Economicsfinal

---Swami Vivekananda---
Economics
Its a Social Science.
Social science studies social activities which create social relation. EconomicsEconomics studies particular type of social activities = Economical activities. Production Exchange Consumption.
2
Economics answers three basic questions

What to Produce?
How to Produce ? Whom to Produce?
Definition of Economics
Adam Smith
( Father of Modern Economics)"Enquiry into nature & Causes of wealth of nation". (1776).
Robbins -
Economic is a science which studies human behavior as a relationship between ends and scares means which have alternative uses.
Economic Resources
Land: Labor: Capital: Organizer:-
.
5
Economic Problem
Why this problem arises-
i. Human wants are unlimited ii. The means are limited iii. Alternative uses of the limited resources. .
Economics can be studied under two heads
Micro Economics.
Study of individual unit.
Macro Economics.
It studies economics as a whole.
Managerial Economics
Management + Economics = Managerial Economics Management =
Coordinating work activities so that they are
completed efficiently and effectively through people.
with and
Managerial Economics It is defined as the integration of economic theory with business practice for the purpose of facilitating decision making.
8
Decision Making
"Decision making as the process of selecting the suitable action from among several alternative course of action". Characteristic of Decision Making. Risk Uncertainty
Uncertainty
Change in demand and supply. Changing business environment. Government polices. External influence on the domestic market. Social and political change.
10
Process of Decision Making.

Defining the objective to be achieved. Collections and analysis of information.
Selecting the best course of action.

Implement the course of action. Continuous monitoring.
11
Scope of Managerial Economics

Scope study how far a particular subject will go.
Demand Analysis Consumption Analysis Production Theory. Cost Analysis Market Structure. Pricing System.
12
Relationship Between ME & other subject

Mathematics & Managerial Economics
Linear programming (LP) is a technique for optimization of a linear objective function. Game theory -An individual's success in making choices depends on the choices of others. Inventory Model. Such as EOQ, EBQ, MRP & MRPII Differential calculus provides a technique of measuring the marginal change in the dependent variables, say Y due to change in the independent variables,
13

Statistic & Managerial Economics
Regression analysis Probability theory Hypothesis testing
14
Regression Analysis
Regression analysis helps us understand how the
typical value of the dependent variable changes when any one of the independent variables is changed.
15

Operations Research
Economics + Mathematics + statistic.

Management, Accountancy theory & ME. Computer & ME
16
Opportunity cost
The concept of opportunity cost related to the
alternative uses of scares resources. Though resources are scares they have alternative uses. The scarcity of resources and alternative use of resources give rise to the concept of opportunity cost. The opportunity cost of availing and opportunity is an opportunity foregone income, expected from the second best opportunity of using the resources. The difference between actual earning & its opportunity cost is called economic profit. The concept of opportunity cost is not just limited to finance but it involved in every kind of managerial 17 decision.
Marginal Principle
The concept of marginal value is widely used in
economic analysis, for ex- marginal utility in consumer analysis, marginal cost in production analysis, & marginal revenue in pricing analysis.
Marginal principle assumes special significance where
maximization or minimization problem is involved.

The term marginal refers to change in total quantity or
value due to a one unit change in its determent.
18
Marginal Principle
Marginal cost MC = TCN- TCN-1 Marginal Revenue MR = TRN- TRN-1 Marginal Utility MU = TUN- TUN-1
19
Marginal Principle
The decision rule One simple decision rule under the marginal principle
is that a business activity must be carried out so long as its MR>MC. The necessary condition for profit maximization output is that MC must be equal to MR. MC=MR In simple words, the profit of a firm is maximised at that level of output where the cost of producing one additional unit equal the revenue from the sale of that unit of output.
20
Incremental Principle
The concept of marginal can be applied only where
MC & MR can be calculated precisely Firms find it difficult to estimate MC & MR reason firms produce & sell their product in bulk. So business managers use incremental principle in their business decisions. The incremental principle is applied to business decisions which involved bulk production & large increase in total cost & total revenue. Such an increase in total cost and total revenue is called incremental cost & incremental revenue.
21
Incremental Principle
Incremental Cost-
Incremental cost can be defined as the arise due to a
business decision. For ex. Cost arise due to adding new plant. Incremental cost includes both fixed cost & variable cost. Incremental Revenue In the increase in the revenue due to a business decision, for ex. Revenue arise due to adding new plant. The use of the incremental concept in business decision is called incremental reasoning. The incremental reasoning is used in accepting or rejecting 22 a business proposition.
Equi Marginal Principle

The equi marginal principle was originally associated
with consumption theory. The law state that the utility maximising consumer distributes his consumption expenditure between various goods & services in such a way that the marginal utility derived from each unit of consumption is the same. The law was over a time applied to business manager to allocation of resources between alternative uses with a view to maximising profit in a case firm carries more than one business activity.
23

The principle suggests that available resources should be
allocated between the alternative options that the marginal productivity gain from the various activities are equalized. For ex. Firm have 100 million Rs. Which can be spend on three project. A,B & C. Each project requires expenditure of 10 million.
Marginal productivity Schedule
Unit Exp/ 10M 1 2 3 4 5 Project A 50 (1) 45 (2) 30 (7) 20 (10) 10 Project B 40 (3) 30 (5) 20 (8) 10 0 Project c 35 (4) 30 (6) 20 (9) 15 12
24

Going by the equi marginal principle the firm will
allocate it total resources among the project in such a way that marginal productivity of each project is the same. MP(A)= MP(B)=MP
25
Time Perspective
All business decision are taken with a certain time
perspective. But all this decisions do not have same time perspective, some have short run outcome or some have long run. Long run decisions would not earn any profit in short period but incur huge amount of initial cost but may be prove profitable in long run. Such as investment in plant, building, machinery, advertisement, or spending in labour well fair. So while taking any investment & business decision business manager has to thing on the time perspective and long run return from the investment.
26
Economic theory of firm

A firm is an entity that draws various types of factors
of production in different amounts from the economy, and converts them into desirable output(s), through a process with the help of suitable technology.
Why do people do business? What motivates the
owners /investors / promoters to take so much of risk and conduct their own businesses, rather than going for a secured employment?
The theory of firm was based on the assumption that
the goal or objective of the firm was to maximize of profit.

27

Profit Maximization Theory
Objective of business is generation of the largest amount of
Profit = (Total Revenue-Total Cost) Traditionally, efficiency of a firm measured in terms of its profit generating capacity
There are two condition for profit maximisation. The necessary or first order condition Requires that marginal revenue (MR) must be equal to marginal cost. The secondary or the second order condition Requires that the necessary condition must be satisfied under the stipulation of decreasing MR & rising MC.
28

Controversy over profit Maximisation.
Though
traditionally theory assume profit maximisation is the sole objective in business practice firms have been pursuing many objective than it. The large firms pursue goals such as sale maximisation, retaining & gaining, market share, achieve the target profit, increase the net worth of share holders. The firms do not posses perfect knowledge of their costs, revenue, and future business environment. They operate in world of uncertainty. Though pricing theories are not exactly applicable in business practice it provides the analytical frame work for decision making. 29
Behavioral Model of firm

Following the crisitisum of the economists theory of
firm some economist highlighted the behavioral theory of firm t0 explain its objective.
Some of this models are as follow
Baumals Sales maximisation firm. Stacklebergs Reaction oriented firm.
Cyert & March Behavioural model.
30
W.J.Baumol suggested sales revenue maximization as an alternative goal to profit maximization. RATIONALISATION OF THE SALES MAXIMIZATION HYPOTHESIS a) There is evidence that salaries and other earnings of top managers are correlated more closely with sales than with profits. b) The banks and other financial institutions keep a close eye on the sales of firms and are more willing to finance firms with large and growing sales. c) Trend in sales revenue is a indicator of the performance of firm. It helps also in handling the employee's awarding efficiency and penalizing inefficiency. 31

Large sales, growing over time, give prestige to the managers, while large profits go into the pockets of shareholders. Large growing sales strengthen the power to adopt competitive tactics, while a low or declining share of the market weakens the competitive position of the firm and its bargaining power vis--vis rivals. But this theory is also question on the following groundIt is argued that in the long run sales maximisation and profit maximisation objective will convert into same.
32

Marris Hypothesis of Maximization of Growth Rate
According to him firms balance growth rate subject to
managerial and financial constraint.

He defines firms balance growth rate (G) as G=GD =Gc
Growth rate of demand for the firms products (GD) and Growth rate of capital supply to the firm (GC)
33
He translate this objective into two set of utility function. Owners utility(shareholders)- aim at maximising profits and market share (Uo ) Managers utility- aim at better salary, job security and growth (Um) Owners utility function implies that growth of demand
for the firms product & supply of the capital.

Therefore (Uo) owner utility means maximisation of
demand for product as well as supply of capital. Means managers utility function reflects in the owner utility function. So managers seek to maximize steady growth of the firm (Um) is directly related with steady growth of the firm . 34

But
this model interdependency .
fail
to
deal
with
oligopolistic
The serious shortcoming of this model is that it ignores
the price determination which is the main concern of profit maximisation.
35

Williamsons Model of Managerial Utility Function
As per him in modern corporations, owner &
managers are two separate entities with separate objective. The relationship between owner and manager is principle & agent nature, so determining the objective of firm is call principle & agent problem. Managers apply their discretionary power to maximize their own utility function But they face constraint of maintaining minimum profit to satisfy shareholders
36

Williamsons Model of Managerial Utility Function
Utility function of managers (Um) depends on: salary, Job
security, power of discretionary investment (ID) Um = f (S, M, ID) S= additional expenditure on staff M= managerial emoluments ID= ( is discretionary investment) The managers of modern organization seek to maximize their own utility subject to minimum level of profit. A minimum profit is required to satisfy the shareholders otherwise their job security is endangered. But this model fail to deal with oligopolistic interdependency .
37
Behavioral Theories
Simons Satisfying Model
Simon had argued that real business world is full of
uncertainty. Biggest challenge before modern businesses is lack of full information and uncertainty about future. Where data are available they have little time & ability to process. They work under many constraints. The objective of maximizing either profit, or sales, or growth is not possible. Instead they seek to achieve a satisfactory level of profit, sales and growth.
38
Behavioral Theories
Behavioral theory has criticized on the following ground It does not explain the firms behavior under
dynamic condition in the long run.

