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if it is a science whether it is a positive science or a normative science or both. Economics - As a science and as an art: Often a question arises - whether Economics is a science or an art or both. (a) Economics is a science: A subject is considered science if It is a systematised body of knowledge which studies the relationship between cause and effect. It is capable of measurement. It has its own methodological apparatus. It should have the ability to forecast. If we analyse Economics, we find that it has all the features of science. Like science it studies cause and effect relationship between economic phenomena. To understand, let us take the law of demand. It explains the cause and effect relationship between price and demand for a commodity. It says, given other things constant, as price rises, the demand for a commodity falls and vice versa. Here the cause is price and the effect is fall in quantity demanded. Similarly like science it is capable of being measured, the measurement is in terms of money. It has its own methodology of study (induction and deduction) and it forecasts the future market condition with the help of various statistical and non-statistical tools. But it is to be noted that Economics is not a perfect science. This is because Economists do not have uniform opinion about a particular event. The subject matter of Economics is the economic behaviour of man which is highly unpredictable. Money which is used to measure outcomes in Economics is itself a dependent variable. It is not possible to make correct predictions about the behaviour of economic variables. (b) Economics is an art: Art is nothing but practice of knowledge. Whereas science teaches us to know art teaches us to do. Unlike science which is theoretical, art is practical. If we analyse Economics, we find that it has the features of an art also. Its various branches, consumption, production, public finance, etc. provide practical solutions to various economic problems. It helps in solving various economic problems which we face in our day-to-day life. Thus, Economics is both a science and an art. It is science in its methodology and art in its application. Study of unemployment problem is science but framing suitable policies for reducing the extent of unemployment is an art. SCOPE OF MANAGERIAL OR BUSINESS ECONOMICS Managerial economics is a developing science which generates the countless problems to determine its scope in a clear-cut way. From the following fields, we can examine the scope of business economics. 1. Demand analysis and forecasting. The foremost aspect regarding scope is demand analysis and forecasting. A business firm is an economic unit which transforms. productive resources into saleable goods. Since all output is meant to be sold, accurate estimates of demand help a firm in minimising its costs of production and storage. A firm must decide its total output before preparing its production schedule and deciding on the resources to be employed. Demand forecasts serves as a guide to the management for maintaining its market share in competition with its rivals, thereby securing its profit. 2. Cost and production analysis. A firm's profitability depends much on its costs of production. A wise manager would prepare cost estimates of a range of output, identify the factors causing variations in costs and choose the cost-minimising output level, taking also into consideration the degree of uncertainty in production and cost calculations. Production process are under the charge of engineers but the business manager works to carry out the production function analysis in order to avoid wastages of materials and time. Sound pricing policies depend much on cost control. The main topics discussed under cost and production analysis are: Cost concepts, cost-output relationships, Economies and Diseconomies of scale and cost control.
3. Pricing decisions, policies and practices. Another task before a business manager is the pricing of a product. Since a firm's income and profit depend mainly on the price decision, the pricing policies and all such decisions are to be taken after careful analysis of the nature of the market in which the firm operates. The important topics covered in this field of study are : Market Structure Analysis, Pricing Practices and Price Forecasting. 4. Profit management. Each and every business firms are tended for earning profit, it is profit which provides the chief measure of success of a firm in the long period. Economists tells us that profits are the reward for uncertainity bearing and risk taking. A successful business manager is one who can form more or less correct estimates of costs and revenues at different levels of output. The more successful a manager is in reducing uncertainity, the higher are the profits earned by him. It is therefore, profit-planning and profit measurement constitute the most challenging area of business economics. 5. Capital management. Still another most challenging problem for a modern business manager is of planning capital investment. Investments are made in the plant and machinery and buildings which are very high. Therefore, capital management require top- level decisions. It means capital management i.e., planning and control of capital expenditure. It deals with Cost of capital, Rate of Return and Selection of projects. 6. Inventory management: A firm should always keep an ideal quantity of stock. If the stock is too much, the capital is unnecessarily locked up in inventories At the same time if the level of inventory is low, production will be interrupted due to non-availability of materials. Hence, a firm always prefers to have an optimum quantity of stock. Therefore, managerial economics will use some methods such as ABC analysis, inventory models with a view to minimising the inventory cost. 7. Linear programming and theory of games : Linear programming and theory of games have came to be regarded as part of managerial economics recently. 8. Environmental issues: There are certain issues of macroeconomics which also form a part of managerial economics. These issues relate to general business, social and political environment in which a business enterprise operates. 9. Business cycles: Business cycles affect business decisions. They refer to regular fluctuations in economic activities in the country. The different phases of business cycle are depression, recovery, prosperity, boom and recession. Thus, managerial economics comprises both micro and macro-economic theories. The subject matter of managerial economics consists of all those economic concepts, theories and tools of analysis which can be used to analyse the business environment and to find out solution to practical business problems. DIFFERENCE BETWEEN BUSINESS ECONOMICS AND ECONOMICS Economics is the social science that studies the production, distribution, and consumption of goods and services. Economics aims to explain how economies work and how economic agents interact. Economic analysis is applied throughout society, in business and finance but also in crime, education, the family, health, law, politics, religion, social institutions, and war. Economic textbooks distinguish between microeconomics ("small" economics), which examines the economic behavior of agents (including individuals and firms) and "macroeconomics" ("big" economics), addressing issues of unemployment, inflation, monetary and fiscal policy. Business economics (also called managerial economics), is a branch of economics that applies microeconomic analysis to specific business decisions. As such, it bridges economic theory and economics in practice. It draws heavily from quantitative techniques such as regression analysis and correlation, Lagrangian calculus (linear). If there is a unifying theme that runs through most of business economics it is the attempt to optimize business decisions given the firm's objectives and given constraints imposed by scarcity, for example through the use of operations research and programming.
Opportunity cost is the cost of any activity measured in terms of the value of the best alternative that is not chosen (that is foregone). It is the sacrifice related to the second best choice available to someone, or group, who has picked among several mutually exclusive choices.[1] The opportunity cost is also the cost of the foregone products after making a choice. Opportunity cost is a key concept in economics, and has been described as expressing "the basic relationship between scarcity and choice".[2] The notion of opportunity cost plays a crucial part in ensuring that scarce resources are used efficiently.[3] Thus, opportunity costs are not restricted to monetary or financial costs: the real cost of output foregone, lost time, pleasure or any other benefit that provides utility should also be considered opportunity costs. Explicit costs Explicit costs are opportunity costs that involve direct monetary payment by producers. The opportunity cost of the factors of production not already owned by a producer is the price that the producer has to pay for them. For instance, a firm spends $100 on electrical power consumed, their opportunity cost is $100. The firm has sacrificed $100, which could have been spent on other factors of production. Implicit costs Implicit costs are the opportunity costs that involve only factors of production that a producer already owns. They are equivalent to what the factors could earn for the firm in alternative uses, either operated within the firm or rent out to other firms. For example, a firm pays $300 a month all year for rent on a warehouse that only holds product for six months each year. The firm could rent the warehouse out for the unused six months, at any price (assuming a year-long lease requirement), and that would be the cost that could be spent on other factors of production. TIME VALUE OF MONEY The time value of money is the value of money figuring in a given amount of interest earned over a given amount of time. The time value of money is the central concept in finance theory.
For example, $100 of today's money invested for one year and earning 5% interest will be worth $105 after one year. Therefore, $100 paid now or $105 paid exactly one year from now both
have the same value to the recipient who assumes 5% interest; using time value of money terminology, $100 invested for one year at 5% interest has a future value of $105.[1]This notion dates at least to Martn de Azpilcueta (14911586) of the School of Salamanca. The method also allows the valuation of a likely stream of income in the future, in such a way that the annual incomes are discounted and then added together, thus providing a lump-sum "present value" of the entire income stream. All of the standard calculations for time value of money derive from the most basic algebraic expression for the present value of a future sum, "discounted" to the present by an amount equal to the time value of money. For example, a sum of FV to be received in one year is discounted (at the rate of interest r) to give a sum of PV at present: PV = FV rPV = FV/(1+r). MARGINALISM Marginalism refers to the use of marginal concepts in economic theory. Marginalism is associated with arguments concerning changes in the quantity used of a good or service, as opposed to some notion of the over-all significance of that class of good or service, or of some total quantity thereof. Market Forces and Equilibrium Summary: Explains market equilibrium and the relation between market demand and supply. Details how market forces determinepricing. Market equilibrium is the situation where, at a certain price level, the quantity demanded by consumers and the quantity supplied by producers of a particular commodity are equal. This means that the market is completely clear of excess supply and demand, and there isn't any tendency for change to either price or quantity. At market equilibrium, consumers are willing to pay the market pricefor the commodity in question and producers are willing and able to sell their goods at that market priceand at that quantity. The price mechanism is a device used to determine the equilibriumprice and equilibrium quantity of goods and also demonstrates how market forces work to achieve market equilibrium. The price mechanism assumes that there is no intervention on the part of the government and the market structure is a pure.
