Introduction to Economics The salient features of Economics

according to Prof. Robbins are as

Economics is a study of human activity follows:
both at individual and national levels. The 1.​ Unlimited wants
economists of early age treated it merely as 2.​ Scarce resources
the science of wealth. 3.​ Alternative uses
4.​ Choice
The reason for this is clear. Every one of us
is involved in efforts aimed at earning Microeconomics
money and spending this money to satisfy
our wants such as food, clothing, shelter, The study of an individual consumer or a
and others. Such activities of earning and firm is called microeconomics (also called
spending money are called economics. the theory of firm).

It was only during the eighteenth century Micro means 'one millionth’.
that "Adam Smith" the father of
economics, defined economics as the study Microeconomics deals with behavior and
of nature and uses of national wealth. problems of single individuals and of micro
organization.
Wealth cannot be the ultimate goal of men.
We work hard daily to keep our life Macroeconomics
comfortable, and to earn money. Merely
procuring money or wealth is not our The study of aggregate or total level of
ultimate objective. We want to buy economic activity in a country is called
necessary goods and services that make macroeconomics. It studies the flow of
life more comfortable, and for this purpose economic resources or factors of production
we need money. (such as Land, Labor, Capital Organisation,
and Technology) from the resource owner to
DEFINITION: the business firms and then from the
business firms to the households.
“Dr. Alfred Marshall” One of the great
economists of the nineteenth century, wrote Management
“Economics is a study of man’s actions in
the ordinary business of life; it enquires how Management is the art of getting things
he gets his income and how he uses it”. done through people in formally organised
Thus, it is on one side, a study of wealth; groups.
and on the other, and more important side, it
is the study of man. Management includes a number of
functions:
Prof. Lionel Robbins defined Economics 1.​ Planning
as “the science which studies human 2.​ Organizing
behavior as a relationship between ends 3.​ Staffing
and scarce means which have alternative 4.​ Directing & Controlling
uses”.
Nature of Managerial Economics The problem may relate to:

Managerial economics is perhaps the Concepts and techniques of managerial

youngest of all the social sciences. Since it economics applied to:
originates from economics it has the basic
features of economics, such as assuming Managerial decision areas
that other things remain the same. ●​ Production
●​ Reduction or control of costs
Further, it is assumed that the firm or the ●​ Determination of price of a given
buyer acts in a rational manner (which product or service
normally does not happen). ●​ Make or buy decisions
●​ Inventory decisions
The buyer is carried away by the ●​ Capital management
advertisements, brand loyalties, incentives ●​ Profit planning and management
and so on and therefore, the innate ●​ Investment decisions
behavior of the consumer will be rational is
not a realistic assumption. This is because for optimum solutions.
the behavior of a firm or a consumer is a
complex phenomenon. The main areas of Managerial Economics
1.​ Demand decision
Other features of Managerial Economics 2.​ Input-output decision
●​ Close to microeconomics 3.​ Price out-put decision
●​ Operates against the backdrop of 4.​ Profit-related decision
macroeconomics 5.​ Investment decision
●​ Normative statements 6.​ Economic forecasting and forward
●​ Prescriptive actions planning
●​ Applied in nature
●​ Offers scope to evaluate each Linkages with other disciplines
alternative ●​ Economics
●​ Interdisciplinary ●​ Operations research
●​ Assumptions and limitations ●​ Mathematics
●​ Statistics
Scope of Managerial Economics ●​ Accountancy
●​ Psychology
The main focus in managerial economies is ●​ Organisational behaviour
to find the optimal solution to a given
managerial problem.
Demand Analysis Unless all these conditions are fulfilled, the
product is not said to have any demand.
The scope of economics broadly comprises
(a)​ Consumption Nature and Types of Demand
(b)​ Production
(c) Exchange, and 1.​ Consumer Demand vs Producer
(d) Distribution Goods

Consumption deals with the behaviour of Consumer goods refers to such products
consumers. To plan his operations, a and services which are capable of satisfying
producer has to understand the consumer human needs.
behaviour pattern before he commits his
funds for production. This is the reason why Examples are bread, apples, rice and so on.
consumption precedes production. This gives direct and immediate satisfaction.

