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Macroecono

Microeconomics

mics

Definition

Macroeconomics is a branch of economics dealing with the performance, structure, behavior, and decision-making of an economy as a whole.

Microeconomics is the branch of economy which is concerned with the behavior of individual entities such as market, firms and households.

Foundation

The foundation of macroeconomics is microeconomics.

Microeconomics consists of individual entities.

Basic

Output and income,

Preference relations, supply

Concepts

unemployment, inflation and deflation.

and demand, opportunity cost.

Applications

Used to determine an economy's overall health, standard of living, and needs for improvement.

Used to determine methods of improvement for individual business entities.

Careers

Economist (general), professor, researcher, financial advisor.

Economist (general), professor, researcher, financial advisor.

Macroeconomics is the branch of economics that looks at economy in a broad sense and deals with factors affecting the national, regional, or global economy as a whole.

Microeconomics looks at the economy on a smaller scale and deals with specific entities like businesses, households and individuals.

Definition

Macroeconomics is a branch of economics dealing with the performance, structure, behavior, and decision-making of an economy as a whole, as opposed to individual markets. This includes national, regional, and global economies. Macroeconomics involves the study of aggregated indicators such as GDP, unemployment rates, and price indices for the purpose of understanding how the whole economy functions, as well as the relationships between such factors as national income, output, consumption, unemployment, inflation, savings, investment, international trade and international finance.

Microeconomics, on the other hand, is the branch of economics that is primarily focused on the actions of individual agents, such as firms and consumers, and how their behavior determines prices and quantities in specific markets. One of the goals of microeconomics is to analyze market mechanisms that establish relative prices among goods and services and the allocation of limited resources among many alternative uses. Significant fields of study in microeconomics include general equilibrium, markets under asymmetric information, choice under uncertainty, and economic applications of game theory.

What are positive statements?

Positive statements are objective statements that can be tested, amended or rejected by referring to the available evidence. Positive economics deals with objective explanationand the testing and rejection of theories. For example:

A fall in incomes will lead to a rise in demand for own-label supermarket foods

If the government raises the tax on beer, this will lead to a fall in profits of the brewers.

The rising price of crude oil on world markets will lead to an increase in cycling to work

A reduction in income tax will improve the incentives of the unemployed to find work.

A rise in average temperatures will increase the demand for sun screen products.

Higher interest rates will reduce house prices

Cut-price alcohol has increased the demand for alcohol among teenagers

A car scrappage scheme will lead to fall in the price of second hand cars

What are Normative Statements?

A value judgement is a subjective statement of opinion rather than a fact that can be tested by looking at the available evidence

Normative statements are subjective statements – i.e. they carry value judgments. For example:

Pollution is the most serious economic problem

Unemployment is more harmful than inflation

The congestion charge for drivers of petrol-guzzling cars should increase to £25

The government should increase the minimum wage to £7 per hour to reduce poverty.

The government is right to introduce a ban on smoking in public places.

The retirement age should be raised to 70 to combat the effects of our ageing population.

Resources are best allocated by allowing the market mechanism to work freely

The government should enforce minimum prices for beers and lagers sold in supermarkets and off-licences in a bid to control alcohol consumption

Focusing on the evidence is called adopting an empirical approach – evidence- based work is becoming more and more important in shaping different government policies and how much funding to give to each.

Key point:

Most economic decisions and policy are influenced by value judgements, which vary from person to person, resulting in fierce debate between competing political parties.

Partial equilibrium theory-the stuff of Part I-focuses on the effects that one change, such as a shift in consumer preferences, has on a one or two markets, disregarding the wider ripples. A partial equilibrium analysis makes sense when the wider ripples are unlikely to be earth-shakingly large. To be precise, when cross-price, cross-income, cross-everything elasticities are at or near zero. For example, with a little imagination you may find a reason why a change in American preference towards low fat food might have in some way or another a effect on the Italian shoe industry or the demand for Dutch tulips. Who knows? Producers of low fat food may like Italian shoes more than the producers of high fat foods. And Italian shoe makers may use their extra earnings to buy more tulips. Ripples can move in funny and unexpected ways. However, the effects on Italian shoes and Dutch tulips will be so small that they are better ignored to keep the analysis simple. Partial equilibrium theory, therefore, asks you to limit the scope of your analysis, reasonably.

Partial equilibrium theory considers the effects of a change on one or a few markets only.

But some problems require a general equilibrium theory. If Saddam Hussein, the deposed ruler of Iraq, had succeeded some years ago in grabbing the oil riches of the Persian Gulf, then the price of oil would have gone up dramatically. In this case the ripple effects would be big and far-reaching. After all, the Persian Gulf counts for enough of production to significantly affect the price of oil. And the price of oil counts for enough in the economy of the world that a rise in its price has big ripple effects. Not ripples; waves. For one, you will pay more at the pump. You also may stay forsake a trip home for Thanksgivings because of a steep rise in the price of a ticket. Your rent may go up as well because a rise in heating expenses. Consequently, an analysis of the effects of Hussein's putative action would have to consider many markets and determine to which new equilibrium all these markets would move. We might even go so far and aspire to include all possible markets to determine the new equilibrium all around, that is, the general equilibrium. In 2005- 2006 the price of oil did go up abundantly, rippling across distant foreign markets,

so much so that politicians in remote areas of the United States began talking (irrationally, we might add) about price controls.

General Equilibrium Analysis:

As against partial equilibrium analysis, general equilibrium analysis is concerned with economic system as a whole.

It recognises the fact that economic system is a network in which all the parts are mutually dependent on one another and in mutual interaction with one another.

Goods are either competitive or substitutes. Some goods are used in the manufacture of other goods. Factors of production are complementary to each other to the extent they can be substituted for each other, they are competitive also. Resources also face competitive demand from producers.

