REVIEWER Managerial Economics (ME)

MODULE 11
“Pricing and Output Decision”

What is pricing and output decisions?

In monopolistic competition, firms make price/output decisions as if they were a monopoly. In other words, they
will produce where marginal revenue equals marginal cost. ... The firm's average costs may increase, or the price may
fall and ultimately economic profits may disappear.

What are pricing decisions?

Pricing decisions are the choices businesses make when setting prices for their products or services. ... Companies
that make simple pricing decisions often try to increase sales by making small, competitive adjustments such as
purchase discounts, volume discounts and purchase allowances.
Many of the analytical tools developed in this chapter are the basis for long-term decision-making and the two
chapters on decision making should be considered together. In previous chapters the importance of determining the
objectives of the firm and the relevant costs of decision-making was emphasized and the problems examined here will
illustrate the importance of this. The chapter begins by analyzing decision-making procedures on the assumption that
complete information is available about demand and costs. Then we examine the ways in which we can develop
decision-making models and procedures which may be useful in the normal situations of limited information being
available.

Where firms accept a price as given as in a highly competitive situation they will be left with a decision about the
level of output, whereas with uncertain demand data, a decision about both price and quantity must be made. One
solution to the problem is to consider price and output decisions separately.

Profit-Volume Analysis with Complete Information

Firms take important decisions which relate to the prices of their products and the level of output of those products.
Our analysis is about a firm's revenues and costs at various levels of output, conventionally termed by accountants the
'profit-volume relationship'. As a starting-point we will assume that a firm is able to obtain information about possible
future prices for its products and the future costs of manufacturing them we shall examine different ways in which a
firm may establish a price if it is unable to obtain complete market information about the prices at which it will be able
to sell its products.
We shall, for simplicity, assume that a firm produces only one product and firstly we shall consider information
about the demand for its product. This information will show the amount of the product demanded in relation to the
price charged and can be expressed in the form of a demand curve shown
The curve is the locus of forecast combinations of prices and quantities demanded, and it shows that the higher the
price the lower the quantity demanded. The slope of the demand curve will depend on the type of product and the
competitive position of the firm. From data about prices and quantities we could construct a curve showing the total
revenue for various levels of sales (see Fig. 11.2). The most important information shown is the elasticity of demand.

Pricing Decisions
The pricing decision is an important one, both for profitability and competitive positioning. Organizations must take
into account supply, demand, competition, expenses, profit margins, differentiation, quality, and legal concerns. The
simplest methods of determining price include concepts such as break-even points, fixed/variable cost analysis, and
marginal analysis. However, there are other concerns that need to be investigated when determining price.

Pricing Inputs
Looking at cost structures and determining break-even points is not always enough when it comes to effective
pricing strategies. As a result, marketers should be familiar with the legalities of pricing (for certain commodities in
particular), the value added to the consumer (willingness to pay), competitive positioning, and potential discounts.
Legal Concerns
For some products, governments will set firm price controls (i.e. price ceilings or price floors) to ensure ethical
and/or accessible pricing for a given population. Just as the name implies, price floors and price ceilings will set
minimum or maximum prices for some goods. This is particularly applicable to rent, real estate, banking, food and other
core necessities. When operating in an industry with price ceilings or price floors, firms must adapt their pricing strategy
to these legalities and ensure compliance.

Price Ceiling : When considering pricing decisions, understanding price floors and price ceilings is important.

Value-Added Pricing
In a perfectly practical and efficient market, the expenses would almost always lead to the appropriate price through
competitive forces. However, we do not live in a world of perfect markets. As a result, there are a number of value-adds
that consumers receive that are not easy or intuitive to measure from a strictly financial perspective. These include:
• Functional Value: This is a typical example of demand, where the product is valued at how well it accomplishes a
function (i.e. fulfills the need)
• Monetary Value: This is another typical value example, where the cost of resources and production correlate
cleanly with the price.
• Social Value: The value a consumer receives can actually be social as well as economic. This is to say that some
products provide intangible value to users. Fashion is a good example here, as some fashion items return
margins that are enormous due to the social perception of a given fashion item (expensive bags, for example).
• Psychological Value: Some items have value to an individual for personal reasons. A collector, for example, may
pay far more than an item is worth due to a strong love for something. People who collect video game action
figures, or deluxe editions, for example.

Competitive Positioning
Another input to pricing is the basic premise of differentiation to achieve higher value. This is not so much an
exception to the above mentioned value-added pricing, but more of a facet of this. Branded items, for example, are
often quite similar to generic versions of the same item. However, these brands add intangible value to the product
above and beyond the cost of producing it. Buying brand name goods may be differentiated based upon celebrity
sponsors, premium perception, social value or a wide variety of other differentiated factors. These can enable
organizations to differentiate for a price premium (i.e. they can charge more for having a strong brand/position).

Discounting
There are also a number of reasons why an organization may offer discounts. Discounting is particularly useful when
it comes to B2B transactions, in which a client might buy a few thousand of a given product and receive a wholesale
price that is significantly lower than the price of buying each product individually. There are also situations in which a
product may be sold at a price that is actually less than the cost of producing it. This is most often done when a
perishable item will soon go bad anyway. In such a situation, selling at a loss is better than getting nothing at all
(opportunity cost!).

SELF-CHECK FN-11.1.1
A. Fill in the blanks with the correct answer.
___________1.are the choices businesses make when setting prices for their products or services
___________2.The value a consumer receives can actually be social as well as economic
___________3.In a perfectly practical and efficient market, the expenses would almost always lead to the appropriate
price through competitive forces
___________4.is the locus of forecast combinations of prices and quantities demanded, and it shows that the higher the
price the lower the quantity demanded
___________5.Looking at cost structures and determining break-even points is not always enough when it comes to
effective pricing strategies

MODULE 12
 “The Economics of Advertising”

Advertising is a prominent feature of modern economic life. Consumers encounter advertising messages as they
watch TV, read magazines, listen to the radio, surf the internet, or simply walk down the street. And the associated
advertising expenditures can be huge. What, then, do economists have to say about advertising? Up until the late 19th
century, this question had a simple answer: nothing. But over the 20th century, research on advertising has proceeded
at a vigorous pace, and a vast literature has now emerged. This volume collects some of the central contributions. These
contributions, which evaluate the economic effects of advertising from theoretical and empirical perspectives, reveal a
number of important lessons. At the same time, advertising is a subtle and difficult subject, with important effects that
remain poorly understood. In short, economists now have quite a lot to say about advertising, but there is also much
that remains to be said. These introductions begin with an historical overview of the development of the economic
analysis of advertising then discuss the specific contributions.

