Economics Final

---Swami Vivekananda---

EconomicsIt’s a Social Science.

Social science studies social activities which create social relation.

Economics- Economics studies particular type of

social activities = Economical activities.ProductionExchangeConsumption.

2

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.

3

Economic Problem

4

Why this problem arises-

i. Human wants are unlimited.

ii. The means are limited

iii. Alternative uses of the limited resources.

.

Economic Resources

5

Land:-

Labor:-

Capital:-

Organizer:-

.

Economics answers three basic questions-Economic problem.

What to Produce?

How to Produce ?

Whom to Produce?

6

Economics can be studied under two heads

7

Micro Economics.Study of individual unit.

Macro Economics. It studies economics as a whole.

Managerial Economics

8

Management + Economics = Managerial Economics Management = Coordinating work activities so that they are completed

efficiently and effectively with and through people.

Managerial Economics It is defined as the integration of economic

theory with business practice for the purpose of facilitating decision making.

.

Decision Making

9

"Decision making as the process of selecting the suitable

action from among several alternative course of action".

Characteristic of Decision Making.RiskUncertainty

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.

11

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

Scope of Managerial EconomicsScope study how far a particular subject will

go.

Demand AnalysisConsumption AnalysisProduction Theory.Cost AnalysisMarket Structure.Pricing System.

12

Relationship Between ME & other subjectMathematics & 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

Relationship Between ME & other subject

Statistic & Managerial Economics

Regression analysisProbability theoryHypothesis testing

14

Regression analysis helps us understand how the typical value of the dependent variable changes when any one of the independent variables is changed.

15

Regression Analysis

Relationship Between ME & other subject

Operations ResearchEconomics + Mathematics + statistic.

Management, Accountancy theory & ME.

Computer & ME

16

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 decision.

Opportunity cost

17

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.

Marginal Principle

18

Marginal cost-MC = TCN- TCN-1

Marginal Revenue-MR = TRN- TRN-1

Marginal Utility-MU = TUN- TUN-1

Marginal Principle

19

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=MRIn 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.

Marginal Principle

20

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.

Incremental Principle

21

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 a business proposition.

Incremental Principle

22

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.

Equi Marginal Principle

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

Project A Project B Project c

1 50 (1) 40 (3) 35 (4)

2 45 (2) 30 (5) 30 (6)

3 30 (7) 20 (8) 20 (9)

4 20 (10) 10 15

5 10 0 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

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.

he 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.

Time Perspective

26

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.

Economic theory of firm

27

28

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.

Traditionally, efficiency of a firm measured in terms of its profit generating capacity

Confusion on measure of profit Confusion on period of time Validity questioned in competitive markets


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.

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.

he 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.


29

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 followBaumal’s Sales maximisation firm.Stackleberg’s Reaction oriented firm.Cyert & March Behavioural model.

Behavioral Model of firm

30

Behavioral Model of firm W.J.Baumol suggested sales revenue

maximization as an alternative goal to profit maximization. RATIONALISATION OF THE SALES

MAXIMIZATION HYPOTHESISa) 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-à-vis rivals.

But this theory is also question on the following ground-

It is argued that in the long run sales maximisation and profit maximisation objective will convert into same.


32

Behavioral Model of firmMarris’ 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 firm’s products (GD) and Growth rate of capital supply to the firm (GC)

33


Growth RateHe 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 firm’s 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


Growth Rate

But this model fail to deal with oligopolistic interdependency .

The serious shortcoming of this model is that it ignores the price determination which is the main concern of profit maximisation.

35

36

Williamson’s 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


37

Williamson’s 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 .


38

Behavioral Theories Simon’s 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.

39

Behavioral TheoriesBehavioral theory has criticized on the following

ground-

It does not explain the firm’s 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 firm’s behavior.

40

Behavioral TheoriesModel 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.

41

Behavioral TheoriesModel 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 & changing business environment.

42

Behavioral TheoriesBehavioral theory has criticized on the following

ground-

It does not explain the firm’s 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 firm’s behavior.

43

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.

Optimization Techniques

44

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.


45

The FunctionalA 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 beDp=500- 5PpIt shows that at 0 pizza price demand equal to 500 unitsMinus 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.

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.


46

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 Differentiation- 1.Derivative of a constant function-

The derivative of a constant function equal zero.

For ex.Y = f(X) ∂Y/∂X = 0

The constant function implies that whatever the value of X the value of Y remain constant.

