MANAGERIAL ECONOMICS
TOPIC 1
INTRODUCTION TO MANAGERIAL ECONOMICS
Managerial Economics can be defined as amalgamation of economic theory with
business practices so as to ease decision-making and future planning by management.
It is a stream of management studies which emphasizes solving business problems and
decision-making by applying the theories and principles of microeconomics and
macroeconomics. It is a specialized stream dealing with the organization’s internal
issues by using various economic theories.
Managerial Economics assists the managers of a firm in a rational solution of obstacles
faced in the firm’s activities. It makes use of economic theory and concepts. It helps in
formulating logical managerial decisions.
The key of Managerial Economics is the micro-economic theory of the firm. It lessens
the gap between economics in theory and economics in practice. Managerial
Economics is a science dealing with effective use of scarce resources. It guides the
managers in taking decisions relating to the firm’s customers, competitors, suppliers as
well as relating to the internal functioning of a firm. It makes use of statistical and
analytical tools to assess economic theories in solving practical business problems.
Microeconomics is the study of decisions made regarding the allocation of resources
and prices of goods and services, macroeconomics is the field of economics that
studies the behavior of the economy as a whole. Managerial Economics applies microeconomic tools to make business decisions. It deals with a firm.
The use of Managerial Economics is not limited to profit-making firms and
organizations. But it can also be used to help in decision-making process of non-profit
organizations (hospitals, educational institutions and other related organization). It
enables optimum utilization of scarce resources in such organizations as well as helps
in achieving the goals in most efficient manner. Managerial Economics is of great help
in price analysis, production analysis, capital budgeting, risk analysis and determination
of demand.
Managerial economics uses both Economic theory as well as Econometrics for rational
managerial decision making. Econometrics is defined as use of statistical tools for
assessing economic theories by empirically measuring relationship between economic
variables. It uses factual data for solution of economic problems. Managerial Economics
is associated with the economic theory which constitutes “Theory of Firm”. Theory of
firm states that the primary aim of the firm is to maximize wealth. Decision making in
managerial economics generally involves establishment of firm’s objectives,
identification of problems involved in achievement of those objectives, development of
various alternative solutions, selection of best alternative and finally implementation of
the decision.
The following figure tells the primary ways in which Managerial Economics correlates to
managerial decision-making.
SCOPE OF MANAGERIAL ECONOMICS
Managerial Economics deals with allocating the scarce resources in a manner that
minimizes the cost. It has a more narrow scope - it is actually solving managerial issues
using micro-economics. Wherever there are scarce resources, managerial economics
ensures that managers make effective and efficient decisions concerning customers,
suppliers, competitors as well as within an organization. The fact of scarcity of
resources gives rise to three fundamental questionsa. What to produce?
b. How to produce?
c. For whom to produce?
The first question relates to what goods and services should be produced and in what
amount/quantities. The managers use demand theory for deciding this. The demand
theory examines consumer behaviour with respect to the kind of purchases they would
like to make currently and in future; the factors influencing purchase and consumption of
a specific good or service; the impact of change in these factors on the demand of that
specific good or service; and the goods or services which consumers might not
purchase and consume in future. In order to decide the amount of goods and services
to be produced, the managers use methods of demand forecasting.
The second question relates to how to produce goods and services. The firm has now
to choose among different alternative techniques of production. It has to make decision
regarding purchase of raw materials, capital equipment, manpower, etc. The managers
can use various managerial economics tools such as production and cost analysis (for
hiring and acquiring of inputs), project appraisal methods (for long term investment
decisions), for making these crucial decisions.
The third question is regarding who should consume and claim the goods and services
produced by the firm. The firm, for instance, must decide which is for niche market, local
market or for foreign market. It must segment the market. It must conduct a thorough
analysis of market structure and thus take price and output decisions depending upon
the type of market.
Managerial economics helps in decision-making as it involves logical thinking.
Moreover, by studying simple models, managers can deal with more complex and
practical situations. Also, a general approach is implemented.
Managerial Economics take a wider picture of firm, i.e., it deals with questions such as
what is a firm, what are the firm’s objectives, and what forces push the firm towards
profit and away from profit. In short, managerial economics emphasizes upon the firm,
the decisions relating to individual firms and the environment in which the firm operates.
It deals with key issues such as what conditions favor entry and exit of firms in market,
why are people paid well in some jobs and not so well in other jobs, etc. Managerial
Economics is a great rational and analytical tool.
Managerial Economics is not only applicable to profit-making business organizations,
but also to non- profit organizations such as hospitals, schools, government agencies,
etc.
Types of Managerial Economics
All managers take the concept of managerial economics differently. Some may be more
focused on customer’s satisfaction while others may prioritize efficient production.
The various approach to managerial economics can be seen in detail below:
Liberal Managerialism
A market is a democratic place where people are liberal to make their choices and
decisions. The organization and the managers have to function according to the
customer’s demand and market trend; else it may lead to business failures.
Normative Managerialism
The normative view of managerial economics states that administrative decisions are
based on real-life experiences and practices. They have a practical approach to
demand analysis, forecasting, cost management, product design and
promotion, recruitment, etc.
Radical Managerialism
Managers must have a revolutionary attitude towards business problems, for instance,
they must make decisions to change the present situation or condition. They focus more
on the customer’s requirement and satisfaction rather than only profit maximization.
References: https://www.managementstudyguide.com/managerial-economicsscope.htm, https://theinvestorsbook.com/managerial-economics.html
Guide activity questions:
1. Why is there a need to study managerial economics?
2. How will you correlate managerial economics to accounting?
TOPIC 2
NATURE AND CHARACTERISTICS OF MANAGERIAL ECONOMICS
Managers study managerial economics because it gives them insight to reign the
functioning of the organization. If manager uses the principles applicable to economic
behavior in a reasonably, then it will result in smooth functioning of the organization.
Managerial Economics is a Science
Managerial Economics is an essential scholastic field. It can be compared to science in
a sense that it fulfils the criteria of being a science in following sense:

Science is a Systematic body of Knowledge. It is based on the methodical
observation. Managerial economics is also a science of making decisions with
regard to scarce resources with alternative applications. It is a body of knowledge
that determines or observes the internal and external environment for decision
making.

In science any conclusion is arrived at after continuous experimentation. In
Managerial economics also policies are made after persistent testing and trailing.
Though economic environment consists of human variable, which is
unpredictable, thus the policies made are not rigid. Managerial economist takes
decisions by utilizing his valuable past experience and observations.

