M

MANAGERIAL ECONOMICS

 DEFINITIONS Adam Smith: Father of modern economics. Wealth of nations. ALFRED MARSHALL: Material welfare: creation of wealth. LEONEL ROBBINS: Science of scarcity or science of choice.

 SCIENCE OF SCARCITY OR SCIENCE OF CHOICE: In 1931, Lionel Robbins challenged the traditional view of the nature of economic science. He defined Economics as follows: Economics is the science which studies human behaviour as a relationship between ends and scarce means which have alternative uses.

 Ends (wants): Wants are unlimited. So, one is compelled to choose between the more urgent and the less urgent wants. Thats why Economics is also called a SCIENCE OF CHOICE. Means (Resources):; Means is limited. Resource means land, labour, capital and entrepreneur (organisation). Since these resources are limited, the ability of the society to produce goods and services is also limited. So, the term SCARCITY is used in respect of means. Means is scarce in relation to ends.

 Scarce means are capable of alternative uses. Economic activity lies in mans utilisation of scarce means having alternative uses for the satisfaction of multiple ends. Means refer to time, money or any oth;er form of property. These are all limited. Ends are unlimited. So, choice-making is essential. Thats why Economics has been called a science of choice.

 According to Prof. Stigler, Economics is the study of the principles governing the allocation of scarce means among competing ends when the objective of allocation is to maximise the satisfaction. Robbins raised his point with two foundation stones, viz: Multiplicity of wants, and Scarcity of means.

 MICRO AND MACRO ECONOMICS These are relative terms. Micro economics refers to study of sub-groups or an element in a large mass of data, whereas macro economics refers to study of the universe ( the entire field of study). For ex: A study of demand for certain product in a given market condition or place is a micro-economic study in relation to the demand condition prevailing in the entire nation or world. So, if the market condition for steel in Bangalore city is under study, then it is micro-economic study in relation to market condition for steel in India (macro) or the world(macro).

Is Economics a science or art? MANAGERIAL ECONOMICS Definitions: McNair & Meriam define ME as ME is the use of economic modes of thought to analyse business situations. Prof. Evan J. Douglas defines: ME is concerned with the application of economic principles and methodologies to the decisionmaking process within the firm or organisation under the conditions of uncertainty.

 SUBJECT-MATTER AND SCOPE OF ME ME is concerned with the application of economic concepts and analysis to the problem formulating rational managerial decisions. There are 4 groups of problem in both decisionmaking and forward planning. They are: 1. Resource allocation. 2. Inventory queuing problem. 3. Pricing problem. 4. Investment problem.

 Study of ME essentially involves the analysis of certain major subjects like: Demand analysis and methods of fore-casting demand. Cost analysis. Pricing theory and policies. Break-even point and analysis. Capital budgeting for investment decisions. The biz firm and objectives. Competition.

GOALS OF MANAGERIAL ECONOMICS 1. Production goal. 2. Inventory goal. 3. Market-share goal. 4. Profit-maximisation goal. 5. Growth-maximisation goal.

CONCEPTS APPLIED IN M E 1. Opportunity cost. 2. Equi-marginal principle. 3. Incremental cost principle. 4. Time perspective (time element). 5. Discounting principle.

 OPPORTUNITY COST It is the maximum possible alternative earnings that will be sacrificed if the productive capacity or service is put to some alternative use. For ex: if an own building is used to run own business, then the rent that could be earned by letting it out is sacrificed. This is an opportunity cost of the productive capacity of an asset.

 This sacrificed benefit is related(deducted)to the revenue/return earned from the project. 2. EQUI-MARGINAL PRINCIPLE This principle is used in determining options in resource allocations. For ex: an input is used in several biz activities. The question is as to how the input is allocated among various activities,e.g., the input is capital.

 The combination of factors of production is such where: MC = MR The knowledge of Equi-marginal principle helps the businessman in selecting the combination of various factors of production.

 3. INCREMENTAL CONCEPT This refers to additional cost incurred due to changes in the level of production acti-vity. When the production pattern is changed, extra cost is incurred. Incremental Cost= New TC Old TC. If the incremental revenue is more than incremental cost, it is welcome. Note: The concept of incremental cost does not arise if the biz is set up afresh. It arises only when a change is contemplated in the existing biz.

 4. TIME PERSPECTIVE Economists use the functional time periods in analysing equilibrium pheno-menon. The functional time periods are: Short period and Long period. Short Period Fixed cost remains constant Long Period Fixed cost vary. Short Period If the expansion is under-taken, the firm tolerates normal losses. Long Period If the loss persists, it indicates complete failure of biz.

 5. DISCOUNTING PRINCIPLE In(capital budgeting) decision-making process, the p.v of the project is discounted from the future net cash-inflow from the project. The present gain is valued more than a future gain.

 PRINCIPLE OF EQUI-MARGINAL UTILITY The marginal utility (mu) theory applies to one commodity at a time. Consumer buys more than one commodity at a time with his given money income. Now, the problem is as to how to allocate a given money on various goods he wants. Consumers main objective in spending money is to attain the equilibrium (E). Equilibrium is a situation in which the consumer gets maximum satisfaction from the consumption of given commodity. So, E = mu/p where, p=price. If p=mu, the consumer is said to have attained E.

 RISK AND UNCERTAINTY The element of risk and uncertainty is involved in all decisions including investment decisions. Uncertainty is a situation where there is more than one possible outcome to a decision but the probability of each specific outcome occurring is not known.

Module-2: DEMAND ANALYSIS

ESTIMATION AND FORECASTING Produce products which have continuous demand in the market. Types of Demand: For managerial decisions, classify the large number of goods and services avail-able in every economy as under: 1. Consumer goods and producer goods: Goods and services used for final consumption are consumer goods. Producer goods refer to the goods used for production of other goods, e.g., P&M, Raw-materials,etc.,.

 2. Perishable and durable goods. 3. Autonomous and Derived demand: The goods whose demand is not tied with the demand for some other goods are said to have autonomous demand, while the rest have derived demand, e.g., pen-ink. 4. Individuals demand and market demand.

 5. Firm and Industry demand: E.g., Demand for Maruthi cars firms demand. Demand for all types of cars Industrys demand. 6. Demand by market segments and by total market. 7. Joint demand and composite demand.

DEMAND CURVE SHIFTS IN DEMAND CURVE a. Increase in Demand. b. Decrease in Demand.

