Economics

1. 1

2. Market
Defined as the institutional relationship between buyers and sellers.
Market refers to the interaction between buyers and sellers of a
good (or service) at a mutually agreed upon price.
◦ Such interaction may be at a particular place, or maybe over the telephone,
or even through the Internet!
Sellers and buyers may meet each other personally, or may not ever
see each other, as in E-commerce.
Thus, the market may be defined as a place, a function, and a
process. 2

3. Typology of markets
oligopoly
Monopolistic/
Perfect
Competition
ilateral
Monopoly
B
monopsony
Number
suppliers
One
Number of buyers
A few Many
Monopoly
One
A few
Many

4. 4
MARKET STRUCTURES AND PRICING

5. Market Morphology
 Markets may be characterized on the basis of:



Number, size and distribution of sellers in any market
Whether the product is homogeneous or differentiated
Number and size of buyers:


large number of buyers but small size of individual buyer, the market will be evenly balanced between buyers and sellers.
small number of buyers but their size is large, the market is driven by buyers’ preferences.
 Absence or presence of financial, legal and technological constraints
 Thus we have:


Perfect Competition
Monopoly 5


Monopolistic competition
Oligopoly

6. 6
Type of market Number of
firms
Nature of
product
Number of
buyers
Freedom of
entry and exit
Examples
Perfect
competition
Very Large Homogeneous
(undifferentiated)
Very Large Unrestricted Agricultural
commodities,
unskilled labour
Monopolistic
competition
Many Differentiated Many Unrestricted Retail stores,
FMCG
Oligopoly Few Undifferentiated
or differentiated
Many Restricted Automobiles,
computers,
universities
Monopoly Single Unique Many Restricted Indian Railways,
Microsoft, Intel
Monopsony Many Undifferentiated
or differentiated
Single Not applicable Arms manufacturers
and Defense
industry
Market Morphology

7. Features of Perfect Competition
Perfect competition may be defined as that market where infinite number
of sellers sell homogeneous good to infinite number of buyers while buyers
and sellers have perfect knowledge of market conditions
Features
Presence of large number of buyers and sellers
Homogeneous product
Freedom of entry and exit
Perfect knowledge
Perfectly elastic demand curve
Nogovernmentalintervention
Pricedetermined by market and Firm is a price taker.
7

8. Features of Monopoly
Single seller
Theentire market is under control of a singlefirm.
Single product

A monopoly exists when a single seller sells a product which has no
substitute or, at least, no close substitute in the market.
Nodifference between firm and industry
Thereis a single firm in the industry
Independent decision making
Firmis regarded as a price maker
Restricted entry

Existence of barriers leads to the emergence and/or survival of a monopoly8

9. Monopoly
Legal Monopoly
Created by the laws of a country in the greater public interest.
Economic Monopoly
Created due to superior efficiency of a particular player.
Natural Monopoly
Formed when the size of the market is so small that it can
accommodate only one player.
Regional Monopoly
Geographical or territorial aspects also help in creation of monopolies.
9

10. 10
Price and Output Decisions in Short Run
In order to maximize profit a
monopoly firm follows the rule of
MR=MC when MC is rising.
A monopoly firm may earn
supernormal profit or normal profit
or even subnormal profit in the short
run.
which unique.
Inthe short run, the firm would reap Firm maximizes profit where
the benefits of supplying a product (i) MR=MC (ii) MC cuts MR from below, at
point E.
Supernormal profit= AEBPE,
since price (AR) > AC
B
PE
QE
E AR
MR
Quantity
Price,
Revenue,
Cost
O
MC
AC
A
AR>AC

11. 11
11
Firm makes normal profit. Firm makes loss.
Price and Output Decisions in Short Run
B
E
PE
QE
AR
AC
MR
MC
Quantity
O
Price,
Revenue,
Cost
MR
AR
MC AC
Quantity
Price,
Revenue,
Cost
O
B
QE
C
E
A
PE
AR=AC AR<AC

12. 12
A monopolist is in full control of the market price
 It would not continue to incur loss in the long run.
 It would try to reduce cost of production
 Otherwise it would close down in the long run.
Monopolist would try to earn at least normal profit in the long run and may
earn supernormal profit due to entry restrictions in the market.
If in the long run a monopoly firm earns supernormal profit
 This would attract competition and high price would make it possible for a new entrant to
survive.
To retain its monopoly power, the firm may have to resort to a low price and
earn only normal profit even in the long run to create an economic barrier to
new entrants.
12
Price and Output Decisions in Long Run