Science principles are universally applicable. Similarly, policies of Managerial
economics are also universally applicable partially if not fully. The policies need
to be changed from time to time depending on the situation and attitude of
individuals to those particular situations. Policies are applicable universally but
modifications are required periodically.
Managerial Economics requires Art
Managerial economist is required to have an art of utilizing his capability, knowledge
and understanding to achieve the organizational objective. Managerial economist
should have an art to put in practice his theoretical knowledge regarding elements of
economic environment.
Managerial Economics for administration of organization
Managerial economics helps the management in decision making. These decisions are
based on the economic rationale and are valid in the existing economic environment.
Managerial economics is helpful in optimum resource allocation
The resources are scarce with alternative uses. Managers need to use these limited
resources optimally. Each resource has several uses. It is manager who decides with
his knowledge of economics that which one is the preeminent use of the resource.
Managerial Economics has components of micro economics
Managers study and manage the internal environment of the organization and work for
the profitable and long-term functioning of the organization. This aspect refers to the
micro economics study. The managerial economics deals with the problems faced by
the individual organization such as main objective of the organization, demand for its
product, price and output determination of the organization, available substitute and
complimentary goods, supply of inputs and raw material, target or prospective
consumers of its products etc.
Managerial Economics has components of macro economics
None of the organization works in isolation. They are affected by the external
environment of the economy in which it operates such as government policies, general
price level, income and employment levels in the economy, stage of business cycle in
which economy is operating, exchange rate, balance of payment, general expenditure,
saving and investment patterns of the consumers, market conditions etc. These aspects
are related to macroeconomics.
Managerial Economics is dynamic in nature
Managerial Economics deals with human-beings. The nature and attitude differ from
person to person. Thus, to cope up with dynamism and vitality managerial economics
also changes itself over a period of time.
Characteristics of Managerial Economics
1. Microeconomics
It studies the problems and principles of an individual business firm or an individual
industry. It aids the management in forecasting and evaluating the trends of the market.
2. Normative economics
It is concerned with varied corrective measures that a management undertakes under
various circumstances. It deals with goal determination, goal development and
achievement of these goals. Future planning, policy-making, decision-making and
optimal utilization of available resources, come under the banner of managerial
economics.
3. Pragmatic
Managerial economics is pragmatic. In pure micro-economic theory, analysis is
performed, based on certain exceptions, which are far from reality. However, in
managerial economics, managerial issues are resolved daily and difficult issues of
economic theory are kept at bay.
4. Uses theory of firm
Managerial economics employs economic concepts and principles, which are known as
the theory of Firm or ‘Economics of the Firm’. Thus, its scope is narrower than that of
pure economic theory.
5. Takes the help of macroeconomics
Managerial economics incorporates certain aspects of macroeconomic theory. These
are essential to comprehending the circumstances and environments that envelop the
working conditions of an individual firm or an industry. Knowledge of macroeconomic
issues such as business cycles, taxation policies, industrial policy of the government,
price and distribution policies, wage policies and antimonopoly policies and so on, is
integral to the successful functioning of a business enterprise.
6. Aims at helping the management
Managerial economics aims at supporting the management in taking corrective
decisions and charting plans and policies for future.
7. Prescriptive rather than descriptive
Managerial economics is a normative and applied discipline. It suggests the application
of economic principles with regard to policy formulation, decision-making and future
planning. It not only describes the goals of an organization but also prescribes the
means of achieving these goals.
References:
http://economics.ezinemark.com/characteristics-of-managerial-economics7d365bf2484f.html, https://www.managementstudyguide.com/managerial-economicsnature.htm
GUIDE ACTIVITY QUESTIONS:
1. How will you classify managerial economics- is it more of microeconomics or
more of macroeconomics? Why?
2. Managerial economics is considered a science. Which branch of science do you
think it belong and why?
TOPIC 3
MANAGERIAL AND MICROECONOMICS
Managerial Economics is basically a blend of Economics and Management. Two
branches of economics - microeconomics and macroeconomics are the major
contributors to managerial economics.
Micro Economics is the study of the behavior of individual consumers and firms
whereas microeconomics is the study of economy as a whole.
Managerial Economics and Micro Economics
All the firms operating in the market have to take under consideration the constituent of
the economic environment for its proper functioning. This economic environment is
nothing but the Micro economics elements.
Micro Economics is a broader concept as compare to Managerial Economics.
Micro Economics forms the foundation of managerial economics. Almost all the
concepts of Managerial Economics are the perceptions of Micro Economics concepts.
Managerial economics can be perceived as an applied Micro Economics. Demand
Analysis and Forecasting, Theory of Price, Theory of Revenue and Cost, Theory of
Supply and Production are major bare bones of Micro Economics that underpins the
Managerial Economics. Managerial Economics applies the theories of Micro Economics
to resolve the issues of the organization and for decision making.
All Managers want to carry out their function of decision making with maximum
efficiency. Their business planning can be effectively planned and performed with
comprehensive knowledge and understanding of micro economic concept and its
applications. Optimum decision making to achieve the objective of the organization, an
example would be is for profit maximizing or for cost minimizing. It is possible with
proper compliance of micro economic know how, regardless of the technological
constraints and given market conditions. Micro Economic Analysis is important as it is
applied to day- to- day dilemma and concerns.
The reliance of Managerial Economics on Micro Economics is made clearer in the
points below:

If a manager wants to increase the price of the product due to increase in cost of
production, he will analyze the price elasticity of demand for that product so that
price rise is not followed by substantial fall in the demand of the product. It is the
application of demand analysis to the real-world situation.

For fixing the price of the products managers applies the pricing theories, cost
and revenue theories of micro economics.

Decisions regarding production and supply of the product in the market,
knowledge of availability of fixed and variable factors of production, state of
technology to be used and availability of raw-material are essential. This can be
determined with the knowledge of theory of production.

Determination of price and output is possible with the acquaintance of market
structures and approaches pertinent for determination of price and output in the
given market setup.

Managerial economics utilizes statistical methods such as game theory, linear
programming for application of Economic Theory in Decision making.

One of the responsibilities of Manager is to workout budgets for different
departments of the organization which is learned from Capital Budgeting and
Capital Rationing.

Cost and benefit analysis helps the manager in decision making.

Study of welfare economics helps Manager in taking care of social
responsibilities of the organization.

Microeconomics is the study that deals with partial equilibrium analysis which is
useful for the manager in deciding equilibrium for his organization.

Managerial Economics also uses tools of Mathematical Economics and
econometrics such as regression analysis, correlation analysis etc.

Theory of firm, an important element of microeconomics, is one of the most
significant elements of Managerial Economics.
Role of Managerial Economics
Pricing
Managerial economics assists businesses in determining pricing strategies and
appropriate pricing levels for their products and services. Some common analysis
methods are price discrimination, value-based pricing and cost-plus pricing.
Elastic vs. Inelastic Goods
Economists can determine price sensitivity of products through a price elasticity
analysis. Some products, such as milk, are consider a necessity rather than a luxury
and will purchase at most price points. This type of product is considered inelastic.
When a business knows they are selling an inelastic good, they can make marketing
and pricing decisions easier.
Operations and Production
Managerial economics uses quantitative methods to analyze production and operational
efficiency through schedule optimization, economies of scale and resource analyses.
Additional analysis methods include marginal cost, marginal revenue and operating
leverage. Through tweaking the operations and production of a company, profits rise as
costs decline.
Investments
Many managerial economic tools and analysis models are used to help make investing
decisions both for corporations and savvy individual investors. These tools are use to
make stock market investing decisions and decisions on capital investments for a
business. For example, managerial economic theory can be used to help a company
decide between purchasing, building or leasing operational equipment.
Risk
Uncertainty exits in every business and managerial economics can help reduce risk
through uncertainty model analysis and decision-theory analysis. Heavy use of
statistical probability theory helps provide potential scenarios for businesses to use
when making decisions.
References: https://sites.google.com/site/economicsbasics/application-of-m-e,
https://www.managementstudyguide.com/managerial-micro-economics.htm
TOPIC 4
PRINCIPLES AND TOOLS OF MANAGERIAL ECONOMICS
Principles of Managerial Economics
Economic principles assist in rational reasoning and defined thinking. They develop
logical ability and strength of a manager. Some important principles of managerial
economics are:
1. Marginal and Incremental Principle
This principle states that a decision is said to be rational and sound if given the firm’s
objective of profit maximization, it leads to increase in profit, which is in either of two
scenarios
If total revenue increases more than total cost.

