MBA I Sem Managerial Economics1733213942352
MBA I Sem Managerial Economics1733213942352
MBA I Sem Managerial Economics1733213942352
FIRST SEMESTER
MANAGERIAL ECONOMICS
Unit - I
Managerial Economics: Basic Concept & Principles
What is Economics?
Economics is the study of firm, households, price, wage, income, industry and commodity either particularly
or aggregate. Economics deals with basically two forces i.e. demand and supply. Where consumer deals with
demand and producer deals with supply. The place where consumer and supplier interact called market.
In other words: Economics is the study of scarcity and its implications for the use of resources, production of
goods and services, growth of production and welfare over time, and a great variety of other complex issues
of vital concern to society.
According to Joel Dean, “The purpose of Managerial economics is to show how economic analysis can be
used in formulating business policies.”
Managerial Economics thus lies on the borderline between economics and business management and serves
as a bridge the two discipline (See Chart )
4. Capital Management:
Of the various types and classes of business problems, the most complex ad troublesome for the business
manager are likely to be those relating to the firm‟s capital investment. Relatively large sums are involved,
and the problems are so complex that their disposal not only requires considerable time and labour but is a
matter for top-level decision. Briefly, capital management implies planning and control of capital expenditure.
The main topics dealt with are: Cost of Capital, Rate of Return and Selection of Projects.
5. Profit Management:
Business firms are generally organized for the purpose of making profits and, in the long run, profits provides
the chief measure of success. In this connection, an important point worth considering is the element of
uncertainty existing about profits because of variations in costs and revenue which, in turn, are caused by
factors both internal and external to the firm. If knowledge about the future were perfect, profit analysis
would have been a very easy task. However, in a world of uncertainty, expectations are not always realized so
that profit planning and measurement constitute the difficult area of Managerial Economic, The important
aspects covered under this area: Nature and Measurement of Profit, Profit policies and Techniques of Profit
Planning like Break Even Analysis.
2. Marginal Principle:
Marginal analysis implies judging the impact of a unit change in one variable on the other. Marginal generally
refers to small changes. Marginal revenue is change in total revenue per unit change in output sold.
3. Incremental Principle:
Incremental concept is closely related to the marginal costs and marginal revenues, for of economic theory. In
actual business situations it often becomes difficult to apply the concept of marginalism which has to be
replaced by incrementalism for in Real world business, one is concerned with not 'unit change' but 'chunk
change'. For instance, in a construction project. The labour which a contractor may change is not by one but
why tens.
Incremental concept involve estimation the impact of decisions alternative on cost and revenues emphasizing
the changes in the total cost and total revenue resulting from change in prices, products, procedures,
investment or whatever may be at stake in the decision.
4. Discounting Principles:
One of the fundamental Idea as in economics is that rupee tomorrow is worth less than a Rupee today. This
seems similar to saying that a bird in hand is worth two in the bush.
"If a decision effect cost and revenues and future dates, it is necessary to discount those costs and revenue to
present value before a valid comparison of alternatives is possible.”
6. Equi-marginal Principle:
This principle deals with the allocation of available resources among the alternative activities. According to
this principle, an output should be so allocated that the value added by the last unit is the same in all cases.
This generalization is called the Equi-marginal principle.
Suppose, a firm has 100 unit of labour at its disposal. The firm engaged in four activities which needs labour
services, viz A, B, C and D. It can enhance any one of these activity by adding more labour but only at the
cost of other activities.
2. Business Operations:
A managerial Economist can also be helpful to the management in making decisions relating to the internal
operations of a firm in respect of such problems as price, investment, expansion etc. Certain relevant
questions in this context would be as follows:
1. What will be a reasonable sales and profit budget for the next year?
2. What will be the most appropriate production schedules and inventory polices for the next six months?
3. What changes in wage and price polices, should be made now?
4. How much cash will be available next month and how should it be invested?
3. Economic Intelligence:
Besides these functions involving sophisticated analysis, managerial economist may also provide general
intelligence service supplying management with economic information of general interest such as competitors
prices and products, tax rates, tariff rates, etc. In fact, a good deal of published material is already available
and it would be useful for a firm to have someone who understands it. The managerial economist can do the
job with competence.