It can not be used to predict exactly future course of
action.
This theory does not deal with the equilibrium of the
firm or industry.
It fails to deal with interdependence of the firms &
its impact on firms behavior.
39
Behavioral Theories
Model by Cyert and March According to him apart from dealing with inadequate information and uncertainty, businesses managers also have to satisfy a variety of stakeholders,(shareholders, customers, financiers, input suppliers etc) who have different and often conflicting goals. Managers responsibility is to satisfy them. This firms behavior is known satisfying behavior. Satisfying behavior aims at satisfying all stakeholders. In order to bridge the gap between this conflicting interest & goals, managers form the aspiration level of the firm combining the following goals. A) Production goal B) Sales & market share goal C) Inventory goal D) profit goal.
40
Behavioral Theories
Model by Cyert and March
Managers form an Aspiration level on basis of past
experience, past performance of the firm, performance of other similar firms, and future expectations.
The aspiration level are modified & revised on the
basis of achievement environment.
&
changing
business
41
Behavioral Theories
Behavioral theory has criticized on the following ground It does not explain the firms behavior under
dynamic condition in the long run.

It can not be used to predict exactly future course of
action.
This theory does not deal with the equilibrium of the
firm or industry.
It fails to deal with interdependence of the firms &
its impact on firms behavior.
42
Optimization Techniques
Managerial economics use some basic tools from
mathematics and other applied sciences to quantify the economic concept and variables. It is known as mathematical economics and econometrics. An optimization techniques is helps to find value of the dependent variable which maximize or minimize the value of independent variable. For ex. Same firms are interested to find out the value of output that maximize their total revenue. Or same firms want to find the level of output that minimize the total cost. An optimization techniques is one of the technique which helps to find maximizing (profit) & minimizing (cost). Or such value of such variables.
43
Economic variables Any economic quantity, value or rate that varies on its
own or due to change in its determinants is an economics variables. For ex. Demand for product, supply of product, price of the product, cost of the product, sales revenue etc. Many of this variables are interdependent and interrelated. Even this economic variables have cause and effect relationship & this relationship can be expressed in a tabular, graphical & functional form. In optimization technique functional relationship between variables are solved.
44
The Functional A function is a mathematical technique of stating the
relationship between any two or more variables having cause and effect relationship. Dp= f(Pp) Demand for pizza and Pp= Price of pizza. Given mathematical demand function would be Dp=500- 5Pp It shows that at 0 pizza price demand equal to 500 units Minus sign shows minus relationship between price & demand, 5 implies that for 1 rupee change demand will change by 5 units. This functions can be solved with differential calculus. 45
Differential
calculus provides a technique of measuring the marginal change in the dependent variables, say Y due to change in the independent variables, say X when the change in X is approaches zero. Differential calculus is applied to analyze & to find solutions to a wide range of economic problem and business decision making. Rules of Differentiation1. Derivative of a constant functionThe derivative of a constant function equal zero. For ex. Y = f(X) Y/X = 0 The constant function implies that whatever the value of 46 X the value of Y remain constant.
Differential Calculus
Rules of Differentiation-
2)Derivative of a power functionThe derivative of a constant function equal zero. For ex. Y = f(X)=aXb Y/X = b aXb -1
Y= 5X3
Y/X = 3*5*X3-1 = 15X2
47
Technique of Maximizing Total Revenue. Suppose a price function is given as P= 500 5Q Find out the optimum quantity that maximize the total
revenue. Total revenue of firm can be defined asTR= P * Q Where P= price & Q= Quantity sold. So TR= (500 5Q)Q = 500Q-5Q2
By rule total revenue is maximum at the level of sale (Q) at which MR=0. That is to total revenue to be maximize, the marginal revenue(MR) the revenue from sale of marginal unit of the product must be equal to zero.
48
Technique of Maximizing Total Revenue. TR= 500Q-5Q2
TR/Q = 500-10Q By setting equation to zero & solving for Q we get O= 500 10Q Q=50 Thus to maximize the revenue firm need to sale 50 units. TR= 500*50-5*(50)2 =25000-12500 = 12500 So at this point total revenue earn by the firm will be 12500 Rs.
49
Technique of optimizing out put.
Suppose a TC function is given as P=400+ 60Q+4Q2 Find out the optimum level of out put. The optimum level of output is the level of out put
which minimizes average cost of production. So Ac= TC/Q AC= (400+ 60Q+4Q2 ) / Q AC= (400/Q)+ 60 + 4Q. The rule of minimization is that its derivatives must be equal to zero. AC/Q = -400/Q2 + 4 -400/Q2 + 4 = 0 Q = 10 It shows that optimum size of output is 10 Units.
50
Maximization of Profit.
TP= TR -TC P=400+ 60Q+4Q2 There are two condition for profit maximization. The necessary or first order condition
Requires that
marginal revenue (MR) must be
equal to
marginal cost.
MC=MR This first order condition can be written as
TR/Q = TC/Q Or TR/Q - TC/Q

The secondary or the second order condition Requires that the necessary condition must be satisfied under the stipulation of decreasing MR & rising MC.
TR/ Q < TC/ Q OR
2TR/2Q+2TC/2Q<0
51
Maximization of Profit.
Suppose that the TR & TC function are given respectively TR= 600Q 3Q2 & TC= 1000+ 100Q+2Q2 With this functions MR & MC can be obtained as follows. MR = TR/Q= 600 6Q MC = TC/Q= 100 +4Q MC=MR 600 6Q= 100 +4Q Q=50 As per first order condition of profit maximization the total profit is maximum at Q = 50
2TR/2Q= MR/Q=-6
2TC/2Q= MC/Q=4 -6 < 4
Or
-6+4 < 0
52
S0 second order of profit maximization is also satisfied at Q =50
Demand and its Determinants

Necessity is the mother of invention
Demand-
Demand is the mother of production.

Meaning of Demand Desire for commodity. Ability to pay. Willingness to pay.
Specific reference to
Time , Price & Place.

53
Demand Function
It specify the factors that influence the demand for the
product. Px = its own price Py = the price of its substitute B, = the income of the purchaser W, = wealth of the purchaser. A, = Advertisement E, = the price expectation. T, = taste or preference of user. U, = all other factors. So Dx = D(Px, Py, B, W, A, E, T, U,)
54
Types of Demand
1.
2. 3.
4.
5. 6. 7. 8. 9.
Direct Demand & Derived Demands. Domestic & Industrial Demand. Autonomous & Induced Demand. Perishable & Durable goods Demand. New & Replacement. Final & Intermediate Demand. Individual & Market Demands Total market & Segmented market Demands. Company & Industry Demands.
55
Law of Demand
It state that when other thing remain same, higher the
price, lower the demand and vise versa. AssumptionIncome of the consumer is constant. Availability of complementary & substitutes. No future price expectation. Taste & preference remain same. No change in population & its structure.
56
Demand Curve
Y D R 4 Price 3 Q
16
25
Quantity Demanded
57
Characteristics
Inverse relationship between Price & quantity
demanded.
Price is independent variable & quantity demanded is
dependent variable.
Reasons underline the law of demandIncome effect. Substitute effect.
58
Exceptions
Conspicuous Consumption (Vabline Goods) . Speculative Market. Giffens goods Ignorance.
59
Utility Concept.
Consumer demand the commodity because they derive or expect to derive utility from the commodity. Product or absolute angle. Utility is the want satisfying propensity of a commodity. Consumer or relative angle Utility is the psychological feeling of satisfaction, pleasure, happiness or wellbeing, which a consumer derives from the consumption, possession or the use of a commodity.
60
Utility Concept.
Total Utilitysum of the utilities derived by a consumer from the various units of goods & services he consume. Tux = u1 + u2 + u3+.un
Marginal Utility
change in the total utility( TU) obtained from the consumption of an additional unit of a commodity. MU = TU Q
61
Law of Diminishing Marginal Utility

As the quantity consumed of a commodity goes on increases, the utility derived from each successive unit goes on decreases, assuming consumption of all other commodities remaining the same.
TC & MC Utility schedules

No. of Unit Consume 1 Total Utility 30 Marginal Utility 30
2
3 4 5 6
50
60 65 60 45
20
10 5 -5 -15
3

Assumption for the law
The unit of the consumer good must be a standard
one. The consumer taste and preference remain same. There must be continuity in the consumption. Consumer is a rational.
63

Limitation of the law
Utility is a psychological phenomenon. It is feeling of
satisfaction, measurability of utility is not possible.

It does not explain the impact of the complementary
and substitute goods of demand.

It is applicable only for one commodity.
64
Utility Approach.
Cardinal Utility Approachit believed that utility can cardinality or quantitatively measurable , like weight length temperature etc .
Ordinal Utility Approach
Utility is immeasurable in cardinal term.
65
Ordinal Utility approach

It is based on the fact that it may not be possible for the
consumer to express the utility of the commodity in absolute term, but introspectively whether a commodity or less or equally useful as compared to other.
The higher order of preference is given to the commodity which
will give a higher utility. (Pioneered by J.R. Hicks & R.G.D Allen also known as Indifference Curve Analysis)
66
Indifference Curve analysis.

Defined as locus of point, each representing a different
combination of two substitute goods, which yield the same utility or level of satisfaction to the consumer.
He is indifference between any two combinations of
goods when it comes to making a choice between them.

It is also called Isoutility curve or Equal utility curve.
67
Indifference Schedule of Commodity X & Y.

Combination Units of Commodity Y 25 15 8 4 2 Units of Commodity X 3 6 9 17 30 Total Utility U U U U U
A B C D E
Five combination A, B, C, D, E of two substitute commodities X & Y as presented in table yield the same level of satisfaction.
68
Properties of Indifference Curve

Indifference curves have a Negative slope. Indifference curves do not intersect nor are they
tangent to one another.

Upper indifference curves indicate a higher level of
satisfaction.
69
Properties of Indifference Curve

Indifference curves are convex to the origin.
Why- 1). The two commodities are imperfect substitutes for one another. 2)The marginal rate of substitutes (MRS) between to commodity goes decreases. (MU of a commodity increases as its quantity decreases and vise versa) Indifference Units of Change in Change in MRS
Point Commodity Y + X Y X
A B C D E
25 + 3 15 + 6 8 + 9 4 + 17 2 + 30
10 7 4 2
3 3 9 13 3.3 2.3 0.4 0.2
Upper indifference curves indicate a higher level of
satisfaction.
70
Consumer Equilibrium
Budget Line-
The budget line shows the market opportunities available to the consumer given his income and the price of X & Y.
Consumer EquilibriumConsumer is equilibrium where the indifference curve is tangent to the budget line.
71
1). Price EffectIt is the change in consumption of goods because of the change in the price of the goods.
2).Income EffectThe increase or decrease in the income can be shown by the parallel shift of the budget line. Income effect result from the increase in real income caused by the change in price of the goods consumed by the consumer.
72
3). Substitute EffectIt is defined as the change in quantity demanded resulting from a change in relative price after real income effect of price is eliminated.
Price Effect = Substitute Effect + Income Effect. PE = SE + IE
73
1).Income EffectThe increase or decrease in the income can be shown by the parallel shift of the budget line. Income effect result from the increase or decrease in real income caused by the change in price of the goods consumed by the consumer.
74
Income EffectY
A1
ICC A Q P
X1
X3
B1
75
Income Consumption CurveDefine as the locus of points representing various equilibrium quantizes of to commodities consumed by a consumer at different level of income, all things remaining constant.
76
3). Price EffectIt is the change in consumption of goods because of the change in the price of the goods.
Income effect. Substitute effect. Price consumption curve(PCC) shows the change in consumption basket due to change in the price of the commodity.
77
Price effect Y
A P Q PCC
X1
X3 B
B1
Price Effect
78
3). Substitute EffectArises due to the consumer inherent tendency to substitute cheaper goods for relatively expensive.
It is defined as the change in quantity demanded resulting from a change in relative price after real income effect of price is eliminated.
79
Price Effect = Income Effect + Substitute Effect PE = IE + SE
Price EffectIt is the change in consumption of goods because of the change in the price of the goods.
Income effect. Substitute effect.

