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Economics & Managerial Economics

Economics may be defined as a branch of knowledge dealing with allocation of scarce
resources among competing ends.

Managerial Economics may be defined as application of economics for problem solving at
the corporate level.

The problems relate to choices & allocation of resources which are basically economic in
nature & are faced by managers all the time.

The focus on managerial economics lies in identifying & solving problems faced by a
manager in a given enterprise situation & not merely on explaining his behaviour or
theorising about firm level phenomena.

As a result ,managerial economics though rooted in economic theory drawas upon &
interacts with other related disciplines.

Broadly three variables influences managerial decisions-(i) Human & behavioural
considerations (ii) technological forces (iii) Environmental Factors


Factors Affecting Managerial Decisions

Often only pure logic does not contribute to decision making.

HUMAN FACTOR

Human behavioural considerations often infuences a manager into compromising or
moderating a decision which would otherwise have made economic sense.

Example,Impact of a decision on an employees morale or motivation, which is outside
economic consideration, is taken into account.

Many enterpreuners prefer to do business on a modest scale fearing that expansion
would hamper their lifestyle and increase their stress levels despite the fact that clear
prospects of increased growth & better earnings await them.

A final decision is therefore taken by considering both economic factors & human
elements.

It is not uncommon for sentiments & emotions to play a part in very important decisions
even if that means a slight erosion in profits as long as there is a long term advantage.

TECHNOLOGY

In the present day business scenario, the influence of technology is too pervasive to be
ignored .

An assessment of technological alternatives ,technological measures of competitors and
new emerging technologies are critical factors in a managerial decisions on planning &
resource allocation within the enterprise.

Even short term production & marketing decisions are bound to take into account
appropriate technical inputs.

However beware that only technological options can provide a basis for decision making-
it has to be essentially an interplay of economic & technological factors.

In fact, economic considerations often decide the fate of technological applications.





ENVIRONMENT

Environmental pressures operating on the enterprise affect managerial decisions when
they are primarily economic in nature.

Economic sense may call for price rise but political & social factors often come in the
way of doing so.

Political parties, consumer groups, trade unions & community organisations constantly
put forth their view points which come in direct conflict with economic decisions.

Similarly social costs such as pollution control measures add a cost to the enterprise &
social organisations tend to come in the way of decisions which would otherwise make
economic sense.

Since the above mentioned cost cannot be ignored in the present day context,state
itself intervenes and this results in additional cost to the enterprise.
Managerial economics & Other Disciplines

It is customary to divide economics into positive & normative economics.

Positive Economics deals with description & explanation of economic behaviour.

Normative economics ,value judgement is made as to what should be done & not to be
done.

Managerial economics is a part of normative economics as its focus is more on explaining
choice & action & less on explaining what has happened.

Thus the system of logic that managerial economics uses comes from this hertage of
economic theory.

The primary task of managerial economics is to fit relevant data into the framework of
logical analysis for enabling decision.

Eg.A decision based on a linear programmingb approach or a pricing decision based on a
model approach.

Another branch of economics which is normative like managerial economics is public
policy analysis which is concerned with managing the government of a country.
DEMAND

Demand refers to consumer response related to purchase of goods &
services in a given market condition.

Law of demand states that other things remaining the same,rise in price
leads to a fall in demand & vice versa ie.they are inversely proportional to
each other.

1.Price of air ticket,impact on air travel/railway travel
2.Price of cylinder/impact on consumer
3.Price of petrol/impact on car demand
4.Price of diesel/impact on purchase of car
5.Price of wheat/impact on demand for rise
6.Govt.introduces rationing for essential goods,demand for these goods in
free market
7. Interest rates reduced by RBI, demand for housing

Determinants of individual demand :
(i) Price of commodity
(ii) Level of income,personal tastes
(iii) Price of substitute goods
(iv) Price of alternate goods



Demand Curve

It is the graphical representation of quantity of a commodity purchased by an
individual at a given price & time.

If the price of the commodity for a heart patient increases,it will not reduce its
demand.In that case,demand curve will have a steeper slope.

If the product concerned is not that essential & it has more substitute goods ,the
consumer will shift to other cheaper option e.g.tooth paste.The slope of the
demand curve will flatten.

Demand curve represents buyers willing to purchase at various prices assuming
other factors to be constant.

Demand curves are also taken as marginal utility curves wheras supply curves
reflect marginal cost curves.

As consumer purchases more & more of a commodity,the utilty drawn from the
extra commodity diminishes.

Diminishing marginal utility is one of the causes behind the downward sloped
demand curve.


Movement & Shift in Demand Curve

Expansion & contraction of demand leads to movement along demand curve.

Increase or decrease in demand leads to shift in demand curve.

Movement along the demand curve takes place where change in demand is caused
only due to price change.In this case,demand curve will remain the same, either
upward or downward movement along the demand curve takes place.Eg.price falls
from Rs.8 to Rs.7 & quantity purchased by consumer increases from 5 units to 7 units.

In the case of shift in demand curve,the demand increases or decreases due to shift in
other variables (income,taste,fashion etc) other than price.The price of X remains
constant but change in other variables increase the demand
viz.income,preference,price of other goods etc. Increase in demand leads to shift in
demand curve in outer direction & decrease in demand leads to shift in demand in
the inner direction.

As a result of shift in demand curve,both equilibrium price & quantity demanded will
change.







Success of a company depends upon the revenue earned by the company.

This in turn depends upon

(i) Companys ability to offer goods & services that the customers want.

(ii) Price that the customer is ready to pay.

Demand, in other words, is nothing but sales of the firm.

Sales depends upon many things such as customers preference,price,income,taste &
preferences.

On the basis of the actual sales,the firm can project its future.

I

Individual Demand & Market Demand
Mr.X Mr.Y
Price Qty demanded quantity demanded
10 0 1

9 1 2

8 2 3

7 5 4

6 8 5

5 12 7

4 15 9

3 18 22

2 20 35

1 20 35
In the first case,Mr.X does not buy anything presuming that it is too expensive.

When the price drops to Rs.9,he purchases only one.

With the price drop, he purchases more because it is less expensive.

But he does not go for anything extra after price dropped to Rs.2

That means even after a further price fall,he will not anything more

In the case of Mr.Y,at Rs.10,he purchases atleast one wheras Mr.X buys nothing.

Upto Rs.4,he purchases at a slow rate

Below Rs.3,he purchases at a faster rate.

As price reaches Rs.2,Mr.Y does not purchase more than 35 as his requirement of that
commodity is fulfilled 7 he does not desire to buy more than 35 of the product.

The demand of X & Y of a given commodity at different prices gives us individual demand
curve.

When we add up all the individual demand curves,we obtain demand for the community.


Demand Analysis

Demand theory mainly based on individual demand.

But more than one firm operates in the market & each of them hold part of the market
share.

Each firms policy decision influences the market.

Thus individual firms demand is not market demand.

