Short Notes:

1. Adam Smiths Invisible Hand Doctrine

The Idea of "invisible hand" was introduced by Adam Smith in his book Wealth of Nations
first published in 1776. Smith uses this concept to describe a paradox of laizzes-faire or
perfect competition, in which every person in an economy is working to achieve his own
selfish goals, leads to benefit of all. The individual neither intends to promote the public nor
he knows how much he is promoting it. Adam Smith compares this process as an invisible
benevolent directing the whole process for benefit of all.
The theory of the Invisible Hand states that if each consumer is allowed to choose freely
what to buy and each producer is allowed to choose freely what to sell and how to produce
it, the market will settle on a product distribution and prices that are beneficial to all the
individual members of a community, and hence to the community as a whole. The reason
for this is that self-interest drives actors to beneficial behavior. Efficient methods of
production are adopted to maximize profits. Low prices are charged to maximize revenue
through gain in market share by undercutting competitors. Investors invest in those
industries most urgently needed to maximize returns, and withdraw capital from those less
efficient in creating value. All these effects take place dynamically and automatically.
It also works as a balancing mechanism. For example, the inhabitants of a poor country will
be willing to work very cheaply, so entrepreneurs can make great profits by building
factories in poor countries. Because they increase the demand for labor, they will increase
its price; further, because the new producers also become consumers, local businesses must
hire more people to provide the things they want to consume. As this process continues, the
labor prices eventually rise to the point where there is no advantage for the foreign
countries doing business in the formerly poor country. Overall, this mechanism causes the
local economy to function on its own.
Based on belief of effectiveness of this so called invisible hand, the doctrine of laissez-faire
which recommends that government should interfere as little as possible in economic
affairs, guided the action of governments in many countries. However, beginning from the
twentieth century, there has been growing feeling that the theoretical assumption on which
the action of invisible hand is dependent, do not exist in reality.
2. The Prisoners Dilemma Game
The prisoner's dilemma is a canonical example of a game analyzed in game theory that
shows why two individuals might not cooperate, even if it appears that it is in their best
interest to do so. It was originally framed by Merrill Flood and Melvin Dresher working at
RAND in 1950. Albert W. Tucker formalized the game with prison sentence payoffs and gave
it the "prisoner's dilemma" name (Poundstone, 1992). A classic example of the prisoner's
dilemma (PD) is presented as follows:
Two men are arrested, but the police do not possess enough information for a conviction.
Following the separation of the two men, the police offer both a similar dealif one testifies
against his partner (defects/betrays), and the other remains silent (cooperates/assists), the
betrayer goes free and the cooperator receives the full one-year sentence. If both remain
silent, both are sentenced to only one month in jail for a minor charge. If each 'rats out' the
other, each receives a three-month sentence. Each prisoner must choose either to betray or
remain silent; the decision of each is kept quiet. What should they do?
If it is supposed here that each player is only concerned with lessening his time in jail, the
game becomes a non-zero sum game where the two players may either assist or betray the

other. In the game, the sole worry of the prisoners seems to be increasing his own reward.
The interesting symmetry of this problem is that the logical decision leads each to betray
the other, even though their individual prize would be greater if they cooperated.
In the regular version of this game, collaboration is dominated by betrayal, and as a result,
the only possible outcome of the game is for both prisoners to betray the other. Regardless
of what the other prisoner chooses, one will always gain a greater payoff by betraying the
other. Because betrayal is always more beneficial than cooperation, all objective prisoners
would seemingly betray the other.
In the extended form game, the game is played over and over, and consequently, both
prisoners continuously have an opportunity to penalize the other for the previous decision. If
the number of times the game will be played is known, the finite aspect of the game means
that by backward induction, the two prisoners will betray each other repeatedly.
In casual usage, the label "prisoner's dilemma" may be applied to situations not strictly
matching the formal criteria of the classic or iterative games, for instance, those in which
two entities could gain important benefits from cooperating or suffer from the failure to do
so, but find it merely difficult or expensive, not necessarily impossible, to coordinate their
activities to achieve cooperation.
3. Circular Flow model
In economics, the terms circular flow of income or circular flow refer to a simple economic
model which describes the reciprocal circulation of income between producers and
consumers. In the circular flow model, the inter-dependent entities of producer and
consumer are referred to as "firms" and "households" respectively and provide each other
with factors in order to facilitate the flow of income. Firms provide consumers with goods
and services in exchange for consumer expenditure and "factors of production" from
households. More complete and realistic circular flow models are more complex. They would
explicitly include the roles of government and financial markets, along with imports and
exports.
Human wants are unlimited and are of recurring nature therefore, production process
remains a continuous and demanding process. In this process, household sector provides
various factors of production such as land, labor, capital and enterprise to producers who
produce by goods and services by coordinating them. Producers or business sector in return
makes payments in the form of rent, wages, interest and profits to the household sector.
Again household sector spends this income to fulfill its wants in the form of consumption
expenditure. Business sector supplies them goods and services produced and gets income in
return of it. Thus expenditure of one sector becomes the income of the other and supply of
goods and services by one section of the community becomes demand for the other. This
process is unending and forms the circular flow of income, expenditure and production.
A continuous flow of production, income and expenditure is known as circular flow of
income. It is circular because it has neither any beginning nor an end. The circular flow of
income involves two basic principles:1. In any exchange process, the seller or producer receives the same amount what buyer or
consumer spends.
2. Goods and services flow in one direction and money payment to get these flow in return
direction, causes a circular flow.

