BEFA UNIT III

UNIT- III

Production, Cost, Market Structures & Pricing:

Production Analysis: production function, Law of returns to scale, Internal and External Economies of Scale.

Cost analysis: Cost concepts, Types of Costs. Break-even Analysis (BEA)

Pricing: Types of Pricing, product life cycle, GST (Goods & service Tax)

Market Structures- Types of competition, Features of Perfect competition, Monopoly and Monopolistic Competition,
oligopoly.

PRODUCTION

Production is the transformation or conversion of resources into commodities over time. Economists view
production as an activity through which utility is created or enhanced for a product. A firm is a business unit
which undertakes the activity of transforming inputs into output of goods and services.

FACTORS OF PRODUCTION

Factors of production is an economic term that describes the inputs that are used in the production of goods or
services in order to make an economic profit. The factors of production include land, labor, capital and
entrepreneurship. These production factors are also known as management, machines, materials and labor, and
knowledge has recently been talked about as a potential new factor of production.

1. Land

Land is short for all the natural resources available to create supply. It includes raw land and anything that comes
from the land. It can be a non-renewable resource.

That includes commodities such as oil and gold. It can also be a renewable resource, such as timber. Once man
changes it from its original condition, it becomes a capital good. For example, oil is a natural resource, but
gasoline is a capital good. Farmland is a natural resource, but a shopping center is a capital good.

The income earned by owners of land and other resources is called rent.

2. Labour

Labor is the work done by people. The value of labor depends on workers' education, skills, and motivation. It
also depends on productivity. That measures how much each hour of worker time produces in output.

The reward or income for labor is wages.

3. Capital

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Capital is short for capital goods. These are man-made objects like machinery, equipment, and chemicals, that
are used in production. That's what differentiates them from consumer goods. For example, capital goods include
industrial and commercial buildings, but not private housing. A commercial aircraft is a capital goodbut a
private jet is not.

The income earned by owners of capital goods is called interest.

4. Entrepreneurship
Entrepreneurship is the drive to develop an idea into a business. An entrepreneur combines the other three factors
of production to add to supply. The most successful are innovative risk-takers.

The income entrepreneurs earn is profits.

PRODUCTION FUNCTION

The production function expresses a functional relationship between physical inputs and physical outputs of a
firm at any particular time period. The output is thus a function of inputs. So, production function is an input –
output relationship. Mathematically production function can be written as Q = Output

f = Function of
Q= f (L1,L2 C,O,T) L1 = Land

Here output is the function of inputs. Hence output becomes the dependent variable and L2 = Labour
C = Capital
inputs are the independent variables.

Definition :

Samueson defines the production function as “The technical relationship which reveals the maximum
amount of output capable of being produced by each and every set of inputs”

Michael R Baye defines the production function as” That function which defines the maximum amount
of output that can be produced with a given set of inputs.”

Assumptions:

Production function has the following assumptions.

1. The production function is related to a particular period of time.

2. There is no change in technology.
3. The producer is using the best techniques available.
4. The factors of production are divisible.
5. Production function can be fitted to a short run or to long run.

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PRODUCTION FUNCTION WITH ONE VARIABLE INPUT

The law of variable proportions which was earlier called as “Law of diminishing returns has played
a vital role in the modern economics theory. Assume that a firms‟ production function consists of fixed quantities
of all inputs (land, equipment, etc.) except labour which is a variable input. If you go on adding the variable input,
say, labor, the total output in the initial stages will increase at an increasing rate, and after reaching certain level
of output the total output will increase at declining rate. If variable factor inputs are addedfurther to the fixed
factor input, the total output may decline. This law is of universal nature and it proved to be true in agriculture.

Assumptions of the Law: The law is based upon the following assumptions:

1. Only one factor is varied

2. The scale of output is unchanged
3. The technique of production is unchanged
4. All units of factor input varied are homogeneous
Three stages of law:
The behaviour of the Output when the varying quantity of one factor is combined with a fixed quantity of the
other can be divided in to three district stages. The three stages can be better understood by following the table.

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From the above graph the law of variable proportions operates in three stages. In the first stage, total product increases at
an increasing rate. The marginal product in this stage increases at an increasing rate resulting in a greater increase in total
product. The average product also increases. This stage continues up to the point where average product is equal to
marginal product. The law of increasing returns is in operation at this stage. The law of diminishing returns starts operating
from the second stage awards. At the second stage total product increases only at a diminishing rate. The average product
also declines. The second stage comes to an end where total product becomes maximum and marginal product becomes
zero. The marginal product becomes negative in the third stage. So the total product also declines. The average product
continues to decline.

We can sum up the above relationship thus when ‘A.P.’ is rising, “M. P.’ rises more than “ A. P; When ‘A. P.” is maximum and
constant, ‘M. P.’ becomes equal to ‘A. P.’ when ‘A. P.’ starts falling, ‘M. P.’ falls faster than ‘ A. P.’.

Thus, the total product, marginal product and average product pass through three phases, viz., increasing diminishing and
negative returns stage. The law of variable proportion is nothing but the combination of the law of increasing and demising
returns.

LAW OF RETURNS TO SCALE

The concept of variable proportions is a short-run phenomenon as in these period fixed factors
cannot be changed and all factors cannot be changed. On the other hand in the long-term all factors can be changed
as made variable. When we study the changes in output when all factors or inputs are changed, we
study returns to scale. An increase in the scale means that all inputs or factors are increased in the same proportion.
In variable proportions, the cooperating factors may be increased or decreased and one faster (Ex. Land in
agriculture (or) machinery in industry) remains constant so that the changes in proportion among the factors result
in certain changes in output. In returns to scale, all the necessary factors or production are increased or decreased
to the same extent so that whatever the scale of production, the proportion among the factors remains the same.

Assumptions

1. Technique of production is unchanged

2. All units of factors are homogeneous
3. Returns are measured in physical terms

When a firm expands, its scale increases all its inputs proportionally, then technically there are three
possibilities.

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1. Law of increasing returns to scale:- if a proportionate/percentage increase in

the output is larger than the proportionate/percentage increase in inputs, thereare
increasing returns.

For example: If a 5% increase in inputs, results in 10% increase in the

output, a firm is said to attain increased returns.

If PFC > 1, it means increasing returns to scale

If PFC = 1, it means constant returns to scale
If PFC < 1, it means decreasing returns to scale

2. Law of constant returns to scale:- if the proportionate increase in all the inputs
is equal to the proportionate increase in output, then situation of constant returns to
scale occurs.

For Example:- If the inputs are increased at 10% and if the resultant output also
increases a 10% then the organization is said to achieve constant returns to scale.

3. Law of decreasing returns to scale:- if the proportionate increase in output is

less than the proportionate increase in input, then a situation of decreasing returns to
scale occurs.

For Example:- If the inputs are increased by 10% and if the resultant output
increases only by 5% then the organization is said to achieve decreasing returns to
scale.

the following table illustrates these laws clearly.

From the above table it is clear that with 1 unit of capital and 3 units of labor, the firm produces 50 units of output.
When the inputs are doubled 2 units of capital and 6 units of labor, the output has gone up to 120 units. Thus
when inputs are increased by 100%, the output has increased by 140%. That is , output has increased by more

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than double. This is governed by law of increasing returns to scale.

