Economics for Decision Making

INTRODUCTION

�ECONOMICS

for

DECISION MAKING

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Module 1

People have limited number of needs which must be satisfied if they are to survive as human beings. Some are material needs, some are psychological needs and some others are emotional needs. People’s needs are limited; however, no one would choose to live at the level of basic human needs if they want to enjoy a better standard of living.

• This is because human wants (desire for the consumption of goods and services) are unlimited. It doesn’t matter whether a person belongs to the middle class in India or is the richest individual in the World, he or she wants always something more.
• For example bigger a house, more friends, more salary etc., Therefore the basic economic problem is that the resources are limited but wants are unlimited which forces us to make choices

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Economics is the study of this allocation of resources, the choices that are made by economic agents. An economy is a system which attempts to solve this basic economic problem. There are different types of economies; household economy, local economy, national economy and international economy but all economies face the same problem.

The major economic problems are

(i) what to produce?

(ii) How to produce?

(iii) When to produce and

(iv) For whom to produce?

Economics is the study of how individuals and societies choose to use the scarce resources that nature and the previous generation have provided. The world’s resources are limited and scarce. The resources which are not scarce are called free goods. Resources which are scarce are called economic goods

Reasons For Studying Economics

• It is a study of society and as such is extremely important.
• It trains the mind and enables one to think systematically about the problems of business and wealth.
• From a study of the subject it is possible to predict economic trends with some precision.
• It helps one to choose from various economic alternatives.

Economics

Economics is the science of making decisions in the presence of scarce resources.

Resources are simply anything used to produce a good or service to achieve a goal.

Economic decisions involve the allocation of scarce resources so as to best meet the managerial goal.

The nature of managerial decision varies depending on the goals of the manager.

Manager

A Manager is a person who directs resources to achieve a stated goal and he/she has the responsibility for his/her own actions as well as for the actions of individuals, machines and other inputs under the manager’s control.

Managerial economics

Managerial economics is the study of how scarce resources are directed most efficiently to achieve managerial goals. It is a valuable tool for analyzing business situations to take better decisions.

Managerial economics- Definitions

• Prof. Evan J Douglas defines Managerial Economics as “Managerial Economics is concerned with the application of economic principles and methodologies to the decision making process within the firm or organization under the conditions of uncertainty”

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• According to Milton H Spencer and Louis Siegelman “Managerial Economics is the integration of economic theory with business practices for the purpose of facilitating decision making and forward planning by management”

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• According to Mc Nair and Miriam, ‘Managerial Economics consists of the use of economic modes of thoughts to analyze business situations’

Economics can be divided into two broad categories: micro economics and macro economics.

• Macro economics is the study of the 5 economic system as a whole. It is related to issues such as determination of national income, savings, investment, employment at aggregate levels, tax collection, government expenditure, foreign trade, money supply etc.,
• Micro economics focuses on the behavior of the individuals, firms and their interaction in markets. Managerial economics is an application of the principles of micro and macro economics in managerial decision making.

Nature Of Managerial Economics

• Managerial economics is concerned with the analysis of finding optimal solutions to decision making problems of businesses/ firms (micro economic in nature).
• Managerial economics is a practical subject therefore it is pragmatic.
• Managerial economics describes, what is the observed economic phenomenon (positive economics) and prescribes what ought to be (normative economics)
• Managerial economics is based on strong economic concepts. (conceptual in nature)
• Managerial economics analyses the problems of the firms in the perspective of the economy as a whole ( macro in nature)
• It helps to find optimal solution to the business problems (problem solving)

Significance of Managerial Economics

• Business Planning
• Cost Control
• Price Determination
• Business Prediction
• Profit Planning and Control
• Inventory Management
• Manages Capital

Significance of Managerial Economics

• Business Planning : Managerial economics assists business organizations in formulating plans and better decision making. It helps in analyzing the demand and forecasting future business activities.
• Cost Control: Controlling the cost is another important role played by managerial economics. It properly analyses and decides production activities and the cost associated with them. Managerial economics ensure that all resources are efficiently utilized which reduces the overall cost.
• Price Determination: Setting the right price is one of the key decisions to be taken by every business organization. Managerial economics supplies all relevant data to managers for deciding the right prices for products.

