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UNIT-2: Demand and Supply

Managerial Economics (KMBN 102)

Dr Ankur Yadav (ankuryadav@[Link])

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DEMAND ANALYSIS

Introduction & Meaning:

Demand in common parlance means the desire for an object. But in economics demand is
something more than this. According to Stonier and Hague, “Demand in economics means
demand backed up by enough money to pay for the goods demanded”. This means that
the demand becomes effective only it if is backed by the purchasing power in addition to
this there must be willingness to buy a commodity.

Thus demand in economics means the desire backed by the willingness to buy a
commodity and the purchasing power to pay. In the words of “Benham” “The demand for
anything at a given price is the amount of it which will be bought per unit of time at that
Price”. (Thus demand is always at a price for a definite quantity at a specified time.) Thus
demand has three essentials – price, quantity demanded and time. Without these,
demand has to significance in economics.

LAW of Demand:

Law of demand shows the relation between price and quantity demanded of a commodity
in the market. In the words of Marshall, “the amount demand increases with a fall in price
and diminishes with a rise in price”.

A rise in the price of a commodity is followed by a reduction in demand and a fall in price
is followed by an increase in demand, if a condition of demand remains constant.

The law of demand may be explained with the help of the following demand schedule.

Demand Schedule.

Price of Appel (In. Rs.) Quantity Demanded

10 1
8 2
6 3
4 4
2 5

When the price falls from Rs. 10 to 8

quantity demand increases from 1 to
2. In the same way as price falls,
quantity demand increases on the
basis of the demand schedule we can
draw the demand curve.

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Price

The demand curve DD shows the inverse relation between price and quantity demand of
apple. It is downward sloping.

Assumptions:

Law is demand is based on certain assumptions:

1. This is no change in consumers taste and preferences.

2. Income should remain constant.
3. Prices of other goods should not change.
4. There should be no substitute for the commodity
5. The commodity should not confer at any distinction
6. The demand for the commodity should be continuous
7. People should not expect any change in the price of the commodity

Exceptional demand curve:

Sometimes the demand curve slopes upwards from left to right. In this case the demand
curve has a positive slope.

Price

When price increases from OP to Op1 quantity demanded also increases from to OQ1 and
vice versa. The reasons for exceptional demand curve are as follows.

1. Giffen paradox:

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The Giffen good or inferior good is an exception to the law of demand. When the price of
an inferior good falls, the poor will buy less and vice versa. For example, when the price of
maize falls, the poor are willing to spend more on superior goods than on maize if the
price of maize increases, he has to increase the quantity of money spent on it. Otherwise
he will have to face starvation. Thus a fall in price is followed by reduction in quantity
demanded and vice versa. “Giffen” first explained this and therefore it is called as Giffen’s
paradox.

2. Veblen or Demonstration effect:

‘Veblan’ has explained the exceptional demand curve through his doctrine of conspicuous
consumption. Rich people buy certain good because it gives social distinction or prestige
for example diamonds are bought by the richer class for the prestige it possess. It the
price of diamonds falls poor also will buy is hence they will not give prestige. Therefore,
rich people may stop buying this commodity.

3. Ignorance:

Sometimes, the quality of the commodity is Judge by its price. Consumers think that the
product is superior if the price is high. As such they buy more at a higher price.

4. Speculative effect:

If the price of the commodity is increasing the consumers will buy more of it because of
the fear that it increase still further, Thus, an increase in price may not be accomplished
by a decrease in demand.

5. Fear of shortage:

During the times of emergency of war People may expect shortage of a commodity. At
that time, they may buy more at a higher price to keep stocks for the future.

5. Necessaries:

In the case of necessaries like rice, vegetables etc. people buy more even at a higher
price.

Factors Affecting Demand:

There are factors on which the demand for a commodity depends. These factors are
economic, social as well as political factors. The effect of all the factors on the amount
demanded for the commodity is called Demand Function.
These factors are as follows:

1. Price of the Commodity:

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The most important factor-affecting amount demanded is the price of the commodity. The
amount of a commodity demanded at a particular price is more properly called price
demand. The relation between price and demand is called the Law of Demand. It is not
only the existing price but also the expected changes in price, which affect demand.

