Managerial Economics


Published on

Managerial Economics as per GBTU syllabus for MBA

Published in: Business, Technology
  • Be the first to comment

No Downloads
Total views
On SlideShare
From Embeds
Number of Embeds
Embeds 0
No embeds

No notes for slide

Managerial Economics

  1. 1. MANAGERIAL ECONOMICSUNDER GUIDANCE OFMr. Yogesh Puri,Sir. By-Shashank Kumar Saxena M.B.A -1st Sem STEP-HBTI
  2. 2. IndexA. IntroductionB. Demand & Elasticity of DemandC. Supply & Elasticity of SupplyD. Demand ForecastingE. ProductionF. CostG. RevenueH. Main Forms of MarketI. National IncomeJ. Business cycle & profit
  3. 3. Introduction
  4. 4. Managerial Economics• Because of application of economic principles to business management the term business economics and managerial economics are used interchangeable. However it is concern with 2 fundamental aspects: - a)-Decision making b)-Forward Planning
  5. 5. Scope• M.E helps managers in taking decisions which involves risk & uncertainty. Some of those are: - a)-Profit Decision b)-Demand decision c)-Price Output Decisions d)-Investment Decisions
  6. 6. Fundamentals of Managerial Economics• Opportunity Cost Principle• Incremental Cost Principle• Time Perspective Principle a)-Short Run Principle b)-Long Run Principle• Discounting Principle• Equi-Marginal Principle
  7. 7. Key Terms • demand • supply • demand schedule • supply schedule • law of demand • law of supply • diminishing marginal utility • supply curve • income effect • determinants of supply • substitution effect • change in supply • demand curve • change in quantity • determinants of demand supplied • normal goods • equilibrium price • inferior goods • equilibrium quantity • substitute good • surplus • complementary good • shortage • change in demand • price ceiling • change in quantity demanded • price floor 3-7
  8. 8. Market• Interaction between buyers and sellers• Buyers demand goods• Sellers supply goods• Assumptions ▫ Standardized good ▫ Competitive market
  9. 9. Demand & Elasticity of Demand
  10. 10. Demand• Schedule or curve• Amount consumers willing and able to purchase at a given price• Other things equal• Individual demand• Market demand• Law of Demand: -Other things equal, as price falls quantity demanded rises and price rises the quantity demanded falls
  11. 11. Cont.• Exceptions to law of demand a)-Griffen goods b)-Snob affect c)-Future exceptation d)-Ignorance e)-Emergency • Demand function:- A mathematical represent of the quantity demanded and factors affecting it. Q=f{P,P0,W,F…….}
  12. 12. Cont.Where, P=Price of commodity. P0 =Population W=Weather Condition F=Future Exception• Two levels: Individual Demand Market Demand
  13. 13. Individual demand curve P 6 5 Price (per unit) P Qd 4 `5 10 3 4 20 3 35 2 2 55 1 D 1 80 0 Q 10 20 30 40 50 60 70 80 Quantity Demanded (units per week)
  14. 14. Individual Demand P 6 Change in Demand 5 Price (per unit) P Qd 4 Change in `5 10 Quantity 3 Demanded 4 20 3 35 2 D2 2 55 1 D1 D3 1 80 0 2 4 6 8 10 12 14 16 18 Q Quantity Demanded (unit per week) 3-14
  15. 15. Reasons for change (increase ordecrease) in demand• Change in income.• Changes in taste, habits and preference.• Change in fashions and customs• Change in distribution of wealth.• Change in substitutes.• Change in demand of position of complementary goods.• Change in population.• Advertisement and publicity persuasion.• Change in the value of money.• Change in the level of taxation.• Expectation of future changes in price.
  16. 16. Elasticity of demand• Elasticity means the degree of responsiveness. When talked in terms of demand, it tells the degree of change/response in demand w.r.t change in price.• In economics, it acts as a tool to measure/describe the steepness or flatness of curves or functions.• Price elasticity of demand is computed along a demand curve. It is a ratio of % changes in demand and price.
  17. 17. Why it is imp.?Law of demand tells us that as the price of a commodity falls, the quantity demanded increases, and vice versa.It does not tell us by how much the quantity demanded increases, as a result of a certain fall in price or vice versa.Law of demand tells us only the direction of change in demand but not the rate at which the change takes place.To know this, we should know the elasticity of demand or Price elasticity of demand.