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• Business Prediction: Managerial economics through the application of various economic tools and theories helps managers in predicting various future uncertainties. Timely detection of uncertainties helps in taking all possible steps to avoid them.
• Profit Planning And Control: Managerial economics enables in planning and managing the profit of the business. It makes an accurate estimate of all cost and revenue which helps in earning the desired profit. 
• Inventory Management: Proper management of inventory is a must for ensuring the continuity of business activities. It helps in analyzing the demand and accordingly, production activities are performed. Managers can arrange and ensure that the proper quantity of inventory is always available within the business organization.
• Manages Capital: Managerial economics helps in taking all decisions relating to the firm’s capital. It properly analyses investment avenues before investing any amount into it to ensure the profitability of an investment.

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FIRM

• A firm is an entity that draws various types of factors of production in different amounts from the economy, and converts them into desirable output(s), through a process with the help of suitable technology.
• Economists have identified five factors of production, namely land, labour, capital, enterprise and organization.
• The process of identifying the potential sources of the factors such as land, labour and capital, collecting them in required quantities and assigning them specific tasks as per their skills is the subject matter of organization.
• An entrepreneur is a person (or group of persons) who decide(s) to undertake the responsibility of the inherent risks in starting a business. 

Objectives of firms

• Profit maximisation
• Profit satisficing
• Long term survival
• Share price maximisation
• Revenue maximisation
• Brand loyalty
• Expansion and market dominance

Loss Leader Pricing

Definition:

• Loss leader pricing is a pricing strategy in which a business intentionally sells a product or service at a price below its cost with the goal of attracting customers into the store or onto the platform. The idea is that while the company may incur a loss on the initial item, it can make up for it through additional sales of other, more profitable products or services once customers are in the door or on the website.

• Let's consider a classic example:

a supermarket selling a popular brand of soda at a significant discount. The supermarket may sell a 12-pack of this soda for $2, even though their cost is $3.50. This low price serves as a "loss leader" to entice customers into the store. While the supermarket loses money on the soda, they expect that many customers, drawn by the great deal on soda, will also purchase higher-margin items like snacks, meats, and vegetables, thereby offsetting the loss.

Advantages

• Customer Attraction: Loss leaders effectively draw in price-sensitive customers who are looking for a deal. This can increase foot traffic to physical stores or website visits.
• Cross-Selling: Once customers are in the store or on the website, businesses have the opportunity to cross-sell or upsell other products or services, potentially boosting overall revenue and profits.
• Competitive Edge: In highly competitive markets, offering loss leaders can give a business a competitive edge, making it more attractive to consumers than rivals.
• Inventory Clearance: It's a useful strategy for clearing out excess inventory or seasonal items that might otherwise go unsold.
• Brand Awareness: Loss leaders can help improve brand awareness and customer loyalty, especially if customers perceive the brand as providing excellent value.

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Disadvantages

• Losses: The most apparent drawback is the immediate loss incurred on the item being sold as a loss leader. This can put pressure on profit margins.
• Customer Expectations: Over time, customers may come to expect unrealistically low prices, making it challenging to return to regular pricing without risking backlash.
• Customer Churn: Some customers may only be attracted by the loss leader and not make additional purchases, resulting in a net loss.
• Inventory Issues: If not managed properly, loss leaders can lead to inventory management problems, including overstocking of loss leader items.
• Legal and Ethical Concerns: In some regions, certain forms of loss leader pricing might be illegal or considered unethical if they're seen as anti-competitive.

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Peak Load Pricing

Definition:

• Peak load pricing is a pricing strategy used by businesses, particularly in industries where demand fluctuates significantly during different times of the day, week, or year. It involves charging higher prices during periods of peak demand and lower prices during off-peak periods to balance supply and demand effectively.