5. Indian Context:
In the Indian context, a managerial economist is expected to perform the following functions:
1. Macro-forecasting for demand and supply
2. Production planning at macro and micro levels
3 .Capacity planning and product-mix determination
4. Economics of various production lines
5. Economics feasibility of new production lines/process and projects
6. Assistance in preparation of overall development plans
7. Preparing briefs, speeches, articles and papers for top management for various Chambers, Committees,
Seminars, Conferences, etc.
6. Specific Functions:
1. Sales Forecasting
2. Industrial Market Research
3. Economic Analysis of Competing Companies
4. Pricing Problems of Industry
5. Capital Projects
6. Production Programmes
7. Security/ Investment Analysis and Forecasts
8. Advice on Public And Trade Relation
9. Advice on Foreign Exchange
10. Economic Analysis of Agriculture
Responsibilities of Managerial Economist:
1. Arrangements of Resources
2. Reasonable Profit on Capital
3. Successful Forecast
4. His Status in the Firm
5. To Caution Against Errors
6. Amicable Relations
7. Evaluation of Decisions
8. Effective Co-ordination
9. Determination of Decision Making Process
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MASTER OF BUSINESS ADMINISTRATION (MBA)
FIRST SEMESTER
MANAGERIAL ECONOMICS
Unit - II
Theory of Demand: Meaning
Demand in economics means desire to buy backed by adequate purchasing power. Mere desire or wish cannot
buy goods. The demand for goods, therefore, denotes that someone is able and willing to buy the goods. For
example, everyone can desire to possess Premier Audi Car but only a few have the ability to buy it. So
everybody cannot be said to have a demand for the car.
“Demand is an effective desire” -Prof. Pension
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Types of Demand:
1. Joint demand
Joint demand is the demand for complementary products and services. These can be products that are
accessories for others or that people commonly purchase together. For example, cereal and milk or peanut
butter and jelly. The two are linked, but the demand for one is not necessarily dependent on the demand for
the other.
2. Composite demand
Composite demand happens when there are multiple uses for a single product. For example, corn can be used
as animal feed, ethanol and food in its whole form. The rise in demand for any of these products leads to a
shortage in supply for the others. This shortage can lead to a rise in price.
3. Short-run and long-run demand:
Short-run demand refers to how people will immediately react to price changes while elements are fixed. For
example, if the demand for a product drastically decreases and a manufacturer has high overhead costs, they
have no choice but to absorb the profits lost. Over time, or in the long run, companies have a chance to adjust
to the new situation by decreasing labor or increasing prices and supplies.
4. Price demand:
Price demand relates to the amount a consumer is willing to spend on a product at a given price. Businesses
use this information to determine at what price point a new product should enter the market. Consumers will
buy items based on their perception of that product's value. Price elasticity refers to how the demand will
change with fluctuations in price.
5. Income demand:
As consumers make more income, quantity demand increases. This means people will buy more overall when
they earn more income. Tastes and expectations also change with an increase in income, reducing the size of
one market and increasing the size of another. Consumers will often buy a product or service because it is
what they can afford but may deem it lower quality. The demand for those lower-quality products will
decrease as income increases.
6. Competitive demand:
Competitive demand occurs when there are alternative services or products a customer can choose from.
From a business's perspective, they can use fluctuations in the price of their competitors to determine how
their own will sell. An example of this is between name-brand and store-brand medicine. If a consumer
prefers a name brand but it is out of stock or the price increases significantly, the store brand will see a rise in
sales.
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7. Direct and derived demand:
Direct demand is the demand for a final good. Food, clothing and cell phones are an example of this. Also
called autonomous demand, it's independent of the demand for other products.