ELASTICITY OF DEMAND
Alfred Marshall introduced and perfected the concept of ED. The law of demand indicates only the direction of change in quantity demanded in response to a change in price. The law of demand makes only the general statement and it ignores the specific aspect. The specific aspect is provided by a concept of EoD.

 Meaning of EoD EoD means a quantitative response to a change in price, income or the price of a related/substitute product. Definition of EoD by Alfred Marshall: The elasticity or responsiveness of demand in a market is great or small according to the amount demanded increases much or little for a given fall in price and diminishes much or little for a given rise in price. Thus, EoD refers very much to price EoD.

KINDS OF EoD: 1. The price EoD 2. The Income EoD 3. The Cross EoD. 1. THE PRICE EoD: Price EoD expresses the responsiveness of quantity demanded to changes in its price.

 Price Elasticity= Proportionate change in quantity demanded/ Proportionate change in its price. eP= ^Q/Q = ^Q/Q X P/^P. ^P/P If 5% change in price leads to 12% change in quantity demanded, price EoD is 12/5= 2.4.

Classification of Price EoD a. Perfectly elastic demand. b. Perfectly inelastic demand. C. Unitary elastic demand. d. Relatively elastic demand. E. Relatively inelastic demand. a. Perfectly elastic demand: If a small change in price leads to big rise in the quantity demanded, it is perfectly elastic demand. The shape of the curve is horizontal straight line.

 B. Perfectly inelastic demand: Even if a big rise in the price of a product does not affect the quantity demanded, it is inelastic demand. ( That means the demand does not show any response to a change in price). Perfectly inelastic demand has zero elasti-city. Demand curve is that of a vertical straight line. This situation is not found in the present day economies. In this case, the seller can charge any price and still sells the same quantity.

 3.Unitary Elastic Demand: This is the dividing line between elastic and inelastic demand. Here, eD=1. That means the response to change in quantity demanded is the same as change in price. The unitary eD curve is that of a rectangular hyperbola.

 The perfectly elastic and perfectly inelastic demand are not in real world and hence they have only theoretical value. There are only two possibilities namely, either the demand is elastic or inelastic. FACTORS DETERMINING Ed: Some important factors are 1. Luxury or Necessity goods 2. % of income 3. Substitutes 4. Time.

 MEASUREMENT OF ELASTICITY Elasticity is a measurable concept. There are 3 ways to measure 1.Ratio method 2. Total Outlay method 3. The Point method. 1. RATIO METHOD: EoD= % change in qnty demanded % change in price

 2. TOTAL OUTLAY METHOD In this method, the changes in the total outlay (expenditure) on the good is calculated. In this method, it is possible to know whether the elasticity is =1, >1 or <1. The total expenditure remains the same, change in price and quantity are the subject-matters. Ex: Price per unit is Rs.50, total expenditure is Rs.500. Price changes to Rs.60 and total expenditure is same, i.e.,Rs.500. Then. EoD=1.

 Ex:2: Original price is Rs.50 and the increased price is Rs.100. The original expenditure is Rs.500 and new expendi-ture is Rs.1500. Then, Ep=1500/500=3. 3. THE POINT METHOD: The Point method assumes a straight line demand curve. Elasticity is represented by the fraction of distance from D to a point on the curve divided by the distance from other end of that point. ( Diagram is to be drawn and explained).

 ARC EoD Under the Point method, EoD is measured when changes in price and quantity demanded are small. If the price changes are large, then we have to measure elasticity over an arc of the demand curve rather than at any specific point on the curve. For ex: price change is from Rs.30 to Rs.45 then we calculate the elasticity by arc method. Under Point method, Old and new prices and quantity are taken to measure EoD. But, under arc method, the average of old and new prices are taken.

 In arc elasticity, the change in price is expressed as a proportion of average of the old price and new price and the previous quantity and the new quantity. So, the Arc elasticity is called the Average elasticity. Arc Ela= Q1- Q2 divided by P1- P2 Q1+Q2 P1+ P2 Ex: Quantity demanded is 500 units at Rs.25 and 250 units at Rs.37.50. Then Arc Ela = 500 250 divided by 25 37.50 = 1.66 500 + 250 25 + 37.50

 INCOME ELASTICITY (Ie) The money income of the consumers also influences significantly the consumption of commodity. Any change in quantity demanded as a result of change in income of consumers, is called income elasticity. Ie= Proportionate change in qnty demande Proportionate change in the income = ^Q/Q = ^Q X I ^I / I Q X ^I

 Ie can be measured in terms of expenditure made on good/service rather than mere change in quantity demanded as a result of change in income. Question: When Ie>1?, Ie<1?, and when Ie=1?. The goods having +ve Ie are superior goods luxury goods. Then, Ie>1. Ie for necessary goods is <1.

 CROSS ELASTICITY OF DEMAND (Ce) This refers to demand for a good in relationship with the price of a close substitute (if one good can be substituted by another good). For ex: when the price of Coca-Cola rises, the consumer may move to Pepsi, and vice-versa. In case of complementary goods also, this cross-elasticity works. For ex: when price of coffee powder falls, then demand for milk rises. contd..

 Ce=Proportionate change in demand for A Proportionate change in the price of B The Ce of demand between two complementary goods is ve. The cross elasticity of demand measures the extent to which products are substitute or complementary to each other.

FACTORS DETERMINING Pe (price elasticity) 1. Nature of a commodity 2. Availability of substitutes 3. Number of uses 4. Complementarity between goods. 5. Postponement of consumption 6. Habit and custom 7. Time.

 CAUSES FOR DOWNWARD SLOPING OF THE DEMAND CURVE According to Alfred Marshall, the demand curve can be derived in two ways, namely, 1. with the help of diminishing marginal utility, and 2. with the help of equimargi-nal utility. There is a close relationship between the demand curve and the law of diminishing marginal utility. In society, there are many income differences between people. Different uses of a product If the price is high, product may be used for only one use, and vice-versa, e.g., electricity.

 EXCEPTIONS TO THE LAW OF DEMAND Under some extra-ordinary situations, the demand curve may deviate. The general nature of a demand curve is downward sloping. But sometimes, it may slope upwards indicating demand rises with every increase in the price of a commodity. Such exceptions are as follows:

 1. Veblen law: According to this law, some consumers measure the utility of a commodity entirely by its price, i.e., the greater the price of a commodity, the greater is its utility. For ex: diamonds. When the price of the diamond increases, demand increases and viceversa.