The economics of Advertising are crucially important in understanding the history of modern mass media as well as
their current state and future directions. Sometimes called “indirect” funding (compared to the “direct” funding
provided by consumers to such media as books and recorded music), advertising as an economic institution involves
several different industries and collectives. Advertising's influence as a revenue stream for media is arguably a more
significant social force than the symbolic power of explicit commercial content like television advertisements.
Advertising revenue fundamentally influences not just the placement of ads in the media, but also the non-advertising
content and dissemination of funded media. This is increasingly true even for media and cultural forms that traditionally
have not depended upon the generation of advertising revenue, such as theatrically released films and video games (→
Media Economics). The shift of advertising revenues to digital media and as a result of the 2008–2009 global recession
have deeply altered the media landscape.

Advertising plays a strong role in the economy: It provides useful information to consumer that tells them about
product and service choices, as well as comparing features, benefits, and prices. With more complete information,
consumers and businesses often choose to purchase additional products and services.

Economics of advertising
Advertising is an invasive aspect of modern society. It is hard to look around without coming across advertising. In a
way, advertising leads to deadweight welfare loss. The money spent on advertising goods does not increase their
quality, nor does it increase the number of goods and services in the economy. However, it does cost a lot leading to
higher prices for consumers.

A rational consumer could say. ‘The more a company spends on advertising the more expensive it will be, therefore,
heavily advertised goods must offer the worst value’
However, most consumers do not think like this. They think, if the firm can afford to spend a lot on advertising it
must be good. Therefore, they trust the good to offer a minimum standard of service.
Nevertheless, it is said advertising does create some benefits. In particular, it helps to improve the information for
consumers.

Problems of advertising
• Invasive into modern life. We have no choice but to view advertising.
• Some advertising could be classed a demerit good. For example, firms have used sexually suggestive images to
increase sales, but this creates problems in defining the image of women in society.
• Cost of advertising which doesn’t improve the product but ultimately leads to higher prices for consumers.
• Persuasive advertising. Attempts to get customers to buy products who are otherwise unlikely to purchase the
good. Sometimes persuasive advertising can verge on the exploitative. For example, subliminal advertising
messages are illegal in most countries.
• Creates barriers to entry. Why do Coca Cola and Pepsi spend so much on advertising? People know what Coca
Cola is by now. One reason is that by spending so much on advertising it makes it very difficult for new firms to
 enter the market. They cannot compete with Coca Cola’s advertising budget, so they are discouraged from
entering the market. Advertising is an example of a sunk cost (non-recoverable cost) and a barrier to entry.
Therefore advertising can create monopoly power, which leads to higher prices for consumers.
• Advertising needs regulating to prevent firms from displaying false information and false claims.

Advantages of advertising
• Increases information. Consumers can be informed of new products.
• Advertising can be used to promote goods and services which improve public health, e.g. use of contraception.
• Consumers like buying goods where they feel they can rely on a minimum standard. They may not be buying the
best value goods, but, at least they know they will not be buying a dud.
• Advertising is not all wasted resources. The advertising industry creates jobs and can create innovative ads. For
example, John Smith ads featuring Peter Kay are worth watching purely for the comedic value.
• Advertising/sponsorship can be vital revenue for many businesses, social and charitable services. For example,
print media relies on advertising to make the newspaper profitable. Without advertising space for sale,
newspapers would be more expensive or there would be fewer for sale. Sponsorship of charitable events is a
form of advertising which helps make the charity event to be more viable.
• Support for sporting events. After the financial problems of the 1976 Montreal Olympics, the Olympic
movement secured the financial backing of major companies, who were able to advertise at the Olympics in
return for guaranteeing the financial future of the Olympics.

Economic analysis of advertising dates to the 1930s and 1940s, when critics attacked it as a monopolistic and
wasteful practice. Defenders soon emerged who argued that advertising promotes competition and lowers the costs of
providing information to consumers and distributing goods. Today, most economists side with the defenders most of the
time.
Advertising comes in many different forms: grocery ads that feature weekly specials, “feel-good” advertising that
merely displays a corporate logo, ads with detailed technical information, and those that promise “the best.” Critics and
defenders have often adopted extreme positions, attacking or defending any and all advertising. But, at the very least, it
seems safe to say that the information firms convey in advertising is not systematically worse than the information
volunteered in political campaigns or used car ads.
Modern economics views advertising as a type of promotion, in the same vein as direct selling by salespersons and
promotional price discounts. If we focus on the problems firms face in promoting their wares, rather than on advertising
as an isolated phenomenon, it is easier to understand why advertising is used in some circumstances and not in others.

Scope
While advertising has its roots in the advance of literacy and the advent of inexpensive mass newspapers in the
nineteenth century, modern advertising as we know it began early in the twentieth century with two new products,
Kellogg cereals and Camel cigarettes. What is generally credited as the first product endorsement also stems from this
period: Honus Wagner’s autograph was imprinted on the Louisville Slugger in 1905.
Advertising as a percentage of GDP has stayed relatively constant since the 1920s, at roughly 2%. About 60% of
advertising is national rather than local. Table 1 shows national and local expenditures since 1940. In 2002, newspapers
accounted for some 19% of total advertising expenditures; magazines for 5 %; broadcast and cable television for 23 %;
radio for 8%; direct mail for 19%; and miscellaneous techniques such as yellow pages, billboards, and the Goodyear
blimp for the remaining 27 %. Internet advertising accounted for 2 % of total advertising expenditures.

One popular argument in favour of advertising is that it provides financial support for newspapers, radio, and
television. In reply, critics remark that advertiser-supported radio and television programming is of low quality because
it appeals to those who are easily influenced by advertising. They also charge that advertiser-supported newspapers and
magazines are too reluctant to criticize products of firms that are actual or potential advertisers.

Economic Function
While discussions of advertising often emphasize persuasion and the creation of brand loyalty, economists tend to
emphasize other, perhaps more important, functions. The rise of the self-service store, for example, was aided by
consumer knowledge of branded goods. Before the advent of advertising, customers relied on knowledgeable
shopkeepers for help in selecting products, which often were unbranded. Today, consumer familiarity with branded
products is one factor making it possible for far fewer retail employees to serve the same number of customers.
Newly introduced products are typically advertised more heavily than established ones, as are products whose
customers are constantly changing. For example, cosmetics, mouthwash, and toothpaste are marked by high rates of
new product introductions because customers are willing to abandon existing products and try new ones. Viewed this
way, consumer demand generates new products and the advertising that accompanies them, not the other way around.

