CA Foundation Business Economics Study Material – Meaning of Production

CA Foundation Business Economics Study Material Chapter 3 Theory of Production and Cost – Meaning of Production

Meaning of Production

  • Production is one of the important economic activity that takes place in any economy apart from consumption and investments.
  • An individual firm is the micro-economic unit which undertake the production of goods and services.
  • A firm’s survival depends upon whether it is able to achieve optimum efficiency in production by minimizing the cost of production.
  • Production is the transformation of resources into goods and services. In other words, production is the act of transformation of INPUTS into OUTPUT which satisfies the wants of some people.
    E.g.- Inputs of sugarcane, capital and labour are used to produce SUGAR.
    Production also includes production of SERVICES like those of lawyers, teachers, doctors, etc.
  • The amount of goods and services that an economy is able to produce determines whether it is rich or poor. A country like U.S.A. is a rich country as its production level is high.
  • Man cannot create or destroy matter.
  • In Economics, the term production means creation of economic utilities in the matter i.e. in the things that already exist.
  • Thus, production means creation of those goods and services which have economic utilities i.e. exchange value.
  • According to James Bates and J.R. Parkinson, “Production is the organized activity of transforming resources into finished products in the form of goods and services; and the objective of production is to satisfy the demand of such transformed resources.”
  • Professor J. R. Hicks has defined production “as any activity whether physical or mental, which is directed to the satisfaction of other people’s wants through exchange.”
  • The definition indicates that the term production covers the whole process from creation of utilities till the satisfaction of human wants.

Utilities may be created or added in many ways, such as :-

1. Form Utility

  • It is created by changing the form of raw materials into finished goods for man’s use.
  • E.g. converting raw cotton into cotton fabric.
  • Form utility is created by manufacturing industries.

2. Place Utility

  • It is created by transporting goods from one place to another.
  • E.g. when goods are taken from factory to marketplace, place utility is created.
  • Transport services are involved in creation of place utility.

3. Time Utility

  • It is created by making things available when they are required.
  • E.g. Banks create time utility by granting overdraft facilities.

4. Service Utility (Personal Utility)

  • It is created by providing personal services to the customers by professionals likes lawyers, doctors, bankers, shopkeepers, teachers, transporters, etc

CA Foundation Business Economics Study Material – Business Cycle

CA Foundation Business Economics Study Material Chapter 5 Business Cycle

All countries have gone through fluctuations in economic activities i.e. ups and downs in its economic activities. In other words, every country passes through a pattern where there are period of economic growth, followed by periods of slowing growth and even failing growth. There are periods of prosperity followed by downturns. Thus,

“The Business Cycle is the periodic fluctuations in economic activity measured by change in Real GDP.”

Although these economic fluctuations are recurrent and occur periodically, they are not at regular interval and are not of same length.

Phases of Business Cycle

A business cycle passes through the following four distinct phases:

  1. Expansion/Boom/ Recovery/ Upswing
  2. Peak/Boom/Prosperity
  3. Contraction/Recession/ Downswing
  4. Trough/Depression

The following figure shows the four stages of the business cycle.
CA Foundation Business Economics Study Material Business Cycle

In the figure above the four phases business cycles are shown. The broken line represents long time growth trend or potential GDP. It shows rising trend of growth over a period of time. The figure starts from Trough when the overall economic activities ie. level of production and employment are at the lowest level. With increase in the economic activities the economy moves into Expansion Phase. But expansion phase cannot continue indefinitely, and after reaching Peak, economy starts contracting i.e. Contraction Phase sets in and continue till it reaches the lowest turning point called Trough. Here cycle completes and new cycle starts.

Expansion

In the expansion phase, there is increase in OUTPUT and EMPLOYMENT. Expansion phase is characterized by-

  1. increase in national output,
  2. increase in employment,
  3. increase in aggregate demand,
  4. increase in capital i.e. investments,
  5. increase in consumer spending,
  6. increase in sales, profits, stock prices, & expansion of bank credit.
  7. increase in standard of living.

There is no INVOLUNTARY UNEMPLOYMENT and whatever unemployment exist is only of FRICTIONAL or STRUCTURAL in nature.
The growth ultimately slows down and reaches its peak.

Peak

Peak phase of the cycle is the highest point. The economy is producing at its maximum level. The economy becomes overheated i.e. unsustainable. The expansion phase ends here. The prices of inputs increase, resulting higher cost of production, leading to higher output prices. Higher output price leads to increased cost of living. Fixed income earners and consumers suffer. Economic growth stabilizes at peak an then starts the downswing.

Contraction

In contraction phase. There is fall in OUTPUT and EMPLOYMENT levels. Contraction phase is characterized by—

  1. fall in the level of investments,
  2. fall in the level of production and employment,
  3. fall in the incomes of people,
  4. demand and consumption of both capital goods and consumer goods fall,
  5. bank credit, shrinks as investments fall,
  6. stock prices fall,
  7. firms become pessimistic about future,
  8. there is lot of excess production capacity in industries.

There is large scale involuntary unemployment.

A severe contraction or recession of economic activities pushes the economy into Depression.

Trough and Depression

The lowest level of economic activity is called trough or depression. All economic activity touch the bottom and the phase of trough is reached. Trough is the turning point into expansion. Increased investments lead to increase in consumption. Therefore, industries expand production and start using their idle production capacity and rate of unemployment falls. With this the cycle is complete.

It is very difficult to predict turning points of business cycles. Changes in different economic activities is used to measure the business cycle and to predict in which direction the economy is headed. There are three types of economic indicators, depending on their timing namely—

  1. Leading Indicators,
  2. Lagging Indicators, and
  3. Coincident Indicators

Leading Indicators signal future changes

  • Leading Indicators change before the economy itself changes Le. change prior to large economic adjustments.
    E.g.– changes in stock prices, profit margins and profits, the house market, manufacturing activity, etc. Leading Indicators should be used with caution as they may not be always accurate.
  • Lagging Indicators usually change after the economy as a whole changes i.e. after the real output changes. Lagging Indicators are useful to confirm the business cycle.
    E.g.– unemployment, the consumer price index, interest rates, lending by banks, etc.
  • Coincident Indicators also called Concurrent Indicators occur at about the same time with business cycle movements. They give us idea about current state of economy.
    E.g.    – GDP, inflation, industrial output, personal income, etc.

Features of Business Cycles

  • Business cycles occur periodically. They do not show same regularity, duration and intensity.
  • The length of different phases of business cycles is not definite and hence do not show smoothness and regularity.
  • Business cycles do not bring about changes in one industry or sector but occur simultaneously in all industries and sectors. Further, it passes from one industry to another.
  • Fluctuations take place not only in the level of output but also in other related variables like consumption, employment, investment, interest rates and price level.
  • Cyclical fluctuations affect adversely the consumption of durable goods like capital goods, scooters, cars, houses, refrigerators, etc. Their demand falls. As a result investments become unstable.
    However, consumption of non-durable goods and services does not vary much during different phases of business cycle. .
  • Business cycles causes lot of uncertainty for businessmen and forecasting becomes difficult. Profits fluctuate.
  • Business cycles affect the inventories of goods. During depression inventories start accumulation more than the desired level. This results reduction in the production. When recovery starts, inventories are below the required level.
  • Business cycles are international in character.

Causes of Business Cycles

Business Cycles may occur due to internal and external causes or a combination of both.

Internal Causes (Endogenous Factors): Internal causes of business cycle are those, which are built within the economic system. They are—

1. Fluctuations in Effective Demand:
Fluctuations in economic activities is due to fluctuations in aggregate effective demand. When aggregate demand falls, it results in lower output, income and employment. This causes a downward spiral. Increase in aggregate demand causes conditions of expansion and boom.

2. Fluctuations in Investments:
Investments fluctuate because of changes in profit expectations of entrepreneurs. High investments brings increase in aggregate demand and thus result in upswing and vice versa.

3. Variations in government spending:
Fluctuations in government spending affects the economic activities and results in business fluctuations.

4. Money Supply:
According to Hawtrey and Friendman, business cycles relate to fluctuations in money and credit supply. Cheap money policy leads to expansion of money and credit supply resulting in increased economic activities and vice versa. .

5. Monetary and Fiscal Policies:
Monetary and Fiscal Policies also cause business cycles. Expansionary policies, like low interest rates, rates increased government spending and tax cuts boost economic activities. It there is inflation opposite will be done resulting in showing down of economy.

6. Psychological Factors:
According to Pigou, business cycles appear because of the optimistic and pessimistic mood of the business community. It business community is optimistic about future market conditions, they make investments. Here, the expansion phase starts ultimately leading to boom and vice versa.

7. Other Factors:
According to Schumpeter, business cycles occur due to innovations that take place from time to time in economic system. (Innovation Theory)
According to Nicholas Kaldor, the present fluctuations in prices are responsible for fluctuations in output and employment in future (Cobweb Theory)

External Causes (Exogenous Factors):

1. Wars:
During war time, all the available resources are used up for the production of arms and ammunitions. This results in the fall of production of capital and consumer goods. This in turn causes fall in income, profits and employment and contraction in economic activities take place which may lead to depression.

2. Post War Reconstruction:
After war, the level of consumption and investment goes upward. Both the government and individuals are involved in construction. E.g.- houses, roads, bridges, communication, etc. The economy picks up resulting in higher output, employment and income.

3. Technology:
Another cause of business is scientific development leading to improved technology. Adoption of new technology for production of new and better goods and services require huge investments. Increased investments increases employment income and profits this gives boost to the economy.