 2. The Giffen Paradox When people allocate a considerable part of their income to buy inferior goods, it is a paradoxical situation. For ex: when the price of rice increases, poor people buy more rice and less meat. But, when price of rice decreases, they buy less rice and more meat. 3. Expectation of future rise in prices. 4. Business Cycle. 5. Speculation.

 EXTENSION AND CONTRACTION IN DEMAND Extension in demand means increase in the quantity demanded owing to a fall in the price of a commodity. Contraction of demand means decrease in the quantity demanded owing to rise in the price of commodity. The extension and contraction in demand take place as a result of changes in price alone. INCREASE AND DECREASE IN DEMAND Increase in demand means consumers buy more units of a commodity at the same price. Decrease in demand means the consumers buy less units of a commodity at the same price.

IMPORTANCE AND USES OF THE CONCEPT OF ELASTICITY

1. TO THE BIZ FIRM: For fixing the prices for products, the biz-man should keep in his mind the likely effect of price change on the demand. If the type of elasticity is known, the price cut or rise and its impact on sales, total revenue and profit can be understood. For ex: When the change in price is made which results in no change in demand (unitary elastic), then there is no point in decreasing the price of the product.

 If EoD>1, any cut in price results in more than proportionate increase in sales and revenue. Then, price cut is advisable. If EoD<1 (Inelastic demand), price cut is of no use as the demand remains constant. So, to increase total revenue and profit, price increase is advisable. DIFFERENT PRICES CAN BE CHARGED IN DIFFERENT MARKETS DEPENDING UPON THE DEGREE OF PRICE ELASTICITY PREVAILING IN EACH MARKET. So, pricing is based on demand consideration and not on cost consideration.

2. TO THE GOVERNMENT AND BUDGET While taxing commodities, the finance minister should keep in his mind the EoD for them. Tax can be imposed on those commodities which have inelastic demand, so that tax revenue for the govt. increases, e.g., cigarettes, petrol, essential commodities, etc.,.

 3. IN INTERNATIONAL TRADE: The exporting country can charge higher on its goods and services to be exported if the demand in the importing country is inelastic, and vice versa. 4. TO POLICY MAKERS (In govt. and Companies): When the people have lot of money due to good crop, etc., charging a bit higher price does not affect the quantity demanded, i.e., demand is inelastic. 5. TO TRADE UNIONS: Demand higher wage from management when demand for the products of the firm is inelastic, and vice-versa.

ESTIMATION OF DEMAND
A biz firm may estimate demand functions for its products, by quantifying the relationship between the demand and determinant variables such as price, fixed cost, variable cost and expenditure, price of substitutes and complements,etc.,. The Demand Estimation is a first step to demand forecasting.

 DEMAND fn EQUATION: An appropriate statistical technique should be chosen to form a required demand equation. The statistical techniques are:

Ch: UTILITY ANALYSIS

Utility is defined as the satisfaction expe-rienced by a consumer when the given commodity is used or consumed. Utility relates consumers mental attitude towards the commodity. Utility depends upon time and space. Utility is a function of intensity of want. A consumer buys a commodity because it has utility which means the commodity has wantsatisfying power.

 THE LAW OF DIMINISHING MARGINAL UTILITY According to this law, as an individual goes on consuming more and more units of a commodity, its utility goes on diminishing. It means, as and when a consumer buys more units of a commodity, the extra utility or satisfaction that he derives from the additional unit goes on falling.

 Note: It is the marginal utility, and not the total utility, that diminishes. The total utility increases but at a decreasing rate. Units consumed (mango) :1 2 3 4 5 6 Marginal Utility :40 35 26 12 -3 -18 Total Utility :40 75 101 113 110 92

 Exception to the Law of Diminishing Marginal Utility 1. Hobbies. 2. Drunkards 3. Misers 4. Music and poetry. 5. Money.

 PRINCIPLE OF EQUI-MARGINAL UTILITY Consumrs Equilibrium The marginal utility theory applies to one commodity at a time. But, normally a consumer buys more than one commodity at a time with his given money income. Now, the question is how to allocate a given amount of money on various commodities he wants. Consumers main objective in spending money is to attain the equilibrium.

 Equilibrium is a situation in which the consumer gets maximum satisfaction from the consumption of a given commodity. Consumers equilibrium can be explained through a simple formula-- E = Mu /P Where, E=Equilibrium, Mu=Marginal Utility, P=Price. If price is equal to Mu, the consumer is said to have attained equilibrium. This can be explained with the help of equi-marginal utility analysis.

 EQUI-MARGINAL UTILITY ANALYSIS A consumer spends his given money on various goods he wants. If he buys more units of one commodity, the additional units bring him diminishing satisfacton. So, he substitutes additional units of that com-modity for another commodity which brings more satisfaction. It is through this process of substitution, he buys more commodities and thereby gets maximum satisfaction. In the process of buying several commodities with his given money income, he equalizes marginal utilities of commodities.

 Consumer is in equilibrium position when the marginal utility of money expenditure on each good is the same. The marginal utility of money on each good is equal to the marginal utility of a good divided by the price of the good. MUE = MUX / PX = MUY /PY It means that a consumer will attain equili-brium when he spends his money income on several commodities in such a way that the MU of each good is proportional to its price.

 If MU of X / Px > MU of Y / Py, then the consumer will substitute x goods for y goods. As a result of this substitution, the MU of x will fall and MU of y rises. This substitution will be carried upto the point where the marginal utilities of both the goods become equal. Hence, this law is called the Law of substitution or the Law of maximum satisfaction.

SUPPLY
Like the concept of demand, the concept of supply is very important in the price theory. Supply refers to a schedule of quantities of a commodity that will be offered for sale at different prices. Prof. John Meyers defines supply as a schedule of the amount of good/commodity that would be offered for sale all possible prices at any one instant of time or during any period of time.

 LAW OF SUPPLY Supply establishes the functional relation-ship between price and commodity offered for sale . It is defined as other things remaining the same as a price of a commodity rises, its supply also rises, as the price falls, its supply also decreases. The quantity offered for sale directly varies with the price, i.e., the higher the price, larger is the supply, and lower the price the lesser is the supply.

 SUPPLY CURVE The supply schedule represents the relationship between price and the quant-ities that producers are willing to produce and sell. ( Draw the supply curve and explain) Supply curve slopes left to right upward. If the price falls too much, supply may come to a stop altogether. The price below which the seller refuses to produce and sell is called the reserve price or the minimum price.