80
Price Effect = Income Effect. + Substitute Effect PE = IE + SE Y
A A1 P R SE IE O Q IC1
X1
X2
X3 B
B3
B1
Price Effect
81
Demand Elasticity
The degree of responsiveness of the demand to the change in its determinants is called elasticity of demand.
Type of demand elasticity's1. Price elasticity.

Income elasticity. 3. Substitute elasticity 4. Advertise elasticity.
2.
82
Characteristics
Inverse relationship between Price & quantity
demanded.
Price is independent variable & quantity demanded is
dependent variable.
Reasons underline the law of demandIncome effect. Substitute effect.
83
Demand Function
It specify the factors that influence the demand for the
product. Px = its own price Py = the price of its substitute B, = the income of the purchaser W, = wealth of the purchaser. A, = Advertisement E, = the price expectation. T, = taste or preference of user. U, = all other factors. So Dx = D(Px, Py, B, W, A, E, T, U,)
84
Demand Elasticity
The degree of responsiveness of the demand to the change in its determinants is called elasticity of demand.
Type of demand elasticity's1. Price elasticity.

Income elasticity. 3. Substitute elasticity 4. Advertise elasticity.
2.
85
Demand Elasticity
Type of demand elasticity1. Price elasticity
Price elasticity is generally define as the responsiveness or sensitivity of demand for commodity to the changes in its price. it is percentage change in demand as a result of percentage change in the price of the commodity. Price Elasticity =
% Change in Quantity demanded % Change in the price of the commodity
86
Demand Elasticity
Y D R 4 Price 3 Q
16
25
Quantity Demanded
87
Calculating Elasticity
ARC Elasticity
The measure of elasticity of demand between any two finite points on a demand curve is known as ARC elasticity. ARC Elasticity =
Q2 - Q1 ( Q1 + Q2 ) / 2 P2 - P1 ( P1 + P2 ) / 2
where Q1 = Initial quantity Q2 = Final quantity P1 = Initial price P2 = Final price
88
Calculating Elasticity
Point Elasticity
For an infinitesimal (very, very small )change in price we use point elasticity.
Y
M Ep P R = PN PM
O N
X
89
Demand Elasticity
Determinant of Price elasticity.1.
2.
3. 4. 5. 6.
Availability of the substitute. Nature of the commodity. Weightage of the total consumption. Time factor in adjustment of consumption pattern. Range of commodity use. Price expectation of buyers
90
Supply Analysis
Supply
The supply of a commodity means the amount of that
commodity which producers are

Ability to supply Willing to supply At a given price.
Quantity supplied refers to a specific amount of
the commodity that will be supplied at a specific price.

91
Supply Function
It specify the factors that influence the supply for the
product. Px = its own price Py = the price of its substitute F, = Price of the factors of production. T, = State of technology E, = Means of transportation & Communication. T, = Taxation policy. U, = Future expectation of prices. So Sn = F(Px, Py, F, T, , E,T,U)
92
Supply Analysis
The Law of Supply
Other thing remaining the same, as the price of a
commodity rises, its supply increases; and the price falls, its supply decrease.
There is a direct positive relationship between price
and quantity supplied.
93
Supply Analysis
The law of supply is accounted by two factors:
Assuming firm cost is constant.

When prices rise, firm substitute production of one
commodity for another.

Higher price means higher profits.
94
Supply Schedule
A supply schedule is a tabular representation of data
on the quantity supplied and the price of the commodity. Supply schedule of Firm A, B, C
Price 2 4 6 8 10 Supply (A Firm) 25 100 200 300 400 Supply (B Firm) 50 100 150 200 250 Supply (C Firm) 75 150 225 300 375 Aggregate Supply 150 350 575 800 1052
95
Supply Curve
Y 4 Price 2 R S
S O
25
Quantity Supplied
100
96
Supply Analysis
Supply Curve: The supply curve shows the minimum price which the
firm would be prepared to receive for different quantities the of the commodity .
It has a positive slope.
Supply curve rise upward from left to right.
97
Supply Analysis
Shift in Supply Curve:-
The shift in supply curve occurs when the producers
are willing to offer more or less of a commodity because of reasons other than the price of the commodity.
This change in supply which occurs because of a
change in any of the determinants of supply, other than price is known as increase or decrease in supply.
98
Supply Analysis
Elasticity of Supply : Elasticity of supply of a commodity measure s changes
in the quantity supplied as a result of a change in the price of commodity.
It is percentage change in quantity supplied as a result of percentage change in the price of the
consumer. % Change in Quantity supplied Supplied Elasticity =
% Change in Price of the commodity
99
Supply Elasticity
Determinant of Supplied elasticity.Nature of the commodity. 2. Time lag. 3. Techniques of production. 4. Estimates of future prices.
1.
100
Production
Creating an utility is known as production. The term production means a process by which resources are transformed into a different and useful commodity or service. In general production means transform input into output. Production also involved intangible input to produce intangible output. Wholesaling, retailing, packaging, assembling are all production activity.
101
Production
Fixed input & Variable input.:-
Fixed input is one whose supply is inelastic in the short run or which remain constant up to certain level of output. Variable input is defined as one whose supply in the short run is elastic or variable input which changes with the change in output. In long run all inputs are variable.
102
Production
Short Run & Long Run:-
Short run refers to a period of time in which the supply of certain inputs ( plant, building, machinery etc) is fixed.
The long run refers to a period of time in which the supply of all the inputs can be changed.
103
Production Function.
Production Function:-
Production function is tool of analysis used to explain the input output relationship. It describes the technological relationship between inputs and output in physical term. More specifically it represent the quantitative relationship between inputs and outputs.
104
Production Function:Economically it stated as belowQ= f(L,L,K,O). More specifically it can be stated asQ= f(Ld, L, k, M, T, t)
Q= quantity produced, Ld = land & building, K= capital T= technology, & t= time. for the sake of convenience the number of variable used in a production function to only twoQ=f(L,K)
105
Production FunctionEconomically it stated as belowQ= f(L,L,K,O). More specifically it can be stated asQ= f(Ld, L, k, M, T, t)
Q= quantity produced, Ld = land & building, L= labor K= capital, M= Material T= technology, & t= time. for the sake of convenience the number of variable used in a production function to only twoQ=f(L,K)
106
Production Law-
Law of production state the relationship between input and out put.
It can be studied under two conditions
Short Run law of production. Law of return to variable inputs. Law of Diminishing return to scale. Long Run. Law of return to scale.
107
Short run law of production-
a)Can employee unlimited variable factors of production. b) Fixed production factors can not be changed.
c) Law state the relationship between varying factors of production and out put therefore known as law of return to variable input or law of diminishing return.
108
Short run law of production- (Diminishing returns)
The law of diminishing returns state the relationship between varying factors of production and out put therefore known as law of return to variable input or law of diminishing return. Assumption of the law1. The state of technology is given 2. Labor is homogeneous. 3. Input prices are given.
109
The law of diminishing returns state that when more & more units of a variable inputs are applied to a given quantity of fixed inputs, the total output initially increase at a increasing rate & then at constant rate but it will eventually increase at diminishing rates. Stages of production1. Stage one increase at increasing rate. 2. Stage two increase but at constant rate. 3. Stage three total production decrease.
110
Stages of Production N0 0f Workers 0 Total Production TP 0 Marginal Production MP 0 Average Production AP 0 Stages of Production.
1
2 3 4 5 6 7 8 9 10 11 12
24
72 138 216 300 384 462 528 576 600 594 552
24
48 66 78 84 84 78 66 48 24 -6 -42
24
36 46 54 60 64 66 66 64 60 54 46 III Negative return
111
I Increasing Return
II Diminishing Return
More specifically the law of diminishing returns can be state as followsGiven the employment of fixed factor (capital) when more and workers are employed the return from the additional worker may initially increase but eventually decrease. Reason for the law1. Indivisibility of fixed factor 2. Division of labour. 3. Per worker marginal productivity decrease after optimum utilization of capital. 112
Application of Short run law of production-
(Diminishing returns)
It provides answer to what number of workers to be
employed at a given fixed input. How much to produce. More application in agriculture sector. May not apply universally to all kinds of production activities.
113
Long Term laws of production.(Law of return to scale)
Production with Two variable inputs.

In this section, we will discuss the relationship between inputs & outputs under the condition that both the inputs capital and labour are Variable factors. The technological relationship between changing scale of inputs and outputs is explained under the laws of returns to scales. the law of return to scale can be explained through the 1) Laws of returns to scales through Production function. 2) Isoquant Curve technique.
114
Law of return to scale, Production function.
Laws of returns to scale explain the behavior of output in response to a proportional and simultaneous change in inputs. When a firm expands its scale there are three technical possibilities.i) Increasing Returns to scale ii) Constant returns to scale, iii) Diminishing returns to scale.
115
i) Increasing Returns to scale Output more than doubles when all inputs are doubled. Causes of increasing returns to scaleTechnical and marginal indivisibility Higher degree of specialization. It is known as economics of scale.
116
ii) Constant returns to scale, When the change in output is proportional to the change in inputs, it exhibits constant returns to scale. for ex if quantities of both the inputs, K and L are double and output is also double the return to scale is said to be constant.
117
iii) Diminishing returns to scale. The firm are faced with decreasing returns to scale when a certain proportionate change in inputs K, and L leads to a less than proportional change in output. Causes of Diminishing return to scale The diminishing return to management. Exhaustibility of natural resources.
118
iii) Diminishing returns to scale. The firm are faced with decreasing returns to scale when a certain proportionate change in inputs K, and L leads to a less than proportional change in output. Causes of Diminishing return to scale The diminishing return to management. Exhaustibility of natural resources.
119
Law of return to scale, Isoquant curve.
Isoquant. Iso (Greek word)= equal And quant ( Latin word) = quantity. Equal production curve, or Production indifference curve. it is locus points representing various combinations of two inputs capital and labour yielding the same output. Assumption1.There are only two inputs (L, K) 2.Two inputs (L,K) can substitute.
120
Insoquant Schedule of input L & K.

