Mod 7,8

MOD -7(ME)

MARKET STRCTURE

What are Markets? The market may be in one specific place.

A market is where buyers and sellers:

meet to exchange goods and services

usually in exchange for money

ESSENTIALS OF MARKET

Commodity for transaction

Network of buyers & sellers

Competition between buyers & sellers

A place or a situation for transaction

TYPES OF MARKET

Perfect competition

Monopolistic competition

Monopoly

Oligopoly

PERFECT COMPETITION:CONDITIONS

Large number of buyers and sellers in the market, no one of them can influence price

Homogeneous goods

Free Entry & Exit of firms

Perfect knowledge of the market

Perfect mobility of factors of production

Non-intervention of government

No transport cost difference

Perfectly elastic demand curve

Closest example is a fruit and vegetable market

WHAT IS NORMAL & SUPER NORMAL PROFIT?

Normal profit- minimum level of profits in order to stay in business

supernormal profits – profits over and above normal profits.

SHORT RUN EQUILBRIUM-Perfect Competition:

Under perfect competition, there is a single ruling market price- the equilibrium price,

determined by the interaction of forces of total demand and total supply

However, in the short run a perfectly competitive firm may earn super normal profit,

or normal profit or can incur losses depending upon the positions of the short run cost

curves.

PRICE DISCIRIMINATION

Monopoly firms –sole objective of earning maximum profits may charge uniform

price or different prices for their products to different customers.

The practice of selling the same commodity at different prices to different buyers is

called price discrimination.

Ex: A book seller selling the same edition of a book in an ordinary cover at Rs. 25 and

with deluxe cover at Rs. 50 and others. Then he is said to be discriminating.

TYPES OF DISCRIMINATION

1. Personal discrimination-Monopolist may charge different prices on the basis of

their income. E.g. Doctors & Lawyers.

2. Place discrimination: different prices for the same commodity in different

regions or localities. E.g. Provision of door to door delivery, drive in facility

in restaurants

Dumping in domestic & foreign markets.

3. Use of trade Discrimination: different prices for different types of uses of the

same commodity.

E.g. Electricity sold at cheaper rate for agricultural purposes and higher rate for

industrial purposes.

4. Age discrimination: On the basis of age of the customers.Buyers below 12 years

of age are charged. Half rates in transport services.

5. Sex discrimination: Some touring agents may provide seats at concessional rate

to the ladies.

6. Size discrimination: price in the retail market is higher than the price in the

whole sale market. Small size toothpaste is dearer relatively then the economy

size toothpaste.

7. Quality variation discrimination: in the form of material used , the nature of

packing, colour, style etc.,

MONOPOLY

A market structure in which only one Producer or seller exists for a Product that has no

close substitutes.

Public utility services like water supply and electricity

Monopolistic competition- is a market structure in which a large number of small sellers

sell differentiated products which are close, but not perfect substitutes for one another.

EXAMPLE: Tooth paste, Blades, Motor cycle & bicycle, Cigarettes, cosmetics, biscuits,

soaps, and detergents, shoes, Ice-creams etc.,

FEATURES OF MONOPOLY.

1. Many firms : each firm contributes only a small portion of the total output & has a

limited control over the price of the product

2. Independent price policy: firms produce different products which are close

substitutes & price is determined considering cost of production & demand.

3. Product differentiation: each firm tries to differentiate its product from that of other

rivals in one way or other.

4. Single seller : There is single producer under Monopoly . So monopoly firm and

industry are identical.

5. No substitutes : There are no close substitutes for the product of monopolist.

6. Absence of competition : There is no competition for a monopolist product as he is

the only seller ruling the market.

7. Price maker : A monopolist is a price maker and not price-taker. He can fix his own

price policy and maximize profit.

8. Inelastic demand curve : A monopoly firm faces a downward slopping demand

curve.

9. No free entry and exit : The monopolist has no immediate rivals due to barriers

which block the entry of new firms. Firm can only earn normal profits.

10. Selling cost : cost on Advertisements & selling mediums in order to popularize their

brand in the market.

11. Lack of perfect knowledge : large no. of products each being substitute of the other.

Seller does not know the exact preference of buyers and hence he cannot get any

added advantage out of the situation.

12. Lack of mobility of factors : Factors of production and goods and services are not

perfectly mobile under MPC.

