Tag: Business economics

Management Notes

Degrees of Price Discrimination

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Price discrimination means charging different prices from different customers or for different units of the same product. In the words of Joan Robinson: “The act of selling the same article, produced under single control at different prices to different buyers is known as price discrimination.” Price discrimination is possible when the monopolist sells in different markets in such a way that it is not possible to transfer any unit of the commodity from the cheap market to the dearer market.

Degrees of price discrimination

Prof. Pigou in his Economics of Welfare describes three degrees of discriminating power which a monopolist may wield. The type of discrimination discussed above is called discrimination of the third degree. We explain below discrimination of the first degree and the second degree.

Discrimination of the First Degree (1st) or Perfect Discrimination

Discrimination of the first degree occurs when a monopolist charges “a different price against all the different units of commodity in. such wise that the price exacted for each was equal to the demand price for it and no consumer’s surplus was left to the buyers.”

Joan Robinson calls it perfect discrimi­nation when the monopolist sells each unit of the product at a separate price. Such discrimination is possible only when consumers are sold the units for which they are prepared to pay the highest price and thus they are not left with any consumer’s surplus.

For perfect price discrimination, two conditions are required

(1) To keep the buyers separate from each other, and

(2) To deal with each buyer on a take-it-or-leave-it basis. When the discriminator of first degree is able to deal with his customers on the above basis, he can transfer the whole of consumers’ surplus to himself. Consider Figure 1. Where DD1 is the demand curve faced by the monopolist. Each buyer is assumed as a price-taker. Suppose the discriminating monopolist sells four units of his product at four different prices:

OQ1 unit at OP1price, Q1Q2 unit at OP2 price, Q2Q3 unit at OP3 price and Q3Q4 unit at OP4 price. The total revenue (or price) obtained by him would be OQ4 AD. This area is the maximum expenditure that the consumers are willing to incur to buy all four units of the product under the first-degree discriminator’s all-or-nothing offer. But with no price discrimination under simple monopoly, the monopolist would sell all four units at the uniform price OP4 and thus obtain the total revenue of OQ4AP4.

This area represents the total expenditure that consumers would actually pay for the four units. Thus the difference between what Quantity the consumers were willing to pay (OQ4 AD) under Fig. 1 the take-it-or-leave-it offer of the first degree discrimi­nator and what they actually pay (OQ4AP4) to the simple monopolist, is consumers’ surplus. This is equal to the area of the triangle DAP4.

Thus under the first-degree price discrimination, the entire consumers’ surplus is pocketed by the monopolist when he charges a separate price for each unit of the product. Price discrimination of the first degree is rare and is to be found in such rare products as diamonds, jewels, precious stones, etc. But a monopolist must have full knowledge of the demand curve faced by him and he should know the maximum price that the consumers are willing to pay for each unit of the product he wants to sell.

Discrimination of the Second Degree (2nd) or Multi-part Pricing

In discrimination of the second degree, the monopolist divides the consumers in different slabs or groups or blocks and charges different prices for different slabs of the same product. Since the earlier units of the product have more utility for the consumers than the later ones, the monopolist charges a higher price for the former units and reduces the price for the later units in the respective slabs.

Such discrimination is only possible if the demand of each consumer below a certain maximum price is perfectly inelastic. Electric supply companies in developed countries practice discrimination of the second degree when they charge a high rate for the first slab of kilowatts of electricity consumed. As more electricity is used, the rate falls with subsequent slabs.

Figure 2 illustrates the second degree discrimination, where DD1is the demand curve for electric­ity on the part of domestic consumers in a town. CP3 represents the cost of generating electricity, so that the electricity company charges M1P1 rate per kw. up to OM1 units. For consuming the next M1 to М2 units, the rate is lowered to M2P2. The lowest rate charged is M3P3 for M2 to M3 units. M3P3 is, however, the lowest rate which will be charged even if a con­sumer consumes more than M3 units of electricity.

If the electricity company were to charge only one rate throughout, say M3P3the total revenue would not be maximized. It would be OCP3 M3But by charg­ing different rates for different unit slabs, it gets the total revenue equal to OM3 x P1M1 + OM2 x P2M2 + OM3x P3M3 Thus the second degree discriminator would take away a part of consumers’ surplus covered by the rectangles ABEP1and BCFP2 .The shaded area in three triangles DAP1 Р1ЕР2, and P2FP3 still remains with consumers as their surplus.