UNIT-2 Cardinal Utility Analysis/Approach: Definition and Explanation: Human wants are unlimited and they are of different intensity. The means at the disposal of a man are not only scarce but they have alternative uses. As a result of scarcity of recourses, the consumer cannot satisfy all his wants. He has to choose as to which want is to be satisfied first and which afterward if the recourses permit. The consumer is confronted in making a choice. For example, a man is thirsty. He goes to the market and satisfy his thirst by purchasing coca cola instead of tea. We are here to examine the economic forces which make him purchase a particular commodity. The answer is simple. The consumer buys a commodity because it gives him satisfaction. In technical term, a consumer purchases a commodity because it has utility for him. We now examine the tools which are used in the analyzes of consumer behavior. Assumptions of Cardinal Utility Analysis: The main assumption or premises on which the cardinal utility analysis rests are as under. (i) Rationality. The consumer is rational. He seeks to maximize satisfaction from the limited income which is at his disposal. (ii) Utility is cardinally measurable. The utility can be measured in cardinal numbers such as 1, 3, 10, 15, etc. The utility is expressed in imaginary cardinal numbers tells us a great deal about the preference of the consumer for a good. (iii) Marginal utility of money remains constant. Another important premise of cardinal utility of money spent on the purchase of a good or service should remain constant. (iv) Diminishing marginal utility. It is also assumed that the marginal utility obtained from the consumption of a good diminishes continuously as its consumption is increased. (v) Independent utilities. According to the Cardinalist school, the utility which is derived from the consumption of a good is a function of the quantity of that good alone. If does not depend at all upon the quantity consumed of other goods. The goods, we can say, possess independent utilities and are additive.
for each other in the satisfaction of various particular wants. As such the marginal utility will decline as the consumer gets additional units of a specific good.Thirdly, the marginal utility of money is constant given the consumers wealth.
From the above table, it is clear that in a given span of time, the first glass of water to a thirsty man gives 20 units of utility. When he takes second glass of water, the marginal utility goes on down to 12 units; When he consumes fifth glass of water, the marginal utility drops down to zero and if the consumption of water is forced further from this point, the utility changes into disutility (-3). Curve/Diagram of Law of Diminishing Marginal Utility:
The law of diminishing marginal utility can also be represented by a diagram.
Schedule:
Units of Money 1 2 3 4 5 $5 MU of Tea 10 8 6 4 2 Total Utility = 30 MU of Cigarettes 12 10 8 6 3 Total Utility = 30
A rational consumer would like to get maximum satisfaction from $5.00. He can spend money in three ways: (i) $5 may be spent on tea only. (ii) $5 may be utilized for the purchase of cigarettes only. (iii) Some rupees may be spent on the purchase of tea and some on the purchase of cigarettes.
These economist are the of view that it is wrong to base the theory of consumption on two assumptions: (i) That there is only one commodity which a person will buy at one time. (ii) The utility can be measured. Their point of view is that utility is purely subjective and is immeasurable. Moreover an individual is interested in a combination of related goods and in the purchase of one commodity at one time. So they base the theory of consumption on the scale of preference and the ordinal ranks or orders his preferences.
Assumptions:
The ordinal utility theory or the indifference curve analysis is based on four main assumptions. (i) Rational behavior of the consumer: It is assumed that individuals are rational in making decisions from their expenditures on consumer goods. (ii) Utility is ordinal: Utility cannot be measured cardinally. It can be, however, expressed ordinally. In other words, the consumer can rank the basket of goods according to the satisfaction or utility of each basket. (iii) Diminishing marginal rate of substitution: In the indifference curve analysis, the principle of diminishing marginal rate of substitution is assumed. (iv) Consistency in choice: The consumer, it is assumed, is consistent in his behavior during a period of time. For insistence, if the consumer prefers combinations of A of good to the combinations B of goods, he then remains consistent in his choice. His preference, during another period of time does not change. Symbolically, it can be expressed as: If A > B, then B > A (iv) Consumers preference not self contradictory: The consumers preferences are not self contradictory. It means that if combinations A is preferred over combination B is preferred over C, then combination A is preferred over combination A is preferred over C. Symbolically it can be expressed: If A > B and B > C, then A > C (v) Goods consumed are substitutable: The goods consumed by the consumer are substitutable. The utility can be maintained at the same level by consuming more of some goods and less of the other. There are many combinations of the two commodities which are equally preferred by a consumer and he is indifferent as to which of the two he receives.
Example:
For example, a person has a limited amount of income which he wishes to spend on two commodities, rice and wheat. Let us suppose that the following commodities are equally valued by him: Various Combinations: a) 16 Kilograms of Rice Plus 2 Kilograms of Wheat b) 12 Kilograms of Rice Plus 5 Kilograms of Wheat c) 11 Kilograms of Rice Plus 7 Kilograms of Wheat d) 10 Kilograms of Rice Plus 10 Kilograms of Wheat e) 9 Kilograms of Rice Plus 15 Kilograms of Wheat It is matter of indifference for the consumer as to which combination he buys. He may buy 16 kilograms of rice and 2 kilograms of wheat or 9 kilograms of rice and 15 kilograms of wheat. All these combinations are equally preferred by him. An indifference curve thus is composed of a set of consumption alternatives each of which yields the same total amount of satisfaction. These combinations can also be shown by an indifference curve.
In fig. 3.1 we measure the quantity of wheat along X-axis (in kilograms) and along Y-axis, the quantity of rice (in kilograms). IC is an indifference curve. It is shown in the diagram that a consumer may buy 12 kilograms of rice and 5 kilograms of wheat or 9 kilograms of rice and 15 kilogram of wheat. Both these combinations are equally preferred by him and he is indifferent to these two combinations. When the scale of preference of the consumer is graphed, by joining the points a, b, c, d, e, we obtain an Indifference Curve IC. Every point on indifference curve represents a different combination of the two goods and the consumer is indifferent between any two points on the indifference curve. All the combinations are equally desirable to the consumer. The consumer is indifferent as to which combination he receives. The Indifference Curve IC thus is a locus of different combinations of two goods which yield the same level of satisfaction.
Formula:
MRSxy = Y X It may here be noted that the marginal rate of substitution (MRS) is the personal exchange rate of the consumer in contrast to the market exchange rate.
Diagram/Figure:
The concept of marginal rate of substitution (MRS) can also be illustrated with the help of the diagram.
In the fig. 3.3 above as the consumer moves down from combination 1 to combination 2, the consumer is willing to give up 4 units of good Y (Y) to get an additional unit of good X (X). When the consumer slides down from combinations 2, 3 and 4, the length of Y becomes smaller and smaller, while the length of X is remain the same. This shows that as the stock of the consumer for good X increases, his stock of good Y decreases. He, therefore, is willing to give less units of Y to obtain an additional unit of good X. In other words, the MRS of good X for good Y falls as the consumer has more of good X and less of good Y. The indifference curve IC slopes downward from left to the right. This means a negative and diminishing rate of substitution of one commodity for the other.
Schedule:
The various alternative market baskets (combinations of goods) are shown in the table below: Market Basket Packets of Biscuits Per Week Packets of Coffee Per Week A 10 0 B 8 1 C 6 2 D 4 3
E 2 4 F 0 5 Income $60 Per Week = Packets of Biscuits Costs $6 = Packets of Coffee is Priced $12 Each
(i) Market basket A in the table above shows that if the whole amounts of $60 is spent on the purchase
of biscuits, then the consumer buys 10 packets of biscuits at a price of $6 each and nothing is left to purchase coffee. (ii) Market basket F shows the other extreme. If the consumer spends the entire amount of $60 on the purchase of coffee, a maximum of 5 packets of coffee can be purchased with it at a price of $12 each with nothing left over for the purchase of biscuits. (iii) The intermediate market baskets B to E shows the mixes of packets of biscuits and packets of coffee that the cost a total of $60. For example, in combination of market basket C, the consumer can purchase 6 packets of biscuits and 2 packets of coffee with a total cost of $60.
Budget Line:
The budget line is an important element analysis of consumer behavior. The indifference map shows peoples preferences for the combination of two goods. The actual choices they will make, however, depends on their income. The budget line is drawn as a continuous line. It identifies the options from which the consumer can choose the combination of goods.
Diagram/Figure:
In the fig. 3.9 the line AF shows the various combinations of goods the consumer can purchase. This line is called the budget line. The slope of the budget line indicates how many packets of biscuits a purchaser must give up to buy one more packet of coffee. For example, the slope at point B on the budget line is Y / X or two packets of biscuits 1 = packet of coffee. This indicates that a move from B to C involves sacrificing two packets of biscuits to gain an additional one packet of coffee. Since AF budget line is straight, the slope is constant at -2 packets of biscuits per one packet of coffee at all points along the line.
Conditions:
Thus the consumers equilibrium under the indifference curve theory must meet the following two conditions: First: A given price line should be tangent to an indifference curve or marginal rate of satisfaction of good X for good Y (MRSxy) must be equal to the price ratio of the two goods. i.e. MRSxy = Px / Py Second: The second order condition is that indifference curve must be convex to the origin at the point of tangency.
Assumptions:
The following assumptions are made to determine the consumers equilibrium position. (i) Rationality: The consumer is rational. He wants to obtain maximum satisfaction given his income and prices. (ii) Utility is ordinal: It is assumed that the consumer can rank his preference according to the satisfaction of each combination of goods. (iii) Consistency of choice: It is also assumed that the consumer is consistent in the choice of goods. (iv) Perfect competition: There is perfect competition in the market from where the consumer is purchasing the goods. (v) Total utility: The total utility of the consumer depends on the quantities of the good consumed.
Explanation:
The consumers consumption decision is explained by combining the budget line and the indifference map. The consumers equilibrium position is only at a point where the price line is tangent to the highest attainable indifference curve from below.
