Subject: BUSINESS ECONOMICS & FINANCIAL ANALYSIS

Subject Code : 22SS0MB01

II YEAR II SEM
A.Y: 2024-25

Lecture Notes
 UNIT-III
Production, Cost, Market Structures & Pricing
Production Analysis: Factors of Production, Production Function, Production
Function with one variable input, two variable inputs, Returns to Scale, Different
Types of Production Functions.
Cost analysis: Types of Costs, Short run and Long run Cost Functions.
Market Structures: Nature of Competition, Features of Perfect competition,
Monopoly, Oligopoly, Monopolistic Competition. Pricing: Types of Pricing, Product
Life Cycle based Pricing, Break Even Analysis, Cost Volume Profit Analysis.

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Production is the transformation or conversion of resources into commodities over
time. Economists view production as an activity through which utility is created or
enhanced for a product. A firm is a business unit which undertakes the activity of
transforming inputs into output of goods and services.

FACTORS OF PRODUCTION
Factors of production is an economic term that describes the inputs that are used in
the production of goods or services in order to make an economic profit. The factors
of production include land, labor, capital and entrepreneurship. These production
factors are also known as management, machines, materials and labor, and
knowledge has recently been talked about as a potential new factor of production.
1. Land
Land is short for all the natural resources available to create supply. It includes raw
land and anything that comes from the land. It can be a non-renewable resource.
That includes commodities such as oil and gold. It can also be a renewable resource,
such as timber. Once man changes it from its original condition, it becomes a capital
good. For example, oil is a natural resource, but gasoline is a capital good. Farmland
is a natural resource, but a shopping center is a capital good.
The income earned by owners of land and other resources is called rent.
2. Labour
Labor is the work done by people. The value of labor depends on workers' education,
skills, and motivation. It also depends on productivity. That measures how much
each hour of worker time produces in output.
The reward or income for labor is wages.
3. Capital
Capital is short for capital goods. These are man-made objects like machinery,
equipment, and chemicals, that are used in production. That's what differentiates
them from consumer goods. For example, capital goods include industrial and
commercial buildings, but not private housing. A commercial aircraft is a capital good
but a private jet is not.
The income earned by owners of capital goods is called interest.
4. Entrepreneurship
Entrepreneurship is the drive to develop an idea into a business. An entrepreneur
combines the other three factors of production to add to supply. The most successful
are innovative risk-takers.
The income entrepreneurs earn is profits.
Production Function
Production function is really an engineering concept that establishes relationship
between the output of a commodity and its inputs. In the traditional terms, economic
theory speaks of four factors of production, land, labour, capital and organization or
management. But in the modem world technology also contributes to output growth
and it is now regarded as an additional determinant. Thus, the output of an industry
is a positive function of the quantities of land, labour, capital, and quality of
management and level of technology that is employed in production.
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It can be represented symbolically as,
Q= f(Ld, Lb, K, M, T)
where Q = output of commodity X
Importance:
Ld = land employed in the production of X
Lb = Labour employed in the production '~
K = capital employed in the production of X
M = management employed in the production of X
T = technology employed in the production of X
Importance:
I. When inputs are specified in physical units, production function helps to estimate
the level of production.
2. It becomes isoquants when different combinations of inputs yield the same level
of output.
3. When price is taken into the consideration, the production function helps to select
the least combination of inputs for the desired output.
4. It indicates the manner in which the firm can substitute one input for another
with altering to total output.
5. It considers the two types of input - output relationships namely law of variable
proportions and law of returns to scale.
In general, production function may be fixed and variable production
functions. In a fixed production function, each level of output requires a unique
combination of inputs. In a variable production function is one in which the same
level of output may be produced by two or more combination of inputs.
Production function can be fitted to a particular firm or industry or for the
economy as a whole. Production function provides the maximum quality of output
which can be produced from the minimum quantities of various inputs that are
revised to produce a given quantity of output. Production function will change with
an improvement in technology. The new production function due to change in
technology has a greater flow of output from the original inputs or the same flow of
output for a lesser input.
The above expression describes a general production function. Under some
specific conditions, one or the other of these various factor inputs may not be
important and the relative importance of a factor of production varies from one type
of product to another. For example, Land is the most important input factor in the
production of wheat where as it is of least importance in the production of a
manufacturing product. For good exposition of production decision problems, it is
convenient to work with two input factors for an output. If labour and capital are the
only two inputs, the above expression reduces to,
Q = f(L, K)
where Q output of commodity X
L unit of labour
K units of capital
Increasing production, 'P' will require variable inputs, and whether the firm can
increase all production factors or few production factors (Few are fixed and remaining
are variable) will depends on the time period it takes into account for increasing
production, that is, whether the firm is thinking in terms of the short run or in terms
of the long run.
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So, based on the time span production function can be classified into two categories:

➢ Short run production function

➢ Long run production function

Short run production function

Short Run is a period of time where output can only be changed by changing the
level of variable inputs. In the short run, some factors are variable and some are
fixed. Fixed factors remain constant in the short run like land, capital, plant,
machinery, etc. Production can be raised by only increasing the level of variable
inputs like labour. Therefore, the situation where the output is increased by only
increasing the variable factors of input and keeping the fixed factors constant is
termed as Short Run Production Function. This relationship is explained by the ‘Law
of Variable Proportions.’
Example: Suppose XYZ Baker’s received an order to deliver 2000 Cakes and Cookies
in 4 days.
In this scenario, the baker cannot immediately install additional ovens to fulfil the
demand. But it can increase the number of workers and make them work overtime
to meet the demand.
Long Run Production Function
Long Run is a span of time where the output can be increased by increasing all the
factors of production whether it is fixed (land, capital, plant, machinery, etc.) or
variable (labour). Long run is enough time to alter all the factors of production. All
factors are said to be variable in the long run. Therefore, the situation where the
output is increased by increasing all the inputs simultaneously and in the same
proportion is termed Long Run Production Function. This relationship is explained
by the ‘Law of Returns to Scale.’
Example: Suppose XYZ Baker’s received an order to deliver 2000 Cakes and Cookies
if the delivery date had been two months.
In this case, XYZ Baker’s had enough time to make the necessary arrangements to
complete the order. It can increase its capacity and complete the order with the same
number of workers.
Production function with one variable input
The concept of production function with one variable inputs and law of returns is
understood with the "law of variable proportion" or “Law of diminishing returns".
Assume that a firms‟ production function consists of fixed quantities of all
inputs (land, equipment, etc.) except labor which is a variable input. If you go on
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adding the variable input, say, labor, the total output in the initial stages will
increase at an increasing rate, and after reaching certain level of output the total
output will increase at declining rate. If variable factor inputs are added further to
the fixed factor input, the total output may decline.
The behaviors of the Output when the varying quantity of one factor is
combines with a fixed quantity of the other factors, the resulting increment of total
product will first increase but decreases after a particular point and can be divided
in to three district stages.
The three stages can be better understood by following the table.
Fixed Variable Total Averag Marginal Product
factor Factor product e (MP)
(FF) (VF) (TP) produc
(Land) (Labour) t (AP)
1 1 20 20 20
1 2 50 25 30 STAGE 1
1 3 90 30 40
1 4 120 30 30
1 5 135 27 15
1 6 144 24 9
1 7 147 21 3 STAGE 2
1 8 148 18.5 1
1 9 148 16.4 0
1 10 145 14.5 -3 STAGE 3

Above table reveals that both average product and marginal product increase in the
beginning and then decline after some point. and the diminishing ratio of marginal
product is faster than average product.
Total product is maximum when the farmer employs 8th worker, nothing is produced
by the 9th worker and its marginal productivity is zero, whereas marginal product of
10th worker is ‘-3’, by just creating credits 10th worker not only fails to make a
positive contribution but leads to a fall in the total output.
Production function with one variable input and the remaining fixed inputs is
illustrated as below

