies or consists of the following three elements: (i) desire to acquire a commodity, (ii) Willingness to pay for it, and (iii) Ability to pay for it. Demand is always at a price. Demand is also expressed with reference to a particular time period. LAW OF DEMAND: The demand for a commodity or service varies inversely with price. When price falls, demand extends and when price rises, demand contracts. People demand a larger quantity of goods and services only at a lower price than at a higher price. The law of demand is also explained in terms of income and substitution effect. The law of demand holds good only when the following conditions are fulfilled: 1) Income of the buyer remains constant. 2) The taste if the buyer remains the same. 3) Prices of related goods-substitutes and complements-remain the same. 4) No new substitutes are discovered.

5) There is no prestige value for the product in question. DEMAND SCHEDULE: A demand schedule contains details of prices and quantities. For each price, certain quantity of a commodity is demanded by the demanders. The demand schedule indicated what quantity is demanded at each of these prices. The demand schedule has two columns. In one column different prices are shown and in the other, the corresponding amounts of the commodity demanded by the consumer. Two types of Demand Schedule: 1) Individual Demand Schedule 2) Market Demand Schedule. D Hypothetical Demand Schedule Price Per Unit Re.1 Rs.2 Rs.3 Rs.4 Rs.5 Rs.6 Quantity Demanded 50 40 30 20 10 Zerc

D 5 ---------4 ------------------PRICE 3 ----------------------------2 -------------------------------------1 -----------------------------------------------D

0 10 20 30 40 50 QUANTITY DEMANDED A demand curve always slopes downwards to the right hand side on account of the operation of the income and substitution effect of a fall in the price of a commodity making the consumer buy more of that commodity whose price has fallen. The negative slope of the demand curve is also attributed to the operation of the Law of Diminishing Marginal Utility. There are some other factors like several uses of the commodity, different incomes, temperaments and attitudes and relief in variety, which also make the slope of the demand curve negative. Milton Friedman: The demand curve is a snapshot at a moment in time and represents the maximum quantities that would be purchased at alternative prices. William J. Baumol: The demand curve is among those devices of economic theory which have found frequent employment in applied economics. In its traditional form, it sums up the response of consumer demand to alternative prices of a product-it can tell management which may be expected to happen to the demand for one of its outputs if the price of that item is changed. EXCEPTIONS TO THE LAW OF DEMAND a. Veblen Commodities b. Fear of Shortage c. Speculation d. Inferior Goods

e. Ignorance

CHANGES IN DEMAND Extension and contraction of demand do not indicate a change in demand. A change in demand, in economics, always means an increase in demand or a decrease in demand. INCREASE IN DEMAND Increase on demand is a situation when more units are demanded at the same price or the same quantity is demanded or sold at a higher price. This is shown by a shift in the demand curve upwards to the right. DECREASE IN DEMAND The decrease in demand shows that less units of the commodity are demanded at the same price; or the same quantity is demanded at a lower price. With decrease in demand, the demand curve gets shifted downwards or to the left.

P Price O R S
T

EXTENSION IN DEMAND Extension in demand is a situation where more units are demanded at a lower price. In this case the consumer moves along the same demand curve. Y C Price D -------------------------D O A B x

x CONTRACTION IN DEMAND The contraction in demand refers to a condition where less units of the commodity are demanded at a higher price. Y I -------------Price D D O B M x

Extension and contraction in demand are thus the result of a change in price. The law of demand has much relevance with the extension and contraction in demand for the law of demand express the price-quantity relation. An increase or decrease in demand, on the other hand, show a shift in the demand curve. This occurs due to a change in the conditions of demand and not because of a change in the price of a commodity.

DEMAND DISTINCTIONS: 1) Consumers Goods and Producers Goods Consumers goods refer to those commodities and services which are produced for direct consumer purchase and are used for final consumption. Producers goods, on the other hand, are those commodities and services which are purchased by the producers and are used for the production of other goods. Consumers goods are further divided into durable consumer goods and non-durable consumer goods. The durable consumer goods are commodities which can be used more than once over a period of time. The non-consumer goods, on the other hand, are those which are used in a single act of consumption. There exists distinctive demand behavior for producers goods and consumers goods. According to Professor Joel Dean, there are mainly three reasons for the for the distinct demand behavior for producers goods. They are: i) The buyers of the producers goods are usually experts and as such as influenced by the careful evaluation of the features of the commodity and are sensitive to even small price differences. ii) They are guided by purely economic motives. They buy products not for their personal use, but for their profit prospects. iii) Since the demand for producers goods is always derived from consumption demand, it varies differently and generally more violently. The demand behavior of durable and non-durable consumers goods is determined by a different set of factors.

