INDUSTRIAL ECONOMICS

ECONOMICS

Economics is the study of how human beings make choice to allocate scarce resources to satisfy their unlimited wants in such a manner that consumers can maximize their satisfaction, producers can maximize their profits and the society can maximize its objectives.

Classification of Economics

Micro Economics- is the economics of individual economic unit like a firm, an industry, a producer and the factors of production.

Macro Economics- relates to the growth of national income, aggregate demand, aggregate supply, aggregate investment level and economy as a whole.

INDUSTRIAL ECONOMICS

It is a distinctive branch of economics which deals with the economic problems of the firms and the industries and their relationship with the society.

It has both micro aspect and macro aspect.

Role of General Economics in Industrial Economics

The problem of decision making

The problem of uncertainty and riskImperfect market conditions, government policies, import and

export

The problem of forecastingPosition of raw materials, the prices of factors of production etc.

OBJECTIVES

Achieving industrial development Information related to the natural resources,

industrial climate, supplies of factors of production etc.

SCOPE OF INDUSTRIAL ECONOMICS

Industrial Efficiency- Determined by production function

Diversification Industrial Finance- Two Dimensions- Source of finance & its effective utilization

Industrial location

The determinants of profitability-Government policies, Advertisement, Size of a firm, market

concentration etc.

The organizational form and its motives Theory of demand- Consumer behavior Theory of production- Producer’s behavior

Cost Analysis- Relation between cost and quantity of output.

Profit Analysis- Most common objective Analysis of pricing theory- Different market

conditions, price discrimination.

PRODUCTION FUNCTION

Production Function

It is the functional relationship between the quantity of product and the quantities of the factors of production required to produce.

Types of production function

Short run production function- It is that time period in which production of a commodity is increased by increasing the use of only variable inputs like labour and raw material while the fixed input remains constant.

Long run production function- It refers to that time period in which production of a commodity can be increased by employing both the variable and the fixed inputs.

CONCEPTS OF PRODUCTION

Total Production- Total amount of goods and services produced in a given period.

Marginal Production- Change in total production due to application of one more or one less unit of variable factor.

Average Production- Per unit production of variable factor.

LEAST COST COMBINATION

Least cost combination

Least cost combination is the optimum combination of the factors of production at which a producer has to pay minimum cost of producing a certain quantity of output.

2concepts- Iso Quant curve Iso Cost line

Iso Quant Curve

It represents all the factor inputs which yield a given quantity of product.

Iso Product Map- A family or a group of equal product curves is called an Iso Product Map.

Properties of Iso Quant Curves

It is convex to the origin- Diminishing marginal rate of technical substitution.

An Iso Quant Curve slopes downwards from left to right.

Two Iso Quant curves never intersect each other.

ISO-COST LINE

Iso cost line represents the various combination of two factors that will incur the same level of total cost.

Suppose total finance available with a firm- Rs. 10,000. Per unit price of labour- Rs.100, Per unit price of Capital- Rs. 1000.

3 Alternatives- Spend all its finance on Capital Spend all its finance on Labour Partly on Capital and partly on Labour.

Determination of Optimum Combination

Firms attain equilibrium at a point where Iso-Cost line is tangent to Isoquant Curve.

MRTSLK= dK/dL = PL/PK

LAW OF VARIABLE PROPORTIONS

Law of Variable Proportions

It predicts the consequences of varying the proportions in which the fixed and variable factors of production are used.

It states that as the proportion of factors is changed, the total production at first increases more than proportionately, then equi-proportionately and finally less than proportionately.

ASSUMPTIONS

One of the factors is variable, while all other factors are fixed.

All units of variable factors are homogenous or equally efficient.

There is no change in technique of production.

Factors of production can be used in different proportions.

STAGES

I Stage- From origin to point where the average output is the maximum.

II Stage- From the point where average output is maximum to where marginal output is zero.

III Stage- Range over which marginal output is negative.

