I BBA MANAGERIAL ECONOMICS MARKET ANALYSISMeaning:

Markets are a type of institution or mechanism that exists to facilitate exchange, coordination and allocation of resources, goods and services between buyers and sellers, between producers, intermediaries and consumers.

Definition:

Prof.Cairncross says, “A market is that mechanism by which buyers and sellers are together. It is not necessarily a fixed place.”

Types of market:

1. Perfect completion.2. Monopoly.3. Monopolistic completion4. Oligopoly5. Duopoly6. Ologopsony7. Duoposony8. Monopsony.

1.Perfect Competition:Meaning: The Perfect Competition is a market structure where a large number of buyers and sellers are present, and all are engaged in the buying and selling of the homogeneous products at a single price prevailing in the market.

In other words, perfect competition also referred to as a pure competition, exists when there is no direct competition between the rivals and all sell identically the same products at a single price.

Features of Perfect Competition

1. Large number of buyers and sellers: In perfect competition, the buyers and sellers are large enough, that no individual can influence the price and the output of the industry. An individual customer cannot influence the price of the product, as he is too small in relation to the whole market. Similarly, a single seller cannot influence the levels of output, who is too small in relation to the gamut of sellers operating in the market.

2. Homogeneous Product:   Each competing firm offers the homogeneous product, such that no individual has a preference for a particular seller over the others. Salt, wheat, coal, etc. are some of the homogeneous products for which customers are indifferent and buy these from the one who charges a less price. Thus, an increase in the price would let the customer go to some other supplier.

3. Free Entry and Exit:   Under the perfect competition, the firms are free to enter or exit the industry. This implies, If a firm suffers from a huge loss due to the intense competition in the industry, then it is free to leave that industry and begin its business operations in any of the industry, it wants. Thus, there is no restriction on the mobility of sellers.

4. Perfect knowledge of prices and technology : This implies, that both the buyers and sellers have complete knowledge of the market conditions such as the prices of products and the latest technology being used to produce it. Hence, they can buy or sell the products anywhere and anytime they want.

5. No transportation cost:   There is an absence of transportation cost, i.e. incurred in carrying the goods from one market to another. This is an essential condition of the perfect competition since the homogeneous product should have the same

price across the market and if the transportation cost is added to it, then the prices may differ.

6. Absence of Government and Artificial Restrictions:   Under the perfect competition, both the buyers and sellers are free to buy and sell the goods and services. This means any customer can buy from any seller, and any seller can sell to any buyer.Thus, no restriction is imposed on either party. Also, the prices are liable to change freely as per the demand-supply conditions. In such a situation, no big producer and the government can intervene and control the demand, supply or price of the goods and services.

Thus, under the perfect competition,   a seller is the price taker and cannot influence the market price.

Price and output determination under perfect completion:

Perfect competition is defined as a market situation where there are a large number of sellers of a homogeneous product. An individual firm supplies a very small portion of the total output and is not powerful enough to exert an influence on the market price.

A single buyer, however large, is not in a position to influence the market price. Market price in a perfectly competitive market is determined by the interaction of the forces of market demand and market supply. Market demand means the sum of the quantity demanded by individual buyers at different prices.

Similarly, market supply is the sum of quantity supplied by the individual firms in the industry. Each seller and buyer takes the price as determined. Therefore, in a perfectly competitive market, the main problem for a profit-maximizing firm is not to determine the price of its product but to adjust its output to the market price so that profit is maximized

Price determination under perfect competition is analyzed under three different time periods:(a) Market Period

(b) Short Run

(c) Long Run

(a) Market Period:In a market period, the time span is so short that no firm can increase its output. The total stock of the commodity in the market is limited. The market period may be an hour, a day or a few days or even a few weeks depending upon the nature of the product.

For example, in the case of perishable commodities like vegetables, fish, eggs, the period may be a day. Since the supply of perishable commodities is limited by the quantity available or stock in day that neither can be increased nor can be withdrawn for the next period, the whole of it must be sold away on the same day, whatever may be the price.

Fig 4.1 shows that the supply curve of perishable commodities like fish is perfectly inelastic and assumes the form of a vertical straight line SS. Let us suppose that the demand curve for fish is given by dd. Demand curve and supply curve intersect each other at point R, determining the price OP. If the demand for fish increases suddenly, shifting the demand curve upwards to d’d’.

The equilibrium point shift from R to R” and the price rises to OP’. In this situation, price is determined solely by the demand condition that is an active agent.

Similarly, if the demand for a product is given, as shown in demand curve SS in figure 4.2. If the supply of the product decreases suddenly from SS to S’S’, the price increases from P to P’. In this case price is determined by supply, the supply being an active agent.

In this case supply curve shifts leftward causing increase in price of the reduced supply goods. Given the demand curve dd and supply curve SS, the price is determined at OP. Demand curve remaining the same, the decrease in supply shifts the supply curve to its left to S’S’. Consequently, the price rises from OP to OP’.

The supply curve of non-perishable but reproducible goods will not be a vertical straight line throughout its length. This is for certain goods can be withdrawn from the market if the price is too low as the seller would not sell any amount of the commodity in the present market period and would like to hold back the whole stock.

The price below which the seller declines to offer for any amount of his product is known as ‘reserve price’. Thus, the seller faces two extreme price-levels; at one he is ready to sell the whole stock and the other he refuses to sell any. The amount he offers for sale will vary with price.

The seller will be ready to supply more at a higher price rather than at a lower one will depend upon his anticipations of future price and intensity of his need for cash. The supply

curve of a seller will, therefore, slope upwards to the right up to the price at which he is ready to sell the whole stock. Beyond this point, the supply curve will become a vertical straight line whatever the price.

(b) Pricing in the Short Run- Equilibrium of the Firm:Short period is the span of time so short that existing plants cannot be extended and new plants cannot be erected to meet increased demand. However, the time is adequate enough for producers to adjust to some extent their output to the increase in demand by overworking their fixed capacity plants. In the short run, therefore, supply curve is elasti

Figure 4.3 shows the average and marginal cost curves of the firm together with its demand curve. Demand curve, in a perfectly competitive market, is also the average revenue curve and the marginal revenue curve of the firm. The marginal cost intersects the average cost at its minimum point. The U-shape of both the cost curves reflects the law of variable proportions operative in the short run during which the size of the plant remains fixed.

The firm is in equilibrium at the point B where the marginal cost curve intersects the marginal revenue curve from below:

The firm supplies OQ output. The QC is the average cost and the firm earns total profit equal to the area shown by ABCD. The firm maximizes its profit. Earlier to the point of equilibrium, the firm does not attain the maximum profit as

each additional unit of output brings more revenue that its cost. Any level of output greater than OQ brings less marginal revenue than marginal cost.

For the equilibrium of a firm the two conditions must be fulfilled:

(a) The marginal cost must be equal to the marginal revenue. However, this condition is not sufficient, since it may be fulfilled and yet the firm may not be in equilibrium. Figure 4.4 shows that marginal cost is equal to marginal revenue at point e’, yet the firm is not in equilibrium as Oq output is greater than Oq’.

(b) The second and necessary condition for equilibrium requires that the marginal cost curve cuts the marginal revenue curve from below i.e. the marginal cost curve be rising at the point of intersection with the marginal revenue curve.

Thus, a perfectly competitive firm will adjust its output at the point where its marginal cost is equal to marginal revenue or price, and marginal cost curve cuts the marginal revenue curve from below.

The fact that a firm is in equilibrium does not imply that it necessarily earns supernormal profits. In the short-run

equilibrium firms may earn supernormal profits, normal profits or may incur losses.

Supernormal profit

Whether the firm makes supernormal profits, normal profits or incurs losses depends on the level of the average cost at the short run equilibrium. If the average cost is below the average revenue, the firm earns supernormal profits. Figure 4.5 illustrates that the average cost QC is less than average revenue QB, and the firm earns profits equal to the area ABCD.

Loss incurring firms

If the average cost is above the average revenue the firm makes a loss. Figure 4.6 shows that the Average cost QF is higher than QG average revenue and the firm is incurring loss equal to the shaded area EFGH. In this case the firm will continue to produce only if it is able to cover its variable costs.

Otherwise it will close down, since by discontinuing its operations the firm is better off; it minimizes its losses. The point at which the firm covers its variable costs is called ‘the closing-down point’. If the price falls below or average costs rise, the firm does not cover its variable costs and is better off if it closes down. Figure 4.7 explains shut- down point.

Equilibrium of the Industry:An industry is in equilibrium at that price at which the quantity demand is equal to the quantity supplied.

Figure 4.8 explains that DD is the industry demand and SS the industry supply. The point E at which industry demand and industry supply equalizes, the price OP is determined. OQ is the quantity demanded and quantity supplied. This, however, is a short run equilibrium where at the market-determined price some firms may be making supernormal profits, normal profits or making losses. In the long run the firms may not continue incurring losses. Loss making firms that cannot adjust their plant will close down.

Firms that are making supernormal profits will expand their capacity. Simultaneously new firms will be attracted into the industry. Free movement of firms in and outside the industry and readjustment of the existing firms in the industry will establish a long run equilibrium in which firms will just be earning normal profits and there will be no tendency of entry or exit from the industry.

(c) Pricing in the Long Run:The long run is a period of time long enough to permit changes in the variable as well as in the fixed factors. In the long run, accordingly, all factors are variable and non- fixed. Thus, in the long run, firms can change their output by increasing their fixed equipment. They can enlarge the old plants or replace them by new plants or add new plants.

Moreover, in the long run, new firms can also enter the industry. On the contrary, if the situation so demands, in the long run, firms can diminish their fixed equipments by allowing them to wear out without replacement and the existing firm can leave the industry.

Thus, the long run equilibrium will refer to a situation where free and full scope for adjustment has been allowed to economic forces. In the long run, it is the long run average and marginal cost curves, which are relevant for making output decisions. Further, in the long run, average variable cost is of no particular relevance. The average total cost is of

determining importance, since in the long run all costs are variable and none fixed.

In the short run a firm under perfect competition is in equilibrium at that output at which marginal cost equals price or Marginal Revenue. This is equally valid in the long run. But, in the long run for a perfectly competition firm to be in equilibrium, besides marginal cost being equal to price, price must also be equal to average cost. If the price is greater than the average cost, the firms will be making supernormal profits.

Lured by these supernormal profits, new firms will enter the industry and these extra profits will be competed away. When the new firms enter the industry, the supply or output of the industry will increase and hence the price of the output will be forced down. The new firms will keep coming into the industry until the price is depressed down to average cost, and all firms are earning only normal profits.

On the other hand, if the price happens to be below the average cost, the firms will be incurring loses. Some of the existing firms will quit the industry. As a result, the output of the industry will decrease and the price will rise to equal the average cost so that the firms remaining in the industry are making normal profits. Hence, in the long run, firms need not be forced to produce at a loss since they can leave the industry, if they are having losses. Thus, for a perfectly competitive firm to be in equilibrium in the long run, price must equal marginal and average cost.

Now when average cost curve is falling, marginal cost curve is below it, and when average cost curve is rising, marginal cost curve must be above it. Hence, marginal cost can be equal to the average cost only at the point where average cost curve is neither falling nor rising, i.e. at the minimum point of average cost curve. Therefore, it is at the point of minimum average cost curve, and the two are equal there.

Thus, the conditions for long run equilibrium of perfectly competitive firm can be written as:Price = Marginal Cost = Minimum Average Cost.

Supernormal profit

The conditions for the long run equilibrium of the firm under perfect competition can be easily understood from the Fig. 4.9, where LAC is the long run average cost curve and LMC in the long run marginal cost curve. The firm under perfect competition cannot be in long run equilibrium at price OP’, because though the price OP’ equals MC at G (i.e., at output OQ) but it is greater than the average cost at this output and, therefore, the firm will be earning supernormal profits.

Since all the firms are assumed to be identical, all would be earning supernormal profits. Hence, there will be attraction for the new firms to enter the industry. As a result, the price will be forced down to the level Op at which price, the firm is in equilibrium at F and is producing OQ” output.

At point F or equilibrium output OQ”, the price is equal to average cost, and hence the firm will be earning only normal profits. Therefore, at price OP, there will be no tendency for the outside firms to enter the industry. Hence, the firm will be in equilibrium at OP price and OQ output.

On the contrary, a firm under perfect competition cannot be in the long run equilibrium at price OP”. Though price OP” is

equal to marginal cost at point E, or at output OQ” but price OP” is lower than the average cost at this point and thus the firm will be incurring losses.

Since all the firms in the industry are identical in respect of cost curves, all would be incurring losses. To avoid these losses, some of the firm will leave the industry. As a result, the price will rise to OP, where again all firms are making normal profits. When the price OP is reached, the firms would have no further tendency to quit.

Thus, to conclude that at price OP, the firm under perfect competition is in equilibrium in the long run when:Price = MC = Minimum AC

Now, at price OP, besides all firms being in equilibrium at output OQ, the industry will also be in equilibrium, since there will be no tendency for new firms to enter or the existing firms to leave the industry, because all will be earning normal profits. Thus, at OP price, full equilibrium, i.e. equilibrium of all the individual firms and also of the industry, as a whole, is achieved in the long run under perfect competition.

Monopoly:

Meaning, Definitions, Features

Meaning:

The word monopoly has been derived from the combination of two words i.e., ‘Mono’ and ‘Poly’. Mono refers to a single and poly to control.

In this way, monopoly refers to a market situation in which there is only one seller of a commodity.

There are no close substitutes for the commodity it produces and there are barriers to entry. The single producer may be in the form of individual owner or a single partnership or a joint stock company. In other words, under monopoly there is no difference between firm and industry.

Monopolist has full control over the supply of commodity. Having control over the supply of the commodity he possesses the market power to set the price. Thus, as a single seller, monopolist may be a king without a crown. If there is to be monopoly, the cross elasticity of demand between the product of the monopolist and the product of any other seller must be very small.

Definitions:“Pure monopoly is represented by a market situation in which there is a single seller of a product for which there are no substitutes; this single seller is unaffected by and does not affect the prices and outputs of other products sold in the economy.” Bilas

“Monopoly is a market situation in which there is a single seller. There are no close substitutes of the commodity it produces, there are barriers to entry”. -Koutsoyiannis

“Under pure monopoly there is a single seller in the market. The monopolist demand is market demand. The monopolist is a price-maker. Pure monopoly suggests no substitute situation”. -A. J. Braff

“A pure monopoly exists when there is only one producer in the market. There are no dire competitions.” -Ferguson

“Pure or absolute monopoly exists when a single firm is the sole producer for a product for which there are no close substitutes.” -McConnel

Features:

1. One Seller and Large Number of Buyers:

The monopolist’s firm is the only firm; it is an industry. But the number of buyers is assumed to be large.

2. No Close Substitutes:There shall not be any close substitutes for the product sold by the monopolist. The cross elasticity of demand between the product of the monopolist and others must be negligible or zero.

3. Difficulty of Entry of New Firms:There are either natural or artificial restrictions on the entry of firms into the industry, even when the firm is making abnormal profits.

4. Monopoly is also an Industry:Under monopoly there is only one firm which constitutes the industry. Difference between firm and industry comes to an end.

5. Price Maker:Under monopoly, monopolist has full control over the supply of the commodity. But due to large number of buyers, demand of any one buyer constitutes an infinitely small part of the total demand. Therefore, buyers have to pay the price fixed by the monopolist.

Nature of Demand and Revenue under Monopoly:Under monopoly, it becomes essential to understand the nature of demand curve facing a monopolist. In a monopoly situation, there is no difference between firm and industry.

Therefore, under monopoly, firm’s demand curve constitutes the industry’s demand curve. Since the demand curve of the consumer slopes downward from left to right, the monopolist faces a downward sloping demand curve. It means, if the monopolist reduces the price of the product, demand of that product will increase and vice- versa. (Fig. 1).