Differential Calculus

47

Rules of Differentiation-

2)Derivative of a power function-The 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


48

Technique of Maximizing Total Revenue.Suppose a price function is given as P= 500 –

5QFind out the optimum quantity that maximize

the total revenue. Total revenue of firm can be defined as-

TR= P * QWhere 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.


49

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

∂TR/∂Q = 500-10QBy setting equation to zero & solving for Q we

get O= 500 –10QQ=50Thus 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.


50

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 = 0Q = 10It shows that optimum size of output is 10 Units.

Total revenue of firm can be defined as-TR= 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.MR is given by the first derivative of the TR function. point where derivative of a constant function equal zero.


51

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=MRThis 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.

∂2TR/∂2Q < ∂2TC/∂2Q OR ∂2TR/∂2Q+∂2TC/∂2Q<0

Find out the optimum level of out put.The output level of out put which minimizes the total level of output.So Ac= TC/Q AC= (400+ 60Q+4Q2 ) / Q AC= (400/Q)+ 60 + 4Q.As per the rule of minimisation function its derivatives must be equal to zero so the value of Q which minimise as can be obtained.∂AC/∂Q = -400/Q2 + 4-400/Q2 + 4 = 0Q = 10It shows that optimum size of output is 10 Units.

Total revenue of firm can be defined as-TR= P * QWhere 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.MR is given by the first derivative of the TR function. point where derivative of a constant function equal zero.


52

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 – 6QMC = ∂TC/∂Q= 100 +4QMC=MR 600 – 6Q= 100 +4QQ=50As 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 S0 second order of profit maximization is also satisfied at Q

=50


Demand and its DeterminantsDemand-

“Necessity is the mother of invention”

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, = AdvertisementE, = 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 Demand1. Direct Demand & Derived Demands.2. Domestic & Industrial Demand.3. Autonomous & Induced Demand.4. Perishable & Durable goods Demand.5. New & Replacement.6. Final & Intermediate Demand.7. Individual & Market Demands8. Total market & Segmented market

Demands.9. Company & Industry Demands.

55

Law of Demand

56

It state that when other thing remain same, higher the price, lower the demand and vise versa.

Assumption-

Income of the consumer is constant.

Availability of complementary & substitutes.No future price expectation.Taste & preference remain same.No change in population & its structure.

57

Y

X

O

Q

25

Demand Curve

D

D

16

3

4Price

Quantity Demanded

R

Characteristics Inverse relationship between Price &

quantity demanded.

Price is independent variable & quantity demanded is dependent variable.

Reasons underline the law of demand-Income effect.

Substitute effect.

58

Exceptions

Conspicuous Consumption (Vabline Goods) .

Speculative Market.

Gffens goods

Ignorance.

59

“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 angleUtility is the psychological feeling of satisfaction, pleasure, happiness or wellbeing, which a consumer a consumer derives from the consumption, possession or the use of a commodity.

60

Utility Concept.

Total Utility-

sum 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

Utility Concept.

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

3

No. of Unit Consume

Total Utility Marginal Utility

1 30 30

2 50 20

3 60 10

4 65 5

5 60 -5

6 45 -15

Law of Diminishing Marginal Utility

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

Law of Diminishing Marginal UtilityLimitation 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

Cardinal Utility Approach-it believed that utility can cardinality or

quantitatively measurable , like weight length temperature etc .

Ordinal Utility ApproachUtility is immeasurable in cardinal

term.

65

Utility Approach.

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

Units of Commodity X

Total Utility

A 25 3 U

B 15 6 U

C 8 9 U

D 4 17 U

E 2 30 U

68

Five combination A, B, C, D, E of two substitute commodities X & Y as presented in table yield the same level of satisfaction.

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)

Upper indifference curves indicate a higher level of satisfaction.

70

Indifference

Point

Units of Commodit

y Y + X

Change in Y

Change in X

MRS

A 25 + 3 - -

B 15 + 6 10 3 3.3

C 8 + 9 7 3 2.3

D 4 + 17 4 9 0.4

E 2 + 30 2 13 0.2

Consumer EquilibriumBudget Line-

The budget line shows the market opportunities available to the consumer given his income and the price of X & Y.

Consumer Equilibrium-Consumer is equilibrium where the

indifference curve is tangent to the budget line.

71

Consumer Equilibrium1). Price Effect-

It is the change in consumption of goods because of the change in the price of the goods.

