ECONOMICS &

MANAGEMENT DECISIONS
MBCE-701

PRAYER

MBCE-701: Contents
1.
2.
3.
4.
5.
6.
7.

Introduction to Managerial Economics.

Laws of Diminishing and Equi-marginal Utility
Demand Analysis
Elasticity of Demand
Demand Forecasting
Supply, Cost and Production
Demand & Supply as Market Forces/
Equilibrium
8. Market Structure and Pricing
9. Pricing Methods
10.Profit Analysis with reference to BEP

Introduction to Managerial Economics.

Unit 1

Economics
Economics is a subject matter that studies
different economic activities as directed
towards the maximization of satisfaction
or maximization of profits at the level of
an individual, and maximization of social
welfare at the level of the country as a
whole.
It is the problem of choice arising out of the
fact that:
I. Resources are scarce, and
II. Resources have alternative uses.

MACRO AND MICRO ECONOMICS

Macro economics is the study of economy as a
whole. It deals with questions relating to national
income, unemployment, inflation, fiscal policies
and monetary policies.
Micro economics is concerned with the study of
individuals like a consumer, a commodity, a
market, and a producer.
Managerial economics is micro-economic in
nature because it deals with the study of a firm,
which is an individual entity. It analyses the supply
and demand in a market, pricing of specific input,
the cost structure of individual goods and
services.

MANAGERIAL ECONOMICS
Managerial Economics is concerned
with the application of economic
concepts and economic analysis to
the problems of formulating rational
managerial decisions.
Managerial Economics integrates
economic theory with business
practice for the purpose of
facilitating decision making and
forward planning.

Decision Making
Decision making is the selection of a course of
action amongst all possible alternatives.
Mangers must make decisions in light of
everything that can be learnt about a
situation, which may not be everything they
should know.
Alternatives are evaluated in terms of
quantitative and qualitative factors. Other
techniques include marginal analysis, and
cost-effectiveness analysis.
Experience, experimentation, research and
analysis come into play in selection of an
alternative.

Economic Decisions by
Managerial Economist

1. What product / service should be

produced?
2. What inputs and production
techniques should be used?
3. How much output should be
produced and shat prices should it
be sold?
4. What are the best sizes and
location?
5. When should equipment be
replaced?

Utility, Law of Diminishing

and Equi-marginal Utility
UNIT:2

Utility
An individual demands commodities due to
their utility.
Utility is the want-satisfying property of a
commodity.
In addition, it is the psychological feeling of
satisfaction; pleasure, happiness or well being
which a consumer derives from consumption,
possession, or the use of a commodity.
Demand for goods in terms of quantity is
based upon their marginal utility (MU)

Total and Marginal Utility

No of units

Total utility

30

Marginal
utility
30

50

20

60

10

65

60

-5

45

-15

Marginal Utility
Marginal utility refers to the change
in satisfaction which results when a
little more or little less of that good is
consumed.
Law of diminishing marginal
utility states that as more and more
units of a commodity are consumed,
marginal utility derived from every
additional unit must decline, also
called fundamental law of
satisfaction.

Marginal Utility Analysis

Purchase of a commodity by a
consumer depends on three factors:
1. Price of the commodity;
2. Marginal (and total) utility of the
commodity;
3. Marginal utility of money.
It is assumed that marginal utility
of money is constant

The law of diminishing marginal utility

The law states , as the quantity consumed

of a commodity increases, the utility
derived from each successive unit
decreases, consumption of all other
commodities remaining the same.
When a person consumes more and more
units of a commodity per unit of time,
keeping the consumption of all other
commodities constant, the utility which he
derives form successive units of
consumption goes on diminishing.

Consumers Equilibrium
The consumer will go on purchasing more
and more of a commodity X until the
marginal utility becomes equal to the
market price of that commodity.
Consumer will strike equilibrium when:
Mu x/ Px = Mum
Likewise, for commodity Y consumer will
strike equilibrium when Mu y/ P y = Mum

Indifference Curve Analysis

Indifference Curve is a diagrammatic
representation of an indifference set. It
shows different combinations of two
commodities between which a consumer
is indifferent. Each combination offers
him the same level of satisfaction.
An indifference curve which is to the
right and above another indifference
curve shows a higher level of satisfaction
to the consumer.

