BUSINESS ECONOMICS

BUSINESS ECONOMICS

Prof. Ramana Shetty

Student Name: Ravindra M

Assingnment: Semester2
K.Ganesh Kumar
Permanent Registration Number - 180101616016
Reg.No.: 180101616028
Batch: Epg34-028
Assignment (30marks)
Subject: Business Economics MGT-405
Prof. Ramanna Shetty
Question 1: Suppose you are the manager of a chain of computer stores. For
obvious reasons you have been closely following developments in the computer
industry, you have just learned that the government has passed a two-prong
program designed to further enhance the computer industry position in the
global economy. The legislation provides increased funding for computer
education in primary and secondary schools, as well as tax breaks for firms that
develop computer software. As result of this legislation, what do you predict will
happen to the equilibrium price and quantity of software? Show graphically the
possible situations. (10 marks)

Abstract

If, I were to be a manager working in software industry sector, I would keep a

track of technological updates, new policies for the sector and analyze its
implications on current and future market scenarios. It would help in upgrading
the overall organizational abilities to meet the changes and catch up to the
market opportunities.

It would be appropriate to think that, with new legislation - support to computer

education in primary and secondary schools shall strengthen computer industry,
a demand for computer software is expected to be increased, with the existing
level of its production to sudden increase in demand, as a result its price will also
increase. This will continue till more skilled people join to catch the opportunity in
the area and increase the production to meet the spurt in software requirement
and quantity demand, Later, it may decrease the price of software with
increased supply and competition.

Scenario 1:

The equilibrium quantity certainly will increase. Accordingly, market price moves
to upward. The Government policy shall boost the market and enable changes
in demand and supply.

The increased funding for computer education at primary and secondary

schools will lead to an
increase in the demand for computer software. The reduction / relaxations in
tax structure on software sales will lead to an increase in manufacturing and
there on supply of software. Therefore, ‘Supply – Demand’ graph expected to
change to rightward, shift in supply is relatively small compared to the rightward
shift in demand, both the equilibrium price and quantity will increase.
 Demand, Supply and Equilibrium price

Comparative Static Analysis

Scenario 1
Small
Large
increase in Price and
Price of
increase in supply quantity
Software
demand S0 rises
S1

P2
New
equilibrium
P1
Initial
equili
brium D1

D0

Q1 Q2 Quantity bought and sold

Scenario 2:

If supply increases by the same amount as demand, there will be no change in

the price but the equilibrium quantity will rise.

Demand, Supply and Equilibrium price

Comparative Static Analysis

Scenario 2
Equal

Price of
increase Price
S0 in supply
Software constant and
S1
quantity
rises

P1

New
Initial equilibrium
equili
brium

D1 Equal
increase in
D0
demand

Q1 Q2
Quantity bought and sold
Scenario 3:

If the increase in supply of software programs is greater than the increase in the
demand for software programs, the price will be below the equilibrium price. As
there is Surplus in supply and shortage in demand. However, this scenario takes
much longer time to date of current changes in Government legislation.

The resulting equilibrium will evoke a lower price and a greater quantity.

Demand, Supply and Equilibrium Curve

Comparative Static Analysis

Scenario 3
Initial Large increase
S0 in supply
Price of
equilibrium Price falls
Software
and quantity
S1
rises

P1
New
equilibrium

P2

D1 Small
increase in
D0
demand

Q2
Q1 Quantity bought and sold

In all cases, the equilibrium quantity increases. But the effect on the market
price depends on the relative magnitudes of the increases in demand and
supply.
Question 2: Fort Inc. competes against many other firms in an industry. Over the
last decade, several firms have entered this industry and, as consequences. Fort
is earning a return on investment that roughly equals the interest rates.
Furthermore, the four-firm concentration ratio and Herfindahl Hirschman index
are both quite small. Based on this information, which market structure best
characterizes the industry in which Fort competes? Explain the characteristics
this market structure and what happens to the Fort Inc's profit in the short-run
and long-run. What are your strategic advices to Fort Inc. to sustain its profit in
the long-run? (10 marks).

Answer 2: With given input information, Fort Inc. competes in a Perfect

competitive market place. Since, the four-firm concentration ratio and
Herfindahl-Hirschman index are both quite small, new competitors entry did
effect returns of the company.

One way to measure the competitiveness of a specific market is to calculate

the percentage of the total market controlled by the top four companies. The
four-firm concentration ratio is determined by adding up the percentage
market share of each of the top four firms in the industry.

The theory is that the higher percentage of the market controlled by these four
firms, the less competitive the market is, Similarly, it is vice-versa.

The Herfindahl-Hirschman Index

The Herfindahl-Hirschman Index (HHI) is a slightly more advanced measure of

market concentration than the four-firm concentration ratio. It is calculated
taking the market share of each firm in the market, squaring each one and
adding up the sum. The total ranges from zero, meaning perfect competition, to
10,000, indicating a monopoly.

A market with an HHI under 1,00 is considered to operate in highly competitive

market structure / industry.

Perfect market Competition

Leaving the Industry
In the Perfect Competition short-run, the firm will continue to produce if he can
recover the average variable cost, as fixed costs are paid regardless of
production.