  18. 18. • It can be represented in the following mathematical form: - Elasticity(e p) = % change in Quantity demanded % change in Price change in Price % change in p = 100. orignal Price % change in p = P ( ) 100 P
  19. 19. Methods of measuring elasticity ofdemand.• Point elasticity method• Expenditure Outlay method• % method
  20. 20. Types of Price Elasticity 1. Perfectly elastic 2. Perfectly Inelastic 3. Unity Elasticity 4. Relatively Elastic 5. Relatively Inelastic.
  21. 21. Factors determining Price Elasticity ofDemand• 1. Nature of the commodity• Extent of use• Range of substitutes• Income level• Proportion of income spent on the commodity• Urgency of demand• Durability• Purchase frequency
  22. 22. Perfectly inelastic demandWhere no reduction in price is needed to cause an increase in demand.The firm can sell the quantity in wants to sell at the prevailing price but none at all at even slightly higher price.The shape of the demand curve is horizontal.The elasticity is = infinite.
  23. 23. Perfectly inelastic demandEven a large change in price, does not change the quantity demanded.Here the shape of the curve is vertical.Elasticity = 0
  24. 24. Unity elasticityA proportionate change in price results in exactly the same proportional change in quantity demanded.Shape of the demand curve is a rectangular hyperbola.Elasticity = 1
  25. 25. Relatively elastic demandA reduction in price leads to more than proportionate change in demand.Shape of the demand curve is flat.Elasticity > 1
  26. 26. Relatively inelastic demandA decline in price leads to less than proportionate increase in demand.Shape of the demand curve is steep.Elasticity < 1
  27. 27. Factors influencingelasticity of demand 1. Nature of the commodity. 2. Availability of Substitutes 3. Number of Uses 4. Consumer‟s Income. 5. Height of Price and Range of Price Change. 6. Proportion of Expenditure. 7. Durability of the Commodity. 8. Habit. 9. Complementary Goods. 10. Time. 11. Recurrence of Demand. 12. Possibility of Postponement.
  28. 28. Supply & Elasticity of Supply
  29. 29. Supply • Schedule or curve • Amount producers willing and able to sell at a given price • Individual supply • Market supply 3-29
  30. 30. Law of Supply • Other things equal, as price rises the quantity supplied rises • Explanations: ▫ Revenue implications ▫ Marginal cost 3-30
  31. 31. Individual Supply P 6 S1 5 Price (per unit) P Qs 4 `5 60 3 4 50 3 35 2 2 20 1 1 5 0 10 20 30 40 50 60 70 Q Quantity Supplied (units per week) 3-31
  32. 32. Determinants of Supply • Resource prices • Technology • Taxes and subsidies • Prices of other goods • Producer expectations • Number of sellers 3-32
  33. 33. Individual Supply P 6 S3 S1 5 S2 Price (per units) P Qs 4 `5 60 3 4 50 3 35 2 2 20 1 1 5 0 10 20 30 40 50 60 70 Q Quantity Supplied (units per week) 3-33
  34. 34. Individual Supply P 6 S3 S1 5 Change in Quantity Supplied S2 Price (per units) P Qs 4 ` 5 60 3 4 50 3 35 2 Change in 2 20 1 Supply 1 5 0 10 20 30 40 50 60 70 Q Quantity Supplied (units per week) 3-34
  35. 35. Elasticity of supply Elasticity(e p) = % change in Quantity demanded % change in Price change in Price % change in p = 100. orignal Price % change in p = P ( ) 100 P •It is defined as the ratio of percentage change in quantity demanded and the percentage change in the price of the commodity. •It tells the degree of responsiveness of quantity supply due to change in its price.
  36. 36. Types of Supply Elasticity 1. Perfectly Elastic 2. Perfectly Inelastic 3. Unit Elasticity 4. More than Elastic 5. Less than Elastic.
