Pricing Economics
Pricing Economics
Pricing Economics
Pricing
Introduction
Pricing is an important, if not the most important function of all enterprises. Since every
enterprise is engaged in the production of some goods or/and service. Incurring some
expenditure, it must set a price for the same to sell it in the market. It is only in
extreme cases that the firm has no say in pricing its product; because there is severe
or rather perfect competition in the market of the good happens to be of such public
significance that its price is decided by the government. In an overwhelmingly large
number of cases, the individual producer plays the role in pricing its product.
It is said that if a firm were good in setting its product price it would certainly flourish in
the market. This is because the price is such a parameter that it exerts a direct
influence on the products demand as well as on its supply, leading to firm’s turnover
(sales) and profit. Every manager endeavors to find the price, which would best meet
with his firm’s objective. If the price is set too high the seller may not find enough
customers to buy his product. On the other hand, if the price is set too low the seller
may not be able to recover his costs. There is a need for the right price further, since
demand and supply conditions are variable over time what is a right price today may
not be so tomorrow hence, pricing decision must be reviewed and reformulated from
time to time.
Price
Price denotes the exchange value of a unit of good expressed in terms of money. Thus
the current price of a maruti car around Rs. 2,00,000, the price of a hair cut is Rs. 25
the price of a economics book is Rs. 150 and so on. Nevertheless, if one gives a little, if
one gives a little thought to this subject, one would realize that there is nothing like a
unique price for any good. Instead, there are multiple prices.
Price concepts
Price of a well-defined product varies over the types of the buyers, place it is received,
credit sale or cash sale, time taken between final production and sale, etc.
It should be obvious to the readers, that the price difference on account of the above
four factors are more significant. The multiple prices is more serious in the case of
items like cars refrigerators, coal, furniture and bricks and is of little significance for
items like shaving blade, soaps, tooth pastes, creams and stationeries. Differences in
various prices of any good are due to differences in transport cost, storage cost
accessories, interest cost, intermediaries’ profits etc. Once can still conceive of a basic
price, which would be exclusive of all these items of cost and then rationalize other
prices by adding the cost of special items attached to the particular transaction, in what
follows we shall explain the determination of this basis price alone and thus resolve the
problem of multiple prices.
The price of a product is determined by the demand for and supply of that product.
According to Marshall the role of these two determinants is like that of a pair of scissors
in cutting cloth. It is possible that at times, while one pair is held fixed, the other is
moving to cut the cloth. Similarly, it is conceivable that there could be situations under
which either demand or supply is playing a passive role, and the other, which is active,
alone appear to be determining the price. However, just as one pair of scissors alone
can never cut a cloth, demand or supply alone is insufficient to determine the price.
Equilibrium Price
The price at which demand and supply of a commodity is equal known as equilibrium
price. The demand and supply schedules of a good are shown in the table below.
Of the five possible prices in the above example, price Rs.30 would be the market-
clearing price. No other price could prevail in the market. If price is Rs. 50 supply would
exceed demand and consequently the producers of this good would not find enough
customers for their demand, thereby they would accumulate unwanted inventories of
output, which, in turn, would lead to competition among the producers, forcing price to
Rs.30. Similarly if price were Rs.10, there would be excess demand, which would give
rise to competition among the buyers of good, forcing price to Rs.30. At price Rs.30,
demand equals supply and thus both producers and consumers are satisfied. The
economist calls such a price as equilibrium price.
It was seen in unit 1 that the demand for a good depends on, a number of factors and
thus, every factor, which influences either demand or supply is in fact a determinant of
price. Accordingly, a change in demand or/and supply causes price change.
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.
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.
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.
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 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.
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.
Pricing under perfect competition
Very short period: It is the period in which the supply is more or less fixed because
the time available to the firm to adjust the supply of the commodity to its changed
demand is extremely short; say a single day or a few days. The price determined in this
period is known as Market Price.
Short Period: In this period, the time available to firms to adjust the supply of the
commodity to its changed demand is, of course, greater than that in the market period.
In this period altering the variable factors like raw materials, labour, etc can change
supply. During this period new firms cannot enter into the industry.
Long period: In this period, a sufficiently long time is available to the firms to adjust
the supply of the commodity fully to the changed demand. In this period not only
variable factors of production but also fixed factors of production can be changed. In
this period new firms can also enter the industry. The price determined in this period is
known as long run normal price.