When the inputs are further doubled that is to 4 units of capital and 12 units of labor, the output has gone to 240
units. Thus, when inputs are increased by 100%., the output has increased by 100%. That is, output has doubled.
This governed by law of constant returns to scale.

When the inputs further doubled, that is, to 8 units of capital and 24 units of labor, the output has gone up to
360 units. Thus, when inputs are increased by 100%, the output has increased by only 50%. This is governed by
law of decreasing returns to scale.
ECONOMIES OF SCALE

Production may be carried on a small scale or o a large scale by a firm. When a firm expands its size of
production by increasing all the factors, it secures certain advantages known as economies of production.
Marshall has classified these economies of large-scale production into internal economies and external
economies.

Internal economies are those, which are opened to a single factory or a single firm independently of the
action of other firms. They result from an increase in the scale of output of a firm and cannot be achieved
unless output increases. Hence internal economies depend solely upon the size of the firm and are different
for different firms.

External economies are those benefits, which are shared in by a number of firms or industries when the
scale of production in an industry or groups of industries increases. Hence external economies benefit all
firms within the industry as the size of the industry expands.

Causes of internal economies:

Internal economies are generally caused by two factors
1. Indivisibilities 2. Specialization.

1. Indivisibilities
Many fixed factors of production are indivisible in the sense that they must be used in a fixed minimum
size. For instance, if a worker works half the time, he may be paid half the salary. But he cannot be
chopped into half and asked to produce half the current output. Thus as output increases the indivisible
factors which were being used below capacity can be utilized to their full capacity thereby reducing costs.
Such indivisibilities arise in the case of labour, machines, marketing, finance and research.

2. Specialization.

Division of labour, which leads to specialization, is another cause of internal economies. Specialization
refers to the limitation of activities within a particular field of production. Specialization may be in labour,
capital, machinery and place. For example, the production process may be split into four departments
relation to manufacturing, assembling, packing and marketing under the charge of separate managers
who may work under the overall charge of the general manger and coordinate the activities of the for
departments. Thus specialization will lead to greater productive efficiency and to reduction in costs.

Internal Economies:

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Internal economies may be of the following types.

A). Technical Economies.

Technical economies arise to a firm from the use of better machines and superior techniques of production.
As a result, production increases and per unit cost of production falls. A large firm, which employs costly
and superior plant and equipment, enjoys a technical superiority over a small firm. Another technical
economy lies in the mechanical advantage of using large machines. The cost of operating large machines
is less than that of operating mall machine. More over a larger firm is able to reduce it’s per unit cost of
production by linking the various processes of production. Technical economies may also be associated
when the large firm is able to utilize all its waste materials for the development of by-products industry.
Scope for specialization is also available in a large firm. This increases the productive capacity of the firm
and reduces the unit cost of production.

B). Managerial Economies:

These economies arise due to better and more elaborate management, which only the large size firms can
afford. There may be a separate head for manufacturing, assembling, packing, marketing, general
administration etc. Each department is under the charge of an expert. Hence the appointment of experts,
division of administration into several departments, functional specialization and scientific co-ordination of
various works make the management of the firm most efficient.

C). Marketing Economies:

The large firm reaps marketing or commercial economies in buying its requirements and in selling its final
products. The large firm generally has a separate marketing department. It can buy and sell on behalf of
the firm, when the market trends are more favorable. In the matter of buying they could enjoy advantages
like preferential treatment, transport concessions, cheap credit, prompt delivery and fine relation with
dealers. Similarly it sells its products more effectively for a higher margin of profit.

D). Financial Economies:

The large firm is able to secure the necessary finances either for block capital purposes or for working
capital needs more easily and cheaply. It can barrow from the public, banks and other financial institutions
at relatively cheaper rates. It is in this way that a large firm reaps financial economies.

E). Risk bearing Economies:

The large firm produces many commodities and serves wider areas. It is, therefore, able to absorb any
shock for its existence. For example, during business depression, the prices fall for every firm. There is
also a possibility for market fluctuations in a particular product of the firm. Under such circumstances the
risk-bearing economies or survival economies help the bigger firm to survive business crisis.

F). Economies of Research:

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A large firm possesses larger resources and can establish it’s own research laboratory and employ trained
research workers. The firm may even invent new production techniques for increasing its output and
reducing cost.

G). Economies of welfare:

A large firm can provide better working conditions in-and out-side the factory. Facilities like subsidized
canteens, crèches for the infants, recreation room, cheap houses, educational and medical facilities tend
to increase the productive efficiency of the workers, which helps in raising production and reducing costs.

External Economies.

Business firm enjoys a number of external economies, which are discussed below:

A). Economies of Concentration:

When an industry is concentrated in a particular area, all the member firms reap some common economies
like skilled labour, improved means of transport and communications, banking and financial services,
supply of power and benefits from subsidiaries. All these facilities tend to lower the unit cost of production
of all the firms in the industry.

B). Economies of Information

The industry can set up an information centre which may publish a journal and pass on information
regarding the availability of raw materials, modern machines, export potentialities and provide other
information needed by the firms. It will benefit all firms and reduction in their costs.

C). Economies of Welfare:

An industry is in a better position to provide welfare facilities to the workers. It may get land at concessional
rates and procure special facilities from the local bodies for setting up housing colonies for the workers. It
may also establish public health care units, educational institutions both general and technical so that a
continuous supply of skilled labour is available to the industry. This will help the efficiency of the workers.

D). Economies of Disintegration:

The firms in an industry may also reap the economies of specialization. When an industry expands, it
becomes possible to spilt up some of the processes which are taken over by specialist firms. For example,
in the cotton textile industry, some firms may specialize in manufacturing thread, others in printing, still
others in dyeing, some in long cloth, some in dhotis, some in shirting etc. As a result the efficiency of the
firms specializing in different fields increases and the unit cost of production falls.

Thus internal economies depend upon the size of the firm and external economies depend upon the size
of the industry.

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DISECONOMIES OF LARGE SCALE PRODUCTION

Internal and external diseconomies are the limits to large-scale production. It is possible that expansion
of a firm’s output may lead to rise in costs and thus result diseconomies instead of economies. When a
firm expands beyond proper limits, it is beyond the capacity of the manager to manage it efficiently. This
is an example of an internal diseconomy. In the same manner, the expansion of an industry may result in
diseconomies, which may be called external diseconomies. Employment of additional factors of production
becomes less efficient and they are obtained at a higher cost. It is in this way that external diseconomies
result as an industry expands.

The major diseconomies of large-scale production are discussed below:

Internal Diseconomies:

A). Financial Diseconomies:

For expanding business, the entrepreneur needs finance. But finance may not be easily available in the
required amount at the appropriate time. Lack of finance retards the production plans thereby increasing
costs of the firm.

B). Managerial diseconomies:

There are difficulties of large-scale management. Supervision becomes a difficult job. Workers do not work
efficiently, wastages arise, decision-making becomes difficult, coordination between workers and
management disappears and production costs increase.

