Is playing with price actually paying the price?

We have heard of terms such as subsidizing, limiting prices to maximum or minimum, etc. Most of these acts are done by governments in order to prevent certain interests, secure essential needs, prevent inflation, etc.

Let’s analyze some example, and see if economically it makes sense.

We all know that price is determined by market forces, and when demand meets supply, we have a price, demanded quantity and supplied quantity. Anybody who tries to play with price artificially is actually disturbing the equilibrium, and creating artificial demand or supply.

Simple examples below:

Setting Max price: Let’s say, price of bread is Rs 30 per bread as per natural demand-supply relationship. Now govt. thinks that bread is an essential commodity, and Rs 30 is too high, so they set the artificial price at Rs 20. What essentially it will do is increase the demand, and decreases the supply, causing shortage of bread. People will eat more bread, as it’s cheap that the natural price and increase the demand and supplier will try to cut supplies, as at this price, it may not be a decent proposition. Now co-relate this with oil subsidy, which is given to contain inflation.

Setting Min price: Let’s say, price of 1Kg of potatoes is Rs 15 per kg, again as per natural demand supply relationship. Now, govt. comes in to help farmers, saying this price is too less, and should be Rs 20 for farmers to get their due. So, it all starts with good intention, but from economist’s point of view, it means, demand is getting reduced, and supply will get increased. So, there will be surplus in the market. What to do with this surplus? Again govt. comes to help, and start buying to store, or destroy. As you can see, for a short run this is fine, but it’s not a viable model. It’s like funding a startup till it dies its own death.

Well there are many other non-economic reasons for which this a kind of policy exist, but above analysis is purely from economist eyes.

So, from economist’s view point, playing with prices is actually paying the price eventually 🙂

 

 

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Demand Elasticities

It’s a measure of sensitivity of the Quantity demanded vis a vis changes in price. In simple words, does quantity change too much or too little on increase/decrease in price.

Mathematically,

E(d) = (Delta)Q/Q     ÷  (Delta)P/P

So,

E(d) >1 : If percentage change in quantity > percentage change in price, it’s called “Elastic” Demand. For ex, demand of air travel will decrease quite a bit with increase in price, and people may prefer trains or other means of transportation, and vice versa for decrease in price.

E(d) < 1: If percentage change in quantity < percentage change in price, it’s called “Inelastic” Demand. For ex, demand for oil is inelastic, as demand of oil doesn’t vary much with price.  As there are not many substitutes available. Other example is demand for insulin doesn’t change, and remains same, as there’s no other alternative.

E(d) = 0 : This is case of perfect inelastic demand. Quantity doesn’t change at any price.

E(d) = ∞ : This is case of perfect elastic demand. Small variations in price leads to huge changes in the quantity.

Elasticity of a product can be calculated from all the historical data, and is helpful in determining the future prices in case production increases or falls. For example, when oil producing countries go out to decrease the production, what will be its effect on price, etc.

Revenue projections w.r.t Elasticity:

Revenue is Price x Quantity Demanded.

If E(d) >1, then increase in price by x%(say 10%) will decrease in quantity demanded by more than x % (say 20%).

So old revenue = PQ

New revenue = (1.1)P x (0.8)Q = 0.88 PQ , so total effect is that revenue got decreased.

If E(d) <1, then increase in price by x%(say 10%) will decrease in quantity demanded by less than x % (say 5%).

So old revenue = PQ

New revenue = (1.1)P x (0.95)Q = 1.045 PQ , so total effect is that revenue got increased.

The Hersey-Blanchard Situational Leadership® Theory

Source: http://www.mindtools.com/pages/article/newLDR_44.htm

The theory states that instead of using just one style, successful leaders should change their leadership styles based on the maturity of the people they’re leading and the details of the task. Using this theory, leaders should be able to place more or less emphasis on the task, and more or less emphasis on the relationships with the people they’re leading, depending on what’s needed to get the job done successfully.