2. Income of the Consumer:

The second most important factor influencing demand is consumer income. In fact, we
can establish a relation between the consumer income and the demand at different levels
of income, price and other things remaining the same. The demand for a normal
commodity goes up when income rises and falls down when income falls. But in case of
Giffen goods the relationship is the opposite.

3. Prices of related goods:

The demand for a commodity is also affected by the changes in prices of the related
goods also. Related goods can be of two types:

(i). Substitutes which can replace each other in use; for example, tea and coffee are
substitutes. The change in price of a substitute has effect on a commodity’s demand
in the same direction in which price changes. The rise in price of coffee shall raise
the demand for tea;

(ii). Complementary foods are those which are jointly demanded, such as pen and ink. In
such cases complementary goods have opposite relationship between price of one
commodity and the amount demanded for the other. If the price of pens goes up,
their demand is less as a result of which the demand for ink is also less. The price
and demand go in opposite direction. The effect of changes in price of a commodity on
amounts demanded of related commodities is called Cross Demand.

4. Tastes of the Consumers:

The amount demanded also depends on consumer’s taste. Tastes include fashion, habit,
customs, etc. A consumer’s taste is also affected by advertisement. If the taste for a
commodity goes up, its amount demanded is more even at the same price. This is called
increase in demand. The opposite is called decrease in demand.

5. Wealth:

The amount demanded of commodity is also affected by the amount of wealth as well as
its distribution. The wealthier are the people; higher is the demand for normal
commodities. If wealth is more equally distributed, the demand for necessaries and

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comforts is more. On the other hand, if some people are rich, while the majorities are
poor, the demand for luxuries is generally higher.

6. Population:

Increase in population increases demand for necessaries of life. The composition of

population also affects demand. Composition of population means the proportion of young
and old and children as well as the ratio of men to women. A change in composition of
population has an effect on the nature of demand for different commodities.

7. Government Policy:

Government policy affects the demands for commodities through taxation. Taxing a
commodity increases its price and the demand goes down. Similarly, financial help from
the government increases the demand for a commodity while lowering its price.

8. Expectations regarding the future:

If consumers expect changes in price of commodity in future, they will change the demand
at present even when the present price remains the same. Similarly, if consumers expect
their incomes to rise in the near future they may increase the demand for a commodity
just now.

9. Climate and weather:

The climate of an area and the weather prevailing there has a decisive effect on
consumer’s demand. In cold areas woolen cloth is demanded. During hot summer days,
ice is very much in demand. On a rainy day, ice cream is not so much demanded.

10. State of business:

The level of demand for different commodities also depends upon the business conditions
in the country. If the country is passing through boom conditions, there will be a marked
increase in demand. On the other hand, the level of demand goes down during
depression.

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ELASTICITY OF DEMAND

Elasticity of demand explains the relationship between a change in price and consequent
change in amount demanded. “Marshall” introduced the concept of elasticity of demand.
Elasticity of demand shows the extent of change in quantity demanded to a change in
price.

In the words of “Marshall”, “The elasticity of demand in a market is great or small

according as the amount demanded increases much or little for a given fall in the price
and diminishes much or little for a given rise in Price”

Elastic demand: A small change in price may lead to a great change in quantity
demanded. In this case, demand is elastic.

In-elastic demand: If a big change in price is followed by a small change in demanded

then the demand in “inelastic”.

Types of Elasticity of Demand:

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There are three types of elasticity of demand:

1. Price elasticity of demand

2. Income elasticity of demand
3. Cross elasticity of demand

1. Price elasticity of demand:

Marshall was the first economist to define price elasticity of demand. Price elasticity of
demand measures changes in quantity demand to a change in Price. It is the ratio of
percentage change in quantity demanded to a percentage change in price.

