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ACADEMIC YEAR: 2016 – 2017


Question & Answers

Syllabus: [Regulation: 2012]

UNIT–I Introduction: Nature and scope of magerial economics-basic
economic problem-macro and micro economic-objectives of the firm.


1. Define Managerial Economics. (Nov/Dec 2011)

Managerial economics deals with integration of economic theory with
business practice for the purpose of facilitating decision making and forward
planning by management.
2. What is a Firm?
c o
The firm defined as an independently administrated business unit.
3. Define the term Economics. (Nov/Dec 2013)
The branch of knowledge concerned with the production, consumption, and
transfer of wealth.
y n
dcovered by macro-economic?(Nov 2014)
u covered area such as unemployment, national income,
4. What are the areas
The macroeconomic
rate of growth, gross domestic product, inflation and price level.

5. Define Macro Economics.

The field of economics that studies the behavior of the aggregate economy.
Macroeconomics examines economy-wide phenomena such as changes in
unemployment, national income, rate of growth, gross domestic product,
inflation and price level.

6. Define an optimum firm.( Nov 2012)

Optimum firm refers to the size of a business more specifically the amount
of growth for a small business.
7. What you mean by Micro economics? (April 2011)

Unit – 1 Answer Page 1 of 14

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The branch of economics that analyzes the market behavior of individual

consumers and firms in an attempt to understand the decision-making
process of firms and households.

8. What are the objectives of business firms? ( Nov 2010)

The basic objectives of the business firms are Profit satisfaction, sales
maximization, Growth maximization, social environmental concerns, co-

9. Point out important concepts of Economics.

a) Choice
b) Opportunity cost
c) Interest rate
d) Demand
e) Supply and Market
f) Competition and Price
c o
10. List out the objectives of the firm.
 Profitability
 Productivity a
 Customer service
 Employee retention
 Marketing
 Gain the good will from the customers.


1. What are the reasons for economic problem? (Nov/Dec 2011)

Unit – 1 Answer Page 2 of 14

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1. What goods are produced and in what quantities by the productive resources
which the economy possesses?

2. How are the different goods produced? That is, what production methods are
employed for the production of various goods and services?

3. How is the total output of goods and services of a society distributed among its

4. Are the use of productive resources economically efficient?

5. Whether all available productive resources of a society are being fully utilized,
or are some of them lying unemployed and unutilized?

6. Is the economy’s productive capacity increasing, declining or remaining static

over time?

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2. What are the relationship between micro economics and macroeconomics?
Microeconomics a
1. It is the study of individualIt is the study of economy as a
economic units of an economya whole and its aggregates.
2. It deals with individualn
individual prices andyindividual national income, general price
income, It deals with aggregates like

output, etc.
3. Its Central u level and national output, etc.
problem is priceIts central problem is
and allocation ofdetermination of level of income
and employment.
4. Its main tools are demand and Its main tools are aggregate
supply of a particular demand and aggregate supply of
commodity/factor. economy as a whole.
5. It helps to solve the central It helps to solve the central
problem of what, how and for problem of full employment of
whom to produce in the economy resources in the economy.
It is concerned with the
6. It discusses how equilibrium of
determination of equilibrium level
a consumer, a producer or an
of income and employment of the
industry is attained.

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Microeconomics Macroeconomics
7. Price is the main determinant of Income is the major determinant of
microeconomic problems. macroeconomic problems.
8. Examples are: individual Examples are: National income,
income, individual savings, pricenational savings, general price
determination of a commodity, level, aggregate demand, aggregate
individual firm's output,supply, poverty, unemployment
consumer's equilibrium. etc.

3. How does managerial economics differ from the traditional economics?

(Nov 2012)

Managerial Economics has been described as economics applied to decision-

making. It may be viewed as a special branch of Economics. However, the main
points of differences are the following:

1. The traditional Economics has both micro and macro aspects whereas
Managerial Economics is essentially micro in character.
2. Economics is both positive and normative science but the Managerial

Economics is essentially normative in nature.
3. Economics deals mainly with the theoretical aspect only whereas Managerial
Economics deals with the practical aspect.
4. Managerial Economics studies the activities of an individual firm or unit. Its

analysis of problems is micro in nature, whereas Economics analyzes problems
both from micro and macro point of views.

5. Economics studies human behavior on the basis of certain assumptions but

these assumptions sometimes do not hold good in Managerial Economics as it
concerns mainly with practical problems.

6. Under Economics we study only the economic aspect of the problems but
under Managerial Economics we have to study both the economic and non-
economic aspects of the problems.

7. Economics studies principles underlying rent, wages, interest and profits but
in Managerial Economics we study mainly the principles of profit only.

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8. Sound decision-making in Managerial Economics is considered to be the

most important task for the improvement of efficiency of the business firm; but
in Economics it is not so.

9. The scope of Managerial Economics is limited and not as wide as that of


4. Explain the objectives of business firms. (April 2011)

Maintaining profitability means making sure that revenue stays ahead of the
costs of doing business, according to James Stephenson, writing for the
"Entrepreneur" website. Focus on controlling costs in both production and
operations while maintaining the profit margin on products sold.
Employee training, equipment maintenance and new equipment purchases all
go into company productivity. Your objective should be to provide all of the

c o
resources your employees need to remain as productive as possible.
Customer Service
Good customer service helps you retain clients and generate repeat revenue.

Keeping your customers happy should be a primary objective of your

Employee Retention
Employee turnover costs you money in lost productivity and the costs

associated with recruiting, which include employment advertising and paying
placement agencies. Maintaining a productive and positive employee
environment improves retention, according to the Dun and Bradstreet website.
Core Values
Your company mission statement is a description of the core values of your
company, according to the Dun and Bradstreet website. It is a summary of the
beliefs your company holds in regard to customer interaction, responsibility to
the community and employee satisfaction.
Growth is planned based on historical data and future projections. Growth
requires the careful use of company resources such as finances and personnel

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Maintain Financing
Even a company with good cash flow needs financing contacts in the event that
capital is needed to expand the organization.
Change Management
Change management is the process of preparing your organization for growth
and creating processes that effectively deal with a developing marketplace.
Marketing is more than creating advertising and getting customer input on
product changes. It is understanding consumer buying trends, being able to
anticipate product distribution needs and developing business partnerships that
help your organization to improve market share.
Competitive Analysis
A comprehensive analysis of the activities of the competition should be an
ongoing business objective for your organization. Understanding where your
products rank in the marketplace helps you to better determine how to improve
your standing among consumers and improve your revenue.
5. Discuss the role of managerial economics in decision making process.
Making decision and process information are the two primary tasks of managers.


 In order to make intelligent decisions, managers must be able to obtain

process and use information.
 The purpose of learning economic theory is to help managers know what
information should be obtained and how to process and use the information.
 General task of managers to use readily available information to make a
decision or carryout a course of action that furthers the goals of the
 Production scheduling
 Demand forecasting
 Market research
 Economic analysis of industry
 Investment appraisal

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 Security management analysis

 Advance on trade
 Pricing and the related decision and analyzing and forecasting environmental
 Managerial economics help in deciding about the production, sales and
inventory schedules of the firm.
 Managerial economics not only provides information regarding their prevent
level but also forecasts their future trend.
 A managerial economics is used best to provide the pricing and profit
 The firm also needs the help of managerial economics for its investment
 For this managerial economics need to forecasting the return on the
investment and the cost that the firm incurs by taking up the investment.

c o
1. Describe the basic economic tools in managerial economics. (Nov/Dec
There are six basic tools of managerial economics. They are:

Content: S
1. The Incremental Concept

2. The Concept of Time Perspective

3. The Opportunity Cost Concept

4. The Discounting Concept

5. The Equi-marginal Concept

6. Risk and Uncertainty

Unit – 1 Answer Page 7 of 14

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1. The Incremental Concept:

A decision is clearly a profitable one if

(i) It increases revenue more than costs.

(ii) It decreases some cost to a greater extent than it increases others.

(iii) It increases some revenues more than it decreases others.

(iv) It reduces costs more than revenues.

2. Concept of Time Perspective:

(i) It may not be able to take up business with higher contributions in the long

(ii) The other customers may also demand a similar low price.
(iii) The image of the firm may be spoilt in the business community.
(iv)The long run effects of pricing below full cost may be more than offset any
short run gain.
(vi)The management realized that the long run repercussions of pricing below
full cost would more than offset any short run gain.
(vii) Reduction in rates for some customers will bring undesirable effect on

customer goodwill. Therefore, the managerial economist should take into
account both the short run and long run effects as revenues and costs, giving
appropriate weight to most relevant time periods.

3. The Opportunity Cost Concept

The concept of opportunity cost implies three things:

1. The calculation of opportunity cost involves the measurement of sacrifices.

2. Sacrifices may be monetary or real.

3. The opportunity cost is termed as the cost of sacrificed alternatives.

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4. It helps in determining relative prices of different goods.

5. It helps in determining normal remuneration to a factor of production.

6. It helps in proper allocation of factor resources.

4. The Discounting Concept

One of the widest known principles of economics is the equi-marginal

principle. The principle states that an input should be allocated so that value
added by the last unit is the same in all cases. This generalization is popularly
called the equi-marginal.

Let us assume a case in which the firm has 100 unit of labour at its disposal.
And the firm is involved in five activities viz., А, В, C, D and E. The firm can
increase any one of these activities by employing more labour but only at the
cost i.e., sacrifice of other activities.
.cbe, therefore, profitable to
An optimum allocation cannot be achieved if the value of the marginal product

ato high marginal value activity,

is greater in one activity than in another. It would

m taken together.
shift labour from low marginal value activity

thus increasing the total value of all products

5. The Equi-marginal Concept
d of the concept of time perspective. Since future is
This concept is an extension
unknown and tincalculable, there is lot of risk and uncertainty in future.
EveryoneS knows that a rupee today is worth more than a rupee will be two years
from now. This appears similar to the saying that “a bird in hand is more worth
than two in the bush.” This judgment is made not on account of the uncertainty
surrounding the future or the risk of inflation.

6. Risk and Uncertainty

Managerial decisions are actions of today which bear fruits in future which is
unforeseen. Future is uncertain and involves risk. The uncertainty is due to
unpredictable changes in the business cycle, structure of the economy and
government policies.

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This means that the management must assume the risk of making decisions for
their institution in uncertain and unknown economic conditions in the future.
Firms may be uncertain about production, market prices, strategies of rivals,

2. Indicate the importance of managerial economics. (Nov/Dec 2011)

 Economics contributes a great deal towards the performance of managerial

duties and responsibilities.

 The manger with working knowledge of economics can performance their

function more efficiently than those without it.

 The basic function of the manager of a business is to achieve the objective of

the firm to the maximum possible extent with limited resources placed at
their disposal.
 The emphasis here is on the maximization of the objectives and limitedness
of the resources.
 It is the unlimited resources such as sun shine, air there is no shortages of
resources but the business organization should have limited resources such

as men, materials, money, so that use the resources as limited and maximize

the profit at best level.

 The study of the economics is the logic, tools and techniques of making
optimum use of the available resources to achieve the given goals.

 Economic provides analytical tools and techniques that managers need to

achieve the goals of the organization by the manager.

 Therefore, a working knowledge of economics not necessarily a formal

degree is essential for the manager.

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3. Explain the nature and scope of managerial economic. (April 2011)

I. Managerial Economics – is it positive or normative?

Economics is divided into two categories (i) positive economics and (ii)
Normative Economics, analysis the strength of business organization.

II. Area of study

 Demand analysis and Forecasting

Accurate estimation of demand by analysis the forces acting on demand

of the product produced by the firm forms the vital issue in taking effective
decision at the firm level.

 Cost and production analysis

In decision making, cost estimates are essential. Production planning,
profit planning ect.
c o
 Pricing decisions, policies and practices
Pricing forms the core of managerial economics. The success of failure of
a firm mainly depends on accurate price decisions to effectively compete in the
 Profit management
t u
AllSbusiness enterprises are profit-making institutions. The success or
failure of a firm is measured only in terms of profit it has made and the
percentage of dividend it has declared.

 Capital Management

Capital management is the most troublesome and also ticklish problem

from the management of a business involving high-level decisions. Capital
management deals with planning and control of capital expenditure, cost of
capital, rate of return and selection of project, ect.

 Linear programming and theory of Games

Unit – 1 Answer Page 11 of 14

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Linear programming and theory of games have come to be regarded as

part of managerial economics recently, as there is a trend towards integration of
managerial economics and operations research.

III. Profits: the central concepts in managerial Economics

Profits are the primary measures of the success of any business. It is the
acid test of the economic strength of the firm. Economic theory makes a
fundamental assumption that maximizing profit is the basic aim of every firm.
Profit maximization continuous to be the objective of the firm and the study of
firm in managerial economics has centered round the concepts of profit.

IV. Optimization

This aims at optimizing a given objective. The aim of linear

programming is to aid the process of optimization and choice. Optimization is
basic to managerial economics in decision-making. m
.c Disciplines.
V. Relationship of managerial economics with other

Managerial economics is closely a

m theory, mathematics, statistics,
related to other subjects like

accounting, and decision-making a

microeconomic theory, macroeconomic
n and operation research.
yconcepts associated with managerial economics?
4. What are the fundamental
 Economic as a branch of knowledge is concerned with the study of
allocation of scarce resources among competing firm.
 Problem of resources allocation are faced by individuals, enterprise, and
nations over the year.
 The scientific concepts of economics as the science of wealth. Adam smith,
who is commonly known as the Father of modern economics, defined as
economics as “an enquiry in to the nature and causes of the wealth of

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 According to the Marshall, economics as “a study of man’s action in the

ordinary business of life, it enquires how he gets his income and how he use
 According to the Robbins economics defined as “economics is the science
which studies human behavior as a relationship between end and scarce
means which have alternative uses”.
Modern Concept
 According to the Lord J.M.Keynes, economics studies how the level of
income and employment in a community are determined.
 Economics studies administration scares resources and other determinates of
income and employment.
 Economics is a study of the factors affecting the size, distribution and
stability of a country’s national income.
 Currently, the theory of economic growth has occupied and important place
in the study of economic with reference to under-developed economics.
 Finally it gives ideas to how the national income grows over the years.
5. “Profit maximization is not the only goals of business firms” - comment.
(April 2011)

When a firm applies profit maximization, it is basically saying that its
primary focus is on profits, and it will use its resources solely to get the biggest
profits possible, regardless of the consequences or the risk involved. Profit

maximization is a generally short-term concept.

