MBA

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Inclusive growth means economic growth that
creates employment opportunities and helps in reducing poverty.
It means having access to essential services in health and
education by the poor. It includes providing equality of
opportunity, empowering people through education and skill
development
1) Equitable opportunities for economic participant
2) Benefit for every section of society during growth
3) Equity of health ,human capital ,environment quality ,social
protection and food safety
4) Poverty reduction
5) Employment generation
6) Agricultural development
7) Social sector development
8) Equal distribution of income
9) Environmental protection
10) Reducing in regional disparities
11) Industrial development
Marketing structure
Market structure is best defined as the organizational and
other characteristics of a market. We focus on those
characteristics which affect the nature of competition and
pricing – but it is important not to place too much emphasis
simply on the market share of the existing firms in an
industry

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Market structure has historically emerged in two separate
types of discussions in economics, that of Adam Smith on
the one hand, and that of Karl Marx on the other hand.
What are the 4 types of market structures?
Four types of market structures.
1) Perfect Competition Market Structure. ...
2) Monopolistic Competition Market Structure. ...
3) Monopoly Market Structure. ...
4) Oligopoly Market Structure.
Generally, there are several basic defining characteristics of a
market structure:
a) The commodity or item that is sold and level of
differentiation between them.
b) The number of companies in the market, the ease or
difficulty of entering the market and the distribution of
market share of the largest firms.
c) The number of buyers and how they work with or
against sellers to influence price and quantity.
d) The relationship between producers or sellers.

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Four types of market structures are as.
1) Perfect Competition Market Structure
In a perfectly competitive market, the forces of supply
and demand determine the amount of goods and services
produced as well as market prices set by the companies in the
market.
Perfect competition assumes the environment or
climate cooperates with the buildings within it.
The perfectly competitive market structure is a
theoretically ideal market; there is free entry and exit, so many
companies move into the market and easily exit when it’s not
profitable. With so many competitors, the influence of one
company or buyer is relatively small and does not affect the
market as a whole.
Buyers and sellers are referred to as price takers rather than
price influencers.
The products within the market are seen as
homogenous, there is little difference between them. Not only
are the products identical, information regarding product quality
and price is perfectly and openly given to the public. The model
assumes each producer is operating at the lowest possible cost to
achieve the greatest possible output.
The perfect competition model is difficult to find
in operation. There are few agricultural and craft markets that
may fit the theory. This model is primarily a reference point
from which economists compare the other market structures.

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2. Monopolistic Competition Market Structure
Unlike perfect competition, monopolistic
competition does not assume lowest possible cost production.
That slight difference in definition leaves room for
huge differences in how the companies operate in the market.
Companies in a monopolistic competition
structure sell very similar products with small differences they
use as the basis of their marketing and advertising.
This is completely different from the perfectly competitive
market structure which excludes advertising. Consider bath soap
— they are all pretty much the same as far as what makes it soap
and its use, but small differences like fragrance, shape, added
oils or color are used in advertising and in setting price.
In monopolistic competition producers are price
maximizes.
When the profits are attractive, producers freely
enter the market. The slight differences between the products
also creates imperfect information regarding quality and price.
Monopolistic competition markets are a hybrid of
two extremes, the perfectly competitive market and monopoly.
Examples of monopolistic competition markets are:
a) Service and repair markets like HVAC repair companies.
b) Beauty salons and spas.
c) And tutoring companies.
3. Monopoly Market Structure
Monopolies and perfectly competitive markets sit
at either end of market structure extremes. However,
both minimize cost and maximize profit. Where there are many
competitors in a perfect competition, in monopolistic markets
there’s just one supplier.

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High barriers to entry into this market leave a “mono-” or lone
company standing so there is no price competition. The supplier
is the price-maker, setting a price that maximizes profits.
There are naturally occurring monopolies and those
created through legislation, such as state-legislated liquor stores.
However, several companies have been criticized as breaking
antitrust laws including:
Microsoft
De Beers
Major League Sports
4. Oligopoly Market Structure
The Oligopoly Market characterized by few
sellers, selling the homogeneous or differentiated products. In
other words, the Oligopoly market structure lies between the
pure monopoly and monopolistic competition, where few sellers
dominate the market and have control over the price of the
product.
Under the Oligopoly market, a firm either produces:
1. Homogeneous product: The firms producing the
homogeneous products are called as Pure or Perfect
Oligopoly. It is found in the producers of industrial
products such as aluminum, copper, steel, zinc, iron, etc.
2. Heterogeneous Product: The firms producing the
heterogeneous products are called as Imperfect or
Differentiated Oligopoly. Such type of Oligopoly is found
in the producers of consumer goods such as automobiles,
soaps, detergents, television, refrigerators, etc.
There are six types of oligopoly market, for detailed description,
click on the link below:

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1. Few Sellers: Under the Oligopoly market, the sellers are
few, and the customers are many. Few firms dominating
the market enjoys a considerable control over the price of
the product.
2. Interdependence: it is one of the most important features
of an Oligopoly market, wherein, the seller has to be
cautious with respect to any action taken by the competing
firms. Since there are few sellers in the market, if any firm
makes the change in the price or promotional scheme, all
other firms in the industry have to comply with it, to remain
in the competition.
Thus, every firm remains alert to the actions of others and
plan their counterattack beforehand, to escape the turmoil.
Hence, there is a complete interdependence among the
sellers with respect to their price-output policies.
3. Advertising: Under Oligopoly market, every firm
advertises their products on a frequent basis, with the
intention to reach more and more customers and increase

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their customer base.This is due to the advertising that
makes the competition intense.
If any firm does a lot of advertisement while the other
remained silent, then he will observe that his customers are
going to that firm who is continuously promoting its
product. Thus, in order to be in the race, each firm spends
lots of money on advertisement activities.
4. Competition: It is genuine that with a few players in the
market, there will be an intense competition among the
sellers. Any move taken by the firm will have a
considerable impact on its rivals. Thus, every seller keeps
an eye over its rival and be ready with the counterattack.
5. Entry and Exit Barriers: The firms can easily exit the
industry whenever it wants, but has to face certain barriers
to entering into it. These barriers could be Government
license, Patent, large firm’s economies of scale, high
capital requirement, complex technology, etc. Also,
sometimes the government regulations favor the existing
large firms, thereby acting as a barrier for the new entrants.
6. Lack of Uniformity: There is a lack of uniformity among
the firms in terms of their size, some are big, and some are
small.
Since there are less number of firms, any action taken by one
firm has a considerable effect on the other. Thus, every firm
must keep a close eye on its counterpart and plan the
promotional activities accordingly.

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Perfect
competition
Monopolistic
competition
Oligopoly Monopoly
Large number of
buyers and sellers
Many sellers Few sellers Single producer
and seller
Homogeneous
product
Differentiated
product
Homogeneous or
differentiated
product
No close
substitutes
available
Perfect substitutes
available
Close substitutes
available
Inter dependent
decision making
Impossible entry
(Pure monopoly)or
may dface threat
of potential
entrants
(contestable
monopoly
Free entry and
exit
Relatively free
entry and exit
Substitutes
many or may not
be available
Prefect
knowledge and
Non –price
competition in
Vary difficulty
entry and exits

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information the form of
advertising and
product
innovation
No advertising
or product
innovation
Strategic pricing
,output decisions
and marketing
efforts
Usually
regulated public
utilities (natural
monopolies that
produce
essential goods
Market structure
Definition:
The Market Structure refers to the characteristics of
the market either organizational or competitive, that describes
the nature of competition and the pricing policy followed in the
market.
Thus, the market structure can be defined as, the
number of firms producing the identical goods and services in
the market and whose structure is determined on the basis of the
competition prevailing in that market.
The term “ market” refers to a place where sellers and
buyers meet and facilitate the selling and buying of goods and
services. But in economics, it is much wider than just a place, It
is a gamut of all the buyers and sellers, who are spread out to
perform the marketing activities.

