ECONOMIC

ANALYSIS FOR
BUSINESS
DECISIONS
Prof. Dr. Prasad Ghodke
Assistant Professor
Modern Institute of Business Studies, Nigdi
 • UNIT 1 : - MANAGERIAL ECONOMICS
• Managerial Economics:
• Concept of Economy, Economics,
• Microeconomics, Macroeconomics.
• Nature and Scope of Managerial Economics,
• Managerial Economics and decision-making.
• Concept of Firm, Market,
• Objectives of Firm: Profit Maximization Model,
Economist Theory of the Firm, Cyert and March’s
Behaviour Theory, Marris’ Growth Maximisation
Model, Baumol’s Static and Dynamic Models,
Williamson’s Managerial Discretionary Theory. (6+1)
 UNIT 1 : - MANAGERIAL ECONOMICS

• Managerial Economics:
• Managerial economics has been generally defined as the study of economic theories, logic and tools of
economic analysis, used in the process of business decision making.
• It involves the understanding and use of economic theories and techniques of economic analysis in
analyzing and solving business problems.
• Economic principles contribute significantly towards the performance of managerial duties as well as
responsibilities. Managers with some working knowledge of economics can perform their functions more
effectively and efficiently than those without such knowledge. Taking appropriate business decisions
requires a good understanding of the technical and environmental conditions under which business
decisions are taken. Application of economic theories and logic to explain and analyse these technical
conditions and business environment can contribute significantly to the rational decision-making process.
• According to McNair and Meriam, "Managerial Economics consists of the use of economic modes of
thought to analyse business situation."
• Spencer and Siegelman have defined Managerial Economics as "The integration of economic theory with
business practices for the purpose of facilitating decision making and forward planning by management."
 Concept of Economy & economics
• Concept of Economy: -
• Local economies
• When we think about a local economy, we’re referring to the
interconnected markets and networks within a particular community. The
local government, organisations, businesses, and people all contribute to
this economy.
• Local businesses may purchase their raw materials from sellers who are
nearby. These sellers may get grants or tax relief from local councils or
governments. People in the area pay tax, work for businesses, and
purchase goods and services.
• National economies
• According to the Bank of England, when we talk of a national economy,
such as the UK economy, we’re referring to a system for distributing scarce
resources. An economy, they suggest, is based on the fact that resources,
such as workers, land and raw materials, are limited. Demand, however, is
infinite.
• Although this principle of distributing scarce resources is at the heart of any
economy, national governments often have radically different approaches to
how they mould and manufacture a nation’s economy. That’s why the US
economy, for example, is very different from the Chinese economy.
• By the time we could move resources and produce across borders, these
national economies again became part of a much wider network of
interconnected nations.
• The global economy
• The world economy (also known as the global economy) refers to the
economy of all humans of the world. This definition includes the various
economic systems and activities that take place within and between
nations.
• This broad scope captures the exchange of capital (money and assets) as
well as the consumption and production of goods. Thanks to globalisation,
international trade, finance and investment all help to power the world’s
economy.
• Concept of Economics: -
Microeconomics,
Macroeconomics
 • Nature of managerial economics
• You need to know about its various characteristics to get more information about managerial
economics. In the mentioned below points let’s read about the nature of this concept:
• Art and Science: Management theory requires a lot of critical and logical thinking and
analytical skills to make decisions or solve problems. Many economists also find it a source
of research, saying it includes applying different economic concepts, techniques and
methods to solve business problems.
• Micro Economics: In managerial economics, managers typically deal with the problems
relevant to a single entity rather than the economy as a whole. It is therefore considered an
integral part of microeconomics.
• Uses Macro Economics: A corporation works in an external world, i.e. it serves the
consumer, which is an important part of the economy.
• For this purpose, it is important that managers evaluate the various macroeconomic factors
such as market dynamics, economic changes, government policies, etc., and their effect on
the company.
• Multidisciplinary: It uses many tools and principles that belong to different
disciplines, such as accounting, finance, statistics, mathematics, production,
operational research, human resources, marketing, etc.
• Prescriptive/Normative Discipline: By introducing corrective steps it aims at
achieving the objective and solves specific issues or problems.
• Management Oriented: This serves as an instrument in managers’ hands to deal
effectively with business-related problems and uncertainties. This also allows for
setting priorities, formulating policies, and taking successful decision-making.
• Pragmatic: The solution to day-to-day business challenges is realistic and rational.
• Both managers take a different view of the principle of managerial economics.
Others may concentrate more on customer service while others may make efficient
production a priority.
 SCOPE OF MANAGERIAL ECONOMICS
• Managerial economics comprises both micro- and macro-economic theories. Generally, the scope of
managerial economics extends to those economic concepts, theories, and tools of analysis used in
analysing the business environment, and to find solutions to practical business problems. In broad
terms, managerial economics is applied economics. The areas of business issues to which economic
theories can be directly applied are divided into two broad categories:
• Operational or internal issues; and,
• Environment or external issues.
• Operational problems, hoare of internal nature. These problems include all those problems
which arise within the business organization and fall within the control of management.
• Some of the basic internal issues include: choice of business and the nature of product (what to
produce); of price (product pricing); how to promote sales; how to face price competition; how to
decide ochoice of size of the firm (how much to produce); choice of technology (choosing the factor
combination); choice n new investments; how to manage profit and capital; andw to manage
inventory.
• Environmental issues: -
• Environmental issues are issues related to the general business environment. These are issues related to
the overall economic, social, and political atmosphere of the country in which the business is situated.
• The factors constituting economic environment of a country include:
• 1. The existing economic system
• 2. General trends in production, income, employment, prices, savings and investment, and so on.
• 3. Structure of the financial institutions.
• 4. Magnitude of and trends in foreign trade.
• 5. Trends in labour and capital markets.
• 6. Governments economic policies.
• 7. Social organizations, such as trade unions, consumers’ cooperatives, and producer unions.
• 8. The political environment.
• 9. The degree of openness of the economy.
• Managerial economics is particularly concerned with those economic factors that form the business
climate. In macroeconomic terms, managerial economics focus on business cycles, economic growth, and
content and logic of some relevant government activities and policies which form the business
environment.
 Managerial Economics and decision-making