4. Natural Factors:
Weather cycles causes fluctuations in agricultural output. If in any year, weather is good the output of agriculture sector will increase. This will also increase the demand for industrial goods and vice versa.

5. Population Growth:
If the population growth rate is higher than the economic growth rate, income level will be low. This will result is lower savings and investments and therefore, lower income and employment.

Relevance of Business Cycles in Business Decision Making

  • Understanding the business cycle is important for all types of business enterprises because it affects the demand for their product and in turn their profits.
  • Knowledge of business cycles, its phases and characteristics help the business enterprises to frame appropriate policies. E.g.-New opportunities for investment, employment and production opens up at the time of prosperity. So understanding the economic environment is important white making business decisions.
  • Business managers have to advantageously respond in complex time during the whole business cycle through boom, downswing, recession and recovery to arrive at sound strategic environment.
  • We have seen that business cycles do not affect all the sector uniformly. Some business are more vulnerable white others are not or less vulnerable to changes in business cycle. Businesses like fashion retailers, electrical goods, restaurants, constructors, advertising, foreign tour operators, etc. are directly linked with economic growth. Such business are called cyclical businesses. So during recession such businesses slump and vice versa.
  • The phase of the business cycle is important to decide on entry into the market by a new firm or to decide about launch of a new product.

CA Foundation Business Economics Study Material – Oligopoly

CA Foundation Business Economics Study Material Chapter 4 Price Determination in Different Markets – Oligopoly

OLIGOPOLY

Introduction:

  • ‘Oligo’ means few and ‘Poly’ means seller. Thus, oligopoly refers to the market structure where there are few sellers or firms.
  • They produce and sell such goods which are either differentiated or homogeneous products.
  • Oligopoly is an important form of imperfect/competition.
  • E.g.- Cold drinks industry; automobile industry; Idea; Airtel. Hutch, BSNL mobile services in Nagpur; tea industry; etc.

Types of Oligopoly:

  • Pure or perfect oligopoly occurs when the product is homogeneous in nature, e.g. Aluminum industry.
  • Differentiated or imperfect oligopoly where products are differentiated. E.g. toilet products.
  • Open oligopoly where new firms can enter the market and compete with already existing firm.
  • Closed oligopoly where entry of new firm is restricted.
  • Collusive oligopoly when some firms come together with some common understanding and act in collusion with each other in fixing price and output.
  • Competitive oligopoly where there is no understanding or collusion among the firms.
  • Partial oligopoly where the industry is dominated by one large firm which is looked upon by other firms as the leader of the group. The dominating firm will be the price leader.
  • Full oligopoly where there is absence of price leadership.
  • Syndicated oligopoly where the firms sell their products through a centralized syndicate.
  • Organized oligopoly where the firms organize themselves into a central association for fixing prices, output, quotas, etc.

Characteristics of Oligopoly Market:

Following are the special features of oligopoly market:

1. Interdependence

  • In an oligopoly market, there is interdependence among firms.
  • A firm cannot take independent price and output decisions.
  • This is because each firm treats other firms as rivals.
  • Therefore, it has to consider the possible reaction to its rivals price-output decisions.

2. Importance of advertising and selling costs

  • Due to interdependence, the various firms have to use aggressive and defensive marketing tools to achieve larger market share.
  • For this the firms spend heavily on advertisement, publicity, sales promotion, etc. to attract large number of customers.
  • Firms avoid price-wars but are engaged in non-price competition. E.g.- free set of tea mugs with a packet of Duncan’s Double Diamond Tea.

3. Indeterminate Demand Curve

  • The nature and position of the demand curve of the oligopoly firm cannot be determined.
  • This is because it cannot predict its sales correctly due to indeterminate reaction patterns of rival firms.
  • Demand curve goes on shifting as rivals too change their prices in reaction to price changes by the firm.

4. Group behaviour

  • The theory of oligopoly is a theory of group behaviour.
  • The members of the group may agree to pull together to promote their mutual interest or fight for individual interests or to follow the group leader or not.
  • Thus the behaviour of the members is very uncertain.

Price and output decisions in an Oligopolistic Market:

As seen earlier, an oligopolistic firm does not know how rival firms react to each other decisions. Therefore, it has to be very careful when it makes decision about its price. Rival firms retaliate to price change by an oligopolistic firm. Hence, its demand curve indeterminate. Price and output cannot be fixed. Some of the important oligopoly models are:

  1. Some economists assume that oligopolistic firms make their decisions independently. Therefore, the demand curve becomes definite and hence equilibrium level of output can be determined.
  2. Some believe that oligopolistic can predict the reaction of rivals on the basis of which he makes decisions about price and quantity.
  3. Cornet considers OUTPUT is the firm’s controlled variable and not price.
  4. In a model given by Stackelberg, the leader firm commits to an output before all other firms. The rest of firms follow it and choose their own level of output.
  5. Bertrand model states PRICE is the control variable for firms and therefore each firm sets the price independently.
  6. In order to pursue common interests, oligopolistic enter into enter into agreement and jointly act as monopoly to fix quantity and price.

Price Leadership:

A large or dominant firm may be surrounded by many small firms. The dominant firm takes the lead to set the price taking into account of the small firms. Dominant firm may adopt any one of the following strategies—

  1. ‘Live and let live’ strategy where dominant firm accepts the presence of small firms and set the price. This is called price-leadership,
  2. In another strategy, the price leader sets the price in such a way that it allows some profits to the follower firms.
  3. Barometric price leadership where an old, experienced, respectful, largest acts as a leader and sets the price. It makes changes in price which are beneficial from all firm’s and industry’s view point. Price charged by leader is accepted by follower firms.

Kinked Demand Curve:

  • In many oligopolistic industries there is price rigidity or stability.
  • The prices remains sticky or inflexible for a long time.
  • Oligopolists do not change the price even if economic conditions change.
  • Out of many theories explaining price rigidity, the theory of kinked demand curve hypothesis given by American economist Paul M. Sweezy is most popular.
  • According to kinked demand curve 4 hypothesis, the demand curve faced by an oligopolist have a ‘Kink’ at the prevailing price level.
  • A kink is formed at the prevailing price because —
    – the portion of the demand curve above the prevailing price is elastic, and
    – the portion of the demand curve below the prevailing price is inelastic

Consider the following figure.
CA Foundation Business Economics Study Material Oligopoly 1

  • In the fig., OP is the prevailing price at which the firm is producing and selling OQ output.
  • At prevailing price OP, the upper portion of demand curve dK is elastic and lower portion of demand curve KD is inelastic.
  • This difference in elasticities is due to the assumption of particular reactions by kinked demand curve theory.

The assumed reaction pattern are –

  1. If the oligopolist raises the price above the prevailing price OP, he fears that none of his rivals will follow him.
    – Therefore, he will loose customers to them and there will be substantial fall in his sales.
    – Thus, the demand with respect to price rise above the prevailing price is highly elastic as indicated by the upper portion of demand curve dK.
    – The oligopolist will therefore, stick to the prevailing prices.
  2. If the oligopolist reduces the price below the prevailing price OP to increase his sales, his rivals too will quickly reduce the price.
    – This is because the rivals fear that their customers will get diverted to price cutting oligopolist’s product.
    – Thus, the price cutting oligopolist will not be able to increase his sales very much.
    – Hence, the demand with respect to price reduction below the prevailing price is inelastic as indicated by the lower portion of demand curve KD.
    – The oligopolist will therefore, stick to the prevailing prices.
    – Each oligopolist will, thus, stick to the prevailing price realising no gain in changing the price.
    – A kink will, therefore, be formed at the prevailing price which remains rigid or sticky or stable at this level.

Other Important Market Forms:

  1. Duopoly in which there are only TWO firms in the market. It is subset of oligopoly.
  2. Monopoly is a market where there is a single buyer. It is generally in factor market.
  3. Oligopsony market where there are small number of large buyers in factor market.
  4. Bilateral monopoly market where there is a single buyer and a single seller. It is mix of monopoly and monopsony markets

CA Foundation Business Economics Study Material – Imperfect Competition : Monopolistic Competition

CA Foundation Business Economics Study Material Chapter 4 Price Determination in Different Markets – Imperfect Competition : Monopolistic Competition

IMPERFECT COMPETITION : MONOPOLISTIC COMPETITION

Introduction

  • We have studied two models that represent the two extremes of market structures namely perfect competition and monopoly.
  • The two extremes of market structures are not seen in real world.
  • In reality we find only imperfect competition which fall between the two extremes of perfect competition and monopoly.
  • The two main forms of imperfect competition are —
    – Monopolistic Competition and
    – Oligopoly

Meaning and features of Monopolistic Competition

  • As the name implies, monopolistic competition is a blend of competitive market and monopoly elements.
  • There is competition because of large number of firms with easy entry into the industry selling similar product.
  • The monopoly element is due to the fact that firms produce differentiated products. The products are similar but not identical.
  • This gives an individual firm some degree of monopoly of its own differentiated product.
  • E.g. MIT and APTECH supply similar products, but not identical.
  • Similarly, bathing soaps, detergents, shoes, shampoos, tooth pastes, mineral water, fitness and health centers, readymade garments, etc. all operate in a monopolistic competitive market.

