2. Explain association between income and types of goods.
In economics a necessity good is a type of normal good. Like any other normal good, when income rises, demand increases. But the increase for a necessity good is less than proportional to the rise in income, so the proportion of expenditure on these goods falls as income rises. This observation for food is known as Engel's law. The income elasticity of a necessity good is thus between zero and one. Necessity goods are goods that we can't live without and won't likely cut back on even when times are tough, for example food, power, water and gas. The more necessary a good is, the lower the price elasticity of demand, as people will attempt to buy it no matter the price. Most necessity goods are usually produced by a public utility (MTC, Railways
Etc).
3. What is meant by Veblen Goods?
Some types of luxury goods, such as high-end wines, designer handbags, and luxury cars, are Veblen goods, in that decreasing their prices decreases people's preference for buying them because they are no longer perceived as exclusive or high-status products. [2] Similarly, a price increase may increase that high status and perception of exclusivity, thereby making the good even more preferable. Often such goods are no better or are even worse than their lower priced counterparts. However, this 'anomaly' is mitigated when one understands that the demand curve does not necessarily have only one peak. The goods generally thought to be Veblen goods are still subject to the curve since demand does not increase with price infinitely. Demand may go up with price within a certain price range, but at the top of that range the demand will cease to increase before it begins to fall again with further price increases.
4. Define Giffen Goods or explain Geffen Paradox.
In economics and consumer theory, a Giffen good is one which people paradoxically consume more of as the price rises, violating the law of demand. In normal situations, as the price of a good rises, the substitution effect causes consumers to purchase less of it and more of substitute goods. In the Giffen good situation the income effect dominates, leading people to buy more of the good, even as its price rises. Evidence for the existence of Giffen goods is limited, but micro economic mathematical models explain how such a thing could exist. Giffen goods are named after Scottish economist Sir Robert Giffen, who was attributed as the author of this idea by Alfred Marshall in his book Principles of Economics. Giffen first proposed the paradox from his observations of the purchasing habits of the Victorian poor.
For most products, price elasticity of demand is negative (note that, although they are negative, price elasticity’s of demand are often reported as positive numbers; see the mathematical definition for more). In other words, price and quantity demanded pull in opposite directions; if price goes up, then the quantity demanded goes down, or vice versa. Giffen goods are an exception to this. Their price elasticity of demand is positive. When price goes up, the quantity demanded also goes up, and vice versa. In order to be a true Giffen good, price must be the only thing that changes to get a change in quantity demand, and a Giffen good should not be confused with products bought as status symbols or for conspicuous consumption (such a situation would indicate a Veblen good). The classic example given by Marshall is of inferior quality staple foods, whose demand is driven by poverty that makes their purchasers unable to afford superior foodstuffs. As the price of the cheap staple rises, they can no longer afford to supplement their diet with better foods, and must consume more of the staple food.
5. Difference between incremental cost and marginal cost.
6. Define opportunity cost.
7. Define the law of demand.
8. What is the difference between direct demand and derived demand?
Direct Demand:
Goods that yield direct satisfaction to the consumers are said to have a direct demand.
This demand comes from the consumer's side.
Demand for food, cloth and house etc. are the examples of direct demand.
All the finished goods have a direct demand.
Derived Demand:
Goods that are needed by the producers are said to have derived demand.
This demand comes from the producer’s side.
Demand for land, labor, capital, etc. are the examples of derived demand.
This refers to the demand forecasting by the firm for its product. The management of a firm is really interested in such forecasting. Generally speaking, demand forecasting refers to the forecasting of demand of a firm. If the firm forecasts demand for a product or service, it can adjust its capacity to likely demand changes.
Barometric techniques examine the relationships between causal or coincident events to predict future events. This approach is based on the logic that key current developments can serve as a barometer of the future. This approach assumes the key developments can be identified, measured and recorded as a statistical time series. The barometric or what is also called the leading indicators approach to forecasting is often traced to work done at the National Bureau of Economic Research in United States from the 1920s through the 1940s.A leading indicator predicts three to six months in the future another event. Examples of indicators include: payroll employment, personal income less transfer payments, an index of industrial production, stock prices, changes in business inventories, consumer expectations, building permits, new orders for goods and materials and retail sales. Interest rates and investment is an example of Barometric technique. The interest rates are a leading indicator, that is, it indicated how investment is likely to change.
11. What is meant by ‘effective demand’?
1. The quantity of a good or service that consumers are actually buying at the current market price.
2. Aggregate actual demand in an economy supported by the consumers' capacity to pay, as opposed to the notional demand. Effective demand excludes the latent demand.