Secular Period: In this period, a very long time is available to adjust the supply fully
to change in demand. This is very long period consisting of a number of decades. As the
period is very long it is difficult to lay down principles determining the price.
The price determined in very short period is known as Market price. Market price is
determined by the equilibrium between demand and supply in a market period. The
nature of the commodity determines the nature of supply curve in a market period.
Under this period goods are classified in to (a) Perishable goods and (b) Non-perishable
goods.
Perishable Goods: In the very short period, the supply of perishable goods like fish,
milk vegetables etc. cannot be increased. And it cannot be decreased also. As a result
the supply curve under very short period will be parallel to the Y-axis or Vertical to X-
axis. Supply is perfectly inelastic. The price determination of perishable goods in very
short period may be shown with the help of the following fig. 6.5
In this figure quantity is represented along X-axis and price is represented along Y-axis.
MS is the very short period supply curve of perishable goods. DD is demand curve. It
intersects supply curve at E. The price is OP. The quantity exchanged is OM. D1 D1
represents increased demand. This curve cuts the supply curve at E1. Even at the new
equilibrium, supply is OM only. But price increases to OP1. So, when demand increases,
the price will increase but not the supply. If demand decreases new demand curve will
be D2 D2. This curve cuts the supply curve at E2. Even at this new equilibrium, the
supply is OM only. But price falls to OP2. Hence in very short period, given the supply,
it is the change in demand that influences price. The price determined in a very short
period is called Market Price.
Non-perishable goods: In the very short period, the supply of non-perishable goods
like cloth, pen, watches etc. cannot be increased. But if price falls, preserving some
stock can decrease their supply. If price falls too much, the whole stock will be held
back from the market and carried over to the next market period. The price below,
which the seller will refuse to sell, is called Reserve Price.
The Price determination of non-perishable goods in very short period may be shown
with the help of the following fig 6.6.
In the given figure quantity is shown on X-axis and the price on Y-axis. SES is the
supply curve. It slopes upward up to the point E. From E it becomes a vertical straight
line. This is because the quantity existing with sellers is OM, the maximum amount they
have is thus OM. Till OM quantity (i.e., point E) the supply curve sloped upward. At the
point S, nothing is offered for sale.
It means that the seller with hold the entire stock if the price is OS. OS is thus the
reserve price. As the price rises, supply increases up to point E. At OP price (Point E),
the entire stock is offered for sale.
Suppose demand increases, the DD curve shift upward. It becomes D1D1 price raises
to OP1. If demand decreases, the demand curve becomes D2D2. It intersects the
supply curve at E3. The price will fall to OP3. We find that at OS price, supply is zero. It
is the reserve price.
Short period is a period in which supply can be increased by altering the variable
factors. In this period fixed costs will remain constant. The supply is increased when
price rises and vice versa. So the supply curve slopes upwards from left to right.
The price in short period may be explained with the help of a diagram.
In the given diagram MPS is the market period supply curve. DD is the initial demand
curve. It intersects MPS curve at E. The price is OP and out put OM. Suppose demand
increases, the demand curve shifts upwards and becomes D1D1. In the very short
period, supply remains fixed on OM. The new demand curve D1D1 intersects MPS at E1.
The price will rise to OP1. This is what happen in the very short-period.
As the price rises from OP to OP1, firms expand output. As firms can vary some factors
but not all, the law of variable proportions operates. This results in new short-run
supply curve SPS. It interests D1 D1 curve at E4. The price will fall from OP1 to OP4.
It the demand decreases, DD curve shifts downward and becomes D2D2. It interests
MPS curve at E2. The price will fall to OP2. This is what happens in market period. In
the short period, the supply curve is SPS. D2D2 curve interests SPS curve at E3. The
short period price is higher than the market period price.
Market price may fluctuate due to a sudden change either on the supply side or on the
demand side. A big arrival of milk may decrease the price of that production in the
market period. Similarly, a sudden cold wave may raise the price of woolen garments.
This type of temporary change in supply and demand may cause changes in market
price. In the absence of such disturbing causes, the price tends to come back to a
certain level. Marshall called this level is normal price level. In the words of Marshall
Normal value (Price) of a commodity is that which economics force would tend to bring
about in the long period.