When many firms operate,demand curve faced by an individual firm is more important than
market demand curve for pricing & output decision.

The firm has to consider the impact of changes in demand due to taste,preference & price of
other goods.

Pricing & output policy of the firm affect the consmers decision to purchase.

Firms demand could also be a function of pricing policy of other firms.Price cut by a firm
will obviously increase its sales at the cost of market shatre of the other firm.

Promotional activities would have a similar effect as above.



Demand Function
D=f(P)
It is the simplest form of demand equation where demand solely depends on price.

When other variables influence demand it is Dx=f(Px:Po;Y,T,Ut)
Dx=demand for commodity X,Px is price of X,Po is price of commodity o,T is time Ut
represents other variables.

A true demand curve which shows how sales vary with price .

This is the curve which must be involved in optimum pricing-out policy calculation.

Sometimes we see only the trend of demand ,whether it is increasing or decreasing over a
period of time t .Then we get, D=f(t)

Market demand can be expressed as Qd=f(P,I,Pz,T) ,where Qd is demand for commodity
q,I is icome,Pz=price of competitive commodity Z.,T is time.

P,I,Pz,T are independent variables that influence demand.
The linear form will be
Qd=a + bP + cI + dPz + eT
where a is the intercept,b is the price elasticity of the product for demand measured,c is
income elasticity d is cross elasticity & e elasticity with respect to time variable.
Marginal Utility

It is the satisfaction derived on the marginal or extra units of commodity
purchased.

Diminishing returns

As ta consumer accumulates more & more quantity of a commodity, the
satisfaction derived by him goes on reducing with the increase in that quantity.

Direct Demand
When a consumer purchases a product for his direct consumption,the demand is
termed as direct demand.

Derived Demand

Sometimes a demand for an item depends upon the demand for the final
product.E.g.demand for labour & other inputs is created due to demand for the
final product.In tourism, demand is direct when sales take place for final
consumption.accommodation,tourist guides,vehicles for transport are derived
demand.


Composite Demand

When two products are demanded for different purposes e.g. fridge which is required
by a shop for commercial purpose & a household for domestic use.

Joint Demand

When two products are demanded at the same time,it is called Joint demand e.g.car &
petrol.

Latent Demand

When a consumers desire is limited by their purchasing power,a late demand exists.

Composite Goods

Composite goods represent what is given up included in the optimal choice subject to
budget constraint.

Giffen Goods
They are highly inferior products which consumer does not buy even after a price fall.
Consumers of low income group will spend a significant portion of their income on
such goods.They keep on moving to other cheap quality items.Hence demand in such
cases will not actually fall on price reduction.
Veblen Goods:
Opposite of Giffen Goods-they are high fashion goods-branded,high quality stuff.

Higher price will not discourage people into buying less.

There is a snob value for designer collection etc.

The rich society patronise such market & feel that if the price reduces,it would be worth
buying.

Hence the demand actually reduces if the price falls.

Price Change,Income effect & substitution effect on Demand

Price change generates two effects: Income effect & Substitution effect.

Income Effect

Eg:Suppose price of x is Rs.10 & you purchase ten units.In case price falls to Rs.6,with the
same amount of money you can buy more.

Price change will give you surplus money that is called income effect of price change.Your
real income increases by 10 6 = 4.


Substitution Effect

In the aforesaid case,after purchasing same amount of X,you can purchase some other
item or you can purchase more of both commodities.this is called substitution effect.

Substitute Goods

Goods which serve the same purpose such as tea & coffee.Slight change in price of one
can affect the demand for the other.Copper & aluminium is another example.

Complementary Goods

When both goods are required at the same time eg. Car & petrol/diesel.Increase in price
of one will decrease the demand for the other & vice versa.

ELASTICITY & DEMAND CURVE

If the demand curve is flat,the demand is more elasic (change in demand on account of
change in price)
Diamond Water Paradox

Diamonds have very less utility value but fetch a very high price whereas in case of water,it is
vice versa. This is called diamond water paradox

This is explained on the basis of MU Marginal Utility.

MU for diamond is very high as it is a scarce commodity, hence it fetches a very high price.

MU of water is low as it is easily available hence its price is low.

In terms of total utility, it is high for water & low for diamond.




Factors affecting demand

1.Price of commodity
2.Disposable Income
3.Distribution of Income
4.Price of other commodity
5.Quality of goods & services
6.Availability of goods & services
7.Population
8.Taste & preference
9.Brand name
10.Advertising
11.Demonstration effect
12.Time
13.Instalment/deferred payment
14.Personal touch
15.Bandwagon effect (positive network
externality)
SUPPLY

The amount of goods & services that firms are able & willing to offer for sale over a
range of price.

Law of supply states that quantity supplied is directly proportional to price.

The supply has a +ve upward slope from left to right.

The simplest equation is Sx=f(px) where sx=supply of commodity ,px=price of
commodity x.

Low prices therefore discourges to produce more whereas high price acts as an
incentive to earn more.

Higher prices attract existing producer to increase supply & it invites new producer to
join the market.

Supply is a flow concept & stock is a part of supply .

Supply is limited to the availability of stock at any point of time.

Individual Supply Schedule

It shows the various amounts of a commodity that a particular firm wants to supply at
different prices in the market ,other factors remaining constant.

Price increase will attract new firms to enter the market.

It encourages a firm to produce more to earn more profit.

Price decrease will discourage new entrants into the market

It will also discourage the firm from producing more.

If the price falls very low even below the cost of production,a firm may not be able to

supply at all.

Thus supply & price are +vely corelated.
Market Supply schedule

The horizontal sum of all firms supplies at different prices gives us market supply.

The supply is directly related to market price we get a +ve slope of the curve.

The short run supply curve has a +ve slope on a/c of a diminishing marginal returns.

After a level of production, the production of additional units require more of variable
factors .

In the short period, it is not possible to increase the fixed factor part & diminishing returns
begin to operate.

The long run supply curve has a +ve slope due to presence of diseconomies of scale like
managerial inefficiency,limited resources etc.

Under competitive industry, a firm likes to reach a level Price=Marginal cost.

Thus aggregate supply curve is the total of marginal cost curves.

Industrial supply=Supply of all the firms.
Shift in Supply Curve

Shift in supply curve takes place when the product price remains the same & the firm
wants to supply more or less.

The supply curve will to either right or left of the original curve.

There can be a change in other variables other than price which affect supply, say if the
firm can produce more at a lesser cost due to improvement in technology & supply more
at the existing price.Here the supply curve will shift outwards.

Similarly if the cost of higher inputs result in increase in cost of production,the firm will
produce less ,supply less at the existing price & the supply curve will move inwards.

In both cases,there will be a change in the equilibrium price & quantity.
Expansion & Contraction of Supply

The movement along the same curve takes place when amount of supply increases or
decreases due to change in price of commodity.

If the price falls to P ,the amount supplied by the firm will fall by QQ.

If the price rises,the firm will supply more of the quantity.(other things other than price
which might influence supply are assumed to be constant.

