Managerial Economics as per GBTU syllabus for MBA

1. MANAGERIAL ECONOMICS
UNDER GUIDANCE OF
Mr. Yogesh Puri,Sir.
By-Shashank Kumar Saxena
M.B.A -1st Sem
STEP-HBTI

2. Index
A. Introduction
B. Demand & Elasticity of Demand
C. Supply & Elasticity of Supply
D. Demand Forecasting
E. Production
F. Cost
G. Revenue
H. Main Forms of Market
I. National Income
J. Business cycle & profit

3. Introduction

4. 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 making
b)-Forward Planning

5. Scope
• M.E helps managers in taking decisions which
involves risk & uncertainty. Some of those are: -
a)-Profit Decision
b)-Demand decision
c)-Price Output Decisions
d)-Investment Decisions

6. Fundamentals of Managerial Economics
• Opportunity Cost Principle
• Incremental Cost Principle
• Time Perspective Principle
a)-Short Run Principle
b)-Long Run Principle
• Discounting Principle
• Equi-Marginal Principle

7. Key Terms
• demand • supply
• demand schedule • supply schedule
• law of demand • law of supply
• diminishing marginal utility • supply curve
• income effect • determinants of supply
• substitution effect • change in supply
• demand curve • change in quantity
• determinants of demand supplied
• normal goods • equilibrium price
• inferior goods • equilibrium quantity
• substitute good • surplus
• complementary good • shortage
• change in demand • price ceiling
• change in quantity demanded • price floor
3-7

8. Market
• Interaction between buyers and
sellers
• Buyers demand goods
• Sellers supply goods
• Assumptions
▫ Standardized good
▫ Competitive market

9. Demand & Elasticity of Demand

10. 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

11. Cont.
• Exceptions to law of demand
a)-Griffen goods
b)-Snob affect
c)-Future exceptation
d)-Ignorance
e)-Emergency
• Demand function:- A mathematical represent of
the quantity demanded and factors affecting it.
Q=f{P,P0,W,F…….}

12. Cont.
Where,
P=Price of commodity.
P0 =Population
W=Weather Condition
F=Future Exception
• Two levels: Individual Demand
Market Demand

13. Individual demand curve
P
6
5
Price (per unit)
P Qd 4
`5 10
3
4 20
3 35 2
2 55 1
D
1 80
0 Q
10 20 30 40 50 60 70 80
Quantity Demanded (units per week)

14. Individual Demand P
6 Change in
Demand
5
Price (per unit)
P Qd 4 Change in
`5 10 Quantity
3 Demanded
4 20
3 35 2
D2
2 55 1
D1
D3
1 80
0
2 4 6 8 10 12 14 16 18 Q
Quantity Demanded (unit per week)
3-14

15. 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.

16. 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.

17. 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.

18. • It can be represented in the following
mathematical form: -
Elasticity(e p) =
% change in Quantity demanded
% change in Price
change in Price
% change in p = 100.
orignal Price
% change in p = P
( ) 100
P

19. Methods of measuring elasticity of
demand.
• Point elasticity method
• Expenditure Outlay method
• % method

20. Types of Price Elasticity
1. Perfectly elastic
2. Perfectly Inelastic
3. Unity Elasticity
4. Relatively Elastic
5. Relatively Inelastic.

21. 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

22. 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.

23. 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

24. 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

25. Relatively elastic demand
A reduction in price leads to more than
proportionate change in demand.
Shape of the demand curve is flat.
Elasticity > 1

26. Relatively inelastic demand
A decline in price leads to less than proportionate
increase in demand.
Shape of the demand curve is steep.
Elasticity < 1

27. Factors influencing
elasticity of demand
1. Nature of the commodity.
2. Availability of Substitutes
3. Number of Uses
4. 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.

