IGNOU ASSIGNMENT SOLUTIONS
MASTER OF COMMERCE (MCOM - SEMESTER 1)
MCO-021 - MANAGERIAL ECONOMICS
MCO & 21 /TMA/2024
Question No. 1
Managerial Economics serves as a link between traditional economics and decision sciences for business decision-making.’ Elucidate the statement
considering the role of managerial economics in optimising resource
allocation, forecasting, pricing strategies, and overall organisational
performance.
Answer:
For most purposes economics can be divided into two broad categories, microeconomics and macroeconomics. Macroeconomics as the name suggests is the study of the overall economy and its aggregates such as Gross National Product, Inflation, Unemployment, Exports, Imports, Taxation Policy etc. Macroeconomics addresses questions about changes in investment, government spending, employment, prices, exchange rate of the rupee and so on. Importantly, only aggregate levels of these variables are considered in the study of macroeconomics. But hidden in the aggregate data are changes in output of a number of individual firms, the consumption decision of consumers like you, and the changes in the prices of particular goods and services.
Although macroeconomic issues are important and occupy the time of media and command the attention of the newspapers, micro aspects of the economy are also important and often are of more direct application to the day to day problems facing a manager. Microeconomics deals with individual actors in the economy such as firms and individuals. Managerial economics can be thought of as applied microeconomics and its focus is on the interaction of firms and individuals in markets.
The economy is the institutional structure through which individuals and firms in a society coordinate their desires. Economics is the study of how human beings in a society go about achieving their wants and desires. It is also defined as the study of allocation of scarce resources to satisfy individual wants or desires. The latter is perhaps the best way to broadly define the study of economics in general. The emphasis is on allocation of scarce resources across competing ends. You should recognize that human wants are unlimited whereas means to fulfill those desires are limited and therefore choice is necessary. Choices necessarily involve trade-offs. For example, if you wish to acquire an M.Com degree, you must take time off to devote to study. Your time has many uses and when you devote more time to study you are allocating it to a particular use in order to achieve your goal. Economics would be a most uninteresting subject if resources were unlimited and no trade offs was involved in decision making.
There are many general insights economists have gained into how the economy functions. Economic theory ties together economists’ terminology and knowledge about economic institutions. An economic institution is a physical or mental structure that significantly influences economic decisions. Corporations, governments, markets are all economic institutions. Similarly cultural norms are the standards people use when they determine whether a particular activity or behaviour is acceptable. For example, Hindus avoid meat and fish on Tuesdays. This has an economic dimension as it has a direct impact on the sale of these items on Tuesdays. Further, economic policy is the action usually taken by the government, to influence economic events. And finally, economic reasoning helps in thinking like an economist. Economists analyze questions and issues on the basis of trade-offs i.e. they compare the cost and the benefits of every issue and make decisions based on those costs and benefits.
A close relationship between management and economics has led to the development of managerial economics. Management is the guidance, leadership and control of the efforts of a group of people towards some common objective. While this description does inform about the purpose or function of management, it tells us little about the nature of the management process. Koontz and O’Donell define management as the creation and maintenance of an internal environment in an enterprise where individuals, working together in groups, can perform efficiently and effectively towards the attainment of group goals.
From the point of view of a firm, managerial economics, may be defined as economics applied to “problems of choice” or alternatives and allocation of scarce resources by the firms. Thus managerial economics is the study of allocation of resources available to a firm or a unit of management among the activities of that unit. Managerial economics is concerned with the application of economic concepts and analysis to the problem of formulating rational managerial decisions. There are four groups of problem in both decisions-making and forward planning which are discussed below:
Resource Allocation: Scare resources have to be used with utmost efficiency to get optimal results. These include production programming and problem of transportation etc. How does resource allocation take place within a firm? Naturally, a manager decides how to allocate resources to their respective uses within the firm, while as stated above, the resource allocation decision outside the firm is primarily done through the market. Thus, one important insight you can draw about the firm is that within it resources are guided by the manager in a manner that achieves the objectives of the firm.
