Economics - Notes

GAMES THEORY - Game theory is a branch of applied mathematics that is used in the social sciences (most notably economics), biology, engineering, political science, international relations, computer science, and philosophy. Game theory attempts to mathematically capture behavior in strategic situations, in which an individual's success in making choices depends on the choices of others. While initially developed to analyze competitions in which one individual does better at another's expense (zero sum games), it has been expanded to treat a wide class of interactions, which are classified according to several criteria. Today, "game theory is a sort of umbrella or 'unified field' theory for the rational side of social science, where 'social' is interpreted broadly, to include human as well as non-human players (computers, animals, plants)" (Aumann 1987). --- There are various types of games –zero sum, non-zero sum: The zero-sum property (if one gains, another loses) means that any result of a zero-sum situation is Pareto optimal (generally, any game where all strategies are Pareto optimal is called a conflict game). Situations where participants can all gain or suffer together are referred to as non-zero-sum. Thus, a country with an excess of bananas trading with another country for their excess of apples, where both benefit from the transaction, is in a non-zero-sum situation. Other non-zero-sum games are games in which the sum of gains and losses by the players are sometimes more or less than what they began with. --- The concept was first developed in game theory and consequently zero-sum situations are often called zero-sum games though this does not imply that the concept, or game theory itself, applies only to what are commonly referred to as games. Non Zero-Sum: Many economic situations are not zero-sum, since valuable goods and services can be created, destroyed, or badly allocated, and any of these will create a net gain or loss. Assuming the counterparties are acting rationally, any commercial exchange is a non-zero-sum activity, because each party must consider the goods it is receiving as being at least fractionally more valuable than the goods it is delivering. Economic exchanges must benefit both parties enough above the zero-sum such that each party can overcome its transaction costs. STRATEGIC BEHAVIOUR - ‘Strategic behaviour’ refers to actions which a firm takes to improve its competitive position relative to actual and potential rivals, in order to gain a permanent commercial ad-vantage, thereby increasing its long-run profits. Carlton and Perloff (1994:382) refer to actions ‘to influence the market environment and so increase profits’; while Martin (1993:46) refers to ‘investment of resources for the purpose of limiting rivals’ choices’. Strategic behaviour thus refers to conduct which is not economically inevitable, but which is the outcome of a conscious attempt to shape the firm’s market environment to its own lasting advantage and to the competitive disadvantage of rivals. There are two categories of strategic behaviour. ‘Non-cooperative behaviour’ occurs when a firm tries to improve its position relative to its rivals by seeking to prevent them from entering a market, to drive them out of business or to reduce their profits. ‘Cooperative behaviour’ occurs when firms in a market seek to coordinate their actions and therefore limit their competitive responses (this does not necessarily imply explicit agreement). Here, only non-cooperative strategic behaviour is considered. --- It is primarily under oligopolistic market conditions that a firm has an incentive to alter its relative position through strategic behaviour. The firm recognises its interdependence and the need to take into account other firms’ reactions when making its own decisions; but it also recognises that it is free to make decisions to alter its commercial environment. These strategies are revealed over time through investment and through tactical moves and countermoves. LINEAR PROGRAMMING - Linear programming (LP) is a technique for optimization of a linear objective function, subject to linear equality and linear inequality constraints. Informally, linear programming determines the way to achieve the best outcome (such as maximum profit or lowest cost) in a given mathematical model and given some list of requirements represented as linear equations. More formally, given a polytope (for example, a polygon or a polyhedron), and a realvalued affine function defined on this polytope, a linear programming method will find a point in the polytope where this function has the smallest (or largest) value. Such points may not exist, but if they do, searching through the polytope vertices is guaranteed to find at least one of them. Linear programs are problems that can be expressed in canonical form: Maximise: - Subject to: represents the vector of variables (to be determined), while and are vectors of (known) coefficients and is a (known) matrix of coefficients. The expression to be maximized or minimized is called the objective function ( in this case). The equations are the constraints which specify a convex polyhedron over which the objective function is to be optimized. Linear programming can be applied to various fields of study. Most extensively it is used in business and economic situations, but can also be utilized for some engineering problems. Some industries that use linear programming models include transportation, energy, telecommunications, and manufacturing. It has proved useful in modeling diverse types of problems in planning, routing, scheduling, assignment, and design.