Example:

• Consider an electricity provider that implements peak load pricing. During the hottest summer months when air conditioning usage is at its highest, the electricity provider charges higher rates per kilowatt-hour (kWh) during the daytime (peak hours) and lower rates during the nighttime (off-peak hours). This encourages consumers to shift their energy-intensive activities to off-peak hours, reducing strain on the grid during peak demand times.

• MC is also high during these peak periods because of capacity constraints. Prices should, thus, be higher during peak periods as Fig. 9.13 shows, where D₁ is the demand curve for the peak period, and D₂ is the demand curve for non-peak period.
• The firm sets MC = MR for each period, such that price P1 is high for the peak period, and the price P2 is lower for the off-peak period, with corresponding quantities Q1 and Q2. This increases the firm’s profit above what it would be if it charged one price for all periods. It is also efficient; the sum of producer and consumer’s surplus is greater because prices are closer to MC

Advantages

• Resource Efficiency: Peak load pricing encourages consumers to use resources during off-peak hours, making more efficient use of existing infrastructure and resources.
• Revenue Maximization: Businesses can maximize their revenue by charging higher prices during periods of high demand when consumers are willing to pay more.
• Balanced Demand: By incentivizing consumers to shift their consumption to off-peak times, peak load pricing can help balance the demand curve, reducing the risk of overloads or shortages.
• Infrastructure Investment: Higher peak pricing can generate additional revenue for businesses, which can be reinvested in infrastructure improvements to maintain reliable service

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Disadvantages

• Customer Discontent: Consumers may find peak load pricing frustrating, as it often means paying more for the same product or service during peak times, which can lead to customer dissatisfaction.
• Complexity: Implementing peak load pricing systems can be complex and costly, involving the need for sophisticated pricing algorithms and monitoring infrastructure.
• Equity Concerns: Peak load pricing can disproportionately impact low-income consumers who may have less flexibility to shift their consumption to off-peak hours.
• Competitive Disadvantage: Businesses that implement peak load pricing may face competition from rivals who offer fixed, lower prices, potentially losing customers.
• Consumer Behavior Change: While the goal is to shift demand to off-peak times, it's not always possible, and consumers may not be motivated enough to change their habits

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Market Structure

Managerial Economics

Syllabus

• Market Structure:
• Perfect Competition: Meaning and characteristics, Price Output Determination
• Case Study : The Exchange Rate of USD and the profitability of US firms
• Monopoly: Meaning, characteristics, Price Discrimination
• Case Study: Monopoly in the Mumbai City Taxi Industry, Discriminating Monopoly Indian Railway
• Monopolistic Competition: Meaning and characteristics
• Case Study : Advertisement Competition in India
• Oligopoly: Meaning, characteristics, Kink Demand Curve, Game Theory
• Case Study: OPEC (The Organization of Petroleum Exporting Countries) Cartel

Market

Market

• In economics, market means a social system through which the sellers and purchasers of a Commodity or a service (or a group of commodities and services )can interact with each other.

�Market�

• In common language, market means a place where goods are purchased.
• However, in economics, market means an arrangement which establish effective relationship between buyers and seller of a commodity. Hence, each commodity has its own market.

�Market�

• They can participate in sale and purchase.
• Market does not refer to a particular place or location.
• It refers to an institutional relationship between purchasers and sellers.
• Market is an arrangement which links buyers and sellers.
• A market can be of different types.

The market differ from one another due to differences in the number of buyers, number of sellers, Nature of the product, influence over price, availability of information, conditions of supply etc.

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• Economists discuss four broad categories of market structures:
• Perfect Completion
• Monopoly
• Monopolistic Competition
• Oligopoly

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Market Structure

�Perfect Competition�

• Perfect competition is a market structure in which large number of sellers sell a homogenous product at uniform price.