28. Supply & Elasticity of Supply

29. Supply
• Schedule or curve
• Amount producers willing and able
to sell at a given price
• Individual supply
• Market supply
3-29

30. Law of Supply
• Other things equal, as price
rises the quantity supplied
rises
• Explanations:
▫ Revenue implications
▫ Marginal cost
3-30

31. Individual Supply P
6
S1
5
Price (per unit)
P Qs 4
`5 60
3
4 50
3 35 2
2 20 1
1 5
0
10 20 30 40 50 60 70 Q
Quantity Supplied (units per week)
3-31

32. Determinants of Supply
• Resource prices
• Technology
• Taxes and subsidies
• Prices of other goods
• Producer expectations
• Number of sellers
3-32

33. Individual Supply P
6
S3
S1
5
S2
Price (per units)
P Qs 4
`5 60
3
4 50
3 35 2
2 20 1
1 5
0
10 20 30 40 50 60 70 Q
Quantity Supplied (units per week)
3-33

34. Individual Supply P
6
S3
S1
5 Change in
Quantity Supplied S2
Price (per units)
P Qs 4
` 5 60
3
4 50
3 35 2
Change in
2 20 1
Supply
1 5
0
10 20 30 40 50 60 70 Q
Quantity Supplied (units per week)
3-34

35. Elasticity of supply
Elasticity(e p) =
% change in Quantity demanded
% change in Price
change in Price
% change in p = 100.
orignal Price
% change in p = P
( ) 100
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.

36. Types of Supply Elasticity
1. Perfectly Elastic
2. Perfectly Inelastic
3. Unit Elasticity
4. More than Elastic
5. Less than Elastic.

37. Perfectly Elastic Supply
•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.
Price Perfectly elastic supply
Es = infinity
Quantity Supply

38. Elastic Supply Curve
•A change in price leads to more than proportionate change in supply.
•Shape of the demand curve is flat.
price
ES > 1
Quantity Supply

39. Perfectly inelastic supply
•Even a large change in price, does not change the quantity supplied.
•Here the shape of the curve is vertical.
Es = 0
Price
Quantity Supply

40. Unit elastic
•A proportionate change in price results in exactly the same proportional
change in quantity supplied.
•Shape of the demand curve is a rectangular hyperbola.
ES = 1
Price
Quantity Supply

41. Inelastic supply
•A change in price leads to less than proportionate change in supply.
•Shape of the demand curve is flat.
ES < 1
Price
Quantity Supply

42. Market Equilibrium

43. Market Equilibrium
• Equilibrium price and quantity
• Surplus and shortage
• Rationing function of price
• Efficient allocation
▫ Productive efficiency
▫ Allocative efficiency
3-43

44. Market Equilibrium
6
6,000 units S
5 Surplus
P Qd P Qs
Price (per units)
` 4 Price Floor
`5 2,000 4
` 5 12,000
4 4,000 4 10,000
3
3 7,000
` 2 Price Ceiling 3 7,000
2 11,000 2
2 4,000
1 16,000 7,000 units 1 1,000
1
Shortage D
0
2 4 6 7 8 10 12 14 16 18
unitss of Corn (thousands per week)
3-44

45. 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

46. Market Equilibrium Price Quantity
• Supply increase; ?
Demand decrease
• Supply decrease;
Demand increase ?
• Supply increase;
Demand increase ?
• Supply decrease;
Demand decrease ?
3-46

47. 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

48. 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

49. Methods Of Demand Forecasting

50. Production function

51. Meaning of production
Its an activity that transforms inputs in to out
puts.

52. Production Function

53. Production Function
Inputs Process Output
Land
Product or
Labour service
generated
Capital
– value added

54. 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.

55. Factors affecting productivity
• Technology
• Inputs
• Labor
• Capital
• Machinery
• Land
• Raw material
• power
• Time period

56. Classification of production function
• Short term production function.
(K & Lb are constant)
• Long run production function.
(Lb is constant)

57. Analysis run attheone factor fixed in supply but all other
• In the short
of least short run
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

58. 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

59. 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.

60. Cost Concepts in Economics

61. Agenda
• Opportunity Cost
• Long Versus Short-Run
• Cost Concepts
• Revenue Concepts
• Production Rules in Short and Long-Run
• Size in Long-Run

62. 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.

63. 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.

64. 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.

65. 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.

66. 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

67. 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.

68. 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

69. 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.