In this simplified image, the relationship between the decision-makers in the circular flow
model is shown. Larger arrows show primary factors, whilst the red smaller arrows show
subsequent or secondary factors.
4. Law of Returns to Scale:
Definition and Explanation:

The law of returns are often confused with the law of returns to scale. The law of returns
operates in the short period. It explains the production behavior of the firm with one factor
variable while other factors are kept constant. Whereas the law of returns to scale operates
in the long period. It explains the production behavior of the firm with all variable factors.
There is no fixed factor of production in the long run. The law of returns to scale describes
the relationship between variable inputs and output when all the inputs, or factors are
increased in the same proportion. The law of returns to scale analysis the effects of scale on
the level of output. Here we find out in what proportions the output changes when there is
proportionate change in the quantities of all inputs. The answer to this question helps a firm
to determine its scale or size in the long run.
It has been observed that when there is a proportionate change in the amounts of inputs,
the behavior of output varies. The output may increase by a great proportion, by in the
same proportion or in a smaller proportion to its inputs. This behavior of output with the
increase in scale of operation is termed as increasing returns to scale, constant returns to
scale and diminishing returns to scale. These three laws of returns to scale are now
explained, in brief, under separate heads.

(1) Increasing Returns to Scale:

If the output of a firm increases more than in proportion to an equal percentage increase in
all inputs, the production is said to exhibit increasing returns to scale.

For example, if the amount of inputs are doubled and the output increases by more than
double, it is said to be an increasing returns returns to scale. When there is an increase in
the scale of production, it leads to lower average cost per unit produced as the firm enjoys
economies of scale.

(2) Constant Returns to Scale:

When all inputs are increased by a certain percentage, the output increases by the same
percentage, the production function is said to exhibit constant returns to scale.
For example, if a firm doubles inputs, it doubles output. In case, it triples output. The
constant scale of production has no effect on average cost per unit produced.

(3) Diminishing Returns to Scale:

The term 'diminishing' returns to scale refers to scale where output increases in a smaller
proportion than the increase in all inputs.
For example, if a firm increases inputs by 100% but the output decreases by less than
100%, the firm is said to exhibit decreasing returns to scale. In case of decreasing returns
to scale, the firm faces diseconomies of scale. The firm's scale of production leads to higher
average cost per unit produced.
Graph/Diagram:

The three laws of returns to scale are now explained with the help of a graph below:

The figure shows that when a firm uses one unit of labor and one unit of capital, point a, it
produces 1 unit of quantity as is shown on the q = 1 isoquant. When the firm doubles its
outputs by using 2 units of labor and 2 units of capital, it produces more than double from q
= 1 to q = 3.
So the production function has increasing returns to scale in this range. Another output from
quantity 3 to quantity 6. At the last doubling point c to point d, the production function has
decreasing returns to scale. The doubling of output from 4 units of input, causes output to
increase from 6 to 8 units increases of two units only.
5. Survey techniques of demand forecasting
Survey methods help us in obtaining information about the future purchase plans of
potential buyers through collecting the opinions of experts or by interviewing the
consumers. These methods are extensively used in short run and estimating the demand for
new products. There are different approaches under survey methods. They are:
A. Consumers interview method: Under this method, efforts are made to collect the
relevant information directly from the consumers with regard to their future purchase plans.
In order to gather information from consumers, a number of alternative techniques are
developed from time to time. Among them, the following are some of the important ones.
Survey of buyers intentions or preferences: It is one of the oldest methods of
demand forecasting. It is also called as Opinion surveys. Under this method,
consumer buyers are requested to indicate their preferences and willingness about
particular products. They are asked to reveal their future purchase plans with
respect to specific items.
B. Direct Interview Method: Under this method, customers are directly contacted and
interviewed. Direct and simple questions are asked to them.
i. Complete enumeration method
Under this method, all potential customers are interviewed in a particular city or a
region.
ii. Sample survey method or the consumer panel method
Under this method, different cross sections of customers that make up the bulk of the
market are carefully chosen. Only such consumers selected from the relevant market
through some sampling method are interviewed or surveyed.

C. Collective opinion method or opinion survey method: Under this method, sales
representatives, professional experts and the market consultants and others are asked to
express their considered opinions about the volume of sales expected in the future.
D. Delphi Method or Experts Opinion Method: Under this method, outside experts are
appointed. They are supplied with all kinds of information and statistical data. The
management requests the experts to express their considered opinions and views about the
expected future sales of the company.
E. End Use or Input Output Method: Under this method, the sale of the product under
consideration is projected on the basis of demand surveys of the industries using the given
product as an intermediate product.
6. Cross elasticity of demand
In economics, the cross elasticity of demand or cross-price elasticity of demand measures
the responsiveness of the demand for a good to a change in the price of another good. It is
measured as the percentage change in demand for the first good that occurs in response to
a percentage change in price of the second good. For example, if, in response to a 10%
increase in the price of fuel, the demand of new cars that are fuel inefficient decreased by
20%, the cross elasticity
of demand would be:-20%/10%=-2. A negative cross elasticity denotes two products that
are complements, while a positive cross elasticity denotes two substitute products. These
two key relationships go against one's intuition, but the reason behind them is fairly simple:
assume products A and B are complements, meaning that an increase in the demand for A
is caused by an increase in the quantity demanded for B. Therefore, if the price of product B
decreases, then the demand curve for product A shifts to the right, increasing A's demand,
resulting in a negative value for the cross elasticity of demand. The exact opposite
reasoning holds for substitutes.
Formula
The formula used to calculate the coefficient cross elasticity of demand is

or:

Results for main types of goods

In the example above, the two goods, fuel and cars (consists of fuel consumption), are
complements; that is, one is used with the other. In these cases the cross elasticity of
demand will be negative, as shown by the decrease in demand for cars when the price for
fuel will rise. In the case of perfect substitutes, the cross elasticity of demand is equal to
positive infinity. Where the two goods are independent, or, as described in consumer theory,
if a good is independent in demand then the demand of that good is independent of the

quantity consumed of all other goods available to the consumer, the cross elasticity of
demand will be zero: as the price of one good changes, there will be no change in demand
for the other good.