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 From the above graph the law of variable proportions operates in three stages.
➢ In the first stage, total product increases at an increasing rate. The marginal
product in this stage increases at an increasing rate resulting in a greater increase
in total product. The average product also increases. This stage continues up to
the point where average product is equal to marginal product.
➢ The law of diminishing returns starts operating from the second stage onwards.
At the second stage total product increases only at a declining rate. The average
product also declines. The second stage comes to an end where total product
becomes maximum and marginal product becomes zero.
➢ The marginal product becomes negative in the third stage. So, the total product
also declines. The average product continues to decline.
We can sum up the above relationship thus when ‘A.P.’ is rising, “M. P.’ rises more
than “A. P; When ‘A. P.” is maximum and constant, ‘M. P.’ becomes equal to ‘A. P.’
when ‘A. P.’ starts falling, ‘M. P.’ falls faster than ‘A. P.’.
Thus, the total product, marginal product and average product pass through three
phases, viz., increasing, diminishing and negative returns stages.
Assumptions of the Law: The law is based upon the following assumptions:
➢ The state of technology remains constant. If there is any improvement in
technology, the average and marginal output will not decrease but increase.
➢ Only one factor of input is made variable and other factors are kept constant. This
law does not apply to those cases where the factors must be used in strictly fixed
proportions.
➢ All units of the variable factors are homogenous.
Production function with two variable inputs
Where the firm increases its output by using more of two inputs that are substitutes
for each other say, Labour and capital.
The behaviour of the production function of a firm which makes use of two variable
inputs or factors of production is analysed by using the concept of isoquants or iso
product curves.
ISOQUANTS
The term Isoquants is derived from the words ‘iso’ and ‘quant’ – ‘Iso’ means equal and
‘quant’ implies quantity. Isoquant therefore, means equal quantity. An isoquant is
also known as "iso product curve" or "equal product curve".
Isoquant are the curves, which represent the different combinations of inputs
producing quantity of output. Any combination on isoquant represents the same level
of output. This is also known as production indifference curves. An isoquant is the
locus of all the combinations of two factors of production that yield the same level of
output.
Let us understand the concept of an isoquant with the help of an example. Suppose
a firm wants to produce 100 units of commodity X and for that purpose can use any
one of the six processes indicated in Table

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 combination Units of Units of quantity
Labour Capital
A 1 10 100
B 2 7 100
C 3 5 100
D 4 4 100
E 6 3 100
F 9 2 100

From above Table, it is clear that all the six processes yield the same level of output,
that is, 100 units of X. The first combination is clearly capital-intensive. Since we
assume possibilities of factor substitution, we find that there are five more processes
available to the firm and in each of them factor intensities differ. The sixth process is
the most labour-intensive or the least capitalintensive. Graphically, we can construct
an isoquant conveniently for two factors of production, say labour and capital. One
such isoquant is shown in Fig.

Fig shows that at point A, B and C same level of output (=100 units) is obtained by
using different combinations of labour and capital. Curve p is known as isoquant.
Features of an ISOQUANT
Downward Sloping
Isoquants slope downward, which means if you reduce one input, you must increase
the other to keep the same level of output. You can't decrease both inputs and
maintain the same output.

Do Not Touch the Axes

Isoquants never touch either the X-axis or the Y-axis. This is because both inputs
(e.g., labor and capital) are always needed to produce a product. If an isoquant
touches the X-axis, it suggests you can produce output with only one input, which is
unrealistic.

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Do Not Intersect
Isoquants representing different output levels never cross, touch, or overlap. If they
did, it would mean that the same amount of labor and capital could produce two
different output levels, which doesn't make sense.

Convex to Origin
Isoquants have a curved shape that is convex to the origin. This curve shows that
labor and capital are not perfect substitutes for each other. When you increase one
input (e.g., labor), you give up less of the other input (e.g., capital) to maintain the
same output. This indicates diminishing returns.

Higher Isoquants Mean More Output

Each isoquant represents a specific level of output. Higher isoquants represent
greater output levels. Moving to a higher isoquant requires using more of both inputs,
which results in increased production.

Marginal Rate of Technical Substitution:

Marginal Rate of Technical Substitution refers to the rate at which one input factor
is substituted with the other attain a given level of output.
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We can understand this concept with the help of following table.

Capital
Combinations Labour MRTS
(Units)
A 1 20 -
B 2 15 5:1
C 3 11 4:1
D 4 8 3:1
E 5 6 2:1
F 6 5 1:1

MRTS is a measure of how inputs can be substituted to maintain output, whereas

the slope of an isoquant represents the same concept graphically. Slope of isoquant
measures, the MTRS of one factor for another input.
Technically we can say it as:

ISOCOSTS
A producer may attempt maximisation of output subject to a given cost or
alternatively, he may seek to minimise cost subject to a given level of output. In both
cases, for choosing optimum quantities of two inputs, viz., labour and capital, he
must consider their physical productivities as well as their prices. While isoquants
represent the productivities of the inputs, their prices are shown by isocost lines.
An isocost line represents various combinations of inputs that may be purchased for
a given amount of expenditure; that is, the producer’s budget.
An isocost line is a locus of points showing the alternative combinations of factors
that can be purchased with a fixed amount of money. In fact, every point on a given
isocost line represents the same total cost.
Suppose total amount is Rs 1000, labor cost is Rs 40 per unit, capital cost is Rs 200
per unit. Alternative combinations are as follows:

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Plotting these values on a graph, joining the points A, B, C, D, then, we will have an
isocost line.
If the level of production changes, the total cost changes and thus the isocost curve
moves upwards, and vice versa.
Law of Returns of Scale
The law of returns to scale operates in the long period. It explains the production
behavior of the firm with all variable factors. The law of returns to scale describes the
relationship between variable inputs and output when all the inputs, or factors are
increased in the same proportion. We find out in what proportions the output changes
when there is proportionate change in the quantities of all inputs.
There are three laws of returns to scale.
Increasing Returns to Scale
If the output of a firm increases more than in proportion to an equal percentage
increase in all inputs, the production is said to exhibit increasing returns to scale.
For Ex: If 5% increase in inputs, results in 10% increase in outputs a firm is said to
attain increased in returns.
Constant Returns to Scale
When all inputs are increased by a certain percentage, the output increases by the
same percentage, the production function is said to exhibit constant returns to scale.
For Ex: If 5% increase in inputs, results in 5% increase in outputs a firm is said to
attain Constant in returns.
Law decreasing returns to scale
The term 'diminishing' returns to scale refers to scale where output increases in a
smaller proportion than the increase in all inputs.
For Ex: If 10% increase in inputs, results in 5% increase in outputs a firm is said to
attain decrease in returns.
The following table illustrates these laws clearly.

From the above table it is clear that with 1 unit of capital and 3 units of labor, the
firm produces 50 units of output. When the inputs are doubled 2 units of capital and
6 units of labor,the output has gone up to 120 units. Thus, when inputs are increased
by 100%, the output has increased by 140%. That is, output has increased by more
than double. This is governed
by law of increasing returns to scale.
When the inputs are further doubled, the output has doubled. This governed by law
of constant returns to scale.
When the inputs further doubled, the output has increased by only 50%. This is
governed by law of decreasing returns to scale.

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Cost
cost is defined as “the amount expenditure, actual or notional, incurred on or
attributable to a specified thing or activity”. It is the number of resources sacrificed
to achieve a specific objective. cost refer to the expenditure incurred to produce a
particular product or services. Cost refers to the amount of expenditure incurred in
acquiring something. In business firm, it refers to the expenditure incurred to produce
an output or provide service. Thus, the cost incurred in connection with raw material,
labour, other heads constitute the overall cost of production.
Cost Concepts:
A managerial economist must have a clear understanding of the different cost
concepts for clear business thinking and proper application. The various relevant
concepts of cost are:
1. Opportunity costs and Outlay costs:
Opportunity costs refer to the „costs of the next best alternative foregone‟. We have
scarce resources and all these have alternative uses. Where there is an alternative,
there is an opportunity to reinvest the resources. In other words, if there are no
alternatives, there are no opportunity costs. It is necessary that we should always
consider the cost of the next best alternative foregone before committing the funds on
a given option. In other words, the benefits from the present option should be more
than the benefits of the next best alternative. Opportunity cost is said to exist when
the resources are scarce and there are alternative uses for these resources. If there is
no alternative, Opportunity cost is zero.
For example: if a firm owns a land, there is no cost of using the land (i.e., the rent) in
firm‟s account. Bust the firm has an opportunity cost of using this land, which is
equal to the rent foregone by not letting the land out on (the return of second best
alternative is regarded as the cost of first best alternative) rent.
Out lay costs are as actual costs which are actually incurred by the firm. these are
the payments made for labour, material, plant, building, machinery traveling,
transporting etc., These are all those expenses appearing in the books of account,
hence based on accounting cost concept.
2. Explicit costs and Implicit costs:
Explicit costs are also called as out-of-pocket cost that involve cash payments. These
are the actual or business costs that appear in the books of accounts. These costs
include payment of wages and salaries, payment for raw-materials, interest on
borrowed capital funds, rent on hired land, Taxes paid etc.
Implicit costs are also called as imputed costs which don‟t involve payment of cash
as they are not actually incurred. They would have been incurred had the owner not
been in possession of the facilities. Ex: Interest on own capital, saving in terms of
salary due to own supervision and rent of own building etc.
3. Historical costs and Replacement costs:
Historical cost is the original cost that has been originally spent to acquire the asset.
of an asset.
Historical valuation is the basis for financial accounts.
A replacement cost is the price that is to be paid currently to replace the same asset.
A replacement cost is a relevant cost concept when financial statements have to be
adjusted for inflation.
4. Short – run costs and long – run costs:

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Short-run is a period during which the physical capacity of the firm remains fixed.
Any increase in output during this period is possible only by using the existing
physical capacity more extensively. So short run cost is that which varies with output
when the plant and capital equipment are constant. Long run is defined as a period
of adequate length during which a company may alter all factors of production with
high degree of flexibility.
5. Out of pocket costs and Books costs:
Out of pocket costs also known as explicit costs are those costs that involve current
cash payment such as purchase of raw material, payment of salary rents payment,
interest on loan etc.
Book costs also called implicit costs do not require current cash payments. a provision
is made in the books of accounts in order to include them in the profit and loss
account and take tax advantages. Simply, we can say that these are the payments
that firm pays it to itself. Depreciation, unpaid interest, salary of the owner is
examples of back costs.
MRITS Page 72
6. Fixed costs, Variable costs and Semi-variable costs:
Fixed cost is that cost which remains constant for a certain level to output. It is not
affected by the changes in the volume of production but fixed cost per unit decreases,
when the production is increased. Fixed cost includes salaries, Rent, Administrative
expenses depreciations etc.
Variable is that which varies directly with the variation in output. An increase in total
output results in an increase in total variable costs and decrease in total output
results in a proportionate decrease in the total variables costs. The variable cost per
unit will be constant. Ex: Raw materials, labour, direct expenses, etc.
Semi-variable costs refer to such costs that are fixed to some extent beyond which
they are variable. Ex: telephone charges, Electricity charges, etc.
7. Past costs and Future costs:
Past costs also called historical costs are the actual cost incurred and recorded in the
book of account these costs are useful only for valuation and not for decision making.
Future costs are costs that are expected to be incurred in the futures. They are not
actual costs. They are the costs forecasted or estimated with rational methods. Future
cost estimate is useful for decision making because decision are meant for future.
8. Controllable costs and Uncontrollable costs:
Controllable costs are ones, which can be regulated by the executive who is in charge
of it. Direct expenses like material, labour etc. are controllable costs.
Some costs are not directly identifiable with a process of product. They are
apportioned to various processes or products in some proportion. These apportioned
costs are called uncontrollable costs.
9. Incremental costs and Sunk costs:
Incremental cost also known as differential cost is the additional cost due to a change
in the level or nature of business activity. The change may be caused by adding a new
product, adding new machinery, replacing a machine by a better one etc.
Sunk costs are those which are not altered by any change – They are the costs
incurred in the past. This cost is the result of past decision, and cannot be changed
by future decisions. Investments in fixed assets are examples of sunk costs. Once an
asset is bought, the funds are blocked forever. They can neither be changed nor
controlled.
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10. Total costs, Average costs and Marginal costs:
Total cost is the total expenditure incurred for the input needed for production. It may
be explicit or implicit. It is the sum total of the fixed and variable costs.
Average cost is the cost per unit of output. It is obtained by dividing the total cost (TC)
by the total quantity produced (Q)
Marginal cost is the additional cost incurred to produce an additional unit of output.
11. Accounting costs and Economic costs:
Accounting costs are the costs recorded for the purpose of preparing the profit & loss
account and balance sheet to meet the legal, financial and tax purpose of the
company. The accounting concept is a historical concept and records what has
happened in the post.
Economic cost refers to cost of economic resources used in production including
opportunity cost. Economics concept considers future costs and future revenues,
which help future planning, and choice, while the accountant describes what has
happened, the economics aims at projecting what will happen.
12. Urgent costs Vs Postponable costs
Urgent costs
those costs such as raw materials, wages necessary to sustain the production activity.
Postponable costs
those cost such as white washing the building etc
13. Separable costs Vs Joint costs
Joint costs are shared by multiple products being produced simultaneously, while
separable costs are specific to individual products. Joint costs are incurred before the
split-off point, whereas separable costs are incurred after the split-off point.
Here are some more examples of joint and separable costs:
Joint costs: Producing bran, semolina, flour, and maida from wheat, or producing
butter, cheese, and cream from milk
Separable costs: Finishing processes or product-specific packaging.
The Cost Function: The Cost-Output Relations
The theory of cost deals with the behavior of cost in relation to a change in output
The basic principle of the cost behavior is that total cost increases with increase in
output
Cost functions express the relationships between cost and its determinants, like the
size of plant. Level of output, prices, technology, etc.
In a mathematical form it can be expressed as
C = f(S, 0, P, T, M)
where C Cost (unit cost or total cost)
S= Size of plant
O = Level of Output
P = Price of inputs used in production
T =Nature of Technology
M = Managerial efficiency
Short-Run Cost:
These are costs incurred within a time frame where at least one factor of production
is fixed. Typically, this refers to a period where capital (buildings, machinery) cannot
be significantly adjusted.
Examples: Rent, salaries of permanent staff, depreciation on equipment (considered
fixed cost in the short run even though the equipment value declines over time).
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 Long-Run Cost:
This concept applies when all factors of production can be varied. In the long run, a
company can adjust its capital, labor, and other resources to meet its production
needs.
Examples: Costs associated with building a new factory, hiring additional staff, or
purchasing new equipment.
Direct Cost:
These costs can be easily identified and directly traced to a specific product or service.
They vary in proportion to the level of production.
Examples: Raw materials used to produce a particular good, direct labor costs
associated with creating that good, commissions paid on sales of a specific product.
Indirect Cost:
These costs are not directly attributable to a single product or service. They are
incurred to support overall production but cannot be easily linked to specific units of
output.
Examples: Factory overhead costs (electricity, utilities), salaries of administrative
staff, insurance costs for the entire facility.

Short run and Long run Cost Functions

Aspect Short-Run Cost Function Long-Run Cost Function
Fixed period of time, where at least one No factors of production are fixed, allowing for
Time Frame factor of production is fixed. adjustments in all inputs.
Limited flexibility as at least one factor of
production is fixed, leading to less scope for Higher flexibility as all factors of production can
Flexibility adjustments. be varied, enabling more adjustments.
Types of Costs Encompasses only variable costs, as there are no
Included Includes both fixed costs and variable costs. fixed factors of production.
Typically exhibits diminishing marginal May exhibit economies or diseconomies of scale,
Shape of Cost returns, leading to U-shaped average total resulting in a variety of shapes for average total
Curves cost curves. cost curves.
Fixed Costs Constant in the short run Can be changed
Variable Costs Vary with output level Can be changed
Total Costs Fixed + Variable Costs Fixed + Variable Costs
Average Costs Total Cost / Output Total Cost / Output
Marginal
Costs Change in Total Cost / Change in Output Change in Total Cost / Change in Output