PRODUCTION FUNCTION – A production function is a function that specifies the output of a firm, an industry, or an entire economy for all combinations of inputs. A meta-production function (sometimes metaproduction function) compares the practice of the existing entities converting inputs X into output y to determine the most efficient practice production function of the existing entities, whether the most efficient feasible practice production or the most efficient actual practice production. In either case, the maximum output of a technologically-determined production process is a mathematical function of input factors of production. Put another way, given the set of all technically feasible combinations of output and inputs, only the combinations encompassing a maximum output for a specified set of inputs would constitute the production function. Alternatively, a production function can be defined as the specification of the minimum input requirements needed to produce designated quantities of output, given available technology. It is usually presumed that unique production functions can be constructed for every production technology. There are several ways of specifying the production function. In a general mathematical form, a production function can be expressed as: Q = f(X1,X2,X3,...,Xn) where: Q = quantity of output - X1,X2,X3,...,Xn = factor inputs (such as capital, labour, land or raw materials). This general form does not encompass joint production, that is a production process, which has multiple co-products or outputs. Cobb-Douglas - The Cobb-Douglas functional form of production functions is widely used to represent the relationship of an output to inputs. It was proposed by Knut Wicksell (1851-1926), and tested against statistical evidence by Charles Cobb and Paul Douglas in 1900-1928. --- For production, the function is Y = ALαKβ, where: Y = total production (the monetary value of all goods produced in a year), L = labor input, K = capital input, A = total factor productivity, α and β are the output elasticities of labor and capital, respectively. These values are constants determined by available technology. Properties: 1. Constant Returns to scale: As mentioned above, the Cobb-Douglas function assumes constant returns as scale i.e., (α+β)=1. It must be noted that Cobb-Douglas function can also accommodate any degree of returns to scale. 2. Elasticity of substitution is equal to one – α = percentage change in factor quantity ratio / percentage change in factor price ratio. Importance: 1. The Cobb function is convenient in Internal and Inter Industry comparisons. Since α and β which are partial elasticity coefficients are pure numbers, they can be easily used for comparing results of different samples having varied units of measurements. 2. Another advantage is that function capture the essential non-linearities of production process and also has the benefit of the simplification of process by transforming the function into a linear form with the help of logarithms. 3. The parameters of a Cobb function in addition to being elasticises, also possess other attributes. Limitations: 1. The Cobb functions includes only two factor inputs – labour and capital, that there are equally important inputs used in the production process. 2. The production assumes constant returns to scale, which is not possible in general. Certain factors of production cannot be increased in the same proportion e.g., entrepreneurship. Even if it is possible to do so, it is not possible to have constant returns to scale in the long runs. 3. There is usual problem of measurements of capital. We know that labour is measured in terms of labour services per hour. With respect to capital, it is quite difficult to measure capital services per hour as it involves depreciation over time. 4. Since the raw material does not figure on the input side, the output side is therefore taken as the net of raw material. Once we assume a constant return to scale, we believe that there is a fixed relation of raw materials of fuel variety. DEMAND - The amount of a particular economic good or service that a consumer or group of consumers will want to purchase at a given price. The demand curve is usually downward sloping, since consumers will want to buy more as price decreases. Demand for a good or service is determined by many different factors other than price, such as the price of substitute goods and complementary goods. In extreme cases, demand may be completely unrelated to price, or nearly infinite at a given price. Along with supply, demand is one of the two key determinants of the market price. Elasticity of Demand - Price elasticity of demand (PED) is defined as the measure of responsiveness in the quantity demanded for a commodity as a result of change in price of the same commodity. It is a measure of how consumers react to a change in price. In other words, it is percentage change in quantity demanded by the percentage change in price of the same commodity. In economics and business studies, the price elasticity of demand is a measure of the sensitivity of quantity demanded to changes in price. It is measured as elasticity that is it measures the relationship as the ratio of percentage changes between quantity demanded of a good and changes in its price. In simpler words, demand for a product can be said to be very inelastic if consumers will pay almost any price for the product, and very elastic if consumers will only pay a certain price, or a narrow range of prices, for the product. Inelastic demand means a producer can raise prices without much hurting demand for its product, and elastic demand means that consumers are sensitive to the price at which a product is sold and will not buy it if the price rises by what they consider too much.

Perfectly Inelastic Perfectly Elastic Determinants: A number of factors determine the elasticity: Substitutes: The more substitutes, the higher the elasticity, as people can easily switch from one good to another if a minor price change is made, Percentage of income: The higher the percentage that the product's price is of the consumer's income, the higher the elasticity, as people will be careful with purchasing the good because of its cost, Necessity: The more necessary a good is, the lower the elasticity, as people will attempt to buy it no matter the price, such as the case of insulin for those that need it., Duration: The longer a price change holds, the higher the elasticity, as more and more people will stop demanding the goods (i.e. if you go to the supermarket and find that blueberries have doubled in price, you'll buy it because you need it this time, but next time you won't, unless the price drops back down again). Breadth of definition: The broader the definition, the lower the elasticity.