In order to describe how long run normal price is determined, it is useful to refer to the
market period as short period also. The market period is so short that no adjustment in
the output can be made. Here cost of production has no influence on price. A short
period is sufficient only to allow the firms to make only limited output adjustment. In
the long period, supply conditions are fully sufficient to meet the changes in demand. In
the long period, all factors are alterable and the new firms may enter into or old firms
leave the; industry.
In the long period all costs are variable costs. So supply will be increased only when
price is equal to average cost.
Hence, in long period normal price will be equal to minimum average cost of the
industry. Will this price be more or less than the short period normal price? The answer
depends on the stage of returns to which the industry is subject. There are three stages
of return on the stage of returns to which the industry is subject. There are three
stages of returns.
In the diagram, MPS represents market period supply curve. DD is demand curve.
DD cuts LPS, SPS and MPS at point E. At point E the supply is OM and the price is
OP. If demand increases from DD to D1D1 market price increases to OP1. In the
short period it is OP2. In the long period supply increases considerably to OM3. So
price has fallen to OP3, which is less than the price of market period.
In this case average cost does not change even though the output
increases. Hence long period supply curve is horizontal to X-axis. The
determination of long period normal price can be explained with the help of the
diagram. In the fig. 6.9, LPS is horizontal to X-axis. MPS represents market period
supply curve, and SPS represents short period supply curve. At point ‘E’ the output
is OM and price is OP. If demand increases from DD to D1D1 market price
increases to OP1. In the short period, supply increases and hence the price will be
OP2. In the long run supply is adjusted fully to meet increased demand. The price
remains constant at OP because costs are constant at OP and market is perfect
market.
If the industry is subject to increasing costs (diminishing returns) the supply curve
slopes upwards from left to right like an ordinary supply curve. The determination of
long period normal price in increasing cost industry can be explained with the help of
the following diagram. In the diagram LPS represents long period supply curve. The
industry is subject to diminishing return or increasing costs. So, LPS slopes upwards
from left to right. SPS is short period supply curve and MPS is market period supply
curve. DD is demand curve. It cuts all the supply curves at E. Here the price is OP and
output is OM. If demand increases from DD to D1D1 in the market period, supply will
not change but the price increases to OP1. In the short period, price increase but the
price increases to OP1. In the short period, price increases to OP2 as the supply
increased from OM to OM2. In the long period supply increases to OM3 and price
increases to OP3. But this increase in price is less than the price increase in a market
period or short period.
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
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 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:
PRICE DISCRIMINATION
When a firm sells its product to its customers of different profile at different prices with
no corresponding in cost, price discrimination is also called as differential pricing.
Customers may differ in their profile in terms of other education, knowledge about the
prevailing prices, quality of the competitive products income groups’ quality of life by
changing different prices to different customer the firm tires to increase its profit by
reducing the surplus
Through price discrimination they can take advantages of a situation where in some
customers may be prepared to pay more.
1. The Basis of price Discrimination:- The following are the factors that determine
the degree of price discrimination
2. Purchasing power:- The firm is likely to charge a high price from a customer who
has the ability to pay a higher price. Urgency quality consciousness, high quality living
and so forth are some of the factors that compel the rich customers to pay a high price.
3. Quality bought:-A customer buying large number of units is relatively charged a
lower rate per unit.
4. Customer from different market conditions:- If the goods are brought for
further processing or resale, the buyer maybe charged a lower price. If the goods are
bought for ultimate consumption, the buyer may be charged relatively higher.
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.
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.
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 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.
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.
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.
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.
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
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.
Duopoly
Duopoly refers to a market situation in which there are only two sellers. As there are
only two sellers any decision 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
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.
PRICING METHODS
The micro – economic principle of profit maximization suggests pricing by the marginal
analysis. That is by equating MR to MC. However the pricing methods followed by the
firms in practice around the world rarely follow this procedure. This is for two reasons;
uncertainty with regard to demand and cost function and the deviation from the
objective of short run profit maximization.
It was seen that there is no unique theory of firm behavior. While profit certainly on
important variable for which every firm cares. Maximization of short – run profit is not a
popular objective of a firm today. At the most firms seek maximum profit in the long
run. If so the problem is dynamic and its solution requires accurate knowledge of
demand and cost conditions over time. Which is impossible to come by?
In view of these problems economic prices are a rare phenomenon. Instead, firms set
prices for their products through several alternative means. The important pricing
methods followed in practice are shown in the chart.