Perfect Competition

Perfect Competition

• A market is said to be Perfectly Competitive if it satisfies the following features:-
• (i) Large number of buyers and sellers : Under perfect competition, there exists a large number of sellers and the share of an individual seller is too small in the total market output.
• As a result a single firm cannot influence the market price so that a firm under perfect competition is a price taker and not a price maker. Similarly, there are a large number of buyers and an individual buyer buys only a small portion of the total output available.
• (ii) Homogenous goods : Under perfect competition all firms sell homogenous goods which are identical in quantity, shape, size, colour, packaging etc. So the products are perfect substitutes of each other.

Large Number Of Buyers And Sellers

Perfect Competition

HOMOGENOUS Products : Identical Or Perfect Substitutes

Perfect Competition

• Differentiated Products: Similar But Not Identical Or Different But Close Substitutes

Perfect Competition

(iii) Price is uniform: as the products of the different sellers in the market are homogenous.

The price is determined forces of demand(buyer’s bidding) and supply (sellers bidding) in the market and accepted by the all sellers are price takers in market.

Hence firms under perfect competition are called price-takers.

Price-Takers

Perfect Competition

• (iv) Free entry and free exit : Any firm can enter or leave the industry whenever it wishes.
• The condition of free entry and free exit ensures that all the firms under perfect competition will earn normal profits in the long run.
• If the existing firms are earning supernormal profits, new firms would be attracted to enter the industry and increases the total supply. This will reduce the market price and the supernormal profit will not sustain. On the other hand if the existing firm incur supernormal loss then firms would leave the industry, thus reducing the supply. As a result, price will again rise and the loss will be wiped out.

Perfect Competition

Perfect Competition

(v) Profit maximization :- The goal of all firms is maximization of profit.

(vi) No Government regulation :- There is no Government intervention in the market.

(vii) Perfect mobility of factors :- Resources can move freely from one firm to another without any restriction. The labours are not unionized and they can move between jobs and skills.

(viii) Perfect knowledge :- Individual buyer and seller have perfect knowledge about market and information is given free of cost. Each firm knows the price prevailing in the market and would not sell the commodity which is higher or lower than the market price.

Similarly, each buyer knows the prevailing market price and he is not allowed to pay a higher price than that. The firm also has a perfect knowledge about the techniques of productions. Each firm is able to make use of the best techniques of production.

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Perfect Competition

(ix)Absence of transport cost

• Transport cost is zero. price of the product is not affected by the cost of transportation.

(x) Perfectly elastic demand curve

• Demand curve reflected by AR curve facing firm under perfect competition is perfectly elastic meaning that the firm can sell as much as it want at the ruling market price . Since price is uniform and given under perfect competition, both AR(price) and MR become equal. Thus, AR and MR curves coincide and become parallel to output axis.

Perfectly elastic demand curve

Imperfect Competition

• Imperfectly competitive markets may be classified as : (i) Monopoly, (ii) Monopolistic Competition,

(iii) Oligopoly and (iv) Duopoly

Monopoly

(1) Monopoly

• Monopoly refers to the market situation where there is one seller and there is no close substitute to the commodities sold by the seller. The seller has full control over the supply of that commodity.
• Since there is only one seller, so a monopoly firm and an industry are the same.
• Monopoly is a form of market structure where there is a single seller producing a commodity having no close substitute.
• The word monopoly is derived from two Greek words-Mono and Poly. Mono means single and Poly means 'seller'. Thus monopoly means single seller.

Monopoly

Features :

• (i) Single seller and large number of buyers : Under monopoly there is one seller and therefore a firm faces no competition from other firms. Though there are large numbers of buyers, no single buyer can influence the monopoly price by his action.
• (ii) No close substitute : Under monopoly there is no close substitute for the product sold by the monopolist. According to Prof. Boulding, a pure monopolist is therefore a firm producing a product which has no substitute among the products of any other firms.
• (iii) Restriction on the entry of new firms : Under monopoly new firms cannot enter the industry.