MARKET
Market is a place where buyer and seller meet, goods and services are offered for the
sale and transfer of ownership occurs. A market may be also defined as the demand
made by a certain group of potential buyers for a good or service. The former one is a
narrow concept and later one is a broader concept. Economists describe a market as
a collection of buyers and sellers who transact over a particular product or product
class (the housing market, the clothing market, the grain market etc.)
Different Market Structures
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Market structure describes the competitive environment in the market for any good
or service. A market consists of all firms and individuals who are willing and able to
buy or sell a particular product. This includes firms and individuals currently engaged
in buying and selling a particular product, as well as potential entrants. The
determination of price is affected by the competitive structure of the market. This is
because the firm operates in a market and not in isolation. In making decisions
concerning economic variables it is affected, as are all institutions in society by its
environment.
Classifications of Markets

Perfect Competition
Perfect competition refers to a market structure where competition among the sellers
and buyers prevails in its most perfect form. In a perfectly competitive market, a
single market price prevails for the commodity, which is determined by the forces of
total demand and total supply in the market.
Characteristics of Perfect Competition
The following features characterize a perfectly competitive market:
A large number of buyers and sellers The number of buyers and sellers is large and
the share of each one of them in the market is so small that none has any influence
on the market price.
Homogeneous products or services The product of each seller is totally
undifferentiated from those of the others.
Free entry and exit Any buyer and seller is free to enter or leave the market of the
commodity.
Perfect knowledge All buyers and sellers have perfect knowledge about the market
for the commodity.
Indifference No buyer has a preference to buy from a particular seller and no seller
to sell to a particular buyer and there is no product differentiation.
Non-existence of transport costs Perfectly competitive market also assumes the
non-existence of transport costs.
Perfect mobility of factors of production Factors of production must be in a
position to move freely into or out of industry and from one firm to the other.
Imperfect Competition
A competition is said to be imperfect when it is not perfect. Imperfect competition is
a competitive market situation where there are many sellers, but they are selling
heterogeneous (dissimilar) goods as opposed to the perfect competitive market
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scenario. Based on the number of sellers and buyers the imperfect markets structure
outlined as below: "Ploy" refers to "Sellers" and "Psony" means "Buyers".
A market is said to be Imperfect Competition when
➢ Products are similar but not identical.
➢ Prices are not uniform.
➢ There is lack of communication.
➢ There are restrictions on the movement of goods.
Monopoly
Monopoly is a part of imperfect competition. The word monopoly is made up of two
syllables, Mono and poly. Mono means single while poly implies selling. Thus
monopoly is a form of market organization in which there is only one seller of the
commodity. There are no close substitutes for the commodity sold by the seller. Pure
monopoly is a market situation in which a single firm sells a product for which there
is no good substitute.

Features of monopoly
The following are the features of monopoly.
Single person or a firm: A single person or a firm controls the total supply of the
commodity. There will be no competition for monopoly firm. The monopolist firm is
the only firm in the whole industry.
No close substitute: The goods sold by the monopolist shall not have closely
competition substitutes. Even if price of monopoly product increase people will not
go in far substitute. For example: If the price of electric bulb increase slightly,
consumer will not go in for kerosene lamp.
Large number of Buyers: Under monopoly, there may be a large number of buyers
in the market who compete among themselves.
Price Maker: Since the monopolist controls the whole supply of a commodity, he is
a price-maker, and then he can alter the price.
Supply and Price: The monopolist can fix either the supply or the price. He cannot
fix both. If he charges a very high price, he can sell a small amount. If he wants to
sell more, he has to charge a low price. He cannot sell as much as he wishes for any
price he pleases.
Downward Sloping Demand Curve: The demand curve (average revenue curve) of
monopolist slopes downward from left to right. It means that he can sell more only
by lowering price.
Entry of other firms: Monopoly exists where there are certain restrictions on the
entry of other firms into business.
Demand curve under Monopoly
In case of monopoly the "MR" is always less than the "AR" because of quantitative
discounts or concessions. Symbolically we can write it as: MR < (AR = P) or (AR = P) >
MR. And both AR and MR curves are having downward sloping from left to right
because of inverse relation between quantity and AR & MR

17
Price output determination

The monopolistic firm attains equilibrium when its marginal cost becomes equal to
the marginal revenue. The monopolist always desires to make maximum profits. He
makes maximum profits when MC=MR. He does not increasing his output if his
revenue exceeds his costs. But when the costs exceed the revenue, the monopolist
firm incur loses. Hence the monopolist curtails his production. He produces up to
that point where marginal cost is equal to the marginal revenue (MR=MC). Thus, the
point is called equilibrium point. The price output under monopoly may be explained
with the help of a diagram.
In the diagram, the quantity supplied or demanded is shown along X-axis. The cost
or revenue is shown along Y-axis. AC and MC are the average cost and marginal cost
curves respectively. AR and MR curves slope downwards from left to right. AC and
MC are U shaped curves. The monopolistic firm attains equilibrium when its marginal
cost is equal to marginal revenue (MC=MR). Under monopoly, the MC curve may cut
the MR curve from below or from a side. In the diagram, the above condition is
satisfied at point E. At point E, MC=MR. The firm is in equilibrium. The equilibrium
output is OM. Up to OM output, MR is greater than MC and beyond OM, MR is less
than MC. Therefore, the monopolist is will be in equilibrium at output OM where
MR=MC and profits are maximized.
The above diagram (Average revenue) = MQ or OP Average cost = MR

18
Profit per unit = Average Revenue-Average cost=MQ-MR=QR Total Profit = QR x
SR=PQRS
If AR > AC; Abnormal or super normal profits. If AR = AC; Normal Profit
If AR < AC ; Loss
Monopolistic competition
Perfect competition and pure monopoly are rare phenomena in the real world. Instead,
almost every market seems to exhibit characteristics of both perfect competition and
monopoly. Hence, in the real world, it is the state of imperfect competition lying
between these two extreme limits that work. Edward. H. Chamberlain developed the
theory of monopolistic competition, which presents a more realistic picture of the
actual market structure and the nature of competition.
Features/Characteristics of Monopolistic Competition
Large Number of Buyers and sellers:
There are large number buyers in the market. But the buyers have their own brand
preferences. So the sellers are able to exercise a certain degree of monopoly over them.
Each seller has to plan various incentive schemes to retain the customers who
patronize his products.
Free Entry and Exist of Firms:
As in the perfect competition, in the monopolistic competition too, there is freedom of
entry and exit. That is, there is no barrier as found under monopoly.
Product Differentiation:
Product differentiation means that products are different in some ways, but not
altogether so. The products are not identical but the same time they will not be
entirely different from each other. IT really means that there are various monopolist
firms competing with each other. An example of monopolistic competition and product
differentiation is the toothpaste produced by various firms. The product of each firm
is different from that of its rivals in one or more respects. Different toothpastes like
Colgate, Close-up, Forehans, Cibaca, etc., provide an example of monopolistic
competition. These products are relatively close substitute for each other but not
perfect substitutes. Consumers have definite preferences for the particular verities or
brands of products offered for sale by various sellers.
Imperfect Knowledge:
Imperfect knowledge about the product leads to monopolistic competition. If the
buyers are fully aware of the quality of the product they cannot be influenced much
by advertisement or other sales promotion techniques. But in the business world we
can see that thought the quality of certain products is the same, effective
advertisement and sales promotion techniques make certain brands monopolistic. For
examples, effective dealer service backed by advertisement-helped popularization of
some brands through the quality of almost all the cement available in the market
remains the same.
Existence of Many firms:
Industry consists of a large number of sellers, each one of whom does not feel
dependent upon others. Every firm acts independently without bothering about the
reactions of its rivals. The size is so large that an individual firm has only a relatively
small part in the total market, so that each firm has very limited control over the price
19
of the product. As the number is relatively large it is difficult for these firms to
determine its price- output policies without considering the possible reactions of the
rival forms. A monopolistically competitive firm follows an independent price policy.
Price – Output Determination under Monopolistic Competition
Since under monopolistic competition different firms produce different varieties of
products, different prices for them will be determined in the market depending upon
the demand and cost conditions.
Each firm will set the price and output of its own product. Here also the profit will be
maximized when marginal revenue is equal to marginal cost.
Short-run equilibrium of the firm:
In the short-run the firm is in equilibrium when marginal Revenue = Marginal Cost.