If total revenue declines less than total cost.
Marginal analysis implies judging the impact of a unit change in one variable on the
other. Marginal generally refers to small changes. Marginal revenue is change in total
revenue per unit change in output sold. Marginal cost refers to change in total costs per
unit change in output produced (While incremental cost refers to change in total costs
due to change in total output). The decision of a firm to change the price would depend
upon the resulting impact/change in marginal revenue and marginal cost. If the marginal
revenue is greater than the marginal cost, then the firm should bring about the change
in price.
Incremental analysis differs from marginal analysis only in that it analysis the change in
the firm's performance for a given managerial decision, whereas marginal analysis often
is generated by a change in outputs or inputs. Incremental analysis is generalization of
marginal concept. It refers to changes in cost and revenue due to a policy change. For
example - adding a new business, buying new inputs, processing products, etc. Change
in output due to change in process, product or investment is considered as incremental
change. Incremental principle states that a decision is profitable if revenue increases
more than costs; if costs reduce more than revenues; if increase in some revenues is
more than decrease in others; and if decrease in some costs is greater than increase in
others.
2. Equi-marginal Principle
Marginal Utility is the utility derived from the additional unit of a commodity consumed.
The laws of equi-marginal utility states that a consumer will reach the stage of
equilibrium when the marginal utilities of various commodities he consumes are equal.
According to the modern economists, this law has been formulated in form of law of
proportional marginal utility. It states that the consumer will spend his money-income on
different goods in such a way that the marginal utility of each good is proportional to its
price, i.e.,
MUx / Px = MUy / Py = MUz / Pz
Where, MU represents marginal utility and P is the price of good.
Similarly, a producer who wants to maximize profit (or reach equilibrium) will use the
technique of production which satisfies the following condition:
MRP1 / MC1 = MRP2 / MC2 = MRP3 / MC3
Where, MRP is marginal revenue product of inputs and MC represents marginal cost.
Thus, a manger can make rational decision by allocating/hiring resources in a manner
which equalizes the ratio of marginal returns and marginal costs of various use of
resources in a specific use.
3. Opportunity Cost Principle
By opportunity cost of a decision is meant the sacrifice of alternatives required by that
decision. If there are no sacrifices, there is no cost. According to Opportunity cost
principle, a firm can hire a factor of production if and only if that factor earns a reward in
that occupation/job equal or greater than it’s opportunity cost. Opportunity cost is the
minimum price that would be necessary to retain a factor-service in it’s given use. It is
also defined as the cost of sacrificed alternatives. For instance, a person chooses to
forgo his present lucrative job which offers him Rs.50000 per month, and organizes his
own business. The opportunity lost (earning Rs. 50,000) will be the opportunity cost of
running his own business.
4. Time Perspective Principle
According to this principle, a manger/decision maker should give due emphasis, both to
short-term and long-term impact of his decisions, giving apt significance to the different
time periods before reaching any decision. Short-run refers to a time period in which
some factors are fixed while others are variable. The production can be increased by
increasing the quantity of variable factors. While long-run is a time period in which all
factors of production can become variable. Entry and exit of seller firms can take place
easily. From consumers point of view, short-run refers to a period in which they respond
to the changes in price, given the taste and preferences of the consumers, while longrun is a time period in which the consumers have enough time to respond to price
changes by varying their tastes and preferences.
5. Discounting Principle
According to this principle, if a decision affects costs and revenues in long-run, all those
costs and revenues must be discounted to present values before valid comparison of
alternatives is possible. This is essential because a rupee worth of money at a future
date is not worth a rupee today. Money actually has time value. Discounting can be
defined as a process used to transform future dollars into an equivalent number of
present dollars. For instance, $1 invested today at 10% interest is equivalent to $1.10
next year.
FV = PV*(1+r)t
Where, FV is the future value (time at some future time), PV is the present value (value
at t0, r is the discount (interest) rate, and t is the time between the future value and
present value.
References:
https://www.managementstudyguide.com/principles-managerial-economics.htm,
https://www.economicsdiscussion.net/managerial-economics/tools-used-in-managerialeconomics/7118
TOPIC 5
ROLE OF MANAGERIAL ECONOMIST
A managerial economist helps the management by using his analytical skills and highly
developed techniques in solving complex issues of successful decision-making and
future advanced planning.
The role of managerial economist can be summarized as follows:
1. He studies the economic patterns at macro-level and analysis it’s significance to
the specific firm he is working in.
2. He has to consistently examine the probabilities of transforming an everchanging economic environment into profitable business avenues.
3. He assists the business planning process of a firm.
4. He also carries cost-benefit analysis.
5. He assists the management in the decisions pertaining to internal functioning of a
firm such as changes in price, investment plans, type of goods /services to be
produced, inputs to be used, techniques of production to be employed,
expansion/ contraction of firm, allocation of capital, location of new plants,
quantity of output to be produced, replacement of plant equipment, sales
forecasting, inventory forecasting, etc.
6. In addition, a managerial economist has to analyze changes in macro- economic
indicators such as national income, population, business cycles, and their
possible effect on the firm’s functioning.
7. He is also involved in advising the management on public relations, foreign
exchange, and trade. He guides the firm on the likely impact of changes in
monetary and fiscal policy on the firm’s functioning.
8. He also makes an economic analysis of the firms in competition. He has to
collect economic data and examine all crucial information about the environment
in which the firm operates.
9. The most significant function of a managerial economist is to conduct detailed
research on industrial market.
10. In order to perform all these roles, a managerial economist has to conduct an
elaborate statistical analysis.
11. He must be vigilant and must have ability to cope up with the pressures.
12. He also provides management with economic information such as tax rates,
competitor’s price and product, etc. They give their valuable advice to
government authorities as well.
13. At times, a managerial economist has to prepare speeches for top management.
Corporate Managerial Economic Decisions:
There are at least eight different types of decisions with which business economists are
likely to be associated in a typical company.
1. Demand Forecasting
It is the task of business economists to produce such forecasts. In other
companies, business economists may collaborate with outside consultants who
generate the demand forecasts. Alternatively, the business economist may serve
as an in-house consultant to those in the company who are actually carrying out
the forecasting exercise.
2. Pricing and Competitive Strategy:
Pricing decisions are often within the purview of company economists. However,
pricing problems are merely a subject of a broader class of economic problem
faced by a company: competitive analysis.
Competitive analysis not only requires anticipation of the response of competitors
to the company’s pricing, advertising and marketing (product market) strategies
but also an evaluation of the impact of the company’s sales turnover (or market
share) on alternative marketing strategies employed by competitors.
Rational pricing and competitive marketing decisions are based on considerable
knowledge of specific product markets and industry behaviour on the part of the
business economist.
3. Cost Analysis:
Information on cost is required for decision mak­ing purposes. This requires
thorough cost analysis. Various cost analysis exercises are carried out by the
cost accountants and industrial engineers.