Derived demand is the demand for a product that comes from the usage of others. For example, the demand
for pencils will result in the demand for wood, graphite, paint and eraser materials. In this example, the
demand for wood is dependent on the demand for its uses.
Derived demand is similar to joint demand because of its connection to other products. It is different from
joint demand because it is dependent on the final product to generate a need. Without the need for those end
products, there is no demand for the intermediate product.
Determinants of Demand
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2. Price of Related Goods:
There are two types of related goods-
1. Complementary goods
2. Substitute or competing goods
3. Consumer’s Income:
To analysis the impact of Income on the demand, the goods can be divided into two
categories:
1. Inferior goods 2. Superior goods
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4. Consumer’s Taste and Preferences:
Taste and preferences of consumer also plays a very important role in determining the demand of a
commodity. The goods, which are preferred by consumer or which are in fashion, will cover a goods, which
are out of fashion. For example, the demand for LED TV is higher than of LCD TV This is because LED TV
is preferred by consumer.
5. Consumer Expectations:
Customer expectations are any set of behaviors or actions that individuals anticipate when interacting with a
company. For Example:
*Quick and easy resolutions to customer complaints
*Access to preferred service channels
*Opportunities to answer questions themselves via help centers
*Personalized experience
*Data protection and privacy
6. Advertisement Expenditure: The purpose and effect of successful advertising is to increase the demand,
that is, to shift the demand curve for the product to the right.
7. Demonstration Effects: If a business, system, etc. has a demonstration effect, othersare influenced by it
and Try to copy it: Multinational hotel companies not only increased tourism on the island but also produced
a strong demonstration effect among local establishments.
8. Population of the Country:
The reason for this is that due to the increase (or decrease) of population size, the number of buyers of the
product increases (or decreases), the structure of the population also affects the demand; for example the
demand for goods for women increases when the population has a larger number of women.
9. Distribution of National Income:
Distribution of Income: Market demand is also influenced by changes in income distribution in society. If
income is evenly distributed, then there will be more demand. If the income is distributed unequally, then
more demand will concentrate on rich people.
Demand Function:
Demand function expresses the functional relationship between demand of the commodity and various factors
affecting it. In other words, demand function describes the relationship between quantities of the commodity
which consumers demand during the specific period and the factor which influence the demand
Demand Schedule:
In elementary economics, the relationship of price to sales or demand, or alternatively, the Price-Quantity
Relation, as it is often called is shown arithmetically in the form of table showing prices and corresponding
quantities. This table is known as „Demand Schedule‟.
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In other simple words, In economics, a demand schedule is a table that shows the quantity demanded of a
good or service at different price levels. A demand schedule can be graphed as a continuous demand curve on
a chart where the Y-axis represents price and the X-axis represents quantity.
Demand Curve:
The demand curve is a graphical representation of the relationship between the price of a good or service and
the quantity demanded for a given period of time. In a typical representation, the price will appear on the left
vertical axis, the quantity demanded on the horizontal axis.
Law of Demand:
Law of demand states that there is an inverse relation between the price of a commodity and its quantity
demanded, assuming all other factors affecting demand remain constant. It means that when the price of a
good falls, the demand for the good rises and when price rises, the demand falls.
Definition of Law of Demand:
According to Professor Marshall, “The greater amount to be sold, the smaller must be price at which it is
offered in order that it may find purchaser, or, in other words, the amount demand increases with a fall in
price and diminishes with a rise price.”
Chief Characteristics of Law of Demand:
1. Inverse relationship
2. Price, an independent variable, and demand, a dependent variable.
3. Other things remain the same
4. Reasons underlying the law of Demand (a) Income Effect (b) Substitution Effect
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Exceptions to the Law of Demand:
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Shifts in demand curve:
A shift in the demand curve occurs when a determinant of demand other than price changes. It occurs when
demand for goods and services changes even though the price didn't. Although different goods and services
will have different demand shifters, the demand shifters are likely to include.