13. 13
Price Discrimination

Discrimination among buyers on the basis of the price charged for the
same good (or service).
Preconditions of Price Discrimination
Market control
Market imperfection and control are necessary
Division of market
when the whole market can be divided into various segments, and
transfer of goods between the markets is not possible, i.e., paying
capacity, demography.
Different price elasticities of demand in different markets
13

14. 14
Bases of Price Discrimination
Personal
Onbasis of the paying capacity and/or the intensity of needs.
Geographical
People living in different areas are required to pay different prices for
the same product.
Time
Thesame person may be required to pay different prices for the same
product, e.g. off season discounts.
Purposeof use
Customers are segregated on basis of their purpose of use.
 E.g. electricity rates are lower for domestic purpose and higher for industrial purpose.
14

15. 15
15
Degrees of Price Discrimination
Pigou has identified three degrees of price discrimination.
First Degree
Seller is able to charge different prices for different units of the same product from
the same consumer.
Joan Robinson referred to it as perfect discrimination.
Second Degree
Divides consumers in groups on the basis of their paying capacities; a person with
lower paying capacity is charged a lower price and vice versa
ThirdDegree
Segregates consumers such that each group of consumers is a separate market, and
charges the price on basis of price elasticity of different groups.
Different rates of ticket for different seats in theatre.

16. Features of Monopolistic Competition
• Chamberlin:
•“Monopolistic competition is a challenge to the traditional viewpoint of
economics that competition and monopoly are alternatives…By contrast it is held
that most economic situations are composites of both competition and
monopoly.”
• Features:
• Large number of buyers and sellers:..
◦ Heterogeneous products.
◦ A differentiated product enjoys some degree of uniqueness in the mindset of customers, be it
real, or imaginary.
◦ Selling costs exist.
◦ Independent decision making. •Imperfect knowledge.
•Unrestricted entry and exit.

17. Price and Output Decisions in Short Run
Joan Robinson said: Each firm has a monopoly over its
product.
Firms have limited discretion over price, due to the existence
of consumer loyalty for specific brands.
The reason for supernormal profit in short run, is supplying a
product which is differentiated, or at least perceived to be
different by the consumer.

18. Total revenue = OPEBQE
Total cost =OAEQ E
Supernormal profit =APEBE
since price OPE > OA
(AR>AC)
Price & Output Decisions in Short Run
Firm maximizes profit where (i) MR=MC; (ii) MC cuts MR
when MC is rising.
Profit maximising output OQE and Price OPE
M
C A
C
E
A
Quantit
y
Price,
Revenue
, Cost
MR
AR
O
PE
QE
B

19. Total revenue = OPEBQE
Total cost =OAEQ E
Loss =AP BE
E
since price OPE < OA
(AR<AC)
Price & Output Decisions in Short Run
Firm maximizes profit where (i) MR=MC; (ii) MC cuts MR
when MC is rising.
Profit maximising output OQE and Price OPE
M
C A
C
E
A
Quantity
Price,
Revenue
, Cost
MR
AR
O
E
QE
P B

20. Total revenue = OPEBQE
Total cost =OAEQE
Normal profit = No loss
no gain
since AR=AC
Price & Output Decisions in Long Run
Firm maximizes profit where (i) MR=MC; (ii) MC cuts MR
when MC is rising.
Profit maximising output OQE and Price OPE
M
C A
C
Quant
ity
Price,
Reven
ue,
Cost
MR
AR
O
E
QE
P B

21. •Just like perfect competition, in monopolistic competition
too all the firms would earn normal profits in the long run.
•In the long run supernormal profit would attract new
firms to the industry till all the firms earn only normal
profits.
•Losses, will force firms to exit the industry till
remaining firms in the market earn only normal profits.
•If all the firms earning only normal profit there will be no
tendency to enter or exit the market.
Price & Output Decisions in Long Run

22. Features of Oligopoly
Derived from Greek word: “oligo” (few) “polo” (to sell)
Few Sellers: small number of large firms compete
Product: Some industries may consist of firms selling
identical products, while in some other industries firms may
be selling differentiated products.
Entry Barriers: No legal barriers; only economic in nature
◦ Huge investment requirements
◦ Strong consumer loyalty for existing brands