In Fig. 1 average revenue curve of the monopolist slopes downward from left to right. Marginal revenue (MR) also falls and slopes downward from left to right. MR curve is below AR curve showing that at OQ output, average revenue (= Price) is PQ where as marginal revenue is MQ. That way AR > MR or PQ > MQ.

Costs under Monopoly:Under monopoly, shape of cost curves is similar to the one under perfect competition. Fixed costs curve is parallel to OX-axis whereas average fixed cost is rectangular hyperbola. Moreover, average variable cost, marginal cost and average cost curves are of U-shape. Under monopoly, marginal cost curve is not the supply curve. Price is higher than marginal cost. Here, it is of immense use to quote that a monopolist is not obliged to sell a given amount of a commodity at a given price.

Determining the Price and Equilibrium of a Firm under Monopoly

Under monopoly, for the equilibrium and price determination there are two different conditions which are:

1. Marginal revenue must be equal to marginal cost.

2. MC must cut MR from below.

However, there are two approaches to determine equilibrium price under monopoly viz.;1. Total Revenue and Total Cost Approach.

2. Marginal Revenue and Marginal Cost Approach.

Total Revenue and Total Cost Approach:Monopolist can earn maximum profits when difference between TR and TC is maximum. By fixing different prices, a monopolist tries to find out the level of output where the difference between TR and TC is maximum. The level of output where monopolist earns maximum profits is called the equilibrium situation. This can be explained with the help of fig. 2.

In Fig. 2, TC is the total cost curve. TR is the total revenue curve. TR curve starts from the origin. It indicates that at zero level of output, TR will also be zero. TC curve starts from P. It reflects that even if the firm discontinues its production, it will have to suffer the loss of fixed costs.

Total profits of the firm are represented by TP curve. It starts from point R showing that initially firm is faced with negative profits. Now as the firm increases its production, TR also increases. But in the initial stage, the rate of increase in TR is less than TC.

Therefore, RC part of TP curve reflects that firm is incurring losses. At point M, total revenue is equal to total cost. It shows that firm is working under no profit, no loss basis. Point M is called the breakeven point. When firm produces more than point M, TR will be more than TC. TP curve also slopes upward. It shows that firm is earning profit. Now as the TP curve reaches point E then the firm will be earning maximum profits. This amount of output will be termed as equilibrium output.

Marginal Revenue and Marginal Cost Approach:According to marginal revenue and marginal cost approach, a monopolist will be in equilibrium when two conditions are fulfilled i.e., (i) MC=MR and (ii) MC must cut MR frombelow. The study of equilibrium price according to this analysis can be conducted in two time period

1. The Short Run

2. The Long Run

1. Short Run Equilibrium under Monopoly:Short period refers to that period in which the monopolist has to work with a given existing plant. In other words, the monopolist cannot change the fixed factors like, plant, machinery etc. in the short period. Monopolist can increase his output by changing the variable factors. In this period, the monopolist can enjoy super-normal profits, normal profits and sustain losses.

These three possibilities are described as follows:Super Normal Profits:

If the price determined by the monopolist in more than AC, he will get super normal profits. The monopolist will produce up to the level where MC=MR. This limit will indicate equilibrium output. In Figure 3 output is measured on X-axis and price on Y-axis. SAC and SMC are the short run average cost and marginal cost curves while AR or MR are the average revenue or marginal revenue curves respectively.

The monopolist is in equilibrium at point E because at point E both the conditions of equilibrium are fulfilled i.e., MR = MC and MC intersects the MR curve from below. At this level of equilibrium the monopolist will produce OQ1  level of output and sells it at CQ1  price which is more than average cost DQ1  by CD per unit. Therefore, in this case total profits of the monopolist will be equal to shaded area ABDC.Normal Profits:

A monopolist in the short run would enjoy normal profits when average revenue is just equal to average cost. We know that average cost of production is inclusive of normal profits. This situation can be illustrated with the help of fig 4.

In Fig. 4 the firm is in equilibrium at point E. Here marginal cost is equal to marginal revenue. The firm is producing OM level of output. At OM level of output average cost curve touches the average revenue curve at point P. Therefore, at point ‘P’ price OR is equal to average cost of the total product. In this way, monopoly firm enjoys the normal profits.

Minimum Losses:

In the short run, the monopolist may have to incur losses. This situation occurs if in the short run price falls below the variable cost. In other words, if price falls due to depression and fall in demand, the monopolist will continue to produce as long as price covers the average variable cost. Once the price falls

Below the average variable cost, monopolist will stop production. Thus, a monopolist in the short run equilibrium has to bear the minimum loss equal to fixed costs. Therefore, equilibrium price will be equal to average variable cost. This situation can also be explained with the help of Fig. 5.

In Fig. 5 monopolist is in equilibrium at point E. At point E marginal cost is equal to marginal revenue and he produces OM level of output. At OM level of output, equilibrium price fixed by the monopolist is OP1. At OP1 price, AVC touches the AR curve at point A.

It signifies that the firm will cover only average variable cost from the prevailing price. At OP1  price, firm will bear loss of fixed cost i.e., A per unit. The firm will bear the total loss equal to the shaded area PP1  AN. Now if the price falls below OP 1, the monopolist will stop production. It is so because if he continues production, he will have to bear the loss of variable costs along with fixed costs.2. Long Run Equilibrium under Monopoly:Long-run is the period in which output can be changed by changing the factors of production. In other words, all variable factors can be changed and monopolist would choose that plant size which is most appropriate for specific level of demand. Here, equilibrium would be attained at that level of output where the long-run marginal cost cuts marginal revenue curve from below. This can be shown with the help of Fig. 6.

In Fig. 6 monopolist is in equilibrium at OM level of output. At OM level of output marginal revenue is equal to long run marginal cost and the monopolist fixes OP price. HM is the long run average cost? Price OP being more than LAC i.e., HM which fetch the monopolist super normal profits. Accordingly, the monopolist earns JM – HM = JH super normal profit per unit. His total super normal profits will be equal to shaded area PJHP1.

Price Discrimination under Monopoly: Types:In monopoly, there is a single seller of a product called monopolist. The monopolist has control over pricing, demand, and supply decisions, thus, sets prices in a way, so that maximum profit can be earned.

The monopolist often charges different prices from different consumers for the same product. This practice of charging different prices for identical product is called price discrimination.

According to Robinson, “Price discrimination is charging different prices for the same product or same price for the differentiated product.”

According to Stigler, “Price discrimination is the sale of various products at prices which are not proportional to their marginal costs.”

In the words of Dooley, “Discriminatory monopoly means charging different rates from different customers for the same good or service.”

According to J.S. Bains, “Price discrimination refers strictly to the practice by a seller to charging different prices from different buyers for the same good.”

Let us learn different types of price discrimination.

Types of Price Discrimination:Price discrimination is a common pricing strategy’ used by a monopolist having discretionary pricing power. This strategy is practiced by the monopolist to gain market advantage or to capture market position.

There are three types of price discrimination, which are shown in Figure-13:

The different types of price discrimination (as shown in Figure-13) are explained as follows:

i. Personal:Refers to price discrimination when different prices are charged from different individuals. The different prices are charged according to the level of income of consumers as well as their willingness to purchase a product. For

example, a doctor charges different fees from poor and rich patients.

ii. Geographical:Refers to price discrimination when the monopolist charges different prices at different places for the same product. This type of discrimination is also called dumping.

iii. On the basis of use:Occurs when different prices are charged according to the use of a product. For instance, an electricity supply board charges lower rates for domestic consumption of electricity and higher rates for commercial consumption.

Degrees of Price Discrimination:Price discrimination has become widespread in almost every market. In economic jargon, price discrimination is also called monopoly price discrimination or yield management. The degree of price discrimination vanes in different markets.

Figure-14 shows the degrees of price discrimination:

These three degrees of price discrimination (as shown in Figure-14) are explained as follows:

i. First-degree Price Discrimination:Refers to a price discrimination in which a monopolist charges the maximum price that each buyer is willing to

pay. This is also known as perfect price discrimination as it involves maximum exploitation of consumers. In this, consumers fail to enjoy any consumer surplus. First degree is practiced by lawyers and doctors.

ii. Second-degree Price Discrimination:Refers to a price discrimination in which buyers are divided into different groups and different prices are charged from these groups depending upon what they are willing to pay. Railways and airlines practice this type of price discrimination.

iii. Third-degree Price Discrimination:

Refers to a price discrimination in which the monopolist divides the entire market into submarkets and different prices are charged in each submarket. Therefore, third-degree price discrimination is also termed as market segmentation.

In this type of price discrimination, the monopolist is required to segment market in a manner, so that products sold in one market cannot be resold in another market. Moreover, he/she should identify the price elasticity of demand of different submarkets. The groups are divided according to age, sex, and location. For instance, railways charge lower fares from senior citizens. Students get discount in cinemas, museums, and historical monuments.

Necessary Conditions for Price Discrimination:Price discrimination implies charging different prices for identical goods.

It is possible under the following conditions:i. Existence of Monopoly:

Implies that a supplier can discriminate prices only when there is monopoly. The degree of the price discrimination depends upon the degree of monopoly in the market.

ii. Separate Market:Implies that there must be two or more markets that can be easily separated for discriminating prices. The buyer of one market cannot move to another market and goods sold in one market cannot be resold in another market.

iii. No Contact between Buyers:Refers to one of the most important conditions for price discrimination. A supplier can discriminate prices if there is no contact between buyers of different markets. If buyers in one market come to know that prices charged in another market are lower, they will prefer to buy it in other market and sell in own market. The monopolists should be able to separate markets and avoid reselling in these markets.

iv. Different Elasticity of Demand:Implies that the elasticity of demand in the markets should differ from each other. In markets with high elasticity of demand, low price will be charged, whereas in markets with low elasticity of demand, high prices will be charged. Price discrimination fails in case of markets having same elasticity- of demand.

Advantages and Disadvantages of Price Discrimination:A monopolist practices price discrimination to gain profits. However, it acts as a loss for the consumers.

Following are some of the advantages of price discrimination:i. Helps organizations to earn revenue and stabilize the business

ii. Facilitates the expansion plans of organizations as more revenue is generated

iii. Benefits customers, such as senior citizens and students, by providing them discounts

In spite of advantages, there are certain disadvantages of price discrimination.

Some of the disadvantages of price discrimination as follows:i. Leads to losses as some consumers end up paying higher prices

ii. Involves administration costs for separating markets.

Price and Output Decisions in Discriminating Monopoly:

Price discrimination is a strategy used by a monopolist under which a given product is sold at different prices.

The main aim of a monopolist of practicing price discrimination strategy is to increase total revenue and earn maximum profit.

However, in case of discriminating monopoly, different prices are charged for output. Let us now discuss how a monopolist decides the equilibrium price and output under the discriminating monopoly with the help of an example.

Assume that a monopolist, Mr. X has divided market into two submarkets, X and Y. He found that the elasticity of demand is greater in market Y than in market X.

The monopolist would earn maximum profits where MR=MC and MC curve cuts MR curve from below, which is shown in Figure-15:

In Figure-15, in case of total market, output OQ has to be distributed in such a way that MR equals MC at E. Thus, a monopolist will sell output OQ1  in market X and OQ 2  in market Y as at these levels of output equals QE that is an equilibrium output. The price charged in both the markets will be equal to AR or demand curve.

Thus, price in market X is OP1  and price in market Y is OP 2. It should be noted that the price charged in market X is greater than the price charged in market Y. This is because the elasticity of demand is greater in market Y than X. Since price in market X is higher, the output sold is low that is OQ1  than OO 2  in market Y. Thus, there must be two conditions for a discriminating monopolist to attain equilibrium given as follows:Marginal Cost of Total Output = Combined Marginal Revenue

Marginal Revenue in Market A = Marginal Revenue in Market B = Marginal Cost

Monopolistic Competition Market

Meaning: Monopolistic competition is a market structure which combines elements of monopoly and competitive markets. Essentially a monopolistic competitive market is one with freedom of entry and exit, but firms can differentiate their products. Therefore, they have an inelastic demand curve and so they can set

prices. However, because there is freedom of entry, supernormal profits will encourage more firms to enter the market leading to normal profits in the long term.

Main Features of Monopolistic Competition

The main features of monopolistic competition are as under:1. Large Number of Buyers and Sellers:There are large number of firms but not as large as under perfect competition.

That means each firm can control its price-output policy to some extent. It is assumed that any price-output policy of a firm will not get reaction from other firms that means each firm follows the independent price policy.

If a firm reduces its price, the gains in sales will be slightly spread over many of its rivals so that the extent to which each of the rival firms suffers will be very small. Thus these rival firms will have no reason to react.

2. Free Entry and Exit of Firms:Like perfect competition, under monopolistic competition also, the firms can enter or exit freely. The firms will enter when the existing firms are making super-normal profits. With the entry of new firms, the supply would increase which would reduce the price and hence the existing firms will be left only with normal profits. Similarly, if the existing firms are sustaining losses, some of the marginal firms will exit. It will reduce the supply due to which price would rise and the existing firms will be left only with normal profit.

3. Product Differentiation:Another feature of the monopolistic competition is the product differentiation. Product differentiation refers to a situation

when the buyers of the product differentiate the product with other. Basically, the products of different firms are not altogether different; they are slightly different from others. Although each firm producing differentiated product has the monopoly of its own product, yet he has to face the competition. This product differentiation may be real or imaginary. Real differences are like design, material used, skill etc. whereas imaginary differences are through advertising, trade mark and so on.

4. Selling Cost:Another feature of the monopolistic competition is that every firm tries to promote its product by different types of expenditures. Advertisement is the most important constituent of the selling cost which affects demand as well as cost of the product. The main purpose of the monopolist is to earn maximum profits; therefore, he adjusts this type of expenditure accordingly.

5. Lack of Perfect Knowledge:

The buyers and sellers do not have perfect knowledge of the market. There are innumerable products each being a close substitute of the other. The buyers do not know about all these products, their qualities and prices.

Therefore, so many buyers purchase a product out of a few varieties which are offered for sale near the home. Sometimes a buyer knows about a particular commodity where it is available at low price. But he is unable to go there due to lack of time or he is too lethargic to go or he is unable to find proper conveyance. Likewise, the seller does not know the exact preference of buyers and is, therefore, unable to get advantage out of the situation.

6. Less Mobility:Under monopolistic competition both the factors of production as well as goods and services are not perfectly mobile.

7. More Elastic Demand:Under monopolistic competition, demand curve is more elastic. In order to sell more, the firms must reduce its price.

Price-Output Equilibrium under Monopolistic Competition:

Price-Output Equilibrium under Monopolistic Competition: Equilibrium in Short-Run and Long Run!Under monopolistic competition, organizations need to make optimum adjustments in the prices and output sold to attain equilibrium.

Apart from this, under monopolistic competition, organizations also need to pay attention toward the design of the product and the way the product is promoted in the market.

Moreover, an organization under monopolistic competition is not only required to study its individual equilibrium, but group equilibrium of all organizations existing in the market. Let us first understand individual equilibrium of an organization under monopolistic competition.

As we know every seller, irrespective of the market structure, is willing to maximize his/her profits. In monopolistic competition, profits are maximized at a point where marginal revenue is equal to marginal cost. The price determined at this point is known as equilibrium price and the output produced at this point is called equilibrium output.

If the marginal revenue of a seller is greater than marginal cost, he/she may plan to expand his/her output. On the other hand, if marginal revenue is lesser than marginal cost, it would be profitable for the seller to reduce his/her output to the level where marginal revenue is equal to marginal cost.

Equilibrium in Short Run:

The short-run equilibrium of a monopolistic competitive organization is the same as that of an organization under monopoly. In the short run, an organization under monopolistic competition attains its equilibrium where marginal revenue equals marginal cost and sets its price according to its demand curve. This implies that in the short run, profits are maximized when MR=MC.