Proportionate change in the quantity demand of commodity

Price elasticity =
Proportionate change in the price of commodity
There are five cases of price elasticity of demand

A. Perfectly elastic demand:

When small change in price leads to an infinitely large change is quantity demand, it is
called perfectly or infinitely elastic demand. In this case E=∞

The demand curve DD1 is horizontal straight line. It shows the at “OP” price any amount
is demand and if price increases, the consumer will not purchase the commodity.

B. Perfectly Inelastic Demand

In this case, even a large change in

price fails to bring about a change
in quantity demanded.

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When price increases from ‘OP’ to ‘OP’, the quantity demanded remains the same. In
other words the response of demand to a change in Price is nil. In this case ‘E’=0.

C. Relatively elastic demand:

Demand changes more than proportionately to a change in price. i.e. a small change in
price loads to a very big change in the quantity demanded. In this case
E > 1. This demand curve will be flatter.

When price falls from ‘OP’ to ‘OP’, amount demanded in crease from “OQ’ to “OQ1’ which
is larger than the change in price.

D. Relatively in-elastic demand.

Quantity demanded changes less than proportional to a change in price. A large change in
price leads to small change in amount demanded. Here E < 1. Demanded carve will be
steeper.

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When price falls from “OP’ to ‘OP1 amount demanded increases from OQ to OQ1, which is
smaller than the change in price.

E. Unit elasticity of demand:

The change in demand is exactly equal to the change in price. When both are equal E=1
and elasticity if said to be unitary.

When price falls from ‘OP’ to ‘OP1’ quantity demanded increases from ‘OP’ to ‘OP1’,
quantity demanded increases from ‘OQ’ to ‘OQ1’. Thus a change in price has resulted in
an equal change in quantity demanded so price elasticity of demand is equal to unity.

2. Income elasticity of demand:

Income elasticity of demand shows the change in quantity demanded as a result of a

change in income. Income elasticity of demand may be slated in the form of a formula.

Proportionate change in the quantity demand of commodity

Income Elasticity =
Proportionate change in the income of the people

Income elasticity of demand can be classified in to five types.

A. Zero income elasticity:

Quantity demanded remains the same, even though money income increases.
Symbolically, it can be expressed as Ey=0. It can be depicted in the following way:

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As income increases from OY to

OY1, quantity demanded never changes.

B. Negative Income elasticity:

When income increases, quantity demanded falls. In this case, income elasticity of
demand is negative. i.e., Ey < 0.

When income increases from OY to OY1, demand falls from OQ to OQ1.

c. Unit income elasticity:

When an increase in income brings about a proportionate increase in quantity demanded,

and then income elasticity of demand is equal to one. Ey = 1

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When income increases from OY to OY1, Quantity demanded also increases from OQ to
OQ1.
d. Income elasticity greater than unity:

In this case, an increase in come brings about a more than proportionate increase in
quantity demanded. Symbolically it can be written as Ey > 1.

It shows high-income elasticity of demand. When income increases from OY

to OY1, Quantity demanded increases from OQ to OQ1.

E. Income elasticity leas than unity:

When income increases quantity demanded also increases but less than proportionately.
In this case E < 1.

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An increase in income from OY to OY, brings what an increase in quantity demanded from
OQ to OQ1, But the increase in quantity demanded is smaller than the increase in income.
Hence, income elasticity of demand is less than one.
3. Cross elasticity of Demand:

A change in the price of one commodity leads to a change in the quantity demanded of
another commodity. This is called a cross elasticity of demand. The formula for cross
elasticity of demand is:

Proportionate change in the quantity demand of commodity “X”

Cross elasticity =

Proportionate change in the price of commodity “Y”

a. In case of substitutes, cross elasticity of demand is positive. Eg: Coffee and Tea

When the price of coffee increases, Quantity demanded of tea increases. Both are
substitutes.

Price of Coffee

b. Incase of compliments, cross elasticity is negative. If increase in the price of one

commodity leads to a decrease in the quantity demanded of another and vice versa.

When price of car goes up from OP to OP!, the quantity demanded of petrol decreases
from OQ to OQ!. The cross-demanded curve has negative slope.

