MOD -7(ME)                                    MARKET STRCTURE  What are Markets? The market may be in one specific place. ...
SHORT RUN EQUILBRIUM-Perfect Competition: Under perfect competition, there is a single ruling market price- the equilibri...
TYPES OF DISCRIMINATION       1. Personal discrimination-Monopolist may charge different prices on the basis of           ...
FEATURES OF MONOPOLY.  1. Many firms: each firm contributes only a small portion of the total output & has a     limited c...
3. Pure Monopoly: It is a market in which there is single seller & large number of       buyers. It is compete negations o...
PRICING UNDER MONOPOLISTIC COMPETITION- LONG RUNFirms in the short run earn super normal profits in a monopolistically com...
PRODUCT DIFFERENTIATIONProduct differentiation is the glaring feature of monopolistic competition.Firms adopt different te...
Oligopoly is market situation with a few sellers (more than two) each selling eitherhomogeneous or hetergenous (differenti...
Importance of advt & selling cost       In oligopoly different firms have to employ various aggressive and defensive      ...
 Centralized cartels: Firms surrender all their rights to a central authority which sets     prices, determine output, qu...
PRICING
 Price denotes two aspects: it is revenue to the seller and its is the perceived value of       the good (or service) to ...
NEW PRODUCT PRICING STRATEGIESThe management can choose between two broad strategies:    1. Market-Skimming Pricing    2. ...
Pre-Requisites For Market Penetration Pricing :Pre-Requisites for Market Penetration Pricing This strategy works only unde...
MOD -8 (M.E)                                            PROFITP- percentage of return on capital.R- reward for taking risk...
1. Gross profit & Net profitGP- refers to the total profits earned by an enterprise.Gross profit=Total revenue-Total Expli...
4.   Accounting Profit & Economic ProfitAccounting Profit: To an accountant , profit is the excess of revenue receipts ove...
BREAK EVEN ANALYSISBEA- economic tool in the hands of business policy makers, for profit planning &forecasting.Acc. Marz, ...
 TR        = total revenue    TC        = total cost    TFC       = total fixed cost    The break-even point (B) is th...
The contribution margin is expressed as a ration to sales.Ex: sales are 200 and the variable costs of these sales is Rs.14...
SalesIt is useful in arriving at make or buy decision.4. The BEA can be useful in determining the target profit sales volu...
Mod 7,8
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Managerial economics MBA VTU NOTES

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Mod 7,8

  1. 1. MOD -7(ME) MARKET STRCTURE What are Markets? The market may be in one specific place. A market is where buyers and sellers:  meet to exchange goods and services  usually in exchange for moneyESSENTIALS OF MARKET Commodity for transaction Network of buyers & sellers Competition between buyers & sellers A place or a situation for transaction TYPES OF MARKET Perfect competition Monopolistic competition Monopoly Oligopoly PERFECT COMPETITION:CONDITIONS  Large number of buyers and sellers in the market, no one of them can influence price  Homogeneous goods  Free Entry & Exit of firms  Perfect knowledge of the market  Perfect mobility of factors of production  Non-intervention of government  No transport cost difference  Perfectly elastic demand curve Closest example is a fruit and vegetable market WHAT IS NORMAL & SUPER NORMAL PROFIT?  Normal profit- minimum level of profits in order to stay in business  supernormal profits – profits over and above normal profits.
  2. 2. SHORT RUN EQUILBRIUM-Perfect Competition: Under perfect competition, there is a single ruling market price- the equilibrium price, determined by the interaction of forces of total demand and total supply However, in the short run a perfectly competitive firm may earn super normal profit, or normal profit or can incur losses depending upon the positions of the short run cost curves.PRICE DISCIRIMINATION Monopoly firms –sole objective of earning maximum profits may charge uniform price or different prices for their products to different customers. The practice of selling the same commodity at different prices to different buyers is called price discrimination. Ex: A book seller selling the same edition of a book in an ordinary cover at Rs. 25 and with deluxe cover at Rs. 50 and others. Then he is said to be discriminating.