  37. 37. Perfectly Elastic Supply•Where no reduction in price is needed to cause an increase in supply.•The firm can sell the quantity in wants to sell at the prevailing price butnone at all at even slightly higher price.•The shape of the demand curve is horizontal. Price Perfectly elastic supply Es = infinity Quantity Supply
  38. 38. Elastic Supply Curve•A change in price leads to more than proportionate change in supply.•Shape of the demand curve is flat. price ES > 1 Quantity Supply
  39. 39. Perfectly inelastic supply•Even a large change in price, does not change the quantity supplied.•Here the shape of the curve is vertical. Es = 0 Price Quantity Supply
  40. 40. Unit elastic•A proportionate change in price results in exactly the same proportionalchange in quantity supplied.•Shape of the demand curve is a rectangular hyperbola. ES = 1 Price Quantity Supply
  41. 41. Inelastic supply•A change in price leads to less than proportionate change in supply.•Shape of the demand curve is flat. ES < 1 Price Quantity Supply
  42. 42. Market Equilibrium
  43. 43. Market Equilibrium• Equilibrium price and quantity• Surplus and shortage• Rationing function of price• Efficient allocation ▫ Productive efficiency ▫ Allocative efficiency 3-43
  44. 44. Market Equilibrium 6 6,000 units S 5 Surplus P Qd P Qs Price (per units) ` 4 Price Floor `5 2,000 4 ` 5 12,000 4 4,000 4 10,000 3 3 7,000 ` 2 Price Ceiling 3 7,000 2 11,000 2 2 4,000 1 16,000 7,000 units 1 1,000 1 Shortage D 0 2 4 6 7 8 10 12 14 16 18 unitss of Corn (thousands per week) 3-44
  45. 45. Market Equilibrium• Change in demand ▫ Shift of the demand curve• Change in supply ▫ Shift of the supply curve• Change in equilibrium price and quantity 3-45
  46. 46. Market Equilibrium Price Quantity • Supply increase; ? Demand decrease • Supply decrease; Demand increase ? • Supply increase; Demand increase ? • Supply decrease; Demand decrease ? 3-46
  47. 47. Demand Forecasting• Forecasting of demand is the art of predicting demand for a product or a service at some future data on the basis of certain present and past behavior patterns of some related events
  48. 48. Objectives of demand forecasting• It enable to produce the required quantities at the right time• Arrange well in advance for the various factors of production viz. raw materials, equipment, machine accessories, labour, building etc.• It is an important aid in effective and efficient planning• It can also help management in reducing its dependence on chance• It is helpful in allocation of national resources• Helpful in setting sales target• Arrangement of funds
  49. 49. Methods Of Demand Forecasting
  50. 50. Production function
  51. 51. Meaning of production Its an activity that transforms inputs in to out puts.
  52. 52. Production Function
  53. 53. Production Function Inputs Process OutputLand Product orLabour service generatedCapital – value added
  54. 54. The production functionThe production function can be mathematically written as Q=F(Lb,L,K,T,t….) Lb=land. L=labor. K=capital. T=Technology. t=time.
  55. 55. Factors affecting productivity• Technology• Inputs• Labor• Capital• Machinery• Land• Raw material• power• Time period
  56. 56. Classification of production function• Short term production function. (K & Lb are constant)• Long run production function. (Lb is constant)
  57. 57. Analysis run attheone factor fixed in supply but all other• In the short of least short run factors capable of being changed• Reflects ways in which firms respond to changes in output (demand)• Can increase or decrease output using more or less of some factors but some likely to be easier to change than others• Increase in total capacity only possible in the long run• Law of variable proportion
  58. 58. Analysis of the long run function• The long run is defined as the period of time taken to vary all factors of production ▫ By doing this, the firm is able to increase its total capacity – not just short term capacity ▫ Associated with a change in the scale of production ▫ The period of time varies according to the firm and the industry
  59. 59. Alternatives of the long run production• Constant returns to the scale out put increases in the same proportion as the increase in the input.• Increasing return to scale out put increases by a greater proportion than the increase in inputs.• Decreasing returns to the scale. output increases in the lesser proportion than the increase in the inputs.
  60. 60. Cost Concepts in Economics
  61. 61. Agenda• Opportunity Cost• Long Versus Short-Run• Cost Concepts• Revenue Concepts• Production Rules in Short and Long-Run• Size in Long-Run
  62. 62. Opportunity Costs• The value of the product not produced because an input was used for another purpose.• The income that would have been received if the input had been used in its most profitable alternative use.• It denotes the real cost of using an input.
  63. 63. Short Versus Long Run• The short run is a period of time sufficiently short that only some of the variables can be changed.• The long run is a period of time that all variables can be changed.
  64. 64. Types of Costs• Variable Costs ▫ These costs exist only if production occurs. ▫ E.g., fuel for tractor, seed, etc.• Fixed Costs ▫ These cost exist whether production occurs or not. ▫ In the long-run there are no fixed costs. ▫ Can be both cash and non-cash expenses. ▫ E.g., depreciation on tractors and buildings, etc.
  65. 65. Types of Costs Cont.• Sunk Costs ▫ Is an expenditure that cannot be recovered. ▫ In essence, it becomes part of fixed costs. ▫ E.g., pre-harvest costs.
  66. 66. Cost Concepts• Total Fixed Costs (TFC) ▫ The summation of all fixed and sunk costs to production.• Total Variable Costs (TVC) ▫ The summation of all variable costs to production.• Total Costs (TC) ▫ The summation of total fixed and total variable costs. ▫ TC=TFC+TVC
  67. 67. Cost Concepts Cont.• Average Fixed Costs (AFC) ▫ The total fixed costs divided by output.• Average Variable Costs (AVC) ▫ The total variable costs divided by output.• Average Total Costs (ATC) ▫ The total costs divided by output. ▫ The summation of average fixed costs and average variable costs, i.e., ATC=AFC+AVC.