SUPPLY FUNCTION The quantity of a product that firm is willing to offer at a particular given price in the market is termed as Supply. Supply of a product and the factor which determine it could be analysed in the firm of supply function. A manager has to analyze the factor to which supply of his product is sensitive too. Ceteris Paribus, supply of product and price of the product are directly related that supply of product is a direct function of the price of the product which gives us an upward sloping supply curve of a product. The supply curve may be linear or non linear. 2 types: Short run supply - In the short run the firm may face a fixed cost even if it produces no output, and we need to check whether it would be better off producing no output rather than y*. If it produces no output it makes a loss equal to FC. Thus the firm's optimal decision is to produce nothing if its best positive output y* yields a loss greater than FC, and otherwise to produce y*. Put differently, the optimal decision is to produce no output if the price is less than the minimum of the firm's average variable cost (in which case for every unit the firm sells it makes a loss). In summary: A firm's short run supply function is given as follows. 1. If price is less than the minimum of the firm's AVC then the optimal output is zero. 2. If the price exceeds the minimum of the firm's AVC then the optimal output y* satisfies the conditions that p = SMC(y*) and SMC is increasing at y*. Long run supply - In the long run the firm pays nothing if it does not operate. Thus its supply function is given by the part of its marginal cost function above its long run average cost function. (If its maximal profit it positive it wants to operate; if its maximal profit it negative it does not want to operate.) In summary: A firm's long run supply function is given as follows. 1. If price is less than the minimum of the firm's LAC then the optimal output is zero. 2. If the price exceeds the minimum of the firm's LAC then the optimal output y* satisfies the conditions that p = LMC(y*) and LMC is increasing at y*. Elasticity of Supply - The price elasticity of supply is defined as a numerical measure of the responsiveness of the quantity supplied of product (A) to a change in price of product (A) alone. It is the measure of the way quantity supplied reacts to a change in price. . When there is a relatively inelastic supply for the good the coefficient is low; when supply is highly elastic, the coefficient is high. Supply is normally more elastic in the long run than in the short run for produced goods. As spare capacity and more capital equipment can be utilised the supply can be increased, whereas in the short run only labor can be increased. Of course goods that have no labor component and are not produced cannot be expanded. Such goods are said to be "fixed" in supply and do not respond to price changes. The quantity of goods supplied can, in the short term, be different from the amount produced, as manufacturers will have stocks which they can build up or run down. The determinants of the price elasticity of supply are: The existence of the naturally occurring raw materials needed for production; the length of the production process; the production spare capacity (the more spare capacity there is in an industry the easier it should be to increase output if the price goes up); the time period and the factor immobility (the ease of resources to move into the industry); the storage capacity of the merchants (if they have more goods in stock they will be able to respond to a change in price more quickly). COST - A cost is the value of money that has been used up to produce something, and hence is not available for use anymore. In economics, a cost is an alternative that is given up as a result of a decision. In business, the cost may be one of acquisition, in which case the amount of money expended to acquire it is counted as cost. In this case, money is the input that is gone in order to acquire the thing. This acquisition cost may be the sum of the cost of production as incurred by the original producer, and further costs of transaction as incurred by the acquirer over and above the price paid to the producer. Usually, the price also includes a mark-up for profit over the cost of production. Costs are often further described based on their timing or their applicability. Cost Concepts: 1. Economic Costs: The economic cost of a decision depends on both the cost of the alternative chosen and the benefit that the best alternative would have provided if chosen. Economic cost differs from accounting cost because it includes opportunity cost. 2. Short Run Costs: The concept of the short-run refers to the decision-making time frame of a firm in which at least one factor of production is fixed. Costs which are fixed in the short-run have no impact on a firms decisions. For example a firm can raise output by increasing the amount of labour through overtime. A generic firm can make three changes in the short-run: Increase production, Decrease production, Shut down. In the short-run, a profit maximizing firm will: Increase production if marginal cost is less than price; Decrease production if marginal cost is greater than price; Continue producing if average variable cost is less than price, even if average total cost is greater than price; Shut down if average variable cost is greater than price. Thus, the average variable cost is the largest loss a firm can incur in the short-run. 3. Long Run Costs: he long-run time frame assumes no fixed factors of production. Firms can enter or leave the marketplace, and the cost (and availability) of land, labor, raw materials, and capital goods can be assumed to vary. In contrast, in the short-run time frame, certain factors are assumed to be fixed, because there is not sufficient time for them to change. This is related to the long run average cost (LRAC) curve, an important factor in microeconomic models. A generic firm can make these changes in the long-run: Enter an industry, Increase its plant, Decrease its plant, Leave an industry. Long run marginal cost (LRMC) refers to the cost of providing an additional unit of service or commodity under assumption that this requires investment in capacity expansion. LRMC pricing is appropriate for best resource allocation, but may lead to a mismatch between operating costs and revenues. In long run equilibrium, the LRMC=Long run average total cost (LRATC) at the minimum of LRATC. In macroeconomic models, the long run assumes full factor mobility between economic sectors, and often assumes full capital mobility between nations. The concept of long run cost is used in cost-volume-profit analysis and product mix analysis.