The basic or primary demand for consumer durables, therefore, consists of newowner demand and the replacement demand. This can be put algebraically as follows: d=N+R Where d stands for demand or sales, N denotes new demand, and R implies replacement demand as estimated by life expectancy and survival of the product. The basic demand function for the consumer non-durable goods takes the following algebraic form: d = f [Y + D + P] Where d stands for demand or sales, f denotes function of Y indicates disposable personal income, D implies demography, P stands for price. 2) Durable Goods and Perishable Goods 3) Derived Demand and Autonomous Demand 4) Industry Demand and Company Demand 5) Market-share Concept of Demand 6) Short-run and Long run Demand 7) Total Market and Market Segments DEMAND FUNCTION (Demand Determinants) Demand determinants are, 1) income of the consumer, 2) price of the commodity or service, 3) prices of Related Goods or services (substitutes and complements) 4) consumers tastes and preferences, 5) Consumers expectations. Qd = f (Y, P, Ps, Pc, w, U) Where Qd stands for quantity demanded, Y denotes consumers income P implies price of the commodity in question Ps indicate prices of the substitutes Pc shows price of complements W stands for consumers tastes and preferences

U denotes consumers expectations and other determinants f indicated unspecified function to be read as function of Income-Demand Schedule Income (in Rs.) Demand for Commodity A (Units) 100 10 200 15 300 20 400 24 500 26 600 27 Y 600 500 income 400 300 200 100 0 E 5 10 15 20 Demand for A 25 30 X EC = Engel Curve C

1) PRICE ELASTICTY OF DEMAND Price elasticity of demand refers to the rate of responsiveness of demand to a change in the price-level. It is measures by using the following formula :
Percentage change in quality demand

Ed = Percentage change in Price Change in the Quatity Demanded Quatity Demanded Change in Price Price

Ed = Q * Q * = Q2 Q1 Q1 = Q2 Q1 P2 P1 OR Q . P P Q
=

P P
*

* P1 Q1

P2 P1 P1

PQ QP

Where Q1 denotes the quantity demanded before price change Q2 indicates the quantity demanded after price change P1 implies price charged originally P2 shows price of a commodity after price change Ed is the coefficient of elasticity is delta meaning a change in P stands for price; and Q stands for quantity demanded.

Five types of price elasticities of demand 1) Perfectly Inelastic Demand 2) Inelastic Demand 3) Unitary Elasticity of Demand 4) Elastic Demand; 5) Perfectly Elastic Demand Y Y Perfect Inelastic demand curve Price Price Ed = 0 O D Quantity Y Y Unitary elasticity Of demand curve Ed = 1 D Quantity Y Ed = Price O Quantity X O

Inelastic demand curve Ed = <1> 0 D X Quantity

Elastic demand curve Ed = > 1 D Quantity

D Perfect elastic demand curve X

Summery Chart showing Types of Price Elasticity S.N Type of the Price Elasticity 1 2 Numerical Value of the coefficient Ed Zero Verbal description Shape of the curve Vertical Steep

Perfectly in elastic demand Inelastic <1>0 Greater Demand than zero, less than one

Quantity demanded does Quantity demanded changes by a smaller percentage than does price Unitary One Quantity demanded elasticity changes by exactly the same percentage as does price Elasticity >1< Greater Quantity demanded demand than one, less changes by a larger than infinity percentage than does price Perfectly Infinity Purchases are elastic demand prepared to buy all they can at some price and none at all even at a slight higher price

Rectangular Hyperbola Flat

Horizontal

Determinants of the Price Elasticity of Demand 1) Nature of a Commodity 2) Substitutes 3) Extent of Use of the Commodity 4) Postponement of the use of the Commodity 5) Consumers Income Spending Activity 6) Habit 7) Time

Practical Implications of Price Elasticity of Demand Is highly useful to its producers and others who deal in that commodity In all forward planning and demand estimated, the concept of price elasticity of demand is of immense importance. The break even analysis of the firm also requires an assessment of the price elasticity of demand. The concept of price elasticity of demand is becoming increasingly irrelevant in the case of those products which are sold either in hire purchase or credit basis

2 ) INCOME ELASTICITY OF DEMAND Income elasticity of demand refers to the rate of responsiveness of quantity demanded to a given change in income. It denotes the effect of a change in the income of a buyer on the quantity demanded. It indicated the extent to which demand changes with a var iation in the consumers income. Ey = Proportionate change in the quantities demanded Proportionate change in income Change in quantity demanded Original quantity demanded = ____________________________________ Change in income Original income = Q2 Q1 Q1 * * Y2 Y 1 Y1 Y Y [Calculus Formula]

= Q * Q * = Q . Y Y Q

Where Q1 stands for original quantity Q2 denotes new quantity demanded Y1 indicates original income Y2 shows the new income delta stands for change in Q is the quantity demanded Y is the income of the consumer. Problem: Find out the income elasticity of demand form the following information National Income (Rs.crores) Demand for product X (units) Solution : IED = q * y q * y = 10,000 50,000 = 01 * 5 * = 2 * 02 * 20 20 2 Period I 20 50,000 Period II 22 60,000

Types of Income Elasticities i) Zero Income Elasticity of Demand ii) Negative Income Elasticity of Demand iii) Positive Income Elasticity of Demand