Budget line
The budget line or the price
opportunity line represents different
combinations of two goods X and Y
which the consumer can buy by
spending all his income.
Consumers equilibrium is
depicted by the point on the budget
line where it touches the indifference
curve tangentially, meaning that the
slopes of indifference curve and the
budget line are equal.

Demand Analysis
Unit 3

Demand Function

Demand function is a comprehensive

formulation which specifies the
factors that influence the demand for
the product.
Dx = D (Px, Py, Pz, B, A, E, T, U)
where Dx is the demand for item; X,
Px is the price of item X; Py is the
price of substitutes; Pz is the price of
complements; B is the income of the
consumer; E is the price expectation
of the user; T is the tastes and
preferences of user; and U stands for

Determinants of Demand
Price of the commodity is the major
determinant of its demand. Price is
the symptom, effect, as well as
cause of demand
Some other determinants of demand
include:
a. Consumers tastes and preferences;
b. Consumers expectations;
c. number of consumers and their
distribution;

Demand Curve
Demand curve considers the price
demand relation, other
factors/determinants of demand,
remaining the same.
The demand curve is negatively
sloped, indicating that the individual
purchases more of the commodity
per time period at lower prices (other
factors being constant).

Demand schedule

Demand Curve

Law of Demand
The inverse relationship between the
price of the commodity and the
quantity demanded per time period
is referred to as the Law of Demand.
A fall in Px leads to an increase in Dx
(so that the slope is negative)
because of the substitution effect
and income effect.

Explanation for Law Of Demand

Law of demand is explained on the
concept of diminishing marginal
utility principle.
In addition attempts have been made
to explain equilibrium of a consumer
through: indifference curve analysis
and Revealed Preference Theory.

Income and Substitution effects

Income effect refers to change in the
quantity demanded when real income of the
buyer changes as a result of change in the
price of the commodity. When price falls, the
real income increases. Accordingly, demand
for the commodity expands.
Substitution effect refers to substitution of
one commodity for the other when it
becomes relatively cheaper. When price of
commodity X falls, it becomes cheaper in
relation to commodity Y. Accordingly X is
substituted for Y

Change in Quantity Demanded

Change in quantity demanded refers
to quantity purchased of a commodity
in response to rise or fall in its price,
other determinants remaining the
same. It is expressed through
movement along the demand curve.
Change in demand refers to increase
or decrease in quantity demanded at
the same price in response to change in
other determinants of demand.

Change in quantity demanded

vs.
change in demand
Change in quantity demanded

Change in demand

Market demand curve

Market demand is the horizontal summation
of individual consumer demand curves

Explanation for Law Of Demand

Law of demand is explained on the
concept of diminishing marginal
utility principle.
In addition attempts have been made
to explain equilibrium of a consumer
through: indifference curve analysis
and Revealed Preference Theory.

Applications of Demand & Supply

Prices are determined by interaction
between the forces of demand and supply.
Such a mechanism is called market
mechanism or Price system. Price system
serves two functions:
1. Serves as price rationing device. It
eliminates shortages and surpluses.
2. Determines allocation of resources- supply,
demand and prices or inputs and outputs
in the market determine the allocation of
resources and ultimate combination of
goods and services to be produced.

SUPPLY
Unit 6

Concept of Supply
Supply is the willingness and ability of
producers to make a specific quantity of
output available to consumers at a
particular price over a given period of time.
Individuals control the inputs or resources
necessary to produce goods.
For a large number of goods, there is an
intermediate step in supply; Individuals
supply factors of production to firms, firms
transform factors of production into
consumable goods.