Causes of Application

Indivisibility of Factors Change in Factor Ratio Imperfect Substitutes

STAGE OF RATIONAL DECISION- The rational decision of the purely

competitive firm will be to operate in stage II

LAW OF RETURNS

Returns- 2 types

Returns to Factor Returns to Scale

Law of Returns to Factor

Laws of return to factor describe increase in production by taking only the one variable factor along with the other fixed factors.

3 parts-

Increasing returns to a factor Constant returns to a factor Decreasing returns to a factor

Increasing Returns to a Factor

As the proportion of one factor in a combination of factors is increased, upto a point, the marginal productivity of the factors will increase.

Reasons Fuller utilization of fixed resources Indivisibility of factors Division of Labour

Constant Returns to a Factor

Constant returns to a factor occur when additional application of the variable factor increases output only at a constant rate.

Reason- Optimum use of fixed factor

Diminishing Returns to a Factor

As we increase the quantity of any one input which is combined with fixed quantity of other inputs, the marginal physical productivity of the variable input must eventually decline.

Causes- Imperfect Substitutes Fixed Factors of Production

LAW OF RETURNS TO SCALE

The term returns to scale refers to the changes in output as all factors change by the same proportion.

3 parts- Increasing Constant Diminishing

Increasing Returns to Scale

It is a situation when proportionate increase in all the factors of production results in more than proportionate increase in output.

Cause- Economies of Scale> Diseconomies of Scale

Constant Returns to Scale

It refers to a situation when a proportionate increase in all the factors of production results in equal proportionate increase in output.

Cause Economies of Scale= Economies of Scale

Diminishing Returns to Scale

It refers to a situation when a proportionate increase in all the factors of production results in less than proportionate increase in output.

Cause- Diseconomies> Economies

THEORY OF COSTS

Ordinarily, the term ‘cost of production’ refers to money expenses incurred in production of a commodity.

But a little reflection would make it clear that money expenses are not the only expenses that are incurred on the production of a commodity.

COSTS

MONEY COSTSOPPORTUNITY

COST

INCREMENTAL AND

SUNK COST

PRIVATE, EXTERNAL

AND SOCIAL COSTS

EXPLICIT COST IMPLICIT COST

OPPORTUNITY COSTS

The opportunity cost of anything is the next best alternative that could be produced instead by the same factors or by an equivalent group of factors, costing the same amount of money.

This concept was first developed by the Austrian School of Economics.

COST FUNCTION

A cost function expresses the relationship between cost and its determinants.

Several factors influence cost. When their relationship to cost is expressed in a functional or mathematical form, it is called cost function.

C=f (S, O, P, T)

S-size of plant, O- level of output, P- price of inputs, T-technology

SHORT-RUN COST FUNCTION

2 TYPES OF COSTS- FIXED COSTS Salary and other expenses of administrative staff. Salary of staff involved directly in the production, but on a fixed

term basis. Wear and tear of machinery. The expenses for the maintenance of buildings.

VARIABLE COSTS Direct labour which varies with output. Raw material. Running expenses of machinery.

SHORT RUN

COSTS

TOTAL COSTSAVERAGE

COSTSMARGINAL

COSTS

TOTAL FIXED COSTS

TOTAL VARIABLE

COSTS

AVERAGEFIXED COSTS

AVGERAGE VARIABLE

COSTS

Total Costs of Production

It refers to the aggregate of expenses on fixed and variable factors of production.

TC= TFC+TVC TC=AC*Q

Total Fixed Costs- It refers to the sum of all the expenses on the fixed factors like land, insurance etc.

Total Variable Costs- It represents the cost of all variable resources, such as labour, raw material, etc.

Total Cost- Sum total of total fixed costs and variable costs.

AVERAGE COSTS

It is the per unit cost of production.

Average Fixed Cost- It is the per unit cost of the fixed factors of production.

AFC=TFC/TQ

Average Variable Cost- It is the per unit cost of the variable factors of production.