• Managerial economics leverages economic

concepts and decision science techniques
to solve managerial problems. It provides
optimal solutions to managerial decision
making issues.
• Steps for Decision-Making
• The steps for decision making like
problem description, objective
determination, discovering alternatives,
forecasting consequences are described
below −
• Define the Problem
• What is the problem and how does it influence managerial objectives are the main questions. Decisions are usually made in the firm’s
planning process. Managerial decisions are at times not very well defined and thus are sometimes source of a problem.
• Determine the Objective
• The goal of an organization or decision maker is very important. In practice, there may be many problems while setting the objectives
of a firm related to profit maximization and benefit cost analysis. Are the future benefits worth the present capital? Should a firm
make an investment for higher profits for over 8 to 10 years? These are the questions asked before determining the objectives of a
firm.
• Discover the Alternatives
• For a sound decision framework, there are many questions which are needed to be answered such as − What are the alternatives?
What factors are under the decision maker’s control? What variables constrain the choice of options? The manager needs to carefully
formulate all such questions in order to weigh the attractive alternatives.
• Forecast the Consequences
• Forecasting or predicting the consequences of each alternative should be considered. Conditions could change by applying each
alternative action so it is crucial to decide which alternative action to use when outcomes are uncertain.
• Make a Choice
• Once all the analysis and scrutinizing is completed, the preferred course of action is selected. This step of the process is said to
occupy the lion’s share in analysis. In this step, the objectives and outcomes are directly quantifiable. It all depends on how the
decision maker puts the problem, how he formalizes the objectives, considers the appropriate alternatives, and finds out the most
preferable course of action.
 Concept of Firm, Market
•
What Is a Firm?
• A firm is a for-profit making business organization—such as a corporation,
limited liability company (LLC), or partnership—that provides professional
services. Most firms have just one location. However, a business firm consists of
one or more physical establishments, in which all fall under the same ownership
and use the same employer identification number (EIN).
• When used in a title, "firm" is typically associated with businesses that provide
professional law and accounting services, but the term may be used for a wide
variety of businesses, including finance, consulting, marketing, and graphic
design firms, among others.
• Types of Firms
• A firm's business activities are typically conducted under the firm's name, but the degree of legal protection—for
employees or owners—depends on the type of ownership structure under which the firm was created. Some
organization types, such as corporations, provide more legal protection than others. There exists the concept of the
mature firm that has been firmly established. Firms can assume many different types based on their ownership
structures:
• A sole proprietorship or sole trader is owned by one person, who is liable for all costs and obligations, and owns
all assets. Although not common under the firm umbrella, there exists some sole proprietorship businesses that
operate as firms.
• A partnership is a business owned by two or more people; there is no limit to the number of partners that can have
a stake in ownership. A partnership's owners each are liable for all business obligations, and together they own
everything that belongs to the business.
• In a corporation, the businesses' financials are separate from the owners' financials. Owners of a corporation are
not liable for any costs, lawsuits, or other obligations of the business. A corporation may be owned by individuals or
by a government. Though business entities, corporations can function similarly to individuals. For example, they
may take out loans, enter into contract agreements, and pay taxes. A firm that is owned by multiple people is often
called a company.
• A financial cooperative is similar to a corporation in that its owners have limited liability, with the difference that
its investors have a say in the company's operations.
 Concept of Market
• Concept of Market:
• In general terms, the word market is associated with a place where transaction occurs
between sellers and buyers. It is defined as an area where a large number of shops sell a
particular product. For example, Mahatma Phule market in Pune is a retail market of
vegetables and Dalai Street in Mumbai is the stock exchange market.
• Apart from this, there are certain cities that specialize in the manufacturing of a particular
product and become national markets. For example, Ahmedabad is known for textiles,
Banaras for silk, Kashmir for shawls, and Darjeeling for tea. Similarly, there are certain
countries that specialize in a particular product, which are termed as international markets.
For example, China is known for electronic products.
• However, in economics, the meaning of market is different from the general meaning of
market. In economic terms, market is defined as a system under which buyers and sellers
negotiate the price of a product, settle the price, and transact their business.
• Moreover, it is not necessary that sellers need to sell their products at a particular place; they can
distribute the products round the world. In economic sense, personal or physical contact between
buyers and sellers is also not necessary.
• They can perform transaction through various modes of communication, such as telephone, Internet
etc.
• Classification of market: -
• Market can be classified on different basis. There are different types of markets on the basis of
geographical area,
• time,
• business volume,
• nature of products,
• consumption,
• competition,
• seller's situation,
• nature of transaction etc. as follows:
• 1. Classification Of Market On The Basis Of Geographical Area
• Market can be classified in local, regional, national and international level on the basis of geographical area:
• i. Local Market
The market limited to a certain place of a country is called local market. This type of market locates in certain
place of city or any area and supplies needs and wants of the local people. Perishable consumer products such as
milk, vegetables, fruits, etc are sold and bought in local markets.
• ii. Regional Market
The market which is not limited to a certain place but expanded in regional level is called regional market. Mostly,
food grains such as wheat, paddy, maize, millet, sugar, oil etc are bought and sold in such regional market.
• iii. National Market
If buying and selling of some products is done in the whole nation, this is called national market. The products
such as clothes, steel, cement, iron, tea, coffee, soap, cigarette, etc are bought and sold nationwide.
• iv. International Or Global Market
Market cannot be limited to any geographical border of any country. If the goods produced in a country are sold in
different countries, this is called international market. today, not any country of the world is self-dependent. All the
countries are exporting the goods produced in other countries. The market of some goods such as gold, silver, tea,
clothes, machines and machinery, medicines etc. has spread the world over.
• 2. Classification Of Market On The Basis Of time
• On the basis of time, market can be divided in very short-term, short-term, long term and very long-term market.
• i. Very Short-term Market
• The market where shortly perishable goods are sold is called very short-term market. The market of milk, fish, meat, fruits and other
perishable goods is called very short-term market. The price of short goods is determined according to the pressure of demand. When
the demand for such goods is high, price rises and when demand declines, the price falls down. If the supply is low and the demand is
high, the price rises higher. In such market supply cannot be increased.
• ii. Short-term Market
• In the short term market, supply of products can be increased using the maximum capacity of installed machines of the firm. The
goods cannot be produced according to the demand for adjustment of supply by expanding or changing the existing machines and
equipment. In short-term market, price of the goods is determined on the basis of interaction between demand and supply. But, as the
supply cannot meet the demand, demand affects price determination in short-term market.
• iii. Long-term Market
• In long-term market, adequate time can be found for supply of products according to demand. New machines and equipment can be
installed for additional production to meet demand. As supply can be decreased or increased according to demand situation, price is
determined by interaction between demand and supply in long-term market. Market of durable products is long-term market.
• iv. Very Long-term Market Or Secular Market
• In secular market, produces can get adequate time to use new technology in production process and bring new changes in products.
They become able to produce and supply goods according to changed needs, interest, fashion etc. of customers. Market research
becomes helpful in doing so.
• 3. Classification Of Market On The Basis Of Volume Of Business
• On the basis of volume of business, type and size, market can be classified in wholesale
market and retail market.
• i. Wholesale Market
• If a large quantity of products are purchased from producers and sold to different
retailers, this is called wholesale market. In wholesale market, the products are not sold
directly to ultimate consumers. But, if consumers want to buy in large quantity, they can
buy from wholesaler.
• ii Retail Market
• The market that sells small quantity of products directly to ultimate consumers is called
retail market.
• 6. Classification Of Market On The Basis Of Competition
• On the basis of competition, market can be classified into monopoly market, perfect market and imperfect market.
• i. Monopoly Market
• If there is full control of producer over market, then such market is called monopoly market. In such market, the
producer determines price of his products in his own will. In such market, only one producer or seller controls
market. In practice, the producer or seller can supply products or achieve monopoly on price only in small or
limited area, but in wide area it becomes impossible.
• ii. Perfect Market
• The market where the number of buyers and sellers is large, homogeneous of products are bought and sold, same
price of similar type products is determined from free interaction between demand and supply is called perfect
market. Perfect competition takes between consumers and producers or buyers and sellers, but in practice perfect
market can be rarely found.
• iii. Imperfect Market
• The market where there is no perfect competition between buyers and seller is called imperfect market. In this
type of market, customers are affected by product discrimination. Post-sale services, packaging, price, nearness of
market, credit facility, discount etc make product discrimination. Customers can buy same types of products from
different sellers according to their desires and comfort. In practice, mostly products are bought and sold in
imperfect market.
• 4. Classification Of Market On The Basis Of Nature Of Product
• On the basis of nature of product, market can be classified in two types as follows:
• i. Commodity Market
• The market where consumer and industrial commodities like clothes, rice, machines, equipment, tea, soap, fruits, vegetables
etc. are bought or sold is called commodity market. In some market only certain special commodities are bought and sold and
in some other different consumer commodities are bought and sold.
• ii. Financial Market
• The market and financial instruments is called financial market. In such market, money, shares, debentures, treasury bills,
commercial papers, security exchanges, loan giving or taking etc are dealt. Dealing of short term fund is called money market
and dealing of long-term fund is called capital market.
• 5. Classification Of Market On The Basis Of Consumption

On the basis of consumption of products, market can be divided as follows:

• i. Consumer Market
• The market of products, which the people buy for consumption is called consumer market. The customers buy consumer
goods, luxury goods etc. for daily consumption or meeting their daily needs from such market.
• ii. Industrial Market
• Generally, raw materials, machines and equipment, machine parts are dealt in industrial market. Domestic consumer goods are
produced using them.
 Objectives of firm
• The goals of the firm are varied. Economists have put forth a number of approaches
relating to economic decisions of management. These can be classified into two
broad groups: -
• A. The Optimising (or Maximising ) Models: -
• 1. Profit- maximising theory ( or Theory of the firm)
• B. The Non- optimising (or Satisficing) Models: -
• 1. Simon’s Model of Satisficing behavior
• 2. R.M. Cyert and J.E. March’s Behavioral Theory of the firm
A. The Optimising (or • 1. Profit Maximization Model
Maximising ) Models: - • Profit Maximization model helps to predict the price-
output behavior of a firm under changing market conditions
1. Profit- maximising theory ( or like tax rates, wages and salaries, bonus, the degree of
Theory of the firm) availability of resources, technology, fashions, tastes and
preferences of consumers etc.
• It is a very simple and unambiguous model.
• It is the single most ideal model that can explain the normal
behavior of a firm.
• It is often argued that no other alternative hypothesis can
explain and predict the behavior of business firms better
than profit-maximization hypothesis.
• This model gives a proper insight in to the working behavior
of a firm. There are well developed mathematical models to
explain this hypothesis in a systematic and scientific manner.
• Profit-maximization implies earning highest possible amount of profits during a given period of
time.
• A firm has to generate largest amount of profits by building optimum productive capacity both in
the short run and long run depending upon various internal and external factors and forces.
• There should be proper balance between short run and long run objectives. In the short run a
firm is able to make only slight or minor adjustments in the production process as well as in
business conditions.
• The plant capacity in the short run is fixed and as such, it can increase its production and sales by
intensive utilization of existing plants and machineries, having over time work for the existing
staff etc.
• Thus, in the short run, a firm has its own technical and managerial constraints.
• But in the long run, as there is plenty of time at the disposal of a firm, it can expand and add to
the existing capacities, build up new plants, employ additional workers etc to meet the rising
demand in the market. Thus, in the long run, a firm will have adequate time and ample
opportunity to make all kinds of adjustments and readjustments in production process and in its
marketing strategies.
• It is to be noted with great care that a firm has to maximize its profits after taking in to consideration
of various factors in to account. They are as follows:
• Pricing and business strategies of rival firms and its impact on the working of the given firm.
• Aggressive sales promotion policies adopted by rival firms in the market.
• Without inducing the workers to demand higher wages and salaries leading to rise in operation costs.
• Without inducing the workers to demand higher wages and salaries government controls and
takeovers.
• Maintaining the quality of the product and services to the customers.
• Taking various kings of risks and uncertainties in the changing business environment.
• Adopting a stable business policy.
• Avoiding any sort of clash between short run and long run profits in the business policy and
maintaining proper balance between them.
• Maintaining its reputation, name, fame and image in the market.
• Profit maximization is necessary in both perfect and imperfect markets. In a perfect market, a firm is
a price-taker and under imperfect market it becomes a price-searcher.
B. The Non- optimising (or • 1. Simon’s Model of Satisficing behavior
Satisficing) Models: -
• Herbert Simon, a noble prize winner, had proposed an
1. Simon’s Model of alternate theory of firm behavior. Herbert Simon’s
Satisficing behavior research focused on decision-making in organizations,
and his contribution to behavioral theories is renowned
2. R.M. Cyert and J.E. March’s as “bounded rationality.”
• According to his theory (Simon, 1956), firms do not aim
Behavioral Theory of the firm at maximizing anything (profits, sales, etc.) due to
imperfections in data and the incompatibility of interests
of the various constituent of an organization.
• According to his Satisficing Model, the biggest
challenge before modern businesses is the lack of full
information and uncertainty about the future. Because of
this, firms have to incur costs in acquiring information in
the present.
• In the face of both these aspects, the objective of maximizing either profit, or sales, or
growth is not possible.
• Actually, they act as constraints to rational decision-making by any firm, because of
which the firm has to function under “bounded rationality” and can only aim at attaining
a satisfactory level of profit, sales, and growth.
• Instead, they set up for themselves some minimum standards of achievement, which
they hope will assure the firm’s viability over a long period of time.
• Simon has suggested that managers would set an aspiration level and then aim to achieve
it. If their behavior or performance exceeds the aspiration level, the target is increased; if
it fails to meet the aspired level, the target is brought down, and search behavior is
adopted simultaneously to find the deviation in the behavior pattern from the aspiration
level.
• The satisfying objective, in fact, is a multiple-goal, and it is very difficult to practice and
achieve.
• This theory believes that the relevant information with the managers
(decision-maker) is far from complete.
• The managers, due to the complexity of calculations, uncertainties of
future, and imperfection of the data to be used for determining 'optimal'
decisions, can not make really optimal decisions, but he is satisfied with
something less. Thus this model is termed as 'satisfying' model.
B. The Non- optimising (or 2. Cyert and March’s Behaviour Theory
Satisficing) Models: - • Cyert and March have put forth a systematic behavioural theory of
the firm. In a modem large multiproduct firm, ownership is
1. Simon’s Model of separate from management. Here the firm is not considered as a
single entity with a single goal of profit maximization by a single
Satisficing behavior
decision-maker, called the entrepreneur.
2. R.M. Cyert and J.E. March’s • Instead, Cyert and March regard the modem business firm as a
group of individuals who are engaged in the decision-making
process relating to its internal structure having multiple goals.
Behavioral Theory of the firm
• They deal not only with the internal organization of the firm but
also with the problem of uncertainty.
• They reject the assumption of certainty in the neo-classical theory
of the firm.
• They emphasize that the modem busi­ness firm is so complex that
individuals within it have limited information and imperfect
foresight with respect to both internal and external developments.
• The following are the key elements of the model.: -
The following are the key elements of the model.: -
• 1. Organizational goals
• 2. Conflicting goals
• 1. Organizational goals
• Cyert and March regard the modem business firm as a complex organisation in which the
deci­sion-making process should be analyzed in variables that affect organisational goals,
expectations, and choices. They look at the firm as an organisational coalition of managers,
workers, shareholders, suppliers, customers, and so on.
• Looked at from this angle, the firm can be supposed to have five different goals:
• 1. Production goal
• 2. Inventory goal
• 3. sales, market share and
• 4. profit goals.
• 1. Production Goal:
• The production goal represents in large part the demand of those coalition
members who are connected with production. It reflects pressures towards such
things as stable employment, ease of scheduling, development of acceptable cost
performance and growth. This goal is related to output decisions.
• 2. Inventory Goal:
• The inventory goal represents the demands of coalition members who are
connected with inventory. It is affected by pressures on the inventory from
salesmen and customers. This goal is related to decisions in output and sales
areas.
• 3. Sales Goal:
• The sales goal aims at meeting the demand of coalition members connected with
sales, who regard sales necessary for the stability of the organisation.
• 4. Market-Share Goal:
• The market-share goal is an alternative to the sales goal. It is related to the
demands of sales management of the coalition who are primarily interested in the
comparative success of the organisation and its growth. Like the sales goal, the
market-share goal is related to sales decisions.
• 5. Profit Goal:
• The profit goal is in terms of an aspiration level with respect to the money
amount of profit. It may also be in the form of profit share or return on
investment. Thus the profit goal is related to pricing and resource allocation
decisions.
• Conflicting Goals:
• The aspiration levels of the individuals within the firm which determine these goals, change
over time as a result of organisational learning. Thus these goals are regarded as the product
of a bargaining- learning process in the organisational coalition.
• But it is not essential that the different goals may be resolved amicably. There may be
conflicts among these goals. The organisational coalition is thus a coalition of conflicting
interests.
• The conflicting interests can be reconciled by the distribution of ‘side payments’ to
members of the coalition. Side payments may be in cash or kind, the latter being mostly in
the form of ‘policy side payments’ i.e., the right to take part in the policy decisions of the
organisation.
• But the actual amount of total side payments is not fixed for the coalition but depends upon
the demand of the members and on the form of the coalition. Demands of coalition
members equal actual side payments only in the long run. But the behavioural theory
focuses on the short-run relation between side payments and demands and on the
imperfections in factor markets.
• In the short run, new demands are being constantly made and the goals of the organisation
are continually adapted, to a greater or lesser extent, to take account of these demands. The
demands of the members of the organisational coalition need not be mutually consistent. But
all demands are not made simultaneously, and the organisation can remain viable by
attending to demands in sequence. A problem will arise when the organisation is not able to
accommodate the demands of its members even sequentially, because it lacks the resources
to do so.
• Satisficing Behaviour:
• Besides side payments, the conflicting goals of the organisation are resolved by subjecting
them to a constant review. This is because ‘aspiration levels’ of coalition members change
with experience. In fact, the aspiration levels change with the process of Satisficing. Each
person in the organisation has a Satisficing level for each of his goals.
• If these levels are reached, they will not seek for more. But if they are not achieved, the
aspiration levels are revised downwards. If they are exceeded, the aspiration levels are raised
upwards. In both situations, the satisfactory levels of performance are changed accordingly.
• Organisational Slack:
• A coalition is sound and workable if payments made to various members of the
coalition are adequate. For this, enough resources are needed to meet all
demands of members. This is ordinarily not possible because disparity arises
between the total resources available to the organisation and the total payments
required to maintain the coalition.
• This difference between total available resources and total necessary payments
is called organisational slack, by Cyert and March. Slack consists in payments to
members of the coalition iii excess of what is required to maintain the
organisation.
• Many forms of slack exist when the organisation operates under market
imperfections. The share­holders may be paid dividends in excess of what is
required to keep them within the organisation. The customers may be charged
lower prices so that they may stick to the products of the firm.
• The workers may be paid wages in excess of what is needed to keep them in the
firm. The executives may be provided with services and personal luxuries more
than what is required to keep them. All such excess payments are slack
expenditures for the firm which every member of the coalition obtains from time to
time.
• Thus “slack is typically not zero”, according to Cyert and March. Rather, it is
positive. Some members of the coalition ordinarily obtain a greater share of the
slack than do others. In general, those members of the coalition who are full-time,
tend to get more slack than the other members.
• Organisational slack plays a constructive role. It keeps the coalition in existence. It
enables the firm in maintaining itself under ‘crisis’ type situation and to adjust
itself to changes in external environ­ment. The organisational slack serves as a
cushion to absorb the shocks. Slack payments are increased during periods of
flourishing business and decreased during periods of bad business. Thus organisa­
tional slack plays both a stabilizing and an adaptive role.
• Decision-making Process:
• The decision-making process in the Cyert-March model rests with the top
management and the lower levels of administration. The top management sets the
organisational goals and allocates the given resources to the various departments
based on their share of the total budget of the firm.
• The share of the budget depends on the bargaining power and the skill of each
manager. The bargaining power is determined by the past performance of each
department. In this process of allocation, the top manage­ment retains some funds to
be allocated at its discretion at any time to any department.
• The decision process at the lower levels provides various degrees of freedom of
action to the administration. Once the budget share is allocated to each department,
each manager has considerable discretion in spending the funds at his disposal.
Decisions taken by managers are implemented by the lower level staff based on their
experiences and the “blue print” rules laid down earlier.
• The decision-making process also depends upon information’s and expectations
formed within the organisation. Information is required to facilitate the decision-
maker. Information is not a costless activity. Search activity is started whenever a
problem arises because search helps to locate and collect information.
• Information determines the aspirations (i.e., demands) of each department which,
in turn, helps the top management in setting goals. Organisational expectations
are related to the hopes and wishes of the decision-maker.
• Given the information and expectations, the top management examines and
decides upon the projects presented by the managers. It evaluates the projects on
the basis of two criteria. The first is the budgetary constraint which is the
availability of funds for the project. The second is an improvement criterion: Is
the project better than the existing one? In making decisions, the top management
follows the rule that leads to a better state in the future than it was in the past.
The Cyert-March model of behaviorism is thus an adaptive rational system.
 UNIT – 2 UTILITY & DEMAND ANALYSIS