 CHANGES IN SUPPLY The changes in supply refer to increase or decrease in supply. Note: Do not get confused increase or decrease in supply with extension and contraction of supply. In the case of extension or contraction of supply, the supply of the commodity moves along the supply curve. In the case of increase or decrease in supply, the supply curve shifts. With the price remaining the same, the supply of a product may rise or may decrease. A movement along the same supply curve indicates changes in quantities offered as result of change in price. contd.

 It does not represent any change in the conditions of supply. A shift in the supply curve indicates increase or decrease in production as result of change in technology, supply of raw-materials,etc.,.

 CAUSES FOR CHANGES IN SUPPLY The supply of a commodity may be affected by changes in the cost of production. If the cost of production rises, the supply price also rises. This will decrease the supply. If the CoP falls, this will lead to greater production and increase in supply.

 Production and supply of agricultural commodities depend upon rainfall, good climate etc.,. Improvement in the technique of production and modern technology will lead increased production and supply.

 DETERMINANTS OF SUPPLY Supply of a commodity has two aspects horizontal and vertical aspects. Horizontal aspect between goods means when two goods compete with each other for factor inputs. The vertical aspect means one good serves as an input to the production of another good. Such linkages determine the changes in supply of a commodity. In the case of horizontal relationship, the relationship between the price and quantity supplied is inverse. If the price of one good rises, the demand for the other goods will increase. In the case of vertical relationship, the relationship between the quantity supplied and the price is positive. When the price of final product is high, it induces the price of raw material to go up.

 ELASTICITY OF SUPPLY Elasticity of supply is the degree of responsiveness to changes in the price of goods. Elasticity of supply means a relative change in the quantity supplied of a commodity in response to a relative change in the price of a good. When the price of a commodity falls very slightly, the supply contracts. Such a supply is called elastic supply. When a big fall in price leads to a small contraction in the supply, the supply is called inelastic supply. A small rise in the price results in a big extension of supply. This is called elastic supply, and a big rise leading to a small extension in supply indicates inelastic supply.

 MEASUREMENT OF ELASTICITY OF SUPPLY Elasticity = Prop.change in qnty supplied of supply Prop.change in price of good OR Elasticity = ^Q / Q ^P / P Point method of measuring elasticity of supply

 FACTORS DETERMINING ELASTICITY OF SUPPLY 1. The nature of commodities 2. Time period. 3. Scale of production. 4. Technique of production. 5. Natural factors.

Ch: PRODUCTION ANALYSIS

Production is defined as value addition. It simply means addition or creation of utility. Utility is added or created with the help pf factor or non-factor inputs. These inputs may be tangible or intangible. The output may also be tangible or intangible. (Utility is a purely subjective concept and is personal).

 PRODUCTION FUNCTION The conversion of inputs to output is described by a production function. The production fn is a technical relationship between inputs and output. It can be expressed as y = f(x), where y is output and x is input.

 Generally, only two factor inputs (two variable inputs) are considered for analysis. These are labour (L) and capital(K). So, the production fn can be described as Oq = f(L,K), where Oq=output quantity. Output is per unit of time. Production fn actually describes the transformation of inputs to outputs at particular time.

 The production fn represents the techno-logy of a firm, i.e., only a certain combin-ation of inputs are feasible ways to produce a given amount of output. The firm must limit itself to technologically feasible production plans. The set of all combination of inputs and outputs that comprise a technologically feasible way to produce is called a production set. (diagram) Production set measures the maximum possible output that can be got from a given amount of input.

 Production fn can be written in many ways. But the COBBDOUGLAS production fn, the multiplicative form, is most widely used. Q = AKa Lb ..K to the power of a, and L to the power of b. (A is constant,i.e., the bottom level production). So, a Cobb-Douglas production fn with parameters A=5000, a=0.5 and b=0.4 wll be: Q = 5000X K to the power of 0.5 X L to the power of 0.4 = 5000 X Square root of KL. So, if 3 units of labour and 5 units of capital is used, maximum production is Q = 5000 X 5 to the power of 0.5 X 3 to the power of 0.4.

 SHORT-RUN AND LONG-RUN PRODUCTION FUNCTION In order to analyse the relationship between factor inputs and outputs, econo-mists classify time periods into short-run and long-runs. SHORT-RUN: is that period of time where the input of only one factor can be increased.The other factor remaning constant. For ex: A manufacturing company cannot build another factory overnight.( K cannot be increased) but labour is increased and produced more.

 Those factors which vary in short-run are known as variable factors. Those which are not, are known as fixed factors. LONG-RUN: Long-run refers to a time period when all inputs are variable. CONCEPTS OF PRODUCT ( TP, AP and MP): Total Product (TP): The total quantity produced by that many units of variable factors, e.g., Labour. For ex: In a factory, if 10,000 bricks are made by 20 labourers, total product is 10,000 units.

 2. AVERAGE PRODUCT (AP): Av. Product = Total Product / Labour. 3. MARGINAL PRODUCT ( MP): MP is the change in total output resulting from the change (using one more or one less unit) of variable factor, say, labour. For ex: If 20 men produce 10,000 bricks and 21 men produce 10,300 bricks, the MP IS 300 bricks. Thus, MP = ^ TP / ^L.

 TWO-INPUT PRODUCTION PROCESS Where, inputs are labour(L) and capital(K)the TP of labour is defined as the maximum rate of output from the combination of varying rates of labour with a fixed capital inputs (bar K). TP of labour = f (L x bar K), and TP of capital ( TP of K) = f (bar L x K)

MP of Labour is: MP of L= ^Q/ ^L MP of capital is: MP of K= ^Q/ ^K.

Q=output.

 1 Labour
( No.of workers)

Table showing TP, MP,AP and output Elasticity of labour (K is constant)

2 Output
TP

3 MP 3 5 4 2 0

4 AP

Output
Elasticity of labor *

OF LABOUR

OF LABOUR

0 1 2 3 4 5

0 3 8 12 14 14

1 4 4 3.5 2.8

1 1.25 1 0.57 0

Output Elasticity of Labour= ^Q/Q = ^Q X L = MP of L ^L/L Q X ^L AP of L

 (Short-run prodn. fn AND Long-run prodn.fn---Diagrams) PRODUCTION FUNCTION: One variable input: In a firm, if all inputs are fixed and only Labour input vary, then output depends on the changes in the amount of labour input. As there is change in labour input (and other inputs like K remaining fixed), it alters proportion/ratio between fixed inputs and and variable input (labour). As labour input is kept on changing, the firm experieces the diminishing returns.