  68. 68. Cost Concepts Cont.• Marginal Costs ▫ The change in total costs divided by the change in output.  TC/ Y ▫ The change in total variable costs divided by the change in output.  TVC/ Y
  69. 69. Side Note on Marginal Cost• How can marginal cost equal both the change in total cost divided by the change in output and the change in total variable cost divided by the change in output when variable costs are not equal to total costs? ▫ Short answer: fixed costs do not change.
  70. 70. Side Note on Marginal Cost Cont.• We want to show that MC = TVC/ Y when TVC TC.• We know that TC = TFC + TVC• This implies that TC = (TFC + TVC)• This implies that TC = TFC + TVC• We know that TFC = 0• Hence, TC = TVC• Divide the previous by Y, we obtain• TC/ Y = TVC/ Y• MC = TVC/ Y
  71. 71. Graphical Representation of CostConcepts ` TC TVC TFC Y
  72. 72. Graphical Representation of CostConcepts Cont. ` MC ATC AVC AFC Y
  73. 73. Notes on Costs• MC will meet AVC and ATC from below at the corresponding minimum point of each. ▫ Why?• As output increases AFC goes to zero.• As output increases, AVC and ATC get closer to each other.
  74. 74. 74Example of Cost ConceptsX Y TFC TVC TC AFC AVC ATC MC10 10 1000 1000 2000 100 100 20016 30 1000 1600 2600 33.33 53.33 86.67 3020 48 1000 2000 3000 20.83 41.67 62.50 22.2222 65 1000 2200 3200 15.38 33.85 49.23 11.7626 81 1000 2600 3600 12.35 32.10 45.45 2532 96 1000 3200 4200 10.42 33.33 43.75 4040 108 1000 4000 5000 9.26 37.04 46.30 66.6750 116 1000 5000 6000 8.62 43.10 51.72 12562 120 1000 6200 7200 8.33 51.67 60.00 30076 117 1000 7600 8600 8.55 64.96 73.51 -466.67
  75. 75. Revenue Concepts• Revenue (TR) is defined as the output price (py) multiplied by the quantity (Y).• Average revenue (AR) equals total revenue divided by output (Y), i.e., TR/Y, which equals py .• Marginal Revenue is the change in total revenue divided by the change in output, i.e., TR/ Y.
  76. 76. Short-Run Decision Making• In the short-run, there are many ways to choose how to produce. ▫ Maximize output. ▫ Utility maximization of the manager. ▫ Profit maximization.  Profit ( ) is defined as total revenue minus total cost, i.e., = TR – TC.
  77. 77. Short-Run Decision Making Cont.• When examining output, we want to set our production level where MR = MC when MR > AVC in the short-run. ▫ If MR AVC, we would want to shut down.  Why? ▫ If we can not set MR exactly equal to MC, we want to produce at a level where MR is as close as possible to MC, where MR > MC.
  78. 78. Intuition for Setting MR = MC• Suppose MR < MC.• This implies that by producing more output, you have a greater addition of cost than you do revenue. ▫ Hence you would not make the change.
  79. 79. Intuition for Setting MR = MC Suppose MR > MC. This implies that by producing more output, you have a greater addition of revenue than you do cost.  Hence you would make the change. You would stop increasing output at the point where the trade-off in additional revenue is just equal to the trade-off in additional costs.
  80. 80. Why Shutdown WhenMR < AVC• If MR < AVC, this implies that you are not bringing in enough revenue from each unit produced to cover your variable costs.• Hence you could minimize your loss if you were to shutdown.
  81. 81. Why Produce WhenATC > MR > AVC• When MR < ATC, the company is making a loss. ▫ Why would it produce?• Since the firm is making something above and beyond its variable cost, it can put some of that revenue towards fixed cost. ▫ This implies that it minimizes its loss by producing.
  82. 82. Profit Scenario Graphically ` Profit MC MR = py ATC ATC AVC AFC Yprofit Y
  83. 83. Loss Minimizing Graphically ` MC Loss ATC ATC AVC MR = py AFC Yloss Y
  84. 84. Shutdown Decision Graphically ` If we did not produce: loss = B MC Loss = A + B ATC ATC B AVC MR = py A AFC Yloss Y
  85. 85. Production Rules for the Long-Run• To maximize profits, the farmer should produce when selling price is greater than ATC at the production level where MC = MR.• To minimize losses, the farmer should not produce when selling price is less than ATC, i.e., shutdown the business.
