Economics Project

Inclusion:-

Features of Different types of Market Price Discrimination Capital Budgeting

Made by- Vaishali Bhanushali

Roll No.-2003

Class- F.Y. Bcom.

Division- B

Mentor- Dr. Sujata Dhopte

Q.1 (a) What are the features of perfect competition?

Perfect Competition :

Perfect competition refers to a competition between large number of buyers and sellers dealing in homogenous product at uniform price. Perfect competition, is said to prevail when the following conditions are found in the market.

(1) Large Number of buyers and sellers:

Both buyers and sellers are in large number, so that individually neither buyer nor seller is in a position to influence the price. Influence of an individual buyer or seller is absolutely insignificant. They will have to accept the price established in the market. A single seller cannot increase the price. if he does he will not get buyers . the buyer cannot bargain for a lower price, as there are enough buyers at the prevailing price.

(2)Homogeneous Commodity:

A commodity sold in the market is homogeneous , that is, identical in equality and quantity. A difference of any type would provide an excuse for the sellers to charge a higher price. When goods are homogenous there is no possibility of charging a higher price by any seller under the pretext of qualitative or quantitative difference.

(3) free Entry and Exit:

There is no restriction whatsoever for any producer to produce a commodity and sell it in the market. Restriction may be in the form of government’s license or permit , non- availability of technology , inadequate finance etc. Similarly a producer is free to wind up his business without any problems, legal or political. Such freedom avoids excess supply or shortages.

(4) Complete Market Information :

A perfect knowledge or complete information about the market –price , demand . supply, etc . is expected to be possessed by all the buyers and sellers . Such knowledge will prevent the buyers from paying a higher price and sellers charging a different price than what is prevent in the market.

(5)Perfect Mobility of factors of production:

Factors of production are assumed to be freely mobile geographically and occupationally. It mainly applies to labour and capital. Perfect

mobility helps diverting the factors to those areas where there is more demand from the one where demand is deficient. It helps adjust supply according to demand.

(6) No Transport Cost:

Factors od production and goods are transported from the place of production to the market without any cost. Transport cost does not arise if we take small geographical areas where production and sale takes place within or town without incurring much transport cost. This condition is assumed to avoid any possibility of charging a higer price on the pretext of transport cost.

Under the above conditions, for a particular commodity there can be only a single uniform price throughout the market.

A distinction is usually made between pure and perfect competition. Of the six condition mentioned above the first there condition make the competition pure and all six conditions make it perfect. The latter is more restrictive market than the former.

Q.1(b) What are the features of Monopoly ?

Monopoly :

Monopoly refers to an imperfect market situation where a single seller sells the product in different markets at uniform or discriminating prices. Monopoly is identified with single firm large number of buyers and the monopolist as the price maker. Following are the features of monopoly market.

(1.) Single seller:

The monopoly market has a single firm. There is no distinction between firm and industry. Since a single firm supplies to the large number of buyers, the firm tends to be large and specializing in its production

(2.) Large number of buyers:

There is a large market even under monopoly. However there may be differences in the elasticity of demand in each segmented market.

(3.) Product:

The product may be homogenous or even differentiated depending on the nature of market and division of submarkets.

(4.) Monopoly power:

The entry into monopoly market for other firms is restricted. This is due to the monopoly power the firm has. The monopoly power is got by the firm due to following factors.

Legal restriction: The law may prevent other firms from entering. E.g. Government monopolies on entry

Exclusive ownership of technology of production: If the technology of production is known only to a single firm the monopoly power remains un effected.

Exclusive ownership of raw material: Access to raw material is held by a single firm, the monopoly power remains intact

Registered trademarks and brands: I case of registered trademarks; firms can not duplicate and compete in a market. It remains as monopoly.

Personal monopolies: Personal monopolies have individual branding. They cannot be duplicated. The personal monopolies continue

(5.) Price discrimination:

With price discrimination a monopolist sells the same product at different prices in different markets at the same time. The objective of price discrimination is profit maximization.

(6). A monopolist faces a downward sloping demand curve:

Under monopoly, there is no distinction between firm and industry. The Demand is direct on to the firm. In case of perfect competition, the Industry faces down ward sloping demand curve and the firm gets the Perfectly elastic demand curve. In case of monopoly the firm directly Faced the downward facing demand curve.

It means that the firm can sell more only by reducing price. With this Difference, the relationship between AR and MR also change

Q.1 (c) What are the features of Monopolistic competition ?

