Micro Economics Meaning Nature And Scope

Economics is the study of those activities of human beings, which are concerned, with the satisfaction of unlimited wants by using the limited resources. Micro means the millionth part. The term micro has been taken from the Greek word mikros meaning small. Under microeconomics we study the individual units like a consumer, a firm, an industry, price determination of a particular commodity etc. In short the microeconomics deals with the study of the economic problems of a single unit like a firm or small economic units or resource owners. The main objective of microeconomics is to study the principles, policies and the problems relating to the optimum allocation of resources. From the theoretical point of view it tells us the functioning of a free enterprise economy. It explains us how through the market mechanism goods and services produced in the economy are distributed.

Nature and scope of Micro EconomicsIn the nature of economics we may consider whether it is a science or an art.

Science not only means the collection of facts but it also means that the facts are arranged in such a manner that they speak for themselves. It means that some laws are discovered through these facts. Thus science is a systematic body of knowledge concerning the relationship between causes and effects of a particular phenomenon.

Characteristics of a science1 First of all the facts are observed. E.g. when price rise the demand contracts.2 The facts in this step are properly classified. Like if price falls how much the

demand has fallen. 3 After the compilation of facts and having knowledge about the magnitude of

a problem a law is framed keeping onto consideration the cause and effect of a fact. E.g. Law of demand

4 The final feature of science is by applying the scientific laws to real life. It is verified whether they are valid or not.

Thus from the above discussion it could be concluded that economics is a science. But some economists believe that it is not an exact science.

Whether it’s a social science or a natural science

Arguments in favour of social science1. Economics is a systematic study. It is the study of the interrelated activities

like production consumption and exchange of wealth.2. Laws of economics show a cause and effect relationship between them3. Laws of economics are based on real experiences of life.

Arguments against economics as a natural law1 The laws of economics are not the exact laws. Like law of economics does not

operate if there is a change in the income of the person or a change in price of substitute goods.

2 Economics laws are far from universal applicability. These laws cannot be applied in all situations and at all the times.

3 The laws of economics cannot be verified in the laboratories. In the exceptional cases even the information or the results obtained through the application can prove to be futile.

Thus economics is not a natural science. It is a social science.

Economics As A Positive Or A Normative Science

Positive science is that science which studies an accurate and true description of events as they happen. Thus it deals with what, how and why. Normative science is suggestive in nature. Normative science tells us what ought to be.

Economics as a positive science

1 Positive science is logical whereas normative science is emotional. Therefore it is more exacts it is based on the logic.

2 If economics studies only the realities of the real world then the chances of the disagreement are less, as the case would be if it studies both.

3 The economists cannot make the rational judgments if they try to analyze both what is and what ought to be.

Economics as a normative science

1. Economics would offer more meaningful conclusions if it gives suggestions too long with the facts.

2. Economics will be more useful if it is fruit bearing too along with the light bearing. Most of the people study economics for the fruits and not for the light merely.

3 if the economist synchronizes the analysis of economic problems with concrete economic policies he would save time. Else it would be difficult if one person finds the solutions and the other tries to justify those solutions.

Thus the argument can be put to an end only by saying that it is both the positive as

well as a normative science

Arguments in favour of economics as an artMany economists like Marshall, Pigou etc. believe that economics is an art also

besides being a scienceEconomics as an art

1. Economics offer a solution to the problems of human beings. It tells us how we can make the judicious use of our resources.

2. It is through the art that we can verify the economic laws. For example the law of demand

3. The doubts can be removed by dividing the economics into science as well as an art.

Arguments against art

1 Science and art are different. If economics is science it cannot be art and if it is an art it cannot be a science.

2 Economic problems are influenced by social and political nature. Therefore economics cannot be considered from the economic point of view only.

UTILITYIt’s the want satisfying power of a commodity.

1. Utility is subjective. It depends upon the human wants. 2. Utility keeps on changing with time and place. 3. It need not be always useful.4. Utility has nothing to do with the morality.