Diagram/Figure:
In the diagram 3.11, there are three indifference curves IC , IC and IC . The price line PT is tangent to 2 the indifference curve IC at point C. The consumer gets the maximum satisfaction or is in equilibrium at point C by purchasing OE units of good Y and OH units of good X with the given money income. The consumer cannot be in equilibrium at any other point on indifference curves. For instance, point R 1 and S lie on lower indifference curve IC but yield less satisfaction. As regards point U on indifference 3 curve IC , the consumer no doubt gets higher satisfaction but that is outside the budget line and hence not achievable to the consumer. The consumers equilibrium position is only at point C where the price 2 line is tangent to the highest attainable indifference curve IC from below.
(2) Slope of the Price Line to be Equal to the Slope of Indifference Curve:
The second condition for the consumer to be in equilibrium and get the maximum possible satisfaction is only at a point where the price line is a tangent to the highest possible indifference curve from below. In 2 fig. 3.11, the price line PT is touching the highest possible indifferent curve IC at point C. The point C shows the combination of the two commodities which the consumer is maximized when he buys OH units of good X and OE units of good Y. Geometrically, at tangency point C, the consumers substitution ratio is equal to price ratio Px / Py. It implies that at point C, what the consumer is willing to pay i.e., his personal exchange rate between X and Y (MRSxy)is equal to what he actually pays i.e., the market exchange rate. So the equilibrium condition being Px / Pybeing satisfied at the point C is: Price of X / Price of Y = MRS of X for Y The equilibrium conditions given above states that the rate at which the individual is willing to substitute commodity X for commodity Y must equal the ratio at which he can substitute X for Y in the market at a given price.
THEORY OF DEMAND
Meanings and Definition of Demand: The word 'demand' is so common and familiar with every one of us that it seems superfluous to define it. The need for precise definition arises simply because it is sometimes confused with other words such as desire, wish, want, etc. Demand in economics means a desire to possess a good supported by willingness and ability to pay for it. If your have a desire to buy a certain commodity, say a car, but you do not have the adequate means to pay for it, it will simply be a wish, a desire or a want and not demand. Demand is an effective desire, i.e., a desire which is backed by willingness and ability to pay for a commodity in order to obtain it.
Characteristics of Demand:
There are thus three main characteristic's of demand in economics. (i) Willingness and ability to pay. Demand is the amount of a commodity for which a consumer has the willingness and also the ability to buy. (ii) Demand is always at a price. If we talk of demand without reference to price, it will be meaningless. The consumer must know both the price and the commodity. He will then be able to tell the quantity demanded by him. (iii) Demand is always per unit of time. The time may be a day, a week, a month, or a year. Example: For instance, when the milk is selling at the rate of $15.0 per liter, the demand of a buyer for milk is 10 liters a day. If we do not mention the period of time, nobody can guess as to how much milk we consume? It is just possible we may be consuming ten liters of milk a week, a month or a year.
when the price of Giffen good falls, its demand also falls. There is a positive price effect in case of Giffen goods.
Diagram/Figure:
Here the price of a commodity falls from $8 to $2. As a result, therefore, the quantity demanded increases from 100 units to 400 units per unit of time. There is extension in demand by 300 units. This movement is from one point price quantity combination (a) to another point (b) along
a given demand curve. On the other hand, if the price of a good rises from $2 to $8, there is contraction in demand by 300 units. We, thus, see that as a result of change in the price of a good, the consumer moves along the given demand curve. The demand curve remains the same and does not change its position. The movement along the demand curve is designated as change in quantity demanded.
Diagram/Figure:
In this figure, (4.4) the original demand curve is DD/. At a price of $12 per unit, consumers purchase 100 units. When price falls to$4 per unit, the quantity demanded increases to 500 units per unit of time. Let us assume now that level of income increases in a community. Now consumers demand 300 units of the commodity at price of $12 per unit and 600 at price of $4 per unit. As a result, there is an upward shift of the demand curve DD2. In case the community income falls, there is then decrease in demand at price of $12 per unit. The quantity demanded of a good falls to 50 units. It is 300 units at price of $4 unit per period of time. There is a downward shift of the demand to the left of the original demand curve.
the quantity demanded is measured to changes, in its price, the elasticity is said be price elasticity of demand.
Formula:
The formula for measuring price elasticity of demand is: Price Elasticity of Demand = Percentage in Quantity Demand
Percentage Change in Price Ed = q X P p Q The elasticity coefficient is greater than one. Therefore the demand for the good is elastic.
Types:
The concept of price elasticity of demand can be used to divide the goods in to three groups. (i) Elastic. When the percent change in quantity of a good is greater than the percent change in its price, the demand is said to be elastic. When elasticity of demand is greater than one, a fall in price increases the total revenue (expenditure) and a rise in price lowers the total revenue (expenditure).
When with a percentage fall in price, the quantity demanded increases so much that it results in the increase in total expenditure, the demand is said to be elastic (Ed > 1). For Example:
Price Per Unit ($) 20 10 Quantity Demanded 10 Pens 30 Pens Total Expenditure ($) 200.0 300.0
(ii) Unitary Elasticity. When the percentage change in the quantity of a good demanded equals percentage in its price, the price elasticity of demand is said to have unitary elasticity. When elasticity of demand is equal to one or unitary, a rise or fall in price leaves total revenue unchanged.
When a percentage fall in price raises the quantity demanded so much as to leave the total expenditure unchanged, the elasticity of demand is said to be unitary (Ed = 1). For Example:
Price Per Pen ($) 10 5 Quantity Demanded 30 60 Total Expenditure ($) 300 300
(iii) Inelastic. When the percent change in quantity of a good demanded is less than the
percentage change in its price, the demand is called inelastic. When elasticity of demand is inelastic or less than one, a fall in price decreases total revenue and a rise in its price increases total revenue. When a percentage fall in price raises the quantity demanded of a good so as to cause the total expenditure to decrease, the demand is said to be inelastic or less than one, i.e., Ed < 1.
For Example:
Price Per Pen ($) 5 2 Quantity Demanded 60 100 Total Expenditure ($) 300 200
Formula:
The formula for measuring the income elasticity of demand is the percentage change in demand for a good divided by the percentage change in income. Putting this in symbol gives. Ey = Percentage Change in Demand Percentage Change in Income Simplified formula: Ey = q X P p Q.
Types:
When the income of a person increases, his demand for goods also changes depending upon whether the good is a normal good or an inferior good. For normal goods, the value of elasticity is greater than zero but less than one. Goods with an income elasticity of less than 1 are called inferior goods. For example, people buy more food as their income rises but the % increase in its demand is less than the % increase in income.
Formula:
The formula for measuring, cross, elasticity of demand is: Exy = % Change in Quantity Demanded of Good X % Change in Price of Good Y The numerical value of cross elasticity depends on whether the two goods in question are substitutes, complements or unrelated.
balls (say by 6%). The cross elasticity of demand which are complementary to each other is, therefore, 6% / 7% = 0.85 (negative). (iii) Unrelated Goods. The two goods which a re unrelated to each other, say apples and pens, if the price of apple rises in the market, it is unlikely to result in a change in quantity demanded of pens. The elasticity is zero of unrelated goods.
(ii) Measurement of Elasticity on a Non Linear Demand Curve: If the demand curve is non linear, then elasticity at a point can be measured by drawing a tangent at the particular point. This is explained with the help of a figure given below:
In figure 6.10, the elasticity on DD/ demand curve is measured at point C by drawing a tangent. At point C: Ed = BM = BC = 400 = 2 (>1). MO CA 200
5. In the Sphere of International Trade: It is of greater significance in the sphere of international trade. It helps to calculate the terms of trade and the consequent gain from foreign trade. If the demand for home product is inelastic, the terms of trade will be profitable to the home country.