2).Income Effect-The 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

Consumer Equilibrium3). Substitute Effect-

It 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

Consumer Equilibrium

1).Income Effect-The 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

75

Y

X

O

P

Q

X1 X3

A

B B1

Income Effect-

A1

ICC

Consumer EquilibriumIncome Consumption Curve-

Define 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

Consumer Equilibrium3). Price Effect-

It 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

78

Y

X

O

P

Q

X1 X3

Price Effect

A

B B1

Price effect

PCC

Consumer Equilibrium3). Substitute Effect-

Arises 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

Consumer EquilibriumPrice Effect = Income Effect + Substitute Effect PE = IE + SE

Price Effect-It is the change in consumption of

goods because of the change in the price of the goods.

Income effect.Substitute effect.

80

81

Y

X

O

P

Q

X1 X3

Price Effect

A

B B1B3

IE

A1

Price Effect = Income Effect. + Substitute Effect PE = IE + SE

R

SE

X2

IC1

Demand ElasticityThe degree of responsiveness of the

demand to the change in its determinants is called elasticity of demand.

Type of demand elasticity's-1.Price elasticity.

2.Income elasticity.3.Substitute elasticity4.Advertise elasticity.

82

Demand The degree of responsiveness of the

demand to the change in its determinants is called elasticity of demand.

Type of demand elasticity's-1.Price elasticity.

2.Income elasticity.3.Substitute elasticity4.Advertise elasticity.

83

Elasticity

Demand Elasticity

Type of demand elasticity-1.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 =

84

% Change in Quantity demanded

% Change in the price of the commodity

85

Y

X

O

Q

25

Demand Elasticity

D

D

16

3

4Price

Quantity Demanded

R

Calculating ElasticityARC ElasticityThe measure of elasticity of demand between

any two finite points on a demand curve is known as ARC elasticity.

ARC Elasticity =

86

Q2 - Q1 ( Q1 + Q2 ) / 2

P2 - P1 ( P1 + P2 ) / 2where Q1 = Initial quantity Q2 = Final quantity P1 = Initial price P2 = Final price

Calculating ElasticityPoint Elasticity

For an infinitesimal (very, very small )change in price we use point elasticity.

87

Y

X

M

N

PN PM

P R

O

Ep

=

Supply Analysis

88

SupplyThe supply of a commodity means the amount

of that commodity which producers are Ability to supplyWilling to supplyAt a given price.

Quantity supplied refers to a specific amount of the commodity that will be supplied at a specific price.

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 technologyE, = Means of transportation &

Communication.T, = Taxation policy.U, = Future expectation of prices.

So Sn = F(Px, Py, F, T, , E,T,U)89

Supply Analysis

90

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.

Supply Analysis

91

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.

Supply Schedule

92

“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

“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 relationship between price and quantity supplied.

Price Supply (A Firm)

Supply (B Firm)

Supply (C Firm)

Aggregate

Supply

2 25 50 75 150

4 100 100 150 350

6 200 150 225 575

8 300 200 300 800

10 400 250 375 1052

93

Y

X

O

Q

100

Supply Curve

S

25

2

4

Price

Quantity Supplied

R

S

Supply Analysis

94

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.

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

Higher price means higher profits.

Supply Analysis

95

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.

Supply Analysis

96

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.

Supplied Elasticity =% Change in Quantity supplied

% Change in Price of the commodity

Supply Elasticity

Determinant of Supplied elasticity.-

1.Nature of the commodity.2.Time lag.3.Techniques of production.4.Estimates of future prices.

97

Production

98

“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.

Production

99

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.

Production

100

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.

Production Function.

101

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.


102

Production Function:-Economically it stated as below-

Q= f(L,L,K,O).

More specifically it can be stated as-Q= 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 two-

Q=f(L,K)


103

Production Function-Economically it stated as below-

Q= f(L,L,K,O).

More specifically it can be stated as-Q= 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 two-

Q=f(L,K)


104

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.


105

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.


106

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 law-1. The state of technology is given2. Labor is homogeneous.3. Input prices are given.


107


“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 production-1.Stage one increase at increasing rate.2.Stage two increase but at constant rate.3.Stage three total production decrease.

108

N0 0f Workers

Total Productio

n TP

Marginal Productio

nMP

Average Productio

n AP

Stages of Productio

n.

0 0 0 0

1 24 24 24

IIncreasing

Return

2 72 48 36

3 138 66 46

4 216 78 54

5 300 84 60

6 384 84 64

7 462 78 66 II Diminishing Return

8 528 66 66

9 576 48 64

10 600 24 60

11 594 -6 54 III Negative

return12 552 -42 46

Stages of Production


109


More specifically the law of diminishing returns can be state as follows-

“Given 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 law-

1.Indivisibility of fixed factor

2.Division of labour.

