PPT Business Eco 10 Oct (2)

8/12/2019 PPT Business Eco 10 Oct (2)

1/99

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


2/99

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 & humanelements.

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.


3/99

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.


4/99

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 theway 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.


5/99


6/99

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 priceleads to a fall in demand & vice versa ie.they are inversely proportional toeach other.

1.Price of air ticket,impact on air travel/railway travel2.Price of cylinder/impact on consumer

3.Price of petrol/impact on car demand4.Price of diesel/impact on purchase of car5.Price of wheat/impact on demand for rise6.Govt.introduces rationing for essential goods,demand for these goods infree market7. 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


7/99

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 slopeddemand curve.


8/99

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.


9/99

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


10/99

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


11/99

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.


12/99

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.


13/99

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.


14/99

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.


15/99

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 tobudget 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


16/99

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 106 = 4.


17/99


18/99

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 MUMarginal 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.


19/99

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 name10.Advertising

11.Demonstration effect

12.Time

13.Instalment/deferred payment

14.Personal touch

15.Bandwagon effect (positive networkexternality)


20/99

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


21/99

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.


22/99

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.


23/99

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.


24/99

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 subsidy6.Goal of producer


25/99


26/99


27/99

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.


28/99

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.


29/99

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


30/99

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


31/99

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.


32/99

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 isvely 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.


33/99

Elasticity

(i) It is a measure of responsivenessit is change in a variable which is

proportionate to change in another.

(ii) Elasticity of demandproportionate 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


34/99


35/99

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


36/99

y

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


37/99

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

Examples:IPrice(Rs.) Units Total Expenditure(Rs)8.00 2 16.007.00 5 35.00

Demand is elastic w.r.t. price.

IIWhen demand changes to 20% & price changes to 10%,elasticity=20/10=2.Hereelasticity> 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.2.00Demand increases from 10 units to 15 units i.e.dq=5Using formula elasticity of demand Ed=dq/dp*p/q=5/2*6/10=1.5Price elasticity > 1 which means demand is elastic.


38/99


39/99

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 asluxury 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


40/99


41/99

Special Cases

1. Inferior Goods: Even when real income rises, demand does not increase & valueof income elasticity isve.

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.

C El ti it f D d


42/99

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/pxwhere 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 isve: When the two goods are complementary.

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


43/99

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 beve.(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 asthere 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 priceexpectation etc.


44/99

Price Elasticity & Decision Making

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

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

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

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

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

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

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


45/99


46/99


47/99

Eventual decision:

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

This final decision determines which article assumes the status of the selectedalternative.


48/99


49/99

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 themarket 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 firstitem & less & less for every additional item.

Calculation:

Market price =Rs.50

Consumer wants to pay-for 1stitem=55, 2nditem=54,3rditem=53,4thitem=50

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


50/99


51/99


52/99

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

A business with constant costing(pricing) has a perfectly elastic curve whichruns 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


53/99

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


54/99

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 TRMR=0.

-


55/99

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

Further under imperfect competition, reduction of price isessential 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 aboveinformation.

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


56/99


57/99

Price Elasticity & Total Revenue

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

If the demand is inelastic,the firm will try to hike prices which will notreduce customer base.In inelastic demand situation,it is not profitable todecrease 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 fixprices where demand is neither elastic or inelastic or at a point of unitelasticity.


58/99

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


59/99

Demand & capacity utilisation:

Due to demand fluctuation,firms often face the problem of capacity

which cannot be increased/decreased at shortnotice.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 overutilised.

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

Thus unerstanding of dem,and behaviour is a must for everybusiness & demand is a function of factors such asincome,taste,fashion, basic need etc.

Yield Management


60/99

e d a age e t

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

attract customers.

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

This may lead to price discrimination or quoting different prices for thesame service.This practice is common where resources to be offeredfor sale are fixed,perishable & customers are willing to pay differentprices 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 beready to buy its goods/services at varied prices.