Therefore, change in the demand or supply of any commodity or factor of production sets in motion a chain reaction. A disturbance in one sector of the economy produces its repercussions on all sides. General equilibrium analysis is concerned with the overall effects of a disturbance.

Instead of taking only a few variables at a time, we take into consideration all the relevant variables which may affect the particular phenomenon in hand. In this type of analysis, all the side-affects of an economic disturbance are analysed in full.

An example will make the concept of general equilibrium clearer. Suppose the demand for India-manufactured consumer goods suddenly increases in Western Europe. Indian exports will increase thereby increasing output, employment and profits in the export industries. Resources will be diverted from other industries to the export industries.

The demand and prices of the substitute commodities will also increase. The increased demand for exports will have economy-wide effects. An all-round analysis of the repercussions of the economic disturbance increased demand for manufactured consumer goods for export can be done only through general equilibrium theory.

General equilibrium analysis deals with the equilibrium of the whole organisation in the economy consumers, producers, resource-owners, firms and industries. Not only should individual consumers and firms be in equilibrium in themselves but also in relation to each other.

Managerial Economics : Definition, Nature, Scope

Managerial economics is a discipline which deals with the application of economic theory to business management. It deals with the use of economic concepts and principles of business decision making. Formerly it was known as “Business Economics” but the term has now been discarded in favour of Managerial

Economics.

Managerial Economics may be defined as the study of economic theories, logic and methodology which are generally applied to seek solution to the practical problems of business. Managerial Economics is thus constituted of that part of economic knowledge or economic theories which is used as a tool of analysing business problems for rational business decisions. Managerial Economics is often called as Business Economics or Economic for Firms.

Nature of Managerial Economics:

The primary function of management executive in a business organisation is decision making and forward planning.

Decision making and forward planning go hand in hand with each other. Decision making means the process of selecting one action from two or more alternative courses of action. Forward planning means establishing plans for the future to carry out the decision so taken.

The problem of choice arises because resources at the disposal of a business unit (land, labour, capital, and managerial capacity) are limited and the firm has to make the most profitable use of these resources.

The decision making function is that of the business executive, he takes the decision which will ensure the most efficient means of attaining a desired objective, say profit maximisation. After taking the decision about the particular output, pricing, capital, raw-materials and power etc., are prepared. Forward planning and decision-making thus go on at the same time.

A business manager’s task is made difficult by the uncertainty which surrounds business decision-making. Nobody can predict the future course of business conditions. He prepares the best possible plans for the future depending on past experience and future outlook and yet he has to go on revising his plans in the light of new experience to minimise the failure. Managers are thus engaged in a continuous process of decision-making through an uncertain future and the overall problem confronting them is one of adjusting to uncertainty.

In fulfilling the function of decision-making in an uncertainty framework, economic theory can be, pressed into service with considerable advantage as it deals with a number of concepts and principles which can be used to solve or at least throw some light upon the problems of business management. E.g are profit, demand, cost, pricing, production, competition, business cycles, national income etc. The way economic analysis can be used towards solving business problems, constitutes the subject-matter of Managerial Economics.

Thus in brief we can say that Managerial Economics is both a science and an art.

Scope of Managerial Economics:

The scope of managerial economics is not yet clearly laid out because it is a

developing

science. Even then the following fields may be said to generally fall

under Managerial Economics:

These divisions of business economics constitute its subject matter.

Recently, managerial economists have started making increased use of Operation Research methods like Linear programming, inventory models, Games theory,

queuing up theory etc., have also come to be regarded as part of Managerial Economics.

1.Demand Analysis and Forecasting: A business firm is an economic organisation which is engaged in transforming productive resources into goods that are to be sold in the market. A major part of managerial decision making depends on accurate estimates of demand. A forecast of future sales serves as a guide to management for preparing production schedules and employing resources. It will help management to maintain or strengthen its market position and profit base. Demand analysis also identifies a number of other factors influencing the demand for a product. Demand analysis and forecasting occupies a strategic place in Managerial Economics.

2.Cost and production analysis: A firm’s profitability depends much on its cost of production. A wise manager would prepare cost estimates of a range of output, identify the factors causing are cause variations in cost estimates and choose the cost-minimising output level, taking also into consideration the degree of uncertainty in production and cost calculations. Production processes are under the charge of engineers but the business manager is supposed to carry out the production function analysis in order to avoid wastages of materials and time. Sound pricing practices depend much on cost control. The main topics discussed under cost and production analysis are: Cost concepts, cost-output relationships, Economics and Diseconomies of scale and cost control.

3.Pricing decisions, policies and practices: Pricing is a very important area of Managerial Economics. In fact, price is the genesis of the revenue of a firm ad as such the success of a business firm largely depends on the correctness of the price decisions taken by it. The important aspects dealt with this area are: Price determination in various market forms, pricing methods, differential pricing, product-line pricing and price forecasting.

4.Profit management: Business firms are generally organized for earning profit and in the long period, it is profit which provides the chief measure of success of a firm. Economics tells us that profits are the reward for uncertainty bearing and risk taking. A successful business manager is one who can form more or less correct estimates of costs and revenues likely to accrue to the firm at different levels of output. The more successful a manager is in reducing uncertainty, the higher are the profits earned by him. In fact, profit-planning and profit measurement constitute the most challenging area of Managerial Economics.

5.Capital management: The problems relating to firm’s capital investments are perhaps the most complex and troublesome. Capital management implies planning and control of capital expenditure because it involves a large sum and moreover the problems in disposing the capital assets off are so complex that they require considerable time and labour. The main topics dealt with under capital management are cost of capital, rate of return and selection of projects.