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Types of Market Structure
1. Perfect Competition Market Structure
2. Monopolistic Competition Market Structure
3. Oligopoly Market Structure
4. Monopoly Market Structure
The major determinants of the market structure are:
1. The number of sellers operating in the market.
2. The number of buyers in the market.
3. The nature of goods and services offered by the firms.
4. The concentration ratio of the company, which shows the
largest market shares held by the companies.
5. The entry and exit barriers in a particular market.
6. The economies of scale, i.e. how cost efficient a firm is in
producing the goods and services at a low cost. Also the
sunk cost, the cost that has already been spent on the
business operations.

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7. The degree of vertical integration, i.e. the combining of
different stages of production and distribution, managed by
a single firm.
8. The level of product and service differentiation, i.e. how
the company’s offerings differ from the other company’s
offerings.
9. The customer turnover, i.e. the number of customers
willing to change their choice with respect to the goods and
services at the time of adverse market conditions.
10. Thus, the structure of the market affects how firm price and
supply their goods and services, how they handle the exit
and entry barriers, and how efficiently a firm carry out its
business operations.
Duopoly
A duopoly is a form of oligopoly occurring when
two companies (or countries) control all or most of the market
for a product or service.
Some of the close examples of duopoly in the present day are
1. Microsoft vs Macintosh- Computer operations system
2. Android Vs iOS - Smartphone operating system
3. Visa Vs Master Card- Payment mehods
4. Coca cola vs Pepsi - soft dinks' making companies
5. Boeing Vs Airbus- large commercial planes
Price structure
A pricing structure is an approach in products
and services pricing which defines various prices, discounts,
offers consistent with the organization goals and strategy .Price
structure can affect how company grows and is perceived by
the customers.

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What is your pricing strategy?
Pricing Strategy. Pricing is one of the classic “4
Ps” of marketing (product, price, place, promotion). ... There are
many factors to consider when developing your pricing
strategy, both short- and long-term. For example, your
pricing needs to: Reflect the value you provide
versus your competitors.
What is pricing and its types?
In other words, cost-based pricing can be defined
as a pricing method in which a certain percentage of the total
cost of production is added to the cost of the product to
determine its selling price. Cost-based pricing can be of
two types, namely, cost-plus pricing and markup pricing.
Market
A market is one of the many varieties of systems,
institutions, procedures, social relations and infrastructures
whereby parties engage in exchange. While parties may
exchange goods and services by barter, most markets rely on
sellers offering their goods or services in exchange for money
from buyers. In other words the place where buyers and sellers
meat.
Pricing
Pricing is the process whereby a business sets the
price at which it will sell its products and services, and may be
part of the business's marketing plan.
Method adopted by a
firm to set its selling price. It usually depends on the firm's
average costs, and on the customer's perceived value of the

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product in comparison to his or her perceived value of the
competing products. Different pricing methods place varying
degree of emphasis on selection, estimation, and evaluation of
costs, comparative analysis, and market situation.
In terms of the
marketing mix some would say that pricing is the least attractive
element. Marketing companies should really focus on generating
as high a margin as possible. The argument is that the marketer
should change product, place or promotion in some way before
resorting to pricing reductions. However price is a versatile
element of the mix as we will see.
Penetration Pricing.
The price charged for products and services is set
artificially low in order to gain market share. Once this is
achieved, the price is increased. This approach was used by
France Telecom and Sky TV. These companies need to land
grab large numbers of consumers to make it worth their while,
so they offer free telephones or satellite dishes at discounted
rates in order to get people to sign up for their services. Once

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there is a large number of subscribers prices gradually creep up.
Taking Sky TV for example, or any cable or satellite company,
when there is a premium movie or sporting event prices are at
their highest – so they move from a penetration approach to
more of a skimming/premium pricing approach.
Economy Pricing.
This is a no frills low price. The costs of
marketing and promoting a product are kept to a minimum.
Supermarkets often have economy brands for soups, spaghetti,
etc. Budget airlines are famous for keeping their overheads as
low as possible and then giving the consumer a relatively lower
price to fill an aircraft. The first few seats are sold at a very
cheap price (almost a promotional price) and the middle
majority are economy seats, with the highest price being paid for
the last few seats on a flight (which would be a premium pricing
strategy). During times of recession economy pricing sees more
sales. However it is not the same as a value pricing approach
which we come to shortly.
Price Skimming.
Price skimming sees a company charge a
higher price because it has a substantial competitive advantage.
However, the advantage tends not to be sustainable. The high
price attracts new competitors into the market, and the price
inevitably falls due to increased supply.
Manufacturers of digital watches used a skimming
approach in the 1970s. Once other manufacturers were tempted
into the market and the watches were produced at a lower unit
cost, other marketing strategies and pricing approaches are
implemented. New products were developed and the market for
watches gained a reputation for innovation.

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The diagram depicts four key pricing strategies
namely premium pricing, penetration pricing, economy pricing,
and price skimming which are the four main pricing
policies/strategies. They form the bases for the exercise.
However there are other important approaches to pricing, and
we cover them throughout the entirety of this lesson.
Psychological Pricing.
This approach is used when the marketer wants
the consumer to respond on an emotional, rather than rational
basis. For example Price Point Perspective (PPP) 0.99 Cents not
1 US Dollar. It’s strange how consumers use price as an
indicator of all sorts of factors, especially when they are in
unfamiliar markets. Consumers might practice a decision
avoidance approach when buying products in an unfamiliar
setting, an example being when buying ice cream. What would
you like, an ice cream at $0.75, $1.25 or $2.00? The choice is
yours. Maybe you’re entering an entirely new market. Let’s say
that you’re buying a lawnmower for the first time and know
nothing about garden equipment. Would you automatically by
the cheapest? Would you buy the most expensive? Or, would
you go for a lawnmower somewhere in the middle? Price
therefore may be an indication of quality or benefits in
unfamiliar markets.
Product Line Pricing.
Where there is a range of products or services
the pricing reflects the benefits of parts of the range. For
example car washes; a basic wash could be $2, a wash and wax
$4 and the whole package for $6. Product line pricing seldom
reflects the cost of making the product since it delivers a range
of prices that a consumer perceives as being fair incrementally –
over the range.

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If you buy chocolate bars or potato chips (crisps) you expect to
pay X for a single packet, although if you buy a family pack
which is 5 times bigger, you expect to pay less than 5X the
price. The cost of making and distributing large family packs of
chocolate/chips could be far more expensive. It might benefit the
manufacturer to sell them singly in terms of profit margin,
although they price over the whole line. Profit is made on the
range rather than single items.
Optional Product Pricing.
Companies will attempt to increase the amount
customers spend once they start to buy. Optional ‘extras’
increase the overall price of the product or service. For example
airlines will charge for optional extras such as guaranteeing a
window seat or reserving a row of seats next to each other.
Again budget airlines are prime users of this approach when
they charge you extra for additional luggage or extra legroom.
Captive Product Pricing
Where products have complements,
companies will charge a premium price since the consumer has
no choice. For example a razor manufacturer will charge a low
price for the first plastic razor and recoup its margin (and more)
from the sale of the blades that fit the razor. Another example is
where printer manufacturers will sell you an inkjet printer at a
low price. In this instance the inkjet company knows that once
you run out of the consumable ink you need to buy more, and
this tends to be relatively expensive. Again the cartridges are not
interchangeable and you have no choice.
Product Bundle Pricing.
Here sellers combine several products in
the same package. This also serves to move old stock. Blu-ray
and videogames are often sold using the bundle approach once

