138
MANAGERIAL ECONOMICS UNDER GUIDANCE OF Mr. Yogesh Puri,Sir. By-Shashank Kumar Saxena M.B.A -1 st Sem STEP-HBTI
MANAGERIAL ECONOMICSUNDER GUIDANCE OFMr. Yogesh Puri,Sir.
By-Shashank Kumar SaxenaM.B.A -1st SemSTEP-HBTI
Index
A. IntroductionB. Demand & Elasticity of DemandC. Supply & Elasticity of SupplyD. Demand ForecastingE. ProductionF. CostG. RevenueH. Main Forms of MarketI. National IncomeJ. Business cycle & profit
Introduction
Managerial Economics
•Because of application of economic principles to business management the term business economics and managerial economics are used interchangeable. However it is concern with 2 fundamental aspects: -a)-Decision makingb)-Forward Planning
Scope
•M.E helps managers in taking decisions which involves risk & uncertainty. Some of those are: -a)-Profit Decisionb)-Demand decisionc)-Price Output Decisionsd)-Investment Decisions
Fundamentals of Managerial Economics•Opportunity Cost Principle•Incremental Cost Principle•Time Perspective Principle
a)-Short Run Principleb)-Long Run Principle
•Discounting Principle•Equi-Marginal Principle
Key Terms• demand• demand schedule• law of demand• diminishing marginal utility• income effect• substitution effect• demand curve• determinants of demand• normal goods• inferior goods• substitute good• complementary good• change in demand• change in quantity demanded
• supply• supply schedule• law of supply• supply curve• determinants of supply• change in supply• change in quantity
supplied• equilibrium price• equilibrium quantity• surplus• shortage• price ceiling• price floor
3-7
Market
•Interaction between buyers and sellers
•Buyers demand goods•Sellers supply goods•Assumptions
▫Standardized good▫Competitive market
Demand & Elasticity of Demand
Demand
•Schedule or curve•Amount consumers willing and able to
purchase at a given price•Other things equal•Individual demand •Market demand•Law of Demand: -Other things equal, as
price falls quantity demanded rises and price rises the quantity demanded falls
Cont.
•Exceptions to law of demanda)-Griffen goodsb)-Snob affectc)-Future exceptationd)-Ignorancee)-Emergency
•Demand function:- A mathematical represent of the quantity demanded and
factors affecting it.Q=f{P,P0,W,F…….}
Where,P=Price of commodity.P0 =PopulationW=Weather ConditionF=Future Exception
•Two levels: Individual Demand Market Demand
Cont.
Individual demand curve 6
5
4
3
2
1
010 20 30 40 50 60 70 80 Quantity Demanded (units per week)
Pri
ce (
per
un
it)
P
Q
D
P Qd
`5
4
3
2
1
10
20
35
55
80
Individual Demand
Individual Demand 6
5
4
3
2
1
0
Quantity Demanded (unit per week)
Pri
ce (
per
un
it)
P Qd
`5
4
3
2
1
10
20
35
55
80
IndividualDemand
P
Q
D1
2 4 6 8 10 12 14 16 18
Demand Can Increase or Decrease
Decrease in Demand
D2
D3
Change in Demand
Change in Quantity
Demanded
3-14
Reasons for change (increase or decrease) in demand• Change in income.• Changes in taste, habits and preference.• Change in fashions and customs• Change in distribution of wealth.• Change in substitutes.• Change in demand of position of
complementary goods.• Change in population.• Advertisement and publicity persuasion.• Change in the value of money.• Change in the level of taxation.• Expectation of future changes in price.
Elasticity of demand•Elasticity means the degree of
responsiveness. When talked in terms of demand, it tells the degree of change/response in demand w.r.t change in price.
• In economics, it acts as a tool to measure/describe the steepness or flatness of curves or functions.
•Price elasticity of demand is computed along a demand curve. It is a ratio of % changes in demand and price.
Why it is imp.?Law of demand tells us that as the price of a
commodity falls, the quantity demanded increases, and vice versa.
It does not tell us by how much the quantity demanded increases, as a result of a certain fall in price or vice versa.
Law of demand tells us only the direction of change in demand but not the rate at which the change takes place.
To know this, we should know the elasticity of demand or Price elasticity of demand.
•It can be represented in the following mathematical form: -
Elasticity(e p) =
% change in p = 100.
