Industrial economics


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Industrial economics

  2. 2. ECONOMICS <ul><li>Economics is the study of how human beings make choice to allocate scarce resources to satisfy their unlimited wants in such a manner that consumers can maximize their satisfaction, producers can maximize their profits and the society can maximize its objectives. </li></ul>
  3. 3. Classification of Economics <ul><li>Micro Economics- is the economics of individual economic unit like a firm, an industry, a producer and the factors of production. </li></ul><ul><li>Macro Economics- relates to the growth of national income, aggregate demand, aggregate supply, aggregate investment level and economy as a whole. </li></ul>
  4. 4. INDUSTRIAL ECONOMICS <ul><li>It is a distinctive branch of economics which deals with the economic problems of the firms and the industries and their relationship with the society. </li></ul><ul><li>It has both micro aspect and macro aspect. </li></ul>
  5. 5. Role of General Economics in Industrial Economics <ul><li>The problem of decision making </li></ul><ul><li>The problem of uncertainty and risk </li></ul><ul><li>Imperfect market conditions, government policies, import and export </li></ul><ul><li>The problem of forecasting </li></ul><ul><li>Position of raw materials, the prices of factors of production etc. </li></ul>
  6. 6. OBJECTIVES <ul><li>Achieving industrial development </li></ul><ul><li>Information related to the natural resources, industrial climate, supplies of factors of production etc. </li></ul>
  7. 7. SCOPE OF INDUSTRIAL ECONOMICS <ul><li>Industrial Efficiency- Determined by production function </li></ul><ul><li>Diversification </li></ul><ul><li>Industrial Finance- </li></ul><ul><li>Two Dimensions- Source of finance & its effective utilization </li></ul><ul><li>Industrial location </li></ul>
  8. 8. <ul><li>The determinants of profitability- </li></ul><ul><li>Government policies, Advertisement, Size of a firm, market concentration etc. </li></ul><ul><li>The organizational form and its motives </li></ul><ul><li>Theory of demand- Consumer behavior </li></ul><ul><li>Theory of production- Producer’s behavior </li></ul>
  9. 9. <ul><li>Cost Analysis- Relation between cost and quantity of output. </li></ul><ul><li>Profit Analysis- Most common objective </li></ul><ul><li>Analysis of pricing theory- Different market conditions, price discrimination. </li></ul>
  11. 11. Production Function <ul><li>It is the functional relationship between the quantity of product and the quantities of the factors of production required to produce. </li></ul>
  12. 12. Types of production function <ul><li>Short run production function- It is that time period in which production of a commodity is increased by increasing the use of only variable inputs like labour and raw material while the fixed input remains constant. </li></ul><ul><li>Long run production function- It refers to that time period in which production of a commodity can be increased by employing both the variable and the fixed inputs. </li></ul>
  13. 13. CONCEPTS OF PRODUCTION <ul><li>Total Production- Total amount of goods and services produced in a given period. </li></ul><ul><li>Marginal Production- Change in total production due to application of one more or one less unit of variable factor. </li></ul><ul><li>Average Production- Per unit production of variable factor. </li></ul>
  15. 15. Least cost combination <ul><li>Least cost combination is the optimum combination of the factors of production at which a producer has to pay minimum cost of producing a certain quantity of output. </li></ul><ul><li>2concepts- </li></ul><ul><li>Iso Quant curve </li></ul><ul><li>Iso Cost line </li></ul>
  16. 16. Iso Quant Curve <ul><li>It represents all the factor inputs which yield a given quantity of product. </li></ul><ul><li>Iso Product Map- A family or a group of equal product curves is called an Iso Product Map. </li></ul>
  17. 17. Properties of Iso Quant Curves <ul><li>It is convex to the origin- Diminishing marginal rate of technical substitution. </li></ul><ul><li>An Iso Quant Curve slopes downwards from left to right. </li></ul><ul><li>Two Iso Quant curves never intersect each other. </li></ul>