How­ever, in some situations, the production process is so complex that they
necessitate the assistance of a business economist whose task it is to provide an
appropriate conceptual framework for defining costs. Business economists are
also expected to par­ticipate in business cost-benefit analysis. Econo­mists also
assist corporate planners in formulating realistic models of production operations.
4. Supply Forecasting:
In a world of demising resources, supply fore­casting is no less important than
demand forecast­ing. The oil price hike of the 1970s and shortage of other raw
materials have increased the impor­tance of forecasting of factor supplies and
prices.
Supply forecasting is not a micro exercise, i.e., an exercise that can be carried
out at the micro level. Such forecasting is to be based on national and
in­ternational developments — both in economics and politics.
5. Resource Allocation:
Economics is a science of choice making. It deals with the allocation of scarce
resources among com­peting alternatives. If there is scarcity but no alter­natives,
choice making is impossible and the prob­lem is not economic in nature; if there
are alternatives but no scarcity (goods or resources are free) economics is not
required.
Resource allocation is important regardless of the economic and political system
of a country. Products must be produced and resources must be al­located.
Economics is often defined in terms of the problem: “How do we allocate scarce
resources sub­ject to a set of constraints?”
The business economist is concerned with how scarce resources are (or ought to
be) allocated within an enterprise.
6. Government Regulation:
There are endless implications of government regulations on the business firm
and at times the le­gal environment of business is as important as the economic
environment. So, it is necessary to examine law-related applications of economic
principles.
7. Capital Investment Analysis:
Just as production decision is a short-term deci­sion, capital investment decision
is a long-term de­cision. Investment refers to expenditure on capital goods. Such
expenditure may involve lakhs or crores of rupees.
Since resources are limited, compa­nies have to allocate scarce resources
among differ­ent activities or- branches of production. The busi­ness economist
plays an important role in capital budgeting decision which is concerned with
alloca­tion of capital expenditure over time.
8. Management of Public Sector Enterprise
Managerial economics can also be applied to the decision-making process of
non-profit seeking and public sector enterprises. Economists in various
government departments and public sector organi­zations are also concerned
with project evaluation and cost-benefit analysis.
In recent years, many large firms have turned to corporate managerial
economists for help in mak­ing decisions which are critical to “the running of the
business”.
References: https://www.economicsdiscussion.net/managerial-economics/noteson-managerial-economics/19271,
https://www.managementstudyguide.com/managerial-economist-role.htm
TOPIC 6
CONSUMER DEMAND
Demand for a commodity refers to the quantity of the commodity that people are willing
to purchase at a specific price per unit of time, other factors (such as price of related
goods, income, tastes and preferences, advertising, etc) being constant. Demand
includes the desire to buy the commodity accompanied by the willingness to buy it and
sufficient purchasing power to purchase it.
Demand may arise from individuals, household and market. When goods are demanded
by individuals (for instance-clothes, shoes), it is called as individual demand. Goods
demanded by household constitute household demand (for instance-demand for house,
washing machine). Demand for a commodity by all individuals/households in the market
in total constitute market demand.
Demand Function
Demand function is a mathematical function showing relationship between the quantity
demanded of a commodity and the factors influencing demand.
Dx = f (Px, Py, T, Y, A, Pp, Ep, U)
In the above equation,
Dx = Quantity demanded of a commodity
Px = Price of the commodity
Py = Price of related goods
T = Tastes and preferences of consumer
Y = Income level
A = Advertising and promotional activities
Pp = Population (Size of the market)
Ep = Consumer’s expectations about future prices
U = Specific factors affecting demand for a commodity such as seasonal changes,
taxation policy, availability of credit facilities, etc.
Law of Demand
The law of demand states that there is an inverse relationship between quantity
demanded of a commodity and it’s price, other factors being constant. In other words,
higher the price, lower the demand and vice versa, other things remaining constant.
Demand Schedule
Demand schedule is a tabular representation of the quantity demanded of a
commodity at various prices. For instance, there are four buyers of apples in the market,
namely A, B, C and D.
PRICE (Rs.
per dozen)
Demand schedule for apples
Buyer A (demand Buyer B (demand Buyer C (demand Buyer D (demand Market Demand
in dozen)
in dozen)
in dozen)
in dozen)
(dozens)
10
1
0
3
0
4
9
3
1
6
4
14
8
7
2
9
7
25
7
11
4
12
10
37
6
13
6
14
12
45
The demand by Buyers A, B, C and D are individual demands. Total demand by the four buyers is market
demand. Therefore, the total market demand is derived by summing up the quantity demanded of a
commodity by all buyers at each price.
Demand Curve
Demand curve is a diagrammatic representation of demand schedule. It is a
graphical representation of price- quantity relationship. Individual demand curve shows
the highest price which an individual is willing to pay for different quantities of the
commodity. While, each point on the market demand curve depicts the maximum
quantity of the commodity which all consumers taken together would be willing to buy at
each level of price, under given demand conditions.
Demand curve has a negative slope, i.e, it slopes downwards from left to right depicting
that with increase in price, quantity demanded falls and vice versa. The reasons for a
downward sloping demand curve can be explained as follows:
1. Income effect- With the fall in price of a commodity, the purchasing power of
consumer increases. Thus, he can buy same quantity of commodity with less
money or he can purchase greater quantities of same commodity with same
money. Similarly, if the price of a commodity rises, it is equivalent to decrease in
income of the consumer as now he has to spend more for buying the same
quantity as before. This change in purchasing power due to price change is
known as income effect.
2. Substitution effect- When price of a commodity falls, it becomes relatively
cheaper compared to other commodities whose price have not changed. Thus,
the consumer tend to consume more of the commodity whose price has fallen,
i.e, they tend to substitute that commodity for other commodities which have not
become relatively dear.
3. Law of diminishing marginal utility- It is the basic cause of the law of demand.
The law of diminishing marginal utility states that as an individual consumes
more and more units of a commodity, the utility derived from it goes on
decreasing. So as to get maximum satisfaction, an individual purchases in such a
manner that the marginal utility of the commodity is equal to the price of the
commodity. When the price of commodity falls, a rational consumer purchases
more so as to equate the marginal utility and the price level. Thus, if a consumer
wants to purchase larger quantities, then the price must be lowered. This is what
the law of demand also states.
Exceptions to Law of Demand
The instances where law of demand is not applicable are as follows:
1. There are certain goods which are purchased mainly for their snob appeal,
such as, diamonds, air conditioners, luxury cars, antique paintings, etc. These
goods are used as status symbols to display one’s wealth. The more
expensive these goods become, more valuable will be they as status symbols
and more will be their demand. Thus, such goods are purchased more at
higher price and are purchased less at lower prices. Such goods are called as
conspicuous goods.
2. The law of demand is also not applicable in case of giffen goods. Giffen
goods are those inferior goods, whose income effect is stronger than
substitution effect. These are consumed by poor households as a necessity.
For instance, potatoes, animal fat oil, low quality rice, etc. An increase in price
of such good increases its demand and a decrease in price of such good
decreases its demand.
3. The law of demand does not apply in case of expectations of change in price
of the commodity, example, in case of speculation. Consumers tend to
purchase less or tend to postpone the purchase if they expect a fall in price of