 LAW OF DIMINISHING MARGINAL RETURNS As more and more factor inputs are employed, and all other inputs quantities remaining fixed, a point will eventually be reached where additional quantities of varying input will yield diminishing marginal contributions to total product. ( Diagram)

 OPTIMAL USE OF THE VARIABLE INPUT The firm should decide as to how much labour it should use in order to maximise profits. The firm can employ an additional unit of labour as long as the extra revenue generated from the sale of output exceeds the extra cost of hiring the unit of labour, i.e., until the extra revenue equals the extra cost. The extra revenue generated by the use of an additional unit of labour is called the Marginal Product of Labour (MRP of labour). This equals the Marginal Product of Labour (MP of labour) times the Marginal Revenue (MR) from the sale of extra output produced. MRP of labour = MP of labour X MR.

 THE PRODUCTION FUNCTION WITH TWO VARIABLE INPUTS By using more of two variable inputs, say, L and K that are substitutes to each other, the firm may increase its output. Different factor combinations are possible based on technical feasibilities. The technical possibilities of producing an output level by various combinations of the two factors can be graphically represented in terms of an isoquant (also called iso-product curve, equalproduct curve or production indifference curve).

 ISOQUANTS Isoquants are a geometric representation of the production function. The same level of output can be produced by different combinations of factor inputs. The curve which is the locus of all possible combinations is called the isoquant. Ex: 1000 meter of output can be produced by 20 units of capital and 50 units of labour. It can also be produced by 40 units of capital and 15 units of labour. ( Diagram)

 TYPES OF ISOQUANTS Depending upon the degree of substituta-bility of factors of production, the production isoquant may assume various shapes: 1. LINEAR ISOQUANT: This type assumes perfect substitutability of factors of production. A given commo-dity may be produced by using only K or only L, or an infinite combination of K and L.

2. INPUT-OUTPUT ISOQUANT This assumes strict complementarity, i.e., zero substitutability of factors of production. There is only one method of production for the commodity. This is also called LIONTIEF ISOQUANT. 3. KINKED ISOQUANT This assumes limited substitutability of K and L. There are only a few processes for producing only one commodity. Substitutability of K and L is possible only at the kinks. It is also called LINEAR PROGRAMMING ISOQUANT.

4. SMOOTH, CONVEX ISOQUANT This form assumes continuous substituta-bility of K and L only over a certain range, beyond which factors cannot be substituted each other. Kinked isoquants are more realistic. Isoquant curve shows how output,X, varies as the factor inputs (L, K) change. A higher isoquant refers to a larger output while a lower isoquant refers to a smaller output. Different curves indiacate different levels of output. ( Diagram: Isoquant map)

 THE ISOCOST LINE The isocost line is the locus of alternative combinations of L and K that a firm can purchase with a given outlay. Since the input prices are assumed constant, they are linear and parallel to each other. Ex: Outlay is Rs. 10,000. Labour cost Rs.100 per unit, and Capital cost Rs.300 per unit. Combination K L X 30 10 Y 20 40 Z 10 70 ( Diagram on Isocost line)
K

 OPTIMUM FACTOR COMBINATIONS The theory of production may be viewed from two angles which are dual to each other. A firm may decide to produce a particular level of output and then try to minimise the cost of total inputs or it may attempt to maximise its output subject to a cost constraint.

 Ex: A firm spends money on two inputs K and L, where the prices of inputs remain fixed. The firm can either buy only OA or only OB or combination of K and L repre-sented by a point (E) lying on the straight-line AB. The line AB is the budget line of the firm. ( Diagram) The slope of the budget line or isocost line is OA/OB. The firm will be in equilibrium at a point where an isoquant is tangent to the budget line AB, i.e., at point E.

RETURNS TO SCALE In the long run, if all the inputs are changed, say, increased proportionately, then the concept of Returns to scale influences the behaviour of output. In the long run, output can be increased by increasing the scale of operations. Increasing the scale of operation means increasing all the factors at the same time and the same proportion. The laws that govern the scale of operation are called the laws of returns to scale.

 This law refers to the long-run because only in the long-run are all the factors of production are variable. Only in the longrun, it is possible to change all the factors of production including K. Returns to scale are classified as: 1. Increasing Returns to Scale: If output increases more than proportionate to the increase in all outputs.

 2. Constant Returns to Scale: If all inputs are increased by a certain proportion, and output increases in the same proportion, then it is Constant returns to scale. 3. Decreasing Return to Scale: If increase in output is less than proportionate to the increase in all inputs, then it is DRS. Increasing return to scale arise when scale of operation increases, a greater division of labour and specialisation takes place besides high-productive P&M. Decreasing return to scale arises when scale of operation increases, and an unmanageable situation arises.

 Causes of IRS: 1. Advanced technology. 2. Highly-efficient management. 3. Specialisation of labour. Causes of DRS: 1.Diminishing return to mgt i.e., lack of coordination. 2. Lack of communication as the firm grows. 3. Exhaustible natural resources, e.g.,Doubling the fishing fleet may not lead to a doubling of the catch of fish.

 ELASTICITY OF SUBSTITUTIO The shape of an isoquant is related to its elasticity of substitution. The elasticity of substitution measures the relative responsiveness of one variable (factor of production) to proportionate change in the prices of other factors of production.

 The concept of elasticity of substitution algebraically measures the degree of substitution between two factors of production, resulting from a change in prices of the factors of production only, so that the output remains the same. Ex: If the price of a factor input, say, L, falls, the producer may substitute L to K to reach a new equilibrium position on the same isoquant. Algebraically, the Es is measured as Elk = % change in K/L ratio % change in MRTS LK
( MRTS = Marginal Rate of Technical Substitution) Elk = Elasticity of L to K.

 Demand elasticity co-efficient always measures the proportional change in a dependent variable (quantity) induced by a proportionate change in the independent variable (price or income or substitute). This applies to production function as well. If production fn is Q= q(L,K), the labour elasticity of output is the proportional change in output resulting from a given proportional change in labour input,L, whereas the input K remaining constant.

 Similarly, the capital elasticity of output is the proportional change in output resulting from a given proportional change in input K, whereas the input L remains constant. Like Demand elasticities, input elasticities can be expressed as: EL = % change in Q (output) = ^Q/ Q % change in L ^L/ L

=^Q X L = ^Q X L = ^Q/^L = MP L Q ^L ^L Q Q/L APL Ek = % change in quantity (output) % change in capital (K) = MPK APK Thus, the input elasticity of output turns out to be a ratio of the inputs MP and AP. In general, marginal and average products vary as the input ratios change. Hence, the input elasticities change as well.

