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Unit-3

Introduction to Markets, Theories of the Firm & Pricing Policies

MARKETS

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, 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.). For business purpose we define a market as people or organizations
with wants (needs) to satisfy, money to spend, and the willingness to spend it.

Size of Market:

The size of market depends up on many factors such as nature of products,

nature of their demand, tastes and preferences of the customers, their income level,
state of technology, extent of infrastructure including telecommunication and information
technology, time factor in term of short-run or long-run and so on.

Market Structure

Market structure refers to the characteristics of a market that influence the behavior and
performance of firms that sell in the market.

The structure of market is based on its following features:

1. The degree of seller concentration: this refers to the number of sellers and their
market share for a given product or service in the market.

2. The degree of buyer concentration: This refers to the number of buyers and their
extent of purchases of a given product or service in the market.
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3. The degree of product differentiation: This refers to the extent by which the
product of each trader is differentiated from that of the other.

4. The conditions of entry into the market: More often, there could be certain
restrictions to enter into or exit from the market. The degree of each with which one can
enter the market or exit from the market also determines the market structure.

Different Market Structures

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 marketing
decisions concerning economic variables it is affected, as are all institutions in society
by its environment.
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Perfect competition: in which buyers and sellers have complete information about a
particular product and it is easy to compared price of products because they are the
same as each other Etc.,

Imperfect competition occurs in a market when one of the conditions in a perfectly

competitive market is left unmet. This type of market is very common. In fact, every
industry has some type of imperfect competition. This includes a marketplace with
different products and services, prices that are not set by supply and demand,
competition for market share, buyers who may not have complete information about
products and prices, and high barriers to entry and exit.
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:
1. 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.
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2. Homogeneous product: The product of each seller is totally undifferentiated

from those of the others.
3. Free entry and exit: Any buyer and seller are free to enter or leave the market of
the commodity.
4. Perfect information available to the buyers and sellers: All buyers and sellers
have perfect knowledge about the market for the commodity.
5. Indifference: No buyer has a preference to buy from a particular seller and no
seller to sell to a particular buyer.
6. Perfect mobility of factors of production: There should not be any restrictions
on the utilization of factors of production such as land, labour, capital and so on.
7. Non-existence of transport costs: Perfectly competitive market also assumes
the non-existence of transport costs.
8. Each firm is a price taker: Perfect market competition situation all firms were
price takers, it means price of the product determined by somebody, same price
followed by all remaining organizations.
Ex; Farmer not fixing price his product, fixed by central and state government.

Total Revenue (TR), Average Revenue (AR), and Marginal Revenue (MR)

Total revenue is the revenue earned by producing and selling ‘n’ number of units.

Total revenue (TR) = price per unit (p) x No. of units produced and sold (Q)

TR = P x Q.

Average Revenue is revenue earned per unit sold. (AR).

AR = TR/Q but TR = (P X Q)

Therefore AR = (P X Q)/Q, that is P, it means AR = P.

Marginal Revenue (MR): MR it referees, to the change in revenue by producing

and selling one more unit.
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Role of the time factor in determination of price:

How quickly can the supply be arranged to meet different situations? In some cases
where the supply cannot be immediately arranged through there is significant and
constant increase in demand, price tends to rise sharply. The price level depends upon
the demand and also supply. A delay in supply may push the price up and vice versa.
Marshall distinguished the following three periods indicating the price supply
equilibrium:

a. Very short period equilibrium: Here, the supply is limited to the stock on hand.
Any addition to the currently available stock is not possible as there is no time to
arrange for additional production.
b. Short-run equilibrium: Here, the firm can expand its output to a marginal extent
by initiating necessary changes in a limited way in the variable factors of
production. In other words, the short run is long enough to make adjustments to
its product in a limited way.
c. Long- equilibrium: Here, the firm can replace its old and obsolete plant and
machinery with the latest one. Long- run is a sufficiently longer period wherein
the firm can make all possible permutation and combinations to attain maximum
profit. New firms may enter the industry while some of the existing firms may
leave the market.

Equilibrium Point: Equilibrium point refers to a position where the firm enjoys
maximum profits and it has no incentive either to reduce or increase its output level. In
perfect competition, the firm has to satisfy two conditions to attain equilibrium: (a) MR =
AR (b) MC curve should cut MR curve from below. In monopoly, the firm attains
equilibrium if it’s MR = MC.
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Perfect Competition: The Individual Firm:

The individual firm under the conditions of perfect competition has no control over
the price. It is a passive ‘price taker’. In other words, it has to accept the price as given
by the market. Market force determines the price and individual firm has absolutely no
control over price determination. In case of agricultural products such as rice, wheat
vegetables and so on, the individual farmer has no control over the market price. Thus
the individual firm has no alternative other than accepting the given market price.

Perfect competition in short runs:

1. Seller got Economic profit or super abnormal profits.

2. Profit = AR=MR=Demand
3. Perfect elastic demand
4. Demand curve horizontal

The demand curve for the output of individual firm is a horizontal line at the given
market price. It is a perfectly elastic demand. The price, average revenue (AR), and
marginal revenue (MR) are equal to each other. The firm cannot change the market
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price even it sells the whole of its volume of production. The only alternative it has is
that it can sell any quantity at the given market price.

Price Competition: The Firm and the Industry:

Price is determined by the market forces, that is, demand and supply for a given
product or service. The pricing strategy in perfect competition is: change the same price
as other firms change. As discussed above, firm have no control over the prices they
change for their products. In case of imperfect competition, the industry demand curve
normally slopes downwards. It is because; it represents the demand from all consumers
at various prices. The industry demand curve is the downward sloping curve DD as
shown in diagram.

Similarly, the supply curve SS normally slopes upwards which means that the
producer will offer more quality to sell at a higher price. It is the price that determines
the quantity demanded and quantity supplied. The ultimate price that prevails in the
market is one at which the quantity demanded is equal to the quantity supplied. This
price is also called equilibrium price, as it balances the forces of demand and supply.

Important points:

1. DD = Demand Curve.
2. SS = Supply curve
3. OP = Price at DD and SS intersect each other, to find equilibrium point.
4. OP, OQ = Unit are supplied and demanded.
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Above diagram shows how the price is determined. DD is the demand curve and SS
is the supply curve. OP is the price at which DD and SS intersect each other. At OP,
OQ units are supplied and demanded.

Price – Output Determination in case of Perfect Compitition:

Short – Run: The price and output of the firm are determined, under perfect
competition, based on the industry price and its own costs. The industry price has
greater say in this process because the firm’s own sales are very small and
insignificant. The process of price output determination in case of perfect competition is
illustrated.

The firm’s demand curve is horizontal at the price determined in the industry
(MR=AR=Price). This demand curve is also known as average revenue curve. This is
because if all the units are sold at the same price, on an average, the revenue to the
firm equals its price.
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When the average revenue is constant (Neither falling nor rising), it will coincide with
the marginal revenue curve. Thus, CC is the demand curve representing the price,
average revenue curve, and also the marginal revenue curve (Price = AR=MR).
Average cost (AC) and marginal cost (MC) are the firm’s average and marginal cost
curves.