Risk S
Pursuing a profit maximization strategy comes with the obvious risk that the
company may be so entrenched in the singular strategy meant to maximize its
profits that it loses everything if the market takes a sudden turn.
Expectation and Goodwill
You also need to consider consequences of profit maximization. If a company
pursues a profit maximization strategy, it creates an environment where price is
a premium and cutting costs is a primary goal. This, in turn, creates a perception
of the company that could lead to a loss of goodwill with customers and

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Cash Flow
For all its drawbacks, profit maximization carries the big advantage of
creating cash flow. When maximizing profit is the primary consideration,
investments, reinvestments and expansions are typically tabled. The company
simply makes do on what it has..
Financing and Investors
Some degree of profit maximization is always present. The goal of a
company is to create profits. It has to profit from its business to stay in business.
Moreover, investors and financiers in the company may require a certain level
of profits to secure funds for expansion.

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Unit – 1 Answer Page 14 of 14

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Question & Answers

Syllabus: [Regulation: 2012]

UNIT–II Theory of Consumer Behaviour-Managerial utility- Analysis
Indifference curve-Law of Demand- Types of Demand- Demand forecasting.


1. What is Elasticity of demand? ( Nov 2012)

The elasticity of demand in a market is great or small according to the
amount demanded increases much or little for a given fall in price and
diminishes much or little for a given rise in price.
c o
2. What are the characteristics of indifference curve? ( Nov 2013)
 Consumer always prefers a large quantity of product to a smaller amount

of that product, provided the amount of other products does no change.

 The consumer is consistent in his choice. If he prefers combination A to

 The marginal rate of

n between two goods is diminishing.
B and B to C, then he must prefer A to C.
3. What are theu
t types of demand? ( Nov 2012)
 Individual and market Demand
 Demand for Firm’s product and industry’s products
 Autonomous and Derived Demand
 Demand for Durable and Non-Durable Goods
 Short-term and Long-term Demand

4. Name the theories of consumer behavior. ( Nov 2014)

 Utility Theory
 Indifference preference Theory

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5. Mention any four determinants of demand. ( April 2011)

 Consumer preference
 Number of buyers
 Price and related goods
 Expectations of the future

6. What is demand forecasting? ( April 2012)

A forecasting is an estimate of a future situation. Forecasting demand
denotes an estimation of the level of demand of the product at a future
period under given circumstances.

7. Define indifference curve. ( April 2012)

An indifference curve is a graph showing combination of two goods that
give the consumer equal satisfaction and utility. Each point on an
indifference curve indicates that a consumer is indifferent between the two
and all points give him the same utility.
8. What is mean by utility analysis? ( Nov 2013)
c o
A subset of consumer demand theory that analysis consumer behavior and
market demand using total utility and marginal utility. The key principle of
utility analysis is the law of diminishing marginal utility, which offers an
explanation for the law of demand and the negative slope of the demand
9. What is the law of diminishing marginal utility? ( Nov 2013)
According to the Alfred Marshall defined as “The additional benefit which a
person derives from a given increase of his stock of a thing diminishes with
every increase in the stock of a thing that he already has”.

10.Define the term Demand. ( April 2014)

“By demand, we mean the various quantities of a given commodity or
services with consumers would buy in one market in a given period of time,
at various prices, or at various incomes, or at various prices of related

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1. Explain the purposes of long term demand forecasting. ( Nov 2010)

 It involves the assessment of long term demand for the product and
involves expansion of production units.
 A multiple product firm must ascertain not only the total demand
situation, but also the demand for different items.
 Long term forecasting involves the study of technological developments,
economic trends and consumer preferences and man-power planning,
long term forecasting enables to take major strategic business decisions.
 When forecasting covering long periods are made, the probability of
error may high.
 Hence, Quality and competent forecasting are essential requirements for
this type.

2. Discuss the need for demand forecasting. ( April 2013)

 For evolving appropriate production policy to avoid problem of over
production under production.
c o
 Proper management of inventories example, purchasing raw materials at
appropriate time when their prices are low and avoiding over stocking.
 To setup reasonable sale target.
 Planning for a new project, expansion and modernization of an existing unit

and technology up gradation.
 Arranging suitable manpower in long run, technique of production may
change. Trained and a killed labour and business executives may be needed
for the new type of job responsibility.
3. Explain the concept of indifference curve. ( April 2014)
Meaning of Indifference Curve:
When a consumer consumes various goods and services, then there are some
combinations, which give him exactly the same total satisfaction. The
graphical representation of such combinations is termed as indifference
Indifference curve refers to the graphical representation of various
alternative combinations of bundles of two goods among which the
consumer is indifferent. Alternately, indifference curve is a locus of points

Unit – 2 Answer Page 3 of 22

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that show such combinations of two commodities which give the consumer
same satisfaction. Let us understand this with the help of following
indifference schedule, which shows all the combinations giving equal
satisfaction to the consumer.
A consumer can rank various combinations of goods and services in order of
his preference. For example, if a consumer consumes two goods, Apples and
Bananas, then he can indicate:

1. Whether he prefers apple over banana; or m

2. Whether he prefers banana over apple; or
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3. Whether he is indifferent between apples and bananas, i.e. both are
equally preferable and both of them give him same level of satisfaction.
Table 1: Indifference Schedule
Combination ofApples a Bananas

Apples and (A) (B)


P 1 15
Q 2 10
S 3
T 5 1

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As seen in the schedule, consumer is indifferent between five combinations

of apple and banana. Combination ‘P’ (1A + 15B) gives the same utility as
(2A + 10B), (3A + 6B) and so on. When these combinations are represented
graphically and joined together, we get an indifference curve ‘IC 1’ as shown
in Fig. 2.4.
In the diagram, apples are measured along the X-axis and bananas on the Y-
axis. All points (P, Q, R, S and T) on the curve show different combinations
of apples and bananas. These points are joined with the help of a smooth
curve, known as indifference curve (IC1). m
c o
Every point on IC1, represents an equal amount of satisfaction to the
consumer. So, the consumer is said to be indifferent between the
combinations located on Indifference Curve ‘IC1’. The combinations P, Q,
R, S and T give equal satisfaction to the consumer and therefore he is
indifferent among them. a
4. Outline the determinants of demand. ( April 2014)
S of Demand
When the price changes, quantity demanded will change. That is a
movement along the same demand curve. When factors other than price
changes, demand curve will shift. These are the determinants of the demand
1. Income: A rise in a person’s income will lead to an increase in demand
(shift demand curve to the right), a fall will lead to a decrease in demand for
normal goods. Goods whose demand varies inversely with income are called
inferior goods (e.g. Hamburger Helper).

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2. Consumer Preferences: Favorable change leads to an increase in

demand, unfavorable change lead to a decrease.
3. Number of Buyers: the more buyers lead to an increase in demand; fewer
buyers lead to decrease.
4. Price of related goods:
a. Substitute goods (those that can be used to replace each other): price of
substitute and demand for the other good are directly related.
5. Expectation of future:
a. Future price: consumers’ current demand will increase if they expect
higher future prices; their demand will decrease if they expect lower future
b. Future income: consumers’ current demand will increase if they expect
higher future income; their demand will decrease if they expect lower future

5. What are the differed types of utilities? Explain (Nov 2013)

Meaning of Utility
c o
Within the world of "teaching marketing", and websites discussing the

various "utilities of marketing", you'll find a variation on whether there are 4
or 5 Types, and sometimes different wordings of the type.

1. Form
When someone makes something, they assemble a product from parts and
you can use it. d
2. Task
When someone does something for you, like put ice cream in a cone, or
change the oil in your car (some marketing education profs and websites
don't use the word Task, they discuss "Promotion" or they merge the
meaning of "task" into "form")

3. Time
Making sure the product is available when people need it.

4. Place

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Making sure the product is accessible, bring it to the customer, or have it in

convenient place.

5. Possession
Letting the customer has the product, usually after they pay, they can
"possess" it and hold it, transport it etc.

6. Explain the concept of Income elasticity of Demand. ( Nov 2013)

 A negative income elasticity of demand is associated with inferior goods;

an increase in income will lead to a fall in the demand and may lead to
changes to more luxurious substitutes.
 A positive income elasticity of demand is associated with normal goods;
an increase in income will lead to a rise in demand. If income elasticity
of demand of a commodity is less than 1, it is a necessity good. If the
elasticity of demand is greater than 1, it is a luxury good or a superior
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 A zero income elasticity of demand occurs when an increase in income is
not associated with a change in the demand of a good. These would
be sticky goods.


7. Sate and explain the law of demand. ( Nov 2012)

Definition of Law of Demand

A microeconomic law that states, all other factors being equal, as the price
of a good or service increases, consumer demand for the good or service will

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decrease, and vice versa. The law of demand says that the higher the price,
the lower the quantity demanded, because consumers’ opportunity cost to
acquire that good or service increases, and they must make more tradeoffs to
acquire the more expensive product.

The chart below depicts the law of demand using a demand curve,
which is always downward sloping. Each point on the curve (A, B, C)
reflects a direct correlation between quantities demanded (Q) and price (P).
So, at point A, the quantity demanded will be Q1 and the price will be P1,
and so on.

c o
The law of demand is so intuitive that you may not even be aware of all the
examples around you.

When shirts go on sale, you might buy three instead of one. The
quantity that you demand increases because the price has fallen.
 When plane tickets become more expensive, you’re less likely to
travel by air and more likely to choose the less expensive options of
driving or staying home. The amount of plane tickets that you demand
decreases to zero because the cost has gone up.

8. Evaluate the theory of consumer behavior. ( April 2012)

Introduction of Consumer Behavior

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The consumer behavior is demand permits us to determine the underlying

factors affecting the level of consumer demand of a given commodity. An
increase in the price of a commodity, we expect consumers to react by
decreasing the quantity they want to buy.

Consumer Behavior - Assumptions

1. Rational Consumer
2.Budget Constraints
3. Consumer Preferences

The Utility Theory of Demand

The utility theory explains consumer behavior in relation to the satisfaction

that a consumer gets the moment he consumes a good. This theory was
developed and introduced in 1870 by a British Economist, William Stanley

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Jevons. When we speak of utility in economics, we refer to the satisfaction
or benefit that a consumer derives of his consumption.

Law of Diminishing Marginal Utilitym

The fundamental assumption of utility theory of demand is that the

satisfaction that a person derives in consuming a particular product

diminishes or declines as more and more of a good is consumed

Indifference Preference Theory

Another theory explaining consumer behavior is the indifference preference

theory. Economist Vilfredo Pareto developed this modern approach to
consumer behavior. Under this, that analysis of consumer behavior is
described in terms of consumer preferences of various combinations of
goods and services depending on the nature, rather than from the
measurability of satisfaction in our previous discussion of the utility theory.

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Indifference Curve

An indifference curve is a locus of points each of which represents a

combination of goods and services that will give equal level of satisfaction to
a consumer. To illustrate this, we consider an individual who prefer a
combination of 2 goods, say, food and clothing. Table 1. Indifference
Schedule ( Food and Clothing)

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Budget Line m
The income of an individual acts as constraints on the qualities of bundles of

goods he can purchase. We can buy commodities only up to the extent that

our income allows us. In the same manner, do prices also constraints our

ability to buy. With a fixed income, the higher the level of prices, the less
will be the quantity we can purchase..

Budget Schedule and Changes in Income

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Consumer Equilibrium

Consumer equilibrium refers to the combination of goods that will give the
highest level of satisfaction to a consumer that is within his purchasing

1. Explain consumer equilibrium using indifference curve analysis. ( April
Understanding Consumer’s Equilibrium by Indifference Curve
Consumer equilibrium refers to a situation, in which a consumer derives
maximum satisfaction, with no intention to change it and subject to given
prices and his given income. The point of maximum satisfaction is achieved
by studying indifference map and budget line together.

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Conditions of Consumer’s Equilibrium:

The consumer’s equilibrium under the indifference curve theory must meet
the following two conditions:
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(i) MRSXY = Ratio of prices or PX/PY .
Let the two goods be X and Y. The first condition for consumer’s
equilibrium is that a
a. If MRSXY > PX/PY, it means that the consumer is willing to pay more for
X than the price prevailing in the market. As a result, the consumer buys
more of X. As a result, MRS falls till it becomes equal to the ratio of prices
and the equilibrium is established.
b. If MRSXY < PX/PY, it means that the consumer is willing to pay less for X
than the price prevailing in the market. It induces the consumer to buys less

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of X and more of Y. As a result, MRS rises till it becomes equal to the ratio
of prices and the equilibrium is established.
(ii) MRS continuously falls:
The second condition for consumer’s equilibrium is that MRS must be
diminishing at the point of equilibrium, i.e. the indifference curve must be
convex to the origin at the point of equilibrium. Unless MRS continuously
falls, the equilibrium cannot be established.

c o
y n
dprices or P /P :
(i) MRS = Ratio of
u E, the absolute value of the slope of the indifference curve

At tangencytpoint
(MRS S between X and Y) and that of the budget line (price ratio) are same.
Equilibrium cannot be established at any other point as MRSXY > PX/PY at
all points to the left of point E and MRSXY < PX/PY at all points to the right
of point E. So, equilibrium is established at point E, when MRSXY = PX/PY.
(ii) MRS continuously falls:

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The second condition is also satisfied at point E as MRS is diminishing at

point E, i.e. IC2is convex to the origin at point E

2. Explain the various factors determining the elasticity of demand. ( Nov


Factors affecting the elasticity of demand of a commodity are as follows:

A change in price does not always lead to the same proportionate change in
demand. For example, a small change in price of AC may affect its demand
to a considerable extent/whereas, large change in price of salt may not affect
its demand. So, elasticity of demand is different for different goods.