DEMAND FORECASTING
Forecasting simply refers to estimating or anticipating future events. It is an attempt to foresee the future by examining the past. Thus demand forecasting means estimating or anticipating future demand on the basis of past data. Objectives of Demand Forecasting A. Short Term Objectives 1. To help in preparing suitable sales and production policies. 2. To help in ensuring a regular supply of raw materials. 3. To reduce the cost of purchase and avoid unnecessary purchase. 4. To ensure best utilization of machines. 5. To make arrangements for skilled and unskilled workers so that suitable labour force may be maintained. 6. To help in the determination of a suitable price policy. 7. To determine financial requirements. 8. To determine separate sales targets for all the sales territories. 9. To eliminate the problem of under or over production. B. Long term Objectives 1. To plan long term production. 2. To plan plant capacity. 3. To estimate the requirements of workers for long period and make arrangements. 4. To determine an appropriate dividend policy. 5. To help the proper capital budgeting. 6. To plan long term financial requirements. 7. To forecast the future problems of material supplies and energy crisis. ME T H O D S O F DEMAND FORECASTING (FOR ESTABLISHED PRODUCTS) There are several methods to predict the future demand. All methods can be broadly classified into two. (A) Survey methods, (B) Statistical methods (A)Survey methods Under this method surveys are conducted to collect information about the future purchase plans of potential consumers. Survey methods help in obtaining information about the desires, likes and dislikes of consumers through collecting the opinion of experts or by interviewing the consumers. Survey methods are used for short term forecasting. Important survey methods are (a) consumers interview method, (b) collective opinion or sales force opinion methodic) experts opinion method, (d) consumers clinic and (f) end use method. (a) Consumers' interview method (Consumers survey): Under this method, consumers are interviewed directly and asked the quantity they would like to buy. After collecting the data, the total demand for the product is calculated. This is done by adding up all individual demands. Under the consumer interview method, either all consumers or selected few are interviewed. When all the consumers are interviewed, the method is known as complete enumeration method. When only a selected group of consumers are interviewed, it is known as sample survey method
Advantages 1. It is a simple method because it is not based on past record. 2. It suitable for industrial products. 3. The results are likely to be more accurate. 4. This method can be used for forecasting the demand of a new product. Disadvantages 1. It is expensive and time consuming. 2. Consumers may not give their secrets or buying plans. 3. This method is not suitable for long term forecasting. 4. It is not suitable when the number of consumer is large. (b)Collective opinion method: Under this method the salesmen estimate the expected sales in their respective territories on the basis of previous experience. Then demand is estimated after combining the individual forecasts (sales estimates) of the salesmen. This method is also known as sales force opinion method. Advantages This method is simple. 1. It is based on the first hand knowledge of Salesmen. 2. This method is particularly useful for estimating demand of new products. 3. It utilises the specialised knowledge of salesmen who are in close touch with the prevailing market conditions. Disadvantages 1. The forecasts may not be reliable if the salespeople are not trained. 2. It is not suitable for long period estimation. 3. It is not flexible. (c)Experts' opinion method: This method was originally developed at Rand Corporation in 1950 by Olaf Helmer, Dalkey and Gordon. Under this method, demand is estimated on the basis of opinions of experts and distributors other than salesmen and ordinary consumers. This method is also known as Delphi method. Delphi is the ancient Greek temple where people come and prey for information about their future. Advantages 1. Forecast can be made quickly and economically 2. This is a reliable method because estimates are made on the basis of knowledge and experience of sales experts. 3. The firm need not spare its time on preparing estimates of demand. 4. This method is suitable for new products. Disadvantages 1. This method is expensive. 2. This method sometimes lacks reliability Statistical Methods Statistical methods use the past data as a guide for knowing the level of future demand. Statistical methods are generally used for long run forecasting. These methods are used for established products. Statistical methods include: (i) Trend projection method, (ii) Regression and Correlation, (iii) Extrapolation method, (iv) Simultaneous equation method, and (v) Barometric method. (i)Trend projection method: Future sales are based on the past sales, because future is the grand-child of the past and child of the present. Under the trend projection method demand is
estimated on the basis of analysis of past data. This method makes use of time series (data over a period of time). We try to ascertain the trend in the time series. The trend in the time series can be estimated by using any one of the following four methods: (a) Least-square method, (b) Free- hand method, (c) Moving average method and (d) semi-average method. (ii) Regression and Correlation: These methods combine economic theory and statistical technique of estimation. Under these methods the relationship between the sales (dependent variable) and other variables (independent variables such as price of related goods, income, advertisement etc.) is ascertained. Such relationship established on the basis of past data may be used to analyse the future trend. The regression and correlation analysis is also called the econometric model building. (iii) Extrapolation: Under this statistical method, the future demand can be extrapolated by applying Binomial expansion method. This method is used on the assumption that the rate of charge in demand in the past has been uniform. (iv) Simultaneous equation method.-This involves the development of a complete econometric model which can explain the behaviour of all the variables which the company can control. This method is not very popular. (v) Barometric technique: This is an improvement over the trend projection method. According to this technique the events of the present can be used to predict the directions of change m the future. Here certain economic and statistical indicators from the selected time series are used to predict variables. Personal income, non-agricultural placements, gross national income, prices of industrial materials, wholesale commodity prices, industrial production, bank deposits etc. are some of the most commonly used indicators. Advantages of Statistical Methods 1The method of estimation is scientific 2Estimation is based on the theoretical relationship between sales (dependent variable) and price, advertising, income etc. (independent variables) 3These are less expensive. 4Results are relatively more reliable. Disadvantages of Statistical Methods 1These methods involve complicated calculations. 2These do not rely much on personal skill and experience. 3These methods require considerable technical skill and experience in order to be effective.
UNIT-3
Meaning of Production Production is the conversion of input into output. The factors of production and all other things which the producer buys to carry out production are called input. The goods and services produced are known as output. Thus production is the activity that creates or adds utility and value. In the words of Fraser, "If consuming means extracting utility from matter, producing means creating utility into matter". According to Edwood Buffa, Production is a process by which goods and services are created" Basic Concepts in Production Theory The firm is an organisation that combines and organises labour, capital and land or raw materials for the purpose of producing goods and services for sale. The aim of the firm is to maximise total profits or achieve some other related aim, such as maximising sales or growth. The basic production decision facing the firm is how much of the commodity or services to produce and how much labour, capital and other resources or inputs to use to produce that output most efficiently. To answer these questions, the firm requires engineering or technological data on production possibilities (the so called production function) as well as economic data on input and output prices. Production refers to the transformation of inputs or resources into outputs of goods and services. For example: IBM hires workers to use machinery, parts and raw materials in factories to produce personal computers. The output of a firm can either be a final commodity (such as personal computer) or an intermediate product such as semiconductors (which are used in the production of computers and other goods). The output can also be a service rather than a good. Examples of services are education, medicine, banking, communication, transportation and many others. To be noted is, that production refers to all of the activities involved in the production of goods and services, from borrowing to set up or expand production facilities, to hiring workers, purchasing ra"w materials, running quality control, cost accounting and so on, rather than referring merely to the physical transformation of inputs into outputs of goods and services. Factors of Production As already stated, production is a process of transformation of factors of production (input) into goods and services (output). The factors of production may be defined as resources which help the firms to produce goods or services. In other words, the resources required to produce a given product are called factors of production. Production is done by combining the various factors of production. Land, labour, capital and organisation (or entrepreneurship) are the factors of production (according to Marshall). We can use the word CELL to help us remember the four factors of production: C. capital; Entrepreneurship; L land: and L labour. Characteristics of Factors of Production 1.The ownership of the factors of production is vested in the households. 2.There is a basic distinction between factors of production and factor services. It is these factor services, which are combined in the process of production. 3.The different units of a factor of production are not homogeneous. For example, different plots of land have different level of fertility. Similarly labourers differ in efficiency. 4.Factors of production are complementary. This means their co-operation or combination is necessary for production. 5.There is some degree of substitutability between factors of production. For
example, labour can be substituted for capital to a certain extent. Production Function Production is the process by which inputs are transformed in to outputs. Thus there is relation between input and output. The functional relationship between input and output is known as production function. The production function states the maximum quantity of output which can be produced from any selected combination of inputs. In other words, it states the minimum quantities of input that are necessary to produce a given quantity of output. The production function is largely determined by the level of technology. The production function varies with the changes in technology. Whenever technology improves, a new production function comes into existence. Therefore, in the modern times the output depends not only on traditional factors of production but also on the level of technology. The production function can be expressed in an equation in which the output is the dependent variable and inputs are the independent variables. The equation is expressed as follows: Q= f (L, K, Tn) Where, Q = output L = labour K = capital T = level of technology n = other inputs employed in production. There are two types of production function - short run production function and long run production function. In the short run production function the quantity of only one input varies while all other inputs remain constant. In the long run production function all inputs are variable. Law of Variable Proportion The law of variable proportion is the modern approach to the 'Law of Diminishing Returns (or The Laws of Returns). This law was first explained by Sir. Edward West (French economist). Adam Smith, Ricardo and Malthus (Classical economists) associated this law with agriculture. This law was the foundation of Recardian Theory of Rent and Malthusian theory of population. The law of variable proportion shows the production function with one input factor variable while keeping the other input factors constant. The law of variable proportion states that, if one factor is used more and more (variable), keeping the other factors constant, the total output will increase at an increasing rate in the beginning and then at a diminishing rate and eventually decreases absolutely. According to K. E. Boulding, "As we increase the quantity of any one input which is combined with a fixed quantity of the other inputs, the marginal physical productivity of the variable input must eventually decline". Assumptions of the Law The law of variable proportion is valid when the following conditions are fulfilled: 1.The technology remains constant. If there is an improvement in the technology, due to inventions, the average and marginal product will increase instead of decreasing. 2.Only one input factor is variable and other factor are kept constant. 3.All the units of the variable factors are identical. They are of the same size and quality. 4.A particular product can be produced under varying proportions of the input combinations. 5.The law operates in the short run.
