Mba First Year Newppt

The Scope and Method of Economics
DR SALABH MEHROTRA (Economics for Manager')
The Study of Economics

Economics is the study of how individuals and societies choose to use the scarce resources that nature and previous generations have provided.
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Why Study Economics?

An important reason for studying economics is to learn a way of thinking. Three fundamental concepts:
Opportunity cost Marginalism, and Efficient markets
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Opportunity Cost
Opportunity cost is the best alternative that we forgo, or give up, when we make a choice or a decision.
Nearly all decisions involve trade-offs.
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Marginalism
In weighing the costs and benefits of a decision, it is important to weigh only the costs and benefits that arise from the decision.
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Marginalism
For example, when a firm decides whether to produce additional output, it considers only the additional (or marginal cost), not the sunk cost.
Sunk costs are costs that cannot be avoided, regardless of what is done in the future, because they have already been incurred.
Efficient Markets
An efficient market is one in which profit opportunities are eliminated almost instantaneously. There is no free lunch! Profit opportunities are rare because, at any one time, there are many people searching for them.
More Reasons to Study Economics

The study of economics is an essential part of the study of society. Economic decisions often have enormous consequences.
During the Industrial Revolution, new manufacturing technologies and improved transportation gave rise to the modern factory system.
The Scope of Economics

Microeconomics is the branch of economics that examines the behavior of individual decision-making unitsthat is, business firms and households.
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Macroeconomics is the branch of economics that examines the behavior of economic aggregates income, output, employment, and so onon a national scale.

Examples of microeconomic and macroeconomic concerns
Production Microeconomics Production/Output in Individual Industries and Businesses How much steel How many offices How many cars Macroeconomics National Production/Output Total Industrial Output Gross Domestic Product Growth of Output
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Prices Price of Individual Goods and Services Price of medical care Price of gasoline Food prices Apartment rents Aggregate Price Level Consumer prices Producer Prices Rate of Inflation
Income Distribution of Income and Wealth Wages in the auto industry Minimum wages Executive salaries Poverty National Income Total wages and salaries Total corporate profits
Employment Employment by Individual Businesses & Industries Jobs in the steel industry Number of employees in a firm Employment and Unemployment in the Economy Total number of jobs Unemployment rate
The Method of Economics

Positive economics studies economic behavior without making judgments. It describes what exists and how it works.
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Normative economics, also called policy economics, analyzes outcomes of economic behavior, evaluates them as good or bad, and may prescribe courses of action.

Positive economics includes:
Descriptive economics, which involves the compilation of data that describe phenomena and facts. Economic theory, which involves building models of behavior.
An economic theory is a general statement of cause and effect, action and reaction.
Managerial Economics Defined

The application of economic theory and the tools of decision science to examine how an organization can achieve its aims or objectives most efficiently. A close interrelationship between management and economics has led to the development of managerial economics.
DR SALABH MEHROTRA (Economics for Manager') 15
What is Managerial Economics?

Douglas - Managerial economics is .. the application of economic principles and methodologies to the decision-making process within the firm or organization. Pappas & Hirschey - Managerial economics applies economic theory and methods to business and administrative decision-making. Salvatore - Managerial economics refers to the application of economic theory and the tools of analysis of decision science to examine how an organisation can achieve its objectives most effectively. DR SALABH MEHROTRA (Economics for
Manager')
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What is Managerial Economics?

Howard Davies and Pun-Lee Lam It is the application of economic analysis to business problems; it has its origin in theoretical microeconomics.
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How Is Managerial Economics Useful?

Evaluating Choice Alternatives
Identify ways to efficiently achieve goals. Specify pricing and production strategies. Provide production and marketing rules to help maximize net profits.
Making the Best Decision

Managerial economics can be used to efficiently meet management objectives. Managerial economics can be used to understand logic of company, consumer, and government decisions.
Principles of Managerial Economics

1 Marginal and Incremental Principle
This principle states that a decision is said to be rational and sound if given the firms objective of profit maximization, it leads to increase in profit, which is in either of two scenarios If total revenue increases more than total cost. If total revenue declines less than total cost.
2. Equi-marginal Principle Marginal Utility is the utility derived from the additional unit of a commodity consumed. The laws of equi-marginal utility states that a consumer will reach the stage of equilibrium when the marginal utilities of various commodities he consumes are equal. According to the modern economists, this law has been formulated in form of law of proportional marginal utility. It states that the consumer will spend his money-income on different goods in such a way that the marginal utility of each good is proportional to its price
3. Opportunity Cost Principle By opportunity cost of a decision is meant the sacrifice of alternatives required by that decision. If there are no sacrifices, there is no cost. According to Opportunity cost principle, a firm can hire a factor of production if and only if that factor earns a reward in that occupation/job equal or greater than its opportunity cost. Opportunity cost is the minimum price that would be necessary to retain a factor-service in its given use. It is also defined as the cost of sacrificed alternatives. 4.Time Perspective Principle According to this principle, a manger/decision maker should give due emphasis, both to shortterm and long-term impact of his decisions. Short-run refers to a time period in which some factors are fixed while others are variable. The production can be increased by increasing the quantity of variable factors. While long-run is a time period in which all factors of production can become variable. Entry and exit of seller firms can take place easily. From consumers point of view, short-run refers to a period in which they respond to the changes in price, given the taste and preferences of the consumers, while long-run is a time period in which the consumers have enough time to respond to price changes by varying their tastes and preferences.
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5. Discounting Principle According to this principle, if a decision affects costs and revenues in long-run, all those costs and revenues must be discounted to present values before valid comparison of alternatives is possible. This is essential because a rupee worth of money at a future date is not worth a rupee today. Money actually has time value. Discounting can be defined as a process used to transform future dollars into an equivalent number of present dollars. For instance, $1 invested today at 10% interest is equivalent to $1.10 next year. FV = PV*(1+r)t Where, FV is the future value (time at some future time), PV is the present value (value at t0, r is the discount (interest) rate, and t is the time between the future value and present value
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BASIS
Scope:
ECONOMIC DEVELOPMENT Concerned with structural changes in the economy Development relates to growth of human capital indexes, a decrease in inequality figures, and structural changes that improve the general population's quality of life It implies changes in income, saving and investment along with progressive changes in socio-economic structure of country(institutional and technological changes)
ECONOMIC GROWTH Growth is concerned with increases in the economy's output Growth relates to a gradual increase in one of the components of Gross Domestic Product: consumption, government spending, investment, net exports It refers to an increase in the real output of goods and services in the country like increase the income in savings, in investment etc.
Growth:
Implication:
Measurement:
Qualitative.HDI (Human Development Index), gender- related index (GDI), Human Quantitative. Increase in real GDP. Shown poverty index (HPI), infant mortality, by PPF. literacy rate etc. Brings qualitative and quantitative changes Brings quantitative changes in the economy in the economy
Effect:
Concept:
Normative concept
Narrower concept than economic development
Relevance:
Economic growth is a more relevant metric Economic development is more relevant to for progress in developed countries. But it's measure progress and quality of life in widely used in all countries because growth developing nations. DR SALABH MEHROTRA (Economics for is a necessary condition for development 22 Manager')
Significance of M.E.
Provides number of tools & techniques to manager Gives information about various concept for the analysis of business problem Helps in making imp. Managerial decision.
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What is Industry? Meaning

The production side of business activity is referred as industry. It is a business activity, which is related to the raising, producing, processing or manufacturing of products. The products are consumer's goods as well as producer's goods. Consumer goods are goods, which are used finally by consumers. E.g. Food grains, textiles, cosmetics, VCR, etc. Producer's goods are the goods used by manufacturers for producing some other goods. E.g. Machinery, tools, equipments, etc. Expansion of trade and commerce depends on industrial growth. It represents the supply side of market.
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Classification / Types of Industries

1. Primary Industry Primary industry is concerned with production of goods with the help of nature. It is a nature-oriented industry, which requires very little human effort. E.g. Agriculture, farming, forestry, fishing, horticulture, etc. 2. Genetic Industry Genetic industries are engaged in re-production and multiplication of certain spices of plants and animals with the object of sale. The main aim is to earn profit from such sale. E.g. plant nurseries, cattle rearing, poultry, cattle breeding, etc. 3. Extractive Industry Extractive industry is concerned with extraction or drawing out goods from the soil, air or water. Generally products of extractive industries come in raw form and they are used by manufacturing and construction industries for producing finished products. E.g. mining industry, coal mineral, oil industry, iron ore, extraction of timber and rubber from forests, etc.
4. Manufacturing Industry Manufacturing industries are engaged in transforming raw material into finished product with the help of machines and manpower. The finished goods can be either consumer goods or producer goods. E.g. textiles, chemicals, sugar industry, paper industry, etc. 5. Construction Industry Construction industries take up the work of construction of buildings, bridges, roads, dams, canals, etc. This industry is different from all other types of industry because in case of other industries goods can be produced at one place and sold at another place. But goods produced and sold by constructive industry are erected at one place. 6. Service Industry In modern times service sector plays an important role in the development of the nation and therefore it is named as service industry. The main industries, which fall under this category, include hotel industry, tourism industry, entertainment industry, etc.
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FACTORS AFFECTING LOCATION OF INDUSTRIES

Factors may be placed into three basic categories: 1. Natural Advantages 2. Acquired Advantages 3. Government Advantages The factors can be listed as follows: a) Cost-[Acquired] b) Closeness to a source of raw materials-[Natural] c) Closeness to a source of power-[Acquired and/or Natural] d) Closeness to a market-[Acquired] e) Closeness to an educated working force-[Acquired] f) Closeness to a method of transport-[Acquired] g) Government Intervention-[Government] h) In a suitable climate-[Natural] i) In a stable political atmosphere-[Government] j) Health facilities-[Acquired]
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What Is The Role Of Industry In Economic Development?