Combination Input Units k OK4 OK3 OK2 OK1 Input Units L OL1 OL2 OL3 OL4 Total Output 100 100 100 100
A B C D
Five combination A, B, C, D of two substitute inputs L & K as presented in table yield the same level output.
121
Properties of Insoquant Curve

Isoquant curves have a Negative slope.
The negative slope in the of the insoquant implies substitution between the
inputs. If one input is increase reduced other input has to be increased.
Isoquant curves do not intersect nor are they tangent
to one another. Upper isoquant represent upper level of output. Isoquant curves are convex to the origin
It is because diminishing Marginal Rate of Technical Substitution. A rate at which a marginal units of labour can substitute a marginal units of capital. Reason for MRTS- 1. No two factors are perfect substitute. 2. Inputs are subject to diminishing marginal return.
122
Optimal Input Combination.

Isocline, Budget Line Budget Constraint Line-
Which represents the alternative combinations of K & L that can be purchased out of the total cost.
Optimal input out put combination. Or least cost
combination.Least cost combination exists at a point where isoquent is tangent to the isocost line.
123
Cobb Douglas Production

The CobbDouglas functional form of production
functions is widely used to represent the relationship of an output to inputs. It was proposed by Knut Wicksell (18511926), and tested against statistical evidence by Charles Cobb and Paul Douglas so it is called Cobb Douglas production function.
The theory is depended on the real practical
experience they get in U.S automobile industry.
124
The cobb Douglas function indicates constant returns to scale. That is if factor of production are each raised by 1% then out put
will also increase by 1%. Mathematically, the function can be stated as Y = ALK, where: Y = total production (the monetary value of all goods produced in a year) L = labor input K = capital input A = total factor productivity and are the output elasticity's of labor and capital, respectively. They are the exponent equal to 1. These values are constants determined by available technology.
125
Out Put elasticity or Elasticity of production Output elasticity measures the responsiveness of output to a change in levels of either labor or capital used in production, when other thing remaining same.
For example if = 0.50, 1% increase in labor would lead to approximately a 0.50% increase in output.
Or = 0.50, 1% increase in capital would lead to approximately a 0.50% increase in output.
So as per the cobb Douglas Production function.
Y = ALK, +,=1 Means 1% increase in input would lead to approximately a 1% increase in output.
126
127
Consider a cobb Douglas production function with
parameters A= 100, = 0.50, =.50
Production table for the production function Y = ALK, Y = 100L.50K.50,

Rate of capital input 1 2 3 4 5 1 2 3 4 5 Rate of labour Input(L)
128
Total Out Put 100 200 400
Cost Function
Some basic costs & Cost concept. Fixed cost:-
Fixed costs those which are fixed in volume for a certain given output. Fixed cost does not vary with variation in the output between zero & certain level of output. Variable Cost Variable costs are those which vary with the variation in the total output.
129
Cost Function
Average variable cost. Counted
Average Variable cost(AVG)= Total Variable cost (TCV) Total out put. (Q) Total cost, Average Fixed cost, Average variable cost. Total cost= Total fixed cost+ Total variable cost. Average Total Cost Average Total Cost(TCV)=
Total cost (TC) Total out put.

130
Cost Out Put Relations
Q
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
FC
10 10 10 10 10 10 10 10 10 10 10 10 10 10 10 10 10
TVC
0 5.15 8.8 11.3 12.8 13.8 14.4 15.1 16 17.6 20 23.7 28.8 35.8 44.8 56.3 70.4
TC
10 15.2 18.8 21.3 22.8 23.8 24.4 25.1 26 27.6 30 33.7 38.8 45.8 54.8 66.3 80.4
AVC
5.15 4.4 3.75 3.2 2.75 2.4 2.15 2 1.95 2 2.15 2.4 2.75 3.2 3.75 4.4
AC
15.2 9.4 7.08 5.7 4.75 4.07 3.58 3.25 3.06 3 3.06 3.23 3.52 3.91 4.42 5.03
MC
5.15 3.65 2.45 1.55 0.95 0.65 0.65 0.95 1.55 2.45 3.65 5.15 6.95 9.05 11.5 14.2
131
Cost Function
Some Important cost relationship When MC falls Ac follows. But the rate of fall in MC is greater than AC. Reason MC decreasing cost is attributed to single marginal unit while in case of AC, decreasing marginal cost is distributed over entire out put.
When MC increases AC also increases but at a lower rate
for the same reason.

MC intersects AC at its minimum point. That is output
optimization point.
132
Cost Function
Cost Curves and the law of diminishing returns Given the employment of fixed factor (capital) when
more and more variable inputs are employed the output from the additional input may initially increase but eventually decrease.
Given the employment of fixed factor (capital) when
more and more variable units are employed the cost from the additional input may initially decrease but eventually increase.
133
Relationship between Production & Cost function.

Cost function is the relationship between a firms costs and the firms output. The cost function is closely related to production function. Production function specifies maximum quantity of out put that can be produced from various combinations of inputs. Where as the cost function combines this information with input price on various outputs and their prices. Thus cost function is combination of production function and input prices.
134
Market Is a system by which buyers and sellers bargain for the price of product, settle the price and transact their business. Buyer Seller. Commodity. Price. How is the price of a commodity can be determined? The market structure influence firms pricing decisions. The nature and degree of competition make the market structure. Depending on the market structure the degree of competition varies between 0 to 1. Higher the degree of competition the lower the firms degree of freedom & control over the price of its own product & vice 135 versa.
Market Structure and Pricing Decision

Types of the market Structure-
1. Perfect Competition2. Imperfect Competitiona). Monopolistic competition. b). Oligopoly c). Monopoly.
The theory of pricing explains pricing decisions and profit behavior of the firms in different kinds of market structure.
136

Perfect Competition1.
2.
3. 4. 5. 6.
Large number of sellers & buyers. Homogeneous product. Perfect mobility of factors of production. Free entry & free exit. Absent of collusion or artificial collusion. No government intervention. CompetitionAs characteristic perfect competition is uncommon phenomenon. Up to some extant we can find perfect competition in Financial market & agriculture market. But it provides starting point and analytical framework for pricing theory.
137
Price Determination Under Perfect Competition.

Price in perfectly competitive market is determined by the market forcesMarket demand & Market supply. Market Demand- refers to the demand for the industry as a hole. It is sum of quantity demanded by each individual consumer.
Market Supply refers to the sum of quantity supplied by the individual firms in industry. So market price is determined for the industry and given to the firm. So sellers are not price makers but they are price takers. 138 138
Market Demand Versus Individual Firm Demand Curve

Price $10
8 6 4 Market demand 1,000 3,000 Quantity Market Market supply Firm Price $10 8
6
4 2 0 10
Individual firm demand
2 0
20
30
Quantity
139
Profit-Maximizing Level of Output

What happens to profit in response to a change in
output is determined by marginal revenue (MR) and marginal cost (MC).

A firm maximizes profit when MC = MR.
140
Profit-Maximizing Level of Output

Marginal revenue (MR) the change in total revenue
associated with a change in quantity sold.
Marginal cost (MC) the change in total cost
associated with a change in quantity produced.

A perfect competitor accepts the market price as given.
As a result, marginal revenue equals price (MR = P).
141
Marginal Cost, Marginal Revenue, and Price

Price = MR Quantity Produced
Marginal Cost Costs
MC
35.00 35.00 35.00 35.00 35.00 35.00 35.00 35.00 35.00 35.00 35.00
0 1 2 3 4 5 6 7 8 9 10
60 50 40 30 20 10 0 1 2 3 4 5 6 7 8 9 10 Quantity
142
28.00 20.00 16.00 14.00 12.00 17.00 22.00 30.00 35.00 54.00 68.00
A A
C B
P = D = MR
The Marginal Cost Curve Is the Supply Curve

The MC curve tells the competitive firm how much it
should produce at a given price.
The firm can produce the quantity at which marginal
cost equals marginal revenue which in turn equals price.
143
Determining Profit and Loss From a Graph

Find output where MC = MR. The intersection of MC = MR (P) determines the quantity the firm will produce if it wishes to maximize profits. The firm makes a profit when the ATC curve is below
the MR curve. The firm incurs a loss when the ATC curve is above the MR curve.
144
MC MC Price Price 65 65 60 60 55 55 50 50 ATC 45 45 40 D A P = MR 40 35 35 P = MR Profit 30 30 B ATC 25 C 25 AVC AVC E 20 20 15 15 10 10 5 5 0 0 1 2 3 4 5 6 7 8 9 10 12 1 2 3 4 5 6 7 8 9 10 12 Quantity Quantity (a) Profit case (b) Zero profit case
Determining Profits Graphically

Price 65 60 55 50 45 40 35 30 25 20 15 10 5 0 Loss
MC
ATC
P = MR AVC
1 2 3 4 5 6 7 8 9 10 12 Quantity
(c) Loss case
145
The Shutdown Point

The firm will shut down if it cannot cover average
variable costs.
A firm should continue to produce as long as price is
greater than average variable cost.
If price falls below that point it makes sense to shut
down temporarily and save the variable costs.
146
Long-Run Competitive Equilibrium

Profits and losses are inconsistent with long-run
equilibrium.
Profits create incentives for new firms to enter, output
will increase, and the price will fall until zero profits are made. The existence of losses will cause firms to leave the industry.
147
Output, Price, and Profit in Perfect Competition

Long-Run Adjustments In short-run equilibrium, a firm may earn an economic profit, earn normal profit, or incur an economic loss and which of these states exists determines the further decisions the firm makes in the long run. In the long run, the firm may: Enter or exit an industry Change its plant size
148
Monopoly Market
Monopoly-
The term pure monopoly signifies an absolute power to produce and sell a product which has no close substitute. In other words a monopoly market is one in which there is only one seller of product having no close substitute. Causes & Kinds of Monopolies1. Legal Restrictions 2. Control over key raw materials 3. Efficiency.
149
Pricing under pure Monopoly

Monopoly Pricing and output decision-
As under perfect competition, pricing and output decision in monopoly market are also based on revenue and cost conditions. AC & MC curves in a competitive and monopoly market are generally identical but revenue conditions differ.
150
Monopoly Profit and Loss

(a)
MC
E 40 32 Total Profit
ATC
50 40 E
(b) ATC MC AVC
Total Loss
D 10,000 Number of MR Subscribers 10,000
D Number of MR Subscribers
151
Profit And Loss

Monopoly firm faces a downward sloping demand
curve, marginal revenue is less than price of output

Monopoly will always produce at an output level
where marginal revenue is positive
A monopoly earns a profit whenever P > ATC A monopoly suffers a loss whenever P < ATC
152
Long run pricing decision in monopoly