  18. 18. ISO-COST LINE <ul><li>Iso cost line represents the various combination of two factors that will incur the same level of total cost. </li></ul><ul><li>Suppose total finance available with a firm- Rs. 10,000. Per unit price of labour- Rs.100, Per unit price of Capital- Rs. 1000. </li></ul>
  19. 19. <ul><li>3 Alternatives- </li></ul><ul><li>Spend all its finance on Capital </li></ul><ul><li>Spend all its finance on Labour </li></ul><ul><li>Partly on Capital and partly on Labour. </li></ul>
  20. 20. Determination of Optimum Combination <ul><li>Firms attain equilibrium at a point where Iso-Cost line is tangent to Isoquant Curve. </li></ul><ul><li>MRTS LK = dK/dL = P L /P K </li></ul>
  22. 22. Law of Variable Proportions <ul><li>It predicts the consequences of varying the proportions in which the fixed and variable factors of production are used. </li></ul><ul><li>It states that as the proportion of factors is changed, the total production at first increases more than proportionately, then equi-proportionately and finally less than proportionately. </li></ul>
  23. 23. ASSUMPTIONS <ul><li>One of the factors is variable, while all other factors are fixed. </li></ul><ul><li>All units of variable factors are homogenous or equally efficient. </li></ul><ul><li>There is no change in technique of production. </li></ul><ul><li>Factors of production can be used in different proportions. </li></ul>
  24. 24. STAGES <ul><li>I Stage- From origin to point where the average output is the maximum. </li></ul><ul><li>II Stage- From the point where average output is maximum to where marginal output is zero. </li></ul><ul><li>III Stage- Range over which marginal output is negative. </li></ul>
  25. 25. Causes of Application <ul><li>Indivisibility of Factors </li></ul><ul><li>Change in Factor Ratio </li></ul><ul><li>Imperfect Substitutes </li></ul><ul><li>STAGE OF RATIONAL DECISION- </li></ul><ul><li>The rational decision of the purely competitive firm will be to operate in stage II </li></ul>
  26. 26. LAW OF RETURNS
  27. 27. Returns- 2 types <ul><li>Returns to Factor </li></ul><ul><li>Returns to Scale </li></ul>
  28. 28. Law of Returns to Factor <ul><li>Laws of return to factor describe increase in production by taking only the one variable factor along with the other fixed factors. </li></ul>
  29. 29. <ul><li>3 parts- </li></ul><ul><li>Increasing returns to a factor </li></ul><ul><li>Constant returns to a factor </li></ul><ul><li>Decreasing returns to a factor </li></ul>
  30. 30. Increasing Returns to a Factor <ul><li>As the proportion of one factor in a combination of factors is increased, upto a point, the marginal productivity of the factors will increase. </li></ul><ul><li>Reasons </li></ul><ul><li>Fuller utilization of fixed resources </li></ul><ul><li>Indivisibility of factors </li></ul><ul><li>Division of Labour </li></ul>
  31. 31. Constant Returns to a Factor <ul><li>Constant returns to a factor occur when additional application of the variable factor increases output only at a constant rate. </li></ul><ul><li>Reason- </li></ul><ul><li>Optimum use of fixed factor </li></ul>
  32. 32. Diminishing Returns to a Factor <ul><li>As we increase the quantity of any one input which is combined with fixed quantity of other inputs, the marginal physical productivity of the variable input must eventually decline. </li></ul><ul><li>Causes- </li></ul><ul><li>Imperfect Substitutes </li></ul><ul><li>Fixed Factors of Production </li></ul>
  33. 33. LAW OF RETURNS TO SCALE <ul><li>The term returns to scale refers to the changes in output as all factors change by the same proportion. </li></ul><ul><li>3 parts- </li></ul><ul><li>Increasing </li></ul><ul><li>Constant </li></ul><ul><li>Diminishing </li></ul>
  34. 34. Increasing Returns to Scale <ul><li>It is a situation when proportionate increase in all the factors of production results in more than proportionate increase in output. </li></ul><ul><li>Cause- </li></ul><ul><li>Economies of Scale> Diseconomies of Scale </li></ul>
  35. 35. Constant Returns to Scale <ul><li>It refers to a situation when a proportionate increase in all the factors of production results in equal proportionate increase in output. </li></ul><ul><li>Cause </li></ul><ul><li>Economies of Scale= Economies of Scale </li></ul>