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c. In case of unrelated commodities, cross elasticity of demanded is zero. A change in

the price of one commodity will not affect the quantity demanded of another.

Quantity demanded of commodity “b” remains unchanged due to a change in the price of
‘A’, as both are unrelated goods.

Factors influencing the elasticity of demand

Elasticity of demand depends on many factors.

1. Nature of commodity:

Elasticity or in-elasticity of demand depends on the nature of the commodity i.e. whether
a commodity is a necessity, comfort or luxury, normally; the demand for Necessaries like
salt, rice etc is inelastic. On the other band, the demand for comforts and luxuries is
elastic.

2. Availability of substitutes:

Elasticity of demand depends on availability or non-availability of substitutes. In case of

commodities, which have substitutes, demand is elastic, but in case of commodities, which
have no substitutes, demand is in elastic.

3. Variety of uses:

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If a commodity can be used for several purposes, than it will have elastic demand. i.e.
electricity. On the other hand, demanded is inelastic for commodities, which can be put to
only one use.

4. Postponement of demand:

If the consumption of a commodity can be postponed, than it will have elastic demand. On
the contrary, if the demand for a commodity cannot be postpones, than demand is in
elastic. The demand for rice or medicine cannot be postponed, while the demand for Cycle
or umbrella can be postponed.

5. Amount of money spent:

Elasticity of demand depends on the amount of money spent on the commodity. If the
consumer spends a smaller for example a consumer spends a little amount on salt and
matchboxes. Even when price of salt or matchbox goes up, demanded will not fall.
Therefore, demand is in case of clothing a consumer spends a large proportion of his
income and an increase in price will reduce his demand for clothing. So the demand is
elastic.

6. Time:

Elasticity of demand varies with time. Generally, demand is inelastic during short period
and elastic during the long period. Demand is inelastic during short period because the
consumers do not have enough time to know about the change is price. Even if they are
aware of the price change, they may not immediately switch over to a new commodity, as
they are accustomed to the old commodity.

7. Range of Prices:

Range of prices exerts an important influence on elasticity of demand. At a very high

price, demand is inelastic because a slight fall in price will not induce the people buy
more. Similarly at a low price also demand is inelastic. This is because at a low price all
those who want to buy the commodity would have bought it and a further fall in price will
not increase the demand. Therefore, elasticity is low at very him and very low prices.

Importance of Elasticity of Demand:

The concept of elasticity of demand is of much practical importance.

1. Price fixation:

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Each seller under monopoly and imperfect competition has to take into account elasticity
of demand while fixing the price for his product. If the demand for the product is inelastic,
he can fix a higher price.

2. Production:

Producers generally decide their production level on the basis of demand for the product.
Hence elasticity of demand helps the producers to take correct decision regarding the
level of cut put to be produced.

3. Distribution:

Elasticity of demand also helps in the determination of rewards for factors of production.
For example, if the demand for labour is inelastic, trade unions will be successful in raising
wages. It is applicable to other factors of production.

4. International Trade:

Elasticity of demand helps in finding out the terms of trade between two countries. Terms
of trade refers to the rate at which domestic commodity is exchanged for foreign
commodities. Terms of trade depends upon the elasticity of demand of the two countries
for each other goods.

5. Public Finance:

Elasticity of demand helps the government in formulating tax policies. For example, for
imposing tax on a commodity, the Finance Minister has to take into account the elasticity
of demand.

6. Nationalization:

The concept of elasticity of demand enables the government to decide about

nationalization of industries.

Demand Forecasting

Introduction:

The information about the future is essential for both new firms and those planning to
expand the scale of their production. Demand forecasting refers to an estimate of future
demand for the product.

It is an ‘objective assessment of the future course of demand”. In recent times,

forecasting plays an important role in business decision-making. Demand forecasting has

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an important influence on production planning. It is essential for a firm to produce the

required quantities at the right time.

It is essential to distinguish between forecasts of demand and forecasts of sales. Sales

forecast is important for estimating revenue cash requirements and expenses. Demand
forecasts relate to production, inventory control, timing, reliability of forecast etc.
However, there is not much difference between these two terms.

