ECONOMICS

Market Structure comparison Number of firms Perfect Competition Monopolistic competition Monopoly Infinite Many One Market Elasticity of Product power demand differentiation None Low High Perfectly elastic Highly elastic (long run)[15] Relatively inelastic None High[16] Profit Excess profits Efficiency maximization condition No Yes/No (Short/Long)
[17]

Pricing power Price taker[14] Price setter[14] Price setter[14]

Yes[13] No[18] No

P=MR=MC[14] MR=MC[14] MR=MC[14]

Absolute (across Yes industries)

Managerial Economics

Managerial Economics can be defined as amalgamation of economic theory with business practices so as to ease decision-making and future planning by management. Managerial Economics assists the managers of a firm in a rational solution of obstacles faced in the firms activities. It makes use of economic theory and concepts. It helps in formulating logical managerial decisions. The key of Managerial Economics is the micro-economic theory of the firm. It lessens the gap between economics in theory and economics in practice. Managerial Economics is a science dealing with effective use of scarce resources. It guides the managers in taking decisions relating to the firms customers, competitors, suppliers as well as relating to the internal functioning of a firm. It makes use of statistical and analytical tools to assess economic theories in solving practical business problems. Study of Managerial Economics helps in enhancement of analytical skills, assists in rational configuration as well as solution of problems. While microeconomics is the study of decisions made regarding the allocation of resources and prices of goods and services, macroeconomics is the field of economics that studies the behavior of the economy as a whole (i.e. entire industries and economies). Managerial Economics applies micro-economic tools to make business decisions. It deals with a firm. The use of Managerial Economics is not limited to profit-making firms and organizations. But it can also be used to help in decision-making process of non-profit organizations (hospitals, educational institutions, etc). It enables optimum utilization of scarce resources in such organizations as well as helps in achieving the goals in most efficient manner. Managerial Economics is of great help in price analysis, production analysis, capital budgeting, risk analysis and determination of demand. Managerial economics uses both Economic theory as well as Econometrics for rational managerial decision making. Econometrics is defined as use of statistical tools for assessing economic theories by empirically measuring relationship between economic variables. It uses factual data for solution of economic problems. Managerial Economics is associated with the economic theory which constitutes Theory of Firm. Theory of firm states that the primary aim of the firm is to maximize wealth. Decision making in managerial economics generally involves establishment of firms objectives, identification of problems involved in achievement of those objectives, development of various alternative solutions, selection of best alternative and finally implementation of the decision. The following figure tells the primary ways in which Managerial Economics correlates to managerial decision-making.

Discounting Principle
According to this principle, if a decision affects costs and revenues in long-run, all those costs and revenues must be discounted to present values before valid comparison of alternatives is possible. This is essential because a rupee worth of money at a future date is not worth a rupee today. Money actually has time value. Discounting can be defined as a process used to transform future dollars into an equivalent number of present dollars. For instance, $1 invested today at 10% interest is equivalent to $1.10 next year. FV = PV*(1+r)t Where, FV is the future value (time at some future time), PV is the present value (value at t0, r is the discount (interest) rate, and t is the time between the future value and present value.

Opportunity cost is the cost of any activity measured in terms of the value of the best alternative that is not
chosen (that is foregone). It is the sacrifice related to the second best choice available to someone, or group, who has picked among several mutually exclusive choices.[1] The opportunity cost is also the cost of the forgone products after making a choice. Opportunity cost is a key concept in economics, and has been described as expressing "the basic relationship between scarcity and choice".[2] The notion of opportunity cost plays a crucial part in ensuring that scarce resources are used