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Monopoly

Monopoly

• (iv) Price maker :- A monopoly firm has full control over the supply of its products and hence it has full control over its price also. A monopoly firm can influence the market price by varying it supply, for e.g., It can make the price of its product by supplying less of it.
• (v) Possibility of Price Discrimination : Price discrimination is defined as that market situation where a single seller sell the same commodity at two different prices in two different markets at the same time, depending upon the elasticity of demand on the two goods in their respective market.
• Under such circumstances a monopolist can incur supernormal loss then firms would leave the industry, thus reducing the supply. As a result, price will again rise and the loss will wiped out.

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Monopoly

Monopoly

• Downward sloping inelastic demand curve of a monopoly firm Demand curve of a firm reflected by its AR curve under monopoly is downward sloping meaning that the monopoly firm can sell more at a lower price and less at a higher price. The demand curve of the monopoly firm is highly inelastic. This is because the product does not have any close substitute.

Monopolistic Competition

(2) Monopolistic Competition

• It is that form of market in which there are large numbers of sellers selling differentiated products which are similar in nature but not homogenous, for e.g.., the different brands of soap.
• This are closely related goods with a little difference in odour, size and shape. We separate them from ach other.
• The concept of monopolistic competition was developed by an American economist “Chamberline”. It is a combination of perfect competition and monopoly.

Monopolistic Competition

Monopolistic Competition

• Monopolistic competition is a market situation in which both monopoly and competitive elements are present.
• The most distinguished features of monopolistic competition which makes it a blending of competition and monopoly is product differentiation.
• Product differentiation refers to the actively created differences in products with respect to brand, trademark, design, packing, colour, size, measurement, weight such that though the products are similar, they are not identical or in other words the products are different but closely related.

Monopolistic Competition

Features :

• (i) Large number of sellers and buyers : In monopolistic competition the number of sellers is large and each other act independently without any mutual dependence. Here the action of an individual firm regarding change in price has no effect on the market price. The firms under monopolistic competition are not price takers.
• (ii) Product Differentiation : Most of the firms under monopolistic sale products which are not homogenous in nature but are close substitutes. Products are differentiated from each other in the following ways:
• (a) Real Differentiation : These types of product differentiation arises due to differences in the quality of inputs used in making these products, differences in location of firms and their sales service.
• (b) Artificial Differentiation : It is made by the sellers in the minds of the buyers of those products through advertisements, attractive packing, etc.

Monopolistic Competition

Monopolistic Competition

• (iii) Non-price competition : In this case, different firms may compete with each other by spending a huge sum of money on advertisements keeping the product prices unchanged.
• (iv) Selling Cost : Expenditure incurred on advertisements and sales promotion by a firm to promote the sale of its product is called selling cost. They are made to persuade a particular product in preference to other products. Some advertisements have become so popular that people use a brand name to describe the product, for e.g.., brand name is used to describe all types of washing powder.

Monopolistic Competition

• (Selling costs are the expenses incurred on advertisement, publicity, salesmanship etc. Selling costs are incurred by the firms to make aware of the product, to attract new customers, to create customer base and loyalty).

Monopolistic Competition

• (v) Free Entry And Free Exit : There are no restrictions on the entry of new firms and the firms decide to leave the industry.
• Every firm under monopolistic competition earns only normal profits in the long run and there arises no supernormal profit nor loss.
• (vi) Independent price policy : A firm under monopolistic competition can influence the price of the commodity to some extent and hence they face an inverse relationship between price and quantity. In this case the price elasticity of demand would be relatively elastic because of the existence of many substitutes.

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Monopolistic Competition

• Downward sloping highly elastic demand curve of a firm under monopolistic competition
• Demand curve of a firm reflected by its AR curve under monopolistic competition is downward sloping. The demand curve is highly elastic. This is because differentiated products under monopolistic competition has more close substitutes.

Oligopoly

(3) Oligopoly

• Oligopoly is a market situation in which there are few firms producing either differential goods or closely differential goods. The number of firms is so small that every seller is affected by the activities of the others.

