2014 ( May )
( General / Speciality )
Course : 202
( Business Economics )
Full Marks : 80
Pass Marks : 32
The figures in the margin indicate full marks for the questions.
1. Answer as directed : 1x8=8
(a) Making successful forecast is one of the responsibilities of a Managerial Economist. (Write True / False)
(b) Price mechanism is based on two strong opposite forces. (Write True / False)
(c) Perfect elasticity of demand curve is parallel / vertical to the base.(Choose the correct answer)
(d) ‘Nature of the commodity’ is not a factor which determine elasticity of supply. (Write True / False)
(e) Iso-product curve should never be horizontal or vertical along base or OX-axis. (Write True / False)
(f) What is production function?
ANS:IT SHOWS FUNCTIONAL RELATIONSHIP BETWEEN FACTORS OF PRODUCTION AND OUTPUT
(g) How many production firms are there in a monopoly market?
(h) Under which market form a firm is a price taker?
Ans: PERFECT COMPETITION
2. Answer the following questions in brief : 4x4=16
(a) Mention four characteristics of Business Economics.
Ans: Nature or Characteristics of Managerial Economics:-
a. Managerial Economics is a Science: Managerial economics is a science because it establishes relationship between causes and effects. It studies the effects of a change in price of a commodity factors and forces on the demand of a particular product. It also studies the effects and implications of the plans, policies and programmes of a firm on its sales and profit.
b. Managerial Economics is an Art: Managerial economics may also be called an art. Because it also develops the best way of doing things. It helps management in the best and most efficient utilization of limited economic resources of the firm.
c. Managerial Economics is a Micro Economics: Entire study of economics may be divided into two segments – Macro economics and Micro economics. Managerial economics is mainly micro-economics. Micro economics is the study of the behaviour and problems of individual economic unit. In managerial economics unit of study is firm or business organization and an individual industry. It is the problem of business firms such as problem of forecasting demand, cost of production, pricing, profit planning, capital, management etc.
d. Managerial Economics is the Economics of firms: Managerial economics largely use that body of economic concepts and principles which is known as ‘Theory of the Firm’ or ‘Economics of the Firm’.
(b) Give four justifications of downward slope of demand curve.
Ans: DEMAND CURVE SLOPE IS DOWNWARD: The demand curve slopes downwards due to the following reasons:
(1) Substitution effect: When the price of a commodity falls, it becomes relatively cheaper than other substitute commodities. This induces the consumer to substitute the commodity whose price has fallen for other commodities, which have now become relatively expensive. As a result of this substitution effect, the quantity demanded of the commodity, whose price has fallen, rises.
(2) Income effect: When the price of a commodity falls, the consumer can buy more quantity of the commodity with his given income, as a result of a fall in the price of the commodity, consumer’s real income or purchasing power increases. This increase induces the consumer to buy more of that commodity. This is called income effect.
(3) Number of consumers: When price of a commodity is relatively high, only few consumers can afford to buy it, And when its price falls, more numbers of consumers would start buying it because some of those who previously could not afford to buy may now afford to buy it, Thus, when the price of a commodity falls, the number of its consumers increases and this also tends to raise the market demand for the commodity.
(4) Multiple use of commodity: There are some commodities which have multiple uses. Their uses depend upon their respective, prices. When their prices rise they are used only for certain selected purposes. That is why their demand goes down.
(c) Explain the concepts of short-run and long-run in production function.
Ans: Short Run Production function: The short run is a period in which at least one input of the factors of production is fixed. It should be noted that usually factory facilities, equipment and machinery including land are fixed, however, the supply can be altered by changing the demand for labor, raw material, factory components and etc. Usually a firm or producers have to pay certain production cost form the expenses such as the construction of building for the management office, manufacturing facilities, salaries or wages of the labor and other overhead costs. In the short run, the firm cost structure has to consider the fixed costs (FC) in a given period of time regardless of production level. The variable cost is associated with the production cost.
Long Run Production Function: The period of production in the long run shows the production operation of a certain period of time. Normally, the firm expansion on the average cost of production may result the increase of production inputs. However, there are some conditions that:
a) If the firm increases or expand its production operation, is it always increases its production output.
b) Is it possible that the average cost of production may follow the same increase (to let say 50-50%) in the production input and output.
c) If the firm increases by its production input, however, the production output decreases.