Factors determining supply

1.Price of Commodity
2.Price of other commodity
3.Price of factors of production
4.Production technique
5.Tax net of subsidy
6.Goal of producer


Exceptions to Law of Supply

(a)Expectation of further change in price.
(b) Agricultural goods
Where resources are limited
(d) High quality artistic goods
(e) Elasticity of supply & so on.

In case of art goods,antiques,rare collections ,price
rise will
not increase supply due to limited availability.

Sometimes supply curve can be a vertical straight
line very perishable goods or service sector items
e.g.supply of milk which is fixed for the day.

Supply of agricultural goods cannot be increased
beyond a certain level.

Thus shape & slope of the supply curves will differ
due to various reasons that may influence supply.

Beveridge Curve

It depicts a negative relationship between unemployment & no of job vacancies.

The curve slopes downwards as lower vacancies are associated with high rate of
unemployment.

If thev curve shifts outwards,it means that given a certain level of vacancies,we have more
unemployment.

Imnward shifting of curve indicates improvement in mismatch.

Th movement of this curve takes place due to following reasons:

1.The curve will move inwards depending upon the availability of new jobs.
This will happen with improvement in economy,reduced labour unrest,mobility of labour
etc.
2.If more labour joins the existing labour force,it will increase unemployment & the curve
will outwards.
3.Some employers do not tend to hire under certain conditions,in this case also the curve
will move in the outward direction.
Other Factors Affecting supply

1.Production cost of goods & services

2.Price of inputs

3.Technology

4.Taxes & subsidy

5.Administered

Supply Chain
Supply Chain includes all continuous adjustments of storage of raw materials,work in
progress,finished goods from the point of production to the end users.

Outsourcing is an important example for managing supply chain in modern days
business.
Advantages of Supply Chain

1.It manages all the bottlenecks efficiently.
2.Producer can keep a watchful eye on the increase in cost in the process & trim wasteful
expenditure.
3.Customer requirement & satisfaction can be easily known.
4.Software on SCM helps efficient management of business.
5.Alternate scenarios for processes and end results can be easily noticed & suitable
remedies adopted to run the process.

Disadvantages of Supply Chain

1.Huge cash flow has to be managed across supply chain
2.Inventory management of raw material,work in progress & finished goods involve
immense task.
3.Competent management of supply chain needs constant sharing of information across
the board .Any misinformation or short information could break the chain & result in
losses for the firm.


Equilibrium
1.Market attains equilibrium when supply equals demand.
2.Demand & supply curves intersect each other & market is cleared.
3.Price is the factor which acts a equiliser betweensupply & demand & brings
about equilibrium in the market.
4.Change in equilibrium reflects change in supply or change in demand or
both.
5.Thus supply & demand for a given commodity determine the equilibrium
price & quantity in a perfectly competitive market.
6.Assuming only price changes,we have
D=f(p)
S=f(p)
In equilibrium,S=D(supply=demand & the market is cleared)
7.The essence of equilibrium is that once its reached,it stays there.
8.Any change is equilibrium will be corrected by price movement.
9.If D<S,there is excess supply of goods & the producer will reduce the price.
10.This will increase demand till equilibrium is reached when market gets
cleared.
11.In equilibrium,there is no pressure on price to change.


Other Factors

1.In the previous slide,we have considered only price as the independent
variable.
2.Shift of demand & supply will occur due to change in variables other than
price.
3.These are change in income, price of substitute goods,emergence of a new
firm in the industry, technology change, taste & preference etc.
Examples:
(i) In the 90s,due to overestimation in the demand in car market,there was
excess supply of cars.Later on price & production were adjusted & income
constraint also acted as a deteriorating factor.Presently you have a glut with
all types of cars for all income groups.
(ii) Rise in income plus credit facilities have led to a spurt in demand in Indian
car market.
(iii) Private sector now freely operated in India & a number in India in white
goods.Free market economy has led to price rise & in times to
come,equilibrium prices also will tend to soar higher.
Stable & Unstable Equilibrium

(i) Price is determined by a balance between production at each price
(supply S) & desire to purchase backed by purchasing power at each
price (demand D).

(ii)New equilibrium E will depend upon the amount of shift in supply curve.

(iii)When demand curve slopes upward to the right & supply curve slopes
upward to the left,we obtain stable equilbrium.

(iv)When both demand & supply curve are sloping downwards to the right &
slope of supply curve is steeper than slope of the demand curve,at point
E ,supply equals demand.But it is not a stable equilibrium point as
divergence point will take the situation away & away from the original
point.So E is an unstable equilibrium situation.

Usefulness of Demand Analysis
(i)Demand theory & demand analysis are useful for assessing the market.

(ii)While individual demand curve reflects individual demand,adding demand
curve at different prices gives us market demand curve.

(iii)When we add all individual demand curves,we get total demand curve for
the community.

(iv)Thus the effective demand is important which is demand backed by
cash& shows the actual purchase.

(v)The demand curve has special importance in applied economics.it sums up
the response consumers demand to alternative prices of its product.

(vi)It tells the management how a price change will affect the demand for one
of its products.

(vii) For normal goods & services,demand curve is vely sloped i.e.lower the
prices,greater is the expected demand & vice versa.

(viii) The more competitive the market,flatter (more elastic) is the demand
curve & more imperfect the market,steeper is the demand curve (inelastic).
Producer has to accordingly bring down prices to increase demand.





Elasticity

(i) It is a measure of responsiveness it is change in a variable which is
proportionate to change in another.

(ii) Elasticity of demand proportionate change in demand due to change in
price ,income, expenditure,advertisement etc.

(iii) Flatter the demand curve,greater will be the value of the resposiveness
i.e.more elastic will be the demand.

(iv) When demand is elastic,percentage change in demand will be more than
the percentage change in price.

(v) When demand is less elastic, percentage change in demand will be less
than the percentage change in price.

D = a+bPx + cY + dt + et

where a=intercept, Px=price of commodity X, y = income,T= time &
ut=other variables.
b=price elasticity of product,c=income elasticity d=cross elasticity
e=elasticity w.r.t. time variable







Demand Curve

The slope of the demand curve depends upon the elasticity of demand.

The elasticity is not constant along the demand curve.

Price elasticity of demand depends upon the slope of the demand curve,price
of the product & quantity.

As price & quantity change,elasticity also changes along the curve.

Starting from high elasticity at the top, it reduces down the curve.

Linear demand curve is given by the equation, Q= a-bp

Types of Elasticity of Demand

1.Price Elasticity of Demand : Relative change in quantity demanded
proportional to change in price .

2.Cross Elasticity of Demand: Relative change in demand for commodity X
due to proportionate change in price of some other goods.

3.Income Elasticity of Demand: Relative change in demand due to
proportionate change in income.

4.Advertising Elasticity of Demand: Relative change in demand due to
proportionate change in advertisement expenditure.