C). Marketing Diseconomies:

As business is expanded, prices of the factors of production will rise. The cost will therefore rise. Raw
materials may not be available in sufficient quantities due to their scarcities. Additional output may depress
the price in the market. The demand for the products may fall as a result of changes in tastes and
preferences of the people. Hence cost will exceed the revenue.

D). Technical Diseconomies:

There is a limit to the division of labour and splitting down of production p0rocesses. The firm may fail to
operate its plant to its maximum capacity. As a result cost per unit increases. Internal diseconomies follow.

E). Diseconomies of Risk-taking:

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As the scale of production of a firm expands risks also increase with it. Wrong decision by the management
may adversely affect production. In large firms are affected by any disaster, natural or human, the
economy will be put to strains.

External Diseconomies:

When many firm get located at a particular place, the costs of transportation increases due to congestion.
The firms have to face considerable delays in getting raw materials and sending finished products to the
marketing centers. The localization of industries may lead to scarcity of raw material, shortage of various
factors of production like labour and capital, shortage of power, finance and equipments. All such external
diseconomies tend to raise cost per unit.

TYPES OF COSTS

Profits are the difference between selling price and cost of production. In general the selling price is not within
the control of a firm but many costs are under its control. The firm should therefore aim at controlling and
minimizing cost. The various relevant concepts of cost are:

1. Opportunity costs and Outlay costs:

Opportunity costs refer to the „costs of the next best alternative foregone‟. We have scarce resources and
all these have alternative uses. Where there is an alternative, there is an opportunity to reinvest the resources. In
other words, if there are no alternatives, there are no opportunity costs. It is necessary that we should always
consider the cost of the next best alternative foregone before committing the funds on a given option. In other
words, the benefits from the present option should be more than the benefits of the next best alternative.
Opportunity cost is said to exist when the resources are scarce and there are alternative uses forthese resources.
If there is no alternative, Opportunity cost is zero.

For example: if a firm owns a land, there is no cost of using the land (i.e., the rent) in firm‟s account.
Bust the firm has an opportunity cost of using this land, which is equal to the rent foregone by not letting the land
out on (the return of second best alternative is regarded as the cost of first best alternative) rent.

Out lay costs are as actual costs which are actually incurred by the firm. these are the payments made
for labour, material, plant, building, machinery traveling, transporting etc., These are all those expenses appearing
in the books of account, hence based on accounting cost concept.

2. Explicit costs and Implicit costs:

Explicit costs are also called as out-of-pocket cost that involve cash payments. These are the actual or
business costs that appear in the books of accounts. These costs include payment of wages and salaries, payment
for raw-materials, interest on borrowed capital funds, rent on hired land, Taxes paid etc.

Implicit costs are also called as imputed costs which don‟t involve payment of cash as they are not
actually incurred. They would have been incurred had the owner not been in possession of the facilities. Ex:
Interest on own capital, saving in terms of salary due to own supervision and rent of own building etc.

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3. Historical costs and Replacement costs:

Historical cost is the original cost that has been originally spent to acquire the asset. of an asset.
Historical valuation is the basis for financial accounts.

A replacement cost is the price that is to be paid currently to replace the same asset. A replacement cost
is a relevant cost concept when financial statements have to be adjusted for inflation.

4. Short – run costs and Long – run costs:

Short-run is a period during which the physical capacity of the firm remains fixed. Any increase in output
during this period is possible only by using the existing physical capacity more extensively. So short run cost is
that which varies with output when the plant and capital equipment are constant.
Long run is defined as a period of adequate length during which a company may alter all factors of
production with high degree of flexibility.

5. Out-of pocket costs and Books costs:

Out-of pocket costs also known as explicit costs are those costs that involve current cash payment such
as purchase of raw material, payment of salary rents payment, interest on loan etc.

Book costs also called implicit costs do not require current cash payments. Depreciation, unpaid
interest, salary of the owner is examples of back costs.

6. Fixed costs, Variable costs and Semi-variable costs:

Fixed cost is that cost which remains constant for a certain level to output. It is not affected by the
changes in the volume of production but fixed cost per unit decreases, when the production is increased. Fixed
cost includes salaries, Rent, Administrative expenses depreciations etc.

Variable is that which varies directly with the variation in output. An increase in total output results in
an increase in total variable costs and decrease in total output results in a proportionate deccease in the total
variables costs. The variable cost per unit will be constant. Ex: Raw materials, labour, direct expenses, etc.

Semi-variable costs refer to such costs that are fixed to some extent beyond which they are variable. Ex:
telephone charges, Electricity charges, etc.

7. Past costs and Future costs:

Past costs also called historical costs are the actual cost incurred and recorded in the book of account
these costs are useful only for valuation and not for decision making.

Future costs are costs that are expected to be incurred in the futures. They are not actual costs. They are
the costs forecasted or estimated with rational methods. Future cost estimate is useful for decision making because
decision are meant for future.

8. Separable costs and Joint costs:

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The costs which can be traced or identified directly with a particular unit, department, or a process of
production are called separable costs or direct costs or traceable costs.

The costs which cannot be identified directly with a particular unit, department or a process of the
production are called joint costs or indirect costs or common costs. These costs are apportioned among various
departments. Ex: Rent, Electricity, Administration salaries, Research and Development expenses etc.

9. Avoidable costs and Unavoidable costs:

Avoidable costs are those costs, which can be reduced if the business activities of a concern are curtailed.
For example, if some workers can be retrenched with a drop in production, the wages of the retrenched workers
are escapable costs.
Unavoidable costs are those that are essential for the sustenance of the business activity and hence they
have to be incurred.

10. Controllable costs and Uncontrollable costs:

Controllable costs are ones, which can be regulated by the executive who is in charge of it. Direct
expenses like material, labour etc. are controllable costs.

Some costs are not directly identifiable with a process of product. They are apportioned to various
processes or products in some proportion. These apportioned costs are called uncontrollable costs.

11. Incremental costs and Sunk costs:

Incremental cost also known as differential cost is the additional cost due to a change in the level or nature
of business activity. The change may be caused by adding a new product, adding new machinery, replacing a
machine by a better one etc.

Sunk costs are those which are not altered by any change – They are the costs incurred in the past. This
cost is the result of past decision, and cannot be changed by future decisions. Investments in fixed assets are
examples of sunk costs. Once an asset is bought, the funds are blocked forever. They can neither be changed
nor controlled.

12. Total costs, Average costs and Marginal costs:

Total cost is the total expenditure incurred for the input needed for production. It may be explicit or
implicit. It is the sum total of the fixed and variable costs.

Average cost is the cost per unit of output. It is obtained by dividing the total cost (TC) by the total
quantity produced (Q)

Marginal cost is the additional cost incurred to produce an additional unit of output.

13. Accounting costs and Economic costs:

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Accounting costs are the costs recorded for the purpose of preparing the profit & loss account and balance
sheet to meet the legal, financial and tax purpose of the company. The accounting concept is a historicalconcept
and records what has happened in the post.

Economic cost refers to cost of economic resources used in production including opportunity cost.
Economics concept considers future costs and future revenues, which help future planning, and choice, while
the accountant describes what has happened, the economics aims at projecting what will happen.

14. Urgent costs and Postponable costs:

Urgent cost are those costs such as raw materials, wages and son, necessary to sustain the productivity.