efficiently.[3] Thus, opportunity costs are not restricted to monetary or financial costs: the real cost of output forgone, lost time, pleasure or any other benefit that provides utility should also be considered opportunity costs. The concept of opportunity cost was first developed in 1914 by Friedrich von Wieser in his book "Theorie der gesellschaftlichen Wirtschaft" Opportunity costs in production Opportunity costs may be assessed in the decision-making process of production. If the workers on a farm can produce either one million pounds of wheat or two million pounds of barley, then the opportunity cost of producing one pound of wheat is the two pounds of barley forgone. Firms would make rational decisions by weighing the sacrifices involved. Explicit costs Explicit costs are opportunity costs that involve direct monetary payment by producers. The opportunity cost of the factors of production not already owned by a producer is the price that the producer has to pay for them. For instance, a firm spends $100 on electrical power consumed, the opportunity cost is $100. The firm has sacrificed $100, which could have been spent on other factors of production. Implicit costs Implicit costs are the opportunity costs that involve only factors of production that a producer already owns. They are equivalent to what the factors could earn for the firm in alternative uses, either operated within the firm or rent out to other firms. For example, a firm pays $300 a month all year for rent on a warehouse that only holds product for six months each year. The firm could rent the warehouse out for the unused six months, at any price (assuming a year-long lease requirement), and that would be the cost that could be spent on other factors of production.

Durable good
A car is a durable good. The gasoline that powers it is a non-durable good. In economics, a durable good or a hard good is a good that does not quickly wear out, or more specifically, one that yields utility over time rather than being completely consumed in one use. Items like bricks or jewellery could be considered perfectly durable goods, because they should theoretically never wear out. Highly durable goods such as refrigerators, cars, or mobile phones usually continue to be useful for three or more years of use, [1] so durable goods are typically characterized by long periods between successive purchases. Examples of consumer durable goods include cars, household goods (home appliances, consumer electronics, furniture, etc.), sports equipment, and toys. Nondurable goods or soft goods (consumables) are the opposite of durable goods. They may be defined either as goods that are immediately consumed in one use or ones that have a lifespan of less than 3 years.

Examples of nondurable goods include fast moving consumer goods such as cosmetics and cleaning products, food, fuel, office supplies, packaging and containers, paper and paper products, personal products, rubber, plastics, textiles, clothing and footwear. While durable goods can usually be rented as well as bought, nondurable goods can generally not be rented. While buying Durable goods comes under the category of Investment demand of Goods, buying Non-Durables comes under the category of Consumption demand of Goods.

Market failure
is a concept within economic theory wherein the allocation of goods and services by a free market is not efficient. That is, there exists another conceivable outcome where a market participant may be made better-off without making someone else worseoff. Market failures can be viewed as scenarios where individuals' pursuit of pure self-interest leads to results that are not efficient that can be improved upon from the societal point-of-view.[1][2] The first known use of the term by economists was in 1958,[3] but the concept has been traced back to the Victorian philosopher Henry Sidgwick.[4] Market failures are often associated with information asymmetries,[5] non-competitive markets, principal-agent problems, externalities,[6] or public goods.[7] The existence of a market failure is often used as a justification for government intervention in a particular market.[8][9] Economists, especially microeconomists, are often concerned with the causes of market failure, and possible means to correct such a failure when it occurs.[10] Such analysis plays an important role in many types of public policy decisions and studies. However, some types of government policy interventions, such as taxes, subsidies, bailouts, wage and price controls, and regulations, including attempts to correct market failure, may also lead to an inefficient allocation of resources, sometimes called government failure.[11] Thus, there is sometimes a choice between imperfect outcomes, i.e. imperfect market outcomes with or without government interventions. But either way, if a market failure exists the outcome is not pareto efficient. Mainstream neoclassical and Keynesian economists believe that it may be possible for a government to improve the inefficient market outcome, while several heterodox schools of thought disagree with this

Forms of Market Failure

Market failure occurs when a market is unable to, or is prevented from, reaching equilibrium. [1] Market failures occur in many forms. The two forms of market failure most associated with the need for regulatory intervention are monopoly (including natural monopoly) and externalities. A natural monopoly is market structure in which the prevailing volume of market demand can be served at a lower average cost by a single firm, rather than by two or more firms. In other words a single firm can meet market demand at a lower cost than two or more competing firms could. Economies of scale are frequently cited as a reason for natural monopoly. In some industries, the fixed costs of initial entry or set-up are so large relative to operational costs that average cost declines over a substantial volume of output. In extreme cases, a firm may not reach the lowest average cost point in its cost function until the available market demand is exhausted. In markets with these characteristics, a single supplier is actually the most efficient form of organization (unlike other monopolies that arise for legal or other reasons).