Law of Supply
More of a good will be supplied the higher
its price, other things remaining constant or
less of a good will be supplied the lower its
price.
Other variables, assumed constant, in the
law of supply refer to:
I. Changes in prices of inputs;
II. Changes in technology;
III. Changes in suppliers expectations; and
IV. Changes in taxes and subsidies,
. For the supply curve See figure 4.5

Supply
the relationship that exists between the price of a good
and the quantity supplied in a given time period,
ceteris paribus.

Supply schedule

Law of supply
A direct relationship exists between
the price of a good and the quantity
supplied in a given time period,
ceteris paribus.

Reason for law of supply

The law of supply is the
result of the law of
increasing cost.
As the quantity of a
good produced rises, the
marginal opportunity
cost rises.
Sellers will only produce
and sell an additional
unit of a good if the
price rises above the
marginal opportunity
cost of producing the
additional unit.

Change in supply vs. change in

quantity supplied
Change in supply

Change in quantity supplied

Determinants of supply

the price of resources,

technology and productivity,
the expectations of producers,
the number of producers, and
the prices of related goods and
services

Equilibrium of Demand and Supply

Equilibrium represents a situation which can
persist. It has no tendency to change. In terms
of price of the commodity, it will be
established where the supply decisions of the
producers and demand decisions of the
consumers are mutually consistent.
In a free market, price is determined by the
interplay of supply and demand. When
quantity demanded is greater than the
quantity supplied, prices tend to rise; when
quantity supplied is greater, prices tend to fall.

Elasticity of Demand &

Supply
UNIT: 4

Elasticity of Demand
Elasticity of demand measures the
degree of responsiveness of/ change in
demand to various factors.
Elasticity of demand is important
primarily as an indicator of how total
revenue changes when a change in
Prices induces changes in quantity
demanded. The total revenues of the
firm will equal to changed price into
quantity sold (TR= P X Q )

Classification Of Demand
Elasticity
1.
2.
3.
4.
5.

Perfectly inelastic demand;

Inelastic demand;
Unitary elastic demand;
Elastic demand;
Perfectly elastic demand.

Numerically Measurement of Elasticity

Elasticity Coefficient (Ed)

Ed = percentage change in quantity
demanded /
Percentage change in price.
Ed =change in quantity
demanded/original quantity
demanded change in price/
original price.
Ed = Q/Q P/ P

Price Elasticity
Price elasticity is percentage change
in quantity demanded per 1 per cent
change in price
Two other measures of elasticity used
are:
1. Arc price elasticity is used to assess
the impact of discrete changes in
price.
2. Point price elasticity is for very small
price changes.

Unit 3 - Elasticity
Price

D1 (inelastic demand curve)

$9.00
D2 (elastic demand curve)

$8.00

60

68

100

Quantity

Elasticity and Competition

Price

D1 (Perfectly
Elastic Demand Curve)

$9.00

D2 (Perfectly
Inelastic Demand Curve)

60

Quantity

Income Elasticity of Demand

Income elasticity of measures

the responsiveness of buyers
purchasing habits in response
to an income change.

Microeconomics

Income Elasticity of Demand

Definition:
Ei = the percentage change in a products
quantity demanded divided by the
percentage change in buyers incomes.
Formula:
(change in Qd / average Qd) / (change in Y /
average Y)
Where Qd = quantity demanded, and Y =
income.
The value can be positive (normal good) or
negative (inferior good).
Microeconomics

Cross Price Elasticity of Demand

The price change of a substitute or

complementary product affects the
quantity demanded of the other
substitute or complementary product.
Substitutes have a positive cross price
elasticity of demand. Complements
have a negative cross price elasticity of
demand.

Microeconomics

Cross Price Elasticity of Demand

The formula for cross price elasticity

of demand is:

Ecp
=

the % change in the quantity demanded

of product A
the % change in the price of related product
B

Microeconomics

Price Elasticity
Price elasticity is percentage change
in quantity demanded per 1 per cent
change in price
Two other measures of elasticity used
are:
1. Arc price elasticity is used to assess
the impact of discrete changes in
price.
2. Point price elasticity is for very small
price changes.