Two goods that complement each other show a negative cross elasticity of demand: as the
price of good Y rises, the demand for good X falls

Two goods that are substitutes have a positive cross elasticity of demand: as the price of
good Y rises, the demand for good X rises

Two goods that are independent have a zero cross elasticity of demand: as the price of good
Y rises, the demand for good X stays constant

7. Differentiate between Economic profit and Business (Accounting) profit

When it comes to profit, it is often assumed that the only kind of profit there is the amount
that is left after the deduction of costs from the revenue, but this is not so. There exits two
kinds or profits, accounting profit and economic profit which bear several differences from
each other.
What is accounting profit?
The accounting profit can be defined as the difference between the total revenue and the
total explicit cost which does not include the opportunity cost such as time and capital
whatsoever. This is obtained by deducting the total amount of costs by the total revenue.
For example, if a company has earned $50,000 one month and the total amount of costs for
that month stands at $10,000 the accounting cost would be calculated as $40,000.
What is economic profit?
The economic profit can be defined as the difference between the sales revenue minus all
implicit and explicit costs including the opportunity cost of equity capital, time and the
owners own resources. This is done so because it is important that the revenue which these
self employed resources could have brought in their best alternative uses should be worked
at and added in the cost as well. Therefore, the economic profit is calculated by deducting
the implicit and explicit costs from the total revenue. For example, if a company has earned
$50,000 one month and the owner has invested $10,000 in the business and the amount of
explicit costs stand at $10,000, the economic profit would be calculated at $30,000 that
month.
What is the difference between economic and accounting profit?
While the accounting profit is calculated without deducting the opportunity cost from the
revenue, the economic profit is calculated by deducting the explicit costs, opportunity cost
and all implicit costs as well from the revenue. In calculating economic profit, in addition to
explicit costs such as the production cost, etc, all other costs including the companys own
building, the owners own resources, the use of its own capital, the time dedicated are
calculated and then deducted from the revenue. This is done so because it is considered
important that one calculates what revenue these assets would have brought in if used in
other projects other than this particular one. This is called the opportunity cost. Accounting
profit need not consider all those factors. And therefore, as a result, the economic profit is
often much lower that the accounting profit.
Another difference would be as opposed to the accounting profit of a company which would
be calculated every year; the economic profit of a company would be only produced ever
leap year.
If the total revenue exceeds both explicit and implicit costs, it is considered that the firm
has earned economic profit.
Summary
1. Accounting profit can be defined as the difference between the total revenue and the
total explicit cost which does not include the opportunity cost.
2. Economic profit as opposed to accounting profit includes the opportunity cost in its
calculations.
3. Economic profit is often lower than accounting profit.

4. As opposed to accounting profit which is calculated for a certain period of time,

economic profit is only calculated every leap year.
8. Monopolistic Competition
Pure monopoly and perfect competition are two extreme cases of market structure. In
reality, there are markets having large number of producers competing with each other in
order to sell their product in the market. Thus, there is monopoly on one hand and perfect
competition on other hand. Such a mixture of monopoly and perfect competition is called as
monopolistic competition. It is a case of imperfect competition.
Monopolistic competition has been introduced by American economist Prof. Edward
Chamberlin, in his book 'Theory of Monopolistic Competition' published in 1933.
Features of Monopolistic Competition
The following are the features or characteristics of monopolistic competition:1. Large Number of Sellers
There are large number of sellers producing differentiated products. So, competition among
them is very keen. Since number of sellers is large, each seller produces a very small part of
market supply. So no seller is in a position to control price of product. Every firm is limited
in its size.
2. Product Differentiation
It is one of the most important features of monopolistic competition. In perfect competition,
products are homogeneous in nature. On the contrary, here, every producer tries to keep
his product dissimilar than his rival's product in order to maintain his separate identity. This
boosts up the competition in market. So, every firm acquires some monopoly power.
3. Freedom of Entry and Exit
This feature leads to stiff competition in market. Free entry into the market enables new
firms to come with close substitutes. Free entry or exit maintains normal profit in the
market for a longer span of time.
4. Selling Cost
It is a unique feature of monopolistic competition. In such type of market, due to product
differentiation, every firm has to incur some additional expenditure in the form of selling
cost. This cost includes sales promotion expenses, advertisement expenses, salaries of
marketing staff, etc.
But on account of homogeneous product in perfect competition and zero competition in
monopoly, selling cost does not exist there.
5. Absence of Interdependence
Large numbers of firms are different in their size. Each firm has its own production and
marketing policy. So no firm is influenced by other firm. All are independent.
6. Two Dimensional Competition

Monopolistic competition has two types of competition aspects viz.

Price competition i.e. firms compete with each other on the basis of price.
Non price competition i.e. firms compete on the basis of brand, product quality
advertisement.

7. Concept of Group
In place of Marshallian concept of industry, Chamberlin introduced the concept of Group
under monopolistic competition. An industry means a number of firms producing identical
product. A group means a number of firms producing differentiated products which are
closely related.
8. Falling Demand Curve
In monopolistic competition, a firm is facing downward sloping demand curve i.e. elastic
demand curve. It means one can sell more at lower price and vice versa.

Short-run equilibrium of the firm under monopolistic competition. The firm maximizes its
profits and produces a quantity where the firm's marginal revenue (MR) is equal to its
marginal cost (MC). The firm is able to collect a price based on the average revenue (AR)
curve. The difference between the firms average revenue and average cost, multiplied by
the quantity sold (Qs), gives the total profit.