Market Demand: 8 Important Elements of Market Demand Introduction:

Market demand is similar to industry demand. It is a broader concept and it involves total demand of a product in an industry. For example, demand of two wheelers in India implies demand of two wheelers produced and marketed by all the companies. It reveals the broader picture of demand. Marketer should keep in

mind the wider scenario of industry/market demand to see his position, often called market share of company in an industry. Market demand plays a vital role in formulating the broad marketing programme.

Definitions:

Term ‘market demand’ can be defined as:

  • 1. Philip Kotler: “Market demand for the product is the total volume that would be

bought by a defined customer group in a defined geographical area in a defined time period in a defined marketing environment under a defined marketing programme.”

  • 2. Thus, market demand indicates total sales of the product to the specific groups

of buyers in a specific period and in defined geographical areas in a given

marketing environment.

Elements of Market Demand:

Systematic analysis of above stated definitions necessarily reveals following elements:

  • 1. Product:

Market demand indicates the total demand of specific products in an industry. The place or scope of product must be specified. In which category or industry the product of company falls. It can be decided on the basis of who are the users and the purpose of using the product. Thus, we must mention the market demand in relation to the specific product.

  • 2. Total Volume:

It shows the total volume of sales in form of unit or value. It suggests the total sales of the product in the industry. For example, total volume means the amount (or units) of total demand of refrigerator in India.

  • 3. Purchase or Buying:

Only the quantity, that is ordered and purchased is included in market demand. Market demand includes units, which are ordered, delivered, or consumed.

  • 4. Customer Groups:

Market demand is expressed in term of different users. Total volume demanded by different groups of customers, such as industrial customers, institutional customers, and individual customers.

5.

Geographic Area:

Market demand can be specified in term of different geographical areas or localities. It may be in term of country, state, region, district, or any geographic unit.

  • 6. Fixed Time Duration:

Market demand is meaningful only if it is expressed in relation to time. For example, demand of two-wheeler during the year 2007. Time may be in term of week, months, quarter, or year.

  • 7. Marketing Environment:

Obviously, market demand is influenced by several factors. These factors constitute the marketing environment. So, it is necessary to mention assumptions about marketing environment comprising economic, cultural, social, political, etc., forces.

  • 8. Definition of Marketing Programme:

Market demand is affected by marketing programme/strategy. So, it is clarified with reference to a specific marketing programme including product, price, promotion, and distribution. Thus, market demand is stated in context with the definite marketing programme.

While estimating market demand, these all elements should be considered for meaningful picture of total demand. Here, we must distinguish market demand from company demand. Market demand is total demand of the product in an industry, and company demand means demand of the individual business unit’s products. Market forecast relates with market demand and sales forecast relates with company demand. However, market demand forecast and sales forecast are taken loosely (i.e., more or less similar).

Demand, a chief economic principle, is the effective want for something and the willingness and ability to pay for it. A relative concept, demand is always attached to a certain price point at a particular point in time. Quantitative demand analysis provides useful guidance to companies and investors trying to determine their market strategy and the growth potential of a product. There are two basic types of demand: individual and market. While both principles overlap in many ways, the scope of individual demand is much narrower than market demand.

Individual Demand

The individual demand is the demand of one individual or firm. It represents the quantity of a good that a single consumer would buy at a specific price point at a specific point in time. While the term is somewhat vague, individual demand can be represented by the point of view of one person, a single family, or a single household.

Market Demand

Market demand provides the total quantity demanded by all consumers. In other words, it represents the aggregate of all individual demands. There are two basic types of market demand: primary and selective. Primary demand is the total demand for all of the brands that represent a given product or service, such as all phones or all high-end watches. Selective demand is the demand for one particular brand of product or service, such as the iPhone or a Michele watch. Market demand is an important economic marker because it reflects the competitiveness of a marketplace, a consumer’s willingness to buy certain products and the ability of a company to leverage itself in a competitive landscape. If market demand is low, it signals to a company that they should terminate a product or service, or restructure it so that it is more appealing to consumers.

Factors Influencing Demand

There are several factors that influence individual and market demand. Individual demand is influenced by an individual’s age, sex, income, habits, expectations and the prices of competing goods in the marketplace. Market demand is influenced by the same factors, but on a broader scale—the taste, habits and expectations of a community and so on. It also considers the number of buyers in the market, the rate at which a certain community is growing and the level of innovation erupting in the marketplace. Market demand can be measured on an international, national, regional, local, or even smaller level.

Other Considerations

Note that where you have a sizable market demand for a product or service, there may be several individuals included in the market who won't buy the service or product. Often, companies will use several pieces of demographic information to parse out very specific subsets of the market they wish to target, such as middle- income middle-aged stay-at-home mothers or urban youths in coastal metropolises. In a monophonic market, where there is only buyer, individual demand and market demand collapse. Since the market encapsulates one person, that individual represents the entire market.

Market Demand Curve is Flatter:

Market demand curve is flatter than the individual demand curves. It happens because as price changes, proportionate change in market demand is more than proportionate change in individual demand.

Determinants of individual demand for a commodity:

  • 1. Price: -Demand for a commodity is mainly influenced by its price. Demand varies inversely with price. Normally, more quantity is demanded at lower prices and less quantity is demanded at higher price.

Price of complementary goods: -Complementary goods have joint demand. More than two or more gods are jointly demanded to satisfy a want. for example,

3.

car and petrol, paper and pen, etc. in such a case, a change in the price of one commodity would also affect the demand for other commodity. If the prices of the petrol rise, the demand for car would fall and vie versa.

  • 4. Income: -Purchasing power or ability to pay is the basic requirement for a

demand. Disposable income is the income at the disposal of the people after paying

direct taxes such as income tax. Generally, rich consumers buy more goods and service than the poor people do.