The firm gets higher profits as long as the price (In this case MR or AR) it receives for
each unit exceeds the average cost (AC) of production.

OC = QD, which is the price.

OF = QE, which is the average cost.

OQ = FE which is the equilibrium output.

Average profit = price minus Average cost.

Here, DE is the average profit and the area CDEF is the total profit which constitutes the
‘supernormal’ or ‘abnormal’ profits.

Based on its cost function and market condition, the firm may make profits, losses, or
just break even in the short – run.
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Long- Run:

Having been attracted by supernormal profits, more and more firms enter the
industry. With the result, to increasing scarce inputs cost among the competing firms
pushing the input prices. Hence, the average cost increases. The entry of more and
more firms will expand the supply pilling down the market price.

As a result, the super normal profits gradually or completely decreased. In the

long run, the firms will be in a position to enjoy only normal profits but not supernormal
profits but not supernormal profits. Normal profits are the just sufficient for the firms to
stay in the business. It is to be noted that normal profits are included in the average cost
curve.

Shows the long - run equilibrium position of the firm under the perfect competition.
Two conditions are to be fulfilled in the long – run:

1. MR = MC
2. AR = AC, and AC must be tangential to AR at its lower point.
3. QE is the price and also the long run average cost (LAC).
4. Long- run marginal cost (LMC) curve passes through the minimum point of the
long – run average cost curve (LAC) at E, while passing through the marginal
revenue curve.
5. E is the equilibrium point and the firm produces OQ units of output.

It can be noted that normal profits are not visible to the naked eye since normal profits
are included in the average cost. Long – run average cost includes the opportunity cost
of staying in business.
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If the price is below long-run average cost of the firm, the firm will have to quit the
industry.
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In short run, if the market price is below the average cost the firm may still supply goods
provided the market price is below the average variable cost.

If the market price is below the average cost, the firm refers to sell the goods even in
the short run for the simple reason that, by not selling the goods, the firm suffers a loss
equal to average fixed cost only. If the market price P1 or more the firm is willing to sell.
If the price is less thus P1 the firm refuses the sell.

Note.

1. MC = marginal cost
2. AC = average cost
3. AVC = average verifiable cost
4. F = the firm supply curve is that portion of the marginal cost curve while begins
from point F.
5. E = Equilibrium point.

In Long – Run: Having been attracting by supernormal profits, more and more firms
enter the industry and expand the supply pulling down the market price.

In long run, the firm will be in a position to enjoy only normal profits but not
supernormal profits. Normal profits means, the firm just sufficient for the firms to stay in
the business.

Monopoly
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.

1. 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.
2. No close substitute: The goods sold by the monopolist shall not have closely
competition substitutes. Even if price of monopoly product increase people will
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not go in far substitute. For example: If the price of electric bulb increase slightly,
consumer will not go in for kerosene lamp.
3. Large number of Buyers: Under monopoly, there may be a large number of
buyers in the market who compete among themselves.
4. Price Maker: Since the monopolist controls the whole supply of a commodity, he
is a price-maker, and then he can alter the price.
5. 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.
6. 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.

Pricing under Monopoly

Monopoly refers to a market situation where there is only one seller.
He has complete control over the supply of a commodity. He is therefore in a position to
fix any price. Under monopoly there is no distinction between a firm and an industry.
This is because the entire industry consists of a single firm.
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Note:

1. Single seller

2. No substitute product

3. Inelasticity demand (price changes > Quality demand changes)

4. Price maker

5. Price or supply

6. AR > MR

Being the sole producer, the monopolist has complete control over the supply of the
commodity. He has also the power to influence the market price. He can raise the price
by reducing his output and lower the price by increasing his output. Thus he is a price-
maker. He can fix the price to his maximum advantages. But he cannot fix both the
supply and the price, simultaneously. He can do one thing at a time. If the fixes the
price, his output will be determined by the market demand for his commodity. On the
other hand, if he fixes the output to be sold, its market will determine the price for the
commodity. Thus his decision to fix either the price or the output is determined by the
market demand.

Price output determination in Monopoly (Equilibrium Point)

In the monopoly, the AC curve downward slopping one. Because monopolist

reduced the price of this product, the quantity demand increased and vice versa. The
marginal revenue (MR) less than the average revenue (AR). Other words, the MR curve
lies below the AR.
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In the monopoly always wants maximum profits. To achieve maximum profits, it is

necessary that the MR should be more then MC. He continue to sell as long as the
marginal revenue exceeds marginal cost. At point E where MR =MC, profit will be
maximized. Profit will diminish if the production is continued beyond this point.

From the below diagram, it can see that the demand curve or average revenue curve
is represented by AR, marginal revenue curve by MR average cost by AC and marginal
cost curve by MC. OQ is the equilibrium output, OP is the equilibrium price, QR is the
average cost and QR is the average profit ( AR – AC is the Avg.profit)

Up to OQ output, MR is greater then MC and beyond OQ, MR is less then MC.

Therefore, the monopolist will be in equilibrium at output OQ where MR = MC and
profits are maximum. OA is the corresponding price to the output level of OQ. The
rectangle PQRS represents the profits earned by the monopolist in the equilibrium
position in the short – run.
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Note:

1. MR , AR
2. OQ = Equilibrium output,
3. OP = Equilibrium price
4. PQRS = represent the profit area.
5. QR = Average profit
6. OSRM = Total output.

If AR > AC = Abnormal or super normal profits.

If AR = AC = Normal Profit

If AR < AC = Loss.

Comparison between perfect competition and monopoly

S.No. Point of comparison Perfect Monopoly

Competition
1 Relationship B/W AR,MR AR = MR AR>MR
2 Profit in Long run Normal profit in Supernormal Profits in the
Long - run Long run.
3 Number of sellers Large no. of Single seller
sellers, Free entry
and exits.
4 Barriers to Entry and Exit Free entry and Strong Barriers
Exit. No barriers
5 Control of Demand Perfect elasticity Perfect inelasticity
6 Relationship B/W firm & Each firm is a part Firm & industry are one and
Industry. of the industry the same.
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Monopolistic competition
Perfect competition and pure monopoly are rate phenomena in the real world.
Instead, almost every market seems to exhibit characteristics of both perfect
competition and monopoly.

Monopolistic competition is said to exist when there are many firms and each one
produces such goods and services that are close substitutes to each other. They are
similar but not identical.

Product differentiation is the essential features of monopolistic competition. Products

can be differentiated by many of unique facilities, advertising, brand loyalty, packing,
pricing, terms of credit, superior maintenance service, and convenient location and so
on.

Characteristics of Monopolistic Competition

The important characteristics of monopolistic competition are:

1. 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 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.

2. 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
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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.
3. Large Number of Buyers: 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.
4. 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.
5. Selling costs: Since the products are close substitute much effort is needed to
retain the existing consumers and to create new demand. So each firm has to
spend a lot on selling cost, which includes cost on advertising and other sale
promotion activities.
6. 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.
7. The Group: Under perfect competition the term industry refers to all collection of
firms producing a homogenous product. But under monopolistic competition the
products of various firms are not identical through they are close substitutes.
Prof. Chamberlin called the collection of firms producing close substitute
products as a group.
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Price – Output Determination under Monopolistic Competition in Short-Run

Under monopolistic competition also will reach equilibrium when its marginal cost
equals its marginal revenue (MC = MR). the demand curve for the firm in case of
monopolistic competition is just similar to that of monopolist.