% change in p =
Pricein change %
demandedQuantity in change %
Price orignal
Pricein change
100 )P
P (
Methods of measuring elasticity of demand.•Point elasticity method•Expenditure Outlay method•% method
Types of Price Elasticity
1. Perfectly elastic2. Perfectly Inelastic3. Unity Elasticity4. Relatively Elastic5. Relatively Inelastic.
Factors determining Price Elasticity of Demand
•1. Nature of the commodity•Extent of use•Range of substitutes•Income level•Proportion of income spent on the
commodity•Urgency of demand•Durability•Purchase frequency
Perfectly inelastic demand
Where no reduction in price is needed to cause an increase in demand.
The firm can sell the quantity in wants to sell at the prevailing price but none at all at even slightly higher price.
The shape of the demand curve is horizontal.
The elasticity is = infinite.
Perfectly inelastic demand
Even a large change in price, does not change the quantity demanded.
Here the shape of the curve is vertical.
Elasticity = 0
Unity elasticity
A proportionate change in price results in exactly the same proportional change in quantity demanded.
Shape of the demand curve is a rectangular hyperbola.
Elasticity = 1
Relatively elastic demand
A reduction in price leads to more than proportionate change in demand.
Shape of the demand curve is flat.
Elasticity > 1
Relatively inelastic demand
A decline in price leads to less than proportionate increase in demand.
Shape of the demand curve is steep.
Elasticity < 1
Factors influencingelasticity of demand
1. Nature of the commodity.2. Availability of Substitutes3. Number of Uses4. Consumer’s Income.5. Height of Price and Range of Price
Change.6. Proportion of Expenditure.7. Durability of the Commodity.8. Habit.9. Complementary Goods.10.Time.11.Recurrence of Demand.12.Possibility of Postponement.
Supply & Elasticity of Supply
Supply•Schedule or curve•Amount producers willing and able to sell at a given price
•Individual supply•Market supply
3-29
Law of Supply
•Other things equal, as price rises the quantity supplied rises
•Explanations:▫Revenue implications▫Marginal cost
3-30
Individual Supply 6
5
4
3
2
1
0
Quantity Supplied (units per week)
Pri
ce (
per
un
it)
P Qs
`5
4
3
2
1
60
50
35
20
5
IndividualSupply
P
Q
S1
10 20 30 40 50 60 70
3-31
Determinants of Supply•Resource prices•Technology•Taxes and subsidies•Prices of other goods•Producer expectations•Number of sellers
3-32
Individual Supply 6
5
4
3
2
1
0
Quantity Supplied (units per week)
Pri
ce (
per
un
its)
P Qs
`5
4
3
2
1
60
50
35
20
5
IndividualSupply
P
Q
S1
Supply Can Increase or Decrease
S2
S3
10 20 30 40 50 60 70
3-33
Individual Supply 6
5
4
3
2
1
0
Quantity Supplied (units per week)
Pri
ce (
per
un
its)
P Qs
` 5
4
3
2
1
60
50
35
20
5
IndividualSupply
P
Q
S1
Supply Can Increase or Decrease
S2
S3
10 20 30 40 50 60 70
Change in Quantity Supplied
Change in Supply
3-34
Elasticity of supply
Elasticity(e p) =
% change in p = 100.
% change in p =
Pricein change %
demandedQuantity in change %
Price orignal
Pricein change
100 )P
P (
•It is defined as the ratio of percentage change in quantity demanded and the percentage change in the price of the commodity.•It tells the degree of responsiveness of quantity supply due to change in its price.
Types of Supply Elasticity
1. Perfectly Elastic2. Perfectly Inelastic3. Unit Elasticity4. More than Elastic5. Less than Elastic.
Perfectly Elastic Supply
Price
Quantity Supply
Perfectly elastic supply
Es = infinity
•Where no reduction in price is needed to cause an increase in supply. •The firm can sell the quantity in wants to sell at the prevailing price but none at all at even slightly higher price.•The shape of the demand curve is horizontal.
Elastic Supply Curve
pri
ce
Quantity Supply
ES > 1
•A change in price leads to more than proportionate change in supply.
•Shape of the demand curve is flat.
Perfectly inelastic supplyP
rice
Es = 0
Quantity Supply
•Even a large change in price, does not change the quantity supplied.•Here the shape of the curve is vertical.