(d) What do you mean by ‘price leadership’? Out of Syllabus
Ans: Price leadership is said to exist when the price at which most or all of the firms in the industry offer to sell is determined by the leader (one of the firms of the industry). This method was formulated by the German economist. Prof. Heinrichvon Stackelberg. This is also known as leadership solution or followership solution.
(1) Price Leadership by a Low-Cost Firm, and
(2) Price Leadership by a Dominant Firm.
(3) The Barometric Price Leadership Model
In the low-cost price leadership model, an oligopolistic firm having lower costs than the other firms sets a lower price which the other firms have to follow. Thus the low-cost firm becomes the price leader.
This is a typical case of price leadership where there is one large dominant firm and a number of small firms in the industry. The dominant firm fixes the price for the entire industry and the small firms sell as much product as they like and the remaining market is filled by the dominant firm itself. It will, therefore, select that price which brings more profits to itself.
The barometric price leadership is that in which there is no leader firm as such but one firm among the oligopolistic firms with the wisest management which announces a price change first which is followed by other firms in the industry. The barometric price leader may not be the dominant firm with the lowest cost or even the largest firm in the industry. It is a firm which acts like a barometer in forecasting changes in cost and demand conditions in the industry and economic conditions in the economy as a whole.
3. (a) What is price mechanism? Discuss the importance of price mechanism in business economics. 4+7=11
Ans: Price Mechanism: Price mechanism refers to the system where the forces of demand and supply determine the prices of commodities and the changes therein. It is the buyers and sellers who actually determine the price of a commodity. Price mechanism is the outcome of the free play of market forces of demand and supply. However, sometimes the government controls the price mechanism to make commodities affordable for the poor people too. For example, the Government of India recently passed an order to decontrol the prices of diesel and remove it from the jurisdiction of the government. Now the prices will be determined by the demand from consumers and supply from the oil companies.
Role of price mechanism:
The price mechanism solves the problem of allocation of resources which is associated with what ,how and for whom to produce.
1. What to produce?
In a free market economy, producers are guided by profit motive. When price of a commodity increases with the increase in demand, the profits increase and this would encourage the production of this commodity. Producers would shift resources from the production of other commodities to this commodity. Therefore, the price mechanism would automatically solve the problem what to produce.
2. How to produce?
It is the question of choice of production technique. There are generally two techniques of production available:
a) Labour-intensive technique (in which more of labour is used than capital)
b) Capital-intensive technique (in which more of capital is used than labour)
If capital is available at a lower rate, firms adopt capital-intensive technique of production. If labour is available at lower rate, firms adopt labour intensive techniques. Therefore, it is the price of labour or the price of capital that will help the producer in deciding whether they should choose capital intensive or labour intensive technique.
3. For whom to produce?
In a market economy, the producers must produce for those who have the ability and willingness to pay the highest price. The income of the consumers determines the ability to pay i.e.; there is a direct relationship between income and consumption pattern. Hence, both the ability and willingness to pay determines who gets the available commodities.
4. Fuller Utilization of the factors
It is through price-mechanism that fuller utilization of the factors is attained in a capitalist economy .Volume of full employment depends upon the volume of production which in its turn, depends upon the level of investment. Amount of investment depends upon saving. Equality between saving and investment is brought about by change in price of capital i.e.; rate of interest. If at any given time, total savings are large and condition of unemployment prevails in the economy ,the rate of interest will fall. Due to fall in the rate of interest there will be increase in investment. Increase in investment will result into increase in production and the condition of less than fuller utilization of the factors will become possible. Classical economists were of the view that under condition of less than full employment of labour, price of labour, i.e.; wage will fall. Fall in wage rate will stimulate demand and condition of full employment of labour will be achieved . In this way, price mechanism will help to achieve fuller utilization of the factors.
(b) Discuss the various problems of business economics. 11
Ans: Basic Problems of an economic system or Problems of business economics
The problem of scarcity of resources which arises before an individual consumer also arises collectively before an economy. On account of this problem and economy has to choose between the following:
(i) Which goods should be produced and in how much quantity?