DEMAND FORECASTING is the activity of estimating the quantity of a product or service that consumers will purchase. Demand forecasting involves techniques including both informal methods, such as educated guesses, and quantitative methods, such as the use of historical sales data or current data from test markets. Demand forecasting may be used in making pricing decisions, in assessing future capacity requirements, or in making decisions on whether to enter a new market. Short Run – In a short run forecast seasonal patters are of prime importance. Such a forecast helps in preparing suitable sales policy and proper scheduling of output to avoid over-stocking or costly delays in meeting the orders. It helps in arriving at suitable price for the product and necessary modifications in advertising and sales techniques. Long Run – Long run forecasts are helpful in proper capital planning. It helps in saving the wastages in material, man-hours, machine time and capacity. Long run forecasting is used for new unit planning, expansion of the existing units, planning long run financial requirements and manpower requirements. Different set of variables is used in than in short term forecasts. Purposes: 1. Better planning and allocation of resources, 2. Appropriate production scheduling, 3. Inventory control, 4. Determining appropriate pricing policies, 5. Setting sales targets and establishing controls and incentives, 6. Planning a new unit or expanding existing one, 7. Planning long term financial requirements, 8. Planning Human Resource Development Strategies Steps: 1. Identification of objective, 2. Determining the nature of goods under consideration, 3. Selecting a proper method of forecasting, 4. Interpretation of results. Scope: 1. Period of forecasting – (a) Short run forecasting – In short run forecasting, we look for factors which bring fluctuation in demand pattern in the market for example weather conditions like monsoon affecting the demand (b) Medium run forecasting – In medium run forecasting is done basically for timing of an activity like advertising expenditure. (c) Long run forecasting: It is done to ascertain the validity of trend. It is done for decision like diversification. 2. Levels: (a) Macroeconomic forecasting – is concerned with business conditions of the whole economy. It is measured with the help of indices like wholesale price index, consumer price index. (b) Industry demand forecasting – gives indication to firm regarding direction in which the whole industry will be moving. It is used to decide the way the firm should plan for future in relating to the industry. (c) Firm demand forecasting – is done for planning companies overall operations like sales forecasting etc. (d) Product line forecasting – helps the firm to decide which of the product or products should have priority in the allocation of firm’s limited resources. 3. General purpose or specific purpose forecast helps the firm in taking general factors into consideration while forecasting for demand. 4. Forecast of established product or a new product. 5. Types of commodity for which forecast is to be done. Goods can be broadly classified into capital goods, consumer durable and non-durable consumer goods. Methods: 1. Survey of buyers’ intentions: also known as Opinion surveys. With intentions surveys, people are asked how they intend to behave in specified situations. In a similar manner, an expectations survey asks people how they expect to behave. Expectations differ from intentions because people realize that unintended things happen. For example, if you were asked whether you intended to visit the dentist in the next six months you might say no. However, you realize that a problem might arise that would necessitate such a visit, so your expectations would be that the event had a probability greater than zero. This distinction was proposed and tested by Juster (1966) and its evidence on its importance was summarised by Morwitz (2001). Delphi - The Delphi technique was developed at RAND Corporation in the 1950s to help capture the knowledge of diverse experts while avoiding the disadvantages of traditional group meetings. The latter include bullying and time-wasting. To forecast with Delphi the administrator should recruit between five and twenty suitable experts and poll them for their forecasts and reasons. The administrator then provides the experts with anonymous summary statistics on the forecasts, and experts' reasons for their forecasts. The process is repeated until there is little change in forecasts between rounds - two or three rounds are usually sufficient. Advantages: 1. Facilitates the maintenance of anonymity of the respondent’s identity throughout the course. 2. Saves time and other resources in approaching a large number of experts for their views. Limitations: 1. Panelists must be rich in their expertise, possess wide knowledge and experience of the subject and have an aptitude and earnest disposition towards the participants. 2. Presupposes that its conductors are objective in their job, possess ample abilities to conceptualize the problems for discussion, generate considerable thinking, stimulate dialogue among panelists and make inferential analysis of the multitudinal views of the participants. Expert Opinions: As the name implies, expert systems are structured representations of the rules experts use to make predictions or diagnoses. Rules are often created from protocols, whereby forecasters talk about what they are doing while making forecasts. Where empirical estimates of relationships from structured analysis such as econometric studies are available, expert systems should use that information. Expert opinion, conjoint analysis, and bootstrapping can also aid in the development of expert systems. Advantages: 1. Very simple and quick method. 2. No danger of a “groupthink” mentality. Collective Opinion: Also called “sales force polling”, salesmen are required to estimate expected sales in their respective territories and sections. Advantages: 1. Simple – no statistical techniques. Based on first hand knowledge. 2. Quite useful in forecasting sales of new products. Disadvantages: 1. Almost completely subjective. 2. Usefulness restricted to short-term forecasting. 3. Salesmen may be unaware of broader economic changes. Naïve models: Naïve forecasting models are based exclusively on historical observation of sales (or other variables such as earnings, cash flows, etc). They do not explain the underlying casual relationships which produces the variable being forecast. Advantage: Inexpensive to develop, store data and operate. Disadvantage: does not consider any possible causal relationships that underlie the forecasted variable. 3naïve models: 1. To use actual sales of the current period as the forecast for the next period; then, Yt+1 = Yt …..2. If we consider trends, then, Yt+1 = Yt + (Yt – Yt-1) …… 3. If we want to incorporate the rate of change, rather than the absolute amount; then, Yt+1 = Yt (Yt / Yt-1). Smoothing Techniques: Higher form of naïve models: A. Moving average: are averages that are updated as new information is received. With the moving average a manager simply employs, the most recent observations, drops the oldest observation, in the earlier calculation and calculates an average which is used as the forecast for the next period. Limitations: 1. One has to retain a great deal of data. 2. All data in

the sample are weighed equally. B. Exponential smoothing: uses weighted average of past data as the basis for a forecast. Yt+1 = aYt + (1-a) Yt or Y new = a Y old + (1-a) Y’ old, where, Y new = exponentially smoothed average to be used as the forecast, Y old = most recent actual data, Y’old = most recent smoothed forecast, a = smoothing constant. Smoothing constant (or weight) has a value between 0 and 1 inclusive. Popular because: simple, inexpensive, time series data often exhibit a persistent growth trend. Disadvantage: this technique yields acceptable results so long as the time series shows a persistent tendency to move in the same direction. Whenever a turning point occurs, however, the trend projection breaks down. The real challenge of forecasting is in the prediction of turning points rather than in the projection of trends. Judgemental approach - Required when: 1. Analysis of time series and trend projections is not feasible because of wide fluctuations in sales or because of anticipated changes in trends; and 2. Use of regression method is not possible because of lack of historical data or because of management’s inability to predict or even identify causal factors. ISOQUANT - An isoquant (derived from quantity and the Greek word iso, meaning equal) is a contour line drawn through the set of points at which the same quantity of output is produced while changing the quantities of two or more inputs. While an indifference curve helps to answer the utility-maximizing problem of consumers, the isoquant deals with the cost-minimization problem of producers. Isoquants are typically drawn on capital-labor graphs, showing the tradeoff between capital and labor in the production function, and the decreasing marginal returns of both inputs. Adding one input while holding the other constant eventually leads to decreasing marginal output, and this is reflected in the shape of the isoquant. A family of isoquants can be represented by an isoquant map, a graph combining a number of isoquants, each representing a different quantity of output. Shapes of Isoquant Curve: If the two inputs are perfect substitutes, the resulting isoquant map generated is represented in fig. A; with a given level of production Q3, input X is effortlessly replaced by input Y in the production function. The perfect substitute inputs do not experience decreasing marginal rates of return when they are substituted for each other in the production function. If the two inputs are perfect complements, the isoquant map takes the form of fig. B; with a level of production Q3, input X and input Y can only be combined efficiently in a certain ratio represented by the kink in the isoquant. The firm will combine the two inputs in the required ratio to maximize output and minimize cost. If the firm is not producing at this ratio, there is no rate of return for increasing the input that is already in excess. Isoquants are typically combined with isocost lines in order to provide a cost-minimization production optimization problem.