Inventory and queuing problem: Inventory problems involve decisions about holding of optimal levels of stocks of raw materials and finished goods over a period. These decisions are taken by considering demand and supply conditions. Queuing problems involve decisions about installation of additional machines or hiring of extra labour in order to balance the business lost by not undertaking these activities.
Pricing Problem: Fixing prices for the products of the firm is an important decision-making process. Pricing problems involve decisions regarding various methods of prices to be adopted.
Investment Problem: Forward planning involves investment problems. These are problems of allocating scarce resources over time. For example, investing in new plants, how much to invest, sources of funds, etc.
Demand analysis and forecasting: It helps a manager in the earliest stage in choosing the product and in planning output levels. A study of demand elasticity goes a long way in helping the firm to fix prices for its products. The theory of cost also forms an essential part of this subject. Estimation is necessary for making output variations with fixed plants or for the purpose of new investments in the same line of production or in a different venture. The firm works for profits and optimal or near maximum profits depend upon accurate price decisions. Theories regarding price determination under various market conditions enable the firm to solve the price fixation problems. Control of costs, proper pricing policies, break-even analysis, alternative profit policies are some of the important techniques in profit planning for the firm which has to work under conditions of uncertainty. Thus managerial economics tries to find out which course is likely to be the best for the firm under a given set of conditions.
Question No. 2
a) In a world of just two goods where all income is spent on the two goods, both goods cannot be inferior. True or False? Explain.
b) Explain the law of diminishing marginal returns and provide an example of the phenomenon.
Answer:
A Part
Demand refers to the quantities of goods that consumers are willing and able to purchase at various prices during a given period of time. For your demand to be meaningful in the marketplace you must be able to make a purchase; that is, you must have enough money to make the purchase. There are, no doubt, many items for which you have a willingness to purchase, but you may not have an effective demand for them because you don’t have the money to actually make the purchase. For example, you might like to have a 3600 -square-foot resort in Mussorie, an equally large beach house in Goa, and a private jet to travel between these places on weekends and between semesters. But it is likely that you have a budget constraint that prevents you from having these items.
For demand to be effective, a consumer must also be willing to make the purchase. There are many products that you could afford (that is, you have the ability to buy them), but for which you may not be willing to spend your income. Each of us has a unique perspective on our own personal satisfaction and the things that may enhance that satisfaction. The important point is that if you do not expect the consumption of something to bring you added satisfaction, you will not be willing to purchase that good or service.
Therefore, you do not have a demand for such things despite the fact that you might be able to afford them. When we discuss demand, we are always referring to purchases made during a given period of time. For example, you might have a weekly demand for soft drinks. If you are willing and able to buy four soft drinks at a price of Rs 5.00 each, your demand is four soft drinks a week. But your demand for shoes may be better described on a yearly basis so that, at an average price of Rs. 800.00 a pair, you might buy three pairs of shoes per year. The important point here is that when we refer to a person’s demand for a product, we usually mean the demand over some appropriate time period, not necessarily over the rest of the person’s life. Think about the last time you spent money. It could have been spent on a car, a computer, a new tennis racquet, or a ticket to a movie, among literally thousands of other things. No matter what you purchased, you decided to buy something because it would please you. You are not forced to make purchases. You do so because you expect them to increase your personal satisfaction. If these things give us satisfaction, we say that they have value to us. Used in this way, value implies value in use. Air has a value in use, because we benefit from breathing air. But air is free. If air has value to us, why is it free? We certainly would be willing to pay for air rather than do without it. But air is available in such abundance that we treat it as a free good. We also get satisfaction from using petrol. Petrol has value in use. But unlike air, we must pay for the petrol we use. That is, petrol has value in exchange as well as value in use. We are willing to exchange something-usually money-for the use of some petrol. Why is air free, but petrol is costly? One important reason is that petrol is scarce, whereas air is abundant. This should start making you think about the role that scarcity plays in the economy. But be careful as you do so. Just because something is scarce does not necessarily mean it will have value in exchange. Another reason that something may not have value in exchange is because it has no value in use. That is, people just do not get any satisfaction from possessing or using it. We all have a limited amount of money that we can exchange for goods and services. The limit varies from individual to individual. For example, a school teacher typically has far less money to spend than a successful investment banker. An unskilled labourer has less money to exchange for goods and services than a skilled labourer. However, we all (even the richest among us) have a limited amount of money for buying things that can bring us satisfaction. As a result, we all make decisions about how we will spend, save, and/or borrow money. This implies that how we choose to allocate our money is an important factor in determining the demand for various goods and services in the economy.