Measures of Price Elasticity of Demand

1.Expenditure method 2.Percentage Method

1.Expenditure Method: It gives us total expenditure incurred by the consumer
on change in price.It is obtained by price of goods X quantity.

Case I
(i) If total expenditure increases due to price fall.
(ii) If total expenditure decreases due to price rise.
Case II
(i) If total expenditure decreases due to price fall.
(ii) If total expenditure increases due to price rise.
Case III
If total expenditure does not change on account of price rise/fall, then
elasticity = 1.

Elasticity also measured as change in quantity/quantity demanded
(q/q)/change in price (p/p) = q/p*p/q

Demand is elastic if % change in demand > % change in price.
Demand is inelastic if % change in demand <% change in price.
Unitary elasticity if % change in demand = % change in price.

Elasticity at a particular point on the demand curve is also called point elasticity of
demand.

Examples:
I
Price(Rs.) Units Total Expenditure(Rs)
8.00 2 16.00
7.00 5 35.00

Demand is elastic w.r.t. price.

II
When demand changes to 20% & price changes to 10%,elasticity=20/10=2.Here
elasticity> 1 and hence demand is elastic.

III
At price (p) of Rs.6.00 quantity demanded (q) is 10 units.
Price falls to Rs.4.00 or change in price dp=Rs.2.00
Demand increases from 10 units to 15 units i.e.dq=5
Using formula elasticity of demand Ed=dq/dp*p/q=5/2*6/10=1.5
Price elasticity > 1 which means demand is elastic.
Arc Elasticity of Demand

Arc elasticity of demand gives us elasticity calculated over a range of prices.

Sometimes we need to calculate elasticity over a range of prices & arc elasticity of
demand provides us the solution.

Instead of taking the initial or final prices,we take the average of the two.

Arc Elasticity of demand=dq/dp*p_/q_ where p_ = av.price & q_ = av.quantity

Income Elasticity of Demand

This represents % change in demand to % change in price.
=Dq/dy*I/Q, where I=Income
Income elasticity is +ve for normal goods & services.Generally,demand is equal to
less than proportionate to rise in income.

For luxury products & services,generally income elasticity >1 i.e.change in
demand is greater than proportionate change in income.
Eg: income rises from Rs.500/- to Rs.1000/-.Therefore demand for goods rises
from 30 units to 40 units.
Income elasticity of demand =dq/dy*y/q = 10/500*500/30=0.33 which is <1
Income elasticity of demand is inelastic.
Importance of Income Elasticity
(a) Important in price determination from different phases of a
business cycle such as targeting a particular income
segment eg.middle income group.
(b) People from this group aspire for many things considered as
luxury in India e.g.foreign trips,becoming club members etc.
(c) Demand for these items is income elastic.
(d) Discounts,rebates,early bird offers etc.tend to bring in
customers for cars,tours,club memberships etc from this
income group.
(e) At the same time,customers from other income groups also
tend to join this bandwagon & the total effect is much higher.
(f) If income elasticity of demand>1,the services & products will
be of normal standard.Therefore price falls or discounts etc
increases demand.
(g) If income elasticity of demand<1,the goods or services are
considered inferior.
(h) Therefore their demand would fall even if price reduction or
discount is offered.
Income Elasticity Of Demand:


This represents % change in demand to % change in price.
=Dq/dy*I/Q, where I=Income

Income elasticity is +ve for normal goods & services.Generally,demand is equal to less
than proportionate to rise in income.

For luxury products & services,generally income elasticity >1 i.e.change in demand is
greater than proportionate change in income.
Eg: income rises from Rs.500/- to Rs.1000/-.Therefore demand for goods rises from 30
units to 40 units.
Income elasticity of demand =dq/dy*y/q = 10/500*500/30=0.33 which is <1
Iincome elasticity of demand is inelastic.

Income Elasticity of demand=% change in quantity demand / change in income
= dq/dy*I/Q
Income elasticity of demand is +ve for normal goods & services.
Generally demand is equal to or less than proportional change in income.

Example: Income of a person increases from Rs.500/- to Rs.1000/-.As a result demand
for the goods increases from Rs.30 units to 40 units.
Special Cases

1. Inferior Goods: Even when real income rises, demand does not increase & value
of income elasticity is ve.


1. Necessities:The income elasticity is +ve but < 1 i.e. it is inelastic.


2. Luxuries: The demand for luxury goods is generally more elastic E>1.
Here a bit of reduction, rebate can attract more customers.
whether an item is considered luxurious depends upon a countrys or
places economic or cultural conditions.




Cross Elasticity of Demand

(1) There are many goods & services which are substitutes for each other.
(2) Some goods & services (complementary goods) are demanded together.
(3) Price change in one commodity will affect the demand for the other.
(4) These are called related goods & services.
(5) For these, change in demand for one product due to proportional change in the
price of the other is called cross elasticity of demand.
(6) It is given by % change in demand for commodity X / % change in price of Y
=dqx/dpy*py/px
where q=quantity, p=price,x & y are two commodities.
Following kinds of change are noticed:
(a)Cross elasticity = infinity : It is possible where the two goods are perfect
substitutes.
(b)Cross elasticity=0: The goods are not related products.
(c)1> cross elasticity >0.Cross price elasticity is not all that effective.
(d) Cross elasticity is ve: When the two goods are complementary.

Cross elasticity of demand helps the firm to see the closeness of the substitute.

Examples of Cross Elasticity of Demand

I(i)Tour packages X & Y to the same route are homogeneous & are substitutes.
(ii)The cross elasticity between these two packages is +ve.
(iii)Rise in demand for one package would reduce the demand for the other.
(iv)Substitute makes the business more competitive.

II(i)Accommodation & transport work as complements for a tour.
(ii) Cross elasticity will be ve.
(iii) Rise in price of accommodation & transport will increase cost of tour.
(iv) It will therefore reduce the demand for tour package.

III(i)Unique tour packages such as adventure tourism can work independently as
there are not many tour operators in this segment.
(ii)Cross elasticity of demand to price change is zero.


You also have advertisement elasticity, market share elasticity, elasticity of price
expectation etc.

Price Elasticity & Decision Making

(i) Price elasticity helps business manager to forecast demand.

(ii) If price elasticity of demand>1,the responsiveness of demand change
more than price change.

(iii) Price rise does not always increase revenue or price fall does not
always increase sales.

(iv) increase/decrease of revenue depends on demand & elasticity of
demand.

(v) Manager has to fix prices carefully so that expected revenue should
be around the actual revenue.

(vi) Firms generally try to make more profit by increasing price & expect
to bring in more customers by price reduction.

(vii) Success or failure of the above objective depends upon the elasticity
of demand for the firms products/services.
Opportunity Cost

It is calculated as the cost of an alternative that must be foregone/given up in
order to pursue another action.

Opportunity Cost=Cost of selected alternative Cost of next best alternative

Mutually Exclusive Economic Alternative:

Group of choices of different utilities-goods,services,investments etc.that a person
can choose usually w.r.t. a certain time frame or a certain amount of money.eg. A
person having Rs.1000/- can buy a shirt,a tie or a DVD .But he chooses the shirt
option.