In a similar vein, “non-informative,” or image, advertising can be usefully thought of as something that customers
demand along with the product. Customers often want to see themselves as athletic, adventuresome, or spontaneous,
and vendors of beer, cars, and cell phones bundle the image and the physical product. When some customers are
unwilling to pay for image, producers that choose not to advertise can supply them with a cheaper product. Often, the
same manufacturer will respond to these differences in customer demands by producing both a high-priced, labelled,
heavily advertised version of a product and a second, low-priced line as an unadvertised house brand or generic product.
In baked goods, canned goods, and dairy products, for example, some manufacturers sell one version under their own
nationally known label and another slightly different version under a particular grocery chain’s private label.

Advertising messages obviously can be used to mislead, but a heavily advertised brand name limits the scope for
deception and poor quality. A firm with a well-known brand suffers serious damage to an image that it has paid dearly to
establish when a defective product reaches the consumer (see brand names). Interestingly, even under central planning,
officials in the Soviet Union encouraged the use of brand names and trademarks in order to monitor which factories
produced defective merchandise and to allow consumers to inform themselves about products available from various
sources.

Advertising plays a strong role in the economy:

• It provides useful information to consumer that tells them about product and service choices, as well as
comparing features, benefits, and prices. With more complete information, consumers and businesses often choose to
purchase additional products and services.
• It “causes an economic chain reaction that (a) generates a net gain in direct sales and jobs due to the promotion
of the industries’ products and services, (b) generates indirect sales and jobs among the first level suppliers to the
industries that incur the advertising expenditures, and (c) generates indirect sales and jobs among all other levels of
economic activity as the sales ripple throughout the economy ”Global Insight, “The Comprehensive Economic Impact of
Advertising Expenditures in the United States,” http://www.naa.org/Resources/Articles/Public-Policy-The-
Comprehensive-Economic-Impact-of-Advertising-Expenditures-in-the-United-States/Public-Policy-The-Comprehensive-
Economic-Impact-of-Advertising-Expenditures- in-the-United-States.aspx (accessed November 1, 2007).
Advertising also plays a significant role in the business cycle. As the broader economy shifts between periods of
growth and recession, advertising shifts its focus. During downturns, like the one we’re in now, ads may focus on the
price of a product or service. If one company curtails advertising in order to cut costs during a downturn, another
company might boost ad spending to grab customers and grow its market share. Advertising helps stimulate economic
growth. In a country in which consumer spending determines the future of the economy, advertising motivates people
to spend more. By encouraging more buying, advertising promotes both job growth and productivity growth both to
help meet increased demand and to enable each consumer to have more to spend.

Economic Rationale to Create Advertising

Companies spend money on advertising because it increases sales of existing products, helps grow adoption of new
products, builds brand loyalty, and takes sales away from competitors. Although the exact return on investment (ROI)
varies tremendously across industries, companies, campaigns, and media channels, studies have found that a dollar
spent on advertising returns $3–20 in additional sales. To compete and grow in today’s diverse, ever-changing
marketplace, businesses must reach their target customers efficiently, quickly alerting them to new product
introductions, improved product designs, and competitive price points. Advertising is by far the most efficient way to
communicate such information.

Economic Rationale to Use Advertising

 The perspective called the economics of information shows how consumers benefit from viewing advertising. By
providing information, advertising reduces consumers’ search costs (time spent looking for products) and reduces
disutility (unhappiness or lost value) from picking the wrong products. Advertising performs the following functions:
• Describing new products and what they do
• Alerting consumers to product availability and purchase locations
• Showing consumers what to look for on store shelves
• Helping them differentiate among competitive choices
• Advising them of pricing information and promotional opportunities
• Saving consumers money by encouraging competition that exerts downward pricing pressures

Economic Rationale to Accept Advertising

The economics of advertising extends to the media channels that depend on advertising revenues. Many form of
advertising support the creation of content and make that content available at a much lower price or free. For example,
roughly 75% of the cost of a newspaper is supported by advertising. If newspapers contained no advertising, they would
cost four times as much to buy on the newsstand. Broadcast radio and TV rely exclusively on ads—people get news,
music, and entertainment for free while advertisers get an audience. Forms of media that the public takes for granted
would be extremely expensive to the reader or viewer or would simply be out of business without the revenues
advertising produces. The demand created by advertising helps the economy to expand S. William Pattis, Careers in
Advertising (Blacklick, OH: McGraw-Hill Professional, 2004), 9.

Advertising supports the arts. Advertisers need music that calls attention to the brand. Musical artists visit ad
agencies to meet with directors of music and pitch songs to them that they can use in ads. They come to agencies
because they know that companies spend tens of millions of dollars on media buys. “The major record labels don’t have
that kind of money,” says Josh Rabinowitz, senior vice president and director of music at Grey Worldwide. What’s more,
“TV ads give you the kind of heavy rotation you can’t get on MTV anymore. In the very near future, some of the best
bands will produce jingles.”Cora Daniels, “Adman Jangles for a Hit Jingle,” Fast Company, July 2007,

SELF-CHECK FN-12.1.1
A. Fill in the blanks with the correct answer.
___________1.is a prominent feature of modern economic life, Consumers encounter advertising messages as they
watch TV, read magazines, listen to the radio, surf the internet, or simply walk down the street. And the associated
advertising expenditures can be huge
___________2.are crucially important in understanding the history of modern mass media as well as their current state
and future directions sometimes called “indirect” funding (compared to the “direct” funding provided by consumers to
such media as books and recorded music), advertising as an economic institution involves several different industries
and collectives
___________3.views advertising as a type of promotion, in the same vein as direct selling by salespersons and
promotional price discounts
___________4.provides useful information to consumers that tells them about product and service choices, as well as
comparing features, benefits, and prices. With more complete information, consumers and businesses often choose to
purchase additional products and services.
___________5.discussions of advertising often emphasize persuasion and the creation of brand loyalty, economists tend
to emphasize other, perhaps more important, functions.

MODULE 13
“The Economics of Advertising”

The government most often directly influences organizations by establishing regulations, laws, and rules that dictate
what organizations can and cannot do. To implement legislation, the government generally creates special agencies to
monitor and control certain aspects of business activity.

Introduction
 Since businesses are strongly affected by public policies, it is in their best interest to stay informed about public
policies and to try to influence governmental decision making and public policy. There are different general ways that
businesses view and act on their relationship with government. One perspective is for businesses to consider business
and government on “two sides” and in opposition to each other. Some have argued that this was the prevailing
dominant mainstream business view in the aftermath of the Great Recession at the end of the first decade of the
twenty-first century. It has been characterized as the “antiregulatory” or “limited government” view, and it has been
associated with those who believe that free markets with a minimal government role is best for the workings of the
economy. This perspective most often focuses businesses’ interactions with government on efforts to minimize
government and reduce the costs and burdens on private business and the general economy associated with
government taxes, regulations, and policies.
Another business perspective on government is that government should favour businesses and incentivize business
performance and investment because businesses are the main source of jobs, innovation, and societal economic well-
being, and therefore government should support businesses with grants, tax credits, and subsidies.
A third general view of businesses and government relations is with business in partnership with government in
addressing societal matters. This is in contrast to government being the regulator to ensure businesses act in a socially
responsible manner.