Yd stands for disposable income, that is, the amount of money available to people to spend. The greater the level of disposable income, the more people can afford to buy and hence the higher the level of demand for most products will be. This assumes of course that they are ‘normal’ goods, purchases of which increase with rising levels of income, as opposed to ‘inferior’ goods that are purchased less frequently as income rises. The use of disposable income rather than just income is justified on the grounds that people do not have total control over their gross incomes. There will, for example, be deductions to be made in the form of taxes. Thus, the level of disposable income can change over time, for example changes in tax rates. The effect of changes in disposable income on the demand for individual products will of course be determined by the ways in which it is spent. This is where the fifth variable, tastes (T), needs to be taken into account. Over a period of time, tastes may change significantly, but this may incorporate a wide range of factors. For example, in case of food, greater availability of alternatives may have a significant effect in changing the national diet. Thus, in India for instance, the demand for bajra has fallen over the past years as people have switched to eating rice and wheat instead. Social pressures may also act to alter tastes and hence demand.
On the other hand, shifter variables, as the name implies cause the demand curve to shift i.e., there is a change in demand. Nearly all goods and services are what economists refer to as normal goods. These are goods for which consumption goes up as the incomes of consumers rise, and the converse is also true. In fact, it is rare to find a demand function that does not include some measure of income as an important independent variable. Goods for which consumption increases as the incomes of consumers rise are called normal goods. Goods for which consumption decreases as the incomes of consumers rise are called inferior goods. This relationship between product demand and income is one of the reasons that so much national attention is given to the level of Gross Domestic Product (GDP) and changes in the rate of growth of GDP. The GDP is the broadest measure of income generated in the economy. In demand analysis, other more narrowly defined measures, such as personal income or disposable personal income, are often used; but these measures are highly correlated with GDP. Thus, looking at the changing trends in GDP is helpful for understanding what may happen to the demand for a product.
B Part
In economics, the law of diminishing marginal returns predicts that at an optimal level of production capacity, increasing the unit or adding a factor of production while holding other factors constant results in lower output levels or lower increases in the output rate. The optimal level of production means that the company maintains a balance between its revenues and expenses. It refers to a level wherein they are getting maximum profit at the lowest cost. At this level, adding a source of output may lead to higher costs but lower returns.
The additional unit or factor of production may refer to additional equipment and personnel. In some cases, hiring more people results in a decrease in efficiency because of less workspace and a disorganized production process. This theory applies only in the short term because most of the other production factors remain fixed. In the long term, these factors may change because of their variable characteristics. Economists may also refer to this theory as the Law of Variable Proportions, Law of Increasing Costs, or Principle of Diminishing Marginal Productivity.
The factors of production
The factors of production include three basic resources, which are land, labour, and capital. These work together to translate input into finished goods or services and compose the primary classification. While they facilitate the production process, the production process doesn't transform or convert them and they don't end up as parts of the end products. The secondary factors include materials and energy that become a part of the end product or which the production process uses or transforms.
Assumptions of diminishing marginal returns law
In the law of diminishing marginal returns, the output doesn't necessarily decrease. What happens is it doesn't increase at the rate that it did in the past. For the theory to be valid, there are some assumptions to describe the event:
- The diminishing returns only happen in production settings or functions.
- All technology involved remains constant and the whole production process stays the same.
- All other production factors remain constant and homogeneous and only one increases.
- The event only occurs in the short term.