Importance of the Law of Variable Proportion The law of variable proportion is one of the most fundamental laws of Economics. The law of variable proportion is applicable not only to agriculture but also to other constructive industries like mining, fishing etc. It is applied to secondary or tertiary sectors too. This law helps the management in the process of decision making. LAWS OF RETURNS TO SCALE The law of variable proportion analyses the behaviour of output when one input factor is variable and the other factors are held constant. Thus it is a short run analysis. But in the long run all factors are variable. When all factors are changed in same proportion, the behaviour of output is analysed with laws of returns to scale. Thus law of returns to scale is a long run analysis. In the long period, output can be increased by varying all the input Factors this law is concerned, not with the proportions between the factors of production, but with the scale of production. The scale of production of the firm is determined by those input factors which cannot be changed in the short period. The term return to scale means the changes in output as all factors change in the same proportion. The law of returns to scale seeks to analyse the effects of scale on the level of output. If the firm increases the units of both factors labour and capital, its scale of production increases. The return to scale may be increasing, constant or diminishing. We shall now examine these three kinds of returns to scale. Increasing Returns to Scale When inputs are increased in a given proportion and output increases in a greater proportion, the returns to scale are said to be increasing. In other words, proportionate increase in all factors of production results in a more than proportionate increase in output It is a case of increasing returns to scale. For example, if the inputs are increased by 40% and output increased by 50%, return to scale are increasing (= >1). It is the first stage of production. If the industry is enjoying increasing returns, then its marginal product increases. As the output expands, marginal costs come down. The price of the product also comes down. Constant Return to Scale When inputs are increased in a given proportion and output increases in the same proportion, constant return to scale is said to prevail. For example, if inputs are increased by 40% and output also increases by 40%, the return to scale are said to be constant ( = 1). This may be called homogeneous production function of the first degree. In case of constant returns to scale the average output remains constant. Constant returns to scale operate when the economies of the large scale production balance with the diseconomies. Decreasing Returns to Sale Decreasing returns to scale is otherwise known as the law of diminishing returns. This is an important law of production. If the firm continues to expand beyond the stage of constant returns, the stage of diminishing returns to scale will start operate. A proportionate increase in all inputs results in less than proportionate increase in output, the returns to scale is said to be decreasing. For example, if inputs are increased by 40%, but output increases by only 30%, ( = < 1), it is a case of decreasing return to scale. Decreasing return to scale implies increasing costs to scale. Production Function with Two Variable Inputs So far we have assumed that the firm is increasing output either by using more of one input (in
laws of return) or more of all inputs (in laws of returns to scale). Let us now consider the case when the firm is expanding production by using more of two inputs (varying) that are substitutes for each other. A production function with two variable inputs can be represented by isoquants. Isoquant is a combination of two terms, namely, iso and quant. Iso means equal. Quant means quantity. Thus isoquant means equal quantity or equal product. Isoquants are the curves which represent the different combination of inputs producing a particular quantity of output. Any point on the isoquant represents or yields the same level of output. Thus isoquant shows all possible combinations of the two inputs (say labour and capital) capable of producing equal or a given level of output. Isoquants are also known as iso product curves or equal product curves or production indifferent curves. An isoquant may be explained with the following example: Equal Product Combinations Combination A B C D Units of labour 20 15 11 8 Units of Capital TotalOutput 1 1000 2 3 4 1000 1000 1000
E 6 5 1000 In the above schedule, there are five possible combinations. All the five combinations yield the same level of output i.e. 1000 units. 20 units of labour and 1 unit of capital produce 1000 units. 15 units of labour and 2 units of capital also produce 1000 units and so on. All combination are equally likely because all of them produce the same level of output i.e. 1000 units. Now if plot these combination of labour and capital, we shall get a curve. This curve is known as an isoquant. In the below diagram units of capital are measured on horizontal axis and units of labour on vertical axis. The five combinations are known as A, B, C, D and E. After joining these points, we get the iso product curve IQ. Here we assume that the level of technology remains constant. We also assume that the input can be substituted for each other. If quantity of labour is reduced, the quantity of capital must be increased to produce the same output. Thus an isoquant shows various combinations of the two inputs in the existing state of technology which produce the same level of output.
Example:
The explicit cost includes wages and salary payments, expenses on the purchase of raw material, light, fuel, advertisements, transportation, taxes and depreciation charges.
Example:
For instance, if a person is working as a manager in his own firm or has invested his own capital or has built the factory at his own land, the reward of all these factors of production at least equal to their transfer prices is, included in the expenses of a business. Implicit costs, thus, are the alternative costs of the self-owned and self-employed resources of a firm. The total costs of a business enterprise is the sum total of explicit and implicit costs. If the implicit costs are not included in the firm's total cost, the cost of the firm will be understated and it will result in serious error.
Example:
The opportunity cost of a good can be given a money value. For instance, a labor is working in a factory and is getting $2000 P.M. The entrepreneur is paying him this amount because he can earn this amount in the next best alternative employment. If he pays less than this amount, he will move to next best alternative occupation, where he can get $2000 P.M. So in order to obtain a productive service say labor in the present occupation, the cost should be equal to the amount which he can get in some alternative occupation. Similarly, a piece of land or capital must be paid as much as they could earn in their next best alternative use. The total alternative earnings of the various factors employed in the production of a good constitute the opportunity cost of a good. In a money economy, opportunity or transfer cost is defined as the amount of money which a firm must make to resource suppliers m order to attract these resources away from alternative lines of production. In the words of Lipsay: "The opportunity cost of using any factor is what is currently foregone by using it"
Normal Profit:
By normal profit of the entrepreneur is meant in economics the sum of money which is necessary to keep an entrepreneur employed in a business. This remuneration should be equal to the amount which he can earn in some other alternative occupation. If this alternative return is not met, he will leave the enterprise and join alternative line of production.
Explanation:
Short run costs of a firm is now explained with the help of a schedule and diagrams.
Schedule:
(in Dollars) Total Fixed Units of Output (in Hundred) Cost 0 1 2 3 4 5 6 1000 1000 1000 1000 1000 1000 1000 Total Variable Cost 0 60 100 150 200 400 700 Total Cost 1000 1060 1100 1150 1200 1400 1700
7 1000 1100 2100 The short run cost data of the firm shows that total fixed cost TFC (column 2) remains constant at $1000/regardless of the level of output. The column 3 indicates variable cost which is associated with the level of output. Total variable cost is zero when production is zero. Total variable cost increases with the increase in output. The variable does not increase by the same amount for each increase in output. Initially the variable cost increases by a rd smaller amount up to 3 unit of output and after which it increases by larger amounts.
Column (4) indicates total cost which is the sum of TFC + TVC. The total cost increases for each level of th output. The rise in total cost is more sharp after the 4 level of output. The concepts of costs, i.e., (1) total fixed cost (2) total variable cost and (3) total cost can be illustrated graphically.
In this diagram (13.1) the total fixed cost of a firm is assumed to be $1000 at various levels of output. It remains the same even if the firm's output is zero.
In the figure (13.2), the total variable cost curve (TVC) increases with the higher level of output. It starts from the origin. Then increases at a diminishing rate up to the 4th units of output. It then begins to rise at an increasing rate.
In the figure (13.3), total cost curve which is the sum of the total fixed cost and variable cost at various levels of output has nearly the same shape. The difference between the two is by only a fixed amount of $1,000. The total variable cost curve and the total cost curve begin to rise more rapidly as production is increased. The reason for this is that after a certain output, the business has passed its most efficient use of its fixed costs machinery, building etc., and its diminishing return begins to set in.
Average Cost:
Definition and Explanation:
The entrepreneurs are no doubt interested in the total costs but they are equally concerned in knowing the cost per unit of the product. The unit cost figures can be derived from the total fixed cost, total variable cost and total cost by dividing each of them with corresponding output.
Types/Classifications:
(1) Average Fixed Cost (AFC):
Average fixed cost refers to fixed cost per unit of output. Average fixed Cost is found out by dividing the total fixed cost by the corresponding output.
Diagram/Curve:
The concept of average fixed cost can be explained with the help of the curve, in the diagram (13.4) the average fixed cost curve gradually falls from left to right showing the level of output. The larger the level of output, the lower is the average fixed cost and smaller the level of output, the greater is the average fixed cost. The AFC never becomes zero.
Formula:
AVC = TVC (Q)
When in the beginning, a firm is not producing to its full capacity, then the various factors of production employed for the manufacture of a particular commodity remain partially absorbed. As the output of the firm is increased, they are used to its fullest extent. So the AVC begins to decrease. When the plant works to its full capacity, the AVC is at its minimum. If the production is pushed further from the plant capacity, then less efficient machinery and less, efficient labour may have to be employed. This results in the rise of AVC. It is in this way we say that as the output of a firm increases, the AVC decreases in the beginning, reaches a minimum and then increases. The AVC can also be represented in the form of a curve.
Diagram/Curve:
The shape of the average variable cost curve (Fig. 13.5) is like a flat U-shaped curve. It shows that when the output is increased, there is a steady fall in the average variable cost due to increasing returns to variable factor. It is minimum when 500 meters of doth are produced. When production is increased to 600 meters, of cloth or more, the average variable cost begins to increase due to diminishing returns to the variable factor.
Formula:
ATC = Total Cost (TC) Output (Q)
Diagram/Curve:
The average total cost is represented here by a shaped curve in Fig. (13.6). The average total cost curve is also like a U-shaped curve. It shows that as production increases from 100 meters to 200 meters of cloth, the cost falls rapidly, reaches a minimum but then with higher level of output, the average fixed cost begins to increase.
Diagram/Figure:
In the diagram 13.7 given above, there are five alternative scales of plant SAC SAC , SAC , SAC and, 5 SAC . In the long run, the firm will operate the scale of plant which is most profitable to it. For example, if the anticipated rate of output is 200 units per unit of time, the firm will choose the 1 smallest plant It will build the scale of plant given by SAC and operate it at point A. This is because of the fact that at the output of 200 units, the cost per unit is lowest with the plant size 1 which is the smallest of all the four plants. In case, the volume of sales expands to 400, units, the size of the plant will be 2 increased and the desired output will be attained by the scale of plant represented by SAC at point B, If 3 the anticipated output rate is 600 units, the firm will build the size of plant given by SAC and operate it at point C where the average cost is $26 and also the lowest The optimum output of the firm is obtained at 3 point C on the medium size plant SAC . If the anticipated output rate is 1000 per unit of time the firm would build the scale of plant given by 5 SAC and operate it at point E. If we draw a tangent to each of the short run cost curves, we get the long average cost (LAC) curve. The LAC is U-shaped but is flatter than tile short run cost curves. Mathematically expressed, the long-run average cost curve is the envelope of the SAC curves. In this figure 13.7, the long-run average cost curve of the firm is lowest at point C. CM is the minimum cost at which optimum output OM can be, obtained.