commodity in future. Similarly, they tend to purchase more at high price
expecting the prices to increase in future.
Reference: https://www.managementstudyguide.com/managerial-economicsarticles.htm
TOPIC 7
PRICE ELASTICITY OF SUPPLY
Just like the law of demand, the law of supply also explains the qualitative relationship
between price and supply. Qualitative relationships do not reveal the complete picture.
For instance, it helps only up to a certain point to know that the quantity supplied as well
as price move in the same direction. However, this is incomplete information.
Economists and decision makers needed to know the magnitude of this movement. It is
for this reason that they created this concept of price elasticity of supply.
In a way, the concept of price elasticity of supply is a mirror image of the concept of
price elasticity of demand. There are however, some minor differences which will be
discussed in this article. The elasticity of supply is based on the seller’s willingness to
change the quantity supplied at different prices. In this article, we will look at this
concept of elasticity of supply in a little bit more detail:
Concept: The definition of price elasticity of supply is as follows:
The measure of how much the quantity supplied of a good respond to a change in the
price of that good, computed as a percentage change in quantity supplied divided by the
percentage change in price.
In simpler words, the idea is to look at how many percentage points does the supply
change if the price changes by 1%. Based on the law of supply it is assumed that the
change will always be in the same direction, if price moves upwards, so does the
quantity supplied and vice versa.
Calculation:
From the definition discussed above, we can derive the formula for price elasticity of
demand as follows:
Price Elasticity of Supply = Percentage Change in Quantity Supplied / Percentage
Change in Prices
= (Q2-Q1) / Q1 * 100 / (P2-P1) / P1 * 100
Let’s consider an example for better understanding. Let’s say that for a given product X,
the price earlier was $2 and the units supplied were 400. Now, the price increased to
$2.5 and the units supplied have changed to 600. In this case, the calculation will be as
follows:
= (600 - 400) / 400 * 100 / ($2.5 - $2) / $2 * 100
= 50% / 25%
=2
In this case the interpretation is that a 1% change in price will lead to a 2% change in
the quantity supplied. As we can see here, that the elasticity of supply could range
anywhere between negative infinity to positive infinity. However in 95% of the cases, it
will be restricted from negative 10 to positive 10.
In many markets as well as well as industries, the idea that the elasticity of supply
remains the same across the supply curve is not well received. There are economists
who believe that suppliers react more to price changes when they first happen and
when they happen in large magnitudes. Hence, in these cases elasticity may be
computed at multiple points on the same curve to receive different elasticity numbers.
In fact, the concept of elasticity has a major correlation with the shape of the supply
curve. However, discussing the same is beyond the scope of this article.
Only One Type: The price elasticity of supply looks at the market from the point of view
of the supplier. Hence, in almost all cases it is only sensitive to prices. It is not affected
by factors such as income levels of suppliers. Hence, we do not have such a concept as
income elasticity of supply. Also, the supply of one product is less likely to interfere in
the quantity supplied of another product. Hence, cross elasticity of supply is also not
much of a consideration. Hence, unlike elasticity of demand where there are different
types possible, the elasticity of supply is more or less based on a single type.
Reference: https://www.managementstudyguide.com/price-elasticity-of-supply.htm
TOPIC 8
DETERMINANT OF PRICE ELASTICITY OF SUPPLY
Like price elasticity of demand, price elasticity of supply is also dependent on many
factors. Some of these factors are within the control of the organization whereas others
may be beyond their control. Regardless of the control, if the management has
knowledge about these factors, it can manage its supply better.
Here is a list of determinants which generally affect the price elasticity of supply in the
market:
Capacity Addition: The theoretical model stated in the law of supply simply assumes
that supply will be able to adjust up and down as and when the price changes. In doing
so, the law of supply ignores the ground realities that are related with supply.
Consider for instance the fact that most manufactured goods today are mass produced
in massive factories and most of these factories are working to their optimum levels.
Hence, if supply has to be increased new capacity needs to be added- new factories
need to be built.
This obviously means that supply will remain stagnant for a while when capacity is
stagnant and may then increase by leaps and bounds when additional capacity is
introduced. This is an important determinant of elasticity of supply. Products where
capacity can be easily added and reduced have an elastic supply whereas products
where it is difficult to increase or decrease capacity have inelastic demand.
Related Infrastructure Growth: Industry is usually an interconnected supply chain. If
one part of the supply chain grows, whereas the rest of the supply chain remains
stagnant, the growth will be lopsided. This affects the elasticity of supply as well.
Consider the case of agriculture. Let’s assume that farmers have got hold of a
revolutionary technique with which they can increase productivity two fold. However,
more production would mean more warehouses, more cold storages and even more
transport vehicles. If this related infrastructure does not grow, producers may have to
willfully cut down their production to avoid wastage. So, if the related infrastructure is
easily scalable, then the supply of such a product will be highly elastic or else it will be
inelastic.
Perishable vs. Non-Perishable: Storage capacity is not the only issue. The supplier
also needs to consider whether or not the goods that they hold are perishable or not.
Perishable goods have a limited shelf life and the buyers know it.
The buyers can wait for some time and producers will have to lower the prices or take
the losses that arise from wastage. The supply of perishable goods is therefore highly
elastic since whatever has been produced has to be disposed off at the earliest.
However, when it comes to non-perishable goods it has been observed that the supply
is usually inelastic since producers can hold on for as long as they have to. They are
under no immediate compulsion to sell and hence the supply is inelastic.
Length of Production Period: The law of supply assumes that changes in price will
produce an immediate effect in the quantity supplied. This may be theoretically correct.
However, this is not possible in reality for many products.
Production is a time and resource consuming process. Hence, it cannot be scaled up or
down with that much ease. In many cases, the time required for production stretches to
many months or even years. Hence, there is a lagging effect on supply. This is another
important determinant of the elasticity of supply. Products whose production times take
longer have relatively inelastic supply compared to those products where the production
time is less.
Marginal Cost of Production: The law of supply also assumes that the profitability of
the supplier does not change with the number of units sold. That is not the case. In
reality, we have something called the economies of scale and diseconomies of scale.
This influences the marginal cost of production.
Hence, it may sometimes make economic sense to sell more whereas at other times, it
may make more economic sense to sell less! Because producers consider marginal
cost of production while making their decisions, it has become an important determinant
in the elasticity of supply.
Long Run vs. Short Run: In the short run, the supply of all products is more or less
inelastic. This is because there are many factors which producers cannot vary in the
short run. However, in the long run, all the factors are variable and hence the supply of
all products is completely elastic. Hence companies must be careful while making
capital decisions.
The above-mentioned list of factors is not exhaustive. However, using the reasoning
behind these factors one can easily come up with more and more factors that may
determine the price elasticity of supply.
Reference: https://www.managementstudyguide.com/determinants-of-price-elasticity-ofsupply.htm
TOPIC 9
MARKETING AND SEASONAL DEMAND FOR GOODS AND SERVICES
What is Seasonal Demand?
Marketing is the process of meeting needs that are both existing as well as unmet. To