A B ISOCOST - an isocost line represents a combination of inputs which all cost the same amount. Although similar to the budget constraint in consumer theory, the use of the isocost pertains to cost-minimization in production, as opposed to utility-maximization. The typical isocost line represents the ratio of costs of labour and capital, so the formula is often written as: , Where w represents the wage of labour, and r represents the rental rate of capital. The slope is: or the negative ratio of wages divided by rental fees. The isocost line is combined with the isoquant line to determine the optimal production point (at a given level of output). The cost function for a firm with two variable inputs - Consider a firm that uses two inputs and has the production function F. This firm minimizes its cost of producing any given output y if it chooses the pair (z1, z2) of inputs to solve the problem Min z1,z2w1z1 + w2z2 subject to y = F (z1, z2), where w1 and w2 are the input prices. Note that w1, w2, and y are given in this problem---they are parameters. The variables are z1 and z2. Denote the amounts of the two inputs that solve this problem by z1*(y, w1, w2) and z2*(y, w1, w2). The functions z1* and z2* are the firm's conditional input demand functions. (They are conditional on the output y, which is taken as given.) The firm's minimal cost of producing the output y is w1z1*(y,w1, w2) + w2z2*(y,w1, w2) (the value of its total cost for the values of z1 and z2 that minimize that cost). The function TC defined by which is called the firm's (total) cost function. (Note that the hard part of the problem is finding the conditional input demands; once you have found these, then finding the cost function is simply a matter of adding the conditional input demands together with the weights w1 and w2.)

ECONOMIES OF SCALE: Economies of scale arise when the cost per unit falls as output increases. Economies of scale are the main advantage of increasing the scale of production and becoming ‘big’. Importance: Firstly, because a large business can pass on lower costs to customers through lower prices and increase its share of a market. This poses a threat to smaller businesses that can be “undercut” by the competition -- Secondly, a business could choose to maintain its current price for its product and accept higher profit margins. For example, a furniture-maker which could produce 1,000 cabinets at £250 each might expand and be able to produce 2,000 cabinets at £200 each. The total production cost will have risen to £400,000 from £250,000, but the cost per unit has fallen from £250 to £200. Assuming the business sells the cabinets for £350 each, the profit margin per cabinet rises from £100 to £150. Types: Internal economies of scale - Internal economies of scale relate to the lower unit costs a single firm can obtain by growing in size itself. There are five main types of internal economies of scale. Bulk-buying economies: As businesses grow they need to order larger quantities of production inputs. For example, they will order more raw materials. As the order value increases, a business obtains more bargaining power with suppliers. It may be able to obtain discounts and lower prices for the raw materials. Technical economies: Businesses with large-scale production can use more advanced machinery (or use existing machinery more efficiently). This may include using mass production techniques, which are a more efficient form of production. A larger firm can also afford to invest more in research and development. Financial economies: Many small businesses find it hard to obtain finance and when they do obtain it, the cost of the finance is often quite high. This is because small businesses are perceived as being riskier than larger businesses that have developed a good track record. Larger firms therefore find it easier to find potential lenders and to raise money at lower interest rates. Marketing economies: Every part of marketing has a cost – particularly promotional methods such as advertising and running a sales force. Many of these marketing costs are fixed costs and so as a business gets larger, it is able to spread the cost of marketing over a wider range of products and sales – cutting the average marketing cost per unit. Managerial economies: As a firm grows, there is greater potential for managers to specialise in particular tasks (e.g. marketing, human resource management, finance). Specialist managers are likely to be more efficient as they possess a high level of expertise, experience and qualifications compared to one person in a smaller firm trying to perform all of these roles. External economies of scale - External economies of scale occur when a firm benefits from lower unit costs as a result of the whole industry growing in size. The main types are: Transport and communication links improve: As an industry establishes itself and grows in a particular region, it is likely that the government will provide better transport and communication links to improve accessibility to the region. This will lower transport costs for firms in the area as journey times are reduced and also attract more potential customers. For example, an area of Scotland known as Silicon Glen has attracted many high-tech firms and as a result improved air and road links have been built in the region. Training and education becomes more focused on the industry: Universities and colleges will offer more courses suitable for a career in the industry which has become dominant in a region or nationally. For example, there are many more IT courses at being offered at colleges as the whole IT industry in the UK has developed recently. This means firms can benefit from having a larger pool of appropriately skilled workers to recruit from. Other industries grow to support this industry: A network of suppliers or support industries may grow in size and/or locate close to the main industry. This means a firm has a greater chance of finding a high quality yet affordable supplier close to their site. DISECONOMIES OF SCALE - Diseconomies of scale are the forces that cause larger firms to produce goods and services at increased per-unit costs. They are less well known than what economists have long understood as "economies of scale", the forces which enable larger firms to produce goods and services at reduced per-unit costs. Causes: Cost of communication: Ideally, all employees of a firm would have one-on-one communication with each other so they know exactly what the other workers are doing.