Ch: COST ANALYSIS

Cost of Production (CoP) = Cost of raw materials + Labour + Overheads (O/hs). O/h means expenses of indirect nature like depreciation of fixed assets, fuel, electricity, administrative expenses, salaries of supervision staff, indirect materials like cotton-waste, welding rods used in welding, factory rent, gas, water, etc. used in producing goods.

 CoP is the most important force in determining the supply of the product. COST CONCEPTS: 1. Actual and Opportunity Cost: Actual cost of raw-materials, wages and o/hs which are recorded in the books of accounts are known as actual cost. Opportunity cost is not the actual cost incurred. But it is the cost of sacrificed alternative.

2.Explicit Cost and Implicit Cost: Explicit Cost is actual expenditure incurred by spending money. Ex: expenditure on rawmaterials, labour, fuel, gas, water,etc. Implicit Cost is non-cash expenses like depreciation on fixed assets, notional (imaginary) interest on capital invested, etc. So, total cost includes both explicit cost and implicit cost.

3. Fixed Cost and Variable Cost: There are both Fixed factors and Variable factors in production. The cost on fixed factors is known as fixed cost and cost on variable factors is known as variable cost. Fixed Cost remains constant for all levels of output and Variable Cost increases proportionately with increase in output and decreases proportionately with decrease in output.

4. Replacement Cost and Historical Cost: Historical cost means the original price of the asset. Replacement cost means the price that would be paid to a new asset to replace the old asset. 5. Incremental Cost and Sunk Cost: Sunk Cost A cost already incurred in the past and which cannot be revised, is called Sunk Cost. (It is historical cost by essence). Incremental Cost This is a cost which is added to the original cost every year. For ex: when sales increases, Advertisement expenses, transport cost,etc., will also increase.

6. SHORT-RUN COST and LONG-RUN COST: The distinction between short-run cost and longrun costs are made on the basis of operational time period in any production activity. The short-run costs are operating costs associated with the level of output. Operating Costs = All items debited to Trading and P&L A/c. Operating Cost varies with the level of output.

Long-run costs are the costs associated with the changing scale of output and the alterations in the size of the plant (factory). Difference between Scale of output and Level of output: Scale of output means increasing the output by many times, i.e., doubling, trebling, etc.,. Level of output change in level of output means increase in output in arithmetic progression like 5000 units, 6000, 7,000, 8,000, etc.

 COST-OUTPUT RELATIONSHIP: Various types of costs are considered in economic analysis. They are: 1. Total cost 2. Total Fixed cost 3. Total Variable cost 4. Average Fixed cost 5.Average Variable cost 6. Average Total cost, and 7. Marginal cost. Total Cost: Total Cost = Total Fixed Cost+Total Variable Cost TC = TFC + TVC.

 2. Total Fixed Cost: Total FC remains same at all levels of output. Fixed Costs are independent of output, in the sense, fixed cost remains same with all levels of output. TFC is also known as Establishment Cost or Establishment Expenses. 3. Average Fixed Cost: Av. FC = TFC/ No. if units of output.

 4. Total Variable Cost: The costs of variable factors employed I n production, such as raw-materials, labour, power and fuel, and variable o/hs like sundry stores, etc., are known as variable cost. TVC varies exactly in proportion to output. 5. Average VC: AVC = Total VC/ Output.

6. Average Total Cost (ATC) or Av. Cost (AC): TC = TFC + TVC. ATC = TC/ Output. 7. Marginal Cost (MC): MC is the addition to the TC caused by producing one more unit. (Diagram of TVC, TC and Diagram of AC and MC). About diagramscontd.

The MC curve falls at first due to more efficient use of variable factors as output increases, then it rises upwards as the addition to the output interfere with the inefficient use of variable factors (such as labour, materials, etc.,). (Diagram of AFC curve and Diagram of AVC curve). (Table of MC and Diagram of MC curve) (Combined Diagram of all AFC, AVC, AC, MC).

LONG-RUN COST CURVES: In long-run, all inputs vary. The fixed cost may double or treble depending on the increase in scale of out-put. Note: In the short-run, the size of plant is fixed. In the long-run, the producers go on adding the work units (fixed assets like L&B and P&M) to produce more and more. The CoP in the long-run is determined by the use of variable factors (labour, raw-materials and variable o/hs). The long-run CoP is the least-possible CoP, i.e., the producer keeps on expanding the plant in order to produce the output at the leastpossible cost. (As the output keeps on increasing, AFC keeps on decreases, and so ATC keeps on decreases).

 LONG-RUN AVERAGE COST: There are several short-run periods in longrun period. The long-run average cost (AVC) depicts the least possible average cost for producing all levels of output. There will be several short-run cost curves in long-run cost curve.

Ch: PERFECT COMPETITION

Market: Market is a place where commodi-ties are sold (In olden days language). It is used to mean any concern (business house like soletraders, firms etc.,). There may be several sub-markets in a market , e.g., each state may be a market in the national market, each layout may be a market in a city, certain age group may be a market for certain product, and so on. The word market has different meaning under different circumstances. Market may be in the internet, and ultimately every human being who desires to buy and sell is a market.

 The market is classified into local, regional, national and international, depending upon the nature of the commodity bought and sold. MARKET FORMS: Broadly speaking, there are two types of market forms, namely 1. Perfect Competition, and 2. Imperfect Competition.

 PERFECT COMPETITION: It is a market form where all sellers are selling homogeneous product at a uniform price. Perfect competition prevails when the following conditions are found in any market: 1. There are large no. of firms producing and selling product. 2. The product sold by all firms are homo-geneous. 3. The buyers and sellers have complete information about the price of the product. 4. There is free entry and exit of firms into industry. 5. Factors of production are perfectly mobile.

 PRICE AND OUTPUT DETERMINATION UNDER PERFECT COMPETITION: Maximising profit is an important objective of every firm. The producers income is classified into two parts. Firstly, he gets wages for his mana-gerial function, which is called salary to proprietor. This wage to him is included in AC of the product. There is another reward to him called surplus(surplus, in accountancy, is called net profit). The surplus is the difference between TR and TC.

 Alfred Marshall calls entrepreneurs wage of management as normal profit, and any surplus as super-normal profit. The normal profit is the wage to the entrepreneur to stay on in business. The entrepreneur continues to produce as long as he gets atleast wage in the conditions of perfect competition.