Measurement of utilityIt can be measured both in terms of money as well as in terms of units. If two

persons pay different sum of money for the same amount of commodity then it is the measurement in terms of money.

Marshall, Jevons and Menger etc have tried to measure it in terms of cardinal numbers. Pareto, Allen, Hicks etc. measured it in ordinal an term that is Indifference curve approach.

Utility has three concepts:1. Initial utility2. Marginal utility 3. Total utility

Marginal utility can further be divided into Positive Marginal Utility or Zero Marginal Utility or Negative Marginal Utility

Quantity Total utility Marginal utility0 0 -1 8 82 14 63 18 44 20 25 20 06 18 -2

Opportunity costs

Opportunity costs may be defined as the expected returns from the second best use of the resources which are foregone due to the scarcity of resources. E.g. if with a sum of Rs. 1 lakhs one can purchase two machines. One yields a profit of Rs.20000 and the other a profit of Rs. 10000. Now the buyer will forego the use which is less productive. It can also be termed as economic rent

(Rs. 20000 – Rs 10000 = Rs. 10000)

Explicit and Implicit costs

Marginal and Incremental costs

It is the change in Total costs due to the production of one more or one less unit of a factor of production.

MC = TCn – TCn-1

Incremental costs refer to the total additional costs associated with the decisions to expand output or to add a new variety of product etc. In the long run when firms expand their production they hire more of men, machinery and equipments. These expenditures are included in the incremental costs. These costs also arise due to change in the product lines, addition or introduction of a new product, replacement of worn out plant and machinery, replacement of old techniques of production with a new one etc.

Sunk costs are those costs, which cannot be increased or decreased by varying the rate of output. Example once it is decided to make incremental investment expenditure and the funds are allocated, all the preceding costs are considered to be the sunk costs as these costs cannot be recovered when there is a change in the market decisions.

EQUILIBRIUM

Equilibrium is a state of balance. In fact sometimes the modern economics is also called as an equilibrium analysis. When the forces act in the opposite direction is in the state of rest they are called as to be in the equilibrium. Equilibrium can be a stable equilibrium, unstable equilibrium or a neutral equilibrium.

1) Stable equilibrium is that equilibrium in which the object concerned after having been disturbed reverts back to the original state.

2) In an unstable equilibrium a slight disturbance further evokes disturbance.3) In the neutral equilibrium the disturbing forces neither bring it back nor they can take it away from the equilibrium position.

Short term or the long-term equilibrium In the short run demand plays an important role in the determination of price

and in the long run both demand and supply plays an important role.

Partial and general equilibriumPartial equilibrium excludes certain variable and studies a few selected items

at a time. This method takes into consideration the impact of one or two variables and keeps all others constant. E.g. demand and supply depends upon many variables but for the sake of simplicity we study only a few aspects.

In case of general equilibrium analysis An analysis that treats various individual units and markets as interrelated and

attempts to trace the consequence of an economic event is called the general equilibrium. In the process of making the decisions the consumers as well as the firms affect the prices of the commodities. The changes in the prices serve as signals to various consumers and firms that affect their decisions accordingly. In this way the changes in the prices will go on bringing the changes in the quantities supplied and demanded until equilibrium in all the markets is not achieved simultaneously.Static and dynamic approaches

The word static generally means a position of rest but in economics it means a state in which there is a continuous, regular, certain and constant movement without any change. According to Clark there is an absence of the following five types of changes 1) size of population 2) supply of capital 3) methods of production 4) forms of business organization and 5) the wants of the people.

Harrod is of the view that static analysis is concerned with the lack of investment in the economy. In static economics we do not study about the sequences, lags etc. its like ordinary demand and supply theory. Example people continue to be born and die but births equal deaths so there is no change in the numbers but the composition of population is changing. The major drawback is that it takes us far from the actual picture assuming the variables constant.

Economic dynamics is a process of change through time.

