UNIT – I Introduction to Managerial Economics

ECONOMICS :

1. Economics is a study of human activity both at individual and national level.

2. Every one of us involved in efforts aimed at earning money and spending this money to satisfy our
wants such as food, Clothing, shelter, and others.

3. Such activities of earning and spending money are called “Economic activities”.

Micro Economics: The study of an individual consumer or a firm is called Micro Economics.

Macro Economics:The study of aggregate or total level of economic activity in a country is called
Macro Economics.
 UNIT – I Introduction to Managerial Economics
1. Managerial Economics as a subject gained popularity in USA after the publication
of book “Managerial Economics” by Joel Dean in 1951.

2. Managerial Economics refers to the firm’s decision making process. It could be

also interpreted as “Economics of Management”.

3. Managerial Economics is also called as “Industrial Economics” or “Business

Economics”.

4. Joel Dean observes managerial economics shows how economic analysis can be
used in formulating policies.
 UNIT – I Introduction to Managerial Economics
Definitions of Managerial Economics:
M.H.SPENCER AND L. SIEGELMAN: Managerial Economics defined as “the
integration of economic theory with business practice for the purpose of facilitating
decision making and forward planning by management”.

BRIGHAM AND PAPPAS: He believe that managerial economics is “The

application of economic theory and methodology to business administration
practice”.

HAYNES, MOTE AND PAUL: Managerial Economics as “economics applied in

decision-making. They consider this as a bridge between the abstract theory and
the managerial practice”.
NATURE OF MANAGERIAL ECONOMICS:

1. Close to microeconomics

2. Operates against the backdrop of macroeconomics

3. Normative statements

4. Prescriptive actions

5. Applied in nature

6. Offers scope to evaluate each alternative

7. Interdisciplinary

8. Assumptions and limitations

1.Close to Microeconomics:
Managerial economics is closely related to microeconomics as it focuses on analyzing individual economic units (e.g., firms)
and their decision-making processes.
2.Operates Against the Backdrop of Macroeconomics:
Managerial economics operates within the broader economic context provided by macroeconomics. Macroeconomic factors
like inflation, GDP growth, and interest rates can influence managerial decisions.
3.Normative Statements:
Managerial economics includes normative analysis, which involves making value judgments about what ought to be done
based on economic principles.
4.Prescriptive Actions:
Managerial economics provides actionable recommendations and strategies to achieve specific objectives, such as profit
maximization or cost minimization.
5.Applied in Nature:
Managerial economics is primarily concerned with real-world business problems and is focused on providing practical
solutions.
6.Offers Scope to Evaluate Each Alternative:
Managerial economics involves comparing and evaluating various alternatives before making decisions, considering factors
like costs, benefits, and risks.
7.Interdisciplinary:
Managerial economics draws upon concepts and tools from various disciplines, including economics, mathematics,
statistics, and business management.
SCOPE OF MANAGERIAL ECONOMICS:

1. Demand Decision

2. Input-Output Decision

3. Price-Output Decision

4. Profit -related Decisions

5. Investment Decisions

6. Economic Forecasting and Forward Planning

1. Demand Decision:
1. Price Elasticity Analysis: Managerial economics helps in understanding how changes in product prices affect the quantity demanded by
consumers. Elasticity analysis helps managers set appropriate prices to maximize revenue.
2. Demand Forecasting: It involves predicting future demand for a product or service, which helps in production planning, inventory management,
and resource allocation.
2. Input-Output Decision:
1. Cost-Benefit Analysis: Managerial economics assists in evaluating the costs and benefits associated with various inputs (e.g., raw materials,
labor, and capital) to determine the most efficient production methods.
2. Production Function Analysis: Managers can use production function analysis to understand how inputs combine to produce outputs and
identify the optimal input combinations for cost minimization or output maximization.
3. Price-Output Decision:
1. Market Structure Analysis: Understanding market structures, such as perfect competition, monopolistic competition, oligopoly, or monopoly,
helps in setting prices and determining production levels.
2. Marginal Analysis: Managers can use marginal cost and marginal revenue analysis to identify the profit-maximizing level of production and
pricing strategy.
4. Profit-Related Decisions:
1. Profit Maximization: Managerial economics aids in determining the level of output and pricing strategies that maximize profit, considering both
revenue and cost factors.
2. Cost Reduction Strategies: It helps in identifying opportunities for cost reduction through efficient resource allocation and process optimization.
5. Investment Decisions:
1. Capital Budgeting: Managerial economics provides tools and techniques for evaluating investment opportunities and selecting projects that offer
the highest return on investment (ROI).
2. Risk Analysis: Managers can assess the risks associated with various investment options and make decisions to minimize risk exposure.
6. Economic Forecasting and Forward Planning:
1. Market Analysis: Managerial economics involves analyzing market trends, consumer behavior, and economic indicators to make informed
decisions about future market conditions.
2. Strategic Planning: It helps in formulating long-term strategies by forecasting economic conditions and identifying opportunities and threats in the
business environment.
DEMAND ANALYSIS:

DEFINITIONS OF DEMAND: Demand in economics means the desire backed

by the willingness to buy a commodity and the purchasing power to pay by
Stonier and Hague.
A product or services is said to have demand when three conditions are
satisfied:
1. Desire on the part of the buyer to buy.
2. Willingness to pay for it.
3. Ability to pay the specified price for it.
DETERMINANTS OF DEMAND: There are so many factors on which the demand
for a commodity depends. These factors are Economic, Social as well as Political factors.
1. PRICE OF THE COMMODITY
2. PRICES OF RELATED GOODS
A. CHANGE IN THE PRICES OF SUBSTITUTES
B. CHANGE IN THE PRICES OF COMPLEMENTARIES
3. INCOME OF THE CONSUMER
4. TASTES AND FASHIONS OF CONSUMERS
5. AFFECT OF WEALTH
6. CHANGE IN POPULATION
7. CHANGES IN CLIMATE AND WEATHER
8. CHANGES IN GOVERNMENT POLICY
9. EXPECTATIONS REGARDING THE FUTURE
10. STATE OF BUSINESS
11. ADVERTISEMENT
12. TECHNICAL PROGRESS
LAW OF DEMAND:
1. ALFRED MARSHALL stated that Law of Demand means: “a
rise in the price of commodity or service is followed by a
reduction in demand and fall in price is followed by an
increase in demand, if the conditions of demand remain
constant.”
2. Law of demand states: The relationship between price and
quantity demanded. As per the law when price is increased
demand will decrease, and similarly, when price is decrease
demand will increase, this law assumed that, other things
remaining constant, the change in price will inversely affect
demand, thus the relationship between price and demand is
inverse.
Demand function: Demand function is a mathematical expression of
relation between the quantity demanded and its determinants. It can be
expressed as follows:
QD = F( P, I, Psc, T, A)
QD = quantity demand
F = functional relational between input
P = price of the product
I = income of the consumer
Psc= price of substituted or complementary
T = taste and preference
A = advertisement
DEMAND SCHEDULE:
DEMAND CURVE
Price of Mangoes Quantity
( Rs.) Demanded

1 25

2 20 Price of Mangoes
( Rs.)

3 15

4 10

5 5
Quantity Demanded

• Demand is shown on OX –axis and price is shown on OY-axis.

DD is the demand curve.
• The demand curve slopes downward from left to right.
ASSUMPTIONS OF LAW OF DEMAND:
1. That the tastes and fashions of the people remain unchanged.

2. That the people’s income remains unchanged / constant.

3. That the prices of related goods remain unchanged / same.

4. That there are no substitutes for the commodity in the market.

5. That the commodity is not the one which has prestige value such as diamonds
etc.

6. That the demand for the commodity should be continuous.

7. That the people should not expect any change in the price of the commodity.
EXCEPTIONS TO THE LAW OF DEMAND:
The following are the important exceptions to the Law of Demand.
1. Giffen Paradox

2. Prestige goods

3. Speculation

4. Trade Cycles

5. Changes in Expectations.
• When price rises demand also rises and
when price falls demand also falls.
• Demand curve slopes upwards from left to
right.
1.Giffen Paradox: The Giffen paradox is an exception to the law of demand
where the demand for a staple, inferior good increases as its price rises. In
other words, when the price of a staple, such as bread or rice, rises
significantly, it can consume a larger portion of a consumer's income. In
such cases, people may reduce their consumption of more expensive
alternatives and buy more of the inferior good.
2.Prestige Goods: Luxury items that people desire more as their prices
increase. The demand for prestige goods is driven by their exclusivity and
status symbol rather than their utility.
3.Speculation: Speculators may buy an asset, like stocks or real estate,
with the expectation that its price will rise further. This speculative demand
can lead to an increase in the quantity demanded as prices rise.
4. Trade Cycles: During economic booms, when incomes are rising and
consumer confidence is high, people may increase their demand for goods
and services even if prices rise. Conversely, during economic downturns,
demand can decrease even if prices fall.
5. Changes in Expectations: If consumers expect prices to rise in the
future, they may increase their current demand to stock up on goods, even if
prices are higher.
II. 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.

• 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: There are 4 types of elasticity of demand.
1. Price elasticity of demand.
2. Income elasticity of demand.
3. Cross elasticity of demand.
4. Advertising elasticity of demand.
1. Price elasticity of demand: It refers to the quantity demanded of a
commodity in response to a given change in price.
Price elasticity is always negative which indicates that the customer tends
to buy more with every fall in the price, the relationship between the price
and the demand is inverse.
Proportionate change in the quantity demand of commodity
Price elasticity = -----------------------------------------------------------------
Proportionate change in the price of commodity
2. Income elasticity of demand: Income elasticity of demand refers to the
quantity demand of a commodity in response to a given change in income
of the consumer.
Proportionate change in the quantity demand of commodity
Income Elasticity = -----------------------------------------------------------------
Proportionate change in the income of the people

3. Cross elasticity of demand: Cross elasticity of demand refers to the quantity

demanded of a commodity in response to a change in the price of a related good, which
may be substitute or complement.
Proportionate change in the quantity demand of commodity “X”
Cross elasticity = --------------------------------------------------------------------------
Proportionate change in the price of commodity “Y”
4. Advertising elasticity of demand: In other words, there is a direct relationship
between the amount of money spent on advertising and its impact on sales. Advertising
elasticity is always positive.