Figure-2 shows the equilibrium in the short run:

Supernormal profit

In Figure-2, AR is the average revenue curve, MR represents the marginal revenue curve, SAC curve denotes the short run average cost curve, while SMC signifies the short run marginal cost. In Figure-2, it can be seen that MR intersects SMC at output OM where price is OP’ (which is equal to MP). This is because P is the, point on AR curve, which is price.

From Figure-2, it can be interpreted from that the organization is earning supernormal profit. Supernormal profit per unit of output is the difference between the average revenue and average cost. In Figure-2, average revenue at equilibrium point is MP and average cost is MT.

Therefore, PT is the supernormal profit per unit of output. In the present case, supernormal profit would be measured by

the area of rectangle P’PTT’ (which is output multiplied by supernormal profit per unit of output).

On the other hand, when marginal cost is greater than marginal revenue, organizations would incur losses, as shown in Figure-3: Normal profit

Figure-3 shows the condition of losses in the short run under monopolistic competition. Here, OP’ is smaller than MT, which implies that average revenue is smaller than average cost. TP is representing the loss that has incurred per unit of output. Therefore total loss is depicted from rectangle T’TPP’.

Equilibrium in Long Run:In the preceding sections, we have discussed that in the short run, organizations can earn supernormal profits. However, in the long run, there is a gradual decrease in the profits of organizations. This is because in the long run, several new organizations enter the market due to freedom of entry and exit under monopolistic competition.

When these new organizations start production the supply would increase and the prices would fall. This would automatically increase the level of competition in the market. Consequently, AR curve shifts from right to left and supernormal profits are replaced with normal profits.

In the long run, the AR curve is more elastic than that of in the short run. This is because of an increase in the number of substitute products in the long- run. The long-run equilibrium of monopolistically competitive organizations is achieved when

average revenue is equal to average cost. In such a case, organizations receive normal profits.

Figure-4 shows the long-run equilibrium position under monopolistic competition:

Normal profit

In Figure-4, P is the point at which AR curve touches the average cost curve (LAC) as a tangent. P is regarded as the equilibrium point at which the price level is MP (which is also equal to OF) and output is OM.

In the present case average cost is equal to average revenue that is MP. Therefore, in long run, the profit is normal. In the short run, equilibrium is attained when marginal revenue is equal to marginal cost. However, in the long run, both the conditions (MR=MC and AR=AC) must hold to attain equilibrium.

OLIGOPOLY MARKETMeaning:

Oligopoly is a market situation in which there are a few firms selling homogeneous or differentiated products. It is difficult to pinpoint the number of firms in the oligopolistic market. There may be three, four or five firms.

 Characteristics of Oligopoly Market;Oligopoly as a market structure is distinctly different from other market forms. Its main characteristics :

1. Interdependence:The foremost characteristic of oligopoly is interdependence of the various firms in the decision making.

This fact is recognized by all the firms in an oligopolistic industry. If a small number of sizeable firms constitute an industry and one of these firms starts advertising campaign on a big scale or designs a new model of the product which immediately captures the market, it will surely provoke countermoves on the part of rival firms in the industry.

Thus different firms are closely inter dependent on each other.

2. Advertising:Under oligopoly a major policy change on the part of a firm is likely to have immediate effects on other firms in the industry. Therefore, the rival firms remain all the time vigilant about the moves of the firm which takes initiative and makes policy changes. Thus, advertising is a powerful instrument in the hands of an oligopolist. A firm under oligopoly can start an aggressive advertising campaign with the intention of capturing a large part of the market. Other firms in the industry will obviously resist its defensive advertising.

Under perfect competition advertising is unnecessary while a monopolist may find some advertising to be profitable when his product is new or when there exist a large number of potential consumers who have never tried his product earlier. But according to Prof. Baumol, “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.”

3. Group Behaviour:

In oligopoly, the most relevant aspect is the behaviour of the group. There can be two firms in the group, or three or five or even fifteen, but not a few hundred. Whatever the number, it is quite small so that each firm knows that its actions will have some effect on other firms in the group. In contrast, under perfect competition there are a large number of firms each attempting to maximise its profits.

Similar is the situation under monopolistic competition. Under monopoly, there is just one profit maximising firm. Whether one considers monopoly or a competitive market, the behaviour of a firm is generally predictable.

In oligopoly, however, this is not possible due to various reasons:(i) The firms constituting the group may not have a common goal

(ii) The group may or may not have a formal or informal organization with accepted rules of conduct

(iii) The group may be dominated by a leader but other firms in the group may not follow him in a uniform manner.

4. Competition:This leads to another feature of the oligopolistic market, the presence of competition. Since under oligopoly, there are a few sellers, a move by one seller immediately affects the rivals. So each seller is always on the alert and keeps a close watch over the moves of its rivals in order to have a counter-move. This is true competition, “True competition consists of the life of constant struggle, rival against rival, whom one can only find under oligopoly.”

5. Barriers to Entry of Firms:As there is keen competition in an oligopolistic industry, there are no barriers to entry into or exit from it. However, in the long-run, there are some types of barriers to entry which tend to restrain new firms from entering the industry.

These may be:(a) Economics of scale enjoyed by a few large firms;

(b) Control over essential and specialized inputs;

(c) High capital requirements due to plant costs, advertising costs, etc.

(d) Exclusive patents; and licenses; and

(e) The existence of unused capacity which makes the industry unattractive.

When entry is restricted or blocked by such natural and artificial barriers the oligopolistic industry can earn long-run supernormal profits.

6. Lack of Uniformity:Another feature of oligopoly market is the lack of uniformity in the size of firms. Firms differ considerably in size. Some may be small, others very large. Such a situation is asymmetrical. This is very common in the American economy. A symmetrical situation with firms of a uniform size is rare.

7. Existence of Price Rigidity:In oligopoly situation, each firm has to stick to its price. If any firm tries to reduce its price, the rival firms will retaliate by a higher reduction in their prices. This will lead to a situation of price war which benefits none. On the other hand, if any firm increases its price with a view to increase its profits; the other rival firms will not follow the same. Hence, no firm would like

to reduce the price or to increase the price. The price rigidity will take place.

8 No Unique Pattern of Pricing Behaviour:

The rivalry arising from interdependence among the oligopolists leads to two conflicting motives. Each wants to remain independent and to get the maxmium possible profit. Towards this end, they act and react on the price-output movements of one another which are a continuous element of uncertainty.

On the other hand, again motivated by profit maximisation each seller wishes to cooperate with his rivals to reduce or eliminate the element of uncertainty. All rivals enter into tacit or formal agreement with regard to price-output changes.

It leads to a sort of monopoly within oligopoly. They may even recognize one seller as a leader at whose initiative all the other sellers raise or lower the price. In this case, the individual seller’s demand curve is a part of the industry demand curve, having the elasticity of the latter. Given these conflicting attitudes, it is not possible to predict any unique pattern of pricing behaviour in oligopoly markets.

9. Indeterminateness of Demand Curve:In market structures other than oligopolistic, demand curve faced by a firm is determinate. The interdependence of the oligopolists, however, makes it impossible to draw a demand curve for such sellers except for the situations where the form of interdependence is well defined. In real business operations, the demand curve remains indeterminate. Under oligopoly a firm can expect at least three different reactions of the other sellers when it lowers its prices.

This happened due to the reason:

(i) It is possible that other maintain the prices they had before. In this case, an oligopolist can hope that its demand would increase substantially as the prices are lowered,

(ii) When an oligopolist reduces his price, the other sellers also lower their prices by an equivalent amount. In this situation although demand of the oligopolist making the first move will increase as he lowers his price, the increase itself would be much smaller than in the first case.

(iii) When a firm reduces its price, the other sellers reduce their prices far more. Under the circumstances the demand for the product of the oligopolistic firm which makes the first move may decrease. Thus uncertainty under oligopoly is inevitable, and as a result, the demand curve faced by each firm belonging to the group is necessarily indeterminate.

Pricing determination under Oligopoly Market

Contents :1. Meaning

2. Price Determination under Oligopoly

3. Non-Price Competition in Oligopoly

1. Meaning

Oligopoly is a market situation in which there are a few firms selling homogeneous or differentiated products. It is difficult to pinpoint the number of firms in the oligopolist market. There may be three, four or five firms.

It is also known as competition among the few. With only a few firms in the market, the action of one firm is likely to affect the others. An oligopoly industry produces either a homogeneous product or heterogeneous products.

The former is called pure or perfect oligopoly and the latter is called imperfect or differentiated oligopoly. Pure oligopoly is found primarily among producers of such industrial products as aluminium, cement, copper, steel, zinc, etc. Imperfect oligopoly is found among producers of such consumer goods as automobiles, cigarettes,’ soaps and detergents, TVs, rubber tyres, refrigerators, typewriters, etc.

2. Price Determination under Oligopoly:

We shall confine our study to the non-collusive oligopoly model of Sweezy, and to the collusive oligopoly models relating to cartels and price leadership.

1. The Sweezy Model of Kinked Demand Curve (Rigid Prices):In his article published in 1939, Prof. Sweezy presented the kinked demand curve analysis to explain price rigidities often observed in oligopolistic markets. Sweezy assumes that if the oligopolistic firm lowers its price, its rivals will react by matching that price cut m order to avoid losing their customers. Thus the firm lowering the price will not be able to

increase its demand much. This portion of its demand curve is relatively inelastic.

On the other hand, if the oligopolistic firm increases its price, its rivals will not follow it and change their prices. Thus the quantity demanded of this firm will fall considerably. This portion of the demand curve is relatively elastic. In these two situations, the demand curve of the oligopolistic firm has a kink at the prevailing market price which explains price rigidity.

Assumptions:The kinked demand curve hypothesis of price rigidity is based on the following assumptions:(1) There are few firms in the oligopolistic industry.

(2) The product produced by one firm is a close substitute for the other firms.

(3) The product is of the same quality. There is no product differentiation.

(4) There are no advertising expenditures.

(5) There is an established or prevailing market price for the product at which all the sellers are satisfied.

(6) Each seller’s attitude depends on the attitude of his rivals.

(7) Any attempt on the part of a seller to push up his sales by reducing the price of his product will be counteracted by the other sellers who will follow his move.

(8) If he raises the price, others will not follow him. Rather they will stick to the prevailing price and cater to the customers, leaving the price-raising seller.

(9) The marginal cost curve passes through the dotted portion of the marginal revenue curve so that changes in marginal cost do not affect output and price.

The Model:Given these assumptions, the price-output relationship in the oligopolist market is explained in Figure 1 where KPD is the kinked demand curve and OP0 the prevailing price in the oligopoly market for the OR product of one seller. Starting from point P, corresponding to the current price OP1, any increase in price above it will considerably reduce his sales, for his rivals are not expected to follow his price increase. This is so because the KP portion of the kinked demand curve is elastic, and the corresponding portion KA of the MR curve is positive. Therefore, any price-increase will not only reduce his total sale but also his total revenue and profit.On the other hand, if the seller reduces the price of the product below OPQ (or P), his rivals will also reduce their prices. Though he will increase his sales, his profit would be less than before. The reason is that the PD portion of the kinked demand curve below P is less elastic and the corresponding part of marginal revenue curve below R is

negative. Thus in both the price-raising and price-reducing situations, the seller will be a loser. He would stick to the prevailing market price OP0 which remains rigid.In order to study the working of the kinked demand curve, let us analyse the effect of changes in cost and demand conditions on price stability in the oligopolistic market.

Changes in Costs:In oligopoly under the kinked demand curve analysis changes in costs within a certain range do not affect the prevailing price. Suppose the cost of production falls so that the new MC curve is MC1, to the right, as in Figure 2. It cuts the MR curve in the gap AB so that the profit maximising output is OR which can be sold at OP0 price.It should be noted that with any cost reduction the new MC curve will always cut the MR curve in the gap because as costs fall the gap AB continues to widen due to two reasons:

(1) As costs fall, the upper portion KP of the demand curve becomes more elastic because of the greater certainty that a

price rise by one seller will not be followed by rivals and his sales would be considerably reduced.

(2) With the reduction in costs the lower portion PD of the kinked curve becomes more inelastic, because of the greater certainty that a price reduction by one seller will be followed by the other rivals.

Thus the angle KPD tends to be a right angle at P and the gap AB widens so that any MC curve below point A will cut the marginal revenue curve inside the gap. The net result is the same output OR at the same price OP0 and larger profits for the oligopolistic sellers.In case the cost of production rises the marginal cost curve will shift to the left of the old curve MC as MC2. So long as the higher MC curve intersects the MR curve within the gap upto point A, the price situation will be rigid. However, with the rise in costs the price is not likely to remain stable indefinitely and if the MC curve rises above point A, it will intersect the MC curve in the portion KA so that a lesser quantity is sold at a higher price. We may conclude that there may be price

stability under oligopoly even when costs change so long as the MC curve cuts the MR curve in its discontinuous portion. However, chances of the existence of price rigidity are greater where there is a reduction in costs than there is a rise in costs.Changes in Demand:We now explain price rigidity where there is a change in demand with the help of Figure 3, D2 is the original demand curve, MR2 is its corresponding marginal revenue curve and MC is the marginal cost curve. Suppose there is decrease in demand shown by D1 curve and MR1 is its marginal revenue curve. When demand decreases, a price-reduction move by one seller will be followed by other rivals.

This will make LD1, the lower portion of the new demand curve, more inelastic than the lower portion HD2 of the old demand curve. This will tend to make the angle at L approach a right angle. As a result, the gap EF in MR1 curve is likely to be wider than the gap AВ of the MR2 curve.The marginal cost curve MC will, therefore, intersect the lower marginal revenue curve MRX inside the gap EF, thus indicating a stable price for the oligopolistic industry. Since the level of the kinks H and L of the two demand curves remains the same,

the same price OP is maintained after the decrease in demand. But the output level falls from OQ2 to OQ1.This case can be reversed to show increase in demand by taking D2 and MR2 as the original demand and marginal revenue curves and D 2and MR2 as the higher demand and marginal revenue curves respectively. The price OP is maintained but the output rises from OQ1 to OQ. So long as the MC curve continues to intersect the MR curve in the discontinuous portion, there will be price rigidity.The whole analysis of the kinked demand curve points out that price rigidity in oligopolistic markets is likely to prevail if there is a price reduction move on the part of all sellers. Changes in costs and demand also lead to price stability under normal conditions so long as the MC curve intersects the MR curve in its discontinuous portion. But price increase rather than price rigidity may be found in response to rising cost or increased demand.

Reasons for Price Stability:There are a number of reasons for price rigidity in certain oligopoly markets:(1) Individual sellers in an oligopolistic industry might have learnt through experience the futility of price wars and thus prefer price stability.

(2) They may be content with the current prices, outputs and profits and avoid any involvement in unnecessary insecurity and uncertainty.

(3) They may also prefer to stick to the present price level to prevent new firms from entering the industry.

(4) The sellers may intensify their sales promotion efforts at the current price instead of reducing it. They may view non-price competition better than price rivalry.

(5) After spending a lot of money on advertising his product, a seller may not like to raise its price to deprive himself of the fruits of his hard labour. Naturally, he would stick to the going price of the product.

(6) If a stable price has been set through agreement or collusion, no seller would like to disturb it, for fear of unleashing a price war and thus engulfing himself into an era of uncertainty and insecurity.

(7) It is the kinked demand curve analysis which is responsible for price rigidity in oligopolistic markets.

It’s Shortcomings:But the theory of kinked demand curve in oligopoly pricing is not without shortcomings.

(1) Even if we accept all its assumptions it is not likely that the gap in the marginal revenue curve will be wide enough for the marginal cost curve to pass through it. It may be shortened even under conditions of fall in demand or costs thereby making price unstable.