Monopolistic Competition :

Monopolistic competition is a case of imperfect competition where limited number of firms, compete with differentiated product at dissimilar prices.

Following are the features of monopolistic competition:

(1.) Existence of large number of firms:The first important feature of monopolistic competition is that there is a large number of firms satisfying the market demand for the product. As there are a large number of firms under monopolistic competition, there exists stiff competition between them. These firms do not produce perfect substitutes. But the products are close substitute for each other.(2) Product differentiations:The various firms under monopolistic competition bring out differentiated products which are relatively close substitutes for each other. So their prices cannot be very much different from each other. Various firms under monopolistic competitors compete with each other as the products are similar and close substitutes of each other. Differentiation of the product may be real or fancied.

Real or physical differentiation is done through differences in materials used, design, color etc. Further differentiation of a particular product

may be linked with the conditions of his sale, the location of his shop, courteous behaviour and fair dealing etc.

(3) Some influence over the price:As the products are close substitutes of others any reduction of price of a commodity by a seller will attract some customers of other products. Thus with a fall in price quantity demanded increases. It therefore, implies that the demand curve of a firm under monopolistic competition slopes downward and marginal revenue curve lies below it.

Thus under monopolistic competition a firm cannot fix up price but has influence over price. A firm can sell a smaller quantity by increasing price and can sell more by reducing price. Thus under monopolistic competition a firm has to choose a price-output combination that will maximize price.

(4) Absence of firm's interdependence:

Under oligopoly, the firms are dependent upon each other and can't fix up price independently. But under monopolistic competition the case is not so. Under monopolistic competition each firm acts more or less independently. Each firm formulates its own price-output policy upon its own demand cost.

(5) Non-price competition:

Firms under monopolistic competition incur a considerable expenditure on advertisement and selling costs so as to win over customers. In order to promote sale firms follow definite -methods of competing rivals other than price. Advertisement is a prominent example of non-price competition.

The advertisement and other selling costs by a firm change the demand for his product. The rival firms compete with each other through advertisement by which they change the consumer's wants for their products and attract more customers.

(6) Free entry and exit:

In a monopolistic competition it is easy for new firms to enter into an existing firm or to leave the industry. Lured by the profit of the existing firms new firms enter the industry which leads to the expansion of output. But there exists a difference.

Under perfect competition the new firms produce identical products, but under monopolistic competition, the new firms produce only new brands of product with certain product variation. In such a law the initial

product faces competition from the existing well- established brands of product.

(7) Selling cost

Selling cost is the cost of generating demand. Under monopolistic competition, the firms engage in non price competition. The firms charging different prices justify their prices by advertising, publicity, field campaign and similar promotional activities.

Selling cot helps in generating demand, brand image and justifying the price. Selling cost does not give utility. Selling cost is a burden on the consumer.

Production cost on the other hand generates utility. The production cost decreases with increasing output in, proportion. This is due to economies of scale. Whereas, the selling cost increases in larger proportions to increasing output. This is because, advertising becomes more and more expensive, with increasing output.

Selling cost makes demand elastic and shifts demand curve u wards. In the diagram it can be seen that, selling cot has increased the average cost. Yet, the demand curve has shifted upwards and also became elastic. This is the advantage the firm receives by spending selling cost.

Q.1(d) What are features of Oligopoly ?

Oligopoly:

Oligopoly is an imperfect market condition identified with limited number of firms with high interdependence competing with differentiated or uniform product at uniform prices.

Following are the features of oligopoly market

(1). Limited number of firms:

The number of firms is limited due to intense competition. The

industry remains as a small group of firms.  In case of perfect competition, monopoly and monopolistic competition, the business firms are assumed to behave in such a way as to maximize their profits. The profit-maximizing behaviour on his part may not be valid. The firms under oligopoly are interdependent as they are in a group.

(2.) Importance of advertising and selling costs:

The firms under oligopolistic market employ aggressive and defensive weapons to gain a greater share in the market and to maximise sale. In view of this firms have to incur a great deal on advertisement and other measures of sale promotion. Thus advertising and selling cost play a great role in the oligopolistic market structure. Under perfect competition and monopoly expenditure on advertisement and other measures is unnecessary. But such expenditure is the life-blood of an oligopolistic firm.

(3.) Indeterminateness of demand curve:

This characteristic is the direct result of the interdependence characteristic of an oligopolistic firm. Mutual interdependence creates uncertainty for all the firms. No firm can predict the consequence of its price-output policy. Under oligopoly a firm cannot assume that its rivals will keep their price unchanged if he makes charge in its own price. As a result, the demand curve facing an oligopolistic firm losses its determinateness.