  86. 86. Note on Cost Concepts• The producer‟s supply curve is the part of the MC curve that is above the shutdown point.
  87. 87. Long-Run Average Costs• The long run average cost (LRAC) curve is the envelope of the short run average cost curves when the size of the operation is allowed to increase or decrease.• Note that a short run average cost curve exists for every possible farm size, as defined by the amount of fixed input available.
  88. 88. Long-Run Average Costs Cont.• In a competitive market, the long run optimal production will occur at the lowest point on the LRAC, i.e., economic profits are driven to zero.
  89. 89. Size in the Long-Run• A measure of size in the long run between output and costs as farm size increases (EOS) is the following: ▫ EOS = percent change in costs divided by percent change in output value
  90. 90. Size in the Long-Run Cont.• If this ratio of EOS is less than one, then there are decreasing costs to expanding production, i.e., increasing returns to size.• If this ratio is equal to one, then there are constant costs to expanding production, i.e., constant returns to size.• If this ratio is greater than one, then there are increasing costs to expanding production, i.e., decreasing returns to size.
  91. 91. 91Economies of Size• This exists when the LRAC is decreasing.• Also known as increasing returns to size.• Usually occurs because of full utilization of capital (tractors and buildings) and labor.• Also occurs because of discount pricing for buying in bulk and selling price benefits for selling large quantities.
  92. 92. 92Diseconomies of Size• This exists when the LRAC is increasing.• Also known as decreasing returns to size.• Usually occurs because a lack of managerial skills.• Also occurs because travel time increases as farm increases. ▫ Livestock: disease control and manure disposal. ▫ Crops: geographical distance away from each other.
  93. 93. Market Structure• Market structure – identifies how a market is made up in terms of: ▫ The number of firms in the industry ▫ The nature of the product produced ▫ The degree of monopoly power each firm has ▫ The degree to which the firm can influence price ▫ Profit levels ▫ Firms‟ behaviour – pricing strategies, non-price competition, output levels ▫ The extent of barriers to entry ▫ The impact on efficiency
  94. 94. Market Structure Perfect PureCompetition Monopoly More competitive (fewer imperfections)
  95. 95. Market Structure Perfect PureCompetition Monopoly Less competitive (greater degree of imperfection)
  96. 96. Main forms of Market Pure Perfect MonopolyCompetition Monopolistic Competition Oligopoly Duopoly Monopoly The further right on the scale, the greater the degree of monopoly power exercised by the firm.
  97. 97. Perfect Competition• One extreme of the market structure spectrum• Characteristics: ▫ Large number of firms ▫ Products are homogenous (identical) – consumer has no reason to express a preference for any firm ▫ Freedom of entry and exit into and out of the industry ▫ Firms are price takers – have no control over the price they charge for their product ▫ Each producer supplies a very small proportion of total industry output ▫ Consumers and producers have perfect knowledge about the market
  98. 98. Perfect Competition Givenaverage the cost ofis the Thethis industry price firm AtThe MC is cost curve profit The assumption of is the output the maximisation,– shaped curve. standard ‘U’ additional demand producing theby the determined firm producesCost/Revenue is(marginal) AC curve =profit. making units the atMR and the normal its MC at an cuts supply of MC industry MC output where of output. It (Q1). asis first (due run alaw of This at whole. levelfirm is a lowest point long to thethe This a because is falls a output The of fraction of the total industry rises mathematical relationship equilibriumreturns) then diminishing supplier within very small position. supply. industry and has no between marginal and average asthe output rises. AC values. control over price. They will sell each extra unit for the same price. Price therefore = MR and AR P = MR = AR Q1 Output/Sales
  99. 99. Perfect Competition Diagrammatic representation Because the model assumes perfect knowledge,MC costs The assume a firm the firm Average and and makes Nowlower ACMarginal wouldCost/Revenue MC gains that advantage nowlower some theexpected is for only a could form of firm to be imply be the modification to short timein the short run, form its product before others copy but price, or gains some earning abnormal profit MC1 the idea or are attracted to the remains the same. (AR>AC) represented a the of cost advantage (sayby new industry by method). What production the existence of grey area. AC abnormal profit. If new firms would happen? enter the industry, supply will increase, price will fall and the AC1 firm will be left making normal profit once again. P = MR = AR Abnormal profit AC1 P1 = MR1 = AR1 Q1 Q2 Output/Sales
  100. 100. Monopolistic or Imperfect Competition• Where the conditions of perfect competition do not hold, „imperfect competition‟ will exist• Varying degrees of imperfection give rise to varying market structures• Monopolistic competition is one of these – not to be confused with monopoly!