  3. 3. TYPES OF DISCRIMINATION 1. Personal discrimination-Monopolist may charge different prices on the basis of their income. E.g. Doctors & Lawyers. 2. Place discrimination: different prices for the same commodity in different regions or localities. E.g. Provision of door to door delivery, drive in facility in restaurants Dumping in domestic & foreign markets. 3. Use of trade Discrimination: different prices for different types of uses of the same commodity. E.g. Electricity sold at cheaper rate for agricultural purposes and higher rate for industrial purposes. 4. Age discrimination: On the basis of age of the customers.Buyers below 12 years of age are charged. Half rates in transport services. 5. Sex discrimination: Some touring agents may provide seats at concessional rate to the ladies. 6. Size discrimination: price in the retail market is higher than the price in the whole sale market. Small size toothpaste is dearer relatively then the economy size toothpaste. 7. Quality variation discrimination: in the form of material used , the nature of packing, colour, style etc.,MONOPOLYA market structure in which only one Producer or seller exists for a Product that has noclose substitutes. Public utility services like water supply and electricityMonopolistic competition- is a market structure in which a large number of small sellerssell differentiated products which are close, but not perfect substitutes for one another.EXAMPLE: Tooth paste, Blades, Motor cycle & bicycle, Cigarettes, cosmetics, biscuits,soaps, and detergents, shoes, Ice-creams etc.,
  4. 4. FEATURES OF MONOPOLY. 1. Many firms: each firm contributes only a small portion of the total output & has a limited control over the price of the product 2. Independent price policy: firms produce different products which are close substitutes & price is determined considering cost of production & demand. 3. Product differentiation: each firm tries to differentiate its product from that of other rivals in one way or other. 4. Single seller: There is single producer under Monopoly . So monopoly firm and industry are identical. 5. No substitutes: There are no close substitutes for the product of monopolist. 6. Absence of competition: There is no competition for a monopolist product as he is the only seller ruling the market. 7. Price maker: A monopolist is a price maker and not price-taker. He can fix his own price policy and maximize profit. 8. Inelastic demand curve: A monopoly firm faces a downward slopping demand curve. 9. No free entry and exit: The monopolist has no immediate rivals due to barriers which block the entry of new firms. Firm can only earn normal profits. 10. Selling cost: cost on Advertisements & selling mediums in order to popularize their brand in the market. 11. Lack of perfect knowledge: large no. of products each being substitute of the other. Seller does not know the exact preference of buyers and hence he cannot get any added advantage out of the situation. 12. Lack of mobility of factors: Factors of production and goods and services are not perfectly mobile under MPC. 13. More elastic demand: MPC have more elastic demand curve i.e if the firm wants to sell more, it must reduce its price. TYPES OF MONOPOLY 1. Natural Monopoly: such monopoly arises due to endowment of resources by nature. Natural advantages such as climatic condition, good location, availability of certain minerals etc. creates natural monopoly. 2. Legal Monopoly: It is also known as statutory monopoly. It is given by law.
  5. 5. 3. Pure Monopoly: It is a market in which there is single seller & large number of buyers. It is compete negations of competition. 4. Limited Monopoly: When there are few sellers & large number of buyers then limited monopoly exist. 5. Public Monopoly : When monopoly is firm is owned , managed & controlled by government then it is called as public monopoly. 6. Simple Monopoly: when monopoly charges same price for his commodity from all buyers in the market then it is called as simple monopoly. PRICING UNDER MONOPOLISTIC COMPETITION – SHORT RUN o A firm under monopolistic competition is a price maker. o The firm has to determine a suitable price for its product which yields a maximum revenue. o In order to maximize its total profit or minimize its losses in the short run, the firm produces that level of output at which marginal cost is equal to marginal revenue(i.e MC=MR) thus equilibrium is determined at the point of intersection of the MC curve and the MR curve .MR =MC intersects each other at output. At output OQ shows equilibrium level of output. Inthis situation price to be determined will be QR or OP. SAC at this output level is QC or OD.Therefore DP supernormal profit DPXOQ = area of rectangle DPRC.