(For your understanding: Demand is the term that economists use to describe the ability and willingness of buyers to purchase a product or service. This is a general term that takes a number of issues into account, such as buyer income, buyer perceptions and buyer needs. Demand is a market force opposite of supply, which is the ability and willingness of producers and service providers to provide products and services on the market. This general idea of demand is often called notional demand, which is composed of both latent demand and effective demand.
Latent Demand
Even if a buyer needs or would be willing to purchase a particular product or service, he cannot do so if he lacks the necessary funds or if he does not know about that product or service. This portion of market demand is called latent demand. The importance of latent demand is that it presents an opportunity for firms to increase revenue by investing in marketing efforts or introducing low-cost products.
Effective demand is a representation of the actual amount of goods or services that buyers are purchasing in a given market. Effective demand is the difference between notional demand and latent demand. Effective demand is a reflection of the extent to which buyers' income, perceptions and needs combine to result in an actual purchase rather than a mere desire to purchase.)
12. Define purchasing power. Purchasing power is the amount of goods or services that can be purchased with a unit of currency. For example, if you had taken one rupee to a store in the 1980, you would have been able to buy a greater number of items than you would today, indicating that you would have had a greater purchasing power in the 1980s. Having money gives one the ability to "command" others' labor, so purchasing power to some extent is power over other people, to the extent that they are willing to trade their labor or goods for money or currency.
13. Define shutdown point in short run operations. ( This is an elaborate answer; you need not answer to this extent; Ask me on Friday 23/11/2012)
When should a firm shut down?
Then answer is when P (price) = AVC (average variable cost). This is the output where firms are indifferent between producing the profit-maximizing quantity (ie. Loss-minimizing quantity) and shutting down operations. Take a look at this graph to help you understand the when and where.
While we’re on the topic, what is the supply curve for each firm? Looking at the graph you’ll
note the MC curve. The supply curve for each firm is simply its marginal cost (MC) curve above the minimum point on the average variable cost (AVC) curve.
The supply curve for the industry is just the (horizontal) summation of each individual firm’s supply curve. Carrying on, what about the items that dictate and influence long run decision making?
Long-Run Decisions:
Forces in a competitive industry ensure that firms earn zero economic profits in the long-run. Competitive industries will adjust in two ways: 1. Entry and exit, 2. Changes in plant size
Entry and Exit:
The prospect of persistent profit of loss causes firms to enter or exit an industry. If firms are making economic profits, other firms enter the industry. This graph shows how where there is room for new entrants in the market and how it eliminates industry profits in the long run.
If firms are making economic losses, some of the existing firms exit the industry. This entry and exit of firms influences prices, quantities, and economic profits. This graph depicts economic losses in the industry.
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Important points: as new firms enter an industry, the price falls and the economic profit of each existing firm decreases. As firms leave an industry, the price rises and the economic loss of each remaining firm decreases. [See graphs above]
Changes in Plant Size: When a firm changes its plant size, it can lower its costs and increase its economic profit. Let’s see in this graph how a firm can increase its profit by increasing its plant size.
Long-Run Equilibrium: Therefore, in the long-run equilibrium for a competitive industry, all firms must be:
1. Maximizing profits (P = MR = MC)2. Earning zero economic profits (P = SRATC)3. Unable to increase profits by altering its scale of operations.
And that concludes our intro into profit maximization and shut down points for firms.
14. Define average cost pricing.
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15. Define peak load pricing
16. Define off season pricing
17. Define induced investment.
18. Define autonomous investment
19. Define foreign exchange.
20. Define foreign imbalance of payment.
21. Define deficit budgeting
The Government budget balance, also commonly referred to as general government balance, public budget balance, or public fiscal balance, is the overall result of a country's general government budget over the course of an accounting period, usually one year. The budget balance is the difference between government revenues (e.g., tax) and spending. A positive balance is called a government budget surplus, and a negative balance is called a government budget deficit. The government budget balance is used to assess the fiscal health of a country.Keynesian economics advocate a government budget deficit during recession or downturn as long as it is limited enough to render the structural government budget balance positive.
22. Explain precautionary motive for money and speculative motive for money
The demand for money is affected by several factors, including the level of income, interest rates, and inflation as well as uncertainty about the future. The way in which these factors affect money demand is usually explained in terms of the three motives for demanding money: the transactions, the precautionary, and the speculative motives.