(1) Consumer Preferences
(2) The prices of related goods and services
(3) Income
(4) Demographic Characteristics
(5) Buyer Expectations.
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Types-Elasticity of Demand
1. Price Elasticity
2. Income Elasticity
Types
Elasticity
3. Arc Elasticity
of
4. Cross Elasticity
Demand
5. Advertising Elasticity.
Price elasticity:
Price elasticity of demand is the ratio of the percentage change in quantity demanded of a product to the
percentage change in price. Economists employ it to understand how supply and demand change when a
product's price changes.
Income Elasticity:
The income of consumer in another basic demand determined and affects the elasticity of demand. The
responsiveness of demand to the change in income is called the “Income Elasticity of Demand.” It is the rate
of change in quantity with respect to change in the income, if other things remaining the same. Income shows
a positive relationship with the demand, except the demand of inferior goods that shows a negative
relationship.
Arc Elasticity:
Arc elasticity is the sensitivity of one variable to another between two points on a curve. It is often used in the
context of the law of demand to measure the inverse relationship between price and demand. Arc elasticity
measures the responsiveness of demand to price changes over a range of values.
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Cross Elasticity:
Cross elasticity of demand refers to the way that changes in the price of one good can affect the quantity
demanded of another good. This relationship can vary depending on whether the two goods are substitutes,
complements, or unrelated to each other.
Advertising Elasticity:
Advertising elasticity is a measure of an advertising campaign's effectiveness in generating new sales.
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MASTER OF BUSINESS ADMINISTRATION (MBA)
FIRST SEMESTER
MANAGERIAL ECONOMICS
Unit - III
Production function:
The term “production function” refers to the relationship between the inputs and the outputs produced by
them. The term “factor of production” and “resources” are used interchangeably with the term “inputs”. The
relationship is purely physical or technological in character, that is, it ignores the prices of inputs and outputs.
The study of the production function is directed towards establishing the maximum output which can be
achieved with a given set of resources or inputs and with a given state of technology.
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Definition of production function:
According to Samuelson, “The production function is the technical relationship telling the amount of output
capable of being produced by each and every set of specified input (of factors of production). It is defined for
a given state of technical knowledge.”
According to Leftwich, “The term production function is applied to the physical relation between a firm’s
input of resources and its output of goods or services per unit of time.”
According to Lipsey & Steiner, “The technical relation between inputs and outputs is referred to in economics
as the Production Function.”
Laws of Production:
Law of Diminishing Return:
This rule is called by the names of Law of Diminishing Marginal Origin, Law of Variable Proportions, Law
of Diminishing Returns, etc. Classical economists have described the diminishing origin rule in the field of
production. Ricardo's Rent Theory and Malthus's Population Theory are based on this rule. This law has been
defined in various ways by classical and modern economists.
Classical Approach:
According to Marshall, “An increase in the capital and labour employed in the cultivation of land causes in
general a less than proportionate increase in the amount the produce raised, unless it happens to coincide with
an improvement in the art of agriculture.”
The main points of Marshall's definition are as follows:
1. The yield of agriculture does not increase in proportion to the increase in the quantity of labor and capital.
2. This rule applies under normal circumstances.
3. There should be no progress in agriculture.
Average Marginal
Unit of Labour & Capital Total Production
Production Production
1 50 50 50
2 90 45 40
3 120 40 30
4 140 35 20
5 150 30 10
6 150 25 0
7 140 20 -10
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Important Feature in Diminishing Production:
1. Production refers to marginal production; it has nothing to do with the cost of production.
2. The rule applies only when increasing labor or other means by keeping one means of production i.e. land
constant.