• Utility & Demand Analysis: Utility – Meaning, Utility analysis, Measurement of utility,
Law of diminishing marginal utility, Indifference curve, Consumer’s equilibrium - Budget
line and Consumer surplus.
• Demand - Concept of Demand, Types of Demand, Determinants of Demand, Law of
Demand, Elasticity of Demand, Exceptions to Law of Demand. Uses of the concept of
elasticity.
• Forecasting: Introduction, Meaning and Forecasting, Level of Demand Forecasting, Criteria
for Good Demand Forecasting, Methods of Demand Forecasting, Survey Methods,
Statistical Methods, Qualitative Methods, Demand Forecasting for a New Products.
(Demand Forecasting methods - Conceptual treatment only (numericals not expected) (8+1)
 Utility – Meaning
• Utility Definition –
• It is a measure of satisfaction an individual gets from the consumption of the
commodities.
• In other words, it is a measurement of usefulness that a consumer obtains from any
good.
• A utility is a measure of how much one enjoys a movie, favorite food, or other goods.
It varies with the amount of desire.
• According to Robinson “Utility is the quality of commodities that makes individuals to
want to buy them”
• Characteristic of Utility
• It is dependent upon human wants.- It is ethically, morally neutral.
• It is immeasurable.- It is psychological and subjective. It is tangible . It
can not measured cardinally and numerically. It can only be expressed
ordinally.
• A utility is subjective. – It means it is psychological conditions of human
beings thus differ from person to person.
• It is a relative term – it is related to time & place.
• It depends on ownership.
• Types of Economic Utility: -
• 1. Form Utility
• 2. Place Utility
• 3. Time Utility
• 4. Possession Utility
• Form: It refers to the specific product or service that a company offers.
• Place: It refers to the convenience and readiness of the services available at a
place to the customer
• Time: It refers to the ease of availability of products or services at the time when a
customer needs.
• Possession: It refers to the benefit a customer derives from the ownership of a
company’s product.
• Types of Utility
• It is basically of three types
• Total Utility
• The sum of the total satisfaction from the consumption of specific goods or services. It increases as
more goods are consumed.
• Total Utility (T.U.) = U1 + U2 + … + Un
• Marginal Utility
• It is the additional satisfaction gained from each extra unit of consumption. It decreases with each
additional increase in the consumption of a good.
• Marginal Utility (M.U.) = Change in T.U. / Change in Total Quantity = Δ TU/ Δ Q
• Average Utility
• One can obtain it by dividing the total unit of consumption by the number of total units. Suppose
there are total n units, then
• Average Utility (A.U.) = T.U. / Number of units = T.U. / n
• Measurement of Utility
• Measurement of a utility helps in analyzing the demand behavior of a
customer. It is measured in two ways
• Cardinal Approach ( Utility is measured in the form of money)
• In this approach, one believes that it is measurable.
• One can express his or her satisfaction in cardinal numbers i.e., the
quantitative numbers such as 1, 2, 3, and so on. It tells the preference of
a customer in cardinal measurement. It is measured in utils.
• Limitation of Cardinal Approach
• In the real world, one cannot always measure utility.
• One cannot add different types of satisfaction from different goods.
• For measuring it, it is assumed that utility of consumption of one good
is independent of that of another.
• It does not analyze the effect of a change in the price.
• Ordinal Approach( Utility can be express in the form of ranking)
• In this approach, one believes that it is comparable. One can express his or her
satisfaction in ranking.
• One can compare commodities and give them certain ranks like first, second,
tenth, etc. It shows the order of preference. An ordinal approach is a qualitative
approach to measuring a utility.
• Limitation of Ordinal Approach
• It assumes that there are only two goods or two baskets of goods. It is not
always true.
• Assigning a numerical value to a concept of utility is not easy.
• The consumer’s choice is expected to be either transitive or consistent. It is
always not possible.
 Law of diminishing marginal utility
Utility:
Utility is the capacity of a commodity through which
• What is the Law of Diminishing human wants are satisfied.
Marginal Utility?
• The law of diminishing marginal utility Utils:
'Utils' is considered as the measurable 'unit' of
states that the amount of satisfaction utility.
provided by the consumption of every
additional unit of good decreases as we
increase that good’s consumption.
• Marginal utility is the change in the
utility derived from consuming another
unit of a good.
• Law of Diminishing Marginal Utility Graph
• If we were to represent the law of diminishing marginal
utility using a graph, it would look like the figure
below.
• In this figure, the
• X-axis represents the number of units of a good
consumed, and
• Y-axis represents the marginal utility of that good.
• Notice that as we increase the number of units,
the marginal utility of every additional unit falls.
• It keeps falling until it becomes zero and then further
sinks to negative.
• After a certain point, consuming that good may cause
dissatisfaction to the consumer.
 Disutility:
• Explanation for the Law of Diminishing Marginal Utility: If you still consume the product after the
• We can briefly explain Marshall’s theory with the help of an saturation point, the total utility starts to fall. This
example. is known as disutility.
• Assume that a consumer consumes 6 apples one after another. • When the first apple is consumed, the marginal utility
is 20.
• The first apple gives him 20 utils (units for measuring utility).
• When he consumes the second and third apple, the marginal • When the second apple is consumed, the marginal
utility of each additional apple will be lesser. utility increases by 15 utils, which is less than the
marginal utility of the 1st apple – because of the
• This is because with an increase in the consumption of apples,diminishing rate.
his desire to consume more apples falls.
• Therefore, this example proves the point that every successive•consumed
Therefore, we have shown that the utility of apples
diminishes with every increase of apple
unit of a commodity used gives the utility with the consumed.
diminishing rate.
• We can explain this more clearly with the help of a schedule • Similarly, when we consumed the 5th apple, we are at
and diagram. our saturation point. If we consume another apple, i.e.
6th apple, we can see that the marginal utility curve has
fallen to below X-axis, which is also known as
‘disutility’.
• Law of Diminishing Marginal Utility – Limitations
• Unrealistic assumptions: Include the conditions of uniformity, consistency, and
stability. It is unlikely to find all of these assumptions at once.
• Inapplicable in certain goods: It implies that the law of diminishing marginal
utility cannot be applied to products, such as televisions and refrigerators. To put
it another way, the consumption of these commodities isn’t constant.
• Consistent marginal utility of money: It is erroneous to assume that the marginal
utility of money will remain constant over time. In addition, the marginal
usefulness of money is decreasing over time.
 Indifference Curve
• What is Indifference Curve?
• An indifference curve is a graphical representation of a
combined products that gives similar kind of satisfaction to a
consumer thereby making them indifferent.
• Every point on the indifference curve shows that an
individual or a consumer is indifferent between the two
products as it gives him the same kind of utility. \
• The indifference curve in economics examines demand
•Here, we understand that all three
patterns for commodity combinations, budget constraints and
products resting in the indifferent
helps understand customer preferences.
curve give him the same satisfaction.
• The theory applies to welfare economics and
microeconomics, such as consumer and producer •However, his preference for those
equilibrium, measurement of consumer surplus, theory of combined products can be arranged in
exchange, etc. the order of preference.
• Indifference Curve Analysis
• The indifference curve analysis work on a simple graph having two-dimensional.
• Each individual axis indicates a single type of economic goods. If the graph is on
the curve or line, then it means that the consumer has no preference for any
goods, because all the good has the same level of satisfaction or utility to the
consumer.
• For instance, a child might be indifferent while having a toy, two comic book,
four toy trucks and a single comic book.
• Indifference Map
• The Indifference Map refers to a set of Indifference Curves that reflects an
understanding and gives an entire view of a consumer’s choices. The below
diagram shows an indifference map with three indifference curves.
• Indifference Curve Assumptions
• The consumer is rational to maximize the satisfaction and makes a
transitive or consistent choice.
• The consumer is expected to buy any of the two commodities in a
combination.
• Consumers can rank a combination of commodities based on their
satisfaction levels. Usually, the combination with the higher satisfaction
level is preferred.
• The consumer behavior remains constant in the analysis.
• The utility is expressed in terms of ordinal numbers/ ranks.
• Assumes marginal rate of substitution to diminish.
• Jack has 1 unit of cloth and 8 units of
the book. He decides to exchange 4
units of books for an additional piece of
cloth. The following situations may
occur:
• Jack is satisfied with 1 unit of cloth and
8 units of books.
• He is also satisfied with 2 units of cloth
and 4 units of books.
• In conclusion, Jack has the same level
of satisfaction and utility in both
situations as a consumer. He can utilize
the following combinations based on his
choice:
 Consumer’s equilibrium
• The consumer’s equilibrium is a point at which a consumer finds his
greatest utility for given prices and income. A consumer is in
equilibrium when his income is sufficient to obtain the desired goods.
• The balance can be obtained from the combination of two goods,
which are within reach of the consumer’s financial budget.
• In this way, the possibility of a higher level of satisfaction can be
achieved where the indifference curve is higher.
• One way to obtain the balance of the consumer is through the
knowledge of what the consumer likes and his economic limitations.
• This will depend on the income that he has and the prices that the
market understands.
• Consumer Equilibrium Graph
• The consumer’s equilibrium can be represented graphically as a
point of tangency where the indifference curve and the economic
constraint meet.
• Therefore, this equilibrium is obtained when the slope of the
indifference curve and the slope of the consumer’s budget line
have the same level of equality.
• The above graph illustrates consumer equilibrium, where –
• AB – Budget line
• I, II, and III – Indifference curves. They are a portion of an
individual’s indifference map.
• Given the limited income sources, a consumer cannot attain a
position beyond the budget line. Infinite numbers of attainable
bundles on AB are represented by R, E, and T. These and the
points on the budget line AB are attainable with the limited
income of the consumer.
• The marginal utility can be positive, negative, or zero. Let’s see what each result means.
• Positive marginal utility
• Positive marginal utility occurs when obtaining more than one item brings
additional satisfaction to the consumer. Suppose you like to eat a slice of lemon cake,
but a second slice would bring you extra joy. So your marginal utility from consuming
pie is positive.
• Negative marginal utility
• Negative marginal utility occurs when consuming too much of an item can cause you
harm. For example, eating two whole lemon tarts can make you sick.
• Zero marginal utility
• Zero marginal utility happens when the consumption of more than one item does not
bring an additional measure of satisfaction. For example, you may feel quite full after
two slices of brownie and still crave it even after having a third slice. In such a scenario,
your marginal utility from eating brownies is zero.
• Conclusion
• Every consumer strives to attain maximum satisfaction from the
commodity he invests in. This satisfaction derives from benefits arising
from the consumption of the product. After consumer equilibrium is
achieved, he will be in no state of further change. The level of satisfaction
will only go down after this stage.