The demand curve as is well known, relates to the various quantities of the product that could be sold it different levels of prices when the quantity to be sold is itself unknown and uncertain the demand curve can't be definite and determinate.

(4) Elements of monopoly:

There exist some elements of monopoly under oligopolistic situation. Under oligopoly with product differentiation each firm controls a large part of the market by producing differentiated product. In such a case it acts in its sphere as a monopolist in lining price and output.

(5). Price rigidity:Under oligopoly there is the existence price rigidity. Prices lend to be rigid and sticky. If any firm makes a price-cut it is immediately retaliated by the rival firms by the same practice of price-cut. There occurs a price-war in the oligopolistic condition. Hence under oligopoly no firm resorts to price-cut without making price-output decision with other rival firms. The net result will be price -finite or price-rigidity in the oligopolistic condition.

(6) Interdependence:The firms under oligopoly are interdependent in making decision. They are interdependent because the number of competition is few and any change in price & product etc by an firm will have a direct influence on the fortune of its rivals, which in turn retaliate by changing their price and output. Thus under oligopoly a firm not only considers the market demand for its product but also the reactions of other firms in the industry. No firm can fail to take into account the reaction of other firms to its price and output policies. There is, therefore, a good deal of interdependences of the firm under oligopoly.

Q.2 What is price- discrimination ? what are the different degrees of price discrimination ?

Price Discrimination :

price discrimination or price differentiation is a pricing strategy where identical or largely similar goods or services are transacted at different prices by the same provider in different markets or territories. Price differentiation is distinguished from product differentiation by the more substantial difference in production cost for the differently priced products involved in the latter strategy. Price differentiation essentially relies on the variation in the customers' willingness to pay. A pricing strategy that charges customers different prices for the same product or service. In pure price discrimination, the seller will charge each customer the maximum price that he or she is willing to pay. In more common forms of price discrimination, the seller places customers in groups based on certain attributes and charges each group a different price.

Price discrimination allows a company to earn higher profits than standard pricing because it allows firms to capture every last dollar of revenue available from each of its customers. While perfect price discrimination is illegal, when the optimal price is set for every customer, imperfect price discrimination exists. For example, movie theaters usually charge three different prices for a show. The prices target various age groups, including youth, adults and seniors. The prices fluctuate with the expected income of each age bracket, with the highest charge going to the adult population

DEGREES OF PRICE DISCRIMINATION

First degree price discrimination

This type of price discrimination requires the monopoly seller of a good or service to know the absolute maximum price (or reservation price) that every consumer is willing to pay. By knowing the reservation price, the seller is able to sell the good or service to each consumer at the maximum price he is willing to pay, and thus transform the consumer surplus into revenues. So the profit is equal to the sum of consumer surplus and producer surplus. The marginal consumer is the one whose reservation price equals to the marginal cost of the product. The seller produces more of his product than he would to achieve monopoly profits with no price discrimination, which means that there is no deadweight loss. Examples of where this might be observed are in markets where consumers bid for tenders, though, in this case, the practice of collusive tendering could reduce the market efficiency.

First-degree occurs when identical goods are sold at different prices to each individual consumer. Obviously, the seller is not always going to be able to identify who is willing to pay more for certain items, but when he or she can, his profit increases. Consumers can see this type of discrimination in the sale of both new and used cars. People will pay different prices for cars with identical features, and the salesperson must attempt to gauge the maximum price at which the car can be sold. This often includes a bargaining aspect, where the consumer attempts to negotiate a lower price.

Second degree price discrimination

In second degree price discrimination, price varies according to quantity demanded. Larger quantities are available at a lower unit price. This is particularly widespread in sales to industrial customers, where bulk buyers enjoy higher discounts.

Additionally to second degree price discrimination, sellers are not able to differentiate between different types of consumers. Thus, the suppliers will provide incentives for the consumers to differentiate themselves according to preference. As above, quantity "discounts", or non-linear pricing, is a means by which suppliers use consumer preference to distinguish classes of consumers. This allows the supplier to set different prices to the different groups and capture a larger portion of the total market surplus.

In reality, different pricing may apply to differences in product quality as well as quantity. For example, airlines often offer multiple classes of seats on flights, such as first class and economy class. This is a way to differentiate consumers based on preference, and therefore allows the airline to capture more consumer's surplus.