3. Marginal product decreases by increasing factors only after a particular stage of production.
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(B) Changes in Scale:
Scale can be defined as the number of times all the ratios are repeated i.e. the number of times the fixed and
variable factors are increased the more it establishes the scale of the firm. In simple words increase in scale
means all the factors increase in same proportion.
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Cost Output relationship in the Long-run:
The conditions of production in the long run are different from the conditions of production in the short run.
To change the quantity of production in the short run only the quantity of variable factors has to be changed
while it is not possible to change the quantity of fixed factors i.e. in the short run a firm cannot change the
size of its plant but in the long run The time is enough that it can also change its plant according to the supply.
In the long run the factors of production cannot be divided into variable factors and fixed factors because in
the long run all the factors of production are variable. Therefore, to increase the amount of production, the
quantity of all factors of production can be increased, that is, in the long run, a firm can also change the size
of its plant, therefore, in the long run, there is no fixed cost for a firm, but all costs are variable.
Since all costs are variable in the long run, only the following two occur in the long run-
Short-run Cost Trends (Per Unit Cost) In Rs. Long-run Cost
Estimation of revenue:
Revenue estimation involves calculating the amount of money your business is likely to earn. You can work
this out by forecasting your business growth rate, the number of customers you have (and will have) and the
prices of your products and services.
Total Revenue:
Total revenue is the total amount of money a company brings in from selling its goods and services. It
determines how well a company is bringing in money from its core operations based on demand and price.
Total Revenue = Unit Sold of Commodity (Q) x Price Per Unit (P)
Average Revenue:
Average revenue is referred to as the revenue that is earned per unit of output. In other words, it is the revenue
that is obtained by the seller on selling each unit of the commodity. Average revenue of a business is obtained
by dividing the total revenue with the total output.
Average Revenue = Total Revenue / Total Unit Sold
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Marginal Revenue:
Marginal revenue is the increase in revenue that results from the sale of one additional unit of output. While
marginal revenue can remain constant over a certain level of output, it follows from the law of diminishing
returns and will eventually slow down as the output level increases.
Marginal Revenue = Change in Total Revenue/Change in Quantity
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MASTER OF BUSINESS ADMINISTRATION (MBA)
FIRST SEMESTER
MANAGERIAL ECONOMICS
Unit - IV
Meaning of Market:
In common parlance, the term „Market‟ refers to a particular place when goods are bought and sold. However,
in Economics the term market has a wider meaning.
In economics, the term „market‟ has no reference to a particular place. The buyers and sellers need not
assemble anywhere. They may be living in distant places. They are coming together unnecessary. They can
do business with the help of Telephone, Telegraph, Ordinary Post or by any other online medium..
Definition of Market:
According to J. M Edwards, “A market is that mechanism by which buyers and sellers are bought together. It
is not necessarily a fixed place.”
According to Joan Robinson, “Market, a means by which the exchange of goods and services takes place as a
result of buyers and sellers being in contact with one another, either directly or through mediating agents or
institutions.”
Market Structures:
Market structure shapes the most important features of a market, including the level of competition, the type
and volume of transaction costs, and the power of firms to influence the terms on which they trade with other
economic factors. Market structure reflects three key elements: the number and relative size of sellers and
buyers, brand diversity, the convenience of entry and potential for exit. At the fundamental level, it comes
down to the nature of competition and how well it encourages and weeds out innovation, quality and cost-
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cutting. It determines whether pricing decisions are obvious or hard to measure and whether new and better
goods and services can enter or replace outdated ones.
Definition:
“Market structure refers to the way that various industries are classified and differentiated inaccordance with
their degree and nature of competition for products and services.”
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Imperfect Market Structures:
Imperfect markets are characterized by having competition for market share, high barriers to entry and exit,
different products and services, and a small number of buyers and sellers. Perfect markets are theoretical and
cannot exist in the real world; all real-world markets are imperfect markets.
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We can study price determination under perfect competition under the following heads.