• Link: - https://www.naukri.com/learning/articles/consumer-equilibrium/
 Demand
• What is demand?
• Demand simply means a consumer’s desire to buy goods and services without any
hesitation and pay the price for it.
• In simple words, demand is the number of goods that the customers are ready and willing
to buy at several prices during a given time frame. Preferences and choices are the basics
of demand, and can be described in terms of the cost, benefits, profit, and other variables.
• The amount of goods that the customers pick, modestly relies on the cost of the
commodity, the cost of other commodities, the customer’s earnings, and his or her tastes
and proclivity.
• The amount of a commodity that a customer is ready to purchase, is able to manage and
afford at provided prices of goods, and customer’s tastes and preferences are known as
demand for the commodity.
• Determinants of Demand
• There are many determinants of demand, but the top five determinants of demand are as follows:
• Product cost: Demand of the product changes as per the change in the price of the commodity. People
deciding to buy a product remain constant only if all the factors related to it remain unchanged.
• The income of the consumers: When the income increases, the number of goods demanded also
increases. Likewise, if the income decreases, the demand also decreases.
• Costs of related goods and services: For a complimentary product, an increase in the cost of one
commodity will decrease the demand for a complimentary product. Example: An increase in the rate of
bread will decrease the demand for butter. Similarly, an increase in the rate of one commodity will
generate the demand for a substitute product to increase. Example: Increase in the cost of tea will raise the
demand for coffee and therefore, decrease the demand for tea.
• Consumer expectation: High expectation of income or expectation in the increase in price of a good also
leads to an increase in demand. Similarly, low expectation of income or low pricing of goods will decrease
the demand.
• Buyers in the market: If the number of buyers for a commodity are more or less, then there will be a shift
in demand.
• Types of Demand
• Few important different types of demand are as follows:
1. Price demand: It refers to various types of quantities of goods or services that a customer will buy at a
quoted price and given time, considering the other things remain constant.
2. Income demand: It refers to various types of quantities of goods or services that a customer will buy at
different stages of income, considering the other things remain constant.
3. Cross demand: This means that the product’s demand does not depend on its own cost but depends on the
cost of the other related commodities.
4. Direct demand: When goods or services satisfy an individual’s wants directly, it is known as direct demand.
5. Derived demand or Indirect demand: The goods or services demanded or needed for manufacturing the
goods and satisfying the consumer indirectly is known as derived demand.
6. Joint demand: To produce a product there are many things that are related to each other, for example, to
produce bread, we need services like an oven, fuel, flour mill, and more. So, the demand for other additional
things to produce a product is known as joint demand.
7. Composite demand: A composite demand can be described when goods and services are utilized for more
than one cause. Example: Coal
• The Law of Demand
• The law of demand is interpreted as ‘the quantity demanded of a product comes
down if the price of the product goes up, keeping other factors constant.’
• In other words, if the cost of the product increases, then the aggregate quantity
demanded decreases.
• This is because the opportunity cost of the customers increases that leads the
customers to go for any other substitute or they may not purchase it. The law of
demand and its exceptions are really inquisitive concepts.
• Consumer proclivity theory assists us in comprehending the combination of two
commodities that a customer will purchase based on the market prices of the
commodities and subject to a customer’s budget restriction.
• The amount of a commodity that a customer actually purchases is the interesting
part. This is best elucidated in microeconomics utilizing the demand function.
 Elasticity of demand Let’s look at some examples:
• Elasticity of Demand
1.The price of a radio falls from Rs.
• To begin with, let’s look at the definition of the elasticity
of demand:
500 to Rs. 400 per unit. As a result, the
demand increases from 100 to 150
• “Elasticity of demand is the responsiveness of the units.
quantity demanded of a commodity to changes in one of
the variables on which demand depends. 2.Due to government subsidy, the price
• In other words, it is the percentage change in quantity of wheat falls from Rs. 10/kg to Rs.
demanded divided by the percentage in one of the 9/kg. Due to this, the demand increases
variables on which demand depends.” from 500 kilograms to 520 kilograms.
• The variables on which demand can depend on are:
In both cases above, you can notice
• Price of the commodity that as the price decreases, the demand
• Prices of related commodities increases. Hence, the demand for
radios and wheat responds to price
• Consumer’s income, etc. changes.
• Price Elasticity
• The price elasticity of demand is the response of the
quantity demanded to change in the price of a
commodity.
• It is assumed that the consumer’s income, tastes,
and prices of all other goods are steady. It is
measured as a percentage change in the quantity
demanded divided by the percentage change in
price. Therefore,
• Income Elasticity
• The income elasticity of demand is the degree of
responsiveness of the quantity demanded to a
change in the consumer’s income. Symbolically,
• Cross Elasticity
• The cross elasticity of demand of a commodity
X for another commodity Y, is the change in
demand of commodity X due to a change in the
price of commodity Y. Symbolically,

Where,
Ec = is the cross elasticity,
Δqx = is the original demand of commodity X,
Δqx = is the change in demand of X,
Δpy = is the original price of commodity Y, and
Δpy = is the change in price of Y.
• Exceptions to the Law of Demand
• Note that the law of demand holds true in most cases. The price keeps fluctuating until an equilibrium is created.
However, there are some exceptions to the law of demand. These include the Giffen goods, Veblen goods, possible
price changes, and essential goods. Let us discuss these exceptions in detail.
• Giffen Goods
• Giffen Goods is a concept that was introduced by Sir Robert Giffen. These goods are goods that are inferior in
comparison to luxury goods. However, the unique characteristic of Giffen goods is that as its price increases, the
demand also increases. And this feature is what makes it an exception to the law of demand.
• The Irish Potato Famine is a classic example of the Giffen goods concept. Potato is a staple in the Irish diet. During
the potato famine, when the price of potatoes increased, people spent less on luxury foods such as meat and bought
more potatoes to stick to their diet. So as the price of potatoes increased, so did the demand, which is a complete
reversal of the law of demand.
• Veblen Goods
• The second exception to the law of demand is the concept of Veblen goods. Veblen Goods is a concept that is named
after the economist Thorstein Veblen, who introduced the theory of “conspicuous consumption“.
• According to Veblen, there are certain goods that become more valuable as their price increases. If a product is
expensive, then its value and utility are perceived to be more, and hence the demand for that product increases.
• And this happens mostly with precious metals and stones such as gold and diamonds and luxury cars such as Rolls-
Royce. As the price of these goods increases, their demand also increases because these products then become a status
symbol.
• The expectation of Price Change
• In addition to Giffen and Veblen goods, another exception to the law of demand is the expectation of price change.
There are times when the price of a product increases and market conditions are such that the product may get more
expensive. In such cases, consumers may buy more of these products before the price increases any further.
Consequently, when the price drops or may be expected to drop further, consumers might postpone the purchase to
avail the benefits of a lower price.
• For instance, in recent times, the price of onions had increased to quite an extent. Consumers started buying and
storing more onions fearing further price rise, which resulted in increased demand.
• There are also times when consumers may buy and store commodities due to a fear of shortage. Therefore, even if the
price of a product increases, its associated demand may also increase as the product may be taken off the shelf or it
might cease to exist in the market.
• Necessary Goods and Services
• Another exception to the law of demand is necessary or basic goods. People will continue to buy necessities such as
medicines or basic staples such as sugar or salt even if the price increases. The prices of these products do not affect
their associated demand.
• Change in Income
• Sometimes the demand for a product may change according to the change in income. If a household’s income
increases, they may purchase more products irrespective of the increase in their price, thereby increasing the demand
for the product. Similarly, they might postpone buying a product even if its price reduces if their income has reduced.
Hence, change in a consumer’s income pattern may also be an exception to the law of demand.
 Forecasting  It is a technique for estimation of probable demand for a
product or services in the future.
• Demand forecasting is the  It is based on the analysis of past demand for that
process of using predictive product or service in the present market condition.
analysis of historical data to  Demand forecasting should be done on a scientific basis
estimate and predict customers' and facts and events related to forecasting should be
future demand for a product or considered.
service.  Therefore, in simple words, we can say that after
gathering information about various aspect of the market
• Demand forecasting helps the and demand based on the past, an attempt may be made
business make better-informed to estimate future demand. This concept is called
supply decisions that estimate the forecasting of demand.
total sales and revenue for a future  For example, suppose we sold 200, 250, 300 units of
period of time. product X in the month of January, February, and March
respectively. Now we can say that there will be a demand
for 250 units approx. of product X in the month of April,
if the market condition remains the same.
• Level of Forecasts:
• Influences demand forecasting to a larger extent. A demand forecast can be
carried at three levels, namely, macro level, industry level, and firm level.
• At Macro level, forecasts are undertaken for general economic conditions,
such as industrial production and allocation of national income. At the
industry level, forecasts are prepared by trade associations and based on the
statistical data.
• The industry level, forecasts deal with products whose sales are
dependent on the specific policy of a particular industry.
• The firm level, forecasts are done to estimate the demand of those
products whose sales depends on the specific policy of a particular firm. A
firm considers various factors, such as changes in income, consumer’s tastes
and preferences, technology, and competitive strategies, while forecasting
demand for its products.
• Criteria for Good
1. Accuracy
demand • Almost all the methods of demand forecasting yield accurate results under
forecasting:- different circumstances. However, not all methods are appropriate to be used for
all kinds of forecasting.
• For example, a lack of statistical data limits the use of regression analysis in
order to predict demand. Therefore, an appropriate selection of forecasting
1. Accuracy technique would ensure the accuracy of results.
2. Timeliness
2. Timeliness
3. Affordability • As discussed earlier, demand forecasting can be short term or long term.
4. Ease of interpretati The demand forecasting methods used for both the time periods vary.
• For example, the demand for a new product, which needs to be introduced
on
in a month’s time, cannot be assessed using the time series analysis
method. This is because this method requires data collected over long
periods.
• 3. Affordability
• The cost for different demand forecasting methods varies based on its implementation,
expertise required, the time period involved, etc. Thus, organizations should select a
method that suits their budget and requirements without compromising on the outcome.
• For example, the complete enumeration method of demand forecasting yields accurate
results but could prove expensive for small-scale organizations.
• Ease of interpretation
• Outcomes generated using demand forecasting methods are generally represented in the
form of statistical or mathematical equations.
• Therefore, it should be ensured that personnel carrying out forecasting are trained and
efficient to use forecasting methods and interpret the results.
• Methods of demand forecasting: - The survey method undertakes three exercises,
which are shown in Figure
• 1. Survey method
• 2. Statistical method
• 3. Qualitative method
• 1. Survey Method:
• Survey method is one of the most common and
direct methods of forecasting demand in the short
term.
• This method encompasses the future purchase
plans of consumers and their intentions.
• In this method, an organization conducts surveys
with consumers to determine the demand for their
existing products and services and anticipate the
future demand accordingly.
• 1. Experts’ Opinion Poll: 2.Market Experiment Method:
• Involves collecting necessary information
• Refers to a method in which experts are regarding the current and future demand for a
requested to provide their opinion about the product.
product. • This method carries out the studies and
• Generally, in an organization, sales experiments on consumer behavior under
representatives act as experts who can assess actual market conditions.
the demand for the product in different areas, • In this method, some areas of markets are
regions, or cities. selected with similar features, such as
population, income levels, cultural
• Sales representatives are in close touch with background, and tastes of consumers.
consumers; therefore, they are well aware of • The market experiments are carried out with
the consumers’ future purchase plans, their the help of changing prices and expenditure,
reactions to market change, and their so that the resultant changes in the demand
perceptions for other competing products. are recorded. These results help in forecasting
• They provide an approximate estimate of the future demand.
demand for the organization’s products. This
method is quite simple and less expensive.
• 3. Delphi method: -
• In this method, questions are individually asked from a group of experts to obtain their
opinions on demand for products in future. These questions are repeatedly asked until a
consensus is obtained.
• In addition, in this method, each expert is provided information regarding the estimates
made by other experts in the group, so that he/she can revise his/her estimates with
respect to others’ estimates.
• In this way, the forecasts are cross checked among experts to reach more accurate
decision making.
• Ever expert is allowed to react or provide suggestions on others’ estimates.
• However, the names of experts are kept anonymous while exchanging estimates among
experts to facilitate fair judgment and reduce halo effect.
 These different statistical methods are shown
• 2. Statistical Methods: in Figure-12:
• Statistical methods are complex set of methods
of demand forecasting. These methods are used
to forecast demand in the long term.
• In this method, demand is forecasted on the
basis of historical data and cross-sectional data.
• Historical data refers to the past data obtained
from various sources, such as previous years’
balance sheets and market survey reports.
• On the other hand, cross-sectional data is
collected by conducting interviews with
individuals and performing market surveys.
Unlike survey methods, statistical methods are
cost effective and reliable as the element of
subjectivity is minimum in these methods.
• 1. Trend Projection Method: Table-1 shows the time-series data of XYZ
Organization:
• Trend projection or least square method is the
classical method of business forecasting. In this
method, a large amount of reliable data is required
for forecasting demand.
• In addition, this method assumes that the factors,
such as sales and demand, responsible for past
trends would remain the same in future.
• In this method, sales forecasts are made through
analysis of past data taken from previous year’s
books of accounts.
• In case of new organizations, sales data is taken
from organizations already existing in the same
industry. This method uses time-series data on sales
for forecasting the demand of a product.
• i. Graphical Method:
• Helps in forecasting the
future sales of an
organization with the help
of a graph.
• The sales data is plotted on
a graph and a line is drawn
on plotted points. Figure-13 shows a curve which is plotted by taking into the
account the sales data of XYZ Organization (Table-1).