As the products are differentiated, each firm has a limited control over a price. These
firms are price makers as far as a given group of customers are concerned. The
demand for their products and services is relatively inelastic. The degree of elasticity of
demand of a firm in monopolistic competition depends up on the extent to which the firm
can resort to product differentiation.

Note:

1. MC = MR and AR < AC = E
2. Each firm limited controls the price.
3. Price makers
4. Relatively inelasticity (Change in price < Change in Quantity demand)
5. Monopolistic competition depending up on product difference.
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6. PS = Average profit
7. E = Equilibrium point
8. OM = Equilibrium output
9. PQRS = Super normal profits
10. MR = Average cost.

In short run, the firms may got supernormal or normal profits, when these is fall in costs
or increase in demand the firms may enjoy supernormal profits.

In other words, the firm satisfy the two conditions.

1. MC = MR.
2. AR < AC

The firm may be losses when the costs rise or demand decreases the demand curve
are a down sloping curve because of product differentiation. The cost functions of a firm
are not different from those of earlier market situation. At E marginal (MC) is equal to
marginal Revenue (MR), extend E to point M on average revenue (AR) curve and point
Q on X axis.

OM is the equilibrium output, OP = MR = Equilibrium price.

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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 Fig 6.17 shows this trend.

Note:

1. Ac curve tangible to AR = E
2. MR = MC at point K
3. OQ = Equilibrium Output
4. OP = Equilibrium price
5. F = AR is higher than the minimum point ‘F’
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Long-Run: Monopolistic Competition industry provides a variety of products and more

varieties result in greater consumer satisfaction. Consumers will be very happy only
when they have more choice as variety is the price of life.

According to above diagramed observed that in long run, the Average cost (AC)
curve at point ‘E’. it can be noted that the average cost curve is tangential to the
average revenue curve at higher than its minimum point ‘F’.

1. MR = MC
2. OQ = Equilibrium Output point
3. Op = Equilibrium price

In long run, a firm under monopolistic competition achieves equilibrium price and
output level when both conditions of equilibrium are satisfied.

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.

Oligopoly is that market situation in which the number of firms is small but each
firm in the industry takes into consideration the reaction of the rival firms in the
formulation of price policy. The number of firms in the industry may be two or more
than two but not more than 20.

Characteristics of Oligopoly
The main features of oligopoly are:

1. Few Firms: There are only a few firms in the industry. Each firm contributes a
sizeable share of the total market. Any decision taken by one firm influence the
actions of other firms in the industry. The various firms in the industry compete
with each other.
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2. Interdependence: As there are only very few firms, any steps taken by one firm
to increase sales, by reducing price or by changing product design or by
increasing advertisement expenditure will naturally affect the sales of other firms
in the industry. An immediate retaliatory action can be anticipated from the other
firms in the industry every time when one firm takes such a decision. He has to
take this into account when he takes decisions. So the decisions of all the firms
in the industry are interdependent.
3. Indeterminate Demand Curve: The interdependence of the firms makes their
demand curve indeterminate. When one firm reduces price other firms also will
make a cut in their prices. So he firm cannot be certain about the demand for its
product. Thus the demand curve facing an oligopolistic firm loses its definiteness
and thus is indeterminate as it constantly changes due to the reactions of the
rival firms.
4. Advertising and selling costs: Advertising plays a greater role in the oligopoly
market when compared to other market systems. According to Prof. William J.
Banumol “it is only oligopoly that advertising comes fully into its own”. A huge
expenditure on advertising and sales promotion techniques is needed both to
retain the present market share and to increase it. So Banumol concludes “under
oligopoly, advertising can become a life-and-death matter where a firm which
fails to keep up with the advertising budget of its competitors may find its
customers drifting off to rival products.”
5. Price Rigidity: In the oligopoly market price remain rigid. If one firm reduced
price it is with the intention of attracting the customers of other firms in the
industry. In order to retain their consumers they will also reduce price. Thus the
pricing decision of one firm results in a loss to all the firms in the industry. If one
firm increases price. Other firms will remain silent there by allowing that firm to
lost its customers. Hence, no firm will be ready to change the prevailing price. It
causes price rigidity in the oligopoly market.
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Price Determination under Oligopoly:

We shall confine our study to the non-collusive oligopoly model of Sweezy, and to
the collusive oligopoly models relating to cartels and price leadership.

1. The Sweezy Model of Kinked Demand Curve (Rigid Prices):

In his article published in 1939, Prof. Sweezy presented the kinked demand

curve analysis to explain price rigidities often observed in oligopolistic markets. Sweezy

assumes that if the oligopolistic firm lowers its price, its rivals will react by matching that

price cut m order to avoid losing their customers. Thus the firm lowering the price will

not be able to increase its demand much. This portion of its demand curve is relatively

inelastic.

On the other hand, if the oligopolistic firm increases its price, its rivals will not

follow it and change their prices. Thus the quantity demanded of this firm will fall

considerably. This portion of the demand curve is relatively elastic. In these two

situations, the demand curve of the oligopolistic firm has a kink at the prevailing market

price which explains price rigidity

Assumptions:

The kinked demand curve hypothesis of price rigidity is based on the following

assumptions:

(1) There are few firms in the oligopolistic industry.

(2) The product produced by one firm is a close substitute for the other firms.

(3) The product is of the same quality. There is no product differentiation.

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(4) There are no advertising expenditures.

(5) There is an established or prevailing market price for the product at which all the

sellers are satisfied.

(6) Each seller’s attitude depends on the attitude of his rivals.

(7) Any attempt on the part of a seller to push up his sales by reducing the price of his

product will be counteracted by the other sellers who will follow his move.

(8) If he raises the price, others will not follow him. Rather they will stick to the prevailing

price and cater to the customers, leaving the price-raising seller.

(9) The marginal cost curve passes through the dotted portion of the marginal revenue

curve so that changes in marginal cost do not affect output and price.

The Model:

Given these assumptions, the price-output relationship in the oligopolist market is

explained in Figure 1 where KPD is the kinked Price demand curve and OP0 the

prevailing price in the oligopoly market for the OR product of one seller.

Starting from point P, corresponding to the current price OP1, any increase in

price above it will considerably reduce his sales, for his rivals are not expected to follow

his price increase. This is so because the KP portion of the kinked demand curve is

elastic, and the corresponding portion KA of the MR curve is positive.

Therefore, any price-increase will not only reduce his total sale but also his total

revenue and profit.

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On the other hand, if the seller reduces the price of the product below OPQ (or P),

his rivals will also reduce their prices. Though he will increase his sales, his profit would

be less than before.

The reason is that the PD portion of the kinked demand curve below P is less

elastic and the corresponding part of marginal revenue curve below R is negative.

Thus in both the price-raising and price-reducing situations, the seller will be a

loser. He would stick to the prevailing market price OP0 which remains rigid.

In order to study the working of the kinked demand curve, let us analyse the effect of

changes in cost and demand conditions on price stability in the oligopolistic market.