In the long run a Monopolist gets an opportunity to
expand the size of the firm sale, more units can be produce at lower price with a view to enhance its long run profits.
So in long run monopolist will earn an economical
profit.
153
Pricing under pure Monopoly

Monopoly Pricing and output decision-
As under perfect competition pricing and output decision in monopoly are also based on revenue and cost conditions. AC & MC curves in a competitive and monopoly market are generally identical but revenue conditions differ.
154
Monopoly &Price Discrimination

Price discrimination. Under certain conditions, a firm with market power is able to charge different customers different prices. This is called price discrimination.
Price discrimination is the ability to charge different prices to different individuals or groups of individuals.
155

Necessary conditions for price discrimination.
Market can be separable. Limit the customers ability to resell its product from one market to another. Different market must have different elasticity of demand; Profit maximizing output is much larger then the quantity demanded.
156
A price-discriminating monopolist can increase both output and profit.
It can charge customers with more inelastic demands a higher price. It can charge customers with more elastic demands a lower price.
157
Perfect Price Discrimination

First degreeA firm with market power could collect the entire consumer surplus if it could charge each customer exactly the price that customer was willing and able to pay. This is called perfect price discrimination or first degree.
Second degreeUnder this monopolist divide the potential buyers into the blocks e.g rich, middle class, poor class & sell the product at different price.
Third degreeSet the different price in different market having deferent price elasticity.
158
Monopolistic Competition
Monopolistic competition
Is a market structure in which there are many firms selling differentiated products. The model of price & output determination under monopolistic competition was developed by Edward H Chamberlin.
159
Characteristics:
Many number of firms in the industry. The products produced by the different firms are
differentiated.
Entry and exit from the industry is relatively easy .
Consumer and producer knowledge imperfect.
160
Major Automobile player in India Ashok Leyland HMT Tractors Royal Enfield Audi AG Honda Motors Co. Ltd. San Motors Bajaj Auto Hyundai Motors Scooters India Ltd BEML Indofarm Tractors Skoda Auto India BMW Kinetic Motor Co. Ltd. Sonalika Tractors Bentley Motors Limited Lamborghini Suzuki Motors Chevrolet LML India Swaraj Mazda Ltd. Daewoo Motors Mahindra & Mahindra Ltd. Tafe Tractors Eicher Motors Maruti Suzuki India Ltd. Tata Motors Escorts Ltd. Mercedes Benz Telcon Fiat India Pvt Ltd Mitsubishi Motors Terex Vectra Force Motor Monto Motors Toyota Kirloskar Motors Ford Motors Nissan Motors TVS Motor Co. General Motors Porsche Volkswagen Hero Honda Reva Electric Co. Volvo Hindustan Motors Rolls-Royce Motor Yamaha Motor
161
Product Differentiation
Product differentiation Implies that the products are different enough that the producing firms exercise a mini-monopoly over their product.
The firms compete more on product differentiation
than on price.
Entering firms produce close substitutes, not an
identical or standardized product.

162
Product Differentiation
Firms may differentiate products by perceived quality, reliability, color, style, safety features,
packaging, purchase terms, warranties and guarantees, location, availability (hours of operation) or any other features. Marketing is often the key to successful differentiation. The goals of advertising include shifting the demand curve to the right and making it more inelastic. Brand names may signal information regarding the product, reducing consumer risk.
163
Monopolistic
Short run profit determination diagram:
Cost/Revenue
This is a short run equilibrium position for a firm in a monopolistic market structure.
MC AC
1.00
Abnormal Profit
0.60
Marginal Cost and The demand curve Average Cost will befacing the the firm will be downward same shape. However, sloping and represents the Since the additional because the products ARdifferentiated earned from sales. revenue received from are in each unit sold the will some way,falls, the firm MR curve lies under theextra only be able to sell AR curve. output by lowering If the firm produces Q1 and price. sells each unit for 1.00 on average with the cost (on We firm produces where average) for each unit being MR = MC (profit 60p, the firm will make 40p x maximising output). At this Q1 in abnormal profit. output level, AR>AC and the firm makes abnormal profit (the grey shaded area).
MR
Q1
D (AR)
Output / Sales
164
Monopolistic or Imperfect Competition

Long run profit determination diagram:
Cost/Revenue
MC AC
MR1 Q 1
MR
AR1
D (AR)
Output / Sales
Because there is relative freedom of entry and exit into the market, new firms will enter encouraged by the existence of abnormal profits. New entrants will increase supply causing price to fall. As price falls, the AR and MR curves shift 165
Monopolistic
Cost/Revenue
MC AC
AR = AC
MR1 Q 2 Q 1
MR
AR1
D (AR)
Output / Sales
Notice that the existence of more substitutes makes the new AR (D) curve more price elastic. The firm reduces output to a point where MC = MR (Q2). At this output AR = AC and the firm will make normal profit.
166
Monopolistic
Cost/Revenue
MC AC
AR = AC
MR1 Q 2
AR1
Output / Sales
Notice that the existence of more substitutes makes the new AR (D) curve more price elastic. The firm reduces output to a point where MC = MR (Q2). At this output AR = AC and the firm will make normal profit.
167
Monopolistic Competition profit loss situation

Monopolistic competitor may make profit, loss or no
profit no loss (normal profit) in short run.

Monopolistic competitor make zero economic profit in
the long run.
168
Oligopoly
Oligopoly Is a market structure in which there is few sellers selling homogenous or differentiated products. For ex industries like cement, steel, petrol cooking gas, chemicals, aluminum, etc.
169
Oligopoly Market
Characteristic of Oligopoly Market.
Small number of sellers. 2. Interdependence of decision making. 3. Barriers to entry. significant economies of scale strong product name recognition 4. Indeterminate price and output. Firms rarely engage in price decrease that is considering a price reduction may wish to estimate that competing firms would also lower their prices and it will give rise to price war. Or if the firm is considering a price increase it may want to know whether other firms will also increase prices or hold existing prices constant.
1.
170
Oligopoly
Oligopoly
Since firms can compete on different levels, and with respect to many choice variables, no one model can neatly capture oligopoly behavior.
Kinked Demand curve -Price leadership
Limit pricing and entry deterrence

Quality competition Game theoretic models that focus on strategies
171
Oligopoly
Kinked Demand Curve Kinked demand curve model of oligopoly was developed by Paul M Sweezy. He has tried to show through his kinked demand curve analysis that price and output once determined under oligopolistic conditions, tend to stabilizer rather than fluctuating.
172
Oligopoly
Kinked Demand Curve An oligopolistic faces a downward sloping demand curve but the elasticity may depend on the reaction of rivals to changes in price and output.
(a) rivals will not follow a price increase by one firm -
therefore demand will be relatively elastic and a rise in price would lead to a fall in the total revenue of the firm.
(b) rivals are more likely to match a price fall by one
firm to avoid a loss of market share. If this happens demand will be more inelastic and a fall in price will also lead to a fall in total revenue. 173
Oligopoly
Kinked Demand Curve. The kinked-demand curve is a demand curve comprised of two segments, one that is relatively more elastic, which results if a firm increases its price, and the other that is relatively less elastic, which results if a firm decreases its price. These two segments are joined at a corner or "kink." This demand curve is used to provide insight into why oligopoly markets tend to keep prices relatively constant.
174
Oligopoly
Kinked Demand Marginal Revenue Curve. As always, the marginal revenue curve lies below the relevant demand curve. If the firm lowers price below P* a strong reaction from competitors occurs in the form of industry wide price drops. This causes MR to drop dramatically, causing a gap in the curve.
175
Pricing Strategies
Price Leadership. Marginality rules determines the profit maximization at the level of output where MR=MC. But in real business world, business follow a variety of pricing rules and methods depending on the conditions faced by them. Some important pricing strategies and methods as follows.1. Cost plus pricing 2. Multiple Product pricing. 3. Skimming pricing policy. 4. Penetration price policy .
176
Pricing Strategies
Cost Plus Pricing. Cost plus pricing is also known as mark up pricing, average cost pricing or full cost pricing. The general practice under this method is to add a fair percentage of profit margin to the average variable cost(AVC).
P= AVC+AVC(m).
177
Pricing Strategies
Product line Pricing. Establishing a single price for all products in a product line, such as for dress materialprice of 2550 for the high-priced line, 1450 for the medium-priced line, and 350 for the lower-priced line.
178
Pricing Strategies
Multiple Product Pricing.
Almost all companies have more than one product in their product . Portfolio. For example refrigerators, TV sets, radio & car models produced by the same company may be treated as different product for at least pricing purpose.
The pricing under these conditions is known as multi Product pricing or product line pricing.
179
Pricing Strategies
Skimming Pricing policy.
This pricing strategy is intended to skim the cream of the market, by setting a high initial price. This initial price would generally accompanied by heavy sales promotion expenditure.
Such pricing is more effective if there is no close substitute product is available.
180
Pricing Strategies
Penetration Pricing policy.
In contrast to skimming price policy the penetration pricing strategy involves a reverse strategy. Under this they fix a lower initial price to trap the market as quickly as possible and intend to maximize the profit.
Such pricing strategy they use where there is more substitute products are available.
181
Almost an eighth Wonder

The Indian economy grew at 7.9% in the JulySeptember period, its fastest pace in the last six quarters. The growth figure surpassed individual projections of more than 25 economists surveyed by various agencies and is second only to Chinas among major economies. Chinese economy grew 8.9% in the September quarter.
182
183

KEY DRIVERS High govt expenditure, funded largely through borrowings
Increased incomes in rural areas due to greater social
spending and high farm goods prices

Higher govt salaries & Pay Commission arrears
Low interest rates & higher incomes driving demand Private consumption growth has picked up at 5.6% in the
quarter against the dismal 1.6% in the previous quarter.

Pickup in investments. Gross fixed capital formation up
7.3% compared to 4.2% in the previous quarter

184

IMPLICATIONS Growth forecast for 2009-10 likely to be hiked to over
7%.
More pressure on govt to start unwinding stimulus
moves, but cloud on demand support if govt expenditure drops.

RBI could tighten rates sooner than expected.
GDP NOS IN LINE WITH 8% GROWTH PROJECTION
185
National Income Concept and Measurement.

National income is the outcome of all economic activities of a nation valued in term of money during a specific period. Economic activityall human activity which create goods & services that can be value in term of money.
Non Economic activityall human activity which create goods & services that can not be value in term of money.
186

Different ways of Measuring national incomeProduction Method GNP- Gross national Product.
Income Method. GNI- Gross national Income. Expenditure Method GNE- Gross national Expenditure.
GNP=GNI=GNE.
187
The Circular-Flow Diagram methods of estimating National Income.