Public utilities and telecommunications carriers have long been viewed as natural monopolies, but technological change may now be gradually eroding their natural monopoly characteristic. That is because modern technology that relies increasingly on fast computers and software is making plant and equipment more modular and scalable than in the past, and is bringing down the minimum scale that a firm must achieve to operate efficiently. An externality is a cost or benefit from an economic decision or activity that is not reflected in market prices, and falls without invitation or compensation on unwitting third parties. For example, cars that pollute the air because they are not equipped with pollution control devices impose a cost on society. If the car owners do not have to pay compensation for that cost, the outcome is a negative externality. On the other hand, the value of any network increases (to existing members) when a new member joins. If that member is not rewarded for having created the collective benefit, the outcome is a positive externality. The effect of an externality is that society as a whole may produce too much of a good or service that produces a negative externality, or too little of a good or service that produces a positive externality.

Regulation as a process
Public services can encounter conflict between commercial procedures (e.g. maximizing profit), and the interests of the people using these services, (see market failure) as well as those that are not (externalities.) Most governments therefore have some form of control or regulation to manage these possible conflicts. This regulation ensures that a safe and appropriate service is delivered, while not discouraging the effective functioning and development of businesses. For example, the sale and consumption of alcohol and prescription drugs are controlled by regulation in most countries, as are the food business, provision of personal or residential care, public transport, construction, film and TV, etc. Monopolies are often regulated, especially those that are difficult to abolish (natural monopoly). The financial sector is also highly regulated. Regulation can have several elements: Public statutes, standards or statements of expectations. A process of registration or licensing to approve and to permit the operation of a service, usually by a named organisation or person. A process of inspection or other form of ensuring standard compliance, including reporting and management of noncompliance with these standards: where there is continued non-compliance, then: A process of de-licensing whereby that organisation or person is judged to be operating unsafely, and is ordered to stop operating at the expense of acting unlawfully.

This differs from regulation in any voluntary sphere of activity, but can be compared with it in some respects. For example, when a broker purchases a seat on the New York Stock Exchange, there are explicit rules of conduct the broker must conform to as contractual and agreed-upon conditions that govern participation. The coercive regulations of the U.S. Securities and Exchange Commission, for example, are imposed without regard for any individual's consent or dissent as to that particular trade. However, in a democracy, there is still collective agreement on the constraint -- the body politic as a whole agrees, through its representatives, and imposes the agreement on the subset of entities participating in the regulated activity. Other examples of voluntary compliance in structured settings include the activities of Major League Baseball, FIFA (the international governing body for professional soccer), and the Royal Yachting Association (the UK's recognised national association for sailing). Regulation in this sense approaches the ideal of an accepted standard of ethics for a given activity, to promote the best interests of the people participating as well as the acceptable continuation of the activity itself within specified limits. In America, throughout the 18th and 19th centuries, the government engaged in substantial regulation of the economy. In the 18th century, the production and distribution of goods were regulated by British government ministries over the American Colonies (see mercantilism). Subsidies were granted to agriculture and tariffs were imposed, sparking the American

Revolution. The United States government maintained a high tariff throughout the 19th century and into the 20th century until the Reciprocal Trade Agreement was passed in 1934 under the Franklin D. Roosevelt administration. However, regulation and deregulation came in waves, with the deregulation of big business in the Gilded Age leading to President Theodore Roosevelt's trust busting from 1901 to 1909, and deregulation and Laissez-Faire economics once again in the roaring 1920's leading to the Great Depression and intense governmental regulation and Keynesian economics under Franklin Roosevelt's New Deal plan. Deregulation returned in the 1950's, along with another economic boom, and business was regulated more heavily in the 1960's and 1970's until President Ronald Reagan deregulated business again in the 1980's with his Reaganomics plan, causing another great economic boom.