I. COST BASED PRICING METHODS
1.Cost plus pricing: This is also called “full cost or mark up” pricing. Hence the
average cot at normal capacity of output is ascertained and then a conventional margin
of profit is added to the cost to arrive at the price in other words find out the product
units total cost and add a percentage of profit to arrive at the selling price.
2. Marginal cost pricing:- In marginal cost pricing selling price is fixed in such a way
that it covers fully the variable or marginal cost and contributes towards recovery at
fixed costs or partly depending upon the market situations.
4. Block pricing:- Block pricing is another way a firm with market power can enhance
its profit. We see block pricing in our day to day life very frequently. Six lox soaps in a
single pack illustrate this pricing method. By selling certain number of units of a product
as one package, the firm earns more than by selling unit wise. The block pricing is a
profit maximization price on each package.
5.Commodity bundling:- commodity bundling refers to the practice of bundling two
or more different product together and selling them at a single ‘bundle price’
commodity bundling is a viable price strategy to enhance profits when consumers differ
with respect to the amounts they are willing to pay for multiple products sold by a firm.
6. Peak-load pricing:- During seasonal period when demand is likely to be higher a
firm may enhance profit by peak load pricing. The firms philosophy is to charge a
higher price during peak times than is charged during off peak times. That the business
is not lost to the competitors. The firm following such a strategy covers the likely losses
during the off peak times from the likely profits from the peak times.
BUSINESS AND NEW ECONOMIC ENVIRONMENT
Imagine you want to do business. Which are you interested in? For example, you want
to get into InfoTech industry. What can you do in this industry? Which one do you
choose? The following are the alternatives you have on hand:
If you choose any one or more of the above, you have chosen the line of activity. The
next step for you is to decide whether.
You want to be only owner (It means you what to be sole trader) or
You want to take some more professionals as co-owners along with you (If
means you what to from partnership with others as partners) or
You want to be a global player by mobilizing large resources across the
country/world
You want to bring all like-minded people to share the benefits of the common
enterprise (You want to promote a joint stock company) or
You want to involve government in the IT business (here you want to suggest
government to promote a public enterprise!)
Before we choose a particular form of business organization, let us study what factors
affect such a choice? The following are the factors affecting the choice of a business
organization:
1. Easy to start and easy to close: The form of business organization should be
such that it should be easy to close. There should not be hassles or long
procedures in the process of setting up business or closing the same.
2. Division of labour: There should be possibility to divide the work among the
available owners.
3. Large amount of resources: Large volume of business requires large volume
of resources. Some forms of business organization do not permit to raise larger
resources. Select the one which permits to mobilize the large resources.
4. Liability: The liability of the owners should be limited to the extent of money
invested in business. It is better if their personal properties are not brought into
business to make up the losses of the business.
5. Secrecy: The form of business organization you select should be such that it
should permit to take care of the business secrets. We know that century old
business units are still surviving only because they could successfully guard their
business secrets.
6. Transfer of ownership: There should be simple procedures to transfer the
ownership to the next legal heir.
7. Ownership, Management and control: If ownership, management and control
are in the hands of one or a small group of persons, communication will be
effective and coordination will be easier. Where ownership, management and
control are widely distributed, it calls for a high degree of professional’s skills to
monitor the performance of the business.
8. Continuity: The business should continue forever and ever irrespective of the
uncertainties in future.
9. Quick decision-making: Select such a form of business organization, which
permits you to take decisions quickly and promptly. Delay in decisions may
invalidate the relevance of the decisions.
10.Personal contact with customer: Most of the times, customers give us clues
to improve business. So choose such a form, which keeps you close to the
customers.
11.Flexibility: In times of rough weather, there should be enough flexibility to shift
from one business to the other. The lesser the funds committed in a particular
business, the better it is.
12.Taxation: More profit means more tax. Choose such a form, which permits to
pay low tax.
These are the parameters against which we can evaluate each of the available forms of
business organizations.
SOLE TRADER
The sole trader is the simplest, oldest and natural form of business organization. It is
also called sole proprietorship. ‘Sole’ means one. ‘Sole trader’ implies that there is only
one trader who is the owner of the business.