[citation needed] A firm with a single worker does not require any communication between employees. A firm with two workers requires one communication channel, directly between those two workers. A firm with three workers requires three communication channels (between employees A & B, B & C, and A & C). Duplication of effort: A firm with only one employee can't have any duplication of effort between employees. A firm with two employees could have duplication of efforts, but this is improbable, as the two are likely to know what each other is working on at all times. When firms grow to thousands of workers, it is inevitable that someone, or even a team, will take on a project that is already being handled by another person or team. Top-heavy companies: The more employees a firm has, the larger percentage of the workforce will be "management". A company with a single worker doesn't need any managers (this refers to managers of people, as opposed to managers of other resources). Office politics: "Office politics" is management behaviour which a manager knows is counter to the best interest of the company, but is in her/his personal best interest. Inertia (unwillingness to change): This will be defined as the "we've always done it that way, so there's no need to ever change" attitude (see appeal to tradition). An old, successful company is far more likely to have this attitude than a new, struggling one.

OBJECTIVES OF A BUSINESS FIRM: Project Maximization: A firm shall choose that level of output at which profit is maximised project is the difference between total revenue and total cost. Mathematically, Total project function of a firm is Π = R – C, Π = Profit, C = Total costs, R = Total Revenue. Clearly R = (f1 (X)) and C = f2 (X), given the price P, X = output level. Sales maximization: An alternative theory to that which argues that firms seek to maximize profits. W.J. Baumol (Economic Theory and Operations Analysis, 1965) is generally recognized as having first suggested that firms often seek to maximize the money value of their sales, i.e. their sales revenue, subject to a constraint that their profits do not fall short of some minimum level which is just on the borderline of acceptability. In other words, so long as profits are at a satisfactory level, management will devote the bulk of its energy and efforts to the expansion of sales. Such a goal may be explained perhaps by the businessman's desire to maintain his competitive position, which is partly dependent on the sheer size of his enterprise, or it may be a matter of the interested management, since management's salaries may be related more closely to the size of the firm's operation than to its profits, or it may simply be a matter of prestige. It is also Baumol's view that short-run revenue maximization may be consistent with long-run profit maximization, and revenue maximization can be regarded as a long-run goal in many oligopolistic firms. Baumol also reasons that high sales attract customers to the popular product, cause banks to be receptive to the firm's financial needs, encourage distributors, and make it easier to retain and attract good employees. MARRIS: In his original model, Marris advocated that corporate growth, g, could be manipulated to maintain an optimum dividend-to-profit retention ratio that keeps the shareholders satisfied but does not retain too high a level of profit, creating a cash-rich business ripe for a take-over. This implies a degree of control on share value that would seem difficult to sustain for even the most effective management team. Marris Model: the gd equation - However has been argued that there are simply too many other factors that could affect the valuation ratio of the business beyond corporate growth. Deciding on how best to achieve growth becomes a crucial issue for management during the life cycle of a firm. Agency costs: There is a benchmark rule: the higher the valuation of a company the less likely is the threat of takeover. This rule, however, intimates that dividends should stay high to maintain the share price. Alternatively management may wish to invest more profits to secure more growth with a risk that the value of the company falls. If the higher valuation were perceived by shareholders to be at a maximum then shareholders would prefer that higher valuation, so it behoves management to persuade shareholders that the risk of a fall in value can be captured by a higher growth rate. Management inability to persuade shareholders gives rise to agency costs. Positive Learning Transfer: A central theme is designing trust is the context of the management decision, that is, how the decision is observed by shareholders. Shareholders may adopt a Bayesian-type rule, seeing what they want to see about management and the firm. Management should resist this. How? They could signal a positive learning transfer to shareholders whereby management with prior experience (in games with) value-growth issues introduce positive expectations of a stronger performance (higher value for the firm). Williamson’s Model of Managerial Discretion - Williamson argues that managers have discretion in pursuing policies which maximize their own utility rather than attempting the maximization of profits which maximize the utility of owner shareholders. Profit act as a constraint to this managerial behaviour, in that the financial market & the shareholders require minimum profit to b paid out in the form of dividends, otherwise the job security is endangered. The managerial utility function includes such variable as salary, security, power, status, prestige, professional excellence. Of these variable only salaries is measurable. The other are non pecuniary & if they are to b operational they must b expressed in terms of other variables with which they r measurable. This is obtained by the concept of expense preference, which is defined as the satisfaction which managers derive from certain types of expenditures. In particular, staff expenses are emoluments. & the funds available for discretionary investment give to managers a positive satisfaction b’coz these expenditure are a souse of security & reflect the power, status, prestige & professional achievement of managers. Staff increases are to certain extent equivalent to promotion, since they increase the range of activity & control of managers over resources. Being the head of a large staff is a symbol of power, status & prestige. Manager’s prestige , power, & status are to a large extend reflected in the amount of emoluments or slack they receive in the form of expense accounts, luxurious offices, company cars, etc. emoluments r economic rents accruing to the managers to leave the firm & seek employment elsewhere. They r discretionary which are made possible b’coz of the strategic