3 stages of diminishing marginal returns
In a diagram, the law of diminishing returns shows an increasing slope reaching a maximum. After this point, it shows a decreasing function. If all the assumptions fall into place, wherein one factor varies while all the others stay the same, economists classify the behaviour of output into three stages:
1. Increase in marginal returns
The total output increases at an increasing rate with each additional unit of the variable input. This stage results in increasing returns because of the abundance of the fixed factors relative to the variable factors. This means that introducing additional variable factors leads to the business' effective utilization of the fixed factors. Effective utilization of the variable factors also happens at this stage. Because of the sufficient number of the variable factors, introducing specialization and division of labour may happen, resulting in higher productivity.
2. Diminishing returns
Throughout this stage, while the total product keeps on increasing, it does so at a diminishing rate. This results from the marginal product falling and becoming less than the average product. The maximum value of the total product marks the end of this stage. It's important because the business often ramps up production to take advantage of the maximum returns.
This stage is a result of the dilution of the efficiency of the fixed factors. After adding variable factors that lead to the efficient utilization of the fixed inputs, the output starts to diminish. This is because the business' further addition of variable factors after this point overworks or saturates the fixed factors, making the process unproductive.
3. Negative returns
This stage starts from the maximum point, which is the optimal and highest output and returns, followed by a decline. This happens because of the crowding of the variable factors resulting in problematic coordination. The variable and fixed factors start to affect one another, causing a decrease in output.
Causes of diminishing returns
At a certain point in a production process, a business' productivity starts to decline. Companies look for the signs when efficiency starts to decrease to be able to implement preventive action plans. The business may stop its production or re-evaluate its operations and pricing strategy. Diminishing returns may result from the following:
Fixed factors of production: The law of diminishing returns happens because some production factors remain fixed. An increase in production rate results from the effective increase of all production factors, which doesn't happen because of the fixed production factors.
Lower productivity levels: In some instances, hiring additional manpower proves to be counterproductive. Some businesses function effectively with a certain number of employees and adding more may create a chaotic environment because of overcrowding or decrease productivity because of excessive socialization.
Limited demand: Sometimes, while a business hires an additional employee to satisfy a product demand, the job may not cover the full output capacity that the employee can deliver. For example, an employee that can deliver ten units of finished goods may only produce five units if this is the demand, resulting in diminishing returns.
Optimum production: If all the production factors work together perfectly, optimum production takes place. After this point, the addition of more and more variable factors results in less efficient combinations with fixed factors, lowering efficiency and leading to diminishing returns.
Negative impact on the work environment: Adding more employees may lower efficiency and productivity because of overcrowding, which creates an uncomfortable atmosphere. Adding new equipment may also result in unintended consequences, such as a change in the production temperature, which may affect the quality of other products in production and lead to a decrease in returns.
Short term: The law of diminishing marginal returns only happens in the short term. This results from the fact that all factors are variable in the long term, which means that they may adjust and work more efficiently together and produce better returns after a certain point in time.
Example 1
A startup business that develops software solutions for customers built a new office with ten computers in it. The company decides to hire software developers and started with five employees. After five months, the demand for their services increased, prompting them to hire an additional two employees. They saw that the current personnel was inadequate and decided to hire more employees. After another five months, they noticed an increase in cost and a decrease in returns that resulted from the office getting overcrowded and cramped that the employees can't work efficiently anymore.
Example 2
A farmer owns one acre of land. He finalized his decision on how much seed, water, and labour to use for the season, with the exception of the amount of fertilizer. While an increase in the amount of fertilizer results in an increase in the corn yield, using too much may poison the crops.
One unit of fertilizer results in an output of 100 ears of corn. Increasing it to two units results in 250 ears of corn and three units in 425 ears of corn, which gave him a 175 marginal increase. When he added a fourth unit of fertilizer, he got 550 ears of corn. This dropped the marginal output from 175 to 125. This means that the law of diminishing returns is already at work.