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1. Nature of commodity:
Elasticity of demand of a commodity is influenced by its nature. A
commodity for a person may be a necessity, a comfort or a luxury.

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i. When a commodity is a necessity like food grains, vegetables, medicines,

etc., its demand is generally inelastic as it is required for human survival and
its demand does not fluctuate much with change in price.
ii. When a commodity is a comfort like fan, refrigerator, etc., its demand is
generally elastic as consumer can postpone its consumption.
iii. When a commodity is a luxury like AC, DVD player, etc., its demand is
generally more elastic as compared to demand for comforts.
iv. The term ‘luxury’ is a relative term as any item (like AC), may be a
luxury for a poor person but a necessity for a rich person.
2. Availability of substitutes:
Demand for a commodity with large number of substitutes will be more
elastic. The reason is that even a small rise in its prices will induce the
buyers to go for its substitutes.
3. Income Level:
Elasticity of demand for any commodity is generally less for higher income
level groups in comparison to people with low incomes. It happens because
rich people are not influenced much by changes in the price of goods.

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4. Level of price:
Level of price also affects the price elasticity of demand. Costly goods like

laptop, Plasma TV, etc. have highly elastic demand as their demand is very

sensitive to changes in their prices.

5. Postponement of Consumption:
Commodities like biscuits, soft drinks, etc. whose demand is not urgent,

have highly elastic demand as their consumption can be postponed in case of

an increase in their prices.

6. Number of Uses:
If the commodity under consideration has several uses, then its demand will
be elastic. When price of such a commodity increases, then it is generally
put to only more urgent uses and, as a result, its demand falls. When the
prices fall, then it is used for satisfying even less urgent needs and demand
7. Share in Total Expenditure:
Proportion of consumer’s income that is spent on a particular commodity
also influences the elasticity of demand for it. Greater the proportion of

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income spent on the commodity, more is the elasticity of demand for it and
8. Time Period:
Price elasticity of demand is always related to a period of time. It can be a
day, a week, a month, a year or a period of several years. Elasticity of
demand varies directly with the time period. Demand is generally inelastic in
the short period.
9. Habits:
Commodities, which have become habitual necessities for the consumers,
have less elastic demand. It happens because such a commodity becomes a
necessity for the consumer and he continues to purchase it even if its price
rises. Alcohol, tobacco, cigarettes, etc. are some examples of habit forming

3. Describe the various methods of demand forecasting? ( April 2011)

Techniques of Demand Forecasting
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The main challenge to forecast demand is to select an effective technique.
There is no particular method that enables organizations to anticipate risks

and uncertainties in future. Generally, there are two approaches to demand
The first approach involvesnforecasting demand by collecting information
dOn the other hand, the second method is to forecast
regarding the buying behavior of consumers from experts or through

demand by t
conducting surveys.

S using the past data through statistical techniques.

Thus, we can say that the techniques of demand forecasting are divided into
survey methods and statistical methods. The survey method is generally for
short-term forecasting, whereas statistical methods are used to forecast
demand in the long run.

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Survey Method:
Survey method is one of the most common and direct methods of forecasting
demand in the short term. This method encompasses the future purchase
plans of consumers and their intentions. In this method, an organization
conducts surveys with consumers to determine the demand for their existing
products and services and anticipate the future demand accordingly.

However, it has its own limitations, which are discussed as follows:

a. Provides estimates that are dependent on the market skills of experts and
their experience. These skills differ from individual to individual. In this
way, making exact demand forecasts becomes difficult.
b. Involves subjective judgment of the assessor, which may lead to over or
c. Depends on data provided by sales representatives who may have
inadequate information about the market.

ii. Delphi Method:
Refers to a group decision-making technique of forecasting demand. In this
method, questions are individually asked from a group of experts to obtain
their opinions on demand for products in future. These questions are
repeatedly asked until a consensus is obtained.

iii. Market Experiment Method:

Involves collecting necessary information regarding the current and future
demand for a product. This method carries out the studies and experiments
on consumer behavior under actual market conditions. In this method, some

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areas of markets are selected with similar features, such as population,

income levels, cultural background, and tastes of consumers.

Statistical Methods:
Statistical methods are complex set of methods of demand forecasting.
These methods are used to forecast demand in the long term. In this method,
demand is forecasted on the basis of historical data and cross-sectional data.

These different statistical methods are shown in

Trend Projection Method:
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Trend projection or least square method is the classical method of business

forecasting. In this method, a large amount of reliable data is required for
forecasting demand. In addition, this method assumes that the factors, such
as sales and demand, responsible for past trends would remain the same in

Barometric Method:
In barometric method, demand is predicted on the basis of past events or key
variables occurring in the present. This method is also used to predict
various economic indicators, such as saving, investment, and income.

Econometric Methods:
Econometric methods combine statistical tools with economic theories for
forecasting. The forecasts made by this method are very reliable than any
other method.

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The different types of statistical measures (as shown in Figure-14) are

discussed as follows:
iii. Index Number:
Refers to the measures used to study the fluctuations in a variable or group
of related variables with respect to time period/base period. They are most
commonly used in economics and financial research to study various factors,
such as price and quantity of a product. The factors that are responsible for
the problem are identified and calculated.

Time Series Analysis: Refers to the analysis of a series of observations over

a period of equally spaced time intervals. For example analyzing the growth

c o
of a company from its incorporation to the present situation. Time series
analysis is applicable in various fields, such as public sector, economics, and

4. Briefly explain the law of diminishing marginal Utility Analysis. ( Nov
2013) a
Law of diminishing marginal utility (DMU) states that as we consume more

and more units of a commodity, the utility derived from each successive unit
goes on decreasing.

In making choices, most people spread their incomes over different kinds of
goods. People prefer a variety of goods because consuming more and more
of any one good reduces the marginal satisfaction derived from further

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consumption of the same good. This law expresses an important relationship

between utility and the quantity consumed of a commodity. Let us
understand this law with the help of an example:

Suppose your father has just come from work and you offer him a glass of
juice. The first glass of juice will give him great satisfaction. The
satisfaction with the second glass of juice will be relatively lesser. With
further consumption, a stage will come, when he would not need any more
glass of juice, i.e. when the marginal utility drops to zero. After that point, if
he is forced to consume even one more glass of juice, it will lead to
disutility. Such a decrease in satisfaction with consumption of successive
units occurs due to ‘Law of diminishing marginal utility’.

1. Cardinal measurement of utility:

It is assumed that utility can be measured and a consumer can express his
satisfaction in quantitative terms such as 1, 2, 3, etc.
2. Monetary measurement of utility:
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It is assumed that utility is measurable in monetary terms.

3. Consumption of reasonable quantity: a

It is assumed that a reasonable quantity of the commodity is consumed. For
example, we should compare MU of glassfuls of water and not of
spoonful’s. If a thirsty person is given water in a spoon, then every
additional spoon will yield him more utility. So, to hold the law true,

suitable and proper quantity of the commodity should be consumed.

4. Continuous consumption:
It is assumed that consumption is a continuous process. For example, if one
ice-cream is consumed in the morning and another in the evening, then the
second ice-cream may provide equal or higher satisfaction as compared to
the first one.

5. No change in Quality:
Quality of the commodity consumed is assumed to be uniform. A second
cup of ice-cream with nuts and toppings may give more satisfaction than the
first one, if the first ice-cream was without nuts or toppings.

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6. Rational consumer:
The consumer is assumed to be rational who measures, calculates and
compares the utilities of different commodities and aims at maximising total

7. Independent utilities:
It is assumed that all the commodities consumed by a consumer are
independent. It means, MU of one commodity has no relation with MU of
another commodity.

8. MU of money remains constant:

As a consumer spends money on the commodity, he is left with lesser
money to spend on other commodities. In this process, the remaining money
becomes dearer to the consumer and it increases MU of money for the
consumer. But, such an increase in MU of money is ignored.

9. Fixed Income and prices:

It is assumed that income of the consumer and prices of the goods which the
consumer wishes to purchase remain constant.

. a
Diagrammatic Explanation of Law of DMU: a
Let us understand the law with the help of Table
Units of IceTotal Utility (inMarginal Utility (in
Cream utils) utils)
1 S 20 20
2 36 16
3 46 10
4 50 4
5 50 0 (Point of Satiety)
6 44 -6

Table 2.2: Law of Diminishing Marginal Utility

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In the diagram, units of ice-cream are shown along the X-axis and MU along the Y-axis.
MU from each successive ice-cream is represented by points A, B, C, D and E. As seen,
the rectangles (showing each level of satisfaction) become smaller and smaller with
increase in consumption of ice-creams.

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Syllabus: [Regulation: 2012]

UNIT–III Production and cost analysis-law of return to scale and economies of scale cost
analysis-different concept-cost-outputs relationship-short run long run-revenue curves of firm-
supply analysis..


1. Define long run costs. ( April 2013)

A period of time in which all factors of production and costs are variable. In the long run,
firms are able to adjust all costs, whereas in the short run firms are only able to influence
prices through adjustments made to production levels.

2. What is mean by cost reduction? ( April 2013)

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The process of looking for, finding and removing unwarranted expenses from
a business to increase profits without having a negative impact on product quality. Many
business managers will engage in periodic cost reduction drives in order to make

their company's operation more efficient and to boost profits.
3. Mention the law of supply. (April 2011)

Decrease in input prices

 Improvements in technology
 Government Policy

Size of the market
 Expectations

4. What you mean by Actual cost. ( April 2011)

An actual amount paid or incurred, as opposed to estimated cost or standard cost. In

contracting, actual costs amount includes direct labor, direct material, and other
direct charges.

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5. Define opportunity cost. ( April 2011)

Opportunity costs are fundamental costs in economics, and are used in computing cost
benefit analysis of a project. Such costs, however, are not recorded in the account
books but are recognized in decision making by computing the cash outlays and their
resulting profit or loss.

6. What are the types of production function? ( Nov 2014)

 Short term production function

 Long term production function

7. Give examples for fixed cost. ( Nov 2014)

 Depreciation

 Insurance

 Interest expense

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Property Tax

 Rent a
 Salary
8. What is Profit? ( Nov 2011) n
dafter total costs are deducted from total revenue, and the basis on
u and dividend is paid. It is the best known measure of success in
The surplus remaining
which tax is computed

an enterprise.

Profit is reflected in reduction in liabilities, increase in assets, and/or increase in owners'

equity. It furnishes resources for investing in future operations, and its absence
may result in the extinction of a company. As an indicator of comparative performance,
however, it is less valuable than return on investment (ROI). Also called earnings, gain,
or income.

9. Define “Cost”. ( Nov 2013)

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An amount that has to be paid or given up in order to get something. In business, cost is
usually a monetary valuation of (1) effort, (2) material, (3) resources, (4) time
and utilities consumed, (5) risks incurred, and (6) opportunity forgone
in production and delivery of a good or service. All expenses are costs, but not all costs
(such as those incurred in acquisition of an income-generating asset) are expenses.

10. How are costs classified? ( Nov 2010)

 Variable cost

 Fixed cost

 Semi-variable cost

 Stepped fixed cost

11. Define short run cost. ( Nov 2012)

In economics, it is the concept that within a certain period of time, in the future, at least
one input is fixed while others are variable. The short run is not a definite period of time,

but rather varies based on the length of the firm's contracts. For example, a firm may
have entered into lease contracts which fix the amount of rent over the next month, year
or several years. Or the firm may have wage contracts with certain workers which cannot
be changed until the contract renewal.
12. What is cost function? ( Nov 2012)

A mathematical formula used to predict the cost associated with a certain action or a

certain level of output. Businesses use cost functions to forecast the expenses associated
with production, in order to determine what pricing strategies to use in order
to achieve desired profit margins.


1. Explain various short run cost curves. ( April 2013)

Short period is a period of time which is not sufficient enough to allow supply to be fully
adjusted with the increased demand. In short-period certain inputs can't be increased or
decreased. There are certain inputs whose amount- cannot be changed irrespective of
output produced. Production can be partly increased by using the existing equipments
more intensively. There are certain factors which are subject to change. These are called

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variable factors. Hence in short period two types of costs viz. fixed costs and variable
costs are incurred.

(I) Total fixed cost (TFC)

Total fixed cost is independent of the volume of output. This cost remains unchanged
regardless of change in output. These costs are incurred on factor inputs which can't be
changed in the short period. These costs continue even of the production if output is zero.
Fixed costs are also called supplementary costs or overhead costs. These costs are in form
of rent, interest and salaries and wages of permanent staff. Total fixed cost curve is a
horizontal straight line parallel to OX-axis. It indicates that TFC remains the same at all
levels of output.

(2) Total variable cost (TVC):

Variable costs vary with the volume of output. This cost depends upon the output. If
output is more TVC is more, on the other hand if output is less TVC is less. These costs
fall to zero when output is zero. Variable costs are also known as prime costs. They
include payments made to the workers, suppliers of raw materials, fuel, power,

transportation etc. which depend on the rate of output.

(3) Total Cost (TC):

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Total cost is the sum total of total fixed cost and total variable cost. Total cost of
production depends on the total volume of production. With the rise in the volume of
production total cost rises. As total fixed cost is unchanged, the rise in total cost is
brought about by the rise in total variable cost. Thus TC = TFC + TVC.

The relation between total final cost, total variable cost and total cost is depicted in the
following diagram.
0 X-axis measures total output and OY-axis measures cost of (TC, TFC, and TVC). TFC

is parallel to OX-axis. OP "is the total fixed cost of zero output. It remains the same at all
levels of output. TVC curve starts from origin. It refers to that when output is zero, TVC
is zero. TVC increases at an increasing rate up to a point and

There after it starts rising at a diminishing rate. The TC curve has the same shape as TVC
but is runs above TVC curve. The distance between TC curve and TVC curve is same
throughout and as such the difference between TC and TVC is the TFC.