These views are not mutually exclusive. For example, the same solar business can use some of its interaction with
government to try to maximize the benefits, such as favorable tax credits, it receives from government and at the same
time work in partnership with government to achieve a social purpose, such as reducing carbon emissions, and then try
to minimize its tax obligations. It is also important, as described by Pacific Gas and Electric (PG&E) CEO Peter Darbee
previously, that the focus of business and government relationships should be on the type of policies required in
response to societal challenges rather than an ideological response about the proper role of government in a free
market economy.

Sustainable businesses, such as the companies presented in the case study chapters in this textbook—such as
Stonyfield Yogurt, Oakhurst Dairy, and Green Mountain Coffee—tend to focus on their responsibility to the environment
and societal impact and also tend to recognize that government policies and programs are often necessary to help them
achieve their objectives and therefore are inclined to try to work with and even partner with government to achieve
desired ends. It is always important for sustainable businesses to understand how their efforts to achieve profits and to
serve a social purpose are both strongly influenced by government policies, and it is always important for sustainable
businesses to manage their relationships with government (local, state, national, and international) effectively.

Types of Business Responses

Once a business has an understanding of how government affects their operations and profitability, it can formulate
strategies for how best to interact with government. There are three general types of business responses to the public
policy environment—reactive, interactive, and proactive.
Reactive responses involve responding to government policy after it happens. An interactive response involves
engaging with government policymakers and actors (including the media) to try to influence public policy to serve the
interests of the business. A proactive response approach entails acting to influence policies, anticipating changes in
public policy, and trying to enhance competitive positioning by correctly anticipating changes in policy. For most
businesses, a combination of the interactive and proactive approaches is the best approach.

In meeting challenges from nongovernmental organizations (NGOs) and the media, businesses may respond in a
variety of ways, including the following:
• Confrontation. It may aggressively attack either the message or the messenger, and in extreme cases, business
has felt justified to sue its critics for libel.
• Participation. Business may develop coalitions or partnerships with NGOs, as McDonald’s did with the
Environmental Defense Fund (EDF; see the following discussion) or as Home Depot did with the Rainforest
Alliance (see the following sidebar).
• Anticipation. Business may adopt issues management programs to forecast emerging issues and to adjust or
change business practices in advance of the passage of stringent laws or regulations.
 When business is in a reactive response mode, it most often engages in confrontation of its adversaries. When it
assumes an interactive response mode, it participates in dialogues with NGOs and the media and develops partnerships
or coalitions to advance new policies and programs. When business behaves in a proactive manner, it anticipates future
pressures and policy changes and adjusts its own internal corporate policies and practices before it is forced to do so.
While a reactive stance may sometimes work, it often only delays needing to engage in a more interactive or proactive
way. An interactive or proactive approach is usually a better way to meet political and societal challenges while also
protecting the reputation of the firm.

Tactics That Businesses Use to Influence Government

Businesses often engage in a variety of tactics to influence government policy. This includes lobbying, political
contributions, and interest group politics.

Business Lobbying
Businesses lobby in different ways. This can include lobbying of Congress and state legislatures and executive branch
agencies directly through its own government relations specialists, through an industry trade association, through
consultants, or through a combination of all those avenues. Businesses may also engage in indirect or grassroots
lobbying by appealing to its own employees, stakeholders, or the general public to make their views known to
policymakers. In order to build a broad grassroots constituency, business may manage “issue advertising” campaigns on
top-priority issues, or purchase issue ads in media outlets that target public policymakers or Washington insiders.

Business lobbying has a strong influence on public policies. There are more than 1,500 private companies in the
United States with public affairs offices in Washington, DC, and more than 75 percent of large firms employ private
lobbyists to make their case for policies that can benefit them. This includes more than 42,000 registered lobbyists in
state capitals across the nation.
Business may engage in reactive defensive lobbying (defending its own freedom from government regulation) or
interactive lobbying (partnering with interest groups on policies that the firm can benefit from). Businesses can also
choose to engage in social lobbying, examples of which include chemical companies with the best environmental track
record joining environmental NGOs in lobbying for an increased budget for the Environmental Protection Agency (EPA)
and retailers wanting to address consumer concerns joining interest groups in pressuring the Consumer Product Safety
Commission to adopt more stringent product safety standards. Corporations showing a willingness to join such public
interest coalitions can gain reputational rewards from NGOs, the media, and public policymakers.

Political Contributions
Businesses also use campaign contributions to support their position and to try to influence public policies that can
help them increase profits. Seven of the ten largest corporations in the world are oil companies, based on revenues.
Their access to funds for lobbying and campaign contributions gives them a significant voice in the political system and
on policies that can impact sustainable businesses.

There are a range of avenues a company might use in making political contributions. The most transparent and
legitimate is that of forming a political action committee (PAC) to which voluntary contributions of employees are
amassed and then given in legally limited amounts to selected candidates. Not surprisingly, larger firms in regulated
industries, or in industries exposed to greater risk from changing public policies, such as oil companies in 2010 during
and after the British Petroleum (BP) Gulf of Mexico oil crisis, use PACs more often than other firms. Beyond contributing
directly to political candidates, firms can also advertise on ballot measure campaigns, and those contributions can come
from corporate assets and are subject to no legal limitations.

A 2010 US Supreme Court decision, Citizens United v. Federal Election Commission ruled that the government could
not ban independent political spending by corporations, as well as labor unions and other organizations, in candidate
elections. This has led to rise of what have become known as “super PACS.” In the 2012 Republican presidential primary,
about two dozen individuals, couples, or corporations gave $1 million or more to Republican super PACs to try to
influence the primary election.

Interest Group Participation

 Business response can include participation in interest group politics. Interest groups play a key role in all
democratic systems of government. However, as an interest group is a group of individuals organized to seek public
policy influence, there is tremendous diversity within interest groups. Business is just one of many interest group sectors
trying to influence public policy (see the discussion previously mentioned). Businesses will encounter interest groups
that may support or conflict with their position on an issue.

Other Business Interactions in the Public Arena

Businesses face a complex array of formal and informal public policy actors beyond (just) government. Business
practices can be strongly influenced by citizen actions that bypass the formal institutions of government. Though they
lack the economic clout and resources of industry as tools of influence, citizen groups do possess other tools. They can
lobby and litigate, and they can get out large groups to demonstrate in public events and use exposure in the news
media as a vehicle for getting their perspective heard.