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they reach the end of their product life cycle. You might also see
product bundle pricing with the sale of items at auction, where
an attractive item may be included in a lot with a box of less
interesting things so that you must bid for the entire lot. It’s a
good way of moving slow selling products, and in a way is
another form of promotional pricing.
Promotional Pricing.
Pricing to promote a product is a very
common application. There are many examples of promotional
pricing including approaches such as BOGOF (Buy One Get
One Free), money off vouchers and discounts. Promotional
pricing is often the subject of controversy. Many countries have
laws which govern the amount of time that a product should be
sold at its original higher price before it can be discounted. Sales
are extravaganzas of promotional pricing!
Geographical Pricing.
Geographical pricing sees variations in price in
different parts of the world. For example rarity value, or where
shipping costs increase price. In some countries there is more
tax on certain types of product which makes them more or less
expensive, or legislation which limits how many products might
be imported again raising price. Some countries tax inelastic
goods such as alcohol or petrol in order to increase revenue, and
it is noticeable when you do travel overseas that sometimes
goods are much cheaper, or expensive of course.
Value Pricing.
This approach is used where external factors
such as recession or increased competition force companies to
provide value products and services to retain sales e.g. value
meals at McDonalds and other fast-food restaurants. Value price
means that you get great value for money i.e. the price that you

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pay makes you feel that you are getting a lot of product. In many
ways it is similar to economy pricing. One must not make the
mistake to think that there is added value in terms of the product
or service. Reducing price does not generally increase value.
Our financial objectives in terms of price will
be secured on how much money we intend to make from a
product, how much we can sell, and what market share will get
in relation to competitors. Objectives such as these and how a
business generates profit in comparison to the cost of
production, need to be taken into account when selecting the
right pricing strategy for your mix. The marketer needs to be
aware of its competitive position. The marketing mix should
take into account what customers expect in terms of price.
There are many ways to price a product. Let’s have a look at
some of them and try to understand the best policy/strategy in
various situations.
Premium Pricing.
Use a high price where there is a unique brand.
This approach is used where a substantial competitive advantage
exists and the marketer is safe in the knowledge that they can
charge a relatively higher price. Such high prices are charged for
luxuries such as Cunard Cruises, Savoy Hotel rooms, and first
class air travel.
Pricing method
In other words, cost-based pricing can be defined
as a pricing method in which a certain percentage of the total
cost of production is added to the cost of the product to
determine its selling price. Cost-based pricing can be of two
types, namely, cost-plus pricing and markup pricing.

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Here are some of the various strategies that businesses
implement when setting prices on their products and
services.
1. Pricing at a Premium. With premium pricing, businesses set
costs higher than their competitors. ...
2. Pricing for Market Penetration. ...
3. Economy Pricing. ...
4. Price Skimming. ...
5. Psychology Pricing. ...
6. Bundle Pricing.
Types of Pricing Methods
An organization has various options for selecting
a pricing method. Prices are based on three dimensions that are
cost, demand, and competition.
The organization can use any of the dimensions or combination
of dimensions to set the price of a product.
Cost-based Pricing:
Cost-based pricing refers to a pricing method in
which some percentage of desired profit margins is added to the
cost of the product to obtain the final price. In other words, cost-

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based pricing can be defined as a pricing method in which a
certain percentage of the total cost of production is added to the
cost of the product to determine its selling price.
Cost-based pricing can be of two types, namely, cost-plus
pricing and markup pricing.
These two types of cost-based pricing are as follows:
i. Cost-plus Pricing:
Refers to the simplest method of determining
the price of a product. In cost-plus pricing method, a fixed
percentage, also called mark-up percentage, of the total cost (as
a profit) is added to the total cost to set the price. For example,
XYZ organization bears the total cost of Rs. 100 per unit for
producing a product. It adds Rs. 50 per unit to the price of
product as’ profit. In such a case, the final price of a product of
the organization would be Rs. 150.
Cost-plus pricing is also known as average cost
pricing. This is the most commonly used method in
manufacturing organizations.
In economics, the general formula given for setting price in case
of cost-plus pricing is as follows:
P = AVC + AVC (M)
AVC= Average Variable Cost
M = Mark-up percentage
AVC (m) = Gross profit margin
Mark-up percentage (M) is fixed in which AFC and net profit
margin (NPM) are covered.
AVC (m) = AFC+ NPM
ii. For determining average variable cost, the first step is to
fix prices. This is done by estimating the volume of the output
for a given period of time. The planned output or normal level of
production is taken into account to estimate the output.

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The second step is to calculate Total Variable Cost (TVC) of the
output. TVC includes direct costs, such as cost incurred in labor,
electricity, and transportation. Once TVC is calculated, AVC is
obtained by dividing TVC by output, Q. [AVC= TVC/Q]. The
price is then fixed by adding the mark-up of some percentage of
AVC to the profit [P = AVC + AVC (m)].
iii. The advantages of cost-plus pricing method are as follows:
a. Requires minimum information
b. Involves simplicity of calculation
c. Insures sellers against the unexpected changes in costs
The disadvantages of cost-plus pricing method are as follows:
a. Ignores price strategies of competitors
b. Ignores the role of customers
iv. Markup Pricing:
Refers to a pricing method in which the fixed amount or the
percentage of cost of the product is added to product’s price to
get the selling price of the product. Markup pricing is more
common in retailing in which a retailer sells the product to earn
profit. For example, if a retailer has taken a product from the
wholesaler for Rs. 100, then he/she might add up a markup of
Rs. 20 to gain profit.
It is mostly expressed by the following formulae:
a. Markup as the percentage of cost= (Markup/Cost) *100
b. Markup as the percentage of selling price= (Markup/ Selling
Price)*100
c. For example, the product is sold for Rs. 500 whose cost was
Rs. 400. The mark up as a percentage to cost is equal to
(100/400)*100 =25. The mark up as a percentage of the selling
price equals (100/500)*100= 20.
Demand-based Pricing:

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Demand-based pricing refers to a pricing method
in which the price of a product is finalized according to its
demand. If the demand of a product is more, an organization
prefers to set high prices for products to gain profit; whereas, if
the demand of a product is less, the low prices are charged to
attract the customers.
The success of demand-based pricing depends on
the ability of marketers to analyze the demand. This type of
pricing can be seen in the hospitality and travel industries. For
instance, airlines during the period of low demand charge less
rates as compared to the period of high demand. Demand-based
pricing helps the organization to earn more profit if the
customers accept the product at the price more than its cost.
Competition-based Pricing:
Competition-based pricing refers to a method
in which an organization considers the prices of competitors’
products to set the prices of its own products. The organization
may charge higher, lower, or equal prices as compared to the
prices of its competitors.
The aviation industry is the best example of
competition-based pricing where airlines charge the same or
fewer prices for same routes as charged by their competitors. In
addition, the introductory prices charged by publishing
organizations for textbooks are determined according to the
competitors’ prices.
Other Pricing Methods:
In addition to the pricing methods, there are other methods that
are discussed as follows:
i. Value Pricing:
Implies a method in which an organization tries to win loyal
customers by charging low prices for their high- quality

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products. The organization aims to become a low cost producer
without sacrificing the quality. It can deliver high- quality
products at low prices by improving its research and
development process. Value pricing is also called value-
optimized pricing.
ii. Target Return Pricing:
Helps in achieving the required rate of return on investment
done for a product. In other words, the price of a product is fixed
on the basis of expected profit.
iii. Going Rate Pricing:
Implies a method in which an organization sets the price of a
product according to the prevailing price trends in the market.
Thus, the pricing strategy adopted by the organization can be
same or similar to other organizations. However, in this type of
pricing, the prices set by the market leaders are followed by all
the organizations in the industry.
iv. Transfer Pricing:
Involves selling of goods and services within the departments of
the organization. It is done to manage the profit and loss ratios
of different departments within the organization. One
department of an organization can sell its products to other
departments at low prices. Sometimes, transfer pricing is used to
show higher profits in the organization by showing fake sales of
products within departments.
Price analysis
In marketing, Price Analysis refers to the analysis
of consumer response to theoretical prices in survey research. In
general business, price analysis is the process of examining and
evaluating a proposed price without evaluating its separate cost
elements and proposed profit.