 EQUILIBRIUM OF THE FIRM TR AND TC: Equilibrium is a situation where the firm is earning maximum profit. Every firm strives hard to attain equilibrium. A firm is said to be in equilibrium when it does not like either to increase or decrease the level of output. The equilibrium point can be found out by comparing TR and TC. Equilibrium is that point where the difference between TR and TC is the greatest, I,e., equilibrium is that point of output where the profit is the greatest. It is very difficult to locate the point of equilibrium by means of TR and TC. Hence, the concept of MR and MC can be very appropriately used to locate the equilibrium point (equilibrium output).

 EQUILIBRIUM OF THE FIRM MR and MC: MR is the revenue of every additional unit of a commodity sold. MC is the cost of every additional unit produced. A firm stops producing the output when MC>MR. So, it produces additional units as long as MR>MC. It stops producing additional units when MR=MC. At that level of output where MR=MC, the profit is the highest. Any unit produced beyond this point results in loss to the firm. So, at output where MR=MC, the firm will be in equilibrium. (Table to prove MC=MR).

 OUTPUT AND PRICE DETERMINATION IN PERFECT COMPETITION: Under perfect competition, individual firms are not able to influence the price. The price of a product, under perfect compe-tition, is determined on the basis of market demand and market supply of the product. (Diagram to show the demand and supply curves) It is the supply curve of the industry and demand curve of the entire market that determines the price. At that price, the quantity demanded is equal to quantity supplied and this price is called the equilibrium price.

CHANGES IN EQUILIBRIUM: When there is a shift in either demand or supply, there is bound to be change in equilibrium. Demand may change owing to change in tastes, income of the consumers, preferences and availability of substitutes, etc.,. Supply may change due to changes in cost of production etc.,. Thus, demand and supply may increase or decrease either in the same way or in the opposite direction.

TIME ELEMENT IN DETERMININT PRICE Alfred Marshall laid emphasis on the role of time element in the determination of price. He divided the time into different periods such as 1. Market period, 2. Short period, and 3. Long period. He divided time into 3 periods not from demand point of view, but from supply point of view. Time is short or long according to the extent to which supply can adjust itself. He says that it takes time for the supply to adjust completely to the changed conditions of demand. This is because supply of a product depends upon changes in technical and technology of production.

MARKET PERIOD: This may be of a period of, say, 2-3 months. The supply remains constant in this period because the method or technical conditions of production cannot be adjusted. So, supply of product in market period is absolutely inelastic.

2. SHORT PERIOD: Short period is defined as a period in which supply can be increased to a limited extent with the existing production technology, in the sense, fixed factor remaining constant, but increasing variable inputs like labour and rawmaterials. The short-run cost curve remains the same. Due to a slight increase in output, the supply curve becomes elastic. The short-run supply curve slopes left to right upwards, indicating as price goes up, supply increases.

3. LONG PERIOD: A long period is defined as a period suffici-ently long enough to expand production facility, fixed factor (expansion of factory) i.e., increasing the scale of output. In the long period, new firms also enter into industry. In the long period, all factors of production become variable including fixed factors. During long period, forces of supply fully adjust to a given change in demand. Then the supply curve becomes more elastic. It has flatter slope compared steep slope in short period.

Time plays a crucial role in determining the price. In the market period, i.e., a very short period, the price will rise very sharply because of fixed supply and sudden spurt in demand. In short period, some limited adjustments (in variable factors such as labour, raw-materials, etc.,) is possible and so output increases marginally; price comes down. Even then the short period price is above original market price. In long period, there will be complete adjustments in demand and supply.

EQUILIBRIUM OF AN INDUSTRY UNDER PERFECT COMPETITION: There is a lot of difference between the equilibrium of a firm and the equilibrium of the industry. A firm will be in equilibrium when MC=MR ( the profit is maximum at this point). An industry will be in equilibrium when all the firms are in equilibrium and earning only normal profits.

Under perfect competition, the price of the product is determined by the combined demand for and supply of the product. The following situation emerges in the case of firms under perfect competition: 1. If AR>AC, the firms will earn super-normal profits. This will attract new firms into the industry. 2. If AR=AC, then the firms will earn only normal profits. This will not attract new firms in to industry. 3. If AR<AC, the firms experience loss and they try to cover AVC. 4. If AR<AVC, the firms stop production.

 When the above changes are taking place, the industry will not be in equilibrium though the firms are in equilibrium. There will not be expansion or contraction of output of the industry. Existing firms do not exit and new firms do not enter the industry. In the long run, all firms make only normal profits. (Diagram)

MONOPOLY
Mono means single or one. Monopoly is a market form in which a single firm is operating in the market. The monopolist controls the entire market supply of single commodity. Such commodity has no substitute. There is a single producer facing a large number of buyers for his product. So, he can charge any price and earn huge profits.

FEATURES OF MONOPOLY: 1. There is only one seller/producer for the product/service. So, under monopoly, there is no distinction between firm and industry. Examples are: Indian Railways, Canteen and shops inside Cinema theatre, ONGC, Telephone dept. in India before private players were allowed. 2.No close substitutes: That means no other firm producing similar product. For ex: Xerox machine, Boeing aeroplane, KFC and its products, etc.,. There should not be cross-elasticity of demand for the monopoly product, eg., NESCAFE Coffee is close substitute of BRU Coffee and so there is cross elasticity between these products.

3. The monopolist can determine any price for his product. 4. There are strong barriers for other firms to enter into the industry. PRICE AND OUTPUT UNDER MONOPOLY Though the monopolist can charge any price, he cannot sell more if he charges high price. So, he restricts output to maintain a steady price for his product. The demand curve for monopolist is downward sloping, which means if he reduces price he can sell more.

A R: The demand curve facing the monopo-list is the Average Revenue i.e., price or selling price. The AR curve (demand curve) slopes downward, which means more quantities can be sold at lower prices. MR: MR refers to sale value (revenue) of additional output or the increment output. Under perfect competition, AR=MR. The AR curve merges with MR curve in perfect competition. But, under monopoly, MR curve falls below the AR curve, which means to sell additional quantities he has to lower the price. Example..

Foeex: A two-wheeler producer produces 10,000 units and sells at Rs. 1,000 per unit. Suppose he wants to increase the revenue (total sales) and so he reduced the price to Rs.900 per unit and sold 14,000 units. Then Revenue(sales value) of 10,000 units=1,00,00,000 Revenue of 14,000 units, i.e., 14,000X Rs.900= 1,26,00,000 So, MR (Additional Revenue)= Rs.26,00,000. Revenue (Sale value) of additional output= 4,000XRs.900= Rs. 36,00,000. So, MR< Sale value of additional output. Thus, under monopoly, MR will be always less than the sale value of additional output.