The economy is at point A and in the normal course of action it would have

D gone to the point B but changes make it go C. Again had there been no changes it wouldhave gone to D but again the changes lead it towards E.

E C

A B

Harrod’s view c d

ba

o t t2

time

From a to b, that is upto the time period t, there is a static growth in the national income but between b and c there is the govt. investment and through the operation of the multiplier there is an increase in the income. This movement between b and c is the subject matter of economic dynamics to Harrod.

Although the dynamic analysis is better than the static analysis but in real life we make use of the comparative static situation in which we compare one equilibrium position with the other and ignore the time element.

MICRO ECONOMICS AND BUSINESSMicroeconomics explains how an individual business firm decides to fix the price and output of their product and what factor combination do they use to produce them. Microeconomics is concerned with the choosing of an appropriate course of action from the number of alternatives present for a business. Microeconomics tells us how to make a rational choice in allocating the scarce resources of the firm while making the decisions regarding price, output, technology, advertising expenditure etc. A business has to make the following decisions with the use of microeconomics

Price output decisions that is how much qty. is to be produced and at what prices it is to be sold. Demand Decisions that is to estimate the correct demand so that there is neither the shortage of the product not there is any surplus.Choice of a technique of production that is what type of technique is to be used whether the capital-intensive technique or the labour intensive technique.Even the advertisement decisions of the firm are projected with the help of microeconomics. A firm will spend on that mode of advertising which has the maximum reach and which has the least costs.

In the long run the firm has to decide about the location of the plant, size of the plant or the choice of the production technique etc. It also tells a business about the investment decisions that is what is the rate of investment over the years or is it profitable to takeover the other firms of not.

THEORY OF DEMAND

The demand in economics means both the desire to purchase as well as the ability to pay for the good.

Demand is different from the quantity demanded. Demand is the quantities that the buyers are willing and able to buy at alternative prices during the given period of time whereas quantity demanded is a specific amount that buyers are willing and able to buy at on price. Nature of demand for a product

With the normal goods the demand has a negative relationship. It means as the price of a commodity falls the quantity demanded for the product goes up.

xD

Price P1

P D Q1 Q

Qty yThe law of demand operates due to the following reasons1 Law of diminishing marginal utility2 Income effect3 Substitution effect4 Different uses 5 Size of consumer group

Exceptions to the law of demand1 Goods having the prestige value or the articles of distinction2 Giffen goods3 In case of emergencies4 Ignorance

INDIVIDUAL DEMAND AND THE MARKET DEMANDIndividual demand is the quantity demanded by an individual person at different possible prices at a given point of time.

Market demand is the quantity demanded by all the persons in the market at different possible prices at a point of time.

A’s demand B’s demand Market demand d Price Price d1 Price D

d d1 D

Quantity Quantity Quantity

Determinants of demand The demand for X commodity is affected by the following factors

1 Price of the commodity2 Prices of related goods3 Income of the consumer4 Tastes and preferences of the consumer5 Expectation of a price change of the commodity6 Population7 Income distribution

8 Bandwagon Effect: it is also called cromo effect. It means that people undertake certain tasks as other as also doing like that. People try to follow the crowd without examining the merits of a particular thing.

9 Snob Effect: preference for the goods because they are different from the good the community preferred. It is the demand for the exclusive goods.

Elasticity of demand and its determinantsElasticity is a measure of the responsiveness of one variable to the change in other. Ed can be

1. Price Elasticity of demand 2. Income elasticity of demand 3. It can be cross elasticity of demand

Methods to measure the price elasticity of demand1 Total expenditure method as given by Marshall

T E > 1

Price E = 1

E E < 1 Total expenditure

2 Proportionate method

Ed = (-) P Q Q P 3 Point elasticity method

In case of a linear demand curve

M E = Price . A E >1

. P E =1 . B E <1

O N

Qty

4 Arc elasticity method

A B C

Determinants of elasticity of demand1. Nature of the commodity2. Availability of substitutes3. Postponement of the use 4. Income of the consumer5. Habit of the consumer6. Time period 7. Joint demand8. Goods with the different uses

Demand as a multivariate function or a dynamic demand functionThe demand in the long run is not only influenced by the price rather it is influences by all other factors that we have assumed constant in the short run. The long run demand for the product depends on the composite impact of all its determinants operating simultaneously. To estimate the long run demand we have to take into consideration all the relevant factors. A demand function, which describes the

relationship between demand and all its variables, is known as the multivariate demand function.