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Price Analysis Basics
Price analysis is usually the preferred approach to
evaluate product options when possible. With this approach, the
price of one provider's products or services is compared against
competing alternatives or substitutes. If there are five
competitors submitting bids or proposals for a particular project,
for instance, a price analysis would include a detailed review of
the benefits of each offering relative to the quoted prices.
Application
The price analysis is used whenever there are several suitable
and relatively equivalent options in a purchase decision. When
companies submit bids for government contract jobs, for
instance, a common price analysis used results in the lowest
price winning the bid when the benefits are similar.
Requirements for pricing analysis also usually include that the
product or service is available on the open market and that
alternatives are relatively similar in benefits.
Cost Analysis Basics
A cost analysis is generally more challenging
because it is open to greater interpretation. This approach
includes a thorough review of the itemized product and service
components and related costs on the solution. Businesses often
have purchasing managers or agents who analyze the value
proposition of a proposal. Using past history, experience and

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general awareness of the costs of each part of the solution, a
decision is made on the merits of the solution alone.
Using Cost Analysis
The most simple point about cost analysis application is that it is
used when price analysis isn't possible. This is usually because
there aren't alternative solutions for comparison or no related
proposals were submitted for a job. New types of research or
product development work or solutions based on unique patents
or products commonly require cost analysis. The challenge with
cost analysis is trying to determine fair value with no marketable
comparison.
Breakeven point pricing method
Definition:
Break-even pricing is an accounting pricing
methodology in which the price point at which a product will
earn zero profit is calculated. In other words, it is the point at
which cost is equal to revenue. ... So, the main motive of the
company would be to increase its market share rather than
earning profits.
Value based pricing methods
Value-based price (also value optimized pricing)
is a pricing strategy which sets prices primarily, but not
exclusively, according to the perceived or estimated value of a

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product or service to the customer rather than according to the
cost of the product or historical prices.
What is life cycle pricing?
A product's life cycle is its progress from when it is
created to when it is discontinued. There are four stages in the
cycle, which are development, growth, maturity, and decline.
The product life cycle helps business owners manage sales,
determine prices, predict profitability, and compete with other
businesses.
Price leadership
Price leadership is the setting of prices in a market
by a dominant company, which is followed by others in the

27. 27
same market. Price leadership is the act of setting the price for
a good or service in an industry.
What is {term}? Price Leadership
Price leadership is when a leading firm in its
sector determines the price of goods or services. This can leave
the leader's rivals with little choice but to follow its lead and
match the prices if they are to hold onto their market share.
Alternatively, competitors may also choose to lower their prices
in the hope of gaining market share.
BREAKING DOWN Price Leadership
The impacts of price leadership are more
apparent in goods or services that offer little differentiation from
one producer to another. Price leadership is also apparent
where consumer demand levels make a particular price selected
by the market leader viable because consumers are drawn from
competing products. There are three primary categories of price
leadership: barometric, collusive and dominant firm.
Types of Price Leadership
The barometric model occurs when a particular
firm is more adept at identifying shifts in applicable market
forces, allowing it to respond more efficiently within the market
sector. If the company is known for its skill in this area, other
producers follow its lead under the assumption that the price
leader is aware of something that they have yet to realize.
The collusive model occurs when a few dominant firms agree to
keep their prices in mutual alignment. This is more common in
industries where the cost of entry is high and the costs of
production are known. Such agreements can be illegal if the
effort is designed to defraud the public. For example, in 2012,

28. 28
Apple was accused of colluding with e-book publishers to
artificially inflate product prices.
The dominant firm model occurs when one
firm controls the vast majority of the market share within an
industry. As the dominant firm adjusts prices, any smaller firms
within the segment must follow suit to retain the small amount
of market share they currently possess.
Price Leadership and Increased Profitability
In cases where the price leader raises prices,
the effects of price leadership can be positive since its
competitors are justified in raising prices higher based on the
actions of the price leader. If all prices rise, the increase can be
instituted without the significant threat of losing market share to
competing products. In fact, higher prices may improve
profitability for all firms as long as overall consumer demand
remains steady.
Potential Negatives of Following Price Leaders
More commonly, undisputed market leaders,
such as the big-box retailers, use their operating efficiencies to
mark down prices relentlessly. This forces smaller rivals to
lower prices to retain market share. Since these smaller firms
often do not have the same economies of scale as the price
leaders, this attempt to match the leader's prices may lead to
mounting losses over a prolonged period to the point where they
may eventually be forced to close their doors.

29. 29
Through his model Chamberlin arrives at a
monopoly solution of pricing and output under oligopoly
wherein oligopolistic firms in an industry jointly maximize their
profits.
1. Cournot's Duopoly Model:
2. Bertrand's Duopoly Model:
3. Edgeworth Duopoly Model:
4. Chamberlin's Oligopoly Model:
Duopoly •
Duopoly is a special type of Oligopoly, where only
two Producers/Sellers exist in one market.
a) There exists Non-collusive oligopoly, means Sellers are
completely independent.
b) The pricing and output of one firm will affect the another
and may set a chain reaction.
c) Cournot and Edgeworth
ignored mutual dependence but Chamberlin recognized the
mutual dependence.
1) Cournot’s Duopoly Model •
This is the earliest duopoly model,
Developed by French Economist AUGUSTIN
COURNOT in 1838. • He considered only two firms
and they are owing Mineral well. • Each firm act on
the assumption that its competition will not change its

30. 30
output and decides its own output so as to maximize
his profit.
Major Assumptions •
They are two independent sellers.
a) They produce and sell homogeneous products.
b) The number of buyers is large.
c) Each producer know the market demand for the
product.
d) Cost of production is assumed to be zero.
e) Both firms have identical cost and identical
demand.
Major Assumptions
a) Each firm decides their own quantity of output and ignores
the role of rival.
b) Consider the supply curve of the rival is constant.
c) Entry of a new firm is blocked.
d) Both firms are aiming maximum profit.
e) Neither of them will fixes the price for its product, but
each accepts the market demand price at which the product
can be sold.
2) Bertrand's Duopoly Model
Bertrand's Duopoly
Model (With Diagram) ADVERTISEMENTS:
Bertrand developed his duopoly model in 1883. His
model differs from Cournot's in that he assumes that

31. 31
each firm expects that the rival will keep its price
constant, irrespective of its own decision about
pricing.
a) In the Bertrand model, each firm select its price
and stands ready to sell whatever quantity is
demanded at that price.
b) Each firm takes the price set by its rival as a
given and sets it own price to maximize its
profits.
c) In equilibrium, each firm correctly predicts its
rival’s price decision.
3) Edgeworth Duopoly Model:
A model of oligopoly was first of all put forward by Cournota
French economist, in 1838. ... Through his model Chamberlin
arrives at a monopoly solution of pricing and output under
oligopoly wherein oligopolistic firms in an industry jointly
maximise their profits.
In microeconomics, the Bertrand–Edgeworth
model of price-setting oligopoly looks at what happens when
there is a homogeneous product (i.e. consumers want to buy

32. 32
from the cheapest seller) where there is a limit to the output of
firms which they are willing and able to sell at a particular price.
4) Chamberlin's Oligopoly Model
Chamberlin's Duopoly Model- A Small Group Model:
Chamberlin's model of duopoly recognizes interdependence if
firms in such a market. ... In other words, his model is also
based on the assumption of homogeneous products, firms of
equal size with identical costs, no entry by new firms and full
knowledge of demand.
Chamberlin’s contribution to the theory of
oligopoly consists in his suggestion that a stable equilibrium can
be reached with the monopoly price being charged by all firms,
if firms recognize their interdependence and act so as to
maximize the industry profit (monopoly profit).
Chamberlin accepts that if firms do not recognize
their interdependence, the industry will reach either the Cournot
equilibrium.
What is the concept of game theory?
Game theory is the process of modeling the strategic
interaction between two or more players in a situation
containing set rules and outcomes. While used in a number of
disciplines, game theory is most notably used as a tool within
the study of economics
How does game theory work?
At its most basic level, game theory is the study of
how people, companies or nations (referred to as agents or
players) determine strategies in different situations in the face of
competing strategies acted out by other agents or players. Game
theory assumes that agents make rational decisions at all times.