It is a one-man form of organization wherein the trader assumes all the risk of
ownership carrying out the business with his own capital, skill and intelligence. He is
the boss for himself. He has total operational freedom. He is the owner, Manager and
controller. He has total freedom and flexibility. Full control lies with him. He can take
his own decisions. He can choose or drop a particular product or business based on its
merits. He need not discuss this with anybody. He is responsible for himself. This form
of organization is popular all over the world. Restaurants, Supermarkets, pan shops,
medical shops, hosiery shops etc.
Features
It is easy to start a business under this form and also easy to close.
He introduces his own capital. Sometimes, he may borrow, if necessary
He enjoys all the profits and in case of loss, he lone suffers.
He has unlimited liability which implies that his liability extends to his personal
properties in case of loss.
He has a high degree of flexibility to shift from one business to the other.
Business secretes can be guarded well
There is no continuity. The business comes to a close with the death, illness or
insanity of the sole trader. Unless, the legal heirs show interest to continue the
business, the business cannot be restored.
He has total operational freedom. He is the owner, manager and controller.
He can be directly in touch with the customers.
He can take decisions very fast and implement them promptly.
Rates of tax, for example, income tax and so on are comparatively very low.
Advantages
The following are the advantages of the sole trader from of business organization:
Disadvantages
1. Unlimited liability: The liability of the sole trader is unlimited. It means that
the sole trader has to bring his personal property to clear off the loans of his
business. From the legal point of view, he is not different from his business.
2. Limited amounts of capital: The resources a sole trader can mobilize cannot
be very large and hence this naturally sets a limit for the scale of operations.
3. No division of labour: All the work related to different functions such as
marketing, production, finance, labour and so on has to be taken care of by the
sole trader himself. There is nobody else to take his burden. Family members
and relatives cannot show as much interest as the trader takes.
4. Uncertainty: There is no continuity in the duration of the business. On the
death, insanity of insolvency the business may be come to an end.
5. Inadequate for growth and expansion: This from is suitable for only small
size, one-man-show type of organizations. This may not really work out for
growing and expanding organizations.
6. Lack of specialization: The services of specialists such as accountants, market
researchers, consultants and so on, are not within the reach of most of the sole
traders.
7. More competition: Because it is easy to set up a small business, there is a high
degree of competition among the small businessmen and a few who are good in
taking care of customer requirements along can service.
8. Low bargaining power: The sole trader is the in the receiving end in terms of
loans or supply of raw materials. He may have to compromise many times
regarding the terms and conditions of purchase of materials or borrowing loans
from the finance houses or banks.
PARTNERSHIP
Partnership is an improved from of sole trader in certain respects. Where there are like-
minded persons with resources, they can come together to do the business and share
the profits/losses of the business in an agreed ratio. Persons who have entered into
such an agreement are individually called ‘partners’ and collectively called ‘firm’. The
relationship among partners is called a partnership.
Indian Partnership Act, 1932 defines partnership as the relationship between two or
more persons who agree to share the profits of the business carried on by all or any
one of them acting for all.
Features
(a) Unlimited liability: The liability of the partners is unlimited. The partnership
and partners, in the eye of law, and not different but one and the same. Hence,
the partners have to bring their personal assets to clear the losses of the firm, if
any.
(b) Number of partners: According to the Indian Partnership Act, the minimum
number of partners should be two and the maximum number if restricted, as
given below:
10 partners is case of banking business
20 in case of non-banking business
(c) Division of labour: Because there are more than two persons, the work can be
divided among the partners based on their aptitude.
(d) Personal contact with customers: The partners can continuously be in touch
with the customers to monitor their requirements.
(e) Flexibility: All the partners are likeminded persons and hence they can take
any decision relating to business.
Partnership Deed
The written agreement among the partners is called ‘the partnership deed’. It contains
the terms and conditions governing the working of partnership. The following are
contents of the partnership deed.
KIND OF PARTNERS
Right of partners
1. Easy to form: Once there is a group of like-minded persons and good business
proposal, it is easy to start and register a partnership.
2. Availability of larger amount of capital: More amount of capital can be raised
from more number of partners.
3. Division of labour: The different partners come with varied backgrounds and
skills. This facilities division of labour.
4. Flexibility: The partners are free to change their decisions, add or drop a
particular product or start a new business or close the present one and so on.
5. Personal contact with customers: There is scope to keep close monitoring
with customers requirements by keeping one of the partners in charge of sales
and marketing. Necessary changes can be initiated based on the merits of the
proposals from the customers.