(2) One of its major shortcomings, according to Prof. Stigler, is that “the theory does not explain why prices that have once changed should settle down, again acquire stability, and gradually produce a new kink.” For instance in Figure 2, the kink occurs at P because OP0 is the prevailing price. But the theory does not explain the forces that established the initial price OP0.(3) Price stability may be illusory because it is not based on the actual market behaviour. Sales do not always occur at list prices. There are often deviations from posted prices because of trade-ins, allowance and secret price concessions. The oligopolistic seller may outwardly keep the price stable but he may reduce the quality or quantity of the product. Thus price stability becomes illusory.

(4) Moreover, it is not possible to statistically compile actual sales prices in the case of many products that may reflect stable prices for them. It is, therefore, doubtful that price stability actually exists in oligopoly.

(5) Critics point out that the kinked demand curve analysis holds during the short run, when the knowledge about the reactions of rivals is low. But it is difficult to guess correctly the rivals’ reactions in the long run. Thus the theory is not applicable in the long-run.

(6) According to some economists, the kinked demand curve analysis applies to an oligopolistic industry in its initial stages or to that industry in which new and previously unknown rivals enter the market.

(7) The kinked demand curve analysis is based on two assumptions: first, other firms will follow a price cut and, second, they will not follow a price rise. Stigler has shown on empirical evidence that in an inflationary period the rise in output prices is not confined only to one firm but is industry-wide. So all firms having similar costs will follow one another in raising price. In Stigler’s words: “There is little historical basis for a firm to believe that price increases will not be matched by rivals and that price decreases will be matched.”

(8) Economists have concluded from this that the kinked demand curve analysis is applicable only under depression. For in an inflationary period when demand increases, the oligopolistic firm will raise price and other firms will also follow it. In such a situation, the demand curve of the oligopolist will have inverted kink. This reverse kink is based on his expectation that all his competitors will follow him when he raises the price of his product, but none will follow a price cut because of inflationary condition.

(9) Stigler further points out those cases in oligopoly industries where the number of sellers is either very small or somewhat large, the kinked demand curve is not likely to be there.

“However”, as pointed out by Professor Baumol, “the analysis does show how the oligopolistic firm’s view of competitive reaction patterns can affect the changeability of whatever price it happens to be charging.”

2. Collusive Oligopoly:Collusive oligopoly is a situation in which firms in a particular industry decide to join together as a single unit for the purpose of maximising their joint profits and to negotiate among themselves so as to share the market. The former is known as the joint profit maximisation cartel and the latter as the market-sharing cartel.

There is another type of collusion, known as leadership, which is based on tacit agreements. Under it, one firm acts as the price leader and fixes the price for the product while other firms follow it. Price leadership is of three types: low-cost firm, dominant firm, and barometric.

(A) Cartels:A cartel is an association of independent firms within the same industry. The cartel follows common policies relating to prices, outputs, sales and profit maximisation and distribution of products. Cartels may be voluntary or compulsory and open or secret depending upon the policy of the government with regard to their formation. Thus cartels have many forms and use many devices in order to follow varied common policies depending upon the type of the cartel. We discuss below the two most common types of cartels: (1) Joint profit maximisation or perfect cartel; and (2) market-sharing cartel.

1. Joint Profit Maximisation Cartel:The uncertainty to be found in an oligopolistic market provides an incentive to rival firms to form a perfect cartel. Perfect cartel is an extreme form of perfect collusion. In this, firms

producing a homogeneous product form a centralised cartel board in the industry. The individual firms surrender their price-output decisions to this central board.

The board determines output quotas for its members, the price to be charged and the distribution of industry profits. Since the central board manipulates prices, outputs, sales and distribution of profits, it acts like a single monopoly whose main aim is to maximise the joint profits of the oligopolistic industry.

Assumptions:The analysis of joint profit maximisation cartel is based on the following assumptions:1. Only two firms A and В are assumed in the oligopolistic industry that forms the cartel.

2. Each firm produces and sells a homogeneous product that is a perfect substitute for each other.

3. The number of buyers is large.

4. The market demand curve for the product is given and is known to the cartel.

5. The cost curves of the firms are different but are known to the cartel.

6. The price of the product determines the policy of the cartel.

7. The cartel aims at joint profit maximisation.

Joint Profit Maximisation Solution:Given these assumptions, and given the market demand curve and its corresponding MR curve, joint profits will be maximised when the industry MR equals the industry MC. Figure 4 illustrates this situation where D is the market (or cartel) demand curve and MR is its corresponding marginal revenue curve. The aggregate marginal cost curve of the industry ΣMС is drawn by the lateral summation of the MC curves of firms A and В, so that ΣMС = MCa + MCb. The cartel solution that maximises joint profit is determined at point E where the ШС curve intersects the industry MR curve.

Consequently, the total output is OQ which will be sold at OP = (QF) price. As under monopoly, the cartel board will allocate the industry output by equating the industry MR to the marginal cost of each firm. The share of each firm in the industry output is obtained by drawing a straight line from E to the vertical axis which passes through the curves MCb and MCa of firms В and A at points Eb and Ea respectively.Thus the share of firm A is OQa and that of firm В is OOb which equal the total output OQ (= OQa + OQb). The price OP and the output OQ distributed between A and В (inns in the ratio of OQa: OQb is the monopoly solution. Firm A with the lower costs

sells larger output OQa than firm В with higher costs so that OQa > OQb. But this does not mean that A will be getting more profit than B.The joint maximum profit is the sum of RSTP and ABCP earned by A and В respectively. It will be pooled into a fund and distributed by the cartel board according to the agreement arrived at by the two firms at the time of the formation of the cartel. A pooling agreement of this type will make it possible for both firms to maximise their joint profit provided the total profits earned by them independently do not exceed the former.

Advantages:Thus perfect collusion by oligopolistic firms in the form of a cartel has certain advantages. It avoids price wars among rivals. The firms forming a cartel gain at the expense of customers who are charged a high price for the product. The cartel operates like a monopoly organisation which maximises the joint profit of firms. Joint profits are generally more than the total profits earned by them if they were to act independently.

Difficulties of a Cartel:The above analysis is based on perfect collusion in which all firms relinquish their individual price-output decisions to a central board of the cartel which acts like a multi-plant monopolist. But this is only a theoretical possibility in the short run because in practice the joint profit maximisation objective cannot be achieved by a cartel. In the long run, there are a

number of difficulties faced by a cartel which tend to break it down.

1. It is difficult to make an accurate estimate of the market demand curve. Each firm thinks that its own demand curve is more elastic than the market demand curve because its product is a perfect substitute for the product of its rivals. Thus if the market demand curve is underestimated so will be its corresponding MR curve which will make the estimation of the market price inaccurate by the cartel.

2. Similarly, the estimation of the market MC curve may be inaccurate because of the supply of wrong data about their MCs by individual firms to the cartel. There is every possibility that the individual firms may supply low-cost data to the central cartel board in order to have larger share of output and profits. This may ultimately lead to the breakdown of the cartel.

3. The formation of a cartel is a slow process which takes a long time for the agreement to arrive at by firms especially if their number is very large. In the meantime, there may be changes in the cost structure and market demand for the product. This renders the cartel agreement useless and it breaks down soon.

4. If a firm’s product is preferred more by consumers than that of the other members of the cartel, the market demand for it may be higher than the quota fixed by the cartel. It may,

therefore, secretly sell more than its quota and if followed by other firms, the cartel will break down.

5. The larger the number of firms in a cartel, the less is its chances of survival for long because of the distrust, threatening and bargaining resorted to by them. The cartel will, therefore, break down.

6. In theory, the cartel-members agree on joint profit maximisation. But in practice, they seldom agree on profit distribution. Large firms want a lower price, a higher output quota and larger profits. So when such problems arise in joint profit distribution in contravention of the cartel agreement, they lead to the breakdown of the cartel.

7. I he price of the product fixed by the cartel cannot be changed even if the market conditions require it to be changed. This is because it takes long time for the members to arrive at an agreed price. This stickiness of the price often leads to the breakdown of the cartel when some members defect from it.

8. Price stickiness gives rise to “chislers” who secretly cut the price or violate the quota agreement. Such secret dealings by firms to raise their own profits tend to break down the cartel.

9. Unless all member firms in the cartel are strongly committed to cooperation, outside disturbances, such as a sharp fall in demand, may lead to the breakdown of the cartel.

10. When a cartel raises the price of the product and increases the profits of its members, it creates an incentive for new firms to enter the industry. Even if the entry of new firms is blocked, it is only a short-run phenomenon because the success of the cartel will lead to the entry of firms in the long run. This will force the cartel to break down. If the new firms are allowed to enter the cartel, it will become unmanageable, increase the defectors and bring its end.

11. Some high-cost uneconomic firms may refuse to shut down or leave the cartel despite the cartel board’s request. This is likely to distort the profit maximisation level of the cartel and thus break it.

12. The cartel’s policy of fixing high price and restricting the quantity of the product may lead to the emergence of substitutes in the long run. The other firms may invent and produce cheaper substitutes which may be accepted by consumers. This will tend to reduce the demand for the cartel’s product, make it more elastic, reduce its joint profits and thus break the cartel.

13. The cartel may not be able to maximise joint profits by not charging a very high price for fear of government interference and regulation.

14. Similarly, the cartel may not charge a very high price and maximise its joint profits in order to have a good public image or reputation.

Thus the chances are greater for individual firms to leave the cartel on account of personal bickering and antagonism of member firms over allotment of quotas and division of profits which are likely to affect adversely joint profit maximisation and end the cartel agreement.

Besides these problems in the working of a cartel, it is more difficult to form and run a cartel for long in the case of a differentiated product than in the case of a homogeneous product. For, it is not possible to rationalise and sort out the differences in the qualities of the product.

2. Market-Sharing Cartel:Another type of perfect collusion in an oligopolistic market is found in practice which relates to market-sharing by the member firms of a cartel. The firms enter into a market-sharing agreement to form a cartel “but keep a considerable degree of freedom concerning the style of their output, their selling activities and other decisions.”

There are two main methods of market-sharing:(a) non-price competition; and

(b) Quota system.

(a) Non-Price Competition Cartel:The non-price competition agreement among oligopolistic firms is a loose form of cartel. Under this type of cartel, the low-cost firms press for a low price and the high-cost firms for

a high price. But ultimately, they agree upon a common price below which they will not sell.

Such a price must allow them some profits. The firms can compete with one another on a non-price basis by varying the colour, design, shape, packing, etc. of their product and having their own different advertising and other selling activities. Thus each firm shares the market on a non-price basis while selling the product at the agreed common price.

This type of cartel is inherently unstable because if one low-cost firm cheats the other firms by charging a lower price than the common price, it will attract the customers of other member firms and earn larger profits. When other firms come to know of this, they will leave the cartel. A price war will start and ultimately the lowest-cost firm will remain in the industry.

In case the cost curves of the firms forming a cartel differ, the low-cost firms may not stick to the common price. They may try to increase their share of the market by means of secret price concessions. They may also resort to better sales promotion methods. Such policies tend to change their demand-cost conditions further. Consequently, price variations among firms become more common. Ultimately, the cartel agreement becomes a farce and a price war starts. This leads to the breaking up of the cartel agreement.

(b) Market Sharing by Quota Agreement:The second method of market sharing is the quota agreement among firms. All firms in an oligopolistic industry enter into a

collusion for charging an agreed uniform price. But the main agreement relates to the sharing of the market equally among member firms so that each firm gets profits on its sales.

Assumptions:This analysis is based on the following assumptions:1. There are only two firms that enter into market-sharing agreement on the basis of the quota system.

2. Each firm produces and sells a homogeneous product which is a perfect substitute for each other.

3. The number of buyers is large.

4. The market demand curve for the product is given and known to the cartel.

5. Each firm has its own demand curve having the same elasticity as that of the market demand curve.

6. The cost curves of the two firms are identical.

7. Both firms share the market equally.

8. Each sells the product at the agreed uniform price.

9. There is no threat of entry’ by new firms.

Market-Sharing Solution:Given these assumptions, the equal market sharing between the two firms is explained in terms of Figure 5 where D is the market demand curve and d/MR is its corresponding MR curve. EMC is the aggregate MC curve of the industry. The

ZMC curve intersects the d/MR curve at point E which determines QA (= OP) price and total output OQ for the industry. This is the monopoly solution in the market-sharing cartel.

How will the industry output be shared equally between the two firms? Now assume that the d/ MR is the demand curve of each firm and mr is its corresponding MR curve. AC and MC are their identical cost curves. The MC curve intersects the mr curve at point e so that the profit maximisation output of each firm is Oq.

Since the total output of the industry is OQ which is equal to 2 x Oq = (OQ = 2Oq), it is equally shared by the two firms as per the quota agreement between them. Thus each firm sells Oq output at the same price qB (=OP) and earns RP per unit profit. The total profit earned by each firm is RP x Oq and by both is RP x 2Oq or RP x OQ.

However, in actuality, there are more than two firms in an oligopolistic industry which do not share the market equally. Moreover, their cost curves are also not identical. In case their

cost curves differ, their market shares will also differ. Each firm will charge an independent price in accordance with its own MC and MR curves.

They may not sell the same quantity at the agreed common price. They may be charging a price slightly above or below the profit maximisation price depending upon its cost conditions. But each will try to be nearest the profit maximisation price. This will ultimately lead to the breaking up of the market sharing agreement.

With Threat of Entry:So far our analysis has been confined to collusive oligopoly without any threat of entry of new firms in the industry. Suppose there is a constant threat of entry into the oligopolistic industry. In that case if the firms agree on the price OP, new firms will enter the industry, reduce their sales and profits. This may ultimately lead to excess capacity and uneconomic firms in the industry. The existence of excess capacity and uneconomic firms will raise the average costs AC to the level of В (not shown in Figure 5) and the firms will be earning only normal profits. Each firm will sell less than Oq.

If the existing oligopolists are wiser, they may forestall entry by charging a price lower than the profit maximisation price OP. In this way the collusive oligopolists by charging a lower price in the present will be earning larger profits in the long-run, and continue their exclusive control over the market by keeping the new entrants out for ever.

We may conclude that perfect collusive oligopoly pricing has not any set pattern of price behaviour. The resultant price and output will depend upon the reaction of the collusive oligopolists towards the profit maximisation price and their attitude towards the existing and potential rivals.

(B) Price Leadership:Price leadership is imperfect collusion among the oligopolistic firms in an industry when all firms follow the lead of one big firm.

There is a tacit agreement among the firms to sell the product at a price set by the leader of the industry (i.e. the big firm). Sometimes, there is a formal meeting and a definite agreement with the leader firm. If the products are homogeneous, a uniform price is established. In case of a differentiated product also prices can be uniform. Whatever price changes take place, the leader announces from time to time, and the other firms follow him.

In America, examples of price leadership industries are:Biscuits, cement, cigarettes, flour, fertilizers, petroleum, milk, rayon, steel, etc. They relate both to pure and differentiated oligopoly.

Price leadership is of various types. But there are three most common price leadership models which we discuss now:1. The Low-Cost Price Leadership Model:

In the low-cost price leadership model, an oligopolistic firm having lower costs than the other firms sets a lower price which the other firms have to follow. Thus the low-cost firm becomes the price leader.

It’s Assumptions:The low-cost firm model is based on the following assumptions:1. There are two firms A and B.

2. Their costs differ. A is the low-cost firm and В is the high-cost firm.

3. They have identical demand and MR curves. The demand curve faced by them is 1/2 of the market demand curve.

4. The number of buyers is large.

5. The market industry demand curve for the product is known to both the firms.

The Model:Given these assumptions, both firms enter into a tacit agreement whereby the high-cost firm В will follow the price set by the price leader firm A and to share the market equally. The price policy to be followed by both is illustrated in Figure 6. D is the industry demand curve and d/MR is its corre-sponding marginal revenue curve which is the demand curve for both the firms and mr is their marginal revenue curve. The cost curves of the low-cost firm A are AC and MC and of the high-cost firm В are ACa and MCb.