Long-run equilibrium of the firm under monopolistic competition. The firm still produces
where marginal cost and marginal revenue are equal; however, the demand curve (and AR)
has shifted as other firms entered the market and increased competition. The firm no longer
sells its goods above average cost and can no longer claim an economic profit
9. Quantitative tools used for Demand Forecasting

Quantitative Forecasting Methods

There are two forecasting models here (1) the time series model and (2) the causal
model. A time series is a s et of evenly spaced numerical data and is o btained by observing
responses at regular time periods. In the time series model , the forecast is based only on
past values and assumes that factors that influence the past, the present and the future
sales of your products will continue.
On the other hand, t he causal model uses a mathematical technique known as the
regression analysis that relates a dependent variable (for example, demand) to an
independent variable (for example, price, advertisement, etc.) in the form of a linear
equation. The time series forecasting methods are described below:
Time Series
Forecasting Method

Description

Nave Approach

Assumes that demand in the next period is the same as demand in most recent
period; demand pattern may not always be that stable
For example:
If July sales were 50, then Augusts sales will also be 50

Time Series
Forecasting Method

Description

Moving Averages
(MA)

MA is a series of arithmetic means and is used if little or no trend is present in the

data; provides an overall impression of data over time
A simple moving average uses average demand for a fixed sequence of periods
and is good for stable demand with no pronounced behavioral patterns.
Equation:
F 4 = [D 1 + D2 + D3] / 4
F forecast, D Demand, No. Period
A weighted moving average adjusts the moving average method to reflect
fluctuations more closely by assigning weights to the most recent data, meaning,
that the older data is usually less important. The weights are based on intuition
and lie between 0 and 1 for a total of 1.0
Equation:
WMA 4 = (W) (D3) + (W) (D2) + (W) (D1)
WMA Weighted moving average, W Weight, D Demand, No. Period

Exponential
Smoothing

The exponential smoothing is an averaging method that reacts more strongly to

recent changes in demand by assigning a smoothing constant to the most recent
data more strongly; useful if recent changes in data are the results of actual
change (e.g., seasonal pattern) instead of just random fluctuations
F t + 1 = a D t + (1 - a ) F t
Where
F t + 1 = the forecast for the next period
D t = actual demand in the present period
F t = the previously determined forecast for the present period
= a weighting factor referred to as the smoothing constant

Time Series
Decomposition

The time series decomposition adjusts the seasonality by multiplying the norma
forecast by a seasonal factor

10.Value Analysis
Value analysis is a systematic effort to improve upon cost and/or performance of products
(services), either purchased or produced. It examines the materials, processes, information
systems, and the flow of materials involved. Value Analysis efforts began in earnest during
WW II. Value Analysis, also called Functional Analysis was created by L.D. Miles. In his
search, Miles found that each material has unique properties that could enhance the product
if the design was modified to take advantage of those properties.
The value of an item is how well the item does its function divided by the cost of the item
(In value analysis value is not just another word for cost):
Value of an item = performance of its function / cost
If implemented diligently, value analysis can result in 1.reduced material use and cost
2.reduced distribution costs
3.reduced waste
4.improved profit margins
5.increased customer satisfaction
6.increased employee morale
Value analysis should be a part of continuous improvement effort.
11.Factors hampering Cost Control
Steps taken by management to assure that the cost objectives set down in the
planning stage are attained and to assure that all segments of the organization
function in a manner consistent with its policies .For effective cost control, most
organizations use standard cost systems, in which the actual costs are compared
against standard costs for performance evaluation and the deviations are
investigated for remedial actions
Reducing costs can be damaging. Before making changes, check that your standards
will not be compromised and that your ability to meet objectives will not be harmed.
Reducing costs which directly affect employees is extremely difficult. Reducing costs
such as training and meeting times is often counterproductive in the longer term.
Poor condition, pay and benefits will not attract and hold good employees. Making
employees redundant brings short-term costs and the risk of possible employment
tribunal proceedings. It may also damage long-term morale
Almost every cost saving has a potential downside.

Production and marketing plans driven by cost-cutting considerations are unlikely to

meet customer requirements
Attempting to control fixed costs is itself a wasteful process
Tighter control of financing may leave you with no safety margin when cash flow is
unexpectedly poor
Cutting short-term investment costs (e.g. training, advertising, equipment or new
product development) can lead to long-term weakness.
Introducing improved procedures can be difficult and expensive. Employees may
resist change, and may need extra training.

12.Production Possibilities Frontier

Under the field of macroeconomics, the production possibility frontier (PPF)
represents the point at which an economy is most efficiently producing its goods and
services and, therefore, allocating its resources in the best way possible. If the
economy is not producing the quantities indicated by the PPF, resources are being
managed inefficiently and the production of society will dwindle. The production
possibility frontier shows there are limits to production, so an economy, to achieve
efficiency, must decide what combination of goods and services can be produced

PPFs are normally drawn as bulging upwards ("concave") from the origin but can also
be represented as bulging downward or linear (straight), depending on a number of
factors. A PPF can be used to represent a number of economic concepts, such
as scarcity of resources (i.e., the fundamental economic problem all societies

face), opportunity cost (or marginal rate of transformation), productive

efficiency, allocation efficiency, and economies of scale. A PPF shows all possible
combinations of two goods that can be produced simultaneously during a given
period of time, ceteris paribus. The combination represented by the point on the PPF
where an economy operates shows the priorities or choices of the economy, such as
the choice between producing more capital goods and fewer consumer goods, or vice
versa.