Market for Goods Goods & Services sold and Services
Revenue Spending Goods & Services bought
Firms
Households
Inputs for production

Wages, rent, and profit
Market for Factors of Production
Labor, land, and capital

Income
188
Flow with Leakages/Injections

Resource Income
Businesses
Investment
FINANCIAL MARKET
Saving
Households
Spending
Government
Taxes
Spending for Goods and Services

189
The circular flow of income
Factor payments
Consumption of domestically produced goods and services (Cd)
190
Factor payments
BANKS, etc
Net saving (S)
191
Investment (I)
Factor payments
BANKS, etc
Net saving (S)
192
Investment (I)
Factor payments
BANKS, etc
GOV.
Net Net taxes (T) saving (S)
193
Investment (I)
Factor payments
Government expenditure (G) BANKS, etc GOV.
Net Net taxes (T) saving (S)
194
Investment (I)
Factor payments
Government expenditure (G) BANKS, etc GOV. ABROAD
Net saving (S)
Import Net expenditure (M) taxes (T)
195
Export expenditure (X) Investment (I) Government expenditure (G) BANKS, etc GOV. ABROAD
Factor payments
Net saving (S)
196
Factor payments
Net saving (S)
WITHDRAWALS
197

INJECTIONS
Factor payments
Net saving (S)
WITHDRAWALS
198

Production Method (GNP).
This method views national income from output side.
This method consists of finding out the Net value of all
commodities & services of the economy for the period & adding them.
To avoid double counting only the value of final goods
and service in included.

GNP = All goods & services produced in the economy Net Prices
199

Income Method (GNI)
This method is also known as factor income method.
It counts the National income from distribution side.

GNI is obtained by totaling all the incomes earn by
factors of production. means GNI= R+W+P+I+NFIA (net factor income from abroad)
But transfer payment is not the part of national
income.
200

Expenditure Method (GDP).
It is additions of all expenditure made on goods &
services in the economy during the specific period.

means it is summation of expenditures made by
households, firms and government together Y = C + I + G + (X M) Y = GDP, C = consumption expenditure, I = investment expenditure, G = Government expenditure, X = exports, M = imports
201
Concepts of National Income
Gross national product (GNP) GNP is defined as the value of all final goods and services produced during a specific period, usually one year plus income earned abroad by the national minus incomes earned locally by the foreigners.
Gross Domestic product (GDP) The Gross domestic product is defined as the market value of all final goods & services produced in the domestic economy during year , plus income earn locally by the foreigners minus income earned abroad by the nationals. GDP= GNP-NFIA (net factor income from abroad). GDP= C + I + G + (X M)
202
Net national product (NNP) It is derived by deducting depreciation or capital consumption from GNP. National Income Net national product income at factor cost is properly known as National Income. It is obtained by deducting indirect taxes and adding subsidies to Net national product.
Private Income Private income may be defined as the income obtained by private individual from any sources, it includes retained earning of corporations.
203

Personal income
Personal income means the spendable income at current prices available to individuals before personal taxes are deducted. It excludes undistributed profit.
Disposable personal income is the income that household and noncorporate businesses have left after satisfying all their obligations to the government. It equals personal income minus personal taxes.
204
Some Accounting RelationshipAt Market price. GNP= GNI (Gross National Income) GDP= GNP less Net Income from abroad. NNP= GNP less depreciation.
At Factor price. GNP(at factor cost)=GNP at market price less indirect tax + subsidies. NNP(at factor cost)= NNP at market price less indirect tax + subsidies. NDP (at factor cost)= NDP at market price less indirect tax + subsidies.
205
Particular
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 Wages & Salaries Imports of goods & services Rent Value added in Agriculture Govt. current expenditure Capital Consumption Value added in Construction Consumers Expenditure Dividends Income from self employment Exports of goods & services Undistributed profit Gross Domestic fixed investment Value added in manufacturing Value added in distribution trade Trading surplus of public corporation Value added in other sectors
Rs. Million
430 220 50 100 140 70 50 450 500 60 650 110 150 150 600 20 270
206
Gross National Product Value added in agri. Value added in Manufacturing Construction Distribution Other sectors GNP Less Dep NNP
RS. millions
Gross National Expenditure
Gross National Income
100
Consumer Exp.
450
Wages & Salaries
430
600
50 150 270 1170 -70 1100
Govt exp
Gross Fixed inv Change in stock Exports less imports GNE less dep NNE
140
150 10 650 -220 1170 -70 1100
Self employment Company profit dividends Retained profits Public corporations Rent GNI less dep NNI
60
500 110 20 50 1170 -70 1100
207
Unemployment
If a person has ability to work, willingness to work but
not able to get job at the given market wage rate then he is called unemployed person.
In common parlance, anybody who is not gainfully
employed in any productive activity, is called unemployed.

Unemployment can divided in Two type. Voluntary unemployment. Involuntary unemployment.
208
Unemployment
Voluntary unemployment
Means the persons within working population, who may be interested in jobs at wage rate higher than the prevailing wage rates in the labour market. And wiling to be unemployed.
Involuntary unemployment
Is situation in which person fail to get jobs even when they are prepared to accept such jobs at the prevelling wage rate.
209
Unemployment
Types of Involuntary unemployment Structural unemployment.
Seasonal unemployment
Disguised unemployment. Cyclical unemployment.
Technological unemployment.
Frictional unemployment.
210
Unemployment
Structural unemployment.
Unemployment caused as a result of the decline of industries and the inability of former employees to move into jobs being created in new industries.
Seasonal unemployment
Unemployment caused because of the seasonal nature of employment tourism, skiing, cricketers, beach lifeguards, etc.
211
Unemployment
Disguised unemployment.
If the total marginal contribution of the worker to the total is zero then it is called as Disguised unemployment.
Cyclical unemployment.
Cyclical unemployment is that which occurs due to cyclical nature of business. During recession phase over all demand for labour is low and during growth demand for labour is high.
212
Unemployment
Technological unemployment.
Unemployment caused when developments technology replace human effort e.g in manufacturing, administration etc.
Frictional unemployment.
in
It is the nature of temporary unemployment caused by continual movement of people between one region to another region and one job to another job.
213
Inflation
Inflation is an increase in the overall level of prices.
According to Milton Friedman- inflation is a sustained increase in price.

Defined as:
A SUSTAINED RISE IN THE AVERAGE LEVEL OF
PRICES
It implies a continuously rising trend in general prices. Deflation, is an continuously decreasing in the overall level of prices.
214
Inflation
Causes of Inflation Demand Pull Factors
Defined as: - Excess demand condition pulls up prices of goods and services and lead to price rise.
Cost pull factors. Some factors of production are responsible for rising
the cost of production it leads to price rise.

215
Inflation
Demand pull factors are as follows. Population pressure.
Mounting govt. expenditure

Growing supply of money Growing deficit financing
Growing black money.
216
Inflation
Cost Push factors are as follows. Oil price hike.
Slow growth rate of agriculture production.

Increase in wages and bonus. Rise in administered prices.
Increase in tax rate.
217
Inflation
Other factors. Increase in procurement prices.
Creation of artificial crisis.

Devaluation of domestic currency.
218
Costs and Consequences of Inflation
Photographs help illustrate how money can become worthless when inflation gets out of control.
Title: Overflowing Riches. Date: 1922. Description: A shopkeeper using a tea chest to store money which won't fit in the cash register during Germany's high inflation.
219
Inflation
Description: Children using notes of money as building blocks during the 1923 German inflation crisis.
220
Costs and Consequences of Inflation

Money loses its value and people lose confidence in
money as the value of savings is reduced Inflation can get out of control - price increases lead to higher wage demands as people try to maintain their living standards. Consumers and businesses on fixed incomes lose out because the their real incomes falls Employees in poor bargaining positions lose out Inflation can favor borrowers at the expense of savers because inflation erodes the real value of existing debts Inflation can disrupt business planning and lead to lower investment Inflation is a possible cause of higher unemployment Rising inflation is associated with higher interest rates this reduces economic growth and can lead to a recession 221
Types of inflation
Creeping inflation It is a situation in which the rise in general price
level is at a very slow rate over a period of time. Under creeping inflation, the price level raises upto a rate of 2% per annum. A mild inflation is generally considered a necessary condition of economic growth.
Walking inflation Walking inflation is a marked increase in the rate
of inflation as compared to creeping inflation. The price rise is around 5% annually.

222
Types of inflation
Running inflation Under running inflation, the price increases is
about 8% to 10% per annum.

Hyper inflation Galloping inflation is a full inflation. Keynes calls
it as the final stage of inflation. It is a stage of inflation which starts after the level of full employment is reached. Here price level rise
223
Inflation
Way to control inflation. (1)Monetary Policy Monetary policy is a policy that influences the
economy through changes in the money supply and available credit. (a) Quantitative controls (b) Qualitative controls .
224
Inflation
Way to control inflation. Fiscal Policy It is the budgetary policy of the government relating
to taxes, public expenditure, public borrowing and deficit financing. Changes in taxation Changes in Govt. Expenditure Public borrowing Control of deficit financing
225
Inflation
Way to control inflation. Others Measures: Price support programme.
Provision subsidies.
Imposing direct control on prices of essential items. Rationing of essential consumer goods in case of acute
emergency.
226
Business Cycle
Gross Domestic Product is a measure of the value of all outputs in an economy in a single year - the value of all goods and services produced Gross domestic Product does not increase at a constant rate over time there are variations in growth rate. There can be times of negative growth or positive growth i.e. GDP decreases & GDP increase. These periodic movements in output, prices, and employment are known as the Economic or Business Cycle
227
Various phases of business Cycle

Expansion of business activities. Peak of boom or prosperity.
Recession
Trough the bottom of depression Recovery & expansion.
228
229
The Phases of the Business Cycle

Expansion Peak
Total Output
Recession
Expansion
Trough
Secular growth trend
Time
230
Various phases of business Cycle

Expansion of business activities. Peak of boom or prosperity.
Recession
Trough the bottom of depression Recovery & expansion.
231
Parts of Economic Cycle Boom

Low levels of unemployment shortages of labour
occur pushing up wage rates

High levels of consumer borrowing and spending
Firms working at full capacity
Profit levels high

Inflation Increasing
Interest rates increasing

Boom in housing market
232
Parts of Economic Cycle Recession

Growth rate of GDP is falling or negative
Firms decrease production and reduce stocks Unemployment rises Inflation falls Investment falls Firms suffer from falling profits, falling returns of
investment, redundancy costs.

233
Parts of Economic Cycle Recovery

Consumer confidence grows leading to increased
borrowing and spending

Firms increase output build up stock levels Spare capacity used, then Investment occurs Unemployment falls it make take more than a year of
recovery for large changes in unemployment levels

234
Government and Economic Cycle

The government will attempt to control fluctuations in
economic growth
Aims to achieve growth at around trend level Use Fiscal and Monetary policy to achieve this
objective.
235
Profit
Profit means different thing to different people. Businessman, Accountant, and Economist used the
term profit with different meaning.