3. Explain supply function. 4. Explain method and steps for demand forecast for a computer company in India. 5. Explain internal economies and external economies for long run operations. 6. Explain situation of the minimum cost of production in the short run and bring
about how does excess capacity work well in dynamic business situation. 7. Draw a neat sketch for private monopoly market structure and indicate the
optimum price and profit. 8. What is meant by ‘market power’?
Market power
Market power is the ability to increase the product's price above marginal cost without losing all
customers. Perfectly competitive (PC) companies have zero market power when it comes to setting
prices. All companies of a PC market are price takers. The price is set by the interaction of demand and
supply in the market or aggregate level. Individual companies simply take the price determined by the
market and produce that quantity of output that maximizes the company's profits. If a PC company
attempted to increase prices above the market level all its customers would abandon the company and
purchase at the market price from other companies. A monopoly has considerable although not unlimited
market power. A monopoly has the power to set prices or quantities although not both. A monopoly is a
price maker. The monopoly is the market and prices are set by the monopolist based on his
circumstances and not the interaction of demand and supply. The two primary factors determining
monopoly market power are the company's demand curve and its cost structure.
9. Explain the markup price strategy in a monopoly market.
9. Define collusive oligopoly and draw a sketch of the oligopoly market structure; indicate price and the profit zone.
10. Explain importance of government intervention in a monopoly market. 11. Explain private sector monopoly structure and argue that government monopoly
has greater value. 12. Give an explanation for; odd number pricing; even number pricing; marginal cost
pricing; full cost pricing and market pricing.
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Pricing strategies for products or services encompass three main ways to improve profits. These are that the business owner can cut costs or sell more, or find more profit with a better pricing strategy. In the downturn of 2008-11, and since, when costs are likely already at their lowest and sales are hard to find, adopting a better pricing strategy is a key option to stay viable.
Merely raising prices is not always the answer, especially in a poor economy. Too many businesses have been lost because they priced themselves out of the marketplace. On the other hand, too many business and sales staff leave "money on the table". One strategy does not fit all, so adopting a pricing strategy is a learning curve when studying the needs and behaviors of customers and clients.
Models of pricing Cost-plus pricing Cost-plus pricing is the simplest pricing method. The firm calculates the cost of
producing the product and adds on a percentage (profit) to that price to give the selling price. This method although simple has two flaws; it takes no account of demand and there is no way of determining if potential customers will purchase the product at the calculated price. This appears in two forms, Full cost pricing which takes into consideration both variable and fixed costs and adds a % markup. The other is Direct cost pricing which is variable costs plus a % markup, the latter is only used in periods of high competition as this method usually leads to a loss in the long run.
Creaming or skimming In market skimming, goods are sold at higher prices so that fewer sales are needed to
break even. Selling a product at a high price, sacrificing high sales to gain a high profit is therefore "skimming" the market. Skimming is usually employed to reimburse the cost of investment of the original research into the product: commonly used in electronic markets when a new range, such as DVD players, are firstly dispatched into the market at a high price. This strategy is often used to target "early adopters" of a product or service.
Limit pricing A limit price is the price set by a monopolist to discourage economic entry into a market,
and is illegal in many countries. The limit price is the price that the entrant would face upon entering as long as the incumbent firm did not decrease output. The limit price is often lower than the average cost of production or just low enough to make entering not profitable. The quantity produced by the incumbent firm to act as a deterrent to entry is usually larger than would be optimal for a monopolist, but might still produce higher economic profits than would be earned under perfect competition. The problem with limit pricing as a strategy is that once the entrant has entered the market, the quantity used as a threat to deter entry is no longer the incumbent firm's best response. This means that for limit pricing to be an effective deterrent to entry, the threat must in some way be made credible. A way to achieve this is for the incumbent firm to constrain itself to produce a certain quantity whether entry occurs or not. An example of this would be if the firm signed a union contract to employ a certain (high) level of labor for a long period of time. In this strategy price of the product become limit according to budget.
Loss leader A loss leader or leader is a product sold at a low price (i.e. at cost or below cost) to
stimulate other profitable sales. This would help the companies to expand its market share as a whole.
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Market-oriented pricing Setting a price based upon analysis and research compiled from the target market. This
means that marketers will set prices depending on the results from the research. For instance if the competitors are pricing their products at a lower price, then it's up to them to either price their goods at an above price or below, depending on what the company wants to achieve .