Postponable costs are those costs which can be conveniently postponed. For example, white washing the
building etc.

BREAK EVEN ANALYSIS

What is the break-even point for a business?

A business’s break-even point is the stage at which its revenue equalizes with its costs.

BEP analysis is also called as CVP analysis. The BEP can be defined as that level of sales at which total revenues
equals total costs and the net income is equal to zero. This is also known as no-profit no-loss point.

Break-even analysis refers to analysis of costs and their possible impact on revenues and volume of the firm.
Hence, it is also called the cost-volume-profit (CVP) analysis. A firm is said to attain the BEP when its total
revenue is equal to total cost(TR=TC).

The main objective of the Break Even Analysis is not only to spot the BEP but also to develop an understanding
of the relationships of cost, volume and price within a company’s practical range of operations.

Assumptions of Break-Even Analysis

1. All cost are divided into fixed and variable

2. Fixed costs remain constant whereas variable costs vary
3. Selling price remains constant
4. There will be no change in the operating efficiency

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Break Even Point Break-even point is that point of output level of the firm where firms total revenues are equal to total costs
(TR = TC). As discussed earlier economic profit is the excess of total revenue than the total costs i.e. (TR – TC) or (TR>TC), so at
break-even point when TR = TC, the firm neither earns profit nor incurs loss or is a situation of zero economic profit. In break-
even analysis Costs can be classified as either a fixed cost or a variable cost. A fixed cost is one that is independent of the level
of sales; rather, it is related to the passage of time. Examples of fixed costs include rent, salaries and insurance. A variable cost
is one that is directly related to the level of sales, such as cost of goods sold and commissions. Thus; Total Costs (TC) = Total
Fixed Costs (TFC) + Total Variable Costs (TVC) Total Revenue (TR) = Total Output (Q) * Price per unit of output (P) = QP Economic
Profit or loss = Total Revenue (TR) - Total Costs (TC) Break-even Point = TR = TC or TR - TC = zero The firm will incurs loss if it
operates below this point and will earn profit if it operates beyond this point. It may however be noted that by producing at
the level of break-even point, a firm covers only its cost of production. Normal profit is included in the cost of production.
Thus, at break-even point a firm gets only normal profit or zero economic profit.

SIGNIFICANCE OF BREAK-EVEN ANALYSIS

1) To ascertain the profit on a particular level of sales volume or a given capacity of production.
2) To calculate sales required to earn a particular desired level of profit.
3) To compare the product lines, sales area, method of sale for individual company.
4) To compare the efficiency of the different firms.
5) To decide whether to add a particular product to the existing product line or drop one from it.
6) To decide to „make or buy‟ a given component or spare part.
7) To decide what promotion mix will yield optimum sales.

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8) To assess the impact of changes in fixed cost, variable cost or selling price on BEP and profits during a
given period.

LIMITATIONS OF BREAK-EVEN ANALYSIS

1) Break-even point is based on fixed cost, variable cost and total revenue. A change in one variable is
going to affect the BEP.
2) All costs cannot be classified into fixed and variable costs. we have semi-variable costs also.
3) In case of multi-product firm, a single chart cannot be of any use. Series of charts have to be made use
of .
4) It is based on fixed cost concept and hence-holds good only in the short-run.
5) Total cost and total revenue lines are not always straight as shown in the figure. The quantity and price
discounts are the usual phenomena affecting the total revenue line.
6) Where the business conditions are volatile, BEP cannot give stable results.

TYPES OF PRICING
Firms set prices for their products through several alternative means. The important pricing methods followed
in practice are shown in the chart.

A. Cost Based Pricing

1. Full cost pricing:-Under this method, price is just equal to the average cost.
2. Cost plus pricing:- Here, the average cost is ascertained and then a conventional margin added to the
cost to arrive at the price. In other words, find out the product unit‟s total cost and add a percentage of
profit to arrive at the selling price. It is commonly followed in departmental stores and other retail shops.
This method is simple to be administered. It may be very difficult to find the selling price in advance due
to complexity of the nature of the project.
3. Marginal cost pricingBreak even pricing or Target profit pricing:- In this method, selling price is
fixed in such a way that it covers full variable or marginal cost and contributes towards recovery of fixed
costs. in the stiff competition, marginal cost offers a guidelines as to how far the selling price can be
lowered.
B. Competition based pricing
Here the price of product is set based on what the competitor charges for a similar product. In other words, a

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reduction in the price of products by the competitor will force us to follow suit. In such a case, how far we can
go on reducing the price?. Here the marginal cost concept comes handy. As long as the price covers the marginal
cost, continue to sell. If not, better stop selling. It is because, every unit sold at less than marginal cost results in
loss.
1. Sealed bid pricing:- This method is more popular in tenders and contracts. Each contracting firm quotes
its price in a sealed cover called “tender”. All the tenders are opened on a scheduled date and theperson
who quotes the lowest price is awarded the contract.
2. Going rate pricing:- Here the prevailing market price is charged. Suppose, when one wants to buy or
sell gold, the prevailing market rate at a given point of time is taken as the basis to determine the price.
C. Demand Based Pricing
1. Perceived value pricing:- This method considers the buyer‟s perception of the value of the product as
the basis of pricing. Here the pricing rule is that the firm must develop procedures for measuring the
relative value of the product as perceived by consumers.
2. Price discriminationDifferential pricing:- Price discrimination refers to the practice of charging
different prices to customers for the same good. In involves selling a product or service for different
prices in different market segments. Price differentiation depends on geographical location of the
consumers, type of consumer, purchasing quantity, season, time of the service etc. E.g. Telephone
charges, APSRTC charges.
D. Strategy based pricing
1. Skimming pricing:- The company follows this method when the product is for the first time introduced
in the market. Under this method, the company fixes a very high price for the product. this strategy is
mostly found in case of technology products. When Samsung introduces a new cell phone model, it fixes
a high price because of the uniqueness of the product.
2. Penetration pricing:- This is exactly opposite to the market skimming method. Here, a low price is
fixed for the product in order to catch the attention of consumers, once the product image and credibility
is established, the seller slowly starts jacking up the price to reap good profits in future. The Rin washing
soap perhaps falls into this category. This soap was sold at a rather low price in the beginning and the
firm even distributed free samples. Today, it is quite an expensive brand and yet it is selling very well.
3. Two-part pricing:- Under this strategy, a firm charges a fixed fee for the right to purchase its goods,
plus a per unit charge for each unit purchased. Entertainment houses such as country clubs, athletic clubs,
etc, usually adopt this strategy. They charge a fixed initiation fee or membership fee plus a charge, per
month or per visit, to use the facilities.
4. Block pricing:- We see block pricing in our day-to-day life very frequently. Four Santhoor soaps in a
single pack with nice looking soap box or five Maggi packets in a single pack with an attractive bowl
indicate this pricing method. The total value of the goods includes consumer‟s surplus as the consumer
is given soap box and bowl along with the products freely. By selling certain number of units of a product
as one package, the firm earns more than by selling unit wise.
5. Commodity bundling:- Commodity bundling means the practice of bundling two or more different
products together and selling them at single „bundle price‟. For example tourist companies offer the
package that includes the travelling charges, hotel, meals and sight-seeing etc, at a bundle price instead

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of pricing each of these services separately.
6. Peak load pricing:- Under this method, high price is charged during the peak times than off-peak times.
RTC increases charges during festivals, Railways charge more fares during tatkal time. During seasonal
period when demand is likely to be higher, a firm may increase profits by peak load pricing.
7. Cross subsidization:- The process of charging high price for one group of customers in order to subsidize
another group.
8. Transfer pricing:- Transfer pricing means a price at which one process forwards their outputwork-in-
progress to the next process for further processing. It is an internal pricing technique.