Selected or Derived Alternative:

It is that alternative that a person would opt for by giving up the opportunity to buy
the rest of the items.The derived alternative in this case would the shirt for which
he has given priority over other items.

Next Best Alternative:It is the article that he would settle for if he did not get
access to the desired article.The next best alternative would be any of the
remaining items but not all of them.
Eventual decision:

It is the choice made by the person from among the mutually exclusive articles
in order to select the desired article.

This final decision determines which article assumes the status of the selected
alternative.
Fixed Proportion & Variable Proportion

Production is subject to fixed proportion when we have fixed ratio of inputs
for various levels of output.

With change in output, input ratio also changes.

Again production is subject to variable output when same output can be
produced with different combinations of inputs i.e.different input ratios.

Variable output arises on account of diminishing productivity factor.
Consumers surplus

The difference between what the consumer is willing to pay to purchase a
commodity & what he actually pays is Consumer surplus.

The surplus is created only when the consumer wants to pay more than the
market price.

It tells us the maximum a consumer will be willing to pay for a given quantity
supplied.

According to law of diminishing returns,the consumer will pay more for the first
item & less & less for every additional item.

Calculation:
Market price =Rs.50

Consumer wants to pay-for 1
st
item=55, 2
nd
item=54,3
rd
item=53,4
th
item=50

Total consumer surplus= (55-50) + (54-50) + (53-50) + (50-50) =12


If the demand for a particular commodity is elastic, CS=0
here price of the commodity matches with what the consumer is willing to pay.

When the demand is inelastic ,CS is infinite.

When the demand is inelastic, consumer surplus is lesser.
Elasticity of Supply

It measures the degree of responsiveness of quantity supplied to the change in
commoditys price.

In the short run,supply tends to be inelastic & in the long run,it tends to be elastic.

At a particular price,supply equals infinity i.e.perfectly elastic ,it means that a firm
can supply any quantity at a given price.(E=infinity)

Where price change will not bring about any change in supply,it is a perfectly
inelastic supply.(E=0)

In between these two extremes, where supply can be increased proportional to
price rise,E=1 & where supply can be increased > the increase in price
,E>1(elastic) & where the supply can increased < increase in price,E<1
inelastic).


Elasticity of supply tells about the condition of production just as elasticity of
demand tells us about behaviour of demand.

A business with constant costing(pricing) has a perfectly elastic curve which
runs parallel to X axis.

Elasticity of supply measured as:

Es=% change in quantity supplied/% change in price.

= dq/dp*p/q

Supply elasticity is normally like a supply curve:

Eg: A supply curve is given as Qs=100P

Plot supply curve & calculate elasticity taking any 2 points on the curve.


P 1 2 3 4
Q 100 200 300 400
Elasticity at Point A=1 Elasticity at point B also=1

At point B,dq/dp*p/q=100/1X1/100=1

Similarly at point C,it is =1

Thus the supply curve Q=100P has elasticity=1
Revenue & Elasticity:

Revenue is the important element in every business.

It is directly related to demand for goods & services offered by a firm.

TR=price(p) X quantity(q) TR=pq

Marginal revenue is the rate of change of total revenue with increase in
sales.

dR/dq=p

Average revenue=TR/Q

Relation between marginal & total revenue

- when total revenue is increasing,marginal revenue is +ve.
- When total revenue is decreasing,marginal revenue is decreasing. At
the maximum point of TR
MR=0.
-



The demand curve of a firm is downward sloping on account
of (a) substitution effect (b) diminishing marginal utility.

Further under imperfect competition, reduction of price is
essential for additional sales.

The growth of firms is explained in terms TR.

TR w.r.t. each price can be obtained if we know demand
behaviour.A sound pricing decision will require the above
information.

Otherwise price reduction will not bring in more buyers &
increase in price will not improve revenue.


Price Elasticity & Total Revenue

When demand is elastic, discounts etc. in order to bring more customers is
resorted to.

This will increase a firms market share & bring more revenue thro more
customers.

The firm needs to compare this extra revenue with extra cost of producing
more.

If the demand is inelastic,the firm will try to hike prices which will not
reduce customer base.In inelastic demand situation,it is not profitable to
decrease price.

The total revenue will fall as cost also rises with increase in quantity.

Objective of maximum sales revenue will be achieved if a firm is able to fix
prices where demand is neither elastic or inelastic or at a point of unit
elasticity.



A firm considers a number of factors before taking a policy decision:

(i) Whether an increase in price of X will increase revenue.
(ii) When this increase in price will increase demand for Y or z.
(iii) What will happen to the sales quantity?
(iv) What will happen to sales revenue?

Relationship between price elasticity & total revenue:

Price ep>1 ep=1 ep<1

Price rises TR falls no change TR rises

Price falls TR rises no change TR falls

Exceptions:
(i) Expectation of further rise in prices
(ii) Prestige goods more demand at higher price
(iii) Superior goods & inferior goods: For superior goods,price will be followed
by demand rise 7 for inferior goods price fall results in fall of demand
(iv) Necessities are purchased by people in same amounts regardless of price
rise/fall.
Demand & capacity utilisation:

Due to demand fluctuation,firms often face the problem of capacity
which cannot be increased/decreased at short
notice.Egs.airlines,hotels.

Other factors are facilities & labour.

During busy season,firms often face maximum utilisation of
capacity & in lean seasons,it is under utilisation of capacity.

Most preferred situation is optimum utilisation of capacity.

Optimum utilisation means resources are utilised but not over
utilised.

Eg.Machinery & other inputs may be fully utilised during peak
season stretching the firm to its capacity.this may not be desirable.

Thus unerstanding of dem,and behaviour is a must for every
business & demand is a function of factors such as
income,taste,fashion, basic need etc.





Yield Management

With a view to meeting demand & variations in demand,a firm always in
a state of adjustment with changes in production,offer of
discounts,rebates etc.In off season,advertisements are published to
attract customers.

Yield management is called revenue management-it helps a firm to
maximise profits/revenues.

This may lead to price discrimination or quoting different prices for the
same service.This practice is common where resources to be offered
for sale are fixed,perishable & customers are willing to pay different
prices for a fixed quantity.

Eg.unsold/cancelled tourism packages are sold at throw away prices.
Similar is hotel industry.

This practice is adopted when a firm is sure that its customers would be
ready to buy its goods/services at varied prices.

Yield=actual revenue/potential revenue where actual revenue=actual
capacity utilised X average price
Potential revenue=total capacityX maximum price





Crude Oil Market

The traditional demand supply theory fails to work here.

The expectation of traders,the supply position,the futures & spot prices lead to
volatility in crude price.

At every stage,there is a MTM factor to reflect the true position.

Under efficient market conditions,spot prices increase with future prices .

This keeps investors go either long or short according to the market conditions.