The second degree price discrimination is practised by telephone companies, railways, companies supplying water, electricity and gas in developed countries where these services are available in plenty. But it is not found in developing countries like India where such services are scarce.

The differences between the first and second degree price discrimination may be noted. In the first degree discrimination, the monopolist charges a different price for each different unit of the prod­uct. But in second degree discrimination, a number of units in one slab (or group or block) are sold at the lowest price and as the slabs increase, the prices charged by the monopolist are lowered. In the case of the former the monopolist takes away the whole of consumers’ surplus. But in the latter case, the monopolist takes away only a portion of the consumers’ surplus and the other portion is left with the buyer.

Conditions under which Price Discrimination is Possible

Price discrimination is possible under following conditions:

  1. Nature of Commodity

In the first place it is said that price discrimination is possible when the nature of the commodity or service is such that there is no possibility of transference from one market to the other.

That is, the goods sold in the cheaper market cannot be resold in the dearer market; otherwise the monopolist’s purpose will be defeated.

  1. Distance of Two Markets

Price discrimination is possible when the two markets or markets are separated by large distance or tariff barriers, so that it is not possible to transfer goods from a cheaper market to dearer markets. For instance, a monopolist may sell the same product at a higher price in Bombay and lower price in Meerut.

  1. Ignorance of the Consumers

Price discrimination is possible when the consumers are ignorant about price discrimination, they are not aware that in one part of the market prices are lower than in the other part. Thus, he purchases in dearer market, than in cheaper market since he is ignorant of the prices that are prevailing in different markets.

  1. Government Regulation

Price discrimination occurs when the government rules and regulations permit. For instance, according to rules, electricity rates are fixed at higher level for industrial purposes and lower for domestic uses. Similarly, railways charge by law higher fares from first class passengers than from the second class passengers. Hence, price discrimination is possible because of legal sanction.

  1. Geographical Discrimination

Price discrimination may be possible on account of geographical situations. The monopolist may discriminate between home and foreign buyers by selling at lower price in the foreign market than in the domestic market. Geographical discrimination is possible because no unit of the commodity sold in one market can be transferred to another.

  1. Difference in Elasticity of Demand

A commodity may have different elasticity of demand in different markets. Thus, the market of a commodity can be separated on the basis of its elasticity of demand.

Hence, a monopolist can charge different prices in different markets classified on the basis of elasticity of demand, low price is charged where demand is more elastic and high price in the market with the less elastic demand or inelastic demand.

  1. Artificial Difference between Goods

A monopolist may create artificial differences by presenting the same commodity under different names and labels, one for the rich and snobbish buyers and the other for the ordinary customers. For instance, a biscuit manufacturer may wrap small quantity of the biscuits, give it separate name and charge a higher price. Thus, he may charge different price for substantially the same product. He may charge Rs. 2/- for 100 gram wrapped biscuits and Rs. 1.50 for unwrapped biscuits.

Management Notes

Law of variable Proportions, Definition, Assumption, Graphical Presentation and Stages of the Law

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The Law of Variable Proportions explains how total production changes when the quantity of one variable factor is increased while other factors remain constant. It is a short-run production law because at least one factor, such as land, machinery, or factory space, remains fixed. As additional units of labour or another variable input are combined with fixed factors, output may initially increase at an increasing rate, then at a diminishing rate, and eventually decline.

Definition of the Law

The Law of Variable Proportions states that when increasing quantities of a variable factor are combined with fixed quantities of other factors, total output initially increases at an increasing rate, then increases at a diminishing rate, and may ultimately decrease. This occurs because the proportion between fixed and variable factors changes as more units of the variable factor are employed. The law is also known as the Law.

Assumptions of the Law of Variable Proportions

1. Short-Run Production Period

The law operates in the short run, when at least one factor of production remains fixed. Factors such as land, factory space, or machinery cannot be changed immediately, while labour or raw materials may be varied. This condition allows the producer to study how changing one input affects total production while other inputs remain constant. The law therefore explains the relationship between variable and fixed factors within a limited production period.

2. One Factor is Variable

The law assumes that only one factor of production is variable, while the quantities of other factors remain unchanged. For example, a firm may increase the number of workers while keeping its machinery, building, and land constant. This assumption helps isolate the effect of the variable factor on total production. If several factors changed simultaneously, it would be difficult to identify which factor caused the change in output.