PRODUCT LIFE CYCLE BASED PRICING

Companies must adapt to the stages of the product life cycle to effectively sell and promote their products.
Depending on the product life cycle stage, a company will develop branding techniques and an appropriate pricing
model. Understanding each stage helps businesses increase profits.

The stages of a product life cycle govern how a product is priced, distributed, and promoted. A new product goes
through multiple stages during the course of its life cycle, including an introduction stage, growth stage, maturity
stage and a decline stage. As a product ages, companies look for new ways to brand it, and also explore
pricing changes. Market and competitor research help businesses assess the proper course of actionto maintain
product profitability.

Introduction Stage
A new product may simply be either another brand name added to the existing ones or an altogether new product.
Pricing a new brand for which there are many substitutes available in market is not a big problem as pricing a
new product for which close substitutes are not available.
There are two type of pricing strategies for new product.
2. Skimming price policy:- Selling a product at a high price, sacrificing high sales to gain a high profit, therefore
„skimming‟ the market. Usually employed to reimburse the cost of investment of the original research into
the product - commonly used in electronic markets when a new range, such as DVD players, are firstly
dispatched into the market at a high price.
3. Penetration price policy:- This pricing policy is adopted generally in the case of new product for which
substitutes are available. This policy requires fixing a lower initial price designed to penetrate the market as
quickly as possible.

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Growth Stage
During the growth stage, a company aims to develop brand recognition and increase their customer base. The
quality of their product is often improved based on early reviews, and technical support is usually enhanced.
Pricing remains generally stable as demand continues with minimal competition. A larger distribution network
is formed to keep up with the pace of demand.
Maturity Stage
In the maturity stage, the steady sales start to decline and companies face greater challenges in the marketplace.
Competitors will often introduce rival products with the intent of grabbing some of the market share. This is the
product life cycle stage in which the customer base is heavily fought over and price decreases most often occur.
Additional features are added to distinguish a product from its competitors. Companies run promotions during
this stage that highlight the primary differences between their product and their competitor‟s products.

Decline Stage
In the decline stage, a company will make important decisions regarding the future of their product. They can
choose to create new iterations of the product with new features, or they can reduce the price and offer it at a
discount. A company may choose to discontinue the product altogether, either disposing of their inventory or
selling it to another company who is willing to manufacture and market it. Promotion at this stage will depend on
whether a company chooses to continue its product, and how they plan to re-market it.

What is GST in India?

GST is known as the Goods and Services Tax. It is an indirect tax which has replaced many indirect taxes in India
such as the excise duty, VAT, services tax, etc. The Goods and Service Tax Act was passed in the Parliament on
29th March 2017 and came into effect on 1st July 2017.
In other words,Goods and Service Tax (GST) is levied on the supply of goods and services. Goods and Services
Tax Law in India is a comprehensive, multi-stage, destination-based tax that is levied on every value
addition. GST is a single domestic indirect tax law for the entire country.

Objectives Of GST
 To achieve the ideology of ‘One Nation, One Tax’

GST has replaced multiple indirect taxes, which were existing under the previous tax regime. The advantage of
having one single tax means every state follows the same rate for a particular product or service. Tax administration
is easier with the Central Government deciding the rates and policies. Common laws can be introduced, such as e-
way bills for goods transport and e-invoicing for transaction reporting. Tax compliance is also better as taxpayers
are not bogged down with multiple return forms and deadlines. Overall, it’s a unified system of indirect tax
compliance.
 To subsume a majority of the indirect taxes in India

India had several erstwhile indirect taxes such as service tax, Value Added Tax (VAT), Central Excise, etc., which
used to be levied at multiple supply chain stages. Some taxes were governed by the states and some by the Centre.
There was no unified and centralised tax on both goods and services. Hence, GST was introduced. Under GST, all
the major indirect taxes were subsumed into one. It has greatly reduced the compliance burden on taxpayers and
eased tax administration for the government.
 To eliminate the cascading effect of taxes

One of the primary objectives of GST was to remove the cascading effect of taxes. Previously, due to different
indirect tax laws, taxpayers could not set off the tax credits of one tax against the other. For example, the excise
duties paid during manufacture could not be set off against the VAT payable during the sale. This led to a cascading
effect of taxes. Under GST, the tax levy is only on the net value added at each stage of the supply chain. This has
helped eliminate the cascading effect of taxes and contributed to the seamless flow of input tax credits across both
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goods and services.
 To curb tax evasion

GST laws in India are far more stringent compared to any of the erstwhile indirect tax laws. Under GST, taxpayers
can claim an input tax credit only on invoices uploaded by their respective suppliers. This way, the chances of
claiming input tax credits on fake invoices are minimal. The introduction of e-invoicing has further reinforced this
objective. Also, due to GST being a nationwide tax and having a centralised surveillance system, the clampdown on
defaulters is quicker and far more efficient. Hence, GST has curbed tax evasion and minimised tax fraud from
taking place to a large extent.
 To increase the taxpayer base

GST has helped in widening the tax base in India. Previously, each of the tax laws had a different threshold limit for
registration based on turnover. As GST is a consolidated tax levied on both goods and services both, it has
increased tax-registered businesses. Besides, the stricter laws surrounding input tax credits have helped bring
certain unorganised sectors under the tax net. For example, the construction industry in India.
 Online procedures for ease of doing business

Previously, taxpayers faced a lot of hardships dealing with different tax authorities under each tax law. Besides,
while return filing was online, most of the assessment and refund procedures took place offline. Now, GST
procedures are carried out almost entirely online. Everything is done with a click of a button, from registration to
return filing to refunds to e-way bill generation. It has contributed to the overall ease of doing business in India and
simplified taxpayer compliance to a massive extent. The government also plans to introduce a centralised portal
soon for all indirect tax compliance such as e-invoicing, e-way bills and GST return filing.
 An improved logistics and distribution system

A single indirect tax system reduces the need for multiple documentation for the supply of goods. GST minimises
transportation cycle times, improves supply chain and turnaround time, and leads to warehouse consolidation,
among other benefits. With the e-way bill system under GST, the removal of interstate checkpoints is most
beneficial to the sector in improving transit and destination efficiency. Ultimately, it helps in cutting down the high
logistics and warehousing costs.
 To promote competitive pricing and increase consumption

Introducing GST has also led to an increase in consumption and indirect tax revenues. Due to the cascading effect
of taxes under the previous regime, the prices of goods in India were higher than in global markets. Even between
states, the lower VAT rates in certain states led to an imbalance of purchases in these states. Having uniform GST
rates have contributed to overall competitive pricing across India and on the global front. This has hence increased
consumption and led to higher revenues, which has been another important objective achieved.
Advantages Of GST
GST has mainly removed the cascading effect on the sale of goods and services. Removal of the cascading effect
has impacted the cost of goods. Since the GST regime eliminates the tax on tax, the cost of goods decreases.
Also, GST is mainly technologically driven. All the activities like registration, return filing, application for refund
and response to notice needs to be done online on the GST portal, which accelerates the processes.