Penetration pricing Setting the price low in order to attract customers and gain market share. The price will
be raised later once this market share is gained.[3] Price discrimination Setting a different price for the same product in different segments to the market. For
example, this can be for different ages, such as classes, or for different opening times, . Premium pricing Premium pricing is the practice of keeping the price of a product or service artificially
high in order to encourage favorable perceptions among buyers, based solely on the price. The practice is intended to exploit the (not necessarily justifiable) tendency for buyers to assume that expensive items enjoy an exceptional reputation, are more reliable or desirable, or represent exceptional quality and distinction.
Contribution margin-based pricing Contribution margin-based pricing maximizes the profit derived from an individual
product, based on the difference between the product's price and variable costs (the product's contribution margin per unit), and on one’s assumptions regarding the relationship between the product’s price and the number of units that can be sold at that price. The product's contribution to total firm profit (i.e. to operating income) is maximized when a price is chosen that maximizes the following: (contribution margin per unit) X (number of units sold)..
Psychological pricing Pricing designed to have a positive psychological impact. For example, selling a product
at $3.95 or $3.99, rather than $4.00. Dynamic Pricing A flexible pricing mechanism made possible by advances in information technology, and
employed mostly by Internet based companies. By responding to market fluctuations or large amounts of data gathered from customers - ranging from where they live to what they buy to how much they have spent on past purchases - dynamic pricing allows online companies to adjust the prices of identical goods to correspond to a customer’s willingness to pay. The airline industry is often cited as a dynamic pricing success story. In fact, it employs the technique so artfully that most of the passengers on any given airplane have paid different ticket prices for the same flight.
Price leadership An observation made of oligopolistic business behavior in which one company, usually
the dominant competitor among several, leads the way in determining prices, the others soon following. The context is a state of limited competition, in which a market is shared by a small number of producers or sellers.
Marginal-cost pricing In business, the practice of setting the price of a product to equal the extra cost of
producing an extra unit of output. By this policy, a producer charges, for each product
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unit sold, only the addition to total cost resulting from materials and direct labor. Businesses often set prices close to marginal cost during periods of poor sales. If, for example, an item has a marginal cost of $1.00 and a normal selling price is $2.00, the firm selling the item might wish to lower the price to $1.10 if demand has waned. The business would choose this approach because the incremental profit of 10 cents from the transaction is better than no sale at all.
Odd pricing In this type of pricing, the seller tends to fix a price whose last digits are odd numbers.
This is done so as to give the buyers/consumers no gap for bargaining as the prices seem to be less and yet in an actual sense are too high. A good example of this can be noticed in telephone promotions of some countries like Ugandawhere instead of writing the price as sh. 40000, they write it as sh. 39999. This pricing policy is common in economies using the free market policy.
Pricing
Perfect Competition
You have studied in the class about perfect competition. There are eight assumptions under which perfect competition operates. They are as follows;
Infinite buyers and sellers – An infinite number of consumers with the willingness and ability to buy the product at a certain price, and infinite producers with the willingness and ability to supply the product at a certain price.
Zero entry and exit barriers – A lack of entry and exit barriers makes it extremely easy to enter or exit a perfectly competitive market.
Perfect factor mobility – In the long run factors of production are perfectly mobile, allowing free long term adjustments to changing market conditions.
Perfect information - All consumers and producers are assumed to have perfect knowledge of price, utility, quality and production methods of products.
Zero transaction costs - Buyers and sellers do not incur costs in making an exchange of goods in a perfectly competitive market.
Profit maximization - Firms are assumed to sell where marginal costs meet marginal revenue, where the most profit is generated.
Homogenous products - The qualities and characteristics of a market good or service do not vary between different suppliers.
Non-increasing returns to scale - The lack of increasing returns to scale (or economies of scale) ensures that there will always be a sufficient number of firms in the industry.
Property rights - Well defined property rights determine what may be sold, as well as what rights are conferred on the buyer.
You need to draw a graph or diagram. First draw the line D or Demand=Average revenue=Marginal Revenue. Average revenue = Total revenue/Price. It is parallel to the X-axis. (Why?) in perfect competition the seller is a price taker. He cannot influence the price by his actions, as he manufactures small quantity and buyers are also large they cannot influence the price. You will see the line in green colour. Then draw the Average total cost curve. It is in red colour. You will find that it has a near boat shape. As the production units will increase due to less fixed cost per unit it comes down initially. Afterwards, it will increase. For example, if the coffee machine in SRM coffee day canteen can make 60 cups per hour and the fixed rent for the machine is 60 rupees per hour, then if you making 30 cups, the fixed cost component will be 60/30=2 rupees. Now if the production goes up to 60 cups then the fixed cost will be 60/60=1rupee. If it goes beyond 60 cups the owner may have to rent a machine at 60 rupees per hour which will increase the fixed costs. Also observe the marginal cost curve meeting the average cost curve at the minimum and then rising. You have to remember this while drawing the graph. Please practice the graph. In the short run, it is possible for an individual firm to make an economic profit or abnormal profit. This situation is shown in this diagram, as the price or average revenue, denoted by P, is above the average cost denoted by C .