Example:
For example, the total cost of producing one pen is $5 and the total cost of producing two pens is $9, then the marginal cost of expanding output by one unit is $4 only (9 - 5 = 4). The marginal cost of the second unit is the difference between the total cost of the second unit and total cost of the first unit. The marginal cost of the 5th unit is $5. It is the difference between the total cost of the 6th unit and the total cost of the, 5th unit and so forth. Marginal Cost is governed only by variable cost which changes with changes in output. Marginal cost which is really an incremental cost can be expressed in symbols.
Formula:
Marginal Cost = Change in Total Cost = TC Change in Output q The readers can easily understand from the table given below as to how the marginal cost is computed:
Schedule:
Units of Output 1 2 3 4 5 6 Total Cost (Dollars) 5 9 12 16 21 29 Marginal Cost (Dollars) 5 4 3 4 5 8
Graph/Diagram:
MC curve, can also be plotted graphically. The marginal cost curve in fig. (13.8) decreases sharply with smaller Q output and reaches a minimum. As production is expanded to a higher level, it begins to rise at a rapid rate.
It is clear from the diagram (13.9), that the long run marginal cost curve and the long run average total cost curve show the same behavior as the short run marginal cost curve express with the short run average total cost curve. So long as the average cost curve is falling with the increase in output, the marginal cost curve lies below the average cost curve. When average total cost curve begins to rise, marginal cost curve also rises, passes through the minimum point of the average cost and then rises. The only difference between the short run and long run marginal cost and average cost is that in the short run, the fall and rise of curves LRMC is sharp. Whereas In the long run, the cost curves falls and rises steadily.
Elements of Market:
The essentials of a market are: (i) Presence of goods and services to be exchanged. (ii) Existence of one or more buyers and sellers. (iii) A place or a region where buyers and sellers of a good get in close touch with each other.
Features/Characteristics or Conditions:
(1) Large number of firms. The basic condition of perfect competition is that there are large number of firms in an industry. Each firm in the industry is so small and its output so negligible that it exercises little influence over price of the commodity in the market. A single firm cannot influence the price of the product either by reducing or increasing its output. An individual firm takes the market price as given and adjusts its output accordingly. In a competitive market, supply and demand determine market price. The firm is price taker and output adjuster. (2) Large number of buyers. In a perfect competitive market, there are very large number of buyers of the product. If any consumer purchases more or purchases less, he is not in a position to affect the market price of the commodity. His purchase in the total output is just like a drop in the ocean. He, therefore, too like the firm, is a price taker.
(3) The product is homogeneous. Another provision of perfect competition is that the good produced by all the firms in the industry is identical. In the eyes, of the consumer, the product of one firm (seller) is identical to that of another seller. The buyers are indifferent as to the firms from which they purchase. In other words, the cross elasticity between the products of the firm is infinite. (4) No barriers to entry. The firms in a competitive market have complete freedom of entering into the market or leaving the industry as and when they desire. There are no legal, social or technological! barriers for the new firms (or new capital) to enter or leave the industry. Any new firm is free to start production if it so desires and stop production and leave the industry if it so wishes. The industry, thus, is characterized by freedom of entry and exit of firms. (5) Complete information. Another condition for perfect competition is that the consumers and producers possess perfect information about the prevailing price of the product in the market. The consumers know the ruling price, the producers know costs, the workers know about wage rates and so on. In brief, the consumers, the resource owners have perfect knowledge about the current price of the product in the market. A firm, therefore, cannot charge higher price than that ruling in the market. If it does so, its goods will remain unsold as buyers will shift to some other seller. (6) Profit maximization. For perfect competition to exist, the sole objective of the firm must be to get maximum profit.
Equilibrium of the Firm Under Perfect Competition orMarginal Revenue = Marginal Cost (MR = MC) Rule: Definition and Explanation:
A firm under perfect competition faces an infinitely elastic demand curve or we can say for an individual firm, the price of the commodity is given in the market. The firm while making changes in the amounts of variable factor evaluates the extra cost incurred on producing extra unit MC (Marginal Cost). It also examines the change in total receipts which results from the sale of extra unit of production MR (Marginal Revenue). So long as the additional revenue from the sale of an extra unit of product (MR) is greater than the additional cost (MC) which a firm has to incur on its production, it will be in the interest of the firm to increase production. In economic terminology, we can say, a firm will go on expanding its output so long as the marginal revenue of any unit is greater than its marginal cost. As production increases, marginal cost begins to increase after a certain point. When both marginal revenue and marginal cost are equal, the firm is in equilibrium. The firm at this equilibrium point is cither ensuring maximum profit or minimizing losses. This is shown with the help of a diagram below:
Diagram/Figure:
In the figure (15.2) quantity of output is measured along OX axis and marginal cost and marginal revenue on OY axis. The marginal cost curve cuts the marginal revenue curve at two points K and T. The competitive firm is in equilibrium, at both these points as marginal cost equals marginal revenue. The firm will not produce OM quantity of good because for OM output, the marginal cost is higher than marginal revenue. Marginal cost curve cuts the marginal revenue curve from above. The firm incurs loss equal to the black shaded area for producing 50 units (OM) of output. As production is increased from 50 units to 350 units (from OM to OS) marginal cost decreases at early levels of output and then increases thereafter. The marginal cost curve cuts the marginal revenue curve from below at point T. The shaded portion between M to S level of output shows profit on production.
When a firm produces OS quantity of output; it earns maximum profit. The point T where MR = MC is the point of maximum profit. In case, the firm increases the level of output from OS, the additional output adds less to Its revenue than to its cost. The firm undergoes losses as is shown in the shaded area. Summing up, profit maximization normally occurs at the rate of output at which marginal revenue equals marginal cost. This golden rule holds good for all market structures. As regards the absolute profits and losses of the firm, they depend upon the relation between average cost and average revenue of the firm.
Short Run Equilibrium of the Price Taker Firm Under Perfect Competition: Definition and Explanation:
By short run is meant a length of time which is not enough to change the level of fixed inputs or the number of firms in the industry but long enough to change the level of output by changing variable inputs. In short period, a distinction is made of two types of costs (i) fixed cost and (ii) variable cost. The fixed cost in the form of fixed factors i.e., plant, machinery, building, etc. does not vary with the change in the output of the firm. If the firm is to increase or decrease its output, the change only takes place in the quantity of variable resources such as labor, raw material, etc. Further, in the short run, the demand curve facing the firm is horizontal. No new firms enter or leave the industry. The number of firms in the industry, therefore, remain the same. Under perfect competition, the firm takes the price of the product as determined in the market. The firm sells all its output at the prevailing market price. The firm, in other words, is a price taker.
Short Run Supply Curve of a Price Taker Firm: Definition and Explanation:In a competitive market, the supply curve of a firm is derived
from its marginal cost curve. Supply curve is that portion of the marginal cost curve which lies above the average variable cost curve. As we already know, the aim of the firm is to maximize profits or minimize losses. The profits are increased it the difference between total receipts and total costs is maximized. When a firm undertakes the production of a particular commodity, it has to pay remuneration to all the factors of production employed. The remuneration or cost of the firm for a short period can be divided into two parts, fixed costs and variable costs. If from the sale of the commodity produced, a firm is earning much more than what it has to spend on it. We say a firm is earning abnormal profits if the total revenue of the firm is equal to total cost, the firm is getting normal profits. In both these cases, it is profitable for the firm to produce the commodity. But if the total receipts fall short of total costs, then three situations can arise. (i) A firm is not in position to meet its variable costs.
(ii) A firm is able to cover its variable costs. (iii) A firm is covering its full variable costs and a part of the fixed costs. Let us explain all these situations with the help of a curve.
Diagram:
Summing up, we can say, that if price falls below the lowest point on the AVC curve, the firm will not produce any output because it is not able to cover even its total variable costs. But if the price is such that it covers its total variable costs, then the firm may carry on production for a short period. So is also the case when it covers its full variable costs and a part of the fixed costs. In the long period, if the firm does not cover its full costs, it will have to dose down its operations sooner or later. So we conclude that the supply curve of the firm that can be regarded as that portion of the MC curve which lies above the AVC curve and not which lies below the AVC curve because it is only at the lowest point on the AVC curve that some output is forthcoming and not below this point. The supply curve of the firm or the rising portion of the MC curve which lies above the AVC curve can be split up into two parts. One part consists of that portion which lies above the lowest point of the ATC curve. If the price line representing MR = AR intersects the MC curve at any point on this rising portion, the firm will be earning abnormal profit (see fig. 15.7). The second part of the supply curve of the firm extends from the lowest point of the AVC curve to the lowest, point of the ATC curve. If price line representing MR = AR passes through the lowest point of the AVC curve, the firm is covering only total variable costs. If the price line cuts the MC curve at any point above the lowest point of the AVC curve and below the lowest point of ATC curve, the firm will be meeting its total variable costs and a part of the fixed costs but not the total costs. The total costs are met only when the price line forms a tangent to the ATC curve.
Explanation:
The industry short run supply curve is briefly explained with the help of the diagram (15.8) below. We assume here that prices of inputs do not change with the change in the size of the firm; However, when all firms increase or decrease output, the factor prices rise or fall respectively.
Diagram:
In figure 15.8(a), we assume that at point P, price or marginal revenue equals marginal cost. The firm at equilibrium point P. ($4) produces and sells 50 units of a commodity. If the equilibrium of MR, MC, price occurs at point K, the firm produces and sells 100 units.
In figure 15.8(b), let us suppose that there are 100 firms in the industry. As all the firms by assumptions, have identical costs, the industry will be producing 5000 units at a market price of ($4) and 10000 units at industrial price of ($8). The industry supply curve, therefore, has a positive slope.