(ii) What technique should be adopted for production?
(iii) For whom goods should be produced?
These three problems are known as the central problems or the basic problems of an economy. This is so because all other economic problems cluster around these problems. These problems arise in all economics whether it is a socialist economy like that of North Korea or a capitalist economy like that of America or a mixed economy like that of India. Similarly, they arise in developed and under-developed economics alike.
There are two aspects of this problem— firstlywhich goods should be produced, and secondlywhat should be the quantities of the goods that are to be produced. The first problem relates to the goods which are to be produced. In other words, what goods should be produced? An economy wants many things but all these cannot be produced with the available resources. Therefore, an economy has to choose what goods should be produced and what goods should not be. In other words, whether consumer goods should be produced or producer goods or whether general goods should be produced or capital goods or whether civil goods should be produced or defense goods. The second problem is what should be the quantities of the goods that are to be produced.
The second basic problem is which technique should be used for the production of given commodities. This problem arises because there are various techniques available for the production of a commodity such as, for the production of wheat, we may use either more of labour and less of capital or less of labour or more of capital. With the help of both these techniques, we can produce equal amount of wheat. Such possibilities exist relating to the production of other commodities also.
Therefore, every economy faces the problem as to how resources should be combined for the production of a given commodity. The goods would be produced employing those methods and techniques, whereby the output may be the maximum and cost of production be the minimum.
The main objective of producing a commodity in a country is its consumption by the people of the country. However, even after employing all the resources of a country, it is not possible to produce all the commodities which are required by the people. Therefore, an economy has to decide as to for whom goods should be produced. This problem is the problem of distribution of produced goods and services. Therefore, what goods should be consumed and by whom depends on how national product is distributed among various people.
All the three central problems arise because resources are scarce. Had resources been unlimited, these problems would not have arisen. For example, in the event of resources being unlimited, we could have produced each and every thing we had wanted, we could have used any technique and we could have produced for each and everybody
An economy has to face the problem of efficiently using its resources. Production can be increased even by improving the use of resources. Resources will be deemed to be better utilised when by reallocating them in various uses, production of a commodity can be increased without adversely affecting the production of other commodities.
In many economies, especially in developing economies, there is a tendency towards under-utilisation of resources. Resources lying idle or not being utilised fully is a recurring problem in many economies. This problem is particularly acute in labour-abundant economies like that of India where large scale unemployment exists. In many economies, a vital resource like land too remains under-utilised. Resources being relatively scarce, they should not be allowed to remain idle as it is a waste.
: The last problem is of growth. Every economy strives to increase its production for increasing standards of living of its people. Economic growth of a country depends upon the fact as to what extent; it can increase its resources. This problem is not confined to developing economies alone. It is also faced by developed economies which strive for increasing their resources in order to increase the material comforts of their technically advanced societies.
4. (a) Define price elasticity of demand. Discuss the factors determining the price elasticity of demand. 4+7=11
Ans: Ans: Elasticity of Demand: Demand is desire backed by willingness to pay and ability to pay i.e. a wish to have a commodity does not become demand. A person wishing to have a commodity should be willing to pay for it and should have ability to pay for it. Thus a desire becomes demand if it is backed by willingness to pay and ability to pay. Demand is meaningless unless it is stated with reference to a price.
Decisions regarding what to produce, how to produce and for whom to produce are taken on the basis of price signals coming from the market. The law of demand explains inverse relationship between price and quantity demanded. When price falls quantity demanded of that commodity will increase. The deficiency of law of demand is removed by the concept of elasticity of demand.
The term elasticity was developed by Alfred Marshall, and is used to measure the relationship between price and quantity demanded. The law states that the price of a commodity falls, the quantity demanded of that commodity will increase, i.e. it explains only the direction of change in demand and not the extent of change. This deficiency is removed by the concept of elasticity of demand.
Elasticity means responsiveness. Elasticity of demand refers to the responsiveness of quantity demanded of a commodity to change in its price.