However, in the long period, economic profit cannot be sustained. The arrival of new firms or expansion of existing firms (if returns to scale are constant) in the market causes the (horizontal) demand curve of each individual firm to shift downward, bringing down at the same time the price, the average revenue and marginal revenue curve. The final outcome is that, in the long run, the firm will make only normal profit (zero economic profit). Its horizontal demand curve will touch its average total cost curve at its lowest point.
Profit under Perfect Competition
In contrast to a monopoly or oligopoly, it is impossible for a firm in perfect competition to earn economic profit in the long run, which is to say that a firm cannot make any more money than is necessary to cover its economic costs. In order not to misinterpret this zero-long-run-profits thesis, it must be remembered that the term 'profit' is also used in other ways. Neoclassical theory defines profit as what is left of revenue after all costs have been subtracted, including normal interest on capital plus the normal excess over it required to cover risk, and normal salary for managerial activity. Classical economists on the contrary defined profit as what is left after subtracting costs except interest and risk coverage; thus, if one leaves aside risk coverage for simplicity, the neoclassical zero-long-run-profit thesis would be re-expressed in the classical parlance as profits coinciding with interest in the long period, i.e. the rate of profit tending to coincide with the rate of interest.
firm is a monopoly when, because of the lack of any viable competition, it is able to become the sole producer of the industry's product. In a normal competitive situation, the price the firm gets for its product is exactly the same as the Marginal cost of producing the product. Because the monopoly firm does not have to worry about losing customers to competitors, it can set a price that is significantly higher the Marginal (Economic) cost of producing (the last unit of) the product. Therefore, a monopoly Situation usually allows the firm to set a monopoly price which is higher than the price that would be found in a more competitive industry., and to generate an economic profit over and above the normal profit that is typically found in a perfectly competitive industry. The economic profit obtained by a monopoly firm is referred to as monopoly profit. The existence of a monopoly, and therefore the existence of a monopoly price and monopoly profit, depend on the existence of barriers to entry: these stop other firms from entering into the industry and sapping away profits.
In a perfectly competitive market, firms are said to be price takers: since a customer can buy widgets from one producer as easily as another, any widget producer on the market faces a horizontal demand curve at the equilibrium price: if the firm tries to sell widgets above the equilibrium price, customers will simply buy their widgets elsewhere and the firm will lose all of their business. (In most actual markets, of course, a situation in which exactly comparable goods are available just as easily from one firm as from another does not exist ? though this situation does seem to exist in Commodity markets, the theory of perfect competition is usually a useful idealized model rather than a naturalistic description).
By contrast, lack of competition in a market creates a downward sloping demand curve for a monopolist or oligopolist: although they will lose some business by raising prices, they will not lose it all, and it may be more profitable in most situations to sell at a higher price. Though monopolists are constrained byconsumer demand, they are not price takers. The monopolist can either have a target level of output that will ensure the monopoly price for the given consumer demand it faces in the industry, or it can set the monopoly price at the onset and adjust output to ensure no excess inventories occur as a result of the output level. Essentially, they can set their own price and accept a level of output determined by the market, or they can set their output quantity and accept the price determined by the market. The price and output are co-determined by consumer demand and the firm's production cost structure.
A firm with monopoly power setting prices will typically set price at the profit maximizing level. The most profitable price that they can set (what will become the monopoly price) is where the optimum output level (where marginal cost (MC) equals marginal revenue (MR), although not in the diagram below) meets the demand curve. Under normal market conditions for a monopolist, this price will be higher than the marginal cost of producing the product, thereby indicating the price paid by the consumer, which is equal to the marginal benefit for the consumer, is above the firm's marginal cost. In the chart below the shaded area represents the profits of the monopolist, except that it is incorrect because the graph does not set MR = MC for
the case of monopoly. The lower half represents the normal profits that would go to a competitive firm (ignoring output losses). The upper half represent the additional economic profit going to the monopolist.Please note that the price under monopoly is higher than that of perfect competition.
Graph:
1.The consumer demand is sloping downwards unlike in perfect competition. (Why?)
2. You have average variable cost also in the diagram. (Why?)
Question: For the same demand curve monopolist provides higher price while perfect competition provides lower price why? Which is better monopoly or perfect competition?