  101. 101. Monopolistic or Imperfect Competition• Characteristics: ▫ Large number of firms in the industry ▫ May have some element of control over price due to the fact that they are able to differentiate their product in some way from their rivals – products are therefore close, but not perfect, substitutes ▫ Entry and exit from the industry is relatively easy – few barriers to entry and exit ▫ Consumer and producer knowledge imperfect
  102. 102. Monopolistic or Imperfect Competition Implications for the diagram: MC This is demandrunandfacingCost/Revenue We assumeCost theQ1 and IfThe firm produces firm the a shortthat equilibrium Marginal Since the additional curve produceswillfirmdownward Averagea be willabeMC where MR = the Cost in£1.00 on position forreceived from sells firm unit for revenue the each (profit maximising output). average shape. falls, (on each unit sold However, same and the cost monopolistic market the the sloping with represents At because the products MR curve level, AR>AC this output AC structure. for from sales. average) lies under the AR earned each unit being and the firm makes in 40p x are differentiated 60p, curve. will make AR the firm abnormal profit (the grey Q1 in abnormal profit.will£1.00 some way, the firm shaded area). to sell extra only be able output by lowering Abnormal Profit price.£0.60 MR D (AR) Q1 Output / Sales
  103. 103. Monopolistic or Imperfect Competition Implications for the diagram: MC Because there is relativeCost/Revenue freedom of entry and exit into the market, new firms will enter AC encouraged by the existence of abnormal profits. New entrants will increase supply causing price to fall. As price falls, the AR and MR curves shift inwards as revenue from each sale is now less. AR1 D (AR) MR1 MR Q1 Output / Sales
  104. 104. Monopolistic or Imperfect Competition Implications for the diagram: MC Notice that the existence Cost/Revenue of more substitutes makes the new AR (D) curve more price elastic. The AC firm reduces output to a point where MC = MR (Q2). At this output AR = AC and the firm will makeAR = AC normal profit. AR1 D (AR) MR1 MR Q2 Q1 Output / Sales
  105. 105. Monopolistic or Imperfect Competition Implications for the diagram: MC This is the long run Cost/Revenue equilibrium position of a firm in monopolistic competition. ACAR = AC AR1 MR1 Q2 Output / Sales
  106. 106. Monopolistic or Imperfect Competition• Some important points about monopolistic competition: ▫ May reflect a wide range of markets ▫ Not just one point on a scale – reflects many degrees of „imperfection‟ ▫ Examples?
  107. 107. Monopolistic or Imperfect Competition• Restaurants• Plumbers/electricians/local builders• Solicitors• Private schools• Plant hire firms• Insurance brokers• Health clubs• Hairdressers• Funeral directors• Estate agents• Damp proofing control firms
  108. 108. Monopolistic or Imperfect Competition• In each case there are many firms in the industry• Each can try to differentiate its product in some way• Entry and exit to the industry is relatively free• Consumers and producers do not have perfect knowledge of the market – the market may indeed be relatively localised. Can you imagine trying to search out the details, prices, reliability, quality of service, etc for every plumber in the UK in the event of an emergency??
  109. 109. Oligopoly• Competition between the few ▫ May be a large number of firms in the industry but the industry is dominated by a small number of very large producers• Concentration Ratio – the proportion of total market sales (share) held by the top 3,4,5, etc firms: ▫ A 4 firm concentration ratio of 75% means the top 4 firms account for 75% of all the sales in the industry
  110. 110. Oligopoly • Features of an oligopolistic market structure: ▫ Price may be relatively stable across the industry – kinked demand curve? ▫ Potential for collusion ▫ Behaviour of firms affected by what they believe their rivals might do – interdependence of firms ▫ Goods could be homogenous or highly differentiated ▫ Branding and brand loyalty may be a potent source of competitive advantage ▫ Non-price competition may be prevalent ▫ Game theory can be used to explain some behaviour ▫ AC curve may be saucer shaped – minimum efficient scale could occur over large range of output ▫ High barriers to entry
  111. 111. Monopoly • Pure monopoly – where only one producer exists in the industry • In reality, rarely exists – always some form of substitute available! • Monopoly exists, therefore, where one firm dominates the market • Firms may be investigated for examples of monopoly power when market share exceeds 25% • Use term „monopoly power‟ with care!