Businesses are influenced by direct citizen activism and protest. Organized interests and nongovernmental
organizations (NGOs) have been the source of influence. After their experiences in affecting public policy in the 1960s
and 1970s, many citizen activists grew skeptical of the government’s ability to respond rapidly and effectively and
discovered they could often accomplish their objectives more directly and quickly. Citizen groups have both confronted
and collaborated with corporations in order to foster change.

Finding that confrontation is often counterproductive and that government lobbying is protracted and ineffective,
NGOs often turn to collaboration with business to resolve issues. Indeed, as both sides have matured and grown less
combative, business and NGOs have learned to work together to resolve problems. There are many examples of such
productive collaboration, the most prominent of which have emerged on the environmental front. For example, the
Rainforest Action Network (RAN) has worked with Home Depot, Lowe’s, and several timber companies in an initiative to
protect old-growth forest. RAN combines elements of activism and even militant protest along with peaceful
collaboration.

The EDF is an example of an NGO working cooperatively, in contrast to a confrontational approach, with
corporations. The EDF was an early actor in this way. In November 1990, the Fund began to work with McDonald’s to
help the company phase out its polystyrene clamshell food containers. It was a collaborative effort to significantly
reduce McDonald’s negative environmental impact by cutting its solid waste. It was the first major partnership between
an environmental group and a Fortune 500 company in an era when environmental and business interests were often at
odds. EDF and McDonald’s worked together to develop a new solid waste reduction plan. The initiative eliminated more
than 300 million pounds of packaging, recycled 1 million tons of corrugated boxes, and reduced waste by 30 percent in
the decade following the initial partnership, and this was all achieved at no additional cost to the company.

Beyond the traditional political tactics, NGOs also have developed new tactics to pressure business. Ralph Nader
pioneered the use of the shareholder resolution to protest such corporate actions as discriminatory hiring, investment in
South Africa, nuclear power, environmental impacts, and corporate campaign donations. Since the 1970s, religious
organizations, most prominently the Interfaith Center on Corporate Responsibility, have been the chief sponsors of such
resolutions. More recently, they have been joined by mainstream shareholder groups, such as large institutional
investors and pension funds, in calling for major changes in corporate governance and more recently for more attention
to businesses’ environmental footprint and contribution to greenhouse gas emissions and global warming.

Businesses have to also understand the importance of another actor in the business and public policy sphere—the
news media. The media provides important functions for both society and business. For example, it influences the public
policy agenda by filtering the various events and interest-group areas of attention and it can serve as a sort of
“watchdog” over both business and government exposing any unethical practices. Business must constantly monitor the
media and be ready to respond. In particular, since the media are usually a pivotal actor in any corporate crisis, company
“crisis management” plans must include steps for dealing appropriately with the media and other critics.

SELF-CHECK FN-13.1.1
A. Fill in the blanks with the correct answer.
___________1.Business may adopt issues management programs to forecast emerging issues and to adjust or change
business practices in advance of the passage of stringent laws or regulations
___________2.It may aggressively attack either the message or the messenger, and in extreme cases, business has felt
justified to sue its critics for libel.
___________3.most often directly influences organizations by establishing regulations, laws, and rules that dictate what
organizations can and cannot do
___________4.also use campaign contributions to support their position and to try to influence public policies that can
help them increase profits
___________5.response involves engaging with government policymakers and actors (including the media) to try to
influence public policy to serve the interests of the business

MODULE 14
“The Economics of Competition”

In economics, competition is a scenario where different economic firms are in contention to obtain goods that are
limited by varying the elements of the marketing mix: price, product, promotion and place.

Introduction
The Economics of Competition uses the South African pharmaceutical industry as a case study to cogently challenge
accepted economic and regulatory views on competition and monopoly, then re-establishes and emphasizes the
importance of foundational economic principles. The book comprehensively explores the concept that monopoly is self-
limiting within unrestricted competition, as well as the various market features of competition, innovation, and market
power. This detailed examination broadens understanding of the economics of competition for both scholars and
practitioners.
Competition is seen as a continuous process in a free market. The Economics of Competition thoughtfully explores
the competitive process in its two mechanisms, the transfer of market share from one rival to another, and innovation of
a new product, new method of production, new market opening, or new source of supply of raw materials. The dynamic
nature of the marketplace is thoroughly examined from the author's inside view of the South African pharmaceutical
industry. This provides a rare opportunity to closely examine an industry considered to be a monopoly while actively
applying economic theories of competition and freedom of choice. The effects of public policy, legislation, and pricing
regulations are discussed in detail. The book has several tables and figures to enhance clarity and is extensively
referenced.

In economics, competition is a scenario where different economic firms [Note 1] are in contention to obtain goods
that are limited by varying the elements of the marketing mix: price, product, promotion and place. In classical economic
thought, competition causes commercial firms to develop new products, services and technologies, which would give
consumers greater selection and better products. The greater the selection of a good is in the market, prices are typically
lower for the products, compared to what the price would be if there was no competition (monopoly) or little
competition (oligopoly). This is because there is now no rivalry between firms to obtain the product as there is enough
for everyone. The level of competition that exists within the market is dependent on a variety of factors both on the
firm/ seller side; the number of firms, barriers to entry, information availability, availability/ accessibility of resources.
The number of buyers within the market also factors into competition with each buyer having a willingness to pay,
influencing overall demand for the product in the market.

The extent of the competition present within a particular market can measured by; the number of rivals, their
similarity of size, and in particular the smaller the share of industry output possessed by the largest firm, the more
vigorous competition is likely to be.
Early economic research focused on the difference between price- and non-price-based competition while modern
economic theory has focused on the many-seller limit of general equilibrium.

Perfect vs imperfect competition

Perfect competition
Neoclassical economic theory places importance in a theoretical market state, in which the firms and market are
considered to be in perfect competition. Perfect competition exists when all criteria are met, which is rarely (if ever)
observed in the real world. These criteria include; all firms contribute insignificantly to the market, all firms sell an
identical product, all firms are price takers, market share has no influence on price, both buyers and sellers have
complete or "perfect" information, resources are perfectly mobile and firms can enter or exit the market without cost.
Under perfect competition, there are many buyers and sellers within the market and prices reflect the overall supply and
demand. Another key feature of a perfectly competitive market is the variation in products being sold by firms. The firms
within a perfectly competitive market are small, with no larger firms controlling a significant proportion of market share.
These firms sell almost identical products with minimal differences or in-cases perfect substitutes to another firms
product.

The idea of perfectly competitive markets draws in other neoclassical theories of the buyer and seller. The buyer in a
perfectly competitive market have identical tastes and preferences with respect to desired product features and
characteristics (homogeneous within industries) and also have perfect information on the goods such as price, quality
and production. In this type of market, buyers are utility maximizers, in which they are purchasing a product that
maximizes their own individual utility that they measure through their preferences. The firm, on the other hand, is
aiming to maximize profits acting under the assumption of the criteria for perfect competition.