If monopoly is prevailing in the market government will intervene or by Competition Law enacted by government will intervene to ensure welfare of the consumers.
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Monopolistic Competition
Monopolistic competition is a type of imperfect competition such that one or two producers sell products that are differentiated from one another as goods but not perfect substitutes (such as from branding, quality, or location). In monopolistic competition, a firm takes the prices charged by its rivals as given and ignores the impact of its own prices on the prices of other firms.In a monopolistically competitive market, firms can behave like monopolies in the short run, including by using market power to generate profit. In the long run, however, other firms enter the market and the benefits of differentiation decrease with competition; the market becomes more like a perfectly competitive one where firms cannot gain economic profit. In practice, however, if consumer rationality/innovativeness is low and heuristics are preferred, monopolistic
competition can fall into natural monopoly, even in the complete absence of government intervention. In the presence of coercive government, monopolistic competition will fall intogovernment-granted monopoly. Unlike perfect competition, the firm maintains spare capacity. Models of monopolistic competition are often used to model industries. Textbook examples of industries with market structures similar to monopolistic competition include restaurants,cereal, clothing, shoes, and service industries in large cities. Monopolistically competitive markets have the following characteristics:
There are many producers and many consumers in the market, and no business has total control over the market price.
Consumers perceive that there are non-price differences among the competitors' products.
There are few barriers to entry and exit.
Producers have a degree of control over price.
The long-run characteristics of a monopolistically competitive market are almost the same as a perfectly competitive market. Two differences between the two are that monopolistic competition produces heterogeneous products and that monopolistic competition involves a great deal of non-price competition, which is based on subtle product differentiation. A firm making profits in the short run will nonetheless only break even in the long run because demand will decrease and average total cost will increase. This means in the long run, a monopolistically competitive firm will make zero economic profit. This illustrates the amount of influence the firm has over the market; because of brand loyalty, it can raise its prices without losing all of its customers. This means that an individual firm's demand curve is downward sloping, in contrast to perfect competition, which has a perfectly elastic demand schedule.
Major characteristics
There are six characteristics of monopolistic competition (MC):
Product differentiation
Many firms
Free entry and exit in the long run
Independent decision making
Market Power
Buyers and Sellers do not have perfect information (Imperfect Information)
MC firms sell products that have real or perceived non-price differences. However, the differences are not so great as to eliminate other goods as substitutes. Technically, the cross price elasticity of demand between goods in such a market is positive. In fact, the XED would be high.[7] MC goods are best described as close but imperfect substitutes.[7] The goods perform the same basic functions but have differences in qualities such as type, style, quality, reputation, appearance, and location that tend to distinguish them from each other. For example, the basic function of motor vehicles is basically the same - to move people and objects from point A to B in reasonable comfort and safety. Yet there are many different types of motor vehicles such as motor scooters, motor cycles, trucks, cars and SUVs and many variations even within these categories.
Many firms
There are many firms in each MC product group and many firms on the side lines prepared to enter the market. A product group is a "collection of similar products".[8] The fact that there are "many firms" gives each MC firm the freedom to set prices without engaging in strategic decision making regarding the prices of other firms and each firm's actions have a negligible impact on the market. For example, a firm could cut prices and increase sales without fear that its actions will prompt retaliatory responses from competitors.
How many firms will an MC market structure support at market equilibrium? The answer depends on factors such as fixed costs, economies of scale and the degree of product differentiation. For example, the higher the fixed costs, the fewer firms the market will support.[9] Also the greater the degree of product differentiation - the more the firm can separate itself from the pack - the fewer firms there will be at market equilibrium.
Free entry and exit
In the long run there is free entry and exit. There are numerous firms waiting to enter the market each with its own "unique" product or in pursuit of positive profits and any firm unable to cover its costs can leave the market without incurring liquidation costs. This assumption implies that there are low start up costs, no sunk costs and no exit costs. The cost of entering and exit is very low.
Independent decision making
Each MC firm independently sets the terms of exchange for its product.[10] The firm gives no consideration to what effect its decision may have on competitors.[10]The theory is that any action will have such a negligible effect on the overall market demand that an MC firm can act without fear of prompting heightened competition. In other words each firm feels free to set prices as if it were a monopoly rather than an oligopoly.
MC firms have some degree of market power. Market power means that the firm has control over the terms and conditions of the exchange. An MC firm can raise it's prices without losing all its customers. The firm can also lower prices without triggering a potentially ruinous price war with competitors. The source of an MC firm's market power is not barriers to entry since they are low. Rather, an MC firm has market power because it has relatively few competitors, those competitors do not engage in strategic decision making and the firms sells differentiated product. Market power also means that an MC firm faces a downward sloping demand curve. The demand curve is highly elastic although not "flat".