13.Utility
Utility is a term used by economists to describe the measurement of "usefulness" that a consumer obtains from any good. Utility may measure how much one
enjoys a movie, or the sense of security one gets from buying a deadbolt. The utility
of any object or circumstance can be considered. Some examples include the utility
from eating an apple, from living in a certain house, from voting for a specific
candidate, from having a given wireless phone plan. In fact, every decision that an
individual makes in their daily life can be viewed as a comparison between the utility
gained from pursuing one option or another.
Total utility is the aggregate sum of satisfaction or benefit that an individual
gains from consuming a given amount of goods or services in an economy. Usually,
the more the person consumes, the larger his or her total utility will be. Marginal
utility is the additional satisfaction, or amount of utility, gained from each extra unit
of consumption. Utility is usually applied by economists in such constructs as
the indifference curve, which plot the combination of commodities that an individual
or a society would accept to maintain a given level of satisfaction. Individual utility
and social utility can be construed as the value of a utility function and a social
welfare function respectively.
14.Actual Cost
Actual cost is the total amount of materials, labor costs, and any directly
associated overhead costs that can be charged to a specific project. The actual cost
is different from the standard cost, although both approaches are often used to
evaluate the profitability of a given project. With actual costs, the goal is to break
down the specifics of the costs involved with the project and determine if the
production process associated with the project is in fact working at optimum
efficiency.

Determining the actual cost is very important when it comes to judging the
profitability of any production process. Knowing how much it actually costs to engage
in that production for a specific period, such as a month, makes it easier to compare
the revenue that is generated for the same period. If the actual cost was exceeded
by the amount of revenue received during the same period, then the company is
operating at a profit. If not, this calculation of the actual cost can motivate business
owners to take a closer look at each expense involved with the manufacturing
process and identify ways to cut costs and increase the chance of becoming
profitable.
Comparing the actual cost of production from a given period to previous
periods can also help identify situations where the cost of production is increasing for
some reason. For example, an investigation may uncover the fact that an excessive
amount of overtime is the reason for the higher production costs. If this is the case,
the business can look closely for the reasons why the overtime took place, and
determine if there is any better way to arrange the use of labor to offset this
increase.

15.3Cs framework of Pricing

Pricing is the process of determining what a company will receive in
exchange for its products. Pricing factors are manufacturing cost, market place,
competition, market condition, and quality of product. Pricing is the manual or
automatic process of applying prices to purchase and sales orders, based on factors
such as: a fixed amount, quantity break, promotion or sales campaign, specific
vendor quote etc.
The 3Cs model suggests that defining the right place is a difficult balancing
exercise that uses three main references as follows:
a) Cost: Cost shows the minimal price, i.e. if you want to be profitable. Cost can be
a tough one to calculate though, since cost can depend on scale of production,
efficiency of production, etc
b) Customer: Customer based pricing is not a specific approach. It is the value
perceived in the eyes of the customer. The more value one adds to the customer,
the higher one could price its offering. Value-based pricing aims at this reference,
and is seen as both difficult to calculate and difficult to sell/obtain. In this case,
the retailer sets the prices according to what they think the customer can afford.
This requires that they know what the customer affords which is not easy. Polls
sometimes help with finding out.

c) Competition: Competition based pricing is an approach where the retailer sets the
prices according to the competition. This is an easy way to lose millions without
noticing. the price the customer could obtain from the competitor sets a
reference framework in the industry. This reference framework obliges a higher
price to correspond to a higher value. Lower price is always easier to sell, but
then there is value given away.

16.Different theories of Profit

There are various theories of profit which have been advanced from time to
time regarding the nature of profit in a competitive economy. Almost all of them
differ basically from one another and are inadequate to explain the actual role of
profit in the operation of free economy. The most important theories are:
a) Dynamic theory of profit: The dynamic theory of profit was given by J.B. Clark.
According to him profit accrues because the society is dynamic by nature. Since
the dynamic nature of society makes future uncertain and any act, the result of
which has to come in future, involves risk. Thus profit is the price of risk taking
and risk bearing. It arises only in a dynamic society which means in a society
where changes does not occur i.e. it is static by nature the risk element
disappears and hence the profit element does not exist there.
Criticism
This theory completely ignores the future or uncertainty. According to Prof. Knight
only those changes, which cannot be foreseen, and which cannot be provided in
advance will yield profits and not others. Also this theory often gives a misleading
conclusion regarding the competition.
b) Marginal productivity theory: According to this theory, profit always equals to the
marginal productivity of the entrepreneur. The marginal productivity of the
entrepreneur cannot be evaluated in the case of the firm because there is only
one entrepreneur in a firm. It is however can be easily done in an industry where
the number of the firms can be calculated and hence the marginal productivity of
various entrepreneurs can be measured. According to this theory the profit
depends upon the marginal production. Greater the marginal production greater
will be the profit.

c) Uncertainty breaking theory of Profit: According to Prof. Knight

Profit is the

reward for uncertainty bearing and not the risk bearing. Prof. Knight has
regarded uncertainty bearing as a factor of production. Knights theory classifies

the position that profit arises because of the joint action of uncertainty bearing
and capital.

d) Risk bearing theory of Profit: This risk bearing theory of profit is associated with
the name of F.B. Hawley. According to him: "Profit is the reward of risk taking
in a business. During the conduct of any business activity, all other factors of
production, i.e., land, labor and capital have their guaranteed incomes from the
entrepreneur. They are least concerned whether the entrepreneur makes profit or
undergoes tosses". Profit is a payment or a reward for the assumption of risks by
the entrepreneur. The 'greater the risk, the higher must be the profits. It is
because if the return on risky enterprise is at the same level as that obtained
from the safe investment, then not a single entrepreneur will invest his capital in
a risky enterprise.

e) Monopoly Theory of Profit: There is no doubt that profits arise from dynamic
changes, innovations and from making a correct estimate of future economic
conditions. Another view point of profit is that monopolistic and monopolistic
competition in the market also gives rise to profits. The firms under monopoly or
monopolistic competition have greater control over the price of the product. They
are the price makers rather than the price takers. As such they raise prices by
restricting the level of output and thus keep profit at higher level. Monopoly
power, thus, is the basic sources of business profits.
However, it can be concluded that all these theories are defective in one way or
the other. The basic defect with these theories is that they particularize certain
aspects of the function of an entrepreneur to the neglect of others.