explain, marketers promote and sell goods and services which the consumers want as
well as determine what they want and which does not exist at the moment.
In other words, marketing is all about identifying which goods and services the
consumers would likely to buy and consume as well as determining which goods and
services cater to unmet needs.
This means that marketing is geared towards satiating and satisfying the needs and
desires of consumers. Having said that, there is also the concept of seasonal demand
for goods and services which means that not all goods and services can be marketed
around the year.
For instance, it is during the summer months that the sales of air conditioners and air
coolers spike whereas it is during the winter months that sales of sweaters and other
clothing spike. Therefore, marketers have to be conscious of the seasonal
variations in demand and hence, tailor their strategies accordingly.
What is Elasticity of Demand?
Indeed, the related concept of elasticity which determines the correlation between
goods and services and seasonal variations is an important concept that marketers
must be aware of.
For instance, everyday FMCG (Fast Moving Consumer Goods) are sold throughout the
year since consumers do not stop consuming soaps and detergents as well as
homecare products according to the seasons. In other words, these goods sell
irrespective of the season and hence, they are deemed to be inelastic to seasonal
variations.
On the other hand, goods such as appliances are bought based on the seasons and
hence, they are elastic to the seasonal variations.
Apart from the example of air conditioners that has already been discussed, it would be
worthwhile to note that goods such as washing machines, TVs to some extent, and in
recent years, Smartphones spike during festival seasons because consumers typically
schedule their purchases to coincide with the happy occasions in addition to setting
aside some money for festival purchases.
Real World Examples
In India, it is not uncommon for consumers and families as well as households to buy
large quantities of gold during Danteras which is considered auspicious for buying gold.
Further, consumers also buy luxury and expensive goods during Diwali as such
purchases are deemed to bring good luck and prosperity for the consumers.
Indeed, the fact that in recent years, there has been a tendency to consume more
during certain seasons has led to marketers’ worldwide announcing sales and discount
bargains to coincide with the festival seasons.
While the Western world always had a practice of Christmas sales and the socalled Black Friday where unheard of discounts are offered, the rest of the world is not
witnessing similar phenomenon wherein marketers are targeting the consumers with
heavy discount sales during important festivals.
Indeed, this has become the norm in Asian countries such as China where the Chinese
New Year witnesses frenetic shopping sprees and hence, marketers being acutely
conscious of the spike in demand tailor their ad campaigns and strategies to take
advantage of the consumers’ propensity to buy more goods and consume more
services.
Rise of Consumerist Societies and Global, Local, and Glocal Strategies
So far we have discussed how seasonal demand is changing the marketing strategies.
Turning to the other aspect of marketing which is fulfilling unmet needs, it is also the
case that just like in the West, Asian marketers have begun to identify those unmet
needs that can be satiated and hence, fulfilled.
For instance, the time share holiday resorts are one such strategy wherein marketers
realize that spurring people to take holidays during summer and winter depending on
their unmet need for travel and leisure is fast catching on in China and India.
There are many tour and travel operators who have created compelling holiday
packages for those consumers who would like to take some time off during summer
when their kids have vacations and hence, would like to travel and tour other parts of
the country and even abroad.
Indeed, while traditionally Asian families used the summer vacations to visit their
relatives and other friends and family acquaintances, the current trend is to encourage
them to travel and tour important tourist destinations of historical and cultural
importance as well as a way out to beat the summer heat by holidaying in exotic locales
within the country as well as abroad.
From the points made so far, it is clear that as societies become consumerist, marketers
have to adopt and adapt to the changing consumer preferences as well as aspirations.
While marketing was always about such adaptation, the stakes are higher now than
before since worldwide countries and the consumers are becoming more homogenized
and similar in their preferences. No wonder that the current breed of eCommerce
portals in China and India are adopting and adapting the Western practices of discount
sales and seasonal bargains to the needs of the local markets in which they operates.
This is the so-called Glocal Strategy at work which combines global thinking with local
execution and hence, is considered a sure-fire strategy to ensure that global trends are
merged with local imperatives to create a win-win strategy for all stakeholders.
Indeed, this can be seen in the way the F&B or the Food and Beverages companies
such as Pepsi, Coke, and McDonald’s tailor their marketing strategies to suit seasonal
variations as well as adapt to local tastes so that consumers worldwide would
experience the consumption of global brands without sacrificing their cultural and social
traditions.
Reference: https://www.managementstudyguide.com/marketing-and-seasonal-demandfor-goods-and-services.htm
TOPIC 10
PRODUCTION AND COST ANALYSIS
There are two types of costs:
1. Explicit cost – the cost that involves the actual monetary payment, the cost that
can be seen or identified explicitly. For example, the salary of an employee
2. Implicit cost – the cost that involves the use of the resources of the owner which
do not include actual monetary payments for use, the cost that cannot be seen
explicitly. For example, the interest rate that the owner could earn from the
capital that the owner invested in hi or her company. In short, the implicit cost
refers to the opportunity cost of input used involving the owner.
The economic cost consists of explicit and implicit costs, whereas the accounting cost
consists of explicit costs only. The economic profit is the difference between total
revenue and economic cost whereas accounting profit is the difference between total
revenue and accounting cost. It is clear that due to the implicit costs, economic profit
could be lower or higher than accounting profit.
There are three types of economic profit:
1. Zero economic profit – means that the total revenue is equal to the total
economic cost. It also means that the firm is able to generate reasonable return
that enables it to keep maintain the level of input for business use. It is also
known as normal economic profit. Zero economic profit implies that the firm will
continue its operation as the input is generating commensurate returns.
2. Negative economic profit – means that total revenue is less than total economic
cost. The firm is not able to generate reasonable returns to maintain input for
business use. It is also known as less-than normal economic profit. We expect
firms to cease operations.
3. Positive economic profit – means that total revenue is more than total economic
cost. The firm is generating extra return for its input. It is also known as excess
economic profit. We expect the firm to continue its operation and, in the future,
to face new competing firms that enter into the business due to the attraction of
excess profit.
Input Productivity
The process of production involves the transformation of input into output given a
certain level of technology. The more productivity of the input, the higher the output
produced.
Measurements of Input Productivity
1. Total product (TP) measures the amount of output produced.
2. Average product (AP) measures the amount of output produced by each input.
Average product = total product / total input
3. Marginal product (MP) measures the additional output produced by an additional
unit of input.
Marginal product = change in total product / change in total input
Sample Problem: compute for the average and marginal product with the following
given:
Labor
Total Product
0
0
1
8
2
20
3
26
4
30
5
32
Average Product
Marginal Product
0
0
The short-run cost of production
Types of production cost:
1. Total fixed cost- the cost of using fixed cost. It is constant regardless of the level
of output.
2. Total variable cost – the cost of using variable cost. It varies accordingly to the
level of output.