23. Duopoly
Duopoly is that type of oligopoly in which only two players operate
(or dominate) in the market.
◦ Used by many economists like Cournot, Stackelberg, Sweezy, to explain the
equilibrium of oligopoly firm, as it simplifies the analysis.
Price and Output Decisions
No single model can explain the determination of equilibrium price
and output
◦ Difficult to determine the demand curve and hence the revenue curve of
the firm

24. “In Corporate firms, there is structural division of ownership and
management which allows managers to set goals which do not
necessarily conform with those of the owners. The shareholders
are the owners. Their utility function includes variables such as
profits,
size of output, size of capital,
market share and public image.
Marris’s Theory of The
Managerial Enterprise

25. Marris’s Theory of
The Managerial Enterprise(contd.)
“
The Managers have other ideas. Their utility function
includes variables such as
Salaries,
Job security, Power and status.

26. Marris’s Theory of
The Managerial
Enterprise(contd.)
• The owners want to maximise their utility while the managers
attempt maximisation of their own utility.
• Both utilities do not necessarily clash, because the most of the
variables of both the utilities, have a strong relationship with a
single variable
• i.e., size of the firm.
• It is reasonable to assume that maximising the long-run growth of
any indicator is equivalent to maximising the long-run growth rate
of the others.

27. Marris’s Theory of
The Managerial Enterprise(contd.)
• Owners being interested in the growth of the firm want
maximisation of the growth of the supply of capital, which is
assumed to maximise the owner’s utility.
• Managers wanting to maximise rate of growth of the firm rather
than absolute size of the firm, believe that growth of demand for
the products is an appropriate indicator of the growth of the firm.

28. • There are two constrains in the Marris’s Model:
• 1. The Managerial Team Constraint.
Since Management is a teamwork, hiring new managers does not
expand managerial capaqcity immediately. New managers take
time to get integrated in the team. Managerial tream constraint
sets limits to both the rate of growth of demand and rate of
growth of capital.
• 2. The Job Security Constraint. Managers want job security. Job
security attained by pursuing a prudent financial policy which
requires the three crucial financial ratios to be maintained at
optimum levels.

29. Policy variables in Marris’s balanced growth model are as follows:
• 1.The firm has the freedom to choose its financial policy, as it subjectively determines
the three financial ratios, liquidity ratio, leverage/debt ratio and retention ratio.
2.The firm can decide its diversification rate, either by expanding the range of its products, or
by merely effecting a change in the style of its existing range of products. OR it can adopt the
two policies simultaneously.
3.Price is not a policy variable of the firm. It is a parameter. Price is taken as given by the
oligopolistic structure of the market. Production costs are also taken as given.
4.The firm has the freedom to decide the level of it advertising and R&D. Since Price and
Production Costs are given, increase in advt. & R&D, will imply lower profit margin and
vice-versa.
•
•
•

30. Marris’s Model:
The rate of growth of demand for the products of the firm:
• The firm is assumed to grow by diversification and not by merger or acquisition.
• The growth of demand for the products of the firm depends on the rate of diversification and
the proportion of successful new products.
The rate of growth of capital supply:
• The shareholders who are the owners, wish to maximise company's capital, which is the
measure of the size of the firm.
• The main source of finance for the growth of the firm is profit but the management can retain
only part of it, for another part has to be distributed as dividend.
The rate of growth of capital is determined by three factors: the three financial ratios
determined by the managers constituting the financial security constraint, the average
rate of profit, and the rate of diversification.

31. Critically examine Marris’s Theory:
R. Marris has made a significant contribution in the form of incorporation of the
financial policies into the decision making process of the corporate firm. His
theory suggests that although the managers and the owners have different
goals, it is possible to find a solution which maximises utility of both.
Nonetheless Marris shows that growth and profits are competing goals. His
model implies that both managers and owners are conscious of the fact that
the firm cannot simultaneously achieve maximum growth and maximum
profits. Marris seems to be correct in arguing that owners of the corporate
firms do prefer the maximisation of the rate of growth and for this they do not
mind sacrificing some profits.