1. Price Determination by Industry
2. Equilibrium or Price Determination of Firm
3. Importance of Time Element in the Price Determination
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Main feature of Equilibrium:
1. Equilibrium means the absence of change, that is, in this situation the firm does not want to make any
change in its price or quantity of production.
2. The firm reaches the stage of stagnation when it gets maximum profit.
3. In the equilibrium state, the cost of production of the firm is minimum
Monopoly: Meaning:
By monopoly, we mean that market situation in which a single producer or firm has complete control over the
supply of a specific commodity.
Definition:
According to Boulding, “A pure Monopolist, therefore, is a firm producing a product which has no effective
substitutes among the products of any other firm „effective‟ in the sense though the monopolist may be
making abnormal profits, other firms cannot encroach on these profits by producing substitute commodities
which might entire purchase away from the product of the monopolist.
Feature of Monopoly:
1. Single Producer or Seller
2. Firm and Industry are Synonymous
3. No Near Effective Substitute
4. Effective Control on Entry of New Firm
5. Independence Price Policy
6. Price Discrimination Possible
7. Full Control on Supply of Goods
8. Abnormal Profit on Long Period
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Pricing Under Monopoly
1. Total Revenue & Total Cost Curves Approach 2. Marginal Analysis
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Definition:
According to Mrs. Joan Robinson, “The act of selling the same article produced under a single control, at
different prices to different buyers is known as price discrimination.”
According to Prof. Stigler, “Price discrimination is defined as the sale of a commodity at two or more prices.”
Monopolistic:
Monopolistic competition refers to a situation in which the seller's products are so differentiated that they are
not complete substitutes for each other. Each producer or seller has a complete monopoly on his product, but
since he has to face competition with incompletely established products in the market, such a situation is
called a monopoly situation.
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Definition:
According to Prof. Leftwitch, “Monopolistic Competition is a market situation in which there are many
sellers of particular product but the product of each is in some way differentiated in the minds of consumers
from the product of other product.”
Features:
1. Large Number of Sellers
2. Product Differentiation of Product Heterogeneity
3. Free Entry of Firm
4. Selling Cost
5. Each Firm is monopolist for its Product
6. Consumer reveals his Preference
7. Existence of both Monopoly and Competition
8. No Restrictions
Product Differentiation:
Product Differentiation is the characteristic or characteristics that make your product or service stand out to
your target audience. It's how you distinguish what you sell from what your competitors do, and it increases
brand loyalty, sales, and growth.
In other words, “Differentiated Product” refers to products that can remain competitive despite being put
against competing products that are very similar. Cars, smart phones, computers, shoes, and perhaps most
notably, bottled water
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Oligopoly:
An oligopoly is a market characterized by a small number of firms who realize they are interdependent in
their pricing and output policies. The number of firms is small enough to give each firm some market power.
Definition:
According to Leftwich, “Market conditions are called oligopoly conditions in which there are a small number
of sellers and so many that the actions of one are important to others.”
Features of Oligopoly:
1. Few Numbers of Sellers
2. Inter-dependence
3. Differential Product
4. Difficult Entry and Exit of New Firm
5. Uncertainty of the Demand Curve
6. Advertisement Activities
7. Price Rigid
8. Group Behavior
9. Inconsistency
Cartels:
“A group of separate companies, that agree to increase profits by fixing prices and not competing with each
other.”
Cartelization or coalition or cartel is also prevalent in imperfect oligopoly market. Cartelization can be either
complete or incomplete. Under perfect cartelization, a central body determines the price and quantity of
output for all oligopolistic firms so that all firms can get maximum profit. Under incomplete cartelization,
there is no such central body that controls price and quantity of product on oligopolistic firms. No tight
controls can be imposed, but only good men's agreements between firms and each form has the right to vary
the price and quantity of production to some extent.
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Assumptions of kinked Demand theory:
1. It is assumed that if one firm cuts its price, other firms will also follow it, so reducing the price of the
commodity will not give any special benefit to one firm.