3.Per worker marginal productivity decrease after optimum utilization of capital.


110

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.


111

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.


112

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 scaleii) Constant returns to scale,iii) Diminishing returns to scale.


113


i) Increasing Returns to scaleOutput more than doubles when all inputs are doubled.

Causes of increasing returns to scale-Technical and marginal indivisibilityHigher degree of specialization.

It is known as economics of scale.


114


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.


115


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 scaleThe diminishing return to management.Exhaustibility of natural resources.


116


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 scaleThe diminishing return to management.Exhaustibility of natural resources.


117

Law of return to scale, Isoquant curve.Isoquant. Iso (Greek word)= equalAnd 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”.

Assumption-1.There are only two inputs (L, K)2.Two inputs (L,K) can substitute.

Insoquant Schedule of input L & K.

Combination Input Units k

Input Units L

Total Output

A OK4 OL1 100

B OK3 OL2 100

C OK2 OL3 100

D OK1 OL4 100

118

Five combination A, B, C, D of two substitute inputs L & K as presented in table yield the same level output.

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.Indifference 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. 119

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.

120

Cobb Douglas Production

The Cobb–Douglas functional form of production functions is widely used to represent the relationship of an output to inputs. It was proposed by Knut Wicksell (1851–1926), 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.

121

122

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 = ALαKβ,where:

Y = total production (the monetary value of all goods produced in a year)L = labor inputK = capital inputA = total factor productivityα and β 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.

123

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 α = 0.50, 1% increase in labor would lead to approximately a 0.50% increase in output.

Or β = 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 = ALαKβ,Α+β,=1Means 1% increase in input would lead to

approximately a 1% increase in output.

124

Consider a cobb Douglas production function with parameters A= 100, α = 0.50, β=.50

Production table for the production function

Y = ALαKβ, Y = 100L.50K.50,Rate of capital input

Total Out Put

1 100

2 200

3

4 400

5

1 2 3 4 5

Rate of labour Input(L)

Cost Function

125

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 CostVariable costs are those which vary with

the variation in the total output.

Cost Function

126

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 CostAverage Total Cost(TCV)= Total cost (TC)

Total out put.

127

Q FC TVC TC AVC AC MC0 10 0 10 1 10 5.15 15.2 5.15 15.2 5.152 10 8.8 18.8 4.4 9.4 3.653 10 11.3 21.3 3.75 7.08 2.454 10 12.8 22.8 3.2 5.7 1.555 10 13.8 23.8 2.75 4.75 0.956 10 14.4 24.4 2.4 4.07 0.657 10 15.1 25.1 2.15 3.58 0.658 10 16 26 2 3.25 0.959 10 17.6 27.6 1.95 3.06 1.55

10 10 20 30 2 3 2.4511 10 23.7 33.7 2.15 3.06 3.6512 10 28.8 38.8 2.4 3.23 5.1513 10 35.8 45.8 2.75 3.52 6.9514 10 44.8 54.8 3.2 3.91 9.0515 10 56.3 66.3 3.75 4.42 11.516 10 70.4 80.4 4.4 5.03 14.2

Cost Out Put Relations

Cost FunctionSome 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.

128

Cost FunctionCost 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”.

129

Relationship between Production & Cost function.

130

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.

Market Structure and Pricing Decision

131

Market-Is a system by which buyers and sellers bargain for the

price of product, settle the price and transact their business.

BuyerSeller.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 versa. 131


132

Types of the market Structure-

1. Perfect Competition-

2. Imperfect Competition-a). Monopolistic competition. b). Oligopolyc). Monopoly.

The theory of pricing explains pricing decisions and profit behavior of the firms in different kinds of market structure.

132


133

Perfect Competition-1.Large number of sellers & buyers.2.Homogeneous product.3.Perfect mobility of factors of production.4.Free entry & free exit.5.Absent of collusion or artificial collusion.6.No government intervention. Competition-

As 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.

133

Price Determination Under Perfect Competition.

Price in perfectly competitive market is determined by the market forces-

Market demand & Market supply.Market 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 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.

134134

Market supply

Marketdemand

1,000 3,000

Price$10

8

6

4

2

0Quantity

Market Firm

Individual firm demand

10 20 30

Price$10

8

6

4

2

0Quantity

135

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.

136

Profit-Maximizing Level of OutputMarginal 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).

137

C

AP = D = MR

Costs

1 2 3 4 5 6 7 8 9 10 Quantity

60

50

40

30

20

10

0

AB

MC

0123456789

10

28.0020.0016.0014.0012.0017.0022.0030.0035.0054.0068.00

Price = MR Quantity Produced

Marginal Cost

35.0035.0035.0035.0035.0035.0035.0035.0035.0035.0035.00

138

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.