Unit elastic
Pri
ce
Quantity Supply
ES = 1
•A proportionate change in price results in exactly the same proportional change in quantity supplied.
•Shape of the demand curve is a rectangular hyperbola.
Inelastic supply
Price
Quantity Supply
ES < 1
•A change in price leads to less than proportionate change in supply.
•Shape of the demand curve is flat.
Market Equilibrium
Market Equilibrium
•Equilibrium price and quantity
•Surplus and shortage•Rationing function of price•Efficient allocation
▫Productive efficiency▫Allocative efficiency
3-43
Market Equilibrium 6
5
4
3
2
1
02 4 6 8 10 12 14 16 18unitss of Corn (thousands per week)
Pri
ce (
per
un
its)P Qd
`5
4
3
2
1
2,000
4,000
7,000
11,000
16,000
MarketDemand
200 Buyers
P Qs
` 5
4
3
2
1
12,000
10,000
7,000
4,000
1,000
MarketSupply
200 Sellers
200 Buyers & 200 Sellers
7
3
D
S
` 4 Price Floor
6,000 unitsSurplus
` 2 Price Ceiling
7,000 unitsShortage
3-44
Market Equilibrium
•Change in demand▫Shift of the demand curve
•Change in supply▫Shift of the supply curve
•Change in equilibrium price and quantity
3-45
Price Quantity
?
?
?
?
Market Equilibrium•Supply increase; Demand decrease
•Supply decrease; Demand increase
•Supply increase; Demand increase
•Supply decrease; Demand decrease
3-46
Demand Forecasting
•Forecasting of demand is the art of predicting demand for a product or a service at some future data on the basis of certain present and past behavior patterns of some related events
Objectives of demand forecasting• It enable to produce the required quantities at the
right time• Arrange well in advance for the various factors of
production viz. raw materials, equipment, machine accessories, labour, building etc.
• It is an important aid in effective and efficient planning
• It can also help management in reducing its dependence on chance
• It is helpful in allocation of national resources• Helpful in setting sales target• Arrangement of funds
Methods Of Demand Forecasting
Production function
Meaning of production
Its an activity that transforms inputs in to out puts.
Production Function
Production Function
Inputs Process Output
Land
Labour
Capital
Product or service
generated– value added
The production function
The production function can be mathematically written as
Q=F(Lb,L,K,T,t….) Lb=land. L=labor. K=capital. T=Technology. t=time.
Factors affecting productivity
• Technology• Inputs • Labor • Capital• Machinery• Land• Raw material• power• Time period
Classification of production function
•Short term production function. (K & Lb are constant)
•Long run production function. (Lb is constant)
Analysis of the short run• In the short run at least one factor fixed in supply but
all other factors capable of being changed• Reflects ways in which firms respond to changes
in output (demand)• Can increase or decrease output using more or less of
some factors but some likely to be easier to change than others
• Increase in total capacity only possible in the long run
•Law of variable proportion
Analysis of the long run function• The long run is defined as the period of time
taken to vary all factors of production▫By doing this, the firm is able to increase its
total capacity – not just short term capacity▫Associated with a change in the scale of
production▫The period of time varies according to the firm
and the industry
Alternatives of the long run production•Constant returns to the scale out put increases in the same
proportion as the increase in the input.•Increasing return to scale out put increases by a greater
proportion than the increase in inputs.•Decreasing returns to the scale. output increases in the lesser
proportion than the increase in the inputs.
Cost Concepts in Economics
Agenda
•Opportunity Cost•Long Versus Short-Run•Cost Concepts•Revenue Concepts•Production Rules in Short and Long-Run•Size in Long-Run
Opportunity Costs•The value of the product not produced
because an input was used for another purpose.
•The income that would have been received if the input had been used in its most profitable alternative use.
•It denotes the real cost of using an input.
Short Versus Long Run
•The short run is a period of time sufficiently short that only some of the variables can be changed.
•The long run is a period of time that all variables can be changed.
Types of Costs
•Variable Costs▫These costs exist only if production occurs.▫E.g., fuel for tractor, seed, etc.
•Fixed Costs▫These cost exist whether production occurs or
not.▫In the long-run there are no fixed costs.▫Can be both cash and non-cash expenses.▫E.g., depreciation on tractors and buildings,
etc.
Types of Costs Cont.