(4) Average fixed cost (AFC):

Average fixed cost is the fixed cost per unit of output. As total fixed cost remains the
same throughout, average fixed cost goes on falling with every increase in output. Since
fixed cost is fixed amount it gets distributed over wide range of output.

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(5) Average variable cost (AVC):

Average variable cost is the variable cost per unit of output. The average cost is obtained
by dividing the total variable cost with the total output. The average variable cost will
generally fall as the output increases from zero to the normal capacity due to the
operation of increasing return. But beyond the normal capacity output the average
variable cost will rise steeply because of the operation of diminishing return. Thus AVC
curve falls first, reaches a minimum and then rises.

(6) Average Cost (AC)

Average cost’s is the total cost per unit of output. Since the total cost is the sum total of
variable cost and total fixed cost, the average cost is the sum of average variable and
average fixed cost. Average cost takes the shape of English letter 'V'. The AC curve goes
on decling till it reaches the minimum and there after it starts rising again. Below is
shown the shape of an 'AC' curve.

(7) Marginal cost (MC)

Marginal cost is the addition to total cost by producing one more unit of output. In other

words marginal cost is the addition to the total cost of producing 'n' units instead of (n-1)

units when 'n' is any given number.

2. Write a short note on average cost with example. ( April 2013)
Average Cost (AVCO) Method
Average cost method (AVCO) calculates the cost of ending inventory and cost of
goods sold for a period on the basis of weighted average cost per unit of inventory.

Weighted average cost per unit is calculated using the following formula

Weighted Average Total Cost of Inventory
Unit Cost Total Units in Inventory

Like FIFO and LIFO methods, AVCO is also applied differently in periodic
inventory system and perpetual inventory system. In periodic inventory system, weighted
average cost per unit is calculated for the entire class of inventory. It is then multiplied
with number of units sold and number of units in ending inventory to arrive at cost of
goods sold and value of ending inventory respectively. In perpetual inventory system, we
have to calculate the weighted average cost per unit before each sale transaction.

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The calculation of inventory value under average cost method is explained with the help
of the following example:


Apply AVCO method of inventory valuation on the following information, first in

periodic inventory system and then in perpetual inventory system to determine the value
of inventory on hand on Mar 31 and cost of goods sold during March.

Mar 1 Beginning Inventory 60 units @ $15.00 per unit

5 Purchase 140 units @ $15.50 per unit

14 Sale 190 units @ $19.00 per unit

27 Purchase 70 units @ $16.00 per unit

29 Sale 30 units @ $19.50 per unit

c o
3. Explain the relationship between Total cost, Average cost and marginal cost. (April
Average cost per unit

Average cost is equal to total cost divided by the number of goods produced.

Total cost/output yn
It is also equal to the sum of average variable costs (total variable costs divided by


Marginal cost

Marginal cost is the change in total cost that arises when the quantity produced changes
by one unit. In general terms, marginal cost at each level of production includes any
additional costs required to produce the next unit. So, the marginal costs involved in
making one more wooden table are the additional materials and labour cost incurred.

Fixed Cost and Variable cost

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Fixed costs are expenses that do not change in proportion to the activity of a
business, within the relevant period or scale of production. For example, a retailer must
pay rent and utility bills irrespective of sales.
In manufacturing, direct material costs are an example of a variable cost. An example of
variable costs is the prices of the supplies needed to produce a product.

A company will pay for line rental and maintenance fees each period regardless of how
much power gets used. And some electrical equipment (air conditioning or lighting) may
be kept running even in periods of low activity. These expenses can be regarded as fixed.
But beyond this, the company will use electricity to run plant and machinery as required.
The busier the company, the more the plant will be run, and so the more electricity gets
used. This extra spending can therefore be regarded as variable.

Along with variable costs, fixed costs make up one of the two components of total cost.
In the most simple production function, total cost is equal to fixed costs plus variable

It is important to understand that fixed costs are "fixed" only within a certain range of

activity or over a certain period of time. If enough time passes, all costs become variable.

c cost; this is not true of

manufacturing where many fixed costs, such asa
In retail the cost of goods is almost entirely a variable
depreciation, are included in the cost of
4. What are the determinate of supply? ( Nov 2014)

t u
When price changes, quantity supplied will change. That is a movement along the same

S of the supply curve.

supply curve. When factors other than price changes, supply curve will shift. Here are
some determinants

1. Production cost:

Since most private companies’ goal is profit maximization. Higher production cost will
lower profit, thus hinder supply. Factors affecting production cost are: input prices, wage
rate, government regulation and taxes, etc.

2. Technology:

Technological improvements help reduce production cost and increase profit, thus
stimulate higher supply.

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3. Number of sellers:

More sellers in the market increase the market supply.

4. Expectation for future prices:

If producers expect future price to be higher, they will try to hold on to their inventories
and offer the products to the buyers in the future, thus they can capture the higher price.

5. Distinguish between variable cost and fixed cost. ( Nov2011)


Meaning The cost which remains same, The cost which changes with
regardless of the volume produced, is the change in output is
known as fixed cost. considered as a variable cost.
Nature Time Related Volume Related

Incurred when Fixed costs are definite, they are

c oVariable costs are incurred

incurred whether the units are only when the units are
produced or not. produced.
Unit Cost a
Fixed cost changes in unit, i.e. as the Variable cost remains same,

units produced increases, fixed cost per unit.

per unit decreases and vice versa, so

the fixed cost per unit is inversely
proportional to the number of output


Behavior It remains constant for a given period It changes with the change in
of time. the output level.
Combination of
S Fixed Production Overhead, Fixed
Administration Overhead and Fixed
Direct Material, Direct Labor,
Direct Expenses, Variable
Selling and Distribution Overhead. Production Overhead,
Variable Selling and
Distribution Overhead.
Examples Depreciation, Rent, Salary, Insurance, Material Consumed, Wages,
Tax etc. Commission on Sales, Packing
Expenses, etc.

6. Write a short note on cost benefits analysis. ( Nov 2011)

Cost Benefit Analysis is typically used by governments to evaluate the desirability of a given
intervention in markets. The costs and benefits of the impacts of an intervention are evaluated in
terms of the social benefits or social cost. The guiding principle is to list all of the parties
affected by an intervention, and place a monetary value of the effect it has on their welfare.

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The process involves monetary value of initial and ongoing expenses vs. expected return.
Constructing plausible measures of the costs and benefits of specific actions is often very

For example, governments can use the technique to decide whether to introduce business
regulation, build a new road or offer a new drug on the state healthcare. In this case, a
value must be put on human life or the environment, often causing great controversy.

The cost-benefit principle says, for example, that we should install a guardrail on a
dangerous stretch of mountain road if the dollar cost of doing so is less than the implicit
dollar value of the injuries, deaths, and property damage thus prevented.

7. What is marginal cost? Analysis its significance in cost analysis. ( Nov 2013)

Meaning of Marginal Cost

The marginal cost of an additional unit of output is the cost of the additional inputs
needed to produce that output. More formally, the marginal cost is the derivative of total
production costs with respect to the level of output.
c o
Significance in cost analysis
 m
The marginal cost is the cost of producing one more unit of a good.
 Marginal cost includes all of the costs that vary with the level of production. For
example, if a company needs to build a new factory in order to produce more goods, the
cost of building the factory is a marginal cost.

Economists analyze both short run and long run average cost. Short run average costs
vary in relation to the quantity of goods being produced. Long run average cost includes
the variation of quantities used for all inputs necessary for production.

 When the average cost declines, the marginal cost is less than the average cost. When the
average cost increases, the marginal cost is greater than the average cost. When the
average cost stays the same (is at a minimum or maximum), the marginal cost equals the
average cost.

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8. Explain the term actual cost and opportunity cost with examples. ( Nov 2010)

Actual cost
The component Actual Costing/Material Ledger was enhanced by the actual cost
component split function. The actual cost component split is used for analysis of
variances through multiple production levels. With this, the actual costs of a material are
grouped into cost components.
The actual cost component split is updated with the following:
 Change in inventory
 Invoice verification
 Order settlement
 Price change
 Material debit/credit
 Account maintenance
 Single-level material price determination
 Multilevel material price determination
 Closing entry
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Opportunity Cost

In economics, “there is no such thing as a free lunch!” Even if we are not asked to
pay money for something, scarce resources are used up in production and there is an
opportunity cost involved.
Opportunity cost measures the cost of any choice in terms of the next best alternative

 Work-leisure choices: The opportunity cost of deciding not to work an extra ten hours a
week is the lost wages foregone. If you are being paid £7 per hour to work at the local
supermarket, if you take a day off from work you might lose over £50 of income

 Government spending priorities: The opportunity cost of the government spending

nearly £10 billion on investment in National Health Service might be that £10 billion less
is available for spending on education or improvements to the transport network.

 Investing today for consumption tomorrow: The opportunity cost of an economy

investing resources in capital goods is the production of consumer goods given up for

Making use of scarce farming land: The opportunity cost of using farmland to grow
wheat for bio-fuel means that there is less wheat available for food production causing

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food prices to rise and increasing the risks of food poverty and malnutrition for millions
of the world’s most vulnerable people


1. Discuss the relationship between cost and output. ( April 2013)

The analysis of the short-run product curves. In the short-run there is at least one
significant input that cannot be varied in the production process. This is usually thought
of as the capital input. In a simple two-input production process, labor is commonly
designated the variable input. The shape of the product curves is determined by this
assumption of the short-run which has at least one fixed and one variable input.

If it can comprehend the basic reasons for why the marginal product curve is shaped
the way it is in the short-run, you will have a good start toward understanding the other
product curves and the cost curves which follow later in the chapter. Marginal
product is the increase in output that is generated by adding one more unit of the variable

input to the production process. If labor is the variable input, marginal product is the
increase in output that accompanies the hiring of an additional unit of labor.
c marginal product will start to
decline. The last unit of labor will add less to output .
It is expected that if production is pushed far enough,

to output. There is a logical reason for this. Ina

than the previous unit of labor added
the short-run, the fixed input (capital) is
being held constant. As variable units of m labor are added to the production process, the
a less capital per worker, labor productivity should
capital to labor ratio will decline. With

yneconomists call it the "law of diminishing returns."

decline. Thus, the marginal product of labor will decline as labor increases. Given the
logical certainty of this outcome,
It should understand the relationship between marginals and averages with respect to

S three numbers.
both the product curves and the cost curves. Suppose you have three numbers and it take
the average of those

Total = 12

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Now add another number (the marginal number) to the average and retake the average.
If the number is greater than the previous average, it will bring the average down. If it is
smaller than the previous average, it will push the average up.

3 3 3
4 4 4
5 5 5
3 5
----- ----- -----
Total 12 15 17

Average 4 3.75 4.25

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The same relationship between marginals and averages exists along the cost curves.
Marginal cost is the additional cost of producing another unit of output. If it is below
average variable or average total cost it will pull them down. And, when it is above them
it will bring them up. Consequently, marginal cost cuts each of these curves at their
respective minimums.

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2. Describe the various types of cost concepts. ( Nov 2011)

Types of cost concepts

Fixed Costs (FC).

The costs which don’t vary with changing output. Fixed costs might include the cost of

. c
building a factory, insurance and legal bills. Even if your output changes or you don’t
produce anything, your fixed costs stays the same. In the above example, fixed costs are
always £1,000. a
Variable Costs (VC).
Costs which depend on the output produced. For example, if you produce more cars, you

have to use more raw materials such as metal. This is a variable cost.

Semi-Variable u
LabourSmight be a semi-variable cost. If you produce more cars, you need to employ
more workers; this is a variable cost. However, even if you didn’t produce any cars, you
may still need some workers to look after empty factory.

Total Costs (TC) – Fixed + Variable Costs

Marginal Costs

Marginal cost is the cost of producing an extra unit. If the total cost of 3 units is 1550,
and the total cost of 4 units is 1900. The marginal cost of the 4th unit is 350.

Opportunity cost

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Opportunity cost is the next best alternative foregone. If may invest £1million in
developing a cure for pancreatic cancer, the opportunity cost is that you can’t use that
money to invest in developing a cure for skin cancer.

Economic Cost.

Economic cost includes both the actual direct costs (accounting costs) plus the
opportunity cost. For example, if you take time off work to a training scheme. You may
lose a weeks pay £350, plus also have to pay the direct cost of £200. Thus the total
economic cost = £550.

Accounting Costs

This is the monetary outlay for producing a certain good. Accounting costs will include
your variable and fixed costs you have to pay.

Sunk Costs.

These are costs that have been incurred and cannot be recouped. If you left the industry

you cannot reclaim sunk costs. For example, if the spend money on advertising to enter

an industry, it can never claim these costs back. If you buy a machine, you might be able
to sell if you leave the industry.

Avoidable Costs.
aproducing cars, you don’t have to pay for extra raw
n known as an escapable cost.
Costs that can be avoided. If you stop

materials and electricity. Sometimes

tuis the total cost to society. It will include the private costs plus also the
Market Failure

Social Costs-This
cost (cost incurred by a third party). May also be referred to as ‘True costs’

External Costs- This is the cost imposed on a third party. For example, if you smoke,
some people may suffer from passive smoking. That is the external cost.

Private costs-The costs you pay. e.g. the private cost of a packet of cigarettes is £6.10

Social Marginal Cost-The total cost to society of producing one extra unit. Social
Marginal Cost (SMC) = Private marginal cost (PMC) + External marginal Cost (XMC)

Average Cost Curves

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 ATC (Average Total Cost) = Total Cost / quantity

 AVC (Average Variable Cost) = Variable cost / quantity

 AFC (Average Fixed Cost) = Fixed cost / quantity

3. What is production function? What are its assumptions? State its uses in decision-
making.( Nov 2013)

c o
Production in economic, terms is generally understood as the transformation of inputs
into outputs. The inputs are what the firm buys, namely productive resources, and outputs

are what it sells. Production is not the creation of matter but it is the creation of value.
Production is also defined as producing goods which satisfy some human want.

Production is a sequence of technical processes requiring either directly or indirectly the

mental and physical skill of craftsman and consists of changing the shape, size and

properties of materials and ultimately converting them into more useful articles.