Oligopoly

• Oligopoly is a market situations in which there are few (more than two) sellers of a commodity such that actions of every seller has predictable effect on the other sellers/rivals.
• Hence, oligopoly is also called competition amongst the few.
• Oligopoly may be of two types can two forms:
• pure oligopoly or oligopoly without product differentiation.
• differentiated oligopoly or oligopoly with product differentiation.

Oligopoly

Oligopoly

Features :

• (i) Few Sellers : There are few sellers in oligopoly market, such that number of sellers is small that each and every seller is affected by the activities of the others.
• (ii) Interdependence : Interdependence among firms is the most important characteristic under Oligopoly. The number of sellers is so less in the market that each of these firms contribute a significant portion of the total output. As a result, when any one of them undertakes any measure to promote sales, it directly affect other firms and they also immediately react.
• Hence every firm decides its policy after taking into consideration the possible reaction of the rival firm. Thus every firm is affected by the activities of the other firms and this is called interdependence of firm.
• (iii) Nature of Product : A firm under oligopoly may produce homogenous goods which is called oligopoly without product differentiation for e.g.. Cooking gas supplied by Indian Oil & HP.

Oligopoly

• Oligopoly may also produce differential products which is called oligopoly with product differentiation for e.g.. Automobile Industry.
• (iv) Barrier to Entry : The existence of oligopoly in the long run requires the existence of barrier to the entry of the new firms. Several factors such as unlimited size of the market, requirement of huge initial investment etc. creates such barrier upon the entry of new firms.

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Oligopoly

Market Structure

Market Structures

Duopoly

Duopoly

• It is a specific type of oligopoly where only two producers exist in one market. In reality, this definition is generally used where only two firms have dominant control over a market.
• Duopoly provides a simplified model for showing the main principles of the theory of oligopoly: the conclusions drawn from analysing the problem of two sellers can be extended to cover situations in which there are three or more sellers. If there are only two sellers producing a commodity a change in the price or output of one will affect the other; and his reactions in turn will affect the first. In other words, in duopolies there are two variables of interest: the prices set by each firm and the quantity produced by each firm.

Duopoly

Duopoly

• Duopoly is a market situation in which there are two sellers of a commodity such that actions of each seller has predictable effect on the other seller/rival.

Price-Rigidity And Paul Sweezy’s Kinked Demand Curve

Price-rigidity And Paul Sweezy’s Kinked Demand Curve

Revenue

• The term revenue refers to the receipts obtained by a firm from the sale of certain quantities of a commodity at various prices. The revenue concept relates to total revenue, average revenue and marginal revenue.

Revenue

• Revenue is the receipt of money from the sale of output by a firm in a given time period.

Concepts of Revenue

• Total Revenue
• Average revenue
• Marginal Revenue

Concepts Of Total Revenue, Average Revenue And Marginal Revenue

• Total Revenue (TR)- Total revenue is the total sale proceeds of a firm by selling certain units of a commodity at a given price.
• If a firm sell 10 units of a commodity at ` 20 each, Them TR = 20 x 10 = ` 200.00
• Thus total revenue its price per unit multiplied by the number of units sold.
• TR = P x Q where P - Price per unit Q - Quantity sold.
• TR = AR X Q = 𝑴𝑹

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Total Revenue (TR)

Concepts Of Total Revenue, Average Revenue And Marginal Revenue

• Average Revenue (AR) - Average Revenue is the revenue earned per unit of output. Average Revenue is found out by dividing the total revenue by the number of units sold.
• AR = TR/Q
• TR = P.Q
• Thus AR = P.Q/Q = P

Concepts Of Total Revenue, Average Revenue And Marginal Revenue

• Average Revenue

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Concepts Of Total Revenue, Average Revenue And Marginal Revenue

• Marginal Revenue - Marginal Revenue is the change in total revenue resulting from sale of an additional unit of the commodity.
• e.g. If a seller realises ` 200.00 after selling 10 units and `225 by selling 11 units, we say MR = (225.00 - 200.00) = ` 25.00
• Mathematically it can be expressed as
• MR = dTR/ dQ
• Where d is the rate of change.