  • 5. Utility: -Utility is the basic purpose for demanding a commodity. If a commodity does not provide utility to the consumer, he will not demand it. For examples, there is no demand for cigarettes for a non-smoker.

  • 6. Quality: -The better the quality, the higher is the demand. Individual will buy a product of better quality even if the price is more.

  • 7. Taste and Habit: -Demand for a commodity depends on taste, fashion and habit. A consumer will buy certain goods on account of force of habit e.g. Cigarette, tobacco, pan masala, wines etc. Therefore the quantity demands of these goods would change when there is a change in habit, such as giving up smoking, wines etc.

  • 8. Advertisement and salesmanship: -Advertising and salesmanship have a tremendous influence on consumers; choice. The demand for many products such as cosmetics, soft drinks, home appliances and consumer durables etc. is promoted through these methods.

Determinants of Market Demand

Definition: The Market Demand is defined as the sum of individual demands for a product per unit of time, at a given price. Simply, the total quantity of a commodity demanded by all the buyers/individuals at a given price, other things remaining same is called the market demand.

There are several factors that determine the demand for a product. These are:

  • 1. Price of the Product: The price of a product is the most important determinant of market demand in the long-run and the only determinant in the short-run. As per the law of demand, the price of a product and its quantity demanded are inversely related, i.e. the quantity demanded increases when the price falls and decreases when the price rises, other things remaining the same.

Here, other things imply that the income of the consumer, the price of the substitute and complementary goods, tastes and preferences and the number of consumers, all remains constant. The price-demand relationship has more significance in the oligopolistic market structure in which the result of a price war among the firm and its rival decides the level of success of the firm.

  • 2. Price of the Related Goods: The market demand for a commodity is also affected by the changes in the price of the related goods. The related goods may be the substitute or complementary goods. Two commodities are said to be a substitute for one another if they satisfy the same want of an individual and the change in the price of one commodity affects the demand for another in the same

direction. Such as, tea and coffee, Maggi and Yippie, Pepsi and Coca- Cola are close substitutes for each other. The increase in the price of either commodity the demand for the other also increases and vice- versa.

A commodity is said to be a complement for another if the use of two goods goes together such that their demand changes (increases or decreases) simultaneously. For example, bread and butter, car and petrol, mattress and cot, etc. are complementary goods. The increase in the price of either commodity the demand for another decreases and vice-versa.

3.

Consumer’s Income: The income is the basic determinant of the quantity demanded of a product as it decides the purchasing power of the consumers. Thus, people with higher disposable income spend a larger amount of income on consumer goods and services as compared to those with lower disposable income. Consumer goods and services can be grouped under four categories: essential goods, inferior goods, normal goods, and prestige or luxury goods. The relationship between the consumer’s income and these goods is explained below:

Essential Consumer Goods: The essential goods are the basic necessities of the life and are consumed by all the persons of the society. Such as food grains, salt, cooking oil, clothing, housing, etc., the demand for such commodities increases with the increase in consumer’s income but only up to a certain limit, although the total expenditure may increase with respect to the quality of goods consumed, other things remaining the same.

Inferior Goods: A commodity is deemed to be inferior if its demand decreases with the increases in the consumer’s income beyond a certain level of income and vice-versa. For example, Bajra, millet, bidi are the inferior goods.

Normal Goods: The normal goods are those goods whose demand increases with the increase in the consumer’s income, such as clothing, household furniture, automobiles, etc. It is to be noted that, demand for the normal goods increases rapidly with the increase in the consumer’s income but slows down with a further increase in the income.

Luxury Goods: The luxury goods are those goods which add to the prestige and pleasure of the consumer without enhancing the earnings. For example, jewelry, stone, gem, luxury cars, etc. The demand for such goods increases with the increase in the consumer’s income.

4.

Consumers’ tastes and preferences: Consumer’s Tastes and preferences play a vital role in determining a demand for a product. Tastes and preferences often depend on the lifestyle, culture, social customs, hobbies, age and sex of the consumers and the religious sentiments attached to a commodity. The change in any of these factors results in the change in the consumer’s tastes and preferences, thereby resulting in either increase or decrease in the demand for a product.

  • 5. Advertisement Expenditure: Advertisement is done to promote sales of a product. It helps in stimulating demand for a product in four ways; by informing the prospective consumers about the availability of a product, by showing its superiority over the competitor’s brand, by influencing the consumer’s choice against the rival product and by setting new fashion and changing tastes of the consumers. The effect of advertisement is said to be fruitful if it leads to the upward shift in the demand curve, i.e. the demand increases with the increase in the advertisement expenditure, other things remaining constant.

  • 6. Consumers’ Expectations: In the short run, the consumer’s expectation with respect to the income, future prices of the product and its supply position plays a vital role in determining the demand for a commodity. If the consumer expects a high rise in the price of the commodity, shall purchase it today at a high current price so as to avoid the pinch of the high price in the future. On the contrary, if the prices are expected to fall in the future the consumer will postpone their purchase with a view to avail benefits of lower prices in the future, especially in case of nonessential goods.

Likewise, an expected increase in the income increases the demand for a product and vice-versa. Also, in the case of scarce goods, if its production is expected to fall short in the future, the consumer will buy it at current higher prices.

  • 7. Demonstration Effect: Often, the new commodities or new models of an existing product are bought by the rich people. Some people buy goods due to their genuine need for them or have excess purchasing power. While some others do so because they want to exhibit their affluence. Once the commodity is in very much fashion, many households buy them not because they have a genuine need for them but their neighbors have purchased it. Thus, the purchase made by such people arises out of feelings as jealousy, equality in society, competition, social inferiority, status consciousness. The purchases made on the account of these factors results in the demonstration effect, also called as Bandwagon Effect.