If the two firms were to act independently, the high-cost firm В would charge OP price per unit and sell OQb quantity, as determined by point В where its MCb curve cuts the mr curve. Similarly, the low-cost firm A would charge OP1price per unit and sell OQa quantity, as determined by point A where its MCa curve cuts the mr curve.As there is a tacit agreement between the two firms, the high-cost firm В has no choice but to follow the price leader firm A. It will, therefore, sell OQa quantity at a lower price OP1even though it will not be earning maximum profits. On the other hand, the price leader A will earn much higher profits at OP1price by selling OQ quantity. Since both A and В sell the same quantity OQa, the total market demand OQ is equally divided between the two, OQ = 20Qa. But if firm В sticks to OP price, its sales will be zero because the product being homogeneous, all its customers will shift to firm A.The price-leader firm A can, however, drive firm В out of the market by setting a lower price than OFF, lower than the average cost ACb of firm B. Firm A would become a monopoly firm. But in such a situation it will have to face legal problems.

Therefore, it will be in its interest to fix OP1 price and tolerate firm В in order to share the market equally and maximise its profits.Price Leadership Model with Unequal Market Share:In the case of the price leadership model with unequal market share, the two firms will have different demand curves along with their different cost curves. The low-cost firm’s demand curve will be more elastic than that of the high-cost firm. The high-cost firm would maximise its profits by selling less at a higher price while the low-cost firm would sell more at a lower price and maximise its profits.

If they enter into a common price agreement, it would be in the interest of the high-cost firm to sell more quantity at a lower price set by the price leader by earning a little less than the maximum profits. But this is only possible so long as the price set by the leader covers the AC of the high-cost firm.

The price leadership model with unequal market shares is illustrated in Figure 7, where the market demand curve is not shown to simplify the analysis. In the figure, Da is the demand curve of the low-cost firm A and MRa is its marginal revenue curve. The demand curve and MR curve of the high-cost firm В are Db and MRb. The low- cost firm A sets the price OP and the quantity OQa when its MCa curve cuts its MRa curve at point A.

The price OP1 and quantity OQb of the high-cost firm В are determined when its MCb curve cuts its MRb curve at point B. Following the price leader firm A, when firm В accepts the price OP, it sells more quantity OQb1 and earns less than maximum profits. It will pay the follower firm to sell this quantity at OP price so long as this price covers its average cost.If it does not follow the leader firm and tries to sell OQb quantity at its profit maximisation price OP1 it will have to close down because its customers will switch over to the leader firm which charges low price OP. However, if there is no agreement for sharing the market between the leader and the follower firms, the follower can adopt the price of the leader (OP) but produce a lower quantity (less than OQb1) than required to maintain the price in the market, and thus push the leader to a non-profit maximisation position by producing less output.2. The Dominant Firm Price Leadership Model:This is a typical case of price leadership where there is one large dominant firm and a number of small firms in the industry. The dominant firm fixes the price for the entire

industry and the small firms sell as much product as they like and the remaining market is filled by the dominant firm itself. It will, therefore, select that price which brings more profits to itself.

Assumptions:This model is based on the following assumptions:(1) The oligopolistic industry consists of a large dominant firm and a number of small firms.

(2) The dominant firm sets the market price.

(3) All other firms act like pure competitors, which act as price takers. Their demand curves are perfectly elastic for they sell the product at the dominant firm’s price.

(4) The dominant firm alone is capable of estimating the market demand curve for the product.

(5) The dominant firm is in a position to predict the supplies of other firms at each price set by it.

The Model:Given these assumptions, when each firm sells its product at the price set by the dominant firm, its demand curve is perfectly elastic at that price. Thus its marginal revenue curve coincides with the horizontal demand curve. The firm will produce that output at which its marginal cost equals marginal revenue. The MC curves of all the small firms combined laterally establish their aggregate supply curve. All these firms behave competitively while the dominant firm behaves

passively. It fixes the price and allows the small firms to sell all they wish at that price.

The case of price leadership by the dominant firm is explained in terms of Figure 8 where DD1 is the market demand curve. ΣMCs is the aggregate supply curve of all the small firms. By subtracting ΣMC from DD1 at each price, we get the demand curve faced by the dominant firm, PNMBD1 which can be drawn as follows. Suppose the dominant firm sets the price OP.

At this price, it allows the small firms to meet the entire market demand by supplying PS quantity. But the dominant firm would supply nothing at the price OP. Point P is, therefore, the starting point of its demand curve. Now take a price OP1 less than OP. The small firms would supply P1C (=OQs ) output at this price OP1 when their ΣMCs curve cuts their horizontal demand curve P1 R at point C. Since the total quantity demanded at OP1price is P1R (=OQ) and the small firms supply P1C quantity, CR (=QSQ) quantity would be supplied by the dominant firm.

By taking P1N= CR on the horizontal line P1R, the dominant firm’s supply becomes P1 N (=OQd). Thus we derive point N on the dominant firm’s demand curve by subtracting the horizontal distance from point P1to N from the demand curve DDV Since the small firms supply nothing at prices below ОР1 because their ΣMCs curve exceeds this price, the dominant firm’s demand curve coincides with the horizontal line Р1В over the range MB and then with the market demand curve over the segment BD1.Thus the dominant firm’s demand curve is PNMBD1.The dominant firm will maximise its profits at that output where its marginal cost curve MCd cuts its MRd, the marginal revenue curve. It establishes the equilibrium point E at which the dominant firm sells OQa output at OP1 price. The small firms will sell OQs output at this price for, the marginal cost curve of the small firms equals the horizontal price line P1 R at C.The total output of the industry will be OQ = OQd + OQs. If ОР2 price is set by the dominant firm, the small firms would sell Р2А and the dominant firm AB. In case a price below ОР2 is set the dominant firm would meet the entire industry demand- and the sales of the small firms would be zero. The above analysis shows that the price- quantity solution is stable because the small firms behave passively as price-takers.However, the real test of dominant firm’s price leadership is the extent to which the other firms follow its lead. The moment the firms cease to follow the price leader, the model breaks down. Besides, if the other firms have different cost curves,

the same price may not maximise short-run profits for all the firms.

The dominant-firm model of price leadership can have a number of variations. There may be two or more large firms among a number of small firms which may enter into collusion for sharing the market at various prices. There may be product differentiation. Nevertheless, the conclusions arrived at help to explain price output policies in all such situations.

3. The Barometric Price Leadership Model:The barometric price leadership is that in which there is no leader firm as such but one firm among the oligopolistic firms with the wisest management which announces a price change first which is followed by other firms in the industry. The barometric price leader may not be the dominant firm with the lowest cost or even the largest firm in the industry.

It is a firm which acts like a barometer in forecasting changes in cost and demand conditions in the industry and economic conditions in the economy as a whole. On the basis of a formal or informal tacit agreement, the other firms in the industry accept such a firm as the leader and follow it in making price changes for the product.

The barometric price leadership develops due to the following reasons:1. As a reaction to the earlier experience of violent price changes and cut-throat competition among oligopolistic firms, they accept one firm as the price leader.

2. Most firms do not possess the expertise to calculate cost and demand conditions of the industry. So they leave their estimation to one leader firm which has the ability to do so.

3. Oligopolistic firms accept one among them as the barometric leader firm which possesses better knowledge and predictive power about changes in direct costs or style and quality changes and changes in the economic conditions as a whole.

It is not essential that a firm selected as the barometric leader must belong to the industry. Even a firm not belonging to the industry may be chosen as the barometric leader.

3. Non-Price Competition in Oligopoly:

There is not much of active price competition in oligopolistic markets. There are occasionally price wars among firms which are due to the failure of communication channels among firms. Usually, prices are stable in an oligopolistic market. Competition among firms is, therefore, for increased market share of the product. The oligopolistic firms know that if they try to increase their market share through price cut, competition among them will lead to an unabated fall in the price and all of them would be losers in the process. Thus, instead of competing through price, they resort to non-price competition.

Non-price Competition refers to the efforts on the part of one oligopolistic firm to increase its sales by some means other

than a price reduction. Some other means are advertising, product differentiation and customer service. These, in turn, include publicity, sales promotion and personal selling; product quality, stylistic and aesthetic quality, brand name and packaging; and service agreement, warranty, guarantee, selling on credit, installment selling, etc.

Thus non-price competition involves efforts by an oligopolist to differentiate his product from that of his rivals by establishing real or imaginary differences in the minds of consumers through the quality of the product, its technological level, and through service, marketing and promotional means.

Economists tend to bundle these different dimensions of non-price competition under product differentiation. An oligopolistic firm tries to differentiate its product from that of its rivals in order to raise the demand for its product and to make its demand curve less elastic.

To achieve these objectives, a firm may seek to have successful product differentiation in a number of ways. It may spend more on advertising and promotion, rather than on the attributes of its product. Or, it may change the features and packaging of its product in such a way that it appeals more to buyers.

Product Attributes:In the case of product variation the firm may choose a brand name or a brand mark for its product which may create an element of distinctiveness and make it easier to identify the

product by buyers. The firm may choose those product attributes which buyers value highly, which it can provide cost-effectively and which its rivals are not in a position to provide. Through its technological efforts, the firm may seek both product and process development for enhancing the quality and features of its product. Similarly, it may direct its technological effort towards the specific requirements of its targeted buyers.

Advertising and Promotion:The main purpose of advertising and promotion is to shift the demand curve for the product upward to the right. So the oligopolistic firm is able to sell more at each and every price. Advertising differentiates one product from another and makes the product better known than others.

Thus advertising pushes the sales of the product of a particular firm as against that of its rivals. Appealing posters, short films on TV showing a famous film star or a model uttering words in praise of a particular product brand and commercial broadcasts all aim at pushing the sales of one firm at the cost of others.

Economists measure advertising and promotion efforts on the part of a firm in terms of Advertising (Promotional) Elasticity of Demand which measures the responsiveness of sales to changes in advertising and promotional expenses.

Thus advertising elasticity:Ea = ∆Q/ ∆A .A/Q

Where Q refers to sales or demand and A to advertising and promotional expenses.Ea is positive because advertising expenses are supposed to increase sales. The higher the advertising elasticity, the greater the incentive for the firm to advertise its product. In fact, E is a measure of the effectiveness of advertising. As advertising expenses increase, their effectiveness increases.But in the case of an oligopolistic firm, the larger the firm’s market shares in the industry, the lower the advertising elasticity of demand is likely to be. If the rival firms react to increases in the firm’s advertising expenses by increasing their own advertising expenses, then these expenses will tend to cancel each other, thereby reducing the advertising elasticity of demand.

Marketing Channels:In the traditional oligopoly theory, no reference is found to the marketing channels which play an important role in the promotion of a product. This is based on the implicit assumption that there is direct marketing of the product to buyers.

Empirical evidences about the working of modern oligopolistic firms reveal that there are a variety of marketing channels that help in increasing the sales of a product as against its rivals. Marketing channels coordinate the flow of the product, its payments, its information and promotional messages from the firm to the ultimate buyer. Thus the various forms of non-price

competition help to increase the market share of the product of an oligopolistic firm.

Duopoly MarketMeaning:

Duopoly is a limiting case of oligopoly, in the sense that it has all the characteristics of oligopoly except the number of sellers which are only two increase of duopoly as against a few in oligopolies. The main distinguishing feature of duopoly (and also of oligopoly) from other market situating is that the sellers’ decisions are not independent of each other.

Characteristics of duopoly:

i. Two producers or sellers of a product

ii. Perfectly identical or almost identical products

iii. Independent price policy followed by both the sellers or they may agree upon a uniform price

iv. Both the sellers may compete with each other or agree to co-operate with each other

 “Duopoly is that situation of a market in which there are two producers of a product, either perfectly identical or almost identical. They are not bound by the agreement regarding price or quantity of production.” Dr. John.Duopoly can be of two types, which are explained as follows:

i. Duopoly without product differentiation:

Refers to a type of duopoly when organizations sell identical products. In such a situation, an agreement may be formed between organizations to set a fixed price or divide the markets. In case, if there is no agreement, the price war may take place among organizations.

The one with the lower price would gain the market share and a simple monopoly would be established. Organizations will be able to maximize the profits in case they collude together by charging same prices.

ii. Duopoly with product differentiation:Refers to a duopoly when the organizations sell differentiated products. There is no fear of rivals and there will be no agreement between the organizations. The organization with better products will gain supernormal profits.

Models of Duopoly Pertaining to Price Output Decisions:

There are three types of duopoly models pertaining to price-output decisions under duopoly market situation;These three models are shown in Figure-5:

1. Cournot’s Duopoly Model:Cournot duopoly model was propounded by a French economist, Augustin Cournot in 1838 for price-output determination under duopoly. Cournot model is based on the market condition in which there are only two sellers, that is duopoly. However, the model is also applicable to oligopolistic market conditions. Let us explain the model with the help of an example taken by Cournot. Suppose there are two producers,

each operating two identical springs of mineral water, being produced at zero cost.

Following assumptions are taken in this model:i. Both the producers operate at zero cost of producing water

ii. Both the producers face the same demand curve with negative slope

iii. Both the producers assumes that competitors will not react to the change in price or output

Figure-6 shows the Cournot’s duopoly model:

In the Figure-6, the demand curve (AR curve) faced by two organizations for mineral water is given by a straight line AB. The total output produced is equal to OB where maximum daily output of each mineral spring is ON = NB. Assume that producer A starts the business first. It implies that he/she is the monopolist and produces ON level of the output, which is the maximum level of output.

Since costs are zero, the profit will be equal to ONPS. The price charged is equal to OP. Now, suppose that the producer B enters into business and notices that producer A is producing ON amount of output. The market which is unsupplied by A is the market open for B equal to NB. B will

produce output assuming that A will not change its price and output (as he is making maximum profits).

The demand curve faced by producer B is equal to SB and thus, MRB can be drawn equal to SH. At this point, price falls to OP1 and thus output produced is equal to NH (one-fourth of the market = ½ of NB=½ of ½=¼). The total profits of producer B are equal of NHCD.From Figure-6, it can be seen that with the entry of producer B, price has fallen to P1, which has decreased the profits of A to ONCP1. Thus, A would make adjustments in price and output assuming that B would not change his output and price levels. He/she would produce ½ of the (OB-NH) of the market.OB-NH =1-¼= ¾

Thus, output produced by A is= ½(3/4) = 3/8.

Now, B will notice that his/her total profits are less than that of A. Thus, he/she will produce ½ of (OB- new output of A)

= ½(1-3/8) = 1/2 5/8= 5/16 of the market

This process of adjustments will continue until both of their market shares are equal to one third. Till that, B would continue to gain and A would continue to lose. This model concludes that under Cournot’s duopoly situation, each seller ultimately supplies one- third of the market. Both the producers charge the same price and one-third of the market remains unsupplied.

Cournot’s model attains the stable equilibrium; however it is criticized on the following grounds:

i. Assumes that each producer would be producing the same level of output. However, this assumption is wrong as output of the rivals does not remain fixed.

ii. Assumes that the cost of production remains nil, which is not true in every kind business.

2. Edge-worth Model:As discussed, in Cournot model, the output of rival organization is assumed to be constant and unchanged. In the Edge-worth model, the price of the rival organization is assumed to be unchanged.

The assumptions of this model are as follows:i. Each organization believes that its rival organization will not change its price

ii. Neither of the organizations can produce an output as large as the competitive output

iii. The maximum possible output is the same for both the organizations

iv. The product is homogenous, which implies there are no brand and quality variations

v. Consumers prefer to buy at the lowest price possible

The Edge-worth model is explained with the help of Figure-7:

In Figure-7 AC is the organization A’s demand curve, whereas AB is the organization’s B’s demand curve. The maximum output that can be produced by A and B is DE and DE’, respectively. Suppose organization A is the first to enter the

market and sets the price P1 where output is D’P1. Now, organization B enters the market and sets price lower than A that is P2.In such a case, organization B captures the market share of A which is equal to ff’. Now, A reacts and lowers its price to P3 and captures B’s market share equal to gg’. This process will continue until price equals P4 and output produced by both A and B equals maximum output.At P4, no one can snatch the market share of each other. Now, A again raises the price to P1 considering that B has fixed its entire supply at P4. B again follows A and thus process continues between P1 and P4.3. Chamberlin Model:Chamberlin model is based on an assumption that both the organizations existing in the market are mutually interdependent on each other.