  112. 112. Monopoly • Monopoly power – refers to cases where firms influence the market in some way through their behaviour – determined by the degree of concentration in the industry ▫ Influencing prices ▫ Influencing output ▫ Erecting barriers to entry ▫ Pricing strategies to prevent or stifle competition ▫ May not pursue profit maximisation – encourages unwanted entrants to the market ▫ Sometimes seen as a case of market failure
  113. 113. Monopoly• Origins of monopoly: ▫ Through growth of the firm ▫ Through amalgamation, merger or takeover ▫ Through acquiring patent or license ▫ Through legal means – Royal charter, nationalisation, wholly owned plc
  114. 114. Monopoly• Summary of characteristics of firms exercising monopoly power: ▫ Price – could be deemed too high, may be set to destroy competition (destroyer or predatory pricing), price discrimination possible. ▫ Efficiency – could be inefficient due to lack of competition (X- inefficiency) or…  could be higher due to availability of high profits
  115. 115. Monopoly• Innovation - could be high because of the promise of high profits, Possibly encourages high investment in research and development (R&D)• Collusion – possible to maintain monopoly power of key firms in industry• High levels of branding, advertising and non-price competition
  116. 116. Monopoly• Problems with models – a reminder: ▫ Often difficult to distinguish between a monopoly and an oligopoly – both may exhibit behaviour that reflects monopoly power ▫ Monopolies and oligopolies do not necessarily aim for traditional assumption of profit maximisation ▫ Degree of contestability of the market may influence behaviour ▫ Monopolies not always „bad‟ – may be desirable in some cases but may need strong regulation ▫ Monopolies do not have to be big – could exist locally
  117. 117. MonopolyCosts / Revenue This is curve for a monopolist Given both the short run and AR (D)the barriers to entry, MC long to equilibrium price the monopolist will be able to likelyrunbe relatively position for a monopoly exploit abnormal profits in to inelastic. Output assumed the£7.00 long profit entry to the be atrun as maximising output (note caution here – not all AC market is restricted. monopolists may aim Monopoly for profit maximisation!) Profit£3.00 MR AR Output / Sales Q1
  118. 118. Monopoly WelfareCosts / Revenue implications of monopolies MC The higher in at competitive be A look back a the diagram for The price priceprice lower monopoly and would £7 output means that £3willlevels perfectunit with output reveal market competition with £7 per would be consumer AC that in is reduced, indicated by output equilibrium, price will be surplusat Q2. at Q1. lower levels Loss of consumer equal to the MC of production. the grey shaded area. On the face of it, consumers surplus We can look therefore at a face higher prices and less comparison of the differences choice in monopoly conditions £3 between price and output in a compared to more competitive competitive situation compared environments. to a monopoly. AR MR Output / Sales Q2 Q1
  119. 119. Monopoly WelfareCosts / Revenue implications of monopolies MC The monopolist will be benefit £7 from additional producer affected by a loss of producer AC surplus shownto the grey equal by the grey shaded but…….. triangle rectangle. Gain in producer surplus £3 AR MR Output / Sales Q2 Q1
  120. 120. Monopoly WelfareCosts / Revenue implications of monopolies MC The value of the grey shaded £7 triangle represents the total welfare loss to society – AC sometimes referred to as the ‘deadweight welfare loss’. £3 AR MR Output / Sales Q2 Q1
  121. 121. National Income• The sum total of the values of all goods and services produced in a year It is the money value of the flow of goods and services available in an economy in a year• It refers to the money value of the flow of goods and services available annually in an economy.• National Income Committee of India 1951 defines National Income as follows:“ A national income estimate measures the volume of commodities and services turned out during a given period counted without duplication.”• Marshall‟s Definition:“The labor and capital resources of a country acting on its natural resources produce annually a certain net aggregate of commodities, material and immaterial including services of all kinds…. This is the true net annual income or revenue of the country or the national dividend.”• The income of a country to a specified period of time, say a year includes all types of goods and services which have an exchange value counting each one of them only once• Double counting If steel has been evaluated in industrial production, it should not be included while calculating the value of steel products, viz, machines and motor cars. To avoid double counting or multiple counting, two methods are used Final products method Value added method.