  • 8. Consumer-Credit Facility: The availability of credit to the consumer also determines the demand for a product. The credit extended by sellers, banks, friends, relatives or from other sources induces a consumer to buy more than what would have not been possible in the absence of the credit. Thus, the consumers with more borrowing capacity consumes more than the ones who borrow less.

  • 9. Population of the Country: The population of the country also determines the total domestic demand for a product of mass consumption. For a given level of per capita income, tastes and preferences, price, income, etc., the larger the size of the population the larger the demand for a product and vice-versa.

the national income also determines the overall demand for a product. Such as, if the national income is unevenly distributed, i.e., the majority of the population falls under the low-income groups, then the market demand for the inferior goods will be more than the other category goods.

Thus, the demand for a commodity can be estimated or analyzed by studying the determinants of market demand and the nature of the relationship between the demand and its determinants.

Demand Equation or Function

This equation expresses the relationship between demand and its five

determinants:

qD = f (price, income, prices of related goods, tastes, expectations)

It says that the quantity demanded of a product is a function of its price, the income of the buyer, the price of related goods (substitutes or complements), the tastes of the consumer, and any expectation the consumer has of future supply, prices, etc.

Law of Demand

The relationship between the quantity demanded and the price is governed by the law of demand. This economic principle describes something you already intuitively know -- if the price goes up, people buy less. The reverse is, of course,

true -- if the price drops, people buy more. However, price is not the only determining factor. Therefore, the law of demand is only true if all other determinants don't change. In economics, this is known as ceteris paribus.

Therefore, the law of demand formally states that, ceteribus paribus, the quantity demanded for a good or service is inversely related to the price.

8 Assumptions of Law of Demands – Explained!

Some of the major assumptions of law of demands are: 1. No change in habits, customs and income of consumers, 2. This law does not apply on necessaries of life, 3. Joint demand, 4. Articles of distinction, 5. Fear of shortage in future, 6. Change in the price of substitutes, 7. Fear of a rise in price in future and 8. Ignorance:

1. No change in habits, customs and income of consumers:

Law of demand tells us that demand goes with a fall in price and goes down with a rise in price. But an increase in price will not bring down the demand if at the same time the income of the buyer has also increased.

2. This law does not apply on necessaries of life:

It is assumed that this law is not applicable in the case of necessaries of life. Because, an increase in the price of flour will not bring down its demand. Likewise a fall in its price will not vary much increase the demand for it.

  • 3. Joint demand:

Goods which have joint demand also falsify the law. Thus, an increase in the demand of cars will lead to more demand for petrol. Whereas the law of demand states that the demand for petrol should increase on it its price falls.

  • 4. Articles of distinction:

Law of demand does not hold goods in case of those goods which confer social distinction. When the price of such goods goes up, their demand shall also increase. For instance, an increase in the price of diamond will raise its demand and a fall in price will lower the demand.

  • 5. Fear of shortage in future:

If there is a fear of shortage of a good in future its demand will increase in present as people would start storing. But according to law of demand its demand should go it when its price falls.

  • 6. Change in the price of substitutes:

This law does not apply in the case of tea and coffee, because these goods are substitutes of each other. When the price of coffee goes up the demand for tea shall increase although there has been no fall in the price of tea.

  • 7. Fear of a rise in price in future:

If consumers think that the price of particular goods will increase in future, they will store it. In other words, the demand of those goods shall increase at the same price. But this law states that demand should go up only if price falls.

  • 8. Ignorance:

It is possible that a consumer may not be aware of the previous price of a good. In this case consumer might start purchasing more of a commodity when its price has actually gone up. A new approach called the ordinal utility approach, developed by Edgeworth, Pareto. Slutsky, Johnson, Hicks and Allen are easier and more helpful in solving the problem of consumer’s demand. The ordinal theory not only requires fewer assumptions but possesses greater predictive power than does its cardinal cousin.

The assumption of cardinally measurable utility has been dispensed with not because utility is not cardinally measurable, but simply because such

measurement is not at all required for analyzing consumer’s behavior. The points of distinction between the cardinal and the ordinal measures of utility.

Extension and Contraction in Demand

In economics, the extension and contraction in demand are used when the quantity demanded rises or falls as a result of changes in price and we move along a given demand curve. When the quantity demanded of a good rises due to the fall in price, it is called extension of demand and when the quantity demanded falls due to the rise in price, it is called contraction of demand.

For instance, suppose the price of bananas in the market at any given time is Rs.12 per dozen and a consumer buys one dozen of them at that price. Now, if other things such as tastes of the consumer, his income, prices of other goods remain the same and price of bananas falls to Rs. 8 per dozen and the consumer now buys 2 dozen bananas, then extension in demand is said to have occurred. On the contrary, if the price of bananas rises to Rs. 15 per dozen and consequently the consumer now buys half a dozen of the bananas, then contraction in demand is said to have occurred.

It should be remembered that extension and contraction in the demand takes place as a result of changes in the price alone when other determinants of demand such as tastes, income, propensity to consume and prices of the related goods remain constant. These other factors remaining constant means that the demand curve remains the same, that is, it does not change its position; only the consumer moves downward or upward on it.