Line P is drawn through mid-points of the curve and S is a

straight line. These lines are extended to get the future
sales for year 2010 which is approximately 47 tons.

This method is very simple and less expensive; however,

the projections made by this method may be based on the
personal bias of the forecaster.
 The barometric method of demand forecasting is a
• 2.Barometric Method: technique that predicts the future trend for a
• In barometric method, demand is predicted on the product or service based on an analysis of external
basis of past events or key variables occurring in the factors such as economic indicators, market trends,
present. and industry-specific variables.
• This method is also used to predict various economic
indicators, such as saving, investment, and income. It assumes that consumers’ expectation for a
• This method was introduced by Harvard Economic product or service is closely related to changes in
Service in 1920 and further revised by National these external factors.
Bureau of Economic Research (NBER) in 1930s.
• This technique helps in determining the general It involves:
trend of business activities. For example, suppose • Collecting data on relevant indicators.
government allots land to the XYZ society for • Creating a model to establish the relationship
constructing buildings. This indicates that there
between the indicators and demand.
would be high demand for cement, bricks, and steel.
• Using the model to forecast future demand.
• The main advantage of this method is that it is
applicable even in the absence of past data.
The accuracy of the forecast will depend on the
• However, this method is not applicable in case of quality of the data and the interdependence
new products. In addition, it loses its applicability between external factors and demand.
when there is no time lag between economic
indicator and demand.
• 3. Qualitative forecasting: -
• Qualitative forecasting is important for helping executives make decisions
for a company.
• Performing qualitative forecasting can inform decisions like how much
inventory to keep, whether a company should hire new staff members and
how they can adjust their sales operations.
• Qualitative forecasting is also crucial for developing projects like marketing
campaigns, as it can provide information about a company's service that can
highlight which elements of the business to feature in advertisements.
• Some benefits of qualitative forecasting include the flexibility to use sources
other than numerical data, the ability to predict future trends and phenomena
in business and the use of information from experts within a company's
industry.
• Industries that use qualitative forecasting
• Companies in almost any industry can use qualitative forecasting to make predictions about their future
operations. Here's how a few industries might use qualitative forecasting:
• Sales: Qualitative forecasting can help companies in sales makes decisions like how much of a product to
produce and when they should order more inventory.
• Healthcare: Healthcare employees can use qualitative forecasting to identify trends in public health and
decide which healthcare operations might be in high demand in the near future.
• Higher Education: Colleges or universities can use qualitative forecasting to predict the number of
students who might enroll for the next term or year.
• Construction and manufacturing: Qualitative forecasting can show construction and manufacturing
companies the quantity of different materials they use to help determine which materials or equipment
they might need for their next project.
• Agriculture: Farmers can use qualitative forecasting to assess their sales and decide which crops to plant
for the next season based on which products consumers purchase most often.
• Pharmaceutical: Qualitative forecasting in pharmaceuticals can help identify which medications are
popular among consumers and which needs people are using pharmaceuticals to predict which kinds of
pharmaceuticals they might benefit from developing.
 UNIT- 3 Supply & Market Equilibrium

• Supply & Market Equilibrium: Introduction, Meaning of Supply and Law of Supply,
Exceptions to the Law of Supply, Changes or Shifts in Supply. Elasticity of supply,
Factors Determining Elasticity of Supply, Practical Importance, Market Equilibrium and
Changes in Market Equilibrium.
• Production Analysis: Introduction, Meaning of Production and Production Function,
Cost of Production.
• Cost Analysis: Private costs and Social Costs, Accounting Costs and Economic costs,
Short run and Long Run costs, Economies of scale, Cost-Output Relationship - Cost
Function, Cost-Output Relationships in the Short Run, and Cost-Output Relationships in
the Long Run. (8+1)
 Introduction
Meaning of Supply and Law of Supply
• Supply  What is Supply?
• The fundamental economic concept that  Supply is related to the price of the products,
states the total amount of a specified given that there is an incentive to supply at a
product or service that is available to higher price, as higher prices produce greater
customers is known as ‘supply.’ revenue and profits.
 Companies always want profit and, therefore,
• It is very closely related to and goes hand
in hand with demand. are more likely to manufacture more products
at higher prices.
• When supply exceeds demand for a  When the price of goods or services is low, the
product or service, the prices of said supply is low, and when the price is high, the
product fall. This is known as the law of supply is also high.
supply and demand.  Therefore, significant price changes would
• Their relationship highly affects the price also affect the equilibrium in the economic
of goods and is a very important topic in market.
the field of economics.
• What Is the Law of Supply?
• The law of supply is the
microeconomic law that states
that, all other factors being equal,
as the price of a good or service
increases, the quantity of goods or
services that suppliers offer will
increase, and vice versa.
• The law of supply says that as the
price of an item goes up, suppliers
will attempt to maximize their
profits by increasing the number
of items for sale.
 • Exceptions to the Law of Some exceptions to law of supply are given
Supply: - below:-
• The normal law of supply is widely  Change in business
applicable to a large number of Products.
• There are certain exceptions to law of  Monopoly
supply, like a change in the price of a
good does not lead to a change in its  Competition
quantity supplied in the positive
direction.  Perishable Goods

• The law of supply is not a universal  Legislation Restricting Quantity

principle that applies to all
circumstances.  Agricultural Products
• There are, in fact, various important
exceptions to the law of supply.  Artistic and Auction Goods
https://www.toppr.com/guides/business-economics-cs/basic-elements-of-dem
and-and-supply/exceptions-law-supply/
• 1. Change in business
• It may happen that the seller may plan to enter 3. Competition
into an entirely new business by exiting the Other market structures like an oligopoly
current one. and monopolistic competition may be facing
more competition, therefore offering to sell
• So when the present business is on the verge of more quantities at lower prices and negating
closure then the seller may sell his goods at lower the law of supply.
prices to clear them off. So here too the law of
supply is not being followed. 4. Legislation Restricting Quantity
• 2. Monopoly Suppliers cannot offer to sell more quantities
• When a small number of producers control the at higher prices where the government has
supply of the market then the law of supply may put some regulations on the quantity of the
not operate. good to be produced or the price ceiling at
which the good is to be sold in the market.
• For example, in the case of monopoly (single
seller) may not necessarily offer a larger quantity
supplied even though the price of goods is higher.
Market control by the monopoly allows it to set
the market price based on demand in the market.
• 5. Perishable Goods
• In cases of perishable goods, the supplier would offer to sell more
quantities at lower prices to avoid losses due to damage to the product.
• 6. Agricultural Products
• Since the production of agricultural products cannot be increased beyond
a certain limit, the supply can also not be increased beyond this limit even
if the prices are higher; the producer is unable to offer more quantities.
• 7. Artistic and Auction Goods
• The supply of such goods cannot be increased or decreased easily
according to its demand. Thus, it is difficult to offer more quantities even
if the prices shoot up.
Change in Supply :-
• Elasticity of supply: -
• The price elasticity of supply is a measure of the degree of responsiveness of the
quantity supplied to the change in the price of a given commodity.
• It is an important parameter in determining how the supply of a particular
product is affected by fluctuations in its market price. It also gives an idea about
the profit that could be made by selling that product at its price difference.
• The price elasticity of supply refers to the response to a change in a good or
service's price by the supply of that good or service. According to basic
economic theory, the supply of goods decreases when its price increases.
• Similarly, one can also study the price elasticity of demand. This illustrates how
easily the demand for a product can change based on changes in price. Price
changes fairly rapidly if the price of a product changes. This is known as price
elasticity of demand.
• Price Elasticity of Supply Formula
• After having understood the elasticity of supply definition in economics,
we now move to the elasticity of supply formula which is based on its
definition.