Exchange deals with how the goods, once Producer goods are those which are used
produced, are sold for a price to the for further processing or production of
customer. goods/services to earn income.
Examples are machinery or a tractor. These
Distribution deals with how the sale goods yield satisfaction indirectly.
proceeds of the goods sold are distributed
among the various factors of production 2.​ Autonomous Demand vs Derived
towards the rent (to the landlord for letting Demand
out his land), wages (for labour), interest (to
capitalist for having provided capital, and Autonomous demand refers to the demand
profits (to the organiser having organised for products and services directly.
the business activity)
Super specialty hospitals can be considered
What is demand? as autonomous whereas the demand for the
hotels around that is called derived demand.
Every want supported by the willingness
and ability to buy constitutes demand for a If there is no demand for houses, there may
particular product or service. In other words, not be demand for steel, cement, bricks and
if I want a car and I cannot pay for it, there so on.
is no demand for the car from my side.
3.​ Durable vs Perishable Goods
A product or service is said to have
demand when three conditions are Here the demand for goods is classified
satisfied: based on their durability.
●​ Desire on the part of the buyer to
buy Examples of perishable goods are -milk,
●​ Willingness to pay for it vegetables, fish, and such.
●​ Ability to pay the specified price for
it.
Cars, furniture, appliances, and such others The demand for sugar from the
can be examples of durable goods. sweets-making industry from this region is
the segment market demand.
4.​ Firm Demand vs Industry Demand
Factors Determining Demand
The firm is a single business unit whereas
industry refers to the group of firms carrying The demand for a particular product
on similar activity. depends on several factors. The following
factors determine the demand for a given
5.​ Short-run Demand vs Long-run product:
Demand
a)​ Price of the product (P)
Joel Dean defines short-run demand as the b)​ Income level of the consumer (I)
demand with its immediate reaction to price c)​ Tastes and preferences of the
changes, income fluctuations and so on. consumer (T)
d)​ Prices of related goods which may
Long-run demand is that demand which will be substitutes/complementary (PR)
ultimately exist as a result of the changes in e)​ Expectations about the prices in
pricing, promotion or product improvement, future (EP)
after enough time is allowed to let the
market adjust itself to the given situation. f)​ Expectations about the incomes in
future (El)
6.​ New Demand vs Replacement g)​ Size of population (SP)
Demand h)​ Distribution of consumers over
different regions (DC)
New demand refers to the demand for the i)​ Advertising efforts (A)
new products and it is the addition to the j)​ Any other factor capable of affecting
existing stock. the demand (O)

In replacement demand, the item is Elasticity of Demand

purchased to maintain the asset in good
condition. Most of the time, it is not enough to
understand the increase or decrease in
7.​ Total Market and Segment Market price and its consequential impact of
Demand change in the quantity demanded.

Let us take the consumption of sugar in a It is necessary to find out the extent of
given region. increase or decrease in each of the
variables for making certain managerial
The total demand for sugar in the region is decisions. This paves the way for the
the total market demand. concept of elasticity of demand.
The term 'elasticity' is defined as the rate c)​ Relatively Elastic Demand
of responsiveness in the demand of a
commodity of a given change in price or any The demand is said to be relatively elastic
other determinants of demand. In other when the change in demand is more than
words, it explains the extent of change in the change in the price.
quantity demanded because of a given
change in the other determining factors, d)​ Relatively Inelastic Demand
may be price or any other factor(s).
The demand is said to be relatively inelastic
Measurements of Elasticity when the change in demand is less than
the change in the price.
The elasticity is measured in the following
ways: e)​ Unitary Elasticity

a)​ Perfectly elastic demand The elasticity in demand is said to be unity

b)​ Perfectly inelastic demand when the change in demand is equal to the
c)​ Relatively elastic demand change in price.
d)​ Relatively inelastic demand
e)​ Unitary elasticity Types of Elasticity