The characteristics of monopolistic competitive market can be summed up as follows:

  1. Large number of buyers and sellers
    • There are large number of firms.
      – So each individual firms can not influence the market.
      – Each individual firm share relatively small fraction of the total market.
    • The number of buyers is also very large and so single buyer cannot influence the market by demanding more or less.
  2. Product Differentiation
    • The product produced by various firms are not identical but are somewhat different from each other but are close substitutes of each other.
    • Therefore, the products are differentiated by brand names. E.g. – Colgate, Close-Up, Pepsodent, etc.
    • Brand loyalty of customers gives rise to an element of monopoly to the firm.
  3. Freedom of entry and exit
    • New firms are free to enter into the market and existing firms are free to quit the market.
  4. Non-Price Competition
    • Firms under monopolistic competitive market do not compete with each other on the basis of price of product.
    • They compete with each other through advertisements, better product development, better after sales services, etc.
    • Thus, firms incur heavy expenditure on publicity advertisement, etc.

Short Run Equilibrium of a Firm in Monopolistic Competition. (Price-Output Equilibrium)

  • Each firm in a monopolistic competitive market is a price maker and determines the price of its own product.
  • As many close substitutes for the product are available in the market, the demand curve (average revenue curve) for the product of individual firm is relatively more elastic.

The conditions of equilibrium of a firm are same as they are in perfect competition and monopoly i.e.

  1. MR = MC, and
  2. MC curve cuts the MR curve from below.

The following figures show the equilibrium conditions and price-output determination of a firm under monopolistic competition.

When a firm in a monopolistic competition is in the short run equilibrium, it may find itself in the following situations —

  1. Firm will earn SUPER NORMAL PROFITS if its AR > AC;
  2. Firm will earn NORMAL PROFITS if its AR = AC; and
  3. Firm will suffer LOSSES if its AR < AC

1. Super Normal Profits (AR > AC):
CA Foundation Business Economics Study Material Imperfect Competition Monopolistic Competition 1
CA Foundation Business Economics Study Material Imperfect Competition Monopolistic Competition 2
The firm will earn NORMAL PROFITS if AC curve is tangent to AR curve i.e. when AR=AC

2. Losses (AR < AC):
CA Foundation Business Economics Study Material Imperfect Competition Monopolistic Competition 3
The firm may continue to produce even if incurring losses if its AR ≥ AVC.

Long Run Equilibrium of a Firm in Monopolistic Competition

  • If the firms in a monopolistic competitive market earn super normal profits, it attracts new firms to enter the industry.
  • With the entry of new firms market will be shared by more firms.
  • As a result, profits per firm will go on falling.
  • This will go on till super normal profits are wiped out and all the firms earn only normal profits.

CA Foundation Business Economics Study Material Imperfect Competition Monopolistic Competition 4

  • In the long run firms in a monopolistic competitive market just earn NORMAL PROFITS.
  • Firms operate at sub-optimal level as shown by point ‘R’ where the falling portion AC curve is tangent to AR curve.
  • In other words firms do not operate at the minimum point of LAC curve ‘L’.
  • Therefore, production capacity equal to QQ, remains idle or unused called excess capacity.
  • This implies that in monopolistic competitive market —
  • Firms are not of optimum size and each firm has excess production capacity
  • The firm can expand its output from Q to Q, and reduce its average cost.
  • But it will not do so because to sell more it will have to reduce its average revenue even more than average costs.
  • Hence, firms will operate at sub-optimal level only in the long run.

CA Foundation Business Economics Study Material – Concepts of Product

CA Foundation Business Economics Study Material Chapter 3 Theory of Production and Cost – Concepts of Product

Product i.e. output refers to the volume of goods produced by a firm in a particular period of time.
There are three concepts relating to the physical production by factors namely-

  1. Total Product (TP),
  2. Average Product (AP), and
  3. Marginal Product (MP).

1. Total Product (TP):

  • The total output produced by all the factors per unit of time is called total product.
  • Total product increases with an increase in the variable factor input.
  • Column Nos. (1) and (2) of the following table shows a total product schedule.

2. Average Product (AP):

  • The. average product means the total product per unit of a variable factor.
  • In other words, it is the total product divided by the number of units of a variable factor.<CA Foundation Business Economics Study Material Concepts of Product 1
  • Column No. (3) of the following table shows the average product of variable factor.

3. Marginal Product (MP):

  • The marginal product means addition made to total product by the use of an extra unit of variable factor.
  • It may be stated as-
    MPn = TPn – TPn-1
    where,
    MPn = Marginal product when ‘n ’ units of variable factors are used
    TP = Total Product
    n = number of units of variable factors used.
  • Marginal Product may also be defined as the change in total output due to use of additional unit of variable factor
    CA Foundation Business Economics Study Material Concepts of Product 2
    Where –
    Δ = a small change Column No. (4) of the following table shows the marginal product schedule.

Table: Product Schedule

Units of Variable Total Product (TP) factor E.g. LABOUR Average Product (AP) Marginal Product (MP)
1 10 10 10
2 30 15 20
3 60 20 30
4 80 20 20
5 90 18 10
6 90 15 0
7 85 12.1 -5

Average product and Marginal product are related to one another.

(i) – When average product of the variable factor is rising, marginal product of the variable factor is more than its average product.
– So when average product curve is rising, the marginal product curve will lie somewhere above it.

(ii) – When average product of the variable factor is falling, marginal product of the variable factor is less than its average product.
– So when average product curve is falling, the marginal product curve will lie somewhere below it.

(iii) – When average product of the variable factor is maximum and constant, marginal product is equal to average product.
– In other words, the marginal product curve cuts the average product curve at its maximum point.

CA Foundation Business Economics Study Material – Fixed Inputs (Fixed Factors) and Variable Inputs (Variable Factors)

CA Foundation Business Economics Study Material Chapter 3 Theory of Production and Cost – Fixed Inputs and Variable Inputs

Fixed Inputs (Fixed Factors) and Variable Inputs (Variable Factors)

Comparison Fixed Inputs Variable Inputs
(i) Meaning
  • The factors which cannot be easily and quickly changed and require long time to make adjustment in them with the changes in the level of output are called fixed inputs or fixed factors of production.
  • In other words, factor inputs whose quantity does not vary from day-to-day are called as fixed inputs.
  • The factors which can be easily and quickly changed and readily adjusted with the changes in the level of output are called variable inputs or variable factors of production.
  • In other words, factor inputs whose quantity may vary from day-to-day are called as variable inputs.
(ii) Examples
  • Examples of fixed inputs – buildings, machinery, plant, top management, etc.
  • It requires long time to make variations in them.
  • E.g. To construct a new factory building with a larger area and capacity.
  • Examples of variable inputs – ordinary labour, raw-material, power, fuel chemicals, etc.
  • It can be readily changed.
(iii) Relation with Output
  • Fixed inputs do not vary with the level of output.
  • Its quantity remains the same, whether the output is more or less or zero in SHORT RUN
  • Variable inputs vary directly with the level of output.
  • Such factors are required more, when output is more; less, when output is less and zero, when output is zero in SHORT RUN.
(iv) Cost
  • The cost of the fixed inputs is called FIXED COST.
  • In the short run the firm has to bear the fixed cost even if the output is zero.
  • Since the quantity of fixed inputs remains the same, fixed cost remains the same whatever be the level of output.
  • The cost of the variable inputs is called VARIABLE COST.
  • Since variable inputs vary directly with the level of output, variable costs are also positively related with output. If output is zero, variable cost is also zero.
  • If output is increased variable cost also increases and vice-versa.

Short Run (Short Period) & Long Run (Long Period)

Comparison Short Run Long Run
(i) Meaning
  • The short run is defined as the period of time in which some factors of production or at least one factor is fixed i.e. does not vary with output.
  • Thus, in the short period some factors are FIXED FACTORS E.g. Factory building, machinery, management, etc. and some are VARIABLE FACTORS E.g. Labour, raw-material, power, fuel, etc.
  • The long run is defined as the period of time in which all factors may vary.
  • In the long run, all factors become variable and so there is no distinction between fixed and variable factors.
(ii) Scale of Production OR Size of the Firm
  • In the short run, the output is produced with a GIVEN SCALE OF PRODUCTION i.e. the size of plant or firm (and so the production capacity) remains unchanged.
  • Hence, production can be increased or decreased only by changing the amount of variable factors.
  • In the long run, the output is produced with the CHANGE IN THE SCALE OF PRODUCTION i.e. the size of plant or firm can be increased (and so the pro­duction capacity).
  • Hence, production can be increased by varying all factors i.e. fixed factors (of short period) as well as variable factors.
(iii) Produc­tion Law
  • The production function which is studied in the short run period is called as the Law of Variable Proportions.
  • The production function which is stud­ied in the long run period is called as the Law of Returns to Scale.
(iv) Decisions about Change in factors
  • The decisions to change the amount of variable factors (like raw material, labour, etc.) are taken very frequently depending upon changes in demand of the commod­ity.
  • Hence, short run is the ‘ACTUAL PRO­DUCTION PERIOD’ during which some factors are fixed while some are variable.
  • Thus, firms operate in the short run period.
  • The decisions to change the amount of fixed factors i.e. scale of production or to close down the firm are taken only once in a while.
  • Hence, long run is the ‘PLANNING PERIOD’.
  • Thus, firms plan in the long run period.
(v) Nature of Supply
  • In the short run period, supply can be adjusted upto a limited extent as per changes in demand.
  • In other words, supply is relatively inelastic.
  • In the long run period, supply can be fully adjusted as per changes in demand.
  • In other words, supply is relatively elastic.
(vi) Nature of Cost
  • In short run period, cost is classified as FIXED COST and VARIABLE COST.
  • Fixed cost is the cost of fixed inputs and Variable cost is the cost of variable inputs.
  • Fixed cost is the main feature of short run period
  • In long run period ALL COSTS ARE VARIABLE.
  • Variable cost is the main feature of long run period.
(vii) Effect on Price
  • In short-run, the price determination of a commodity is more influenced by –
    (a) The demand forces than supply forces because supply in short-run is rela­tively inelastic, and
    (b) The UTILITY of the commodity.
  • The short-run price is called SUB-NOR­MAL PRICE
  • In long-run, the price determination of a commodity is more influenced by-
    (a) The supply forces than demand forces because supply in long-run is relatively elastic, and
    (b) The COST OF PRODUCTION of the commodity.
  • The long-run price is called NORMAL PRICE.
(viii) Average Cost Curve
  • The short-run average cost curve is ‘U’ shaped.
  • Its U-shape is explained with the Law of Variable Proportions.
  • The long-run average cost curve is also U shaped.
  • But its U- shape is not as prominent as short-run average cost curve.
  • Its U-shape is explained with the Law of Returns to Scale.
  • Long-run average cost curve is also called ‘PLANNING CURVE’ and ‘ENVELOPE CURVE’.
(ix) Profit of Firms In the short-run period –