Types of demand Forecasting:

Based on the time span and planning requirements of business firms, demand forecasting
can be classified in to 1. Short-term demand forecasting and
2. Long – term demand forecasting.

1. Short-term demand forecasting:

Short-term demand forecasting is limited to short periods, usually for one year. It relates
to policies regarding sales, purchase, price and finances. It refers to existing production
capacity of the firm. Short-term forecasting is essential for formulating is essential for
formulating a suitable price policy. If the business people expect of rise in the prices of
raw materials of shortages, they may buy early. This price forecasting helps in sale policy
formulation. Production may be undertaken based on expected sales and not on actual
sales. Further, demand forecasting assists in financial forecasting also. Prior information
about production and sales is essential to provide additional funds on reasonable terms.

2. Long – term forecasting:

In long-term forecasting, the businessmen should now about the long-term demand for
the product. Planning of a new plant or expansion of an existing unit depends on long-
term demand. Similarly a multi product firm must take into account the demand for
different items. When forecast are mode covering long periods, the probability of error is
high. It is vary difficult to forecast the production, the trend of prices and the nature of
competition. Hence quality and competent forecasts are essential.

Prof. C. I. Savage and T.R. Small classify demand forecasting into time types. They are 1.
Economic forecasting, 2. Industry forecasting, 3. Firm level forecasting. Economics
forecasting is concerned with the economics, while industrial level forecasting is used for
inter-industry comparisons and is being supplied by trade association or chamber of
commerce. Firm level forecasting relates to individual firm.

Methods of forecasting:

Several methods are employed for forecasting demand. All these methods can be grouped
under survey method and statistical method. Survey methods and statistical methods are
further subdivided in to different categories.

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1. Survey Method:

Under this method, information about the desires of the consumer and opinion of exports
are collected by interviewing them. Survey method can be divided into four type’s viz.,
Option survey method; expert opinion; Delphi method and consumers interview methods.

a. Opinion survey method:

This method is also known as sales-force composite method (or) collective opinion
method. Under this method, the company asks its salesman to submit estimate of future
sales in their respective territories. Since the forecasts of the salesmen are biased due to
their optimistic or pessimistic attitude ignorance about economic developments etc. these
estimates are consolidated, reviewed and adjusted by the top executives. In case of wide
differences, an average is struck to make the forecasts realistic.

This method is more useful and appropriate because the salesmen are more knowledge.
They can be important source of information. They are cooperative. The implementation
within unbiased or their basic can be corrected.

B. Expert opinion method:

Apart from salesmen and consumers, distributors or outside experts may also e used for
forecasting. In the United States of America, the automobile companies get sales
estimates directly from their dealers. Firms in advanced countries make use of outside
experts for estimating future demand. Various public and private agencies all periodic
forecasts of short or long term business conditions.

C. Delphi Method:

A variant of the survey method is Delphi method. It is a sophisticated method to arrive at

a consensus. Under this method, a panel is selected to give suggestions to solve the
problems in hand. Both internal and external experts can be the members of the panel.
Panel members one kept apart from each other and express their views in an anonymous
manner. There is also a coordinator who acts as an intermediary among the panelists. He
prepares the questionnaire and sends it to the panelist. At the end of each round, he
prepares a summary report. On the basis of the summary report the panel members have
to give suggestions. This method has been used in the area of technological forecasting. It
has proved more popular in forecasting. It has provided more popular in forecasting non-
economic rather than economic variables.

D. Consumers interview method:

In this method the consumers are contacted personally to know about their plans and
preference regarding the consumption of the product. A list of all potential buyers would
be drawn and each buyer will be approached and asked how much he plans to buy the

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listed product in future. He would be asked the proportion in which he intends to buy. This
method seems to be the most ideal method for forecasting demand.