13. More elastic demand : MPC have more elastic demand curve i.e if the firm wants to

sell more, it must reduce its price.

TYPES OF MONOPOLY

1. Natural Monopoly: such monopoly arises due \to endowment of resources by nature.

Natural advantages such as climatic condition, good location, availability of certain

minerals etc. creates natural monopoly.

2. Legal Monopoly: It is also known as statutory monopoly. It is given by law.

3. Pure Monopoly: It is a market in which there is single seller & large number of

buyers. It is compete negations of competition.

4. Limited Monopoly: When there are few sellers & large number of buyers then limited

monopoly exist.

5. Public Monopoly : When monopoly is firm is owned , managed & controlled by

government then it is called as public monopoly.

6. Simple Monopoly: when monopoly charges same price for his commodity from all

buyers in the market then it is called as simple monopoly.

PRICING UNDER MONOPOLISTIC COMPETITION – SHORT RUN

o A firm under monopolistic competition is a price maker.

o The firm has to determine a suitable price for its product which yields a maximum

revenue.

o In order to maximize its total profit or minimize its losses in the short run, the firm

produces that level of output at which marginal cost is equal to marginal revenue(i.e

MC=MR) thus equilibrium is determined at the point of intersection of the MC curve

and the MR curve .

MR =MC intersects each other at output. At output OQ shows equilibrium level of output. In

this situation price to be determined will be QR or OP. SAC at this output level is QC or OD.

Therefore DP supernormal profit DPXOQ = area of rectangle DPRC.

PRICING UNDER MONOPOLISTIC COMPETITION- LONG RUN

Firms in the short run earn super normal profits in a monopolistically competitive market,

some new firms will be attracted to enter the business, as the group is open.

On accounts of rival’s entry the demand curve faced by the typical firm will shift to the origin

and it will also tend to be more elastic, as its share in the total market is reduced due to

competition from an increasing No. of close substitutes.

In the long run equilibrium when AR=AC. AR is tangent the average cost curve LAC at R.

Therefore, the equilibrium output in the long run is OQ and the corresponding price is QR or

OP. At this point Average cost is also QR and so is average revenue. Therefore there is no

supernormal profits: only normal profits which forms cost of production

Why firm is required to attain equilibrium ?

To Stay in business.

Equilibrium of firm requires equality of MR with MC.

MC=MR

PRODUCT DIFFERENTIATION

Product differentiation is the glaring feature of monopolistic competition.

Firms adopt different technique to differentiate their products from one another.

There are many ways of making products different from one another.

Branding – most common & essential aspect of unique identification of the product.

Ex: IFB washing machine, Sony music system.

Product differentiation may take mainly two forms:

A) Real Product Difference:

Quality: when products are produced out of materials of higher quality & durability.

When they are extraordinary on the basis of workmanship, color, design size, shape, style,

fragrance etc.,

When personal care is taken to produce it.

B) Imaginary Product Difference:

Producers adopt different methods to differentiate their products from that of close substitutes

in the following manner.

Proper allocation of sales depots in busy commercial

Depots

Selling goods under different trade marks

different brands and packing them in attractive

wrappers or containers.

Working hours convenient customers.

Courteous treatment to customers and developing friendly relations with them

Offering gifts, discounts, guarantee of repairs & other free services, sales on credit, or

credit cards.

Agreement to take back goods if they are unsatisfactory. Air-conditioned stores etc.,

OLIGOPOLY

In economics, a situation in which few companies control the major part of a particular

market ………

The term Oligopoly is derived from two greek words “Oligos” means a few and “Poly”

means to sell.

Oligopoly is market situation with a few sellers (more than two) each selling either

homogeneous or hetergenous (differentiated products)

This type of markets are characterized by a few sellers where each one or at least one of them

commands a significant portion of the total supply of the product in the market.

E.g. Oligopolistic industries in the Indian context are automobile, steel Cement,

cigarettes, soaps and detergents.

FEATURES:

1. Small no of Large sellers

2. Interdependence

3. Advertising and selling costs

4. Conflict or collude attitude of the firms

5. Under oligopoly new entry is difficult. It is neither free nor barred.

6. Lack of uniformity in size of the firm is another feature of oligopoly

Small Number of Firms

In contrast to monopolistic competition and perfect competition, an oligopoly consists of a

small number of firms.