Price Regulation
It is claimed that an advantage of price regulation is that it does not affect decisions about which production process to use, and that fewer problems of implementation and enforcement are encountered. The conventional analysis is summarized in Figure 3.4. An unregulated and profit maximizing natural monopolist produces output q* and sells at price p*. If a regulated price of p is imposed, the monopolist's marginal revenue schedule is affected. Given that the monopolist can sell extra units of output up to the amount q at the regulated price p, marginal revenue over this range of output is simply given by the imposed maximum price. Further increases in output beyond q will require that price falls below p, and marginal revenue will then follow the original curve labelled MR. The full marginal revenue curve of the price constrained monopolist is therefore given by the discontinuous line pabMR. A regulated profit maximizing monopolist will therefore produce output q. Up to q marginal revenue under regulation exceeds marginal cost. Beyond q marginal cost exceeds regulated marginal revenue. Figure 3.4 The efficiency gain from price regulation

Regulation has resulted in a gain to consumers of the area p*eap through the fall in price and increase in output. Geometrically this is equal to the area eabd. (The original marginal revenue curve shows the extra payment made by consumers for an

additional unit of output, i.e. allowing for the fact that price is falling, while the demand curve shows the maximum that they would have been prepared to pay. Thus the vertical distance between the two curves is the gain to consumers of an extra unit of consumption.) The profits of the monopolist have fallen by area bed (the difference between marginal cost and marginal revenue). Thus the gain to consumers minus the loss to producers is represented by the shaded area eacd. These changes have occurred apparently without the effects on input decisions involved with rate of return regulation. The terms upon which the various inputs may be used are not influenced by a regime of simple price control, and a profit maximizing but regulated firm will operate with the same cost curves as an unregulated one.

Price elasticity of demand

Determinants The overriding factor in determining PED is the willingness and ability of consumers after a price change to postpone immediate consumption decisions concerning the good and to search for substitutes ("wait and look"). [24] A number of factors can thus affect the elasticity of demand for a good: [25] Availability of substitute goods: the more and closer the substitutes available, the higher the elasticity is likely to be, as people can easily switch from one good to another if an even minor price change is made;[25][26][27] There is a strong substitution effect.[28] If no close substitutes are available the substitution of effect will be small and the demand inelastic.[29] o Breadth of definition of a good: the broader the definition of a good (or service), the lower the elasticity. For example, Company X's fish and chips would tend to have a relatively high elasticity of demand if a significant number of substitutes are available, whereas food in general would have an extremely low elasticity of demand because no substitutes exist.[30] Percentage of income: the higher the percentage of the consumer's income that the product's price represents, the higher the elasticity tends to be, as people will pay more attention when purchasing the good because of its cost; [25][26] The income effect is substantial.[31] When the goods represent only a negligible portion of the budget the income effect will be insignificant and demand inelastic,[32] Necessity: the more necessary a good is, the lower the elasticity, as people will attempt to buy it no matter the price, such as the case of insulin for those that need it.[10][26] Duration: for most goods, the longer a price change holds, the higher the elasticity is likely to be, as more and more consumers find they have the time and inclination to search for substitutes. [25][27] When fuel prices increase suddenly, for instance, consumers may still fill up their empty tanks in the short run, but when prices remain high over several years, more consumers will reduce their demand for fuel by switching to carpooling or public transportation, investing in vehicles with greater fuel economy or taking other measures.[26] This does not hold for consumer durables such as the cars themselves, however; eventually, it may become necessary for consumers to replace their present cars, so one would expect demand to be less elastic.[26] Brand loyalty: an attachment to a certain brandeither out of tradition or because of proprietary barrierscan override sensitivity to price changes, resulting in more inelastic demand. [30][33] Who pays: where the purchaser does not directly pay for the good they consume, such as with corporate expense accounts, demand is likely to be more inelastic