2. Statistical Methods:

Statistical method is used for long run forecasting. In this method, statistical and
mathematical techniques are used to forecast demand. This method relies on post data.

a. Time series analysis or trend projection methods:

A well-established firm would have accumulated data. These data are analyzed to
determine the nature of existing trend. Then, this trend is projected in to the future and
the results are used as the basis for forecast. This is called as time series analysis. This
data can be presented either in a tabular form or a graph. In the time series post data of
sales are used to forecast future.

b. Barometric Technique:

Simple trend projections are not capable of forecasting turning paints. Under Barometric
method, present events are used to predict the directions of change in future. This is done
with the help of economics and statistical indicators. Those are (1) Construction Contracts
awarded for building materials (2) Personal income (3) Agricultural Income. (4)
Employment (5) Gross national income (6) Industrial Production (7) Bank Deposits etc.

c. Regression and correlation method:

Regression and correlation are used for forecasting demand. Based on post data the
future data trend is forecasted. If the functional relationship is analyzed with the
independent variable it is simple correction. When there are several independent variables
it is multiple correlation. In correlation we analyze the nature of relation between the
variables while in regression; the extent of relation between the variables is analyzed. The
results are expressed in mathematical form. Therefore, it is called as econometric model
building. The main advantage of this method is that it provides the values of the
independent variables from within the model itself.

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planning is now a new addition to the scope of managerial economics with the emergence
of multinational corporations. The perspective of strategic planning is global.

It is in contrast to project planning which focuses on a specific project or activity. In fact

the integration of managerial economics and strategic planning has given rise to be new
area of study called corporate economics.

B. Environmental or External Issues:

An environmental issue in managerial economics refers to the general business

environment in which the firm operates. They refer to general economic, social and
political atmosphere within which the firm operates. A study of economic environment
should include:

a. The type of economic system in the country.

b. The general trends in production, employment, income, prices, saving and
investment.
c. Trends in the working of financial institutions like banks, financial corporations,
insurance companies
d. Magnitude and trends in foreign trade;
e. Trends in labour and capital markets;
f. Government’s economic policies viz. industrial policy monetary policy, fiscal policy,
price policy etc.

The social environment refers to social structure as well as social organization like trade
unions, consumer’s co-operative etc. The Political environment refers to the nature of
state activity, chiefly states’ attitude towards private business, political stability etc.

The environmental issues highlight the social objective of a firm i.e.; the firm owes a
responsibility to the society. Private gains of the firm alone cannot be the goal.

The environmental or external issues relate managerial economics to macro economic

theory while operational issues relate the scope to micro economic theory. The scope of
managerial economics is ever widening with the dynamic role of big firms in a society.

Managerial economics relationship with other disciplines:

Many new subjects have evolved in recent years due to the interaction among basic
disciplines. While there are many such new subjects in natural and social sciences,
managerial economics can be taken as the best example of such a phenomenon among
social sciences. Hence it is necessary to trace its roots and relation ship with other
disciplines.

1. Relationship with economics:

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The relationship between managerial economics and economics theory may be viewed
form the point of view of the two approaches to the subject Viz. Micro Economics and
Marco Economics. Microeconomics is the study of the economic behavior of individuals,
firms and other such micro organizations. Managerial economics is rooted in Micro
Economic theory. Managerial Economics makes use to several Micro Economic concepts
such as marginal cost, marginal revenue, elasticity of demand as well as price theory and
theories of market structure to name only a few. Macro theory on the other hand is the
study of the economy as a whole. It deals with the analysis of national income, the level of
employment, general price level, consumption and investment in the economy and even
matters related to international trade, Money, public finance, etc.
The relationship between managerial economics and economics theory is like that of
engineering science to physics or of medicine to biology. Managerial economics has an
applied bias and its wider scope lies in applying economic theory to solve real life
problems of enterprises. Both managerial economics and economics deal with problems of
scarcity and resource allocation.

2. Management theory and accounting:

Managerial economics has been influenced by the developments in management theory

and accounting techniques. Accounting refers to the recording of pecuniary transactions of
the firm in certain books. A proper knowledge of accounting techniques is very essential
for the success of the firm because profit maximization is the major objective of the firm.