Imperfect information
No sellers or buyers have complete market information, like market demand or market supply.
Short-run equilibrium of the firm under monopolistic competition. The firm maximizes its profits and produces a quantity where the firm's marginal revenue (MR) is equal to its marginal cost (MC). The firm is able to collect a price based on the average revenue (AR) curve. The difference between the firms average revenue and average cost, multiplied by the quantity sold (Qs), gives the total profit.
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Long-run equilibrium of the firm under monopolistic competition. The firm still produces where marginal cost and marginal revenue are equal; however, the demand curve (and AR) has shifted as other firms entered the market and increased competition. The firm no longer sells its goods above average cost and can no longer claim an economic profit.
There is waste under this market which is not existing in Perfect Competiiton.
1 Huge Expenditure on Advertisement .
2. Excess capacity.
3. Existence of inefficient firms.
4. Lack of standardized products.
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Oligopoly
An oligopoly is a market form in which a market or industry is dominated by a small number of sellers (oligopolists). Because there are few sellers, each oligopolist is likely to be aware of the actions of the others. The decisions of one firm influence, and are influenced by, the decisions of other firms. Strategic planning by oligopolists needs to take into account the likely responses of the other market participants.
Description
Oligopoly is a common market form for example Verizon, AT&T, Sprint, Nextel, and T-Mobile together control 89% of the US cellular phone market. In Indian environment Air Tel, DOCOMO, VODAPHONE are examples of oligopolistic market in telecom sector.
Oligopolistic competition can give rise to a wide range of different outcomes. In some situations, the firms may employ restrictive trade practices (collusion, market sharing etc.) to raise prices and restrict production in much the same way as a monopoly. Where there is a formal agreement for such collusion, this is known as a cartel. A primary example of such a cartel is OPEC which has a profound influence on the international price of oil.
Firms often collude in an attempt to stabilize unstable markets, so as to reduce the risks inherent in these markets for investment and product development. There are legal restrictions on such collusion in most countries. There does not have to be a formal agreement for collusion to take place (although for the act to be illegal there must be actual communication between companies)–for example, in some industries there may be an acknowledged market leader which informally sets prices to which other producers respond, known as price leadership. In the case of cement manufacturers in India they colluded to restrict production and arrived at higher margins.
In other situations, competition between sellers in an oligopoly can be fierce, with relatively low prices and high production. This could lead to an efficient outcome approaching perfect competition. The competition in an oligopoly can be greater when there are more firms in an industry than if, for example, the firms were only regionally based and did not compete directly with each other.
Thus the welfare analysis of oligopolies is sensitive to the parameter values used to define the market's structure. In particular, the level of dead weight loss is hard to measure. The study of product differentiation indicates that oligopolies might also create excessive levels of differentiation in order to stifle competition.
Characteristics
Profit maximisation conditions: An oligopoly maximises profits by producing where marginal revenue equals marginal costs.
Ability to set price: Oligopolies are price setters rather than price takers.
Entry and exit: Barriers to entry are high. The most important barriers are economies of scale, patents, access to expensive and complex technology, and strategic actions by incumbent firms designed to discourage or destroy nascent firms. Additional sources of barriers to entry often result from government regulation favoring existing firms making it difficult for new firms to enter the market.
Number of firms: "Few" – a "handful" of sellers. There are so few firms that the actions of one firm can influence the actions of the other firms.
Long run profits: Oligopolies can retain long run abnormal profits. High barriers of entry prevent sideline firms from entering market to capture excess profits.
Product differentiation: Product may be homogeneous (steel) or differentiated (automobiles).
Perfect knowledge: Assumptions about perfect knowledge vary but the knowledge of various economic actors can be generally described as selective. Oligopolies have perfect knowledge of their own cost and demand functions but their inter-firm information may be incomplete. Buyers have only imperfect knowledge as to price, cost and product quality.