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GST is a multi-stage tax charged on each value addition. It is imposed on goods and services on every
level of the distribution chain. There are 4 types of GST which are given below

1. Central Goods and Services Tax (CGST)

2. State Goods and Services Tax (SGST)
3. Integrated Goods and Services Tax (IGST)
4. Union Territory Goods and Services Tax (UTGST)

How Many Rates are there in GST?

The different GST tax slabs are given below.

1. 5%
2. 12%
3. 18%
4. 28%

GST council has fixed over 1300 goods and 500 services under the above 4 given tax slabs. Around
81% of all goods and services fall below or in the 18% tax slab.

GST Tax Structure

The four-tier tax structure of GST has the following slabs: a zero rate, a lower rate, two standard rates, and a higher
rate. Here’s a brief overview of each GST rate.
Zero rate
The zero rate tax is a nil tax that is applied on goods and services. Zero rated items include milk, eggs, curd,
unpacked food grains and health & educational services.
Lower rate
A lower rate of 5% will be applied on items like sugar, tea, edible oil, coal, spices, and cotton fabric. This, along
with the zero rate, will help prevent inflation from having much of an impact on the prices of essential items.
Standard rate
There are two standard rates that have been finalized by the GST Council: 12% and 18%.
Processed food, butter, and mobile phones will be taxed at 12%. Capital goods, industry intermediaries, toiletries,
computers and printers will be taxed the second standard rate of 18%.
Higher rate
A higher rate of 28% will be levied on white goods. This includes items such as washing machines, high-end
motorcycles, air conditioners, refrigerators, small cars, etc.

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MARKET

Market is a place where buyer and seller meet, goods and services are offered for the sale and transfer of
ownership occurs. A market may be also defined as the demand made by a certain group of potential
buyers for a good or service. The former one is a narrow concept and later one, a broader concept.
Economists describe a market as a collection of buyers and sellers who transact over a particular product
or product class (the housing market, the clothing market, the grain market etc.). For business purpose
we define a market as people or organizations with wants (needs) to satisfy, money to spend, and the
willingness to spend it. Broadly, market represents the structure and nature of buyers and sellers for a
commodity/service and the process by which the price of the commodity or service is established. In this
sense, we are referring to the structure of competition and the process of price determination for a
commodity or service. The determination of price for a commodity or service depends upon the structure
of the market for that commodity or service (i.e., competitive structure of the market). Hence the
understanding on the market structure and the nature of competition are a pre-requisite in price
determination.

Different Market Structures

Market structure describes the competitive environment in the market for any good or service. A market
consists of all firms and individuals who are willing and able to buy or sell a particular product. This includes
firms and individuals currently engaged in buying and selling a particular product, as well as potential
entrants.

The determination of price is affected by the competitive structure of the market. This is because the firm
operates in a market and not in isolation. In marking decisions concerning economic variables it is affected,
as are all institutions in society by its environment.

Perfect Competition

Perfect competition refers to a market structure where competition among the sellers and buyers prevails
in its most perfect form. In a perfectly competitive market, a single market price prevails for the
commodity, which is determined by the forces of total demand and total supply in the market.

Characteristics or features of Perfect Competition

The following features characterize a perfectly competitive market:

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1. A large number of buyers and sellers: The number of buyers and sellers is large and the share of
each one of them in the market is so small that none has any influence on the market price.
2. Homogeneous product: The product of each seller is totally undifferentiated from those of the
others.
3. Free entry and exit: Any buyer and seller is free to enter or leave the market of the commodity.
4. Perfect knowledge: All buyers and sellers have perfect knowledge about the market for the
commodity.
5. Indifference: No buyer has a preference to buy from a particular seller and no seller to sell to a
particular buyer.
6. Non-existence of transport costs: Perfectly competitive market also assumes the non-existence
of transport costs.
7. Perfect mobility of factors of production: Factors of production must be in a position to move
freely into or out of industry and from one firm to the other.

Under such a market no single buyer or seller plays a significant role in price determination. One the other
hand all of them jointly determine the price. The price is determined in the industry, which is composed
of all the buyers and seller for the commodity. The demand curve facing the industry is the sum of all
consumers’ demands at various prices. The industry supply curve is the sum of all sellers’ supplies at
various prices.

Pure competition and perfect competition

The term perfect competition is used in a wider sense. Pure competition has only limited assumptions.
When the assumptions, that large number of buyers and sellers, homogeneous products, free entry and
exit are satisfied, there exists pure competition. Competition becomes perfect only when all the
assumptions (features) are satisfied. Generally pure competition can be seen in agricultural products.

Equilibrium of a firm and industry under perfect competition

Equilibrium is a position where the firm has no incentive either to expand or contrast its output. The firm
is said to be in equilibrium when it earn maximum profit. There are two conditions for attaining equilibrium
by a firm. They are:

Marginal cost is an additional cost incurred by a firm for producing and additional unit of output. Marginal
revenue is the additional revenue accrued to a firm when it sells one additional unit of output. A firm
increases its output so long as its marginal cost becomes equal to marginal revenue. When marginal cost
is more than marginal revenue, the firm reduces output as its costs exceed the revenue. It is only at the
point where marginal cost is equal to marginal revenue, and then the firm attains equilibrium. Secondly,
the marginal cost curve must cut the marginal revenue curve from below. If marginal cost curve cuts the
marginal revenue curve from above, the firm is having the scope to increase its output as the marginal
cost curve slopes downwards. It is only with the upward sloping marginal cost curve, there the firm attains
equilibrium. The reason is that the marginal cost curve when rising cuts the marginal revenue curve from
below.

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The equilibrium of a perfectly competitive firm may be explained with the help of the fig. 6.2.

In the given fig. PL and MC represent the Price line and Marginal cost curve. PL also represents Marginal
revenue, Average revenue and demand. As Marginal revenue, Average revenue and demand are the same
in perfect competition, all are equal to the price line. Marginal cost curve is U- shaped curve cutting MR
curve at R and T. At point R marginal cost becomes equal to marginal revenue. But MC curve cuts the MR
curve fro above. So this is not the equilibrium position. The downward sloping marginal cost curve indicates
that the firm can reduce its cost of production by increasing output. As the firm expands its output, it will
reach equilibrium at point T. At this point, on price line PL; the two conditions of equilibrium are satisfied.
Here the marginal cost and marginal revenue of the firm remain equal. The firm is producing maximum
output and is in equilibrium at this stage. If the firm continues its output beyond this stage, its marginal
cost exceeds marginal revenue resulting in losses. As the firm has no idea of expanding or contracting its
size of out, the firm is said to be in equilibrium at point T.