Question No. 3
Production is related to costs. In fact, cost function can be derived from estimated production function. In view of empirical determination of production function, can you think of some limitations of statistical analysis relating to cost function? Apart from limitations also explain how these estimated cost function is useful to a manager.
Answer:
Cost function is a mathematical tool that helps economists and business managers to analyze the relationship between production costs and output levels. It can be used to find the optimal level of production that minimizes the total cost, or to compare the efficiency of different production methods. However, cost function is not a perfect representation of reality, and it has some limitations and considerations that need to be taken into account. In this section, we will discuss some of the main challenges and assumptions that are involved in using cost function for economic and business analysis. We will cover the following points:
1. Cost function is based on historical data. This means that it reflects the past behavior of the firm, and it may not be accurate for predicting the future costs. For example, if the firm changes its production technology, or faces new market conditions, the cost function may become obsolete and need to be updated. Moreover, historical data may not be available or reliable for some firms, especially new entrants or innovators, which makes it difficult to estimate their cost function.
2. Cost function is influenced by external factors. These are factors that are beyond the control of the firm, such as the prices of inputs, taxes, subsidies, regulations, demand, competition, etc. These factors can affect the cost function in different ways, depending on the type and degree of their impact. For example, an increase in the price of a key input will increase the cost function, while a decrease in the demand will decrease the output level and the cost function. Therefore, when using cost function, it is important to consider the external factors that may affect the firm's costs and adjust the cost function accordingly.
3. Cost function is subject to different types of errors. These are errors that arise from the estimation and measurement of the cost function, and they can affect the accuracy and validity of the cost function. Some of the common sources of errors are:
- Specification error: This is the error that occurs when the functional form of the cost function is not appropriate for the data. For example, if the cost function is assumed to be linear, but the data shows a nonlinear relationship between costs and output, the cost function will be misspecified and produce biased results.
- Estimation error: This is the error that occurs when the parameters of the cost function are not estimated correctly. For example, if the sample size is too small, or the data is not representative of the population, the estimates of the cost function will be inaccurate and unreliable.
- Measurement error: This is the error that occurs when the data used to estimate the cost function is not measured correctly. For example, if the costs or the output are not recorded properly, or there are errors in the accounting system, the data will be erroneous and affect the cost function.
4. Cost function is based on simplifying assumptions. These are assumptions that are made to simplify the analysis and make the cost function easier to use. However, these assumptions may not hold in reality, and they may limit the applicability and generalizability of the cost function. Some of the common assumptions are:
- Homogeneous output: This is the assumption that the firm produces only one type of output, or that the outputs are identical and can be aggregated into a single measure. However, in reality, many firms produce multiple types of outputs, or outputs that differ in quality, features, or characteristics. In this case, the cost function may not capture the differences in the costs of producing different outputs, and it may overestimate or underestimate the total cost.
- constant returns to scale: This is the assumption that the cost function exhibits constant returns to scale, which means that the cost increases proportionally with the output. However, in reality, many firms experience increasing or decreasing returns to scale, which means that the cost increases more or less than proportionally with the output. In this case, the cost function may not reflect the economies or diseconomies of scale that the firm faces, and it may overstate or understate the optimal level of production.
- No fixed costs: This is the assumption that the cost function does not include any fixed costs, which are costs that do not vary with the output. However, in reality, many firms have fixed costs, such as rent, depreciation, salaries, etc. In this case, the cost function may not account for the sunk costs or the opportunity costs that the firm incurs, and it may ignore the effects of fixed costs on the profitability and the break-even point of the firm.
These are some of the main limitations and considerations of cost function that need to be kept in mind when using it for economic and business analysis. Cost function is a useful and powerful tool, but it is not a flawless or comprehensive one. Therefore, it is important to use it with caution and critical thinking, and to complement it with other methods and tools that can provide more insights and perspectives on the firm's costs and performance.
Limitations of Different Types of Statistical Analysis
Each of the methods discussed above has certain limitations.