Managerial Economics requires a proper knowledge of cost and revenue information and
their classification. A student of managerial economics should be familiar with the
generation, interpretation and use of accounting data. The focus of accounting within the
firm is fast changing from the concepts of store keeping to that if managerial decision
making, this has resulted in a new specialized area of study called “Managerial
Accounting”.

3. Managerial Economics and mathematics:

The use of mathematics is significant for managerial economics in view of its profit
maximization goal long with optional use of resources. The major problem of the firm is
how to minimize cost, hoe to maximize profit or how to optimize sales. Mathematical
concepts and techniques are widely used in economic logic to solve these problems. Also
mathematical methods help to estimate and predict the economic factors for decision
making and forward planning.

Mathematical symbols are more convenient to handle and understand various concepts
like incremental cost, elasticity of demand etc., Geometry, Algebra and calculus are the
major branches of mathematics which are of use in managerial economics. The main
concepts of mathematics like logarithms, and exponentials, vectors and determinants,
input-output models etc., are widely used. Besides these usual tools, more advanced
techniques designed in the recent years viz. linear programming, inventory models and
game theory fine wide application in managerial economics.

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4. Managerial Economics and Statistics:

Managerial Economics needs the tools of statistics in more than one way. A successful
businessman must correctly estimate the demand for his product. He should be able to
analyses the impact of variations in tastes. Fashion and changes in income on demand
only then he can adjust his output. Statistical methods provide and sure base for decision-
making. Thus statistical tools are used in collecting data and analyzing them to help in the
decision making process.

Statistical tools like the theory of probability and forecasting techniques help the firm to
predict the future course of events. Managerial Economics also make use of correlation
and multiple regressions in related variables like price and demand to estimate the extent
of dependence of one variable on the other. The theory of probability is very useful in
problems involving uncertainty.

5. Managerial Economics and Operations Research:

Taking effectives decisions is the major concern of both managerial economics and
operations research. The development of techniques and concepts such as linear
programming, inventory models and game theory is due to the development of this new
subject of operations research in the postwar years. Operations research is concerned with
the complex problems arising out of the management of men, machines, materials and
money.

Operation research provides a scientific model of the system and it helps managerial
economists in the field of product development, material management, and inventory
control, quality control, marketing and demand analysis. The varied tools of operations
Research are helpful to managerial economists in decision-making.

6. Managerial Economics and the theory of Decision- making:

The Theory of decision-making is a new field of knowledge grown in the second half of this
century. Most of the economic theories explain a single goal for the consumer i.e., Profit
maximization for the firm. But the theory of decision-making is developed to explain
multiplicity of goals and lot of uncertainty.

As such this new branch of knowledge is useful to business firms, which have to take
quick decision in the case of multiple goals. Viewed this way the theory of decision making
is more practical and application oriented than the economic theories.

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7. Managerial Economics and Computer Science:

Computers have changes the way of the world functions and economic or business activity
is no exception. Computers are used in data and accounts maintenance, inventory and
stock controls and supply and demand predictions. What used to take days and months is
done in a few minutes or hours by the computers. In fact computerization of business
activities on a large scale has reduced the workload of managerial personnel. In most
countries a basic knowledge of computer science, is a compulsory programme for
managerial trainees.

To conclude, managerial economics, which is an offshoot traditional economics, has

gained strength to be a separate branch of knowledge. It strength lies in its ability to
integrate ideas from various specialized subjects to gain a proper perspective for decision-
making.

A successful managerial economist must be a mathematician, a statistician and an

economist. He must be also able to combine philosophic methods with historical methods
to get the right perspective only then; he will be good at predictions. In short managerial
practices with the help of other allied sciences.

THE ROLE OF MANAGERIAL ECONOMIST

Making decisions and processing information are the two primary tasks of the managers.
Managerial economists have gained importance in recent years with the emergence of an
organizational culture in production and sales activities.

A management economist with sound knowledge of theory and analytical tools for
information system occupies a prestigious place among the personnel. A managerial
economist is nearer to the policy-making. Equipped with specialized skills and modern
techniques he analyses the internal and external operations of the firm. He evaluates and
helps in decision making regarding sales, Pricing financial issues, labour relations and
profitability. He helps in decision-making keeping in view the different goals of the firm.