139

Determining Profit and Loss From a GraphFind 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.

140

(a) Profit case (b) Zero profit case (c) Loss case

Quantity Quantity Quantity

Price65 60 55 50 45 40 35 30 25 20 15 10

5 0

65 60 55 50 45 40 35 30 25 20 15 10

5 01 2 3 4 5 6 7 8 9 10 12 1 2 3 4 5 6 7 8 9 10 12

D

MC

A P = MR

B ATCAVC

E

Profit

C

MC

ATC

AVC

MC

ATC

AVC

Loss

65 60 55 50 45 40 35 30 25 20 15 10

5 0 1 2 3 4 5 6 7 8 910 12

P = MRP = MR

Price Price

141

The Shutdown PointThe 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.

142

Long-Run Competitive EquilibriumProfits 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.

143

Output, Price, and Profit in Perfect CompetitionLong-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

144

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 Monopolies-1. Legal Restrictions2. Control over key raw materials3. Efficiency.

145

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.

146

E

MR10,000

40

MC

32

Total Profit

ATC

D

E

Total Loss

AVCATC

MR10,000

40

MC

D

50

(a)

Number of Subscribers

(b)

Number of Subscribers

147

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

Profit And Loss

148

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.

Long run pricing decision in monopoly

149

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.

150

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.

151

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.

Monopoly &Price Discrimination

152

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.

Monopoly &Price Discrimination

153

Perfect Price DiscriminationFirst degree-

A 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 degree-Under this monopolist divide the potential

buyers into the blocks e.g rich, middle class, poor class & sell the product at different price.

Third degree- Set the different price in different market

having deferent price elasticity.154

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.

155


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.

156


Major Automobile player in India

Ashok Leyland HMT Tractors Royal EnfieldAudi AG Honda Motors Co. Ltd. San Motors

Bajaj Auto Hyundai Motors Scooters India LtdBEML Indofarm Tractors Skoda Auto IndiaBMW 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 TelconFiat 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. VolvoHindustan Motors Rolls-Royce Motor Yamaha Motor


157

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.

158

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.

Product Differentiation

159

Short run profit determination diagram:

Cost/Revenue

Output / Sales

MC

AC

Marginal Cost and Average Cost will be the same shape. However, because the products are differentiated in some way, the firm will only be able to sell extra output by lowering price.

D (AR)

The demand curve facing the firm will be downward sloping and represents the AR earned from sales.

MR

Since the additional revenue received from each unit sold falls, the MR curve lies under the AR curve.

We firm produces where MR = MC (profit maximising output). At this output level, AR>AC and the firm makes abnormal profit (the grey shaded area).

Q1

1.00

0.60

Abnormal Profit If the firm produces Q1 and sells each unit for 1.00 on average with the cost (on average) for each unit being 60p, the firm will make 40p x Q1 in abnormal profit.

This is a short run equilibrium position for a firm in a monopolistic market structure.

160

Monopolistic or Imperfect Competition

Cost/Revenue

Output / Sales

MC

AC

D (AR)MR

Q1

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 inwards as revenue from each sale is now less.

AR1MR1

Long run profit determination diagram:

161

Monopolistic

Cost/Revenue

Output / Sales

MC

AC

D (AR)MR

Q1

AR1MR1

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.Q

2

AR = AC


162

Monopolistic

Cost/Revenue

Output / Sales

MC

AC

AR1MR1

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.Q

2

AR = AC


163

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.

164

OligopolyOligopoly

“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.

165

Oligopoly Market

166

Characteristic of Oligopoly Market. 1.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. 166

Oligopoly

OligopolySince 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

167

OligopolyKinked 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.

168

OligopolyKinked 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.

169

OligopolyKinked 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.

170

OligopolyKinked 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.

171

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 pricing2.Multiple Product pricing.3.Skimming pricing policy.4.Penetration price policy .

172

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).

173

Pricing Strategies Product line Pricing.

Establishing a single price for all products in a product line, such as for dress material-

price of 2550 for the high-priced line, 1450 for the medium-priced line, and 350 for the lower-priced line.

174

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.

175

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.

176

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.

177

Almost an eighth Wonder

The Indian economy grew at 7.9% in the July-September 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 China’s among major economies.

Chinese economy grew 8.9% in the September quarter.

178

Almost an eighth Wonder

179

Almost an eighth WonderKEY 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 180

Almost an eighth WonderIMPLICATIONS

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’

181

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 activity-all human activity which create goods &

services that can be value in term of money.