32. Critically examine Marris’s Theory:(contd.)
The main weakness of Marris’s Theory is that he assumes given production
costs and a price structure. He does not explain determination of either costs
or prices.
A. Koutsoyiannis writes “Oligopolistic interdependence is not satisfactorily dealt
with in Marris’s model. Really Marris brushes aside the mechanism by which
prices ar determined. This is a serious shortcoming of the model, in view of
Marris’s assumption that the growth of the firm is achieved mainly via the
introduction of new products which will (sooner rather than later) be imitated by
competitors.”

33. WILLIAMSON’S THEORY OF MANAGERIAL
DISCRETION

34. WILLIAMSON’S THEORY OF MANAGERIAL
DISCRETION
Williamson is of the opinion that the managers of a modern
business firm organised as a corporate unit do not maximise the
profits which result in the maximisation of the utility of the
owners.
Onstead they maximise their own utility using their discretion.
However, for their job security, managers attempt to ensure a
certain minimum of
profit to shareholders in the form of dividends. Thus profit is a
constraint to the manager’s discretion.

35. WILLIAMSON’S THEORY OF MANAGERIAL
DISCRETION
• Managers’ utility depends on such variables as salary, job security,
power, prestige, status, job satisfaction and professional excellence.
Of these variables only salary can be quantified. Therefore,
Williamson uses measurable variables like staff empenditures,
managerial emoluments and discretionary investment in the utility
function of managers on the assumption that these are the source
of the job security and reflect power, prestige, status and
professional achievements of managers.

36. • According to Williamson, utility function of the self-seeking
managers depends on the following factors:
1. Salaries and Other Forms of Monetary Compensation
2. Number of Staff under the Control of a Manager
3. Management Slack
4. Magnitude of Discretionary Investment Expenditure by the
Manager:

37. | Pricing |
Price denotes two aspects:
•It is revenue to the seller and
•It is the perceived value of the good
(or service) to the buyer.
Market structure also affects pricing decisions.
Change in government policy regarding taxation, subsidies and
administered prices would also lead to change in existing
price.

38. Pricing Strategies

39. Penetration Pricing

40. Penetration Pricing
Price set to ‘penetrate the market’
‘Low’ price to secure high volumes
Typical in mass market products – chocolate bars, food stuffs,
household goods, etc.
Suitable for products with long anticipated life cycles
May be useful if launching into a new market

41. Market Skimming

42. Market Skimming
High price, Low volumes
Skim the profit from the
market
Suitable for products that
have short life cycles or which
will face competition at some
point in the future (e.g. after
a patent runs out)
Examples include: Playstation,
jewellery, digital technology,
new DVDs, etc.
Many are predicting a firesale in
laptops as supply exceeds demand.
Copyright: iStock.com

43. Value Pricing

44. Value Pricing
Price set in accordance with
customer perceptions about
the value of the
product/service
Examples include status
products/exclusive products
Companies may be able to set prices
according to perceived value.
Copyright: iStock.com

45. Loss Leader

46. Loss Leader
Goods/services deliberately sold below cost to encourage
sales elsewhere
◦Typical in supermarkets, e.g. at Christmas, selling bottles of gin
at `300 in the hope that people will be attracted to the store
and buy other things
Purchases of other items more than covers ‘loss’ on item
sold

47. Psychological Pricing

48. Psychological Pricing
• Used to play on consumer
perceptions Classic example - `499!
•Links with value pricing – high value goods priced
according to what consumers THINK should be the
price

49. Going Rate (Price Leadership)

50. Going Rate (Price Leadership)
In case of price leader, rivals have difficulty in competing on price
– too high and they lose market share, too low and the price
leader would match price and force smaller rival out of market
May follow pricing leads of rivals especially where those rivals
have a clear dominance of market share
Where competition is limited, ‘going rate’ pricing may be
applicable – banks, petrol, supermarkets, electrical goods – find
very similar prices in all outlets

51. Tender Pricing

52. Tender Pricing
Many contracts awarded on a tender basis
Firm (or firms) submit their price for carrying out
the work
Purchaser then chooses which represents best
value
Mostly done in secret

53. Price Discrimination

54. Price Discrimination Charging a different price
for the same good/service
in different markets
Requires each market to
be impenetrable
Requires different price
elasticity of demand in
each market
Prices for rail travel differ for the same journey
at different times of the day
Copyright: iStock.com

55. Destroyer Pricing/Predatory Pricing

56. Destroyer/Predatory Pricing
Deliberate price cutting or offer of ‘free
gifts/products’ to force rivals (normally smaller and
weaker) out of business or prevent new entrants
Anti-competitive and illegal if it can be proved