Monopoly

The word monopoly is made up of two syllables, Mono and poly. Mono means single while poly implies selling.
Thus monopoly is a form of market organization in which there is only one seller of the commodity. There are no
close substitutes for the commodity sold by the seller. Pure monopoly is a market situation in which a single firm
sells a product for which there is no good substitute.

Features of monopoly

The following are the features of monopoly.

1. Single person or a firm: A single person or a firm controls the total supply of the commodity. There will be
no competition for monopoly firm. The monopolist firm is the only firm in the whole industry.
2. No close substitute: The goods sold by the monopolist shall not have closely competition substitutes. Even
if price of monopoly product increase people will not go in far substitute. For example: If the price of
electric bulb increase slightly, consumer will not go in for kerosene lamp.
3. Large number of Buyers: Under monopoly, there may be a large number of buyers in the market who
compete among themselves.
4. Price Maker: Since the monopolist controls the whole supply of a commodity, he is a price-maker, and
then he can alter the price.
5. Supply and Price: The monopolist can fix either the supply or the price. He cannot fix both. If he charges a
very high price, he can sell a small amount. If he wants to sell more, he has to charge a low price. He cannot
sell as much as he wishes for any price he pleases.
6. Downward Sloping Demand Curve: The demand curve (average revenue curve) of monopolist slopes

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downward from left to right. It means that he can sell more only by lowering price.

Types of Monopoly

Monopoly may be classified into various types. The different types of monopolies are explained below:

1. Legal Monopoly: If monopoly arises on account of legal support or as a matter of legal privilege, it is
called Legal Monopoly. Ex. Patent rights, special brands, trade means, copyright etc.
2. Voluntary Monopoly: To get the advantages of monopoly some private firms come together voluntarily to
control the supply of a commodity. These are called voluntary monopolies. Generally, these monopolies
arise with industrial combinations. These voluntary monopolies are of three kinds (a) cartel (b) trust (c)
holding company. It may be called artificial monopoly.
3. Government Monopoly: Sometimes the government will take the responsibility of supplying a commodity
and avoid private interference. Ex. Water, electricity. These monopolies, created to satisfy social wants, are
formed on social considerations. These are also called Social Monopolies.
4. Private Monopoly: If the total supply of a good is produced by a single private person or firm, it is called
private monopoly. Hindustan Lever Ltd. Is having the monopoly power to produce Lux Soap.
5. Limited Monopoly: if the monopolist is having limited power in fixing the price of his product, it is called
as ‘Limited Monopoly’. It may be due to the fear of distant substitutes or government intervention or the
entry of rivals firms.
6. Unlimited Monopoly: If the monopolist is having unlimited power in fixing the price of his good or
service, it is called unlimited monopoly. Ex. A doctor in a village.
7. Single Price Monopoly: When the monopolist charges same price for all units of his product, it is called
single price monopoly. Ex. Tata Company charges the same price to all the Tata Indiaca Cars of the same
model.
8. Discriminating Monopoly: When a Monopolist charges different prices to different consumers for the
same product, it is called discriminating monopoly. A doctor may take Rs.20 from a rich man and only Rs.2
from a poor man for the same treatment.
9. Natural Monopoly: Sometimes monopoly may arise due to scarcity of natural resources. Nature provides
raw materials only in some places. The owner of the place will become monopolist. For Ex. Diamond mine
in South Africa.

Pricing under Monopoly

Monopoly refers to a market situation where there is only one seller. He has complete control over the supply of a
commodity. He is therefore in a position to fix any price. Under monopoly there is no distinction between a firm
and an industry. This is because the entire industry consists of a single firm.

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Being the sole producer, the monopolist has complete control over the supply of the commodity. He has also the
power to influence the market price. He can raise the price by reducing his output and lower the price by increasing
his output. Thus he is a price-maker. He can fix the price to his maximum advantages. But he cannot fix both the
supply and the price, simultaneously. He can do one thing at a time. If the fixes the price, his output will be
determined by the market demand for his commodity. On the other hand, if he fixes the output to be sold, its market
will determine the price for the commodity. Thus his decision to fix either the price or the output is determined by
the market demand.

The market demand curve of the monopolist (the average revenue curve) is downward sloping. Its corresponding
marginal revenue curve is also downward sloping. But the marginal revenue curve lies below the average revenue
curve as shown in the figure. The monopolist faces the down-sloping demand curve because to sell more output, he
must reduce the price of his product. The firm’s demand curve and industry’s demand curve are one and the same.
The average cost and marginal cost curve are U shaped curve. Marginal cost falls and rises steeply when compared
to average cost.

Price output determination (Equilibrium Point)

The monopolistic firm attains equilibrium when its marginal cost becomes equal to the marginal revenue. The
monopolist always desires to make maximum profits. He makes maximum profits when MC=MR. He does not
increasing his output if his revenue exceeds his costs. But when the costs exceed the revenue, the monopolist firm
incur loses. Hence the monopolist curtails his production. He produces up to that point where additional cost is
equal to the additional revenue (MR=MC). Thus point is called equilibrium point. The price output determination
under monopoly may be explained with the help of a diagram.

In the diagram 6.12 the quantity supplied or demanded is shown along X-axis. The cost or revenue is shown along
Y-axis. AC and MC are the average cost and marginal cost curves respectively. AR and MR curves slope
downwards from left to right. AC and MC and U shaped curves. The monopolistic firm attains equilibrium when its
marginal cost is equal to marginal revenue (MC=MR). Under monopoly, the MC curve may cut the MR curve from
below or from a side. In the diagram, the above condition is satisfied at point E. At point E, MC=MR. The firm is in
equilibrium. The equilibrium output is OM.

The above diagram (Average revenue) = MQ or OP

Average cost = MR
Profit per unit = Average Revenue-Average cost=MQ-MR=QR
Total Profit = QRXSR=PQRS

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The area PQRS resents the maximum profit earned by the monopoly firm.

But it is not always possible for a monopolist to earn super-normal profits. If the demand and cost situations are not
favorable, the monopolist may realize short run losses.

Through the monopolist is a price marker, due to weak demand and high costs; he suffers a loss equal to PABC.

If AR > AC -> Abnormal or super normal profits.

If AR = AC -> Normal Profit
If AR < AC -> Loss

In the long run the firm has time to adjust his plant size or to use existing plant so as to maximize profits.

Monopolistic competition

Perfect competition and pure monopoly are rate phenomena in the real world. Instead, almost every market seems
to exhibit characteristics of both perfect competition and monopoly. Hence in the real world it is the state of
imperfect competition lying between these two extreme limits that work. Edward. H. Chamberlain developed the
theory of monopolistic competition, which presents a more realistic picture of the actual market structure and the
nature of competition.

Characteristics of Monopolistic Competition

The important characteristics of monopolistic competition are:

1. Existence of Many firms: Industry consists of a large number of sellers, each one of whom does not feel
dependent upon others. Every firm acts independently without bothering about the reactions of its rivals.
The size is so large that an individual firm has only a relatively small part in the total market, so that each
firm has very limited control over the price of the product. As the number is relatively large it is difficult for
these firms to determine its price- output policies without considering the possible reactions of the rival
forms. A monopolistically competitive firm follows an independent price policy.