2. It is assumed that the oligopolistic industry is in a mature stage. This stage can occur without product
differentiation and with product differentiation. Therefore, without any coalition, the industry can establish a
price or price pool that is considered satisfactory to all firms.
3. It is assumed that if one firm increases the price, the other firms will not follow it i.e. will not increase the
price.
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Price Leadership:
Price leadership refers to a situation where prices and price changes established by a dominant firm, or a firm
are accepted by others as the leader, and which other firms in the industry adopt and follow. For example, if
companies in a particular market follow a price leader by setting higher prices, then all producers in that
market stand to profit, as long as demand remains steady. Price leadership also has the potential to eliminate
(or reduce) price wars.
According to Arthur Burns, “Price competition comes under price leadership if the same price changes are
always or often carried out by the same firm and if other sellers always or often follow the same price
changes.”
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MASTER OF BUSINESS ADMINISTRATION (MBA)
FIRST SEMESTER
MANAGERIAL ECONOMICS
Unit - V
National Income
National Income is referred to as the total monetary value of all services and goods that are produced by a
nation during a period of time.
In other words, it is the sum of all the factor income that is generated during a production year. National
income serves as an indicator of the nation's economic activity.
Definition:
According to Prof. Alfred Marshall, “The labor and capital of a country acting on its natural resources
annually produce a net aggregate of commodities, material and immaterial including services of all kinds”
According to National Income committee of India, “National Income estimates measures the value of
commodities and services turned out during a given period”
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1. Product Method:
This method views national income from the output side. The production method is also known as Value
Added Method. Net Output Method or simply Output method.
This method consists of finding out the Net Value of all commodities and services produced in various sectors
of the economy during a year and adding them up. The total obtained is called the Final Products Total.
Under this method first of all, the economy of a country is divided into different sectors such as agriculture,
manufacturing, trade, transport, communications, mining, constructions, banking, insurance, electricity, gas
and water supply and so on. Then the value of gross product of all producers in a sector is totaled up and from
this summation is subtracted the value of intermediate products in order to avoid double counting. When we
add up the net figure of this type from each sector, use get GNP
This production method enables us to trace the origin of national income aggregate to different sectors of the
economy. Hence this method is also known as National Income by Industrial Origin.
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Fourthly, illegal income is not in included in GNP because its counting is not possible as they are must most
often not declared and such cannot be accumulated for .
Fifthly, in case of goods and services meant for sell-consumption, for example, farmers produce kept for self-
consumption or self-occupied house of an owner, imputed values of such produce or imputed rent is included
in GNP.
Income Method:
This method is also called Factor Income Method, Factor Share Method, Income Distributed Method or
National Income by Distributive Share Method.
In this method: we calculate national income from distribution side. In other words, this method national
income after it has been distributed and appears as income earned or received by individuals of the country.
According to this method national income is obtained by totalling all the incomes according to the various
factors of production used in producing national product. Thus national income is calculated for example by
adding up the rent of land, wages and salaries of employees, profit of entrepreneurs. Interest on capital and
income of self-employed people.
Notably transfer payments are not counted as national income. For example, if an individuals sells his house,
the purchase price is not income. It is a transfer payment which represents no addition to national output.
Likewise income of a beggar, scholarships to orphans, aid to needy person or relief payments are not counted
as income because they are obtained without producing anything.
Expenditure Method:
National Income under this method, is arrived at by adding up all the expenditure made on the goods and
services during the specific period. As such GNP is found out by totalling:
1. Personal Consumption expenditure (C), that is total of private individuals expenditure on
Consumption of consumer goods and services.
2. Domestic Private investment (I) that is, total of private businesses spending on new investments,
replacement and renewals (that is expenditure on plants and equipment)
3. Net Export of Goods and Services (X-M), is also called loosely as „Foreign Investments‟ in other
words, surplus of all the goods and services we provide to foreigners over and above what they
provide to us. Thus we calculate:
(a) The total of our exports to foreigners (wheat, shipping etc.,) plus our earnings from factors of
production we own abroad (dividends and interest payable to us).