ADVANTAGES OF LARGE SCALE PRODUCTION CAN BE DISADVANTAGES OF SMALL SCALE PRODUCTION AND VICE VERSA
Advantage of Large scale production: Efficient use of capital equipment: There is large scope for use of machinery, which results in lower costs. A Large producer can install an up-to- date and expensive machinery. He can also have own repairing unit. Specialized in machinery can be employed for each job. The result is that production is very economical. Small producer with small markets can't keep the machinery continuous working. Keeping it idle is uneconomical. A large Producer can work it continuously and reap resulting economies. Using of specialized labor: Specialized labor produce a large output and of better quality. It is only in a large business organization that every person can be put on the job that he can best perform. Better utilization of special in management: The use of capable manager's time in an enlarged scale production. His assistance and specialized may be used in a large-scale production where his ability is more fruitful. Economies of buying and selling: While purchasing raw material and other accessories, a big business can secure especially favorable term an account of its large custom. He can attract customer by offering a greater variety and by ensuring prompt execution of the orders, placed with it when he selling a product. Economy in rent: A large-scale producer makes a saving in rent too. If the same factory made to produce a large Quantity of goods, the same amount of rent is divided over a large output. This means a smaller addition to the cost per unit in the form of rent. Experiment and research: A large concern can afford to spend liberally on research and experiments. Successfully research may lead to the discovery of cheaper process. Advertisement and salesman ship: A big concern can afford to spend large amount of money on advertisement and salesmanship. Amount of money spent on advertisement per unit comes to a low figure when production is on large scale. Salesman can make a careful study of individual markets and thus acquire a hold on new market or strengthen it on old ones. Utilization of by-products: A big producer will not have to throw away any of it's by products or waste products. It will be able to make an economical use of them. Meeting adversity: A big business can show better resistance in times of adversity. It has much better recourses. Losses can easily bear. Cheap credit: A large business can secure credit facilities at cheap rate. Its credit in the money market is high and banks are only two willing to give advance. Low cost of credit reduces cost of production. Disadvantage of large-scale production: Over-worked management: A large-scale producer cannot pay off that you can think of full attention to every detail. Costs often rise on account of the employees or waste of material by them. This is due to the lack of supervision. Owing to laxity of control costs of production go up. The management is overworked. Individual tastes ignored: Large-scale production is a mass production or standardized production. Goods of uniform quality are turned out irrespective of the preferences of individual customers. Individual tastes are not therefore, satisfied. This results in a loss of custom. Personal element: Paid employees generally manage a large-scale business. The owner is usually absent. The sympathy and personal touch, which ought to exit between the master and the men, are missing frequent misunderstandings lead to strikes and lack outs. This is positively harmful to the business. Possibility of depression: large-scale production may result overhead production. Production may exceed demand and cause depression unemployment. It is not always easy or profitable to dispose of a large output. Dependence on foreign market: A large-scale producer has generally to depend on foreign markets. The foreign markets may be cut off by war or some other political upheaval this makes the business risky. Cut throat competition: Large-scale producers must fight for the markets. These are wasteful competition, which does not to society. Many promising businesses are ruined by senses competition. There is also competition and biddings for resorts and inputs. International complications and war: When the large-scale producer operates on an international scale, their interest clash either on the score of markets or of materials. These complications sometimes lead to armed conflicts. Many a modem war a rose on account of scramble for materials & markets. Lack of adaptability: A large scale producing units find it's very difficult to switch on from one business to another, in a depression small firms are able to move away from declining trades to flourishing ones easily. In this way they are able to avoid losses. This adaptability is lacking in a big business.