In the above diagram we can observe AR is the average revenue curve. NMR marginal
revenue curve, SMC short-run marginal cost curve, SAC short-run average cost
curve, MR and SMC interest at point E where output in OM and price MQ (i.e. OP).
Thus the equilibrium output or the maximum profit output is OM and the price MQ
or OP. When the price (average revenue) is above average cost a firm will be making
supernormal profit. From the figure it can be seen that AR is above AC in the
equilibrium point. As AR is above AC, this firm is making abnormal profits in the
short-run. The abnormal profit per unit is QR, i.e., the difference between AR and AC
at equilibrium point and the total supernormal profit is OR X OM.
This total abnormal profits is represented by the rectangle PQRS. As the demand
curve here is highly elastic, the excess price over marginal cost is rather low. But in
monopoly the demand curve is inelastic. So the gap between price and marginal cost
will be rather large. If the demand and cost conditions are less favorable the
monopolistically competitive firm may incur loss in the short-run.
A firm incurs loss when the price is less than the average cost of production. MQ is
the average cost and OS (i.e. MR) is the price per unit at equilibrium output OM. QR
is the loss per unit. The total loss at an output OM is OR X OM. The rectangle PQRS
represents the total loses in the short run.
Oligopoly
The term oligopoly is derived from two Greek words, oligos meaning a few, and pollen
meaning to sell. Oligopoly is the form of imperfect competition where there are a few
firms in the market, producing either a homogeneous product or producing products,
which are close but not perfect substitute of each other.

20
Long – Run Equilibrium of the Firm:
A monopolistically competitive firm will be long – run equilibrium at the output level
where marginal cost equal to marginal revenue. Monopolistically competitive firm in
the long run attains equilibrium where MC=MR and AC=AR shows this trend.

Characteristics/Features of Oligopoly
The main features of oligopoly are:
Monopoly Power:
There is a clement of monopoly power in oligopoly. Since there are only a few firms
and each firm has a large share of the market. In its share of the market, it controls
the price and output. Thus, an oligopoly has some monopoly power.
Interdependence of Firms:
Under oligopoly, there are only a few firms, each producing a homogeneous or slightly
differentiated product. Since the number of firms is small, each firm enjoys a large
share of the market and has a significant influence on the price and output decisions.
Thus, there is interdependence of firms. No firm can ignore the actions and reactions
of rival firms under oligopoly.
Conflicting Attitude of Firms:
Under oligopoly, two types of conflicting attitudes are found in the firms. On the one
hand, firms realize the disadvantages of mutual competition and desire to combine
to maximize their joint profits. This tendency leads to the formation of collusion. On
the other hand, the desire to maximize one‟s individual profit may lead to conflict
and antagonism; the firms come into clash with one another on the question of
distribution of profits and allocation of markets. Thus, 4. Few firms. In this market,
only few sellers are found:
Nature of product:
If the firms product homogeneous product, it becomes pure oligopoly. The firms with
product differentiation constitute impure oligopoly.
Interdependence among firms:

21
 In oligopoly market, each firm treats the other as its rival firm. It is for this reason
that each firm while determining price of its product, takes into account the reaction
of the other firms to its own action.
Large number of consumers:
In this market, there are large numbers of consumers to demand the product.
Homogeneous or Differentiated Products:
Oligopolistic firms can sell products that are:
Homogeneous: Products are nearly identical, with competition focused on price and
marketing (e.g., aluminum).
Differentiated: Products have distinct features or branding, allowing for some
variation in pricing and competition based on those unique selling points (e.g.,
smartphones).
Barriers to Entry:
Oligopolies often have high barriers to entry, making it difficult for new firms to
compete. These barriers can be things like economies of scale, government
regulations, or brand loyalty.
Summary of Different Market Structure

PRICE
Pricing is an important, if not the most important function of all enterprises. Since
every enterprise is engaged in the production of some goods or/and service. Incurring
some expenditure, it must set a price for the same to sell it in the market. It is only
in extreme cases that the firm has no say in pricing its product; because there is
severe or rather perfect competition in the market of the good happens to be of such
public significance that its price is decided by the government. In an overwhelmingly
large number of cases, the individual producer plays the role in pricing its product.
Price denotes the exchange value of a unit of good expressed in terms of money. Thus,
the current price of a Maruti car around Rs. 2,00,000, the price of a haircut is Rs. 25
the price of a economics book is Rs. 150 and so on. Nevertheless, if one gives a little,

22
if one gives a little thought to this subject, one would realize that there is nothing like
a unique price for any good. Instead, there are multiple prices.
TYPES OF PRICING
Here are the common types of pricing policies companies use, with examples:

Cost-based pricing policy

A cost-based pricing policy calculates the average cost of production for a good or
service and then accounts for the profit margin your company desires. This policy is
a traditional approach to doing business because it considers the costs of doing
business in a straightforward and adjustable manner. If a material you require for
production goes up in price, you simply raise the price of the good proportionally. One
downside of this policy is that it can be difficult to know what you need to charge
ahead of time or if the scale of production changes.
Example: A painter wants to sell paintings for twice as much as they cost to make.
Each painting uses an average of ₹ 20 worth of paint, a ₹10 canvas and one day's
labor, which the painter values at ₹150. Since the total cost of production is ₹180, the
painter doubles the cost for a sale price of ₹360.
Marginal cost pricing or Target profit pricing
In this method, selling price is set to cover product variable cost (costs that change
with production) and contributes towards recovery of fixed costs (like rent or salaries).
Example: A factory produces a product where:
Variable cost per unit (materials, labor): ₹10
Fixed costs (rent, salaries): ₹1,000
If the company sells 100 units, it needs to price each unit above ₹10 to start covering
fixed costs.
If they price it at ₹15. ₹10 covers the variable cost.
The extra ₹5 per unit contributes toward the fixed costs.
Competition-based pricing policy
Your business might use a competition-based pricing policy to respond to what
competitors are charging for similar products. When pricing based on competition,
your company considers what segment of the market it wants to appeal to and the
competitors from which it seeks to take market share.
Competition-based pricing policy can be useful because it's a simple way to determine
price. It also can be both accurate and low-risk, since you likely understand what
your consumers already pay for what you're offering. However, sometimes, this
approach might lead your company to overlook strengths of your product that could
23
command higher prices. Since many companies use a competitive-based pricing
policy, one firm's inaccurate pricing can also result in widespread pricing mistakes.
Sealed Bid Pricing:
Sealed bid pricing is a method commonly used in tenders and contracts. In this
approach, firms submit sealed bids or proposals containing their proposed prices for
a particular project or contract. The bids are opened at a specified time, and the
contract is typically awarded to the bidder with the lowest price.
Example: Consider a government agency soliciting bids for the construction of a new
highway. Several construction companies submit sealed bids with their proposed
prices for the project. After opening the bids, the agency selects the construction
company with the lowest bid as the winner of the contract.
Going Rate Pricing:
Going rate pricing involves charging the prevailing market price for a product or
service. This pricing strategy is often used in commodity markets where products are
similar, and pricing is primarily influenced by market conditions and competitors.
Example: Imagine a company that produces a common household item, such as
paper towels. In a market where several competitors offer similar products, the
company might set its prices based on the going rate, which is the average price
established by competitors. If the prevailing market price for a roll of paper towels is
$2, the company would likely set its price in a similar range to remain competitive.
These pricing strategies are adapted to specific market conditions and types of
transactions.
Demand Based Pricing
Perceived value pricing:
This method considers the buyers perception of the value of the product as the basis
of pricing. Here the pricing rule is that the firm must develop procedures for
measuring the relative value of the product as perceived by consumers.
Example: Consider a high-end smart phone manufacturer that releases a new model
with advanced features, a sleek design, and cutting-edge technology. The company
conducts market research to understand how consumers perceive the value of these
features. Based on the findings, the company sets a premium price for the smart
phone, as it believes that the perceived value of the product justifies the higher cost.
Price discrimination or Differential pricing:
Price discrimination refers to the practice of charging different prices to customers for
the same good. In involves selling a product or service for different prices in different
market segments. Price differentiation depends on geographical location of the
consumers, type of consumer, purchasing quantity, season, time of the service etc.
Example: Airlines commonly use price discrimination based on factors such as timing
and customer type. Consider a situation where an airline offers different prices for the
same flight depending on when the ticket is purchased. Early bookings may receive
lower prices, while last-minute bookings may incur higher costs. Additionally, airlines
often use different pricing tiers for business class, economy class, and other
categories, tailoring prices to different customer segments.