  36. 36. Diminishing Returns to Scale <ul><li>It refers to a situation when a proportionate increase in all the factors of production results in less than proportionate increase in output. </li></ul><ul><li>Cause- </li></ul><ul><li>Diseconomies> Economies </li></ul>
  38. 38. <ul><li>Ordinarily, the term ‘cost of production’ refers to money expenses incurred in production of a commodity. </li></ul><ul><li>But a little reflection would make it clear that money expenses are not the only expenses that are incurred on the production of a commodity. </li></ul>
  40. 40. OPPORTUNITY COSTS <ul><li>The opportunity cost of anything is the next best alternative that could be produced instead by the same factors or by an equivalent group of factors, costing the same amount of money. </li></ul><ul><li>This concept was first developed by the Austrian School of Economics. </li></ul>
  41. 41. COST FUNCTION <ul><li>A cost function expresses the relationship between cost and its determinants. </li></ul><ul><li>Several factors influence cost. When their relationship to cost is expressed in a functional or mathematical form, it is called cost function. </li></ul><ul><li>C=f (S, O, P, T) </li></ul><ul><li>S-size of plant, O- level of output, </li></ul><ul><li>P- price of inputs, T-technology </li></ul>
  42. 42. SHORT-RUN COST FUNCTION <ul><li>2 TYPES OF COSTS- </li></ul><ul><li>FIXED COSTS </li></ul><ul><li>Salary and other expenses of administrative staff. </li></ul><ul><li>Salary of staff involved directly in the production, but on a fixed term basis. </li></ul><ul><li>Wear and tear of machinery. </li></ul><ul><li>The expenses for the maintenance of buildings. </li></ul><ul><li>VARIABLE COSTS </li></ul><ul><li>Direct labour which varies with output. </li></ul><ul><li>Raw material. </li></ul><ul><li>Running expenses of machinery. </li></ul>
  44. 44. Total Costs of Production <ul><li>It refers to the aggregate of expenses on fixed and variable factors of production. </li></ul><ul><li>TC= TFC+TVC </li></ul><ul><li>TC=AC*Q </li></ul>
  45. 45. <ul><li>Total Fixed Costs- It refers to the sum of all the expenses on the fixed factors like land, insurance etc. </li></ul><ul><li>Total Variable Costs- It represents the cost of all variable resources, such as labour, raw material, etc. </li></ul><ul><li>Total Cost- Sum total of total fixed costs and variable costs. </li></ul>
  46. 46. AVERAGE COSTS <ul><li>It is the per unit cost of production. </li></ul><ul><li>Average Fixed Cost- It is the per unit cost of the fixed factors of production. </li></ul><ul><li>AFC=TFC/TQ </li></ul><ul><li>Average Variable Cost- It is the per unit cost of the variable factors of production. </li></ul><ul><li>AVC=TVC/TQ </li></ul>
  47. 47. <ul><li>Why AC Curve is a </li></ul><ul><li>U-Shaped Curve? </li></ul>
  48. 48. <ul><li>AC Curve is the sum of AFC and AVC. </li></ul><ul><li>Total fixed costs remains constant at different level of output, it follows that average fixed cost falls as the level of output is increased. </li></ul><ul><li>AVC is a dish shaped curve, influenced by law of variable proportions. </li></ul><ul><li>Hence, as long as average variable costs fall, Average total costs also falls. Beyond this point , for some time, though the AVC may be rising, the falling fixed cost overbears it resulting in declining AC. But ultimately AC must rise. </li></ul>
  49. 49. MARGINAL COST <ul><li>Marginal Cost is the addition to the total cost as a result of a unit increase in the output. </li></ul><ul><li>MC n = TC n – TC n-1 </li></ul>
  50. 50. Relation between Marginal Cost & Average Cost <ul><li>When average cost falls with an increase in output, marginal cost is less than the average cost. </li></ul><ul><li>MC begins to rise at a lesser level of output than AC. </li></ul><ul><li>The MC curve cuts the average cost curve at its minimum point. </li></ul><ul><li>With increase in AC, marginal cost rises at a faster rate. </li></ul>
  51. 51. <ul><li>When MC>AC, it pulls A Upwards. </li></ul><ul><li>When MC<AC, it pushes AC downwards. </li></ul><ul><li>When MC=AC, A is constant. </li></ul>
  52. 52. Long Run Costs Long Run Costs Long Run Total Costs Long run Average Costs Long Run Marginal Costs