3. Fixed Factors Remain Constant

The quantities of fixed factors, such as land, machinery, buildings, and equipment, are assumed to remain unchanged throughout the analysis. The producer increases the variable factor without expanding the capacity of these fixed resources. As more variable inputs are combined with fixed factors, their proportion changes, influencing productivity. This assumption is essential for explaining why output may initially rise rapidly, later increase slowly, and eventually decline.

4. Technology Remains Unchanged

The law assumes that technology and production methods remain constant during the period of analysis. No new machinery, improved techniques, or technological innovations are introduced while the variable factor increases. If technology changes, output may rise because of improved production methods rather than the additional input. Keeping technology constant makes it possible to examine the effect of changing factor proportions on production more accurately.

5. Homogeneous Units of Variable Factor

All units of the variable factor are assumed to be homogeneous, meaning they have similar quality, efficiency, and productive capacity. For example, workers are treated as having equivalent skills and working ability. If later workers were more skilled or less efficient than earlier workers, changes in output could result from differences in worker quality. This assumption ensures that variations in production are mainly explained by changes in the quantity of the variable factor.

6. Factors Can Be Combined in Different Proportions

The law assumes that variable and fixed factors are divisible and can be combined in different proportions. A producer can add more units of labour to a given quantity of land or machinery. This flexibility allows the producer to observe how changes in the input combination affect total production. If factors could only be used in fixed proportions, it would be difficult to examine the changing productivity associated with increasing one factor while holding another constant.

7. Efficient Management and Organization

The law generally assumes that management and organizational conditions remain unchanged during the production process. The producer is expected to use available resources in a reasonably consistent manner without sudden changes in supervision, work organization, or operating practices. If management becomes significantly better or worse while inputs are changing, output may be affected by those changes. This assumption helps focus the analysis on the relationship between variable and fixed factors.

8. Output is Measurable

The law assumes that production can be measured in physical units, such as tonnes, kilograms, pieces, or units of service. This makes it possible to calculate Total Production (TP), Average Production (AP), and Marginal Production (MP) as the variable factor changes. Accurate measurement helps identify increasing returns, diminishing returns, and negative returns. The assumption is especially useful for comparing output levels under different input combinations and explaining the stages of the law clearly.

Graphic Presentation

In fig. 1, on OX axis, we have measured number of labourers while quantity of product is shown on OY axis. TP is total product curve. Up to point ‘E’, total product is increasing at increasing rate. Between points E and G it is increasing at the decreasing rate. Here marginal product has started falling. At point ‘G’ i.e., when 7 units of labourers are employed, total product is maximum while, marginal product is zero. Thereafter, it begins to diminish corresponding to negative marginal product. In the lower part of the figure MP is marginal product curve.

Up to point ‘H’ marginal product increases. At point ‘H’, i.e., when 3 units of labourers are employed, it is maximum. After that, marginal product begins to decrease. Before point ‘I’ marginal product becomes zero at point C and it turns negative. AP curve represents average product. Before point ‘I’, average product is less than marginal product. At point ‘I’ average product is maximum. Up to point T, average product increases but after that it starts to diminish.

Three Stages of the Law

1. First Stage

First stage starts from point ‘O’ and ends up to point F. At point F average product is maximum and is equal to marginal product. In this stage, total product increases initially at increasing rate up to point E. between ‘E’ and ‘F’ it increases at diminishing rate. Similarly marginal product also increases initially and reaches its maximum at point ‘H’. Later on, it begins to diminish and becomes equal to average product at point T. In this stage, marginal product exceeds average product (MP > AP).

2. Second Stage

It begins from the point F. In this stage, total product increases at diminishing rate and is at its maximum at point ‘G’ correspondingly marginal product diminishes rapidly and becomes ‘zero’ at point ‘C’. Average product is maximum at point ‘I’ and thereafter it begins to decrease. In this stage, marginal product is less than average product (MP < AP).

3. Third Stage

This stage begins beyond point ‘G’. Here total product starts diminishing. Average product also declines. Marginal product turns negative. Law of diminishing returns firmly manifests itself. In this stage, no firm will produce anything. This happens because marginal product of the labour becomes negative. The employer will suffer losses by employing more units of labourers. However, of the three stages, a firm will like to produce up to any given point in the second stage only.

In Which Stage Rational Decision is Possible

To make the things simple, let us suppose that, a is variable factor and b is the fixed factor. And a1, a2 , a3….are units of a and b1 b2b3…… are unit of b.