AC AND MC UNDER MONOPOLY The CoP or TC of a monopolist is the same as firm under perfect competition. Like a firm under perfect competition, the equilibrium of a monopolist also is when MC=MR (when MC =MR, the profit is maximum, and so that stage is called equilibrium).

MONOPOLY POWER The price per unit (AR) under monopoly is greater than MC while under perfect competition it is equal to MC ( i.e., when AR=MC, output should not be increased). The monopolist will attain equilibrium at the level of output where the elasticity of demand for his product is >1. So, he will not fix any definite price for his product at any level of output/sales until the elasticity is 1, i.e., unitary Ed, where ^Q/^P=1. MR will be negative at those levels of output where elasticity is <1. Since MC cant be negative, the monopolist cant be in equilibrium at those output levels where Ed<1.

MONOPOLISTIC COMPETITION
In real world, both perfect competition and monopoly do not exist. Prof. Joan Robinson and Prof. E.H.Chamb-erlain instead suggested The economies of imperfect competition and The theory of Monopolistic competition respectively. Monopolistic competition of Prof. Chamber-lain and Imperfect Competition theory of Mrs.Joan Robinson though similar in many ways but differ in interpretation.

The fundamental characteristic of an imperfect competition is that the average revenue curve is a downward sloping curve. As a result of this, MR curve lies below AR curve.The difference between the AR and the MR at equilibrium output is regarded as the degree of imperfection.

Though the contents of the theory of imper-fect competition and monopolistic compe-tition are similar, critics have regarded Chamberlains theory is more convincing than that of Mrs.Joan Robinsons. Monopolistic Competition is defined as a market form in which there is keen competition between producers of differentiated products which are close substitutes. Though products are similar, they are different to the extent of packing, services, attraction, etc.,. Since products are differentiated, there is an element of monopoly in the product. On the other hand, as there are large number of firms producing the products, there is competition among them. So, combination of monopoly and competition. Each firm is called a competing monopolist. Most of the FMCG products are of this nature.

CHARACTERISTICS OF MONOPOLISTIC COMPETITION: 1. Large number of buyers and sellers: Since there are many firms, the individual firm produces only a small part in the total output of all the firms put together. Each firm has a very limited control over the price of the product. 2. Product differentiation: This is the most important characteristic of mono-polistic competition. Each produces identifies his product by means of attractive packaging or colour or shape of any other thing. The products are close substitutes.

3. Large number of buyers: Each buyer has a preference for the speci-fic brand of the product. A minor increase in the product of his brand will not result in his migration to other brand. 4. Free entry: Under monopolistic competition, there is free entry and exist of the firms in the industry. This makes competition strong. 5. Sales promotion: Since the products are differentiated, to impress upon the people about their superiority, the producer undertakes challenging sales promotion. The amount of money spent on sales promotion is called selling costs. contd.

6. Dual Competition: The firms in monopolistic competition face two types of competition, viz., 1. price competition, and 2. product differentiation. The competition that is done in monopolistic competition is characterised as price cutting, underselling, unfair competition, cut-throat competition, etc.,.(these are not done perfect competition).

OUTPUT AND PRICE DETERMINATION UNDER MONOPOLISTIC COMPETITION Under perfect competition, price is determined by the combined action of all buyers and sellers. But in monopolistic competition, each firm determines price. Each firm determines the price on the basis of market condition, such as demand and cost. Each firm wants to attain equilibrium.

The producer has to take decisions pertaining to price, output and selling cost by himself. He has to watch carefully the decisions or policies of price and product of his rival firms. He has to bear in mind all these facts while deciding about the quantity of output and price.

EQUILIBRIUM OF A FIRM UNDER MONO-POLISTIC COMPETITION: The demand curve for the product of an indi-vidual firm in monopolistic competition is downward sloping. This is the AR curve of the firm. The position and the elasticity of demand depend upon availability of substitutes and their prices. The demand curve of firms under monopolistic competition is more elastic. If a firm charges higher price, many customers shift to rival firms. So, the demand curve is a downward sloping curve. The MR curve falls below AR curve.

The formation of cost curves depends upon combined effect of fixed factors and variable factors. The AC curve is U shaped. The MC curve takes the usual shape of cutting the AC curve at its lowest point and then rises above the AC curve. The firms in monopolistic competition have to follow the conditions of equilibrium in the same way as the firms in perfect competition and monopoly, i.e., MC=MR and also MC>MR after the point of equilibrium. In other words, the MC curve must cut MR curve from below.

OLIGOPOLY
Oligopoly is defined as a market form, where there are more than two or a few sellers enjoying monopolistic competition. Oligopoly is often referred to as competition among few. In oligopoly there may be sellers more than three and within ten. When products of few sellers are homoge-neous, such a situation is called Pure Oligopoly or Oligopoly without product differentiation. When the products of the sellers are differentiated, it is called Differentiated Oligopoly.

CHARACTERISTICS OF OLIGOPOLY: 1. There are a few sellers in the market supplying either homogeneous products or differentiated products. 2. The firms have a degree of interdepend-ence in decision-making regarding what output to be produced and what price to be determined. 3.The firms have a high degree of cross elasticities of demand for their products, so there is always a fear of rivals in the industry. 4. There is heavy advertising in oligopoly. 5. There is group behaviour in Oligopoly, in the sense, the firms behave in a manner of inter-dependence. 6. Indeterminateness of the demand curve.

PRICE AND OUTPUT DETERMINATION UNDER OLIGOPOLY: Since firms are inter-dependent, the reaction patterns of the rivals are uncertain. Determination of price and output depends upon the demand and cost considerations.

PRICE LEADERSHIP Determining prices independently is rare in oligopolistic markets. There is some understanding among oligopolists which may be formal or tacit. Under formal agreement, they fix the price and output after consultations and discussions. Under tacit agreement, they come to an understanding without any face to face contact.

There are various types of price leadership: 1. There is a price leadership by a dominant firm.(the firm producing a very large portion of the output is a dominant firm). 2. There is a barometric price leadership, under which an old and experienced, large and most respected firm plays the role of custodian and protects the interests of all firms. 3. There is an exploitative and aggressive price leadership under which the dominant firm establishes the leadership by following aggressive price policies and thus compel other firms to follow it.