6. Quick decisions and prompt action: If there is consensus among partners, it
is enough to implement any decision and initiate prompt action. Sometimes, it
may more time for the partners on strategic issues to reach consensus.
7. The positive impact of unlimited liability: Every partner is always alert about
his impending danger of unlimited liability. Hence he tries to do his best to bring
profits for the partnership firm by making good use of all his contacts.
Disadvantages:
The joint stock company emerges from the limitations of partnership such as joint and
several liability, unlimited liability, limited resources and uncertain duration and so on.
Normally, to take part in a business, it may need large money and we cannot foretell
the fate of business. It is not literally possible to get into business with little money.
Against this background, it is interesting to study the functioning of a joint stock
company. The main principle of the joint stock company from is to provide opportunity
to take part in business with a low investment as possible say Rs.1000. Joint Stock
Company has been a boon for investors with moderate funds to invest.
The word ‘ company’ has a Latin origin, com means ‘ come together’, pany means ‘
bread’, joint stock company means, people come together to earn their livelihood by
investing in the stock of company jointly.
Company Defined
Lord justice Lindley explained the concept of the joint stock company from of
organization as ‘an association of many persons who contribute money or money’s
worth to a common stock and employ it for a common purpose.
“Company is an artificial person created by law with perpetual succession and common
seal”. According to company act 1956.
Features
There are two stages in the formation of a joint stock company. They are:
The persons who conceive the idea of starting a company and who organize
the necessary initial resources are called ‘promoters’. The vision of the promoters forms
the backbone for the company in the future to reckon with.
The promoters have to file the following documents, along with necessary fee,
with the register of joint stock companies to obtain certificate of Incorporation.
For Certificate of Incorporation
A. name clause
B. situation clause
C. objects clause
D. capital clause
E. liability clause
F. subscription clause
3)Details about directors:- The list of names and addresses of the proposed directors
and their willingness in writing to act such in case of registration of a public company.
The Registrar of joint stock companies per uses and verifies whether all these
documents are in order or not. If he is satisfied with the information furnished, he will
register the documents and then issue a certificate of Incorporation. If it is private
company, it can start its business operations immediately after obtaining certificate of
Incorporation.
2) File prospectus with Registrar: - After seeking permission from SEBI, file the
prospectors with the Registrar of joint stock companies.
4) Allotting shares: - Normally shares are allotted as applied for. In case of over
subscription, the basis of allotment is finalized in consultation with the stock exchange
under which it is proposed to be listed and the allotment is made on lottery basis. In
case of unsuccessful applicants, the money received with the share application will be
refunded within a specified time, failing which the company is bound to pay with
interest and also liable for legal action.
A public company can short its operations immediately from the date of
obtaining the certificate of commencement of Business.
1. Memorandum of association
2. Articles of association
3. Prospectus
While drafting the contents of these documents the promoters should take a special
care to fit their vision into the contents of these documents. Otherwise, it will be
difficult to change its contents at a later date.
Prospectus is the first and basic document that supports the structure of
the company. An investor will go through prospectus to assess the feasibility of his
investment in the company.
Concepts of prospectus:
All that shines is not gold. The company from of organization is not without any
disadvantages. The following are the disadvantages of joint stock companies.
Disadvantages
PUBLIC ENTERPRISES
Public enterprises occupy an important position in the Indian economy. Today, public
enterprises provide the substance and heart of the economy. Its investment of over
Rs.10,000 crore is in heavy and basic industry, and infrastructure like power, transport
and communications. The concept of public enterprise in Indian dates back to the era of
pre-independence.
Genesis of Public Enterprises
Higher production
Greater employment
Economic equality, and
Dispersal of economic power
The government found it necessary to revise its industrial policy in 1956 to give it a
socialistic bent.
The Industrial Policy Resolution 1956 states the need for promoting public enterprises
as follows:
The achievements of public enterprise are vast and varied. They are:
Let us see the different forms of public enterprise and their features now.
Departmental Undertaking
This is the earliest from of public enterprise. Under this form, the affairs of the public
enterprise are carried out under the overall control of one of the departments of the
government. The government department appoints a managing director (normally a
civil servant) for the departmental undertaking. He will be given the executive authority
to take necessary decisions. The departmental undertaking does not have a budget of
its own. As and when it wants, it draws money from the government exchequer and
when it has surplus money, it deposits it in the government exchequer. However, it is
subject to budget, accounting and audit controls.