Dx = f ( Px, M, Py, T, A )Theory of consumer behaviourDifferent theories have been developed time to time to explain the consumer behaviour. The major breakthrough was achieved in the form of cardinal utility analysis. Marshall gave this theory.According to this theory as a consumer goes on consuming more and more units of a commodity the utility derived from each successive unit goes on diminishing. Assumptions;1 Utility is measurable in cardinal numbers.2 Marginal utility of money remains constant3 Marginal utility of every commodity is independent4 There is a continuous consumption f the commodity.5 Every unit of the commodity consumed is same in size.6 No change in the price of the commodity and its substitutes.7 No change in the tastes character, fashion and habits of the consumer.

Cups of coffee consumed everyday

Total utilty (utils) Marginal utility

1 12 122 22 103 30 84 36 65 40 46 41 17 39 -28 34 -5

______________

Exceptions

1 Good book or poem2 Misers3 Drunkards4 Initial units

Importance

Basis of laws of consumptionVarity in consumptionDifference in value in use and value in exchange Basis of progressive taxation.

CriticismCardinal measurement of utility is not possible.Marginal utility of money is not constant.Every commodity is not an independent commodityUnrealistic assumptions.

Law of equi marginal utility or law of substitutionThis law was again developed by Marshall. It is also known as the Gossen’s second law. According to this law, a consumer allocates his limited income in such a way that the last unit of money spent on different commodities gives the consumer the same level of satisfaction. AssumptionsSame as above + consumer is a rational person

Rupees spent MU of Mangoes MU of MilkI 12 10

II 10 8III 8 6IV 6 4V 4 2

MU of mangoes MU of milk

-------------------------------------------------

Importance

In the field of consumptionIn the field of productionIn the field of exchange Distribution of income between saving and consumption.

Criticism

Consumers are not fully rationalMinute calculations are not possibleIgnorance of the consumerInfluence of fashions, customs and habits.Cardinal measurement of utility is not possibleConstancy of marginal utility of money is not possible

Indifference curve analysis

Hicks and Allen gave this approach. An IC is a locus of all such points located on

an indifference curve, which gives the consumer the same level of satisfaction. The

different points on the depicted IC show the same level of satisfaction.

But we must bear in mind the concepts of the Marginal Rate Of Substitution and the Diminishing Marginal Rate Of Substitution. The MRS is the rate at which the consumer is willing to sacrifice the number of units of another commodity, so that his over-all level of satisfaction may remain unchanged.

The marginal rate of substitution is the amount of one good (i.e. work) that has to

be given up if the consumer is to obtain one extra unit of the other good (leisure).

The equation is below.

The marginal rate of substitution (MRS) = change in good X /change in good YThe DMRS states that the MRS of good X for good Y will go on diminishing while the level of the satisfaction of the consumer remains the same.

Combination Mangoes Milk MRSA 1 10B 2 7 3 : 1C 3 5 2 : 1D 4 4 1 : 1

Indifference Map

ASSUMPTIONS 1 Rational consumer2 Ordinal utility3 DMRS4 Consistency in selection5 Transitivity.

Properties of ICAn IC has a negative slope or that it slopes downwards

IC are convex to the point of origin

Two IC cannot intersect each other

Higher IC represents the higher level of satisfaction

IC need not be parallel to each other

Straight line Indifference curve

Price Line or the Budget Line

It may be defined as a set of combinations of two commodities that can be purchased if whole of the given income is spent on them.