a)​ Perfectly Elastic Demand The following are the four types of elasticity
of demand:
When any quantity can be sold at a given
price, and when there is no need to reduce a.​ Price elasticity of demand
price, the demand is said to be perfectly b.​ Income elasticity of demand
elastic. In such cases, even a small c.​ Cross elasticity of demand
increase in price will lead to complete fall in d.​ Advertising elasticity of demand
demand.
a.​ Price Elasticity of demand
b)​ Perfectly Inelastic Demand
Elasticity of demand in general refers to
When a significant degree of change in price elasticity of demand. In other words, it
price leads to little or no change in the refers to the quantity demanded of a
quantity demanded, then the elasticity is commodity in response to a given change in
said to be perfectly inelastic. In other words, price.
the demand is said to be perfectly inelastic
when there is no change in the quantity Price elasticity is always negative which
demanded even though there is a big indicates that the customer tends to buy
change (increase or decrease) in price. more with every fall in the price. The
relationship between the price and the
demand is inverse.
 b.​ Income Elasticity of Demand l)​ Government policy

Income elasticity of demand refers to the DEMAND FORECASTING

quantity demanded of a commodity in
response to a given change in income of the It is necessary to measure demand
consumer. accurately in terms of quantity and its value
for several purposes.
Income elasticity is normally positive, which
indicates that the consumer tends to buy Demand forecasting is helpful not only at
more and more with every increase in the firm level but also at the national level.
income.
Methods of demand forecasting
c.​ Cross Elasticity of Demand
Forecasting demand is not an easy
Cross elasticity of demand refers to the exercise.
quantity demanded of a commodity in
response to a change in the price of a It may be easy only in the case of a very
related good, which may be a substitute or few products or services. Where the
complement. demand for the product does not change
from time to time or competition is not
d.​ Advertising Elasticity significant, it may be relatively easy to
forecast demand for a particular product or
It refers to increase in the sales revenue service.
because of change in the advertising
expenditure. In other words, there is a direct There are many methods of forecasting
relationship between the amount of money demand.
spent on advertising and its impact on
sales. Advertising elasticity is always To forecast demand, we needed to build a
positive. certain base of information. To build such an
information base, we need to consider what
Factors Governing Elasticity of Demand the customers say, what the customers do,
a)​ Nature of product and how the customers behave in a given
b)​ Time frame marketing situation.
c)​ Degree of postponement
d)​ Number of alternative uses The different methods of forecasting
e)​ Tastes and Preferences of the demand can be grouped under (a) survey
consumer methods and b) statistical methods
f)​ Availability of close substitutes
g)​ In case of complimentary or joint 1.​ Survey methods
goods (a) Survey of buyer intentions
h)​ Level of prices ●​ Census method
i)​ Availability of subsidies ●​ Sample method
j)​ Expectation of prices (b) Sales force opinion method
k)​ Durability of the product
 2.​ Statistical methods supplied of a good or service can change
(a) Trend projection method infinitely in response to any change in price.
●​ Trend line by observation
●​ Least square method This means that producers are willing to
●​ Time series analysis supply any quantity at a specific price, but
●​ Moving averages method absolutely nothing at a slightly lower price.
●​ Exponential smoothing
(b) Barometric techniques The supply curve for perfectly elastic supply
(c) Simultaneous equations method is a horizontal line.
(d) Correlation and regression
method Perfectly inelastic supply

3.​ Other methods Perfectly inelastic supply refers to a

(a) Expert opinion method situation where the quantity supplied of a
(b) Test marketing good or service remains cons​tant
(c) Controlled experiments regardless of changes in its price.
(d) Judgmental approach
This means that producers are unable to
Supply Elasticity adjust the quantity they offer for sale, even if
the price increases or decreases.
Supply elasticity, also known as price
elasticity of supply, measures how much the A perfectly inelastic supply curve is vertical,
quantity supplied of a good or service indicating that the quantity supplied is fixed
changes in response to a change in its at a specific point.
price.
Relatively elastic supply
It's calculated as the percentage change in
quantity supplied divided by the percentage Relatively elastic supply means that the
change in price. quantity of a good supplied responds
substantially to changes in its price.
Key Concepts:
Specifically, a small change in price leads to
Elasticity a proportionally larger change in the
quantity supplied. This indicates that
Refers to the responsiveness of one producers are quite sensitive to price
variable to changes in another, In this case, fluctuations and can easily adjust their
it's the responsiveness of supply to changes production levels.
in price.
Relatively inelastic supply
Perfectly elastic supply
Relatively inelastic supply means that the
Perfectly elastic supply, in economics, is a quantity of a good or service supplied does
theoretical concept where the quantity not change much in response to a change
in price.
In other words, producers are not very In other words, the production here is the
responsive to price changes when it comes function of these five variable inputs.
to adjusting the amount they supply.
Mathematically, this is expressed as:
This is reflected in the price elasticity of
supply value between O and 1. Q= f(L1, L2, C, O, T)