Stage I is characterized by increasing AP, so that the total product must also be increasing. This means that the efficiency of the variable factor of production is increasing i.e., output per unit of a is increasing. The efficiency of b, the fixed factor, is also increasing, since the total product with b1 is increasing.

The stage II is characterized by decreasing AP and a decreasing MP, but with MP not negative. Thus, the efficiency of the variable factor is falling, while the efficiency of b, the fixed factor, is increasing, since the TP with b1 continues to increase.

Finally, stage III is characterized by falling AP and MP, and further by negative MP. Thus, the efficiency of both the fixed and variable factor is decreasing.

Rational Decision

Stage II becomes the relevant and important stage of production. Production will not take place in either of the other two stages. It means production will not take place in stage III and stage I. Thus, a rational producer will operate in stage II.

Suppose b were a free resource; i.e., it commanded no price. An entrepreneur would want to achieve the greatest efficiency possible from the factor for which he is paying, i.e., from factor a. Thus, he would want to produce where AP is maximum or at the boundary between stage I and II.

If on the other hand, a were the free resource, then he would want to employ b to its most efficient point; this is the boundary between stage II and III.

Obviously, if both resources commanded a price, he would produce somewhere in stage II. At what place in this stage production takes place would depend upon the relative prices of a and b.

Condition or Causes of Applicability

There are many causes which are responsible for the application of the law of variable proportions.

  • Under Utilization of Fixed Factor

In initial stage of production, fixed factors of production like land or machine, is under-utilized. More units of variable factor, like labour, are needed for its proper utilization. As a result of employment of additional units of variable factors there is proper utilization of fixed factor. In short, increasing returns to a factor begins to manifest itself in the first stage.

  • Fixed Factors of Production

The foremost cause of the operation of this law is that some of the factors of production are fixed during the short period. When the fixed factor is used with variable factor, then its ratio compared to variable factor falls. Production is the result of the co-operation of all factors. When an additional unit of a variable factor has to produce with the help of relatively fixed factor, then the marginal return of variable factor begins to decline.

  • Optimum Production

After making the optimum use of a fixed factor, then the marginal return of such variable factor begins to diminish. The simple reason is that after the optimum use, the ratio of fixed and variable factors become defective. Let us suppose a machine is a fixed factor of production. It is put to optimum use when 4 labourers are employed on it. If 5 labourers are put on it, then total production increases very little and the marginal product diminishes.

  • Imperfect Substitutes

Mrs. Joan Robinson has put the argument that imperfect substitution of factors is mainly responsible for the operation of the law of diminishing returns. One factor cannot be used in place of the other factor. After optimum use of fixed factors, variable factors are increased and the amount of fixed factor could be increased by its substitutes.

Such a substitution would increase the production in the same proportion as earlier. But in real practice factors are imperfect substitutes. However, after the optimum use of a fixed factor, it cannot be substituted by another factor.

Applicability of the Law of Variable Proportions

The law of variable proportions is universal as it applies to all fields of production. This law applies to any field of production where some factors are fixed and others are variable. That is why it is called the law of universal application.

The main cause of application of this law is the fixity of any one factor. Land, mines, fisheries, and house building etc. are not the only examples of fixed factors. Machines, raw materials may also become fixed in the short period. Therefore, this law holds good in all activities of production etc. agriculture, mining, manufacturing industries.

  • Application to Agriculture

With a view of raising agricultural production, labour and capital can be increased to any extent but not the land, being fixed factor. Thus when more and more units of variable factors like labour and capital are applied to a fixed factor then their marginal product starts to diminish and this law becomes operative.

  • Application to Industries

In order to increase production of manufactured goods, factors of production has to be increased. It can be increased as desired for a long period, being variable factors. Thus, law of increasing returns operates in industries for a long period. But, this situation arises when additional units of labour, capital and enterprise are of inferior quality or are available at higher cost.

As a result, after a point, marginal product increases less proportionately than increase in the units of labour and capital. In this way, the law is equally valid in industries.

Postponement of the Law

The postponement of the law of variable proportions is possible under following conditions:

(i) Improvement in Technique of Production

The operation of the law can be postponed in case variable factors techniques of production are improved.

(ii) Perfect Substitute

The law of variable proportion can also be postponed in case factors of production are made perfect substitutes i.e., when one factor can be substituted for the other.