AVC=TVC/TQ

Why AC Curve is a

U-Shaped Curve?

AC Curve is the sum of AFC and AVC.

Total fixed costs remains constant at different level of output, it follows that average fixed cost falls as the level of output is increased.

AVC is a dish shaped curve, influenced by law of variable proportions.

Hence, as long as average variable costs fall, Average total costs also falls. Beyond this point , for some time, though the AVC may be rising, the falling fixed cost overbears it resulting in declining AC. But ultimately AC must rise.

MARGINAL COST

Marginal Cost is the addition to the total cost as a result of a unit increase in the output.

MCn = TCn – TCn-1

Relation between Marginal Cost & Average Cost

When average cost falls with an increase in output, marginal cost is less than the average cost.

MC begins to rise at a lesser level of output than AC.

The MC curve cuts the average cost curve at its minimum point.

With increase in AC, marginal cost rises at a faster rate.

When MC>AC, it pulls A Upwards.

When MC<AC, it pushes AC downwards.

When MC=AC, A is constant.

Long Run Costs

Long Run Costs

Long Run Total Costs

Long run Average Costs

Long RunMarginal Costs

Long Run Total Costs

It is the summation of several short run total cost curves.

The long run cost of production is the least possible cost of producing any given level of output when all inputs are variable.

Long run Average Cost

It shows the lowest average cost of producing output when all inputs can be varied freely.

LAC curve is U shaped. Why?

Long Run Marginal Cost

It is that curve which shows the extra cost incurred in producing one more unit of output when all inputs can be changed.

MARKETS

MONOPOLY

Monopoly is a market situation in which there is a single seller, there are no close substitutes for commodity it produces, there are barriers to entry.

Features of Monopoly

One seller and large number of Buyers Monopoly is also an industry Restriction on the entry of the new firms No close Substitutes Price Maker Price Discrimination

Causes or Sources of Monopoly

Control over raw material or ownership of Natural resources

Patents Technical Barriers Government Policy Limiting Pricing Policy

Price & Output Determination under Monopoly

2 Approaches-

1. Total Revenue and Total Cost Analysis

2. Marginal Revenue and Marginal Cost Analysis

Short Period

Long Period

Price Determination under Short Period

Super Normal Profit Normal Profit Minimum Loss

Price Determination under Long Period

Comparison Between Monopoly and Perfect Competition

Goals of the firm Assumptions Regarding Production Assumption Regarding number of seller and

buyers Assumption regarding Entry Implication regarding shape of Demand

Curve Comparison Regarding Price contd….

Comparison Regarding Output

In Perfect Competition- MC=MR=AR=LAC Comparison Regarding Profits Utilization of Resources

DISCRIMINATING MONOPOLY

Discriminating monopoly means charging different rates from different customers for the same good or service.

It becomes possible where there is no competition in the market and different buyers show different elasticity of demand for the product.

Types- Personal Price Discrimination Geographical Price Discrimination Price Discrimination according to Use

Conditions of Price Discrimination

Existence of Monopoly Separate market Difference in the elasticity of demand Expenditure in dividing and subdividing market to be

minimum Production of commodity to Order Legal Sanction Product Differentiation Behavior of the Consumers

When is Price Discrimination Profitable?

It is profitable when the price elasticity of demand is different in different markets

. MR=AR((E-1)/E)

It is profitable to transfer the commodity from less marginal revenue market to more marginal revenue market.

Price & Output Determination Under Discriminating Monopoly

In order to get maximum profit 2 conditions must be fulfilled-

1. Must get same marginal revenue in both markets- MR1=MR2

2. Equality between MR & MC-

MR1=MR2=MC

Effects of Price Discrimination

Beneficial Effects- 1. Beneficial to the Poor

2. Public Utility Services

3. Full Utilization of Resources

Harmful Effects-1. No proper Use of Factors of Production

2. Less Production