3) CROSS ELASTICITY OF DEMAND Ec = Proportionate change in the quantitiy of X Proportionate change in price of Z Change in quantity demanded of X Quantity demanded of X = ____________________________________ Change in price of Z Price of Z = Qx * Qx * = Qx . X Pz_ Qx Pz = Qx . X Pz_ Pz Qx where Qx indicates quantity demanded of X Pz shows the price of related commodity Z delta means change in 4) ADVERTISING OR PROMOTIONAL ELASTICITY OF DEMAND Ec = . Proportionate change in Sales . Proportionale change in Advt. and other promotional expenditure Change in Sales = Change in Advt.expenditure Sales Advt. Expenditure = Q * Q * = Q. X A A Q A A [ calculus formula] Pz Pz

DEMAND FORECASTING: PURPOSES AND METHODS

Demand forecasting is of immense importance to business planning. A forecast is an estimate of a future situation. Forecasting of demand, therefore, means an estimation of the level of demand that might be realized in future under given circumstances. Forecasting is done either for a short-period or for a long period The purposes of short-term forecasting are: 1. 2. 3. 4. 5. 6. Evolving a suitable production and sales policy. Helping purchase planning to reduce the cost of operation. To determine appropriate price policy. Fixing the sales targets. Establishing controls and creating incentives. To determine financial requirements.

The purposes of long-term Forecasting are: 1. Planning the establish of a new unit or expanding the existing unit. 2. Long-term financial planning. 3. Man-power planning. Methods or Techniques of Forecasting

Demand Forecasting Trend Projection Method Problem : An air-conditioner manufacturing companys sales record showed its saleas follows. Year 1998 1994 25 1995 30 1996 40 1997 50 65

Sales (in Rs.crores)

Calculate the demand for ACs for next three years. Solution. 1) 2) 3) 4) Find out Time Deviation from Mid-year Square up Time Deviation. Calculate Product of Time Deviation to sales. Find out value of A and B by using equation y=a+bx, where a is constant variable and and b implies rate of growth. 5) Find out trend values for next three years. Year 1994 1995 1996 mid year 1997 1998 = 5 Sales (y) 25 30 40 50 65 y=210 Time Deviation Square up TD (x) -2 4 -1 0 +1 +2 x=0 1 0 1 4 x2 =10 Product of TD to sales -50 80 -30 0 +50 180 +130 xy=100

y = a + bx a [constant variable] = y = 210 = 42 n 5 b [rate of growth] = xy = 100 = 10

x2

10

y = 42+10x to get trend values, for next three years: in Rs. Crores 1999 = 42 + 10 [3] = 42 + 30 = 72 2000 = 42 + 10 [4] = 42 + 40 = 82 2001 = 42 + 10 [5] = 42 + 50 = 92 The probable sales during next three years could be Rs.72 crores, Rs.82 crores and Rs. 92 crores Forecasting Demand for New Products 1) Evolutionary Approach 2) Substitute Approach 3) Growth Curve Approach 4) Opinion Poll Approach 5) Sales-experience 6) Vicarious Approach CRITERIA OF A GOOD FORECASTING METHOD 1) Accuracy 2) Plausibility 3) Durability 4) Flexibility 5) Economy 6) Availability

MODULE 5 PRODUCTION AND COST ANALYSIS 1) INTRODUCTION Production is an organized activity of transforming inputs into outputs. Inputs refer to all those things, which a firm buys to produce a particular product. Output means the quantity of goods in the finished form produced by the firms by using the inputs. The term inputs has a wider connotation than the term factors of production. Inputs refer not only to the various factors of production like the land, labour, capital and organization, but include all those things bought by the firms as necessary for production a commodity. Production thus always results in either the addition of values or the creation of utilities. To quote James Bates and J.R. Parkinson : Production is the organized activity of transforming resources into finished products in the form of goods and services; and the objective of production is to satisfy the demand for such transformed resources. The net output of an enterprise consists of the value added to materials by the processes of production. 2) PRODUCTION FUNCTION A production function denotes the relationship between the physical inputs and physical outputs of a firm. It shows the technological relationship between the physical inputs and physical outputs of a firm. = f [L.Lb, C. M. T] Where stands for output; L denotes land employed in the production of ; Lb implies labour used in the production of C indicated capital invested in the production of ; M stands for management required for producing ; T denotes technology employed in the production of f indicates the function