Changes in Costs:

In oligopoly under the kinked demand curve analysis changes in costs within a

certain range do not affect the prevailing price. Suppose the cost of production falls so

that the new MC curve is MC1, to the right, as in Figure 2. It cuts the MR curve in the

gap AB so that the profit maximising output is OR which can be sold at OP 0 price.

It should be noted that with any cost reduction the new MC curve will always cut

the MR curve in the gap because as costs fall the gap AB continues to widen due

to two reasons:
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(1) As costs fall, the upper portion KP of the demand curve becomes more elastic

because of the greater certainty that a price rise by one seller will not be followed by

rivals and his sales would be considerably reduced.

(2) With the reduction in costs the lower portion PD of the kinked curve becomes more

inelastic, because of the greater certainty that a price reduction by one seller will be

followed by the other rivals.

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Thus the angle KPD tends to be a right angle at P and the gap AB widens so that any

MC curve below point A will cut the marginal revenue curve inside the gap. The net

result is the same output OR at the same price OP0 and larger profits for the

oligopolistic sellers.

In case the cost of production rises the marginal cost curve will shift to the left of the old

curve MC as MC2. So long as the higher MC curve intersects the MR curve within the

gap up to point A, the price situation will be rigid. However, with the rise in costs the

price is not likely to remain stable indefinitely and if the MC curve rises above point A, it

will intersect the MC curve in the portion KA so that a lesser quantity is sold at a higher

price. We may conclude that there may be price stability under oligopoly even when

costs change so long as the MC curve cuts the MR curve in its discontinuous portion.

However, chances of the existence of price rigidity are greater where there is a

reduction in costs than there is a rise in costs.

29

OTHER MARKET STRUCTURES

Duopoly
Duopoly refers to a market situation in which there are only two sellers. As there are
only two sellers any decision taken by one seller will have reaction from the other Eg.
Coca-Cola and Pepsi. Usually these two sellers may agree to co-operate each other
and share the market equally between them, So that they can avoid harmful
competition.

The duopoly price, in the long run, may be a monopoly price or competitive price, or it
may settle at any level between the monopoly price and competitive price. In the short
period, duopoly price may even fall below the level competitive price with the both the
firms earning less than even the normal price.

Monopsony
Mrs. Joan Robinson was the first writer to use the term monopsony to refer to market,
which there is a single buyer. Monoposony is a single buyer or a purchasing agency,
which buys the show, or nearly whole of a commodity or service produced. It may be
created when all consumers of a commodity are organized together and/or when only
one consumer requires that commodity which no one else requires.

Bilateral Monopoly
A bilateral monopoly is a market situation in which a single seller (Monopoly) faces a
single buyer (Monoposony). It is a market of monopoly-monoposy.

Oligopsony
Oligopsony is a market situation in which there will be a few buyers and many sellers.
As the sellers are more and buyers are few, the price of product will be comparatively
low but not as low as under monopoly.
30

Marries Managerial Theory of Firm

Working on the principle of segregation of managers from owners, Marris

proposed that owners (shareholders) aim at profits and market share, whereas
managers aim at better salary, job security and growth.
These two sets of goals can be achieved by maximising balanced growth of the
firm (G), which is dependent on the growth rate of demand for the firm's products (GD)
and growth rate of capital supply to the firm (GC). Hence growth rate of the firm is
balanced when the demand for its product and the capital supply to the firm grow at the
same rate.

Marris further said that firms face two constraints in the objective of maximisation of
balanced growth, which are explained below:

i. Managerial Constraint

Among managerial constraints, Marris stressed on the importance of the role of human
resource in achieving organisational objectives. According to him, skills, expertise,
efficiency and sincerity of team managers are vital to the growth of the firm. Non
availability of managerial skill sets in required size creates constraints for growth:
organisations on their high levels of growth may face constraint of skill ceiling among
the existing employees. New recruitments may be used to increase the size of the
managerial pool with desired skills; however new recruits lack experience to make quick
decisions, which may pose as another constraint.

ii. Financial Constraint

This relates to the prudence needed in managing financial resources. Marris suggested
that a prudent financial policy will be based on at least three financial ratios, which in
turn set the limit for the growth of the firm. In order to prove their discretion managers
will normally create a trade off and prefer a moderate debt equity ratio (rj), moderate
liquidity ratio (r2) and moderate retained profit ratio (r3). (Let us mention here that the
ratios used in the financial constraint are dealt with in detail in any standard text book on
31

Financial Management and are beyond the scope of this book). However a brief
description is given hereunder:

(a) Debt equity ratio (r1):

This is the ratio between borrowed capital and owners* capital. High value
of debt equity ratio may cause insolvency; hence a low value of this ratio is
usually preferred by managers to avoid insolvency. However, a low value of r,
may create a constraint to the growth of the firm in terms of dependence on high
cost capital, i.e., equity.

 Debit Ratio = Long Term Debit / Long Term Assets or Total Debit /
Total Assets.

(b) Liquidity ratio (r2):

This is the ratio between current assets and current liabilities and is an indicator
of coverage provided by current assets to current liabilities. According to Marris, a
manager would try to operate in a region where there is sufficient liquidity and safety
and hence would prefer a high liquidity ratio. But a high r2 would imply low yielding
assets, since liquid assets either do not earn at all (like cash and inventory), or earn low
returns (like short term securities). (c) Retention ratio (r3) this is the ratio between
retained profits and total profits.

In other words, it is the inverse of dividend payout ratio, i.e., the retained profits
are that portion of net profit which is not distributed among shareholders. A high
retention ratio is good for growth, as retained profits provide internal source of funds.
However, a higher r3 would imply greater volume of retained profits, which may
antagonise the shareholders. Hence managers cannot afford to keep a very high value
of retention ratio.

 Current Ratio = Current Assets / Current Liabilities

 Quick Ratio = Quick Assets / Current Liabilities

32

 Retention Ratio = it refers to owners, how much money required to

reinvesting in the company.

Policy variables in Marris’s balanced growth model are as follows:

1. The firm has the freedom to choose its financial policy, as it subjectively
determines the three financial ratios, liquidity ratio, leverage/debt ratio and retention
ratio.
2. The firm can decide its diversification rate, either by expanding the range of
its products, or by merely effecting a change in the style of its existing range of
products. OR it can adopt the two policies simultaneously.
3. Price is not a policy variable of the firm. It is a parameter. Price is taken as
given by the oligopolistic structure of the market. Production costs are also taken as
given.
4. The firm has the freedom to decide the level of it advertising and R&D. Since
Price and Production Costs are given, increase in advt. & R&D, will imply lower profit
margin and vice-versa.
33

Williamson’s Managerial Theory of the firm

The theory of Managerial Utility Maximisation was developed separately

by Berle-Means-Galbralth and Williamson. It is also known as Managerial
Discretion Theory. The Theory is based on the concept that shareholders or
owners of the firm and managers are (two separate groups. The owners or the
shareholders want high dividends and are. Therefore, interested In maximising
profits, the managers, on the other hand, have different motives other than profit
maximisation. Once the managers have achieved a level of profit that will pay
satisfactory dividends to shareholders and still ensure growth.