Methods of Production:

There are three methods of production:

a) Unit production

b) Mass production

c) Batch production

The unit production is otherwise known as job-order production. This type of

production is used for things which cannot be produced on large scale, things of high
artistic nature, i.e. production of exclusive goods. This is a method to meet the individual
requirements of customers. This type of production requires lot of flexibility in operation.

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Mass production uses mechanical aids for material handling. This type of production
requires specially planned layout, special purpose machines, jigs and fixtures, automatic
machines, etc. Mass production is continuous production, i.e. it does not have any non-
producing time.

Batch production is generally adopted in medium size enterprises. It is a stage in-

between unit production and mass production. It is bigger in scale than unit production
while it is smaller than mass production. In this type of production, variety of products is
manufactured in lots at regular interval. Therefore, this is known as batch production. The
theory of production centres round the concept of production function which we explain

The Production Function:

The production function expresses a functional relationship between quantities of inputs

and outputs. It shows how and to what extent output changes with variations in inputs
during a specified period of time. In the words of Stigler, “The production function is the

name given to the relationship between rates of input of productive services and the rate

of output of product. It is the economist’s summary of technical knowledge.” Q =f

(L, M, N, К, T)…………. (1)

where Q stands for the output of a good per unit of time, L for labour, M for management

(or organisation), N for land (or natural resources), К for capital and T for given

technology, and refers to the functional relationship.

The production function with many inputs cannot be depicted on a diagram. Moreover,

given the specific values of the various inputs, it becomes difficult to solve such a

production function mathematically. Economists, therefore, use a two-input production

function. If we take two inputs, labour and capital, the production function assumes the

Q = f (L, K) ….(2)

4. Briefly explain the various costs that are helpful in decision-making process. ( Nov

Importance of Costing in Managerial Decision Making

Managers make decisions that govern how a company reaches its goals. Many of these
goals have financial aspects, such as revenue and profit targets. The level of costs
included in such decisions has a major impact on the finances of the company. Reliable
reporting of actual costs, accurate estimation of projected costs and the appropriate

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integration of such costs in managerial decisions is a key component of business

operations that meet their targets and further the goals of the company.

Relevant Costs

Typical managerial decision making selects one of two or more alternatives. Costs that
remain the same no matter which alternative the manager chooses are not relevant to the
decision. In a cost-based decision on out-sourcing, a manager has to consider the cost of
the subcontract and the savings in-house.

Fixed Costs

The type of cost impacts a manager's decision making. Fixed costs are totals that remain
the same independently of the volume of production. Higher production levels result in a
reduced cost-per-unit as far as fixed costs are concerned. Typical fixed costs are facility
related, such as heating and insurance.

Variable Costs

A type of cost with a different impact on managerial decisions is the variable cost.

Variable costs stay the same on a cost-per-unit basis, but their totals increase with the
volume of production. Typical variable costs are materials used in production and direct
labor to make the products.
Step Costs
Step costs are a combination of fixed and variable costs that a manager has to consider to

avoid major discrepancies in cost calculations. They act as fixed costs up to a certain

limit and then change to a new value. Typical step costs are those associated with

machine capacity or batch processing.

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Syllabus: [Regulation: 2012]
UNIT–IV Pricing methods and stratergies- Objectives- Factors –General
considerations of pricing – Methods of pricing – Roll of Government – Dual pricing
– Price Discrimination.


1. Define Dual pricing. ( April 2013)

The Dual price system is following as two types of pricing one is bulk purchase another
one for small quantity of purchase is separate price system is called dual pricing.

2. What is skimming price? ( April 2013)

High price aimed at higher income groups for luxury or status goods, or at extracting

maximum returns from a market for a new technology product before competitors emerge.

.c 2011)
What are the conditions for price discrimination? ( April
 First Degree: charge whatever the market will bear e.g. auction.
 Second Degree: discount for quantity purchases

 Third Degree: market separated into distinct groups

d pricing? ( April 2011)

4. What is meant by transfer

S Price charged by individual entities for goods or services supplied to one another in
multi-department, multi-office, or multinational firms. Transfer price policy is generally aimed at
evaluating financial performance of different business units (profit centers) of a conglomerate,
and or to shift earnings from a high tax jurisdiction to a low-tax one. Tax authorities usually
frown upon transfer pricing aimed at tax avoidance and insist that each internal part of the
firm deals with the other on 'arm's Length (Market price) basis. Also called transfer cost.
5. What are the advantages of dual pricing? ( Nov 2014)

 Decisions are better and more timely because of the manager’s proximity to local
 Top managers are not distracted by routine, local decision problems.
 Managers’ motivation increases because they have more control over results.

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 Increased decision making provides better training for managers for higher level
positions in the future.
6. What are the roles of government in pricing? ( Nov 2014)

 To improve market infrastructure

 To improve information
 To improve institutional infrastructure

7. Write any two objectives of pricing. ( Nov 2013)

 Increase Sales Volume

 Increase Market Share

8. What is price discrimination? ( Nov 2012)

A pricing strategy that charges customers different prices for the same product or service.
In pure price discrimination, the seller will charge each customer the maximum price that he or
she is willing to pay. In more common forms of price discrimination, the seller places customers
in groups based on certain attributes and charges each group a different price.

9. What do you meant by penetration pricing? ( Nov 2010)
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A marketing strategy used by firms to attract customers to a new product or service.
Penetration pricing is the practice of offering a low price for a new product or service during its

initial offering in order to attract customers away from competitors. The reasoning behind this

marketing strategy is that customers will buy and become aware of the new product due to its

lower price in the marketplace relative to rivals.

10. Define pricing. ( Nov 2013)

Method adopted by a firm to set its selling price. It usually depends on the firm's average

costs, and on the customer's perceived value of the product in comparison to his or her perceived
value of the competing products. Different pricing methods place varying degree of emphasis
on selection, estimation, and evaluation of costs, comparative analysis, and market situation. See
also pricing strategy.

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1. What are the conditions to be fulfilled to practice price discrimination?( April 2013)

Price discrimination is the practice of charging different people more than one price for
the same commodity sellers sell to different customers, for reasons not associated with cost. For
example Doctors in private practice, solicitors and business consultants vary their fees sometimes
according to the income of their clients. We can therefore say that when a producer or seller
charges different customers different prices, that producer price discriminates. Many of the best
examples of price discrimination apply to services which must be consumed on the spot rather
than goods that can be resold.

Price discrimination in a standardized commodity is not likely to work. This is because

the group buying at a lower price may resell to the group paying the higher price, thereby
preventing the monopolist from charging some customers a higher price. Effective price

discrimination is possible only when the different markets within which the monopolist sells can

be separated from one another to prevent resale of the product from one group to another. Certain

conditions are necessary if price discrimination should be successful. These conditions are
discussed below.
1. There must be Monopoly Power

For price discrimination to be possible and successful the producer must control the
supply and distribution of the commodity. This is to ensure that the commodity cannot possibly

be obtained elsewhere in the same market. If consumers can get the commodity elsewhere, the
discrimination cannot be successful.

2. No possibility of resale

It should not be possible for those buying at lower prices to resell to those buying at
higher price. If this were the case, those group of buyers at which the discrimination is targeted
would get the commodity from those buying at lower prices. This condition is particularly
applicable to those services which must be consumed on the spot rather than goods that can be
resold. Example medical services provided by doctors in private practice.

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3. There must be no leakage of information between the markets

For price discrimination to be successful, information must not be leaked to those buying
at higher prices that others are buying the same commodity at lower prices. If this should be the
case, the consumer paying a higher price would buy the commodity through those paying lower
prices or he may refuse to buy the commodity altogether.

4. The markets must be separated

The markets need to be separated mainly, by differences in income. This would enable
the monopolist to sell the same commodity at different prices to consumers in the different
markets. Markets can be possibly separated even in the same area so long as differences in
income exist. For example expensive doctors in private practice frequently charge lower prices to
less well-off patients but charge reasonably high prices to the very rich whose demand for the
best medical care is very inelastic. Market separation is important because it avoids the situation
where the commodity would be bought in the market with low prices and resold into the market
with high price. A producer who has a domestic and foreign market can practice price
discrimination by selling at different prices in the two markets, separated by distance.
5. There must be different price elasticity of demand in the different markets.

A very important condition for successful price discrimination is that price elasticity of
demand in the markets into which the monopolist sells must be different. If the demand in one

market is elastic, the demand in the other market could be comparatively less or more elastic, and

not necessarily that, when the demand in one market is elastic that of the other market must be


2. Explain the objectives of pricing policy. (April 2011)

Pricing Policies:

The decision of pricing is very important in any business. Price once fixed is never
permanent. It needs to be reviewed and revised according to the market conditions.

Objectives of Pricing Policy:

To Maximize Profits:
Every firm tries to maximize their profits. So they should have a price policy, which
fetches them maximum revenue. Every firm should have a price policy keeping the long run
prospects in mind.

Price Stability:

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Always fluctuating price is not for the goodwill of the company. A stable price always
wins the confidence of customers.

Capture the Market:

Producer’s aim is to capture the market and to do so, he fixes comparatively lower price
for his product, while introducing a product to capture the lion share of market. But once they
gain stability and consistency they can change their price policy.

Facing Competitive Situation:

Every producer should fix the price, keeping the price of the competitor in mind in some
types of market structure prices are fixed in such a way so as to restrict the entry of rival firms in
the industry.

Ability to Pay:
The price should be fixed according to the ability of consumer to pay; high price for rich
customers and low for poor customers. This can be applied in case of services given by doctors,
lawyers etc.

Prices once fixed cannot be kept constant forever it has to be revised according to the

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condition and the economic situation. The main objective of pricing policy is to maximize profit

for the firm, stability is necessary to win the confidence of the customers and it should be able to
capture enough market for the firm.
3. Explain the cost-oriented pricing methods. ( Nov 2014)

Cost-oriented Method

Because cost provides the base for a possible price range, some firms may consider cost-oriented

methods to fix the price.

Cost-oriented methods or pricing are as follows

1. Cost plus pricing

Cost plus pricing involves adding a certain percentage to cost in order to fix the price. For
instance, if the cost of a product is Rs. 200 per unit and the marketer expects 10 per cent profit on
costs, then the selling price will be Rs. 220. The difference between the selling price and the cost
is the profit. This method is simpler as marketers can easily determine the costs and add a certain
percentage to arrive at the selling price.

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2. Mark-up pricing

Mark-up pricing is a variation of cost pricing. In this case, mark-ups are calculated as a
percentage of the selling price and not as a percentage of the cost price. Firms that use cost-
oriented methods use mark-up pricing.

Since only the cost and the desired percentage markup on the selling price are known, the
following formula is used to determine the selling price:

Average unit cost/Selling price

3. Break-even pricing

In this case, the firm determines the level of sales needed to cover all the relevant fixed
and variable costs. The break-even price is the price at which the sales revenue is equal to the cost
of goods sold. In other words, there is neither profit nor loss.

For instance, if the fixed cost is Rs. 2, 00,000, the variable cost per unit is Rs. 10, and the selling
price is Rs. 15, then the firm needs to sell 40,000 units to break even. Therefore, the firm will

plan to sell more than 40,000 units to make a profit. If the firm is not in a position to sell 40,000

limits, then it has to increase the selling price.

. c
The following formula is used to calculate the break-even point:

Contribution = Selling price – Variable cost per unit a

4. Target return pricing

In this case, the firm sets prices in order to achieve a particular level of return on

investment (ROI).

The target return price can be calculated by the following formula:

Target return price = Total costs + (Desired % ROI investment)/ Total sales in units

For instance, if the total investment is Rs. 10,000, the desired ROI is 20 per cent, the total cost is
Rs.5000, and total sales expected are 1,000 units, then the target return price will be Rs. 7 per unit
as shown below:

5000 + (20% X 10,000)/ 7000

Target return price = 7

The limitation of this method (like other cost-oriented methods) is that prices are derived from
costs without considering market factors such as competition, demand and consumers’ perceived

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value. However, this method helps to ensure that prices exceed all costs and therefore contribute
to profit.

5. Early cash recovery pricing

Some firms may fix a price to realize early recovery of investment involved, when
market forecasts suggest that the life of the market is likely to be short, such as in the case of
fashion-related products or technology-sensitive products.

Such pricing can also be used when a firm anticipates that a large firm may enter the market in
the near future with its lower prices, forcing existing firms to exit. In such situations, firms may
fix a price level, which would maximize short-term revenues and reduce the firm’s medium-term

4. What are the guidelines for price fixation? ( Nov 2014)


Price fixing is an agreement (written, verbal, or inferred from conduct) among

competitors that raises, lowers, or stabilizes prices or competitive terms. Generally, the antitrust

laws require that each company establish prices and other terms on its own, without agreeing with

a competitor. When consumers make choices about what products and services to buy, they

expect that the price has been determined freely on the basis of supply and demand, not by an
agreement among competitors. When competitors agree to restrict competition, the result is often

higher prices. Accordingly, price fixing is a major concern of government antitrust enforcement.

A plain agreement among competitors to fix prices is almost always illegal, whether
prices are fixed at a minimum, maximum, or within some range. Illegal price fixing occurs

whenever two or more competitors agree to take actions that have the effect of raising, lowering

or stabilizing the price of any product or service without any legitimate justification. Price-fixing
schemes are often worked out in secret and can be hard to uncover, but an agreement can be
discovered from "circumstantial" evidence. For example, if direct competitors have a pattern of
unexplained identical contract terms or price behavior together with other factors (such as the
lack of legitimate business explanation), unlawful price fixing may be the reason. Invitations to
coordinate prices also can raise concerns, as when one competitor announces publicly that it is
willing to end a price war if its rival is willing to do the same, and the terms are so specific that
competitors may view this as an offer to set prices jointly.

Not all price similarities, or price changes that occur at the same time, are the result of
price fixing. On the contrary, they often result from normal market conditions. For example,
prices of commodities such as wheat are often identical because the products are virtually
identical, and the prices that farmers charge all rise and fall together without any agreement
among them. If a drought causes the supply of wheat to decline, the price to all affected farmers

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will increase. An increase in consumer demand can also cause uniformly high prices for a product
in limited supply.