If current & future prices do not go in tandem,arbitrarge opportunities arise which
bring prices back in line.

Market analysts play a crucial role by providing different scenarios of price
changes ahead of traders findings.

future prices reflect traders expectations.

Expansion of world economy increases demand for crude thereby rendering it
price inelastic.

Geo political factors play an important role in determination of crude price.

Any favourable change in a single variable can bring down the price.

This behaviour is in essence a case of dynamic disequilibrium.

Gold market

It is a volatile commodity where demand & supply equilibrium fails to
work.

Gold price is driven by a combination of international factors & local
factors.

There is lot of emotional & sentimental value attached to gold in India
.There is buying demand in festival season earlier it was purely
jewellery but in recent years bullion demand has gone up.

Jewellery (scrap gold) is sold in times of liquidity crunch or pledged
for taking loan.

Gold price is derived from its value in US $ & normally there is an
inverse relationship between the two.

Gold price goes up when there is demand for buying from the central
banks of countries & goes down when they commence its sale.

Speculators also hold long positions in gold in good numbers.

There is hardly a case for equilibrium situation in gold market.


Consumer Behaviour

It is the study of what the consumers buy,how they buy,why they
buy & when they buy.

It attempts to understand the buyers decision making process
both as an individual & as a group.

General public, institutions,govt.bodies,producers can be taken
together as consumers as they purchase commodities & create
a demand for them .

Economic factors such as income ,price & non-economic factors
such as age,family size,taste & preference & education
influence consumer demand.

Social/cultural factors play a role in shaping up consumers
demand.

Legal factors such as govt & regulator policy influence
consumer behaviour.
Scenario in India

The average Indian consumer, earlier,would only just satisfy
his necessities with his limited resources.(simple living & high
thinking)

Days have changed & now you have the Indian consumer with
a higher per capita income,higher disposable income &
consequently, higher purchasing power.

Availability of EMI facilities, credit/debit cards, net banking,
personal loans have all contributed to increased consumerism.

A section of farmers in a number of states have become more
wealthy & contributed to rural prosperity whch has increased
demand for goods.

However, heterogenity is noticed in peoples income pattern
which influences consumer demand.

There are broadly three categories of consumers.
First Category:

More than 40% of our population is at BP level.

Most of them work in informal sector & live on the margins of society.

Their major portion of limited income is spent towards basic needs
such as food,clothing & shelter.

Of late,even the low income earners capacity to purchase has slightly
increased.

The result being they are able to save some money.

This saving combined with generous loans offered by many entities
enable them to have some spare cash for buying some durable
consumer goods after meeting their normal requirements.

It is well established that with rising income & food consumption
reaching saturation,there is some appetite left for non-food items also.


Second category:

This is the typical middle class group.

While their income is not very high,they are subject to social
pressures of high living with a limited savings.This sub group is the
lower middle class.

The group slightly above this tier comprises the highly skilled
,educated professionals who are able to save reasonably well and
are able to afford decent houses,good cars & even club
memberships.

This group creates significant amount of consumer demand.

Third Category: This group is negligibly small in our country.

They maintain a very high standard of living even comparable with
western countries.

Their spending on all types of luxury goods creates a good demand
in fashion & branded items ,


Consumer Behavioural Analysis

Basics:
1.Consumer preference for one good to another or one bundle of
goods to another.
2.Consumer allocates his limited income to alternative choice of
goods.
3.Consumer tries to maximise his utility & thus satisfaction subject to
his budget & preference.

Consumer Demand Theory-Approaches:

I Cardinal Utility Approach:

1.Utility is measurable & can be numbered.
2.Individual always tries to maximise his utility.
3.Diminishing marginal utility is an important factor in consumer
decision.

II Ordinal approach:
Cardinal theory was revisited & improved by Preference theory-
popularly called Indifference Curve approach.
Individual can show his preference of goods by ranking goods & services.
Eg.For three goods A,B & C, an individual can prefer A to B & B to C.

Individual is a rational human being. Once he makes a decision,it will remain
the same assuming other conditions as constant.

This leads to Law of Transitivity : If A is preferable to B & B is preferable to C,
then A is preferable to C.

Marginal utility is replaced by Marginal Rate of Substitution.

Ranking need not be numbered.Instead ranking A at 8,B at 5 & C at 3,he can
simply say that he prefers A to B & B to C.

This theory is good enough to accommodate the desired concept of
Indifference Curve analysis.

Indifference Curve analysis approaches the whole world,whereas utility
analysis touches upon logic.It presumes an introspective ordinalist who states
his preference.

In ordinal analysis,equilibrium will be reached when
MRS=price ratios -dq2/dq1=p1/p2

Indifference curve Analysis or Preference Analysis

A consumer with his constraints of limited income has to decide which
goods & services to buy.This decision can be analysed w.r.t. the
following:

(a) Many goods & services available in market. Information on which
particular goods & services customer prefers is necessary.

(b) There has to be relation between consumer income & price of goods.
Budget constraint brings about a trade off between the two.

(c) Consumer may be indifferent to all combinations which give him same
level of satisfaction.He will choose that particular bundle of goods
which gives him maximum satisfaction subject to budget limitation.

(d) Consumer choice will help him to analyse demand pattern.

(e) Price change will lead to change in preference & purchase behaviour.

For simple analysis, indifference curve model includes two commodities
with given income & price of goods.




Indifference Curve:

It is a geometrical representation of two commodity models.

On a single curve,any combination of two goods will give same
level of satisfaction & represents utility function of consumer.

Therefore an individual will be indifferent to any combination on
the same curve & for this reason,this curve is called indifference
curve.

Only income & price will change the situation.

With rise in income, individual will have power to buy both
commodities & will shift to the higher IC curve.

With fall in income,he will shift to the lower IC curve.

In between 2 curves ,there are infinite curves & that is called
Indifference map.

The actual purchase will depend upon his purchasing power i.e.
budget line.



If an individual derives more utility out of product X as compared to product Y,
It can be said that he would prefer product X to product Y.

Depending on his income,he can choose a combination anywhere on a give IC
curve,assuming other things to be the same.

The aim of IC analysis is to find out the condition where the individual can
maximise his satisfaction by choosing a particular bundle of goods subject to
his budget constraints.

(Explanation of maximum utility point in graph).
Without assigning any number to utility value,the same idea can be expressed
with assumption of ranking & showing preferences:

Let us consider the equation U=f(q1,q2)

Where for 2 goods,q1 of Q1 & q2 of Q2 are consumed.

We know that MU diminishes as we consume more & more of a commodity.

The diminishing marginal utility theory is substituted by diminishing marginal
rate of substitution.

As per this theory,as we substitute more of q1 with q2,the marginal utility drawn
from additional product diminishes 7 time will come when the consumer will not
substitute more of q1 with q2.

Now he begins to substitute q2 with q1 & soon ,MU drawn from q1 will also
diminish.