According to E.K. Estham, “Elasticity of demand is a measure of the responsiveness of quantity demanded to a change in price”.
According to Muyers “Elasticity of demand is a measure of the relative change in the amount purchased in response to any change in price or a given demand curve”.
According to A.K. Cairncross “The elasticity of demand for a commodity it is the rate at which quantity bought changes as the price changes.”
Price Elasticity: Price elasticity of demand may be defined as the degree of responsiveness of quantity demanded of a commodity in response to change in its price i.e. it measures how much a change in price of a good affects demand for that good, all other factors remaining constant. It is calculated by dividing the proportionate change in quantity demanded by the proportionate change in price.
EP= Proportionate change in quantity demanded/ Proportionate change in price
FACTORS INFLUENCING PRICE ELASTICITY OF DEMAND
1. Nature of commodity: Elasticity depends on whether the commodity is a necessity, comfort or luxury. Necessities of life have inelastic demand and comforts and luxuries have elastic demand.
2. Availability of substitutes: Goods with substitutes have elastic demand and goods without substitutes have inelastic demand. For example: coffee and tea are substitutes. If price of tea increases, people may switch over to coffee. If price of coffee raises people may shift to tea. The demand of salt is inelastic.
3. Uses of the commodity: Certain goods can be put to many uses. Example – electricity. Such goods have elastic demand because as the price decreases, they will be put to more uses.
4. Proportion of income spent on commodity: For some goods, consumers spend only a small part of their income. The demand will be inelastic. For e.g.: - salt and matches
5. Price of goods: Generally cheap goods have inelastic demand and expensive goods have elastic demand.
6. Income of consumers: Very rich people have inelastic demand for goods and poor people have elastic demand. Because rich people will buy the commodity at all levels of prices where poor people there is a change in quantity of consumption according to change in price.
7. Time period: Elasticity would be more in the long run than in the short run. Because in the long run consumers can adjust their demand by switching over to cheaper substitutes. Production of cheaper substitutes is possible only in the long run.
8. Distribution of income and wealth in the society: If there is unequal distribution of income, the demand of commodities will be relatively inelastic. If the distribution of income and wealth in the society is equal there will be elastic demand for commodities.
(b) Define elasticity of supply. Discuss the factors determining the elasticity of supply. 4+7=11
Ans: Elasticity of Supply: Supply is responsive to price changes. The extent to which supply extends for a given price rise is known as elasticity of supply. Elasticity of supply may also be defined as the ratio of the percentage change or the proportionate change in quantity supplied to the percentage or proportionate change in price.
Es = proportionate change in supply/Proportionate change in price or
= (change in quantity supplied/Original quantity supplied) × (Change in price/Original price)
Let Q = Original supply
ΔQ = Change of supply
P = Original price and
ΔP = Change of price, then
Es = (ΔQ/Q) / (ΔP/P) = (ΔQ/Q) × (P/ΔP) = (ΔQ/ΔP) × (P/Q)
Factors Determining Elasticity of Supply: Following factors affect the elasticity of supply of a commodity:
a) Nature of the Inputs used: The elasticity of supply depends on the nature of inputs used for the production of commodity. If factors of production are those which are commonly used (and therefore easily available), supply of the commodity will be elastic. On the other hand, if specialized factors are used (which are not easily available), supply will be less elastic.
b) Natural Constraints: The elasticity of supply is also influenced by the natural constraints in the production of a commodity. If we wish to produce more teak wood, it will take years of plantation before it becomes usable. Supply of teak wood will therefore be less elastic.
c) Risk Taking: The elasticity of supply depends on the willingness of entrepreneurs to take risk. If entrepreneurs are willing to take risk, the supply will be more elastic. On the other hand, if entrepreneurs hesitate to take risk, the supply will be inelastic.
d) Nature of the Commodity: Perishable goods are relatively less elastic in supply than durable goods, because it is difficult to store the perishables.
e) Cost of Production: Elasticity of supply is also influenced by cost of production. If production is subject to law of increasing costs, then supply of such goods will be inelastic.
f) Time Factor: Longer the time period, greater will be the elasticity of supply. Because, over a long period of time, more and more factors are easily available and their input can be changed to increase (or decrease) output of the commodity.
g) Technique of Production: If the technique is complex and needs large stock of capital, then the supply of the commodity will be less elastic, because production cannot be easily increased. On the other hand, goods involving simple technique of production will have more elastic supply.