Price fixing relates not only to prices, but also to other terms that affect prices to
consumers, such as shipping fees, warranties, discount programs, or financing rates. Antitrust
scrutiny may occur when competitors discuss the following topics:

 Present or future prices

 Pricing policies

 Promotions

 Bids

 Costs

 Capacity

 Terms or conditions of sale, including credit terms

 Discounts m
c o
 Identity of customers
 Allocation of customers or sales areas a
 Production quotas

 R&D plans

A defendant is allowed to argue that there was no agreement, but if the government or a

private party proves a plain price-fixing agreement, there is no defense to it. Defendants

may not justify their behavior by arguing that the prices were reasonable to consumers, were
necessary to avoid cut-throat competition, or stimulated competition.

5. What are the different types of price discrimination? ( Nov 2011)

Price discrimination is the practice of charging a different price for the same good or
service. There are three types of price discrimination – first-degree, second-degree, and third-
degree price discrimination.

First degree

Discrimination, alternatively known as perfect price discrimination, occurs when a firm

charges a different price for every unit consumed.

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The firm is able to charge the maximum possible price for each unit which enables the firm
to capture all available consumer surpluses for itself. In practice, first-degree discrimination is

c o
Second degree

Second-degree price discrimination means charging a different price for different

quantities, such as quantity discounts for bulk purchases.

Third degree
Third-degree price discrimination means charging a different price to different consumer

groups. For example, rail and tube travelers can be subdivided into commuter and casual
travelers, and cinema goers can be subdivide into adults and children. Splitting the market into
peak and off peak use is very common and occurs with gas, electricity, and telephone supply, as
well as gym membership and parking charges. Third-degree discrimination is the commonest

Necessary conditions for successful discrimination

 Price discrimination can only occur if certain conditions are met.

 The firm must be able to identify different market segments, such as domestic users and
industrial users.

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 Different segments must have different price elasticity (PEDs).

 Markets must be kept separate, either by time, physical distance and nature of use, such
as Microsoft Office ‘Schools’ edition which is only available to educational institutions,
at a lower price.

 There must be no seepage between the two markets, which means that a consumer cannot
purchase at the low price in the elastic sub-market, and then re-sell to other consumers in
the inelastic sub-market, at a higher price.

 The firm must have some degree of monopoly power.

6. Discuss the significance of pricing decisions in practice. ( Nov 2013)

Pricing Decision

Organizations producing goods and services need to set the price for their
product. Setting the price for an organization's product is one of the most important decisions a
manager faces. It is one of the most crucial and difficult decisions a firm's manager has to make.

Pricing is a profit planning exercise. Cost is one of the major considerations in price

determination of the product. It is one of the three major factors which influence pricing decision.
The two other factors are customers and competitors.
. c
In a situation where the product has many substitutes, customers decide the price. That is,
the demand of customers are the paramount importance in setting the price of the product. In such

a situation, the firm should try to deliver the value, in the form of product and/or service, at the
target cost so that a reasonable profit can be earned. Similarly, under competitive condition, price
is determined by market forces and an individual firm or an individual customer can

not influence the price.


When there are only few players in the market, competitors usually, react to the price
changes and, therefore, pricing decisions are influenced by the possible reaction of competitors.
As such management must keep watchful eye on the firm's competitors. That is, knowledge of
competitors' strategy is essential for pricing decision in an oligopoly situation.


Cost is the third major factor. Its role in price setting varies widely among industries.
Some industries determine price by market forces and in some industries, managers set prices a
on the basis of production costs. Firms want to charge a price that covers its costs like production

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costs, distribution costs and costs relate with selling the product and also including a fair return
for its effort.

7. Explain the major factors governing pricing policies. ( Nov 2012)

A company’s price level sends signals about the quality of its products to the customer. A
customer always compares the company’s prices with those of its competitors. The competitors
also keep an eye on the price levels of a company.

Very low prices may invite price wars, while high prices without sufficient additional
features or quality invite bad publicity. Distribution channel members also exert pressure on
prices by demanding higher margins.

c o

1. Price-quality relationship

Customers use price as an indicator of quality, particularly for products where objective
measurement of quality is not possible, such as drinks and perfumes. Price strongly influences
quality perceptions of such products.

If a product is priced higher, the instinctive judgment of the customer is that the quality of the
product must be higher, unless he can objectively justify otherwise.

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2. Product line pricing

A company extends its product line rather than reduce price of its existing brand, when a
competitor launches a low price brand that threatens to eat into its market share. It launches a low
price fighter brand to compete with low price competitor brands.

3. Explicability

The company should be able to justify the price it is charging, especially if it is on the higher side.
Consumer product companies have to send cues to the customers about the high quality and the
superiority of the product.

A superior finish, fine aesthetics or superior packaging can give positive cues to the customers
when they cannot objectively measure the quality of the offering. A company should be aware of
the features of the product that the customers can objectively evaluate and should ensure superior
performance of those features.

4. Competition

A company should be able to anticipate reactions of competitors to its pricing policies and moves.

Competitors can negate the advantages that a company might be hoping to make with its pricing

policies. A company reduces its price to gain market share.

5. Negotiating margins
A customer may expect its supplier to reduce price, and in such situations the price that the

customer pays is different from the list price. Such discounts are pervasive in business markets,

and take the form of order-size discounts, competitive discounts, fast payment discounts, annual
volume bonus and promotions allowance.

Negotiating margins should be built, which allow price to fall from list price levels but still
permit profitable transactions. It is important that the company anticipates the discounts that it

will have to grant to gain and retain business and adjust its list price accordingly. If the company
does not build potential discounts into its list price, the discounts will have to come from the
company’s profits.

6. Effect on distributors and retailers

When products are sold through intermediaries like retailers, the list price to customers must
reflect the margins required by them Sometimes list prices will be high because middlemen want
higher margins. But some retailers can afford to sell below the list price to customers. They run
low-cost operations and can manage with lower margins. They pass on some part of their own
margins to customers.

7. Political factors

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Where price is out of line with manufacturing costs, political pressure may act to force down
prices. Exploitation of a monopoly position may bring short term profits but incurs backlash of a
public enquiry into pricing policies. It may also invite customer wrath and cause switching upon
the introduction of suitable alternatives.

8. Earning very high profits

It is never wise to earn extraordinarily profits, even if current circumstances allow the company to
charge high prices. The pioneer companies are able to charge high prices, due to lack of
alternatives available to the customers.

The company’s high profits lure competitors who are enticed by the possibility of making profits.
The entry of competitors in hordes puts tremendous pressure on price and the pioneer company is
forced to reduce its price. But if the pioneer had been satisfied with lesser profits, the competitors
would have kept away for a longer time, and it would have got sufficient time to consolidate its

9. Charging very low prices

It may not help a company’s cause if it charges low prices when its major competitors are

c o
charging much higher prices. Customers come to believe that adequate quality can be provided
only at the prices being charged by the major companies. If a company introduces very low
prices, customers suspect its quality and do not buy the product in spite of the low price. If the
cost structure of the company allows, it should stay in business at the low price. Slowly, as some

customers buy the product, they spread the news of its adequate quality.

The customers’ belief about the quality-price equation starts changing. They start believing that
adequate quality can be provided at lower prices. The companies which have been charging

higher prices come under fire from customers. They either have to reduce their prices or quit.



1. Explain the various methods of pricing strategies. ( April 2013)

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Pricing is one of the four elements of the marketing mix, along with product, place and
promotion. Pricing strategy is important for companies who wish to achieve success by finding
the price point where they can maximize sales and profits. Companies may use a variety of
pricing strategies, depending on their own unique marketing goals and objectives.

Premium Pricing

Premium pricing strategy establishes a price higher than the competitors. It's a strategy
that can be effectively used when there is something unique about the product or when the
product is first to market and the business has a distinct competitive advantage. Premium pricing
can be a good strategy for companies entering the market with a new market and hoping to
maximize revenue during the early stages of the product life cycle.

Penetration Pricing

A penetration pricing strategy is designed to capture market share by entering the market
with a low price relative to the competition to attract buyers. The idea is that the business will be
able to raise awareness and get people to try the product. Even though penetration pricing may
initially create a loss for the company, the hope is that it will help to generate word-of-mouth
and create awareness amid a crowded market category.
Economy Pricing
c o
Economy pricing is a familiar pricing strategy for organizations that include Wal-Mart,

whose brand is based on this strategy. Aldi, a food store, is another example of economy pricing

strategy. Companies take a very basic, low-cost approach to marketing--nothing fancy, just the

bare minimum to keep prices low and attract a specific segment of the market that is very price

Price Skimming

Businesses that have a significant competitive advantage can enter the market with a
price skimming strategy designed to gain maximum revenue advantage before other competitors
begin offering similar products or product alternatives.

Psychological Pricing

Psychological pricing strategy is commonly used by marketers in the prices they establish
for their products. For instance, $99 is psychologically "less" in the minds of consumers than
$100. It's a minor distinction that can make a big difference.

2. Describe the pricing methods employed by businessmen. (Nov 2014)

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 Competitive Pricing: After surveying your competitors’ prices, you can use their average or
mean prices on which to base your prices. You can decide to price above, below or the same as
your competitors depending upon your overall marketing and pricing strategy.

Note: This pricing method assumes your cost structure is identical to your competitors, it does not
guarantee you will be profitable only competitive.

 Cost plus Mark-Up Pricing: This pricing method focuses on your cost structure as a starting
point to build your price list, not your customers’ prices. Knowing your costs, you add the
amount of profit margin you want to realize by each product/service you sell. Note: This pricing
method will assure you achieve a predictable profit margin per unit sold; it will not assure selling
prices that are competitive either with your competitors and/or with the perceptions of your
customers possibly stifling sales and total company profit.

 Perceived Value Pricing: This pricing method bases the product/service price on the effective
value to the customer, relative to alternative products in the marketplace.

Note: This is similar to competitive pricing but gives prominence to the customer's perception
over the competitors pricing.

c o
Note: This pricing method requires market research to determine real customer perceived value.

 a
Cost plus Perceived Value Pricing: Sometimes called market-oriented Pricing this pricing
method combines Cost plus Mark-Up and Perceived Value pricing to mitigate the drawbacks to

each. It starts with the product/service cost and then adjusts the final markup with a price relative
to both the competitive and customer market price environment and not just an arbitrary profit
margin percent markup.
 tu
Premium Pricing: Use a high price where there is a uniqueness about the product or service.
This method is used where a substantial competitive product/service advantage exists.

 Psychological Pricing: - In this method, the price is based on factors such as perception of
product quality, popular price points, and what the consumer perceives to be a fair value. This
pricing strives to promote a positive psychological impact on the customer. A popular example of
this type of pricing is selling a product at $19.95 rather than $20.

 Economy Pricing: This is a no frills low price. The cost of marketing and manufacture are kept
at a minimum. Supermarkets often have the economy or generic brands for soap, spaghetti, at
prices lower than branded products.

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3. What are the factors which influence the price of a commodity? Elucidate. ( Nov

Cash prices are derived from the futures markets by removing the effect of the cost of
carrying the commodity i.e. by stripping out the financial cost of carry price. The driving factors
behind the volatility in the prices of the commodities’ cash prices arises because they have
different characteristics than financial products.

Factors that affect commodity prices

Production related

Commodities are capital-intensive products i.e. they are influenced by natural factors like
weather conditions, crop diseases, size of land cultivated and factors related to production like
labor patterns, development in the tools and technologies used. Other than these there are factors
like the economic and political environment which manifest itself in the form of trade constraints,
subsidies, taxes to mention a few. Altogether these factors affect the cost of producing the
commodity and the demand for it in a market where there is more than one participant.

Storage and Transportation constraints

c o
All commodities have a real physical form and therefore there is a need for storage prior
to distribution. This is not the case of financial products so inventory cost and storage do not have
such a large impact on the market prices. This factor does not however affect the prices across all

commodity asset classes in the same magnitude but rather depends on the type of commodity in
Economic and Demand related patterns

In recent times the uncertainties in the global financial system have made commodities a

favorable investment alternative to financial instruments. Typical examples would be gold and

silver. The increasing involvement of developing markets as suppliers expose the prices to the
political and production related constraints in these countries like economic policy, infrastructure
and labor conditions. This sometimes pushes prices higher.

Costs involved in storage

There are two types of costs involved in storing commodities. One is the financial cost and the
other is the cost of physical storage and they both need to be factored in when computing the
forward prices.

Seasonality – Some examples of such factors include weather related patterns, operational risk,
climatic conditions and politics.

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4. Explain the different between full cost pricing and marginal cost pricing. ( Nov

Full-Cost Pricing

Full-cost pricing seeks to include every cost of running a business in the cost of producing goods.
These costs include rent, a fixed cost or initial outlays of money for purchasing and renovating a
location, which is a sunk cost. The pricing manager attributes total costs of the business equally to
each item produced for sale. Full costs are higher than marginal costs, because they include more
than just the variable costs associated with production.

Full-Cost Issues

Full-cost pricing generally fails to achieve the theoretically optimal profit-maximizing price. This
is because the manager will include sunk and fixed costs in the decisions about how much of each
item to produce and what their prices should be. However, those costs, by definition, do not vary
with the level of production, so they should not affect production-level decisions. On the other
hand, full cost is relatively easy to measure -- simply add up all the costs of the business and
divide by the amount of items the owner or manager wants to sell.
Marginal Cost Pricing

c o
In marginal cost pricing, the benchmark cost for each outcome is the cost required to produce it.
This cost does not include fixed costs of the business, such as rent payments, which do not vary

with the level of production. Marginal cost is only the cost of the labor, material and other direct

inputs for producing each item. Under marginal cost pricing, the business would first decide how

much to produce and then set its price based on the marginal cost of the last unit it produces.

Advantages and Disadvantages

From the perspective of economics theory, marginal-cost pricing leads to the most profitable

prices in any type of market. However, it can be difficult for a business owner in the real world to
calculate marginal costs, because owners and managers tend to conflate marginal costs with other
types of costs, such as fixed costs and sunk costs.