Unitary elastic supply Where:

●​ Q is the quantity of production,
Unitary elastic supply, also known as unit ●​ f explains the function, that is, the
elastic supply, occurs when the percentage type of relation between inputs and
change in quantity supplied is exactly equal outputs,
to the percentage change in price. ●​ L1, L2, C, O, T refer to land, labour,
capital, organization and technology
In simpler terms, if the price of a good respectively.
increases by a certain percentage, the
quantity supplied of that good will also These inputs have been taken in
increase by the same percentage. conventional terms.

The price elasticity of supply for a unitarily Production function with one variable
elastic good is exactly 1. input and law of returns:

Theories of Production and Concepts The Law of Returns states that when at
least one factor of production is fixed or
The Production Function factor input is fixed and when all other
factors are varied, the total output in the
Samuelson defines production function as initial stages will increase at an increasing
"the technical relationship which reveals the rate, and after reaching a certain level of
maximum amount of output capable of output the total output will have a declining
being produced by each and every set of rate.
inputs". It is defined for a given state of
technical knowledge. If variable factor inputs are added further to
the fixed factor input, the total output may
Michael R Baye defines production function decline.
as "that function which defines the
maximum amount of output that can be This law is of universal nature and it proved
produced with a given set of inputs". to be true in agriculture and industry also.
The law of returns is also called the Law of
Input-output relationship or production Variable Proportions or the Law of
function: Diminishing Returns.

The inputs for any product or service are

land, labour, capital, organization and
technology.
Production function with two variable It explains the behavior of the returns when
inputs and laws of returns: the inputs are changed simultaneously. The
returns to scale are governed by laws of
Let us consider a production process that returns to scale.
requires two inputs, capital (C) and labour
(L) to produce a given output (Q). RETURNS TO FACTORS

There could be more than two inputs in a A.​ Total productivity

real life situation, but for a simple analysis, -​ The total output generated at varied
we restrict the number of inputs to two only. levels of inputs of a particular factor
(constant), is called total productivity.
In other words, the production function
based on two inputs can be expressed as: B.​ Average productivity
Q= f(C, L) -​ The total physical product divided by
the number units of that particular
Where C refers to capital, L is labour. factor used yields averages
productivity.
Normally, both capital and labour are
required to produce a product. To some C.​ Marginal productivity
extent, these two inputs can be substituted -​ The marginal physical product is the
for each other. Hence the producer may additional output generated by
choose any combination of labour and adding an additional unit of the
capital that gives him the required number factor under study, keeping the other
of units of output. factors constant.

Marginal Rate Of Technical ECONOMIES AND DISECONOMIES OF

Substitutions: SCALE

The marginal rate of technical substitution The economies of scale result because of
(MRTS) refers to the rate at which one input an increase in the scale of production.
factor is substituted with the order to attain a
given level of output. A.​ Internal economies
B.​ External economies
In other words, the lesser units of one input
must be compensated by increasing INTERNAL ECONOMIES
amounts of another input to produce the
same level of output. Internal economics refer to the economies
in production costs which accrue to the firm
RETURNS TO SCALE AND RETURNS TO alone when it expands its output.
FACTOR
a)​ Managerial economies:
Returns to scale refers to the returns -​ As the firm expands, the firm needs
enjoyed by the firms as a result of changing qualified managerial functions:
in all the inputs.
 marketing, finance, production, HR produce and sell at full capacity or
and other professional ways. not.