His role in decision-making applies to routine affairs such as price fixation, improvement
in quality, Location of plant, expansion or contraction of output etc. The role of managerial
economist in internal management covers wide areas of production, sales and inventory
schedules of the firm.

The most important role of the managerial economist relates to demand forecasting
because an analysis of general business conditions is most vital for the success of the
firm. He prepares a short-term forecast of general business activity and relates general
economic forecasts to specific market trends. Most firms require two forecasts one
covering the short term (for nest three months to one year) and the other covering the
long term, which represents any period exceeding one-year. He has to be ever alert to
gauge the changes in tastes and preferences of the consumers. He should evaluate the
market potential. The need to know forecasting techniques on the part of the managerial

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economics means, he should be adept at market research. The purpose of market

research is to provide a firm with information about current market position as well as
present and possible future trends in the industry. A managerial economist who is well
equipped with this knowledge can help the firm to plan product improvement, new product
policy, pricing, and sales promotion strategy.

The fourth function of the managerial economist is to undertake an economic analysis of

the industry. This is concerned with project evaluation and feasibility study at the firm
level i.e., he should be able to judge on the basis of cost benefit analysis, whether it is
advisable and profitable to go ahead with the project. The managerial economist should
be adept at investment appraisal methods. At the external level, economic analysis
involves the knowledge of competition involved, possibility of internal and foreign sales,
the general business climate etc.

Another function is security management analysis. This is very important in the case of
defense-oriented industries, power projects, and nuclear plants where security is very
essential. Security management means, also that the production and trade secrets
concerning technology, quality and other such related facts should not be leaked out to
others. This security is more necessary in strategic and defense-oriented projects of
national importance; a managerial economist should be able to manage these issues of
security management analysis.

The sixth function is an advisory function. Here his advice is required on all matters of
production and trade. In the hierarchy of management, a managerial economist ranks
next to the top executives or the policy maker who may be doyens of several projects. It
is the managerial economist of each firm who has to advise them on all matters of trade
since they are in the know of actual functioning of the unit in all aspects, both technical
and financial.

Another function of importance for the managerial economist is a concerned with pricing
and related problems. The success of the firm depends upon a proper pricing strategy.
The pricing decision is one of the most difficult decisions to be made in business because
the information required is never fully available. Pricing of established products is different
from new products. He may have to operate in an atmosphere constrained by government
regulation. He may have to anticipate the reactions of competitors in pricing. The
managerial economist has to be very alert and dynamic to take correct pricing decision in
changing environment.

Finally the specific function of a managerial economist includes an analysis of environment

issues. Modern theory of managerial economics recognizes the social responsibility of the
firm. It refers to the impact of a firm on environmental factors. It should not have adverse
impact on pollution and if possible try to contribute to environmental preservation and
protection in a positive way.

The role of management economist lies not in taking decision but in analyzing, concluding
and recommending to the policy maker. He should have the freedom to operate and
analyze and must possess full knowledge of facts. He has to collect and provide the

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quantitative data from within the firm. He has to get information on external
business environment such as general market conditions, trade cycles, and
behavior pattern of the consumers. The managerial economist helps to co-
ordinate policies relating to production, investment, inventories and price.

He should have equanimity to meet crisis. He should act only after analysis and
discussion with relevant departments. He should have diplomacy to act in
advisory capacity to the top executive as well as getting co-operation from
different departments for his economic analysis. He should do well to have
intuitive ability to know what is good or bad for the firm.

He should have sound theoretical knowledge to take up the challenges he has

to face in actual day to day affairs. “BANMOL” referring to the role of
managerial economist points out. “A managerial economist can become a for
more helpful member of a management group by virtue of studies of economic
analysis, primarily because there he learns to become an effective model
builder and because there he acquires a very rich body of tools and techniques
which can help to deal with the problems of the firm in a far more rigorous, a
far more probing and a far deeper manner”.

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