1. Both time-series and cross-section analysis are restricted to a relatively narrow range of observed values. Extrapolation of the production function outside that range may be seriously misleading. For example, in a given case, marginal productivity might decrease rapidly above 85% capacity utilization; the production function derived for values in the 70%-85% capacity utilization range would not show this.
2. Another limitation of time series analysis is the assumption that all observed values of the variables pertains to one and the same production function. In other words, a constant technology is assumed. In reality, most firms or industries, however, find better, faster, and/or cheaper ways of producing their output. As their technology changes, they are actually creating new production functions. One way of coping with such technological changes is to make it one of the independent variables.
3. Theoretically, the production function includes only efficient (least-cost) combinations of inputs. If measurements were to conform to this concept, any year in which the production was less than nominal would have to be excluded from the data. It is very difficult to find a time-series data, which satisfy technical efficiency criteria as a normal case.
4. Engineering data may overcome the limitations of time series data but mostly they concentrate on manufacturing activities. Engineering data do not tell us anything about the firm’s marketing or financial activities, even though these activities may directly affect production.
5. In addition, there are both conceptual and statistical problems in measuring data on inputs and outputs.
It may be possible to measure output directly in physical units such as tons of coal, steel etc. In case more than one product is being produced, one may compute the weighted average of output, the weights being given by the cost of manufacturing these products. In a highly diversified manufacturing unit, there may be no alternative but to use the series of output values, corrected for changes in the price of products. One has also to choose between ‘gross value’ and ‘net value’. It seems better to use “net value added” concept instead of output concept in estimating production function, particularly where raw-material intensity is high.
The data on labour is mostly available in the form of “number of workers employed” or “hours of labour employed”. The ‘number of workers’ data should not be used because, it may not reflect underemployment of labour, and they may be occupied, but not productively employed. Even if we use ‘man hours’ data, it should be adjusted for efficiency factor. It is also not advisable that labour should be measured in monetary terms as given by expenditure on wages, bonus, etc.
The data on capital input has always posed serious problems. Net investment i.e. a change in the value of capital stock, is considered most appropriate. Nevertheless, there are problems of measuring depreciation in fixed capital, changes in quality of fixed capital, changes in inventory valuation, changes in composition and productivity of working capital, etc.
Finally, when one attempts an econometric estimate of a production function, one has to overcome the standard problem of multi-collinearity among inputs, autocorrelation, homoscadasticity, etc.
MANAGERIAL USES OF PRODUCTION FUNCTION
There are several managerial uses of the production function. It can be used to compute the least-cost combination of inputs for a given output or to choose the input combination that yields the maximum level of output with a given level of cost. There are several feasible combinations of input factors and it is highly useful for decision-makers to find out the most appropriate among them. The production function is useful in deciding on the additional value of employing a variable input in the production process. So long as the marginal revenue productivity of a variable factor exceeds it price, it may be worthwhile to increase its use. The additional use of an input factor should be stopped when its marginal revenue productivity just equals its price. Production functions also aid long-run decision-making. If returns to scale are increasing, it will be worthwhile to increase production through a proportionate increase in all factors of production, provided, there is enough demand for the product. On the other hand, if returns to scale are decreasing, it may not be worthwhile to increase the production through a proportionate increase in all factors of production, even if there is enough demand for the product. However, it may in the discretion of the producer to increase or decrease production in the presence of constant returns to scale, if there is enough demand for the product.
Question No. 4
Classify and explain different market structures based on certain factors and support your answer with the help of examples.
Answer:
A variety of market structures will characterize an economy. Such market structures essentially refer to the degree of competition in a market.
There are other determinants of market structures such as the nature of the goods and products, the number of sellers, number of consumers, the nature of the product or service, economies of scale etc. We will discuss the four basic types of market structures in any economy.
One thing to remember is that not all these types of market structures actually exist. Some of them are just theoretical concepts. But they help us understand the principles behind the classification of market structures.
Market is a place where goods and services are bought and sold. It is the place where goods are traded in. market is classified into two major classifications. Perfect competition and Imperfect competition. Under imperfect competition monopoly, monopolistic and oligopoly market come.