3. Total cost – the sum of the total fixed cost and the total variable cost.
Formula:
Average total cost – total cost / output
Average fixed cost – total fixed cost / output
Average variable cost = total variable cost / total output
Marginal cost – change in total cost / change in output
Sample Activity:
Output
TFC
TVC TC
0
20
0
20
1
20
60
80
2
20
90
110
3
20
110
130
4
20
120
140
ATC AFC AVC MC
Graded Activity: Candy Factory
Output
TFC
TVC TC
0
10
0
10
1
10
30
40
2
10
60
70
3
10
90
100
4
10
110
120
5
10
130
140
6
10
150
160
7
10
180
190
8
10
200
210
9
10
220
230
ATC AFC AVC MC
TOPIC 11
PERFECT COMPETITION
A market structure in which there are a great number of small firms selling
homogeneous or identical products with none of these firms possessing the market
power and ability to change the price of their products by increasing or restricting
production. Examples are the agricultural market and foreign exchange market
Characteristics:
1.
2.
3.
4.
5.
Many sellers and buyers
Homogeneous products
Price takers
Freedom of entry and exit
Perfect knowledge
As the perfectly competitive firms are price takers, they cannot change the price of their
products but can decide on their output levels.
The perfect competitive firms can make three types of profits in the short-run.
a. Normal profit: TR = TC, the firm is said to make normal or zero profits, also
known as break-even. This is the level of profits where the total revenue is just
enough to cover the total costs, persuading firms to stay in the industry in the
long run but not enough to encourage new firms to enter the industry.
b. Subnormal profit: TR < TC, the firm is said to make subnormal or negative
economic profits also known as losses. This level of negative profits compels
some firms to leave the industry in the long run as they cannot cover their costs.
c. Supernormal profit: TR > TC, the firm is said to make supernormal or positive
economic profits, also known as abnormal profits. This level of profits attracts
new firms into the industry in the long run.
Profit Maximization Output. the profit maximizing output for a firm is the output
where marginal revenue is equals marginal cost.
Agribusiness of Cervania and San Jose
Output
TC
TVC TFC
MC
AFC AVC ATC TR
0
60
40
20
1
75
55
20
24
2
85
65
20
24
3
94
74
20
24
4
102
82
20
24
0
MR
Profits
24
-60
Graded Activity – Jewe Agribusiness
Output
TC
TVC TFC
MC
AFC AVC ATC TR
MR
1
112
92
20
24
2
124
104
20
24
3
139
119
20
24
4
159
139
20
24
5
182
162
20
24
6
212
192
20
24
Profits
TOPIC 12
MONOPOLY AND MONOPOLISTIC COMPETITION
Monopoly refers to a sole seller who produces goods or services that lack viable
substitute goods. Barriers to entry are the fundamental source of monopoly power.
Primary features of a monopoly:
1. Market power- the ability to alter the price of its product
2. Sole seller – a monopoly has no direct competition due to the fact that a patent
gives a firm the exclusive tight to produce a product.
Patent is a grant of property rights to an invention. Example – facebook, google,
apple
Three major types of barriers:
a. Control of natural resources – owing the key resource that is critical to the
production of a final good. Example – DeBeers, the South African diamond
company
b. Legal barriers – provide exclusive control of the production and selling of certain
goods through intellectual property rights including patents and copyrights.
Example – in the early 1990s, Nintendo had effective control of the video game
market.
Intellectual property right – the general term for the assigned property right
through patent, trademark and copyright. It allows the holder to exercise
monopoly on the use of the items for a specified period.
Trademark is a way for a business to help people to identify the products that the
business makes from products by another business. Example – word, phrase,
symbol, logo, design or picture – IBM, NBC, Apple
Copyright is a law that gives the owners of work or legal means to protect an
author’s work. Example- books, poems, plays, songs, films and artwork
c. Economies of scale – decrease the cost for a relatively large range of production,
making a single producer more efficient than a large number of producers.
Example specialized labor or machinery
Other barriers to entry:
1. Capital requirements – large investment in capital is required.
2. Technological superiority – limits and prevents the entry of firms that do not have
sufficient capital to finance the use of the best available technology.
3. Deliberate actions – this includes actions such as collusion and anti-competitive
practice which work to prevent the entry of firms and reduces market
competitiveness
Government – Created Monopolies
Actions have been taken by the government to prevent firm’s entries.
1. By granting a patent and copyright – patents are granted to a firm that
develops a new product or a new method of producing an existing product. A
patent gives an exclusive right to a firm for a period of 20 years for the
invented product. For copyright, the government guarantees that no one is
permitted to print and sell the works without permission.
2. By granting a firm a government franchise – unlike patent or copyright,
government gives a firm an exclusive right to sell a particular product in a
specific market. For example, the Postal service
Natural Monopolies refer to firms that are able to produce a product and sell it in the
market more efficiently than any larger number of smaller firms. Example – utility
service
Price Discrimination is selling the same product at different prices to different
consumers. The purpose of practicing price discrimination is to increase monopolist’s
profits. Successful price discrimination requires a firm having:
a.
b.
c.
d.
Market power
Some consumers with greater willingness to pay more than other consumers pay
Information about prices that consumers are in fact willing to pay
A different market segments
Examples of Price discrimination
1. Pricing with two-part tariffs – this is when a consumer pays an initial fee for the
right to buy the good and an additional fee for unit of related goods purchased.
Example – airline company – charge a price for a seat, an additional fee for
purchase of food, checked luggage
2. Discount Coupons/ vouchers – consumers who spend time collecting coupons
and discounts printed in the newspapers or magazines will enjoy goods at a
lower price than others.
3. Quantity discounts – consumers who buy goods in bulk usually enjoy a discount
rate compared to those who buy in small amounts.
4. Movie/traveling/theme park tickets - charging different price for children and
senior citizens perhaps, they are less willing than others to pay full price.
5. Airlines – the king of price discrimination. Airline companies frequently charge
different prices for different consumers such as working adults and children as
they attempt to fill up as many seats as possible on each flight. Different prices
also may be imposed based on the number of days in advance that a ticket is
purchased.
MONOPOLISTIC COMPETITION
A monopolistically competitive industry is characterized as an industry that
comprises many firms where there is minimal restriction to enter or exit the
industry. Each firm produces goods that are similar but not identical to that
produced by its competitors. It is a hybrid between perfect competition and
monopoly. It is comparable to perfect competition in terms of the large number of
extremely competitive firms operating in the market. It is comparable to the
monopolistic market structure in which each firm in the monopolistically
competitive industry has market control. Example – restaurants, hotels, pubs,
coffee shops, hair salons
Characteristics of Monopolistic Competition
Monopolistic competition is a market structure that has the following
characteristics:
a. A large number of firms operate in the market and firms are free to enter and
exit in the industry
b. Each firm produces a differentiated product and firms compete with each
other in terms of price, product quality and marketing
Number of firms and ease of entry
The presence of a large number of firms in monopolistic competition implies the
following:
a. Small market share
b. Lack of collusion
c. Self-determination of price and output – because there are so many firms,
each one acts independently of others, each firm determines it price and
output without taking into account the reaction of rival firms.
Product Differentiation
Each individual firm or manufacturer has absolute monopoly over its own product
which is slightly different from other similar products. This enables the individual
firm to set its own price, it is a price maker and not a price taker.
There are four main types of differentiation:
1. Physical product differentiation – firms can make their product different in
terms of size, design, color, shape, performance ot other physical features.