Non Economic activity-all human activity which create goods &

services that can not be value in term of money.

182

National Income Concept and Measurement.Different ways of Measuring national income-

Production Method GNP- Gross national Product.

Income Method.GNI- Gross national Income.

Expenditure MethodGNE- Gross national Expenditure.

GNP=GNI=GNE.

National income is the outcome of all economic activities of a nation valued in term of money during a specific period”.

Economic activity-all human activity which create goods & services that can be value in term of money.

Non Economic activity-all human activity which create goods & services that can not be value in term of money.

183

184

Firms Households

Market for Factors

of Production

Market for Goods

and Services

SpendingRevenue

Wages, rent, and

profit

Income

Goods & Services

sold

Goods & Services bought

Labor, land, and capital

Inputs for production

BusinessesBusinesses HouseholdsHouseholds

Spending for Goods and Services

Resource Income

GovernmentGovernmentSpendingSpendingTaxesTaxes

FINANCIALFINANCIAL MARKETMARKET

SavingSavingInvestmentInvestment

185

Factorpayments

Consumption ofdomestically

produced goodsand services (Cd)

The circular flow of incomeThe circular flow of income

186

Factorpayments



BANKS, etc

NetNetsaving (S)saving (S)


187

Factorpayments



BANKS, etc

Investment (I)Investment (I)



188

Factorpayments



BANKS, etc GOV.



NetNettaxes (T)taxes (T)


189

Factorpayments



BANKS, etc GOV.


GovernmentGovernmentexpenditure (expenditure (GG))




190

Factorpayments



BANKS, etc GOV. ABROAD





ImportImportexpenditure (M)expenditure (M)


191

Factorpayments






ExportExportexpenditure (X)expenditure (X)





192

Factorpayments










WITHDRAWALSWITHDRAWALS


193

Factorpayments











WITHDRAWALSWITHDRAWALS

INJECTIONSINJECTIONS

194

National Income Concept and Measurement.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

195

National Income Concept and Measurement.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.

196

National Income Concept and Measurement.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

197

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) 198

Concepts of National Income 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.

199

Concepts of National Income

Personal incomePersonal 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.

200

Concepts of National Income Some Accounting Relationship-

At 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.

201

Particular Rs. Million1 Wages & Salaries 4302 Imports of goods & services 2203 Rent 504 Value added in Agriculture 1005 Govt. current expenditure 1406 Capital Consumption 707 Value added in Construction 508 Consumers Expenditure 4509 Dividends 50010 Income from self employment 6011 Exports of goods & services 65012 Undistributed profit 11013 Gross Domestic fixed investment 15014 Value added in manufacturing 15015 Value added in distribution trade 600

16Trading surplus of public corporation 20

17 Value added in other sectors 270 202

203

Gross National Product

RS. millions

Gross National Expenditure Gross National Income

Value added in agri. 100 Consumer Exp. 450 Wages & Salaries 430Value added in Manufacturing 600 Govt exp 140 Self employment 60

Construction 50 Gross Fixed inv 150Company profit

dividends 500Distribution 150 Change in stock 10 Retained profits 110Other sectors 270 Exports 650 Public corporations 20GNP 1170 less imports -220 Rent 50Less Dep -70 GNE 1170 GNI 1170

less dep -70 less dep -70NNP 1100 NNE 1100 NNI 1100

Unemployment

204

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.

Unemployment

205

Voluntary unemploymentMeans 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 unemploymentIs situation in which person fail to get jobs

even when they are prepared to accept such jobs at the prevelling wage rate.

Unemployment

206

Types of Involuntary unemployment

Structural unemployment.Seasonal unemploymentDisguised unemployment.Cyclical unemployment.Technological unemployment.Frictional unemployment.

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 unemploymentIs situation in which person fail to get jobs even when they are prepared to accept such

jobs at the prevelling wage rate.

Unemployment

207

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 unemploymentUnemployment caused because of the seasonal nature of employment – tourism, skiing, cricketers, beach lifeguards, etc.

Unemployment

208

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.

Unemployment

209

Technological unemployment.Unemployment caused when developments in technology replace human effort – e.g in manufacturing, administration etc.

Frictional unemployment.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.

Inflation

210

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

PRICESIt implies a continuously rising trend in general

prices.

Deflation, is an continuously decreasing in the overall level of prices.

Inflation

211

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.

Inflation

212

Demand pull factors are as follows.

Population pressure.Mounting govt. expenditureGrowing supply of moneyGrowing deficit financingGrowing black money.