Thus introduction of 2 goods results in substitution of MU with MRS.
1.Price Change
The budget line will shift from ab to ab keeping income & price of Q2
constant.

Fall in price of Q1 will increase the affordability of the consumer.

This will lead to increase in consumption of Q1

This will also lead to consumption of Q1 & Q2.

In between two budget lines, there will be many IC curves.

But we will consider the IC curve to which the budget line is tangent.

Consumer will be at the higher IC curve i.e,IC2.

He will achieve equil;ibrium when the new budget line is at tangent to IC curve
IC2.

If price of Q1 rises & Q2 remains same,the budget line moves inwards.

Our Consumer will now spending less on Q1,substituting Q1 with Q2 & start
spending more on Q2.
Y (income)=pq1.Q1 + pq2.Q2


Income Changes:

Assuming that the price remains the same,the budget line would shift outwards
parallel to the original budget line.

The slope of budget line will remain the same & consumer will be able to
purchase more of two products or more of one product.

Decrease in income will result in shift of budget line inwards & reduce
spending power of consumer.

For a given utility U1,we can write U1=f( Q1,Q2)
Rate of commodity substitution can be obtained by differentiating,
dU1=f 1dQ1+f2 dQ2
Assuming total change in utility =0
0=f1dQ1+f2dQ2
or dQ1/dQ2=f1/f2
-dQ1/dQ2 is the slope of the Indifference curve
In other words,in order to remain in the same indifference curve,it is the rate
at which an individual would be willing to substitute Q1 for Q2.
The ve slope dQ1/dQ2 indicates the rate of commodity substitution =MU of
2 goods

Summary of indifferent Curve Analysis:

1.You have two commodities Q1& Q2 & a portion of both commodities
is consumed.

2.A single IC curve explains locus of all bundles of goods that give the
same level of satisfaction.

3.MU is relaced by MRs.

4.Diminishing MRs holds i.e.an individual will sacrifice less & less of
commodity Q1 in order to get more of commodity Q2 or vice versa.

5.Individual always tries to maximise satisfaction & that point will be
reached when the budget line is tangential to IC curve.This is the
equilibrium condition.

6.Change in income will lead to shift in IC & budget curve & a new
equilibrium point is reached.
TWO INDIFFERENCE CURVES NEVER INTERSECT

1.Take two points A & B on the same IC.
2.Let the two curves have a common point C(not admissible in our
theory).
3.The consumer will derive same level of satisfaction at any point on
IC1.
4.Let us consider points a,b & c on IC1.
5.All are drawn on IC1.
6.IC2 lies above IC1& that is not reachable.
7.The contradiction arises as the point b lies above IC2 which is not
reachable.
8.C is supposed to be the common point lying on both IC1 & IC2 which
is not actually possible.
9.Thus the 2 IC curves cannot intersect each other.
Exceptions:

Complementary goods & Substitute goods:

We need both the goods for use car & petrol.

We use them with a limited combination.

Here there are no A,B points portion.

In same cases,the combination will the same-left & right shoe.Here A & B
will be at the same point.

In case two goods which are perfect substitutes,IC is a straight line here
consumer is happy to consume either of the goods.



Monopolistic Competition

It is based on the following assumptions:

Heterogeneous product: Each firm produces one definite range or brand of product
different from others in the industry.

Every firm has its downward sloping highly elastic demand curve.

Goods are close substitutes but not homogeneous.

Many producers in the market ignore the action & response of others to determine their
own pricing & output policy.

Non price competition is the main essence of competition in this type of market.

Brand loyalty gives monopoly power to a particular firm to fix higher price without losing
much of its customers & gives opportunity to earn more economic profit.

There is no entry barrier, exit is also possible.

Higher profit margin brings in more players & hence the existing players market share go
down.

There is symmetry-new firms enter with their own brand of differentiated product
And take away customers from the existing firm.
Short Run Equilibrium

Industry will attain equilibrium when MR=MC for all firms.

Long Run Equilibrium

Each firm is in equilibrium when MR=MC & earning large economic profits.

In the long run,the existing firms will not change their price as they are in
equilibrium when their MR=MC.

But high economic profits will invite more players in the long run .As new firms
join the market, their economic profits gradually disappear & gradual shifting of
demand curve takes place.

In the long run,existing firms have no motivation to change their price output
policy as they are already in equilibrium.

A new firm will adjust its prices ultimately to attain equilibrium when their
MR=MC.In the long run,there will be no extra economic profits & condition will
be similar to that of a perfect competition.
MR
D
D
AC
MC
E
D
D
P
Q
Short Term equilibrium
Inefficiency of Monopolistic Competition

It is market inefficient since the cost of production & prices
become very high compared with its relative benefits.

Producers restrict their outputs & produce at levels where AC is
not a minimum.

Advertisements & promotional activities increase the price of the
final product & the consumer pays a higher rate without getting a
quality product.

Market is also inefficient as MC < price & firm restricts its output.



E LRAC
MC
MR
MR
D D
Long term equilibrium
Oligopoly Market

It is a market dominated by a few large sellers.

(i)Size of each firm in this market is large compared to the overall size of
market.The no & size of firms decide controlling power in market over
others.

(ii)Oligopolist produces either identical or differentiated.Identical products
satisy industrial needs such as processed raw material or intermediate
products used as inputs by firms e.g.steel ,petroleum etc.Differentiated
products satisy customer needs such as consumer durables/goods such
as car,domestic appliances,computers,mobile phones etc.

(iii) Strong barrier to entry either natural or strategically developed .
Commonly used barriers are investment requirement (for becoming
large) & take the advantage of scale, brand loyalty promotion,split of
market share etc.
Features:

(i) Interdependence: Each firm watches other firms & action of
one firm affects the others decision.

(ii) Rigid prices:Once the price is settled,it does not change
frequently.

(iii) Dont go in for price war.Instead use non-price competition such
as advertisement & promotion .It works as a strong barrier for
new entrants.

(iv) Mergers:Become very big players thro mergers.

(v) Collusion:Collude secretly to control price & market share.

(vi)Takeover:This happens when their profit margin goes below
expectations or used as strategy by multinationals for market
penetration.


D

E
D
Cost &
revenue
quantity
D
KINKED DEMAND CURVE
kink
D
KINKED DEMAND CURVE

(i) Price rise will not be followed by other firms but price fall will be followed by
all.Producers do not like to give up their customers in favour of other
firms.On the other hand,price rise by one firm will not be followed by
others.Price rise will lead to fall in revenue as buyer will move to others.

(ii) Frequent price change will create dissatisfaction among customers.

(iii) Frequent price changes will make accounting difficult.

Kink vanishes where price leadership exists where dominant player fixes the
price & is usually followed by other firms.

Again collusion among producers take place where market price & market share
is decided & acts as barrier to other entrants.

Instead of profit maximisation,they go in sales maximisation where the objective
is clearly to hold the market share.




CARTELS

There is formal agreement among oligopolists regarding price,output ,market
share,divisions of market segment ,appointment of common sales agencies
or even division of profits.