  • The firms under perfect competition on being at equilibrium may earn normal profits, super normal profits or incur losses;
  • The monopoly firm on being at equi­librium may earn normal profits, super normal profits or incur losses;
  • The firms under monopolistic competi­tion on being at equilibrium may earn normal profits, super normal profits or incur losses.
 In the long run period-

  • The firms under perfect competi­tion earn only NORMAL PROFITS and operate at optimum level.
  • The monopoly firm can earn SUPER NORMAL PROFITS and operate at sub-optimum level.
  • The firms under monopolistic competition earn only NORMAL PROFITS and operate at sub-opti­mum level.

CA Foundation Business Economics Study Material – Production Function

CA Foundation Business Economics Study Material Chapter 3 Theory of Production and Cost – Production Function

Production Function

  • Output is a function of inputs i.e. factor services such as land, labour and capital which are used in production. In other words, production is a transformation of PHYSICAL INPUTS into PHYSICAL OUTPUT.
  • The functional relationship between physical inputs and physical output, per unit of time under a given state of technology is called production function.
  • It can also be expressed in the form of a mathematical equation in which output is the dependent variable and inputs are the independent variables.
    Q = f (a, b, c ………… n)
    Where –
    Q denotes quantity of output of a commodity per unit of time
    f stands for function of i.e. depends on a, b, c,… n denotes quantity of various inputs.

Assumptions of Production Function:
The production function is based on the following assumptions:

  1. It is specified with reference to a specified period of time.
  2. It is assumed that the state of technology remains the same, during the period of time.
  3. It is assumed that the firm uses best and most efficient technique available in production.
  4. It is assumed that the factors of production are divisible into viable units.

The production function can be explained under two heads:
1. The short run production function in which input – output relations are analysed where –

  • One input is variable, all other inputs are fixed, (described as the Law of Variable Proportions) OR
  • Two inputs are variable, all other factors are fixed (explained with the help of isoquants)

2. The long run production function in which input- output relations are analysed where all the inputs are variable (described as the Law of Returns to Scale).

Cobb-Douglas Production Function
Q = f (L, K).
Where –
Q = Output; L = Labour; K = Capital

Paul H. Douglas and C.W. Cobb of the U.S.A. studied the production function of the American manufacturing industries. This production function applies to the whole of manufacturing in U.S.A. rather than to an individual firm. In this case, output is manufacturing production and inputs used are labour and capital.

The conclusion of study is that labour contributed 3 /4th and capital about 1 /4th in the manufacturing production.

CA Foundation Business Economics Study Material – Factors of Production

CA Foundation Business Economics Study Material Chapter 3 Theory of Production and Cost – Factors of Production

Factors of Production

Land:

Generally, land means earth’s surface.
However, in economics land refers to all the free gifts of nature i.e. natural resources. Land includes natural resources:

  1. on the surface of earth; E.g. Soil, forest, plots of land, etc.
  2. below the surface of earth, E.g. mineral deposits, etc. and
  3. above the surface of earth, E.g. climate, sunshine, rain, etc.

Land has the following characteristics

  1. Primary Factor. Land is the original and primary or natural factor of production. It provides various natural resources for production.
  2. Free Gift of Nature. Land is the creation of nature and not man made. It is a free gift of nature to mankind.
  3. Inelastic Supply. Land is fixed in supply. Its supply cannot be either increased or decreased by any human efforts. However, its supply is relatively elastic from the point of view of a firm.
  4. Lacks Geographical Mobility. Land cannot be moved bodily from one place to another. However, land is said to be mobile in the sense it can be put to many alternative uses.
  5. Passive Factor. Land does not yield any result unless human efforts and capital are employed.
  6. Heterogeneous. Land differs in nature, fertility, uses and productivity from one place to another.
  7. Permanent. It means that land cannot be destroyed. The productive power of soil is original and indestructible according to RICARDO.
  8. Diminishing Returns. The land is subject to the Law of Diminishing Returns more quickly in the cultivation of land.

Labour:

  • Labour in economics means any work whether physical or mental done in exchange for some monetary reward.
  • Anything done out of love and affection is not labour in economic sense.

Labour has the following peculiarities (characteristics) which makes it different from other factors:

1. Labour is inseparable from labourer

  • All other suppliers of factors can be separated from the factors which they supply. E.g. Land can be separated from its owner.
  • However, the labourer cannot be separated from the work which he performs. E.g. A doctor has to attend his patients in person. Labour is connected with HUMAN EFFORTS.

2. Human Factor

  • It is a live factor of production. Hence, labour has feelings and temperament.
  • So it is very much affected by surroundings, working, conditions, motivation, leisure, recreation, working hours, etc.

3. Highly perishable

  • Labour cannot be stored for future use. It is highly perishable.
  • A day lost without work means a day’s work gone forever.
  • Hence, labourer has weak bargaining power and has to accept even low wages.

4. The labourer sells his services and not himself

  • In the labour market it is labour which is brought and sold and not the labourer.

5. Heterogeneous

  • Labour power differs from labourer to labourer.
  • Labour power depends upon physical strength, education, skill, training, efficiency, etc.
  • Hence, labour can be classified as unskilled, semi-skilled and skilled labour.
  • The skilled labour is called as human capital.

6. Mobile

  • Labour is a mobile factor.
  • Labour is much less mobile than capital.
  • Labourer is human being and hence has attachment with his family, custom, religion, culture, etc. and so is hesitant to move from one place to another.

7. Active Factor

  • Labour is the most active factor of production. Other factors are made operative with the use of labour.

8. Labour has sociological characteristics.

  • Employment of labour involves problems relating to labour welfare.
  • E.g. Social security like provident fund, gratuity, medical benefits, pension, etc.
  • Other factors do not have such characteristics.

9. Supply curve of labour is backward sloping.

10. The supply of labour is inelastic in short run.

Capital:

  • In ordinary language, capital is used in the sense of money.
  • But in economics the term ‘Capital’ means man made stock of goods like factories, machines, tools, equipments, raw materials, dams, canals, transport vehicles, etc. which are used in production.
  • Thus, ‘Capital’ in economics is used in the sens(e of real capital i.e. capital goods.
    Capital has therefore, been rightly defined as “produced means of production” and as “man made instrument of production”.

Land and labour are primary or original factors of production. But capital is produced by man working with nature to help in the production of further goods. Following are the main characteristics of capital: –

1. Capital is man made
Capital is not produced by nature. It is artificial as it is produced by man.

2. Capital is productive
Use of capital increases the overall productivity in a given process. It provides tools and implements to labour for production.

3. Supply of capital is elastic

  • The supply of capital can be adjusted to demand.
  • The stock of capital depends on capital formation.
  • Thus, by raising the rates of savings and investments the supply of capital can be increased.

4. All capital is wealth

  • Capital is that part of wealth which is used in further production of wealth.
  • Hence, capital has all the characteristics of wealth like utility, scarcity, transferability and price.

5. Capital is a passive factor
It alone is unable to produce anything. It is ineffective without the use of labour and land.

6. Capital is the most mobile factor.
It has both place as well as occupational mobility.

7. Capital is durable
Physical capital assets like plant and machinery, factory buildings, etc. last over a long time in the process of production. However, they are subject to depreciation.

8. Capital involves social cost

  • In the creation of capital, the money to be used for present consumption has to be diverted.
  • Sacrifice of present consumption and enjoyment of the people is treated as a social cost.

Types of capital

CA Foundation Business Economics Study Material Factors of Production 1

  • Fixed Capital. Those durable physical assets which can be repeatedly used in the process of production for long periods are called fixed capital. E.g. Machinery, Plant, Tools, Factories, Railways, etc.
  • Circulating or Working Capital. Working capital refers to those goods which are used up in the single act of production. Such goods are used only ONCE in production. E.g. raw materials, power, fuel, etc. They are single use producer’s goods.
  • Sunk Capital. Sunk capital is the capital which is used to produce only one single commodity. It can be put to a single specialized use only. E.g. A brick kiln can be used only to bake brick and nothing else. Sunk capital therefore, lacks occupational mobility.
  • Floating Capital. Floating capital is that which can be put to several uses. E.g. electricity, money, leather, etc.
    Real Capital. Real capital refers to the physical capital goods like machinery, raw material, factory buildings, etc. which help in production.
  • Human Capital. The human capital is in the form of people who are equipped with education, skills, training, good health, etc. A faster economic growth can be achieved with the accumulation of human capital.
  • Tangible Capital. Tangible capital is one which can be seen and touched. E.g. machinery, tools, etc. in other words, it is real capital.
  • Intangible Capital. It cannot be seen or touched. It can only be felt. E.g. goodwill, etc.
    Money Capital. It is in the form of shares, debentures, bonds, stock certificates, etc. Money is invested in expectations of returns.
  • Individual Capital. Capital resources having personal or private ownership of an individual or group of individuals is called individual capital. E.g. Tata Enterprises.
  • Social Capital. The capital which is owned by the society as a whole is called as social capital. E.g. roads, railways, schools, dams, canals, etc.

