the concept of an industry

8/3/2019 The Concept of an Industry

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THE CONCEPT OF AN INDUSTRY

Book uses partial equilibrium approach. Basis of the approach: INDUSTRY.

Importance of the concept of an industry

Concept important for economic analysis. Important in the study of competition.

Reasons for its importance:

(a) Reduces complex interrelationships of all firms of an economy to

manageable dimensions. General equilibrium approach depicting each firm

behaviour by an equation might appear appropriate. General equilibrium

approach and current applications designed to deal with a different range of

problems. More relevant for aggregate variables. Cannot include detailed

information required for the study and the prediction of behavior of individual

economic units. Concept of industry includes firms in some form of close

relationship with one another. Firms in a group mostly behaviorally

interdependent.

(b) Helps to derive a set of general rules to predict behavior of competingmembers of the group making up the industry.

(c) Helps to analyze effects of entry of a firm on existing firms, equilibrium price

and equilibrium output.

Concept of industry as a tool of analysis important for empirical research.

Concept useful in concrete empirical investigations after the industrys content

has been empirically determined to suit the purpose of the research (Triffin. R,MONOPOLISTIC COMPETITION AND GENERAL EQUILIBRIUM THEORY

(Harvard University Press, Cambridge, Mass, 1939)

Businessmen conscious of belonging to an industry. Decisions taken assuming


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probable reactions of other firms in the industry. Publish data are normally

grouped on the basis of standard industrial classifications. Government policy

designed with regard to industries. Government measures aims and

performance in terms of industries rather than individual firms.

Criteria for the classification of firms into industries

Two criteria used:

(a) Market criterion: product being produced. Firms grouped if products are

close substitutes.

(b) Technological criterion: the methods of production. Firms grouped if

processes and /or raw materials are similar.

Meaningfulness of classification criterion depends on market structure and

purpose of study or decision.

Market criterion: similarity of products

Include in an industry firms whose products are sufficiently si milar to be close

substitutes for the buyer. Measure by cross elasticity of demand:

Ec = dqj / dp i x p i / pj

Where: q j = quantity produced by the jth firm

pi = price charged by the ith firm.

Required value of the cross elasticity to classify the ith and jth firm into anindustry depends on extent of differentiation. Degree of closeness or similarity

between products defined on an empirical basis, depending on purpose.

Definition for products maybe broad or narrow. Product definitions based on

technical substitutability and economic substitutability (similar price ranges).


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Products within a group are both technical and economic substitutes.

THEORY OF DEMAND

The theory of demand is meant to find out various factors affecting demand.

Conventional demand law concentrates only on price and so can be misleading.

Demand is a multivariate relationship simultaneously affected by many factors.

Traditional demand theory concentrates on four determinants:

1. Price of the commodity.

2. Price of other commodities.

3. Income.

4. Taste.

Limitations of the traditional demand theory:

a) Examines only final consumer demand.

b) Non interrelationship between markets i.e. partial approach.c) Firms sell directly to consumers.

d) Ignores demand for investment goods & intermediate goods.

THEORY OF CONSUMER BEHAVIOUR

Traditional demand theory starts with an individual consumers behaviour.

Fundamental assumptions:

a)AXIOM OF UTILITY MAXIMISATION: Consumer is so rational as to plan his

income expenditure for the attainment of the highest possible satisfaction.


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b) FULL KNOWLEDGE: Knows all information relevant to his decision:

knowledge of commodities, knowledge of prices & knowledge of his income.

Utilities of different baskets of consumption must be compared to achieve the

rational utility maximization objective.

The two basic approaches to the comparison of utilities are:

1) CARDINALIST APPROACH.

2) ORDINALIST APPROACH.

CARDINALIST APPROACH

BASIC ASSUMPTIONS

1) The Cardinal Measurability of Utility:

Utility is expressed in quantitative terms and so can be compared with respect to

size.

Utility is measurable only in principle and on the other hand not only in

principle but also actually measurable in terms of money.

It has been argued that desires cannot be measured directly, but only indirectly

by the outward phenomena to which they give rise: and that in those cases with

which economics is chiefly concerned the measure is found in the price which a

person is willing to pay for the fulfillment or satisfaction of his desire. (Marshall,Alfred, Principles of Economics, Book III, Chp. 3. pp: 78)

2) Hypothesis of Independent Utilities:


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Utility of a consumer depends on the quantity of the concerned good only and is

independent of other goods.

3) Quantities of Commodities:

Utility depends on quantities of individual commodities.