They are free to increase their own emoluments and also the size of their
staff and expenditure on them. In the words of Williamson, "7b the extent that the
pressure from the capital market and competition in the product market is
imperfect, the manager, therefore, has discretion to pursue goals other than
profits." Further Berle and Means suggested that "The lack of corporate
democracy leaves owners or shareholders with little or no power to change
corporation policy."

According to Williamson, "Managerial Utility function may be expressed as

follows:

U = f (S, M. ID)

It will be read as : Managerial utility is a function (f) of additional expenditure on

staff, managerial emoluments and discretionary investment.

(Here, U = managerial utility; S = additional expenditure on staff; M = managerial

emoluments and ID = discretionary investment).
34

Managerial utility function maximises the utility of the managers rather than profits of the
firm. The manager is expected to follow policies which maximise the following
components of his utility function.

i. Expansion of Staff:

The manager will like to increase the quality and number of staff reporting to him. This
will lead to an increase in the salary of the staff. More staff are valued because they
lead to the manager getting more salary, more prestige and more security.

ii. Increase in Managerial Emoluments:

Managerial Utility also depends on managerial emoluments. It includes facilities like

entertainment allowance, luxurious office, staff car, company phone, etc. Expenditure of
this nature reflects to a large extent the prestige, power and status of the manager.

iii. Discretionary Power of Investment:

Managerial utility also depends on the discretion of the manager to undertake

investment beyond those required for normal operations. The manager is in a position
to invest in advanced technology and modem plants. Such investments may or may not
be economically efficient. These investments may be undertaken for the self-satisfaction
of the manager.

According to the theory, in a firm, shareholders and managers are two separate groups.
The firm tries to get maximum returns on investment and get maximum profit, whereas
managers try to maximize profit in their satisfying function.

At last, Williamson’s managerial discretion theory shows the utility function of a

manager. In this theory, the firm will try to get maximum returns or maximum profit
where as manager try to maximum utility satisfying function. They are in equilibrium
when the utility has maximum amount.
35

Pricing Methods

1. Average cost pricing

2. Limit pricing
3. Market skimming pricing
4. Internet pricing
a. Flat rate pricing
b. Usage sensitive pricing
5. Priority pricing

1. Average Cost Pricing

This is a policy of setting prices close to average cost. It is a way to maximise

sales, whilst maintaining normal profits. It is sometimes known as sales maximisation. It
will be used by firms who are seeking to increase market share and who don’t seek to
maximise profits.

Average cost pricing will occur in perfect competition because firms can only
make normal profit. However, it will only occur in oligopoly if firms have a specific goal
of maximising sales whilst not making a loss..

2. Limit Pricing Definition

Limit Pricing is a pricing strategy a monopolist may use to discourage entry. If a

monopolist set its profit maximising price (where MR=MC) the level of supernormal
profit would be so high it attracts new firms into the market. Limit pricing involves
reducing the price sufficiently to deter entry. It leads to less profit than possible in short-
term, but it can enable the firm to retain its monopoly position and long-term profitability.

3. Skimming Pricing

Price skimming, also known as skim pricing, is a pricing strategy in which a firm
charges a high initial price and then gradually lowers the price to attract more price-
sensitive customers. The pricing strategy is usually used by a first mover who faces little
to no competition. Price skimming is not a viable long-term pricing strategy, as
competitors eventually launch rival products and put pricing pressure on the first
company.
36

4. Dynamic pricing or Internet Pricing:

Dynamic pricing, also called real-time pricing, is an approach to setting the cost
for a product or service that is highly flexible. The goal of dynamic pricing is to allow a
company that sells goods or services over the Internet to adjust prices on the fly in
response to market demands.

a. Flat Rate pricing: Entrepreneurs create businesses to capitalize on new ideas,

but even the most innovative products and services can fail if managers fail to
set prices that attract customers and produce profit. Flat-rate pricing or flat-fee
pricing is a pricing model where a business charges a fixed rate for a service
instead of charging by the hour or for use of a service. Flat-fee pricing is
common in service industries such as shipping, legal services and creative
services. Flat- rate pricing has several advantages and disadvantages with
respect to other pricing methods.
b. Usage sensitive pricing is the selection of usage charging rates based on
actual usage of services or resources. Usage sensitive pricing may vary
based on the time of day, the duration of data transfer or call, or the type of
media transferred Ex: Local Telephone Services.

5. Priority pricing: When a client has multiple pricing options available to pay for a
single service, Pricing Option Priority determines the order in which those pricing
options are used. For example, if a client enrolls in a yoga class and has both a
10-class pass and an unlimited pass on account, then the pricing option with the
highest priority will be used first.

.
37

UNIT 4

A business cycle is a cycle of fluctuations in the Gross Domestic Product (GDP) around
its long-term natural growth rate. It explains the expansion and contraction in economic
activity that an economy experiences over time.

A business cycle is completed when it goes through a single boom and a

single contraction in sequence. The time period to complete this sequence
is called the length of the business cycle. A boom is characterized by a
period of rapid economic growth whereas a period of relatively stagnated
economic growth is a recession. These are measured in terms of the growth
of the real GDP, which is inflation-adjusted.

Stages /Feature/Phases of the Business Cycle

In the diagram above, the straight line in the middle is the steady growth
line. The business cycle moves about the line. Below is a more detailed
description of each stage in the business cycle:
38

1 Expansion

The first stage in the business cycle is expansion. In this stage, there is an
increase in positive economic indicators such as employment, income,
output, wages, profits, demand, and supply of goods and services. Debtors
are generally paying their debts on time, the velocity of the money supply
is high, and investment is high. This process continues as long as economic
conditions are favourable for expansion.

2 Peak

The economy then reaches a saturation point, or peak, which is the second
stage of the business cycle. The maximum limit of growth is attained. The
economic indicators do not grow further and are at their highest. Prices are
at their peak. This stage marks the reversal point in the trend of economic
growth. Consumers tend to restructure their budgets at this point.

3 Recession

The recession is the stage that follows the peak phase. The demand for
goods and services starts declining rapidly and steadily in this phase.
Producers do not notice the decrease in demand instantly and go on
producing, which creates a situation of excess supply in the market. Prices
tend to fall. All positive economic indicators such as income, output, wages,
etc., consequently start to fall.

4 Depression

There is a commensurate rise in unemployment. The growth in the

economy continues to decline, and as this falls below the steady growth
line, the stage is called depression.

5 Trough

In the depression stage, the economy’s growth rate becomes negative.

There is further decline until the prices of factors, as well as the demand
39

and supply of goods and services, reach their lowest point. The economy
eventually reaches the trough. It is the negative saturation point for an
economy. There is extensive depletion of national income and expenditure.

6 Recovery

After this stage, the economy comes to the stage of recovery. In this phase,
there is a turnaround from the trough and the economy starts recovering
from the negative growth rate. Demand starts to pick up due to the lowest
prices and, consequently, supply starts reacting, too. The economy
develops a positive attitude towards investment and employment and
production starts increasing.

Employment begins to rise and, due to accumulated cash balances with the
bankers, lending also shows positive signals. In this phase, depreciated
capital is replaced by producers, leading to new investments in the
production process.