  53. 53. Long Run Total Costs <ul><li>It is the summation of several short run total cost curves. </li></ul><ul><li>The long run cost of production is the least possible cost of producing any given level of output when all inputs are variable. </li></ul>
  54. 54. Long run Average Cost <ul><li>It shows the lowest average cost of producing output when all inputs can be varied freely. </li></ul><ul><li>LAC curve is U shaped. Why? </li></ul>
  55. 55. Long Run Marginal Cost <ul><li>It is that curve which shows the extra cost incurred in producing one more unit of output when all inputs can be changed. </li></ul>
  56. 56. MARKETS
  57. 57. MONOPOLY <ul><li>Monopoly is a market situation in which there is a single seller, there are no close substitutes for commodity it produces, there are barriers to entry. </li></ul>
  58. 58. Features of Monopoly <ul><li>One seller and large number of Buyers </li></ul><ul><li>Monopoly is also an industry </li></ul><ul><li>Restriction on the entry of the new firms </li></ul><ul><li>No close Substitutes </li></ul><ul><li>Price Maker </li></ul><ul><li>Price Discrimination </li></ul>
  59. 59. Causes or Sources of Monopoly <ul><li>Control over raw material or ownership of Natural resources </li></ul><ul><li>Patents </li></ul><ul><li>Technical Barriers </li></ul><ul><li>Government Policy </li></ul><ul><li>Limiting Pricing Policy </li></ul>
  60. 60. Price & Output Determination under Monopoly <ul><li>2 Approaches- </li></ul><ul><li>Total Revenue and Total Cost Analysis </li></ul><ul><li>Marginal Revenue and Marginal Cost Analysis </li></ul><ul><li>Short Period </li></ul><ul><li>Long Period </li></ul>
  61. 61. Price Determination under Short Period <ul><li>Super Normal Profit </li></ul><ul><li>Normal Profit </li></ul><ul><li>Minimum Loss </li></ul><ul><li>Price Determination under Long Period </li></ul>
  62. 62. Comparison Between Monopoly and Perfect Competition <ul><li>Goals of the firm </li></ul><ul><li>Assumptions Regarding Production </li></ul><ul><li>Assumption Regarding number of seller and buyers </li></ul><ul><li>Assumption regarding Entry </li></ul><ul><li>Implication regarding shape of Demand Curve </li></ul><ul><li>Comparison Regarding Price </li></ul><ul><li>contd…. </li></ul>
  63. 63. <ul><li>Comparison Regarding Output </li></ul><ul><li>In Perfect Competition- MC=MR=AR=LAC </li></ul><ul><li>Comparison Regarding Profits </li></ul><ul><li>Utilization of Resources </li></ul>
  64. 64. DISCRIMINATING MONOPOLY <ul><li>Discriminating monopoly means charging different rates from different customers for the same good or service. </li></ul><ul><li>It becomes possible where there is no competition in the market and different buyers show different elasticity of demand for the product. </li></ul><ul><li>Types- </li></ul><ul><li>Personal Price Discrimination </li></ul><ul><li>Geographical Price Discrimination </li></ul><ul><li>Price Discrimination according to Use </li></ul>
  65. 65. Conditions of Price Discrimination <ul><li>Existence of Monopoly </li></ul><ul><li>Separate market </li></ul><ul><li>Difference in the elasticity of demand </li></ul><ul><li>Expenditure in dividing and subdividing market to be minimum </li></ul><ul><li>Production of commodity to Order </li></ul><ul><li>Legal Sanction </li></ul><ul><li>Product Differentiation </li></ul><ul><li>Behavior of the Consumers </li></ul>
  66. 66. When is Price Discrimination Profitable? <ul><li>It is profitable when the price elasticity of demand is different in different markets </li></ul><ul><li>. </li></ul><ul><li>MR=AR((E-1)/E) </li></ul><ul><li>It is profitable to transfer the commodity from less marginal revenue market to more marginal revenue market. </li></ul>
  67. 67. Price & Output Determination Under Discriminating Monopoly <ul><li>In order to get maximum profit 2 conditions must be fulfilled- </li></ul><ul><li>Must get same marginal revenue in both markets- MR1=MR2 </li></ul><ul><li>Equality between MR & MC- </li></ul><ul><li>MR1=MR2=MC </li></ul>
  68. 68. Effects of Price Discrimination <ul><li>Beneficial Effects- </li></ul><ul><li>Beneficial to the Poor </li></ul><ul><li>Public Utility Services </li></ul><ul><li>Full Utilization of Resources </li></ul><ul><li>Harmful Effects- </li></ul><ul><li>No proper Use of Factors of Production </li></ul><ul><li>Less Production </li></ul>
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