Formula:
Price = Marginal Cost = Minimum Average Total Cost
Explanation:
The long run is a period of time during which the firms are able to adjust their outputs according to the changing conditions. If the demand for a product increases, all the firms have sufficient time to expand their plant capacities, train and engage more labor, use more raw material, replace old machines, purchase new equipments, etc., etc. If the demand for a product declines, the firms reduce the number of workers on the pay roll, use less raw material. In short, all inputs used by a firm are variable in the long run. It is assumed that all the firms in the competitive industry are producing homogeneous product and an individual firm cannot affect the market price. It takes the market price as given. It is also assumed that all the firms in a competitive industry have identical cost' curves. The industry it is assumed is, a constant cost industry. In the long run, it is for further assumed that all the firms in a competitive industry have access to the same technology. When the period is long and profit level of the competitive industry is high, then new firms enter the industry. If the profit level is below the competitive level, the firm then leave the industry. When all the competitive firms earn normal profit, then there is no tendency for the new firms to enter or leave the industry. The firms are then in the long run equilibrium.
Diagram:
The case of long-run equilibrium of a firm can be easily explained with .the help of a diagram given below:
Long Run Supply Curve for the Industry: Definition and Explanation:
While explaining the short run supply curve for the firm, we stated that the supply curve in the short run is that portion of the marginal cost curve which lies above the average variable cost curve, it is because of the fact that when the variable casts of a firm are realized, the firm decides to produce the goods. In the short run, the firm is in equilibrium when the MR is equal to MC and both are equal to price. If this equilibrium takes place at the level above the minimum point of ATC curve, the firm is earning abnormal profits and if it is below the minimum point of ATC, then it is suffering losses. In the long run, a firm cannot operate at a loss, however small it may be. The firm also cannot earn abnormal profits because in that case new firms enter into the industry. The supply of the goods increases in the market and price comes down to the level of normal price. In case of fall in demand, the capacity of the existing firms is contracted, old firms also withdraw from the industry and thus supply is automatically adjusted to demand. The firm, In the long run, is in equilibrium when price = marginal revenue = marginal cost = average total cost of the firm at the lowest point. When all the firms producing a single commodity are in equilibrium, the industry is in full equilibrium. Each firm in the industry is earning only normal profits. The short run supply curve of the industry is derived as stated earlier by the lateral summation of that part of the marginal cost curves of all the firms which lie above the minimum point on the AVC curves. The long run supply curve, however, cannot be obtained by this method because in the long run the variations is demand produce long run adjustments in the output and also in the costs of productions of these firms. The changes in output take place because of the (1) greater or leaser production by the existing firms, (2) entry of new firms in the industry or withdrawals of old firms and (3) the emergence of external economies and diseconomies. The emergence of external economies and diseconomies has a very important bearing on the shape of the long run supply curve. When an industry in the long run expands its size for greater production, it enjoys certain external economies such as (1) technical economies, (2) managerial economies (3) communications economies, (4) financial economies and (5) risk bearing economies. Internal economies may also arise out of the marketing facilities enjoyed by the firms in the purchase of raw material (6) in securing special concessional transport rates, etc., etc. The internal economies also lead to reduction in cost. (1) If the size of the firm is expanded continuously, it meets diseconomies as well. For instance, coordination and organization of factors become difficult (2) capital may not be available in the required quantity (3) entrepreneurial inertia also stands in the way of expansion of the industry (4) the prices of raw material also increase due to greater demand by ail firms (5) the productivity of the additional factors may also be less. The appearances of these diseconomies result in increasing the marginal cost and average total cost of the firms to the higher levels. If the economies and diseconomies cancel each other, the
industry wilt experience constant cost in the long run. We, therefore conclude that the shape of the supply curve of the industry, depends upon the behavior of the cost in the long run.
In figure 15.10(a) the firm is in the long-run equilibrium at point N where: Price = MC = Minimum Average Cost The firm produces output OP and sells at price OK per unit The firm like all other firms in the industry make normal profits. In figure 15.10(b), it is shown that when the market demand for .a product increases, / the demand curve DD shifts upwards. The new firms enter the industry and each firm produces at its minimum point of average cost which is OK. The industry is thus producing any quantity of output at a price of OK. The supply curve of the industry is perfectly elastic at a price OK in the long run.
In the figure 15.11(a) it is shown that when the demand for a commodity increases, more firms enter into the industry. In order to attract more units of the factors, the firms pay higher prices for them. The cost curves of the firms, move up. The minimum average cost of the firm equals marginal cost equals price at point F. The firm in the long run is in equilibrium at point F and produce the best level of output OT. When the costs of the firms rise with the expansion of output, the supply 'curve of the industry Fig. 15.11(b) also slants upward. The industry is now in equilibrium at point R, with industry output OT and Price OK.
In the Fig. (15.12) the firm is in equilibrium at point K in the long run because at point K, MR = MC = Price = Minimum AC. It will produce OT output at price ON. The total supply by all the firms (supply of industry) producing the commodity at price ON will be OH. If the demand for the product increases, the existing firms will expand their sizes and the new firms will enter the industry/Due to technological developments and the economies of large scale production, the MC, AC, and price fall. At the lower price OP, the firm is in equilibrium at point F. Here MC = AC = Price. The supply of a firm increases from OT to OH at a decreasing cost. The supply of the industry at lower price OP increases from OH to OK. The long run equilibrium supply curve slopes downward from left to right.
Explanation:
Monopoly, therefore, indicates a case where: (i) There is only a single seller of a product or service in the market. (ii) The goods produced by a sole seller has not close substitutes. (iii) The entry of new firms into the industry is effectively barred by legal or natural barriers. (iv) The firm being the sole supplier of a product constitutes industry. Firm and industry thus have single identity. Or we can say monopoly is a single firm identity. (v) The single seller affects no other seller by its own action in the market. The other sellers too cannot affect the price and output of the monopolist. (vi) The demand curve facing the monopolist is negatively sloped. The monopolist being the only seller of the commodity in the market can increase the total sale by lowering the price and if, he raises the price, he would not lose all his sale. The demand curve facing a monopolist is less than perfectly elastic, i.e., . it slopes downward from left to right. For the monopoly to exist, it is not necessary that the size of a firm should .be large. Even a small firm may have a monopoly. For instance, a local water company or a local electricity company, supplying water and electricity in the city possesses all the characteristics of a monopoly.
Short Run Equilibrium Price and Output Under Monopoly: Short Run Equilibrium of the Monopoly Firm:
In the short period, the monopolist behaves like any other firm. A monopolist will maximize profit or minimize losses by producing that output for which marginal cost (MC) equals marginal revenue (MR). Whether a profit or loss is made or not depends upon the relation between price and average total cost (ATC). It may be made clear here that a monopolist does not necessarily makes profit. He may earn super profit or normal profit or even produce at a loss in the short ran.
Explanation:
(a) Short Run Monopoly Equilibrium With Positive Profit:
In the short period, if the demand for the product is high, a monopolist increase the price and the quantity of output. He can increase the, output by hiring more labor, using more raw material, increasing working hours etc. However, he cannot change his fixed plant and equipment. In case, the demand for the product falls, he then decreases the use of variable inputs, (like labor, material etc.).
Diagram/Curve:
In the long run, all the factors of production including the size of the plant are variable. A monopoly firm will maximize profit at that level of output for which long run marginal cost (MC) is equal to marginal revenue (MR) and the LMC curve intersects the MR curve from below. In the figure (16.6), the monopoly firm is in equilibrium at point E where LMC = MR and LMC cuts MR curve from below. QP is the equilibrium price and OQ is the equilibrium output.
Definition:
Monopolistic/Imperfect competition as the name signifies is a blend of monopoly and competition. It is a systematic and realistic theory of price analysis in this imperfectly competitive world. Monopolistic competition is a market situation in which there are relatively large number of small firms which produce or sell similar but not identical commodities to the customers. According to Leftwitch: "Monopolistic competition is a market situation in which there are many sellers of a particular product, but the product of each seller is in some way differentiated in the minds of consumers from the product of every other seller". In the words of J.S. Bain: "Monopolistic competition is found in the industry where there is a large number of small sellers selling differentiated but close substitute products".
selling similar products. Same is the case with many other firms in the market like plywood manufacturing, jewellery making, wood furniture, book stores, departmental stores, repair services of all kinds, professional services of doctors, technicians, etc., etc. These firms and others which have an element of monopoly power and also face competition over the sale of product or service in the market are called monopolistically competitive firms.
Equilibrium Price and Output in the Long Run Under Monopolistic/Imperfect Competition: Long Run Zero Economic Profits:
In the long run, the firms are able to alter the scale of plant according to the changed conditions of demand for a product in the market. They can also leave or enter the industry. If the firms are earning abnormal profits in the short run, then new firm will enter the 'product group' (industry). The tendency of the new firms to enter the industry continues till the abnormal profits are competed away and the firms
economic profits are zero. In case the monopolistically competitive firms realize losses in the short-run, then some of the firms will leave the industry. The exit of the firm continues till zero economic profits are restored with the operating firms. In the long-run, there are no entry barriers for the new firms. The incoming firms install latest machinery and try to differentiate their products from those of the established firms. The old firms operating with .the used machinery try to match up with the new entrants by improved variety of products in their group. They increase expenditure on advertisement and on other sales promotional measures. They employ more qualified staff for. making technical improvement in their products. Since all the firms for their existence incur additional expenditure for improving the quality of the products, the cost curves of all the firms move up. Due to entry of new firms in the industry and higher costs of production, the output of each competing firm is reduced. There is, therefore, a waste in the economic resources of the country. The equilibrium price and output in the long-run is explained with the help of a diagram.