•Sunk Costs▫Is an expenditure that cannot be recovered.▫In essence, it becomes part of fixed costs.▫E.g., pre-harvest costs.
Cost Concepts
•Total Fixed Costs (TFC)▫The summation of all fixed and sunk costs to
production.•Total Variable Costs (TVC)
▫The summation of all variable costs to production.
•Total Costs (TC)▫The summation of total fixed and total variable
costs.▫TC=TFC+TVC
Cost Concepts Cont.
•Average Fixed Costs (AFC)▫The total fixed costs divided by output.
•Average Variable Costs (AVC)▫The total variable costs divided by output.
•Average Total Costs (ATC)▫The total costs divided by output.▫The summation of average fixed costs and
average variable costs, i.e., ATC=AFC+AVC.
Cost Concepts Cont.
•Marginal Costs▫The change in total costs divided by the
change in output. TC/Y
▫The change in total variable costs divided by the change in output. TVC/Y
Side Note on Marginal Cost
•How can marginal cost equal both the change in total cost divided by the change in output and the change in total variable cost divided by the change in output when variable costs are not equal to total costs?▫Short answer: fixed costs do not change.
Side Note on Marginal Cost Cont.•We want to show that MC = TVC/Y when
TVC TC.•We know that TC = TFC + TVC•This implies that TC = (TFC + TVC)•This implies that TC = TFC + TVC•We know that TFC = 0•Hence, TC = TVC•Divide the previous by Y, we obtain• TC/Y = TVC/Y•MC = TVC/Y
Graphical Representation of Cost Concepts
`
Y
TC
TVC
TFC
Graphical Representation of Cost Concepts Cont.
`
Y
ATC
MC
AVC
AFC
Notes on Costs
•MC will meet AVC and ATC from below at the corresponding minimum point of each.▫Why?
•As output increases AFC goes to zero.•As output increases, AVC and ATC get
closer to each other.
74
Example of Cost Concepts
Y TFC TVC TC AFC AVC ATC MC
10
30
48
65
81
96
108
116
120
117
1000
1000
1000
1000
1000
1000
1000
1000
1000
1000
1000
1600
2000
2200
2600
3200
4000
5000
6200
7600
2000
2600
3000
3200
3600
4200
5000
6000
7200
8600
100
33.33
20.83
15.38
12.35
10.42
9.26
8.62
8.33
8.55
100
53.33
41.67
33.85
32.10
33.33
37.04
43.10
51.67
64.96
200
86.67
62.50
49.23
45.45
43.75
46.30
51.72
60.00
73.51
30
22.22
11.76
25
40
66.67
125
300
-466.67
X
10
16
20
22
26
32
40
50
62
76
Revenue Concepts•Revenue (TR) is defined as the output
price (py) multiplied by the quantity (Y).•Average revenue (AR) equals total
revenue divided by output (Y), i.e., TR/Y, which equals py.
•Marginal Revenue is the change in total revenue divided by the change in output, i.e., TR/Y.
Short-Run Decision Making
•In the short-run, there are many ways to choose how to produce.▫Maximize output.▫Utility maximization of the manager.▫Profit maximization.
Profit () is defined as total revenue minus total cost, i.e., = TR – TC.
Short-Run Decision Making Cont.•When examining output, we want to set
our production level where MR = MC when MR > AVC in the short-run.▫If MR AVC, we would want to shut down.
Why?▫If we can not set MR exactly equal to MC,
we want to produce at a level where MR is as close as possible to MC, where MR > MC.
Intuition for Setting MR = MC
•Suppose MR < MC.•This implies that by producing more
output, you have a greater addition of cost than you do revenue.▫Hence you would not make the change.
Intuition for Setting MR = MC Suppose MR > MC. This implies that by producing
more output, you have a greater addition of revenue than you do cost. Hence you would make the change.
You would stop increasing output at the point where the trade-off in additional revenue is just equal to the trade-off in additional costs.
Why Shutdown WhenMR < AVC•If MR < AVC, this implies that you are not
bringing in enough revenue from each unit produced to cover your variable costs.
•Hence you could minimize your loss if you were to shutdown.
Why Produce When ATC > MR > AVC•When MR < ATC, the company is making
a loss.▫Why would it produce?
•Since the firm is making something above and beyond its variable cost, it can put some of that revenue towards fixed cost.▫This implies that it minimizes its loss by
producing.