The firm in a perfectly competitive market will operate in two economic time horizons; the short-run and long-run.
In the short-run the firm adjusts its quantity produced according to prices and costs. While in the long run the firm is
adjusting its methods of production to ensure they produce at a level where marginal cost equals marginal revenue. In a
perfectly competitive market, firms/producers earn zero economic profit in the long run.

Imperfect competition
Imperfectly competitive markets are the realistic markets that exist in the economy. Imperfect competition exist
when; buyers might not have the complete information on the products sold, companies sell different products and
services, set their own individual prices, fight for market share and are often protected by barriers to entry and exit,
making it harder for new firms to challenge them. An important differentiation from perfect competition is, in markets
with imperfect competition, individual buyers and sellers have the ability to influence prices and production. Under
these circumstances, markets move away from the neoclassical economic definition of a perfectly competitive market,
as the market fails the criteria and this inevitably leads to opportunities to generate more profit, unlike in a perfect
competition environment, where firms earn zero economic profit in the long run. These markets are also defined by the
presence of monopolies, oligopolies and externalities within the market.
The measure of competition in accordance to the theory of perfect competition can be measured by either; the
extent of influence of the firm's output on price (the elasticity of demand), or the relative excess of price over marginal
cost.

Types of imperfect competition

Monopoly
Monopoly is the opposite to perfect competition. Where perfect competition is defined by many small firms
competition for market share in the economy, Monopolies are where one firm holds the entire market share. Instead of
industry or market defining the firms, monopolies are the single firm that defines and dictates the entire market.
Monopolies exist where one of more of the criteria fail and make it difficult for new firms to enter the market with
minimal costs. Monopoly companies use high barriers to entry to prevent and discourage other firms from entering the
market to ensure they continue to be the single supplier within the market. A natural monopoly is a type of monopoly
that exists due to the high start-up costs or powerful economies of scale of conducting a business in a specific industry.
These types of monopolies arise in industries that require unique raw materials, technology, or similar factors to
operate. Monopolies can form through both fair and unfair business tactics. These tactics include; collusion, mergers,
acquisitions, and hostile takeovers. Collusion might involve two rival competitors conspiring together to gain an unfair
market advantage through coordinated price fixing or increases. Natural monopolies are formed through fair business
practices where a firm takes advantage of an industry's high barriers. The high barriers to entry are often due to the
significant amount of capital or cash needed to purchase fixed assets, which are physical assets a company needs to
operate. Natural monopolies are able to continue to operate as they typically can as they produce and sell at a lower
cost to consumers than if there was competition in the market. Monopolies in this case use the resources efficiently in
order to provide the product at a lower price. Similar to competitive firms, monopolists produces a quantity at that
marginal revenue equals marginal cost. The difference here is that in a monopoly, marginal revenue does not equal to
price because as a sole supplier in the market, monopolists have the freedom to set the price at which the buyers are
willing to pay for to achieve profit-maximizing quantity.

Oligopoly
Oligopolies are another form of imperfect competition market structures. An oligopoly is when a small number of
firms collude, either explicitly or tacitly, to restrict output and/or fix prices, in order to achieve above normal market
returns. Oligopoly can be made up of two or more firms, however, it is a market structure that is very highly
concentrated. Only a few firms dominate, for example, major airline companies like Delta and American Airlines operate
with a few close competitors, but there are other smaller airlines that are competing in this industry too. Similar factors
that allow monopolies to exist also facilitate the formation of oligopolies. These include; high barriers to entry, legal
privilege; government outsourcing to a few companies to build public infrastructure (e.g railroads) and access to limited
resources, primarily seen with natural resources within a nation. Companies in an oligopoly benefit from price-fixing,
setting prices collectively, or under the direction of one firm in the bunch, rather than relying on free-market forces to
do so. Oligopolies can form cartels in order to restrict entry of new firms into the market and ensure they hold market
share. Governments usually heavily regulate markets that are susceptible to oligopolies to ensure that consumers are
not being over charged and competition remains fair within that particular market.

Monopolistic competition
Monopolistic competition characterises an industry in which many firms offer products or services that are similar,
but not perfect substitutes. Barriers to entry and exit in a monopolistic competitive industry are low, and the decisions
of any one firm do not directly affect those of its competitors. Monopolistic competition exists in-between monopoly
and perfect competition, as it combines elements of both market structures. Within monopolistic competition market
structures all firms have the same, relatively low degree of market power; they are all price makers, rather than price
takers. In the long run, demand is highly elastic, meaning that it is sensitive to price changes. In order to raise their
prices, firms must be able to differentiate their products from their competitors in terms of quality, whether real or
perceived. In the short run, economic profit is positive, but it approaches zero in the long run. Firms in monopolistic
competition tend to advertise heavily because different firms need to distinguish similar products than others. Examples
of monopolistic competition include; restaurants, hair salons, clothing, and electronics.

Dominant firms
In several highly concentrated industries, a dominant firm serves a majority of the market. Dominant firms have a
market share of 50% to over 90%, with no close rival. Similar to a monopoly market, it uses high entry barrier to prevent
other firms from entering the market and competing with them. They have the ability to control pricing, to set
systematic discriminatory prices, to influence innovation, and (usually) to earn rates of return well above the
competitive rate of return. This is similar to a monopoly, however there are other smaller firms present within the
market that make up competition and restrict the ability of the dominant firm to control the entire market and choose
their own prices. As there are other smaller firms present in the market, dominant firms must be careful not to raise
prices too high as it will induce customers to begin to buy from firms in the fringe of small competitors.

Effective competition
Effective competition exists when there are four firms with market share below 40% and flexible pricing. Low entry
barriers, little collusion, and low profit rates. The main goal of effective competition is to give competing firms the
incentive to discover more efficient forms of production and to find out what consumers want so they are able to have
specific areas to focus on.

Competitive Equilibrium
Competitive equilibrium is a concept in which profit-maximising producers and utility-maximising consumers in
competitive markets with freely determined prices arrive at an equilibrium price. At this equilibrium price, the quantity
supplied is equal to the quantity demanded. This implies that a fair deal has been reached between supplier and buyer,
in-which all suppliers have been matched with a buyer that is willing to purchase the exact quantity the supplier is
looking to sell and therefore, the market is in equilibrium.

The competitive equilibrium in economic theory is considered to be a part of game theory which deals with decision
making of firms in large markets. The overall concept acts as a benchmark for evaluating efficiency in the market and
how far off the market is from equilibrium.
The competitive equilibrium has many applications for predicting both the price and total quality in a particular
market. It can also be used to estimate the quantity consumed by each individual and the total output of each firm
within a market. Furthermore, through the idea of a competitive equilibrium, particular government policies or events
can be evaluated and decide whether they move the market towards or away from the competitive equilibrium.