A famous statistical production function is Cobb-Douglas Production function, Paul H. Douglas and C. W. Cobb of the USA have studied the production function of the American manufacturing industries. In its original form, the Cobb-Douglas Production Function applies not to an individual firm, but to the whole of manufacturing in the United States. In this case, output is manufacturing production inputs used are labour and capital. The conclusion drawn form this famous statistical study is that labour contributed about th and capital about th of the increases in the manufacturing production. Cobb-Douglas function is stated as: Q = KLa C(1-a) Where Q is output, L the quantity of labour and C the quantity of capital, K are positive constants. The function is linear and homogeneous. It shows constant returns to scale. Economic theory considers two kinds of input-output relations in production functions : (1) the relation where quantities of certain inputs are fixed and quantities of other inputs vary ; and (2) the relation where all inputs are variable. The first type of production function explains the Law of Variable Proportions or non-proportional Returns and the second type of production function deals with the Law of Returns to Scale. Production function is of immense utility to the managers and executives in the decision-making process at the firm-level. it helps in computing the leastcost input combination for given output or maximum output-input combination for a given cost. It is useful in arriving at optimum and economic combination of inputs for getting a certain set level of output. 3 LAWS OF PRODUCTION Production analysis in economic theory considers two types of input output relationships: (1) when quantities of certain inputs are fixed and others are variable ; and (2) when all inputs are variable. These two types of relationship have been explained in the form of laws : Law of Variable Proportions ; (ii) Laws of Returns to scale. Let us, therefore, briefly analysis these laws of production. A. Law of Variable Proportions According to this, law, when increasing quantities of the variable factor(s) are applied to the fixed factor production, after a certain point, each successive unit of a variable factor brings forth a less than proportionate increase in the total product, i.e., the total product increases but at a diminishing rate.

The Law of Variable Proportions shows the relationship between the amount of inputs used in physical terms and the amount of output obtained thereof. It is propounded on the assumption that the state of technology remains the same and no new methods of production are introduced during a given period in which law applies. This law sates three types of productivities of an in put factor-total, average and marginal physical productivities. The total product (TP ) is the total amount of output obtained by employing increasing quantities of one input, keeping other input-factors constant. The total product for any input factor a is the amount of output obtained by employing increasing quantities of a when all other input factors are constant. Average and marginal physical product are derived from the total product. The average product (AP) is obtained by dividing the total product by the number of factor units employed. The average product for factor input a (APa) is APa = Q , a Where Q stands for the total output and a for the number of factors units employed. The marginal product is the net addition made to the total product by employing one more unit of the factor of production. In other words, the marginal product of a factor input a (MPa) indicated the change in output associated with a given change in the factor unit, it may be written as : MPa = Q A Where Q stands for change in output ; and A denoted change in the factor unit.

Production Function with One Variable Input Units of Labour Total Product AP = Q MP = Q L L 1 10 10 2 24 12 3 39 13 4 52 13 5 6 7 8 9 10 60 66 70 72 72 70 12 11 10 9 8 7

14 15 13 8 6 4 2 zero

stage I

stage II

-2} stage III

The operation of the law may be explained in brief as follows Stage Total Product Marginal Product Average Product Increased in the Increases reaches Increases continues to 1 beginning at an maximum at point B increase increasing rate [A] and and then stars then at a diminishing diminishing rate [after point A] Continuous to Continuous to diminish Reaches maximum at C 2 increase at a diminishing rate Continuous to diminish Reaches maximum at Becomes zero at K1 point K and then starts diminishing 3 Diminishes Negative beyond K1 Continuous to diminish G. L. Thinkette : If given a certain combination of factors of production producing a given output, all the factors are increased in the same proportion and the output increases in the same proportion, returns to scale are constant. If output increases more than proportionately, there are increasing returns to scale; and if output increases less than proportionately, there are decreasing returns to scale. Example : 1 Increasing returns to scale Factors Total Product X : Y 2 : 1 4 : 2 6 : 3 5 12 21 Average product per unit of Y 5 6 7

Example : 2 Constant returns to scale Factors Total Product X : Y 8 : 4 10 : 5 32 50

Average product per unit of Y 8 8

Example : 3 Decreasing returns to scale Factors Total Product X : Y 12 : 6 14 : 7 48 49

Average product per unit of Y 8 7

4 ISOQUANTS
A Production function with two variable inputs is explained with the help of the isoquants. Isoquants are the equal product curves. They show the combinations of the factors of production yielding the same level of product. The term isoquants is derived from the words iso and quant. Iso means equal and quant implies quantitiy. I.e., output or product. Isoquant, means equal product. Isoquants of inputs are the curves which represent the different combinations of inputs producing a particular quantity of output Professor Stonier and Hague : The equal product curve.. is similar to an indifference curve. It shows all those combinations of factors which yield a given quantity of product, just as an indifference curve shows all those combinations of goods which provide a given level of satisfaction. Combination K L M N O Equal Product Combination Factor Factor X Y 1 11 2 7 3 4 4 2 5 1 Total Output 60 units 60 units 60 units 60 units 60 units

Properties of the Isoquants i) ii) iii) Isoquants slope downwards from left to right, Isoquants are convex to the origin O Two isoquants never intersect each other.