33. 33
Game theory is the science of strategy. It
attempts to determine mathematically and logically the actions
that “players” should take to secure the best outcomes for
themselves in a wide array of “games.” The games it studies
range from chess to child rearing and from tennis to takeovers.
But the games all share the common feature of interdependence.
That is, the outcome for each participant depends on the choices
(strategies) of all. In so-called zero-sum games the interests of
the players conflict totally, so that one person’s gain always is
another’s loss. More typical are games with the potential for
either mutual gain (positive sum) or mutual harm (negative
sum), as well as some conflict.
What does national income mean?
National income is the total value a country's
final output of all new goods and services produced in one year.
Understanding how national income is created is the starting
point for macroeconomics.
What is national income?
The total amount of income accruing to a country
from economic activities in a financial year's time is known as
national income. It includes payments made to all resources in
the form of wages, interest, rent and profits. This is the true net
annual income or revenue of the country or national dividend
National Income Concept
a) National Income is the total value of all final
goods and services produced by the country in
certain year. The growth of National Income
helps to know the progress of the country.
• In other words, the total amount of income
accruing to a country from economic activities in

34. 34
a year’s time is known as national income. It
includes payments made to all resources in the
form of wages, interest, rent and profits.
b) From the modern point of view, national income
is defined as “the net output of commodities and
services flowing during the year from the
country’s productive system in the hands of the
ultimate consumers.”
National Income Accounting (NIA)
National Income Accounting is a method or technique
used to measure the economic activity in the national economy
as a whole.

35. 35
NIA is mainly done for:
a) Policy Formulation: It helps in comparing the estimates of the
past from the future and also forecast the growth rates in future.
For example, if a country has a GDP of Rs. 103 Lakh which is 3
Lakh rupees higher than the last year, it has a growth rate of 3
per cent.
b) Effective Decision Making: To estimate the contribution of
each of the sectors of the economy. It helps the business to plan
for production.
c) International Economic Comparison: It helps in comparing
the level of development of countries and provides useful insight
into how well an economy is functioning, and where money is
being generated and spent. One can compare the standard of
living of different nations and its growth rate.
There are various terms associated with measuring of National
Income.
A. GDP (GROSS DOMESTIC PRODUCT)
a) Here the catch word is ‘Domestic’ which refers to
‘Geographical Area’
b) The total value of all final goods and services produced within
the boundary of the country during a given period of time
(generally one year) is called as GDP.
f) In this case, the final produce of resident citizens as well as
foreign nationals who reside within that geographical
boundary is considered.

36. 36
Types of GDP: Real GDP and Nominal GDP
a) Real GDP: Refers to the current year production of goods
and services valued at base year prices. Such base year prices
are Constant Prices.
b) Nominal GDP: Refers to current year production of final
goods and services valued at current year prices.
Which one is a better measure?
a) Real GDP is a better measure to calculate the GDP because
in a particular year GDP may be inflated because of high
rate of inflation in the economy.
b) Real GDP therefore allows us to determine if production
increased or decreased, regardless of changes in the inflation and
purchasing power of the currency.

37. 37
B. GROSS NATIONAL PRODUCT (GNP)
a) Here the catch word is ‘National’ which refers to all the
citizens of a country.
b) GNP is the total value of the total production or final goods
and services produced by the nationals of a country during a
given period of time (generally one year).
c) In this case, the income of all the resident and non-resident
citizens (who resides in abroad) of a country in included
whereas, the income of foreigners who reside within India is
excluded.
d) The GNP contains the income earned by Indian Nationals
(both in Indian Territory and Abroad) only.
GDP and GNP are measured on the basis of Market Price and
Factor Cost.
a) Market Price
It refers to the actual transacted price which
includes indirect taxes such as custom duty, excise duty, sales
tax, service tax etc. (impending Goods and Services Tax). These
taxes tend to raise the prices of the goods in an economy.
c) Factor Cost
It is the cost of factors of production i.e. rent for land
interest for capital, wages for labour and profit for

38. 38
entrepreneurship. This is equal to revenue price of the final
goods and services sold by the producers.
Revenue Price (or Factor Cost) = Market Price – Net Indirect
Taxes
Net Indirect Taxes = Indirect Taxes – Subsidies
Hence, Factor Cost = Market Price – Indirect Taxes +
Subsidies
C. Net National Product (NNP): NNP = GNP – Depreciation
It is calculated by subtracting Depreciation from
Gross National Product.
Depreciation
Wear and Tear of goods produced.
This deduction is done because a part of current
produce goes to replace the depreciated parts of the products
already produced. This part does not add value to current year’s
total produce. It is used to keep the products already produced
intact and hence it is deducted.
D. Net Domestic Product (NDP): NDP = GDP – Depreciation
a) It is the calculated GDP after adjusting the value of
depreciation. This is basically, Net form of GDP, i.e. GDP –
total value of wear and tear.
b) NDP of an economy is always lower than its GDP, since
their depreciation can never be reduced to zero. The concept of
NDP and NNP are not used to compare different economies
because the method of calculating depreciation varies from
country to country.

39. 39
E. National Income at Factor Cost (NIFC):
• It is the sum of all factors of income earned by the residents of
a country (Indian) both from within the country as well as
abroad.
• National Income at Factor Cost = NNP at Market Price –
Indirect Taxes + Subsidies
• In India, and many developing countries across the world,
National Income is measured at factor cost instead of market
prices. Some of the reasons for the same are lack of uniformity
in taxes, goods not being printed with their prices, etc.
F. Transfer Payments
• A payment made by the government to individuals for whom
there is no economic activity is produced in return. For example:
Old Age Pensions, Scholarship etc.
G. Personal Income
• It refers to all of the income collectively received by all of the
individuals or households in a country.
• It includes compensation from a number of sources including

40. 40
salaries, wages and bonuses received from employment or self
employment; dividends and distributions received from
investments; rental receipt from real estate investments and
profit sharing from businesses.
• In National Income Accounting, some income is attributed to
individuals, which they do not actually receive. For Example:
Undistributed Profits, Employees’ contribution for social
security, corporate income taxes etc. which needs to be deducted
from National Income to estimate the Personal Income.
• PI = NI + Transfer Payments – Corporate Retained
Earnings, Income Taxes, Social Security Taxes.
H. Disposable Personal Income
• It is the amount left with the individuals after paying Personal
Taxes such as Income Tax, Property Tax, and Professional Tax
etc. to spend as they like.
• DPI = PI – Taxes (Income Tax i.e. Personal Taxes)
• DPI results into Savings and Expenditure i.e. (Spend and
Save). This concept is very useful for studying and
understanding the consumption and saving behaviour of the
individuals.
WHAT ARE THE FACTORS THAT AFFECT NATIONAL
INCOME?
Several factors affect the national income of a country. Some of
them have been listed below:
1. Factors of Production
Normally, the more efficient and richer the resources, higher
will be the level of National Income or GNP

41. 41
(a) Land
Resources like coal, iron and timber are essential for heavy
industries so that they must be available and accessible. In
other words, the geographical location of these natural
resources affects the level of GNP.
b)Capital
Capital is generally determined by investment. Investment in
turn depends on other factors like profitability, political stability
etc.
c)Labour
The quality or productivity of human resources is more
important than quantity. Manpower planning and education
affect the productivity and production capacity of an economy.
Entrepreneur
(e) Technology
This factor is more important for Nations with fewer natural
resources. The development in technology is affected by the
level of invention and innovation in production.
(f) Government
Government can help to provide a favourable business
environment for investment. It provides law and order,
regulations.
(g) Political Stability
A stable economy and political system helps in appropriate