Yield=actual revenue/potential revenue where actual revenue=actual

capacity utilised X average pricePotential revenue=total capacityX maximum price

Crude Oil Market


61/99

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 whichbring 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 itprice inelastic.


62/99

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.


63/99


64/99


65/99

Scenario in India

The average Indian consumer, earlier,would only just satisfy

his necessities with his limited resources.(simple living & highthinking)

Days have changed & now you have the Indian consumer witha 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 morewealthy & contributed to rural prosperity whch has increased

demand for goods.

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

There are broadly three categories of consumers.


66/99

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 needssuch 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 entitiesenable 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 consumptionreaching saturation,there is some appetite left for non-food items also.


67/99

Second category:

This is the typical middle class group.

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

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

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 withwestern countries.

Their spending on all types of luxury goods creates a good demand

in fashion & branded items ,


68/99

Consumer Behavioural Analysis

Basics:

1.Consumer preference for one good to another or one bundle ofgoods to another.2.Consumer allocates his limited income to alternative choice ofgoods.3.Consumer tries to maximise his utility & thus satisfaction subject tohis 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 consumerdecision.

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


69/99

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 cansimply say that he prefers A to B & B to C.

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

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

In ordinal analysis,equilibrium will be reached when

MRS=price ratios -dq2/dq1=p1/p2


70/99

Indifference curve Analysis or Preference Analysis

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

following:

(a) Many goods & services available in market. Information on whichparticular 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 samelevel 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.


71/99

Indifference Curve:

It is a geometrical representation of two commodity models.

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

Therefore an individual will be indifferent to any combination onthe 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 bothcommodities & 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 calledIndifference map.

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


72/99

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 ICcurve,assuming other things to be the same.

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

(Explanation of maximum utility point in graph).


73/99

Without assigning any number to utility value,the same idea can be expressedwith 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 marginalrate of substitution.

As per this theory,as we substitute more of q1 with q2,the marginal utility drawnfrom additional product diminishes 7 time will come when the consumer will notsubstitute more of q1 with q2.

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

Thus introduction of 2 goods results in substitution of MU with MRS.

1.Price Change


74/99

gThe budget line will shift from ab to ab keeping income & price of Q2constant.

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 curveIC2.

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.=

Income Changes:


75/99

Income Changes:

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

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

Decrease in income will result in shift of budget line inwards & reducespending 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 dQ2Assuming total change in utility =0

0=f1dQ1+f2dQ2

ordQ1/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 rateat which an individual would be willing to substitute Q1 for Q2.Theve slopedQ1/dQ2 indicates the rate of commodity substitution =MU of2 goods


76/99

Summary of indifferent Curve Analysis:

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

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

3.MU is relaced by MRs.

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

5.Individual always tries to maximise satisfaction & that point will bereached 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 newequilibrium point is reached.

TWO INDIFFERENCE CURVES NEVER INTERSECT


77/99

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 onIC1.4.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 notreachable.8.C is supposed to be the common point lying on both IC1 & IC2 whichis not actually possible.9.Thus the 2 IC curves cannot intersect each other.


78/99

Exceptions:

Complementary goods & Substitute goods:

We need both the goods for usecar & 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 & Bwill be at the same point.

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

Monopolistic Competition


79/99

It is based on the following assumptions:

Heterogeneous product: Each firm produces one definite range or brand of productdifferent 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 losingmuch 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 productAnd take away customers from the existing firm.


80/99

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 firmsjoin the market, their economic profits gradually disappear & gradual shifting ofdemand curve takes place.

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

A new firm will adjust its prices ultimately to attain equilibrium when theirMR=MC.In the long run,there will be no extra economic profits & condition willbe similar to that of a perfect competition.

Short Term equilibrium


81/99

MRD

D

AC

MC

E

D

D

P

Q

Short Term equilibrium

Inefficiency of Monopolistic Competition


82/99

Inefficiency of Monopolistic Competition

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

Producers restrict their outputs & produce at levels where AC isnot a minimum.