Role in market success

Competition is generally accepted as an essential component of markets, and results from scarcity—there is never
enough to satisfy all conceivable human wants—and occurs "when people strive to meet the criteria that are being used
to determine who gets what." In offering goods for exchange, buyers competitively bid to purchase specific quantities of
specific goods which are available, or might be available if sellers were to choose to offer such goods. Similarly, sellers
bid against other sellers in offering goods on the market, competing for the attention and exchange resources of buyers.
[17]:105
The competitive process in a market economy exerts a sort of pressure that tends to move resources to where they
are most needed, and to where they can be used most efficiently for the economy as a whole. For the competitive
process to work however, it is "important that prices accurately signal costs and benefits." Where externalities occur, or
monopolistic or oligopolistic conditions persist, or for the provision of certain goods such as public goods, the pressure of
the competitive process is reduced.

In any given market, the power structure will either be in favour of sellers or in favour of buyers. The former case is
known as a seller's market; the latter is known as a buyer's market or consumer sovereignty. In either case, the
disadvantaged group is known as price-takers and the advantaged group known as price-setters. Price takers must
accept the prevailing price and sell their goods at the market price whereas price setters are able to influence market
price and enjoy pricing power.
Competition bolsters product differentiation as businesses try to innovate and entice consumers to gain a higher
market share and increase profit. It helps in improving the processes and productivity as businesses strive to perform
better than competitors with limited resources. The Australian economy thrives on competition as it keeps the prices in
check.

Historical views
In his 1776 The Wealth of Nations, Adam Smith described it as the exercise of allocating productive resources to
their most highly valued uses and encouraging efficiency, an explanation that quickly found support among liberal
economists opposing the monopolistic practices of mercantilism, the dominant economic philosophy of the time.[22]
[23] Smith and other classical economists before Cournot were referring to price and non-price rivalry among producers
to sell their goods on best terms by bidding of buyers, not necessarily to a large number of sellers nor to a market in final
equilibrium.

Later microeconomic theory distinguished between perfect competition and imperfect competition, concluding that
perfect competition is Pareto efficient while imperfect competition is not. Conversely, by Edgeworth's limit theorem, the
addition of more firms to an imperfect market will cause the market to tend towards Pareto efficiency.[25] Pareto
efficiency, named after the Italian economist and political scientist Vilfredo Pareto (1848-1923), is an economic state
where resources cannot be reallocated to make one individual better off without making at least one individual worse
off. It implies that resources are allocated in the most economically efficient manner, however, it does not imply equality
or fairness.

Appearance in real markets

 Real markets are never perfect. Economists who believe that perfect competition is a useful approximation to real
markets classify markets as ranging from close-to-perfect to very imperfect. Examples of close-to-perfect markets
typically include share and foreign exchange markets while the real estate market is typically an example of a very
imperfect market. In such markets, the theory of the second best proves that, even if one optimality condition in an
economic model cannot be satisfied, the next-best solution can be achieved by changing other variables away from
otherwise-optimal values.

Time variation
Within competitive markets, markets are often defined by their sub-sectors, such as the " short term" / "long term",
"seasonal" / "summer", or "broad" / "remainder" market. For example, in otherwise competitive market economies, a
large majority of the commercial exchanges may be competitively determined by long-term contracts and therefore
long-term clearing prices. In such a scenario, a “remainder market” is one where prices are determined by the small part
of the market that deals with the availability of goods not cleared via long term transactions. For example, in the sugar
industry, about 94-95% of the market clearing price is determined by long-term supply and purchase contracts. The
balance of the market (and world sugar prices) are determined by the ad hoc demand for the remainder; quoted prices
in the "remainder market" can be significantly higher or lower than the long-term market clearing price. Similarly, in the
US real estate housing market, appraisal prices can be determined by both short-term or long-term characteristics,
depending on short-term supply and demand factors. This can result in large price variations for a property at one
location.

Anti-competitive pressures and practices

Competition requires the existing of multiple firms, so it duplicates fixed costs. In a small number of goods and
services, the resulting cost structure means that producing enough firms to effect competition may itself be inefficient.
These situations are known as natural monopolies and are usually publicly provided or tightly regulated.
The printing equipment company American Type Founders explicitly states in its 1923 manual that its goal is to
'discourage unhealthy competition' in the printing industry.
International competition also differentially affects sectors of national economies. In order to protect political
supporters, governments may introduce protectionist measures such as tariffs to reduce competition.

Critiques of Perfect competition

Economists do not all agree to the practicability of perfect competition .There is debate surrounding how relevant it
is to real world markets and whether it should be a market structure that should be used as a benchmark.
Neoclassical economists believe that perfect competition creates a perfect market structure, with the best possible
economic outcomes for both consumers and society. In general, they do not claim that this model is representative of
the real world. Neoclassical economists argue that perfect competition can be useful, and most of their analysis stems
from its principles.

Economists that are critical of the neoclassical reliance on perfect competition in their economic analysis believe
that the assumptions built into the model are so unrealistic that the model cannot produce any meaningful insights. The
second line of critic to perfect competition is the argument that it is not even a desirable theoretical outcome. These
economists believe that the criteria and outcomes of perfect competition do not achieve a efficient equilibrium in the
market and other market structures are better used as a benchmark within the economy.

SELF-CHECK FN-14.1.1
A. Fill in the blanks with the correct answer.
___________1.is a concept in which profit-maximising producers and utility-maximising consumers in competitive
markets with freely determined prices arrive at an equilibrium price
___________2.are another form of imperfect competition market structures
___________3.theory places importance in a theoretical market state, in which the firms and market are considered to
be in perfect competition
___________4 is a scenario where different economic firms are in contention to obtain goods that are limited by varying
the elements of the marketing mix: price, product, promotion and place.
___________5.is generally accepted as an essential component of markets, and results from scarcity—there is never
enough to satisfy all conceivable human wants—and occurs "when people strive to meet the criteria that are being used
to determine who gets what.

MODULE 15
“The Economics Analysis of Cost”

Definition: In economics, the Cost Analysis refers to the measure of the cost – output relationship, i.e. the
economists are concerned with determining the cost incurred in hiring the inputs and how well these can be re-arranged
to increase the productivity (output) of the firm.