If there is an increase in the income of the consumer, the budget line shifts

It can also increase due to the change in the price

Consumer equilibrium through the Indifference curvesThere are two conditions of the consumer equilibrium:1) Price line should be tangent to the Indifference curve2) Indifference curve must be convex to the point of origin.

Income effect Substitution effect and Price effect

INCOME EFFECT

Another important item that can change is the income of the consumer. As long as

the prices remain constant, changing the income will create a parallel shift of the

budget constraint. Increasing the income will shift the budget constraint right since

more of both can be bought, and decreasing income will shift it left.

Depending on the indifference curves the amount of a good bought can either

increase, decrease or stay the same when income increases. In the diagram below,

good Y is a normal good since the amount purchased increased as the budget

constraint shifted from BC1 to the higher income BC2. Good X is an inferior good

since the amount bought decreased as the income increases.

Price effect

These curves can be used to predict the effect of changes to the budget constraint.

The graphic below shows the effect of a price shift for good y. If the price of Y

increases, the budget constraint will shift from BC2 to BC1. Notice that since the

price of X does not change, the consumer can still buy the same amount of X if they

choose to buy only good X. On the other hand, if they choose to buy only good Y,

they will be able to buy less of good Y since its price has increased.To maximize

the utility with the reduced budget constraint, BC1, the consumer will re-allocate

consumption to reach the highest available indifference curve which BC1 is tangent

to. As shown on the diagram below, that curve is I1, and therefore the amount of

good Y bought will shift from Y2 to Y1, and the amount of good X bought to shift

from X2 to X1. The opposite effect will occur if the price of Y decreases causing

the shift from BC2 to BC3, and I2 to I3.

How demand curve can be obtained through the price Effect

Substitution effect

Every price change can be decomposed into an income effect and a

substitution effect. The substitution effect is a price change that changes the slope

of the budget constraint, but leaves the consumer on the same indifference curve.

This effect will always cause the consumer to substitute away from the good that is

becoming comparatively more expensive. If the good in question is a normal good,

then the income effect will re-enforce the substitution effect. If the good is inferior,

then the income effect will lessen the substitution effect. If the income effect is

opposite and stronger than the substitution effect, the consumer will buy more of

the good when it becomes more expensive. An example of this might be a Giffen good.

Applications of Indifference curves

1 In the field of consumption.With the help of consumer equilibrium one can find out the position of consumer equilibrium.

2 Consumer surplus Money Income

No. of Ice creams

3 It has helped us to solve the problems of price effect, income effect and substitution effect.

4 In the field of exchange5 In the field of Public Finance6 Effects of rationing7 In the field of production.

THEORY OF PRODUCTION AND COSTSProduction function refers to the functional relationship between the physical

output and the physical inputs. Thus it is the relationship between the quantity of output and the quantities of inputs used in the process of production. Example x = f ( a, b, c, d….)Production function can be of both the fixed proportions type and the variable proportions type. In the fixed proportions type the labour as well as the capital are used in the fixed proportions. Example if the technical coefficient of production is 1/5, i.e. to produce 200 units of a commodity 40 labourers are employed then it continues to be the same for all the units.

Capital 300 200 100 5 10 15 LabourVariable proportions type production function In this type of the production function different factors of production can be used to produce a given level of output.

One variable input Law of increasing returns to a factor or diminishing costs: it occurs when more and more units are employed and the marginal production goes on increasing or the average costs start diminishing.

It could be due to the indivisibility of factors or the increase in efficiency arising out of the division of labour.

AC MP

Labour labour

Law of Diminishing returns or the increasing returns: It occurs when as a result of increase in the factors of production cost of production per unit of the commodity goes on increasing.

MP AC

Labour labour

It could be due to the fixed factors of production or more than the optimum production or imperfect factor substitutability between the factors.Law of constant costs or the constant returns to the factor: It takes place when the additional application of the variable factor increases the output only at a constant rate.