57. Absorption/Full Cost Pricing

58. Absorption/Full Cost Pricing
•Full Cost Pricing – attempting to set price to cover both
fixed and variable costs
•Absorption Cost Pricing – Price set to ‘absorb’ some of the
fixed costs of production

59. Marginal Cost Pricing

60. Marginal Cost Pricing
Marginal cost – the cost of producing ONE extra or ONE fewer
item of production
MC pricing – allows flexibility
Particularly relevant in transport where fixed costs may be
relatively high
Allows variable pricing structure – e.g. on a flight from London to
New York – providing the cost of the extra passenger is covered,
the price could be varied a good deal to attract customers and fill
the aircraft

61. Marginal Cost Pricing
Example:
Aircraft flying from Delhi to Mumbai– Total Cost
(including normal profit) = `1,50,000 of which `1,30,000 is
fixed cost*
Number of seats = 160, average price = `937.5
MC of each passenger = 20,000/160 = `125.0
If flight not full, better to offer passengers chance of flying
at `125.0 and fill the seat than not fill it at all!

62. Contribution Pricing

63. Contribution Pricing
Contribution = Selling Price – Variable (direct costs)
Prices set to ensure coverage of variable costs and a
‘contribution’ to the fixed costs
Similar in principle to marginal cost pricing
Break-even analysis might be useful in such
circumstances

64. Target Pricing

65. Target Pricing
Setting price to ‘target’ a specified profit level
Estimates of the cost and potential revenue at
different prices, and thus the break-even have to be
made, to determine the mark-up
Mark-up = Profit/Cost x 100

66. Cost-Plus Pricing

67. Cost-Plus Pricing
Calculation of the average cost (AC) plus a
mark up
AC = Total Cost/Output

68. Demand Interdependence: A firm may produce goods which can
either be substitutes or complementary in demand.
In case of substitutes, Seller has two options:
◦ Charge the same price for the two goods or
◦ Differentiate the products from each other and take advantage of perceived
value pricing.
In case of complements, suitable strategy would be either
◦ Product bundling or
◦ Loss leader, depending upon company’s objective and market conditions.
Multi Product Pricing/ Product Line Pricing

69. Supply (or Production) Interdependence: Some goods are jointly
produced as an outcome of production process.
The firm has to first decide whether to sell only the primary
product or both the products.
For the primary product it can adopt any of the pricing strategies
depending upon the market structure or life cycle stages of the
product.
Alternatively it may adopt full costing for the primary product and
marginal costing for the joint product.
Multi Product Pricing/ Product Line Pricing

70. Business Cycle
The term business cycle is referred to the recurrent ups and downs in
the level of economic activity that extend over a period of time. The
business fluctuations occur in aggregate variable such as national
income, employment and price level.
Business cycle is also called as “Trade Cycle”

71. 4 Phases of Business Cycle
 Prosperity Phase : Expansion or Boom or Upswing of
economy.
 Recession Phase : from prosperity to recession (upper turning
point).
 Depression Phase : Contraction or Downswing of economy.
 Recovery Phase : from depression to prosperity (lower turning
Point).

72. Prosperity: Expansion & Peak
When there is an expansion of output, income,
employment, prices and profits, there is also a rise in the standard of living. This
period is termed as Prosperity phase.
 Rise in the national output & trade
 Rise in consumer and capital expenditure
 Rise in the Price of raw materials and finished goods
 Rise in the level of income & employment
Fig.1

73. Recession & Turning Point
•During a recession period, the economic activities slow down.
When demand starts falling, the overproduction and future
investment plans are also given up. There is a steady decline in
the
• output, income, employment, prices and profits.

74. Depression & Trough
When there is a continuous decrease of output, income,
employment, prices and
profits, there is a fall in the standard of living and depression sets in.
During the phase of Depression:
 The growth rate become negative
The level of national income and expenditure declines
 Price of consumer and capital goods decline
 Workers lose their job

75. Recovery Phase
As the recovery gathers momentum, some firms plan additional
investment; some undertake renovation programmes, and some
undertake both. These activities generate construction activities in
both consumer & capital goods sector. As a result more employment is
generated and wage rates moving upward.

76. Fig.3
Business Cycle-MartinThomas

77. Thank you…