Profit Scenario Graphically`
Y
ATC
MC
AVC
AFC
MR = py
Profit
ATC
Yprofit
Loss Minimizing Graphically`
Y
ATC
MC
AVC
AFC
Loss
ATC
Yloss
MR = py
Shutdown Decision Graphically`
Y
ATC
MC
AVC
AFC
Loss = A + B
ATC
Yloss
MR = py
A
B
If we did not produce: loss = B
Production Rules for the Long-Run•To maximize profits, the farmer should
produce when selling price is greater than ATC at the production level where MC = MR.
•To minimize losses, the farmer should not produce when selling price is less than ATC, i.e., shutdown the business.
Note on Cost Concepts
•The producer’s supply curve is the part of the MC curve that is above the shutdown point.
Long-Run Average Costs
•The long run average cost (LRAC) curve is the envelope of the short run average cost curves when the size of the operation is allowed to increase or decrease.
•Note that a short run average cost curve exists for every possible farm size, as defined by the amount of fixed input available.
Long-Run Average Costs Cont.
•In a competitive market, the long run optimal production will occur at the lowest point on the LRAC, i.e., economic profits are driven to zero.
Size in the Long-Run
•A measure of size in the long run between output and costs as farm size increases (EOS) is the following:▫EOS = percent change in costs divided by
percent change in output value
Size in the Long-Run Cont.
•If this ratio of EOS is less than one, then there are decreasing costs to expanding production, i.e., increasing returns to size.
•If this ratio is equal to one, then there are constant costs to expanding production, i.e., constant returns to size.
•If this ratio is greater than one, then there are increasing costs to expanding production, i.e., decreasing returns to size.
91
Economies of Size
•This exists when the LRAC is decreasing.•Also known as increasing returns to size.•Usually occurs because of full utilization
of capital (tractors and buildings) and labor.
•Also occurs because of discount pricing for buying in bulk and selling price benefits for selling large quantities.
92
Diseconomies of Size•This exists when the LRAC is increasing.•Also known as decreasing returns to size.•Usually occurs because a lack of
managerial skills.•Also occurs because travel time increases
as farm increases.▫Livestock: disease control and manure
disposal.▫Crops: geographical distance away from each
other.
Market Structure• Market structure – identifies how a market
is made up in terms of:▫ The number of firms in the industry▫ The nature of the product produced▫ The degree of monopoly power each firm has▫ The degree to which the firm can influence price▫ Profit levels▫ Firms’ behaviour – pricing strategies, non-price
competition, output levels ▫ The extent of barriers to entry▫ The impact on efficiency
Market Structure
More competitive (fewer imperfections)
Perfect Competition
Pure Monopoly
Market Structure
Less competitive (greater degree of imperfection)
Perfect Competition
Pure Monopoly
Main forms of MarketPerfect
Competition
Pure Monopoly
Monopolistic Competition Oligopoly Duopoly Monopoly
The further right on the scale, the greater the degree of monopoly power exercised by the firm.
Perfect Competition• One extreme of the market structure spectrum• Characteristics:
▫ Large number of firms▫ Products are homogenous (identical) – consumer
has no reason to express a preference for any firm▫ Freedom of entry and exit into and out
of the industry▫ Firms are price takers – have no control
over the price they charge for their product▫ Each producer supplies a very small proportion
of total industry output▫ Consumers and producers have perfect knowledge
about the market
Perfect CompetitionCost/Revenue
Output/Sales
The industry price is determined by the demand and supply of the industry as a whole. The firm is a very small supplier within the industry and has no control over price. They will sell each extra unit for the same price. Price therefore = MR and AR
P = MR = AR
MC
The MC is the cost of producing additional (marginal) units of output. It falls at first (due to the law of diminishing returns) then rises as output rises.
AC
The average cost curve is the standard ‘U’ – shaped curve. MC cuts the AC curve at its lowest point because of the mathematical relationship between marginal and average values.
Q1
Given the assumption of profit maximisation, the firm produces at an output where MC = MR (Q1). This output level is a fraction of the total industry supply.
At this output the firm is making normal profit. This is a long run equilibrium position.
Perfect CompetitionDiagrammatic representation
Cost/Revenue
Output/Sales
P = MR = AR
MC
AC
Q1
Now assume a firm makes some form of modification to its product or gains some form of cost advantage (say a new production method). What would happen?