Recovery continues until the economy returns to steady growth levels. It

completes one full business cycle of boom and contraction. The extreme
points are the peak and the trough.
40

Sole Trader Business

The sole trader carries on business by himself and for himself. He is the proprietor,
manager and controller of business. He raises the necessary capital; organizes the
business; enjoys the profits and bears the losses.

Features of Sole Trader Business

The important features of sole proprietorship are as follows.

1. A Sole Trader business is owned by only one person.

2. The business is controlled by a single individual.

3. The risk arising out of a sole trade concern is borne by a single person.

4. The liability of the owner of the business is unlimited.

5. The business firm has no separate legal-entity.

6. To set up sole proprietorship, no legal formalities are necessary.

7. Decisions are made by a single person.

Advantages
1. Simple to set up and operate.

2. You retain complete control of your assets and business decisions.

3. Fewer reporting requirements.

4. Any losses incurred by your business activities may be offset against other
income, such as your investment income or wages (subject to certain conditions).

5. Allows you to use your individual tax file number (TFN) to lodge tax returns.

6. You are not considered an employee of your own business and therefore don’t
pay payroll tax, superannuation or workers’ compensation on income you draw
from the business.
41

7. Relatively easy to change business structure if your business grows or if you

wish to wind things up.

Disadvantages

1. you have unlimited liability for debts as there’s no legal distinction between
private and business assets
2. your capacity to raise capital is limited
3. all the responsibility for making day-to-day business decisions is yours
4. retaining high-calibre employees can be difficult
5. it can be hard to take holidays
6. You’re taxed as a single person the life of the business is limited.

Partnership Company
A partnership firm is an organization which is formed with two or more
persons to run a business with a view to earn profit. Each member of such a group
is known as partner and collectively known as partnership firm. These firms are
governed by the Indian Partnership Act, 1932.

Following are the characteristics of Partnership Firm:

1. Number of Partners : Minimum number of person required to start a partnership

firm is two and maximum limit is 10 in case of banking business and 20 in case of all
other types of business.

2. Contractual relationship: A written agreement known as partnership deed which

is signed by all the partners, binds them in a contractual relationship.

3. Voluntary Registration: Registration of partnership firm is not compulsory. Since

the registration provides various benefits to the firm thus it is desirable.

4. Competence of Partners: Every partner must be competent enough to enter into

the partnership agreement. He should not be minor (in some cases minor can be
admitted only to the benefits of the partnership), lunatic or insolvent.

5. Sharing of Profit and Loss: In partnership firm all the profits and losses are
shared by the partners in any ratio as agreed. If it is not given then they share it
42

equally.

6. Unlimited Liability: Liability of partners of a partnership firm is unlimited. They

are jointly held liable for the debts and losses of the firm.

7. Legal Status: Partnership firm has no distinct legal status separate from its
partners.

8. Transfer of Interest: No partner can transfer its interest in the firm to anybody
without the consent of other partners.

9. Principal - Agent Relationship: This relationship is based on mutual trust and

faith among the partners in the interest of the firm. Business of the firm may be
carried on by all the partners or any one of them acting for all. According to this,
every partner is an agent when he is working on behalf of other partners and he is
the principal when other partners act on his behalf.

Advantages of Partnership Firm:

1. Easy Formation : Registration is not compulsory in the case of Partnership firm.

It can be formed without any legal formality and expenses. Thus they are simple and
economical to form and operate.

2. Larger Resources: Due the more number of members the partnership firm has
larger resources for the business operations as compared to sole proprietorship.

3. Flexibility in operation: Due to the limited number of partners there is flexibility

in the operations of business as the partners can amend any objectives or change
any operations any time by mutual consent.

4. Better Management: Business of a partnership firm is very well managed by all

the partners as they take interest in the daily affairs of business because of the
ownership, profit and control.

5. Sharing of Risk: In partnership every partner bears the risks individually as it is

easier compared to sole proprietorship.

6. In a partnership firm interest of every partner is protected against any fraud.P

43

Disadvantages of partnership Firm:

1. Instability : A partnership firm does not exist for an indefinite period of time. The
death, insolvency or lunacy of a partner may lead to dissolution of the partnership
firm.

2. Unlimited Liability: Liability of every partner in a partnership firm is unlimited as

any of the partners may be called upon to pay all the debts even from its personal
properties. A single wrong decision by one partner can lead other partners in heavy
losses and liabilities.

3. Lack of Harmony: According partnership agreement every partner has equal

rights. Some situations might occur in which one or the other partner will not agree
on the same thing which will cause difference of opinion resulting mistrust and
disharmony among the partners.

4. Limited Capital: Due to the restriction on the maximum number of members, a

limited amount of capital can be raised.

5. No legal status: A partnership firm does not have a legal status like a Joint Stock
Company.

6. In a partnership firm it is not easy to transfer ownership. Consent of every partner

is required in order to transfer ownership.

Partnership deed
Partnership deed is an agreement between the partners of a firm that
outlines the terms and conditions of partnership among the partners. ... It specifies
the various terms such as profit/loss sharing, salary, interest on capital, drawings,
admission of a new partner, etc.

The partnership deed contains the following details:

i) Business of the firm: Business to be undertaken by the partners of the firm
ii) Duration of Partnership: Whether the duration of the partnership firm, is for
limited period or for a specific project
iii) Sharing of profit/loss: Ratio of sharing profits & losses of firm among partners
iv)Salary and commission: Details of the salary, and commission if any, payable to
partners
44

v) Capital contribution: Capital contribution to be made by each partner and the

interest on said capital to be paid to partners
vi) Partner’s Drawings: Policy regarding the drawings from the firm allowed to each
partner and interest if any to be paid by partner, to firm on such drawings
vii) Partner’s Loan
viii) Duties & Obligations of partners
ix) Admission, Death & Retirement of partner
x) Accounts & Audit

Types of Partnership Business/ Company

1. Working Partner
A Working Partner is one who contributes capital to the business and takes active part
in its management. Hence, he is called active partner.

2. Sleeping Partner
A Sleeping Partner is one who contributes only capital to the business, but does not
take part in its management. He is also called dormant partner or financing partner.

3. Nominal Partner
A Nominal Partner does not contribute capital. Neither does he take active part in the
management. His contribution in a partnership is limited to allowing the other partners to
make use of his name.

4. Partner by Estoppel
Partner by Estoppel is not a partner of the firm but by his words and conduct he leads
the outsiders to believe that he is also a partner of the firm. Usually this arises, when the
outgoing partner fails to give notice about his retirement.

5. Limited Partner
In foreign countries like U.K., the law of the land permits the admission of partners with
limited liability. But in India, no one can be a limited partner. There is only one
exception. The liability of a minor admitted for the benefits of partnership is limited to the
extent of his capital contribution.
45

6. Secret Partner
A Secret Partner is actually a partner of the firm. But he does not hold out to the public
as a partner of the firm but keeps his existence as secret. His liability is also unlimited.

7. Partner by Holding Out

Though a Partner by Holding Out is not a partner, he knowingly permits himself to be a
partner of the firm by his activities.

8. Sub – Partner
A Sub-Partner has no direct contact with the firm. He is only next to a partner.

9. Partner in Profit
A Partner in Profit becomes a partner whenever the firm earns profit. His liability is also
unlimited.