  6. 6. PRICING UNDER MONOPOLISTIC COMPETITION- LONG RUNFirms in the short run earn super normal profits in a monopolistically competitive market,some new firms will be attracted to enter the business, as the group is open.On accounts of rival‟s entry the demand curve faced by the typical firm will shift to the originand it will also tend to be more elastic, as its share in the total market is reduced due tocompetition from an increasing No. of close substitutes.In the long run equilibrium when AR=AC. AR is tangent the average cost curve LAC at R.Therefore, the equilibrium output in the long run is OQ and the corresponding price is QR orOP. At this point Average cost is also QR and so is average revenue. Therefore there is nosupernormal profits: only normal profits which forms cost of productionWhy firm is required to attain equilibrium ?  To Stay in business.  Equilibrium of firm requires equality of MR with MC.  MC=MR
  7. 7. PRODUCT DIFFERENTIATIONProduct differentiation is the glaring feature of monopolistic competition.Firms adopt different technique to differentiate their products from one another.There are many ways of making products different from one another.Branding – most common & essential aspect of unique identification of the product.Ex: IFB washing machine, Sony music system.Product differentiation may take mainly two forms: A) Real Product Difference:Quality: when products are produced out of materials of higher quality & durability.When they are extraordinary on the basis of workmanship, color, design size, shape, style,fragrance etc.,When personal care is taken to produce it.B) Imaginary Product Difference:Producers adopt different methods to differentiate their products from that of close substitutesin the following manner.  Proper allocation of sales depots in busy commercial  Depots  Selling goods under different trade marks  different brands and packing them in attractive  wrappers or containers.  Working hours convenient customers.  Courteous treatment to customers and developing friendly relations with them Offering gifts, discounts, guarantee of repairs & other free services, sales on credit, or credit cards.  Agreement to take back goods if they are unsatisfactory. Air-conditioned stores etc.,OLIGOPOLYIn economics, a situation in which few companies control the major part of a particularmarket ………The term Oligopoly is derived from two greek words “Oligos” means a few and “Poly”means to sell.
  8. 8. Oligopoly is market situation with a few sellers (more than two) each selling eitherhomogeneous or hetergenous (differentiated products)This type of markets are characterized by a few sellers where each one or at least one of themcommands a significant portion of the total supply of the product in the market. E.g. Oligopolistic industries in the Indian context are automobile, steel Cement, cigarettes, soaps and detergents.FEATURES: 1. Small no of Large sellers 2. Interdependence 3. Advertising and selling costs 4. Conflict or collude attitude of the firms 5. Under oligopoly new entry is difficult. It is neither free nor barred. 6. Lack of uniformity in size of the firm is another feature of oligopolySmall Number of FirmsIn contrast to monopolistic competition and perfect competition, an oligopoly consists of asmall number of firms. Each firm has a large market share The firms are interdependent The firms have an incentive to colludeExamples of oligopoly Supermarkets Banking industry Chemicals Oil Medicinal drugs BroadcastingInterdependence: Each firm has to be conscious of the reactions of its rivals, since the no. offirms are very few, any change in price, output, product etc., by one firm will have directeffect on the policy of other firm.