Applications of Demand & Supply

Prices are determined by interaction
between the forces of demand and supply.
Such a mechanism is called market
mechanism or Price system. Price system
serves two functions:
1. Serves as price rationing device. It
eliminates shortages and surpluses.
2. Determines allocation of resources- supply,
demand and prices or inputs and outputs
in the market determine the allocation of
resources and ultimate combination of
goods and services to be produced.

Demand Forecasting
UNIT: 5

Demand Forecasting
All business decisions are based on some
forecast of the level of future economic
activity in general and demand for the
firms product in particular.
A forecast is a prediction or estimate of a
future situation.
Data for use in forecasting can be
obtained from experts opinion, surveys
and market experiment.
Various statistical methods have been
developed for forecasting do demand.

Methods of Demand Forecasting

Broadly there are two approaches to the
problem of business forecasting:
To obtain information about the intentions
of consumers by means of market research,
survey, economic intelligence and the like.
To use past experience as a guide, and by
extrapolating past trends to estimate the
level of future demand.
The first approach is often used for shortterm forecasting and the second approach
for long-term forecasting.

Forecasting Techniques
Forecasting
techniques
Survey
methods

Expert
opinion

cons
umer
s

Statistical
methods

Tend methods
Regression
method
Indicator method

Interview Method

Interview
methods

Complete
examination

Sample survey

End use
method

Statistical Methods

Fitting a trend line by observation.

Trend through Least Squares Method.
Time series analysis
Moving average.
Exponential weighted moving
average method.

Supply, Cost and

Production
UNIT: 6

Production
The total amount of output produced
by a firm is a function of the levels of
input usage by the firm
Total Physical Product (TPP) function a short-run relationship between the
amount of labor and the level of
output, ceteris paribus.

Production
Production refers to the transformation of
resources into output of goods and services.
Production function is the physical
relationship between a firms inputs of
resources and its output of good and
services per unit of time.
The marginal rate of substitution measures
how one factor of production is substituted
for another while keeping the output
constant.

Production
The Production function is a concept
that defines the maximum rate of
output resulting from specific input
rates.
The Short-run is that period of time for
which the rate of input use of at least
one factor of production is fixed.
In the long run, the output rates of all
factors of production are variable.
A firm operates in the short-run but
plans in the long-run

Variable and Fixed Proportions

Law of variable proportions states that as
equal increments of one input are added,
the input of other productive services being
constant, beyond a certain point, the
resulting increments of product will
decrease.
Output can be increase by changing all
factors of production. In such a case, the
output can change in more than proportion,
equal proportion or less than proportion

Law of Diminishing Marginal Returns

The law of Diminishing marginal

returns states that when increasing
rates of a variable input are
combined with a fixed rate of another
input, a point will be matched where
marginal product will decline

Isoquants
An isoquant shows all combinations of
capital and labour that will produce a
specified rate of output.
The slope of the isoquant is the
marginal rate of technical substitution
or the rate at which one input can be
substituted for another so that given
rate of output is maintained.
The Isoquant function is the set of all
combinations of capital and labour that
can be purchased for a specified cost.

Returns to Scale
The concept of returns to scale
shows the changes in production
when all inputs are varied
proportionately.
It increases if output increases more
than in proportion to change in
inputs and decreases when vice
versa

Economies of scale
PLANT ECONOMIES FIRM ECONOMIES
Division of labour and Quantity discounts
specialization
Superior technology

Low cost fund

raising

Better productivity
per price

Sales promotion

Low equipment cost

Managerial
efficiencies

Total physical product (TPP)

Law of diminishing returns

as the level of a variable input rises
in a production process in which
other inputs are fixed, output
ultimately increases by progressively
smaller increments.