MP AC

Labour LabourLaw of variable proportions

Returns to scale When all the factors of production are increased in the same proportion and as a result output increases more than proportionately then it is known as constant returns to scale. Example P = f (L, K) If both the labour and capital are increased in the same proportion and a result there is a change in the output it will be termed as returns to scale.

P1 = f (mL, mK)

Two variable input

Meaning of the equal product curves:An iso product curve shows all the combinations of the two inputs physically

capable of producing a given level of output. In the able given below we can have an estimate regarding the equal product combinations.

Combinations Factor Z1 Factor Z2

A 1 12B 2 8C 3 5D 4 3E 5 2

Consumer side Producer sideIndifference Curve Isoquant IC’s are level sets of consumer’s utility function.

Isoquants are level sets of production function.

Every point on an IC represents a combination of consumption goods that yields the same level of utility.

Every point on an isoquant represents a combination of inputs that yields the same output.

Iso – Product Map

Marginal Rate of Technical Substitution Marginal Rate Of Technical Substitution (MRTS) is the increase in productivity a company experiences when it substitutes on unit of labour input - ie, an hour worked by a factory worker - for one unit of capital - ie, a machine on the factory floor.

A positive MRTS indicates that it is advantageous for a company to make this substitution, and a negative MRTS implies that the company would drop in productivity if it did this.

An iso cost line is that line which shows the various combinations of two factors that can be purchased with the given amount of money.

Change in the iso cost curves

Producer’s equilibrium with the equal product curves

The expansion path

INCREASING, CONSTANT AND DIMINISHING RETURNS TO SCALE

Decreasing returns to scale

If an increase in all inputs in the same proportion k leads to an increase of output of a proportion less than k, we have decreasing returns to scale.

Constant returns to scale

If an increase in all inputs in the same proportion k leads to an increase of output in the same proportion k, we have constant returns to scale. Example: If we increase the number of machinists and machine tools each by 50%, and the number of standard pieces produced increases also by 50%, then we have constant returns in machinery production.

Increasing returns to scale If an increase in all inputs in the same proportion k leads to an increase of output of a proportion greater than k, we have increasing returns to scale.

RIDGE LINES OR THE ECONOMIC REGION OF PRODUCTION

Between the shaded area the factors of production can be substituted for each other. No producer will operate at the points outside the ridge lines, as it is an inefficient zone. The production outside the ridgelines involves an increase in both

the labour as well as capital to produce the same amount of output. Hence this area is called the region of economic nonsense. A rational producer will operate in the region bounded by the two ridgelines where the iso quants are negatively sloping and marginal products of factors are diminishing but positive.

Cost analysis Fixed costs: These are the costs that do not change with the change in the level of output. These costs remain fixed at all the levels of output. Even if the output is zero these costs are to be borne by the producer.Variable costs these are the costs, which change with the change in the level of output. These costs rise as the level of output also goes high. Total cost: These costs are the summation of the fixed costs and the variable costs.

TC = FC + VC

Marginal costMarginal cost is the change in the total costs due to the production of one more or one less unit of output.  

Marginal cost = the change in total costs   the change in output

 Using mathematical notation where the Greek letter delta is used to signify - change in.

 MC = TC

  Q

Average fixed costs: these are aobtained by dividing the fixed costs with outputAverage variable costs: these are obtained by dividing the variable costs with the outputAverage total costs: these are obtained by dividing the total costs with the output.

Relationship between short run variable costs.

Relationship between AC and MC

Long run average cost curve

Long run average cost curve is the summation of the short run average cost curves. Therfore it is also called the envelope curve.

Revenue function

AR and MR curvesAR is the revenue per unit of the output sold. It is obtained by dividing the Total Revenue with Q. Precisely it is the demand curve of the firm.

MR is the change in the TR due to the sale of one more or one less unit of the output.