Capital Formation

  • Capital formation means a sustained increase in the stock of real capital in a country.
  • It is thus, an addition of capital goods like machines, tools, factories, transport facilities, power, etc. in the country.
  • Such capital goods are used for further production of goods and thus increases the production capacity of the country.
  • Capital formation is also known as investment.
  • Capital formation plays an important role in the development of an economy generally, higher the rate of capital formation, more economically developed an economy would be.

There are mainly three stages of capital formation which are as follows:-

1. Savings
Savings represents that part of income which is not consumed. Level of savings in a country depends on – (i) ability to save, and (ii) willingness to save.

(i) ability to save

  • Ability to save depends upon the income of an individual.
  • Higher the income, higher is the savings.
  • This is because with the increase in income the propensity to consume falls and propensity to save increases.
  • This is true in case of both the individuals and the economy.

(ii) willingness to save

  • A person with ability to save must also have willingness to save.
  • Willingness to save depends upon individual’s concern about future. If a person is foresighted and wants to make future secure, he will save more.
  • Willingness to save also depends upon family affection, desire for the growth and promotion of business, desire for prestige and power habits, sound banking system, stability in the money value, State’s taxation policy, etc.

2. Mobilization of Savings.

  • The money so saved by the households must enter into circulation i.e. must be mobilized and make them available to the businessmen or entrepreneurs who require it for investment purposes.
  • This requires a network of banks, financial institutions (like UTI, IDBI, etc.), insurance companies, etc.
  • Such facilities help to promote high rate of mobilization and canalization of savings.

3. Investments

  • The final stage is the investment of savings into capital assets like machinery, tools, buildings, dams, etc.
  • Investment requires a large number of honest, dynamic, daring, efficient and skilled entrepreneurs in the economy.
  • Investments also depends upon the factors like expected profits, rate of interest, size of market, stability in the money value, internal peace and security, fear of foreign aggression, etc.

Entrepreneur:

  • The most important factor in production i.e. enterprise is provided by entrepreneur.
  • An entrepreneur is a person or group of persons who bring together the different factors of production i.e. land, labour and capital at one place; combine them in right proportions; initiate the process of production by making them work together and bear the risks and uncertainty involved in it.

He is therefore also called the organizer, the manager or risk bearer. An entrepreneur performs the following functions:-

1. Initiating a business enterprise

  • The first function of an entrepreneur is to start a business. For this he brings together the different factors of production like land, labour and capital.
  • He pays them their respective remuneration i.e. rent for land, wages to labour and interest to capital.
  • Any surplus left after factor payment is his reward i.e. profit which is not fixed.
  • If his planning goes wrong he may also incur losses.

2. Risk and Uncertainty bearing

  • Main function of an entrepreneur is to bear risk and uncertainty. According to Prof. F. H. Knight there are two types of risks namely –
    1. Foreseeable or insurable risks e.g. risk of fire, thefts, accidents, etc.
    2. Unforeseeable or non-insurable risk e.g. technological risks due to inventions, fluctuations in demand due to change in fashion etc., trade cycles, changes in govt, policies, etc.
  • Foreseeable risks can be predicted and hence can be insured. Such risks do not cause uncertainty and thus do not give rise to profits.
  • Unforeseeable risks involve uncertainty and give rise to profits.
  • True entrepreneurship lies in bearing non-insurable risks and uncertainties.

3. Innovations

  • Prof. Joseph A. Schumpeter considers innovation as the true function of the entrepreneur.
  • Innovation refers to all those changes in the production process the objective of which is to reduce the cost of production and increase profits.
  • Innovations in wider sense includes introduction of new or improved production methods, a new machine, a new plant, use of a new source of raw material, change in the internal organizational set-up, etc.
  • Such innovations give rise to profits but temporarily because once these are adopted by other firms, the profits could disappear.
  • Hence, entrepreneur has to continuously introduce new innovations and contribute to technological progress and economic growth of the country.

Enterprise’s objectives and constraints
Earning profit is considered to be the prime objective of every business. However, earning profit cannot be the only objective of the business because an enterprise functions in the economic, social, political and cultural environment. Hence, an enterprise has to set us objectives in relation to such environment. The objectives of an enterprise are as follows:

1. Organic objectives: The basic purpose of all kinds of enterprises is to SURVIVE and EXIST i.e. to stay alive. This is possible only when it is able to recover its costs and earn profits. Once the enterprise is assured of its survival, it will aim at growth and expansion.

  • Growth as on objective has gained importance with the rise of professional managers. H.L. Marris’s and other economists assert that managers of a corporate firm are interested in maximizing the growth rate rather than in profit maximization.
  • Owners are interested in profits, capital, market share and public reputation.
  • For growth and expansion of the firm it is necessary that adequate profits are made so as to provide internal funds for further investment.
  • Growth and profit are both positively related to the size of the firm. Both of the objectives converge in one namely A STEADY GROWTH IN THE SIZE OF THE FIRM.
  • Managers prefer balanced rate of growth over profits. The growth rate and growth is measured in terms of sales, number of branches, number of employees, etc.

2. Economic Objectives: The basic and important objective of every business is to earn profit. Accordingly therefore, the firm determines the price and output policy in a j manner that profits can be maximized.

  • Investors expect sufficient returns from their company. Similarly, creditors and employees are also interested in profitable enterprise.
  • The definition of profits in economic sense has different meaning than accountants’ definition of profits.
  • Accounting Profit = Total Revenue – Accounting Cost (Explicit Cost)
  • Economic Profit = Total Revenue – Economic Cost (i.e. Explicit + Implicit Cost)
  • Profit maximization objective has been criticized because all firms do not aim to maximize profits. E.g.-
    (i) Some firm try to achieve SECURITY with reasonable level of profit.
    (ii) Some firms may try to MAXIMISE SALES (Prof. Baumol)
    (iii) Some economists point that owners and managers of a company try to MAXIMISE THEIR UTILITY rather than profit.

3. Social Objectives: A business enterprise is an integral part of society. It lives in a society. It cannot grow unless it meets the needs of the society. It makes use of resources of society. Therefore, it owes something to society. Some of the important social objectives j of business are-

  • To maintain continuous and desired quantity of unadulterated goods of standard quality.
  • To avoid unfair trade practices.
  • To avoid profiteering and anti-social practices.
  • To create opportunities for gainful employment for the people in the society. A business should specially consider the handicapped, disabled and poor people.
  • To avoid air, water or noise pollution.

4. Human Objectives: Employees are precious resources who contribute abundantly to the success in business. Therefore, the overall development of its employees, keep them motivated and taking care of employees should be major objectives of an organization. The common human objectives are-

  • To provide fair deal to the employees at different levels.
  • To provide good working conditions.
  • To pay competitive and satisfactory wages and salaries.
  • To impart training to employees and keep updating their knowledge.
  • To provide opportunities to employees in decision making process on the matters affecting them.

5. National Objectives: An enterprise should try to fulfil the nations need and aspirations. It should work towards implementation of national plans and policies. Some of the national objectives are- .

  • To remove inequality of opportunities and provide opportunities to all irrespective of caste and religion to work and to progress.
  • To produce according to national priorities.
  • To help country achieve self-sufficiency in production of all types of goods and thus reduce dependence on other countries.
  • To provide education and training to young men to bring about skill formation for achieving growth and development.
  • All the enterprises have multiple objectives and therefore, the need to set priorities by balancing of the objectives.

In the pursuit of the above objectives an enterprise’s action may get constrained in following ways-

  • Lack of knowledge and information about many variable that affect business.
  • Constraints may be experienced due to governments’ restrictions on the production, price and movement of factors.
  • There may be infrastructural bottleneck.
  • Changes in business and economic conditions; change in government policies about location, prices, taxes, etc.; natural calamities like fire, flood, famine, etc.
  • Constraints are also faced due to inflation, rising interest rates, unfavourable exchange rate, capital and labour costs, etc.

Enterprise’s Problems
A business enterprise face many problem from its start, through its life time till it is closed down. Following are the main problems:

1. Problems relating to objectives: An enterprise functions in the economic, social, political and cultural environment. Therefore, it has a set of many objectives in relation to its environment.

These multifarious objectives many times conflict with one another. Hence, the enterprise faces the problem of choosing and striking balance between them.
E.g.- Social responsibility objective may run into conflict with expansion of production activity resulting in pollution.

2. Problems relating to location and size of the plant: An enterprise has to decide about ‘ the LOCATION of its plant. In doing so, it has to consider many costs like cost of labour, facilities and cost of transportation to decide where its plant should be located.

Another problem faced is about SIZE of the firm, whether it should be a small scale or large scale unit. Before deciding upon the scale of operations several aspects will have to be considered like technical, managerial, marketing, financial, etc.

3. Problems relating to selecting and Organising physical facilities: A firm has to decide about the nature of production process to be used and the type of equipments required for it. This will depend upon the require^ volume of production
This choice will be based on-
(i) the evaluation of costs of different equipments, and (ii) efficiency
It has also to prepare layout of plant.