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Concepts Of Total Revenue, Average Revenue And Marginal Revenue

• Marginal Revenue (MR) is the rate of change in total revenue with respect to change in output.

Concepts Of Total Revenue, Average Revenue And Marginal Revenue

TR, AR And MR Under Im-perfect Competition

TR, AR and MR under Perfect Competition

Profit

• Profit is defined as the gap between total revenue and total cost.
• Profit(∏ ) =Total Revenue – Total Cost
• When profit is negative, a firm is said to be suffering from loss.

Profit

• BREAK -EVEN POINT
• Break-even point indicates the level of output at which Total Revenue just equals Total Cost .
• EQUILIBRIUM OFA FIRM
• A firm is said to in equilibrium when it maximises its profit at given level of output.
• Thus, at firm’s equilibrium, profit(TR-TC) is maximum.

Break-Even Point and Firm’s Equilibrium(Maximum Profit)

Break-Even Point and Firm’s Equilibrium(Maximum Profit)

• The firm is in equilibrium (maximum profit =CB=AQ) at Q level of output after which the gap between TR and TC goes on narrowing. TR again becomes equal to TC at upper break even point E.
• Upper break-even E point is not of much relevance as it lies beyond firm's profit maximizing level.
• Further, it lies beyond the firm’s capacity.
• The lower break even point D at output S is much significance as the firm would not plan to expand if it can not sell its output equal to at least S.

�Equilibrium Of A Firm�

• A firm is said to in equilibrium when it maximises its profit at given level of output. Thus, at firm’s equilibrium, profit(TR-TC) is maximum.
• Conditions For Profit Maximisation/Firm’s Equilibrium:
• MR=MC (Necessary Condition)
• MC must be rising at the profit maximising/equilibrium point i.e. MC curve must cut MR curve from bellow(Sufficient Condition)

Equilibrium of a firm /Profit Maximisation by a firm

Equilibrium of a firm /Profit Maximisation

• At point E , MR=MC and MC curve cuts MR curve from bellow. At E, both necessary and sufficient conditions are satisfied. Hence E is the point of equilibrium at which the firm maximises its profit.
• Q is the equilibrium or profit maximising output. The firm will not produce beyond point E or output Q . Because after point E, MR < MC. As a result of which the firm will suffer loss.

Thanks…

Introduction

• The theory of consumer behavior is based on an axiom that a consumer is a utility maximizing entity.
• The classical and new classical economists held the view that utility is cardinally or quantitatively measureable.It can be measured in cardinal numbers like weight, height, length etc.
• Acc. to Modern economist utility is ordinally measureable in terms of ‘less than’ or ‘more than’

In 1881,british economist Edgeworth first of all propounded indifference curve analysis. After a decade later, Irving Fisher used indifference in 1892 to explain consumers equilibrium. Both Edgeworth and Fisher believed only in cardinal numbers. Later it was discussed in detail by Hicks in his book ‘value and capital.’

Definition and meaning

• “ An indifference curve is a locus of all such points which shows different combinations of two commodities which yield equal satisfaction to the consumer.”
• Acc to Kotsoyiannis, “An indifference curve is the locus of points – particular combination of good which yield the same utility to the consumer, so that he is indifferent as to the particular combination he consumes.”