17.Superior and Inferior goods

Superior goods make up a larger proportion of consumption as income rises, and therefore
are a type of normal goods in consumer theory. Such a good must possess two economic
characteristics: it must be scarce, and, along with that, it must have a high price. The
scarcity of the good can be natural or artificial; however, the general population (i.e.,
consumers) must recognize the good as distinguishably better. Possession of such a good
usually signifies "superiority" in resources, and usually is accompanied by prestige.

The prestige-value of some superior goods is so high that a price decline would lower
demand; these are Veblen goods.
The income elasticity of a superior good is above one by definition, because it raises the
expenditure share as income rises. A superior good also may be a luxury good that is not
purchased at all below a certain level of income. Examples would include smoked salmon
and caviar, and most other delicacies. On the other hand, superior goods may have a wide
quality distribution, such as wine and holidays; however, though the number of such goods
consumed may stay constant even with rising wealth, the level of spending will go up, to
secure a better experience.
Inferior goods: In consumer theory, an inferior good is a good that decreases in demand
when consumer income rises, unlike normal goods, for which the opposite is observed.
[1]
Normal goods are those for which consumers' demand increases when their income
increases. Inferiority, in this sense, is an observable fact relating to affordability rather than
a statement about the quality of the good. As a rule, these goods are affordable and
adequately fulfil their purpose, but as more costly substitutes that offer more pleasure (or
at least variety) become available, the use of the inferior goods diminishes.
Depending on consumer or market indifference curves, the amount of a good bought can
either increase, decrease, or stay the same when income increases.

Good Y is a normal good since the amount purchased increases from Y1 to Y2 as the budget
constraint shifts from BC1 to the higher income BC2. Good X is an inferior good since the
amount bought decreases from X1 to X2 as income increases.

18.Isoquants & MRTS

In economics, an isoquant is a contour line drawn through the set of points at which
the same quantity of output is produced while changing the quantities of two or more
inputs. While an indifference curve mapping helps to solve the utility-maximizing
problem of consumers, the isoquant mapping deals with the cost-minimization
problem of producers. Isoquants are typically drawn on capital-labor graphs, showing
the technological tradeoff between capital and labor in the production function, and
the decreasing marginal returns of both inputs. Adding one input while holding the
other constant eventually leads to decreasing marginal output, and this is reflected in
the shape of the isoquant. Isoquants may take a wide variety of forms. When we
draw a "typical" one we usually assume that it is smooth and convex to the origin, as
in the following figure.

In economic theory, the Marginal Rate of Technical Substitution (MRTS) - or Technical

Rate of Substitution (TRS) - is the amount by which the quantity of one input has to be
reduced (

) when one extra unit of another input is used (

), so that output

remains constant (

).

Where

are the marginal products of input 1 and input 2, respectively,

and

and
is Marginal Rate of Technical Substitution of the input
for
. Along an isoquant, the MRTS shows the rate at which one input (e.g. capital or labor) may
be substituted for another, while maintaining the same level of output. The MRTS can also
be seen as the slope of an isoquant at the point in question.
For a typical production function, with isoquants convex to the origin, the MRTS diminishes
as more of input 1 is used. We say that such a production function has a diminishing
marginal rate of technical substitution.

The marginal rate of technical substitution (MRTS) measures the slope of an isoquant. As
such, it measures the amount by which capital can be reduced if another unit of labor is
added and still maintain a constant level of production.
It turns out that MRTS is equal to the negative of the ratio of the marginal product of labor
to the marginal product of capital (i.e., MRTS=-MPL/MPK). Note that if MPL and MPK are
constant, then MRTS is also constant, so it is not necessarily true that MRTS changes along
an isoquant.
In many production processes, however, it is reasonable to assume that the ratio of
MPL/MPK is very large when a firm is using a lot of capital relative to its labor input. On the
other hand, MPL/MPK becomes very small when the firm uses a lot of labor and very little
capital. In such instances the slope of an isoquant gets flatter and flatter as more labor is
substituted for capital, since the productivity of labor relative to the productivity of capital
keeps falling.

19.Multiple Regression Analysis

In statistics, regression analysis includes many techniques for modeling and

analyzing several variables, when the focus is on the relationship between a
dependent variable and one or more independent variables. More specifically,
regression analysis helps one understand how the typical value of the dependent
variable changes when any one of the independent variables is varied, while the
other independent variables are held fixed.
Multiple regression analysis is a technique used to establish the relationship between
quantifiable variables in which data on dependent and independent variables is
plotted on a scatter graph or diagram, and trends are indicated through a line of best
fit, using two or more independent variables. Multiple Regression analysis is more
amenable to ceteris paribus analysis because it allows us to explicitly control for
many other factors that simultaneously affect the dependent variable. This is
important both for testing economic theories and for evaluating policy effects when
we must reply on non-experimental data. Because MR models can accommodate
many explanatory variables that may be correlated, we can hope to infer causality in
cases where simple regression analysis would be misleading. MRA is also useful for
generalizing functional relationships between variables.