FORMS OF MONOPOLY Natural monopoly A natural monopoly is a company which experiences increasing returns to scale over the relevant range of output. [71] A natural monopoly occurs where the average cost of production "declines throughout the relevant range of product demand". The relevant range of product demand is where the average cost curve is below the demand curve. [72] When this situation occurs it is always cheaper for one large company to supply the market than multiple smaller companies, in fact, absent government intervention in such markets will naturally evolve into a monopoly. An early market entrant which takes advantage of the cost structure and can expand rapidly can exclude smaller companies from entering and can drive or buy out other companies. A natural monopoly suffers from the same inefficiencies as any other monopoly. Left to its own devices a profit-seeking natural monopoly will produce where marginal revenue equals marginal costs. Regulation of natural monopolies is problematic. [citation needed] Fragmenting such monopolies is by definition inefficient. The most frequently used methods dealing with natural monopolies is government regulations and public ownership. Government regulation generally consists of regulatory commissions charged with the principal duty of setting prices. [73] To reduce prices and increase output regulators often use average cost pricing. By average cost pricing, the price and quantity are determined by the intersection of the average cost curve and the demand curve.[74] This pricing scheme eliminates any positive economic profits since price equals average cost. Average cost pricing is not perfect. Regulators must estimate average costs. Companies have a reduced incentive to lower costs. Regulation of this type has not been limited to natural monopolies. [74] Government-granted monopoly A government-granted monopoly (also called a "de jure monopoly") is a form of coercive monopoly by which a government grants exclusive privilege to a private individual or company to be the sole provider of a commodity; potential competitors are excluded from the market by law, regulation, or other mechanisms of government enforcement. Copyright, patents and trademarks are examples of government-granted monopolies In economics, a government-granted monopoly (also called a "de jure monopoly") is a form of coercive monopoly by which a government grants exclusive privilege to a private individual or firm to be the sole provider of a good or service; potential competitors are excluded from the market by law, regulation, or other mechanisms of government enforcement. As a form of coercive monopoly, government-granted monopoly is contrasted with a non-coercive monopoly or an efficiency monopoly, where there is no competition but it is not forcibly excluded. Amongst forms of coercive monopoly it is distinguished from government monopoly or state monopoly (in which government agencies hold the legally enforced monopoly rather than private individuals or firms) and from government-sponsored cartels (in which the government forces several independent producers to partially coordinate their decisions through a centralized organization). Advocates for government-granted monopolies often claim that they ensure a degree of public control over essential industries, without having those industries actually run by the state. Opponents often criticize them as political favors to corporations. Government-granted monopolies may be opposed by those who would prefer free markets as well as by those who would prefer to replace private corporations with public ownership. Under mercantilist economic systems, European governments with colonial interests often granted large and extremely lucrative monopolies to companies trading in particular regions, such as the Dutch East India Company. Today, governmentgranted monopolies may be found in public utility services such as public roads, mail, water supply, and electric power, as well as certain specialized and highly regulated fields such as education and gambling. In many countries lucrative natural resources industries, especially the petroleum industry, are controlled by government-granted monopolies. Franchises granted by governments to operate public transit through public roads are another example.

FACTORS AFFECTING DEMAND OF A PRODUCT

The economic determinants of demand are: (1) Price. As price goes up generally demand goes down. (2) Income. As real income increases consumer spending habits change. A large part of one's income is committed to regular payments, the remainder is called discretionary income. Obviously, as real income increases discretionary income increases. In this case, the general pattern is for consumers to switch from inferior (basic) to superior (luxury/differentiated) goods. "Inferior" here does not necessarily mean "bad", but indicates a product which is perceived to have less quality and to be less distinctive, and therefore to command a lower price. (3) The state of the economy as a whole - for example, whether the economy is booming, or in recession. This affects average incomes so the impact on a business is not really distinct from the second point. In a recession real incomes fall and consumers tend to switch from superior to inferior goods; this is called "trading down". The opposite process - "trading up" - occurs during (1) booms, (2) the general increase in living-standards; (3) improvements in income during the lifetime of a consumer or household; (4) existence of substitutes- that is, the more near alternatives there are to a product, the more likely consumers are to change from your product. (4) Substitutes. A substitute is an alternative to a product. For example, a substitute for tinned cat food is fresh raw meat. The one is not a perfect substitute for the other; however, one brand of tinned cat food can be almost identical in quality to another, and so constitute a perfect substitute. The more substitutes there are and the less difference there is between the substitutes, the more sensitive the demand for a product will be to changes in price. In other words, it is the presence of substitutes that determines whether the demand for a good will be elastic or inelastic.

Principle of Least Cost Combination

The objective of profit maximization can be achieved by two ways, one by increasing output and other by minimizing the cost. The minimization of cost can be possible by deciding the use of more than one resource in substitution of other resources. The objective of factor-factor relationship is two fold: 1) Minimization of cost at a given level of Output. 2) Optimization of output to the fixed factors through alternative resource use combinations. y =f (x1, x2, x3, x4.. xn) Y is the function of x1 and x2 while other inputs are kept at constant. The relationship can be better explained by the principle of least cost combination. Principle of Least Cost combination: A given level of output can be produced using many different combinations of two variable inputs. In choosing between the two completing resources, the saving in the resource replaced must be greater than the cost of resource added. The principle of least cost combination states that if two factor inputs are considered for a given output the least cost combination will be such where their inverse price ratio is equal to their marginal rate of substitution. 1. Marginal Rate of substitution: MRS is defined as the units of one input factor that can be substituted for a single unit of the other input factor. So MRS of x2 for one unit of x1 is Number of unit of replaced resource (x2) =-------------------------------------------------------Number of unit of added resource (x1) 2. Price Ratio (PR) = Cost per unit of added resource = -------------------------------------------------Cost per unit of replaced resource Price of x1