70. 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

71. Graphical Representation of Cost
Concepts
`
TC
TVC
TFC
Y

72. Graphical Representation of Cost
Concepts Cont.
`
MC
ATC
AVC
AFC
Y

73. 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. 74
Example of Cost Concepts
X Y TFC TVC TC AFC AVC ATC MC
10 10 1000 1000 2000 100 100 200
16 30 1000 1600 2600 33.33 53.33 86.67 30
20 48 1000 2000 3000 20.83 41.67 62.50 22.22
22 65 1000 2200 3200 15.38 33.85 49.23 11.76
26 81 1000 2600 3600 12.35 32.10 45.45 25
32 96 1000 3200 4200 10.42 33.33 43.75 40
40 108 1000 4000 5000 9.26 37.04 46.30 66.67
50 116 1000 5000 6000 8.62 43.10 51.72 125
62 120 1000 6200 7200 8.33 51.67 60.00 300
76 117 1000 7600 8600 8.55 64.96 73.51 -466.67

75. 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.

76. 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.

77. 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.

78. 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.

79. 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.

80. Why Shutdown When
MR < 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.

81. 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.

82. Profit Scenario Graphically
` Profit
MC
MR = py
ATC
ATC
AVC
AFC
Yprofit Y

83. Loss Minimizing Graphically
`
MC
Loss
ATC
ATC
AVC
MR = py
AFC
Yloss Y

84. Shutdown Decision Graphically
`
If we did not produce:
loss = B MC
Loss = A + B
ATC
ATC
B AVC
MR = py A AFC
Yloss Y

85. 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.

86. Note on Cost Concepts
• The producer‟s supply curve is the part of the
MC curve that is above the shutdown point.

87. 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.

88. 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.

89. 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

90. 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. 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. 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.

93. 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

94. Market Structure
Perfect Pure
Competition Monopoly
More competitive (fewer imperfections)

95. Market Structure
Perfect Pure
Competition Monopoly
Less competitive (greater degree
of imperfection)

96. Main forms of Market
Pure
Perfect
Monopoly
Competition
Monopolistic Competition Oligopoly Duopoly Monopoly
The further right on the scale, the greater the degree
of monopoly power exercised by the firm.

97. 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

98. Perfect Competition Givenaverage the cost ofis the
Thethis industry price firm
AtThe MC is cost curve profit
The assumption of is
the output the
maximisation,– shaped curve.
standard ‘U’ additional demand
producing theby the
determined firm produces
Cost/Revenue is(marginal) AC curve =profit.
making units the atMR
and the normal its
MC at an cuts supply of MC industry
MC output where of output. It
(Q1). asis first (due run alaw of
This at whole. levelfirm is a
lowest point long to thethe
This a because is
falls a output The of
fraction of the total industry rises
mathematical relationship
equilibriumreturns) then
diminishing supplier within
very small position.
supply. industry and has no
between marginal and average
asthe
output rises.
AC values.
control over price. They will
sell each extra unit for the
same price. Price therefore
= MR and AR
P = MR = AR
Q1 Output/Sales

99. Perfect Competition
Diagrammatic representation Because the model assumes
perfect knowledge,MC costs
The assume a firm the firm
Average and and makes
Nowlower ACMarginal would
Cost/Revenue
MC gains that advantage nowlower
some theexpected is for only a
could form of firm to be
imply be the modification to
short timein the short run, form
its product before others copy
but price, or gains some
earning abnormal profit
MC1 the idea or are attracted to the
remains the same.
(AR>AC) represented a the
of cost advantage (sayby new
industry by method). What
production the existence of
grey area.
AC abnormal profit. If new firms
would happen?
enter the industry, supply will
increase, price will fall and the
AC1 firm will be left making normal
profit once again.
P = MR = AR
Abnormal profit
AC1
P1 = MR1 = AR1
Q1 Q2 Output/Sales

100. 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!