5. (a) What is iso-product curve? Discuss its main characteristics. 4+7=11
Ans: Isoquants and its Properties
an isoquant is a locus of points, different combinations labour and capital .An isoquant Curve. ‘ISO’ is of Greek origin and means equal or same and ‘quant’ means quantity. The isoquant shows- the whole range of ways of the same level of output. The modern economists are using isoquant, or ‘ISO’ product curves for determining the optimum factor combination to produce certain units of a at the least cost.
The concept of Iso-quant can be further comprehended through an illustration below: Suppose there are two input factors Viz. Labour and Capital. The different combinations of these factors are used to have the same level of output as shown in the schedule below:
Iso-quant Map: An iso-quant map shows the different iso-quant curves representing the different combinations of factors of production, yielding the different levels of output. Thus, higher the iso-quant curve, the higher is the level of output.
Properties or Features of Isoquant
The following are the important properties of isoquants:
1. Isoquant is downward sloping to the right. This means that if more of one factor is used less of the other is needed for producing the same output.
2. A higher isoquant represents larger output.
3. No isoquants intersect or touch each other. If so it will mean that there will be a common point on the two curves. This further means that same amount of labour and capital can produce the two levels of output which is meaningless.
4. Isoquants need not be parallel to each other. It so happens because the rate of substitution in different isoquant schedules need not necessarily be equal. Usually they are found different and therefore, isoquants may not be parallel.
5. Isoquant is convex to the origin. This implies that the slope of the isoquant diminishes from left to right along the curve. This is because of the operation of the principle of diminishing marginal rate of technical substitution.
6. No isoquant can touch either axis. If an isoquant touches X axis then it would mean that without using any labour the firm can produce output with the help of capital alone. If an isoquant touches Y axis, it would mean that without using any capital the firm can produce output with the help of labour alone. This is impossible.
7.Isoquants have negative slope. This is so because when the quantity of one factor (labour) is increased the quantity of other factor (capital) must be reduced, so that total output remains the same.
(b) What is called production expansion path? Discuss how it can be expressed with the help of budget line and iso-product curve. 4+7=11
Ans: : As financial resources of a firm increase, it would like to increase its output. The output can only be increased if there is no increase in the cost of the factors. In other words, the level of total output of a firm increases with increase in its financial resources. By using different combinations of factors a firm can produce different levels of output. Which of the optimum combinations of factors will be used by the firm is known as Expansion Path. It is also called Scale-line.
In the words of Stonier and Hague, “Expansion path is that line which reflects least cost method of producing different levels of output.”
Expansion path can be explained with the help of Fig. 16. On OX-axis units of labour and on OY-axis units of capital are given.
The initial iso-cost line of the firm is AB. It is tangent to IQ at point E which is the initial equilibrium of the firm. Supposing the cost per unit of labour and capital remains unchanged and the financial resources of the firm increase.
As a result, firm’s new iso-cost-line shifts to the right as CD. New iso-cost line CD will be parallel to the initial iso-cost line. CD touches IQ at point E which will constitute the new equilibrium point. If the financial resources of the firm further increase, but cost of factors remaining the same, the new iso-cost line will be GH.
It will be tangent to Isoquants curve IQ2 at point E which will be the new equilibrium point of the firm. By joining together equilibrium points E, E and E , one gets a line called scale-line or Expansion Path. It is because a firm expands its output or scale of production in conformity with this line
An isoquant represents combinations of two inputs that yield the same level of output. However, not all points of an isoquant are relevant for production. Such points may be called infeasible points. One should consider only feasible portions of an isoquant. This is because of the fact that no rational producer will produce where marginal product of an input is either zero or negative.
If the isoquant is backward bending and upward sloping, marginal product of any input will be negative, and, hence, this portion of the isoquant may be considered as economically non-sensible region of production. Only the negatively sloped segment of the isoquant is relevant for production or economically feasible.