• Here, ES denotes the elasticity of supply which is equal to the percentage

change in quantity supplied divided by the percentage change in the price
of the commodity.
• Factors Determining Elasticity of Supply: -
• Elasticity of supply plays a very important role in determining prices of products. The
extent of rise in price of a commodity depends on the elasticity of supply. Various factors,
which determine the elasticity of supply of a product, are given below.
• (I) Marginal Cost:
• Elasticity of supply of a commodity depends on the marginal cost of production. The
elasticity of supply of a commodity would be less if the marginal cost of production goes
up. In the short run, diminishing marginal returns operates as some factors are fixed. This
gives rise to expansion of marginal cost of production.
• The expansion of marginal cost causes the elasticity of supply in the short run less elastic.
On the other hand in the long run the supply curve of a commodity is more elastic.
• In the increasing cost industry the supply of a commodity is more elastic. In the constant
cost industry the supply of a commodity is perfectly elastic. In the decreasing cost industry
the supply curve slopes negatively.
• (2) Producers response:
• The elasticity of supply for a product depends on the producers’ responsiveness to the
change in its price. The quantity supplied of a commodity will not change if the
producers do not react positively to the increase in prices. Producers do not always
increase the quantity supplied of a commodity to a rise in price.
• He may not raise supply in response to the rise in price. In some developed countries
agricultural producers meet their fixed money income by selling smaller quantities of
food grain. Thus with further rise in price they produce and sell smaller quantities rather
that more.
• (3) Infrastructural facilities:
• The expansion of supply of a commodity also depends on the availability of productive
facilities and inputs. The agricultural producer can not increase in response to the rise in
price unless there is sufficient flow of fertilizers, irrigation etc. In case of industrial
goods the expansion of supply is inhibited by the shortage of power, fuel and the
essential raw materials.
• (4) Possibility of Substitution:
• The change in supply in response to the change in price depends on the possibility of substitution of a product
for others. If the market price of potato rises, resources will be shifted from there cultivation like tomato and
employed in the cultivation of potato. The greater the possibility of shifting of resources to the potato
cultivation, the greater is the elasticity of supply of potato.
• (5) Duration of time:
• The elasticity of a product also depends on the length of time. If the time is longer producers get sufficient
time to make adjustment for changing output in response to the change in price. The greater the reaction of
output, the greater the elasticity of supply.
• On the basis of time market is divided into three types,
• (i) Market period (ii) Short-run (iii) long-run.
• In the market period the supply is perfectly inelastic as there is no more production. In the short run, output
can be changed by changing the variable factors only. Thus during short period the supply is elastic.
• In the long run supply of a commodity is more elastic as the firms can adjust all factors of production and also
new firms can enter or leave the industry.
• Market Equilibrium: -
• Changes in market • Similarly, the increase or decrease in supply, the
equilibrium: - demand curve remaining constant, would have an impact
• Changes in either demand or supply on equilibrium price and quantity.
cause changes in market equilibrium.
•Both supply and demand for goods may change
• Several forces bring­ing about changes simultaneously causing a change in market equilibrium.
in demand and supply are constantly
working which cause changes in market • Supply-demand analysis is an im­portant tool of
equilibrium, that is, equilibrium prices economics with which we can make forecasts about how
and quantities. prices and quantities will change in response to changes
• The demand may increase or decrease, in demand and supply.
the supply curves remaining unchanged.
This would cause a change in •We explain below the impact of changes in demand and
equilibrium price and quantity. supply on equilibrium price and quantity.
• https://www.yourarticlelibrary.co
m/economics/market/changes-in-
market-equilibrium-impact-of-in
crease-and-decrease/37161
• Impact of Increase in Demand on Market
Equilibrium:
https://www.geeksforgeeks.org/effects-of-changes-in-demand-a
• Increase in demand affects prices and nd-supply-on-market-equilibrium/
quantities. Suppose there is increase in
income of the working class due to the
enhancement of their salaries by the Pay
Commission.
• As a result of this increase in income, their
demand for cloth for shirting will increase
causing a shift in the entire demand curve for
cloth to the right.
• This will raise the equilibrium price and
quantity of cloth, the supply curve of cloth
remaining unchanged as is shown in Fig.
24.2. It is important to understand the chain of
causation which leads to the increase in price
and quantity as a result of increase in demand.
 PRODUCTION FUNCTION : -
Production Analysis  The production function is a mathematical equation
• Introduction, determining the relationship between the factors and quantity
of input for production and the number of goods it produces
• Meaning of Production most efficiently.
and Production  It answers the queries related to marginal productivity, level
Function, of production, and cheapest mode of production of goods.
 Four major factors of production are – entrepreneurship,
• Cost of Production. labor, land, and capital.
 They form an integral part of inputs in this function. The
production function helps the producers determine the
maximum output that firms and businesses can achieve using
the above four factors.
 In addition, it aids in selecting the minimum input
combination for maximum output production at a certain
price point.
• Cost of Production: -
• Cost of production is the total cost incurred by a
business to either produce a product or offer their services.
• Production costs typically include supplies and raw
materials that are consumed during production, along with
labor expenses.
• In simple terms, it is the sum of all expenses necessary to
produce and sell a product or service.
• Costs of production overview
• The costs of production overview will explain the different types of costs that firms incur
when producing goods or services and how they can be categorized into fixed and
variable costs in both short-run and long-run production.
• What is short-run production?
• Short-run production in microeconomic theory is when at least one of the factors of
production (land, labour, capital, or technology) is fixed and can’t be changed.
• The company can produce more output in the short run by adding more variable factors to
the fixed factors of production.
• What is long-run production?
• Long-run production in microeconomic theory is the period where the scale of all factors
of production is variable and can be changed.
• In the long run, the company can benefit from economies of scale as the scale and
capacity of production can increase. For example, a company can increase the quantity of
its labour force while simultaneously increasing the quantity of capital.
• Types of Production Costs
• When
manufacturing a product or offering a specif
ic service
, a business can incur multiple types of
expenses. Let’s take a look at the most
common types of costs of production:
• 1.Variable Costs
• Variable costs are expenses that change with
production volume; these costs rise when
production increases and fall when it decreases.
With a production volume of zero, there are no
variable costs associated with it. Variable costs
include things like utilities, direct labor, raw
materials, and commissions.
• 2. Fixed Costs
• Unlike variable costs, fixed costs do not fluctuate with production volume; these costs
remain the same whether there is zero production or running at full capacity.
• Fixed costs are generally considered time-limited, meaning that they are fixed to output
for a specific period; most production costs vary from period to period. Employee salary,
rent, and leased equipment are some examples of fixed costs of product
• 3. Marginal Cost
• Marginal cost determines how much it would take to produce one additional product
unit, showing the total cost increase from that extra product.
• Variable expenses mainly affect the marginal cost, as fixed costs do not change with the
level of output. Marginal costs are typically used to decide where resources should be
allocated to optimize the profits of production.
• Marginal costs will vary with production volume and are affected by things like price
discrimination, asymmetrical information, transaction costs, and externalities.
• 4.Average Cost
• The average cost is essentially the expenses that occur from producing one unit or offering
one service;
• this can be found in two ways:
• by dividing the total production costs by the amount of product created or
• by adding together the average variable and fixed costs.
• Average expenses are crucial when it comes to making decisions on how to price a product or
service. Ideally, average costs should be minimized to increase the profit margin without
increased expenses.
• 5.Total costs
• A company’s total costs are made up of the fixed costs and variable costs added together, as
shown in this formula:
• Total Costs (TC) = Fixed Costs (FC) = Variable Costs (VC)
• When a company produces more and increases its output, the company’s total cost of
production will increase.
 Cost of materials
• Factors affecting cost of production The costs of raw materials that are necessary for
• Several factors can affect the cost of production for a given manufacturing can vary depending on the year, the
product or service. Here are several to consider: economy and availability. For example, the price
of steel might rise or fall depending on the
• Demand financial stability of the steel mill or the costs of
• As a company's success grows, the demand for certain international transportation. The prices of oil and
products also increases. To fill customers' orders, a company gasoline affect almost every industry due to their
may buy more raw supplies, hire new laborers, expand the association with shipping and product delivery.
production facility or even open a second location. Ideally, a
company can use the profits gained from new customers to Tax rates
offset the increased cost of production. Taxes are an indirect production cost that can
• Technology contribute significantly to a company's
annual overhead. Taxes may be higher or
• Automated machines have replaced some jobs that human lower during a certain year depending on
laborers performed traditionally. Many companies use changes in the local or federal
manufacturing robots instead of employees to lower the costs government. Factors such as a company
associated with labor wages. Additionally, updating factory hiring several new employees, an increase in
equipment, installing new computer systems or educating national insurance or a tax on employees can
employees on the use of new digital interfaces can speed up contribute to higher production costs.
the manufacturing process and also lower the cost of
production.
 Cost Analysis Cost analysis, also known as cost-benefit analysis, is the
process of calculating the potential earnings from a
• Cost Analysis: situation or project and subtracting the total cost
associated with completing it.
• Private costs and Social Costs,
• Accounting Costs and Economic It predicts the profit gained from a project and compares
costs, the project's cost to its estimated financial benefits.
• Short run and Long Run costs,
• Economies of scale,
• Cost-Output Relationship - Cost
Function, Cost-Output
Relationships in the Short Run,
and
• Cost-Output Relationships in the
Long Run. (8+1)
• PRIVATE COST & SOCIAL COST: -
External costs, on the other hand, are not
• Private costs for a producer of a good, service, or reflected on firms' income statements or in
activity include the costs the firm pays to purchase consumers' decisions. However, external
capital equipment, hire labor, and buy materials or costs remain costs to society, regardless of
other inputs. While this is straightforward from the who pays for them.
business side, it also is important to look at this issue
from the consumers' perspective. Social costs include both the private costs
• Field, in his 1997 text, Environmental Economics and any other external costs to society
provides an example of the private costs a consumer arising from the production or consumption
faces when driving a car:1 of a good or service.
• The private costs of this (driving a car) include the The social costs include all these private
fuel and oil, maintenance, depreciation, and even the costs (fuel, oil, maintenance, insurance,
drive time experienced by the operator of the car. depreciation, and operator's driving time)
• Private costs are paid by the firm or consumer and and also the cost experienced by people
other than the operator who are exposed to
must be included in production and consumption
the congestion and air pollution resulting
decisions. In a competitive market, considering only
from the use of the car.
the private costs will lead to a socially efficient rate
of output only if there are no external costs.
• ACCOUNTING COST: -
• What is the meaning of accounting costs?
• Accounting costs measure the monetary value of taking an action. They are the explicit
costs involved with the business. For example, if a company wants to open a satellite
office in a new market, they must make investments, such as new hires, computer
equipment, software systems, rent, and inventory.
• Ex: - They include rent, supplies, insurance, and payroll expenses etc.
• ECONOMIC COSTS: -
• The economic cost is the total expenditure a firm faces when using economic resources
to produce goods and services.
• Economic cost involves all the expenses a firm faces, those it can manage, and those
beyond the company's control. Some of these economic costs include capital, labor, and
raw materials. However, the company may use other resources, some of which have
expenses that are not as readily apparent but are still significant.
• SHORT RUN COST LONG RUN COST: -
• What is Short Run Costs?
• It is the cost incurred in production during a fixed period of time when all the factors
and inputs vary, except one. Assessing the short run costs of an organisation or an
economy helps us to study how it behaves in response to sudden environmental
changes.
• What is Long Run Cost?
• Long Run Cost is the minimum cost at which a certain level of output can be
achieved in the long run when all factors of production are variable.
• These costs enable a business to understand its asset value and make necessary
improvements in the production cycle. As a result, this helps organisations analyse
their factors of production and expand or reduce their operational costs accordingly.
• https://navi.com/blog/long-run-costs-short-run-costs/
• ECONOMES OF SCALE: -
• What Are Economies of Scale?
• Economies of scale are cost advantages gain by companies when
production becomes efficient. Companies can achieve economies of scale
by increasing production and lowering costs. This happens because costs
are spread over a larger number of goods. Costs can be both fixed and
variable.
• https://www.investopedia.com/terms/e/economiesofscale.asp
• Cost-Output Relationship - Cost • The cost-output relationship plays an
important role in determining the optimum
Function, Cost-Output Relationships in
level of production. Knowledge of the cost-
the Short Run, and output relation helps the manager in cost
control, profit prediction, pricing, promotion
• Cost-Output Relationships in the Long etc. The relation between cost and its
Run. determinants is technically described as the
cost function.
• Cost output relationship shows how the
cost changes if output level change. • C= f (S, O, P, T ….)
• Where;
• Every cost shows different type of
• C= Cost (Unit or total cost)
behavior with change level of output.
• S= Size of plant/scale of production
• Here we are showing the cost output • O= Output level
relationship in short run and long run.
• P= Prices of inputs
• T= Technology
• Considering the period the cost function can be classified as
(1)short-run cost function and
(2)long-run cost function
In economics theory, the short-run is defined as that period during which
the physical capacity of the firm is fixed and the output can be increased
only by using the existing capacity allows to bring changes in output by
physical capacity of the firm.