Average physical product (APP)

APP = TPP / amount of input
Quantity
of labor
0
5
10
15
20
25
30
35
40
45

TPP
0
50
120
180
220
250
270
275
275
270

APP
10
12
12
11
10
9
7.86
6.88
6

Marginal physical product (MPP)

the additional output that results
from the use of an additional unit of
a variable input, holding other inputs
constant
measured as the ratio of the change
in output (TPP) to the change in the
quantity of labor (or other input)
used

Computation of MPP and APP

Quantity
of labor
0
5
10
15
20
25
30
35
40
45

TPP
0
50
120
180
220
250
270
275
275
270

APP
10
12
12
11
10
9
7.86
6.88
6

MPP
10
14
12
8
6
4
1
0
-1

Note that the MPP is positive when an

increase in labor results in an increase in
output; a negative MPP occurs when output
falls when additional labor is used.

TPP

Shape of MPP curve

MPP rises when
TPP increases
at an increasing
rate, and
declines when
TPP increases
at a decreasing
rate.
MPP is negative
if TPP declines
when labor use
rises

Relationship of APP and MPP

APP rises when
MPP > APP
APP falls when
MPP < APP
APP is
maximized
when MPP =
APP

Cost Analysis

Total costs
Short run and Long run
Short run costs:
fixed costs costs that do not vary
with the level of output. Fixed costs
are the same at all levels of output
(even when output equals zero).
variable costs costs that vary
with the level of output (= 0 when
output is zero)

Example

Example (cont.)

Fixed costs

Variable costs

TC, TVC, and TFC

Example (cont.)

Average variable cost

Average variable cost (AVC) = TVC /
Q

Average total cost

Average total cost (ATC) = TC / Q
ATC = AFC + AVC (since TFC + TVC = TC)

Marginal cost
Marginal cost (MC) = cost of an additional
unit of output

Average fixed cost

AVC, ATC, and MC

Note that the MC curve intersects the AVC

and ATC at their respective minimum points

Long-run costs
In the long run, a firm may choose its level of
capital, and will select a size of firm that provides
the lowest level of ATC.

Economies and diseconomies of scale

Economies of scale factors that lower
average cost as the size of the firm rises
in the long run
Sources: specialization and division of labor,
indivisibilities of capital, etc.

Diseconomies of scale factors that raise

average cost as the size of the firm rises
in the long run
Sources: increased cost of managing and
coordination as firm size rises

Constant returns to scale average costs

do not change as firm size changes

Long-run average total cost

(LRATC)

Minimum efficient scale

Minimum efficient scale = lowest
level of output at which LRATC is
minimized

Market Equilibrium
Unit 7

Market Equilibrium

Price Above Equilibrium

If the price exceeds the equilibrium price,
a surplus occurs:

Price below equilibrium

If the price is below the equilibrium
a shortage occurs:

Demand Rises

Demand Falls

Supply Rises

Supply Falls

Market Structure
UNIT: 8

Market Structure
The competitive environment or the
market structure in which and industry
operates plays a decisive role in price and
output decisions of a firm.
Consumer demand sets the ceiling or the
upper limit, and the cost of production sets
the floor or the lower limit of price to be
set.
Competitive environment helps the firm
decide where the prices might be set.

Types of Industries/ Market Structures

We distinguish between four types of

industries:
1. Pure (Perfect) Competition
2. Monopolistic Competition
3. Oligopoly
4. Monopoly

Microeconomics

Pure Competition characteristics

1. Many sellers
2. Low barriers to enter
3. Competitors products are
identical
4. Buyers have perfect information

Microeconomics

A Purely Competitive Firms Total Revenue Curve

Price,
Revenue

Total Revenue

240
220
200

100

110

120

Quantity

Microeconomics

Monopolistic Competition and

Oligopoly
Characteristics of a monopolistically
competitive industry include:
1. Many sellers
2. Low barriers to enter
3. Differentiated products
4. Advertising on a local level

Microeconomics

 Monopolistic Competition
Short-run economic profits
are possible.
Long-run economic profits are
unlikely because of unrestricted and
relatively easy access entry into
industry.

Microeconomics

 Monopolistic Competition
Firms maximize profits where MC = MR in
the upward sloping portion of the MC
curve, as long as the price is greater than
AVC.
See next slide for the short-run profitmaximizing diagram.