MR = TRn - TRn-1

AR and MR curves for monopoly and monopolistic competition

Revenue Revenue

AR AR MR MR

Monopoly monopolistic

BREAK EVEN ANALYSIS

PRICING UNDER PERFECT COMPETITION

Perfect competition is a market situation characterized by the following features:

Large number of buyers and sellersHomogeneous productsNo selling costs Same AR and MR curvesPerfect mobility Perfect knowledgeNo extra transportation costs

In the pure competition the conditions of Perfect mobility and Perfect knowledge are missing.

SHORT RUN EQUILIBRIUM IN PERFECT COMPETITIONIn the short run in perfect competition the firms may get normal profits, super

normal profits of it may incur the loss. First of all the firm earning the super normal profits is shown in the diagram.

In the diagram the firm incurring the loss is shown but the extent of loss should not exceed the average variable costs.

The shut down point of the firm is given below

Long run equilibrium of the firm

Long run equilibrium of the firm

Constant cost industry

Increaing cost industry

Decreasing cost industry

Price and output determination under monopolyA monopoly is a market situation in which there is

1. One seller2. Large number of buyers3. No entry or exit of firms4. No distinction between firm and industry5. Price discrimination6. AR and MR curves downward sloping7. No close substitutes

Causes of monopoly1. Government policy2. Entry lag3. Unfair competition4. Business mergers

Determination of price and equilibrium under monopoly

losses under monopoly

In the long run also the monopoly firm continues to earn the super normal profits.

Discriminating monopoly

When a monopolist charges different prices from different people for the same product, he is said to be a discriminating monopolist.

Degrees of price discrimination

First-degree price discrimination: here the monopolist charges a different price for each unit of the commodity sold. He charges what the consumer is willing and able to pay. Thus there is the maximum exploitation of the consumers in this case.

Second degree price discrimination: here the buyers are divided into different groups and from each group the monopolist charges a different price.

Third degree price discrimination: here the monopolist splits the entire market into a few sub markets and thus charge a different price in each sub market

MONOPOLISTIC COMPETITIONIt is a market situation in which there are a large number of small sellers, selling

differentiated but close substitute products.AssumptionsLarge number of firms and buyersProduct differentiationFreedom of entry and exit of firmsSelling costs Imperfect knowledgeNon-price competition

Short and long run equilibrium in monopolistic competition

Under utilization in the long run

Group equilibrium

product differentiation in the long run

Selling costs

The costs incurred on advertising, publicity and salesmanship are known as selling costs. The need for the advertising arises if the buyers are not available about the product or there are many rivals for the firm. In this case the selling cost is assumed to be a fixed cost. By adding selling costs to the original curve the new curve so obtained will be above the original curve. The area FP indicates the maximum net return in this case.

MC

F E

AR MR

Pricing under oligopoly

Kinked demand curve

Price leadership under monopolyUnder this system one firm becomes a leader and set the price which is to be followed by all the firms. It often happens that price leadership is established as a result of price war between the firms and as a result one firm comes out as a leader. Price leadership is mainly of the following typesBy a dominant firm (which produces a bulk of ots products)Barometric price leadership (which can predict furutre well as well as custodian of othere firms)Aggressive price leadership ( due to aggressive price policies)

MCb

MCa

Price D

MR N M Quantity

Firm A has a lower MC. The profit maximising price of firm A is lower than the firm B. It means that now the Firm A will dictate the terms for the firm B whose profit maximising price is higher. If B does not follow the conditions as dictated by A then it will be ousted by A. COURNOT MODEL OF OLIGOPOLY

s

P c z R Q

0

A H BIn the diagram before the entrance of B, A produces the output OA

which is 1/2 of OB. The price is OC and the profits are OAPC. B produces the output AH which is 1/4 of OB. The price falls from OAPC to OARZ total profit being OHQZ. When B produces the AH which is ¼ of the whole the total output left for A is ½ ( 1 – ¼) = 3/8. What is now not produced by A is produced by B that is (1-1/8) = 5/16. Now A may react by producing ½ (1 – 5/16) = 11/32. This process will continue till equilibrium utput and price are reached.