Here 3 types of cost has been taken for showing relationship with output i.e. Total cost, fixed
cost, variable cost, average fixed cost, average variable cost and average total cost.
• 1. Cost-Output Relationship in the Short-Run
• The cost concepts made use of in the cost behavior are Total cost, Average cost, and Marginal cost.
• Total cost is the actual money spent to produce a particular quantity of output. Total Cost is the
summation of Fixed Costs and Variable Costs.
• TC=TFC+TVC
• Up to a certain level of production Total Fixed Cost i.e., the cost of plant, building, equipment etc,
remains fixed. But the Total Variable Cost i.e., the cost of labor, raw materials etc., vary with the
variation in output.
• Average cost is the total cost per unit. It can be found out as follows.
• AC=TC/Q
• The total of Average Fixed Cost (TFC/Q) keep coming down as the production is increased and
Average Variable Cost (TVC/Q) will remain constant at any level of output.
• Marginal Cost is the addition to the total cost due to the production of an additional unit of product. It
can be arrived at by dividing the change in total cost by the change in total output.
• In the short-run there will not be any change in Total Fixed C0st. Hence change in total cost implies
change in Total Variable Cost only.
• The short-run cost-output
relationship can be shown
graphically as follows.
• In the above graph the “AFC’ curve continues to fall as output rises an account of its
spread over more and more units Output. But AVC curve (i.e. variable cost per unit)
first falls and than rises due to the operation of the law of variable proportions.
• The behavior of “ATC’ curve depends upon the behavior of ‘AVC’ curve and ‘AFC’
curve.
• In the initial stage of production both ‘AVC’ and ‘AFC’ decline and hence ‘ATC’ also
decline. But after a certain point ‘AVC’ starts rising. If the rise in variable cost is less
than the decline in fixed cost, ATC will still continue to decline otherwise AC begins to
rise. Thus the lower end of ‘ATC’ curve thus turns up and gives it a U-shape.
• That is why ‘ATC’ curve are U-shaped. The lowest point in ‘ATC’ curve indicates the
least-cost combination of inputs.
• Where the total average cost is the minimum and where the “MC’ curve intersects ‘AC’
curve, It is not be the maximum output level rather it is the point where per unit cost of
production will be at its lowest.
• The relationship between ‘AVC’, ‘AFC’ and ‘ATC’ can be summarized up
as follows:
• If both ‘AFC’ and ‘AVC’ fall, ‘ATC’ will also fall.
• When ‘AFC’ falls and ‘AVC’ rises
• ATC’ will fall where the drop in ‘AFC’ is more than the raise in ‘AVC’.
• ‘ATC’ remains constant is the drop in ‘AFC’ = rise in ‘AVC’
• ‘ATC’ will rise where the drop in ‘AFC’ is less than the rise in ‘AVC’
• 2. Cost-output Relationship in the Long-Run
• Long run is a period, during which all inputs are variable including the one,
which are fixes in the short-run. In the long run a firm can change its output
according to its demand.
• Over a long period, the size of the plant can be changed, unwanted buildings
can be sold staff can be increased or reduced.
• The long run enables the firms to expand and scale of their operation by
bringing or purchasing larger quantities of all the inputs. Thus in the long run
all factors become variable.
• The long-run cost-output relations therefore imply the relationship between the
total cost and the total output. In the long-run cost-output relationship is
influenced by the law of returns to scale.
• In the long run a firm has a number of
alternatives in regards to the scale of
operations.
• For each scale of production or plant
size, the firm has an appropriate short-
run average cost curves.
• The short-run average cost (SAC)
curve applies to only one plant whereas
the long-run average cost (LAC) curve
takes in to consideration many plants.
• The long-run cost-output relationship is
shown graphically with the help of
“LCA’ curve.
• To draw on ‘LAC’ curve we have to start with a number of ‘SAC’ curves.
• In the above figure it is assumed that technologically there are only three
sizes of plants — small, medium and large, ‘SAC’, for the small size,
‘SAC2’ for the medium size plant and ‘SAC3’ for the large size plant.
• If the firm wants to produce ‘OP’ units of output, it will choose the
smallest plant. For an output beyond ‘OQ’ the firm wills optimum for
medium size plant.
• It does not mean that the OQ production is not possible with small plant.
Rather it implies that cost of production will be more with small plant
compared to the medium plant.
• For an output ‘OR’ the firm will choose the largest plant as the cost of
production will be more with medium plant.
• Thus the firm has a series of ‘SAC’ curves. The ‘LCA’ curve drawn will
be tangential to the entire family of ‘SAC’ curves i.e. the ‘LAC’ curve
touches each ‘SAC’ curve at one point, and thus it is known as envelope
curve.
• It is also known as planning curve as it serves as guide to the entrepreneur
in his planning to expand the production in future.
• With the help of ‘LAC’ the firm determines the size of plant which yields
the lowest average cost of producing a given volume of output it
anticipates.
 UNIT- 4
Revenue Analysis and Pricing Policies
• Introduction, Revenue: Meaning and Types, Relationship between Revenues and Price
Elasticity of Demand, Pricing Policies, Objectives of Pricing Policies, Cost plus pricing.
Marginal cost pricing. Cyclical pricing. Penetration Pricing. Price Leadership, Price Skimming.
Transfer pricing.
• Price Determination under Perfect Competition- Introduction, Market and Market Structure,
Perfect Competition, Price-Output Determination under Perfect Competition, Short-run
Industry Equilibrium under Perfect Competition, Short-run Firm Equilibrium under Perfect
Competition, Long-run Industry Equilibrium under Perfect Competition, Long-run Firm
Equilibrium under Perfect Competition.
• Pricing Under Imperfect Competition- Introduction, Monopoly, Price Discrimination under
Monopoly, Bilateral Monopoly, Monopolistic Competition, Oligopoly, Collusive Oligopoly
and Price Leadership, Pricing Power, Duopoly, Industry Analysis.
• Profit Policy: Break Even analysis. Profit Forecasting. Need for Government Intervention in
Markets. Price Controls. Support Price. Preventions and Control of Monopolies. System of
Dual Price.