Microeconomics

Monopolistic Competition and Oligopoly

Price,
MR,
AR,
Costs
in
$7
Dollars

MC

ATC
AVC

$6

D (AR)
MC=MR

MR
400

Quantity
Produced

 Monopolistic Competition
In the long run, due to low barriers to
enter, firms in monopolistic
competition earn zero economic
profits.
See next slide for the long-run profitmaximizing diagram.

Microeconomics

Monopolistic Competition and Oligopoly

Price, MR,
AR, Costs
in Dollars

M
C

Plr

Long-run
equilibrium
price

ATC
AVC
D (AR)

MC=MR

MR

Long-run
equilibrium
quantity

Qlr

Quantity
Produced

Oligopoly
Characteristics of an oligopoly
industry include:
1. A Few firms (2, 3, 4, ...) control the
majority of the sales
2. More difficult to start up (barriers
to enter)
3. Firms are interdependent
4. Firms mostly advertise on a
national scale
Microeconomics

Examples of oligopoly industries

Automobile
Beer
Breakfast Cereal
Soft Drinks
Oil (Wholesalers)
Steel
Airlines
Aircraft Manufacturers
Internet Search
Microeconomics

Oligopoly
Oligopoly firms maximize where
MC = MR, in the upward sloping
part of the MC curve, as long as
price exceeds AVC.
Long-run profits are possible,
because of barriers to enter the
industry.
Because of interdependence, rival
firms must take each others
actions into account.

Microeconomics

If you were the president of Coca Cola,

inc. and Pepsi lowered its price, what
would you do?

1. Keep the price of coke

the same
2. Raise the price of coke
3. Also lower the price of
coke
4. Not sure

If you were the president of Coca Cola, inc.

and Pepsi raised its price, what would you
do?

1. Keep the price of

coke the same
2. Raise the price of
coke
3. Lower the price of
coke
4. Not sure

kinked demand curve.

Lets say that when firm B increases

its price, firm A does not change its
price.
And lets say that when firm B lowers its
price, firm A also lowers its price.
The demand curve for firm A will then
be a kinked demand curve.

Microeconomics

Price
$10

Monopolistic
Competition and
Oligopoly

D2
D1

Curre $8
nt
marke
$6
t
price

MR1
D1

$4

$2

MR2
1

D2
9 10

Quantity

 Oligopoly
Firm As demand curve D1 is more
elastic, because when firm B raises its
price above the current price of $8, firm
A does not raise it. Firm A gains
significant market share.
Firm As demand curve D2 is less
elastic, because when firm B lowers its
price below $8, firm A lowers it as well,
and sales remain relatively constant.
Microeconomics

Oligopoly and Collusion

The temptation to collude (cartel

forming) is greater in oligopoly than
in other industries.
There are also barriers to collusion:
High prices attract competitors from
outside the cartel.
Rival firms cant always agree on the
terms.
Cheating (charging a slightly lower
price) is profitable.
There may be legal consequences.

Monopolistic Competition and Oligopoly

Price, MR,
AR, Costs
in Dollars

M
C

Plr

Long-run
equilibrium
price

ATC
AVC
D (AR)

MC=MR

MR

Long-run
equilibrium
quantity

Qlr

Quantity
Produced

Pricing Methods
Multi product pricing.
Price discrimination.
International price discrimination and
dumping.
Pricing methods in practice:- cost
based pricing; market penetration
pricing; price skimming; loss leader
pricing; ..

 Oligopoly
Firm As demand curve D1 is more
elastic, because when firm B raises its
price above the current price of $8, firm
A does not raise it. Firm A gains
significant market share.
Firm As demand curve D2 is less
elastic, because when firm B lowers its
price below $8, firm A lowers it as well,
and sales remain relatively constant.
Microeconomics

Oligopoly and Collusion

The temptation to collude (cartel

forming) is greater in oligopoly than
in other industries.
There are also barriers to collusion:
High prices attract competitors from
outside the cartel.
Rival firms cant always agree on the
terms.
Cheating (charging a slightly lower
price) is profitable.
There may be legal consequences.