24
Both pricing strategies highlight the importance of understanding customer
perceptions and market conditions to set prices that maximize revenue and meet
consumer expectations.
Strategy-Based Pricing:
Strategy-based pricing involves setting prices in alignment with the overall business
strategy. This approach considers various factors, such as the positioning of the
product or service in the market, the brand image, and the long-term goals of the
business. It goes beyond simply covering costs or responding to market conditions
and aims to use pricing as a strategic tool to achieve broader business objectives.
Skimming pricing:-
The company follows this method when the product is for the first time introduced
in the market. Under this method, the company fixes a very high price for the product.
this strategy is mostly found in case of technology products. When Samsung
introduces a new cell phone model, it fixes a high price because of the uniqueness of
the product.
Example When Samsung introduces a new cell phone model, it fixes a high price
because of the uniqueness of the product.
Penetration pricing:-
This is exactly opposite to the market skimming method. Here, a low price is fixed for
the product in order to catch the attention of consumers, once the product image and
credibility is established, the seller slowly starts jacking up the price to reap good
profits in future. The Rin washing soap perhaps falls into this category. This soap was
sold at a rather low price in the beginning and the firm even distributed free samples.
Today, it is quite an expensive brand and yet it is selling very well.
Two-part pricing:-
Under this strategy, a firm charges a fixed fee for the right to purchase its goods, plus
a per unit charge for each unit purchased. Entertainment houses such as country
clubs, athletic clubs, etc, usually adopt this strategy. They charge a fixed initiation
fee or membership fee plus a charge, per month or per visit, to use the facilities.
Block pricing:-
We see block pricing in our day-to-day life very frequently. Four Santhoor soaps in a
single pack with nice looking soap box or five Maggi packets in a single pack with an
attractive bowl indicate this pricing method. The total value of the goods includes
consumer‟s surplus as the consumer is given soap box and bowl along with the
products freely. By selling certain number of units of a product as one package, the
firm earns more than by selling unit wise.
Commodity bundling:-
Commodity bundling means the practice of bundling two or more different products
together and selling them at single „bundle price‟. For example tourist companies
offer the package that includes the travelling charges, hotel, meals and sight-seeing
etc, at a bundle price instead of pricing each of these services separate.
Peak load pricing:-
Under this method, high price is charged during the peak times than off-peak times.
RTC increases charges during festivals, Railways charge more fares during tatkal

25
time. During seasonal period when demand is likely to be higher, a firm may increase
profits by peak load pricing.
Cross subsidization: -
The process of charging high price for one group of customers in order to subsidize
another group.
Transfer pricing: -
Transfer pricing means a price at which one process forwards their output (work-in-
progress) to the next process for further processing. It is an internal pricing technique.
PRODUCT LIFE CYCLE BASED PRICING
Companies must adapt to the stages of the product life cycle to effectively sell and
promote their products. Depending on the product life cycle stage, a company will
develop branding techniques and an appropriate pricing model. Understanding each
stage helps businesses increase profits.
The stages of a product life cycle govern how a product is priced, distributed, and
promoted. A new product goes through multiple stages during the course of its life
cycle, including an introduction stage, growth stage, maturity stage and a decline
stage. As a product ages, companies look for new ways to brand it, and also explore
pricing changes. Market and competitor research help businesses assess the proper
course of action to maintain product profitability.

Introduction Stage
A new product may simply be either another brand name added to the existing ones
or an altogether new product. Pricing a new brand for which there are many
substitutes available in market is not a big problem as pricing a new product for
which close substitutes are not available.
There are two type of pricing strategies for new product.
Skimming price policy:- Selling a product at a high price, sacrificing high sales to
gain a high profit, therefore “skimming” the market. Usually employed to reimburse
the cost of investment of the original research into the product - commonly used in
electronic markets when a new range, such as DVD players, are firstly dispatched
into the market at a high price.
Penetration price policy:- This pricing policy is adopted generally in the case of new
product for which substitutes are available. This policy requires fixing a lower initial
price designed to penetrate the market as quickly as possible.

26
Growth Stage
During the growth stage, a company aims to develop brand recognition and increase
their customer base. The quality of their product is often improved based on early
reviews, and technical support is usually enhanced. Pricing remains generally stable
as demand continues with minimal competition. A larger distribution network is
formed to keep up with the pace of demand.
Pricing Strategies:
Maintain Price: If demand is strong, companies may maintain the current price to
maximize profits.
Moderate Price Reductions: Small price cuts can encourage wider adoption without
sacrificing too much profit margin.
Maturity Stage
In the maturity stage, the steady sales start to decline and companies face greater
challenges in the marketplace. Competitors will often introduce rival products with
the intent of grabbing some of the market share. This is the product life cycle stage
in which the customer base is heavily fought over and price decreases most often
occur. Additional features are added to distinguish a product from its competitors.
Companies run promotions during this stage that highlight the primary differences
between their product and their competitor’s products.
Pricing Strategies:
❖ Competitive Pricing: Focus on maintaining a competitive price to stay in the
game as the market becomes saturated with similar products.
❖ Promotional Pricing: Use discounts, sales, and bundles to stimulate demand
and defend market share.
Decline Stage
In the decline stage, a company will make important decisions regarding the future
of their product. They can choose to create new iterations of the product with new
features, or they can reduce the price and offer it at a discount. A company may
choose to discontinue the product altogether, either disposing of their inventory or
selling it to another company who is willing to manufacture and market it. Promotion
at this stage will depend on whether a company chooses to continue its product, and
how they plan to re-market it.
Pricing Strategies:
❖ Price Reductions: Lower prices to clear out remaining inventory and maximize
profit before discontinuing the product.
❖ Loss Leaders: Sell products below cost to attract customers and potentially sell
them higher-margin products.

Stage Description Pricing Strategies

New product enters Price skimming,

Introduction
the market Penetration Pricing

27
 Stage Description Pricing Strategies

Maintain Price, Moderate

Growth Demand increases
Price Reductions

Competitive Pricing,
Maturity Market saturation
Promotional Pricing

Price Reductions, Loss

Decline Sales decline
Leaders

BREAK EVEN ANALYSIS

BEP analysis is also called as CVP analysis When it is used in the broader sense it
means it is a system of analysis that can be used to determine the probable profit or
loss at any given level of output. Under this sense, break-even analysis refers to the
study of relationship between cost, volume and profit at different levels of production
or output.
The BEP can be defined as that level of sales at which total revenues equals total costs
and the net income is equal to zero. This is also known as no-profit no-loss point.
Break-even analysis refers to analysis of costs and their possible impact on revenues
and volume of the firm. Hence, it is also called the cost-volume-profit (CVP) analysis.
A firm is said to attain the BEP when its total revenue is equal to total cost (TR=TC).
The main objective of the Break-Even Analysis is not only to spot the BEP but also
to develop an understanding of the relationships of cost, volume and price within a
company’s practical range of operations.
Assumptions of break – even analysis
The following are the important assumptions of Break-Even Analysis.
I. The costs can be segregated into fixed cost and variable cost.
2. Total fixed cost remains the same.
3. Variable cost per unit remains constant.
4. The selling price does not change.
5. There will be no change in the general price level.
6. There is one product or in the case of multiple products, the present sales mix
continues.
7. There is a constant demand for the product, it means, whatever is produced can
be sold out.
8. Volume of the production is the only factor that influences the cost.