AC1
MC1
AC1Abnormal profit
Q2
Because the model assumes perfect knowledge, the firm gains the advantage for only a short time before others copy the idea or are attracted to the industry by the existence of abnormal profit. If new firms enter the industry, supply will increase, price will fall and the firm will be left making normal profit once again.
P1 = MR1 = AR1
The lower AC and MC would imply that the firm is now earning abnormal profit (AR>AC) represented by the grey area.
Average and Marginal costs could be expected to be lower but price, in the short run, remains the same.
Monopolistic or Imperfect Competition
•Where the conditions of perfect competition do not hold, ‘imperfect competition’ will exist
•Varying degrees of imperfection give rise to varying market structures
•Monopolistic competition is one of these – not to be confused with monopoly!
Monopolistic or Imperfect Competition
•Characteristics:▫Large number of firms in the industry▫May have some element of control over price
due to the fact that they are able to differentiate their product in some way from their rivals – products are therefore close, but not perfect, substitutes
▫Entry and exit from the industry is relatively easy – few barriers to entry and exit
▫Consumer and producer knowledge imperfect
Monopolistic or Imperfect CompetitionImplications for the 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 assume that the 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.
Monopolistic or Imperfect Competition
Implications for the diagram:Cost/Revenue
Output / Sales
MC
AC
D (AR)MRQ1
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
Monopolistic or Imperfect Competition
Implications for the diagram:Cost/Revenue
Output / Sales
MC
AC
D (AR)MRQ1
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.
Q2
AR = AC
Monopolistic or Imperfect Competition
Implications for the diagram:Cost/Revenue
Output / Sales
MC
AC
AR1MR1
This is the long run equilibrium position of a firm in monopolistic competition.
Q2
AR = AC
Monopolistic or Imperfect Competition
•Some important points about monopolistic competition:▫May reflect a wide range of markets▫Not just one point on a scale – reflects
many degrees of ‘imperfection’
▫Examples?
Monopolistic or Imperfect Competition
• Restaurants• Plumbers/electricians/local builders• Solicitors• Private schools• Plant hire firms• Insurance brokers• Health clubs• Hairdressers• Funeral directors• Estate agents• Damp proofing control firms
Monopolistic or Imperfect Competition
• In each case there are many firms in the industry
• Each can try to differentiate its product in some way
• Entry and exit to the industry is relatively free• Consumers and producers do not have perfect
knowledge of the market – the market may indeed be relatively localised. Can you imagine trying to search out the details, prices, reliability, quality of service, etc for every plumber in the UK in the event of an emergency??
Oligopoly•Competition between the few
▫May be a large number of firms in the industry but the industry is dominated by a small number of very large producers
•Concentration Ratio – the proportion of total market sales (share) held by the top 3,4,5, etc firms:▫A 4 firm concentration ratio of 75% means the
top 4 firms account for 75% of all the sales in the industry
Oligopoly•Features of an oligopolistic market
structure:▫ Price may be relatively stable across the industry –
kinked demand curve?▫ Potential for collusion▫ Behaviour of firms affected by what they believe their rivals
might do – interdependence of firms▫ Goods could be homogenous or highly differentiated▫ Branding and brand loyalty may be a potent source of competitive
advantage▫ Non-price competition may be prevalent▫ Game theory can be used to explain some behaviour▫ AC curve may be saucer shaped – minimum efficient scale
could occur over large range of output▫ High barriers to entry
Monopoly•Pure monopoly – where only
one producer exists in the industry•In reality, rarely exists – always
some form of substitute available!•Monopoly exists, therefore,
where one firm dominates the market•Firms may be investigated for examples
of monopoly power when market share exceeds 25%
•Use term ‘monopoly power’ with care!
Monopoly• Monopoly power – refers to cases where firms
influence the market in some way through their behaviour – determined by the degree of concentration in the industry▫ Influencing prices▫ Influencing output▫ Erecting barriers to entry▫ Pricing strategies to prevent or stifle competition▫ May not pursue profit maximisation – encourages
unwanted entrants to the market▫ Sometimes seen as a case of market failure
Monopoly
•Origins of monopoly:▫Through growth of the firm▫Through amalgamation, merger
or takeover▫Through acquiring patent or license▫Through legal means – Royal charter,
nationalisation, wholly owned plc
Monopoly
•Summary of characteristics of firms exercising monopoly power:▫Price – could be deemed too high, may be set
to destroy competition (destroyer or predatory pricing), price discrimination possible.