b)​ Commercial economies: h)​ Economies of larger dimension:

-​ The transactions of buying and -​ Large scale production is required to
selling raw materials and other take advantage of bigger size plants.
operating suppliers such as spars
and so on. i)​ Economies of research and
development:
c)​ Financial economies: -​ Large organizations such as Dr.
-​ There could be cheaper credit Reddy's labs, Hindustan Lever
facilities from the financial spend heavily on R&D and bring out
institutions to meet the capital several innovative products.
expenditure or working capital
requirements. EXTERNAL ECONOMIES

d)​ Technical economies: External economies refers to all the firms in

-​ Increase in the scale of production the industry, because of growth of the
follows when there is sophisticated industry as a whole because of growth of
technology available and the firm is ancillary industries.
in a position to hire qualified
technical manpower to make use of ●​ Economies of concentration:
it.
Because all the firms are located at one
e)​ Marketing economies: place, it is likely that there is better
-​ It handles the issues related to infrastructure in terms of approach roads,
design of customer surveys, transportation facilities such as railway lines
advertising material, promotion and so on, banking and communication
campaign, handling of sales and facilities, availability of skilled labour and
marketing staff, renting of hoardings, such factors.
launching a new product and so on.
●​ Economies of R&D:
f)​ Risk-bearing economies:
-​ As there is growth in the size of the All the firms can pool resources together to
firm, there is an increase in the risk finance R & D activities and thus share the
also. Sharing the risk with the benefits of research.
insurance companies is the first
priority. ●​ Economies of welfare:

g)​ Indivisibilities and automated There could be common facilities such as

machinery: canteen, industrial housing, community
-​ To manufacture goods, a plant of halls, schools and colleges, employment
certain minimum capacity is required 'bureau' hospitals and so on, which can be
whether the firm would like to
used in common by the employees in the INTRODUCTION TO MARKETS & NEW
whole industry. ECONOMIC ENVIRONMENT

DISECONOMIES MARKET

Diseconomies are mostly managerial in Markets constitute an important phase in

nature. economic activity. All the goods and
services that are produced need to be sold
Problems of planning, coordination, to the consumer for a price.
communication and control may become
increasingly complex as the firm grows in Markets facilitate this process. We cannot
size resulting in increasing average cost per imagine a society without markets even for
unit. a while.

Sometimes, the firm may also collapse. MARKET DEFINED

COST ANALYSIS Market is defined as a place or point at

which buyers and sellers negotiate their
The managerial economist is concerned exchange of well-defined products and
with making managerial decisions. services.

Different business proposals are evaluated Traditionally, a market was referred to as a

in terms of their costs and revenues. public place in a village or town where
provisions and other objectives were
To know what costs are to be examined, it is brought for sale. Based on the location,
necessary to understand what 'cost' is and markets are classified as rural, urban,
how to analyse the same. national, or world markets.