Joint Stock Company

A joint stock company is described as a voluntary association of persons

recognised by law, having a distinct name, a common seal, formed to carry on business
for profit, with capital divisible into transferable shares, limited liability, corporate body
and perpetual succession..
Each joint stock company share is transferable, and if the company is public, then its
shares are marketed on registered stock exchanges. Private joint stock company
shares can be transferred from one party to another party. However, the transfer is
limited by agreement and family member.

Features of Joint Stock Company

1. Separate Legal Entity – A joint stock company is an individual legal entity, apart
from the persons involved. It can own assets and can because it is an entity it
can sue or can be sued. Whereas a partnership or a sole proprietor, it has no
such legal existence apart from the person involved in it. So the members of the
joint stock company are not liable to the company and are not dependent on
each other for business activities.
2. Perpetual – Once a firm if born, it can only be dissolved by the functioning of
law. So, company life is not affected even if its member keeps changing
3. Number of Members – For a public limited company, there can be an unlimited
number of members but minimum being seven. For a private limited company,
46

only two members. In general, a partnership firm cannot have more than 10
members in one business.
4. Limited Liability – In this type of company, the liability of the company’s
shareholders is limited. However, no member can liquidate the personal assets
to pay the debts of a firm.
5. Transferable share – A company’s shareholder without consulting can transfer
his shares to others. Whereas, in a partnership firm without any approval of other
partners, a partner cannot move his share.
6. Incorporation – For a firm to be accepted as an individual legal entity it has to
be incorporated. So, it is compulsory to register a firm under a joint stock
company.

Types of Joint Stock Company based on incorporation.

The joint stock company is divided into three different types.
 Chartered Company: The companies that form by the order of the king of
England are called the charter company. These companies were formed
before 1844. For example, East India Company, Chartered Bank of England,
the charter of the British South Africa Company, given by Queen Victoria
(More information here)
47

 Statutory Company: Companies that are formed by the order of the

President, or by the Legislative Committee or by bill of Parliament are called
Statutory Company. These Companies are operated by those laws. For
example, municipal councils, universities, central banks and government
regulators, Central Bank. (More information here)

 Registered Corporation: Companies that are formed under the prevailing

law of the company are called the registered company. The corporation that
has filed a registration statement with the SEC prior to releasing a new stock
issue. It is two types-

i) Unlimited Company: The liabilities of the shareholders of this company are

unlimited. For example, British all-terrain vehicle manufacturer Land Rover,
GlaxoSmithKline Services Unlimited.

ii) Limited Company / Limited Corporation: The liabilities of the shareholders are
limited. For example, charitable organisations, Financial Services Authority. This
liability of a company can be of two types.

a) By Guarantee

b) By share value. The company limited by share can be of two types.

• Private Limited Company, where the number of shareholder ranges from two to
fifty. The share of these companies can’t be traded in the stock market.

• Public Limited Company, where the number of shareholder ranges from seven to
share limitation. The share of the public limited company is traded in the stock
market.

Procedure of Formation of a Joint Stock Company

Joint Stock Company is formed, registered and guided by the Companies Act
1994. The promoters by themselves or by their appointed person (advocate,
consultancy firm, or consultant) undertook the task of formation. However, the task of
formation could be discussed in steps.
48

1. Promotional Steps:

The person who undertook the task of formation is called promoter or entrepreneur.
For Public Limited Company there should be at least seven (7) and for Private
Limited Company, there should be at least two (2) promoters. These promoters
undertook the following tasks:

a) Planning: Here the promoters decide about the objectives, area, type, capital
structure of the new business. Based on these factors, the promoters go forward.

b) Feasibility Analysis: Here the promoters undertook the feasibility analysis for
the new venture: both from existing and potential viewpoint. Promoters undertook
different tools like SWOT (Strength, Weakness, Opportunity and Threat) Analysis;
Competitive Analysis, etc. Being assured of the potentiality of the business the
promoters go for the further.

c) Naming the Company: The name of the company should be such that is not
used by any other existing company; it is not a name of the King or Queen or
President. The Public Limited Company should use (pvt.) Limited and the Public
Limited Company must use Limited at the end of the company name. The promoter
upon deciding the name, they submit the name in black and white for Clearance in
the registrar office. The registrar upon verifying the uniqueness of the proposed
name gives clearance of using the name.

2. Registration or Incorporation:

To incorporate the new company the promoters needs go through the following
steps:
49

a) Collecting Registration Form and Filling it up: The promoters have to collect
the registration form and other papers for a fee from the registrar office. Then they
should fill up it by themselves or should take the help of the consultants or
advocates.

b) Preparing Documents and Submitting for Registration: The promoters have

to submit the filled-up form with fees and the following documents in the registrar
office:

• Memorandum of Association

• Articles of Association

• Capital Structure of the proposed Company

• List of Directors and the amount of the sponsored share they purchased

• Declaration regarding the proposed name of the company

• Declaration of an advocate or chartered accountant or any director of a proposed

company that the company has followed all the rules and regulations of Company
Act 1994.

The registrar being satisfied on the paper submitted for the proposed company
issues' Certificate of Incorporation. On getting that certificate the Private Limited
Company can start its business but the Public Limited Company has to go to
another step to start its business.
50

c) Obtaining Certificate of Commencement: Here the promoters should make the

Prospectus for the company. This prospectus needs to be published in the daily
newspaper. To get the Certificate of Commencement, the promoters need to submit
the following documents to the registrar:

• A copy of Prospectus

• Name, address, designation, occupation, etc. of Directors

• Directors’ written Letter of Agreement that they want to work as director of that
company.

• Declaration that the directors have fully paid the minimum amount of sponsor
share.

• Declaration by the company secretary or other authorized person that the above
affairs have maintained all rules and regulation of Company Act 1994.

The registrar being satisfied on the paper submitted for the proposed company
issues' Certificate of Commencement. On getting that certificate the Public Limited
Company can start its business.

3. Flotation Stage

If the sponsor directors are unable to provide the adequate capital, public limited
company can float their share in the capital market (Stock Exchange) to get required
capital. By this time, the company can do its other functions.
51

Advantages of Joint Stock Company:

1. Larger Capital- The huge capital required by modern enterprises would

not be possible under other forms of organisations like sole individual
proprietorship and even in partnership. The joint stock company by its
widespread appeal to investors of all classes can raise adequate
resources of capital required by large-scale enterprise

 2. Limited Liability- Liability of the shareholders of a company is limited to the

face value of the shares they have purchased. It has a stimulating effect on
investment. The private property of shareholder is not attachable to recover the
dues of the company.

 3. Stability of Existence- The organisation of a company as a separate legal

entity gives it a character of permanence or continuity. As an incorporated body,
a company enjoys perpetual existence.

 4. Economies of Scale- Since the company operates on a large scale, it would

result in the realisation of economies in purchases, management, distribution or
selling. These economies would provide goods to the consumer at a cheaper
price.

 5. Scope for Expansion- As there is no restriction to the maximum number of

members in a public company, expansion of business is easy by issuing new
shares and debentures.