Leadership Styles

According to Hersey and Blanchard, there are four main leadership styles:

  • Telling (S1) – Leaders tell their people exactly what to do, and how to do it.
  • Selling (S2) – Leaders still provide information and direction, but there’s more communication with followers. Leaders “sell” their message to get the team on board.
  • Participating (S3) – Leaders focus more on the relationship and less on direction. The leader works with the team, and shares decision-making responsibilities.
  • Delegating (S4) – Leaders pass most of the responsibility onto the follower or group. The leaders still monitor progress, but they’re less involved in decisions.

As you can see, styles S1 and S2 are focused on getting the task done. Styles S3 and S4 are more concerned with developing team members’ abilities to work independently.

Maturity Levels

According to Hersey and Blanchard, knowing when to use each style is largely dependent on the maturity of the person or group you’re leading. They break maturity down into four different levels:

  • M1 – People at this level of maturity are at the bottom level of the scale. They lack the knowledge, skills, or confidence to work on their own, and they often need to be pushed to take the task on.
  • M2 – At this level, followers might be willing to work on the task, but they still don’t have the skills to do it successfully.
  • M3 – Here, followers are ready and willing to help with the task. They have more skills than the M2 group, but they’re still not confident in their abilities.
  • M4 – These followers are able to work on their own. They have high confidence and strong skills, and they’re committed to the task.

The Hersey-Blanchard model maps each leadership style to each maturity level, as shown below.

Maturity Level Most Appropriate Leadership Style
M1: Low maturity S1: Telling/directing
M2: Medium maturity, limited skills S2: Selling/coaching
M3: Medium maturity, higher skills but lacking confidence S3: Participating/supporting
M4: High maturity S4: Delegating

The Savitha Deshpande case- Learnings

– An eternal question for the leaders- Where do i put most of my time on ?  On High Performers or Low Performers ?
– There has to be an appropriate balance- not too skewed in either direction.
– The Managerial Grid by R.R. Blake- http://en.wikipedia.org/wiki/Managerial_grid_model offers some answer to this situation. “Middle of the Road” style sometimes considered best.

– Whether a leader shows Concern for People or Concern for Task, the answer could be more situational, context based.

– A leader has to put efforts to understand the low performance of their employees and then act accordingly. Sometimes, leaders start addressing performance problems without understanding the real reason.

– Whatever gets rewarded in the organizations gets done.

– Leaders should be concerned with making people grow.

– Employee oriented behavior by the Managers does not mean being Open and friendly with the team members alone. Its more about showing empathy  than sympathy.

– Leaders should give special care to understand how they are percieved by their employees.

The Vroom’s theory of Work motivation

The most widely accepted explanations of motivation has been propounded by Victor Vroom. His theory is commonly known as expectancy theory. The theory argues that the strength of a tendency to act in a specific way depends on the strength of an expectation that the act will be followed by a given outcome and on the attractiveness of that outcome to the individual. To make this simple, expectancy theory says that an employee can be motivated to perform better when there is a belief that the better performance will lead to good performance appraisal and that this shall result into realization of personal goal in form of some reward. Therefore an employee is :

Motivation = Valence x Expectancy.

Valence: How attractive is the outcome ?
Expectance: The possibility that i will get what i desire i.e. my goals.

The theory focuses on three things :

Efforts and performance relationship
Performance and reward relationship
Rewards and personal goal relationship

Source: http://www.laynetworks.com/Theories-of-Motivation.html

The Porter-Lawler theory of motivation

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Actual performance in a job is primarily determined by the effort spent. But it is also affected by the person’s ability to do the job and also by individual’s perception of what the required task is. So performance is the responsible factor that leads to intrinsic as well as extrinsic rewards. These rewards, along with the equity of individual leads to satisfaction. Hence, satisfaction of the individual depends upon the fairness of the reward.
Source: http://www.laynetworks.com/Theories-of-Motivation.html

Intrinsic and Extrinsic Rewards

– When people get promoted, the people want to find who else got promoted. People always tend to assess the fairness of the system first.