▫Efficiency – could be inefficient due to lack of competition (X- inefficiency) or… could be higher due to availability of high profits
Monopoly
•Innovation - could be high because of the promise of high profits, Possibly encourages high investment in research and development (R&D)
•Collusion – possible to maintain monopoly power of key firms in industry
•High levels of branding, advertising and non-price competition
Monopoly
•Problems with models – a reminder:▫ Often difficult to distinguish between a monopoly
and an oligopoly – both may exhibit behaviour that reflects monopoly power
▫ Monopolies and oligopolies do not necessarily aim for traditional assumption of profit maximisation
▫ Degree of contestability of the market may influence behaviour
▫ Monopolies not always ‘bad’ – may be desirable in some cases but may need strong regulation
▫ Monopolies do not have to be big – could exist locally
MonopolyCosts / Revenue
Output / Sales
AC
MC
ARMR
AR (D) curve for a monopolist likely to be relatively price inelastic. Output assumed to be at profit maximising output (note caution here – not all monopolists may aim for profit maximisation!)
Q1
£7.00
£3.00
Monopoly Profit
Given the barriers to entry, the monopolist will be able to exploit abnormal profits in the long run as entry to the market is restricted.
This is both the short run and long run equilibrium position for a monopoly
MonopolyCosts / Revenue
Output / Sales
AC
MC
ARMR
Welfare implications of monopolies
A look back at the diagram for perfect competition will reveal that in equilibrium, price will be equal to the MC of production.
We can look therefore at a comparison of the differences between price and output in a competitive situation compared to a monopoly.
Q1
£3
The price in a competitive market would be £3 with output levels at Q1.
Q2
£7 The monopoly price would be £7 per unit with output levels lower at Q2.
On the face of it, consumers face higher prices and less choice in monopoly conditions compared to more competitive environments.
Loss of consumersurplus
The higher price and lower output means that consumer surplus is reduced, indicated by the grey shaded area.
MonopolyCosts / Revenue
Output / Sales
AC
MC
ARMR
Welfare implications of monopolies
Q1
£3
Q2
£7The monopolist will be affected by a loss of producer surplus shown by the grey triangle but……..
The monopolist will benefit from additional producer surplus equal to the grey shaded rectangle.
Gain in producer surplus
MonopolyCosts / Revenue
Output / Sales
AC
MC
ARMR
Welfare implications of monopolies
Q1
£3
Q2
£7
The value of the grey shaded triangle represents the total welfare loss to society – sometimes referred to as the ‘deadweight welfare loss’.
National Income
• The sum total of the values of all goods and services produced in a year It is the money value of the flow of goods and services available in an economy in a year
• It refers to the money value of the flow of goods and services available annually in an economy.
• National Income Committee of India 1951 defines National Income as follows:“ A national income estimate measures the volume of commodities and services turned out during a given period counted without duplication.”
• Marshall’s Definition:“The labor and capital resources of a country acting on its natural resources produce annually a certain net aggregate of commodities, material and immaterial including services of all kinds…. This is the true net annual income or revenue of the country or the national dividend.”
• The income of a country to a specified period of time, say a year includes all types of goods and services which have an exchange value counting each one of them only once
• Double counting If steel has been evaluated in industrial production, it should not be included while calculating the value of steel products, viz, machines and motor cars. To avoid double counting or multiple counting, two methods are used Final products method Value added method.
N.I Concepts The following are the concepts of national income Gross National
Product – GNP Net National Product – NNP Personal Income – PI Per capita Income – PCI
• Gross National Product National Income is the sum total of values of all goods and services produced during a year The money value of this total output is known as Gross National Product – GNP
Gross National Product Example: If A,B,C,D,… are goods and services and If a,b,c,d,…are their prices respectively The GNP is calculated as follows GNP= Axa+Bxb+Cxc+Dxd….