4. Problems relating to Finance: A firm also has to do good financial planning. For this an enterprise will have to determine-

  • amount of funds required,
  • demand and cost of its products,
  • profits on investments, and
  • capital structure

5. Problems relating to Organisation Structure: An enterprise faces problem relating to organizational structure. It has to divide the total work of the enterprise by creating different departments in order to carry on the specialized functions by each department. It has to clearly define the roles and relationships of all positions also.

6. Problems relating to Marketing: For survival and growth, a firm has to properly do marketing of its products and services.

  • It has to identify its actual and potential customers, tools of marketing, etc.
  • After identifying the market, the firm has to decide upon product, promotion, price and place aspects.

7. Problems relating to Legal Formalities: Many legal formalities are to be carried out at the time of formation, during the life time and at closure.
E.g.- assessing various taxes and paying, maintenance of records, filing various returns, adhering to laws formulated by Govt., etc.

8. Problems relating to Industrial Relations: This problem relates to winning worker’s co-operation, enforcing discipline among workers, workers participation in management, dealing with trade unions, etc.

 

CA Foundation Business Economics Study Material – Monopoly

CA Foundation Business Economics Study Material Chapter 4 Price Determination in Different Markets – Monopoly

MONOPOLY

Introduction:

  • ‘Mono’ means single and ‘Poly’ means seller.
  • So monopoly refers to that market structure where there is a single firm producing and selling a commodity which has no close substitute.
  • As there is no rival firms producing close substitute,
    – the monopoly firm itself is industry, and
    – its output constitutes the total market supply.

Features of Monopoly Market:

Following are the main features of the monopoly market:

  1. Single seller and Large number of buyers
    • There is only one seller or producer of a commodity in the market but there are many buyers.
    • As a result, the monopoly firm has full control over the supply of the commodity.
  2. No close substitutes.
    • The commodity sold by the monopolist generally has no close substitutes.
    • Therefore, the cross elasticity of demand between monopolist’s commodity and other commodity is zero or less than one.
    • As a result monopoly firm faces a downward sloping demand curve.
  3. Restrictions to entry for new firms.
    • The monopoly firm controls the situation in such a way that it becomes difficult for new firms to enter the monopoly market and compete with monopoly firm.
    • There are many barriers to the entry of new firm which can be economic, institutional or artificial in nature.
  4. Price maker
    • A monopoly firm has full control over the supply of the commodity
    • Price is solely fixed by the monopoly firm.
    • So, a monopoly firm is a “price maker”.

Sources of Monopoly:

The sources of monopoly may be listed as follows:

  1. Patents, copyrights and trade marks.
    • Legal support provided by the government to promote inventions, to produce a particular commodity, etc. by granting patents, copyrights, trademarks, etc. creates monopoly.
  2. Control of raw materials.
    • If one firm acquires the sole ownership or control of essential raw materials, then the other firms cannot compete.
  3. Economies of large scale.
    • The monopoly firm may be very big and enjoy economies of large scale of production.
    • The cost of production is therefore low, hence it may supply goods at low prices.
    • This leaves no scope for new firms to enter the market.
  4. Government control on entry
    E.g. – In defense production; public utility services like water, transportation, electricity, etc.
  5. Business combines.
    • Monopolies are created by forming cartels, pools, syndicates, etc. by the firms producing the same goods to control price and output.

Average Revenue and Marginal Revenue Curves under Monopoly

  • Monopoly firm constitutes industry.
  • Therefore, the entire demand of the consumers faces the monopolist.
  • The demand curve of a monopoly firm is the same as the market demand curve of the commodity.
  • As the demand curve of the consumers for a commodity slopes downward, the monopolist faces a downward sloping demand curve.
  • This means that monopolist can sell more quantity only by lowering the price of the commodity
  • The demand curve facing the monopolist is also his average revenue curve. Thus, average revenue curve of the monopolist slopes downwards
  • As the demand curve i.e. average revenue curve slopes downwards, marginal revenue curve will be below it.

CA Foundation Business Economics Study Material - Monopoly 1
CA Foundation Business Economics Study Material - Monopoly 2

  • In the figure above, AR curve of the monopolist slopes downward and MR curve lies below it.
  • At a quantity OQ, average revenue ie. price is OP (=QT) and marginal revenue is QK which is less than average revenue OP (=QT).

Thus, in case of monopoly —

  1. AR and MR are both negatively sloped curves,
  2. MR curve lies half way between the AR curve and the Y-axis,
  3. AR cannot be zero i.e. AR curve cannot touch X-axis,
  4. MR can be zero or even negative i.e. MR curve can touch or cut the X-axis.

Short Run Equilibrium of the Monopoly Firm (Price – Output Equilibrium)

  • A monopolist will produce an output that maximizes his total profits.
  • A monopolist will maximize his total profits when —
    1. Marginal Cost = Marginal Revenue (MC = MR), and
    2. Marginal cost curve cuts the marginal revenue curve from below.
  • When a monopoly firm is in the short run equilibrium, it may find itself in the following situations —
    1. Firm will earn SUPER NORMAL PROFITS if its AR > AC;
    2. Firm will earn NORMAL PROFITS if its AR = AC, and
    3. Firm will suffer LOSSES if its AR < AC.

1. Super Normal Profits (AR > AC):
The monopoly firm would earn super normal profits if at the equilibrium output AR > AC.

CA Foundation Business Economics Study Material - Monopoly 3
CA Foundation Business Economics Study Material - Monopoly 4

2. Normal Profits (AR = AC):
The monopoly firm would earn normal profits if at the equilibrium output AR = AC.

CA Foundation Business Economics Study Material - Monopoly 5

3. Losses (AR < AC):
The monopoly firm would suffer losses, if at the equilibrium output its AR < AC.

CA Foundation Business Economics Study Material - Monopoly 6

If monopoly firm’s AR > AVC or AR = AVC, it can continue to produce though it suffer losses at the equilibrium level of output. .

Long Run Equilibrium of a Monopoly Firm:

  • The long run equilibrium of the monopoly firm is attained where its MARGINAL COST = MARGINAL REVENUE ie. MC = MR.
  • The monopoly firm can continue to earn super normal profits even in the long run.
  • This is because entry to the market for new firms is blocked.
  • All costs are variable costs in the long run and these must be recovered.
  • This means that monopoly firm does not suffer loss in the long run.
  • However, if it is unable to recover variable costs, it should shut down.

Fig. Shows the long run equilibrium of a monopoly firm.

CA Foundation Business Economics Study Material - Monopoly 7

  • Thus, we find that monopoly firm continue to earn super normal profits in long run.
  • A monopoly firm does not produce at the lowest point of LAC curve ie. does not produce at optimum level because of absence of competition.
  • In other words, it operates at sub-optimum level and therefore, does not produce optimum output.

Price Discrimination:

  • A monopoly firm is also the industry.
  • A single firm controls the entire supply.
  • Therefore, the firm has the power to sell the same commodity to different buyers at different prices.
  • When the firm charge different prices to different customers for the same commodity, it is engaged in price discrimination.
    E.g. – Electricity supplying firm charge higher rate per unit of electricity from industrial units than domestic consumers.

Conditions for price discrimination:
Price discrimination is possible under the following conditions:

  1. Existence of two or more than two sub-markets.
    • The monopolist should be able to divide the total market for his commodity into two or more sub-markets.
    • Such division of market may be on the basis of income, geographic location, age, sex, etc.
    • E.g. on the basis of income, a doctor may charge high fees from rich patients than from poor.
  2. Different markets should have different price elasticity of demand.
    • The difference in price elasticity of demand in different markets enables the monopolistto discriminate among customers.
    • He can charge higher price in inelastic market and lower price in elastic market.
  3. No possibility of resale.
    • It should not be possible for buyers to purchase the commodity from a cheaper market and sell it in the costlier markets.
    • In other words, there should be no contact among the buyers of the two markets.
  4. Control over supply.
    • The supply should be in full control of the monopolist.

Price-output determination under price discrimination

  • Suppose a discriminating monopolist sell his output in market ‘A’ and market ‘B’.
  • Market ‘A’ has less elastic demand and market ‘B’ has more elastic demand.
  • Suppose the monopolist has only one production facility then he is faced with the questions—
    • How much to produce?
    • How much to sell in each market?
    • How much price to charge in each market?
  • The monopolist will first decide profitable level of total output (ie. where MR = MC) and then allocate the quantity between two markets.
  • The condition for equilibrium here would be —
    1. MC = MRa = MRb. It means that MC must be equal to MR in individual markets separately.
    2. MC = AMR (aggregate marginal revenue). It means that the monopolist must be in equilibrium not only in individual markets but also when the two markets are treated as one.

The process of price determination under price discrimination is shown in the following figure —

CA Foundation Business Economics Study Material - Monopoly 8

  • In the fig. – MC curve intersect the AMR curve at point E
  • Point E shows the total output is OQ.
  • When a perpendicular EH is drawn, it intersect MRa at E1 and MRb at E2. These are the equilibrium point of market A and B
  • Point Et shows that quantity sold in market A is OQ1 and the price charged is OP1
  • Point E2 shows that quantity sold in market B is OQ2 and the price charged is OP2
  • Price charged in market ‘A’ is higher than in market ‘B’.
  • Thus, a discriminating monopolist chargers a higher price in the market ‘A’ having less elastic demand and a lower price in the market ‘B’ having more elastic demand.
  • The marginal revenue is different in different markets.

E.g. – Suppose the single monopoly price is Rs. 40 and elasticity of demand in market A and B is 2 and 4 respectively.