Inflation

213

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.

Inflation

214

Other factors.

Increase in procurement prices.Creation of artificial crisis.Devaluation of domestic currency.

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.

Costs and Consequences of Inflation

215

Description: Children using notes of money as building blocks during the 1923 German inflation crisis.

216

Costs and Consequences of InflationMoney 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

217

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 inflationWalking inflation is a marked increase in the

rate of inflation as compared to creeping inflation. The price rise is around 5% annually.

218

Types of inflation

Running inflationUnder running inflation, the price

increases is about 8% to 10% per annum.

Hyper inflationGalloping 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

219

Inflation

220

Way to control inflation. (1)Monetary PolicyMonetary policy is a policy that influences

the economy through changes in the money supply and available credit.

(a) Quantitative controls (b) Qualitative controls .

Inflation

221

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 taxationChanges in Govt. ExpenditurePublic borrowingControl of deficit financing

Inflation

222

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.

Business CycleGross 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

223

Various phases of business Cycle

Expansion of business activities.

Peak of boom or prosperity.

Recession

Trough the bottom of depression

Recovery & expansion.

224

225

Expansion ExpansionRecession

Secular growth trend

DownturnUptu

rn

Trough

Peak

0

Tot

al O

utpu

t

Time

226

Various phases of business Cycle

Expansion of business activities.

Peak of boom or prosperity.

Recession

Trough the bottom of depression

Recovery & expansion.

227

Parts of Economic Cycle - BoomLow 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

228

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.

229

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

levels230

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.

231

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.

232

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.

233

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)

234

Theories of profitWhat 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.

235

Dynamic Theory. This theory is given by J. B.Clark’s 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.

236

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.

237

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.

238

Theories of profitSchumpeter’s 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 includes-

1.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.

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.

239

MONETARY POLICYMONETARY POLICY

240


INTRODUCTIONINTRODUCTION

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.

241


OBJECTIVESOBJECTIVES

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.

242

SCOPE OF MONETARY POLICYSCOPE 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 MarketSome 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.

243

• 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.

OPEN MARKET OPERATIONSOPEN MARKET OPERATIONS

244

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.

Discount Rate or Bank Rate policy

245

• 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.

Working of the discount rate policyWorking of the discount rate policy

246

• 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.

Cash Reserve ratioCash Reserve ratio

247

• 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.

Statutory Liquidity RequirementStatutory Liquidity Requirement

248

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 lion’s 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.

Credit RationingCredit Rationing

249

• The banks provide loans only up to a certain The banks provide loans only up to a certain percentage of the value of the mortgaged percentage of the value of the mortgaged property.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 central bank is empowered to increase the lending margin with a view to decrease the lending margin with a view to decrease the bank credit.the bank credit.

Change in Lending Margins

250

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.

MoralMoral SuasionSuasion

251

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.

Expansionary Policy / Contractionary Policy

252

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.

Expansionary Policy / Contractionary Policy

253

Mahatma Gandhi

Quoted by

Pranab Mukherjee

254

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. ShawG.K. Shaw

255

Fiscal Policy Fiscal Policy Objective-Economic Growth: By creating conditions for

increase in savings & investment.Employment: By encouraging the use of labour-

absorbing technologyStabilization: fight with depressionary trends and

booming (overheating) indications in the economyEconomic 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.

256

• 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.

Fiscal Policy

257

Fiscal PolicyInstruments of Fiscal Policy

Fiscal policy instruments are operated by government at various levels Central, State & local. Broadly these instruments are listed below:-

Public RevenuePublic ExpenditurePublic Debt.

258

Fiscal Policy Public Revenue Government normally raise revenue

through taxation. Direct taxes- Direct 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.

259

Fiscal Policy Public Revenue Indirect taxes- Indirect 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.

260

Fiscal Policy Public Revenue Non tax revenue- With 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.

261

Government ExpenditureGovernment spending on the purchase of

goods & services.Payment of wages and salaries of government

servantsPublic investmentTransfer payments

Fiscal Policy

262

Fiscal PolicyPublic Debt.If public expenditure exceeds public revenue then

government has to rise public debt. Internal borrowings 1. Borrowings from the public by means of

treasury bills and govt. bonds2. Borrowings from the central bank

(monetized deficit financing) External borrowings 1. Foreign investments2. International organizations like World Bank

& IMF3. Market borrowings

263

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.

Fiscal Policy

264

Fiscal PolicyBudget.“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

265

266

From where Rupees Come

267

Where the rupee Goes

268

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 is its capital expenditure.