= ----------------------Price of x2 Therefore the least cost combination of two inputs can be obtained by equating MRS with inverse price ratio. i.e. x2 * Px2 = x1 * Px1

What Does Economies Of Scale Mean? The increase in efficiency of production as the number of goods being produced increases. Typically, a company that achieves economies of scale lowers the average cost per unit through increased production since fixed costs are shared over an increased number of goods. There are two types of economies of scale: -External economies - the cost per unit depends on the size of the industry, not the firm. -Internal economies - the cost per unit depends on size of the individual firm.

PRICE RIGIDITY IN OLIGOPOLY

Price Rigidity: Kinked Demand Curve Our study of pricing and market structure has so far suggested that a firm maximizes profit by setting MR = MC. While this is also true for oligopoly firms, it needs to be supplemented by other behavioural features of firm rivalry. This becomes necessary because the distinguishing feature of oligopolistic markets is interdependence. Because there are a few firms in the market, they also need to worry about rival firms behaviour. One model explaining why oligopolists tend not to compete with each other on price, is the kinked demand curve model of Paul Sweezy. In order to explain this characteristic of price rigidity i.e. prices remaining stable to a great extent, Sweezy suggested the kinked demand curve model for the oligopolists. The kink in the demand curve arises from the asymmetric behaviour of the firms. The proponents of the hypothesis believe that competitors normally follow price decreases i.e. they show the cooperative behaviour if a firm reduces the price of its products whereas they show the non-cooperative behaviour if a firm increases the price of its products. Let us start from P1 in Figure 13.3. If one firm reduces its price and the other firms in the market do not respond, the price cutter may substantially increase its sales. This result is depicted by the relative elastic demand curve, dd. For example, a price decrease from P1 to P2 will result in a movement along dd and increase sales from Q1 to Q2 as customers take advantage of the lower price and abandon other suppliers. If the price cut is matched by other firms, the increase in sales will be

GAME THEORY
Game theory is a mathematical method for analyzing calculated circumstances (games) where a persons success is based upon the choices of others.[1] An alternative term suggested "as a more descriptive name for the discipline" is interactive decision theory.[2] Game theory is mainly used in economics, political science, and psychology, and other, more prescribed sciences, like logic or biology. The subject first addressed zero-sum games, such that one person's gains exactly equal net losses of the other participant(s). Today, however, game theory applies to a wide range of class relations, and has developed into an umbrella term for the logical side of science, to include both human and non-humans, like computers. Classic uses include a sense of balance in numerous games, where each person has found or developed a tactic that cannot successfully better his results, given the other approach. Mathematical game theory had beginnings with some publications by mile Borel, which led to his book Applications aux Jeux de Hasard. However, his results were limited, and the theory regarding the non-existence of blended-strategy equilibrium in two-player games was incorrect. Modern game theory began with the idea regarding the existence of mixed-strategy equilibria in two-person zero-sum games and its proof by John von Neumann. Von Neumann's original proof used Brouwer's fixed-point theorem on continuous mappings into compact convex sets, which became a standard method in game theory and mathematical economics. His paper was followed by his 1944 book Theory of Games and Economic Behavior, with Oskar Morgenstern, which considered cooperative games of several players. The second edition of this book provided an axiomatic theory of expected utility, which allowed mathematical statisticians and economists to treat decision-making under uncertainty. This theory was developed extensively in the 1950s by many scholars. Game theory was later explicitly applied to biology in the 1970s, although similar developments go back at least as far as the 1930s. Game theory has been widely recognized as an important tool in many fields. Eight game-theorists have won the Nobel Memorial Prize in Economic Sciences, and John Maynard Smith was awarded the Crafoord Prize for his application of game theory to biology.

PRICING TECHNIQUES
Competition-based pricing

Setting the price based upon prices of the similar competitor products. Competitive pricing is based on three types of competitive product: Products have lasting distinctiveness from competitor's product. Here we can assume o The product has low price elasticity. o The product has low cross elasticity. o The demand of the product will rise. Products have perishable distinctiveness from competitor's product, assuming the product features are medium distinctiveness.