42. 42
allocation of resources. Wars, strikes and social unrests will
discourage investment and business activities.
Methods of National Income Calculation
There are three approaches and methods of measuring National
Income:
A. Income Method
a) By this National Income is calculated compiling income of
factors of production viz., land, labour, capital and
entrepreneur.
• National Income = Total Wage + Total Rent + Total
Interest + Total Profit
b) In Indian context, since 1993 as per the System of National
Accounts (SNA), National Income is total of the following:
• GDP = Compensation of Employees + Consumption of
Fixed Capital + (Other Taxes on Production – Subsidies of
Production) + Gross Operating Surplus
c) Compensation of employees: (Wage) salaries paid in cash
and kind and other benefits provided to employees.
d) Consumption of Fixed Capital: wear and tear of machinery
which are replaced by new parts.
e) Other Taxes on Production minus Subsidies: Net tax on
production.
f) There is a difference between tax on products and tax on
production. Tax on products includes taxes like sales tax and
excise duty. Tax on production is tax imposed irrespective of
production like license fees and land tax.
g) Gross Operating Surplus: balance of value added after

43. 43
deducting the above three components. It goes to pay rent of
land and interest of capital.
B. Product Method (or Value Added Method, Output
Method)
• It is used by economists to calculate GDP at market prices,
which are the total values of outputs produced at different stages
of production.
Some of the goods and services included in production are:
• Goods and services actually sold in the market.
• Goods and services not sold but supplied free of cost. (No
Charge/Complementary)
Some of the goods and services not included in production
are:
• Second hand items and purchase and sale of the same. Sale and
purchase of second cars, for example, are not a part of GDP
calculation as no new production takes place in the economy.
• Production due to unwarranted/ illegal activities.
• Non-economic goods or natural goods such as air and water.
• Transfer Payments such as scholarships, pensions etc. are
excluded as there is income received, but no good or service is
produced in return.
• Imputed rental for owner-occupied housing is also excluded.
• Here the Gross Value of final goods and services produced in a
country in certain year is calculated.
• GDP is a concept of value added; it is the sum of gross value
added of all resident producer units (institutional sectors, or
industries) plus that part of taxes (total) less subsidies, on
products which is not included in the valuation of output.
• Gross Value Added = Output of Final Goods and Services
– Intermediate Consumption

44. 44
• National Income = Gross Value Added + Indirect Taxes –
Subsidies
C. Expenditure Method
• It measures all spending on currently-produced final goods and
services only in an economy.
• In an economy, there are three main agencies which buy goods
and services: Households, Firms and the Government.
This final expenditure is made up of the sum of 4
expenditure items, namely;
• Consumption (C): Personal Consumption made by
households, the payment of which is paid by households directly
to the firms which produced the goods and services desired by
the households.
• Investment Expenditure (I): Investment is an addition to
capital stock of an economy in a given time period. This
includes investments by firms as well as governments sectors.
• Government Expenditure (G): This category includes the
value of goods and service purchased by Government.
Government expenditure on pension schemes, scholarships,
unemployment allowances etc. are not included in this as all of
them come under transfer payments.
• Net Exports (X-IM): Expenditures on foreign made products
(Imports) are expenditure that escapes the system, and must be
subtracted from total expenditures. In turn, goods produced by
domestic firms which are demanded by foreign economies
involve expenditure by other economies on our production
(Exports), and are included in total expenditure. The
combination of the two gives us Net Exports.
• National Income = Consumption (C) + Investment
Expenditure (I) + Government Expenditure (G) + Net
Exports (X-IM)

45. 45
• Calculating GDP (National Income) is extremely important
as the performance of the economy is fixed by means of this
method. The results would help the country to forecast the
economic progress, determine the demand and supply,
understand the buying power of the people, the per capita
income, the position of the economy in the global arena. The
Indian GDP is calculated by the expenditure method.
Gross Domestic Product
Gross domestic product is a monetary measure of
the market value of all the final goods and services produced in
a period of time, often annually or quarterly. Nominal GDP
estimates are commonly used to determine the economic
performance of a whole country or region, and to make
international comparisons..

46. 46
Gross National Product
The total value of goods produced and services provided by
a country during one year, equal to the gross domestic
product plus the net income from foreign investments.
Net national product
Net national product refers to gross national product, i.e.
the total market value of all final goods and services produced
by the factors of production of a country or other polity during a
given time period, minus depreciation. Similarly, net domestic
product corresponds to gross domestic product minus
depreciation
Measurement of National Income
Methods of Measuring National Income:
There are four methods of measuring national income. Which
method is to be used depends on the availability of data in a
country and the purpose in hand.
(1) Product Method:
According to this method, the total value of final
goods and services produced in a country during a year is
calculated at market prices. To find out the GNP, the data of all
productive activities, such as agricultural products, wood
received from forests, minerals received from mines,
commodities produced by industries, the contributions to
production made by transport, communications, insurance
companies, lawyers, doctors, teachers, etc. are collected and
assessed at market prices. Only the final goods and services are
included and the intermediary goods and services are left out.

47. 47
(2) Income Method:
According to this method, the net income payments
received by all citizens of a country in a particular year are
added up, i.e., net incomes that accrue to all factors of
production by way of net rents, net wages, net interest and net
profits are all added together but incomes received in the form
of transfer payments are not included in it. The data pertaining
to income are obtained from different sources, for instance, from
income tax department in respect of high income groups and in
case of workers from their wage bills.
(3) Expenditure Method:
According to this method, the total expenditure
incurred by the society in a particular year is added together and
includes personal consumption expenditure, net domestic
investment, government expenditure on goods and services, and
net foreign investment. This concept is based on the assumption
that national income equals national expenditure.
(4) Value Added Method:
Another method of measuring national income is the
value added by industries. The difference between the value of
material outputs and inputs at each stage of production is the
value added. If all such differences are added up for all
industries in the economy, we arrive at the gross domestic
product.
Business cycle
The business cycle, also known as the economic
cycle or trade cycle, is the downward and upward movement of
gross domestic product around its long-term growth trend. The
length of a business cycle is the period of time containing a
single boom and contraction in sequence.

48. 48
Business Cycle Phases. Business cycles are
identified as having four distinct phases: expansion, peak,
contraction, and trough. An expansion is characterized by
increasing employment, economic growth, and upward pressure
on prices.
contracyclical
Being or acting in opposition to an economic cycle
Contra-cyclical can be used to indicate a direction
relative to the primary cycle. It can further be specified whether
it is 'simultaneous' (following or opposite-winding), or instead
synchronized, that is, occurring between one or more primary
motions, such as the winding wheel in a mechanical watch
Factors Influencing International Trade
International trade is the exchange of goods between
countries. International trade enables consumers all over the
world to buy French wines, Columbian coffee, Korean television
sets and German automobiles. International trade between
nations creates the global economy where prices are influenced

49. 49
by a variety of factors such as global events, exchange rates,
politics and protectionism. Political shifts in one country can
impact manufacturing costs and employee wages in another
country. The result of such shifts could raise or lower the prices
of imported goods for local shoppers on everyday products.
The Influence of Tariffs and Trade Barriers
Ideally, trade with other nations increases the
number of goods consumers can choose from, and multinational
competition will lower the cost of those goods. Dumping is one
international trade practice that is discouraged through the
strategic use of tariffs. Dumping is when a trade partner exports
a high volume of cheaper goods than what is available from
domestic production in order to gain a competitive advantage in
foreign markets. To slow or stop the dumping of lower priced
international goods, a government may impose tariffs or taxes
on those imported goods.
A frequent complaint about international trade is
the low cost of foreign labor and lack of overseas regulation
regarding safety and quality. Tariffs can be imposed to protect
consumers from potentially dangerous products such as tainted
foods which may include imported meats or inferior products
such as defective airbags. Quality standards and regulations can
vary greatly from one country to another. International trade
should stimulate mutual benefit and positive relationships
between countries, but sometimes the opposite is true. Countries
may also set tariffs to retaliate against a trading partner they
believe is breaking the rules or going against its foreign policy
objectives.
Influence of Politics and Protectionism
In some cases, a government will impose tariffs
on imported goods for political reasons. It may want to fulfill a

50. 50
campaign promise, boost growth in a specific industry or make a
strong statement to members of the international community. A
government may adopt a policy of protectionism and restrict
trade through tariffs because it is concerned that international
trade threatens the domestic economy by harming particular
industries. While this type of protectionism has been known to
work in the short-term, it’s often detrimental in the long-term
because it makes the country raising the tariffs less competitive
internationally.
Trade protectionism can eventually weaken
the industries it was implemented to protect. If a domestic
industry has no competition, manufacturers may not work as
hard to remain competitive in the marketplace. The result is the
domestic product could decline in quality compared to similar
international products. Continued protectionist policies can
eventually cause industry slowdowns and domestic jobs will be
lost to global suppliers. Protectionism is an expensive
proposition because governments will often choose to subsidize
industries and it can drive up the price of lesser quality goods.
What are the main factors affecting international trade ?
Any countries bilateral or multilateral trade
affected by geographical position, natural resources, economic
development level and political factors.
1. The geographical location. Mid-latitude moderate climate,
coastal areas, the transportation is convenient, good for
development of international trade. High-latitude climate cold,
inland mountainous area traffic block, adverse to the
development of international trade. Japan to "trading", it has to
do with its island position. In addition, is advantageous to the
development of bilateral trade between neighbors.