position tht managers have in the running of the business. Finally the status & power of managers is associated with the discretion they have in undertaking investments beyond those required for the normal operation of the firm. These minimum investment requirements r includes in the minimum profit constraint together with the amount of profits required for a satisfactory dividend policy. Staff expenditure, emoluments & discretionary investment expenses are measurable in money terms & will be used as proxy- variables to replace the no-operational concept appearing in the marginal utility function .thus the utility function of the managers may b written in the form U=f(S,M,Id) where S= staff expenditure, including managerial salaries. M = managerial emoluments. Id = discretionary investments. Weakness of Managerial Models. - The managerial model are considered to be naïve in reference to their coverage of organizational behavior within competitive market such as oligopoly. They offer no consideration of R&D activities which many organizations undertake as a matter of course. the main criticism are:1) profit is considered to be given that is, exogenous to the model; this is particularly true of the min profit constraint included in many cases therefore there is no consideration of the manner in which desirable profit levels are obtained. 2) it is assumed that profits are used to fund growth. however marries does consider the balance b/w internal & external finances of his work.3) prices r assumed to b constant & organizations r assumed to b operating within stable oligopoly environments.4) quantities produced r related to the revenues of the organization, not to advertising or other factors.5) R&D & product line extensions are ignored.

MARKETS – Perfect Competition: It is a market which utopian in nature and as such exists rather rarely. It is studied more for its analytical value. It has the following characteristics: 1. There are large number of buyers and sellers. 2. Product is homogeneous. 3. Neither the buyer nor the seller can influence the price of the produce. The firm is price taker and sells at market price over which it has no control. Similarly buyer also buys at a market price and has no influence on it. Thus price in the market is termed as Exogeneous Variable. 4. Any buyer or seller can enter or leave the market that there exists no restriction on the entry or exit of the firms/buyers. The equilibrium level of output and price in this market could be determined both in the short run as well as long run. Monopoly: A monopoly exists when a specific individual or enterprise has sufficient control over a particular product or service to determine significantly the terms on which other individuals shall have access to it. Monopolies are thus characterized by a lack of economic competition for the good or service that they provide and a lack of viable substitute goods. The verb "monopolize" refers to the process by which a firm gains persistently greater market share than what is expected under perfect competition. - A monopoly should be distinguished from monopsony, in which there is only one buyer of a product or service ; a monopoly may also have monopsony control of a sector of a market. Likewise, a monopoly should be distinguished from a cartel (a form of oligopoly), in which several providers act together to coordinate services, prices or sale of goods. Monopolies can form naturally or through vertical or horizontal mergers. A monopoly is said to be coercive when the monopoly firm actively prohibits competitors from entering the field. Monopolistic competition is a common market structure where many competing producers sell products that are differentiated from one another (ie. the products are substitutes, but are not exactly alike). Many markets are monopolistically competitive, common examples include the markets for restaurants, cereal, clothing, shoes and service industries in large cities. The "founding father" of the theory of monopolistic competition was Edward Hastings Chamberlin, in his pioneering book on the subject, Theory of Monopolistic Competition (1933). Monopolistically competitive markets have the following characteristics: - There are many producers and many consumers in a given market, and no business has total control over the market price. - Consumers perceive that there are non-price differences among the competitors' products. - There are few barriers to entry and exit. - Producers have a degree of control over price. OLIOGOPOLISTIC MARKET - An oligopoly is a market form in which a market or industry is dominated by a small number of sellers (oligopolists). The word is derived from the Greek oligo 'few' plus -opoly as in monopoly and duopoly. Because there are few participants in this type of market, each oligopolist is aware of the actions of the others. The decisions of one firm influence, and are influenced by, the decisions of other firms. Strategic planning by oligopolists always involves taking into account the likely responses of the other market participants. This causes oligopolistic markets and industries to be at the highest risk for collusion. Characteristics: Interdependence: The most important feature of oligopoly is the interdependencies in decision making of the few firms which comprise the industry. This is because when number of competitors is few, any change in price, output, product etc., by a firm will have a direct effect on the fortune of its rivals, which will then retaliate in changing their own prices, output and products as the case may be. 2. A great importance of advertising and selling costs under conditions of market situation characterised by oligopoly. It is only under oligopoly that advertising comes fully into its own. Under perfect competition, advertising by an individual firm is unnecessary in view of the fact that he can sell any amount of his product at the going price. 3. Group Behaviour: Further, another important feature of oligopoly is that for its proper solution analysis of group behaviour is important. Theories of perfect competition, monopoly and monopolistic competition present no difficult problem of making suitable assumption about human behaviour. 4. Indeterminateness of Demand Curve Facing an Oligopolist. Another important feature is the indeterminateness of the demand curve facing an oligolist. The demand curve shows what amounts of his product a firm will be able to sell at various prices. Factors: 1. Economies of large scale production, 2. Absolute cost advantage of existing firms, 3. Financial capital requirements, 4. Merger and restricting competition, 5. Product differentiation.