I) Isoquants are Downwards Slopping

II) Isoquants are Convex to the Origin III) Two isoquants never intersect each other Optimum Combination of Inputs

5. COST CONCEPTS i) ii) iii) iv) v) vi) vii) viii) ix) x) xi) xii) xiii) Opportunity v/s. Outlay Costs Past v/s. Future Costs Traceable v/s. Common Costs Out-of-Pocket and Book Costs Incremental Costs v/s. Sunk Costs. Escapable and Unavoidable Cost Shut-down and Abandonment Costs Controllable and Non-controllable Costs Replacement v/s. Historical Costs Urgent and Postponable Costs Private and Social Costs Short run & Long run Costs Fixed and Variable Costs

xiv)

Total Cost, Average Cost and Marginal Cost

Total cost of production means the total money expenses incurred for buying the input required for producing a commodity or a service. It includes all payments made in cash to various factors of production and all those charges, which would have otherwise been paid for the use of owners factors of production in producing a commodity or service. Average cost is the unit cost of production. It is the cost per unit of output. It can be computed by using the following formula : AC = TC Q AC stands for average cost; TC denotes total cost; Q implies units of output produced.

Where,

Marginal cost is the additional cost of producing one more unit of output. It is the net addition made to the total cost of production by producing one more unit of a commodity. MC(n) = TC(n)-TC(n-1) = [TVC(n)+TFC]-[TVC9(n-1)+TFC] = TVC(n)-TVC(n-1) Where, n stands for any volume of output, MC denotes marginal cost, TC indicates total cost TFC means total fixed cost, TVC stands for total variable cost. Relationship between Marginal Cost and the Average Cost f Production Average cost and marginal cost of production are related to each other in the following manners: When AC is Falling Constant Increasing MC is Less than the average cost Also constant More than the average cost Marginal Cost 6 4 2 Marginal Cost 8 8 8

1. When the AC is falling, MC is less than AC Units of output Total Cost Average Cost 1 8 8 2 14 7 3 18 6 4 20 5 2. When the AC is constant, MC is equal to the AC Units of output Total Cost Average Cost 1 8 8 2 16 8 3 24 8 4 32 8

3. When the AC is increasing, MC is more than the AC Units of output Total Cost Average Cost 1 8 8 2 18 9 3 30 10 4 44 11

Marginal Cost 10 12 14

S.No 1 2 3 4 5 6 7 8

Classification of Cost Distinctions Classification Basic of Distinction Opportunity costs vs. Nature of Sacrifice Outlay costs Past costs vs. Future Degree of Anticipation Costs Short-run costs vs. Long Degree of adaptation to run costs present output Fixed costs vs. Variable Degree of variation with costs output rate Traceable costs vs. Tractability of unit of Common costs operations Out-of-pocket vs. Book Immediacy of expenditure costs Incremental costs vs. Relation of added activity Sunk costs Excapable costs vs. Relation to contraction or Unavoidable costs retrenchment

9 10 11

Shut-down vs. Abandonment costs Controllable vs. Noncontrollable costs Replacement vs. Historical costs

Relation to suspension or Abandonment of operation Controllability Timing of valuation

6. DETERMINANTS OF COST Cost function, may be written algebraically as follows C = f(Q,PF,EF,T) Where, C stands for the cost of production, Q denotes the size of output, PF indicates prices of all factor-units used in production EF implies efficiencies of the factor-inputs, T shows the extent of technical progress, And f is function of. 7. BREAK-EVEN ANALYSIS Break-even analysis is of vital importance in determining the practical application of cost functions. It has proved to be highly useful to the company executives in profit forecasting and planning and also to the investment analysis. It highlights the areas of economic strength and weaknesses of the firm and indicates the safety margin, volume needed to attain expected profit, verifications in prices and costs, capacity to expand, effect of alternative prices, equipment section and how to plan the production. Break-even analysis is thus not only for projecting profits but also for other purposes such as cost control and price determination. A break-even chart is a graphical technique used to indicate the short run relation of total cost and total revenue of rate of output. It involve the study of revenues and costs in relation to the volume of output. The break-even point is determined either in terms of physical units or in terms of money.

Break-even output

=. Fixed cost . Selling price Variable cost per unit

=. Fixed Cost . Unit Contribution

= FC . P-VC

Let us suppose that a firm produces a single product. It has a fixed cost of Rs. 20,000 p.a. The variable costs of the firm are Rs. 5 per unit and the selling price is Rs.10 per unit. In this case, the break-even point would be;
= FC . Price-VC

= 20000 10-5 = 20000 5 = 4000 Units The firm makes zero net profit at this point which can be demonstrated as foolows: Total Revenue Obtained Total Costs Incurred @Rs.10 per unit X 4000 units sold Fixed cost Rs. 20,000 = Rs. 40,000 Variable costs @Rs.5 per unit X 4000 units Rs. 20,000 Rs. 40,000 Rs. 40,000 To compute break-even point, some people use the equation technique which is given below : Sales = VC + FC + Net income

Break-even turnover = .

Fixed cost 1 Variable cost per unit Price per unit

=.