GNP is most frequently used national income concept It is statistically a simpler concept as it takes no account of depreciation and replacement problems
• Net National Product - NNP: This refers to the net production of goods and services in a country during a year NNP is also called National Income at Market Prices We get NNP, by deducting the depreciation from GNP Therefore NNP = GNP - Depreciation
• Personal Income - PI: Income earned by all the individuals and institutions during a year in a country The entire national income does not reach individuals and institutions A part of it goes by way of corporate taxes Undistributed profits Social security contributions People sometimes get incomes without any productive activity They are called Transfer Payments Example: Unemployment benefits, old age pensions etc. Such transfer payments are not included in the National Income However they are added to Personal Income
PI is computed by using the following formula PI = National Income –(Corporate taxes, undistributed profits, social security contributions) + Transfer Payments
• Per Capita Income – PCI: If the national income is divided by the total population, we get per capital income PCI = NI/Population
PCI may be expressed either in money terms or in real terms
NI – Methods of computation :
There three methods of NI computation:-•Net Product method •Factor Income method •Expenditure method
•“Inflation is nothing more than a sharp upward rise in price level.”
•Too much money chasing, too few goods.”•Inflation is a state in which the value of
money is falling i.e. price are rising.”
Inflation
KINDS OF INFLATION
•On the basis of rate of inflation•On the basis of degree of control•On the basis of causes•Others
CAUSES OF INFLATION
•Demand pull inflation•Cost push inflation
EFFECTS OF INFLATION
•They add inefficiencies in the market, and make it difficult for companies to budget or plan long-term.
•Uncertainty about the future purchasing power of money discourages investment and saving.
EFFECTS OF INFLATION
•There can also be negative impacts to trade from an increased instability in currency exchange prices caused by unpredictable inflation.
•Higher income tax rates.• Inflation rate in the economy is higher
than rates in other countries; this will increase imports and reduce exports, leading to a deficit in the balance of trade.
Business Cycle• Business cycle or trade cycle is a part of
the capitalistic economy. • The business cycle refers to fluctuation in
economic activities such as levels of income, employment, prices and output, occurs more or less in regular time sequences.
• Business cycle is characterized by upward and downward movement of economic activities.
• In a business cycle, there are wave-like fluctuations in aggregate employment, income output and price level.
Business cycle• The short-term variations in economic
activity are known as BUSINESS CYCLE.• Economic history shows that the economy
never grows in a smooth and even pattern.
• Upward and downward movements in output, inflation, interest rates, and employment form the Business Cycles that characterizes all market economies
Busines cycle• Business Cycles are the irregular
expansions and contractions in economic activity.
• Business Cycles are economy-wide fluctuations in total National Output, Income, and Employment, usually last for a period of 2 to 10 years, marked by widespread expansion or contraction in most sectors of the economy.
Phases of business cycle
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Business Cycle is typically divided into four phases:
a) The recovery
b) The prosperity
c) The recession
d) The depression
Depression Recession merges into depression when there is a general
decline in economic activity. There is considerable reduction in the production of goods
and services, employment, income, demand and prices. The general decline in economic activity leads to a fall in
bank deposits. When credit expansion stops, even business community is
not willing to borrow. Thus, a depression is characterized by mass
unemployment – general fall in prices, wages, profits, interest rate, consumption expenditure, investment – bank loans and advances falling – factories close down – capital goods industries are also closed down.
During this phase, there will be pessimism leading to closing down of business firms.
Recovery Recovery denotes the turning point of
business cycle from depression to prosperity.
There is a slow rise in output, employment, income and price – demand for commodities go up steadily.
There is increase in investment – bank and financial institutions are also willing to granting loans and advances.
Pessimism gives way to optimism. The process of recovery becomes combative
and leads to prosperity
Prosperity In this period, demand, output, employment and income
are at a high level, they tend to raise prices. But wages, salaries, interest rates, rentals and taxes do
not rise in proportion to the rise in prices. The gap between prices and cost increases - the margin
of profit increases. The increase of profit and the prospect of its
continuance commonly cause a rapid rise in stock market values.
The economy is engulfed in waves of optimism. Larger profit expectation further increase – investment
which is helped by liberal bank credit. This leads to peak or boom.
Recession
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Recession starts downward movement of economic activities from peak/boom.
It is a state in which there is general deceleration in the economic activity resulting in cuts in production and employment falling prices of stock market.
Banking and financial institutional loans and advances beginning to decline.
As a result profit margins decline further because costs starts overtaking prices.
Recession may be mild/severe – it lead to a sudden explosive situation emanating from banking system and stock markets.
Such experience of the United States in 1873, 1893, 1907, 1933 and 2007.
Thank You for your Patience and Keen Interest.