Industry is the key element in the economic development of any country or region. In its purest terms, industry is the production of items from raw materials. However, that definition has changed over the generations with industry covering a much wider range of activities. A growing industrial sector is crucial to greater economic development and takes in a number of areas as a country develops. A good example to demonstrate this is in Scotland, where traditional industries such as shipbuilding and coal-mining have virtually disappeared to be replaced by 'softer' industries such as financial services and tourism. Ensuring steady industrial growth helps to compliment and sustain continued economic development. If industry is growing at too fast a rate it can become unsustainable, which can create DR SALABH MEHROTRA (Economics forrecession. Recession is 28 Manager') defined as negative economic growth over a period of time.
Continue.
A well developed industrial sector, covering various different areas is vital to the economic development of a country. With a variety of different industrial sectors that feed off each other, a well balanced industrial sector is at the centre of economic development. With a strong industrial base, economic planning becomes less risky, being able to plan ahead also assists industrial growth with profits re-invested into infrastructure development which in turn helps to boost and attract industry. Without a vibrant, strong industrial base economic development is much more risky and can be effected by external factors that are difficult to control. Providing encouragement and support to industry is essential if it is to grow and develop, supporting start-up industries and encouraging diversity all contribute towards a positive economic climate. Any economic development plan must have industry at the core. By encouraging and providing for industry, an economy will grow in tandem which in turn encourages further industrial development.
Management utility maximization

The model (introduced by Oliver Williamson) postulates that with the advent of the modern corporation and resulting separation of management from ownership.
Managers are more interested in maximizing their
utility measured in terms of their compensation (i.e. salaries, stock options etc.), the size of their staff, extent of control over the corporation, lavish offices etc. than maximizing corporate profits. This referred to as the Principle-agent problem.
utility
Defined as amount of satisfaction he get from the consumption of goods. Unit of utility is utilis. Utility is of two types: Total &marginal utility Total utility: sum total of utility derived from the consumption of all the units of the commodity Marginal utility: refers to additional utility from the consumption of additional unit of commodity
UNITS
TU 0 8 14 18 20 20 18
MU 0 8 6 4 2 0 -2
Relationship b/w TU & MU
O 1 2 3 4 5 6
1. When TU is max. MU became zero 2. When TU increases MU remains positive. 3. When TU starts to decline Mu becomes negative.
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MARGINAL UTILITY ANALYSIS

Assumptions The basic propositions of this traditional approach are: Cardinal measure of utility: Utility is a measurable and quantifiable concept.
A person can specify that he gets five units of utility by consuming one unit of
good A etc. Utilis is an imaginary unit of measuring utility. Independent utilities: Utility is additive; i.e. the utilities derived from
different independent goods can be added to get the measure of total utility.
Constant marginal utility of money: The marginal utility of money remains constant for a particular consumer when he spends money on various goods.
All other commodities except money are subject to the law of diminishing Cont.
marginal utility.
The Law of Diminishing Marginal Utility Marginal utility refers to the change in satisfaction which results when a little more or little less of that good is consumed. For example, when a thirsty person takes five bottles of cold drink continuously, the consumption of first bottle gives him utility, second bottle gives him lesser utility than first but his total utility increases. Third bottle gives him still less utility but increases total utility. The utility from fourth bottle may be zero as he is no more thirsty. But the fifth bottle may cause uneasiness and thus give negative utility, i.e., the total utility may now actually go down.
Bottle consumed 0 1 2 3 4 Total Utility (Units) 0 14 23 27 27 Marginal Utility (Units) 14 9 4 0
5
6
24
18
3
6
Cont.
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T.U.
M.U.
Cont.
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Consumer's Equilibrium Law of Equi-marginal Utility or the principle of Equi-marginal utility says that the consumer
would maximize his utility if he allocates his expenditure on various goods he consumes such that the utility of the last rupee spent on each good is equal i.e.
MUx=MUy Suppose the consumer's income is RS 5
He wants to spent on two commodities i.e. orange & apple

1unit of each goods costs 1RS Rs spent 1 2 3 4 5 Mu of orange 10 (1) 8(3) 6(5) 4 2 MU of apple 9(2) 6(4) 4 2 1
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Cont.
INDIFFERENCE CURVE ANALYSIS

Assumptions The following assumptions about the consumer psychology are implicit in this analysis: Transitivity: If a consumer is indifferent to two combinations of two goods, then he is unaware of the third combination also. Diminishing marginal rate of substitution: The scarcer a good the greater is its Rationality: The consumer aims to maximize his total satisfaction and has got complete market information. Ordinal Utility: Utility in this approach is not measurable. A consumer can only specify his preference for a particular combination of two goods, he cannot specify how much.
Cont.
substitution value.
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Properties of indifference curve

Slopes downwards from left to right. Two indifference curve never intersect each other. Higher indifference curve yield higher satisfaction
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The Indifference Curve If a consumer is asked whether he prefers combination 1 of two goods X and Y (assuming that the market price of X and Y are fixed) or combination 2, he may give one of the following answers: he prefers combination 1 to 2 he prefers combination 2 to 1 he is indifferent about combinations 1 and 2. Indifference Combination of X and Y goods
Combination
1 2 3
Units of X
3 4 5
Units of Y
21 15 11
4
5
6
7
8
6
Cont.
The Indifference Curve
Set of indifference curves is called Indifference map

Cont.
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Marginal rate of Substitution

It is rate at which a consumer can exchange a small of one commodity for a small amount of another commodity without affecting his total utility. MRsxy=
law of diminishing marginal rate of substitution: it state
loss of Y Loss of x
that with every increase in the qty. of commodity of X the consumer will be willing to leave less qty of commodity of Y.
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The Budget Line The budget line is also known as the price line, the consumption possibility line or the price opportunity line. It represents different combinations of two goods X and Y which the consumer can buy by spending all his income.
Example A consumer having Rs 1200 as income can buy 600 units of Y at Rs 2 per unit or 300 units of X at Rs 4 per unit as shown in Figure. The straight line joining the two points A and B is called the budget line. At any point on AB, the consumer spends all his income but point C is unattainable. At point D or any other point in DOAB he does not spend all his income.
Cont.
Concept of Demand
Demand is one of the crucial requirements for the existence of any business enterprise. A
firm is interested in its own profit and/or sales, both of which depend partially upon the demand for its product. The decisions which management takes with respect to production, advertising, cost allocation, pricing, etc., call for an analysis of demand. Demand for a commodity implies Desire to acquire it Willingness to pay for it, and Ability to pay for it.
Cont.
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Demand Function and Demand Curve Demand function is a comprehensive formulation which specifies the factors that influence the demand for the product. Dx Where Dx Px = = = f (Px, Py, Pz, B, E, T, U) Demand for item x Price of item x
Py
Pz B E T U
=
= = = = =
Price of substitutes
Price of complements Income of consumer Price expectation of the user Taste or preference of user All other factors
Cont.
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Demand schedule & demand curve

Demand schedule: it refers to a table / tabular statement which shows relationship b/w price & demand. It is of two types: individual & market. Demand curve: it is a graphic representation of demand schedule expressing the relationship b/w price & demand . It is of two types: individual & market.
An Individual's Demand Schedule for Commodity x

Price x (per Unit) Px 2.0 1.5 1.0 0.5 Quantity of x demanded (in Units) Dx 1.0 2.0 3.0 4.5
Demand Curve
Cont.
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Individual Demand and Market Demand To study a market, there are a number of buyers. The change from an individual to a market demand schedule can be done easily by summing up the quantities demanded by each consumer at various possible prices.
P P P
D1 35
Q P
D2 39
D3 26
100
D(Total) Q
Cont.
Market Demand Curve
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A demand curve follow the law of demand: when a price rises, quantity demanded falls, and vice versa Exceptions to law of demand: Giffen goods Necessity of life Articles of conspicuous consumption (status symbol) Ignorance Abnormal conditions Expectations regarding future price
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Change in demand
Shifts in the Demand Curve If any of the components held constant in drawing a demand curve change, there is a shift in the demand curve. It is of two types.
a. Increase in Demand (demand increases due to other factors price remains constant)
b. Decrease in demand (demand decreases due to other factors price remains constant)
Cont.
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Increase in Demand in Demand DR SALABH MEHROTRA (Economics Decrease for

Manager')
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Movement along demand curve

Extension of demand: demand increases due to fall in price Contraction of demand: demand decreases due to rise in price
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P D
P3 P1 P2 D
Price
c
Quantity
extension
D1
D2
Movement along a Demand Curve

Cont.
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determinants of demand
Price of the commodity Income of consumer: 1)normal/ superior goods .2) inferior goods Price of related commodity: substitute goods & complementary goods Taste & preference Population Future expectations Distribution of income (i.e. if it is in favor of poor demand for necessity good increase) Govt policy.(favorable/ un favorable) Promotional effect on demand
P P2 P ric e o f T ea P1 D
D1 Q2 Q1
Amount demanded of coffee/milk SUBSTITUTE GOODS CASE P P ric e o f B u tt er P2 P1 D D D
D1 Q2 Q1
Q
Cont.
Amount demanded of butter per day COMPLEMENTARY GOODS CASE DR SALABH MEHROTRA (Economics for Manager')
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Types of Demand For a purposeful demand analysis for managerial decisions, it is necessary to classify the
large number of goods and services available in every economy. Policy decisions are also
facilitated by an understanding of demand at various levels of aggregation. A classification in these respects is as follows: a. Consumer good (goods& service used for final consumption for human& other living
being )and producer goods( used for production of other goods plant, machine, raw material etc.) b. Perishable ( demand depends on present conditions to meet present needs)and
durable goods ( it is more complicated for demand analysis because it is subject to future
needs) c. Autonomous (whose demand is independent of any other goods)and derived
Cont.
demand. But there is hardly any product which is autonomous but degree varies
d) Individual's demand and market demand (firm should be concern with market demand& consumer should be with individual demand) e) Firm and industry demand f) Demand by market segments and by total market( if market is large in terms of geog. Area, product use, customer size distribution channel etc) then it is imp. to distinguish market by specific segments for a meaningful analysis.
Elasticity of Demand
DEMAND ELASTICITIES
The contribution of the concept of elasticity lies in the fact that it not only tells us that consumer's demand responds to price changes but also the degree of responsiveness of consumers to a price change.
Classification of Demand Curves According to Their Elasticity

when price changes we can classify all demand curves in the following five categories: i. Perfectly inelastic demand curve (Ed=o) fig a ii. Inelastic demand curve(Ed<1) fig d iii. Unitary elastic demand curve(Ed=1) fig b iv. Elastic demand curve(Ed>1) fig e v. Perfectly elastic demand curve(Ed=) fig c
(a)
(b)
Cont.
(c)
Ed<1
10
Ed>1 fig e
10
fig d
5 5
50
70
50
150
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Price Elasticity of Demand (Ed) Ed Value Term for Elasticity of demand Perfectly inelastic <1 Relatively Inelastic Unitary elastic
How total revenues or expenditures are affected by price changes Price increases Price decreases
Zero
0 < Ed
Ed = 1 a > Ed >1
Relatively elastic Perfectly elastic
revenue Increase Proportionally with price increase less than proportionally with price Unaffected by price changes Decrease but less than proportionally Total revenue falls to zero
Decrease proportionally with price Decrease less than proportionally with price
Increase, but less than proportionally Increase more than proportionally
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Factors Determining Elasticity of Demand

Some important factors that determine the elasticity of demand are:
i. ii. Luxury or Necessity Goods (nature of goods) Percentage of Income spent on the commodity
iii.
Habitual necessities
iv. Substitutes v. Time
vi. Number of uses the commodity satisfied vii. Shifting of requirement
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Numerical Measurement of Elasticity