Fixed cost
Unit Contribution Ratio

=.FC. 1 VC P Taking the same example, break-even turnover in money terms can be calculated. BET = FC . 1 VC P = . FC . 1 VC P = . 20000. 1- 5 10 = 20000 1. 2 = 20000 X 2 1 = 40,000 Another formula to compute break-even turnover is money terms is : Break even = . Fixed cost .

Unit Contribution Ratio

Contribution Ratio = . Sales Variable Costs . Sales

8. OPTIMUM FIRM The optimum firm means the best or the most efficient size of the firm. Its costs of production per unit are at a minimum. According to Professor E.A.G Robinson the optimum firm is one which, in existing conditions of technique and organizing ability, has the lowest average cost of production per unit when all those costs which must be covered in the long-run are included. The optimum of a firm depends mainly upon the economics of scale. He has classified these economics as technical, managerial, financial, marketing and risk-bearing. These forces operate making for a technical optimum size, optimum managerial unit, and optimum financial and optimum sales unit respectively.

Price Theory and Practices

SHORT AND LONG PERIOD

FIRM UNDER PERFECT COMPETITION Firm, under perfect competition, has no choice regarding the price policy. It has no control over the price. It accepts the price that prevails in the market. The price gets determined by the forces of demand and supply as discussed earlier. In perfect competition, the firm reaches equilibrium at point Q where the marginal cost curve intersects the marginal revenue curve from below.

PRICE DETERMINATION UNDER MONOPOLY

Monopoly is a market structure where there is only one seller of the commodity. It is characterized by the absence of competition. The seller under monopoly faces no threat of competition. He is the price-maker. He exercises sufficient control over price and output. Under such conditions, there is no distinction between the firm and industry. The firm and the industry coincide by definition.

A comparison between the output of the monopolist firm and that of competitive industry can be made with the help of Fig.

Price output Comparison Perfect Competition Price Output OU OQ2 < > Monopoly OP OQ1

1) Personal Discrimination 2) Place Discrimination 3) Trade Discrimination

1) Price discrimination of the First Degree, 2) Price Discrimination of the Second Degree and 3) Trade Discrimination of the Third Degree.

PRICE DISCOUNTS AND DIFFERENTIALS

Price discounts and differentials have been acquiring lot of significance in managerial pricing in recent years. In a market where competition is imperfect and products are being differentiated, it becomes necessary for the firm to maintain price differences by offering various types of discounts. Discount structures thus occupy a pivotal place in practicing price discrimination and differentiation. Discount structures are general schedules of price variation along several dimensions of a product-service package. They are useful not only in practicing price discrimination. But also for a variety of purposes. They help us in getting most desirable types of customer, invading new markets and for facing the competition more effectively in the market. The discount structures may be broadly classifies as follows: 1) Distributor Discounts. 2) Quantity Discounts.

3) Cash Discounts, 4) Geographical Discount Structures, 5) Time Differentials. According to Professor Joel Dean, price differentials are adopted on the bases on (i) the trade status of the buyers; (ii) the amount of his purchase; (iii) the location of the purchaser; (iv) the promptness of payment; (v) the time of purchase and (vi) the personal situation 1) Distributor Discounts: the distributor discounts are price deductions that systematically make the net price vary according to the position of the buyer in the chain of distribution. A distributors discount thus is a deduction from the list price granted to a particular type of marketer. 2) Quantity Discounts: Quantity discounts refer to the reductions in the net price, which are systematically related. Quantity discounts may take different forms; a) Quantity discounts on the basis of size b) Quantity discounts based on the form of calculation. c) Quantity discounts related to the number of transactions 3) Cash Discounts: Cash discounts denote reduction in the price depending upon or related to the promptness of payment. A typical example of cash discount would be: 2% off if paid in 10 days Full Invoice Price due in 30 days The size of cash discounts differs widely from percent 10 days to as much as 4% 70 days. Cash discounts are treated as the most suitable device to avoid bad credit risks. 4) Geographical Discount Structure: Geographical discount structure pertains to geographical price differentials. This type of

discount structure is based on the location of the buyer. The basic purpose behind devising these structures is to exploit the transport cost differences arising on account of locational distances between the manufacturing unit and the customers.

PRICE AND OUTPUT DECISIONS UNDER MONOPOLOSTIC COMPETITION

Products produced by various firms under monopolistic competition are similar but not identical. Product differentiation is the fundamental feature of the monopolistic competition. Since products are differentiated, there will not exist any unique price under monopolistic competition. Each firm enjoys a monopoly position as regards its product. The demand for the product therefore is highly elastic and not perfectly elastic. Each firm has faced a downward sloping demand curve. The curve does not have a steep slope, as there is a competition from close substitutes. There will not be a single price, but a cluster of prices under monopolistic competition. However, the price of an individual firms commodity is determined by its cost, demand and objectives of the company. In addition, the government regulations also influence the pricing process under monopolistic competition. It is the competition of substitutes that makes the demand curve more elastic.