  9. 9. Importance of advt & selling cost In oligopoly different firms have to employ various aggressive and defensive marketing weapons to gain a greater share in the market. It is only under oligopoly that advertisement comes fully into its ownFEATURES OF OLIGOPOLY  Conflict or collude attitude of the firms:  Firms may realize the disadvantages of competition & rivalry and desire to unite together to maximise their profits.  On the other hand firms guided by individualistic considerations may continuously come in clash and conflict with another.  This creates uncertainty in the market.OUTPUT DECISIONS UNDER OLIGOPOLY  As the action and reaction affect one fortune, the oligopoly firms have no alternative but to react to the actions of the competitors.  There are several approaches to determine the price and output by oligopoly firms:Approaches to determine the price & the output –oligopolyThree important approaches to determine the output by oligopoly firms; 1. Collusions or agreements (CARTELS) 2. Kinked Demand curve 3. Price leadershipCARTELS  Collusion is just opposite of competition.  The term collusion means to “play together” in economics. .  It means that firms co-operate with each other in taking joint actions to keep their bargaining position stronger against the consumer.  Collusion- bases on their oral or written agreements.  Collusion based on oral agreements leads to the creation of what is called as “gentleman‟s agreements” it does not consist of any record.  Collusion based written agreements creates what is know as CARTELS
  10. 10.  Centralized cartels: Firms surrender all their rights to a central authority which sets prices, determine output, quotas for each firm, distributes profits.  Objective; Maximises Joint profits, hence cartel acts as a monopolist.  Market sharing cartels: have restrictive assumptions of identical costs for all firms. Practically firms hv. Unequal costs and every firms want to have some dgree of independent action.  Therefore Market sharing is short lived.PRICE LEADERSHIP  Mutual suspicion and distrust among member firms and their unwillingness to surrender all their sovereignty makes the collusion imperfect.  Price leadership: A strong firms which is enjoying the benefits of large scale production will dominate the small firms.  The price fixed by the dominating firms will be followed by all other small firms.  Hence, the dominating firm becomes the price leader.  All other firms following the price policy of the dominating firm in the industry are called as price followers.KINKED DEMAND CURVE MODEL  KDC- first used by Prof. M. Sweezey to explain price rigidity under oligopoly.  It represents the behaviour of Oligopoly firm which has not incentive either to increase or decrease its price.  In this model, the firm is afraid to change its price.  Look at logic of the model. Consequences of raising price Consequences of lowering price
  11. 11. PRICING
  12. 12.  Price denotes two aspects: it is revenue to the seller and its is the perceived value of the good (or service) to the buyer. It determines sales revenue, market share and profits.  Pricing decisions are more important for a new product and an existing product.  Among various pricing strategies cost plus pricing (Full cost pricing) is one in which price of the product is the sum of cost plus a profit margin.FULL COST PRICINGVIK Technologies has invested Rs. 10 crore in plant and machinery, with a capacity toproduce 10,000 units of television per month. Total variable cost is estimated at Rs. 5 croreand the firm expects a return of 20% on total investment. What should be the price of TV ifwe suppose that the firm can sell its entire output?Solution:  Base price = TC = 10 + 5 = Rs. 15 crore  Margin = 20% of 15 = 3 crore  Total revenue = 15 +3 = 18 crore  Price = 18,00,00,000/10000= Rs. 18,000 per TVThis method of pricing is very simple & convenient.But not suitable when competition is tough or when a new firm is trying to enter new market. For a long time Indian Co‟s used cost plus Or full cost pricingPRODUCT LINE PRICING  Pricing different products within the same product range at different price points.  An example would be the video manufacturer offering different video recorders with different features at different prices.
  13. 13. NEW PRODUCT PRICING STRATEGIESThe management can choose between two broad strategies: 1. Market-Skimming Pricing 2. Market-Penetration PricingMarket-Skimming Pricing : Market-Skimming Pricing Skim means to take the cream. In this strategy thecompany initially sets high prices to skim revenues layer by layer from the market. It meanswhen the price of the new product would be higher only some segments of the market wouldadopt the product at a high price. Market-Skimming Pricing Layer by layer means different layers of customers.Initially when the prices are high only some segments purchase the product, giving revenueto the company from customers who cant wait until the prices get low. With initial salesgoing down and competitors threaten to introduce similar products, the company lowers theprice to attract the price-sensitive layer of customers. In this way the company skims amaximum amount of revenue from the various segments / layers of the market. Market GiantIntel uses this strategy.Market Skimming Feasibility : Market Skimming Feasibility This strategy is feasible only under certain conditions : Theproduct‟s quality and image must support its higher price. Enough buyers must want theproduct at higher price. Cost of producing a smaller volume cannot be so high that theycancel the advantage of charging more. Competitors should not enter the market because theywould undercut the high price.Market – Penetration Pricing : Market – Penetration Pricing It means setting a low price for a new product in order toattract a large number of buyers and a large market share. Some companies set a low initialprice in order to penetrate the market quickly. The high sales volume results in falling costswhich allows the company to reduce its price even further. Dell used this strategy to enter thepersonal computer market. Walmart & other discount retailers also use this strategy.