 6. Public Confidence- Formation and working of companies are well regulated

by the provisions of the Companies Act. The provisions regarding compulsory
publication of some documents, accounts, director’s report, etc., create
confidence in public. Their accounts are audited by a chartered accountant and
are to be published. This creates confidence in the public about the functioning of
the company.

 7. Transferability of Shares- The shareholders of a public company are entitled

to transfer the shares held by them to others. The shares of most joint stock
companies are listed on the stock exchange and hence can be easily sold.
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 8. Professional Management- The management of a company vests in the

directors duly elected by shareholders. Normally, experienced persons are
elected as directors. Thus, the available skill is utilized for the benefit of the
company. The company organisation, therefore, is like a bridge between the skill
and capital.

 9. Tax Benefits- Company pays lower tax on a higher income. This is because
of the reason that the company pays tax on the flat rates. Similarly, company
gets some tax concessions if it establishes itself in a backward area.

 10. Risk Diffused- The membership of a company is large. The business risk is
divided among several members of the company. This encourages investment of
small investors.

Disadvantages of Joint Stock Company:

1. Difficulty in formation- The legal formalities and procedures required in the

formation of a company is many. It has to approach large number of people for its
capital and it cannot commence business, unless it has obtained a certificate of
incorporation and a certificate to commence business.

2. Lack of Secrecy- Every issue is discussed in the meeting of the board of directors.
The minutes of meeting and accounts of the firm’s profit and loss etc., have to be
published. In this situation maintenance of secrecy is difficult.

3. Delay in Decision Making- In company form of organisation, all important decisions

are taken by the board of directors and shareholders in general meeting. Hence,
decision making process is time consuming. Board of directors itself has often to be at
the mercy of bureaucracy.

4. Concentration of Economic Power- The company form of organisation gives scope

for concentration of economic power in a few hands. It gives easy scope for the
formation of combinations which results in monopoly. Large joint stock companies tend
to form themselves into combinations or associations exercising monopolistic power
which may prove detrimental to other firms in the same line or to the consumers.
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Types of Companies and Forms of Organizing Public Sector (based on public interest)

Companies can either be the private company or public company. Also, there are
many types of public sector organizations such as departmental undertakings, government
companies etc. So let us take a more detailed look at both these types of companies and
public sector organizations.

1. Private Sector Companies

Private sector companies are companies which are not run by the government. They are
the part of a country’s economic system and is run by individual and companies with the
intention to earn the profit.

2. Public Sector Organizations

Public sector organizations are formed in three different forms:

1. Departmental undertakings

2. Public corporations/statutory corporations

3. Government company

1. Departmental Undertakings
This is the oldest form of public sector enterprises. The departmental undertaking is
considered as one of the departments of government. It has no separate existence than
the government. It functions under the overall control of one ministry or department of
government.

For example, Railways, post & telegraph, broadcasting, telephone service etc.

Features of departmental undertakings:-

The main characteristics of departmental undertakings are:-

1. They operate under the overall control of one of the ministries of central or state
government.

2. They are a part of government only, there is no separate entity.

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3. The revenue of departmental undertakings is deposited in the treasury of

government.

4. They are financed from the annual budgets of the government.

Merits of departmental undertakings:

 It is very easy to form a departmental undertaking as no registration is compulsory.

 There is direct parliamentary control. The performance of departmental

undertakings can be discussed in parliament. So there is public accountability.

 The revenue of departmental undertaking is deposited in the treasury of the

government. So these undertakings help to increase the government revenue.

2. Public Corporation/Statutory Corporation

A statutory corporation is a body corporate formed by a special act of parliament or by the
central or state legislature. It is fully financed by the government. Its powers, objects,
limitations etc. are also decided by the act of the legislature.

For example Indian airlines, air India, state bank of India, life insurance corporation of
India, food corporation of India, oil & natural gas corporation, etc.

Features of a public corporation:-

The main characteristics of a public corporation are:-

 It is created by an act of parliament or central or state legislature.

 The powers, objectives & limitations of a public corporation are defined in the act
only.

 Under total control of central or state government operations of public corporations

takes place.

 a public corporation is a separate legal entity. It gets incorporated automatically

when the act is passed in the parliament.

Merits of a public corporation:-

 A public corporation is able to manage its affairs with independence & flexibility.
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 A public corporation is relatively free from red tape, as there is less file work & less
formality to be completed before taking decisions.

 The activities of the public corporation are discussed in parliament. This ensures the
protection of public interest.

3. Government Companies
The company in which at least 51% of the paid-up share capital is held by the central or
state government or partly by central or state government is Government Company. The
government companies are governed & ruled by the provisions of the companies act,
2013 like any other registered companies. For example, steel authority of India, state
trading corporation, Hindustan machine tools.

Features of Government Company:-

 Registration: The government company gets incorporated under the companies act,
1956. All the provisions of companies act are applicable to a government company.

 Ownership: The government company is wholly or partly owned by the government.

The share capital of these companies is owned by the government of India in the
name of the president.

 Management: The government is managed by the board of directors, who are

nominated by the government & other shareholders. The government has the
authority to appoint a majority of the directors.

Merits of Government Company:-

 The government company is relatively free from government & political interference.

 The government company is managed, financed & audited just as any other private
sector company. It can, therefore, secure greater flexibility, freedom of operation &
quickness of action in running the enterprise.

 The government companies can avail & accommodate managerial skill, technical
know-how or expertise of the private enterprise of the private enterprise by
conveniently collaborating with it.
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Difference between Public Company and Private Company

S.No. Points of Difference Public Company Private Company

Minimum 7:
Maximum and minimum Maximum
1 number of members Unlimited Minimum 2: Maximum 50
No restrictions on
2 Transfer of shares transfer of shares Restricted
Prospectors can be Prohibited from issues of
3 Issue of prospectus issued prospectus
Prohibited from accepting
deposits from public.
However, it can accept
deposits from its
members, directors or
4 Acceptance of deposits Can accept their relatives.
Rs. 5 Lakh or
higher, as may be Rs. 1 lakh or higher as
5 Minimum paid up capital prescribed may be prescribed.

Important Questions for Unit-3

1. What is mean of Markets? Explain basic features of markets?

2. What is Perfect Competition? Explain through diagram how can you
determined price – output determination in short & long term
situation.
3. What do you know about Monopoly competition? Explain price
determination through diagram.
4. What is different between Perfect and Monopoly completion?
5. Define Monopolistic Competition. Explain through Illustrate price
determination in long and short run situation.
6. What is mean by Oligopoly Competition? Explain through diagram.
7. What do you know about Marries and Williamson’s managerial
theories? Explain.
8. Write Short note about Pricing Methods:
a. Average cost pricing
b. Limit pricing
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c. Skimming pricing
d. Internet pricing / Dynamic pricing
9. What do you know about “Business Cycle” Explain through
Diagram? Explain Features/phases of Business Cycle.
10. Define Sole Trade/Preparatory ship. Explain features, advantages
and disadvantages.
11. Define partnership business/company and explain types, features,
advantages and disadvantages.
12. Explain partnership deed.
13. What do you know about Joint Stock Company? Explain overview.
14. What do you know about Public Enterprises Company? Explain.

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