U = f (x1, x2, .. xn)

U = U1(x1) + U2(x2) + . + Un(xn) older version implying additive

utility function. Ignored in latter versions of cardinal utility theory as unrealistic

and unnecessary.

4) Constancy of Marginal Utility of Money:

This assumption helps to measure utility in all circumstances.

Marginal utility curve is same as demand curve. Otherwise it would be above the

MU curve for fall in price and below MU curve for a rise in price.

5) Introspective Method:

Analysis through self observation out of guess work or intuition or experience.

Reconstruction of others minds through own experience.

Attribute to another what we know of our own mind.


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GRAPHIC REPRESENTATION OF TU AND MU

Total utility curve is drawn on three assumptions:

1. TU increases at a decreasing rate.

2. Presence of satiation quantity or satiety point.

3. Decreasing TU means negative MU.

Marginal utility is the net change in total utility due to successive units of

consumption which is the slope of the tangent at various points of the TU curve:

U = f (qx)

MU = dU / dQ

Utility from consuming a commodity depends on tastes and preferences and so

reflect it.

So utility is uniquely subjective and not comparable.

LAW OF DIMINISHING MARGINAL UTILITY

Utility is related to desire or want which cannot be measured directly.

Desire gives rise to outward expressions which alone can be measure.

In economics it is the price an individual is willing to pay, as an indication of

ones intensity of want or desire.


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In utility theory the concern is only with desire that is meant to be satisfied and

anticipated satisfaction fairly corresponds with realized satisfaction.

Statement

Total utility increases with increase in product quantity but the speed on

increase diminishes and so successive additional benefit decreases.

Marginal purchase: Quantity of a commodity a consumer is just tempted to buy

after a doubt whether it is worth spending on it.

Marginal utility: Utility of consumers marginal purchase.

The marginal utility of a thing to anyone diminishes with every increase in the

amount of it he already has (Marshall, Alfred, Principles of Economics, Book III,

Chp. 3, pp. 79)

Based on the assumption that the consumer is the same at the beginning as at

the end of it. (Marshall)

The price a consumer is willing to pay is the measure of the utility of the

commodity at a quantity which is at the margin or terminus or end of his

purchase. So if the MRP is the demand price then the price at the margin is

called marginal demand price.

Statement in terms of price:

The larger the amount of a thing that a person has the less, other tings

being equal (i.e. the purchasing power of money, and the amount of

money at his command being equal), will be the price which he will pay for


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a little more of it: or in other words his marginal price for it diminishes.

(Marshall, Alfred, Principles of Economics, Book III, Chp. 3, pp.80)

MATHEMATICAL APPENDIX: INTERPRETATION

In a one commodity model when the value the consumer places on every

additional unit of the commodity is more than the amount paid for it, the

individual will continue consuming the product and increase ones total utility.

So the utility maximizing consumer will adjust ones purchases the marginal

demand price equals utility of the product at the marginal quantity.

Thus quantity of marginal utility is equal to the price. And when the consumption

of other commodities are held constant due to the convenience of independent

and additive utility assumptions, the MU schedule is the demand schedule and

the MU curve is the demand curve of the concerned consumer.

CONSUMERS EQUILIBRIUM

The consumer either buys commodity X or keeps back his money income Y.

Thesis 1: Consumer attains equilibrium when MUx = Px

MUx > Px better to purchase more units of commodity X.

Px > MUx better to cut down consumption of X and keep back money income.

In case of two or more commodities consumers equilibrium is the ra tio of

marginal utility to price of the respective commodities such that MUx /Px = MUy

/Py = ----------- MUn /Pn

DERIVATION OF THE DEMAND CURVE OF THE CONSUMER

Total utility increases at a decreasing rate and further geometrically marginal


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utility is the slop of the total utility curve representing the function U = f (Qx).

If marginal utility is measured in monetary units then MUx curve will become the

demand curve and the y axis will be used to measure the price per unit

because the quantity of a commodity that a consumer consumes is at the point

when utility at the margin is equal to the price.

However negative marginal utility section of the curve in the fourth quadrant will

not required for us because there are no negative quantities demanded in

economics.

CRITIQUE OF THE CARDINAL APPROACHES:

1. Assumption of cardinal utility is doubtful because satisfaction cannot be

objectively measured.

2. Constant marginal utility of money is unrealistic because as money income

increases marginal utility of money decreases.

3. Diminishing marginal utility established by introspection a generalization

that must be taken for granted.