  14. 14. Pre-Requisites For Market Penetration Pricing :Pre-Requisites for Market Penetration Pricing This strategy works only under theseconditions: The market must be highly price sensitive. A low price should produce moremarket growth. Production & distribution costs must fall with the increase in the salesvolume. Lastly the low price must keep out the competitors. And the company adopting thisstrategy should maintain its low price position in order to achieve permanent or long termprice advantage.
  15. 15. MOD -8 (M.E) PROFITP- percentage of return on capital.R- reward for taking risks in business.O- owners motive.F- fair remuneration.I- Innovation & creativityT- TechnologyProfit = Total revenue – total costProfit means different things for different people  Wages- labor  Rent- owners  Interest- money lenders It is a motive force of a business undertaking.The objective of any firm is to maximize profit.NATURE OF PROFIT ¤ Reward for the service of the entrepreneur ¤ Price or remuneration paid for the management. ¤ Reward for the ownership of capital. ¤ Percentage of return on capital invested. ¤ Difference between total revenue and total cost. ¤ Reward for taking risk in business. ¤ Residual income of to entrepreneur after paying remuneration to all factors.PROFIT – MEASUREMENT 1. Gross profit & Net profit 2. Normal profit & Super normal profit 3. Optimum profit & Maximum profit 4. Accounting Profit & Economic profit
  16. 16. 1. Gross profit & Net profitGP- refers to the total profits earned by an enterprise.Gross profit=Total revenue-Total Explicit costsIt is the excess of income after meeting all kinds of actual or explicit costs.Net profit- refers to the income received by the enterprise after all factors of productionincluding those contributed by the organizer himself are paid off.NP= Total revenue – Total cost.2. Normal Profit & supernormal profitNormal profit is the minimum amount necessary to induce an entrepreneur to remain andwork in the business.Supernormal Profit – is the excess of income over and above normal profit.Total production = 10,000 unitsTPC detail - Rent – 10,000/- Wages - 20,000/- Interest - 10,000/- Profit - 10,000/- 50,000/-Cost per unit = Rs.50,000/10000=Rs.5/-(consists of Rs.1/-rent, 2/-,wages,1/- interest & Rs.1/- profit)Rs 1/- is normal profit which is includes in production cost.If the seller is selling the product at the rate of Rs.8/- in that case, heEarns a supernormal profit of Rs. 3/- (8/- minus 5/- = 3/-)Market price – Production cost per unit = SNP 8.00 5.00 = 3.003. Optimum profit & Maximum profitThe term “OP‟ refers to the most ideal or most desirable level of profit earned by a businessunit.But there is no yardstick to indicate the ideal level of profit.It is relative concept and change with the time.Maximum Profit: refers to the highest possible profit that may be earned by a firm.