– People always assess fairness by comparing the decisions taken against their reference groups. So even though they get promoted it doesn’t mean they will be happy because if they find that someone else they perceive to be a lower performer than them gets promoted (along with them), they lose enthusiasm.

– As a leader, imbibe a sense of fairness and equity in the team. Keep a record of performance, rely on accurate data points.

– Make use of both Extrinsic and Intrinsic approaches to reward employees.
– Extrinsic approaches are the ones like Promotions, Bonuses etc., typically the ones that are defined within the system.

– Intrinsic approaches can be created by a leader e.g. by simply asking “What do you want to learn in next 3 months ?” a leader shows his concern to the team member that he/she is ready to address one of the employee’s core needs i.e. to facilitate skills development.

Effort and Performance

– As a leader, find a link between effort and Performance.
– One of the jobs of a leader is to define Performance. Define for your employees, what is the specific definition of performance.
– At the most basic level, everyone who joins the organization wants to perform.
– As a leader, make it a habit to communicate the definition of performance proctively to your employees.
– Superior the definition of Performance, the superior will be the performance.
– Performance is as much about Skill as much it is about will.

Managerial Accounting- Change in mindset

Why is Managerial Accounting required? Where does it help? Why it is so important now than before.

This kind of Accounting helps stake holders internal to the company to understand cost structure, make price decisions as well as plan and budget. The accounting practice is free from GAAP(though it can use it, but there’s no obligation) and can be tailor made for different requirements.

Let’s understand the change in mindset, and why managerial accounting plays more important role now than before.

Cost + Profit = Selling Price (Monopoly): This is the formula used by monopolistic organizations, where profit is at your discretion. Since it’s a monopoly, it can demand decent profit, and Selling Price is determined via cost and profit factors.

Selling Price – Cost = Profit (Competition): This is the competition era, where Selling Price is determined by market forces and organizations don’t have much say in it. With pressure on ever decreasing selling prices, and ever increasing costs, profits keeps on diminishing.

Selling Price – Profit = Cost (Change in mindset): The funny part is that we have written the same equation in different ways and mathematically all are same, but when it comes to accounting, meanings are different. In this, we are saying that selling price is determined by market, profit is something you would like to have and can’t reduce, and only thing to play with is cost.

Since cost has attained the center stage, managerial accounting has become that much more important, with real focus on reducing costs, and making decisions governed by cost(of course there are many other factors).

Four Type of markets

Four types of markets are-
Competitive market
Monopoly market
Oligopoly
Monopolistic competition

Competitive market
– Free entry/exit
– Large# of buyers and sellers
– Price is lowest to the consumer
– This type of market is best in terms of resource allocation.
– A market in which no firm has the power to affect the market price of a good.
– A market where several firms are competing with each other for the same product.

Monopoly market
– Has large entry barriers
– A monopoly does not have a Supply curve because the monopoly does not take the price as given. Instead a monopoly can dictate price.
– The Quantity that maximizes the profits is in the hands of a seller.
– Apart from the dominant player, no one else able to enter e.g. in India, Railways is a public monopoly. In US, Raliways is a Private monopoly because of large initial investments.
– Another example, DRDO is a legal monopoly.
– There can be a monopoly for Political, Ideological reasons. LIC was such an example. It followed, Russian model of 1970’s for Socialism which implied that if things go pricate, goods produce will mostly benefit the Rich.
– In mainframe Computers, IBM was a monopoly because of the cost. IBM didnt even sell but only leased.

Oligopoly:
– Entry barriers are still there but there are a few sellers
– Each company tries to  find out what the competitor does. Interdependence is the key.
– There are no simple rules to profit maximization here e.g. different firms can collaborate and create a monopoly.
– Another behavior is price war e.g. Airline Industry.
– Firms anticipate what is best for the other firms and based on that decide their internal strategies and prices.
– Mobile phones industry are example of Oligopoly.

Monopolistic Competition:
– No entry barrier
– Existence of niche markets

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