Management Notes

Measuring Elasticity of Demand

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A change in the price of a commodity affects its demand. We can find the elasticity of demand, or the degree of responsiveness of demand by comparing the percentage price changes with the quantities demanded. In this article, we will look at the concept of elasticity of demand and take a quick look at its various types.

Elasticity of Demand

Elasticity of demand refers to the degree of responsiveness of the quantity demanded of a commodity to a change in one of its determinants, such as price, income, or the price of related goods. It measures how strongly consumers respond to changes in economic conditions. The concept is important because two commodities may experience the same percentage change in price but show different changes in quantity demanded. Elasticity therefore helps businesses understand consumer sensitivity and make appropriate pricing, production, and marketing decisions.

The following points highlight the top five methods used for measuring the elasticity of demand. The methods are:

  • Price Elasticity of Demand
  • Income Elasticity of Demand
  • Cross Elasticity of Demand
  • Advertisement or Promotional Elasticity of Sales
  • Elasticity of Price Expectations.

Method 1. Price Elasticity of Demand

Price elasticity of demand is a measure of the responsiveness of demand to changes in the commodity’s own price. It is the ratio of the relative change in a dependent variable (quantity demanded) to the relative change in an independent variable (Price). In other words, price elasticity is the ratio of a relative change in quantity demanded to a relative change in price.

Also, elasticity is the percentage change in quantity demanded divided by the percentage in price.

Symbolically, we may rewrite the formula:

If percentages are known, the numerical value of elasticity can be calculated. The coefficient of elasticity of demand is a pure number i.e. it stands by itself, being independent of units of measurement. The coefficient of price elasticity of demand can be calculated with the help of the following formula.

Where,

Q is quantity, P is price, ΔQ/Q relative change in the quantity demanded and ΔP/P Relative change in price.

It should be noted that a minus sign (-) is generally inserted in the formula before the fraction with a view to making the coefficient of elasticity a non-negative value.

The price elasticity can be measured between two finite points on a demand curve (called arc elasticity) or on a point (called point elasticity).

Method 2. Income Elasticity of Demand

The responsiveness of quantity demanded to changes in income is called income elasticity of demand. With income elasticity, consumer incomes vary while tastes, the commodity’s own price, and the other prices are held constant.

The income elasticity of demand for a good or service may be calculated by the formula:

where- ey stands for the coefficient of income elasticity, Y for income.

Whereas price-elasticity of demand is always negative, income-elasticity of demand is always positive (except for inferior goods) as the relationship between income and quantity demanded of a product is positive. For inferior goods the income elasticity of demand is negative because as income increases, consumers switch over to the consumption of superior substitutes.

Method 3. Cross Elasticity of Demand

Demand is also influenced by prices of other goods and services. The cross elasticity measures the responsiveness of quantity demanded to changes in price of other goods and services. Cross elasticity of demand is defined as the percentage change in quantity demanded of one good caused by a 1 percentage change in the price of some other good.

Cross elasticity is used to classify the relationship between goods. If cross elasticity is greater than zero, an increase in the price of y causes an increase in the quantity demanded of x, and the two products are said to be substitutes. When the cross- elasticity is greater than zero, the goods or services involved are classified as complements Increases in the price of y reduces the quantity demanded of that product. Diminished demand for y causes a reduced demand for x. Bread and butter, cars and tires, and computers and computer programs are examples of pairs of goods that are complements.

The coefficient is positive if A and B are substitutes because the price change and the quantity change are in the same direction. The coefficient is negative if A and B are complements, because changes in the price of one commodity cause opposite changes in the quantity demanded of the other. Other things such as consumer taste for both commodities, consumer incomes and the price of the other commodity are held constant.

Method 4. Advertisement or Promotional Elasticity of Sales

The advertisement expenditure helps in promoting sales. The impact of advertisement on sales is not uniform at all level of total sales. The concept of advertising elasticity is significant in determining the optimum level of advertisement outlay particularly in view of competitive advertising by rival firms. An advertising elasticity could be defined as the percentage change in quantity demanded for a percentage change in advertising. Advertising might be measured by expenditure.

Advertising elasticity may be measured by the following formula:

Method 5. Elasticity of Price Expectations

People’s price expectations also play a significant role as a determinant of demand. J.R. Hicks, the English economist, in 1939, devised the concept of elasticity of price expectations. The elasticity of price expectations may be defined as the ratio of the relative change in expected future prices to the relative change in current prices.

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