Each firm has a large market share

The firms are interdependent

The firms have an incentive to collude

Examples of oligopoly

Supermarkets

Banking industry

Chemicals

Oil

Medicinal drugs

Broadcasting

Interdependence: Each firm has to be conscious of the reactions of its rivals, since the no. of

firms are very few, any change in price, output, product etc., by one firm will have direct

effect on the policy of other firm.

Importance of advt & selling cost

In oligopoly different firms have to employ various aggressive and defensive

marketing weapons to gain a greater share in the market.

It is only under oligopoly that advertisement comes fully into its own

FEATURES OF OLIGOPOLY

Conflict or collude attitude of the firms:

Firms may realize the disadvantages of competition & rivalry and desire to unite

together to maximise their profits.

On the other hand firms guided by individualistic considerations may continuously

come in clash and conflict with another.

This creates uncertainty in the market.

OUTPUT DECISIONS UNDER OLIGOPOLY

As the action and reaction affect one fortune, the oligopoly firms have no alternative

but to react to the actions of the competitors.

There are several approaches to determine the price and output by oligopoly firms:

Approaches to determine the price & the output –oligopoly

Three important approaches to determine the output by oligopoly firms;

1. Collusions or agreements (CARTELS)

2. Kinked Demand curve

3. Price leadership

CARTELS

Collusion is just opposite of competition.

The term collusion means to “play together” in economics. .

It means that firms co-operate with each other in taking joint actions to keep their

bargaining position stronger against the consumer.

Collusion- bases on their oral or written agreements.

Collusion based on oral agreements leads to the creation of what is called as

“gentleman’s agreements” it does not consist of any record.

Collusion based written agreements creates what is know as CARTELS

Centralized cartels: Firms surrender all their rights to a central authority which sets

prices, determine output, quotas for each firm, distributes profits.

Objective; Maximises Joint profits, hence cartel acts as a monopolist.

Market sharing cartels: have restrictive assumptions of identical costs for all firms.

Practically firms hv. Unequal costs and every firms want to have some dgree of

independent action.

Therefore Market sharing is short lived.

PRICE LEADERSHIP

Mutual suspicion and distrust among member firms and their unwillingness to

surrender all their sovereignty makes the collusion imperfect.

Price leadership: A strong firms which is enjoying the benefits of large scale

production will dominate the small firms.

The price fixed by the dominating firms will be followed by all other small firms.

Hence, the dominating firm becomes the price leader.

All other firms following the price policy of the dominating firm in the industry are

called as price followers.

KINKED DEMAND CURVE MODEL

KDC- first used by Prof. M. Sweezey to explain price rigidity under oligopoly.

It represents the behaviour of Oligopoly firm which has not incentive either to

increase or decrease its price.

In this model, the firm is afraid to change its price.

Look at logic of the model.

Consequences of raising price

Consequences of lowering price

PRICING

Price denotes two aspects: it is revenue to the seller and its is the perceived value of

the good (or service) to the buyer. It determines sales revenue, market share and

profits.

Pricing decisions are more important for a new product and an existing product.

Among various pricing strategies cost plus pricing (Full cost pricing) is one in which

price of the product is the sum of cost plus a profit margin.

FULL COST PRICING

VIK Technologies has invested Rs. 10 crore in plant and machinery, with a capacity to

produce 10,000 units of television per month. Total variable cost is estimated at Rs. 5 crore

and the firm expects a return of 20% on total investment. What should be the price of TV if

we suppose that the firm can sell its entire output?

Solution:

Base price = TC = 10 + 5 = Rs. 15 crore

Margin = 20% of 15 = 3 crore

Total revenue = 15 +3 = 18 crore

Price = 18,00,00,000/10000= Rs. 18,000 per TV

This method of pricing is very simple & convenient.

But not suitable when competition is tough or when a new firm is trying to enter new market.

For a long time Indian Co’s used cost plus Or full cost pricing

PRODUCT LINE PRICING

Pricing different products within the same product range at different price points.

An example would be the video manufacturer offering different video recorders with

different features at different prices.

NEW PRODUCT PRICING STRATEGIES

The management can choose between two broad strategies:

1. Market-Skimming Pricing

2. Market-Penetration Pricing

Market-Skimming Pricing :

Market-Skimming Pricing Skim means to take the cream. In this strategy the

company initially sets high prices to skim revenues layer by layer from the market. It means

when the price of the new product would be higher only some segments of the market would

adopt the product at a high price.

Market-Skimming Pricing Layer by layer means different layers of customers.

Initially when the prices are high only some segments purchase the product, giving revenue

to the company from customers who cant wait until the prices get low. With initial sales

going down and competitors threaten to introduce similar products, the company lowers the

price to attract the price-sensitive layer of customers. In this way the company skims a

maximum amount of revenue from the various segments / layers of the market. Market Giant

Intel uses this strategy.

Market Skimming Feasibility :

Market Skimming Feasibility This strategy is feasible only under certain conditions : The

product’s quality and image must support its higher price. Enough buyers must want the

product at higher price. Cost of producing a smaller volume cannot be so high that they

cancel the advantage of charging more. Competitors should not enter the market because they

would undercut the high price.

Market – Penetration Pricing :

Market – Penetration Pricing It means setting a low price for a new product in order to

attract a large number of buyers and a large market share. Some companies set a low initial

price in order to penetrate the market quickly. The high sales volume results in falling costs

which allows the company to reduce its price even further. Dell used this strategy to enter the

personal computer market. Walmart & other discount retailers also use this strategy.

Pre-Requisites For Market Penetration Pricing :

Pre-Requisites for Market Penetration Pricing This strategy works only under these

conditions: The market must be highly price sensitive. A low price should produce more

market growth. Production & distribution costs must fall with the increase in the sales

volume. Lastly the low price must keep out the competitors. And the company adopting this

strategy should maintain its low price position in order to achieve permanent or long term

price advantage.

MOD -8 (M.E)

PROFIT

P- percentage of return on capital.

R- reward for taking risks in business.

O- owners motive.

F- fair remuneration.

I- Innovation & creativity

T- Technology

Profit = Total revenue – total cost

Profit means different things for different people

Wages- labor

Rent- owners

Interest- money lenders

It is a motive force of a business undertaking.

The objective of any firm is to maximize profit.

NATURE OF PROFIT

¤ Reward for the service of the entrepreneur

¤ Price or remuneration paid for the management.

¤ Reward for the ownership of capital.

¤ Percentage of return on capital invested.

¤ Difference between total revenue and total cost.

¤ Reward for taking risk in business.

¤ Residual income of to entrepreneur after paying remuneration to all factors.

PROFIT – MEASUREMENT

1. Gross profit & Net profit

2. Normal profit & Super normal profit

3. Optimum profit & Maximum profit

4. Accounting Profit & Economic profit

1. Gross profit & Net profit

GP- refers to the total profits earned by an enterprise.

Gross profit=Total revenue-Total Explicit costs

It is the excess of income after meeting all kinds of actual or explicit costs.

Net profit- refers to the income received by the enterprise after all factors of production

including those contributed by the organizer himself are paid off.

NP= Total revenue – Total cost.

2. Normal Profit & supernormal profit

Normal profit is the minimum amount necessary to induce an entrepreneur to remain and

work in the business.

Supernormal Profit – is the excess of income over and above normal profit.

Total production = 10,000 units

TPC detail - Rent – 10,000/-

Wages - 20,000/-

Interest - 10,000/-

Profit - 10,000/-

50,000/-

Cost per unit = Rs.50,000/10000=Rs.5/-(consists of Rs.1/-rent, 2/-,wages,

1/- interest & Rs.1/- profit)

Rs 1/- is normal profit which is includes in production cost.

If the seller is selling the product at the rate of Rs.8/- in that case, he

Earns a supernormal profit of Rs. 3/- (8/- minus 5/- = 3/-)

Market price – Production cost per unit = SNP

8.00 5.00 = 3.00

3. Optimum profit & Maximum profit

The term “OP’ refers to the most ideal or most desirable level of profit earned by a business

unit.

But there is no yardstick to indicate the ideal level of profit.

It is relative concept and change with the time.

Maximum Profit: refers to the highest possible profit that may be earned by a firm.

4. Accounting Profit & Economic Profit

Accounting Profit: To an accountant , profit is the excess of revenue receipts over the total

explicit cost incurred in generating this Revenue.

Economic Profit: Accounting profit – Implicit costs

Ex: Imputed costs like entrepreneurs wages, rental income, self owned land, interests on self

capital from accounting profit can be called as economic profit.

DETERMINANTS OF SHORT TERM PROFIT

Firms aim at maximizing short run profits.

Elasticity of demand for the product

Annual objectives

Financial objectives

Seasonal demand

DETERMINANTS OF LONG TERM PROFIT

Firms aim at maximizing long run profits.

Prevention of potential competition

Attainment of industry leadership

Prevention of Government intervention

Maintenance of consumer good will

Strategic objectives of the firm

BREAK EVEN ANALYSIS

BEA- economic tool in the hands of business policy makers, for profit planning &

forecasting.

Acc. Marz, Curry & Frank – BEA indicates at what level cost & revenue are in equilibrium.

The main objective of BEA is to trace the relationship between Cost, price & revenue

Significance of BEA:

B- Business Decision Making

E- Economic Research

A- Analysis for Investment

Meaning of break-Even Analysis

BEA- indicates where profit starts, the area of loss & profits , Margin of safety &

optimum level of operation etc.,

In Break-Even Analysis, the break-even point is located at that level of output at

which the net income or profit is zero. At this point, total cost is equal to total

revenue. Hence, the break-even point is the no-profit-no-loss zone.

ASSUMPTIONS OF BREAK-EVEN ANALYSIS

The cost function and the revenue function are linear.

The total cost is divided into fixed and variable costs.

The selling price is constant.

The volume of sales and the volume of production are identical.

Average and marginal productivity of factors are constant.

The product-mix is stable in the case of a multi-product firm.

Factor price is constant.

THE BREAK-EVEN CHART

Break even chart – accepted by business economists, Co. executives, Investment analysts,

Govt. agencies & even trade unions.

Break-even Analysis is essentially cost volume profit analysis(CVPA).

It is an analytical tool for tracing relationships among key business such as costs, revenues

and profits at different output levels.

TR = total revenue

TC = total cost

TFC = total fixed cost

The break-even point (B) is the point at which TR = TC

Profit is zero at OQ level of output.

How to calculate BEP in terms of physical units?

Suppose the fixed costs of a factory are Rs.10,000 per year, the variable costs are Rs. 2.00 per

unit and the selling price is Rs. 4.00 per unit. The Break even point would be

Formula :

BEP = TFC/SP-VC TFC=10,000/-

BEP= 10000 /4-2 SP = 4.00/- per unit

VC= 2.00/- per unit

BEP= 10000 / 4 - 2 = 5,000 units

Now the BEP in terms of physical unit will be 5,000 units.

BEP-in terms of sales value

Multiproduct firms cannot calculate BEP in terms of Physical units of a particular product

because total fixed costs are the same for several products even though total variable costs

change.

It is convenient to calculate their BEP in terms to total sales value expressed in rupees.

Here, again the breakeven point would be the point where the contribution margin (sales

value - variable costs) would equal the fixed costs.

The contribution margin is expressed as a ration to sales.

Ex: sales are 200 and the variable costs of these sales is Rs.140/-

The contribution margin ration is 200-140

LIMITATION OF BEA :-

It is Static.

It is Unrealistic.

It has many shortcomings.

Its scope is limited to the short run only.

It Assumes Horizontal Demand Curve with the given Price of the Product.

It is Difficult to Handle Selling Costs in the BEA.

The Traditional BEA is Very Simple.

USEFULNESS OF BEA

1. The BEA provides microscopic view of the profit structure of the firm.

2 Empirical cost functions required in BEA can be of great help for cost control in

business.

3. The BEA can be used for determining the ‘safety margin’ regarding the extent to which

the firm can permit a decline in sales without causing losses.

Sales - BEP

Safety Margin = X 100

Sales

It is useful in arriving at make or buy decision.

4. The BEA can be useful in determining the target profit sales volume.

TFC – Target Profit

Target Sales Volume = Contribution Margin

5. BEA is highly significant in business decision making prtaining to pricing policy, Sales

Projection, Capital Budgeting etc.,

However, this technique is to be used cautiously.

SAFETY MARGIN

“Safety Margin” associates with the proposed volume. The safety margin refers to the extent

to which the firm can afford a decline in sales before it starts incurring losses.

Safety Margin = sales-BEP/sales X100

Sales=8,000

BEP=5000units

SM=8000-5000/8000X100

=37.5%

It reveals minimum extent of sales effort expected of the management.

PROBLEM