Increase and decrease in demand In case of expansion and contraction of demand, we have seen that the change takes place as a result of changes in price, all other factors remaining constant. When all the other factors influencing demand also

change, there is an increase or decrease in demand and the demand curve shifts either to its right or left. If the income of a consumer rises, he would be able to purchase the commodities which he earlier could not afford. This would result in an increase in demand and therefore, the demand curve shifts to the right. If, on the other hand, the goods are out of fashion, the demand of that good will decline,

resulting in the shift of the demand curve to the left. and decrease due to the following reasons:

Demand may also increase

Increase in demand (A shift in the demand curve towards the right)

Rise in income Rise in the price of substitutes Fall in the price of a complement Favourable change in tastes of a good Increase in population Goods in fashion

Decrease in demand (A shift in the demand curve towards the left)

Rise in income Rise in the price of substitutes Fall in the price of a complement Favourable change in tastes of a good Increase in population Goods in fashion

The different types of demand

ii. Organization and Industry Demand:

Refers to the classification of demand on the basis of market. The demand for the products of an organization at given price over a point of time is known as organization demand. For example, the demand for Toyota cars is organization demand. The sum total of demand for products of all organizations in a particular industry is known as industry demand.

For example, the demand for cars of various brands, such as Toyota, Maruti Suzuki, Tata, and Hyundai, in India constitutes the industry’ demand. The distinction between organization demand and industry demand is not so useful in a highly competitive market.

This is due to the fact that in a highly competitive market, organizations have insignificant market share. Therefore, the demand for an organization’s product is of no importance. However, an organization can forecast the demand for its products only by analyzing the industry demand.

iii. Autonomous and Derived Demand:

Refers to the classification of demand on the basis of dependency on other products. The demand for a product that is not associated with the demand of other products is known as autonomous or direct demand. The autonomous demand arises due to the natural desire of an individual to consume the product.

For example, the demand for food, shelter, clothes, and vehicles is autonomous as it arises due to biological, physical, and other personal needs of consumers. On the other hand, derived demand refers to the demand for a product that arises due to the demand for other products.

For example, the demand for petrol, diesel, and other lubricants depends on the demand of vehicles. Apart from this, the demand for raw materials is also derived demand as it is dependent on the production of other products. Moreover, the demand for substitutes and complementary goods is also derived demand.

iv. Demand for Perishable and Durable Goods:

Refers to the classification of demand on the basis of usage of goods. The goods are divided into two categories, perishable goods and durable goods. Perishable or non-durable goods refer to the goods that have a single use. For example, cement, coal, fuel, and eatables. On the other hand, durable goods refer to goods that can be used repeatedly.

For example, clothes, shoes, machines, and buildings. Perishable goods satisfy the present demand of individuals. However, durable goods satisfy both present as well as future demand of individuals. Therefore, consumers purchase durable items by considering its durability.

In addition, durable goods need replacement because of their continuous use. The demand for perishable goods depends on the current price of goods and customers’ income, tastes, and preferences and changes frequently, while the demand for durable goods changes over a longer period of time.

v. Short-term and Long-term Demand:

Refers to the classification of demand on the basis of time period. Short-term demand refers to the demand for products that are used for a shorter duration of time or for current period. This demand depends on the current tastes and preferences of consumers.

For example, demand for umbrellas, raincoats, sweaters, long boots is short term and seasonal in nature. On the other hand, long-term demand refers to the demand for products over a longer period of time.

Generally, durable goods have long-term demand. The long-term demand of a product depends on a number of factors, such as change in technology, type of competition, promotional activities, and availability of substitutes. The short-term and long-term concepts of demand are essential for an organization to design a new product.

  • 6. Joint demand:

In finished products as in case of bread, there is need for so many things—the services of the flour mill, oven, fuel, etc. The demand for them is called joint demand. Similarly for the construction of a house we require land, labor, capital, organization and materials like cement, bricks, lime, etc. The demand for them is, thus, called a ‘joint demand.’

  • 7. Composite demand:

A commodity is said to have a composite demand when its use is made in more than one purpose. For example the demand for coal is composite demand as coal has many uses—as fuel for a boiler of a factory, for domestic fuel, for oven for steam-making in railways engine, etc.

  • 1. Price demand:

Price demand refers to the different quantities of the commodity or service which consumers will purchase at a given time and at given prices, assuming other things remaining the same. It is the price demand with which people are mostly concerned and as such price demand is an important notion in economics. Price demand has inverse relation with the price. As the price of commodity increases its demand falls and as the price decreases, its demand rises.

Income demand:

2.

Income demand refers to the different quantities of a commodity or service which consumers will buy at different levels of income, assuming other things remaining constant. Usually the demand for a commodity increases as the income of a person increases unless the commodity happens to be an inferior product. For example, coarse grain is a cheap or inferior commodity. The demand for such commodities decreases as the income of a person increases. Thus, the demand for inferior or cheap goods is inversely related with the income.

  • 3. Cross demand:

When the demand for a commodity depends not on its price but on the price of other related commodities, it is called cross demand. Here we take closely connected or related goods which are substitutes for one another.

For example, tea and coffee are substitutes for one another. If the price of coffee rises, the consumer will be induced to buy more of tea and, hence, the demand of tea will increase. Thus in case of substitutes, when the price of one related commodity rises, the demand of the other related commodity increases and vice- versa.

But in case of complimentary or joint demand goods, e.g., pen and ink, horses and carriages etc. when the price of one commodity rises, the demand for it will fall and as a result of it the demand for the other joint commodity also falls (even though its price remains the same). For example, if the price of horses increases, their demand will fall and as a result of it the demand for carriages will also fall even though their price does not change.

Network Externalities: Bandwagon Effect and Snob Effect

Network externalities are the effects on a user of a product or service of others using the same or compatible products or services. Positive network externalities exist if the benefits (or, more technically, marginal utility) are an increasing function of the number of other users. Negative network externalities exist if the benefits are a decreasing function of the number of other users. For example, Facebook likely confers positive network externalities since it is more useful to a

user if more people are using it as well.

Conversely, a road probably confers

negative network externalities since a consumer of the road creates traffic for other consumers of the road.