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Syllabus: [Regulation: 2012]

UNIT–V Market forms- market structure-basis of market classification-output
determination perfect competition-monopoly-monopolistic competition-


1. What is market? ( April 2012)

A regular gathering of people for the purchase and sale of provisions, livestock,
and other commodities.

2. What is oligopoly? ( April 2012)

A situation in which a particular market is controlled by a small group of
firms. An oligopoly is much like a monopoly, in which only one company exerts control

over most of a market. In an oligopoly, there are at least two firms controlling the market.

3. Define Duopoly. ( Nov 2013)

Market situation in which only sellers supply a particular commodity to
many buyers. Either seller can exert some control over the output and prices, but must
consider the reaction of its sole competitor (unless both have formed an
illegal collusive duopoly).

4. What is meant by perfect completion? ( April 2014)

The theoretical free-market situation in which the following conditions are met:
(1) buyers and sellers are too numerous and too small to have
any degree of individual control over prices, (2) all buyers and sellers seek to maximize
their profit (income), (3) buyers and seller can freely enter or leave the market, (4) all buyers and
sellers have access to information regarding availability, prices,
and quality of goods being traded, and (5) all goods of a particular nature are homogeneous,
hence substitutable for one another. Also called perfect market or pure competition.

5. What are the causes of monopoly? ( Nov 2010)

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 Government regulation that prevent anyone from competing; and

 Declining average cost so that economies of scale mean that it would be more expensive
for two firms to produce the desired amount of a good or service than for two or more
(this is known as a 'natural monopoly').

6. What is monopoly? ( Nov 2012)

A market structure characterized by a single seller, selling a unique product in the

market. In a monopoly market, the seller faces no competition, as he is the sole seller of
goods with no close substitute.

7. What are the main features of monopoly? ( April 2011)

 One seller and large number of buyers

 No close substitute

 Strong barriers to the entry into the industry exist m

c o
 Nature of demand curve

8. What are the disadvantages of monopoly? ( April 2011)

 Monopoly avoids duplication and hence wastage of resources.
 A monopoly enjoys economics of scale as it is the only supplier of product or service in
the market. The benefits can be passed on to the consumers.
 Due to the fact that monopolies make lot of profits, it can be used for research and
development and to maintain their status as a monopoly.
 Monopolies may use price discrimination which benefits the economically weaker
sections of the society. For example, Indian railways provide discounts to students
travelling through its network.
 Monopolies can afford to invest in latest technology and machinery in order to be
efficient and to avoid competition.

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9. What is are the factors determining the size of the market? ( Nov 2014)

(A) Nature of the commodity

 Wide demand

 Durability

 Portability

 Grading and Sampling

 Adequate supply

(B) General conditions

 Peace and Security

 Stable Currency and Efficient Financial Institutions

 Government Policy
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 Transport and Communication

 Degree of division of labor

10. What is perfect competition? ( Nov 2013)

Perfect competition is a market structure where many firms offer a homogeneous
product. Because there is freedom of entry and exit and perfect information, firms will
make normal profits and prices will be kept low by competitive pressures.

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1. Points the characteristics of oligopoly. ( April 2012)

Characteristics of Oligopoly:

1. Interdependence:

The firms under oligopoly are interdependent in making decision. They are
interdependent because the number of competition is few and any change in price &
product etc by an firm will have a direct influence on the fortune of its rivals, which in
turn retaliate by changing their price and output. Thus under oligopoly a firm not only
considers the market demand for its product but also the reactions of other firms in the
industry. No firm can fail to take into account the reaction of other firms to its price and
output policies. There is, therefore, a good deal of interdependences of the firm under

2. Importance of advertising and selling costs:

The firms under oligopolistic market employ aggressive and defensive weapons to

gain a greater share in the market and to maximize sale. In view of this firms have to

incur a great deal on advertisement and other measures of sale promotion. Thus
advertising and selling cost play a great role in the oligopolistic market structure. Under
perfect competition and monopoly expenditure on advertisement and other measures is
unnecessary. But such expenditure is the life-blood of an oligopolistic firm.

3. Group behavior:
Another important feature of oligopoly is the analysis -of group behaviour. In

case of perfect competition, monopoly and monopolistic competition, the business firms
are assumed to behave in such a way as to maximize their profits. The profit-maximizing
behaviour on his part may not be valid. The firms under oligopoly are interdependent as
they are in a group.

4. Indeterminateness of demand curve:

This characteristic is the direct result of the interdependence characteristic of an

oligopolistic firm. Mutual interdependence creates uncertainty for all the firms. No firm
can predict the consequence of its price-output policy. Under oligopoly a firm cannot
assume that its rivals will keep their price unchanged if he makes charge in its own price.
As a result, the demand curve facing an oligopolistic firm losses its determinateness.

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The demand curve as is well known, relates to the various quantities of the product that
could be sold it different levels of prices when the quantity to be sold is itself unknown
and uncertain the demand curve can't be definite and determinate.

5. Elements of monopoly:

There exist some elements of monopoly under oligopolistic situation. Under

oligopoly with product differentiation each firm controls a large part of the market by
producing differentiated product. In such a case it acts in its sphere as a monopolist in
lining price and output.

6. Price rigidity:

Under oligopoly there is the existence price rigidity. Prices lend to be rigid and
sticky. If any firm makes a price-cut it is immediately retaliated by the rival firms by the
same practice of price-cut. There occurs a price-war in the oligopolistic condition. Hence
under oligopoly no firm resorts to price-cut without making price-output decision with
other rival firms. The net result will be price -finite or price-rigidity in the oligopolistic
condition. m
.c ( April 2012)
2. Identify the difference between monopoly and oligopoly.

a economic market An economic market
Meaning An
condition where one seller condition where numerous
d dominates the entire market. sellers have their presence in

one single market. A small
number of large firms that

S High prices may be charged
dominate the industry.
Moderate/fair pricing due to
since there is no competition competition in market. But
much higher than perfect
competition (where there is a
large number of buyers and
Characteristics A single firm controls a large A small number of firms
market share in the industry, dominate the industry. These
thereby gaining the ability to firms compete with each other
set price. based on product
differentiation, price, customer
service etc.

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Barriers to entry A monopoly usually exists Barriers to entry are very high
when barriers to entry are very as it is difficult to enter the
high - either due to industry because of economies
technology, patents, of scale.
distribution overheads,
government regulation or
capital-intensive nature of the
Sources of Power Market making ability by Market making ability because
virtue of being virtually the of very few firms in the
only viable seller in the industry. Each firm can
industry. therefore significantly
influence the market by setting
price or production quantity.
Examples Microsoft (Operating systems, Health insurers, wireless
productivity suites), Google carriers, beer (Anheuser-
(web search, search Busch and MillerCoors),
advertising), DeBeers media (TV broadcasting, book

(diamonds), Monsanto (seeds), publishing, movies), etc.

Long Island Rail Road etc.

3. Describe the meaning of oligopoly. ( April 2014)

. c
Meaning and Definition of Oligopoly:

The term oligopoly is derived from two Greek words “Oligoi” means a few and

“Poly” means to sell. Under oligopoly, we come across a few producers specializing in

the production of identical goods or differentiated goods competing with one another.

The products traded by the oligopolists may be differentiated or homogeneous. In the
case of former, we can give the e.g., of automobile industry where different model of
cars, ambassador, fiat etc., are manufactured. Other examples are cigarettes,
refrigerators, T.V. sets etc., pure or homogeneous oligopoly includes such industries as
cooking and commercial gas cement, food, vegetable oils, cable wires, dry batteries,
petroleum etc., In the modern industrial set up there is a strong tendency towards
oligopoly market situation. To avoid the wastes of competition in case of competitive
industries and to face the emergence of new substitutes in case of monopoly industries,
oligopoly market is developed. e.g., an electric refrigerator, automatic washing
machines, radios etc.

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Characteristics of Oligopoly:
 Interdependence:
Each and every firm has to be conscious of the reactions of its rivals. Since the
number of firms is very few, any change in price, output, product etc., by one firm
will have direct effect on the policy of other firms. Therefore, economic calculations
must be made always with reference to the reactions of the rival firms, as they have a
high degree of cross elasticity’s of demand for their products.
 Indeterminateness of the demand curve:

Under oligopoly, there will be the element of uncertainty. Firms will not know the
particular factors which could affect demand. Naturally rise or fall in the demand for
the product cannot be speculated. Changes that would be taking place may be
contrary to the expected changes in the product curve. Thus, the demand curve for the
product will be indeterminate or indefinite.

 Conflicting attitude of firms:

Under oligopoly, on the one hand, firms may realize the disadvantages of

competition and rivalry and desire to unite together to maximize their profits. On the

other hand firms guided by individualistic considerations may continuously come in
clash and conflict with one another. This creates uncertainty in the market.
 Element of monopoly and competition: m
Under oligopoly, a firm has some monopoly power over the product it produces

but not on the entire market. But monopoly power enjoyed by the firm will be limited

by the extent of competition.
 Price rigidity:
Generally, prices tend to be sticky or rigid under oligopoly. This is because of the
fact that if one firm changes its price, other firms may also resort to the same

 Aggressive or defensive marketing methods:

Firms resort to aggressive and sometimes defensive marketing methods in order

to either increase their share of the market or to prevent a decline of their share in the
market. If one adopts extensive advertisement and sales promotion policy it provokes
others to do the same. Remarks in this connection- “Under oligopoly, advertising can
become a life and death matter where a firm which fails to keep up with the

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advertising budget of its competitors may find its customers drifting off to rival
 Constant struggle:

Competition is of unique type in an oligopolistic market. Hence, competition

consists of constant struggle of rivals against rivals.
 Lack of uniformity:

Lack of uniformity in the rise of different oligopolies is another remarkable

 Small number of large firms:

The numbers of firms in the market are small. But the size of each firm is big. The
market share of each firm is sufficiently large to dominate the market.
 Existence of kinked demand curve:

A kinked demand curve is said to occur when there is a sudden change in the

slope of the demand curve. It explains price rigidity under oligopoly.

4. Explain the various types of market. ( April 2014)

Types of Markets
1.Physical Markets
y n
dmerchandise from them in exchange of money. Shopping malls,
Physical market is a set up where buyers can physically meet the sellers and

department t uretail stores are examples of physical markets.

purchase the desired
2.Non Physical Markets/Virtual markets

In such markets, buyers purchase goods and services through internet. In such a
market the buyers and sellers do not meet or interact physically, instead the transaction
is done through internet. Examples - Rediff shopping, eBay etc.

3.Auction Market

In an auction market the seller sells his goods to one who is the highest bidder.

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4.Market for Intermediate Goods

Such markets sell raw materials (goods) required for the final production of other

5.Black Market

A black market is a setup where illegal goods like drugs and weapons are sold.

6.Knowledge Market

Knowledge market is a set up which deals in the exchange of information and

knowledge based products.

7.Financial Market

Market dealing with the exchange of liquid assets (money) is called a financial

Financial markets are of following types:

1.Stock Market
. c
A form of market where sellers and buyers exchange shares is called a stock


2.Bond Market
y n
A market place where buyers and sellers are engaged in the exchange of debt

securities, usually the form of bonds is called a bond market. A bond is a contract

fixed S
signed by both where one party promises to return money with interest at

3.Foreign Exchange Market

In such type of market, parties are involved in trading of currency. In a foreign

exchange market (also called currency market), one party exchanges one country’s
currency with equivalent quantity of another currency.

4.Predictive Markets

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Predictive market is a set up where exchange of good or service takes place for
future. The buyer benefits when the market goes up and is at a loss when the market

5. Explain the advantages and disadvantages of monopoly. ( Nov 2010)

Advantages of monopoly

 Monopoly avoids duplication and hence wastage of resources.

 A monopoly enjoys economics of scale as it is the only supplier of product or service in

the market. The benefits can be passed on to the consumers.

 Due to the fact that monopolies make lot of profits, it can be used for research and
development and to maintain their status as a monopoly.

 Monopolies may use price discrimination which benefits the economically weaker
sections of the society. For example, Indian railways provide discounts to students

travelling through its network.

 Monopolies can afford to invest in latest technology and machinery in order to be
efficient and to avoid competition.
Disadvantages of monopoly a
 Poor level of service.
 No consumer sovereignty.
 Consumers may be charged high prices for low quality of goods and services.

Lack of competition may lead to low quality and out dated goods and services.

6. Explain the features of monopolistic competition. ( Nov 2010)

Features of Monopolistic Competition:

1. Large Number of Sellers:

There are large numbers of firms selling closely related, but not homogeneous
products. Each firm acts independently and has a limited share of the market. So, an
individual firm has limited control over the market price. Large number of firms leads to
competition in the market.

2. Product Differentiation:

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Each firm is in a position to exercise some degree of monopoly (in spite of large
number of sellers) through product differentiation. Product differentiation refers to
differentiating the products on the basis of brand, size, colour, shape, etc. The product of
a firm is close, but not perfect substitute of other firm.

Implication of ‘Product differentiation’ is that buyers of a product differentiate between

the same products produced by different firms. Therefore, they are also willing to pay
different prices for the same product produced by different firms. This gives some
monopoly power to an individual firm to influence market price of its product.

Explore More about Product Differentiation:

1. The product of each individual firm is identified and distinguished from the products
of other firms due to product differentiation.

2. To differentiate the products, firms sell their products with different brand names, like
Lux, Dove, Lifebuoy, etc.

3. The differentiation among different competing products may be based on either ‘real’
or ‘imaginary’ differences.
c o
(i) Real Differences may be due to differences in shape, flavour, colour, packing, after
sale service, warranty period, etc.
(ii) Imaginary Differences mean differences which are not really obvious but buyers are

made to believe that such differences exist through selling costs (advertising).
4. Product differentiation creates a monopoly position for a firm.

t uof product differentiation (i.e. better brand image) makes demand for
5. Higher degree
the product less elastic and enables the firm to charge a price higher than its
competitor’s products. For example, Pepsodent is costlier than Babool.