This is shown in Fig. 3.5 where we have drawn three isoquants showing different levels of output for different labour-capital combinations. This diagram separates economic region of production from uneconomic region of production. Region in which marginal products of all inputs are positive constitutes economic region of production.
Or the region in which input substitution takes place may be called economic region of production. In an uneconomic region, as marginal product of an input becomes either zero or negative, the question of input substitution does not arise. Production in such region is, for obvious reasons, unprofitable or infeasible.
At point A on IQ, the firm employs certain units of labour and capital. Since the tangent to IQ at point A is parallel to the vertical axis, marginal product of capital (MP ) is zero. If more capital is used, marginal product of capital should be negative. In other words, beyond point A, MP is negative. At point B on IQ , MP is zero and beyond point B on IQ , MP is negative.
Thus, points between A and B represent positive marginal productivities of both labour and capital. Here substitution between two inputs takes place. Similarly, points Aand A on IQ and IQ describe zero MP while points beyond A and A describe negative MP . Points B and B on IQ and IQ represent zero MP and beyond B and B describe negative MP .
A rational producer will produce in that region where marginal productivities of inputs are positive. By joining points A, A and A (i.e., points of zero marginal products) we get OR line and by joining points B, B and B (points of zero marginal products) we get OL line. These lines are called ridge lines. They give the boundaries of the economic region of production where input substitution takes place.
Any point on the Isoquants outside the upper ridge line OR and the lower ridge line OL constitute uneconomic region of production. Production must take place inside the ridge lines. Note that the ridge lines separate the relevant (i.e., negatively sloped) from the irrelevant portions (i.e., positively or zero sloped) of the Isoquants.
6. (a) State the features of a perfectly competitive market. Explain the importance of perfect competitive market. 6+6=12
Ans: Features of Perfect Competition: Different definitions given by different economists point out the distinct features of perfect competition. We can list various features which point out that the form of a market is perfectly competitive. In other words, there are some necessary conditions which must be satisfied if the market is to be perfectly competitive. We can explain these below:
1) Large number of small, unorganized firms: The first condition which a perfectly competitive market must satisfy is concerned with the seller’s side of the market. The market must have such a large number of sellers that on one seller is able to dominate in the market. No single firms can influence the price of the commodity. These firms must be all relatively small as compared to the market as a whole. Their individual outputs should be just a fraction of the total output in the market.
2) A large number of small, unorganized buyers: On the buyer’s side the perfectly competitive market must also satisfy this condition. There must be such a large number of buyers that no one buyer is able to influence the market price in any way. Each buyer should purchase just a fraction of the market supplies. Further the buyers should not have any king of union or organization so that they compete for the market demand on an individual basis.
3) Homogeneous products: Another pre-requisite of perfect competition is that all the firms or sellers must sell completely identical or homogeneous goods. Their products must be considered to be identical by all the buyers in the market. There should not be any differentiation of products by sellers by way of quality, variety, colour, design, packing or other selling conditions of the product.
4) Free entry and free exit for firms: under perfect competition, there is absolutely no restriction on entry of new firms in the industry or the exit of the firms from the industry which want to leave it. This condition must be satisfied especially for long period equilibrium of the industry.
5) Perfect knowledge among buyers and sellers about market conditions: Another pre-requisite of perfect competition is that both buyers and sellers must be having perfect knowledge about the conditions in which they are operating. Seller must know the prices being quoted or charged by other sellers in the market from the buyers. Similarly buyers must know the prices being charged by different sellers.
6) Perfect mobility: Another feature of perfect competition is that goods and services as well as resources are perfectly mobile between firms. Factors of production can freely move from one occupation to another and from one place to another. There is no barrier on their movement. No one has monopoly or control over the factors of production. Goods can be sold to a place where their prices are the highest. There should not be any kind of limitation on the mobility of resources.
7) Absence of transport cost: Another feature of perfect competition is that all the firms have equal access to the market. Price of the product is not affected by the cost of transportation of goods. In other words, we can say that the market price charged by different sellers does not differ due to location of different sellers in the market. Thus, there is complete absence of transport cost of the product from one part of the market to other.