Second-degree discrimination refers to companies charging lower prices for higher quantities. In companies where a client orders in bulk and is able to purchase a high number of the same items at once, the client may get a discounted rate. This rate would not apply to a client who only orders a few items at a time. This degree is common in retail stores, where a reduced price may be offered if a shopper buys two T-shirts instead of just one. This form helps to get rid of merchandise and generate more revenue for a company.

Third degree price discrimination

In third degree price discrimination, price varies by attributes such as location or by customer segment, or in the most extreme case, by the individual customer's identity; where the attribute in question is used as a proxy for ability/willingness to pay.

This involves charging a different price to different groups of consumers. These groups of consumers can be identified by particular characteristics such as age, sex, location.

Third degree price discrimination is based on understanding the market, and occurs with great frequency. This type takes many different forms, but in all cases, attempts to derive the most sales from each segmented “group” of consumers. For example, senior citizens are considered a group and are often offered discounts at movie theatres, for transportation, in restaurants, and even in retail stores where seniors may have a “senior day” each week that allows them to take a discount on merchandise. “Students” are another segmented group that may be offered lower prices. Both seniors and students have a higher elasticity of demand and can generally afford to pay less than the average worker.

Q.3 Discuss the meaning and importance of capital budgeting ?

Capital Budgeting :

Capital budgeting (or investment appraisal) is the planning process used to determine whether an organization's long term investments such as new machinery, replacement machinery, new plants, new products, and research development projects are worth the funding of cash through the firm's capitalization structure (debt, equity or retained earnings). It is the process of allocating resources for major capital, or investment, expenditures. One of the primary goals of capital budgeting investments is to increase the value of the firm to the shareholders.

Capital budgeting is the planning of long-term corporate financial projects relating to investments funded through and affecting the firm's capital structure. Management must allocate the firm's limited resources between competing opportunities (projects), which is one of the main focuses of capital budgeting. Capital budgeting is also concerned with the setting of criteria about which projects should receive investment funding to increase the value of the firm, and whether to finance that investment with equity or debt capital. Investments should be made on the basis of value-added to the future of the corporation. Capital budgeting projects may include a wide variety of different types of investments, including but not limited to, expansion policies, or mergers and acquisitions. When no such value can be added through the capital budgeting process and excess cash surplus exists and is not needed, then management is expected to pay out some or all of those surplus earnings in the form of cash dividends or to repurchase the company's stock through a share buyback program.

Choosing between capital budgeting projects may be based upon several inter-related criteria. (1) Corporate management seeks to maximize the value of the firm by investing in projects which yield a positive net present value when valued using an appropriate discount rate in consideration of risk. (2) These projects must also be financed appropriately. (3) If no positive NPV projects exist and excess cash surplus is not needed to the firm, then financial theory suggests that management should return some or all of the excess cash to shareholders (i.e., distribution via dividends).

IMPORTANCE OF CAPITAL BUDGETING

Capital budgeting decisions are of great importance in business planning on account of the following reasons :

(1) Profitability :

Capital budgeting decisions affect the profitability of the firm. They relate to fixed assets which will have a bearing on the competitive position of the firm. A right investment decision can yield low returns. Capital budgeting can help to select most profitable projects for investing the funds available to the firm.

(2) Irreversibility :

Capital investment decisions, once made, are not easily reversible without significant loss. This is because such decisions involve buying land, constructing building, buying and installing plants and machinery, recruiting managerial and other essential staff ,etc .and undoing all this could lead to large financial loss. It is also difficult to find a market for second-hand plant and machinery. Therefore, all investment decisions should be made after a careful analysis.

(3)Future Cost Structure :

Since capital expenditure decisions have their spread over a long time span, they will affect the firms’ future cost structure. Further, the firm’s break even points, sales, future costs, etc. depends upon the firm’s selection of assets.

(4)Limited Resources :

Since capital resources are limited, and investment opportunities are plenty and varied in terms of returns there is need for thoughtful, wise and correct investment decisions .A good investment decisions can bring large returns to the investors. Incorrect decisions would result in low returns and sometimes losses. This can also prevent the firms from taking other investors requires several months of advance planning.

(5)Long Gestation Period

The gestation period between the starting of the project and the plant goes into operation is long. Further, long-term investments provide a framework for future development of the business. Thus, large investment projects should be made after a careful analysis .for all the above reasons, all investment decisions should be made after a thorough and careful analysis