Long run equilibrium

In the long run, with the entry of new firms in the industry, the price of the
product will go down as a result of the increase in supply of output and also the
cost will go up as a result of more intensive competition for factors of
production. The firms will continue entering the industry until the price is equal to
average cost so that all firms are earning only normal profits.

The firms will continue leaving the industry until the price is equal to average
cost so that the companies remaining in the field are making only normal profits.
A firm making normal profits will remain in the industry.

In the Perfect Competition Long Run, the loss-making firms will exit the industry,
and new firms will enter the market. Losses are the key to establishing Long Run
equilibrium.

Scenario of Perfect Competitive Market - “A perfect market is one in which the

buyers have no preferences as between different units of the commodity
offered for sale, sellers are quite indifferent to whom they sell and both buyers
and sellers have full knowledge of prices in other part of the market.”

A Perfect Competitive market has the following basic characteristics or features.

(1) Large Number of Buyers and Sellers:

Since there are large number of buyers and sellers, no single buyer or seller by his
action can influence the total supply or price of the commodity. Once the price
is determined by the market, each seller and buyer has to accept it.

(2) Homogeneous Product:

The product sold by all the seller is homogeneous or identical in every respect,
i.e., quality, design, packing etc. The buyers therefore, do not prefer the product
of one seller to that of another.
As a result, all the sellers have to sell their product at a uniform price. If any of
the seller tries to sell his product at a higher price, his product will be out of the
market.

(3) Perfect Knowledge of Market:

Buyers and sellers have perfect knowledge about the market conditions.
Whenever there is any change in the market that is immediately made known
to all the buyers and sellers. Eg: through Advertisements.

(4) Freedom of Entry and Exit:

There is no restriction upon the entry of a new firm in the market or upon the exit
of an existing firm. Due to these characteristics, all firms can get only normal
profit in the long-run. In the short-run, the number of sellers in the market is fixed.

(5) Uniform or Single Price:

Under perfect competition the price of product is determined by the market.
Seller’s contribution to the total supply of product is negligible. So an individual
seller is price-taker. He is not price maker. He can sell more or less at the given
price.

(6) Perfect Mobility of Factors:

Factors of production are perfectly mobile under the perfect competition. In
other words, factors of production can freely move from one industry to
another.

(7) Absence of Selling and Transportation Cost:

Perfect competition assumes that all producers and purchasers of a commodity
are sufficiently close to each other and as a result, there are no selling and
distribution cost.

Conditions of Perfect Competition:

A firm in a perfectly competitive market may generate a profit in the short-run,

but in the long-run it will have economic profits of zero.

Perfect Competition in the Short Run: In the short run, it is possible for an individual
firm to make an economic profit. This scenario is shown in the below diagram, as
the price or average revenue, denoted by P, is above the average cost denoted
by C.
[ P1: Price of good; C: Cost of the good; A: Equilibrium market price; B: Break even;
MR: Marginal Revenue; SRAC: Short run average cost Q1: Quantity sold; D1:
Demand curve; AR1: Average Revenue; MR1: Marginal Revenue; E: Average total
cost at Quantity2; D: Price of the good ]

Over the long-run, if firms in a perfectly competitive market are earning positive
economic profits, more firms will enter the market, which will shift the supply
curve to the right. As the supply curve shifts to the right, the equilibrium price will
go down. As the price goes down, economic profits will decrease until they
become zero.

When price is less than average total cost, firms are making a loss. Over the
long-run, if firms in a perfectly competitive market are earning negative
economic profits, more firms will leave the market, which will shift the supply
curve left. As the supply curve shifts left, the price will go up. As the price goes
up, economic profits will increase until they become zero. In sum, in the long-run,
companies that are engaged in a perfectly competitive market earn zero
economic profits. The long-run equilibrium point for a perfectly competitive
market occurs where the demand curve (price) intersects the marginal cost
(MC) curve and the minimum point of the average cost (AC) curve.

Perfect Competition in the Long Run: In the long-run, economic profit cannot be
sustained. The arrival of new firms in the market causes the demand curve of each
individual firm to shift downward, bringing down the price, the average revenue
and marginal revenue curve. In the long-run, the firm will make zero economic
profit. Its horizontal demand curve will touch its average total cost curve at its
lowest point.

The Demand Curve in Perfect Competition

A perfectly competitive firm faces a demand curve is a horizontal line equal to
the equilibrium price of the entire market.
Demand Curve for a Firm in a Perfectly Competitive Market: The demand curve
for an individual firm is equal to the equilibrium price of the market. The market
demand curve is downward-sloping.
Perfect Competition Long-Run Profit Maximization Formula

Where Long Run Marginal Cost (Long Run MC) = Short Run Marginal Cost (SMC)
= Marginal Revenue (MR)

The demand curve for a firm in a perfectly competitive market varies

significantly from that of the entire market. The market demand curve slopes
downward, while the perfectly competitive firm’s demand curve is a horizontal
line equal to the equilibrium price of the entire market. The horizontal demand
curve indicates that the elasticity of demand for the good is perfectly elastic.
This means that if any individual firm charged a price slightly above market
price, it would not sell any products.
A strategy often used to increase market share is to offer a firm’s product at a
lower price than the competitors. In a perfectly competitive market, firms
cannot decrease their product price without making a negative profit. Instead,
assuming that the firm is a profit-maximizer, it will sell its goods at the market
price only.