8) Absence of selling cost: Under conditions of perfect competition, there is no need of selling costs. We know that under perfect competition, goods are completely homogeneous. Price of the product is also the same for a single product. Firms have no control over the price of the product. When they cannot change the price and when their goods are completely similar, firms need not make any expenditure on publicity and advertisement.
(b) Discuss the equilibrium price determination in the long-run under perfect competition with the help of suitable diagram. 12
Meaning of Firm’s Equilibrium: A firm is in equilibrium when it is satisfied with its existing amount of output. A firm in equilibrium has no tendency either to increase or decrease its output. . It needs neither expansion nor contraction. It wants to earn maximum profits.
In the words of A.W. Stonier and D.C. Hague, “A firm will be in equilibrium when it is earning maximum money profits.”
Equilibrium of the firm can be analysed in both short-run and long-run periods. A firm can earn the maximum profits in the short run or may incur the minimum loss. But in the long run, it can earn only normal profit.
Equilibrium of the firm can be studied by two approaches:
1) Total Revenue and Total Cost Approach.
2) Marginal Cost and Marginal Revenue Approach.
Total Revenue and Total Cost Approach: According to this approach, profits are the difference between total revenue and total cost.
Marginal Revenue and Marginal Cost Approach:
a) All firms in an industry use homogeneous factors of production.
b) Their costs are equal. Therefore, all cost curves are uniform.
c) They use homogeneous plants so that their SAC curves are equal.
d) All firms are of equal efficiency.
e) All firms sell their products at the same price determined by demand and supply of the industry so that the price of each firm is equal to AR = MR.
According to this approach, a firm is in equilibrium when two conditions are fulfilled:
a) Marginal Cost should be equal to Marginal Revenue (MC = MR)
b) MC curve cuts MR curve from below.
Determination of Equilibrium of the Firm: Equilibrium of the firm can be analysed in both short-run and long-run periods. A firm can earn the maximum profits in the short run or may incur the minimum loss. But in the long run, it can earn only normal profit.
In the long-run, it is possible to make more adjustments than in the short-run. The firm can adjust its plant capacity and scale of operations to the changed circumstances. Therefore, all costs are variable. Firms must earn only normal profits. In case the price is above the long-run AC curve firms will be earning supernormal profits.
Attracted by them, new firms will enter the industry and supernormal profits will be competed away. If the price is below the LAC curve firms will be incurring losses. As a result, some of the firms will leave the industry so that no firm earns more than normal profits. Thus “in the long-run firms are in equilibrium when they have adjusted their plant so as to produce at the minimum point of their long-run AC curve, which is tangent (at this point) to the demand (AR) curve defined by the market price” so that they earn normal profits.
a) Firms are free to enter into or leave the industry.
b) All firms are of equal efficiency.
c) All factors are homogeneous. They can be obtained at constant and uniform prices.
d) Cost curves of firms are uniform.
e) The plants of firm: are equal having given technology.
f) All firms have perfect knowledge about price and output.
Given these assumptions, each firm of the industry will be in the following two conditions.
(1) In equilibrium, its short-run marginal cost (SMC) must equal to its long-run marginal cost (LMC) as well as its short-run average cost (SAC) and its long-run average cost (LAC) and both should be equal to MR=AR=P. Thus the first equilibrium condition is:
SMC = LMC = MR = AR = P = SAC = LAC at its minimum point, and
(2) LMC curve must cut MR curve from below.
Both these conditions of equilibrium are satisfied at point E in Figure 3 where SMC and LMC curves cut from below SAC and LAC curves at their minimum point E and SMC and LMC curves cut AR = MR curve from below. All curves meet at this point E and the firm produces OQ optimum quantity and sell it at OP price.
Since we assume equal costs of all the firms of industry, all firms will be in equilibrium m the long-run. At OP price a firm will have neither a tendency to leave nor enter the industry and all firms will earn normal profit.
7. (a) What is price discrimination? Discuss the possibilities of price discrimination under monopoly market. 3+8=11 Out of Syllabus
(b) What is oligopoly market? Discuss how the price is determined under oligopoly market with the help of kinked demand curve model. 3+8=11 Out of Syllabus