DU university Question paper for B.com 1st year - 2007

Attempt five questions in all. All questions carry equal marks.

Q.1 What is Production possibility curve? How is it used to explain the centralproblems of an economy?

Q. 2a. Explain the meaning of price elasticity of demand.b. If two straight line demand curves intersect each other, which of them will

have higher elasticity of demand at the point of intersection?

c. Explain cross- elasticity of demand and income elasticity of demand.


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Q. 3 Using suitable diagrams, explain how the burden f excise duty varies on

buyers and sellers on the basis of elasticity of demand for a given elasticity ofsupply.

Q.4

a. What is meant by indifference curves ? Explain why it is generally convex toorigin?

b. Explain equilibrium of a consumer with the help of a indifference curvestechnique.

Q.5

a. Distinguish between Diminishing returns to a factor and diminishing returns toscale.

b. Why is the SR AC curve U-shaped?

Q.6 Explain the term economic rent according to Modern Theory Rent. Why

economic rent arises? Under what conditions a factor of production does notearn economic rent? Use diagrams

Q.7 Explain how international trade takes place when there are:

a. Absolute cost differences andb. Comparative cost differences

Also explain the criticism of the theory of Comparative cost differences?

Q 8. How do equilibrium price and equilibrium quantity respond to changes in

prices of raw materials and change in technology? Explain Diagrammatically.

The Indifference Curve Theory - PART I

Introduction

The indifference curve is a geometrical tool that has been used to swap for theneo-classical cardinal utility conception. The indifference curve study measures


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efficacy in essence. It portrays customer's mannerism in terms of his likings andpenchants or standing for diverse permutations of two products such as A and

B. According to Watson, "An indifference schedule is a list of permutations,preferring none of any other." A sole indifference curve concerns just one stage

of contentment.

Postulations of Indifference Curve

The indifference curve study holds some of the hypothesis of the Cardinal

Theory discards others and devises its own.

1. 1. The customers perform realistically so as to exploit contentment

2. There are two commodities A and B

3. The customer possesses complete information about the prices of thecommodities in the market.

4. The prices of the two commodities are set

5. The customer's likings, behaviour and earnings stay the same all throughthe study

6. He prefers more of A to less of B or vice versa

7.An indifference curve is negatively inclined downwards


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8.An indifference curve is constantly curved to the source

9.An indifference curve is even and incessant which means that thecommodities are vastly separable and that levels of contentment also varyin an incessant manner

10. The customer fixes up the two commodities in a degree of choiceswhich means that he has both choice and indifference for thecommodities.

11. Both choice and indifference are transitive. If the permutation X ispreferable to Y and Y to Z, then X is preferable to Z

12. The customer is in a situation to instruct all feasible permutations ofthe two commodities

Properties of Indifference Curve

A higher indifference curve to the right of another signifies a higher level ofcontentment and preferable permutation of the two commodities. In between two

indifference curves there can several other indifference curves, one for everypoint in-between the spaces of two curves. The Parameters set to indifference

curves are completely random. Numbers have no significance in the indifferencecurve swot. The tilt of an indifference curve is negative, downward inclined and

from left to right means that the customer to be indifferent to all the permutationson an indifference curve must leave less units of good A in order to have more

of B. An indifference curve can neither touch nor intersect each other so thatone indifference curve passes through only one point on an indifference map.


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An indifference curve cannot touch either axis. It is curved to the origin. Theconvexity rule entails that as the customer surrogates A for B, the marginal rate

of substitution reduces. It means that the volume A is enhanced by the samevolume of B reduced by smaller units. The tilt of the curve becomes lesser as we

move to the right. Indifference curves are not essentially parallel to each other.They are like bangles. But as a substance of principle, their 'effective region' is

in the form of sections.

Marginal Rate of Substitution

The marginal rate of substitution is the rate of swap amidst some units of

commodities A and B which are uniformly preferred. The marginal rate ofsubstitution A for B (MRS)ab is the amount of B that will be missed for acquiring

each extra unit of A. This rate is explained below in the tablet below.