1. Perfect competition: It is a market structure where large number sellers and buyers are involved in buying and selling of goods at equilibrium price which is fixed by the industry. Good sold in this market are homogenous in nature and have no substitutes. Sellers are price takers as they sell their products at equilibrium price only. This market is hypothetical and is myth as no such market exists actually. It is based on number of hypothetical conditions like no transport cost, no advertisement cost, full knowledge of markets among buyers and sellers etc.
Perfect competition refers to the market structure where competition among the sellers and the buyers exists in its most perfect from. In such a market, there is a single price, which is determined by the interaction of demand and supply.
1.Many Sellers : There are many sellers or firms selling a commodity in the market. Their number is so large that any single seller or firm cannot influence a given market price. So an individual seller or a firm is a price-taker.
2.Many Buyers : There are many actual buyers. Their number is so large that any single buyer cannot influence a given market price. This is because his individual demand is a very small fraction in the total market demand so buyer is also a price-taker.
3.Homogeneous Products : All firms or producers produce and sell identical products i.e. same in respect of size, shape, color, packaging, etc. So there is no difference in between various products, which are perfect substitutes for each other.
4.Free Entry and Exit:-There is perfect freedom for new firms or sellers to enter a market or an industry without any legal, economic, or any other type of restrictions or barriers, Likewise, the existing producers or sellers are free to leave the market.
5.Perfect Knowledge: -There is perfect knowledge on the part of the buyers and sellers regarding the market conditions especially regarding the prevailing market price and quantity of supply. So a single price would prevail (exists) for a commodity in the entire market.
6.Perfect Mobility of Factors of Production: - The factors of production are perfectly free to move from one firm to another or from one industry to another or from one region to another or from one occupation to another. This ensures freedom of entry and exit for individuals and firms.
7.Transport Costs: -It is assumed that there are no transport costs. The transport costs incurred by buyers and sellers to take the advantage of price changes, in a market, are ignored.
8.Non-Intervention by the Government:-It is assumed that the government does not interfere with the working of a market economy, i.e. it does not interfere with the economic activities in the form of controls on the supply of raw materials, tariffs, subsidies, rationing, licensing etc.
2. Imperfect competition:
a. Monopoly: it is a market structure where only singer seller exists with number of buyers. The goods sold by monopolist have no close substitute so cross elasticity of demand is zero in this market. The goods sold are generally of special kind. Monopolist, being the single seller, carries price discrimination and sells the same product to many buyers at different rates. There are many types of monopoly such as legal, natural, technical, pure monopoly.
The word ‘Monopoly’ is derived from two words ‘Mono’ which means single and ‘Poly’ which means sellers. Hence monopoly is a market situation in which there is one seller of product who controls the entire market supply’
1. Single producer or seller: Monopoly is the market structure where only one seller is involved in business activities. He has full control over his business. He is the sole authority to take decision regarding production and pricing policies.
2. No Distinction between Firm and the industry: In this market there is no distinction between firm and industry as it is featured with one seller. There are no competitors. So the distinction between firm and industry disappears.
3. No close substitute: Monopoly market does not face competition there is no close substitute available for his product. The monopolist produces all the output in a market.
4. Absence of competition: There is no competition for monopoly. So the product sold by monopolist has no substitute or complementary product. Cross elasticity of demand is zero in monopoly market.
5. Price maker: Monopoly is a price maker being having control over his business. He does carry price discrimination by charging various prices to different consumers.
6. Complete control : Monopoly has complete control over the production and market supply. Decision about production is the sole decision of his. Entry to new firms are restricted.
7. Downward Sloping demand curve : Monopolist faces a downward sloping demand curve which indicates that it can sell more at a lower price.
b. Monopolistic competition: It is a market where are there are many sellers and buyers who are engaged in selling and buying goods. This market is a combination of perfect competition and monopoly. Prof. Chamberlin gave term’ Group ‘to this market as it has independent policies still competes in the open market. No entry is restricted in this market. This market deals in differentiation goods which are not exactly identical. Selling cost is the main feature of this market as without advertisement this market cannot sustain.