Let us understand Chamberlin model with the help of Figure-8:

Suppose there are two organizations A and B in the market. Organization A enters the market first. In Figure-8, BC is the demand curve and OL is the total output produced by A which is sold at price OA. The total profit is OLPA. Now, producer B enters the market and produce LM level of output. Thus, the total quantity produced is equal to OL + LM – OM.

Duopsony

 A market condition in which there are only two buyers, thus exerting great influence on price.

MonopsonyMeaning:

A monopsony is a situation of the market wherein only one buyer exists in a particular area, typically along with many sellers. These sellers end up competing for the buyer’s purchases by lowering their prices.

In the case of both monopsony and the much more well-known situation of , market conditions are imperfect. However, monopolies describe a situation with one seller/producer of goods/services, and many buyers; conversely, monopsonies involve the other side of the buying and selling equation. Notably, even though monopsony and monopoly differ, companies with monopsony power are often dominant enough that they may also have partial or full monopolies. A monopsony is a situation of the market wherein only one buyer exists in a particular area, typically along with many sellers. These sellers end up competing for the buyer’s purchases by lowering their prices.

The main effect of monopsony is that the single buyer in a given industry has control of the market. That buyer has far too much power in setting the price of the goods or services that they alone are buying. This can be quite problematic for the economy, and so ought to be avoided..One example of this market situation is that of large supermarkets.

Monopsony Pricing.Monopsony refers to a market situation when there is a single buyer of a commodity or service. It applies to any situation in which there is a ‘monopoly’ element in buying.

For example, when consumers of a certain commodity are organised, or when a socialist government regulates imports, or when a certain individual happens to have a taste for some commodity which no one else requires, or when a single big

factory in an isolated locality is the sole buyer of some grades of labour, there is monopsony.

Monopsony can be formally defined, in the words of Liebhafsky, as “the case of a single buyer who is not in competition with any other buyers for the output which he seeks to purchase, and as a situation in which entry into the market by other buyers is impossible”.The analysis of monopsony pricing is similar to that under monopoly pricing. Just as a monopolist is able to influence the price of the product by the amount he offers for sale, similarly the monopolist is able to influence the supply price of his purchases by the amount he buys.

Again, the monopolist aims at the maximisation of his profits, while the monopolist aims at the maximisation of his surplus. The monopolist equates his marginal cost with his marginal D revenue to maximise his profits. The monopolist regulates his purchases in such a way that marginal cost equals marginal utility whereby his consumer’s surplus is the maximum.

The determination of price under monopsony is explained in Figure 1. The supply curve of the industry is the average cost of the monopolist. It is from the industry that he buys the product. This is represented by the curve AC/S in the figure.

MC is its corresponding marginal cost curve. MU is the marginal utility curve of the monopolist.

The monopolist equilibrium is established at E where the marginal utility of the product to the monopolist equals the marginal cost. He buys OM quantity at OA (=MB) price which is the supply price for that output. The surplus obtained by the Quantity monopolist is the area DEBA—the difference between what he is Fig. 1 prepared to pay ODEM and what he actually pays OABM e.g., (DEBA = ОDEM – OABM).

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Baumol’s Sales Maximisation ModelProf. Baumol in his book Business Behaviour, Value and Growth (1967) has presented a managerial theory of the firm based on sales maximisation. He discusses two models of sales maximisation: a static model and a dynamic model. We shall analyse only his static model of sales maximisation with its variants of single product model without advertisement.

Assumptions:

The model is based on the following assumptions:1. There is a single period time horizon of the firm.

2. The firm aims at maximising its total sales revenue in the long run subject to a profit constraint.

3. The firm’s minimum profit constraint is set competitively in terms of the current market value of its shares.

4. The firm is oligopolistic whose cost curves are U-shaped and the demand curve is downward sloping. Its total cost and revenue curves are also of the conventional type.

The Model:Baumol’s findings of oligopoly firms in America reveal that they follow the sales maximisation objective. According to Baumol, with the separation of ownership and control in modern corporations, managers seek prestige and higher salaries by trying to expand company sales even at the expense of profits.

Being a consultant to a number of firms, Baumol observes that when asked how their business went last year, the business managers often respond, “Our sales were up to three million dollars”. Thus, according to Baumol, revenue or sales maximisation rather than profit maximisation is consistent with the actual behaviour of firms.

Baumol cites evidence to suggest that short-run revenue maximisation may be consistent with long-run profit maximisation. But sales maximisation is regarded as the short-run and long-run goal of the management. Sales maximisation is not only a means but an end in itself.

He gives a number of arguments in support of his theory.1. A firm attaches great importance to the magnitude of sales and is much concerned about declining.

2. If the sales of a firm are declining, banks, creditors and the capital market are not prepared to provide finance to it.

3. Its own distributors and dealers might stop taking interest in it.

4. Consumers might not buy its product because of its unpopularity.

5. Firm reduces its managerial and other staff with fall in sales.

6. But if firm’s sales are large, there are economies of scale and the firm expands and earns large profits.

7. Salaries of workers and management also depend to a large extent on more sales and the firm gives them bonus and other facilities.

By sales maximisation, Baumol means maximisation of total revenue. It does not imply the sale of large quantities of output, but refers to the increase in money sales (in rupee, dollar, etc.). Sales can increase up to the point of profit maximization where the marginal cost equals marginal revenue.

If sales are increased beyond this point money sales may increase at the expense of profits. But the oligopolistic firm wants its money sales to grow even though it earns minimum profits. Minimum profits refer to the amount which is less Quantity than maximum profits. The minimum profits are determined on the basis of firm’s need to maximize sales and also to sustain growth of sales.

Minimum profits are required either in the form of retained earnings or new capital from the market. The firm also needs minimum profits to finance future sales. Further, they are essential for a firm for paying dividends on share capital and for meeting other financial requirements.

Thus minimum profits serve as a constraint on the maximisation of a firm’s revenue. “Maximum revenue will be obtained only” according to Baumol, “at an output at which the elasticity of demand is unity, i.e. at which marginal revenue is zero.”

This is the condition which replaces the “marginal cost equals marginal revenue profit maximisation rule.” This is shown in Figure 5 where the profit maximisation firm produces OQ output where MC = MR at point E. But the sales maximisation firm will produce OQ1 output where MR is zero.Baumol’s model is illustrated in Figure 6 where TC is the total cost curve, TR the total revenue curve, TP the total profit curve and MP the minimum profit or profit constraint line. The firm maximises its profits at OQ level of output corresponding to the highest point В on the TP curve.

But the aim of the firm is to maximise its sales rather than profits. Its sales maximisation output is OK where the total revenue KL is the maximum at the highest point of TR

This sales maximisation output OK is higher than the profit maximisation output OQ. But sales maximisation is subject to minimum profit constraint. Suppose the minimum profit level of the firm is represented by the line MP.

The output OK will not maximise sales as the minimum profits OM are not being covered by total profits KS. For sales maximisation the firm should produce that level of output which not only covers the minimum profits but also gives the highest total revenue consistent with it.

This level is represented by OD level of output where the minimum profits DC (=OM) are consistent with DE amount of total revenue at the price DE/OD, (i.e., total revenue/total output). Baumol’s model of sales maximisation points out that the profit maximisation output OQ will be smaller than the sales maximisation output OD, and price higher than under sales maximisation.

The reason for a lower price under sales maximisation is that both total revenue and total output are equally higher while under profit maximisation total output is much less as compared to total revenue. Imagine if QB is joined to TR in Figure 6. “If at the point of maximum profit”, writes Baumol, “the firm earns more profit than the required minimum, it will pay the sales maximiser to lower his price and increase his physical output.”Implications or Superiority of the Model:Baumol’s sales maximisation model has some important implications which make it superior to the profit maximisation model of the firm.

1. The sales maximising firm prefers larger sales to profits. Since it maximises its revenue when MR is zero, it will charge lower prices than that charged by the profit maximising firm. In Figure 43.5, the sales maximisation price Q1P1 is lower than the profit maximisation price QP which is determined when the MC curve cuts the MR curve at point E.2. It follows from the above that the sales maximising output will be larger than the profit maximising output. In Figure 43.4, the profit maximisation firm produces OQ output while the sales maximisation firm produces OQ1 output, OQ1 > OQ.3. The sales maximiser would spend more on advertisement in order to earn larger revenue than the profit maximiser subject to the minimum profit constraint.

4. There may be a conflict between pricing in the short-run and long-run. In the short-run, when output cannot be increased, revenue can be increased by raising the price. But in the long- run, it would in the interest of the sales maximisation firm to keep the price low in order to compete more effectively for a large share of the market to earn more revenue.

5. The profit maximization firm is assumed to act rationally which goes against the actual behaviour of firms. On the other hand, the Baumol firm behaves satisfactorily for the purpose of earning minimum profits at a fair sales maximization output.

Criticism:Baumol’s sales maximisation model is not free from certain weaknesses.

1. Rosenberg has criticised the use of the profit constraint for sales maximisation by Baumol. Rosenberg has shown that it is difficult to specify exactly the relevant profit constraint for a firm. This is explained in Figure 7. Sales revenue of the firm is measured along the vertical axis and profit on the horizontal axis. R refers to the profit constraint. For any two combinations with profits below the constraint, the one with the larger profit will be preferred.

2. According to Shepherd, under oligopoly a firm faces a kinked demand curve and if the kink is large enough, total revenue and profits would be the maximum at the same level of output. So both the sales maximiser and the profit maximiser would not be producing different levels of output.

3. Hawkins has shown that if the firm is engaged in any form of non-price competition such as good packaging, free service, advertising, etc., Shepherd’s conclusions become invalid. When the sales maximiser spends more on advertising, his output will be more than that of the profit maximiser. This is because the kink of the former’s demand curve will occur to the right of the kink of the profit maximiser.

4. Hawkins has also shown that Baumols’s conclusion that a sales maximiser will in general produce and advertise more than a profit maximiser, is invalid. According to Hawkins, a sales maximiser “may choose a higher, lower or identical output, and a higher, lower or identical advertising budget. It depends on the responsiveness of demand to advertising rather than price cuts.”

5. In the case of multiproduct, Baumol has argued that revenue and profit maximisation yield the same results. But Williamson has shown that sale maximisation yields different results from profit maximisation.

6. Another weakness of this model is that it ignores the interdependence of the prices of oligopolistic firms.

7. The model fails to explain “observed market situations in which price are kept for considerable time periods in the range of inelastic demand.”

8. The model ignores not only actual competition, but also the threat of potential competition from rival oligopolistic firms.

9. The model does not show how equilibrium in an industry, in which all firms are sales maximisers, will be attained. Baumol does not establish the relationship between the firm and industry.

10. Prof Hall in his analysis of 500 firms came to the conclusion that firms do not operate in accordance with the object of sales maximisation.

Despite these criticisms, there is no denying the fact that sales maximisation forms an important goal of firms in the present day business world.

Demand ForecastingAn organization faces several internal and external risks, such as high competition, failure of technology, labor unrest, inflation, recession, and change in government laws.

Therefore, most of the business decisions of an organization are made under the conditions of risk and uncertainty.

An organization can lessen the adverse effects of risks by determining the demand or sales prospects for its products and services in future. Demand forecasting is a systematic process that involves anticipating the demand for the product and services of an organization in future under a set of uncontrollable and competitive force

Some of the popular definitions of demand forecasting are as follows:According to Evan J. Douglas, “Demand estimation (forecasting) may be defined as a process of finding values for demand in future time periods.”

In the words of Cundiff and Still, “Demand forecasting is an estimate of sales during a specified future period based on proposed marketing plan and a set of particular uncontrollable and competitive forces.”

Demand forecasting enables an organization to take various business decisions, such as planning the production process, purchasing raw materials, managing funds, and deciding the price of the product. An organization can forecast demand by making own estimates called guess estimate or taking the help of specialized consultants or market research agencies. Let us discuss the significance of demand forecasting in the next section.

Significance of Demand Forecasting:Demand plays a crucial role in the management of every business. It helps an organization to reduce risks involved in business activities and make important business decisions. Apart from this, demand forecasting provides an insight into the organization’s capital investment and expansion decisions.

The significance of demand forecasting is shown in the following points:i. Fulfilling objectives:Implies that every business unit starts with certain pre-decided objectives. Demand forecasting helps in fulfilling these objectives. An organization estimates the current demand for its products and services in the market and move forward to achieve the set goals.

For example, an organization has set a target of selling 50, 000 units of its products. In such a case, the organization would perform demand forecasting for its products. If the demand for the organization’s products is low, the organization would take corrective actions, so that the set objective can be achieved.

ii. Preparing the budget:Plays a crucial role in making budget by estimating costs and expected revenues. For instance, an organization has forecasted that the demand for its product, which is priced at Rs. 10, would be 10, 00, 00 units. In such a case, the total expected revenue would be 10* 100000 = Rs. 10, 00, 000. In this way, demand forecasting enables organizations to prepare their budget.

iii. Stabilizing employment and production:Helps an organization to control its production and recruitment activities. Producing according to the forecasted demand of products helps in avoiding the wastage of the resources of an organization. This further helps an organization to hire human resource according to requirement. For example, if an organization expects a rise in the demand for its products, it may opt for extra labor to fulfill the increased demand.

iv. Expanding organizations:Implies that demand forecasting helps in deciding about the expansion of the business of the organization. If the expected demand for products is higher, then the organization may plan to expand further. On the other hand, if the demand for products is expected to fall, the organization may cut down the investment in the business.

v. Taking Management Decisions:Helps in making critical decisions, such as deciding the plant capacity, determining the requirement of raw material, and ensuring the availability of labor and capital.

vi. Evaluating Performance:

Helps in making corrections. For example, if the demand for an organization’s products is less, it may take corrective actions and improve the level of demand by enhancing the quality of its products or spending more on advertisements.

vii. Helping Government:Enables the government to coordinate import and export activities and plan international trade.

Objectives of Demand Forecasting:

Demand forecasting constitutes an important part in making crucial business decisions.

The objectives of demand forecasting are divided into short and long-term objectives, which are shown in Figure-1:

The objectives of demand forecasting (as shown in Figure-1) are discussed as follows:

i. Short-term Objectives:Include the following:a. Formulating production policy:Helps in covering the gap between the demand and supply of the product. The demand forecasting helps in estimating the

requirement of raw material in future, so that the regular supply of raw material can be maintained. It further helps in maximum utilization of resources as operations are planned according to forecasts. Similarly, human resource requirements are easily met with the help of demand forecasting.

b. Formulating price policy:Refers to one of the most important objectives of demand forecasting. An organization sets prices of its products according to their demand. For example, if an economy enters into depression or recession phase, the demand for products falls. In such a case, the organization sets low prices of its products.

c. Controlling sales:Helps in setting sales targets, which act as a basis for evaluating sales performance. An organization make demand forecasts for different regions and fix sales targets for each region accordingly.

d. Arranging finance:Implies that the financial requirements of the enterprise are estimated with the help of demand forecasting. This helps in ensuring proper liquidity within the organization.

ii. Long-term Objectives:Include the following:a. Deciding the production capacity:Implies that with the help of demand forecasting, an organization can determine the size of the plant required for production. The size of the plant should conform to the sales requirement of the organization.

b. Planning long-term activities:Implies that demand forecasting helps in planning for long term. For example, if the forecasted demand for the

organization’s products is high, then it may plan to invest in various expansion and development projects in the long term.