What is Monopoly ? Meaning and Concept

The term monopoly is derived from Greek words 'mono' which means single and 'poly' which means seller. So, monopoly is a market structure, where there only a single seller producing a product having no close substitute.

This single seller may be in the form of an individual owner or a single partnership or a Joint Stock Company. Such a single firm in market is called monopolist. Monopolist is price maker and has a control over the market supply of goods. But it

does not mean that he can set both price and output level. A monopolist can do either of the two things i.e. price or output. It means he can fix either price or output but not both at a time.

does not mean that he can set both price and output level. A monopolist can do

Characteristics / Features of Monopoly Following are the features or characteristics of Monopoly :- A single seller has complete control over the supply of the commodity. There are no close substitutes for the product. There is no free entry and exit because of some restrictions. There is a complete negation of competition. Monopolist is a price maker.

Since there is a single firm, the firm and industry are one and same i.e. firm coincides the industry.

Monopoly firm faces downward sloping demand curve. It means he can sell more at lower price and vice versa. Therefore, elasticity of demand factor is very important for him.

Definition and Classification of Oligopoly!

The term ‘Oligopoly’ is coined from two Greek words ‘Oligoi meaning ‘a few’ and ‘pollein means ‘to sell’.

It occurs when an industry is made up of a few firms producing either an identical product or differentiated product.

In simple words, “Oligopoly is a situation in which there are so few sellers that each of them is conscious of the results upon the price of the supply which he individually places upon the market”-The number of sellers is greater than one, yet not big enough to render negligible the influence of any one upon the market price.

Definition:

“Oligopoly is that situation in which a firm bases its markets policy in part on the expected behaviour of a few close rivals.” – J. Stigier

“Oligopoly is a market structure characterized by a small number of firms and a great deal of interdependence.” -Mansfield

Classification of Oligopoly:

Oligopoly situation can be classified on different bases:

1. Basis of Product Differentiation:

On the basis of product differentiation, oligopoly may be classified as Pure or Perfect Oligopoly and Imperfect or Differentiated Oligopoly. In the case of pure oligopoly, the product of different firms in the industry is identical or homogeneous while in the case of differentiated oligopoly, the products of different firms are not identical but rather differentiated products. Thus, differentiated oligopoly will exist

where the competing firms produce products which are close substitutes but not perfect substitutes.

The distinction between pure oligopoly and differentiated oligopoly does not play a significant role in the analysis. In real situation, firms in most oligopolistic industries produce differentiated products. But theoretically we may determine price and output in both kinds of oligopoly.

  • 2. Basis of Entry of Firms:

On the basis of the possibility of entry of new firms into the industry, oligopoly may be classified as Open Oligopoly and Closed Oligopoly. An open oligopoly provides full freedom to new firms to enter into the industry. In the situation of open oligopoly there is no restriction of any kind for the desiring firms to enter into the market. A closed oligopoly, on the other hand, refers to that market situation where only the few firms control the entire market and new firms are not allowed to enter the industry.

  • 3. Basis of Price Leadership:

On the basis of presence or absence of price leadership, oligopoly may be classified as Partial Oligopoly and Full Oligopoly. Partial oligopoly refers to that market situation where the industry is dominated by one large firm (known as the leader) and the other firms (known as the followers) of the industry follow the price policy determined by their leader. Full oligopoly, on the other hand, refers to that market situation where there is no leader and no followers.

  • 4. Basis of Agreement:

On the basis of agreement, oligopoly is classified as Collusive Oligopoly and Non- collusive Oligopoly. A collusive oligopoly refers to that market situation where the firms of the industry follow a common policy of pricing. In other words, they combine together to avoid competition among themselves regarding the price and output of the industry. A non- collusive oligopoly refers to that market situation where there is no agreement among the firms regarding the price and output of the entire market. In other words, the firms under non-collusive oligopoly act independently.

Collusive Oligopoly: Price and Output Determination under Cartel!

In order to avoid uncertainty arising out of interdependence and to avoid price wars and cut throat competition, firms working under oligopolistic conditions often enter into agreement regarding a uniform price-output policy to be pursued by them.

The agreement may be either formal (open) or tacit (secret). But since formal or open agreements to form monopolies are illegal in most countries, agreements reached between oligopolists are generally tacit or secret. When the firms enter into such collusive agreements formally or secretly, collusive oligopoly prevails.

Reasons for the Possible Breakdowns of Cartels

Most cartel arrangements experience difficulties and tensions and some cartels collapse completely. Several factors can create problems within a collusive agreement between suppliers:

Enforcement problems: The cartel aims to restrict production to maximize total profits of members. But each individual seller finds it profitable to expand production. It may become difficult for the cartel to enforce its output quotas and there may be disputes about how to share out the profits. Other firms – not members of the cartel – may opt to take a free ride by selling just under the cartel price.

Falling market demand creates excess capacity in the industry and puts pressure on individual firms to discount prices to maintain their revenue

The successful entry of non-cartel firms into the industry undermines a cartel's control of the market. Rapid technological change can often undermine a cartel e.g. a new entrant with an innovative and success alternative business model.

The exposure of illegal price-fixing by market regulators such as the European Union Competition Commission and the UK's Competition and Markets Authority.

The exposure of price-fixing by whistle-blowing firms – these are firms previously engaged in a cartel that decides to withdraw from it and pass on information to the competition authorities

Foundation of De Beers Diamond Cartel

In 1867, the accidental discovery of diamonds in South Africa laid the foundation of the modern diamond industry. Within months of the first discovery, prospectors from around the world rushed to pan the waters of the Vaal River.

However, the bulk of the diamonds did not lie on bed of the river, but instead inside deep volcanic pipes. This forced the miners to pool their resources and cooperate with each other.