Advice to Fort Inc. to Maximise its Profits:

Under perfect competition, Fort Inc. is a price taker of its good since none of the
firms can individually influence the price of the good to be purchased or sold.
As the objective it must choose each of its output levels to maximize its
profits. The key goal for a perfectly competitive firm in maximizing its profits is to
calculate the optimal level of output at which its Marginal Cost (MC) = Market
Price (P). As shown in the graph above, the profit maximization point is where
MC intersects with MR or P. If the above competitive firm produces a quantity
exceeding qo (competitive firm’s output quantity), then MR and Po would be
less than MC, the firm would incur an economic loss on the marginal unit, so the
firm could increase its profits by decreasing its output until it reaches qo. If the
above competitive firm produces a quantity fewer than qo, then MR and
Po would be greater than MC, the firm would incur profit, but not to its
maximum. Therefore, the firm could increase its profits by increasing its output
until it reaches qo.
Question3: A certain town in a state obtains all of its electricity from one
company, South Electric. Although the company is a monopoly, it is owned by
the citizens of the town, all of whom split the profits equally at the end of each
year. The CEO of the company claims that because all of the profits will be
given back to the citizens, it makes economic sense to charge a monopoly
price for electricity. Do you agree with the CEO's argument? Give reasons. What
are the social costs of monopoly power? What are the measures do you suggest
to control monopoly power? 10 marks

Answer 3: With the given inputs, South EIectic company is operating in a

monopoly market.

To illustrate the same on Economic descriptive synopsis - there is no supply

curve because monopolists are price makers and not price takers. In a
competitive market, firms have to take the market price as given. The supply
curve describes the quantities they will put on the market at any given price.

Advantages of Monopolistic Market:

If the firm is a monopoly it does not need that information because it is price
maker. In a competitive market, marginal cost tells us the social cost of
producing a product, and the demand curve tells us about the social benefit of
producing the product in the market. The competitive price/ output is
determined, where marginal cost intersects the demand curve, as on the left. As
we know that at the competitive price/output combination social value is
maximized. While a monopolist can charge any price for its product, that price is
nonetheless constrained by demand for the firm’s product. No monopolist, even
one that is thoroughly protected by high barriers to entry.

- Because the monopolist is the only firm in the market, its demand curve is
the same as the market demand curve.
- Because of the monopolist’s restriction of output, you can see that there
are people who would be willing to pay up to the marginal cost who are
not being served. The reduced output is the difference between QC –
QM, which leads to loss of economic value from a monopoly the loss is
called deadweight loss.

Threats to Monopolistic market players:

1. Anti monopoly legislation

Many countries of the world have enacted legislation to check monopolies. The
Government may enforce Monopolistic and Restrictive Trade Practices Act, to
prevent monopolies, measures may be imposed to promote fair competition and
banned unfair practices in the market

2. Promoting fair competition

With a result of govt. policies, new competitors may arrive in the market, that may
ensure efficiency of firms and results in better quality, and lower price and variety
of choice to the to consumers.

3. Consumer associations
 Consumers unite and form consumer’s associations to protect and promote
their interests. The consumer associations can fight against unfair trade
practices, exploitation etc. In the developed countries consumer associations
are very strong. In India, the consumer movement is not so strong because of
lack of awareness among consumers regarding their rights and they ignore
exploitation and unfair trade practices in the market. It should give them some
reasonable powers.

4. Media publicity
Media plays an important role as they provide information to the consumers
about their rights and unfair trade practices that are taking place in the market.
As media create awareness among consumers about the wrongful acts of
combinations in the market. This will lead to negative publicity of the sales and
profitability of monopolistic markets. this will force them to stop unfair trade
practices and not to exploit the consumers and they will adopt ethical business
practices.

5. Governmental action
As government also play a major role in this so, might impose higher taxes and
restrict subsides to monopolies. As this may help them to stop unfair trade
practices in the market, and consumers will not be exploited.

“No, I will not support the proposal of CEO to have a monopoly market structure
for price of electricity”

In general, a monopolistic market structure would produce less output and

charge higher prices which leads to a decline in consumer surplus and a
deadweight welfare loss. The higher prices would lead to allocate inefficiency
and supernormal profits, leading to reduced benefits to consumers and unequal
distribution of income.

This also raises a question about equity. The higher prices would exploit low
income consumers and their purchasing power might be transferred to
shareholders in the form of dividends leading again to unequal distribution of
income.

A monopoly tends to be less motivated towards economic efficiency such as

cutting costs or increasing productivity. There is also a possibility that a
monopoly would experience diseconomies of scale as the higher it gets bigger,
their average costs increase. Furthermore, the lack of competition could
discourage a monopoly from investing in research and development, leading to
lack of innovation and worse products.