Monopolistic Competition and Oligopoly

Price, MR,
AR, Costs
in Dollars

M
C

Plr

Long-run
equilibrium
price

ATC
AVC
D (AR)

MC=MR

MR

Long-run
equilibrium
quantity

Qlr

Quantity
Produced

Monopoly
Characteristics of a Monopoly
A monopoly industry is an
industry with only one seller (mono
= 1; poly = seller).
Most monopolies have significant
economies of scale.

Microeconomics

Reasons for Monopoly Forming

Monopolies exist for the following reasons:

1. Legal barriers ( Postal Service)
2. Patents and copyrights (games, books, tv
shows)
3. Licenses (doctors, taxi drivers)
4. Trade restrictions (prescription
medication)
5. Exclusive ownership (DeBeers Diamonds
Co.)
6. Economies of Scale
(Microsoft, Intel)
Microeconomics

Types of monopolies

We distinguish between these two types

of monopolies:
1. Government-granted. The government
grants the monopoly. Examples: U.S.
Postal Service, gas and electric
companies.
2. Free market. The monopoly is earned
through innovations, efficiency, or
resource control. Examples: Microsoft,
Intel, DeBeers.
Microeconomics

Types of monopolies

In the case of government-granted

monopolies, there is little incentive for the
monopoly to earn profits. Economic
efficiency is unlikely.
In the case of free market monopolies,
there is a threat of competition. Most firms
keep their monopoly status by operating
efficiently, offering quality products and
low prices.
Microeconomics

 A Monopolists Demand and

Marginal Revenue Curve

Revenu
e

Demand=AR
MR
Quantity
Microeconomics

 The Profit Maximizing Quantity

MC

Revenue

MR=MC
Demand = AR
MR

Profit-maximizing
quantity

Qpm

Quantity
Microeconomics

 The Profit Maximizing Price -monopoly

MC

Revenue
Ppm

Profitmaximizi
ng
price

Demand = AR
MR
Qpm

Quantity
Microeconomics

Monopoly-The Profit Area

MC

Revenue

ATC

$30
$27

Demand = AR
MR
2,000

Quantity
Microeconomics

Do we need anti-trust
laws?
Some Economists are of the view that
they do more harm than good.
Others are of the view that If a
company achieves its monopoly
status through efficiency and
innovation, then its services, low
cost, and low prices can be
beneficial for society and our
economy.
Microeconomics

Pricing Methods
Unit 9

Pricing Methods
Multi product pricing.
Price discrimination.
International price discrimination and
dumping.
Pricing methods in practice:- cost
based pricing; market penetration
pricing; price skimming; loss leader
pricing; ..

Profit Analysis and BEP

UNIT:10

Profits
Profit is regarded as a reward for the
entrepreneurial functions of final decision
making and ultimate uncertainty bearing.
Three important aspects about profits are:
I. Profit is a residual income and not
contractual or certain income as in the case
of other factors of production.
II. There is much greater fluctuation in profits
than in rewards for any other factors.
III. Profits may be negative , whereas rent,
wages, and interest must always be positive.

Profit Classifications
Gross profit and Net Profit.
Normal Profit and Supernormal Profit.
Accounting Profit and Economic Profit.
Economic Profit = total revenue
(explicit cost + Imputed cost). Or
Economic Profit = Accounting profit
imputed cost.
Imputed or implicit costs are the costs of
those employed resources which
belong to the owner himself.

Theories of Profit
1. Risk and Uncertainty Theory- Profit is the reward
for risk bearing and uncertainties.
2. Dynamic Theory- Profit is the consequence of
frictions and imperfections in the Economy.
3. Innovation Theory of Profits - Profit is the reward
for successful innovation.
4. Profit is a reward for organizing other factors of
production.
All the above theories are in a sense
complementary, since many factors like risk,
uncertainty, innovation, monopoly powers etc.
affect every business.