Indifference curve schedule

Indifference curve – A diagrammatic representation

Assumptions

• Rational consumer
• Ordinal utility
• Diminishing marginal rate of substitution
• Non satiety
• Transitivity
• Consistency in selection
• Independent scale of preferences

Properties of indifference curve

1.An indifference curve has negative slope

2.An indifference curve is convex towards the origin

3.Two indifference curves never cut each other

4.Higher indifference curve represent higher satisfaction level

5. Indifference curve touches neither x-axis nor y-axis

6. Indifference curve need not be parallel to each other

7. Indifference curve becomes complex in case of more than two commodities

conclusion

There are several unrealistic assumptions of cardinal utility analysis but still it was the first theory to explain consumer equilibrium. Marshallian theory left the distinction between the income and substitution effects of the price change unanalyzed. It has too many weaknesses and these limitations has been removed by the Hicks-Allen indifference curve approach. Indiffernce curve is superior than utility analysis because of its less assumptions.

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ISOQUANTS

Production function with two variable inputs or equal product curves

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According to Ferguson, “ An isoquant is a curve showing all possible combinations of inputs physically capable of producing a given level of output”

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• An isoquant represents all those combinations of inputs which are capable of producing the same level of output

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• An isoquant is also known as Production-Indifference curve

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Various combination of X and Y to produce a given level of output

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Each of the factor combinations A,B,C,D and E represents the same level of production Say 100 units.

When we plot them, we get a isoquant curve :

FACTOR-Y

X-axis

0

Y-axis

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12

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8

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6

4

1 2 3 4

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FACTOR-X

5

ISOQUANT CURVE

5

Assumptions of Isoquants

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• Only two factors or inputs of production
• Factors of production are divisible into small units and used in various proportions
• Technical conditions of production are not possible to change at any point of time
• Different factors of production are used in a most efficient way

Properties of Iso quants

• Isoquants are Negatively Sloped : They normally slope from left to right means they are negatively sloped . The reason is when the quantity of one factor is reduced , the same level of output can be achieved only when the quantity of other is increased

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• Higher Isoquants Represents Larger Output : Higher isoquant is one that is further from he point of origin. It represents a larger output hat is obtained by using either same amount of one factor and the greater amount of both the factors

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 No Two Isoquants Intersect or Touch each other : Isoquant do no intersect or touch each other because they represent different level of output

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 Isoquants are convex to the origin : In most production processes the factors of production have substituability. Labour can be substituted for capital and ice versa. however the rate at which one factor is substituted for the other in production process i.e marginal rate of technical substitution (MRTS) also tends to fall

Significance of isoquant curve in cost analysis

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1. The iso-quant curve helps firms adjust their input against their output the is a method used in microeconomics to measure the influence of input on production levels and output possibilities.

2. The iso-quant curve line is an important component for analyzing producer behaviour. The iso-cost line illustrates all the possible combination of two factor that can be used at given costs and for a given producer’s budget

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3. A firm can produce a given level of output using efficiently different combination of two inputs . The iso-quant curve used for choosing efficient combination of the inputs , the producer selects that combination of factor which has the lower cost of production

4. The iso-quant plays a similar role in the firm’s decision making ,the firm faces many iso-cost lines depending upon the different level of expenditure the firm might make a firm may incur low cost by producing relatively lesser output or it may incur relatively high cost by producing a relatively large quantity

Iso-Cost line represent the price of the factor. It shows various combination of two factors which the firm can buy with, given outlay.

ISO-COST / EQUAL-COST LINE :-

Suppose a firm has Rs.1000 to spend on the two factors X and Y.

If the price of factor X is Rs.10 and that of Y is Rs.20, the firm can spend its outlay on X and Y or it can spend the entire outlay on Y and buy 50 units of it with zero units of Y or it can spend the entire outlay on Y and buy 50 units of it with zero units of X factor. In between, it can have any combination of X and Y.

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One can show iso-cost line diagrammatically also. The X-axis shows the units of factor X and Y-axis the units of factor Y. when entire Rs.1000 are spend on factor X we get OB and when entire amount is spent on factor Y we get OA. The straight line AB which joins point A and B will pass through all combinations of factors X and Y which the firms can buy with outlay of Rs.1000. The line AB is called Iso-cost line .

ISOQUANT CURVE & ISOCOST CURVE

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E

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C

A

D

F

O

B

Factor-X

Factor-

Y