E d Percentage change in quantity demanded Percentage change in price
One calculates these percentage changes, of course, by dividing the change in price by the original price and the consequent change in quantity demanded by the original quantity demanded. Thus we can restate our formula as: This formula can also be written as Ed=
Q 1- Q 0 Q0 P1 - P0 P0 Change in quantity d emanded Original q uantity de manded E = Change in price d Original i n price
Where
P0 = Original Price P1 = New price Q0 = Original quantity demanded Q1 = New quantity demanded Sometimes we may also find this written as
DQ Q DP P
Ed =
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Price Elasticity of Demand

The concept of price elasticity of demand is a numerical measure of the extent to which quantity demanded responds to a change in price, other determinants of demand being kept constant. ep
% change in quantity demanded % change in price
Cont.
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A review of the basic formula of elasticity will show that it follows from the definition of price elasticity.
ep =
% change in quantity demanded % change in price
where,
% change in Quantity demanded =
New Quantity Old Quantity 100 Old Quantity
and % change in price = Let P Q DQ DP
New Price Old Price 100 Old Price

= Old price = Old quantity = New quantity Old quantity = New price Old price
DQ 100 ( ) 100 DQ P . DP Q 65
ep
Q (-) DP P
Income Elasticity
The income elasticity of demand is a numerical measure of the degree to which quantity demanded responds to a change in income, other determinants of demand being kept constant. For example, let there be two goods, clothing and salt. Let the consumers income increase by 5%. Then the percentage change (increase) in quantity demanded would be different for clothing and different for salt (the percentage increase in quantity demanded for clothing is likely to be much higher than that for salt). Thus, clothing and salt are said to have a different income elasticity of demand. Thus, for the same percentage increase in income (i.e., 5%) the percentage increase in the quantity demanded for different goods is different. Income elasticity of demand provides us with a numerical measure of this difference. Thus, income elasticity of demand allows us to compare the sensitivity of the demand for various goods for the same change in income. From the definition, e1 =
%change in quantity demanded %change in income
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Cross Elasticity of Demand

The concept of cross elasticity provides a numerical measure of the percentage change in quantity demanded due to a change in price of other commodities. It measure the degree
to which quantity demanded is a function of the price of all other commodities. From the definition,
E c=
%change in quantity demanded of good X %change in price of good Y
Cont.
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Importance of Elasticity of Demands

The concept of elasticity of demand is quite useful. To business firms In international trade
In fiscal policy
Demand Forecasting
Forecasts can be classified into two broad categories
i. Passive forecasts
ii. Active forecasts Passive forecast is one where prediction about the future is based on the assumption that the firm does not change the course of its action, and active forecast is where forecasting is done under the condition of likely future changes in the actions by the firm.
Methods of Demand Forecasting

Forecasting of demand is done for knowing the future demand of a product. The choice of method of demand forecasting will depend on various factors like convenience to handle, relevance of purpose (knowing future demand) applicable to available data and also inexpensive.
Survey Methods
Statistical Methods
Opinion
Poll Methods
Consumer Survey Methods
Trend Projection
Methods
Barometric Methods
Econometric Methods
Expert
Delphi
Opinion Method
Method
Least
Graphical
Squvants
Method
Method
Regression Method
Simultaneous Equations Method
Complete Enumeration Method
Sample Survey
Method
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Survey Methods of Demand Forecasting
Survey Methods
Opinion Poll Method
Consumer Survey Method
Expert Opinion Method
Delphi Method
Complete Enumeration Method
Sample Survey Method
Types of Demand Forecasting by Survey Methods
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Statistical Methods of Demand Forecasting
Statistical Methods
Trend Projection Methods
Barometric Methods
Econometric Methods
Graphical Methods
Least Squares Methods
Regression Method
Simultaneous Equation Method
Types of Statistical Methods
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Trend Method:
is based on analysis of past sales patterns. The trend method is used
when available sales data are different of time periods

Graphical Method: The time-series data on the variable (e.g. sales) under forecast are used to fit a trend line graphically. For example, the graph below shows the sale of passenger cars in a country from 1985-2001.
Trend Line Actual Sales Sales ($)
85 86 87
Time
01
Cont.
Sale of Passenger Cars

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Least Square Method: The trend line can be projected for knowing the future demand by two methods linear trend and exponential trend.
linear trend . When the time series data shows a rising trend in the sales, then a straight
line trend equation of the following kind is used S=a+bt
where S=annual sales, t-time (in years) a and b are constants. The parameter b gives the
measures of annual increase in sales. The coefficients of a and b are estimated by the following two equations: S S= na+bSt S St=aSt + bSL2 where n is the number of time period (years).
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Barometric Method of Forecasting

Barometric method uses economic indicators as barometer to forecast trends in business activities. This method is based on the work done by NBEF (national Bureau of Economic Research) of U.S. Barometric method are classified into three categories leading indicators, coincident indicators and lagging indicators.
Leading Indicators
Indicator Level (Value)
Coincident Indicators
Lagging Indicators
Peak Business Cycle
Time Trough
Barometric Indicators
Leading Indicators are variables which moves up and down ahead of other related variable like new orders for durable goods, enrolment in school etc. Coincidental series are ones that moves up or down along with level of general economic activities like number of employees in the non agricultural sectors, rate of unemployment Lagging series consist of those indicators that follow a change after some time/ are variables which fall behind other related variables e.g. average duration of unemployment, labor cost per- unit of output
Econometric Method
The econometric methods incorporate statistical tools with economic theories to estimate
the economic variables and to forecast economic events. The forecasts made through econometric methods are more reliable. An econometric method consists of a single-equation regression model or a system of simultaneous equations. Single equation regression serves the purpose of demand forecasting in case of many commodities. But, in case of economic variables due to complex relationships, a single equation regression model is not appropriate. In this case, a
system of simultaneous equations is used to estimate and forecast. The econometric

methods are described here under two methods: Regression method; Simultaneous equations method.
Regression Methods of Demand Forecasting

In regression techniques of demand forecasting, the analysts estimate the demand function for a product. In the demand function, quantity to be forecast is a department variable and the variables that affect or determine the demand (the department variable) one called as independent or explanatory variables. The hypothetical data of consumption of sugar given in table.
Year 1995-96 1996-97 1997-98 1998-99 2000-2001 2001-2002 2002-2003 Population (millions) 10 12 15 20 25 30 40 Consumption of Sugar Sugar Consumed (000) tones) 40 50 60 70 80 90 100
Cont.
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Calculation of Terms
Year (X)
1995-96 1996-97 1997-98 1998-99 2000-01 2001-02 2002-03
population Consumed (Y)

10 12 15 20 25 30 40
Sugar
X2
Xy
40 50 60 70 80 90 100
100 144 225 400 625 900 1600

490
400 400 900 1400 2000 2700 4000
n 7
152
2 t
3994
Yt 12 ,000
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Simultaneous Equation Method

Simultaneous equation method considers the interdependence of both dependent and independent variables. The steps of simultaneous method can be presented in simple form as: To develop a complete model and specify the assumptions regarding the variables included in the model. Endogenous variables are variables that are determined within the model. Exogenous variables are those that are determined outside the model. Examples of exogenous variables are money supply, tax rates, time, climate etc. To collect data on both exogenous and endogenous variables. To estimate the model through some appropriate method (e.g. least square method) and predict the values of exogenous variables. The model is solved for each endogenous variable in terms of exogenous variable. Prediction is mode by putting the values of exogenous variables into the equations.
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The Production Process

Production is a process in which economic resources or inputs (composed of natural
resources like labour, land and capital equipment) are combined by entrepreneurs to create economic goods and services (outputs or products).
Production Management
I N P U T S
Labour Natural Resources, Land Capital, Equipment Machines
Pollution
Goods & Services
O U T P U T S
CONTROL
Some basic concepts

Short period in which only variable factors can be changed long period in which both variable & fixed factors can be changed total product: is the total quantity produced by the many units of variable & fixed factor Average product: is the total output divided by the number of units of the variable factor .APL=TP/L Marginal product: is the addition in total product due to per units change in variable factors .MPL=TP/ L
The Production Function

The task of a production unit is to organize a production process a process of combining the different factors in some proportion so that those inputs can be efficiently transformed into products or outputs. Various terms are used for inputs and outputs.
INPUTS OUTPUTS Factors Quantity (Q) Factors of production Total Product (P) Resources Product 'A production function defines the relationship between inputs and the maximum amount that can be produced within a given period of time with a given level of technology
Q=f(L,K,N,R,E)
Q= output L= Labour N= Land input R= Raw material
k=capital E= efficiency parameter Two special features of a production function are given below: a. Labour and capital are inputs to produce any quantity of a good, DR SALABH MEHROTRA (Economics for b. Labour and capital are substitutes to each other in production. Manager')
Cont.
and
83
Types of production function

Short Run Production function or Law of Variable Proportion or One variable input Case
long Run Production or Production with all variable input
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Short Run Production function or Law of Variable Proportion

It shows the maximum output a firm can produce when only one of its inputs can be changed ,while other inputs remaining fixed, it can be , Q=f(L,K) Q= output, L= labour ,K= fixed amount of capital
thus it is possible to substitute some capital by labour As a result ratio b/w fixed & variable inputs also changes This law states that beyond a certain a certain point further increase in employment of variable factors will lead to smaller increase in total output Therefore it is also called Diminishing Marginal Returns
Law of Variable Proportion has three stages increasing returns to Variable Factors Diminishing returns to Variable Factors Negative returns to Variable Factors
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Production function: One variable input Case: Short Run Analysis or Law of Variable Proportion or Diminishing Marginal Returns
Production Function with One Variable Input
Number of land Labour Units (L) Total Product of Labour (TPL) Average Product of Labour (APL) 20 25 30 30 28 25 21.5 16.25 11.1 Marginal Product of Labour (MPL) 30 40 30 20 10 0 -20 - 30
stages
1 2 3 4 5 6 7 8 9
20 50 90 120 140 150 150 130 100
increasing returns
Diminishing returns Negative returns
Cont.
87
The Three Stages of Production

Total Physical Product Marginal Physical Product Average Physical Product
Stage I
Increases at an
increasing rate
Increases and reaches

its maximum
Increases (but
slower than MPP)
Stage II
Increases at a diminishing rate and becomes maximum Starts diminishing and becomes equal to zero Starts diminishing
Stage III
Reaches its maximum, becomes constant and then starts declining Keeps on declining and becomes negative continues to diminish but must always be greater than zero
Cont.
88
Fixed inputs grossly under utilized, specialization and team work cause APP to increase when additional X is used
Specialization and teamwork continue and result in greater output when additional X is used, fixed input is being properly utilized.
Fixed inputs capacity is reached, additional X causes output to fall
Cont.
89
The Production Function with Two Variable Inputs