Examples: Total factory overhead (the dependent variable) is related to both laborhours and machine-hours (the independent variables). Sales of a popular soft drink (
the dependent variable) is a function of various factors, such as its price, advertising,
taste, and the prices of its major competitors (the independent variables).

20.Firm & its Objectives

A business firm is an economic unit. It is a producing unit. It converts inputs in to

outputs. It is a legal entity on the basis of ownership and contractual relationship
organized for production and sale of goods and services. All business units are set
up and managed by people and are called by various names like shops,
firms, enterprise, production and business concerns etc. They can take several
forms like sole trader, partnership concern, Joint Stock Company, cooperatives
or even public utilities. They produce and supply different goods and services for the
direct satisfaction of consumers for producing other final goods and services. Each
firm lays down its own objectives. They are fundamental to the very existence of a
firm. They are the endpoint towards rational activity. They indicate the
very existence of a firm and guide the actions of a firm. They indicate how a firm
has to organize its activities and perform its functions. A modem
business unit has multiple objectives and they are multidimensional in their nature. Some of them are competitive while others are
supplementary in nature. A few other objectives are mutually interconnected and a
few others are opposing in nature. These objectives are determined
by various factors and forces like corporate environment, socioeconomic conditions, and the nature of power in the organization and
extraneous conditions, and constraints under which a firm operates. Each business
unit defines its own objectives which may have to satisfy the needs of those groups
whose cooperation makes the continued existence of the business e.g. the
shareholders, management, employees, suppliers and consumers etc. Thus, we
come across multiple and diversified objectives.
a) Profit Maximization: Profit maximization is the process of obtaining the highest
possible level of profit through the production and sale of goods and services.
This is the guiding principle underlying the analysis of short-run production by a
firm. In particular, economic analysis is assumed that firms undertake actions and
make the decisions that increase profit.
b) Sales Maximization: A reasonable and often pursued objective of firms is to
maximize sales, that is, to sell as much output as possible. Clearly sales lead to
revenue, meaning that maximizing sales is also bound to maximize revenue. But
as the analysis of short-run production indicates, maximizing sales does NOT
necessarily maximize profit.
c) Growth maximization: This is similar to sales maximization and may involve
mergers and takeovers.

d) Pursuit of Personal Welfare: The people who make decisions for a business are, in
fact, people. They have likes and dislikes. They have personal goals and
aspirations just like people who do not make decisions for firms. On occasion
these people use the firm to pursue their own personal welfare. When they do,
their actions could enhance the firm's profit maximization or, in many cases,
prevent profit maximization.
e) Pursuit of social welfare: The people who make decisions for firms also have
social consciences. Part of their likes and dislikes might be related to the overall
state of society. As such, they might use the firm to pursue social welfare, which
could enhance or prevent the firm's profit maximization.
Natural Selection: Whichever objective a firm pursues on a day-to-day basis, the
notion of natural selection suggests that successful firms intentionally or
unintentionally maximize profit. That is, the firms best suited to the economic
environment, and thus generate the most profit, are the ones that tend to
survive.

21.Input Output Analysis

Input-output analysis is an economics term that refers to the study of the effects
that different sectors have on the economy as a whole, for a particular nation or
region. This type of economic analysis was originally developed by Wassily Leontief
(1905 1999), who later won the Nobel Memorial Prize in Economic Sciences for his
work on this model. Input-output analysis allows the various relationships within an
economic system to be analyzed as a whole, rather than individual components.
Because the input-output model is fundamentally linear in nature, it lends itself well to rapid
computation as well as flexibility in computing the effects of changes in demand.
The structure of the input-output model has been incorporated into national accounting in
many developed countries, and as such forms an important part of measures such as GDP.
In addition to studying the structure of national economies, input-output economics has
been used to study regional economies within a nation, and as a tool for national and
regional economic planning. Indeed a main use of input-output analysis is for measuring the
economic impacts of events as well as public investments or programs But it is also used to
identify economically related industry clusters and also so-called "key" or "target"
industries-- that are most likely to enhance the internal coherence of a specified economy.
By linking industrial output to satellite accounts articulating energy use, effluent production,
space needs, and so on, input-output analysts have extended the approaches application to
a wide variety of uses.

The ultimate goal of the Input-Output Analysis technique is to generate a Total

Requirements Table that shows the flows of rupees between industries in the production of
output for a given sector.
To arrive at this final result, IO Analysis requires two earlier steps:
1) Transactions table: Contains basic data on the flows of goods and services among
suppliers and purchasers during a study year.
2) Direct requirements table: Derived from the transactions table, this shows the inputs
required directly from different suppliers by each intermediate purchaser for each unit of
output that purchaser produces.
Problems with Input Output Analysis

Practical issues: Data needs and complexity: IO models are tremendously complex
and very data hungry. This typically places these models in the hands of experts.

Theoretical issues:
-

Time/Data issues: Usually a single years data are used to develop the Total
Requirements Table. But 1) purchases may actually reflect a longer term
investment and 2) short term trends may impact the data.

IO assumes a linear relationship between increasing demand for inputs and

outputs: This assumes away 1) externalities and 2) increasing/ decreasing
returns to scale.

Industrial categorization: IO models still assume that each industry 1) has a

single, homogeneous production function and 2) each produces one product.
These assumptions do not reflect the real economy very well.

22.Derived Demand
Derived demand is a term in economics, where demand for one good or service
occurs as a result of the demand for another intermediate/ final good or service. This
may occur as the former is a part of production of the second. For example, demand
for coal leads to derived demand for mining, as coal must be mined for coal to be
consumed. As the demand for coal increases, so does its price. The increase in price
leads to a higher demand for the resources involved in mining coal. And therefore:

Where MRP is the marginal revenue product of labor, MPP is the marginal physical
product of labor, and P is the price of the physical product of labor.