In other words, the cost analysis is concerned with determining money value of inputs (labor, raw material), called
as the overall cost of production which helps in deciding the optimum level of production.
There are several cost concepts relevant to the business operations and decisions and for the convenience of
understanding these can be grouped under two overlapping categories:

1. Cost Concepts Used for Accounting Purposes: Generally, the accountants use these cost concepts to study the
financial position of the firm. They are concerned with arranging the finances of the firm and therefore keep a track of
the assets and liabilities of the firm. The accounting costs are used for taxation purposes and calculating the profit and
loss of the firm. These are:
• Opportunity Cost
• Business Cost
• Full Cost
• Explicit Cost
• Implicit Cost
• Out-of-Pocket Cost
• Book Cost

2. Analytical Cost Concepts Used for Economic Analysis of Business Activities: These cost concepts are used by
the economists to analyze the likely cost of production in the future. They are concerned with how the cost of
production can be managed or how the input and output can be re-arranged such that the overall profitability of the
firm gets improved. These costs are:
• Fixed Cost
• Variable Cost
• Total Cost
• Average Cost
• Marginal Cost
• Short-run Cost
• Long-Run Cost
• Incremental Cost
• Sunk Cost
• Historical Cost
• Replacement Cost
• Private Cost
• Social Cost
In business, the manager must have a clear understanding of the cost-output relation as it helps in cost control,
marketing, pricing, profit, production, etc. The cost-output relation can be expressed as:

C = f (S, O, P, T)
Where, C =cost, S = Size of the firm, O = output, P = Price and T = Technology.
 With the increase in the size of the firm, the economies of scale also increase and as a result the cost of per unit
production comes down. There is a positive relation between the cost and the output, as the output increases the cost
also increases and vice-versa. Likewise, the price of inputs is directly related to the price, as the input price increases the
cost of production also increases. But however, the technology is inversely related to the cost, i.e. with an improved
technology the cost of production decreases.
Thus, the cost analysis is pivotal in business decision-making as the cost incurred in the input and output is to be
carefully understood before planning the production capacity of the firm.

What is Economic Analysis? Definition and Examples?

Economic analysis involves assessing or examining topics or issues from an economist’s perspective. Economic
analysis is the study of economic systems. It may also be a study of a production process or an industry. The analysis
aims to determine how effectively the economy or something within it is operating. For example, an economic analysis
of a company focuses mainly on how much profit it is making.
Economists say that economic analysis is a systematic approach to find out what the optimum use of scarce
resources is.
Template.net, which supplies ready-made analysis templates, says that economic analysis involves comparing at
least two alternatives in achieving, for example, a certain goal under specific constraints and assumptions.
Economic analyses factor in the opportunity costs that people or companies employ. They measure, in monetary
terms, what the benefits of a project are to the economy or community.
Opportunity cost is all about evaluating the option you gave up when you made a choice.
FBSMY.com, which has an economic calendar, has the following definition of the term:
“Economic is the study of economic systems or a production process. The aim is to determine whether it operates
effectively and how profitable it is.”
Put simply; economic analysis is all about analyzing the economic aspects of something.
Apart from economists, statisticians and mathematicians may also carry out economic analysis.

According to the Asian Development Bank: “Economic analysis is a means to help bring about a better allocation of
resources that can lead to enhanced incomes for investment or consumption purposes.
Therefore, it is best undertaken at the early stages of the project cycle.

Economic Analysis – Methods

For companies, the goal of an economic analysis is to provide a clear picture of the current economic climate.
Specifically, what the impact of the economic climate is or might be on the company’s ability to operate commercially.
In this context, ‘economic climate‘ means ‘economic conditions,’ i.e., the state of the overall economy.
The people conducting the analysis carry out an in-depth appraisal of the market’s strengths and weaknesses. They
may choose from several different methods.

Cost/Benefit Analysis
This type of economic analysis tries to determine a project’s feasibility. Some people may refer to it as a feasibility
study.
Those carrying out the study weigh its costs against its potential benefits.
A business may perform a cost-benefit analysis before, for example, purchasing four robots for the warehouse. Each
robot can do the work of five human workers.
Currently, the business has 20 warehouse employees. They earn $30,000 per year each, i.e., they represent a total
annual wage bill of $600,000.
Without factoring in wage increases and inflation, the business will have spent $6 million on warehouse staff over a
10-year period.
The robots cost $150,000 each. The price includes ten years of free maintenance. Therefore, the cost of automating
the warehouse is $600,000.
The company must also employ a roboticist, whose salary is $50,000 per year.
Over a ten-year period, the cost of the robots plus the roboticist will be $600,000 + $500,000 = $1.1 million.
The company will save $4.9 million over that ten-year period if it replaces the human workers with robots.
It might save even more after that because nobody knows for certain how long the robots will last.
 After looking at the cost/benefit analysis, the directors will probably decide to go ahead with the project.
Many sociologists and economists today warn that automation will soon take millions of human jobs. What will
society be like in future if most people are unemployed?
The subject of automation is not only present in companies targeting manufacturing, it’s also quite present in service
industries as well. For example, financial companies all over the world have been planning to re-adjust their operations
departments. For example, it’s clearly visible in this bitcoin lifestyle review by Inside Bitcoins that the age of a personal
assistant on financial platforms is slowly dying out due to automation.
Although companies can afford to have employees similar to the past, the reality of the modern markets has shifted
so much towards a profit-oriented policy that employees are simply not a focus anymore

Cost/Effectiveness
In this type of analysis, we weigh a project’s effectiveness against its price. In this case, however, a low cost does not
necessarily mean superior effectiveness.
Using the same ‘warehouse and robots’ scenario, researchers have also determined that human workers are better
at spotting defects.
The warehouse workers’ duties do not include checking the quality of the goods. However, they often identify faults
and report them.
The company addresses the defects before shipping out the products.
The cost/effectiveness analysis finds that losing this fault detection feature might cost more than $4.9 million over a
decade.
The company will probably lose some dissatisfied customers. Additionally, fixing defects after delivering products is
much more expensive than doing so beforehand.
After reading the cost-effectiveness analysis, the directors may halt the project. Perhaps one of them may suggest
purchasing the robots but keeping on one or two human workers.
Cost/benefit and cost/effectiveness analyses are just two of several types of economic analysis.
These analyses methods contribute to the economic assumptions that economists make when they create economic
models

SELF-CHECK FN-15.1.1
A. Fill in the blanks with the correct answer.
___________1.is the study of economic systems It may also be a study of a production process or an industry. The
analysis aims to determine how effectively the economy or something within it is operating
___________2.In this type of analysis, we weigh a project’s effectiveness against its price. In this case, however, a low
cost does not necessarily mean superior effectiveness.
___________3.This type of economic analysis tries to determine a project’s feasibility. Some people may refer to it as a
feasibility study
___________4.is concerned with determining money value of inputs (labour, raw material), called as the overall cost of
production which helps in deciding the optimum level of production.
___________5.is the study of economic systems or a production process, The aim is to determine whether it operates
effectively and how profitable it is