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

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

Long term equilibrium


83/99

E LRAC

MC

MRMR

D D

Oligopoly Market


84/99

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 overothers.

(ii)Oligopolist produces either identical or differentiated.Identical productssatisy industrial needs such as processed raw material or intermediateproducts used as inputs by firms e.g.steel ,petroleum etc.Differentiated

products satisy customer needs such as consumer durables/goods suchas car,domestic appliances,computers,mobile phones etc.

(iii) Strong barrier to entryeither natural or strategically developed .Commonly used barriers are investment requirement (for becominglarge) & take the advantage of scale, brand loyalty promotion,split ofmarket share etc.

Features:


85/99

Features:

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

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

(iii) Dont go in for price war.Instead use non-price competition suchas 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 belowexpectations or used as strategy by multinationals for marketpenetration.

KINKED DEMAND CURVE


86/99

D

E

DCost &revenue

quantity

D

kink

D

KINKED DEMAND CURVE


87/99

KINKED DEMAND CURVE

(i) Price rise will not be followed by other firms but price fall will be followed byall.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 byothers.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 theprice & is usually followed by other firms.

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

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


88/99

KINKED DEMAND CURVE


89/99

(1) In an oligopoly market,investors face 2 demand curves DD & DD but doknow 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 theirclients to rival firms. Price cut will not give substantial revenue .

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

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

CARTELS


90/99

CARTELS

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

Public Cartels:Government authorised for peoples benefis such ascoffee,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


91/99

State Electricity board have monopoly over generation and distribution of electricity inmany 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 runBSNL.

Monopolistic CompetitionSome restaurants enjoy monopolistic competition because of their popularity andreputation.Demand for some specific models of automobiles outstrips the production capacity. This

creates situation of monopolistic competition. Similar monopolistic situation develops forsome given periods for different capital goods product from time to time.Some newspaper in some places enjoy almost monopolistic position in spite of existenceof other competitors.Manufacture of some high precision products, such as multi-cylinder diesel engine fuelinjection pumps, enjoy monopolistic competition because their competitors are not able to

match their quality


92/99

Reaction Curves


93/99

Reaction Curves

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

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

Each firm chooses its best possible level of output given its reaction onbasis 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 & thatmakes the demand curve for the other firm.

Q=Q1+ Q2Where 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 totalproduced by all producers in market (Q1& Q2 are the only producers)


94/99

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 byequating 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=TRTC = QxP-QXTC =216-72=144

Under optimal condition, P=MC

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

Market Failure


95/99

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

(ii) Perfect competition & price mechanism are ideal conditions for theeconomy 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 conditione.g.monopoly, oligopoly etc.

(vi) USA offered the best example of market oriented economy till its crisis afew years ago. The country & its markets limped back towards normalcyamidst slow growth.

In India,we see the presence of maximum market failure or distortion ofmarket.


96/99

(i) Adverse role played by middlemen leading to abnormal hike in pricesof 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


97/99

y p g yway of taxes, subsidies, minimum wages, price control,regulation.Efforts tocorrect may lead to further market failure,distortion.

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

9.Market failure & govt. intervention: when market does not function in theinterest 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 inlabour exploitation.

10.Few oligopolists curtail output ,try to block new entrants, fix their ownprices 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 adverselyor favourably & causes distortions.Eg.Pollution created by one firm hasnegative impact o other firms. Producers do not like to offer publicoods/services for collective consum tion as it wil affect their rivate ain.

12.Public goods :Health sector,public transport,infra ,power etc.constitute publicgoods/services Public goods are in the interests of the public but in private


98/99

goods/services.Public goods are in the interests of the public but in privatehands they may not work as individually they may not be very profitable.

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

14.Inequality of income & wealth.


99/99

Documents

PPT Business Eco 10 Oct (2)