PRICE AND OUTPUT DECISIONS UNDER OLIGOPOLY

Oligopoly is one the most important types of imperfect competition existing in the modern world. It implies competition among a few. There are only few sellers of a product and the actions taken by any individual seller exert a profound influence on the rivals. There is a personalized competition under oligopoly. Firms act as rivals of each other. The most important feature of oligopolistic market in interdependence in decision-making. 1) Price Wars 2) Price cuts to elbow out competitors 3) Price Leadership: Price Leadership implies that the firms in an industry follow the lead of one firm. When the products of the firms are identical, prices are usually uniform. Bt if there are differentiated products; prices can be uniform or may conform to a definite pattern of differentials. The leader announces the price change from time to time and, in the course of time, other firms follow suit. Price leadership is the best way of avoiding the unpleasantness of price retaliation. Price leadership is mainly of

two types (i) Dominate Price Leadership; and (ii) Barometric Price Leadership Price leadership os, in essence, a tacit(understood) concurrence by major firms in the industry with the wisdom of the leaders pricing decision. It greatly reduces the number of possible reactions of a price change, and thus gives a modicum of certainty to the pricing aspects of market forecasting The dominant price leaders are chosen on the basis of lower costs of the leader, or its larger size or its aggressive behaviour or some combination of these. The most common method is price leadership by the largest firm in an industry. The requisites of a price leader are (i) a substantial share of the market, (ii) a reputation for sound pricing decisions based on better information and more experienced judgment than other firms; and (iii) Initiative, Generally a company which first develops a product or area is in a position to retain the price leadership 4) Collusion: Another solution to oligolopoy pricing is in the form of collusion. It implies agreement among the firms as regards price or division of the market. This puts an end to price or retaliation. Collusion converts oligopoly into monopoly. However, there is always a risk because sometimes firms may not keep up their promises and break the agreement. Collusion is regarded illegal under the provisions of Anti-trust laws. 5) Non-Price Competition: Firms under oligopoly may sometimes prefer non-price competition. They would like to compete as regards product variation and sales promotion. They may prefer to compete in advertising, style, sales activity, brand names, designs, structures and models etc. But this sort of competition raises certain problems of welfare economics. However, such cases the danger of destructive competition is less. 6) Secret Price Concessions Oligopoly and the Kinky Demand Curve

PRICING METHODS IN PRACTICE

Many pricing methods, based on different considerations, are employed in practice. While fixing the price, firm is guided by some company objectives such as Profit maximization, sales Maximisation, Growth Maximisation, Establishing a favourable Image with Public of Government or Limiting Competition. Every firm sets certain objectives and tries to accomplish them. I. FULL-COST PRICING : This method of pricing is the simplest of different pricing methods used by business firms. It is very common method of determining the selling prices of products. It is also known as cost-plus pricing, margin pricing and mark-up pricing. A firm, under this method, competes the selling pricing of its product by adding certain percentage to the average total cost of the product. II. RATE OF RETURN PRICING : Rate of return pricing is merely a refinement of the full-cost pricing. In this method, the manufacturer considers a pre-determined target rate of return on capital invested. Return %age mark-up on cost = Capital Employed X Planned Rate of Total Annual Cost

I V. ACCEPTANCE PRICING : this method of pricing conforms with the system of price leadership. A firm initiates price changes and the other firms in the industry merely follow the pattern set the leader. Other firms accept the leadership. The emphasis here is on the market. Firm makes necessary price adjustments to suit the general price structure in the industry. Hence this technique is known as acceptance pricing or going rate pricing. Normally, industry tries to determine the lowest price that the seller can afford to accept considering various alternatives. According to Professor Joel Dean, a useful concept for this purpose is parity price. A parity price is one that yield the same total contribution profits as would have been obtained from the available alternative uses of the plan facilities. V. CUSTOMARY PRICES: Customery prices may be defined as those prices which more or less remain fixed having prevailed for considerably long period of time. Only if there is a significant change in costs, the customery prices change. While changing the customary price, it is necessary for us to study the pricing policies and practices adopted by the competing firms. Another approach is to effect price change only in a limited market segment and know the consumer reaction to decide whether any change would be digested by the market. INUITIVE PRICES: Intuitive pricing is basically a psychological approach to pricing. Prices under this method are based on the feel of the market. This method is highly subjective and its applicability differs from situation to situation. Prices under this method are determined on the basis of anticipated trends in costs and demand. EXPERIMENTAL PRICING: Experimental pricing is also known as trial-and-error pricing. This method of pricing has acquired lot of prominence in recent years. It is used to arrive at an optimum price. Trends in demand are taken into consideration while determining price under this method. Initially a sample test market is selected, experimental statistical design is prepared and then prices are varied. By varying the prices it is observed which

VI.