Public Cartels:Government authorised for peoples benefis such as
coffee,sugar,petrol approved by International Commodity Agreement.
Introduce especially during shortages.Govt.controls pricing,output etc.

Private Cartels:Private cartels are made by big,medium & small firms.
Anti trust laws:

Management of cartels depend upon the following:

(i) Types of product sold
(ii) Number of firms
(iii) Cost of production of each member firm
(iv) Demand pattern
(v) Sales pattern

KINKED DEMAND CURVE

(1) In an oligopoly market,investors face 2 demand curves DD & DD but do
know which they are facing.

(2) Below E (equilibrium point),demand is inelastic.

(3) Price cut by one firm will be folllowed by others for fear of conceding their
clients to rival firms. Price cut will not give substantial revenue .

(4) Above point E, the demand curve is more elastic where price rise by one
firm will not result in price rise by others.

(5) It will lead to fall in revenue as buyer will move to others.

CARTELS

There is formal agreement among oligopolists regarding price,output ,market
share,divisions of market segment ,appointment of common sales agencies
or even division of profits.

Public Cartels:Government authorised for peoples benefis such as
coffee,sugar,petrol approved by International Commodity Agreement.
Introduce especially during shortages.Govt.controls pricing,output etc.

Private Cartels:Private cartels are made by big,medium & small firms.
Anti trust laws:

Management of cartels depend upon the following:

(i) Types of product sold
(ii) Number of firms
(iii) Cost of production of each member firm
(iv) Demand pattern
(v) Sales pattern

MONOPOLY
Indian Railways has monopoly in Railroad transportation

State Electricity board have monopoly over generation and distribution of electricity in
many of the states.

Hindustan Aeronautics Limited has monopoly over production of aircraft.

There is Government monopoly over production of nuclear power.

Operation of bus transportation within many cities.

Land line telephone service in most of the country is provided only by the government run
BSNL.

Monopolistic Competition
Some restaurants enjoy monopolistic competition because of their popularity and
reputation.
Demand for some specific models of automobiles outstrips the production capacity. This
creates situation of monopolistic competition. Similar monopolistic situation develops for
some given periods for different capital goods product from time to time.
Some newspaper in some places enjoy almost monopolistic position in spite of existence
of other competitors.
Manufacture of some high precision products, such as multi-cylinder diesel engine fuel
injection pumps, enjoy monopolistic competition because their competitors are not able to
match their quality

Oligopoly

Airlines industry

Petroleum refining

Power generation and supply in most of the parts of the country
Automobile industry

Long distance road transportation by bus. Many of these routes
have buses operated by limited numbers of operators.

Mobile telephony.

Internet service providers

Reaction Curves

These curves reflect how much a firm will produce given the output of
another firm.

The firms move together & there is no incentive to produce unilaterally.

Each firm chooses its best possible level of output given its reaction on
basis of rival firms output.

At equilibrium,one firms comes to know what the other firm is producing
& maximises its own output & profit at equilibrium point.

This output, know as Cournot output, lies between competitive &
monopoly output.

When the first firm fixes its output, there is a residual demand & that
makes the demand curve for the other firm.

Q=Q1+ Q2
Where Q=total output ,Q1 & Q2 are the ouputs of the respective firms.
Consider a product Q given by equation P=30+Q where is Q is the total
produced by all producers in market.(Q1& Q2 are the only producers).

Let market demand P=30-Q

Let us assume AC= MC=Rs.6.00

Let us assume that a single firm selects its output & maximises by
equating MR=MC.

The marginal revenue equation is given by MR=30-2q

Thus 30-2q=6 & therefore Q=12.

Substituting the value of Q in P=30-Q, P=18.

Profit=TR TC = QxP-QXTC =216-72=144

Under optimal condition, P=MC

30-Q=6 Thus Q=24 , P=6 Profit=0






Market Failure

(i) It means that the market is not functioning in a desired way i.e.the
production of goods & services in the market is not efficient.

(ii) Perfect competition & price mechanism are ideal conditions for the
economy to bring about efficient allocation of resources among producers &
consumers which will bring maximum social welfare in the society.

(iii) Any departure from these conditions will cause market failure.

(iv) Market failure is also corrected by government intervention.

(v) But in fact, market functioning is normally dominated by imperfect condition
e.g.monopoly, oligopoly etc.

(vi) USA offered the best example of market oriented economy till its crisis a
few years ago. The country & its markets limped back towards normalcy
amidst slow growth.
In India,we see the presence of maximum market failure or distortion of
market.

(i) Adverse role played by middlemen leading to abnormal hike in prices
of items like vegetables,fruits etc.
(ii) Spiralling prices of real estate .
(iii) Failure to observe minimum wages rules,prevalence of child labour
etc.
(iv) Many lay offs taking place in the corporate sector without
compensations etc.

Situations of Market Breakdown:

(i) Presence of supernormal profits.
(ii) The social cost associated with production cost & wastage of
resources .
(iii) Monopoly,oligopoly power.
(iv) Product differentiation thro brand name, patent right or advertising.
(v) Producers with excess capacity set high prices (>MC) causing
allocation inefficiency & suboptimal equilibrium.
(vi) High expenses on promo activities & lack of competition lead to
higher price for customer & poor standard of living.
7.Market failure of any kind provides the grounds for market intervention by
way of taxes, subsidies, minimum wages, price control,regulation.Efforts to
correct may lead to further market failure,distortion.

8.A perfect market always assumes that information about
technology,pricing etc is available to everyone & free of cost & insufficiency
of information leads to market failure .

9.Market failure & govt. intervention: when market does not function in the
interest of the public, legislation tends to correct this anamoly.

Labour interest is protected by labour laws such as Minimum Wages Act etc.
In the unorganised sector,this order is often ignored/by passed resulting in
labour exploitation.

10.Few oligopolists curtail output ,try to block new entrants, fix their own
prices arbitrarily ,agreement & collusion,cartelisation etc.

11.In a perfect competition,we assume there are no externalities.say patent,
Existence of externalities affects other producers either adversely
or favourably & causes distortions.Eg.Pollution created by one firm has
negative impact o other firms. Producers do not like to offer public
goods/services for collective consumption as it wil affect their private gain.
12.Public goods :Health sector,public transport,infra ,power etc.constitute public
goods/services.Public goods are in the interests of the public but in private
hands they may not work as individually they may not be very profitable.

13.Cost of public services such as street transport,electricity ,public park,police
etc. will be less than the cost for setting up these services individually.Merit
goods such as education,public library will have lesser social cost or more of
individual cost.Similarly,access to public property for public & not specifically for
private persons (such as limited access to some routes only on payment of
huge toll etc) is of less use to the market.

14.Inequality of income & wealth.





This is normally done by government e.g. capital intensive business ,services
such as infra,power,railways etc.
Desirable
equilibrium
Actual equilibrium
P
Q
Social
demand
Pvt. demand