  17. 17. 4. Accounting Profit & Economic ProfitAccounting Profit: To an accountant , profit is the excess of revenue receipts over the totalexplicit cost incurred in generating this Revenue.Economic Profit: Accounting profit – Implicit costsEx: Imputed costs like entrepreneurs wages, rental income, self owned land, interests on selfcapital from accounting profit can be called as economic profit.DETERMINANTS OF SHORT TERM PROFITFirms aim at maximizing short run profits. Elasticity of demand for the product Annual objectives Financial objectives Seasonal demandDETERMINANTS OF LONG TERM PROFITFirms aim at maximizing long run profits. Prevention of potential competition Attainment of industry leadership Prevention of Government intervention Maintenance of consumer good will Strategic objectives of the firm
  18. 18. BREAK EVEN ANALYSISBEA- economic tool in the hands of business policy makers, for profit planning &forecasting.Acc. Marz, Curry & Frank – BEA indicates at what level cost & revenue are in equilibrium.The main objective of BEA is to trace the relationship between Cost, price & revenueSignificance of BEA:B- Business Decision MakingE- Economic ResearchA- Analysis for InvestmentMeaning of break-Even Analysis  BEA- indicates where profit starts, the area of loss & profits , Margin of safety & optimum level of operation etc.,  In Break-Even Analysis, the break-even point is located at that level of output at which the net income or profit is zero. At this point, total cost is equal to total revenue. Hence, the break-even point is the no-profit-no-loss zone.ASSUMPTIONS OF BREAK-EVEN ANALYSIS  The cost function and the revenue function are linear.  The total cost is divided into fixed and variable costs.  The selling price is constant.  The volume of sales and the volume of production are identical.  Average and marginal productivity of factors are constant.  The product-mix is stable in the case of a multi-product firm.  Factor price is constant.THE BREAK-EVEN CHARTBreak even chart – accepted by business economists, Co. executives, Investment analysts,Govt. agencies & even trade unions.Break-even Analysis is essentially cost volume profit analysis(CVPA).It is an analytical tool for tracing relationships among key business such as costs, revenuesand profits at different output levels.
  19. 19.  TR = total revenue  TC = total cost  TFC = total fixed cost  The break-even point (B) is the point at which TR = TC  Profit is zero at OQ level of output.How to calculate BEP in terms of physical units?Suppose the fixed costs of a factory are Rs.10,000 per year, the variable costs are Rs. 2.00 perunit and the selling price is Rs. 4.00 per unit. The Break even point would beFormula :BEP = TFC/SP-VC TFC=10,000/-BEP= 10000 /4-2 SP = 4.00/- per unit VC= 2.00/- per unitBEP= 10000 / 4 - 2 = 5,000 unitsNow the BEP in terms of physical unit will be 5,000 units.BEP-in terms of sales valueMultiproduct firms cannot calculate BEP in terms of Physical units of a particular productbecause total fixed costs are the same for several products even though total variable costschange.It is convenient to calculate their BEP in terms to total sales value expressed in rupees.Here, again the breakeven point would be the point where the contribution margin (salesvalue - variable costs) would equal the fixed costs.
  20. 20. The contribution margin is expressed as a ration to sales.Ex: sales are 200 and the variable costs of these sales is Rs.140/-The contribution margin ration is 200-140LIMITATION OF BEA :-  It is Static.  It is Unrealistic.  It has many shortcomings.  Its scope is limited to the short run only.  It Assumes Horizontal Demand Curve with the given Price of the Product.  It is Difficult to Handle Selling Costs in the BEA.The Traditional BEA is Very Simple.USEFULNESS OF BEA 1. The BEA provides microscopic view of the profit structure of the firm. 2 Empirical cost functions required in BEA can be of great help for cost control in business.3. The BEA can be used for determining the „safety margin‟ regarding the extent to whichthe firm can permit a decline in sales without causing losses. Sales - BEP Safety Margin = X 100
  21. 21. SalesIt is useful in arriving at make or buy decision.4. The BEA can be useful in determining the target profit sales volume. TFC – Target ProfitTarget Sales Volume = Contribution Margin5. BEA is highly significant in business decision making prtaining to pricing policy, SalesProjection, Capital Budgeting etc.,However, this technique is to be used cautiously.SAFETY MARGIN“Safety Margin” associates with the proposed volume. The safety margin refers to the extentto which the firm can afford a decline in sales before it starts incurring losses.Safety Margin = sales-BEP/sales X100Sales=8,000BEP=5000unitsSM=8000-5000/8000X100=37.5%It reveals minimum extent of sales effort expected of the management.PROBLEM

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