In 1874, an Englishman named Cecil Rhodes arrived at Kimberley Mine and began renting very effective steam-powered pump to the miners which was used to pump out water from the mines. He soon installed pumps at other mines in the area and shortly thereafter began purchasing claims in the mines themselves.

As Rhodes acquired these mines, he started facing following challenges of the diamond trade:

The sheer volume of diamonds flowing from the South African mines to other parts of world threatened to destroy the scarcity that had long defined the stones’ value. This would definitely tarnish the luxury value associated with diamond.

South Africa’s individual miners were unable to control their production. They mined the stones they found and tried to sell them all. On the contrary, their buyers preferred to purchase only the largest and most beautiful stones.

Solution to these problems was to form a well-integrated organization to manage the flow of diamonds from South Africa. Idea behind this was to keep supplies low and prices high. And if excess supply ever hovered on the market, De Beers itself would acquire and stockpile these stones.

So, Rhodes signed a formal agreement with his buyers (local diamond distributors) to form a Diamond Syndicate. Under its terms, the distributors would buy

diamonds exclusively from Rhodes and sell them in agreed-upon numbers, at agreed-upon prices.

In 1880, Rhodes formed the De Beers Mining Company and by 1890, Rhodes controlled all of South Africa’s major mines, along with the distribution channels for their output.

These mechanisms remained in place until Rhodes’ death in 1902. Then, Ernest Oppenheimer, a German who had risen to prominence in South Africa’s diamond industry, began to worry that the Diamond Syndicate was still too independent. Syndicate had the potential to challenge the producers by shifting either supply or price.

So, as Oppenheimer advanced through the ranks of the diamond trade, he started tightening the noose on channels of production and distribution. In 1925, Oppenheimer gained control of the Diamond Syndicate. In 1929, he also took control of De Beers, thus achieving near total integration of South Africa’s diamond trade.

He now controlled a system that brought diamond from mine to the end-customer. At the core of this diamond cartel was the Central Selling Organization (CSO) which was later re-structured to Diamond Trading Company (DTC), a London-based group. It acted as the chief intermediary between the stones mined in any given year and the consumers who would eventually purchase or polish or wear them.

Ten times a year, an elite group of dealers ("sightholders") would gather at CSO headquarters. There, the dealers would each be presented with an individual parcel of stones, chosen by the CSO to reflect both what the dealer was hoping to sell in the subsequent weeks and what De Beers wanted to place into the market.

Through this mechanism, De Beers was able to determine not only the precise size and quality of diamonds available each year, but also their price. Dealers were encouraged not to purchase diamonds from any sources outside the CSO, nor even to repurchase a "used" stone.

DTC Sightholders are amongst the world's leading diamond dealers. They collectively handle approximately 75% of the World’s diamonds. These are based mainly in the traditional cutting centers of Antwerp, Tel Aviv, Mumbai, Johannesburg and New York, as well as in Botswana, Namibia, Russia, China and Canada.

Managing Production

By 1950s, South Africa’s vast stock of diamonds began to diminish. Also, new discoveries of diamond deposits were made in other countries across Africa, Australia and Soviet Union.

For De Beers, these new players raised the challenged that had long haunted Rhodes and Oppenheimer: the threat of diamonds flooding the market and destroying the hard-won "illusion of scarcity" and thus depressing prices.

So, De Beers moved swiftly to bring the new producers into the fold of its diamond cartel. The South African company signed long-term contracts with the diamond- producing countries, guaranteeing to purchase a fixed proportion of the country’s output at a fixed price. This ensured De Beers to maintain strong control on diamond production.

Managing Demand

In 1948, De Beers came up with its famous and clever slogan "A diamond is forever", later hailed byAdvertising Age as the slogan of the century.

This slogan told diamond customers that their purchases were heirlooms, too valuable ever to be sold. This effectively killed the resale market while maintaining the demand of new diamond always high.

Through fine print and other media campaigns, De Beers conveyed to its customers (mostly male) that several months’ salary was the recommended price, with attention duly paid to the diamond cartel’s own criteria of color, cut, clarity and carat.

Benefit of Kimberley Process Certification

In order to flush out Conflict Diamonds from supply chain, the Kimberley Process Certification System (KPCS) was formed in 2003 by joint effort of various countries, NGO’s and diamond industry.

Per rules laid by KPCS, every individual who handles a diamond (from the miner to the jeweler) is responsible for maintaining an identity tag affixed to the stone at the time of extraction. With such a system, theoretically at least, no warlord in Liberia or Sierra Leone can slip diamonds into the pipeline.

KPCS proved exceedingly good for De Beers. It strengthened the De Beers’ principle of curbing excess supply of diamond and preventing new suppliers from entering the business. Like the diamond cartel itself, this new international system restricts supply and enhances the power of big, established players.

Kimberley Process keeps the warlords, small diggers and the shady traders out of the acceptable stream of commerce. It also imposes costs (for tagging, monitoring and auditing) that make it even more difficult for new or smaller players to enter the global market.

Conclusion

In the diamond market, (unlike oil market) sharp changes in price could mean a long-term shift in how consumers view diamonds, and how consumers think about the price that they pay.

It can be safely said that since Rhodes’s time, the diamond cartel has managed to impress upon consumers that diamonds are both valuable and scarce and that these should be purchased based on quality rather than price.

Much of this cartel’s success can be attributed to its leading player, De Beers - which has enforced the rules - and its ability to bring new producers into the fold and convince them not to sell outside its confines.

Note: In 2011, Oppenheimer family sold their 40% stake in De Beers to Anglo- American which earlier had 45% shares. So, with 85% stakes owned by Anglo- American, in 2012 De Beers became the member of Anglo American plc group.