Profit Measurement
Accounting Method based on inclusiveness
of cost, depreciation, valuation of stock,
treatment of deferred expenses, and capital
gains and losses.
Break Even Analysis examines the
relationship among total revenue, total costs
and total profit of the firm at various levels of
output.
Break Even Point is that volume of sales
where the firm breaks even i.e. the total casts
equal total revenue. Losses cease to occur
while profits have not yet begun.

Breakeven Analysis
Defined
Breakeven analysis examines the
short run relationship between
changes in volume and changes in
total sales revenue, expenses and
net profit
Also known as C-V-P analysis (Cost
Volume Profit Analysis)

Break Even Point (BEP)

It is a point of zero profit.
BEP = Fixed costs (selling price variable
cost per unit).
Example fixed costs Rs. 10000 (selling
price Rs. 5per unit variable cost Rs. 3 per
unit)
Therefore BEP = Rs.. 10000 (5-3)
= 5000 units.
Hence 5000 units will be the point at which
the manufacturing unit would not make any
loss or profit.

Methods of Break-Even Analysis

The break even chart.
The Algebraic method.

Uses of Breakeven
Analysis
C-V-P analysis is an important tool in terms
of short-term planning and decision
making
It looks at the relationship between costs,
revenue, output levels and profit
Short run decisions where C-V-P is used
include choice of sales mix, pricing policy
etc.

D
Decision making and Breakeven Analysis: Examples

How many units must be sold to

breakeven?
How many units must be sold to achieve
a target profit?
Should a special order be accepted?
How will profits be affected if we
introduce a new product or service?

Key Terminology: Breakeven

Analysis

Break even point-the point at which a

company makes neither a profit or a loss.
Contribution per unit-the sales price
minus the variable cost per unit. It
measures the contribution made by each
item of output to the fixed costs and profit
of the organisation.

Key Terminology ctd.

Margin of safety-a measure in which the
budgeted volume of sales is compared
with the volume of sales required to break
even
Marginal Cost cost of producing one
extra unit of output

Breakeven Formula
Fixed Costs
*Contribution per unit

*Contribution per unit = Selling Price per unit

Variable Cost per unit

Breakeven Chart

Margin of Safety
The difference between budgeted or
actual sales and the breakeven point
The margin of safety may be
expressed in units or revenue terms
Shows the amount by which sales
can drop before a loss will be
incurred

Decision making and

Breakeven Analysis:
Examples

Example 1
Using the following data, calculate
the
breakeven point and margin of
safety in units:
Selling Price = 50
Variable Cost = 40
Fixed Cost = 70,000
Budgeted Sales = 7,500 units

Example 1: Solution
Contribution = 50 - 40 = 10 per
unit
Breakeven point = 70,000/10 =
7,000 units
Margin of safety = 7500 7000 =
500 units

Target Profits
What if a firm doesnt just want to
breakeven it requires a target profit
Contribution per unit will need to
cover profit as well as fixed costs
Required profit is treated as an
addition to Fixed Costs

Example 2
Using the following data, calculate
the level of
sales required to generate a profit
of 10,000:
Selling Price = 35
Variable Cost = 20
Fixed Costs = 50,000

Example 2: Solution
Contribution = 35 20 = 15
Level of sales required to generate
profit of 10,000:
50,000 + 10,000
15
4000 units

Limitations of B/E
analysis
Costs are either fixed or variable
Fixed and variable costs are clearly
discernable over the whole range of output
Production = Sales
One product/constant sales mix
Selling price remains constant
Efficiency remains unchanged
Volume is the only factor affecting costs

Absorption and Marginal Costing

Compared

Absorption
Fixed costs included
in Product Cost
FC not treated as
period cost
closing/opening
stock values
Under/over
absorption of costs
Complies with
Financial Accounting
standards

Marginal
Fixed costs not
included in Product
Cost
FC treated as period
cost
No under/over
absorption of costs
Does not comply with
Financial Accounting
standards