Interdependence: The distinctive feature of an oligopoly is interdependence.Oligopolies are typically composed of a few large firms. Each firm is so large that its actions affect market conditions. Therefore the competing firms will be aware of a firm's market actions and will respond appropriately. This means that in contemplating a market action, a firm must take into consideration the possible reactions of all competing firms and the firm's countermoves. It is very much like a game of chess or pool in which a player must anticipate a whole sequence of moves and countermoves in determining how to achieve his objectives. For example, an oligopoly considering a price reduction may wish to estimate the likelihood that competing firms would also lower their prices and possibly trigger a ruinous 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. This high degree of interdependence and need to be aware of what the other guy is doing or might do is to be contrasted with lack of interdependence in other market structures. In a PC market there is zero interdependence because no firm is large enough to affect market price. All firms in a PC market are price takers, information which they robotically follow in maximizing profits. In a monopoly there are no competitors to be concerned about. In a monopolistically competitive market each firm's effects on market conditions is so negligible as to be safely ignored by competitors.
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Above the kink, demand is relatively elastic because all other firms' prices remain unchanged. Below the kink, demand is relatively inelastic because all other firms will introduce a similar price cut, eventually leading to a price war. Therefore, the best option for the oligopolist is to produce at point E which is the equilibrium point and the kink point. This is a theoretical model proposed in 1947, which has failed to receive conclusive evidence for support.
In an oligopoly, firms operate under imperfect competition. With the fierce price competitiveness created by this sticky-upward demand curve, firms use non-price competition in order to accrue greater revenue and market share.
"Kinked" demand curves are similar to traditional demand curves, as they are downward-sloping. They are distinguished by a hypothesized convex bend with a discontinuity at the bend–"kink". Thus the first derivative at that point is undefined and leads to a jump discontinuity in the marginal revenue curve.
Classical economic theory assumes that a profit-maximizing producer with some market power (either due to oligopoly or monopolistic competition) will set marginal costs equal to marginal revenue. This idea can be envisioned graphically by the intersection of an upward-sloping marginal cost curve and a downward-sloping marginal revenue curve (because the more one
sells, the lower the price must be, so the less a producer earns per unit). In classical theory, any change in the marginal cost structure (how much it costs to make each additional unit) or the marginal revenue structure (how much people will pay for each additional unit) will be immediately reflected in a new price and/or quantity sold of the item. This result does not occur if a "kink" exists. Because of this jump discontinuity in the marginal revenue curve, marginal costs could change without necessarily changing the price or quantity.
1. Explain what the suitable fiscal measures to control business cycles are. 2. Explain what the suitable monetary measures to control business cycles are. 3. Explain business cycles with clear diagram showing different phases. 4. Explain demand pull and cost push inflation. 5. Explain impact of inflation on various social segments; creditors; debtors;
shareholders; debenture holder; permanent income and pensioners; agriculture and manufacturing.
6. Explain new economic policy of India (Liberalization, Privatization and Globalization.
7. Explain impact of globalization on Indian economy. 8. What are the various components of national income and explain different
methods to measure the same.
Demand-pull inflation is asserted to arise when aggregate demand in an economy outpaces aggregate supply. It involves inflation rising as real gross domestic product rises and unemployment falls, as the economy moves along the Phillips curve. This is commonly described as "too much money chasing too few goods". More accurately, it should be described as involving "too much money spent chasing too few goods", since only money that is spent on goods and services can cause inflation. This would not be expected to persist over time due to
increases in supply, unless the economy is already at a full employment level.
According to Keynesian theory, the more firms will employ people, the more people that are employed, the higher aggregate demand (AD) will become. This greater demand will make firms employ more people in order to output more. Due to capacity constraints, this increase in output will eventually become so small that the price of the good will rise. At first, unemployment will go down, shifting AD1 to AD2, which increases demand (noted as "Y") by (Y2 - Y1). This increase in demand means more workers are needed, and then AD will be shifted from AD2 to AD3, but this time much less is produced than in the previous shift, but the price level has risen from P2 to P3, a much higher increase in price than in the previous shift. This increase in price is called inflation. Demand-pull inflation is in contrast with cost-push inflation, when price and wage increases are being transmitted from one sector to another. However, these can be considered as different aspects of an overall inflationary process.: demand-pull inflation explains how price inflation starts, and cost-push inflation demonstrates why inflation once begun is so difficult to stop.
Cost Push Inflation
Cost-push inflation is a type of inflation caused by substantial increases in the cost of important goods or services where no suitable alternative is available. A situation that has been often cited of this was the oil crisis of the 1970s, which some economists see as a major cause of the inflation experienced in the Western world in that decade. It is argued that this inflation resulted from increases in the cost of petroleum imposed by the member states of OPEC. Since petroleum is so important to industrialised economies, a large increase in its price can lead to the increase in the price of most products, raising the inflation rate. This can raise the normal or built-in inflation rates, reflecting adaptive expectations and the price/wage spiral, so that a supply shock can have persistent effects.
