Economics Notes

COSTS IN THE SHORT RUN:

The short - run is defined as a period in which the supply of at least one element of the inputs cannot be changed by the firm. Short- run are the costs that can vary with the degree of utilization of the plant and other fixed factors.
Total cost: Once money resources of the firm have been invested into building, machinery and other fixed assets, their amount cannot be changed. In the short – run, there are certain resources whose amount cannot be changed when the desired rate of output changes [fixed input]. There are other resources whose quantity used can be changed with the output change [variable inputs]. Since certain inputs do not change with the change in output, the cost to the firm of these fixed resources is also fixed. The cost of inputs whose quantity can be changed in the short –run is known as variable cost. Thus the total cost [T C] to a firm for a given level of output in the short – run is the sum total of the total fixed cost [TFC] and total variable cost [TVC] .
TC = TFC + TVC
Fixed costs are also known as constant cost or overhead costs. Variable costs are also known as prime costs or direct costs

Average costs: Average cost [AC] is the per unit cost

AFC = TFC / Output [Q]

Average variable cost [AVC] is the variable cost per unit of output.

AVC = TVC / Output [Q]

Thus ATC = TC / Q = TFC /Q + TVC /Q = AFC +AVC

AFC is a downward sloping curve to the right and it is a rectangular hyperbola since AFC and the quantity produced are constant.

The AVC curve will be generally U shaped. The AVC falls as output increases due to the operation of increasing returns. But beyond the normal capacity output, the AVC will rise up due to the operation of diminishing returns.

ATC = TC / Q

TVC +TFC
ATC = -------------------- [TC = TVC +TFC]
Q

TVC TFC
ATC = ------ + ------
Q Q
ATC = AVC +AFC

Marginal cost: Marginal cost is the addition to the total cost by the last unit of output. It is addition to the total cost of producing ‘n’ units.

MC n = TC n – TC n – 1

MC is the rate at which the total cost changes with output. It is the slope of total cost curve. TC first rises at a decreasing rate and later on at an increasing rate. MC which is graphically the slope of TC curve [and of TVC] will also first decline, then rise.

LONG – RUN COST CURVES: In the long –run all factors of production are variable and the entrepreneur has before him a number of alternative plant sizes and levels of output which he can adopt. The long run cost curve is therefore called a ‘planning curve’.
The long run cost curve is derived from the short – run cost curves as the long period is made up of short periods. The long run cost curve is an envelope of the family of short – run cost curves.

PRICING POLICIES

Formulating price policies and setting the prices are the most important aspects of managerial decision – making. Price is the source of revenue as well as a device a firm can use to expand its market.

The factors governing prices may be divided into external factors and internal factors. The external factors are:

1] the elasticity of supply and demand,

2] the good will of the company,

3] the extent of competition in the market,

4] the trend in the market,

5] the purchasing power of the buyers and

6] the government policy towards prices.

The external factors are:

1] the costs and

2] the management policy towards the gross margin and the sales turnover In addition the basic characteristics of the product, the stage of the product in the product life cycle, the use pattern and turnaround rate of the product and the extent of distinctiveness of the product and the extent of product differentiation practiced by the firm are also among the internal factors.

Following are the general conditions which must be kept in mind while formulating the price policy.
1] Objectives of business
2] Competitive situation in which the company is placed
3] Product and promotional policies
4] Nature of price sensitivity
5] Conflicting interest of manufacturers and middlemen
6] Routinization of pricing – number of pricing decision, speed required for pricing decision, quality of available information, competitive market.
7] Active entry of non – business group into the determination of prices

OBJECTIVES OF PRICING POLICIES

The following are some of the main objectives of pricing policy
1] Maximization of profit
2] Promotion of the long – range.
3] Adaptation of prices to fit the diverse competitive situation
4] Flexibility to vary prices to meet the changes in economic conditions affecting the various consumer industries
5] Stabilization of prices and margin
6] Market penetration

PRICING METHODS

There are generally two types of methods usually employed by businessmen.
1] Cost oriented and

2] Competition oriented.

1] COST ORIENTED:
a] Cost – plus or Full cost pricing
b] Pricing for a rate of return also called target – pricing
c] Marginal cost pricing

COST – PLUS or FULL COST PRICING: This is the most common method used for pricing. Under this method, the price is set to cover costs [materials, labour and overhead] and a pre – determined percentage for profit.
PRICING FOR A RATE OF RETURN: An important problem that a firm might have to face is one of adjusting the prices to changes in costs. For this purpose the popular policies that are often followed are:
1] Revise prices to maintain a constant percentage mark – up over costs
2] Revise prices to maintain profits as a constant percentage of total sales
3] Revise prices to maintain a constant return on invested capital.

MARGINAL COST PRICING: Both under full cost pricing and the rate of return pricing, prices are based on total costs comprising fixed and variable costs. Under marginal cost pricing, prices are determined on the basis of marginal cost .

MARKET AND MARKET STRUCTURE

In the words of Cournot, a French economist, ‘ Economists understand by the term market not any particular market place in which things are bought and sold but the whole of any region in which buyers and sellers are in such free intercourse with one another that the price of the same goods tends to equality easily and quickly’’
Thus, the essentials of a market are: a] a commodity which is dealt with; b] the existence of buyers and sellers; c] a place- be it a certain region, a country, or the entire world; and d] such intercourse between buyers and sellers that one price should prevail for the same commodity at the same time.

Classification of Markets

Markets may be classified:
a] on the basis of area as local, national and world markets;
b] on the basis of time, as market price, short – period price, long period price or secular markets covering a generation; and
c] on the basis of nature of competition as perfect markets and imperfect market.

MARKET STRUCTURE:

Market structure refers to the organizational features of an industry that influence the firm’s behaviour in its choice of price and output .Market structure is classified on the basis of organizational features of the industry, more specifically on the basis of degree of competition among the firms. In general, the organizational features include the number of firms, distinctiveness of their products, elasticity of demand and the degree of control over the price of the product.
The market structure is generally classified on the basis of the degree of competition as:
A] Perfect competition
B] Imperfect competition
a] Monopolistic competition
b] Oligopoly
c] Duopoly
C] Monopoly