28
The point where total revenue is just equal to the total cost is called Break-even point.
At break-even point, there is no profit or no loss to the business.
Units of products/sales are shown on the horizontal axis OX and costs and revenues
are shown on vertical axis OY. The variable cost line is drawn first. It increases along
with volume of production and sales. The total cost line is parallel to variable cost
line. It is derived by adding total fixed costs line to the total variable cost line. The
total revenue line (TR) starts from point (0) and increases along with volume of
production or sales intersecting total cost line at point BEP. To the right of the BEP
is profit zone and to the left of the BEP is the loss zone. A perpendicular from the
BEP to the horizontal axis at point M shows OM is the quantity produced at OP the
cost at BEP.
KEY TERMS USED IN BREAK EVEN ANALYSIS
Selling Price (S): The price at which a product or service is sold to customers.
Variable Costs (V): Costs that change in proportion to the production level, including
raw materials, direct labor costs, and utilities.
Eg. Electric power and fuel, packing materials consumable stores. It should be noted
that variable cost per unit is fixed.
Fixed Costs (F): Costs that remain constant regardless of the production level, such
as rent, insurance, and salaries of administrative staff.
Eg. Manager’s salary, rent and taxes, insurance etc.
Total Cost (TC): The sum of all costs incurred in production and sales, including
both fixed and variable costs.
TC=FC+VC
Total Revenue (TR): The total income generated from selling products or services,
calculated by multiplying the price per unit by the quantity sold.
Total revenue = (Selling Price per unit x No of units sold)
Break-Even Point (BEP): The production or sales volume at which total revenue
equals total cost, resulting in neither profit nor loss.

29
Average Variable Cost (AVC): The total variable cost divided by the number of units
produced, representing the variable cost per unit.
Contribution Margin (CM): The difference between the selling price and the variable
cost per unit, indicating the amount available to cover fixed costs and contribute to
profit. and it contributed towards fixed costs and profit. It helps in sales and pricing
policies and measuring the profitability of different proposals. Contribution is a sure
test to decide whether a product is worthwhile to be continued among different
products.
Contribution = Sales – Variable cost
Margin of safety: Margin of safety is the excess of sales over the break-even sales. It
can be expressed in absolute sales amount or in percentage. It indicates the extent
to which the sales can be reduced without resulting in loss. A large margin of safety
indicates the soundness of the business. The formula for the margin of safety is:
MOS (in Units) = Actual Sales (in Units) – BEP (in Units)
FORMULAS:
Selling price = fixed cost + Variable cost + profit
Selling price – Variable cost = fixed cost + profit
= Contribution
Contribution per unit = Selling price per unit – Variable cost per unit
Profit volume ratio or contribution margin ratio
Contribution Margin
Contribution Margin Ratio = × 100
Sales Revenue
Determination of Break-even point in units
Fixed costs
Break even point =
Contibution margin per unit
Where contribution margin per unit = selling price per unit – variable cost per unit
Determination of Break-even point in value
Fixed costs
Break even point = Contibution margin ratio
Where contribution margin ratio = (selling price – variable cost)/selling price

Margin of Safety (MOS)

profit
Margin of safety sales margin of safetysales = P/Vra𝑡𝑖𝑜
Margin of safety unit = Total units – BEP units
Margin of safety sales = Margin of safety units x Selling price per unit
SIGNIFICANCE OF BREAK-EVEN ANALYSIS
1) To ascertain the profit on a particular level of sales volume or a given capacity of
production.
2) To calculate sales required to earn a particular desired level of profit.
3) To compare the product lines, sales area, method of sale for individual company.
4) To compare the efficiency of the different firms.
5) To decide whether to add a particular product to the existing product line or drop
one from it.
6) To decide to „make or buy‟ a given component or spare part.
7) To decide what promotion mix will yield optimum sales.
8) To assess the impact of changes in fixed cost, variable cost or selling price on BEP
and profits during a given period.
30
LIMITATIONS OF BREAK-EVEN ANALYSIS
1) Break-even point is based on fixed cost, variable cost and total revenue. A change
in one variable is going to affect the BEP.
2) All costs cannot be classified into fixed and variable costs. we have semi-variable
costs also.
3) In case of multi-product firm, a single chart cannot be of any use. Series of charts
have to be made use of .
4) It is based on fixed cost concept and hence-holds good only in the short-run.
5) Total cost and total revenue lines are not always straight as shown in the figure.
The quantity and price discounts are the usual phenomena affecting the total
revenue line.
6) Where the business conditions are volatile, BEP cannot give stable results.
PROBLEMS AND SOLUTIONS:
1. A firm has a fixed cost of Rs. 10,000, selling price per unit is Rs.5 and variable
cost per unit is Rs. 3.
a. Determine break-even point in terms of volume and also sales value.
b. Calculate the margin of safety considering that the actual production is 8000
units.
Solution: 𝒂
F
.BEP (in units) =
C per unit Note:

BEP in units can be calculated only when unit sales price and unit variable cost
are given.
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 = 𝑆𝑒𝑙𝑙𝑖𝑛𝑔 𝑝𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 − 𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑐𝑜𝑠𝑡 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡

=𝑆−𝑉=5−3=2
𝐵𝐸𝑃 𝑖𝑛 𝑢𝑛𝑖𝑡𝑠 = 𝐹 /𝐶 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 = 10000 /2 = 5000 𝑢𝑛𝑖𝑡𝑠
𝐹
𝐵𝐸𝑃 𝑖𝑛 𝑠𝑎𝑙𝑒𝑠 =
𝑃/𝑉 𝑟𝑎𝑡𝑖𝑜
𝐶 2
𝑃/𝑉𝑟𝑎𝑡𝑖𝑜 = 𝑋 100 = × 100 = 40%
𝑆 5
F 10000
BEP in sales = = = Rs. 25000
P/ V ratio 40%

(or)

𝐵𝐸𝑃 𝑖𝑛 𝑠𝑎𝑙𝑒𝑠 = 𝐵𝐸𝑃 𝑢𝑛𝑖𝑡𝑠 × 𝑆𝑒𝑙𝑙𝑖𝑛𝑔 𝑃𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 = 5000 𝑥 5 = 25000
𝒃. 𝑀𝑎𝑟𝑔𝑖𝑛 𝑜𝑓 𝑠𝑎𝑓𝑒𝑡𝑦 𝒔𝒂𝒍𝒆𝒔
𝑃
𝑀𝑎𝑟𝑔𝑖𝑛 𝑜𝑓 𝑠𝑎𝑓𝑒𝑡𝑦 𝑠𝑎𝑙𝑒𝑠 =
𝑃/ 𝑉 𝑟𝑎𝑡𝑖𝑜

Profit = Total Sales – (Total Variable cost + Fixed cost)

Profit = Contribution – Fixed cost
Contribution = Sales – Variable cost
Total Sales = Total Units sold × Selling price per unit = 8000 × 5 = Rs. 40000
Total variable cost × Variable cost per unit = 8000 × 3 = Rs. 24000
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Profit = Total Sales – (Total Variable cost + Fixed cost) = 40000 – (24000+10000) =
Rs. 6000
P 6000
Margin of safety sales = = = Rs. 15000
P/ V ratio 40%
(or)
Margin of safety sales = Margin of safety units × Selling price per unit
Margin of safety unit = Total units – BEP units = 8000 – 5000 = 3000
Margin of safety sales = Margin of safety units × Selling price per unit = 3000 × 5 =
Rs.15000
2. A high-tech rail can carry a maximum of 36,000 passengers per annum at a fare
of Rs. 400. The variable cost per passenger is Rs. 150 while the fixed costs are
Rs.25,00,000 per year. Find the break-even point in terms of number of passengers
and also in terms of fare collections.
Solution:
𝒂. BEP (in number of passengers)
𝐹
𝐵𝐸𝑃 (𝑖𝑛 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑝𝑎𝑠𝑠𝑒𝑛𝑔𝑒𝑟𝑠) =
𝐶𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
Contribution per passenger = 𝑆𝑒𝑙𝑙𝑖𝑛𝑔 𝑝𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑝𝑎𝑠𝑠𝑒𝑛𝑔𝑒𝑟 − 𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑐𝑜𝑠𝑡 𝑝𝑒𝑟 𝑝𝑎𝑠𝑠𝑒𝑛𝑔𝑒𝑟
= 𝑆 − 𝑉 = 400 − 150 = 250
𝐹 2500000
𝐵𝐸𝑃 𝑖𝑛 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑝𝑎𝑠𝑠𝑒𝑛𝑔𝑒𝑟𝑠 = 𝐶 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 = = 10000 𝑝𝑎𝑠𝑠𝑒𝑛𝑔𝑒𝑟𝑠
250