Monopolistic competition was introduced by Prof. E.H. Chamberlin and Prof. Mrs. Joan Robinson. Monopolistic competition is the type of market structure where there exist monopoly on one side and perfect competition on other side. Simply we can also say that it is a mixture of monopoly and perfect competition.
1.Large number of firm :In a Monopolistic competition there is relatively large number of firms each satisfying a small share of the market demand for the product. As there are large number of firms there exists stiff competition between them. But the size of the firm will be relatively small.
2.Product Differentiation : In a Monopolistic competition the products produced by various firms are not identical but slightly different from each other, which means the products are not same but are similar and hence their prices are not much different. They are close substitutes of each other.
3.Selling Cost : Firms in Monopolistic competition incur expenditure to promote sales, which is called as ‘Selling Cost’. Selling cost is incurred in the form of advertisement like on T.V., Radio, Press, Exhibitions, free samples etc. Selling cost tries to influence consumers demand and promote sales.
4.Free entry and exist : In a Monopolistic competition it is easy for the new firms to enter and the existing firm to leave it. Free entry means that when in the industry existing firms are making supernormal profit new firms enter in the industry and the losses will compel them to leave the industry or group.
5.Absence of Interdependence : Under Monopolistic competition firms are large but not their size. They are too small. It means every firm has its own policies like production, output, price policy etc. Thus the policy of an individual firm cannot influence the policy of other firms which means all firms are independent but not interdependent.
6.Concept of Group : In Monopolistic Competition the word ‘industry’ loses its significance as Prof. Chamberlin has used the word ‘Group’ which means number of producers whose goods are fairly close substitutes.
7.Nature of Demand Curve :-In a Monopolistic competition the demand curve slopes downward from left to right, which an individual firms can sell more by lowering price. DD curve of monopolistic always slopes negatively.
C. Oligopoly: This market structure has a few sellers and many buyers. The sellers in this market have interdependence policies and compete with each other with competitive nature. Survival is difficult in this market as competition is tough and there is reaction of each seller for other seller’s action of policies. Price rigidity is the main feature of this market. Cartel is an example of such as market.
Oligopoly is a market situation where there are only few sellers in a given line at production. Mr. Feller defines Oligopoly as “Competition among the few”. In this type of market the firm may be producing either homogeneous products or may be having product differentiation in the given line of production. Features:-
1. Few Sellers:-Under Oligopoly there are few sellers producing or supplying either homogeneous products or differentiated products.
2. Interdependence:-The firms have a high degree of interdependence in their business policies about fixing of price and determination of output.
3. Advertisement & selling cost :-Advertisement and selling cost have strategic importance to the firms under oligopoly. Each firm tries to attract maximum number of consumers towards its products by spending huge amount of money on advertisement and publicity.
4. High Cross elasticity’s of demand:-Under Oligopoly the firms have a high degree of cross elasticity’s of demand. So there is always a fear of retaliation by the rivals. For e.g. if coke reduces its price by 2 Rs. Pepsi may retaliate by reducing its price by 3 Rs.
5. Constant Struggle:-Competition is of unique type in a Oligopolistic market. Here competition consists of constant struggle of rivals against rivals (competitors).
6. Lack of Uniformity:-In Oligopoly the size of the firms are not uniform. Some firms are very big in size and some firms are very small in size. Uneven sizes of firms are found in this market.
7. Price Rigidity:-In Oligopoly market each firm sticks to its own price. This is because it is in constant fear of retaliation by the rivals if it reduces the price.
8. Kinked Demand Curve:-According to Mr. Paul Sweezy firm is an Oligopolistic market have Kinky demand curve. This is because when a firm changes its price the other firms also change their price. Hence the demand curve of an Oligopolistic is not definite it goes on changing.
Question No. 5
Write short notes on the following :
a) Opportunity cost
b) Marginal cost
c) Monopoly power
d) Determinants of Price Elasticity
Answer:
