Managerial Economics Notes

Theoretical Foundation of Managerial analytical tools to help us understand and analyze such
problems. Managerial Economics may be taken as economics
Economics Topics: applied to problems of choice of alternatives of economic
nature and allocation of the resources by the firms. In other
» MEANING AND NATURE OF MANAGERIAL ECONOMICS
words, managerial economics involves analysis of allocation
» SIGNIFICANCE OF MANAGEERIAL ECONOMICS
of the resources available to a firm or a unit of management
» SCOPE OF MANAGERIAL ECONOMICS among the activities of that unit. It is thus concerned with
» ROLE OF A MANAGERIAL ECONOMIST IN BUSINESS choice or selection among alternatives.
» MODEL OF PROFIT MAXIMIZATION OR THE THEORY OF
FIRM Definition of Managerial Economics
» MANAGERIAL THEORIES OF THE FIRM
» MORE ECONOMICS TOPICS Some of the popular definitions of managerial economics are:

MEANING AND NATURE OF MANAGERIAL

“Managerial economics…is the integration of economics
ECONOMICS
theory with business practice for the purpose of facilitating
decision-making and forward planning by management.”
Managerial Economics is economics applied in decision- ___Spencer and Siegelman.
making. It is that branch of economics that serves as a link
between abstract theory and managerial practice. Managerial “Managerial economics… is the use of economics mode of
economics is concerned with the business firm and the thought to analyze business situation.”___McNair and
economic problems that every management need to solve. Meriam.

Economics as a science is concerned with the problem of “A fundamental academic subject which seeks to understand
allocation of scarce resources among competing ends. These and to analyse the problems of business decision-
problems of allocation are on a regular basis confronted by making.”____ Hague.
individuals, households, firms as well as economies.
Economics provide us with a number of concepts and As is evident, there are different projections of the subject
matter on managerial economics by different authorities, but
the following features seem common to these viewpoints. 4. Takes the help of macro-economics to understand and
adjust to the environment in which the firm operates.
1. Concerned with decision-making of economic nature. We know that the decisions of the firm are made almost
This implies that managerial economics deals with always within the broad framework of economic environment
identification of economic choices and allocation. within which firm operates, known as micro-economic
conditions. With regards to these conditions, we may stress
2. Micro-economic in character, where the unit of study is a these points.
firm. It concentrates on the study of the firm and not on the
working of the economy. i) The economy in which the business operates is
The chief source of concepts and analytical tools predominantly a free enterprise economy using price and
for managerial economics is micro-economic theory, also market.
known as price theory, some of the popular micro- economic
concepts are the elasticity of demand, marginal cost, the ii) The present-day economy is the one undergoing rapid
long-run economies and diseconomies of scale, opportunity technological and economic changes.
cost, present value and market structures. Managerial
economics also uses some of the well-accepted models in iii) The intervention of government in economic affairs has
price theory, such as model for monopoly price, kinked increased in recent times and there is no likelihood that this
demand model, the model of price discrimination and the intervention will stop in future.
behavioral and managerial models.
These external conditions are beyond the control of the firm,
3. Concerned with normative micro-economics, where the hence the firm needs to adjust itself to the changes in these
economist says what he thinks should happen rather than conditions to survive and grow. This sort of a management is
what does happen to the firm. called a progressive management.
When applies that the decisions of the firm are made almost
always within the broad framework of economic environment 5. Goal-oriented and prescriptive
within which thee firm operates, known as maco-economic It deals with how decisions should be mad e by managers to
conditions. With regards to these conditions, we may stress achieve the organizational goals. Knowledge of managerial
these points. economics helps in making wise choices—as managrs
continue to face the problem of scarcity of resources and 1. Managerial Economics a number of tools and techniques
making suitable choices to allocate them appropriately in to enable a Manager to become a more competent model
order to achieve organizational goals. builder. With the help of these models, the Manager can
capture the essential relationships that represent the real
6. Pragmatic situation while eliminating the relatively less important
Managerial Economics concentrate on making economics details.
theory more application- oriented. It is concerned with those
analytical tools which are useful in improving decision- 2. Managerial Economics provides most of the concepts that
making. are needed for the analysis of business problems. Concepts
like elasticity of demand, fixed and various costs, short and
7. Both ‘conceptual’ and ‘Metrical’ long-run costs, opportunity costs.net present value etc. help
An intelligent application of quantitative techniques to in understand and solving a decision problem.
business presupposes considered judgement and hard and
careful thinking about the nature of the particular problem to 3. Managerial Economics helps in making decisions such as:
be solved. Managerial Economics provides necessary
conceptual tools to achieve this. Moreover, it helps the *What should be the product mix?
decision makers by providing measurement of various *Which is the production technique and the input-mix that is
economic entities and their relationships. This material least costly?
dimension of managerial economics is complementary to its *What should be the level of output and price for the
conceptual framework. product?
*How to take investment decisions?
*How much should a firm advertise and how to allocate the
SIGNIFICANCE OF MANAGERIAL ECONOMICS advertisement fund between different Media?

Management is concerned with decision-making; Managerial

SCOPE OF MANAGERIAL ECONOMICS
Economics helps the decision-making process in the following
ways:
Managerial Economics has a close connection with
economics theory (micro as well as macro-economics), manager bears in mind while making his decision of allocation
operations research, statistics, mathematics and the theory of of scarce resources.
decision-making. Managerial Economics also draw together
and relates ideas from various functional areas of 5. Pricing and output: Once the quantity of output is ready
management like production, marketing, finance & for sale, the firm has to decide its price bearing in mind the
accounting, project management etc. A professional conditions in the market, In fact pricing is a very important
management economist has to integrate the concept and aspect of managerial economics as firm’s revenue-earnings
methods from all these discipline and functional area in order largely depend on its pricing policy.
to understand and analyse practical managerial problems.
6. Profit: Profit management is also a study in Managerial
The following aspects thus constitute the subject-matter of Economics.
managerial economics:
7. Investment and Capital Building: For maximizing its profits,
1. Objectives of a Business firm: The role of the top the firm needs to take care of its long-range decisions i.e.it
management is to decide what will be the objectives of a has to evaluate its investment decisions and carry on a
firm. sensible policy of capital budgeting.

2. Demand Analysis and Demand Forecasting: The very first 8. Product Policy, Sales Promotion and Market Strategy: An
thing to find out in a new business venture is the nature and intelligent market management also helps the firm to grow.
amount of demand for the product, both at present and in Market management includes product competition like
future, Demand analysis and forecasting therefore help in the advertising, product design etc.
choice of the product and in planning the output levels.
The managerial economics, taking the help of economics
3. Production and Cost: Once the output is decided, the concepts and relationships, tries to find out which course is
manager then needs to choose the best input-mix and the likely to be the best for the firm under a given set of
technology. He will maximize his profits only if he produces th conditions.
desired level of output at the minimum possible cost.
*Managerial Economics and Traditional Economics:
4. Competition: Competition is one of the essential a *Managerial Economics and Operation Research:
*Managerial Economics and Statistics: organizations goals.
*Managerial Economics and the Theory of Decision-Making:

ROLE OF A MANAGERIAL ECONOMIST IN BUSINESS

MODEL OF PROFIT MAXIMIZATION OR THE THEORY
OF FIRM
The two most important role of a managerial economist is to
process information and make decisions. These decisions can
be specific in nature or may be general tasks. Profit maximization as the single goal of the firm has been
the traditional approach to the theory of the firm. Profit
Business is influenced not only by what decisions are taken maximization means the striving for the largest absolute
within the firm but also by the general business environment. amount of profits over a time period, both short term and
While the internal factors are within the firm but also by the long term. The short run is a period where production
general business environment. While the internal factors are adjustments cannot be made quickly in matters of demand
within its control, the external factors lie outside its sphere of and supply. Long run however enables adjustment to changed
control. The firm can make only timely adjustments to these conditions. In the short run for instance, there are production
external factors. The role of the managerial economist is to and financial constraints in expanding the firm even though it
understand these external factors and to suggest policies would yield maximization higher profits. But given sometime,
which the firm should follow to make the best use of these most of the constraints can be overcome. So, short-term
external and internal factors. profit differs from long-term profit maximization. Profit
maximization can be viewed from the point of view of the
The external factors comprise of general economic condition control wielded by a firm over price and output
of the economy, demand for the product, input cost of the determination. Where the firm operates under condition of
firm, market conditions of raw material and finished product, perfect competition among several firms, the price is
firm’s share in the market, government’s economic policies determined in the market by supply and demand conditions.
and central bank’s monetary policies, annual budgets of the The individual firm has to maximize profits at this given price.
government etc. The managerial economist must obtain and They are price-taker firms. On the other hand, when there is
process information with regard to these changes, advise the imperfect competition, the number of sellers is small enough
management regarding their likely effects on the operations so that each firm has some control over its selling price. The
of the firm and suggest possible ways to further the firms in these markets are called price searchers because they
must constantly search out the price that will maximize equal to marginal cost. Therefore, OQ1 is the profit
profits. Though profit maximization can be viewed from maximizing output.
many angles, the marginal approach helps to formulate a rule
which is applicable for both price-takers and price- Increase in production in a firm result in output going beyond
searchers .Profit can be defined as the difference between OQ1.The firm will increase output as long as it does not add
total revenue (TR) and total cost (TC). Profit = TR_TC more additional cost than additional revenue. The generalized
decision-making rule for this firm can be stated as follows.
The output which yields the maximum profits is the ideal to
be achieved. As long as marginal revenue exceeds marginal cost, the firm
should expand its output. The firm should produce that level
of output which equates marginal revenue with marginal
cost.

Marginal revenue is the change in total revenue which comes

from selling an additional unit of output. Marginal cost is the
change in cost which results from producing and additional
unit of output. The profit-maximization rule in simple terms
means that the firm should continue production as long as
incremental cost of production is less than the likely increase
in revenue. Profit maximization rule of equating marginal
cost with marginal revenue to arrive at an equilibrium output
is illustrated as below;

TC and TR represent total cost and total revenue curves

respectively. The gap between the two curves is maximum
(K1K2) at OQ1 output. Here the slopes of the two curves
shown by “tangents” are also equal i.e. marginal revenue is
 1. In the case of owner managed firms it is only natural that
thy should get the adequate and maximum returns
.Maximizing profit, is therefore ,a rational behavior of the
firm.

2. Profit maximization is a necessity in perfect competition

for the survival of the firm. When there are many firms as
under prefect completion, it can survive only if the firm
makes profits. Under monopoly, there are no rivals but the
owner would instinctively wish to purpose maximization for is
efforts.

There is no doubt that in a competitive world, the main

AC and AR are the average cost and average revenue curves measure of business efficiency is the profit made by a firm. In
respectively. MC is the marginal cost and MR is the marginal a dynamic society, profitability is essential for survival of the
revenue. As the firm expands its output in the beginning, business.
there is fall in marginal revenue and a rise in marginal cost. So
long as marginal revenue is higher than marginal cost, and
MANAGERIAL THEORIES OF THE FIRM
additional output raises profit. When the output reaches OM,
marginal revenue equals marginal cost at E and the firm gets The main argument of managerial theories is that in modern
a profit of PQRS (the shaded area).Beyond OM output, since large firms, ownership and control are divorced. Managers,
the MC curve is higher than MR curve ,it shows that the firm therefore, have a primary role in the effective control of the
suffer losses on expansion of output. The maximum profit is firm. The firms then seem to behave so as to maximize
shown by the shaded rectangular area. Thus profits are managerial objectives rather than shareholders’ profits. Like
maximum when MR=MC. the traditional theory of firm it is the profit maximization,
while in the managerial theories it is the function of different
There are some reasons why a firm should adopt the profit combinations of variable like salary, power, status, growth and
maximization goal: job security. Managerial theories are broadly classified into
three categories: vi. Large and increasing sales help the firm in bigger market
share which also gives it a greater competitive power.
a) Sales Revenue Maximization Mode by Baumol.
b) Managerial Utility Models. Assumptions of Baumol’s Sales Maximization Model
c) Growth Maximization Models.
*Sales maximization goal is subject to a minimum profit
(a) Sales Maximization Process Baumol’s Model. constraint. However, Baumol does not give a clear definition
of minimum profit except to propose it represents, “the funds
The Firms Prefer Sales maximization because: to pay some satisfactory rate of dividends, to reinvest for
growth and ensure financial safety.”
i. Financial institutions evaluate the success and strength of
the firm in terms of rate of growth of its sales revenue. *Advertisement costs are independent of production costs.

ii. Empirical evidence shows that the stock earnings and *Advertisement is a major instrument of sales revenue
salaries of the top management are correlated more closely maximization I,e. because advertisement will shift the
with sales than with profits. demand curve to the right.

iii. Increasing sales revenue over a period of time gives *Price of the product is assumed to be given and the firm has
prestige to the top management, but profits are enjoyed only to decide on its output.
by the shareholders.
The sales maximization model is explained with the help of
iv. Growing sales means higher salaries and better perquisites. the following figure:
Hence sales revenue maximization results in a healthy
personnel policy.

v. It is difficult for managers to present spectacular profits

year after year. Hence they prefer a safe and steady
performance with satisfactory profits but good sales.
 MORE ECONOMICS TOPICS

MACRO-ECONOMIC ENVIRONMENT: Consists of the level and

direction of aggregate economic quantities like the aggregate
markets for goods and services, national income, level of
employment, government policies etc.

MICRO-ECONOMIC ANALYSIS: Deals with the behavior of

individual economic units which include consumers, firms,
investors etc. It reveals how firms, industries, and markets
take decision, why do they differ from one another, and how
these economics units are affected by government policies
(b) Managerial Utility Models and international economic condition.

There are two main versions of the cases where managers in NORMATIVE APPROACH: Is prescriptive approach in that it
the modern large corporations are asked to influence the attempts to prescribe what ought to be done.
goals of the firm and not go along wholly pursuing the goals
of the owners. ASPIRATION LEVEL: Demands of the different groups of the
organization-coalition, competing for the given resources of
(c) Growth Maximization Models the firm, take the form of aspiration levels.

Growth of the firm is obviously the cornerstone of corporate EXPENSE PREFERENCE: Certain discretionary expenditures
strategy, Rate of growth and potential of growth are generally that provide satisfaction to managers, like discretionary
used as yardsticks to measure corporate success. Growth of a power of investing in projects, which may enhance his status
firm must be financed either from retained earnings or from and esteem.
market borrowing or both.
FIXED COSTS: That cannot be eliminated in short run.
Marshall, Taussig, Robertson and Bober have defined profits
MANAGERIAL SLACK: The company fund which the manager in a broad sense. Hansen defined profits as ‘the residual
is allowed to spend for his own ends, like entertainment payment, what is left to the producer’s income after all other
expense, staff car, Luxurious office. payments have been met’’. Similarly, Drucker said, “the
surplus of current income over past cost is profit.”
NON-PECUNIARY ASPECTS: Relate to physical inputs, and
other variable (i.e. non-financial variables). DYNAMIC STATE: The economic state where the future is
likely to be different from the present, but this change is
OPTIMAL DECISION: Enables the decision-maker (firm)to unpredictable.
attain its desired objective most closely.
GROSS PROFIT: The difference between receipts and payment
OLIGOPOLISTIC MARKET STRUCTURE: Market with large over a time period.
number of buyers but a small number of sellers; where some
of the sellers dominate the market, Further, action of each INFLATION ACCOUNTING: To judge the impact of changing
firm in oligopoly affects the other sellers in the market, which prices on the profitability and financial health of the firm.
invites reaction from rivals in term of price cuts, changes in
quality, advertising, new product line etc. INNOVATION: All those measures taken by an entrepreneur
which reduce cost or enhance demand (i.e., finding new
SATISFYING BEHAVIOUR: When the goal of the firm is not to products, sale-territories, technology, etc.).
maximize but only to satisfy a goal/ goals. The owners/
shareholders, according to this concept, are satisfied with NET PROFIT: Profit net of implicit cost.
adequate return and growth since they really cannot judge
when profits are maximized. NORMAL PROFIT: The minimum expected return to keep an
entrepreneur in his present business.
PROFITS: Profits may considered a reward for making
innovations ,a reward for accepting risks and uncertainties MONOPOLY PROFIT: Profit that arises due to disequilibrium
and the result of imperfections in the market structure. and imperfection in the market. The term profits is also used
_____Henry Grayson for monopoly profits. An entrepreneur earns monopoly
profits not because he performs any entrepreneurial activity, OPPORTUNITY COST: Represents the benefits or revenue
but because he has a certain degree of monopoly power in forgone by pursuing one course of action rather than another.
the product market. His monopoly profits are in direct
proportion to the extent of his monopoly power. Monopoly MARGINAL PRODUCTIVITY: Output that results from one
profits exist because of disequilibirum and imperfect additional unit of a factor of production(such as a labour hour
competition. They tend to persist because the economy can or a machine hour),all other factors remaining constant,
rarely adjust instantaneously to changes in cost and demand Whereas the marginal cost indicates the added cost incurred
conditions. And so long as the monopoly power exists with in producing an additional unit of output, marginal product
the producer he keeps on earning 'monopoly profits'. indicates the added output accruing to an additional input.
Since marginal product is measured in physical units
RISK: Those unpredictable changes that can be insured produced, it is also called marginal physical product.
against.
PERFECT COMPETITION: A market structure in which (a) the
UNCERTAINTY: Those unpredictable changes that cannot be firms take market price as given ,since an individual firm
insured against. produces only a small fraction of total industry output; (b) the
product of all firms is a interferences with the activities of
WINDFALL PROFITS: Profits due to changes in the general buyers and seller; and (e) there is perfect knowledge and
price level in the market. These profits arise due to changes in mobility.
the general price level in the market. If the producers and
traders buy their inputs and raw materail when prices are low DEFINITIONS OF THE MARKET: A market is a body of persons
and sell their output when, due to some unforseen external in such commercial relations that ach can easily acquaint
factors, the prices have abruptly gone up, then the profits himself with the rates at which certain kinds of exchanges of
resulting there from called 'windfall profits'. it must be noted goods or services are from time to time made by the others.
that these windfall profits just happen to come in the way of
these producers and traders; they never planned their The word market has been generalized so as to mean
business operations for earning them. These come anybody of persons who are in intimate business relations
unexpectedly and cannot therefore be treated as a reward for and carry on extensive transactions in any commodity.
any specific activity of the entrepreneur. __Jevons
Market is any area over which buyers and sellers are in close implies a market structure, where there is a single seller. In
touch with one another, either directly or through dealers, economic theory, monopoly is characterized by sole producer
that the price obtainable in one part of the market affects the selling a distinct product for which there are no close
prices paid in other parts.__ Benham. substitutes and there are strong barriers to entry. This sole
producer (may be known as monopolist) controls the entire
EQUILIBRIUM PRICE: The price at which the quantity supply of the market. Thus, the supply curve of the firm and
demanded by consumers of a product is equal to the quantity the industry will be one and the same.
supplied by sellers of a product.
NORMAL PROFIT: The rate of profit just sufficient under
FREE ENTRY: The absence of barriers to entry into a market. conditions of free entry, to keep firms from leaving a given
In a market characterized by free entry, greater than normal industry in the run.
profit serves the function of drawing new firms into the
industry. PERFECT COMPETION: A market structure in which (a) the
firms take market price as given, since an individual firm
MARKET STRUCTURE: The number and relative sizes of produces only a small fraction of total industry output; (b) the
buyers and sellers in a particulars market, the nature of product of all firms is homogeneous;(c) there is freedom of
product and the degree of ease of entry of firms into the entry into and exit from the industry; (d) there are no
market determine the market structure. For example, in interferences with the activities of buyers and seller; and (e)
perfect competition, large number of buyers and sellers are there is perfect knowledge and mobility. Perfect competition
competing with each other for buying and selling a has an edge over other realistic and complicated market
homogenous good, while free entry and exit is permitted. forms, as it is relatively simple to handle. This kind of idealistic
market structure provides a yardstick or a standard against
MONOPOLY: A market structure characterized by the which other more realistic market forms can be compared,
existence of only one firm in the industry. For a firm to retain evaluated and understood better.
monopoly control there must be complete barriers to entry
into the industry. Monopoly is a market form, which has PRICE TAKERS: Firms that cannot influence the market price.
always attracted the attention of economists. This word has It refers to firms in perfect competitive markets.
come from Greek words, monos(single), polein (selling),
which mean alone to sell. Therefore, in literary terms, it PRICE DISTRIBUTION: Charging different prices for the same
product from consumers in different markets segments states, not companies. also called trust.
(based on the price elasticity of demand in each market
segment). DUOPOLY: A market form in which there are large number of
buyers but only two sellers with mutual interdependence.
PROFT-MAXIMIZING RULE: Produce up to the point where Two firms in the industry · Strong control over price.· Uses
marginal revenue is equal to marginal cost; and at higher Non price competition to compete· Very strong Barriers to
output levels marginal revenue is less than marginal cost. entryNote. a pure dupoly very rarly occurs in real life the
more common is two dominate firms who hold majority of
SHUTDOWN POINT: The point at which the firm must the market share.
consider stopping its production activity because the short
run loss remains the same (that is, equal to total fixed cost) KINKED DEMAND CURVE: A graphical representation of a
whether the firm produces or not. In a perfectly competitive situation wherein rival firms do not follow the price increase
situation this point is found at the lowest point of a firm’s of a firm but follow its price cuts. Such a demand curve is
average variable cost curve. more elastic for prices above the going market price and less
elastic for prices below the going price.
CARTEL: A group of firms that have joined together to make
arrangements on pricing and market strategy. Cartel MONOPOLISTIC COMPETITION: A market structure
agreement is an agreement of companies or sections of characterized by the existence of many firms in the industry,
companies having common interests to form an association or where each seller attempts to differentiate its product from
a cartel. Such agreements are designed by companies to its rivals, so that he has some control over price. Monopolistic
prevent extreme or unfair competition and allocate markets, competition pertains to a market situation where there is a
and to promote the interchange of knowledge resulting from relatively large number of small producers or suppliers selling
scientific and technical research, exchange of patent rights, similar but not identical products. Monopolistic competition
and standardization of products.A group of companies or is a market structure characterized by many firms selling
countries which collectively attempt to affect market prices by products that are similar but not identical, so firms compete
controlling production and marketing. Illegal in the United on other factors besides price. Monopolistic competition is
States and the European Union. Very few major cartels exist; sometimes referred to as imperfect competition, because the
the most prominent example is OPEC, a cartel which can not market structure is between pure monopoly and pure
be considered illegal because it is made up of sovereign competition.
 a price that subsequently determines what other firms in the
OLIGOPOLY: A market structure characterized by the industry will charge for their products (known as followers).
existence of a few dominant firms in an industry (each
recognizing their mutual interdependence) having substantial PRODUCT DIFFERENTIATION: A wide variety of activities,
barriers to entry. An oligopoly is a market dominated by a few such as design changes and advertising that rival firms
large suppliers. The degree of market concentration is very employ to attract customers by distinguishing their product
high (i.e. a large % of the market is taken up by the leading from competitors’ products
firms). Firms within an oligopoly produce branded products
(advertising and marketing is an important feature of
competition within such markets) and there are also barriers
to entry.The term oligopoly is derived from two Greek words: Theory of Competition and Models of
‘oligi’ means few and ‘polein’ means to sell. Oligopoly is a
market structure in which there are only a few sellers (but Markets and Economics Topics:
more than two) of the homogeneous or differentiated
» INTRODUCTION
products. So, oligopoly lies in between monopolistic
» CONCEPT OF MARKET
competition and monopoly.Oligopoly refers to a market
» WHAT IS A FIRM
situation in which there are a few firms selling homogeneous
or differentiated products. Oligopoly is, sometimes, also » TRADE CYCLES - MEANING AND CHARACTERISTICS
known as ‘competition among the few’ as there are few INTRODUCTION TO THEORY OF FIRM
sellers in the market and every seller influences and is
influenced by the behaviour of other firms. important
characteristic of an oligopoly is interdependence between The theory of demand provides an explanation of the
firms. This means that each firm must take into account the consumer’s behavior in order to reduce the demand for a
likely reactions of other firms in the market when making commodity. Similarly, the theory of firm explains the goals
pricing and investment decisions. This creates uncertainty in and objectives of a firm with a view to determine the supply
such markets - which economists seek to model through the of a commodity. The theory of demand (through behavior of
use of game theory. consumer) and the theory of firm (through the behaviour of
firm) together enable us to ascertain the price and output of
PRICE LEADERSHIP: It occurs when a firm in an oligopoly sets a commodity or service by the free interplay of the forces of
demand and supply in the market in the absence of market bids and offers, using bargaining and haggling. The term
intervention. The nature of the demand curve and the price- ‘potential’ here implies that if the prevailing price of the
output business decisions depend upon the type of the commodity happens to be higher or lower than the one at
market in which the commodity is produced and sold. The which some transactors plan to deal, those buyers or sellers
market type along with its size, the behavior of markets and in the two cases respectively are eliminated from the market.
transactors therein help in making the analytical evaluation of Thus, market determines who buyers and sellers are, what
operational efficiency of business firms. The behavior of the the price will be and what quantities will be brought and
transactors is read in terms of the ‘market strategy and sold. Market is actually the essence of business. All business
tactics’ chosen by them in a given market environment so as decisions relating to price , output, product style,
to survive and grow their market share. There is a good deal advertisement ,investment, etc. are taken in the light of
of market dependence. The market behaviour of one may actual as well as potential competition by new entrants.`
condition that of other. Non-market environment also affects
market behaviour, through Government regulation, NATURE OF COMPETITION
consumer’s forum, traders’ guild, manufacture’ association,
etc. Competition has different meanings. The term always
denotes the presence in a specific market of two or more
seller and two or more buyers of a definite commodity, each
CONCEPT OF MARKET seller acting independently of every other seller and each
buyer independently of every other
buyer. Competition implies freedom in economic life. It has
In common parlance, the term ‘markets ‘means a particular been considered as a healthy sign in consumption,
place or locality, where goods are bought and sold. We often production, distribution and exchange . The presence and the
speak of the Mumbai market, the New York market, the Rani pressure of competitive market forces in the modern business
Bagh market and so on. In economics, however, this term is units force the producers to produce as efficiency as possible.
used in a broader sense. If reefers to a complex set of Those who are inefficient and not able to cover up their
activities by which actual and potential buyers as well as minimum cost of production will automatically leave the
sellers with each other and the price as well as the output are market. The more perfect the competition, the more perfect
determined. In the process of determining the terms at which the market will be.
the exchange would take place, they may make all sorts of
PERFECT COMPETITION • Perfect Mobility of Factors of Production.
• Perfect Knowledge.
• Absence of Transportation and Selling Costs.
In economic theory, perfect competition has a meaning
diametrically opposite to the everyday use of this term as PURE COMPETITION VERSUS PERFECT COMPETETION
synonymous to rivalry. The perfect competition means
complete freedom in economic life and absence of rivalry
among firms. It prevails, when all the conditions given here Some economists, notably E.H. Chamberlin and F.H. Knight
are simultaneously present in the market. However, most of make distinction between pure competition and perfect
these stringent conditions are unlikely to be present in the competition. According to Chamberlin, “Pure competition is
real world. The real world consists of various imperfections unallowed by monopolyelments.it is much simpler and less
and monopolistic tendencies. The market is rarely perfect in exclusive concept than perfect competition for the letter may
the actual sense. This suggests that perfect competition is a be interpreted to involve perfect in many other respects than
purely theoretical market from, which is never observed in in the absence of monopoly e.g. perfect mobility or perfect
reality. However, the stock market is close approximation knowledge or such other perfection as the particulars theorist
of perfect competition. Here, any particular stock is finds convenient or useful to him.”
homogenous, there is no information cost (information is
readily available through published prices), free entry and exit Usually, the term pure competition and perfect
conditions for the transactors having insignificant control on competition and perfect competition are used
price. interchangeably, since in both the cases sellers as well as
buyers are price takers with no control over the prevailing
The following features serve as a necessary set of market price, Further, the demand and supply curves of the
assumptions or conditions underlying the model of perfect firms as well as industry are similar in either situations.
competition.
MONOPOLY

• Large Number of Sellers and Buyers.

• Homogenous Product. Monopoly is a market from, which has always attracted the
• Free Entry and Exit. attention of economists. This word has come from the Greek
• Absence of Government Regulation. words, monos (single), polein (selling), which mean alone to
sell, Therefore, in literary terms, it implies a market structure, ORIGIN OF MONOPOLY (Kinds Of Monopoly)
where there is a single seller. In economic
theory, monopoly is characterized by sole producer selling a
The origin of monopoly may be legal or technological or both.
district products for which there are no close substitutes and
A firm can continue to enjoy the monopoly power, or
there are strong barriers to entry. This sole producer (may be
competitive advantage, so long as, it can prevent the entry of
known as monopolist) controls the entire supply of the
other firms into the industry. The moment other firms are
market. Thus, the supply curve of the firm and the industry
able to enter into the industry, the position changes radically
will be one and the same. Under these circumstances, the
and the erstwhile monopoly loses its monopoly power
monopolist will tend to have complete control over the price
leading to a change in the market from affecting check over
of the product sold by him. That is why monopolist is a price
pricing strategies. Following factors are responsible for
maker rather than a price taker and he need not fear the
creating conditions for the emergence and growth
actions and reactions of rivals, at last in the near future. In
of monopoly
other words, the monopolist operates unfettered by the
competition of rivals. The level up to which the monopolist
• Control over Strategic Raw Material: Ownership and
can raise the price, depends upon the elasticity of demand,
control of entire or most of the supply of basic input and
while cost condition determine the level, down to which the
strategic raw materials or exclusive knowledge of production
monopolist can lower the price.
and distribution techniques by a single firm lead
to monopoly conditions.
Pure monopoly implies complete absence of competition
both in short-run as well as long-run, while under perfect
• Small size of market: Sometimes, the size of the market or
competition, the competition is complete. In the actual
technology is such that output of only one firm of optimum
world, there is neither pure monopoly nor perfect
size is sufficient to meet the demand of the entire market
competition. Between these two extreme opposite limiting
comfortably. Under these circumstances, all the firms except
cases, lie various real intermediate market situations like
the largest and the most efficient.
monopolistic competition, oligopoly, (increasing order of
degree of monopoly and hence imperfections).These market
• Patents, Copy Rights and Licenses: Legal backing provided
forms differ from each other in respect of degree of
by the Government to produce a particular product through
imperfections.
granting of patents ,copy rights, trade marks, licenses, and
quota for a given period may create and MONOPOLISTIC COMPETITION
perpetuate monopoly.

Monopolistic competition refers to a market structure in

• Limit pricing: Sometimes, the existing firm adopts a limit
which there are many sellers selling similar but differentiated
price policy combined with other policies such as heavy
products and there is existence of free entry and free exit of
advertising or continuous product differentiation to prevent
firms. In other words, it is a situation, where there is a keen,
entry by potential firms.
but, not perfect competition among sellers producing close,
but not perfect substitutes. Consumer goods like tooth
• Public Utilities: The Government generally undertakes the
pastes, brushes, bathing soaps, detergents, textiles, television
production of the product or of the essential services like
sets, refrigerators, automobiles, etc. fall under the category of
transportation, electricity, water, communication etc. to avoid
monopolistic competition in the Indian market. Here, each
the exploitation of the consumers. We often
firm is a monopolist of its own differentiated product. But,
find monopoly tendencies in these services on account of
the products supplied by the firms are close substitutes of
economics of large scale.
each other. Hence, Price and output decisions of a firm
depend upon the policies of the rivals only to some extent.
• Monopolistic Combinations: Monopoly may be the result
of combinations. It is possible for a number of competing FEATURES OF MONOPOLISTIC COMPETITION
firms in an industry to come to a voluntary agreement among
themselves to eliminate competition in the matter of price,
A firm under monopolistic competition faces competition
output and market share.
from rival firms producing similar products(close substitutes).
At the same time, unlike a perfectly competitive firm, it has
• Fiscal Monopoly: There are certain monopolies, created by
some influence over the price of the product. That is why, it
the Government itself. Printing of currency notes and stamps,
has downward sloping average revenue and marginal revenue
minting of coins, etc. are some examples. The nature of these
curves. The greater is the difference between average
services is that they cannot be entrusted to private
revenue (price) and marginal revenue, the greater is the
enterprises.
degree of imperfection and vice-versa. The main features
of monopolistic competition are:
• Many Sellers: The numbers of firms under monopolistic competition .This highly simplifying
under monopolistic competition are fairly large, though, it is assumption will mean similar effects on the demand and cost
not as large as found under perfect competition. Each firm conditions of the firms on account of changes in the quality of
shall be a small size firm controlling only a small part of the their products and/or selling costs.
total market.
• Free Entry and Exit: Under monopolistic competition, there
• Product Differentiation: product differentiation is one of is freedom of entry and exit of the firms in the long run. New
the most distinguishing features of monopolistic competition. firms enter the group .When the existing firms earn super
According to Chamberlin, it is the basic characteristic of normal profits by differentiating their products, This will
monopolistic competition. H defines product differentiation result in a decrease in the demand of existing products at
as follows, “A general class of product is differentiated, if any least to some extent and/or an increase in the cost.
significant basis exists for distinguishing the goal (or
services)of one seller from those of another. Product • Other characteristics: Other characteristics
differentiation may involve qualitative material or of monopolistic competition are actually the basic
workmanship differences in the products. assumptions of chamberlin’s large group model. These
assumptions are mostly same as those of pure competition
• Sales promotion or Selling Cost: Advertising and other except that of homogeneous product (which is replaced by
selling expenses have an important role the assumption of product differentiation).
under monopolistic competition on account of imperfect
knowledge on the part of buyers. Advertising broadens the (i) The goal of the firm is profit maximization both in the
market and encourages competition. Salesman salaries, other short-run as in the long-run.
expenses of sales department, window displays and different (ii) The price of factor inputs and technology are given.
types of demonstrations are some examples of selling (iii) The firm is assumed to behave as if it possessed
expenses. Advertisement may, however, be broadly classified information regarding the demand and cost curves with
as promotional advertisement and competitive certainty.
advertisement. (iv) The long-run is assumed to consist of identical short-run
periods, independent of on another, so that decisions in one
• Identical Demand and Cost Curves: Demand and cost period neither affect future periods nor are affected by past
curves are assumed to be identical actions.
OLIGOPOLY growth in the market. Thus, each firm acts as a strategic
competitor.

Apart from the case of large number of small firms producing

• Mutual Interdependence: As the number of firms is small,
differentiated products, we also often find a small number of
each (sizeable) firm has to to its price, or promotion. This will
big firms, whose products may or may not be differentiated.
enable the firm to know how the buyers of its influence the
Such situation leads to another market from, termed
price, output and profits of other firms in the market. On the
as oligopoly. This term is derived from two Greek words,
other hand, it cannot fail to take into account the reactions of
‘oligi’, which means a few and ‘polien’ which means ‘to
other firms to its price and output policy. Therefore, there is a
sell.’ Oligopoly is defined as the market structure in which
good deal of interdependence of the firm under oligopoly.
there are a few and ‘polien’ which means ‘to sell’. Oligopoly is
Successful decision making depends on the prediction of the
defined as the market structure in which there are a few
reactions of the rival firms be as unpredictable as possible to
sellers of the homogeneous or differentiated products, who
rivals. Since more than one reaction-pattern is possible from
intensively complete against each other and recognize
other firms, we must make assumption about the reaction of
interdependence in their decision making. Actual number of
others before providing certain and determinate solution of
sellers under oligopoly depends on the size of the market. If
price-output fixation under oligopoly.
there are only two sellers, it’s called duopoly.

FEATURES OF OLIGOPOLY • Entry of Firms: On the basis of ease of entry of competitors

in the market, oligopoly may be classified as open or closed.
Under open oligopoly, new firms are free to enter the
Some special characteristics are found under oligopoly, which
market. On the other hand, closed oligopoly is dominated by
distinguish it from other market forms. Main features of
a few large firms with blockaded entry of new firms.
oligopolistic market are:
• Leadership: On the basis of presence of price leadership,
• Few Dominant Firms : Under oligopoly, Few large sellers
the oligopoly situation may be classified as partial or full
dominate the market for a product. Each seller has sizeable
.Partial oligopoly refers to the market situation, where one
influence on the market, Every firm possesses a large number
large firm (called price leader) dominate the market and the
of market’s total demand .It uses all resources at its disposal
other firms (called followers) look to the price leader with
to counter the actions of rival firms to ensure its survival and
regard to the policy of price fixations. Full oligopoly, on the
contrary, exists, where no firm is dominant enough to take independent unit producing goods and services for sale.
the role of a price leadership is a conspicuous by its absence. According to prof .Watson,” A firm is a unit engaged in
production for a sale at a profit and with the objective of
• Agreement: Oligopoly may be classified into collusive and maximizing the profit’. A firm is also taken as an income
non-collusive oligopoly on the basis of agreement or producing unit having some particular characteristics.
understanding among the firms. Collusive oligopoly refers to
a market situation, where the firms, instead of competing Equilibrium of a Firm: By equilibrium, we mean a point of
with each other, combine together and follow a common rest. It is also called of no change .Whenever a firm attains a
price and follow a common price policy. The collusion may be stage from which it does not want to move forward or
open or tacit (secret). On the other hand, non- backward, it is said to be in equilibrium. So we can say that
collusive oligopoly implies absence of any agreement or a firm is in equilibrium when it has no firm will be in
understanding. equilibrium when it is of no advantage to increase or
decrease its output,’ Thus we conclude that a firm is in
• Coordination: An oligopoly situation may be classified into equilibrium when it is earning maximum profits or minimizing
organized and syndicated oligopoly on the basis of the degree losses.
of coordination found among the firms. Under
organized oligopoly, the firms organize themselves into a Assumptions of Equilibrium of a Firm: The concept of
central association for fixing price, output, quota, etc. On the equilibrium of a firm rests on the following assumptions.
contrary, syndicated or unorganized oligopoly refers to a
situation, where the firms sell their products through the • Rational firm: Rational firm always aims at earning
centralized syndicate. maximum profits. In case of losses in the short-run, it earns
only minimum losses. The concept of firm’s equilibrium
applies only to a rational firm.
WHAT IS A FIRM
• Production of one Commodity: It is assumed that
a firm produces only a single commodity. Cost of a factor of
Generally a firm is taken as a production unit producing an production is also taken as constant and fixed. In other words,
output. It considers the market conditions and aims at a firm can get the required and desired units of a factor at the
producing the desired output at the least cost. A firm is an given price.
 between total revenue (TR) and total cost (TC) is maximum.
• Estimation of Marginal Revenue and marginal Cost: Only in such a position, he does not want any change. We can
Another assumption of firm’s equilibrium is that it can easily find the equilibrium of a firm with the help of this approach
estimate its marginal revenue and marginal costs. Thus total both under perfect and imperfect market conditions.
revenue and total costs can also be calculated by a firm.
EQUILIBRIUM OF THE FIRM UNDER PERFECT COMPETITION
Conditions for Equilibrium: It is already clear that a firm is in
equilibrium only when it earns maximum profit or has Perfect competition is a market in which there is a large
minimum losses. This condition for equilibrium applies to all number of buyers and sellers. They are selling homogenous
types of markets i.e., under perfect competition, in monopoly goods .There is also free entry and exit of the firms. A firm is a
and under monopolistic competition. Therefore, we can say small portion of the whole industry. Price is fixed by the
that a firm will be willing to stick to its present position only if industry. Firm is only a price-taker. It cannot affect price. In
it earns maximum profits, whatever the form of market may other words, a firm can sell as much as it desires only at the
be. There are two methods for determination of a firm. They given price. That is why the total revenue curve of a firm is an
are: upward sloping line drawn at an angle. The shape of the TR
curve tells that the total revenue of the firm is increasing with
• Total Revenue and Total Cost Approach the increase I production at the same rate. It is generally
• Marginal Revenue and Marginal Cost Approach assumed that the total cost of production continue to rise as
output is increased. The rate of increase falls at first and then
TOTAL REVENUE AND TOTAL COST APPROACH starts rising. The following diagram shows the application of
total revenue & total cost approach for finding out the profit
Total Revenue and Total Cost Approach is the simplest way to maximizing output.
determine the equilibrium of a firm. In order to calculate the
profit of a firm, we find out the difference between the total
revenue and total cost at different levels of output. A firm is
said to be in equilibrium when the difference between total
revenue and total cost is maximum, Every rational producer
will try to maximize his profits. For this purpose, he will
increase his production up to the point where the difference
EQUILIBRIUM OF A FIRM UNDER IMPERFECT COMPETITION

Profit Maximization Case: Under imperfect competition,

Minimization of Loss Case: A firm can undergo losses also in
a firm has control over the price of a commodity. It is,
the short run. In this case, a firm will be in equilibrium when
therefore, a price-maker and not a price-taker. Under
its losses are minimum. For this purpose also we find the
imperfect competition a firm can sell larger output only at a
vertical distance between TR and the TC curves. A firm is said
falling price. Therefore, the total revenue curve continuous to
to be in equilibrium when the distance between the TR and
rise from left upwards to the right. But the rate of rise
TC curves is minimum. This can be shown as below:
continues to fall as output sold increases. The total cost curve
also rises with increasing output. Profit is the vertical distance
between the TR and TC. The firm chooses that level of output
where the vertical distance between TR and TC is the
maximum. This output is shown as below:
 revenue and total costs approach.

THE MARGINAL REVENUE AND MARGINAL COST APPROACH

Marginal revenue and marginal cost approach is another

method to know the equilibrium of a firm. This approach is
advocated by modern economists like Mrs. Joan Robinson.
Marginal revenue is the addition made to the total revenue
by the sale of one more unit of the output. Marginal cost is
the addition made to the total cost by producing an
additional unit of the output. In order to know the
equilibrium level of output, a firm compares its marginal
revenue and marginal cost. It will be profitable for a firm to
Defects of the TR-TC Approach:
increase its production when marginal revenue exceeds
marginal cost. Similarly, if marginal revenue is less that the
Through the total revenue and total cost approach is the
marginal cost of output, a rational firm will reduce its output.
simplest approach, yet it suffers from some defects. Its main
By reducing output, a firm can minimize its losses. In this way,
shortcomings are as under :
a firm will be in equilibrium only when its marginal revenue
equals marginal cost.
• It is very difficult to find the maximum vertical distance
between total revenue and total cost curves.
EQUILIBRIUM OF A FIRM UNDER PERFECT COMPETITION

• This approach is based on the total costs and total revenue.

Perfect competition is characterized by the presence of large
It ignores the per unit cost of an output.
number of buyers and sellers. Firms sell identical
goods. Firm has not control over the price. Firm is a price-
• It becomes difficult to find out the equilibrium of an
taker. It can sell as much as it wants only at the given price. In
industry with the help of this approach.
this way, firms can sell varying amounts of output at the fixed
Due to these defects, modern economists have used marginal
and given price .Due to this reason, average revenue (AR) and
revenue and marginal cost approach in place of the total
marginal revenue (MR) are the same. And AR=MR is a
horizontal straight line. It is generally assumed that marginal
cost falls at first and then starts rising. In below figure the Under imperfect competition, AR and MR of a firm are two
price given to the firm P. MC is the marginal cost curve. Point different things. This is because under imperfect competition,
K1 is the breakeven point because at this point MC curve cuts a firm is a price-maker. It can sell more by lowering the price
MR curve from above. This is not a point of firm’s equilibrium of its output. That is why AR and MR curves of a firm fall
because it satisfies only the first of the two conditions of downward from left to right. White MC and AC rise from left
equilibrium. The profit-maximizing output is OM because at to right. The conditions of equilibrium of a firm are the same
this output MR is equal to MC and MC curve cuts MR from as apply under perfect competition, In other words,
below. Thus we can conclude that a firm is in equilibrium only a firm will be in equilibrium if it’s MR is equal to MC and MC
if it satisfies two conditions. These are: cuts MR from below:

(i) MR=MC
(ii) MC rises to intersect the horizontal MR line.

The superiority of the marginal approach shown in the

diagram given above is that we can read all the three things
directly from the diagram in which a firm is interested. The
EQUILIBRUIM OF A FIRM UNDR IMPERFECT COMPETITION three things are:
 TRADE CYCLES - MEANING AND CHARACTERISTICS
(i) Equilibrium output = OM
(ii) Equilibrium Price = PM
Trade cycles or business cycles are a prominent feature of the
(iii) Total Profit = Area PCNK
capitalist economies. Business cycles refer to the regular
EQUILIBRIUM CONDITION OF THE INDUSTRY fluctuations in economic activity in the economy activity in
the economy as a whole. The expansions, recessions,
contractions and revivals of aggregate economic activity occur
Industry is a group of firms producing homogenous goods.
and recur in an unchanged sequence .In Keynes’ words,
The concept of the industry is very important under perfect
“A business cycle is composed of periods of good trade
competition because in this market form, is fixed by the
characterized by rising prices and low unemployment
industry. Firm is only a price-taker.
percentages alternating with periods of bad trade
characterized by falling prices and high unemployment
An industry is said to be in equilibrium when it has no
percentages”. Thus, a market feature of a business cycle is the
tendency either to expand or contract its output over the long
boom being followed by a depression, recovery and again
run.
boom conditions in a free- enterprise economy which is
industrialized.
An industry likes to stick to a level of output only when the
demand for and supply of output produced by the industry
Trade cycles have the following characteristics:
are equal. If on a particular price level, demand is more than
the supply of output, it will be profitable for the industry to
• One a business cycle is an economy-wide phenomenon.
increase production.
When depression sets in the industrial sector, it cannot be
restricted there. Soon it spreads to agriculture, trade and
Similarly if demand is less than its supply, industry will reduce
transport sectors; so is the case during boom.
its output. Thus an industry is in equilibrium only when the
demand for and supply of its production are equal to each
• Two, a business cycle shows a wave-like variation in
other at a particular price.
economic activity. The expression or prosperity is followed by
a depression and so on. The economy moves from one
extreme to another almost like a pendulum.
 consumer goods output. Later on the capital goods output
• Three, business fluctuations tend to recur. Thy come again also picks up.
and again after the lapse of some time. The time or
periodicity is not always the same. Nor are the causes always • The employment criterion is to study the volume of
the same. Some trade cycles may last only two or three years employment in the industrial sector. The onset of a recession
while others may be six to eight years in duration. is indicated by an unusual lay-off of workers in the major
industries. The open unemployment percentage as measured
• Four, trade cycles are self-reinforcing or cumulative. Once by the proportion of unemployed to the whole labour force
the cyclical movement starts in one direction, it tends to feed goes up significantly. The start of recovery is clear when more
on itself. The force of the economic crises tends to increase. and more jobs are made available by the manufacturing
Once the prosperity phase starts, it tends to run out of firms.
control of the policy makers.
• The price-level criterion judges the different phases on the
Economists have suggested the following for main criteria for basis of the general price level. Prosperity is generally
making the different stages or phases of a trade cycle. associated with rising prices and depression with falling
prices. The general price index, both when it rises and falls
• The consumption criterion is that with the onset of a markedly, shows cyclical changes.
depression, there is a sudden and significant fall in the real
consumption of the people in general and the working class in PHASES (OR STAGES) OF A TRADE CYCLE
particular. Likewise, the recovery phase shows a definite rise
in the per capita real consumption of the people. A business cycle is short-term picture of the behaviour of real
output in a private enterprise economy. Industrialized
• The production criterion is to watch the volume and economies having free-market mechanism have economic
composition of production of production in the economy. growth over the long period. But the process of economic
During depression, the capital goods industries show a growth is often shaken by business cycles which show up-
significant fall in production first and other industries are turn and down-turn of income, output and employment.
affected later. The construction industry shows a market A business cycle can be shown to be a wave-like path of the
downward trend. Similarly in the case of recovery, the economy’s real output as shown in figure. Economists often
demand for consumer goods goes up to encourage the describe a business cycle with the help of distinct phases or
stages. The four phases of a business cycle are: (i) slump, (ii) (ii) Recovery: Recovery shows the upturn of the output and
recovery, (iii) boom and (iv) deflation. employment of the economy from the state of depression.
Recovery is most probably the result of the fresh demand for
plant and equipment arising from the consumer goods
industries which had been postponing this investment during
depression. The capital goods have a limited life. They wear
out completely after some time and need replacement. This
replacement demand starts the recovery process .Although
prices remain more or less stable, wages and other incomes
show a noticeable rise.

(iii) Boom or Prosperity: During the recovery phase, rise in

output and incomes of the people induces substantial
increase in aggregate spending. This has a multiplier effect. As
effective demand increases, income rises faster than before.
The whole process becomes self-reinforcing. The cumulative
We can describe the four phases of a typical trade cycle as
process of rising investment and employment forges ahead.
follows:
As investors become more confident, expanding productive
activity takes the economy to a boom or prosperity phase.
(i) Slump or Depression: This is the most critical and fearful
According to Haberler, Prosperity is “A state of affairs in which
stage of a trade cycle. Harberler has described depression as
the real income consumed, real income produced and the
“ a state of affairs in which real income consumed or volume
level of employment are high or rising, and there are no idle
of production per head and the rate of employment are
resources or unemployed workers or very few of either.”
falling and are sub- normal in the sense that there are idle
resources and unused capacity, especially unused labour.”
(iv) Recession: The end of prosperity phase comes because of
Depression or slump leads to redistribution of the national
certain tendencies in the private- enterprise economy
income. Profits and wages fall faster relatively to rent and
prevalent during the boom conditions.
other fixed incomes of shareholders go down fast.

Firstly, as price rise, wages tend to lag behind .As a result,

 purchasing power of workers, who form a majority of the (iv)Externalities, (v)Public goods, (vi)Market
people, tends to lag behind the supply of consumer goods. intervation
 5. What are the features of perfect competition?
Secondly, expansion of production is hampered by shortages Do you agree with the view that it is a myth? If it is so,
of some inputs and bottlenecks in production. then why do economists use it or explaining the
behaviour of firms?
Thirdly, excessive demand for labour and material pushes up
 6. Distinguish between pure and perfect
competition.
both the factor and the product prices but in a
 7. How does monopoly arise? What are its
disproportionate fashion.
distinguishing characteristics?
 8. What is monopolistic comptetion? View its
Fourthly, the non-availability of credit beyond a particular rate examples and salient features. Why is it impossible or
of expansion might also act as a serious break on prosperity. deficient to define the "industry" in this case?
Situation where the business cycle takes a downward turn  9. Explain the features of Oligopoly. How is it
from the state of boom. Output, Profits and employment start different from monopoly. What are various types
falling gradually. Business psychology is pessimistic. of oligolpoly markets.
 10. What is a firm? So how a firm maximizes its
Review Questions profit under perfect comptetion?
 1. Explain the concept of market. What Macro Economic Theory Topics:
characteristics (elements) have to be considered while
» INTRODUCTION OF MACROECONOMICS
identifying a market form.
 2. Distinguish between perfect and imperfect » NATURE OF MACROECONOMICS
competition. » IMPORTANCE OF MACROECONOMICS
 3. Discuss the various criteria for classifiying » NATIONAL INCOME
the markets. Explain different market forms on the
basis of various aspects of the market strucuture in the INTRODUCTION OF MACROECONOMICS
form of a table or a chart. What is the operational use of
price and quantity cross elasticity of demand?
Recall that managerial macroeconomics is constituted of
 4. Write short notes on (i)Elements of market
theory of demand and supply, theory of production and cost
strucutre, (ii)Market mecanism, (iii)Market fialure,
conditions, market structure and level of competition ,pricing
principles and practices ,capital budgeting and investment
decisions. The micro level managerial decisions are made Macroeconomics seeks to answer the following types of
generally with a short-run perspective assuming that the question:
general economic condition and business environment of the
country would continue to remain the same and the charges, • Which factors and forces determine the GDP and GNP of a
if any, would not be of much significance from business point country?
of view. Macroeconomics examines the economy as a whole
to explain broad aggregates and their interactions "top • How are GDP and GNP determined and which factors
down," that is, using a simplified form of general –equilibrium determine growth and depression in the economy?
theory. Such aggregates include national income and output,
the unemployment rate and price inflation and sub • How is the aggregate employment determined and what
aggregates like total consumption and investment spending causes unemployment?
and their components. It also studies effects of monetary
policy and fiscal policy. • What causes inflation and deflation in a country and how do
they affect the economy?
WHAT IS MACROECONOMICS
• How do government policies-monetary and fiscal-affect the
It is the study of economy as a whole. The study of the economy and as well as business activities?
economy as a whole is carried out by analyzing the behaviour
of and interaction between macroeconomics variables
including national output (GDP and GNP), aggregate NATURE OF MACROECONOMICS
employment, the general price level, aggregate consumption,
saving and investment, price level and economics transactions
with the rest of the world. Precisely, macroeconomics studies The nature of a subject is determined on the basis of whether
the relationship and interaction between a science has a purely positive (theoretical) or normative
the macroeconomic variables and other internal and external (policy) orientation or both. A positive science has only
‘factors or forces’ that determine the level and growth of theoretical orientation whereas a science having normative
national output and employment, the general price level and orientation aims at setting norms for finding solution to
the balance of payments position of an economy. practical problems and provides policy
guidelines Macroeconomics has both positive (theoretical) will always be in equilibrium in the long-run.
and policy orientations.
THE KEYNESIAN REVOLUTION: The collapse of the classical
economics necessitated a fresh look at the working of the
IMPORTANCE OF MACROECONOMICS economic system and devising corrective measures and
safeguards against the failure of the market economy, it was
in this background that Keynes published his General Theory
Lies in providing a theoretical framework for finding solutions which laid the foundation of macroeconomics.
to three major macroeconomic problems confronting most
countries of the world, viz.,(i) problems of economic growth , THE POST-KEYNESIAN DEVELOPMENTS: Until the 1970s, the
(ii) unemployment and (iii) inflation. Keynesian thoughts and policies had global appeal and
application. However, Keynesian economics started showing
As regards the problems of economic growth, both developed signs of failures during the 1970s. This raised the doubt about
and underdeveloped countries have been striving, especially the relevance and applicability of Keynesian economics.
after the Second World War, to achieve and maintain a high Consequently, several other schools
growth rate. While industrially advanced nations have of macroeconomic thoughts emerged, viz., Monetarism,
succeeded in achieving a high growth rate during the post- supply-side macroeconomics, New
war II period, most of them, excepting japan, are still striving Classical macroeconomics and New Keynesianism.
to achieve a reasonably high growth of the economy and to
sustain it over a long period of time. NEW CLASSICAL MACROECONOMICS: During the 1980s, the
Keynesian view was attacked by another group of economists,
PRE-KEYNESIAN ERA: The pre- Keynesian era refers to the called radicalists led by Robert E. Lucus, the Nobel Laureate of
period of economic thoughts of classical and pre-classical 1995, their views known as new classical macroeconomics.
economists. Their macroeconomic thought were in the forms
of certain ‘postulates’ which can be summarized .If market SUPPLY-SIDE ECONOMICS: Another school
forces of demand and supply are allowed to have free play, of macroeconomics that emerged meanwhile is called
i.e., the laissez-faire system, then (i)there will always be full “Supply-Side Economics”. While Keynesians and monetarists
employment in the long –run,(ii) there will be neither have both built their arguments for ‘what determines the
overproduction nor under-production and (iii) the economy aggregate demand ’on the basis of the factors operating on
the demand side of the market,” supply-side economists’,” led productive system in the hands of the ultimate consumers.
by Arthur Laffer, emphasized the role of the factors operating
on the supply-side of the market. JM.Keynes, a famous economist defined National Income as -
”National Income is the money value of all goods and
NATIONAL INCOME
services produced in the country during a year.”

Methods of Measuring National Income

Is the final outcome of all economic activities of a nation
valued in terms of money. National income is the most
important macroeconomic variable and determinant of the PRODUCT METHOD
business level and economic status of a country. National
income is the money value of all final goods and services >> The total value of the final goods and services produced in
produced in a country during a period of one year. National a country during a year is calculated at market price.
income is the money value of all the final goods and services
produced by a country during a period of one year. National >> All productive activities such as agricultural products,
income consists of a collection of different types of goods and commodities produced at industries, etc are collected and
services of different types. assessed at market price.

In common terms, National Income means the total value of >> Only final goods and services are included and the
goods and services produced annually in a country. intermediary goods and services are left.

In other words, National Income is the total amount of >> Money sent by Indian citizens working aboard are also
income accruing to a country from economic activities in a added.
year‘s time.
GROSS NATIONAL INCOME = Money Value of total goods and
National Income helps us to know the economic progress services + Income from abroad
achieved and to make comparative study.
INCOME METHOD
Simon Kuznets defines it as ―The net output of commodities
and services flowing during the year from the country‘s >> The net income payments received by all citizens of a
country in a particular year are added up. CONCEPTS OF NATIONAL INCOME

>> Income details are obtained from Income Tax Dept. (High GROSS DOMESTIC PRODUCT (GDP)
Income) and Wages Bills. (Workers) GROSS NATIONAL PRODCUT (GNP)
NATIONAL DOMESTIC PRODUCT (NDP)
>> Income by way of net wages, net rents, net interest, net NET NATIONAL PRODUCT (NNP)
profits are added together but incomes received in form of PERSONAL INCOME
transfer payments are exempted. PER CAPITA INCOME
PERSONAL DISPOSABLE INCOME
GROSS NATIONAL INCOME = Rent + Wages + Interest + Profit
+ Income from abroad LIMITATIONS IN MEASURING NATIONAL INCOME

EXPENDITURE METHOD o Non availability of reliable statistics

o Service of Housewives
The total expenditure incurred by the society in a particular o Owner-occupied Houses
year is added together. This includes personal consumption o Self Employed persons
expenditure, net domestic investment, government o Goods meant for self-consumption
expenditure on goods and services, net foreign investment. o Illegal Activites
o Wages and Salaries paid in Kind
GROSS NATIONAL INCOME = Individual Expenditure + o Intermediate and Final Goods
Government Expenditure o Second-hand Goods and Assets
o Price Changes
VALUE ADDED METHOD o Transfer Payments etc..
>> The difference between the value of material outputs and
inputs at each stage of production is the value added. Review Questions
 1. What is macroeconomics? How is it different
>> All such difference are added up for all industries in the from microeconomics? What are the uses and
economy, to arrive at the GDP limitations of macroeconomics?
 2. Is macroeconomics a positive science or a
normative science? Expalin in this regard the
importance of macroeconomics.
 3. What is the scope of macroeconomics? How is
it different from the scope of microeconomics?
 4. What are the major macroeconomics issues
confronting the economies of the worlds? How do you
think macroeconomics can help in solving related
problems?
 5. What is the relevance of national
income statistics in business decisions? What kinds of
business decisions are influenced by the change
in national income?
 6. Describe the various methods of
measuring national income. How is a method chosen
for measuring national income?
 7. Disntinguish between net product method and
factor income method. Which of these methods is
followed in India?
 8. Does the method of measuring national
income of a 'closed economy' differe from one followed
in an 'open economy'? How is foreign income treated
in national income estimates?
 9. What is meant by economy growth? How is
economic growth is measured?
 10. What can be the possible use of growth
theories in business decisions.