𝒃. 𝐵𝐸𝑃 𝑖𝑛 𝐹𝑎𝑟𝑒 𝑐𝑜𝑙𝑙𝑒𝑐𝑡𝑖𝑜𝑛

𝐹
𝐵𝐸𝑃 𝑖𝑛 𝐹𝑎𝑟𝑒 𝑐𝑜𝑙𝑙𝑒𝑐𝑡𝑖𝑜𝑛 =
𝑃/𝑉𝑟𝑎𝑡𝑖𝑜
𝐶 250
𝑃/𝑉𝑟𝑎𝑡𝑖𝑜 = × 100 = × 100 = 62.50%
𝑆 400
𝐹
𝐵𝐸𝑃 𝑖𝑛 𝐹𝑎𝑟𝑒 𝑐𝑜𝑙𝑙𝑒𝑐𝑡𝑖𝑜𝑛 = = 2500000/ 62.50% = 𝑅𝑠. 4000000
𝐶𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
3. From the following data, calculate,
a. P/V Ratio, b. Profit when sales are Rs. 20,000
Fixed expenses Rs. 4,000, Break-even point Rs. 10,000
Solution:
𝒂. P/V Ratio
𝑃/ 𝑉 𝑟𝑎𝑡𝑖𝑜 = 𝐶/𝑆 = (𝑆 – 𝑉)/ 𝑆 = 𝐹 + 𝑃 /𝑇𝑜𝑡𝑎𝑙 𝑆𝑎𝑙𝑒𝑠 = 𝐹/ (𝐵𝐸𝑃 𝑠𝑎𝑙𝑒𝑠)
= 𝑃/ (𝑀 /𝑆 𝑠𝑎𝑙𝑒𝑠) = 1 –(𝑉/𝑆) = 𝐷𝑖𝑓𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝑖𝑛 𝑝𝑟𝑜𝑓𝑖𝑡𝑠/ 𝐷𝑖𝑓𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝑖𝑛 𝑠𝑎𝑙𝑒𝑠
𝑃 /𝑉 𝑟𝑎𝑡𝑖𝑜 = 𝐹 /(𝐵𝐸𝑃 𝑠𝑎𝑙𝑒𝑠) = (4000 /10000) ×100 = 40%
b. What is profit when total sales are Rs. 20000?
Total sales = BEP sales + Margin of safety sales
Note: - Contribution of total sales includes profit and fixed cost.

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= C = (P+F)
Contribution of total sales = Total sales × P/V ratio
= 20000 × 40% = 8000
C = (P+F) P = C – F = 8000-4000 = Rs. 4000
OBJECTIVE QUESTIONS
1. How many types of input-output relations discussed by the Law of production
( )
(a) Five (b) Four (c) Two (d) Three
2. When a firm expands its Size of production by increasing all factors, it secures
certain advantages, known as ( )
(a) Optimum Size (b) Diseconomies of Scale (c) Economies of Scale (d) None
3. When producer secures maximum output with the least cost combination of
factors of production, it is known as_______ ( )
(a) Consumer’s Equilibrium (b) Price Equilibrium (c) Producer’s Equilibrium
(d) Firm’s Equilibrium
4. _________ is a ‘group of firms producing the same are slightly Different products
for the same market or using same raw material’. ( )
(a) Plant (b) Firm (c) Industry (d) Size
5. When proportionate increase in all inputs results in an equal Proportionate
increase in output, then we call____________. ( )
(a) Increasing Returns to Scale (b) Decreasing Returns to Scale (c) Constant
Returns to Scale (d) None
6. When different combinations of inputs yield the same level of output Known as
_______ ( )
(a) Different Quants (b) Output differentiation
(c) Isoquants (d) Production differentiation
7. Conversion of inputs in to output is called as _________________. ( )
(a) Sales (b) Income (c) Production (d) Expenditure
8. When Proportionate increase in all inputs results in more than equal
Proportionate increase in output, then we call _____________. ( )
(a) Decreasing Returns to Scale (b) Constant Returns to Scale
(c) Increasing Returns to Scale (d) None
9. When Proportionate increase in all inputs results in less than Equal
Proportionate increase in output, then we call _____________. ( )
(a) Increasing Returns to Scale (b) Constant Returns to Scale
(c) Decreasing Returns to Scale (d) None
10. A curve showing equal amount of outlay with varying Proportions of Two inputs
are called ( )
(a) Total Cost Curve (b) Variable Cost Curve
(c) Isocost Curve (d) Marginal Cost Curve
11. The cost of best alternative forgone is_______________ ( )
(a) Outlay cost (b) Past cost (c) Opportunity cost (d) Future cost
12. If we add up total fixed cost (TFC) and total variable cost (TVC), we get________
( )
(a) Average cost (b) Marginal cost (c) Total cost (d) Future cost
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13. ________ costs are theoretical costs, which are not recognized by the Accounting
system. ( )
(a) Past (b) Explicit (c) Implicit (d) Historical
14. _____cost is the additional cost to produce an additional unit of output. ( )
(a) Incremental (b) Sunk (c) Marginal (d) Total
15. Exchange value of a unit of good expressed in terms of money is called ( )
(a) Cost (b) Capital (c) Price (d) Expenditure
16. The price of a product is determined by the ______of that product ( )
(a) Place and time (b) Production and sales
(c) Demand and supply (d) Cost and income
17. The price at which demand and supply of a commodity equal is Known as( ) (a)
High price (b) Low price (c) Equilibrium price (d) Marginal price
18. A market where large number of buyers and sellers dealing in Homogeneous
product with perfect knowledge is called ( )
(a) Imperfect competition (b) Monopoly
(c) Perfect competition (d) Monopolistic competition
19. in which market, single market price prevails for the commodity ( )
(a) Monopoly market (b) Oligopoly market (c) Perfect competition market
(d) Duopoly market
20. The Price determined in the very short period is known as_____. ( )

(a) Secular price (b) Normal price (c) Market price (d) Short run price
Note: Answer is “C” for all the abovequestions
FILL IN THE BLANKS
21.Implicitcosts are those business costs, which do not involve any cash payment.
22. The opposite of Past cost is Future cost.
23. Long period is a period during which the existing physical capacity of the Firm
can be changed
24. What is the formula for Profit-Volume Ratio Contribution?
--------------- X 100
Sales
25. Break-Even sales is a point of sales at which there is neither profit nor loss.
26. What is the formula for Margin of Safety Break-Even sales Actual sales – Break
Even sales
27. What is the formula for Break-Even Point in Units?
_ _Fixed cost _____
Contribution per unit
28. What is the Other Name of Profit Volume Ratio Marginal Ratio
29. When selling price per unit is 10/- , Variable cost per unit is 6/- and fixed cost
is 40,000/- What is the break-even sales amount,1, 00,000/-
30. ‘Contribution” is the excess amount of Actual Sales over Variable cost.
31. Equilibriumis a position where the firm has no incentive either to expand or
contrast its output
32. Marginal revenue, Average revenue and Demand are the same in Perfect
competitionMarket
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33.Short run is a period in which supply can be increased by altering the Variable
factors and fixed costs will remain constant.
34. The total supply of a good is produced by a single private person or Firm is
called as Private monopoly
35. If Average Revenue is less than the Average Cost, Monopoly secures Losses
36. In Monopoly market environment, seller is the Price maker
37. Tenders are based on sealed bid pricing
38. Charging Very Low price in the beginning and increasing it gradually is called
Penetration pricing.
SUBJECTIVE QUESTIONS
Define Isoquants and explain its features.
Explain briefly Contribution, Break-Even Point (BEP), Margin of Safety (M/S), Profit-
Volume (P/V) Ratio.
What is Monopoly? Explain the features of monopoly.
Define Market and explain various classifications of the market.
Define Cost Analysis and explain cost concepts.
Given the following information relating to a company:
Sales: Rs. 4,00,000
Variable cost: Rs. 2,50,000
Fixed cost: Rs. 1,80,000
Calculate:
i) Contribution
ii) P/V ratio
iii) BEP in u nits iv) BEP in Rs
Define Production and explain factors of production.
Explain the production function with two variable input.
Explain the law of returns to scale.
Explain the production function with one input variable?.
What is a Monopoly?. Explain its features and price-output determination in
Monopoly.
Explain price-output determination in perfect competition.
Explain features and price-output determination in monopolistic competition
Explain different methods of pricing.
Explain the feature of Oligopoly.
Explain the product life cycle based pricing

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