Derived demand applies to both consumers and producers. Producers have a derived
demand for employees. The employees themselves are not demanded; rather, the
skills and productivity that they bring are. This is similar to the concept of joint
demand or complimentary goods. One good or service is the compliment of another.

23. Industry Demand & Firm Demand and Autonomous Demand

Industry demand and Company demand:
Industry demand has reference to the total demand for the products of a particular
industry, e.g. the demand for textiles. Company demand has reference to the demand
for the product of a particular company which is a part of that industry, e.g., the
demand for textiles produced by the DCM. The company demand may be expressed as
a percentage of industry demand. The percentage so calculated would indicate the
market share of the company. The market-share of the company normally depends on
the nature of competition and the market structure. Under monopoly where a single
firm constitutes the industry, company-demand and industry-demand will be same.
Under non monopoly situation, the market share will depend on factors like price
spread (i.e., the difference between the price charged by one company and the price
charged by another company), product improvement, promotional expenditure like
advertisement, and governmental interference like protection. The study of industry
demand is useful guide to analysis and forecasting of company demand.
Autonomous Demand:
When a particular commodity is demanded for its own sake it is known as
autonomous demand.
Unless a product is totally independent of the use of other
products, it is difficult to talk about autonomous demand. In the present world of
dependence, there is hardly any autonomous demand. Nobody today consumes just a
single commodity; everybody consumes a bundle of commodities. Even then, all direct
demand may be loosely called autonomous.
24. Breakeven Analysis and its link to economic concepts
It is based on categorising production costs between those which are "variable" (costs that
change when the production output changes) and those that are "fixed" (costs not directly
related to the volume of production).
Total variable and fixed costs are compared with sales revenue in order to determine the
level of sales volume, sales value or production at which the business makes
neither a profit nor a loss (the "break-even point").

The Break-Even Chart

In its simplest form, the break-even chart is a graphical representation of costs at various
levels of activity shown on the same chart as the variation of income (or sales, revenue)
with the same variation in activity. The point at which neither profit nor loss is made is

known as the "break-even point" and is represented on the chart below by the intersection
of the two lines:

In the diagram above, the line OA represents the variation of income at varying levels of
production activity ("output"). OB represents the total fixed costs in the business. As output
increases, variable costs are incurred, meaning that total costs (fixed + variable) also
increase. At low levels of output, Costs are greater than Income. At the point of
intersection, P, costs are exactly equal to income, and hence neither profit nor loss is made.
Fixed Costs
Fixed costs are those business costs that are not directly related to the level of production
or output. In other words, even if the business has a zero output or high output, the level of
fixed costs will remain broadly the same. In the long term fixed costs can alter - perhaps as
a result of investment in production capacity (e.g. adding a new factory unit) or through the
growth in overheads required to support a larger, more complex business.
Variable Costs
Variable costs are those costs which vary directly with the level of output. They represent
payment output-related inputs such as raw materials, direct labour, fuel and revenue-related
costs such as commission.
A distinction is often made between "Direct" variable costs and "Indirect" variable costs.
Direct variable costs are those which can be directly attributable to the production of a
particular product or service and allocated to a particular cost centre. Raw materials and the
wages those working on the production line are good examples.
Indirect variable costs cannot be directly attributable to production but they do vary with
output. These include depreciation (where it is calculated related to output - e.g. machine
hours), maintenance and certain labour costs.

Semi-Variable Costs
Whilst the distinction between fixed and variable costs is a convenient way of
categorizing business costs, in reality there are some costs which are fixed in nature
but which increase when output reaches certain levels. These are largely related to the
overall "scale" and/or complexity of the business. For example, when a business has
relatively low levels of output or sales, it may not require costs associated with
functions such as human resource management or a fully-resourced finance
department. However, as the scale of the business grows (e.g. output, number people
employed, number and complexity of transactions) then more resources are required.
If production rises suddenly then some short-term increase in warehousing and/or
transport may be required. In these circumstances, we say that part of the cost is
variable and part fixed.
A firm's break-even point occurs when at a point where total revenue equals total costs.
Break-even analysis depends on the following variables:
1 Selling Price per Unit: The amount of money charged to the
customer for each unit of a product or service.
2 Total Fixed Costs: The sum of all costs required to produce the first
unit of a product. This amount does not vary as production increases
or decreases, until new capital expenditures are needed.
3 Variable Unit Cost: Costs that vary directly with the production of
one additional unit.
Total Variable Cost The product of expected unit sales and variable
unit cost, i.e., expected unit sales times the variable unit cost.
4 Forecasted Net Profit: Total revenue minus total cost. Enter Zero (0)
if you wish to find out the number of units that must be sold in order
to produce a profit of zero (but will recover all associated costs)
Each of these variables is interdependent on the break-even point analysis. If
any of the variables changes, the results may change.
Total Cost: The sum of the fixed cost and total variable cost for any given
level of production, i.e., fixed cost plus total variable cost.
Total Revenue: The product of forecasted unit sales and unit price, i.e.,
forecasted unit sales times unit price.
Break-Even Point: Number of units that must be sold in order to produce a
profit of zero (but will recover all associated costs). In other words, the breakeven point is the point at which your product stops costing you money to
produce and sell, and starts to generate a profit for your company.
The graphic method of analysis (below) helps in understanding the concept of
the break-even point. However, the break-even point is found faster and more
accurately with the following formula:
Q = FC / (UP - VC)
where:
Q = Break-even Point, i.e., Units of production (Q),
FC = Fixed Costs,
VC = Variable Costs per Unit
UP = Unit Price
Therefore,

Break-Even Point Q = Fixed Cost / (Unit Price - Variable Unit Cost)