CA Foundation Business Economics Study Material - Monopoly 9

  • It is clear from the above example that the marginal revenue is different in different markets when elasticity of demand at the single price is different.
  • MR is higher in the market having high elasticity and vice versa.
  • In the above example, since marginal revenue in market ‘B’ is more, it will be profitable for monopolist to transfer some units of the commodity from market ‘A’ to ‘B’.
  • When monopolist transfers the commodity from market A to B, he is practicing price discrimination.
  • As a result, the price of commodity will increase in market A and will decrease in market B.
  • Ultimately the marginal revenue in the two market will become equal.
  • When marginal revenue becomes equal in the two markets, it will no longer be profitable to transfer the units of commodity from market A to B.

Objectives of Price discrimination:
To earn maximum profit; to dispose off surplus stock; to enjoy economies of scale; to capture foreign markets etc.

Degrees of price discrimination:
Pigou classified price discrimination as follows:

  1. first degree price discrimination where the monopolist fix a price which take away the entire consumer’s surplus,
  2. second degree price discrimination where the monopolist take away only some part of consumer’s surplus. Here price changes according to the quantity sold. E.g. large quantity sold at a lower price,
  3. third degree price discrimination where the monopolist charges the price according to location customer segment, income level, time of purchase etc.

 

CA Foundation Business Economics Study Material Chapter 5 Business Cycles – MCQs

CA Foundation Business Economics Study Material Chapter 5 Business Cycles – MCQs

MULTIPLE CHOICE QUESTIONS

1. The term business cycle refers to –
(a) fluctuations in aggregate economic activity over time.
(b) ups and down in the production of goods
(c) increasing unemployment
(d) declining savings

2. Expansion phase all but one of the following characteristics.
(a) Increase in national output
(b) Increase in consumer spending
(c) Excess production capacity of industries
(d) Expansion of bank credit

3. Which one of the following is not the characteristic of business cycle?
(a) They are recurrent
(b) They are not at regular intervals
(c) They have uniform causes
(d) All the above

4. The turning points of the business cycle are
(a) Expansion and Peak
(b) Peak and Contraction
(c) Contraction and Trough
(d) Peak and Trough

5. _____ refers to the top or the highest point of business cycle.
(a) Expansion
(b) Peak
(c) Expansion and Peak
(d) None of the above

6. Involuntary unemployment is almost zero in the _____ phase of business cycle.
(a) Expansion
(b) Contraction
(c) Trough
(d) Depression

7. The economy is said to be overheated at the _____ phase of business cycle.
(a) Expansion
(b) Peak
(c) Contraction
(d) Depression

8. Cost of living increases when business cycle is _____
(a) expanding
(b) contracting
(c) at peak
(d) at lowest point

9. There is large scale of involuntary unemployment in the _____ phase of business cycle.
(a) expansion
(b) peak
(c) contraction
(d) none of the above

10. Fall in the level of investments, fall in production, fall in employment, fall stock prices, etc. are found during _____ phase of business cycle.
(a) expansion
(b) boom
(c) peak
(d) contraction

11. All but one are the endogenous factors of business cycle
(a) War
(b) Changes in government spending
(c) Money supply
(d) Fluctuations in investments

12. _____ is the severe form of recession with lowest level of economic activity.
(a) Upswing
(b) Depression
(c) Downswing
(d) Peak

13. Fall in the interest rates is a typical feature of
(a) recovery
(b) boom
(c) depression
(d) contraction

14. During depression _____ industry suffer from excess production capacity.
(a) capital goods
(b) consumer durable goods
(c) non-durable goods
(d) both ‘a’ and ‘b’

15. The great depression of _____ caused enormous misery and human sufferings
(a) 1929 – 33
(b) 1919 – 23
(c) 1940 – 53
(d) 1950 – 63

16. The lowest level of economic activity is called _____
(a) contraction
(b) trough
(c) recovery
(d) none of the above

17. There is end of pessimism and the beginning of optimism at ______
(a) expansion
(b) peak
(c) trough
(d) depression

18. Which of the following is not the features of business cycle?
(a) Business cycle follow perfectly timed cycle
(b) Business cycle vary in intensity
(c) Business cycle vary in length
(d) Business cycle have no set pattern

19. The trough of a business cycle occur when _____ hits its lowest point.
(a) the money supply
(b) the employment level
(c) inflation in the economy
(d) aggregate economic activity

20. Industries that are most adversely affected by business cycles are the _____
(a) Durable goods and services sector
(b) Non-durable goods and services
(c) Capital goods and Non-durable goods sectors
(d) Capital goods and durable goods sectors

21. _____ indicators change before the economy itself changes.
(a) Lagging
(b) Coincident
(c) Leading
(d) concurrent

22. _____ indicators change after the economy as a whole changes.
(a) Lagging
(b) Coincident
(c) Leading
(d) Concurrent

23. Changes in stock prices, profit margins and profits, manufacturing activity, etc. are examples of _____ indicator.
(a) Leading
(b) Lagging
(c) Concurrent
(d) Coincident

24. A variable that moves later than aggregate economic activity is called _____
(a) a leading variable
(b) a coincident variable
(c) a lagging variable
(d) a cyclical variable

25. While _____ indicators forecast economic fluctuation, _____ indicators confirm the trends.
(a) lagging ; leading
(b) lagging ; coincident
(c) coincident ; leading
(d) leading ; lagging

26. A variable that occur simultaneously with the business cycle movements is _____ indicator.
(a) Leading
(b) Lagging
(c) Coincident
(d) Cyclical

27. Coincident indicators show _____
(a) the current state of business cycle
(b) the rate of change of expansion
(c) the rate of change of contraction
(d) all the above

28. At the time of Great Depression of 1930s, the global GDP fell by around _____
(a) 12%
(b) 14%
(c) 15%
(d) 10%

29. Which one of the following is not correct about business cycle?
(a) They occur simultaneously in all industries and sectors
(b) They affect not only output level but also other related variables
(c) They are international in character
(d) None of the above

30. Which of the following describes best a typical trade cycle?
(a) Economic expansions are followed by economic contractions
(b) Inflation is followed by rising income and employment
(c) Economic expansions are followed by economic growth and development
(d) Stagflation followed by rising employment

31. During upswing, the unemployment rate and output _____
(a) rises ; falls
(b) rises ; rises
(c) falls ; rises
(d) falls ; falls

32. Which of the following does not occur during expansion phase?
(a) Consumer spending increases
(b) Employment increases as demand for labour rises
(c) Business profits and business confidence increase
(d) None of the above

33. When aggregate economic activity is declining, the economy is said to be in _____
(a) contraction
(b) an expansion
(c) a trough
(d) a turning point

34. Which one of the following is not an example of coincident indicator?
(a) GDP
(b) inflation
(c) retail sales
(d) New orders for plant and machinery

35. Which one of the following is an example of lagging indicator?
(a) personal income
(b) new orders for plant and equipment
(c) the consumer price index
(d) slower deliveries

36. _____ is of the view that fluctuations in economic activities are because of fluctuations in aggregate effect demand.
(a) Keyens
(b) Schumpeter
(c) Nicholas Kaldor
(d) Joan Robinson

37. High rate of investment brings _____
(a) high level of employment
(b) increase in the aggregate demand
(c) increase in output
(d) all the above

38. If any unemployment exists during expansion phase of business cycle, it is _____ un employment.
(a) voluntary and frictional
(b) technological and structural
(c) frictional and structural
(d) structural and involuntary

39. The most probable outcome of increase in aggregate demand is _____
(a) expansion of economic activity
(b) contraction of economic activity
(c) stable economic activity
(d) volatile economic activity

40. According to _____ a trade cycles is a purely monetary phenomena
(a) Keyens
(b) Hawtrey
(c) Schumpeter
(d) Nicholas Kaldor

41. Optimistic and pessimistic mood of the business community also affects the economic activities is the view of _____
(a) Hawtrey
(b) Schumpeter
(c) Pigou
(d) Keyens

42. According to _____ trade cycles occur due to onset of innovations
(a) Hawtrey
(b) Adam Smith
(c) JM Keyens
(d) Schumpeter

43. Business cycles appear due to present fluctuations in prices affecting the output and employment in future is _____
(a) Cobweb theory by Nicholas Kaldor
(b) Ordinal theory by Allen & Hicks
(c) Cobweb theory by J.M. Keyens
(d) None of the above

44. Production of _____ goods fall during the war times.
(a) arms and ammunition
(b) non-durable and capital
(c) capital and weapons
(d) capital and consumer

45. During war times most of the productive resources are diverted for the production of
(a) capital goods
(b) consumer goods
(c) weapons and arms
(d) service

46. Economic recession is characterized by all of the following except _____
(a) Decline in investments, employment
(b) Increase in the price of inputs due to increased demand for inputs
(c) Investors confidence is shaken
(d) Demand for goods, services decline

47. Production of new and better goods and services using new technology results in _____
(a) expansion of employment
(b) increase in the incomes and profits
(c) boost to economy
(d) all the above

48. Understanding the business cycle is important for business managers because _____
(a) they affect the demand for their products
(b) they affect their profits
(c) to frame appropriate policies and forward planning
(d) all the above

49. Businesses whose fortunes are closely linked to the rate of economic growth called _____
(a) Cyclical business
(b) Capital good business
(c) Both ‘a’ and ‘b’
(d) None of the above

50. If the population growth rate is higher than the economic growth rate it will result in _____
(a) higher income ; lower savings ; lower employment
(b) lower income ; lower savings ; lower investment
(c) higher investment ; lower income ; higher saving
(d) lower income ; lower savings ; higher employment

Answers

CA Foundation Business Economics Study Material Chapter 5 Business Cycles - MCQs answers

CA Foundation Business Economics Study Material – Perfect Competition

CA Foundation Business Economics Study Material Chapter 4 Price Determination in Different Markets – Perfect Competition

PERFECT COMPETITION

Introduction:

Perfect competition is a market structure where there are large number of firms (seller) which produce and sell homogeneous product. Individual firm produces only a small portion of the total market supply.