For Layman profit means all income flow to the
investor.
For Accountant profit means excess of revenue over all
the paid-out cost.

For economist concept of profit is of pure profit called
as economic profit. Pure profit is return above the opportunity cost.

236
Profit
Accounting Profit Vs Economical profit. Accounting Profit -
Accounting profit is surplus of revenue over and above
paid cost. Including manufacturing and administration cost.

Accounting profit can be calculate as follows
= TR- (W+R+I+M) Where W = wages, R= Rent,
I = Interest,
M = Material.
237
Profit
Accounting Profit Vs Economical profit. Economical Profit It takes into account the implicit and explicit costs.
Implicit cost is opportunity cost.

Economical Profit=
TR- (Explicit Costs +Implicit costs)
238
Theories of profit
What are the source of profit?
Economist have given various opinion on this
question which has created controversy and led to emergence of various theories of profit.
Profit as Rent of ability This theory is given by F.A. Walker.
According to him profit is the rent of exceptional
abilities that entrepreneurs may posses.

As like land profit is the difference between the
earning of least and most efficient entrepreneur.

239
Dynamic Theory. This theory is given by J. B.Clarks F.A. Walker. According to him profit arise in only a dynamic economy
not in a static one. Static economy is one in which absolute freedom of competition, population capital are stationary, product are homogeneous (perfect competition). Dynamic economy is one which 1) Increase in population. 2)Increase in capital formation. 3)Improvement in production technique 4) Multiplication of consumer wants. Entrepreneur how take advantage of changing condition make profit. In dynamic economy dis appearance and re emergence of profit is continuous process.
240
Hawleys Risk Theory of profit. -
This theory is given by F.B. Hawley in 1893.

According to him profit is simply the price paid by
society for assuming business risk.

In business risk arise for such reason as obsolescence
of product, fall in price, non availability of certain raw material etc.

According to him profit consist of two part- 1) Risk
which is all ready suffered or assumed by entrepreneur. 2)Inducement to suffer the consequences of being exposed to risk in their entrepreneur adventure. The reason why he mentioned profit above actuarial is because risk taking is annoying, trouble some, disturbance anxiety of various kind.
241
Knights theory of profit- According to him profit is residual return for bearing
uncertainty not risk.

He divided risk into two part. Calculable & non
calculable risk. Calculable risk is those whose probability of occurrence can be estimated with available data. (Fire, theft, accident etc). Next is the risk of which occurrence can not be estimated such as change in test of consumer, change in government policy etc. that is uncertainty faced by entrepreneur.
Entrepreneurs are making decisions under uncertain
condition. In this condition if their decision proved right they would earn profit.
242
Theories of profit
Schumpeters innovation theory of profit- This theory was developed by Joseph Schumpeter. His theory of profit is embedded in his theory of
Economic development.
His theory start with the stationary of static economic
equilibrium. In such profit can be made only by introducing innovations in business, it may includes1.
Introducing of new product.
2. New method of production. 3. Opening of new market 4. New sources of raw material 5. Organising the industry in new innovative manner.
243
MONETARY POLICY
244
MONETARY POLICY
INTRODUCTION
Monetary Policy is essentially a programme of action undertaken by the Monetary Authorities, generally the Central Bank, to control and regulate the supply of money with the public and the flow of credit with a view to achieving pre-determined macro-economics goals. At the time of inflation monetary policy seeks to contract aggregate spending by tightening the money supply or raising the rate of return.
245
MONETARY POLICY
OBJECTIVES
To achieve price stability by controlling inflation and deflation.
To promote and encourage economic growth in the economy. To ensure the economic stability at full employment or potential level of output.
246
SCOPE OF MONETARY POLICY

The scope of Monetary policy depends on two factors
1. Level of Monetization of the Economy In this all economic transactions are carried out with money as a medium of exchange . This is done by changing the supply of and demand for money and the general price level. It is capable of affecting all economics activities such as Production, Consumption, Savings, Investment etc. 2. Level of Development of the Capital Market Some instrument of Monetary Policy are work through capital market such as Cash Reserve Ratio (CRR) etc. When capital market is fairly developed then the Monetary Policy effects the level of economic activities by the change in capital market. It works faster and more effectively.
247
OPEN MARKET OPERATIONS

The open market operations is sale and purchase of government securities and Treasury Bills by the central bank of the country. When the central bank decides to pump money into circulation, it buys back the government securities, bills and bonds. When it decides to reduce money in circulation it sells the government bonds and securities. The central bank carries out its open market operations through the commercial banks.
248
Discount Rate or Bank Rate policy
Discount rate or bank rate is the rate at which central bank rediscounts the bills of exchange presented by the commercial bank. The central bank can change this rate increase or decrease depending on whether it wants to expand or reduce the flow of credit from the commercial bank.
249
Working of the discount rate policy

A rise in the discount rate reduces the net worth of the government bonds against which commercial banks borrow funds from the central bank. This reduces commercial banks capacity to borrow from the central bank.
When the central bank raises its discount rate, commercial banks raise their discount rate too. Rise in the discount rate raises the cost of bank credit which discourages business firms to get their bill of exchange discounted.
250
Cash Reserve ratio

The cash reserve ratio is the percentage of total deposits which commercial banks are required to maintain in the form of cash reserve with the central bank. The objective of cash reserve is to prevent shortage of cash for meeting the cash demand by the depositors. By changing the CRR, the central bank can change the money. When economic conditions demand a contractionary monetary policy, the central bank raises the CRR. And when economic conditions demand monetary expansion ,the central bank cuts down the CRR.
251
Statutory Liquidity Requirement
In India ,the RBI has imposed another reserve requirement in addition to CRR. It is called statutory liquidity requirement. The SLR is the proportion of the total deposits which commercial banks are statutorily required to maintain in the form of liquid assets in addition to cash reserve ratio.
252
Credit Rationing
When there is a shortage of institutional credit
available for the business sector, the large and financially strong sectors or industries tend to capture the lions share in the total institutional credit.
As a result the priority sectors and essential industries
are of necessary funds. Below two measures are generally adopted: Imposition of upper limits on the credit available to large industries and firms Charging a higher or progressive interest rate on the bank loans beyond a certain limit.
253
Change in Lending Margins

The banks provide loans only up to a certain
percentage of the value of the mortgaged property.

The gap between the value of the mortgaged property
and amount advanced is called Lending Margin.

The central bank is empowered to increase the
lending margin with a view to decrease the bank credit.

254
Moral Suasion
The moral suasion is a method of persuading and
convincing the commercial banks to advance credit in accordance with the directives of the central bank in overall economic interest of the country.
Under this method the central bank writes letter to
hold meetings with the banks on money and credit matters.
255
Expansionary Policy / Contractionary Policy

An Expansionary Policy increases the total supply of
money in the economy while a Contractionary Policy decreases the total money Supply into the market.
Expansionary policy is traditionally used to combat a
recession by lowering interests rates.

Lowered interest rates means lower cost of credit
which induces people to borrow and spend thereby providing steam to various industries and kick start a slowing economy.
256
Expansionary Policy / Contractionary Policy

A Contractionary Policy results in increasing interest
rates to combat inflation. An Economy growing in an unconstrained manner leads to inflation Hence increasing interest rates increase the cost of credit thereby making people borrow less. Due to lesser borrowing the amount of money in the system reduces which in turn brings down inflation. A Contractionary Policy is also known as TIGHT POLICY as it tightens the flow of money in order to contain Inflationary forces.
257
Mahatma Gandhi
Quoted by Pranab Mukherjee
258
Fiscal Policy
The word fisc means state treasury and fiscal policy refers to policy concerning the use of state treasury or the govt. finances to achieve the macroeconomic goals. The term fiscal policy refers to the expenditure a government undertakes to provide goods and services and to the way in which the government finances these expenditures. Any decision to change the level, composition or timing of govt. expenditure or to vary the burden ,the structure or frequency of the tax payment is fiscal policy. - G.K. Shaw 259
Fiscal Policy
Fiscal Policy Objective Economic Growth: By creating conditions for increase in
savings & investment. Employment: By encouraging the use of labour-absorbing technology Stabilization: fight with depressionary trends and booming (overheating) indications in the economy Economic Equality: By reducing the income and wealth gaps between the rich and poor. Price stability: employed to contain inflationary and deflationary tendencies in the economy.
260
Fiscal Policy
TYPES OF FISCAL POLICY
DISCRETIONARY FISCAL POLICY Deliberate change in government expenditure and taxes to
influence national output and prices.

NON-DISCRETIONARY FISCAL POLICY: Built-in tax and expenditure mechanism so designed that
taxes and government spending vary automatically with changes in national income.
261
Fiscal Policy
Instruments of Fiscal Policy
Fiscal policy instruments are operated by government
at various levels Central, State & local. Broadly these instruments are listed below: Public Revenue Public Expenditure Public Debt.
262
Fiscal Policy

Public Revenue Government normally raise revenue through taxation. Direct taxesDirect taxes are imposed on income, wealth and property of the individual or corporate unit. Direct taxes like income tax and wealth tax are imposed to insure distributive justice.
263
Fiscal Policy

Public Revenue Indirect taxesIndirect taxes are imposed on commodities. Such as Central Sales Tax, Customs, Service Tax, excise duty & octroi. Indirect taxes are normally used to revenue rising. Means a small amount of taxes spread widely over a large number of commodities, a huge amount of revenue can be raised.
264
Fiscal Policy

Public Revenue Non tax revenueWith tax revenue Gov. also earn revenue through non tax sources such as Profit of public enterprise. Disinvestment of share of public enterprise. Even borrowing internally and externally.
265
Fiscal Policy
Government Expenditure Government spending on the purchase of goods & services. Payment of wages and salaries of government servants Public investment Transfer payments
266
Fiscal Policy
Public Debt. If public expenditure exceeds public revenue then government has to rise public debt. Internal borrowings 1. Borrowings from the public by means of
2.
1. 2. 3.
treasury bills and govt. bonds Borrowings from the central bank (monetized deficit financing) External borrowings Foreign investments International organizations like World Bank & IMF Market borrowings
267
Fiscal Policy
Budget A budget is a detailed plan of operations for some
specific future period.