Factors Influencing Demand Forecasting:Demand forecasting is a proactive process that helps in determining what products are needed where, when, and in what quantities. There are a number of factors that affect demand forecasting.

Some of the factors that influence demand forecasting are shown in Figure-2:

The various factors that influence demand forecasting (“as shown in Figure-2) are explained as follows:i. Types of Goods:Affect the demand forecasting process to a larger extent. Goods can be producer’s goods, consumer goods, or services. Apart from this, goods can be established and new goods. Established goods are those goods which already exist in the market, whereas new goods are those which are yet to be introduced in the market.

Information regarding the demand, substitutes and level of competition of goods is known only in case of established goods. On the other hand, it is difficult to forecast demand for the new goods. Therefore, forecasting is different for different types of goods.

ii. Competition Level:

Influence the process of demand forecasting. In a highly competitive market, demand for products also depend on the number of competitors existing in the market. Moreover, in a highly competitive market, there is always a risk of new entrants. In such a case, demand forecasting becomes difficult and challenging.

iii. Price of Goods:Acts as a major factor that influences the demand forecasting process. The demand forecasts of organizations are highly affected by change in their pricing policies. In such a scenario, it is difficult to estimate the exact demand of products.

iv. Level of Technology:Constitutes an important factor in obtaining reliable demand forecasts. If there is a rapid change in technology, the existing technology or products may become obsolete. For example, there is a high decline in the demand of floppy disks with the introduction of compact disks (CDs) and pen drives for saving data in computer. In such a case, it is difficult to forecast demand for existing products in future.

v. Economic Viewpoint:Play a crucial role in obtaining demand forecasts. For example, if there is a positive development in an economy, such as globalization and high level of investment, the demand forecasts of organizations would also be positive.

Apart from aforementioned factors, following are some of the other important factors that influence demand forecasting:a. Time Period of Forecasts:Act as a crucial factor that affect demand forecasting. The accuracy of demand forecasting depends on its time period.

Forecasts can be of three types, which are explained as follows:1. Short Period Forecasts:

Refer to the forecasts that are generally for one year and based upon the judgment of the experienced staff. Short period forecasts are important for deciding the production policy, price policy, credit policy, and distribution policy of the organization.

2. Long Period Forecasts:Refer to the forecasts that are for a period of 5-10 years and based on scientific analysis and statistical methods. The forecasts help in deciding about the introduction of a new product, expansion of the business, or requirement of extra funds.

3. Very Long Period Forecasts:Refer to the forecasts that are for a period of more than 10 years. These forecasts are carried to determine the growth of population, development of the economy, political situation in a country, and changes in international trade in future.

Among the aforementioned forecasts, short period forecast deals with deviation in long period forecast. Therefore, short period forecasts are more accurate than long period forecasts.

4. Level of Forecasts:Influences demand forecasting to a larger extent. A demand forecast can be carried at three levels, namely, macro level, industry level, and firm level. At macro level, forecasts are undertaken for general economic conditions, such as industrial production and allocation of national income. At the industry level, forecasts are prepared by trade associations and based on the statistical data.

Moreover, at the industry level, forecasts deal with products whose sales are dependent on the specific policy of a particular industry. On the other hand, at the firm level, forecasts are done to estimate the demand of those products whose sales depends on the specific policy of a particular firm. A firm considers various factors, such as changes in income, consumer’s tastes and preferences, technology, and

competitive strategies, while forecasting demand for its products.

5. Nature of Forecasts:Constitutes an important factor that affects demand forecasting. A forecast can be specific or general. A general forecast provides a global picture of business environment, while a specific forecast provides an insight into the business environment in which an organization operates. Generally, organizations opt for both the forecasts together because over-generalization restricts accurate estimation of demand and too specific information provides an inadequate basis for planning and execution.

Steps of Demand Forecasting:The Demand forecasting process of an organization can be effective only when it is conducted systematically and scientifically.

It involves a number of steps, which are shown in Figure-3:

The steps involved in demand forecasting (as shown in Figure-3) are explained as follows:1. Setting the Objective:Refers to first and foremost step of the demand forecasting process. An organization needs to clearly state the purpose of demand forecasting before initiating it.

Setting objective of demand forecasting involves the following:a. Deciding the time period of forecasting whether an organization should opt for short-term forecasting or long-term forecasting

b. Deciding whether to forecast the overall demand for a product in the market or only- for the organizations own products

c. Deciding whether to forecast the demand for the whole market or for the segment of the market

d. Deciding whether to forecast the market share of the organization

2. Determining Time Period:Involves deciding the time perspective for demand forecasting. Demand can be forecasted for a long period or short period. In the short run, determinants of demand may not change significantly or may remain constant, whereas in the long run, there is a significant change in the determinants of demand. Therefore, an organization determines the time period on the basis of its set objectives.

3. Selecting a Method for Demand Forecasting:Constitutes one of the most important steps of the demand forecasting process Demand can be forecasted by using various methods. The method of demand forecasting differs from organization to organization depending on the purpose of forecasting, time frame, and data requirement and its availability. Selecting the suitable method is necessary for saving time and cost and ensuring the reliability of the data.

4. Collecting Data:Requires gathering primary or secondary data. Primary’ data refers to the data that is collected by researchers through observation, interviews, and questionnaires for a particular research. On the other hand, secondary data refers to the data that is collected in the past; but can be utilized in the present scenario/research work.

5. Estimating Results:Involves making an estimate of the forecasted demand for predetermined years. The results should be easily interpreted

and presented in a usable form. The results should be easy to understand by the readers or management of the organization.

Methods of Demand Forecasting:

The following points highlight the top seven methods of demand forecasting demand.

1. Survey of Buyer’s Intentions 2. Collective Opinion or Sales Force Composite Method3. Trend Projection 4. Executive Judgment Method 5. Economic Indicators 6. Controlled Experiments 7. Expert’s Opinions.

Demand Forecasting Method 1. Survey of Buyer’s-Intentions:This is a short-term method of knowing and estimating customer’s demand. This is direct method of estimating demand of customers as to what they intend to buy for the forthcoming time—usually a year.

By this the burden of forecasting goes to the buyer. This method is useful for the producers who produce goods in bulk.

Still their estimates should not entirely depend upon it. This method does not hold good for household consumers because of their inability to foresee their choice when they see the alternatives. Besides the household consumers there are many which make this method costly and impracticable. It does not expose and measure the variables under management control.

Demand Forecasting Method  2. Collective Opinion or Sales Force Competitive Method:Under this method, the salesman are nearest persons to the customers and are able to judge, their minds and market. They better understand the reactions of the customers to the firms products and their sales trends. The estimates of the different salesmen are collected and estimates sales are predicted.

These estimates are revised from time to time with changes in sales price, product, designs, publicity programmes, expected changes in competition, purchasing power, income distribu-tion, employment and population. It makes use of collective wisdom of salesmen, departmental heads and top executives.

Advantages:(1) It is simple, common sense method involving no mathematical calculations.

(2) It is based on the first-hand knowledge of salesman and the persons directly connected with sales.

(3) This method is particularly useful for sales of new product. It has the salesman’s judgment.

Dis-advantages:(1) It is a subjective approach.

(2) This method can be used only for short-term forecasting.

For long-term planning it is not useful.

Demand Forecasting Method # 3. Trend Projection or Time Trend of the Time Series:This is the most popular method of analysing time series and is generally used to project the time trend of the time series. A trend line can be filled through the series in visual or statistical way by the method of least squares.

The analyst can make a plausible algebraic relation—may it be linear, a quadratic or logarithmic between sales on one hand and independent variable time on the other. The trend line is then projected into the future for purpose of extrapolation.

Advantages:This method is most popular as it is simple and in-extensive and because of time series data often exhibits a persistent growth trend.

Assumptions:

The basic assumption of this method is that the past rate of change of the variable under study will be continuing in future. This assumption gives good safe results till the time series exhibits a persistent tendency to move in the same direction.

When the burning point comes, the trend projection breaks down. Even though a forecaster could hope normally to be correct in most forecasts when the turning points are few and spaced at long intervals from each other.

In fact, the actual challenge of forecasting is in the prediction of turning points rather than in the trend projection. At such turning points the management will have to change and revise its sales and projection strategies most drastically.

There are four factors responsible for the characterization of time series.

They are:1. Fluctuations and turning points.

2. Trend seasonal variations.

3. Cyclical fluctuations, and

4. Irregular or random forces.

The problem in forecasting is to separate and measure each of these factors.

This time series is expressed by the following equation:O = TSCI

where, O = observed data

T = a secular tend

S = a seasonal factor

C = cyclical element

I = an irregular movement.

The usual practice is to calculate the trend first from the basic data. The trend values are then taken out from the observed data (TSCI /T). The next step is to reckon the seasonal index that is utilised to remove the seasonal effect (SCI/S).

It is fitted through chain to the remainder that also gives the irregular effect. This approach to the breaking up of time series data is an analytical device of usefulness for the knowledge of the nature of business fluctuations.

Assumptions:(a) Analysis of movements would be in the order of trend, seasonal variations and cyclical changes.

(b) The effects of every component are not dependent on any other components.

Demand Forecasting Method # 4. Executive Judgment Method:Under this method opinions are sought from the executives of different discipline i.e., marketing, finance, production etc. and

estimates for future demands are made. Thus, this is a process of combining, averaging or evaluating in some other way the opinions and views of the top executives.

Advantages:The main advantages of this method are:1. The forecasts can be made speedily by analysing the opinions and views of top executives. The techniques is quite easy and simple.2. No need of elaborate statistics:There is no need of collecting elaborate. Statistics for the forecasts hence it is not much expensive.

3. Only feasible method to follow:In the absence of adequate data is it the only feasible method to be followed.

Dis-advantages:The chief dis-advantages of the of this method are:(1) No factual basis of such forecast:There is no factual basis of such forecasts, so the method is inferior to others.

(2) No accuracy:Accuracy cannot be claimed under this method.

(3) Responsibility for the accuracy of data cannot be fixed on any one.5. Economic Indicators:This method has its base for demand forecasting on few economic indicators.

(a) Construction contracts:For demand towards building materials sanctioned for Cement.

(b) Personal Income:Towards demand of consumer goods.

(c) Agricultural Income:

Towards demand of agricultural imports instruments, fertilisers, manner etc.

(d) Automobiles Registration:Towards demand of car parts and petrol. These and other economic indicators are given by specialised organisation. The analyst should establish relationship between the sale of the product and the economic indicators to project the correct sales and to measure as to what extent these indicators affect the sales. To establish relationship is not an easy task especially in case of New Product where there is no past records.

Steps:Following steps may be remembered:(a) If there is any relationship between the demand for a product and certain economic indicator.

(b) Make the relationship by the method of least squares and derive the regression equation. Supposing the relationship is Linear the equation will be of the form y = α + bx. There can be curvilinear relationship also.

(c) Once the regression equation is obtained any value of X (economic indicator) can be applied to forecast the value of Y (demand).

(d) Past relationship may not recur. Therefore, need for value judgments are felt. Other new factors may also have to be taken into consideration.

Limitations:The limitations of economic indicators are as follows:(1) It is difficult to find out an appropriate economic indicator.

(2) For few products it is not good, as no past data are available.

(3) This method of forecasting is best suited where relationship of demand with a particular indicator is

characterised by a Time Lag, such as construction contracts will give consequence to demand for building materials with some amount of Time Lag.

But where the demand does not Lag behind the particular economic index, the utility is restricted because forecast may have to be based on projected economic index itself that may not result true.

Demand Forecasting Method # 6. Controlled Experiments:Under this method, an effort is made to ascertain separately certain determinants of demand which can be maintained, e.g., price, advertising etc. and conducting the experiment, assuming etc., and conducting the experiment, assuming that the other factors remain constant.

Thus, the effect of demand determinants like price, advertisement packing etc., on sales can be assessed by either varying them over different markets or by varying them over different time periods in the same market.

For example:Different prices would be associated with different sales on that basis the price, quantity relationship is estimated in the form of regression equation and used for forecasting purposes. It must be noted that the market divisions here must be homogeneous with regard to income, tastes etc.

Such experiments have been conducted widely in the USA and were successful. This is a new experiment. This is quite new and less applied.

The main reasons for non-application of this method so far as follows:1. The method is expensive and time consuming.

2. It is risky because it may lead to un-favourable reactions on dealers, consumers and competitors.

3. It is not always easy to determine what conditions should be taken to be constant and what factors should be regarded as variable, so as to separated and measures their influence on demand.

4. It is hard to satisfy the homogeneity of market conditions. In-spite of these drawbacks, controlled experiments have sufficient potentialities to become a useful method for business research and analysis in future.

Demand Forecasting Method # 7. Expert’s Opinions:Under this method expert’s opinions are sought from specialists in the field, outside the organisations or the organisation collects opinions from such specialists; views of expert’s published in the newspaper and journals for the trade, wholesalers and distributors for the company’s products, agencies and professional experts.

These opinions and views are analysed and deductions are made therefrom to arrive at the figure of demand forecasts.

Advantages:The advantages of this method are:(1) Forecasts can be done easily and speedily.

(2) It is based on expert’s views and opinions hence estimates are nearly accurate.

(3) The method is suitable where past records of sales are not available.

(4) The method is economical because survey is done to collect the data. The expenses of seeking the opinions and views of experts are much less than the expenses of actual survey.

Dis-advantages:The important dis-advantages of this method are:(1) Estimates for a market segment cannot be possible.

(2) The reliability of forecasting is always subjective because forecasting is not based on facts.

Survey and Statistical Methods

The main challenge to forecast demand is to select an effective technique.

There is no particular method that enables organizations to anticipate risks and uncertainties in future. Generally, there are two approaches to demand forecasting.

The first approach involves forecasting demand by collecting information regarding the buying behavior of consumers from experts or through conducting surveys. On the other hand, the second method is to forecast demand by using the past data through statistical techniques.

Thus, we can say that the techniques of demand forecasting are divided into survey methods and statistical methods. The survey method is generally for short-term forecasting, whereas statistical methods are used to forecast demand in the long run.

These two approaches are shown in Figure-10:

Let us discuss these techniques (as shown in Figure-10).

Survey Method:Survey method is one of the most common and direct methods of forecasting demand in the short term. This method encompasses the future purchase plans of consumers and their intentions. In this method, an organization conducts surveys with consumers to determine the demand for their existing products and services and anticipate the future demand accordingly.

The survey method undertakes three exercises, which are shown in Figure-11:

The exercises undertaken in the survey method (as shown in Figure-11) are discussed as follows:

i. Experts’ Opinion Poll:Refers to a method in which experts are requested to provide their opinion about the product. Generally, in an organization, sales representatives act as experts who can assess the demand for the product in different areas, regions, or cities.

Sales representatives are in close touch with consumers; therefore, they are well aware of the consumers’ future purchase plans, their reactions to market change, and their perceptions for other competing products. They provide an approximate estimate of the demand for the organization’s products. This method is quite simple and less expensive.

However, it has its own limitations, which are discussed as follows:

a. Provides estimates that are dependent on the market skills of experts and their experience. These skills differ from individual to individual. In this way, making exact demand forecasts becomes difficult.

b. Involves subjective judgment of the assessor, which may lead to over or under-estimation.

c. Depends on data provided by sales representatives who may have inadequate information about the market.

d. Ignores factors, such as change in Gross National Product, availability of credit, and future prospects of the industry, which may prove helpful in demand forecasting.

ii. Delphi Method:

Refers to a group decision-making technique of forecasting demand. In this method, questions are individually asked from a group of experts to obtain their opinions on demand for products in future. These questions are repeatedly asked until a consensus is obtained.

In addition, in this method, each expert is provided information regarding the estimates made by other experts in the group, so that he/she can revise his/her estimates with respect to others’ estimates. In this way, the forecasts are cross checked among experts to reach more accurate decision making.