Therefore, a single firm cannot affect the price.
– Price is fixed by industry.
– Firm is only a price taker.
– So the price of the commodity is uniform.

Features of perfect competition

Following are the main features of perfect competition:

  1. Large number of buyers and sellers:
    • The number of buyers and sellers is so large that none of them can influence the price in the market individually.
    • Price of the commodity is determined by the forces of market demand and market supply.
  2. Homogeneous Product:
    • The product produced by all the firms in the industry are homogeneous.
      – They are identical in every respect like colour, size, etc.
      – Products are perfect substitutes of each other.
  3. Free entry and exit of the firms from the markets:
    • New firms are free to enter the industry any time.
    • Old firms or loss incurring firms can leave industry any time.
    • The condition of free entry and exit applies only to the long run equilibrium of the industry.
  4. Perfect knowledge of the market:
    • Under perfect competition, all firms (sellers) and buyers have perfect knowledge about the market.
    • Both have perfect information about prices at which commodities can be sold and bought.
  5. Perfect mobility:
    • The factors of production can move freely from one occupation to another and from one place to another.
  6. No transport cost:
    • Transport cost is ignored as all the firms have equal access to the market.
  7. No selling cost:
    • Under perfect competition commodities traded are homogeneous and have uniform price.
    • Therefore, firm need not make any expenditure on publicity and advertisement.

Equilibrium of the Industry:

  • Industry is a group of firms producing identical commodities.
  • Under perfect competition, price of a commodity is determined by the interaction between market demand and market supply of the whole industry.
  • The equilibrium price is determined at a point where demand for and supply of the whole industry are equal to each other.
  • No individual firm can influence the price.
  • Firm has to accept the price determined by the industry.
  • Therefore, the firm is said to be price taker and industry, the price maker.

Equilibrium of the industry is illustrated as follows:

CA Foundation Business Economics Study Material - Perfect Competition

The above table and fig. shows that at a price of ₹ 6 per unit, the quantity demanded equals quantity supplied.
The industry is at equilibrium at point ‘E’, where the equilibrium price is ₹ 6 and equilibrium | quantity is 60 units.

Equilibrium of a firm:

  • We have already seen that under the perfect competition, the price of the commodity is determined by the forces of market demand and market supply le. price is determined by industry.
  • Individual firm has to accept the price determined by the industry. Hence, firm is a PRICE TAKER.

CA Foundation Business Economics Study Material - Perfect Competition 1

  • In the table – the equilibrium price for the industry has been fixed at ₹ 6 per unit through the inter-action of market demand and supply.
  • Table – shows that the firm has no choice but to accept and sell their commodity at a price that has been determined by the industry ie. ₹ 6 per unit.
  • The firm cannot charge higher price than the market price of ₹ 6 per unit because of fear of loosing customers to rival firms.
  • There is no incentive for the firm to lower the price also.
  • Firm will try to sell as much as it can at the price of ₹ 6 per unit.
  • Table – shows that firm’s AR = MR = Price.

CA Foundation Business Economics Study Material - Perfect Competition 2

  • Fig. shows that being a price taker firm, it has to sell at a given price i.e. ₹ 6 per unit.
  • Therefore, firm’s demand curve is a horizontal straight line parallel to X-axis i.e. a perfectly elastic demand curve.
  • We know that price of a commodity is also the AR for the firm.
  • Therefore, demand curve also shows the AR for different quantities sold by the firm.
  • As every additional unit is sold at a given price i.e. ₹ 6 per unit, the MR = AR and the two curves coincides.
  • Thus, in a perfectly competitive market a firm’s AR = MR = Price = Demand Curve

Conditions for equilibrium of a firm:

  • In perfect competition, the firms are price takers and output adjusters.
  • This is because the price of the commodity is determined by the forces of market demand and market supply ie. by whole industry and individual firm has to accept it.
  • Therefore firm has to simply choose that level of output which yields maximum profit at the prevailing prices.
  • The firm is at equilibrium when it maximises its profit.
  • The output which helps the firm to maximise its profit is called equilibrium output.
  • There are two conditions for the equilibrium of a firm. They are —
    1. Marginal Revenue should be equal to the marginal cost i.e. MR = MC. (First order condition)
    2. Firm’s marginal cost curve should cut its marginal revenue curve from below i.e. marginal cost curve should have positive slope at the point of equilibrium. (Second order condition)
  • If MR > MC, there is incentive to produce more and add to profits.
  • If MR < MC, the firm will have to decrease the output as cost of production of additional units is high.
  • When MR = MC, it is equilibrium output which maximises the profits.

CA Foundation Business Economics Study Material - Perfect Competition 3

  • Fig. shows that OP is the price determined the industry and firm has to accept it.
  • At prevailing price OP the firm faces horizontal demand curve or average revenue curve.
  • Since the firm sells every additional unit at the same price, marginal revenue curve coincides with average revenue curve.
  • In the fig. at point ‘A’, MR = MC but second condition is not fulfilled.
  • Therefore, OQ1 is not equilibrium output. Firm should expand output beyond OQ1 because
    – it will result in the fall of marginal cost, and
    – add to firm’s profits.
  • In the fig. at point ‘B’ not only
    MR = MC
    but MC curve cuts the MR curve from below Le. it has positive slope.
  • Therefore, OQ2 is the equilibrium level of output and point ‘B’ represents equilibrium of firm.

Supply curve of the firm in a competitive market

In a perfectly competitive industry, the MC curve of the firm is also its supply curve. This can be explained with the help of following figure.

CA Foundation Business Economics Study Material - Perfect Competition 4

  • The fig. shows that at the market price OP1 the firm faces demand curve D,.
  • At OP1 price the firm supplies OQ1 quantity because here MC=MR.
  • If the price rises to OP2 the firm faces demand curve D2.
  • At OP2 price the firm supplies OQ2 quantity.
  • Similarly at OP3 and OP4 price corresponding supplies are OQ3 and OQ4 respectively.
  • Thus, the firm’s marginal cost curve indicates the quantities of output which it will supply at different prices.
  • It can be observed that the competitive firm’s short run supply curve is identical only with that portion of MC curve, which lies above the AVC.
  • Hence, price ≥ AVC.

Short Run Equilibrium of a Competitive Firm. (Price – Output Equilibrium)

A competitive firm in the short run attains equilibrium at a level of output which satisfies the following two conditions:

  1. MC = MR, and
  2. MC curve cuts the MR curve from below.

When a competitive firm, is in short run equilibrium, it may find itself in any of the following situations —

  1. it break evens i.e. earn NORMAL PROFITS where Average Revenue = Average Cost i.e. AR = AC.
  2. it earns profit i.e. earn SUPER NORMAL PROFITS where Average Revenue > Average Cost i.e. AR > AC.
  3. it suffer LOSSES where Average Revenue < Average Cost i.e. AR < AC.

Normal Profits (AR = AC):
A firm would earn normal profits if at the equilibrium output AR=AC.
CA Foundation Business Economics Study Material - Perfect Competition 5

Super Normal Profits (AR > AC):
A firm would earn super normal profits if at the equilibrium output AR > AC.
CA Foundation Business Economics Study Material - Perfect Competition 6

Losses (AR < AC):
A firm suffer losses, if at the equilibrium level of output, its AR < AC.
CA Foundation Business Economics Study Material - Perfect Competition 7
CA Foundation Business Economics Study Material - Perfect Competition 8

  • When the firm incur losses, a question arises whether it should continue to produce or should it shut down ?
  • The answer to this lies in the cost structure of the firm.
  • Total cost of a firm = Total Fixed Costs + Total Variable Costs
  • Fixed costs once incurred cannot be recovered even if the firm shuts down.
  • Therefore, whether to shut down or not depends on variable costs alone.
  • If AR (Price) > AVC or AR = AVC, the firm can continue to produce even though it suffer losses at the equilibrium level of output.
  • If AR (Price) < AVC, the firm should shut down.

Long run Equilibrium of a Competitive Firm

  • In a perfectly competitive market there is no restriction on the entry or exit of firms.
  • Therefore, if existing firms are earning super normal profits in the short run, they will attract new firms to enter the industry.
  • As a result of this, the supply of the commodity increases. This brings down the price per unit.
  • On the other hand, the demand for factors of productions rises which pushes up their prices and so the cost of production rises.
  • Thus, the price line or AR curve will go down and cost curves will go up.
  • As a result of this, price line or AR curve becomes tangent to long run average cost curve. This wipes out super normal profit.
  • Hence, in long run firms earn only normal profits.

CA Foundation Business Economics Study Material - Perfect Competition 9

  • Fig. Shows that long run LMR = LMC = LAC = LAR = Price
  • The firm is at equilibrium at point E1
  • E1 is the minimum point of LAC curve. Thus firm produces equilibrium output OQ1 at the minimum or optimum cost.
  • In the long run under competitive market —
    – Firms earn just normal profits, and
    – competitive firms are of optimum size because they produce at optimum cost Le. at the lowest point of long run average cost curve.