It is an estimate prepared in advance of the period to
which it applies.
268
Fiscal Policy
Budget.
A budget is a detailed plan of operations for some specific future period
Keeping budget balanced (R=E) or deficit (R<E) or surplus (R>E) as a matter of policy is itself a fiscal instrument.
An accumulated deficit over several years (or centuries) is referred to as the government debt A deficit is a flow. And a debt is a stock. Debt is essentially an accumulated flow of deficits
269
From where Rupees Come

Non debt capital 1% service tax and other taxes 5% Non tax revenue 12%
Excise 9%
Borrowing & other Liabilities 34%
Customs 8% Income Tax 9%
Corporation tax 22%
270
Where the rupee Goes

Non plan Assistance State & UT plan to state assistance 4% 7% state share of taxes & duties 14% Other non plan expenditure 14%
Central plan 20%
subsidies 10% interest 19%
Defence 12%
271
Capital Budgeting
Definition-
Capital budgeting is essentially a process of conceiving,
analyzing, evaluating and selecting the most profitable project for investment.
Is the process of evaluating and selecting long term
investments that are consistent with the goal of shareholders wealth maximization.
Significance of capital budgeting. Capital expenditure is generally irreversible. The survival of the firm depends on how well the firm
planned its capital expenditure.
272
Capital Budgeting
Capital expenditure-
Capital expenditure means the expenditure of acquiring
assets that yield returns over a number of years. For the purpose of capital budgeting only long term expenditure will be taken in to consideration.
For ex. Expenditure on new capital expenditure. Expenditure on long term assets by new firm.
Expenditure on diversification of assets.

Expenditure on advertisement. Expenditure on research & developments.
273
Choice of decision rules One of the essential requirement of capital budgeting is the choice of criteria for accepting or rejecting a project. While deciding the criteria objective of the firm should be considered. Such as profit maximisation, asset building, regular cash flow, or maximisation of short or long run gain. Steps in determining the decision rule 1). Define the objective of the investment.
Capital Budgeting
2). Select the criteria for evaluating the project. A) Pay back period
B). Discounted cash flow (present value criteria)

C). Internal rate of return.
A) B)
3) The third step is to decide the approach for the final selection.
Accept reject approach Ranking approach.

274
Capital Budgeting
Criteria for evaluating the project.
Pay Pack Period Method The pay back period is also known as pay off period. The pay back period method is the simplest & one of the most widely used methods of project evaluation. The pay back period is defined as the time required to recover the total investment outlay from the gross earning. Pay back period = Total Investment / gross return per period. For example if a project costs Rs. 40,000 million and is expected to yield an annual income of Rs. 8000 million then its pay-off period is computed as follows: Pay off period = Rs 40,000 million/ 8000 million Pay off period= 5 years.
275
Capital Budgeting
Pay Pack Period Method In case of projects yield cash in varying amount, the pay back period may be obtained through the cumulative total of annual returns until the total equal the investment outlay.
Year 1 2 Total fixed outlay 10,000 Annual cash flows 4000 3500 Cumulative total of col. 4000 7500
3 4
5
2500 1500
1000
10,000 11,500
12,500
As the table shows, the cumulative total of annual cash flows
breaks even with the total outlay of the project (Rs. 10,ooo million)at the end of 3rd years.
276
Pay Pack Period Method After the pay back period of each project is calculated projects are ranked in increasing order of their pay back period. The project with shorter pay off period is preferred to those with longer pay off period.
Project 1 2 3 4 Pay back period year 6 3 4 5 Rank 4 1 2 3
Capital Budgeting
Drawbacks It assumes that cash inflows are known with a high degree of
certainty.
It ignores the period and the subsequent returns, after the pay off
period.
277
The concept of present value: (Time value of money) Money earn today is more valued more than money receivable tomorrow.
Because Liquidity An opportunity to invest it and earn return on it.
Capital Budgeting
This is known as time value of money. It is applied to investment
decisions.
There is difference between investment and the return from the
investment. That is the time lag between investment and return.

During this time lag investor loose interest on the expected
incomes.
Suppose that Rs. 100 is deposited in a bank @ 10% interest rate.
After one year it will increase to 110.

Rs.
110 expected value of Rs. 110.
return, this means that Rs 100 is the present

278
The concept of present value: (Time value of money)
Capital Budgeting
Future Value is the value at some future time of a present
amount of money, or a series of payments, evaluated at a given interest rate.
FV1 = P0 (1+i)n
Present Value is the current value of a future amount of
money, or a series of payments, evaluated at a given interest rate.

PV0 = FVn / (1+i)n
Here FV= Future value PV= Present value i= interest rate n= number of year.
279
Capital Budgeting
Present Value of income streams (An Annuity )represents
a series of equal payments (or receipts) occurring over a specified number of equidistant periods.
Means income is earn over the years. current value of a
future amount of money, or a series of payments, evaluated at a given interest rate.
PVAn = R/(1+i)1 + R/(1+i)2 + ... + R/(1+i)n

R = Periodic Cash Flow.
280
Capital Budgeting
Net Present Value & Investment decision.

The investment decision accepting or rejecting a project is
taken on the basic of net present value. The net present value (NPV) may be defined as the difference between the present value (PV) of an income stream & the cost of investment(C). NPV= PV-C
If investment is a recurring expenditure, the total present
cost(TPC) for n years can be calculated TPC = C/(1+i)1 + C/(1+i)2 + ... + C/(1+i)n The net present value (NPV)can be calculated as NPV= PV-TPC
281
Capital Budgeting
The investment decision rule can be stated as follows If NPA>0 then the project is acceptable If NPA=0 the project is accepted or rejected on the
economic considerations.
If NPA<0 the project is rejected.
282
Internal Rate of return.

rate.
Capital Budgeting
Is also called marginal rate of investment. Or break even
It can be defined as the rate of interest or return which
renders the discounted present value of its marginal yields exactly equal to the investment cost of the project.
IRR is the rate of return (r) at which the discounted present
value of receipts and expenditure are equal.
283
Internal Rate of return.

Cost of project Project A Project B 100 100
Capital Budgeting
1st year O 130 2nd year 140 0
IRR for project A = 18.3% IRR for project B= 30% The project is accepted which gives
higher IRR- means
higher return on investment.
284
Capital Budgeting
Capital budgeting is not only one of the most important
tasks of business management, but also a complicated procedure. Managers skills, experience, intuition, and forecasting are perhaps needed more in taking appropriate investment decisions.
285
LEVELS OF DEMAND FORECASTIONING

MICRO LEVEL: It refers to the demand forecasting by the individual business firm for estimating the demand for its products. INDUSTRY LEVEL: It refers to demand estimate for the product of the industry as the whole. It relates to the market demand as a whole. MACRO LEVEL: It refers to the aggregate demand for the industrial output by the nation as the whole.
287
TYPES OF DEMAND FORECASTING

SHORT TERM FORECASTING Relate to a period not exceeding a year. Usually day to day information's which are concerned with tactical decisions under the given resource constraints ; In short term forecasting a firm is primarily concerned with the optimum utilization of its existing production capacity.
289
SHORT TERM FORECASTING SERVE THE FOLLOWING PURPOSE
EVOLVING
SALES POLICY
DETERMING PRICE POLICY
EVOLVING A PURCHACE POLICY

FIXATION OF SALES TARGETS
DETERTERMING SHORT-TERM FINANCIAL PLANNING

290
LONG TERM FORECASTING Refers
to the forecasts prepared for long period during which the firms scale of operations or the production capacity may be expanded or reduced.
Relates to in formations which are vital for undertaking strategic decisions of the business pertaining to its expansion or contradiction over a period of time.
291
LONG TERM FORCASTING SERVE THE PURPOSE BUSINESS PLANNING:Long demand potential will provide the required guidelines for Planning of a new business unit or for the expansion or Of the exiting one. Capital budgeting by a firm is based on the long term demand forecasting. MANPOWER PLANNING:It is essential to determine long-term sales forecast for an appropriate manpower planning by the firm in view of its long term growth and progress of the business . LONG-TERM FINANCIAL PLANNING: In the view of the long and sales forecasting and the production planning, it becomes easier for the firm to determine its long-term financial planning and programmers for raising the funds from the capital market.
292
FORECASTING METHODS
SURVEY METHODS
STATISTICAL METHODS
Customer survey method
Collective opinion method
Market experiments method
Time series analysis
Regression analysis
Graphical method
Moving average method
Least square method

293
QUALITATIVE METHODS
- SURVEY OF BUYERS INTENSIONS
- A) Complete enumeration method
- B) Sample survey method

- C) The end use method.
- OPINIONS METHOD
- A)Experts Opinion method - B) Delphi method - C) Market Experimentation method.
294
QUANTITATIVE METHODS
- TIME SERIES MODELS
A) Graphical method
B) Moving Average method C) Least square method.
- CAUSAL MODELS
- Regression Model.
295

Economicsfinal

Transféré par

Informations du document

Titre original

Copyright

Formats disponibles

Partager ce document

Partager ou intégrer le document

Options de partage

Avez-vous trouvé ce document utile ?

Ce contenu est-il inapproprié ?

Droits d'auteur :

Formats disponibles

Economicsfinal

Transféré par

Droits d'auteur :

Formats disponibles

---Swami Vivekananda---

Economics answers three basic questions

Economics can be studied under two heads

Study of individual unit.

It studies economics as a whole.

Coordinating work activities so that they are

completed efficiently and effectively through people.

Process of Decision Making.

Selecting the best course of action.

Scope of Managerial Economics

Relationship Between ME & other subject

Relationship Between ME & other subject

Regression analysis Probability theory Hypothesis testing

Regression analysis helps us understand how the

Relationship Between ME & other subject

Economics + Mathematics + statistic.

maximization or minimization problem is involved.

value due to a one unit change in its determent.

Incremental cost can be defined as the arise due to a

Equi Marginal Principle

Equi Marginal Principle

Equi Marginal Principle

Economic theory of firm

the goal or objective of the firm was to maximize of profit.

Economic theory of firm

Objective of business is generation of the largest amount of

Economic theory of firm

Behavioral Model of firm

Cyert & March Behavioural model.

Behavioral Model of firm

Behavioral Model of firm

Behavioral Model of firm

According to him firms balance growth rate subject to

managerial and financial constraint.

Marris Hypothesis of Maximization of Growth Rate

Behavioral Model of firm

for the firms product & supply of the capital.

Behavioral Model of firm

this model interdependency .

The serious shortcoming of this model is that it ignores

the price determination which is the main concern of profit maximisation.

Behavioral Model of firm

As per him in modern corporations, owner &

Behavioral Model of firm

Utility function of managers (Um) depends on: salary, Job

dynamic condition in the long run.

its impact on firms behavior.

basis of achievement environment.

dynamic condition in the long run.

its impact on firms behavior.

Technique of Maximizing Total Revenue. TR= 500Q-5Q2

Technique of optimizing out put.

marginal revenue (MR) must be

MC=MR This first order condition can be written as

TR/Q = TC/Q Or TR/Q - TC/Q

S0 second order of profit maximization is also satisfied at Q =50

Demand and its Determinants

Demand is the mother of production.

Time , Price & Place.

Law of Diminishing Marginal Utility

TC & MC Utility schedules

Law of Diminishing Marginal Utility

Law of Diminishing Marginal Utility