51. 51
2. Natural resources. A country is rich in natural resource type
and degree directly affect the country's international trade in
primary products. Such as Zaire said as "Mid-Africa gem ", in
the national export commodities, minerals (70% ~ 80%).
3. The level of economic development. Economic development
level can directly affect a country's foreign trade commodity
structure and the position in international trade. The United
States, Japan and the European Union's national economic
development level is high, the imports and exports accounted for
half of the world and the population of the country accounts for
only about 1/7 of the world. Developing countries relatively
backward economy, foreign trade is relatively less.
4. Political factors. The world's political relations, the policy of
a country also has a big impact to international trade. The gulf
war after Iraq's oil exports plummeted, is due to political
reasons. In China since the late 1970 s adopted a policy of
opening to the outside world, foreign trade development quickly.
Factors Affecting International Trade Flows
a) Inflation
A relative increase in a country’s inflation rate will
decrease its current account, as imports increase and
exports decrease.
b)National Income
A relative increase in a country’s income level will
decrease its current account, as imports increase.
c) Government Restrictions
A government may reduce its country’s imports by
imposing tariffs on imported goods, or by enforcing a
quota. Note that other countries may retaliate by imposing
their own trade restrictions.

52. 52
Sometimes though, trade restrictions may be imposed on
certain products for health and safety reasons.
Factors
Exchange Rates
If a country’s currency begins to rise in value,
its current account balance will decrease as imports
increase and exports decrease.
Note that the factors are interactive, such that their
simultaneous influence on the balance of trade is a complex
one.
Disequilibrium
The situation in which an economy is experiencing
change, for example, when the demand for goods at a particular
price is not equal to the supply of goods at that price:
It is important to regulate disequilibrium in order to
minimize its impact on the corporate marketplace.It is a lack of
equilibrium; imbalance.
Methods to Correct Disequilibrium in Balance of Payments
a) Here we detail about the four methods adopted to correct
disequilibrium in balance of payments.
b) The two important tools of reducing aggregate expenditure
are the use of:
c) We explain them below:
d) Tight Monetary Policy:
e) Contractionary Fiscal Policy:
f) Income-Absorption Approach to Devaluation:
g) Conclusion:

53. 53
Methods to Correct Disequilibrium in Balance of Payments
Here we detail about the four methods adopted to correct
disequilibrium in balance of payments.
Method 1# Trade Policy Measures: Expanding Exports and
Restraining Imports:
Trade policy measures to improve the balance of payments refer
to the measures adopted to promote exports and reduce imports.
Exports may be encouraged by reducing or abolishing export
duties and lowering the interest rate on credit used for financing
exports. Exports are also encouraged by granting subsidies to
manufacturers and exporters.
Besides, on export earnings lower income tax can be levied to
provide incentives to the exporters to produce and export more
goods and services. By imposing lower excise duties, prices of
exports can be reduced to make them competitive in the world
markets.
On the other hand, imports may be reduced by imposing or
raising tariffs (i.e., import duties) on imports of goods. Imports
may also be restricted through imposing import quotas,
introducing licenses for imports. Imports of some inessential
items may be totally prohibited.
Before the economic reforms carried out since 1991. India had
been following all the above policy measures to promote exports
and restrict imports so as to improve its balance of payments
position. But they had not achieved full success in their aim to
correct balance of payments disequilibrium.
Therefore, India had to face great difficulties with regard to
balance of payments. At several occasions it approached IMF to
bail it out of the foreign exchange crisis that emerged as a result
of huge deficits in the balance of payments. At long last,
economic crisis caused by persistent deficits in balance of

54. 54
payments forced India to introduce structural reforms to achieve
a long-lasting solution of balance of payments problem.
Method 2# Expenditure-Reducing Policies:
The important way to reduce imports and thereby reduce deficit
in balance of payments is to adopt monetary and fiscal policies
that aim at reducing aggregate expenditure in the economy. The
fall in aggregate expenditure or aggregate demand in the
economy works to reduce imports and help in solving the
balance of payments problem.
The two important tools of reducing aggregate expenditure
are the use of:
(1) Tight monetary policy and
(2) Concretionary fiscal policy.
We explain them below:
Tight Monetary Policy:
Tight monetary is often used to check aggregate expenditure or
demand by raising the cost of bank credit and restricting the
availability of credit. For this bank rate is raised by the Central
Bank of the country which leads to higher lending rates charged
by the commercial banks. This discourages businessmen to
borrow for investment and consumers to borrow for buying
durable consumers goods.
This therefore leads to the reduction in investment and
consumption expenditure. Besides, availability of credit to lend
for investment and consumption purposes is reduced by raising
the cash reserve ratio (CRR) of the banks and also undertaking
of open market operations (selling Government securities in the
open market) by the Central Bank of the country.
This also tends to lower aggregate expenditure or demand which
will helps in reducing imports. But there are limitations of the
successful use of monetary policy to check imports, especially in

55. 55
a developing country like India. This is because tight monetary
policy adversely affects investment increase in which is
necessary for accelerating economic growth.
If a developing country is experiencing inflation, tight monetary
policy is quite effective in curbing inflation by reducing
aggregate demand. This will help in reducing aggregate
expenditure and, depending on the income propensity to import,
will curtail imports. Besides, tight monetary policy helps to
reduce prices or lower the rate of inflation. Lower price level or
lower inflation rate will curb the tendency to import, both on the
part of businessmen and consumers.
But when a developing country like India is experiencing
recession or slowdown in-economic growth along with deficits
in balance of payments, use of tight monetary policy that
reduces aggregate expenditure or demand will not help much as
it will adversely affect economic growth and deepen economic
recession. Therefore, in a developing country, monetary policy
has to be used along with other policies such as a appropriate
fiscal policy and trade policy to tackle the problem of
disequilibrium in the balance of payments.
Contractionary Fiscal Policy:
Appropriate fiscal policy is also an important means of reducing
aggregate expenditure. An increase in direct taxes such as
income tax will reduce aggregate expenditure. A part of
reduction in expenditure may lead to decrease in imports.
Increase in indirect taxes such as excise duties and sales tax will
also cause reduction in expenditure.
The other fiscal policy measure is to reduce Government
expenditure, especially unproductive or non-developmental
expenditure. The cut in Government expenditure will not only

56. 56
reduce expenditure directly but also indirectly through the
operation of multiplier.
It may be noted that if tight monetary and contractionary fiscal
policies succeed in lowing aggregate expenditure which causes
reduction in prices or lowering the rate of inflation, they will
work in two ways to improve the balance of payments. First, fall
in domestic prices or lower rate of inflation will induce people
to buy domestic products rather than imported goods. Second,
lower domestic prices or lower rate of inflation will stimulate
exports. Fall in imports and rise in exports will help in reducing
deficit in balance of payments.
However, it may be emphasised again that the method of
reducing expenditure through contractionary monetary and fiscal
policies is not without limitations. If reduction in aggregate
demand lowers investment, this will adversely affect economic
growth. Thus, correction in balance of payments may be
achieved at the expense of economic growth.
Further, it is not easy to reduce substantially government
expenditure and impose heavy taxes as they are likely to affect
incentives to work and invest and invite public protest and
opposition. We thus see that correcting the balance of payments
through contractionary fiscal policy is not an easy matter.
Method 3# Expenditure – Switching Policies: Devaluation:
A significant method which is quite often used to correct
fundamental disequilibrium in balance of payments is the use of
expenditure-switching policies. Expenditure switching policies
work through changes in relative prices. Prices of imports are
increased by making domestically produced goods relatively
cheaper. Expenditure switching policies may lower the prices of
exports which will encourage exports of a country. In this way