Diagram:
In the figure (17.3), the higher shifted long-run marginal cost curve intersects the higher shifted marginal revenue curve at point M. The firm at this raised equilibrium point, produces the reduced level of output OK. It sells this output at price TK as at point T, LAC is a tangent to the demand or average revenue curve at its minimum point. The total revenue of the firm is equal to the area OETK. The total costs of the firm are also equal to the area OETK. The firm is earning only zero or normal economic profits. As the monopolistically competitive firm sets a price higher than that minimum average cost in the long-run, the firm therefore produces a smaller output. Since all the firms in the product group produce less at higher price, there is, therefore, an apparent waste of resources and exploitation of the consumers. The advocates of monopolistic competition are of the opinion that if consumers get differentiated products at slightly higher prices (than with no choice under perfect competition), the consumers are then not exploited. There is no wasting of resources either, as the consumer's welfare increases with the product differentiation.
Monopolistic competition refers to the market organization where there are a fairly large number of firms which sell somewhat differentiated products. A single firm in the product group (industry) has little impact on the market price. However, if it reduces price, it can expect a considerable increase in its sales. The firm may also attract buyers away from other firms by creating imaginary or real difference through advertising, branding and through many other sales promotion measures (non-price competition). If the firm raises its price, it will not lose all its customers. This is because of the fact that the product is differentiated from competing firms due to price and nonprice factors. The demand curve (AR curve) of the monopolistic firm is therefore, highly elastic and is downward sloping. As regards the marginal revenue curve, it slopes downward and lies below the demand curve because price is lowered of all the units to sell more output in the market.
making maximum of profits. In the short-run, a monopolistically competitive firm may be realizing abnormal profits or suffering losses. If it is earning profits, no new firms can enter the industry in the short-run. In case, it is suffering, losses but covering full variable cost, the firm will continue operating so that the losses are minimized. If the full variable cost is not met, the firm will close down in the short-run. The short-run equilibrium with profits and short run equilibrium with losses of a monopolistically competitive firm are explained with the help of two separate diagrams as under.
Diagram:
In the figure (17.1), the downward sloping demand curve (AR curve) is quite elastic. The MR curve lies below-the average curve except at point N. The SMC curve which includes advertising and sales promotional costs is drawn in the usual fashion. The SMC curve cuts the MR curve from below at point Z. The firm produces and sells an output OK, as at this level of output MR = MC. The firm sells output OK at OE/KM per unit price. The total revenue of the firm is equal to the area OEMK, whereas the total cost of producing output OK is OFLK. The total profits of the firm are equal to the shaded rectangle FEML. The firm earns abnormal profits in the short run.
OLIGOPOLY Oligopoly is a situation in which few large firms compete against each other and there is an element of interdependence in the decision making of these firms. A policy change on the part of one firm will have immediate effects on competitors, who react with their counter policies. Features Following are the features of oligopoly which distinguish it from .other market structures : 1. Small number of large sellers. The number of sellers dealing in a homogeneous or differentiated product is small. The policy of one seller will have a noticeable impact on market, mainly on price and output. 2.Interdependence. Unlike perfect competition and monopoly, the oligopolist is not independent to take decisions. The oligopolist has to take into account the actions and reactions of his rivals while deciding his price and output policies. As the products of the oligopolist are close substitutes, the cross elasticity of demand is very high. 3.Price rigidity. Any change in price by one oligopolist invites retaliation and counter- action from others, the oligopolist normally sticks to one price. If an oligopolist reduces his price, his rivals will also do so and therefore, it is not advantageous for the oligopolist to reduce the price. On the other hand, if an oligopolist tries to raise the price, others will not do so. As a result they capture the customers of this firm. Hence the oligopolist would never try to either reduce or raise the price. This results in price rigidity. 4.Monopoly element. As products are differentiated the firms enjoy some monopoly power. Further, when firms
collude with each other, they can work together to raise the price and earn some monopoly income. 5.Advertising. The only way open to the oligopolists to raise his sales is either by advertising or improving the quality of the product. Advertisement expenditure is used as an effective tool to shift the demand in favour of the product. Quality improvement will also shift the demand favorably. Usually, both advertisements as well as variations in designs and quality are used simultaneously to maintain and increase the market share of an oligopolist. 6. Group behaviour. The firms under oligopoly recognise their interdependence and realise the importance of mutual cooperation. Therefore, there is a tendency among them for collusion. Collusion as well as competition prevail in the oligopolistic market leading to uncertainty and indeterminateness. 7. Indeterminate demand curve. It is not possible for an oligopolist to forecast the nature and position of the demand curve with certainty. The firm cannot estimate the sales when it decides to reduce the price. Hence the demand curve under oligopoly is indeterminate. TYPES OF OLIGOPOLY. Oligopoly may be classified in the following ways: a. Perfect and imperfect oligopoly. On the basis of the nature of product, oligopoly may be classified into perfect (pure) and imperfect (differentiated) oligopoly. If the products are homogeneous,then oligopoly is called as perfect or pure oligopoly. If the products are differentiated and are close substitutes, then it is called as imperfect or differentiated oligopoly. b. Open or closed oligopoly. On the basis of possibility of entry of new firms, oligopoly may be classified into open or closed oligopoly. When new firms are free to enter, it is open oligopoly. When few firms dominate the market and new firms do not have a free entry into the industry, it is called closed oligopoly. c. Partial and full oligopoly. Partial oligopoly refers to a situation where one firm acts as the leader and others follow it. On the other hand, full oligopoly exists where no firm is dominating as the price leader. d. Collusive and non- collusive oligopoly. Instead of competition with each other, if the firms follow a common price policy, it is called collusive oligopoly. If the collusion is in the form of an agreement, it is called open collusion. If it is an understanding between the firms, then it is a secret collusion. On the other hand, if there is no agreement or understanding between oligopoly firms, it is known as non-collusive oligopoly. e. Syndicated and organised oligopoly. Syndicated oligopoly is one in which the firms sell their products through a centralised syndicate. Organised oligopoly refers to the situation where the firms organise themselves into a central association for fixing prices, output, quota etc.
MODELS OF OLIGOPOLY
1. Cournot's model of oligopoly : Augustin Cournot, a French economist, published his theory of duopoly in 1838. Cournot dealt with a case of duopoly. He has taken the case of two identical mineral springs
operated by two owners. His model is based on the following assumptions : 1.The product is homogenous. 2.There is no cost of production. The average cost and marginal cost are zero. 3.Output of the rival is assumed to be constant. 4.The market demand for the product is linear.
DB is the market demand curve. OB is the total quantity of mineral water which can be produced and supplied by the two producers. If both the producers produce the maximum quantity of OB, the price will be zero. This is because cost of production is assumed to be zero. Cournot assumes that one producer say X starts production first. He will produce OA output and his profit will be OAPK. Suppose the second producer Y enters into the market. He assumes that the first producer will continue to produce the same. So Y considers PB as his demand curve. With this demand curve, he will produce AH amount of output. The total output will now be OA + AH = OH and the price will fall to OF. The total profits for both the producers will be OHQR. Out of this total profits, producers X will get OAGF and Y will receive AHQG. Now that the profits of producers X are reduced from OAPK to OAGF by producers Y producing AH output, producer X will reconsider the situation. But he will assume that producer Y will continue to produce AH output. Therefore, he reduces his output from OA to OT. Now the total output will be OT + AH = ON and the price will be OS and the total profits of the two will be ONRS. Out of the total profits, X will get OTLS and Y will get TNRL. Now the producer Y will reappraise his situation. Believing that producer X will continue producing OT, the producer Y will find his maximum profits by producing output equal to 1/2 TB. With this move of producer Y, producer X will find his profits reduced. Therefore, X will reconsider his position. This process of adjustment and readjustment by each producer will continue, until the total output OM is produced and each is producing the same amount of output. In the final position, producer X produces OC amount of output and producer Y produces CM amount of output and OC = CM. 2. Bertrand's model Joseph Bertrand, a French mathematician criticised Cournot's duopoly solution and put forward a substitute model of oligopoly. In Bertrand's model, each producer assumes his rival's price to be constant. The products produced and sold by the two producers are completely identical. The two producers have identical costs. Moreover, the productive capacity of the producers is unlimited. Bertrand's model can be explained with an example. There are two producers A and B. If A goes into business first, he will set the price at the monopoly level, which is the most profitable for him. Suppose B also enters into the business
and starts producing the same product as produced by A. B assumes that A will go on charging the same pricei Therefore, he can undercut the price changed by A to capture the whole market. He will set a price slightly lower than I A's price. A's sales fall to zero. Now A will reconsider his price policy. He assumes that, B will continue to charge the same price. There are two alternatives open to him. First, he may match the price cut made by B or he may charge the same price as B charges. In this case, he will secure half the market. Secondly, he may undercut B and set a slightly lower price than that of B. In this case A will seize the entire market. Evidently the latter course looks more profitable and thus A undercuts B and sets a price lower than B's price. Now producer B will react and think of changing his price, He also has two alternatives: He may match A's price or undercut him. Since undercutting is more profitable, B will set a price a little lower than A and seize the whole market. But again A will be forced to undercut B. This price war will go on until price falls to the level of cost. When price is equal to cost, neither of them will like to cut the price further or raise the price and therefore, the equilibrium has been achieved. In Bcrtrand's model, equilibrium is achieved when market price is equal to the average cost of production and the combined equilibrium output of the two duopolies is equal to the competitive output.