A firm may increase its output by using more of two variable inputs that are substitutes for
each other, e.g., labour and capital. The technical possibilities of producing an output level by various combinations of the two
factors can be graphically represented in terms of an isoquant (also called iso-product

curve, equal-product curve or production indifference curve).
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Isoquants
Isoquants are a geometric representation of the production function. The same level
of output can be produced by various combinations of factor inputs. Assuming continuous variation in the possible combination of labour and capital, we can draw a curve by plotting all these alternative combinations for a given level of output. This curve which is the locus of all possible combination is called the 'isoquant'.
OR
it is defined as the locus of various combinations of two inputs in the existing state of technology to produce a given level of output.
OR
It is a curve that shows all possible combinations of inputs that gives same level of output
Isocost Lines If a firm uses only labour and capital, the total cost or expenditure of the firm can be represented by C = wL + rK where C = total cost w = wage rate of labour
L = quantity of labour used

r = rental price of capital K = quantity of capital used
Isocost line
Cont.
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Returns to Scale Returns to scale are classified as follows: 1. 2. 3. Increasing Returns to Scale (IRS) Constant Returns to Scale (CRS) Decreasing Returns to Scale (DRS)
Returns to scale
Cont.
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Economies of Scale
These occur when mass producing a good results in lower average cost. Average costs fall per unit Average costs per unit = total costs / quantity produced Economies of scale occur within an firm (internal) or within an industry (external).
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Internal and External Economies

Internal Economies of Scale As a business grows in scale, its costs will fall due to internal economies of scale. An ability to produce units of output more cheaply.
External Economies of Scale Are those shared by a number of businesses in the same industry in a particular area.
External Economies of Scale

These are advantages gained for the whole industry, not just for individual businesses.
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Examples of External Economies

As businesses grow within an area, specialist skills begin to develop. Skilled labour in the area local colleges may begin to run specialist courses. Being close to other similar businesses who can work together with each other. Having specialist supplies and support services nearby. Reputation
Diseconomies of Scale
Occur when firms become too large or inefficient Average costs per unit start to rise
98
Diseconomies of Scale
Types of diseconomy of scale Example
Communication
When firms grow there can be problems with communication As the number of people in the firm increases it is hard to get the messages to the right people at the right time In larger businesses it is often difficult for all staff to know what is happening
As a business grows control of activities gets harder As the firm gets bigger and new parts of the business are set up it is increasingly likely people will be working in different ways and this leads to problems with monitoring As businesses grow it is harder to make everyone feel as though they belong Less contact between senior managers and employees so employees can feel less involved Smaller businesses often have a better team environment which is lost when they grow
Coordination and control problems
Motivation
Causes of operation of law of increasing returns

Division of labor or specialization Economics of management i.e. increases in managerial efficiency Capacity utilization with the increase in units of labor Favorable factor ratio Economics of buying and selling ( higher barraging power, quick availability of freight, cheap credit facility etc.
Limitation & Scope

This law applies only at initial stage because initially increase in variable factors improves productivity of labor & capital It cannot continue indefinitely. This law applies all the field of production till an optimum ratio is established
101
Causes of operation of diminishing return

Fixity of one or more factors of production Scarcity of productive resources Going beyond the optimum combination of factors of production Factor of production are not perfect substitutes for one another
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Importance of law of diminishing return

It has universal application It is base of Malthusian population theory Base of determination of standard of living Responsible for migration of population Base of marginal productivity theory
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The Cobb-Douglas Production Function

The Cobb-Douglas production model was identified by the economist & C.W. Cobb&Paul Douglas This function is based on the empirical study of American manufacturing industries. It takes into accounts only two inputs labor and capital The simplest production function is the Cobb-Douglas model. It has the following form: Q=ALbCc where Q stands for output, L for labor, and C for capital. The parameters a, b, and c (the latter two being the exponents) are estimated from empirical data. The equation tells that output depends directly on L &C and that part of output which cannot be explained by L & C is explained by A which is residual often called technical change The production function proposed by Cobb Douglas has contribution to increase in manufacturing industries and of labor
If b + c = 1, the Cobb-Douglas model shows constant returns to scale. If b + c > 1, it shows increasing returns to scale, and if b + c < 1, diminishing returns to scale.
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Properties of Cobb-Douglas production function

There are constant return to scale Elasticity of substitution is equal to one b and c represent the labor and capital shares of output respectively. If one of the inputs is zero, output will also be zero The marginal product of labor is equal to the increase in output when the labor input is increased by one unit. The average product of labor is equal to the ratio between output and labor input
105
Importance Of Cobb-Ddouglas Production Function

Convenient for international and inter industry comparison. Captures the non linear production process Used to investigate the nature of long run production function Simplest form of production function with 2 varriables
106
Criticisms of function
Based on assumption perfect competition Consider only two inputs labor & capital Based on assumption of constant returns to scale Assumes all units of inputs of production are identical in nature There is problem of measurement of capital which takes only the quantity of capital available for production It does not fit to all industries. The parameters cannot give proper and correct economic implication.
Concept of Supply
Supply is the willingness and ability of producers to make a specific quantity of output
available to consumers at a particular price over a given period of time.
Cont.
108
Law of Supply Supply refers to the various quantities offered for sale at various prices. According to the Law of Supply, more of a good will be supplied the higher its price, other things constant or less of a good will be supplied the lower its price, other things remaining constant.
The Supply Curve

Cont.
109
Price A
Supply by B C
Market
0.00
0.50 1.00 1.50 2.00
0
1 2 3 4
0
0 1 2 3
0
0 0 0 0
0
1 3 5 7
3.00
3.50 4.00
6
7 8
5
5 5
0
2 2
11
14 15
Cont.
110
Important shift factors of supply are: Price of commodity Natural factors Changes in the prices of inputs used in production of a good
Changes in technology
Changes in suppliers expectations Changes in taxes and subsidies
Cont.
The major variables other than price are:
Movements along a supply curve
Movements along a supply curve

Cont.
112
Shifts in Supply versus movement along a Supply Curve
Cont.
113
ELASTICITY OF SUPPLY
The elasticity of supply, Es, is measured by using the formulae
Es
or Es
Percentage change inquantity supplied Percentage change inprice
P dQ Q dP
Where P = original price, Q= original quantity supplied, dP = change in price, dQ = change in

quantity supplied.
Cont.
114
Factors influencing Elasticity of Supply

1) Nature of product 2) Time factor 3) Ability to store the product 4) Barriers to entry 5) Future expectation 6) nature of inputs
Degree of Elasticity of Supply
1.
Relatively Inelastic Supply 0 < Es < 1 Quantity supplied changes less than proportionally to (by a smaller percentage than) price
2.
Relatively Elastic Supply 0 < Es < Quantity supplied changes more than proportionally to (by a larger percentage than) price
116
Cont.
3.
Perfectly Inelastic Supply Es = 0 Quantity supplied remains the same, whatever the price
4.
Perfectly Elastic Supply Es = Suppliers will produce an unlimited quantity at the existing price
5.
Unit Supply Elasticity Es = 1 Quantity supplied changes in proportion to (by the same percentage as) price.
Cont.
(Price) Elasticity of Supply (Es)

Costs
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Costs
In buying factor inputs, the firm will incur costs Costs are classified as:
Fixed costs costs that are not related directly to production rent, rates, insurance costs, admin costs. They can change but not in relation to output Variable Costs costs directly related to variations in output. Raw materials primarily
119
Costs
Total Cost - the sum of all costs incurred in production TC = FC + VC Average Cost the cost per unit of output AC = TC/Output Marginal Cost the cost of one more or one fewer units of production MC = TCn TCn-1 units
120
Short run costs

In the short run consider fixed and variable costs Average total cost line is U-shaped as when diminishing returns start to kick in the average total cost per unit increases
121
Costs in the Short Run The short run cost-output relationship needs to be discussed in terms of: Total cost and output Average costs and output Marginal cost and output
Cont.
122
Total cost
Total variable cost

Total fixed cost

123
Total cost: total cost is the sum of total variable cost and total fixed cost TC = TVC+TFC Total variable cost: total variable cost (TVC) at any output level consists of payments to the variable factors used to produce that output. TVC = TC-TFC
124
Short Run Average Costs and Output
Average Fixed Cost (AFC)
Average fixed cost is the total fixed cost divided by the number of units of output
produced. Therefore,
AFC=
TFC Q
Cont.
125
Average Variable Cost (AVC) Average variable cost is the total variable cost divided by the number of units of output
produced. Therefore,
AVC =
TVC Q
Thus, average variable cost is the variable cost per unit of output.
We know that the total variable cost (TVC) at any output level consists of payments to the
variable factors used to produce that output.
Cont.
126
Average Total Cost (ATC) The average total cost or what is called simply average cost is the total cost divided by the number of units of output produced. Therefore,
ATC = TC Q
Since the total cost is the sum of total variable cost and total fixed cost, the average total cost is also the sum of average variable cost and average fixed cost. This can be proved as follows:
ATC =
TC Q
TVC+ TFC Q
Since TC = TVC+TFC Therefore,

ATC=
TVC TFC + Q Q
Cont.
= AVC + AFC
127
Short Run Marginal Cost (MC) and Output Marginal cost is the addition to the total cost caused by producing one more unit of output.
In other words, marginal cost is the addition to the total cost of producing n units instead of n-1 units.
MCn = TCnTCn-1
In symbols, marginal cost is rate of change in total cost with respect to a unit change in
output, i.e.,
MC =
d(TC) dQ
where d in the numerator and denominator indicates the change in TC and Q respectively. Marginal cost is due to change in variable cost because it is only variable cost that change
in short run .The independence of the marginal cost from the fixed cost can be proved
algebraically as follows:
MCn = = = = TCn TCn1 (TVCn + TFC) (TVCn1 + TFC) TVCn + TFC TVCn1 TFC TVCn TVCn1
Cont.
128
The Relationship between MC, AC and TC Unit of goods produced 1 10 11 12 Total Cost TC Average Cost AC=TC/units produced 3=2/1 500 481.82 462.5 300 250 MC={(TCn)(TCn1)
2 5000 5300 5550
13
14 15
5700
5950 6350
438.46
425.0 423.33
150
250 400
Advantage of TC: break-even analysis profit of firm Advantage of AC: calculating per unit profit of a firm Advantage of MC: to decide whether a firm needs to expand or not
Cont.
129
AFC declines continuously AVC declines first, reaches a minimum point and rises there afterward ATC declines first reaches a minimum & rises thereafter When ATC attains its minimum MC equals ATC MC first declines reaches a minimum then rises. MC equals AVC & ATC when these curves attain minimum levels MC lies below both AVC & ATC when they are declining MC lies above when AVC& ATC are rising.
MC
Average Cost Marginal Cost
ATC
AVC
AFC X Q1 Q2 Quantity Q3
130
The Short Run Cost Function

Mathematically,
AVC = TVC/Q AFC = TFC/Q ATC=TC/Q=(TFC+TVC)/Q=AFC+AVC
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The Short Run Cost Function

Table illustrates how the short run cost measures can be calculated.
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The LR Relationship Between Production and Cost

In the long run, all inputs are variable. In the long run, there are no fixed costs The long run cost structure of a firm is related to the firms long run production process. The firms long run production process is described by the concept of returns to scale.
133

Economists hypothesize that a firms long-run production function may exhibit at first increasing returns, then constant returns, and finally decreasing returns to scale. When a firm experiences increasing returns to scale
A proportional increase in all inputs increases output by a greater percentage than costs. Costs increase at a decreasing rate

When a firm experiences constant returns to scale
A proportional increase in all inputs increases output by the same percentage as costs. Costs increase at a constant rate
When a firm experiences decreasing returns to scale

A proportional increase in all inputs increases output by a smaller percentage than costs. Costs increase at an increasing rate
The Long-Run Cost Function

Long run marginal cost (LRMC) measures the change in long run costs associated with a change in output. Long run average cost (LRAC) measures the average per-unit cost of production when all inputs are variable. In general, the LRAC is u-shaped.
136

When LRAC is declining we say that the firm is experiencing economies of scale. Economies of scale implies that per-unit costs are falling. When LRAC is increasing we say that the firm is experiencing diseconomies of scale. Diseconomies of scale implies that per-unit costs are rising.

The figure illustrates the general shape of the LRAC.
138

Reasons for Economies of Scale
Increasing returns to scale Specialization in the use of labor and capital Indivisible nature of many types of capital equipment Productive capacity of capital equipment rises faster than purchase price Discounts from bulk purchases Lower cost of raising capital funds Spreading promotional and R&D cost Management efficiencies

Reasons for Diseconomies of Scale
Decreasing returns to scale Disproportionate rise in transportation costs Input market imperfections Management coordination and control problems Disproportionate rise in staff and indirect labor
Cost
The Long Run Average Cost Curve is Derived from Short Run Cost Curves
Per Unit
Suppose there are three plants SAC 1 operate with average costs SAC1,SAC2 & SAC3 If firm plans to produce Q1 output it C 2 will choose smallest plant C 1 It will choose medium plant size if it plans to produce Q2 Larger plant if it produce Q3 output If the firm starts with smallest plant and faces increase in demand it will increase its output It will continue producing with small plant(have lowest cost level ) beyond Q1 as average cost is still lower in compare to medium plant It is only when demand for its 0 product reaches the level Q2 the firm Q Q 1 2 has to choose b/w plant A OR B Process go on & on for further plant DR SALABH MEHROTRA (Economics for
Manager')
SAC
2
SAC
3
SAC
4
Output (Q) Q
3
Q
4
141
Explanation of the U-shape of the Long Run Average Cost Curve

Cost Per Unit
SAC 1 LMC SAC 2 SAC 3 SAC 4 SAC 5 SM LAC
SAC 6
X*
Short Run and Long Run Cost Curves
Output (Q)
142
Explanation of the U-shape of the Long Run Average Cost Curve

Let assume there are many plant size suitable for certain level of output we will get as many SAC curves , intersecting each other. The intersection points are so close to each other that we get almost a continuous curve know as long run average cost curve or envelope curve LRAC is normally U-shaped means average cost first declines as output increase & rises after a point This U-Shaped can be explain with returns to scale because in long run all inputs can be changed Returns to scale increase with initial increaes in output after remaining constant for a while they decrease ,because in the beginning long run average cost of production falls as output increased likewise it increase beyond a point in decrease return .

In the long run the firm is able to adjust its plant size. LRAC tells us the lowest possible per-unit cost when all inputs are variable. What is the LRAC in the graph?
144

In the long run the firm is able to adjust its plant size. LRAC tells us the lowest possible per-unit cost when all inputs are variable. What is the LRAC in the graph?
145
Learning curves
Learning by doing in economics refers to process by which producers learn from experience Production technique available to real world are regularly changing because of learning by doing Technological change on the other hand is an increase in the range of production techniques The concept of learning curve represent the extent to which average cost declines in relation to increase in output This concept is based on the assumption that individuals who perform anything over number of times will get better Learning curve initially has a steeper slope, then it becomes flatter indicating that it would be very hard to realize cost advantage as most of the learning opportunities are already exploited.
146
The Learning Curve
A downward slope in the learning curve indicates the presence of the learning curve effect. It shows workers improve their productivity with practice The learning curve effect acts to shift the SRAC downward.
147
Economies of Scope
The reduction of a firms unit cost by producing two or more goods or services jointly rather than separately.
148
Opportunity costs
A benefit, profit, or value of something that must be given up to acquire or achieve something else. Since every resource (land, money, time, etc.) can be put to alternative uses, every action, choice, or decision has an associated opportunity cost. Opportunity costs are fundamental costs in economics, and are used in computing cost benefit analysis of a project. Such costs, however, are not recorded in the account books but are recognized in decision making by computing the cash outlays and their resulting profit or loss.
149
Accounting Cost Monetary value of economic resources used in performing an activity. Economic Cost, The sacrifice involved in performing an activity, or following a decision or course of action. It may be expressed as the total of opportunity cost (cost of employing resources in one activity than the other) and accounting costs (the cash outlays) Real Cost When cost is expressed in terms of physical or mental efforts put in by a person in the making of a product, it is called as real cost OR The overall actual expense involved in creating a good or service for sale to consumers. The real cost of production for a business typically includes the value of all tangible resources such as raw materials and labor that are used in the production process. Money Cost When cost is expressed in terms of money, it is called as money cost. It relates to money outlays by a firm on various factor inputs to produce a commodity.
150
Market and Criteria for Market Classification

Market A market is any organization whereby buyers and sellers of a good are kept in close touch with each other. It is precisely in this context that a market has four basic components i. consumers ii. sellers iii. a commodity iv. a price. Criteria for Market Classification There are many possible ways of categorizing market structures, the following characteristics are frequently employed. i. ii. Classification by area Classification by the nature of transactions
iii.
iv. v. vi.
Classification by the volume of business

Classification on the basis of time Classification by the status of sellers Classification by the nature of competition
Perfect competition
Generally, a perfectly competitive market exists when every participant is a "price taker", and no participant influences the price of the product it buys or sells. Specific characteristics may include: Large number of buyers and sellers Infinite consumers with the willingness and ability to buy the product at a certain price, and infinite producers with the willingness and ability to supply the product at a certain price. Free entry and exit barriers It is relatively easy for a business to enter or exit in a perfectly competitive market. Perfect factor mobility - In the long run factors of production are perfectly mobile allowing free long term adjustments to changing market conditions. Perfect information - Prices and quality of products are assumed to be known to all consumers and producers. Zero transaction costs - Buyers and sellers incur no costs in making an exchange (perfect mobility). Profit maximization - Firms aim to sell where marginal costs meet marginal revenue, where they generate the most profit. Homogeneous products The characteristics of any given market good or service do not vary across suppliers. Uniform price
Monopolistic competition
Large number of buyers and sellers but less than perfect. product differentiation many firms free entry and exit in long run Independent decision making Market Power Buyers and Sellers have im-perfect information Downward slopping demand curve but more elasticity.
Examples restaurants, professions solicitors, etc., building firms plasterers, plumbers, etc.
153
Monopoly
Single seller: In a monopoly there is one seller of the good who produces all the output.[ Therefore, the whole market is being served by a single firm, and for practical purposes, the firm is the same as the industry. Market power: Market power is the ability to affect the terms and conditions of exchange so that the price of the product is set by the firm (price is not imposed by the market as in perfect competition).Although a monopoly's market power is high it is still limited by the demand side of the market. A monopoly faces a negatively sloped demand curve not a perfectly inelastic curve. Consequently, any price increase will result in the loss of some customers. Firm and industry: In a monopoly, market, a firm is itself an industry. Therefore, there is no distinction between a firm and an industry in such a market. Price Discrimination: A monopolist can change the price and quality of the product. He sells more quantities charging less price against the product in a highly elastic market and sells less quantities charging high price in a less elastic market. DR SALABH MEHROTRA (Economics for
Manager')
154
What is an oligopoly?
An oligopoly is an economic condition in which there are so few independent suppliers of a particular product .Oligopoly is a form of market where there is domination of a limited number of suppliers and sellers called Oligopolists.In an oligopoly, there are at least two firms controlling the market. An oligopoly is a market dominated by a few large suppliers. The degree of market concentration is very high. Firms within an oligopoly produce branded products and there are also barriers to entry. Another important characteristic of an oligopoly is interdependence between firms. This means that each firm must take into account the likely reactions of other firms in the market when making pricing and investment decisions. The retail gas market is a good example of an oligopoly because a small number of firms control a large majority of the market.
155
What is an Oligopoly?
Oligopoly is best defined by the market conduct (behaviour) of firms A market dominated by a few large firms I.e. Competition amongst the few High level of market concentration Concentration ratio is the market share of the leading firms Each firm tends to produce branded / differentiated products
What is an Oligopoly?
Entry barriers long run supernormal profits Mutual interdependence between competing firms (important) Intensive non-price competition is common Periodic aggressive price wars Strong tendency for many market structures to tend towards oligopoly in the long run
Market consolidation Exploitation of economies of scale
Interdependence - either firm will not take an action unless it considers the reaction from the other firms
Market Structure
Examples of oligopolistic structures:
Supermarkets Banking industry Chemicals Oil Medicinal drugs Broadcasting
158
Pricing and Output in Monopolistic Competition

The demand curve of a monopolistically competitive firm is highly, but not perfectly, elastic.
The price elasticity of demand for a monopolistic competitor depends on the number of rivals and the degree of product differentiation. The larger the number of rival firms and the weaker the product differentiation, the greater the price elasticity of each firms demand.
.
159
The Short Run: Profit or Loss

The monopolistically competitive firm maximizes profit or minimizes loss in the short run. It produces a quantity Q at which MR = MC and charges a price P based on its demand curve.
When P > ATC, the firm earns an economic profit. When P < ATC, the firm incurs a loss.
160
The Long Run: Only a Normal Profit

In the long-run, firms will enter a profitable monopolistically competitive industry and leave an unprofitable one. A monopolistic competitor will earn only a normal profit and price just equals average total cost at the MR = MC output.
161

Because entry to the industry is relatively easy, economic profits attract new rivals.
As new firms enter, the demand curve faced by the typical firm shifts to the left, reducing its economic profit. When entry of new firms has reduced demand to the extent that the demand curve is tangent to the ATC curve at the profit-maximizing output, the firm is just making a normal profit, leaving no incentive for new firms to enter.

When the industry suffers short-run losses, some firms will exit in the long run.
As firms exit, the demand curve of surviving firms begins to shift to the right, reducing losses until the firms are just making normal profit.
163
Pricing and Output in Monopolistic Competition
164
Price determination in perfect market
In the short-run, it is possible for an individual firm to make an economic profit. This situation is shown in this diagram, as the price or average revenue, denoted by P, is above the average cost denoted by C
.
165
in the long period, economic profit cannot be sustained. The arrival of new firms or expansion of existing firms (if returns to scale are constant) in the market causes the (horizontal) demand curve of each individual firm to shift downward, bringing down at the same time the price, the average revenue and marginal revenue curve. The final outcome is that, in the long run, the firm will make only normal profit (zero economic profit). Its horizontal demand curve will touch its average total cost curve at its lowest point.
166
Price and Output Determination in monopoly

Objective of monopolies
Maximize profits
First determine profit-maximizing output Then determine price required to sell output
Alternatively, they can first determine profit-maximizing price

Then from market demand curve determine level of output that can be sold at this price
Resulting profit-maximizing price/output combination will be the same

Regardless of which method is employed
Both are based on a monopolys determining its equilibrium price and output given market demand curve
Market demand curve is downward sloping

If a monopoly reduces output, price it receives for this output will increase
The Profit-Maximizing Output Level

To maximize profit, the firm should produce level of output where MC = MR and
MC curve crosses MR curve from below
For a monopoly, price and output are not independent decisions

But different ways of expressing the same decision
DR SALABH MEHROTRA (Economics for 168 Manager')
Monopoly Price and Output Determination

Monthly Price per Subscriber
$60
MC
40
D 10,000 MR
30,000 Number of Subscribers
Profit And Loss

A monopoly earns a profit whenever P > ATC
Its total profit at best output level equals area of a rectangle
Height equal to distance between P and ATC Width equal to level of output
A monopoly suffers a loss whenever P < ATC

Its total loss at best output level equals area of a rectangle
Height equal to distance between ATC and P Width equal to level of output
Monopoly Profit and Loss

(a) Dollars (b)
MC
E
ATC
Dollars $50
ATC MC AVC E
$40 32 Total Profit D 10,000
40
Total Loss
D 10,000
MR
Number of Subscribers
MR
Number of Subscribers
Equilibrium in Monopoly Markets

A monopoly market is in equilibrium when the only firm in market
The monopoly firm is maximizing profit
For monopolyas for perfect competition we have different expectations about equilibrium in short-run and equilibrium in long-run
Short-Run Equilibrium
Monopoly may earn an economic profit or suffer an economic loss What if a monopoly suffers a loss in short-run?
Any firm should shut down if P < AVC at output level where MR = MC
If monopoly suddenly finds that P < AVC, government will usually not allow it to shut down,
Instead use tax revenue to make up for firms losses
Long-Run Equilibrium
As perfectly competitive firms cannot earn a profit in long-run equilibrium However, monopolies may earn economic profit in long-run A privately owned monopoly suffering an economic loss in long-run will exit the industry
Should not find privately owned monopolies suffering economic losses in long-run
: Profit Maximization and Price Determination in a Monopoly Market
Price E
MC AC
P*
A D MR 0 Q*
Quantity per week
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Cartel Theory of Oligopoly

A cartel is defined as a group of firms that gets together to make output and price decisions. The conditions that give rise to an oligopolistic market are also conducive to the formation of a cartel; in particular, cartels tend to arise in markets where there are few firms and each firm has a significant share of the market. In the U.S., cartels are illegal; however, internationally, there are no restrictions on cartel formation. The organization of petroleum-exporting countries (OPEC) is perhaps the best-known example of an international cartel; OPEC members meet regularly to decide how much oil each member of the cartel will be allowed to produce.
176
Kinked demand curve model of oligopoly: assumption, rivals will match all price cuts but not price increases. Under this assumption, its as if each firm faces a kinked demand curve, with 2 sections to it: more elastic above the existing price, since rivals wont match a price increase, and less elastic below the existing price, since rivals quickly match price cuts.
177
Kinked demand curve model is an attempt to explain rigid prices in oligopoly: That is, firms might not change price very often. Why? Firm is reluctant to raise price if its competitors do not, since it could lose sales to them, and little reason is seen to lower price if competitors quickly match the price cut, since little will be gained.
178
Price
Kinked Demand Curve

Starting price
E
P1
MR Gap
D MR
179
Q1
Quantity
179
Above the kink, demand is relatively elastic because all other firms' prices remain unchanged. Below the kink, demand is relatively inelastic because all other firms will introduce a similar price cut, eventually leading to a price war. Therefore, the best option for the oligopolist is to produce at point E which is the equilibrium point and the kink point.
Graph explanation: Let P1 and Q1 be the existing price and quantity for this oligopoly firm: due to the assumptions of this model, the demand curve has a kink in it at this price and output. Because of the strange shape of the demand curve, the MR curve is
discontinuous, or has a gap in it.

181
What does the kinked demand curve illustrate?

There is a great deal of price stability and nonprice competition is important
182
Inflation
Inflation is an increase in the overall price level. Sustained inflation occurs when the overall price level continues to rise over some fairly long period of time.
Causes of Inflation
1. Over-expansion of money supply i.e. excess liquidity in the economy leads to inflation because too many money would be chasing too few goods. 2. Expansion of Bank Credit Rapid expansion of bank credit is also responsible for the inflationary trend in a country. 3. Deficit Financing: The high doses of deficit financing which may cause reckless spending, may also contribute to the growth of the inflationary spiral in a country. 4. A high population growth it leads to increase in demand and money income and cause a high price rise. 5. Excessive increase in the price of fuel or food products due to political, economic or natural reasons will lead to inflation for short- as well as long-term.
Effects of Inflation on economy.

1. People start consuming or buying less of these goods and services as their income is limited. This leads to slowdown not only in consumption but also production. This is because manufactures will produce fewer goods due to high costs and anticipated lower demand. 2. Banks will increase interest rates as inflation increases interest rate .This makes borrowing costly for both consumers and corporate. Thus people will buy fewer automobiles, houses and other goods. Industries will not borrow money from banks to invest in capacity expansion because borrowing rates are high. 3. Higher interest rates lead to slowdown in the economy. This leads to increase in unemployment because companies start focusing on cost cutting and reduces hiring. 4. Rising inflation can prompt trade unions to demand higher wages, to keep up with consumer prices. Rising wages in turn can help fuel inflation. 5. Inflation affects the productivity of companies. They add inefficiencies in the market, and make it difficult for companies to budget or plan long-term. Inflation can act as a drag on productivity as companies are forced to shift resources away from products and services in order to focus on profit and losses from currency inflation.
185
kinds of inflation
Cost Push Inflation
Cost-push inflation occurs when businesses respond to rising production costs, by raising prices in order to maintain their profit margins. There are many reasons why costs might rise: Rising imported raw materials costs perhaps caused by inflation in countries that are heavily dependent on import of these commodities. Rising labor . costs - caused by wage increases which exceed any improvement in productivity. This cause is important in those industries which are labour-intensive. Firms may decide not to pass these higher costs onto their customers (they may be able to achieve some cost savings in other areas of the business) but in the long run, wage inflation tends to move closely with price inflation because there are limits to the extent to which any business can absorb higher wage expenses. Higher indirect taxes imposed by the government for example a rise in the rate of excise duty on alcohol and cigarettes, an increase in fuel duties or perhaps a rise in the standard rate of Value Added Tax or an extension to the range of products to which VAT is applied. These taxes are levied on producers (suppliers) who, depending on the price elasticity of demand and supply for their products, can opt to pass on the burden of the tax onto consumers. For example, if the government was to choose to levy a new tax on aviation fuel, then this would contribute to a rise in cost-push inflation
186
Demand Pull Inflation

Demand-pull inflation is likely when there is full employment of resources .In these circumstances an increase in AD will lead to an increase in prices. AD might rise for a number of reasons some of which occur together at the same moment of the economic cycle A depreciation of the exchange rate, which has the effect of increasing the price of imports and reduces the foreign price of exports. If consumers buy fewer imports, while foreigners buy more exports, AD will rise. If the economy is already at full employment, prices are pulled upwards. A reduction in direct or indirect taxation. If direct taxes are reduced consumers have more real disposable income causing demand to rise. A reduction in indirect taxes will mean that a given amount of income will now buy a greater real volume of goods and services. The rapid growth of the money supply perhaps as a consequence of increased bank and building society borrowing if interest rates are low. Economists believe that the root causes of inflation are monetary in particular when the monetary authorities permit an excessive growth of the supply of money in circulation beyond that needed to finance the volume of transactions produced in the economy. Rising consumer confidence and an increase in the rate of growth of house prices both of which would lead to an increase in total household demand for goods and services Faster economic growth in other countries providing a boost to exports overseas
187
Control of inflation
Monetary Policy Fiscal Policy
188
Monetary Policy
The central bank designs the monetary policy in keeping with the government's economic policy. Monetary policy is about expansion and contraction of money and the central bank is the implementing body of the monetary policy.
189
Monetary Policy
The instrument of monetary policy (methods of credit control) may be broadly divided into the following parts:
Quantitative methods; a. Open Market Operations b. Bank Rate c. Cash Reserve Ratio (CRR) d. Statutory Liquidity Ratio (SLR) e. Repo (Repurchase) rate& Reverse Repo rate(Liquidity Adjustment facility) Qualitative methods a. Selective Credit Controls (SCC)
b. c.
Moral Suasion margin requirement
190
Quantitative methods
What is Bank Rate? This is the rate at which central bank (RBI) lends long term money to other banks or financial institutions. If the bank rate goes up, long-term interest rates also tend to move up, and vice-versa. Thus, it can said that in case bank rate is hiked, in all likelihood banks will hikes their own lending rates to ensure and they continue to make a profit

Open market operation; it is sale and purchase of government securities by RBI through commercial banks to common people. If RBI wants to reduce money supply it will purchase government securities .
191
CRR means Cash Reserve Ratio. Banks in India are required to hold a certain proportion of their deposits in the form of cash. However, actually Banks dont hold these as cash with themselves, but deposit such case with Reserve Bank of India (RBI) / currency chests, which is considered as equivalent to holding cash with themselves..This minimum ratio (that is the part of the total deposits to be held as cash) is stipulated by the RBI and is known as the CRR or Cash Reserve Ratio. . Therefore, higher the ratio (i.e. CRR), the lower is the amount that banks will be able to use for lending and investment. Thus, it is a tool used by RBI to control liquidity in the banking system.
SLR stands for Statutory Liquidity Ratio. This term is used by bankers and indicates the minimum percentage of deposits that the bank has to maintain in form of gold, cash or other approved securities. Thus, we can say that it is ratio of cash and some other deposits It regulates the credit growth in India.
193
Repo (Repurchase) rate is the rate at which the RBI lends shot-term money to the banks. When the repo rate increases borrowing from RBI becomes more expensive. Therefore, we can say that in case, RBI wants to make it more expensive for the banks to borrow money, it increases the repo rate; similarly, if it wants to make it cheaper for banks to borrow money, it reduces the repo rate Reverse Repo rate is the rate at which banks park their short-term excess liquidity with the RBI. The RBI uses this tool when it feels there is too much money floating in the banking system. An increase in the reverse repo rate means that the RBI will borrow money from the banks at a higher rate of interest. As a result, banks would prefer to keep their money with the RBI
194
Qualitative methods
margin requirement ,it is gap between value of security and
amount of loan if RBI wants to reduce money supply it will increase the gap between the two.
Selective credit control; any step in this will affect only

selective sector not the entire economy.
Moral Suggestion; it includes moral suggestion by government

/RBI
195
Fiscal policy
Fiscal policy is the projected balance sheet of the country, prepared by the chief finance officer of the country i.e. the finance minister of the country. functions of fiscal policy
The first is the function of allocation in the budget policy to make provisions for social goods. It is a process by which the total resources are divided between private and social goods and by which the mix of social goods is chosen. The Second is the distribution function of budget policy. This includes distribution of income and wealth in accordance with what the society considers a fair or just distribution. The third is the stabilization function of a budget policy, that is having high employment, a reasonable degree of price stability, an appropriate rate of economic growth, with due considerations of its effects on trade and the balance of payment.
196
Components of fiscal policy

Taxation Public expenditure Deficit financing Public borrowing.
197
Business Cycle The cyclical movement of ups and downs in business and economic activity.
Cyclical Fluctuations
198
Prosperity A prolonged period of growing business and economic activity. The Phases of a Trade Cycle
199
Recession A deep widespread downward movement of the business and economic activity. Depression A prolonged period of declining business and economic activity.
200
CIRCULAR FLOW OF INCOME

The Circular Flow of Income 2 Sector Model
PRODUCT MARKET Goods & Services Payment for Goods & Services
Payment of factor income Factor Services
FACTOR MARKET
201
Two Sector Model with Financial Sector

PRODUCT MARKET
Goods and Services

Payment for goods & services Savings (Leakage) FINANCIAL SECTOR Investment (Injection)
Payment of factor income Factor Services
FACTOR MARKET
Savings : Residual income that households do not use to purchase goods and services Investment : Expenditure on capital goods DR SALABH MEHROTRA (Economics for
Manager')
202
Three Sector Model

PRODUCT MARKET Goods and Services
Payment for goods & services Savings (Leakage) Payment of factor income Factor Services FACTOR MARKET Investment (Injection)
Financial Sector
Taxes (Leakage) (Injection) Factor payments & Transfer payments
Taxes (Leakage) Government purchases & (Injection) subsidies
GOVERNMENT
Equilibrium is achieved when leakages = injections DR SALABH MEHROTRA (Economics for Savings + Taxes = Investment + Govt. Purchase + Payments Manager')
203
Four Sector Model

Payment for Imports (Leakage) Factor Income (Injection) Rest of the World Payment for Imports (Leakage) Export Receipts (Injection)
PRODUCT MARKET Goods and Services Payment for goods & services
Savings (Leakage)
Financial Sector Payment of factor income
Investment (Injection)
Taxes (Leakage) Factor payments & Transfer payments
Factor Services FACTOR MARKET Government (Leakage)
Taxes
(Injection)
Government purchases & (Injection) subsidies
In Equilibrium : Leakages = Injections DR SALABH (Economics for & Transfers + Exports Savings + Taxes + Imports = Investment + MEHROTRA Govt. Expenditure
Manager')
204
Domestic Product vs National product

National income is the income earned by residents of an economy Domestic income = income of residents in the domestic territory + income of non-residents in the domestic territory National income = income of residents in the domestic territory + income of residents from abroad National income = Domestic income + net factor income from abroad
205
Gross Domestic Product

Money value of all final goods and services produced within the domestic territory and valued at market prices in a given time period
Time period Product Money value : typically one year : India 1 April to 31 March : output of goods and services : converting output into a common denominator of money
206
Normal Resident of a country

Normal Resident is defined as a person who
Ordinarily resides in a country Economic interest lies within the economic territory Resident
Household
Production unit
Resident Citizen
Citizenship based on nationality Resident based on economic interest
Normal Residents of a country

All households in an economy resident households Households = Resident + Non-resident households Non-resident households in a domestic territory include :
Foreign visitors on conferences, vacations, tours Seasonal workers within the domestic territory Diplomats of other countries living within the domestic territory Foreign employees in international organisations Foreign consultants, technicians, engineers who come on projects
Resident households outside the domestic territory include:

Citizens of a country employed in their own embassies, consulates, military bases Medical patients and students (as long as they continue to be a part of a household of their home country) Citizens working in the local offices of international organisations
208
Domestic Product vs National Product

Domestic Product is the output produced within the economic or domestic territory of a country
Indian High Commission Islamabad Domestic territory Includes :
i. ii. Political boundaries High commissions, embassies military bases located overseas Ships, fishing vessels, air crafts owned by residents Embassies, aid agencies of foreign governments situated in India Offices of international organisations such as World Bank, IMF etc
World Bank Office UK High Commission
iii.
Domestic territory excludes :

i. ii.
Indian Airline flying from Kathmandu to Colombo DR SALABH MEHROTRA (Economics for
Manager')
209
Net factor income from abroad (NFIFA)

NFIFA = Factor income earned by residents abroad - Factor income earned by non-residents in the domestic territory
minus Factor income earned by non-residents within the domestic territory
Factor Income
Factor income earned by residents abroad

Factor Income
Indian Security Guard

Factor Services
UK High Comm. Delhi (abroad)
British Security Guard
Indian High Comm., London (domestic territory) Factor Services

210
Gross Product vs Net Product

Gross product includes depreciation Depreciation
Wear and tear of plant and machinery with use Foreseen obsolescence
New clothes
Also called
Replacement cost Consumption of capital wear and tear
Gross product = net product + depreciation Net product = gross product - depreciation
If Gross product is Rs 200 and Depreciation is Rs 50, then Net product is Rs 150 Faded clothes
Final vs Intermediate Goods

Intermediate Products
Goods and services used for furthering production
Final Products
Goods and services used for directly satisfying the wants of consumers
Tasty Food Restaurant
Household
Vegetables
Food
Vegetables
Food
No good is either intermediate or final Distinction is based on the USE of the good
212
Problem of Double Counting

Occurs when the value of a commodity is counted more than once in valuing the output of an economy
MILK
Sugar Chocolate Yummy Chocolate Factory Rs. 100 Output = Rs. 100
Cocoa Rs. 15 + Rs. 25 + Rs. 10 Input = Rs. 50
Output available is valued at Rs. 100 and not Rs. 150 (50 + 100) Rs. 50 (value of inputs) is already included in Rs. 100 (value of output)
Problem of Double Counting

Leads to overestimation of output Can be avoided by :
taking only final goods and services taking value added at each production process
Farmer Wheat Rs. 20 Value Added 20 0 = 20
Miller Flour Rs. 30 30 20 = 10
Baker Bread Rs. 40 40 30 = 10
Customer Bread Rs. 40
Total value added = 20 + 10 + 10 = Rs. 40 (Economics for Value of final productDR =SALABH Rs. MEHROTRA 40 Manager')
214
Product at Market Price vs Product at Factor Cost

Factor Cost + Net Indirect Taxes = Market Prices
Paid to factors of production ___ Paid by households
Indirect Tax Factor Cost: Rs. 100 Sales Tax: 10% Market Price: Rs. 100 + Rs. 10 = Rs. 110
Indirect Tax
Subsidy Subsidy Factor Cost: Rs. 100 Subsidy: 10% Market Price: Rs. 100 - Rs. 10 = Rs. 90
Rs. 100
Rs. 10
Factory Government
Government Rs. 10
Factory Rs. 100

215
Results in : price
DR SALABH MEHROTRA (Economics for Results Manager')
in : price
Factor Income vs Transfer Receipts

Factor Income Arise due to the result of productive activity Paid to factors of production Included in national income estimates e.g. : rent, wages, interest, profits Transfer Receipts Do not arise due to any productive activity Not paid to factors of production Excluded from national income estimates e.g. : scholarships to students, old age pension, lotteries, remittances received from abroad
216
Recapitulate
Gross Market price
- Consumption of Capital - Net Indirect Taxes - Net Factor Income from Abroad
Net Factor Cost Domestic
National
217
National Income Aggregates

1. 2. 3. 4. 5. 6. 7. 8. Gross Domestic Product at market price (GDPMP) Gross National Product at market price (GNPMP) Net Domestic Product at market price (NDPMP) Net National Product at market price Gross National Product at factor cost Net Domestic Product at factor cost Net National Product at factor cost (NNPMP) (GNPFC) (NDPFC) (NNPFC) Gross Domestic Product at factor cost (GDPFC)
218
Definitions
GDPMP
Value of all final goods and services Produced in the domestic territory in a given time period Valued at market price Includes depreciation
GNPMP
Value of all final goods and services Produced by the residents of an economy in a given time period Valued at market prices Includes net factor income from abroad Includes depreciation
219
Definitions
NDPMP
Value of all final goods and services Produced in the domestic territory in a given time period Valued at market prices Excludes depreciation
NNPMP
Value of all final goods and services Produced by the residents of an economy in a given period Valued at market price Includes net factor income from abroad Excludes depreciation
220
Definitions
GDPFC
Value of factor income received by factors of production in a given time period Takes place within the domestic territory Does not include net indirect taxes Includes depreciation
GNPFC
Value of factor income received by residents of a country in a given time period Includes net factor income from abroad Does not include net indirect taxes Includes depreciation
221
Definitions
NDPFC or Domestic Income
Value of factor incomes received by factors of production in a given time period Takes place within the domestic territory Excludes net indirect taxes Excludes depreciation
NNPFC or National Income

Value of factor incomes received by residents of a country in a given time period Includes net factor income from abroad Does not include net indirect taxes Does not include depreciation
222
Value Added Method Concepts

Measures national income by calculating the net value added at factor cost by each production unit Value of output = Sales + D in stock Sales = Domestic sales + exports D in stock = closing stock opening stock D in stock > 0 current years output not sold; therefore needs to be added to sales D in stock < 0 previous years output sold; therefore deduct to get this years output
223

When D in stock > 0
Current output
=
Sales
Change in stock
(100kg)
(80kg)
(20kg) *Current years output not sold+
When D in stock < 0

Current output = Sales Change in stock
(100kg)
(120kg)
(20kg) *Previous years output sold 224 in the current year]

Value added is the contribution a firm makes to the flow of goods and services in an economy Value added = Value of output Intermediate consumption Value added = Gross Value Added at market price Valued by using the prices paid by the consumers Includes:
Depreciation Net indirect taxes Factor payments
225
Farmer Wheat Rs. 20

Value of output Intermediate consumption Value Added
Miller Flour Rs. 30
Baker Bread Rs. 40
Customer Bread Rs. 40
20
30
40
-0
20
- 20
10
Value Added in Production Process
- 30
10
Value of final good
20 + 10 + 10 = Rs 40
DR SALABH MEHROTRA (Economics for Sum of value added is Manager') equal to value of final good
Rs 40
226

For a Firm :
Gross Value Added at market price = Value of output intermediate consumption
Depreciation
Net Indirect Taxes
Factor Payment
Net Value Added at market price = GVAMP Depreciation Net Value Added at factor cost = NVAMP NIT NVACFC = Factor payments = Wages + Rent + Interest + Profits
For an Economy :
GVAMP = GDPMP NVAFC = NDPFC
227
Value Added Method Steps

Identification and classification of production units
Primary Sector Secondary Sector Tertiary Sector
Calculation of NVAFC for each production unit Calculation of NDPFC [ NVAFC] Add Net Factor Income from Abroad (NFIFA) to estimate National Income
228
Net Value Added Method - Precautions

Avoid double counting
Use only value added by each firm Use only final goods and services
Imputed rent of owner-occupied dwellings included Imputed value of own-account-production included Production of illegal activities not included Services of a housewife / family member towards family not included
229
Income Method Concepts

Measures the factor incomes paid (distributed) to the owners of factors of production NVAFC = wages + rent + interest + profits Includes:
Compensation of Employees Operating Surplus Mixed income of self - employed
230

Compensation of Employees : (COE)
remuneration paid to employees in return for work undertaken in the production process
Compensation of Employees
Wages & Salaries in cash

Basic Salary Dearness Allowance Travel Allowance
Wages & Salaries in kind

House Car Free education
Employers contribution to Social Security

Provident Fund Pension Fund
231
Employers contribution
Wage of Rs 300
Employees contribution from wage
Rs. 100
Rs. 100
Provident Fund
COE = Rs. 300 + Rs. 100 = Rs. 400 and NOT Rs. 500 Employees contribution comes from net salary

Operating Surplus (OS)
Excess of NVAFC after COE has been deducted Income from property and entrepreneurship Operating Surplus
Property Income
Entrepreneurial Income
Rent (royalties)
Interest
Profits
Corporate Tax
Dividend
Retained Earnings
233

Mixed Income of Self - Employed
Income earned has elements of more than one type of factor incomes Difficult to segregate into COE and OS Accrues to self employed people
Dr Sahais Residence
Doctors fee includes:

Wages as a doctor Rent for the space used as a clinic Profit for the risk of starting a clinic at home
234
Income Method Steps

Identification and classification of production units Classification of factor incomes Estimation of factor incomes Price per unit of factor quantity of factor employed Domestic Income Estimation of National Income by adding NFIFA
235
Income Method Precautions

Transfer receipts not included Illegal income not included Imputed value of owner-occupied dwellings included Imputed value of own-account-production included Income from sale of second hand goods not included
Brokerage fee / Commissions earned included
Income from sale of assets not included Income from windfalls like lotteries not included
236
Expenditure Method Concepts

Measures national income by taking into account the total expenditure made by different sectors of the economy Includes the following components
Private final consumption expenditure Investment Government Purchases Net Exports
237

Private final consumption expenditure
Expenditure incurred by households on the purchase of goods and services
Includes purchases made by non-profit institutions Includes purchases made by households abroad
238

Investment
Addition to capital stock of an economy Improves the productive capacity of an economy Includes:
Business fixed investment
Change in stock
Residential construction
Public investment
239

Government Purchases of Goods and Services
Teachers Salary
Chalk Government School
Electricity
Stationery Government provides education
Government transfers not included
240

Net Exports : Exports (X) minus Imports (M)
Sale of goods abroad (Export) Reflects the demand from the rest of the world for domestic product X > M ROW is demanding more than domestic demand X < M ROW is demanding less than domestic demand
Purchase of goods from abroad (imports)
241
Expenditure Method Steps

Identification and classification of sectors Estimation of final expenditure Calculation of domestic income
GDPMP = C + I + G + X M NDPMP = GDPMP Consumption of Capital NDPFC = NDPMP Net Indirect Taxes
Estimation of National Income by adding Net Factor Income from Abroad to domestic Income
242
Expenditure Method Precautions

Expenditure on only final goods and services included Expenditure on second hand goods not included
Expenditure on brokerage fee / commissions included
Imputed value of owner-occupied dwellings included Imputed value of own-account-production included Expenditure on financial assets not included
243
Reconciliation of the 3 Methods

PRODUCTION OR VALUE ADDED INCOME EXPENDITURE PFCE GVAMP all sector - NIT - Depreciation COE + OS + MISE + Gross Investment + Government Expenditure + Net Exports GDPMP - Depreciation - NIT NDPFC + NFIFA National Income NDPFC + NFIFA National Income
NDPFC + NFIFA National Income

244
Pricing Strategy
Pricing strategy :it refers to method companies use to price their products or services. Almost all companies, large or small, base the price of their products and services on production, labor and advertising expenses and then add on a certain percentage so they can make a profit. There are several different pricing strategies, such as penetration pricing, price skimming, discount pricing, product life cycle pricing and even competitive pricing. Penetration Pricing: A small company that uses penetration pricing typically sets a low price for its product or service in hopes of building market share, which is the percentage of sales a company has in the market versus total sales. The primary objective of penetration pricing is to garner lots of customers with low prices and then use various marketing strategies to retain them. For example, a small Internet software distributor may set a low price for its products and subsequently email customers with additional software product offers every month. A small company will work hard to serve these customers to build brand loyalty among them.
245
Price skimming
Skimming involves setting a high price before other competitors come into the market. This is often used for the launch of a new product which faces little or no competition usually due to some technological features. Such products are often bought by early adopters who are prepared to pay a higher price to have the latest or best product in the market. Good examples of price skimming include innovative electronic products, such as the Apple iPad and Sony PlayStation 3. There are some other problems and challenges with this approach : Price skimming as a strategy cannot last for long, as competitors soon launch rival products which put pressure on the price (e.g. the launch of rival products to the iPhone or iPod). Distribution (place) can also be a challenge for an innovative new product. It may be necessary to give retailers higher margins to convince them to stock the product, reducing the improved margins that can be delivered by price skimming. A final problem is that by price skimming, a firm may slow down the volume growth of demand for the product. This can give competitors more time to develop alternative products ready for the time when market demand (measured in volume) is strongest.
246
Full Cost Pricing
Full cost plus pricing seeks to set a price that takes into account all relevant costs of production. This could be calculated as follows: Total budgeted factory cost + selling / distribution costs + other overheads + MARK UP ON COST Factory Costs The first factor that the full cost plus strategy takes into account is the factory costs of making the item per unit. This does not mean that the business actually creates the product. Manufacturers create products and may consider factory costs associated with buying supplies and operating equipment. Distributors, on the other hand, consider factory costs as the prices at which they must buy items from the manufacturer. These prices are lower than consumer costs, but still represent a significant investment of business funds and make a necessary starting place.
247
Distribution Costs Distribution costs refer to all the costs of the business associated with moving products into the hands of consumers. Distributors may or may not have to pay for transportation from the manufacturer, but if they do, they must consider it, along with all storage, costs of their own. Markup With the factory and distribution costs in hand, the business can add the two together and find a full cost for a product. The business then adds a markup, an additional cost that creates the price consumers pay. This markup is what creates profit for the business, which the business can use to pay employees, expand, offer dividends and conduct many other activities. There is a lot of room for different markups or margins within the full cost plus strategy, allowing companies to customize it to their market
248

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The Scope and Method of Economics

DR SALABH MEHROTRA (Economics for Manager')

The Study of Economics

DR SALABH MEHROTRA (Economics for Manager')

Why Study Economics?

DR SALABH MEHROTRA (Economics for Manager')

DR SALABH MEHROTRA (Economics for Manager')

More Reasons to Study Economics

The Scope of Economics

DR SALABH MEHROTRA (Economics for Manager')

The Scope of Economics

The Scope of Economics

DR SALABH MEHROTRA (Economics for Manager')

The Method of Economics

DR SALABH MEHROTRA (Economics for Manager')

The Method of Economics

The Method of Economics

Managerial Economics Defined

What is Managerial Economics?

What is Managerial Economics?

DR SALABH MEHROTRA (Economics for Manager')

How Is Managerial Economics Useful?

Making the Best Decision

Principles of Managerial Economics

DR SALABH MEHROTRA (Economics for Manager')

Narrower concept than economic development

DR SALABH MEHROTRA (Economics for Manager')

What is Industry? Meaning

DR SALABH MEHROTRA (Economics for Manager')

Classification / Types of Industries

FACTORS AFFECTING LOCATION OF INDUSTRIES

DR SALABH MEHROTRA (Economics for Manager')

What Is The Role Of Industry In Economic Development?

Management utility maximization

Relationship b/w TU & MU

DR SALABH MEHROTRA (Economics for Manager')

MARGINAL UTILITY ANALYSIS

DR SALABH MEHROTRA (Economics for Manager')

DR SALABH MEHROTRA (Economics for Manager')

He wants to spent on two commodities i.e. orange & apple

DR SALABH MEHROTRA (Economics for Manager')

INDIFFERENCE CURVE ANALYSIS

DR SALABH MEHROTRA (Economics for Manager')

Properties of indifference curve

DR SALABH MEHROTRA (Economics for Manager')

The Indifference Curve

Set of indifference curves is called Indifference map

DR SALABH MEHROTRA (Economics for Manager')

Marginal rate of Substitution

DR SALABH MEHROTRA (Economics for Manager')

DR SALABH MEHROTRA (Economics for Manager')

DR SALABH MEHROTRA (Economics for Manager')

Demand schedule & demand curve

An Individual's Demand Schedule for Commodity x

DR SALABH MEHROTRA (Economics for Manager')

Market Demand Curve

DR SALABH MEHROTRA (Economics for Manager')

DR SALABH MEHROTRA (Economics for Manager')

DR SALABH MEHROTRA (Economics for Manager')

Increase in Demand in Demand DR SALABH MEHROTRA (Economics Decrease for

Movement along demand curve

DR SALABH MEHROTRA (Economics for Manager')

Movement along a Demand Curve