2. Product Differentiation: Product differentiation means that products are different in some ways, but not

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altogether so. The products are not identical but the same time they will not be entirely different from each
other. IT really means that there are various monopolist firms competing with each other. An example of
monopolistic competition and product differentiation is the toothpaste produced by various firms. The
product of each firm is different from that of its rivals in one or more respects. Different toothpastes like
Colgate, Close-up, Forehans, Cibaca, etc., provide an example of monopolistic competition. These products
are relatively close substitute for each other but not perfect substitutes. Consumers have definite preferences
for the particular verities or brands of products offered for sale by various sellers. Advertisement, packing,
trademarks, brand names etc. help differentiation of products even if they are physically identical.
3. Large Number of Buyers: There are large number buyers in the market. But the buyers have their own
brand preferences. So the sellers are able to exercise a certain degree of monopoly over them. Each seller
has to plan various incentive schemes to retain the customers who patronize his products.
4. Free Entry and Exist of Firms: As in the perfect competition, in the monopolistic competition too, there is
freedom of entry and exit. That is, there is no barrier as found under monopoly.
5. Selling costs: Since the products are close substitute much effort is needed to retain the existing consumers
and to create new demand. So each firm has to spend a lot on selling cost, which includes cost on
advertising and other sale promotion activities.
6. Imperfect Knowledge: Imperfect knowledge about the product leads to monopolistic competition. If the
buyers are fully aware of the quality of the product they cannot be influenced much by advertisement or
other sales promotion techniques. But in the business world we can see that thought the quality of certain
products is the same, effective advertisement and sales promotion techniques make certain brands
monopolistic. For examples, effective dealer service backed by advertisement-helped popularization of
some brands through the quality of almost all the cement available in the market remains the same.
7. The Group: Under perfect competition the term industry refers to all collection of firms producing a
homogenous product. But under monopolistic competition the products of various firms are not identical
through they are close substitutes. Prof. Chamberlin called the collection of firms producing close substitute
products as a group.

Price – Output Determination under Monopolistic Competition

Since under monopolistic competition different firms produce different varieties of products, different prices for
them will be determined in the market depending upon the demand and cost conditions. Each firm will set the price
and output of its own product. Here also the profit will be maximized when marginal revenue is equal to marginal
cost.

Short-run equilibrium of the firm:

In the short-run the firm is in equilibrium when marginal Revenue = Marginal Cost. In Fig 6.15 AR is the average
revenue curve. NMR marginal revenue curve, SMC short-run marginal cost curve, SAC short-run average cost
curve, MR and SMC interest at point E where output in OM and price MQ (i.e. OP). Thus the equilibrium output or
the maximum profit output is OM and the price MQ or OP. When the price (average revenue) is above average cost
a firm will be making supernormal profit. From the figure it can be seen that AR is above AC in the equilibrium
point. As AR is above AC, this firm is making abnormal profits in the short-run. The abnormal profit per unit is
QR, i.e., the difference between AR and AC at equilibrium point and the total supernormal profit is OR X OM. This
total abnormal profits is represented by the rectangle PQRS. As the demand curve here is highly elastic, the excess
price over marginal cost is rather low. But in monopoly the demand curve is inelastic. So the gap between price and
marginal cost will be rather large.

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If the demand and cost conditions are less favorable the

monopolistically competitive firm may incur loss in the
short-run fig 6.16 Illustrates this. A firm incurs loss when the price is less than the average cost of production. MQ
is the average cost and OS (i.e. MR) is the price per unit at equilibrium output OM. QR is the loss per unit. The
total loss at an output OM is OR X OM. The rectangle PQRS represents the total loses in the short run.

Long – Run Equilibrium of the Firm:

A monopolistically competitive firm will be long – run

equilibrium at the output level where marginal cost equal to
marginal revenue. Monopolistically competitive firm in the long run attains equilibrium where MC=MR and
AC=AR Fig 6.17 shows this trend.

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Oligopoly

The term oligopoly is derived from two Greek words, oligos meaning a few, and pollen meaning to sell. Oligopoly
is the form of imperfect competition where there are a few firms in the market, producing either a homogeneous
product or producing products, which are close but not perfect substitute of each other.

Characteristics of Oligopoly

The main features of oligopoly are:

1. Few Firms: There are only a few firms in the industry. Each firm contributes a sizeable share of the total
market. Any decision taken by one firm influence the actions of other firms in the industry. The various
firms in the industry compete with each other.
2. Interdependence: As there are only very few firms, any steps taken by one firm to increase sales, by
reducing price or by changing product design or by increasing advertisement expenditure will naturally
affect the sales of other firms in the industry. An immediate retaliatory action can be anticipated from the
other firms in the industry every time when one firm takes such a decision. He has to take this into account
when he takes decisions. So the decisions of all the firms in the industry are interdependent.
3. Indeterminate Demand Curve: The interdependence of the firms makes their demand curve indeterminate.
When one firm reduces price other firms also will make a cut in their prices. So he firm cannot be certain
about the demand for its product. Thus the demand curve facing an oligopolistic firm loses its definiteness
and thus is indeterminate as it constantly changes due to the reactions of the rival firms.
4. Advertising and selling costs: Advertising plays a greater role in the oligopoly market when compared to
other market systems. According to Prof. William J. Banumol “it is only oligopoly that advertising comes
fully into its own”. A huge expenditure on advertising and sales promotion techniques is needed both to
retain the present market share and to increase it. So Banumol concludes “under oligopoly, advertising can
become a life-and-death matter where a firm which fails to keep up with the advertising budget of its
competitors may find its customers drifting off to rival products.”
5. Price Rigidity: In the oligopoly market price remain rigid. If one firm reduced price it is with the intention
of attracting the customers of other firms in the industry. In order to retain their consumers they will also
reduce price. Thus the pricing decision of one firm results in a loss to all the firms in the industry. If one
firm increases price. Other firms will remain silent there by allowing that firm to lost its customers. Hence,
no firm will be ready to change the prevailing price. It causes price rigidity in the oligopoly market.

Other Market Structures

Duopoly

Duopoly refers to a market situation in which there are only two sellers. As there are only two sellers any decision

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taken by one seller will have reaction from the other Eg. Coca-Cola and Pepsi. Usually these two sellers may agree
to co-operate each other and share the market equally between them, So that they can avoid harmful competition.

The duopoly price, in the long run, may be a monopoly price or competitive price, or it may settle at any level
between the monopoly price and competitive price. In the short period, duopoly price may even fall below the level
competitive price with the both the firms earning less than even the normal price.

Monopsony

Mrs. Joan Robinson was the first writer to use the term monopsony to refer to market, which there is a single buyer.
Monoposony is a single buyer or a purchasing agency, which buys the show, or nearly whole of a commodity or
service produced. It may be created when all consumers of a commodity are organized together and/or when only
one consumer requires that commodity which no one else requires.

Bilateral Monopoly

A bilateral monopoly is a market situation in which a single seller (Monopoly) faces a single buyer (Monoposony).
It is a market of monopoly-monoposy.

Oligopsony

Oligopsony is a market situation in which there will be a few buyers and many sellers. As the sellers are more and
buyers are few, the price of product will be comparatively low but not as low as under monopoly.

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