Permutations A B MRS of A

and B

1 1 18 -

2 2 13 5:1

3 3 9 4:1

4 4 6 3:1

5 5 4 2:1

6 6 3 1:1

To have the second permutation and yet to be at the same level of contentment,

the customer is prepared to relinquish 5 units of B for acquiring an extra unit ofA. The marginal rate of substitution of A for B is 5:1. The rate of substitution will

then be the number of units of B for which one unit of A is a substitute. As thecustomer continues to have extra units of A, he is keen to give away less and

less units of B so that the marginal rate of substitution falls from 5:1 to 1:1 in thesixth permutation. Prof. Hicks has defined it in these words - "suppose we start

with a given quantity of commodities and then go on increasing the amount of Aand diminishing that B in such a way that the customer is left neither better off

nor worse off on balance then the amount of B which has to be subtracted inorder to set off a second unit of A will be less than that which has to be


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subtracted in order to set off the first unit. In other words the more A issubstituted for B, the less will be the marginal rate of substitution of A for B."

Now let us construct the model representing marginal rate of substitution.(MRS)ab = B / A, at point o, (MRS)ab = mn/no and likewise other

parameters are derived.

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Theory of Consumer Choice

Another useful technique for considering how consumers choose between alternativesatisfaction is indifference curve analysis. For this technique we build a pattern of

indifference curves, each recording a chain of choices between alternatives which giveequal satisfaction.

Indifference curve adopted the concept of ordinal utility instead of cardinal utility. It

implies that the consumer is capable of simply comparing different levels of satisfaction

Thus the basis of indifference curve approach is the preference indifferencehypothesis. According to it when a consumer is presented with a number of variouscombinations of goods, he can order or rank them in scale of preferences. Indifferenc

curve approach, as presented by Hicks-Allen is the basic tool ofordinal analysis odemand.

An Indifference curve, according to Hics-Allen, represents all thosecombinations of goods that give equal satisfaction to the consumer so he will be

indifferent between them and it will not matter to him which one he gets. In otherwords, all the combinations lying on a consumers indifference curve are equallydesirable or preferable to him. Let us assume the following indifferent schedule.

Indifference schedule or Indifference Set

It shows various combinations of two goods which yield a consumer the same

satisfaction, thus he is indifferent in regard to choice among the combination.

Good X 1 2 3 4 5

Good Y 12 8 5 3 2

Graphical presentation of Indifference Curve


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Properties of Indifference Curve

1. Indifference curves slope downward to the right.2. These are convex to the origin. This is indication of diminishing MRSxy3. These can not intersect each other4.A higher Indifference curve represents a higher level of satisfaction.

Unemployment takes place when people have no jobs and they are willingand seeking for work. Some People give importance to the number of

unemployed individuals but Economists focus on rate ofunemployment which

can be measure as dividing unemployed workers divided by all individuals in thelabor force.

Unemployment Rates = Unemployed Workers / Total Labour Force

The International Labor Organization (ILO) describes 4 different methods forcalculation of unemployment rate.

1. Labour Force Sample Surveys2. Official Estimates3. Social Insurance Statistics4. Employment Office Statistics


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Types of Unemployment

1. Normal, Transitional Unemployment

According to economists this exists at all times at a rate of 2-3 percent andharms no one. For individuals or groups, it lasts for a few months when people

move from job to job for better wages or wait for better opportunities.

2. Casual and Seasonal Unemployment

Some occupations are adversely affected by weather conditions and workers in

these trades expect a certain amount of casual unemployment. Seasonalunemployment often occurs in agriculture, dockyard, hotels, restaurants and

construction business. Such unemployment is inevitable and tends to beovercome by casual labour.

3. Frictional Unemployment

This type of unemployment exists because of friction in the labour market. Jobs

may exists but people do not go to take up jobs away from home for domesticreasons such as children's education, family and friendly ties and, housing

problem in a new place.

4. Structural Unemployment

It is caused by a change in the demand for the products of a given industry. The

closing of the particular industry may cause structural changes in the nation'sindustry as a whole. If labour is specific, it is immobile between industries and

unemployment results. The pace of modern technology is so fast that it makespast techniques obsolete, causing unemployment in old industries.

5. Cyclical Unemployment

Both external and internal factors such as wars, strikes, population changes,

political disturbances, floods, droughts, changes in consumption patterns,investment, savings, spending, supply of credit, business outlook etc. bring

about this type of unemployment. This type of unemployment was a serious


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problem before the Second World War. Now it has been largely mastered byGovernment activity to control the development of cycles.

Causes of Unemployment

In todays modern economy many factors contribute to unemployment.Unemployment causes are varied and due to the following factors

Inflation

DisabilityRecessions

Rapid changes in technologyAttitude towards employers

Perception of employeesEmployee valuesDiscriminating Factors like ethnicity, race, age etc. in work place

the concept of an industry

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