Capital Budgeting

269

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.

process of evaluating and selecting long term investments that are consistent with the goal of shareholders wealth maximization.

Capital budgeting is essentially a process of conceiving, analyzing, evaluating and selecting the most profitable project for investment.

Significance of capital budgeting.Capital expenditure is generally irreversible. The survival of the firm depends on how well the firm planned is its capital expenditure.

Capital Budgeting

270

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. 2). Select the criteria for evaluating the project. A) Pay back period B). Discounted cash flow (present value criteria) C). Internal rate of return. 3) The third step is to decide the approach for the final selection.A) Accept reject approach

B) Ranking approach.

Capital expenditure is 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.- scolded 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.

process of evaluating and selecting long term investments that are consistent with the goal of shareholders wealth maximization.Capital budgeting is essentially a process of conceiving, analyzing, evaluating and selecting the most profitable project for investment.

Significance of capital budgeting.Capital expenditure is generally irreversible. The survival of the firm depends on how well the firm planned is its capital expenditure.

Capital Budgeting

271

Criteria for evaluating the project.Pay Pack Period MethodThe 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 millionPay off period= 5 years.

Capital Budgeting

272

Pay Pack Period MethodIn 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.

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.

Capital Budgeting

Year Total fixed

outlay

Annual cash flows

Cumulative total of col.

1 10,000 4000 4000

2 3500 7500

3 2500 10,000

4 1500 11,500

5 1000 12,500

273

Pay Pack Period MethodAfter 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.

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.

Capital Budgeting

Project Pay back periodyear

Rank

1 6 4

2 3 1

3 4 2

4 5 3

274

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.

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

Capital Budgeting

275

The concept of present value: (Time value of money)Future ValueFuture 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.

FVFV11 = PP00 (1+i)n

Present ValuePresent Value is the current value of a future amount of money, or a series of payments, evaluated at a given interest rate.

PVPV00 = FV= FVnn / (1+i) / (1+i)nn

Here –

FV= Future value i= interest rate

PV= Present value n= number of year.

Money earn today is more valued more than money receivable tomorrow. Because Liquidity An opportunity to invest it and earn return on it.

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.

The rate of interest is 10% Rs. 110 expected return, this means that Rs 100 is the present value of Rs. 110.

Capital Budgeting

276


Present Value of income streamsPresent Value of income streams ((An An AnnuityAnnuity )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.

PVAPVAnn = R/(1+i) = R/(1+i)1 1 + R/(1+i)+ R/(1+i)2 2

+ ... + R/(1+i)+ ... + R/(1+i)nn

R = Periodic Cash Flow.

Capital Budgeting

277


Net Present Value & Investment decision.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-CNPV= PV-CIf investment is a recurring expenditure, the total

present cost(TPC) for n years can be calculated

TPC = C/(1+i)TPC = C/(1+i)1 1 + C/(1+i)+ C/(1+i)2 2

+ ... + C/(1+i)+ ... + C/(1+i)nn

The net present value (NPV)can be calculated asNPV= PV-TPCNPV= PV-TPC

Capital Budgeting

278


The investment decision rule can be stated as The investment decision rule can be stated as followsfollows

If NPA>0 then the project is acceptableIf NPA=0 the project is accepted or rejected on

the economic considerations.If NPA<0 the project is rejected.

Capital Budgeting

279

Internal Rate of return.Is also called marginal rate of investment. Or break even rate.

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.

The project is accepted which gives higher IRR- means higher return on investment.

Capital Budgeting

280

Internal Rate of return.

IRR for project A = 18.3%IRR for project B= 30%

The project is accepted which gives higher IRR- means higher return on investment.

Capital Budgeting

Cost of project

1st year 2nd year

Project A 100 O 140

Project B 100 130 0

281

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.

Capital Budgeting

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.

283

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.

285

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

286

LONG TERM FORECASTING

Refers to the forecasts prepared for long period during which the firm’s 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.

287

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.

288

FORECASTING METHODS

SURVEY METHODS STATISTICALMETHODS

Customer surveymethod

Collective opinionmethod

Market experimentsmethod

Time series analysis

Regression analysis

Graphicalmethod

Moving averagemethod

Least square method

289

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.

290

QUANTITATIVE METHODS

- TIME SERIES MODELS A) Graphical method

B) Moving Average method

C) Least square method.

- CAUSAL MODELS - Regression Model.

291

Date post:	20-Nov-2014
Category:	Documents
Upload:	pravin
View:	136 times
Download:	6 times

Economics Final

Documents