Example – electrical goods
2. Marketing differentiation – firms can differentiate their products by distinctive
packaging and other promotional techniques. Example – canned goods for
packaging while promotional techniques could include reward/ loyalty scheme
3. Human capital differentiation – firm can create differences in the services
provided through the skill of its employees, the level of training received,
distinctive uniforms. Example – service with a smile or fast service through an
express counter
4. Differentiation through distribution – firms can use different distribution
networks to reach their buyers. Example online shopping
TOPIC 13
OLIGOPOLY
It is a market structure with a small number of firms, none of which can keep the others
from having a significant influence. The concentration ratio measures the market share
of the largest firms. Examples – cable television services, entertainment (music and
films), pharmaceutical, automobile, cellular phone
Characteristics:
a. A few firms control most of the market share
b. Product could be homogeneous or differentiable
c. Significant barriers to entry exist
The Equilibrium of Oligopoly firms
Mutual interdependence is the central characteristic of oligopoly firms. In achieving
equilibrium (profit maximization), each firm is aware that its actions will influence the
other firms in the market and that the actions of other firms will affect it as well. Thus,
the reactions of other firms need to be taken into consideration.
The Cartel Theory
It assumes that the firms cooperate and act as a group in determining price and output.
it aims to control output in order to increase profit. One of the most obvious problems is
that firms have an incentive to cheat.
The Kinked Demand Curve Theory
According to the Theory of Kinked Demand Curve, the mutual interdependence among
the oligopoly firms is as follows: if one firm decreases price, the other firms will follow
suit; if one firm increases price, other firms will not follow. This implies that at the
equilibrium price, an increase in price will lead to a huge drop in quantity demand and a
decrease in price will leaf to only a slight increase in quantity demand. One important
implication is the price rigidity. Price rigidity is when the price remains stable or rigid as
firm will find no gain to lower it or increase it.
The Price Leadership Theory
There is one large or dominant firm which acts as a price leader and determines the
price in the market. The other firms are fringe and act as price takers, accepting the
price that is fixed by the dominant firm. It is important to note that the dominant firm
determines the price in the market by taking into consideration the reaction of the other
fringe firms in the market. This control can leave the recording firm’s rivals with little
chance but to follow its leader and match the prices if they are to hold their market
share.
Game Theory
It is a mathematical approach to analyzing the strategic behavior of decision makers
who try to achieve equilibrium in a situation of mutual interdependence among the
decision makers. It analyzes the situation as to how the players behave, what their
objectives are and how they achieve the optimal outcome for each player.
The Role of Government
It is its role to protect the welfare of consumers and increase efficiency.
There are three types of mergers or collaboration agreements:
1. Horizontal agreement/ merger – an agreement or merger that involves firms
selling a similar product in the market. Example if the Proton and Perodua (the
two car manufacturers in the Malaysia) enter into agreement of collaboration or
merge.
2. Vertical agreement/merger – an agreement or merger that involves firms in a
similar industry sector but selling products at different levels of production or with
different distribution chains. Example if Proton, the car seller and GT Radial, a
supplier of car tires of Proton enter into an agreement or merger
3. Conglomerate agreement or merger – an agreement or merger that involves
firms in different industry sectors selling different products. Example – if the
Proton, car seller and Tesco, supermarket store enters into an agreement or
merger
Regulating Competition: Antitrust Laws
It prohibits unfair competition and arrangements and combination aimed to restrain
trade or prevent by artificial means free competition in the market.
In the Philippines, Philippine Competition Law (RA10667) promotes and protect
competitive market.
In the US, the Sherman Antitrust Act, the Clayton Act and the Federal Trade
Commission Act
Topic 14
THE RISE OF THE INFORMAL ECONOMY
The Rise of the Informal Economy and the Need to Embrace it and engage with it
What is the Informal Economy or the System D?
We seem them everywhere and we even do business with them without pausing to
think whether they belong to the organized economy or the informal economy. The we
that are being referred to are the street vendors, the service providers, the waiters and
waitresses in restaurants and hotels, the drivers who ferry us around in their taxis and
countless other workers who are faceless and nameless in our interactions as part of
our daily existence.
While the formal economy consists of salaried employees with defined pension
schemes and assured perks and benefits, the workers in the informal economy do not
have such luxuries and instead, they have to contend with variable pay and work that
sometimes dries up, living on the edge of cities, and generally not being counted as part
of the workforce. This rise of the informal economy has been dubbed as the growth of
the “System D” that is as crucial and critical to the success of the global economy as the
formal economy. The workers in this informal economy have been characterized as the
“Precariat” class or those whose lives are forever precarious and liquid. However, the
point to note here is that businesses have begun to realize the importance of this
System D and have started to engage with it and embrace it.
The Perils of Not Including the Informal Economy in the Mainstream
The informal economy does not pay taxes to the government, does not appear in the
official GDP (Gross Domestic Product) figures except in those cases where the
government imputes a certain amount to their contributions based on rough
calculations. This means that the informal economy does not appear in any of the
official policies and programs and is instead operating outside the pale of the
formal and the organized sector. However, estimates suggest that the size of the
informal economy as a percentage of the total economy could be as high as a third or
even half and hence, there has to be a way of estimating and including their
contributions as part of the computation of the statistics. Further, the sheer number of
jobs created by the informal economy makes it a key component of the overall economy
and this is more the reason why businesses and policymakers must step up their efforts
to include this component in the mainstream. Already, there are many countries in Asia
where the courts and the government are devising ways and means of accommodating
the informal economy within the mainstream and regularizing their existence by passing
laws and statutes that absorb them into the formal economy.
The Case for Engagement with the Informal Sector
Studies have shown that by 2020, the informal economies in many parts of the
world would be more than the formal economies and the rise of the mobile,
itinerant, and global workforce that thrives in the parallel realm would be
impossible to ignore. In recent months, Saudi Arabia has started the process of
integrating the informal workers or the Precariat class into the mainstream and India has
already taken steps to engage with the informal sector. Considering the fact that many
businesses that operate in the informal economy do not have an incentive to be part of
the mainstream, there is a need for a deeper engagement with the informal sector and
ensures that it contributes to the mainstream. Further, there is also the aspect of illegal
activities and undesirable elements taking advantage of the fungible nature of the
informal economy and proving to be a threat to the existence of the states.
Finally, in as much as globalization has helped the rise of the global worker, it has also
contributed to the rise of the Precariat class as the shrinking of the world, and the
borderless nature of the process has helped the informal economy more than it has
helped the formal economy. Therefore, one can no longer dismiss the informal economy
as being peripheral and as the points made in this article show, we would soon reach a
situation where the informal economy would overtake the formal one.
Reference: https://www.managementstudyguide.com/currency-wars-and-financialcrisis.htm