57. 57
by changing relative prices, expenditure-switching policies help
in correcting disequilibrium in balance of payments.
The important form of expenditure switching policy is the
reduction in foreign exchange rate of the national currency,
namely, devaluation. By devaluation we mean reducing the
value or exchange rate of a national currency with respect to
other foreign currencies. It should be remembered that
devaluation is made when a country is under fixed exchange rate
system and occasionally decides to lower the exchange rate of
its currency to improve its balance of payments.
Under the Bretton Woods System adopted in 1946, fixed
exchange rate system was adopted, but to correct fundamental
disequilibrium in the balance of payments, the countries were
allowed to make devaluation of their currencies with the
permission of IMF. Now, Bretton Woods System has been
abandoned and most of the countries of the world have floated
their currencies and have thus adopted the system of flexible
exchange rates as determined by market forces of demand for
and supply of them.
However, even in the present flexible exchange rate system, the
value of a currency or its exchange rate as determined by
demand for and supply of it can fall. Fall in the value of a
currency with respect to foreign currencies as determined by
demand and supply conditions is described as depreciation.
If a country permits its currency to depreciate without taking
effective steps to check it, it will have the same effects as
devaluation. Thus, in our analysis we will discuss the effects of
fall in value of a currency whether it is brought about through
devaluation or depreciation. In July 1991, when India was under
Bretton-Woods fixed exchange rate system, it devalued its rupee

58. 58
to the extent of about 20%. (From Rs. 20 per dollar to Rs. 25 per
dollar) to correct disequilibrium in the balance of payments.
Now, the question is how devaluation of a currency works to
improve balance of payments. As a result of reduction in the
exchange rate of a currency with respect to foreign currencies,
the prices of goods to be exported fall, whereas prices of imports
go up. This encourages exports and discourages imports. With
exports so stimulated and imports discouraged, the deficit in the
balance of payments will tend to be reduced.
Thus policy of devaluation is also referred to as expenditure
switching policy since as a result of reduction of imports, people
of a country switches their expenditure on imports to the
domestically produced goods. It may be noted that as a result of
the lowering of prices of exports, export earnings will increase if
the demand for a country’s exports is price elastic (i.e., er > 1).
And also with the rise in prices of imports the value of imports
will fall if a country’s demand for imports is elastic. If demand
of a country for imports is inelastic, its expenditure on imports
will rise instead of falling due to higher prices of imports.
Devaluation: Marshall Lerner Condition. It is clear from above
that whether devaluation or depreciation will lead to the rise in
export earnings and reduction in import expenditure depends on
the price elasticity of foreign demand for exports and domestic
demand for imports.
Marshall and Lerner have developed a condition which states
that devaluation will succeed in improving the balance of
payments if sum of price elasticity of exports and price elasticity
of imports is greater than one. Thus, according to Marshall-
Lerner Condition, devaluation improves balance of payments if
ex + em > 1
where

59. 59
ex stands for price elasticity of exports
em stands for price elasticity of imports
If in case of a country ex + em < 1, the devaluation will adversely
affect balance of payments position instead of improving it. If ex
+ em = 1, devaluation will leave the disequilibrium in the
balance of payments unchanged.
Income-Absorption Approach to Devaluation:
Further, for devaluation to be successful in correcting
disequilibrium in the balance of payments a country should have
sufficient exportable surplus. If a country does not have
adequate amount of goods and services to be exported, fall in
their prices due to devaluation or depreciation will be of no
avail.
This can be explained through income-absorption approach put
forward by Sidney S Alexander. According to this approach,
trade balance is the difference between the total output of goods
and services produced in a country and its absorption by it.
By absorption of output of goods and services we mean how
much of them is used up for consumption and investment in that
country. That is, absorption means the sum of consumption and
investment expenditure on domestically produced goods and
services.
Expressing algebraically we have;
B = Y – A
Where:
B = trade balance or exportable surplus
Y = national income or value of output of goods and services
produced
A = Absorption or sum of consumption and investment
expenditure

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It follows from above that if expenditure or absorption is less
than national product, it will have positive trade balance or
exportable surplus. To create this exportable surplus,
expenditure on domestically produced consumer and investment
goods should be reduced or national product must be raised
sufficiently.
To sum up, it follows from above that for devaluation or
depreciation to be successful in correcting disequilibrium in the
balance of payments, the sum of price elasticities of demand for
a country s exports and imports should be high (that is, greater
than one) and secondly it should have sufficient exportable
surplus. The devaluation will also not be successful in the
achievement of its aim if other countries retaliate and make
similar devaluation in their currencies and thus competitive
devaluation of the exchange rate may start.
After Independence India devalued its currency three times, first
in 1949, the second in June 1966 and third in July 1991 to
correct the disequilibrium in the balance of payments. The
devaluation of June 1966 was not successful for some time to
reduce deficit in the balance of payments.
This is because the demand for bulk of our traditional exports
was not very elastic and also we could not reduce our imports
despite their higher prices. However devaluation of July 1991
proved quite successful as after it our exports grew at a rapid
rate for some years and growth of imports remained within safe
limits.
Method 4# Exchange Control:
Finally, there is the method of exchange control. We know that
deflation is dangerous; devaluation has a temporary effect and
may provoke others also to devalue. Devaluation also hits the

61. 61
prestige of a country. These methods are, therefore, avoided and
instead foreign exchange is controlled by the government.
Under it, all the exporters are ordered to surrender their foreign
exchange to the central bank of a country and it is then rationed
out among the licensed importers. None else is allowed to
import goods without a licence. The balance of payments is thus
rectified by keeping the imports within limits.
After the Second War World a new international institution’
International Monetary Fund (IMF)’ was set up for maintaining
equilibrium in the balance of payments of member countries for
a short term. Member countries borrow from it for a short period
to maintain equilibrium in the balance of payments. IMF also
advises member countries how to correct fundamental
disequilibrium in the balance of Payments when it does arise. It
may, however, be mentioned here that no country now needs to
be forced into deflation (and so depression) to root out the
causes underlying disequilibrium as had to be done under the
gold standard. On the contrary, the IMF provides a mechanism
by which changes in the rates of foreign exchange can be made
in an orderly fashion.
Conclusion:
In short, correction of disequilibrium calls for a judicious
combination of the following methods:
(i) Monetary and fiscal changes affecting income and prices in
the country;
(ii) Exchange rate adjustment, i.e., devaluation or appreciation
of the home currency;
(iii) Trade restrictions, i.e., tariffs, quotas, etc.;
(iv) Capital movement, i. e., borrowing or lending aboard; and
(v) Exchange control.

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No reliance can be placed on any single tool. There is room for
more than one approach and for more than one device. But the
application of the tools depends on the nature of the
disequilibrium.
There are, we have said, three types of disequilibrium:
(1) Cyclical disequilibrium,
(2) secular disequilibrium,
(3) Structural disequilibrium (at the goods and the factor level).
It is more appropriate that fiscal measures should be used to
correct cyclical disequilibrium in the balance of payments. To
correct structural disequilibrium adjustment in exchange rate
should be avoided. Capital movements are needed to offset
deep-seated forces in secular disequilibrium.
The main methods of desirable adjustment are, therefore,
monetary and fiscal policies which directly affect income, and
exchange depreciation (that is, devaluation) which affects prices
in the first instance. Devaluation or depreciation of exchange
rate can also have income effect through price effects. Monetary
and fiscal policies affect relative prices also.