Examples for departmental undertakings are Railways, Department of Posts, All India
Radio, Doordarshan, Defence undertakings like DRDL, DLRL, ordinance factories, and
such.
Features
Advantages
PUBLIC CORPORATION
Having released that the routing government administration would not be able to cope
up with the demand of its business enterprises, the Government of India, in 1948,
decided to organize some of its enterprises as statutory corporations. In pursuance of
this, Industrial Finance Corporation, Employees’ State Insurance Corporation was set up
in 1948.
Public corporation is a ‘right mix of public ownership, public accountability and business
management for public ends’. The public corporation provides machinery, which is
flexible, while at the same time retaining public control.
Definition
Examples of a public corporation are Life Insurance Corporation of India, Unit Trust of
India, Industrial Finance Corporation of India, Damodar Valley Corporation and others.
Features
Disadvantages
Government Company
Section 617 of the Indian Companies Act defines a government company as “any
company in which not less than 51 percent of the paid up share capital” is held by the
Central Government or by any State Government or Governments or partly by Central
Government and partly by one or more of the state Governments and includes and
company which is subsidiary of government company as thus defined”.
Government companies differ in the degree of control and their motive also.
Features
Advantages
QUESTIONS
1. Define a joint stock company & explain its basic features, advantages &
disadvantages
2. Write short notes pm (a) Sole trader (b) Stationery corporation.
3. Explain in basic features of Government Company from of public enterprise.
4. What do you mean by sole proprietorship? Explain its meant and limitations.
5. Define partnership from of business. Explain its salient features.
6. What are the factors governing choice of form of business organization.
7. Write short notes on (a) public company (b) Government Company (c) Private
Company
8. What is the need of public enterprises? Explain the recent achievement of public
enterprises
9. What is a partnership deed? Discuss the main contents partnership deed.
10. Write short note on (a) Departmental undertaking (b) articles of association
11. ‘Small is beautiful’. Do you think, this is the reason for the survival of the sole
trader from of business organization? Support your answer with suitable
examples.
12. Explain how a firm attains equilibrium in the short run and in the long run under
conditions of perfect competition.
13. Explain the following with the help of the table and diagram under perfect
competition and monopoly
14. Total Revenue
15. Marginal Revenue
16. Average Revenue
17. Define monopoly. How is price under monopoly determined?
18. Explain the role of time factor in the determination of price. Also explain price-
O/P determination in case of perfect competition.
19. (a) Distinguish between perfect & imperfect markets (b) What are the different
market situations in imperfect competition.
20. “Perfect competition results in larger O/P with lower price than a monopoly”
Discuss.
21. Compare between monopoly and perfect competition.
22. What is price discrimination? Explain essential conditions for price discrimination.
23. Explain the following (a) Monopoly (B) Duopoly (c) Oligopoly (d) imperfect
competition.
24. What is a market? Explain, in brief, the different market structures.
25. Monopoly is disappearing from markets. Do you agree with this statement? Do
you advocate for monopoly to continue in market situations.
QUIZ
1. Exchange value of a unit of good expressed in terms of money
is called ( )
(a) Cost (b) Capital
(c) Price (d) Expenditure
10. Under which pricing method, price just equals the total cost ( )
(a) Marginal cost pricing (b) Cost plus pricing
(c) Full cost pricing (d) Going rate pricing
11. ______ is a place in which goods and services are bought and sold. ( )
(a) Factory (b) Workshop
(c) Market (d) Warehouse
17. Marginal revenue, Average revenue and Demand are the same
in ________ Market Environment ( )
(a) Monopoly (b) Duopoly
(c) Perfect Competition (d) Imperfect Competition
21. Charging Very Low price in the beginning and increasing it gradually
is called ________ ( )
(a) Differential pricing (b) Sealed bid Pricing
(c) Penetration Pricing (d) Skimming Pricing
25. “People may come and people may leave, but I go on forever” is
Applicable to ______ Business organization. ( )
(a) Sole proprietorship (b) Partnership
(c) Company (d) Joint Hindu Family
36. ____ partner can enjoy profits but no liability for losses. ( )
(a) Active (b) Sleeping (c) Minor (d) Nominal
39. If either state government of central government or both have got not
less than 51% of share in the organization. Then that is called____. ( )
(a) Private organization (b) Partnership organization
(c) Government organization (d) Joint sector organization