MODELS: Sweezy: An industry is characterized as a Sweezy Oligopoly if the following are true. - There are few firms in the market serving many customers, The firms produce differentiated products, Each from believes that rivals will cut their prices in response to a price reduction but will not raise their prices in response to a price increase, Barriers to entry exist. Unlike monopolistic competition and pure competition, oligopolistic competition is hardly anonymous. Because there are few sellers each knows the others identity. Every marketing and production decision needs to take into account the different possible reactions of competitors. And even if there are no deliberate decisions under consideration, the oligopoly firm’s management needs to monitor the activities of the competition and be prepared to react accordingly. Cartels: A cartel is a formal (explicit) agreement among firms. It is a formal organization of producers that agree to coordinate prices and production.[1] Cartels usually occur in an oligopolistic industry, where there is a small number of sellers and usually involve homogeneous products. Cartel members may agree on such matters as price fixing, total industry output, market shares, allocation of customers, allocation of territories, bid rigging, establishment of common sales agencies, and the division of profits or combination of these. The aim of such collusion is to increase individual members' profits by reducing competition. Competition laws forbid cartels. Identifying and breaking up cartels is an important part of the competition policy in most countries, although proving the existence of a cartel is rarely easy, as firms are usually not so careless as to put agreements to collude on paper. Several economic studies and legal decisions of antitrust authorities have found that the median price increase achieved by cartels in the last 200 years is around 25%. Private international cartels (those with participants from two or more nations) had an average price increase of 28%, whereas domestic cartels averaged 18%. Less than 10% of all cartels in the sample failed to raise market prices. PRICE LEADERSHIP MODEL is an observation made of oligopolistic business behavior in which one company, usually the dominant competitor among several, leads the way in determining prices, the others soon following. In the long run price leadership could have a negative impact on the dominant firm. Over time, as the supply from the fringe (smaller) competitors in the market increases the residual demand of the dominant firm decreases. In such a scenario, if the dominant firm intends to continue as the price leader in the market, it can do so only at the cost of decreasing its supply to the market, consequently sacrificing its market share. Unheeded to, the gradual loss in market share could see the once dominant player lose its position of dominance in the market. Classical economic theory holds that price stability is ideally attained at a price equal to the incremental cost of producing additional units. Monopolies are able to extract optimum revenue by offering fewer units at a higher cost. An oligopoly where each firm acts independently tends toward equilibrium at the ideal, but such covert cooperation as price leadership tends toward higher profitability for all, though it is an unstable arrangement. In dominant firm price leadership, follower firms set the same price as an established leader. The price leader may be the largest firm that dominates the industry. In barometric firm price leadership, the most reliable firm emerges as the best barometer of market conditions, or the firm could be the one with the lowest costs of production, leading other firms to follow suit. Although this firm might not be dominating the industry, its prices are believed to reflect market conditions which are the most satisfactory, as the firm would most likely be a good forecaster of economic changes. DECISION MAKING Decision making is commonly defined a choosing from among alternatives. Decision is a choice made from alternative courses of action in order to deal with a problem. A problem is the difference between a desired situation and the actual situation. Therefore, decision making is a process of choosing among alternative courses of action to solve a problem. The decision making process is construed as searching the environment for conditions calling for a decision; inventing, developing and analysing the available courses of action; and choosing one of the particular courses of action. A second and more detailed method is the following: 1. Identify the problem, 2. Diagnose the situation, 3. Collect and analyse data relevant to the issue, 4. Ascertain solution that may be used in solving the problem, 5. Analyse these alternative solutions, 6. Select the approach that appears most likely to solve the problem, 7. Implement it. Models: 1. State The Problem - The first and arguably the most important step in the decision making model in five steps is to identifying the problem. Until you have a clear understanding of the problem or decision to be made, it is meaningless to proceed. If the problem is stated incorrectly or unclearly then your decisions will be wrong. 2. Identify Alternatives - Sometimes your only alternatives are to do it or don't do it. Most of the time you will have several feasible alternatives. It is worth doing research to ensure you have as many good alternatives as possible. 3. Evaluate The Alternatives This is where the analysis begins. You must have some logical approach to rank the alternatives. Two such logical approaches are discussed at Example Of A Decision Matrix and at Sample SWOT Analysis. It is important to realize that these analysis methods are only one of the five steps in the decision making model. 4. Make A Decision - You have evaluated your alternatives. Two or more of your high ranked alternatives may be very close in the evaluations. You should eliminate all of the alternatives that were low ranked. Now it is time to go back and examine the inputs you made to evaluation criteria for the close high ranked alternatives. Do you still feel comfortable with the inputs you made? When you have made any changes it is time for some subjection. You have eliminated the alternatives that do not make logical sense. Now it is time to let your subconscious work. Review all the details of the remaining high ranked close alternatives, so they are completely clear in your mind. Completely leave the project alone for a few days. When you return to the project, the decision will likely be very clear in your head. This only works if you have done your homework! 5. Implement Your Decision - A decision has no value unless you implement it. If you are not good with implementation, then find someone that is. Part of the implementation phase is the follow up. The follow up ensures that the implementation sticks.