  122. 122. N.I Concepts The following are the concepts of national income Gross National Product – GNP Net National Product – NNP Personal Income – PI Per capita Income – PCI• Gross National Product National Income is the sum total of values of all goods and services produced during a year The money value of this total output is known as Gross National Product – GNP Gross National Product Example: If A,B,C,D,… are goods and services and If a,b,c,d,…are their prices respectively The GNP is calculated as follows GNP= Axa+Bxb+Cxc+Dxd…. GNP is most frequently used national income concept It is statistically a simpler concept as it takes no account of depreciation and replacement problems• Net National Product - NNP: This refers to the net production of goods and services in a country during a year NNP is also called National Income at Market Prices We get NNP, by deducting the depreciation from GNP Therefore NNP = GNP - Depreciation
  123. 123. • Personal Income - PI: Income earned by all the individuals and institutions during a year in a country The entire national income does not reach individuals and institutions A part of it goes by way of corporate taxes Undistributed profits Social security contributions People sometimes get incomes without any productive activity They are called Transfer Payments Example: Unemployment benefits, old age pensions etc. Such transfer payments are not included in the National Income However they are added to Personal Income PI is computed by using the following formula PI = National Income – (Corporate taxes, undistributed profits, social security contributions) + Transfer Payments• Per Capita Income – PCI: If the national income is divided by the total population, we get per capital income PCI = NI/Population PCI may be expressed either in money terms or in real terms
  124. 124. NI – Methods of computation :There three methods of NI computation:-• Net Product method• Factor Income method• Expenditure method
  125. 125. Inflation• “Inflation is nothing more than a sharp upward rise in price level.”• Too much money chasing, too few goods.”• Inflation is a state in which the value of money is falling i.e. price are rising.”
  126. 126. KINDS OF INFLATION• On the basis of rate of inflation• On the basis of degree of control• On the basis of causes• Others
  127. 127. CAUSES OF INFLATION• Demand pull inflation• Cost push inflation
  128. 128. EFFECTS OF INFLATION• They add inefficiencies in the market, and make it difficult for companies to budget or plan long- term.• Uncertainty about the future purchasing power of money discourages investment and saving.
  129. 129. EFFECTS OF INFLATION• There can also be negative impacts to trade from an increased instability in currency exchange prices caused by unpredictable inflation.• Higher income tax rates.• Inflation rate in the economy is higher than rates in other countries; this will increase imports and reduce exports, leading to a deficit in the balance of trade.
  130. 130. Business Cycle • Business cycle or trade cycle is a part of the capitalistic economy. • The business cycle refers to fluctuation in economic activities such as levels of income, employment, prices and output, occurs more or less in regular time sequences. • Business cycle is characterized by upward and downward movement of economic activities. • In a business cycle, there are wave-like fluctuations in aggregate employment, income output and price level.
  131. 131. Business cycle • The short-term variations in economic activity are known as BUSINESS CYCLE. • Economic history shows that the economy never grows in a smooth and even pattern. • Upward and downward movements in output, inflation, interest rates, and employment form the Business Cycles that characterizes all market economies
  132. 132. Busines cycle • Business Cycles are the irregular expansions and contractions in economic activity. • Business Cycles are economy-wide fluctuations in total National Output, Income, and Employment, usually last for a period of 2 to 10 years, marked by widespread expansion or contraction in most sectors of the economy.
  133. 133. 133 of 23Phases of business cycleBusiness Cycle is typically divided intofour phases:a) The recoveryb) The prosperityc) The recessiond) The depression
  134. 134. Depression Recession merges into depression when there is a general decline in economic activity. There is considerable reduction in the production of goods and services, employment, income, demand and prices. The general decline in economic activity leads to a fall in bank deposits. When credit expansion stops, even business community is not willing to borrow. Thus, a depression is characterized by mass unemployment – general fall in prices, wages, profits, interest rate, consumption expenditure, investment – bank loans and advances falling – factories close down – capital goods industries are also closed down. During this phase, there will be pessimism leading to closing down of business firms.
  135. 135. Recovery  Recovery denotes the turning point of business cycle from depression to prosperity.  There is a slow rise in output, employment, income and price – demand for commodities go up steadily.  There is increase in investment – bank and financial institutions are also willing to granting loans and advances.  Pessimism gives way to optimism.  The process of recovery becomes combative and leads to prosperity
  136. 136. Prosperity In this period, demand, output, employment and income are at a high level, they tend to raise prices. But wages, salaries, interest rates, rentals and taxes do not rise in proportion to the rise in prices. The gap between prices and cost increases - the margin of profit increases. The increase of profit and the prospect of its continuance commonly cause a rapid rise in stock market values. The economy is engulfed in waves of optimism. Larger profit expectation further increase – investment which is helped by liberal bank credit. This leads to peak or boom.
  137. 137. of 23Recession  Recession starts downward movement of economic activities from peak/boom.  It is a state in which there is general deceleration in the economic activity resulting in cuts in production and employment falling prices of stock market.  Banking and financial institutional loans and advances beginning to decline.  As a result profit margins decline further because costs starts overtaking prices.  Recession may be mild/severe – it lead to a sudden explosive situation emanating from banking system and stock markets.  Such experience of the United States in 1873, 1893, 1907, 1933 and 2007.
  138. 138. Thank You for yourPatience and KeenInterest.