Products have little distinctiveness from competitor's product. assuming that: o The product has high price elasticity. o The product has some cross elasticity. o No expectation that demand of the product will rise. Cost-plus pricing

Cost-plus pricing is the simplest pricing method. The firm calculates the cost of producing the product and adds on a percentage (profit) to that price to give the selling price. This method although simple has two flaws; it takes no account of demand and there is no way of determining if potential customers will purchase the product at the calculated price. This appears in 2 forms, Full cost pricing which takes into consideration both variable and fixed costs and adds a % markup. The other is Direct cost pricing which is variable costs plus a % markup, the latter is only used in periods of high competition as this method usually leads to a loss in the long run. Creaming or skimming

Selling a product at a high price, sacrificing high sales to gain a high profit, therefore skimming the market. Usually employed to reimburse the cost of investment of the original research into the product: commonly used in electronic markets when a new range, such as DVD players, are firstly dispatched into the market at a high price. This strategy is often used to target "early adopters" of a product or service. These early adopters are relatively less price-sensitive because either their need for the product is more than others or they understand the value of the product better than others. In market skimming goods are sold at higher prices so that fewer sales are needed to break even. This strategy is employed only for a limited duration to recover most of investment made to build the product. To gain further market share, a seller must use other pricing tactics such as economy or penetration. This method can come with some setbacks as it could leave the product at a high price to competitors. [1] Limit pricing

A limit price is the price set by a monopolist to discourage economic entry into a market, and is illegal in many countries. The limit price is the price that the entrant would face upon entering as long as the incumbent firm did not decrease output. The limit price is often lower than the average cost of production or just low enough to make entering not profitable. The quantity produced by the incumbent firm to act as a deterrent to entry is usually larger than would be optimal for a monopolist, but might still produce higher economic profits than would be earned under perfect competition. The problem with limit pricing as strategic behavior is that once the entrant has entered the market, the quantity used as a threat to deter entry is no longer the incumbent firm's best response. This means that for limit pricing to be an effective deterrent to entry, the threat must in some way be made credible. A way to achieve this is for the incumbent firm to constrain itself to produce a certain quantity whether entry occurs or not. An example of this would be if the firm signed a union contract to employ a certain (high) level of labor for a long period of time. Loss leader

A loss leader or leader is a product sold at a low price (at cost or below cost) to stimulate other profitable sales. Market-oriented pricing

Setting a price based upon analysis and research compiled from the targeted market. Penetration pricing

Setting the price low in order to attract customers and gain market share. The price will be raised later once this market share is gained.[2] Price discrimination

Setting a different price for the same product in different segments to the market. For example, this can be for different ages or for different opening times, such as cinema tickets. Premium pricing

Premium pricing is the practice of keeping the price of a product or service artificially high in order to encourage favorable perceptions among buyers, based solely on the price. The practice is intended to exploit the (not necessarily justifiable) tendency for buyers to assume that expensive items enjoy an exceptional reputation or represent exceptional quality and distinction. Predatory pricing

Aggressive pricing intended to drive out competitors from a market. It is illegal in some places. Contribution margin-based pricing

Contribution margin-based pricing maximizes the profit derived from an individual product, based on the difference between the product's price and variable costs (the product's contribution margin per unit), and on ones assumptions regarding the relationship between the products price and the number of units that can be sold at that price. The product's contribution to total firm profit (i.e., to operating income) is maximized when a price is chosen that maximizes the following: (contribution margin per unit) X (number of units sold).. Psychological pricing

Pricing designed to have a positive psychological impact. For example, selling a product at $3.95 or $3.99, rather than $4.00. Dynamic pricing

A flexible pricing mechanism made possible by advances in information technology, and employed mostly by Internet based companies. By responding to market fluctuations or large amounts of data gathered from customers - ranging from where they live to what they buy to how much they have spent on past purchases - dynamic pricing allows online companies to adjust the prices of identical goods to correspond to a customers willingness to pay. The airline industry is often cited as a dynamic pricing success story. In fact, it employs the technique so artfully that most of the passengers on any given airplane have paid different ticket prices for the same flight. Price leadership

An observation made of oligopic business behavior in which one company, usually the dominant competitor among several, leads the way in determining prices, the others soon following.