Ever expert is allowed to react or provide suggestions on others’ estimates. However, the names of experts are kept anonymous while exchanging estimates among experts to facilitate fair judgment and reduce halo effect.

The main advantage of this method is that it is time and cost effective as a number of experts are approached in a short time without spending on other resources. However, this method may lead to subjective decision making.

iii. Market Experiment Method:Involves collecting necessary information regarding the current and future demand for a product. This method carries out the studies and experiments on consumer behavior under actual market conditions. In this method, some areas of markets are selected with similar features, such as population, income levels, cultural background, and tastes of consumers.

The market experiments are carried out with the help of changing prices and expenditure, so that the resultant changes in the demand are recorded. These results help in forecasting future demand.

There are various limitations of this method, which are as follows:

a. Refers to an expensive method; therefore, it may not be affordable by small-scale organizations

b. Affects the results of experiments due to various social-economic conditions, such as strikes, political instability, natural calamities

Statistical Methods:Statistical methods are complex set of methods of demand forecasting. These methods are used to forecast demand in the long term. In this method, demand is forecasted on the basis of historical data and cross-sectional data.

Historical data refers to the past data obtained from various sources, such as previous years’ balance sheets and market survey reports. On the other hand, cross-sectional data is collected by conducting interviews with individuals and performing market surveys. Unlike survey methods, statistical methods are cost effective and reliable as the element of subjectivity is minimum in these methods.

These different statistical methods are shown in Figure-12:

The different statistical methods (as shown in Figure-12).

Trend Projection Method:Trend projection or least square method is the classical method of business forecasting. In this method, a large amount of reliable data is required for forecasting demand. In addition, this method assumes that the factors, such as sales and demand, responsible for past trends would remain the same in future.

In this method, sales forecasts are made through analysis of past data taken from previous year’s books of accounts. In case of new organizations, sales data is taken from organizations already existing in the same industry. This method uses time-series data on sales for forecasting the demand of a product.

Table-1 shows the time-series data of XYZ Organization:

The trend projection method undertakes three more methods in account, which are as follows:

i. Graphical Method:Helps in forecasting the future sales of an organization with the help of a graph. The sales data is plotted on a graph and a line is drawn on plotted points.

Let us learn this through a graph shown in Figure-13:

Figure-13 shows a curve which is plotted by taking into the account the sales data of XYZ Organization (Table-1). Line P is drawn through mid-points of the curve and S is a straight line. These lines are extended to get the future sales for year 2010 which is approximately 47 tons. This method is very simple and less expensive; however, the projections made by this method may be based on the personal bias of the forecaster.

ii. Fitting Trend Method:Implies a least square method in which a trend line (curve) is fitted to the time-series data of sales with the help of statistical techniques.

In this method, there are two types of trends taken into account, which are explained as follows:a. Linear Trend:Implies a trend in which sales show a rising trend.

In linear trend, following straight line trend equation is fitted:S = A+BT

Where

S= annual sales

T=time (in years)

A and B are constant

B gives the measure of annual increase in sales

b. Exponential Trend:Implies a trend in which sales increase over the past years at an increasing rate or constant rate.

The appropriate trend equation used is as follows:Y = aTb Where

Y= annual sales

T= time in years

a and b are constant

Converting this into logarithm, the equation would be:Log Y = Log a + b Log T

The main advantage of this method is that it is simple to use. Moreover, the data requirement of this method is very limited (as only sales data is required), thus it is inexpensive method.

However, this method also suffers from certain limitations, which are as follows:1. Assumes that the past rate of changes in variables will remain same in future too, which is not applicable in the practical situations.

2. Fails to be applied for short-term estimates and where trend is cyclical with lot of fluctuations

3. Fails to measure relationship between dependent and independent variables.

iii. Box-Jenkins Method:Refers to a method that is used only for short-term predictions. This method forecasts demand only with stationary time-series data that does not reveal the long-term trend. It is used in

those situations where time series data depicts monthly or seasonal variations with some degrees of regularity. For instance, this method can be used for estimating the sales forecasts of woolen clothes during the winter season.

Barometric Method:In barometric method, demand is predicted on the basis of past events or key variables occurring in the present. This method is also used to predict various economic indicators, such as saving, investment, and income. This method was introduced by Harvard Economic Service in 1920 and further revised by National Bureau of Economic Research (NBER) in 1930s.

This technique helps in determining the general trend of business activities. For example, suppose government allots land to the XYZ society for constructing buildings. This indicates that there would be high demand for cement, bricks, and steel.

The main advantage of this method is that it is applicable even in the absence of past data. However, this method is not applicable in case of new products. In addition, it loses its applicability when there is no time lag between economic indicator and demand.

Econometric Methods:Econometric methods combine statistical tools with economic theories for forecasting. The forecasts made by this method are very reliable than any other method. An econometric model consists of two types of methods namely, regression model and simultaneous equations model.

These two types of methods are explained as follows:i. Regression Methods:Refer to the most popular method of demand forecasting. In regression method, the demand function for a product is estimated where demand is dependent variable and variables that determine the demand are independent variable.

If only one variable affects the demand, then it is called single variable demand function. Thus, simple regression techniques are used. If demand is affected by many variables, then it is called multi-variable demand function. Therefore, in such a case, multiple regression is used.

The simple and multiple regression techniques are discussed as follows:a. Simple Regression:Refers to studying the relationship between two variables where one is independent variable and the other is dependent variable.

The equation to calculate simple regression is as follows:Y = a + bx

Where, Y = Estimated value of Y for a given value of X

b = Amount of change in Y produced by a unit change in X

a and b = Constants

The equations to calculate a and b are as follows:

Let us learn to calculate simple regression with the help of an example. Suppose a researcher wants to study the relationship between the employee (sales group) satisfaction and sales of an organization.

He/she has taken the feedback from the employees in the form of questionnaire and asked them to rate their satisfaction level on a 10-pointer scale where 10 is the highest and 1 is the lowest. The researcher has taken the sales data for every individual member of the sales group. He/she has taken the average of monthly sales for an year for every individual.

The collected data is arranged in Table-2:

The calculation of mean for employee satisfaction (X) and sales is as follows:

This is the regression equation in which the researcher can take any value of X to find the estimated value of Y.

For example, if the value of X is 9, then the value of Y would be calculated as follows:Y = -1.39 + 1.61X

Y = -1.39 + 1.61(9)

Y= 13.1

With the help of preceding example, it can be concluded that if an employee is satisfied, then his/her output would increase.

b. Multiple Regression:Refers to studying the relationship between more than one independent and dependent variables.

In case of two independent variables and one dependent variable, following equation is used to calculate multiple regression:Y = a + b1X1 +b2X2

Where, Y (Dependent variable) = Estimated value of Y for a given value of X1 and X1

X1 and X2 = Independent variables

b1 = Amount of change in Y produced by a unit change in X1

b2 = Amount of change in Y produced by a unit change in X2

a, b1 and b2 = Constants

The equations used to calculate a and b values are as follows:

The number of equations depends on the number of independent variables. If there are two independent variables, then there would be three equations and so on.

Let us learn to calculate multiple regression with the help of an example. Suppose the researcher wants to study the relationship between intermediate percentage, graduation percentage, and MAT percentile of a group of 25 students.

It is important to note that intermediate percentage and graduation percentage are independent variables and MAT percentile is dependent variable. The researcher wants to find out whether the percentile in MAT depends on the percentage of intermediate and graduation or not.

The collected data is shown in Table-3:

The equations required to calculate multiple regression are as follows:

These equations are used to solve the multiple regression equation manually. However, you can also use SPSS to find out multiple regression.

If we use SPSS in the preceding example, we would get the output shown in Table-4:

Table-5 shows the summary of the regression model. In this table, R is the correlation coefficient between the independent and dependent variables, which is very high in this case. R Square shows that a large part of variation in the model is shown by employment opportunities in a state. Standard error of estimate is quite low that is 1.97. It also indicates that the variation in the present data is less.

Table-6 shows the coefficients of regression model:

Table-6 shows that the calculated t value is greater than the significance t value. Thus, the coefficients show cause and effect relationship between the independent and dependent variables.

Table-7 shows the AN OVA table for the two variables under study:

Table-7 shows the analysis of variation in the model. The regression row shows the variation occurred due to regression model. However, the residual row shows the variation that occurred by chance. In Table-7, the value of sum of squares for regression row is greater than the value of sum of squares for residual row; therefore, most of the variations are produced only due to model.

The calculated F value is very large as compared to the significance value. Therefore, we can say that the intermediate percentage and graduation percentage have a strong effect on the MAT percentile of a student.

Simultaneous Equations:Involve several simultaneous equations.

There are two types of variables that are included in this model, which are as follows:i. Endogenous Variables:Refer to inputs that are determined within the model. These are controlled variables.

ii. Exogenous Variables:Refer to inputs of the model. Examples are time, government spending, and weather conditions. These variables are determined outside the model.

For developing a complete model, endogenous and exogenous variables are determined first. After that, necessary data on both exogenous and endogenous variables are collected. Sometimes, data is not available in required form, thus, it needs to be adjusted into the model.

After the development of necessary data, the model is estimated through some appropriate method. Finally, the model is solved for each endogenous variable in terms of exogenous variable. The prediction is finally made.

Other Statistical Measures:

Apart from statistical methods, there are other methods for demand forecasting. These measures are very specific and used for only particular datasets. Therefore, there usage cannot be generalized for all types of research.

These measures are shown in Figure-14:

The different types of statistical measures (as shown in Figure-14) are discussed as follows:iii. Index Number:Refers to the measures used to study the fluctuations in a variable or group of related variables with respect to time period/base period. They are most commonly used in economics and financial research to study various factors, such as price and quantity of a product. The factors that are responsible for the problem are identified and calculated.

There are mainly four types of index numbers, which are as follows:a. Simple index number:Refers to the number that measures a relative change in a single variable with respect to the base year.

b. Composite index number:Refers to the number that measures a relative change in a group of related variables with respect to the base year.

c. Price index number:Refers to the number that measures a relative change in the price of a commodity in different time periods.

d. Quantity index number:Refers to the number that measures a relative change in the physical quantity of goods produced, consumed or sold for a commodity in different time periods.

Time Series Analysis: Refers to the analysis of a series of observations over a period of equally spaced time intervals. For example analyzing the growth of a company from its incorporation to the present situation. Time series analysis is applicable in various fields, such as public sector, economics, and research.

There are various components of time series analysis, which are as follows:a. Secular Trend:Refers to the trend that is denoted by T and prevalent over a period of time. Secular trend for a data series can be upward or downward. The upward trend shows the increase in a variable, such as increase in prices of commodities; whereas, the downward trend shows the declining phases, such as decline in the rate of diseases and sales for a particular product.

b. Short Time Oscillation:Refers to a trend that remains for a shorter period of time.

It can be classified into the following three trends:1. Seasonal trend:Refers to the trend that is denoted by S and occurs year after year for a particular period. The reason for such trends is weather conditions, festivals, and some other customs. Examples of seasonal trend are the increase in the demand for woolens in winters and increase in sales for sweet near Diwali.

2. Cyclical Trend:Refers to the trend that is denoted by C and lasts more than for an year. Cyclical trends are neither continuous nor seasonal in nature. An example of cyclical trend is business cycle.

3. Irregular trend:Refers to the trend that is denoted by I and is short and unpredictable in nature. Examples of irregular trends are earthquakes, volcano eruptions, and floods.

Decision Tree Analysis:Refers to the model that is used to take decision in an organization. In the decision tree analysis, a tree-type structure is drawn to decide the best solution for a problem. In this analysis, we first find out different options that we can apply to solve a particular problem.

After that, we can find out the outcome of each option. These options/decisions are connected with a square node while the outcomes are demonstrated with a circle node. The flow of a decision tree should be from left to right.

The shape of the decision tree is shown in Figure-15:

Let us understand the working of a decision tree with the help of an example. Suppose an organization wants to decide the type of segmentation to increase the customer base.

This problem can be solved by using the decision tree shown in Figure-16:

In Figure-16, the decision tree shows two types of segmentation, namely demographic segmentation and geographical segmentation. Now, we would analyze the outcomes of these two segmentations. To analyze the demographic segmentation, the company has to incur S 40,000

(estimated cost). The outcome of the demographic segmentation can be good, moderate, and poor.

The estimated revenue projected for three years for the three options (good, moderate, and poor) are as follows:Good = $ 21500000

Moderate = $ 950000

Poor= S300000

The probabilities assigned to the outcomes are 0.4 for good, 0.5 for moderate, and 0.1 for poor.

Now, we calculate the outcomes of demographic segmentation in the following manner:Good= 0.4*2100000 = 840000

Moderate = 0.5*950000=475000

Poor = 0.1*300000= 30000

Similarly, in case of geographical segmentation, the cost incurred is $ 70000 (estimated cost). The outcome of the geographical segmentation can be good and poor.

The estimated revenue projected for three years for the two options (good and poor) are as follows:Good = $ 1350000

Poor= $ 260000

The probabilities assigned to the outcomes are 0.6 for good and 0.4 for poor.

Now, we calculate the outcomes of geographical segmentation in the following manner:Good= 0.6*1350000 = $ 810000

Poor = 0.4*260000 = $ 104000

Now, we would analyze the two outcomes for taking a decision to select one segmentation out of the two segmentations in the following manner:For demographic segmentation:Good= 840000-40000= $ 800000

Moderate = 475000-40000= $ 435000

Poor = 30000-40000= $ (10000)

Similarly, for geographical segmentation:Good= 810000-70000= $ 740000

Poor =104000-70000= $ 340000

As we can see from the calculation that if we select the demographic segmentation, then the maximum estimated profit would be $ 800000. In demographic segmentation, there are chances of incurring losses (10,000), if the product is not successful in the market.

If we select geographical segmentation, then the maximum estimated profit would be$ 740000. In geographical segmentation, we would earn less profit (S 340000), if the product is not successful in the market. Therefore, it is better to use geographical segmentation for marketing the product, as no loss is involved in it.

Methods of Demand Forecasting for a New Product

The demand forecasting is the scientific tool to predict the likely demand of a product in the future. It is the starting point of fulfilling a customer order and based on the forecasted demand, a firm commits its resources, capacities and capabilities for a period of time to create goods and services that its customers value and are willing to pay for. Hence, According to American Marketing Association, “Demand forecasting is an estimate of sales in dollars or physical units for a specified future period under a proposed marketing plan.” The demand of new product can be forecasted by anyone of the following techniq

Substitute Approach Evolutionary Approach

Buyers or consumers view Vicarious approach (or Experts’ opinion) Sales experience approach (or Market test method)

Substitute ApproachIt is based on the assumption that a new product will be analyzed as a substitute of an existing product. In this method, the demand of substitute product is analyzed and on the basis of such analysis (or survey) forecasts are made for the new product to be introduced in the market.

Evolutionary ApproachThis method of sales forecasting is based on the assumption that the new product will be considered an improvement over existing products. It is further assumed that the new product can follow some life-cycles as of existing products. The sales of existing product are analyzed and efforts are made to forecast the sales of the new product of the enterprise on this basis.

Buyers or consumers viewIn this method, the potential buyers of the product are contacted and efforts are made to know their opinions regarding new product. Efforts are also made to guess the quantity to be purchased by these consumers. Sales forecasts of the new product are based on these opinions and estimates.

Vicarious approach (or Experts’ opinion)This approach of sales forecasting of new product is based on the opinion of experts in the field of marketing, who know the needs, desires, tastes and preferences of customers. Experts are contacted and their opinions are collected regarding the utilities and possible demand of the product. Sales forecasts are prepared on the basis of opinion of these experts.

Sales experience approach (or Market test method)In this method, the new product is offered for sale in a sample market for a fixed period. The results of the sales of the product are considered to be the base of forecasting the demand for the new product. The results of sales of the product in these segments are collected and deeply analyzed.

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