The Concept And Nature Of Cost A market is said to exist wherever there is
potential for trade.
Costs refers to the expenditure incurred to
produce a particular product or service. All SIZE OF THE MARKET
costs involve a sacrifice of some kind or
other to acquire some benefit. The size of the market depends on many
factors such as the nature of products,
For example, If I want to eat food, I should nature of their demand, tastes and
be prepared to sacrifice money. preferences of the customers, their income
level, state of technology, extent of
Costs may be monetary or non-monetary; infrastructure including telecommunications
tangible or intangible, determined and information technology, time factor in
subjectively or objectively. Social costs such terms of short-run or long-run and so on.
as pollution, noise or traffic congestion add
another dimension to the cost concept.
MARKET STRUCTURE The following are the features of perfect
competition. In other words, these are the
Market structure refers to the characteristics assumptions underlying perfect markets.
of a market that influence the behavior and
performance of firms that sell in that market. (a)​ Large number of buyers and sellers
(b)​ Homogeneous products or services
The structure of market is based on its (c)​ Freedom to enter or exit the market
following features: (d)​ Perfect information available to the
(a)​ The degree of seller concentration buyers and sellers
(b)​ The degree of buyer concentration (e)​ Perfect mobility of factors of
(c)​ The degree of product differentiation production
(d)​ The conditions of entry into the (f)​ Each firm is a price taker
market
IMPERFECT COMPETITION
Types of Competition
A competition is said to be imperfect when it
Based on the degree of competition, the is not perfect. In other words, when any or
markets can be divided into perfect markets most of the mentioned conditions do not
and imperfect markets. exist in a given market, it is referred to as an
Imperfect market.
In perfect markets, there is said to prevail
perfect competition and in case of imperfect Based on the number of buyers and sellers,
markets, imperfect competition. the Imperfect markets are classified as
explained below:
Perfect competition is said to exist when
certain conditions are fulfilled. These Based on the number of buyers and seller,
conditions are ideal and hence only the structure of market varies as outlined:
imaginative, not realistic.
'poly' refers to the seller and 'psony'
PERFECT COMPETITION AND PERFECT means buyer.
MARKET
MONOPOLY
A market structure in which all firms in an
industry are price takers and in which there If there is only one seller, a monopoly
is freedom of entry into and exit from the market is said to exist.
industry is called Perfect Competition.
An extreme version of an imperfect market
The market with perfect competition is monopoly. Here a single seller completely
conditions is known as "Perfect Market". controls the entire industry.
Monopoly refers to a situation where a
FEATURES: single firm is in a position to control either
supply or price of a particular product or
service.
It cannot control or determine both price and close substitutes to each other. They are
supply as it cannot control demand. similar but not identical.
Monopoly exists where there are certain
restrictions on the entry of other firms into There are no restrictions on the entry and
business or where there are no close with the result, many firms who feel they
substitutes for a given product or service. can offer a relatively better product or
service, enter the market.
FEATURES OF MONOPOLY
1.​ There is a single firm dealing in a DUOPOLY
particular product or service.
2.​ There are no close substitutes and If there are two sellers, duopoly is said to
no competitors. Intellectual Property exist. If Pepsi and Coke are the two
Rights (IPRs), exclusive possession companies in soft drinks, this market is
of factors of production including called duopoly.
latest technology make the firm
more monopolistic in nature. OLIGOPOLY
Railways had a monopoly over the
distribution system till the road Another variety of imperfect competition is
transport system developed in terms oligopoly. If there is competition among a
of fuel efficient heavy trucks. few sellers, oligopoly is said to exist.
3.​ The monopolist can decide either
the price or quantity, not both. Monopsony
4.​ The products and services provided
by the monopolist bear inelastic If there is only one buyer, a monopsony
demand. market is said to exist.
5.​ Monopoly may be created through
statutory grant of special privileges Duopsony
such as licenses, permits, patent
rights, and so on. If there are two buyers, duopsony is said to
exist
MONOPOLISTIC COMPETITION
Oligopsony
When a large number of sellers produce
differentiated products, monopolistic If there are a few buyers, oligopsony is said
competition is said to exist. to exist.

A product is said to be differentiated when

its important features vary. It may be
differentiated based on real or perceived Pricing
differences.
In economics, pricing is the process of
Monopolistic competition is said to exist determining the monetary value of a product
when there are many firms and each one or service. It's a crucial element in business
produces such goods and services that are
strategy, impacting both profitability and them, or pricing above them depending on
customer perception. the competitive landscape and the product's
unique selling points.
Pricing is influenced by various factors
including production costs, market demand, Demand Oriented Pricing
and competition, and it plays a key role in
achieving a balance between supply and In a free market, prices are determined by
demand. the interaction of supply and demand. When
demand exceeds supply, prices tend to rise,
PRICING OBJECTIVES and when supply exceeds demand, prices
tend to fall.
Pricing objectives refers to the general and
specific objectives which a firm sets for itself Strategy Based Pricing
in establishing the price of its products and
or services and these are not much different Businesses use various pricing strategies,
from the marketing objectives of a firm or its such as market-skimming (high initial price)
overall business objectives. or market-penetration (low initial price), to
achieve specific objectives like maximizing
PRICING METHODS profit or gaining market share.