VII.

price maximizes profit or sales. Experimental pricing is popular in pricing the new products especially in the retail trade. VIII. CHARM PRICES: Charm prices are defined as those prices which end with odd figures such as Rs. 4.95 and Rs. 5.67 and have effect than even prices such as Rs.5 and Rs.10

PRACTICAL PRICING PROBLEMS

A) Multiple Product Pricing B) Product-Line Pricing: Product-line pricing is an important practical for many industrial units. Since almost every firm manufactures several related products, the product line policy has become a significant aspect of price policy. A product line may be defined as a group of products, which have similar physical features and perform generally similar functions. The product line pricing refers to the determination of prices of individual products and finding the proper relationship among the prices of members o f a product group.

D) Pricing A New Product CHOICE OF PRICE STRATEGY There are two alternative price strategies suggested for new products viz. 1) Skimming Price Strategy 2) Penetration Price Strategy 1) Skimming Price : This is a strategy of pricing under which products are priced at a higher level and large promotional expenditures are incurred in the early stages of market development. Initially high price accompanied by heavy promotional expenditure constitute a skimming price strategy.

Skimming prices have proved to be successful under the following conditions: i) Products have low price elasticity of demand ii) Where firms need funds to finance the product through its costly initial phases of introduction. iii) In a market where the buyer has no measuring rod for comparison of value and utility. iv) Where life cycle of the product is expected to be short. v) Where it is possible to take the cream of the market at high price before attempting to penetrate the more pricesensitive areas. vi) Where demand elasticties of the product are not known vii) Where the market is small but profitable, the firm may operate economically with limited manufacturing facilities and small sales force with a high skimming price. 2) Penetrating Price : Under the strategy of penetrating price, the initial price of the new product is nearer the usual of customary level. A low penetration price is found appropriate viii) The demand for the product enjoys high price elasticity in the initial stages. ix) Product acceptability is greater for the mass of consumers x) Firms enjoy substantial cost savings from volume production. xi) The product does not have strong patent protection xii) The treat of competition is substantial The purpose of low penetration price strategy is to create barriers for the entry of prospective competitors. It is the major instrument for penetrating mass markets early. It is meant to serve as an active agent for market penetration. This policy is said to be inappropriate where the total market is expected to be small and where the product calls for recovery over a long period.

Transfer Prices: Transfer prices relate to the prices charged by different divisions of the same firm for commodities and services exchanged between them. This system of pricing has become common in the modern industrial system consisting of multiproduct multi process companies. E) Resale Price Maintenance: Resale price maintenance is a form of vertical price control by the manufactures between the various stages in the distribution channel. Under this method, manufacturers maintain a uniform retail-selling price of branded products. They fix and stipulate the prices below which goods should not be resold at any outlet. Resale price maintenance means maintenance of uniform retail selling of branded products by their manufactures who fix and stipulate the prices below which goods should not be resold at any outlet. F) Dual Pricing : This is a price control device under which a product is sold at two different prices. In this two-price system, a fixed price is applicable to a part of the output and the remaining part of the output is sold freely on the market. G) Promotional Pricing: Promotional pricing refers to infrequent price reductions for products sales promotional. Such pricing policy may be resorted to during off-season sales when price reductions are necessary for sales promotion. Promotional pricing can become an integral part of the overall pricing strategy of the firm. A firm can resort to periodical and regular series of promotional so that a substantial part of part of total sales are made at reduced prices. Promotional pricing may not lead permanent increase in the sales volume. It can be used only as a tactical rather than practical and regular price strategy.

PROFITS
Profit is the income received by an organizer. It is the reward for the services of an entrepreneur. A firm makes profit when it receives a surplus after it has paid interest on capital, wages to labourers and rent for land. Profit, in other words, is the residual income, which is equal to the difference between the total revenue and the total cost of production. Profit earned by the entrepreneur may be broadly divided into two categories viz., the Gross Profit and the Net Profit. Gross profit of the entrepreneur refers to the whole of the income earned by him. It consists of the reward for the factors of production supplied by the organizer himself, reward management and reward for the organization of production. It is possible that the organizer may employ his own land or capital. The reward for such factors supplied by him is therefore included in the Gross Profits. Similarly, the organizer may himself manage the whole production instead of employing a salaried manager. The wages of management are to be included in the gross profits because the organizer would have earned the same wages had he been elsewhere. Gross profit also includes within it the net profits i.e., reward for undertaking the functions as an organizer. Profits in a business arise mainly on account of the following factors (i) Risk Taking and uncertainty bearing. (ii) Monopolistic control or Imperfections in the market. (iii) Element of Luck or Chance. (iv) Innovations, and

(v)

Differences in Abilities of Entrepreneurs.

Profits of the firm can be limited by a number of factors. In fact, modern firms themselves try to limit the profits on account of a number of reasons. The factors limiting the profits are as follows. (1) Creation of Competition (2) Creation of substitutes (3) Heavy Taxation (4) Increased wages (5) Increased cost of Input (6) Ceiling on profits.

THEORIES OF PROFITS
1) 2) 3) 4) 5) Risk Theory of Profits Uncertainty bearing Theory of profits Rent Theory of Profits Dynamic Theory of Profits Innovation Theory of Profits.