(b) The total what we import from foreigners plus what we must pay them for their ownership of
production factors located in our country.
(c) The surplus of (a) over (b) which represents our net export figures.
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Circular Flow of Income
The circular flow of income or circular flow is a model of the economy in which the major exchanges are
represented as flows of money, goods and services, etc. between economic agents. The flows of money and
goods exchanged in a closed circuit correspond in value, but run in the opposite direction. The circular flow
analysis is the basis of national accounts and hence of macroeconomics.
Two
Sector
Model
Three
Sector
Model
Four
Sector
Model
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Circular Flow of Income - Two Sector Model
In the basic two-sector circular flow of income model, the economy consists of two sectors: Households and
Firms. Some sources refer to Households as Individual or the Public and to Firms as Businesses or the
Productive Sector.
The model assumes that there is no Financial Sector, no Government Sector and no Foreign Sector.
The model assumes that
(a) Through their expenditures, households spend all of their income on goods and services or consumption.
(b) Through their expenditures, households purchase all output produced by firms.
This means that all household expenditures become income for firms. The firms then spend all of this income
on factors of production such as labor, capital and raw materials, transferring all of their income to the factor
owners (which are households). The factor owners (households), in turn, spend all of their income on goods,
which leads to a circular flow of income.
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Circular Flow of Income in two Sector Economy
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Circular Flow of Income - Four Sector Economy:
The Four-Sector Model adds the Foreign Sector to the Three-Sector Model. (The foreign sector is also known
as the External Sector, the Overseas Sector, or the Rest of the World.
Thus, the four-sector model includes:
(1) Households (2) Firms (3) Government (4) the Rest of the world.
The foreign sector comprises:
(a) Foreign Trade (imports and exports of goods and services)
(b) Inflow and Outflow of capital (foreign exchange).
Again, each flow of money has a corresponding flow of goods (or services) in the opposite direction. Each of
the four sectors receives some payments from the other in lieu of goods and services which makes a regular
flow of goods and physical services. The addition of the foreign sector
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Inflation- Meaning:
In economics, Inflation refers to a general increase in the prices of goods and services in an economy. When
the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation
corresponds to a reduction in the purchasing power of money.
Definition:
According to Crowther, “Inflation is a stage in which the volume of money is falling i.e.price are rising.”
According to Milton Friedman, “Inflation is a steady and sustained rise in price.”
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Types of Inflation:
1. Open and Suppressed Inflation
2. Credit Inflation
3. Deficit Induced Inflation
4. Wage Induced Inflation
5. Profit Induced Inflation
6. Demand Induced Inflation
7. Comprehensive and Sectoral Inflation
8. Full or Partial Inflation
9. War Time Inflation
10.Post war Inflation
Causes of Inflation:
1. Demand Pull Inflation
2. Increasing Public Debt
3. Increasing in Private Investment
4. Reduction in Taxes
5. Reduction in Public Debt
6. Increased Money Supply
7. Increase in Population
8. Natural Causes
9. Rising Wages
10.Policies and Regulations
Effect of Inflation:
• Poor Economic Growth
• Increase wages
• Income Distribution
• Unemployment
• International Competitiveness
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Differentiation between Deflation, Stagflation & Inflation:
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Business Cycle:
Meaning:
Business cycles are a type of fluctuation found in the aggregate economic activity of a nation -- a cycle that
consists of expansions occurring at about the same time in many economic activities, followed by similarly
general contractions (recessions). This sequence of changes is recurrent but not periodic.
Definition:
A Business cycle is the natural expansion and contraction of economic growth that happens in an economy
over a period of time. The rise and fall of an economy's gross domestic product (GDP) defines the start and
end of a business cycle, which is also known as an economic cycle or a trade cycle.
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