The following are the different methods of Generally, the objectives of pricing are:
pricing. a)​ To maximize profits
1.​ Cost-based Pricing b)​ To increase sales
2.​ Competition oriented Pricing c)​ To increase the market share
3.​ Demand-oriented pricing d)​ To satisfy customers
4.​ Strategy based pricing e)​ To meet the competition
f)​ To generate internal resources to
Cost-Based Pricing finance expansion and growth
g)​ To maximize the value of the firm for
This method involves calculating the cost of different stakeholders.
producing a product or service and then
adding a markup to determine the selling Game Theory
price.
Game theory in managerial economics is
Economy pricing, a type of cost-based the study of strategic decision-making
strategy, focuses on offering the lowest among interdependent players (such as
possible price by minimizing costs and firms, managers, or consumers) where the
maximizing volume. outcome of one player's decision depends
on the decisions of others.
Competition-Oriented Pricing
Key Concepts
This strategy involves setting prices based
on the prices of competitors. It can involve ●​ Players: Decision-makers (e.g.,
matching competitor prices, pricing below firms in a competitive market).
 ●​ Strategies: Possible actions each cooperation (i.e., maintaining high
player can take. prices).
●​ Payoffs: The outcomes (often profits ●​ Effect: Reduces incentive to start a
or losses) resulting from the price war.
combination of strategies.
●​ Games: Scenarios where players Price Leadership
interact under specific rules (e.g., ●​ Strategy: One dominant firm sets
price wars, advertising battles). the price; others follow.
●​ Game Type: Sequential game - the
Why Game Theory Matters leader moves first.
●​ Goal: Establish a stable market
It helps managers make better decisions by price without explicit collusion.
anticipating competitors' reactions and ●​ Effect: Creates predictable pricing
planning accordingly. behavior, especially in oligopolies.

Common Applications Predatory Pricing

●​ Strategy: Firm temporarily sets a
●​ Pricing strategies (e.g., price very low price to drive out
matching or undercutting competitors.
competitors). ●​ Game Theory Context: A dynamic
●​ Product launches (deciding when game where future payoff (monopoly
and how to introduce new products). pricing) justifies short-term losses.
●​ Advertising and marketing ●​ Risk: Can backfire if competitors
campaigns. don't exit or if regulators intervene.
●​ Negotiations and bidding in
auctions. Collusive Pricing
●​ Collusion or competition in ●​ Strategy: Competing firms agree
oligopolistic markets. (formally or tacitly) to set high prices.
●​ Game Type: Cooperative game.
Pricing strategies in game theory involve ●​ Challenge: Each firm has an
firms making pricing decisions while incentive to cheat by secretly
considering how competitors will respond, lowering prices (Prisoner's
since the profit of one firm depends not only Dilemma).
on its price but also on the prices set by ●​ Solution: In repeated games, the
others. threat of punishment can sustain
cooperation.
Price Matching
●​ Strategy: A firm promises to match Bertrand Competition
any competitor's price cut. ●​ Assumption: Two or more firms
●​ Goal: Discourage competitors from choose prices simultaneously.
lowering prices. ●​ Prediction: Firms will continue
●​ Game Theory Insight: In a undercutting each other until prices
repeated game, this is a form of reached marginal cost (zero
punishment strategy that promotes economic profit)
 ●​ Realism: Happens mostly when Game Theory Insight: Use sequential
products are identical and capacity game models to decide whether first-mover
is unlimited. or second-mover advantage is better.

Stackelberg Pricing 2.​ Pricing Strategy

●​ Strategy: One firm (the leader) sets
its price first; the other firm (the How to Apply Game Theory to Pricing:
follower) responds.
Identify Players: Determine who the key
●​ Game Type: Sequential-move
players are in the market (competitors,
game.
customers, etc.).
●​ Advantage: The leader gains a
first-mover advantage. Analyze Payoffs: Consider the potential
outcomes (profits, market share, etc.) for
Penetration Pricing as a Game Strategy each player under different pricing
●​ Strategy: Set a low price to quickly scenarios.
gain market share, then raise prices.
●​ Game Theory Use: In entry Model Interactions: Use game theory
deterrence games, it can influence models (like the Prisoner's Dilemma or
how incumbents react to new Nash Equilibrium) to analyze how players
entrants. might react to each other's choices.