6. Some more examples of Product Differentiation:

(i) Toothpaste: Pepsodent, Colgate, Neem, Babool, etc.

(ii) Cycles: Atlas, Hero, Avon, etc.

(iii) Tea: Brooke Bond, Tata tea, Today tea, etc.

(iv) Soaps: Lux, Hamam, Lifebuoy, Pears, etc.

3. Selling costs:

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Under monopolistic competition, products are differentiated and these differences

are made known to the buyers through selling costs. Selling costs refer to the expenses
incurred on marketing, sales promotion and advertisement of the product. Such costs are
incurred to persuade the buyers to buy a particular brand of the product in preference to
competitor’s brand. Due to this reason, selling costs constitute a substantial part of the
total cost under monopolistic competition.

It must be noted that there are no selling costs in perfect competition as there is perfect
knowledge among buyers and sellers. Similarly, under monopoly, selling costs are of
small amount (only for informative purpose) as the firm does not face competition from
any other firm.

4. Freedom of Entry and Exit:

Under monopolistic competition, firms are free to enter into or exit from the
industry at any time they wish. It ensures that there are neither abnormal profits nor any
abnormal losses to a firm in the long run. However, it must be noted that entry under

monopolistic competition is not as easy and free as under perfect competition.

5. Lack of Perfect Knowledge:

c o
Buyers and sellers do not have perfect knowledge about the market conditions.

Selling costs create artificial superiority in the minds of the consumers and it becomes

very difficult for a consumer to evaluate different products available in the market. As a

result, a particular product (although highly priced) is preferred by the consumers even if
other less priced products are of same quality.

6. Pricing Decision:

A firm under monopolistic competition is neither a price- taker nor a price-maker.
However, by producing a unique product or establishing a particular reputation, each
firm has partial control over the price. The extent of power to control price depends
upon how strongly the buyers are attached to his brand.

7. Non-Price Competition:

In addition to price competition, non-price competition also exists under

monopolistic competition. Non-Price Competition refers to competing with other firms
by offering free gifts, making favourable credit terms, etc., without changing prices of
their own products.

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Firms under monopolistic competition compete in a number of ways to attract

customers. They use both Price Competition (competing with other firms by reducing
price of the product) and Non-Price Competition to promote their sales.

7. Explain the main features of oligopoly. ( April 2011)

Features of Oligopoly:

The main features of oligopoly are elaborated as follows:

1. Few firms:

Under oligopoly, there are few large firms. The exact number of firms is not
defined. Each firm produces a significant portion of the total output. There exists severe
competition among different firms and each firm try to manipulate both prices and
volume of production to outsmart each other. For example, the market for automobiles in
India is an oligopolist structure as there are only few producers of automobiles.

The number of the firms is so small that an action by any one firm is likely to

affect the rival firms. So, every firm keeps a close watch on the activities of rival firms.

2. Interdependence:
Firms under oligopoly are interdependent. Interdependence means that actions of

one firm affect the actions of other firms. A firm considers the action and reaction of the

rival firms while determining its price and output levels. A change in output or price by
one firm evokes reaction from other firms operating in the market.

For example, market for cars in India is dominated by few firms (Maruti, Tata,
Hyundai, Ford, Honda, etc.). A change by any one firm (say, Tata) in any of its vehicle
(say, Indica) will induce other firms (say, Maruti, Hyundai, etc.) to make changes in their
respective vehicles.

3. Non-Price Competition:

Under oligopoly, firms are in a position to influence the prices. However, they try
to avoid price competition for the fear of price war. They follow the policy of price
rigidity. Price rigidity refers to a situation in which price tends to stay fixed irrespective
of changes in demand and supply conditions. Firms use other methods like advertising,
better services to customers, etc. to compete with each other.

If a firm tries to reduce the price, the rivals will also react by reducing their prices.
However, if it tries to raise the price, other firms might not do so. It will lead to loss of

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customers for the firm, which intended to raise the price. So, firms prefer non- price
competition instead of price competition.

4. Barriers to Entry of Firms:

The main reason for few firms under oligopoly is the barriers, which prevent entry
of new firms into the industry. Patents, requirement of large capital, control over crucial
raw materials, etc, are some of the reasons, which prevent new firms from entering into
industry. Only those firms enter into the industry which is able to cross these barriers. As
a result, firms can earn abnormal profits in the long run.

5. Role of Selling Costs:

Due to severe competition ‘and interdependence of the firms, various sales

promotion techniques are used to promote sales of the product. Advertisement is in full
swing under oligopoly, and many a times advertisement can become a matter of life-and-
death. A firm under oligopoly relies more on non-price competition.

Selling costs are more important under oligopoly than under monopolistic competition.

6. Group Behaviour:
c o
Under oligopoly, there is complete interdependence among different firms. So,

price and output decisions of a particular firm directly influence the competing firms.

Instead of independent price and output strategy, oligopoly firms prefer group decisions

that will protect the interest of all the firms. Group Behaviour means that firms tend to
behave as if they were a single firm even though individually they retain their
independence. d
7. Nature of the Product:

The firms under oligopoly may produce homogeneous or differentiated product.

i. If the firms produce a homogeneous product, like cement or steel, the industry
is called a pure or perfect oligopoly.

ii. If the firms produce a differentiated product, like automobiles, the industry is
called differentiated or imperfect oligopoly.

8. Indeterminate Demand Curve:

Under oligopoly, the exact behaviour pattern of a producer cannot be determined

with certainty. So, demand curve faced by an oligopolist is indeterminate (uncertain). As

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firms are inter-dependent, a firm cannot ignore the reaction of the rival firms. Any change
in price by one firm may lead to change in prices by the competing firms. So, demand
curve keeps on shifting and it is not definite, rather it is indeterminate.


1. Mention the features of perfect competition. ( April 2012)

Main Features of Perfect Competition

The following are the characteristics or main features of perfect competition :-

1. Many Sellers

In this market, there are many sellers who form total of market supply.
Individually, seller is a firm and collectively, it is an industry. In perfect competition,
price of commodity is decided by market forces of demand and supply. i.e. by buyers and

sellers collectively. Here, no individual seller is in a position to change the price by

controlling supply. Because individual seller's individual supply is a very small part of
total supply. So, if that seller alone raises the price, his product will become costlier than

other and automatically, he will be out of market. Hence, that seller has to accept the

price which is decided by market forces of demand and supply. This ensures single price

in the market and in this way, seller becomes price taker and not price maker.

2. Many Buyers
y n
Individual buyer cannot control the price by changing or controlling the demand.

t u
Because individual buyer's individual demand is a very small part of total demand or

SIn this way, all buyers are price takers and not price makers. This also
market demand. Every buyer has to accept the price decided by market forces of demand
and supply.
ensures existence of single price in market.

3. Homogenous Product

In this case, all sellers produce homogeneous i.e. perfectly identical products. All
products are perfectly same in terms of size, shape, taste, colour, ingredients, quality,
trade marks etc. This ensures the existence of single price in the market.

4. Zero Advertisement Cost

Since all products are identical in features like quality, taste, design etc., there is
no scope for product differentiation. So advertisement cost is nil.

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5. Free Entry and Exit

There are no restrictions on entry and exit of firms. This feature ensures existence
of normal profit in perfect competition. When profit is more, new firms enter the market
and this leads to competition. Entry of new firms competing with each other results into
increase in supply and fall in price. So, this reduces profit from abnormal to normal level.

When profit is low (below normal level), some firms may exit the market. This
leads to fall in supply. So remaining firms raise their prices and their profits go up. So
again this ensures normal level of profit.

6. Perfect Knowledge

On the front of both, buyers and sellers, perfect knowledge regarding market and
pricing conditions is expected. So, no buyer will pay price higher than market price and
no seller will charge lower price than market price.

7. Perfect Mobility of Factors

This feature is essential to keep supply at par with demand. If all factors are easily

mobile (moveable) from one line of production to another, then it becomes easy to adjust
supply as per demand.

Whenever demand is more additional factors should be moved into industry to

increase supply and vice versa. In this way, with the help of stable demand and supply,

we can maintain single price in the Market.
8. No Government Intervention

t u has been controlled by the forces of demand and supply, there is no

Since market
government intervention in the form of taxes, subsidies, licensing policy, control over the
supply of raw materials, etc.

9. No Transport Cost

It is assumed that buyers and sellers are close to market, so there is no transport
cost. This ensures existence of single price in market.

2. Briefly classify markets. ( Nov 2013)

Classification or Types of Market

The classification or types of market are depicted in the following chart.

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c o
Generally, the market is classified on the basis of:
1. Place, a
2. Time and
3. Competition.
On the basis of Place, the market is classified into:

Local Market or Regional Market.

2. National Market or Countrywide Market.

3. International Market or Global Market.

On the basis of Time, the market is classified into:

1. Very Short Period Market.

2. Short Period Market.

3. Long Period Market.

4. Very Long Period Market.

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On the basis of Competition, the market is classified into:

1. Perfectly Competitive Market Structure.

2. Imperfectly Competitive Market Structure.

Both these market structures widely differ from each other in respect of their features,
price, etc. Under imperfect competition, there are different forms of markets like
monopoly, duopoly, oligopoly and monopolistic competition.

1. A monopoly has only one or a single (mono) seller.

2. Duopoly has two (duo) sellers.

3. Oligopoly has little or fewer (oligo) number of sellers.

4. Monopolistic competition has many or several numbers of sellers.

3. Explain the equilibrium of monopolistic competition. ( April 2014)

Equilibrium under monopolistic competition
In the short run supernormal profits are possible,c
. but in the long run new firms are
attracted into the industry, because of lowbarriers to entry, good knowledge and an
opportunity to differentiate.
a run
Monopolistic competition in the short

At profit maximisation, MC = MR, and output is Q and price P. Given that price (AR) is

above ATC at Q, supernormal profits are possible (area PABC).

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As new firms enter the market, demand for the existing firm’s products becomes
more elastic and the demand curve shifts to the left, driving down price. Eventually, all
super-normal profits are eroded away.

Monopolistic competition in the long run

Super-normal profits attract in new entrants, which shifts the demand curve for
existing firm to the left. New entrants continue until only normal profit is available. At
this point, firms have reached their long run equilibrium.

c o
Clearly, the firm benefits most when it is in its short run and will try to stay in the short
run by innovating, and further product differentiation.

Examples of monopolistic competition

Examples of monopolistic competition can be found in every high street.

Monopolistically competitive firms are most common in industries where differentiation

is possible, such as:

 The restaurant business

 Hotels and pubs
 General specialist retailing
 Consumer services, such as hairdressing

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The survival of small firms

The existence of monopolistic competition partly explains the survival of small

firms in modern economies. The majority of small firms in the real world operate in
markets that could be said to be monopolistically competitive.

The advantages of monopolistic competition

1. There are no significant barriers to entry; therefore markets are relatively contestable.
2. Differentiation creates diversity, choice and utility. For example, a typical high street in
any town will have a number of different restaurants from which to choose.
3. The market is more efficient than monopoly but less efficient than perfect competition -
less allocatively and less productively efficient. However, they may be dynamically
efficient, innovative in terms of new production processes or new products. For example,
retailers often constantly have to develop new ways to attract and retain local custom.

The disadvantages of monopolistic competition

. c
There are several potential disadvantages associated with monopolistic competition,
1. Some differentiation does not create utility but generates unnecessary waste, such as
excess packaging. Advertising may also be considered wasteful, though most is

informative rather than persuasive.

2. As the diagram illustrates, assuming profit maximisation, there is allocative inefficiency

in both the long and short run. This is because price is above marginal cost in both cases.
In the long run the firm is less allocatively inefficient, but it is still inefficient.

4. Describe the criteria for market segmentation. ( April 2011)

There are following criteria for an effective segmentation:

i. Measurable and Obtainable:

The size, profile and other relevant characteristics of the segment must be
measurable and obtainable in terms of data.

It has to be possible to determine the values of the variables used for segmentation
with justifiable efforts. This is important especially for demographic and geographic

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variables. For an organisation with direct sales (without intermediaries), the own
customer database could deliver valuable information on buying behaviour (frequency,
volume, product groups, mode of payment etc).

ii. Relevant:

The size and profit potential of a market segment have to be large enough to
economically justify separate marketing activities for this segment. If a segment is small
in size then the cost of marketing activities cannot be justified.

iii. Accessible:

The segment has to be accessible and servable for the organisation. That means,
the customer segments may be decided considering that they can be accessed through
various target-group specific advertising media such as magazines or websites the target
audience likes to use.

iv. Substantial:

The segments should be substantial to generate required returns. Activities with

small segments will give a biased result or negative results.
v. Valid:
This means the extent to which the base is directly associated with the differences

in needs and wants between the different segments. Given that the segmentation is
essentially concerned with identifying groups with different needs and wants, it is vital

that the segmentation base is meaningful and that different preferences or needs show

clear variations in market behaviour and response to individually designed marketing


vi. Unique or Distinguishable or Differentiable:

The market segments have to be that diverse that they show different reactions to
different marketing mixes. If not then there would have been no use to break them up in

vii. Appropriate:

The segments must be appropriate to the organisation’s objectives and resources.

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viii. Stable:

The segments must be stable so that its behaviour in the future can be predicted
with a sufficient degree of confidence.

ix. Congruous:

The needs and characteristics of each segment must be similar otherwise the main
objective of segmentation will not be served. If within a segment the behaviour of
consumers are different and that they react differently, then a unique marketing strategy
cannot be implemented for everyone. This will call for a further segmentation.

x. Actionable or Feasible:

It has to be possible to approach each segment with a particular marketing

programme and to draw advantages from that. The segments that a company wishes to
pursue must be actionable in the sense that there should be sufficient finance, personnel
and capability to take them all. Hence, depending upon the reach of the company, the
segments must be selected.
xi. Some general considerations:
c o
Apart from the above-mentioned characteristics, the segment must have some
other features:
i. Growth potential

ii. Profitable

t u
iii. Less risk prone

iv. LessS
competition intensive

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