101. 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

102. Monopolistic or Imperfect Competition
Implications for the diagram:
MC
This is demandrunandfacing
Cost/Revenue We assumeCost theQ1 and
IfThe firm produces firm
the a shortthat equilibrium
Marginal
Since the additional
curve
produceswillfirmdownward
Averagea be willabeMC
where MR = the
Cost in£1.00 on
position forreceived from
sells firm unit for
revenue
the each
(profit maximising output).
average shape. falls, (on
each unit sold However,
same and the cost
monopolistic market the the
sloping with represents
At because the products
MR curve level, AR>AC
this output
AC structure. for from sales.
average) lies under the
AR earned each unit being
and the firm makes in 40p x
are differentiated
60p, curve. will make
AR the firm
abnormal profit (the grey
Q1 in abnormal profit.will
£1.00 some way, the firm
shaded area). to sell extra
only be able
output by lowering
Abnormal Profit price.
£0.60
MR D (AR)
Q1
Output / Sales

103. Monopolistic or Imperfect
Competition
Implications for the diagram:
MC Because there is relative
Cost/Revenue
freedom of entry and exit
into the market, new
firms will enter
AC 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.
AR1 D (AR)
MR1 MR
Q1 Output / Sales

104. Monopolistic or Imperfect
Competition
Implications for the diagram:
MC Notice that the existence
Cost/Revenue
of more substitutes makes
the new AR (D) curve
more price elastic. The
AC firm reduces output to a
point where MC = MR
(Q2). At this output AR =
AC and the firm will make
AR = AC
normal profit.
AR1 D (AR)
MR1 MR
Q2 Q1 Output / Sales

105. Monopolistic or Imperfect
Competition
Implications for the diagram:
MC This is the long run
Cost/Revenue
equilibrium position
of a firm in monopolistic
competition.
AC
AR = AC
AR1
MR1
Q2 Output / Sales

106. 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?

107. 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

108. 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??

109. 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

110. 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

111. 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!

112. 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

113. 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

114. 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

115. 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

116. 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

117. Monopoly
Costs / Revenue
This is curve for a monopolist
Given both the short run and
AR (D)the barriers to entry,
MC long to equilibrium price
the monopolist will be able to
likelyrunbe relatively position
for a monopoly
exploit abnormal profits in to
inelastic. Output assumed the
£7.00
long profit entry to the
be atrun as maximising output
(note caution here – not all
AC market is restricted.
monopolists may aim
Monopoly for profit maximisation!)
Profit
£3.00
MR AR
Output / Sales
Q1

118. Monopoly
Welfare
Costs / Revenue implications of
monopolies
MC
The higher in at competitive be
A look back a the diagram for
The price priceprice lower
monopoly and would
£7
output means that £3willlevels
perfectunit with output reveal
market competition with
£7 per would be consumer
AC that in is reduced, indicated by
output equilibrium, price will be
surplusat Q2. at Q1.
lower levels
Loss of consumer equal to the MC of production.
the grey shaded area.
On the face of it, consumers
surplus We can look therefore at a
face higher prices and less
comparison of the differences
choice in monopoly conditions
£3 between price and output in a
compared to more competitive
competitive situation compared
environments.
to a monopoly.
AR
MR
Output / Sales
Q2 Q1

119. Monopoly
Welfare
Costs / Revenue implications of
monopolies
MC
The monopolist will be
benefit
£7 from additional producer
affected by a loss of producer
AC surplus shownto the grey
equal by the grey
shaded but……..
triangle rectangle.
Gain in producer
surplus
£3
AR
MR
Output / Sales
Q2 Q1

120. Monopoly
Welfare
Costs / Revenue implications of
monopolies
MC The value of the grey shaded
£7 triangle represents the total
welfare loss to society –
AC sometimes referred to as
the ‘deadweight welfare loss’.
£3
AR
MR
Output / Sales
Q2 Q1

121. 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.

122. 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

123. • 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

124. NI – Methods of computation :
There three methods of NI computation:-
• Net Product method
• Factor Income method
• Expenditure method

125. Inflation
• “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.”

126. KINDS OF INFLATION
• On the basis of rate of inflation
• On the basis of degree of control
• On the basis of causes
• Others

127. CAUSES OF INFLATION
• Demand pull inflation
• Cost push inflation

128. 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.

129. 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.

130. 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.

131. 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

132. 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.

133. 133 of 23
Phases of business cycle
Business Cycle is typically divided into
four phases:
a) The recovery
b) The prosperity
c) The recession
d) The depression

134. 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.

135. 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

136. 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.

137. of 23
Recession
 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.

138. Thank You for your
Patience and Keen
Interest.