In the context of product or service Develop Pricing Strategies: Based on the

launches, companies often face analysis, develop pricing strategies that
decisions like: maximize the business's desired outcomes
(e.g., profit, market share) while considering
●​ When to launch? potential competitor reactions.
●​ At what price?
●​ What features to include? By incorporating game theory principles into
●​ How to react to competitors? pricing strategies, businesses can make
more informed decisions, anticipate
Game theory provides a framework to competitive responses, and ultimately
anticipate and strategically plan around achieve better business outcomes.
these decisions, especially in competitive
markets. 3.​ Feature Wars

1.​ Timing the Product Launch Scenario: Competing app developers

choose how many features to include at
Scenario: Two tech firms are developing launch.
similar smartphones.
More features increase cost but attract
Game: If Firm A launches first (with slightly users.
fewer features), it could gain market share
early. But Firm B could delay, observe, and Game: Adding features is like an arms race
launch a better product. if one app adds a feature, the other feels
pressure to match or exceed it.
 4.​ Punishment Strategies
Encourages stable strategies, like not
Example: A firm may threaten to launch a starting costly ad wars.
competing product at a loss (predatory
pricing) if a rival enters their market. Practical Applications and Examples

Used as a deterrence mechanism in (1)​ Advertising Wars (Prisoner's

repeated games. Dilemma)
Why game theory matters in advertising
●​ Firms may both prefer to limit
advertising to save costs.
Advertising is strategic: The effect of your
●​ But fear of being undercut often
ad campaign often depends on what your
drives both to advertise heavily -
competitors do.
leading to lower profits overall.
●​ Example: Coca-Cola and Pepsi:
Marketing campaigns often involve:
both could profit by lowering ad
●​ Deciding whether to launch ads or
spending, but competition keeps
remain silent.
budgets high.
●​ Choosing ad timing and intensity.
●​ Deciding on target markets or media
(2)​ Preemptive Advertising
channels.
(First-Mover Advantage)
Types of Games in Advertising
●​ A firm might launch a massive
campaign before competitors to
Simultaneous games
build brand loyalty.
●​ Competitors then have to decide:
Competing firms decide on their advertising
respond (high cost) or stay silent.
budgets or strategies at the same time,
without knowing the other's choice.
(3)​ Niche Targeting (Coordination
Game)
Example: Two smartphone brands planning
global launch campaigns.
●​ Competing firms may choose to
target different market segments.
Sequential games
●​ This avoids head-to-head conflict
and benefits all players.
One firm acts first, and the other responds.

(4)​ Punishment Strategies

Example: A market leader launches a
campaign, and competitors decide whether
●​ If a competitor breaks an implicit
to counter-advertise.
truce (e.g., starts negative ads), a
firm may retaliate with even stronger
Repeated games
ads next time.
●​ The threat of punishment
Firms interact multiple times; past behavior
discourages aggressive advertising.
affects future strategies.
Application: Collusion vs. Competition

a)​ Collusion (Cooperative Game)

Firms cooperate, either formally (cartel) or

informally, to:
●​ Set higher prices
●​ Limit output
●​ Share the market

Goal: increase joint profits

Example: OPEC coordinating oil production
to influence prices

Game theory insight

●​ Collusion can be the "best" joint
outcome.
●​ But it's unstable because each firm
has an incentive to secretly cheat
(e.g., undercut the agreed price to
gain market share).

b)​ Competition (Non-cooperative

Game)
●​ Firms act independently, trying to
increase their own profit.

Often leads to:

●​ Lower prices
●​ Higher output
●​ Lower profits for all

Why Game Theory Matters in Oligopolies

●​ Actions by one firm directly affect
others.
●​ Firms must think strategically: "If I
lower my price, what will my rival
do?"

Game theory shows likely outcomes when

firms:
●​ Act independently
●​ Coordinate or collude