Proportionate change in the quantity demand of product “X”

Advertising elasticity = ---------------------------------------------------------------------------------
Proportionate change in advertisement costs.
Measurement Elasticity of Demand:
1. Perfectly elasticity of demand
2. Perfectly inelasticity of demand
3. Relatively elasticity of demand
4. Relatively inelasticity of demand
5. Unity elasticity of demand

1. Perfectly elasticity of demand: When the percentage change in quantity

demanded is infinite even if the percentage change in price is zero,
the demand is said to be perfectly elastic. Price Elasticity of Demand can
be measure using:
PED= %change in quantity demanded
%change in price

E= ∞ /4= ∞ i.e. E= ∞
2. Perfectly inelasticity of demand: When the percentage change in
quantity demanded is zero no matter how price is changed, the demand is
said to be perfectly inelastic.

E= 0 /4=0 i.e. E= 0
3. Relatively elasticity of demand: When the percentage change in quantity
demanded is greater than the percentage change in price, the demand is said
to be elastic.
E=4/2=2 i.e. E>1
4. Relatively inelasticity of demand: More change in the price of the goods
but less change in demand for the goods. The proportionate change in price
is more than the proportionate change in demand.
E=2/4=0.5 i.e. E<1
5. Unity elasticity of demand: The percentage change in demand for the
product is equal to the percentage change in price.
E=4/4=1 i.e. E=1
DEMAND FORECASTING:

• Demand forecasting is the art as well as the science of predicting the likely
demand for a product or service in the future.

• This prediction is based on past behavior patterns and the continuing

trends in the present.

• Hence, it is not simply guessing the future demand but is estimating the
demand scientifically and objectively.
DEMAND FORECASTING:
• Demand forecasting refers to an estimate of future demand for the product.
• Forecasting plays an important role in business decision – making.
• The survival and prosperity of a business firm depend on its ability to meet
the consumer's needs efficiently and adequately.
• Demand forecasting has an important influence on production planning.
• It is essential for a firm to produce the required quantities at the right time.
• It is also essential to distinguish between forecasting of demand and
forecast of sales:
• sales forecasts are important for estimating revenue, cash requirements and
expenses.
• whereas, demand forecasting relate to production, inventory control, timing,
reliability of forecast etc.
METHODS OF DEMAND FORECASTING:
1. Survey methods

2. Statistical methods

3. Expert opinion methods

4. Test marketing

5. Controlled experiments

6. Judgmental approach
METHODS OF DEMAND FORECASTING:
1. Survey Methods:
When the demand needs to be forecasted in the short run, say a year, then the most
feasible method is to ask the customers directly that what are they intending to buy in the
forthcoming time period. Thus, under this method, potential customers are directly
interviewed. It can be done in any of the following ways:

• Complete Enumeration Method: Under this method, nearly all the potential buyers are
asked about their future purchase plans.

• Sample Survey Method: Under this method, a sample of potential buyers are chosen
scientifically and only those chosen are interviewed.

• End-use Method: It is especially used for forecasting the demand of the inputs. Under
this method, the final users i.e. the consuming industries and other sectors are
identified.
2. Statistical Methods:
• The statistical method is one of the important methods of demand forecasting.
• Statistical methods are scientific, reliable and free from biases.
• The major statistical methods used for demand forecasting are:
1. Trend Projection Method:
• This method is useful where the organization has a sufficient amount of accumulated past
data of the sales.
• This date is arranged chronologically to obtain a time series.
• Thus, the time series depicts the past trend and on the basis of it, the future market trend
can be predicted.
• It is assumed that the past trend will continue in the future.
• Thus, on the basis of the predicted future trend, the demand for a product or service is
forecasted.
2. Regression Analysis:
• This method establishes a relationship between the dependent variable and
the independent variables.
• In our case, the quantity demanded is the dependent variable and income, the
price of goods, the price of related goods, the price of substitute goods, etc.
are independent variables.
• The regression equation is derived assuming the relationship to be linear.
• Regression Equation: Y = a + bX. Where Y is the forecasted demand for a
product or service.
3. Expert Opinion Method
• Well informed persons are called experts; These persons are generally the outside experts
and they do not have any interest in the results of a particular survey.
• As expert is good at forecasting and analysis the future trend in a give product or service at a
given level of technology.
• The service of an expert could be advantageously used when a firm uses general economic
forecasting or special industry fore casting prepared outside the firm.
• Usually, market experts have explicit knowledge about the factors affecting demand. Their
opinion can help in demand forecasting.
• Under this method, experts are given a series of carefully designed questionnaires and are
asked to forecast the demand. They are also required to give the suitable reasons.
• The opinions are shared with the experts to arrive at a conclusion.
• This is a fast and cheap technique.
4. Test Marketing:
• It is likely that opinions given by buyers, salesman or other experts may be, at times,
misleading. This is the reason why most of the manufactures favour to test their
product or service in a limited market as test – run before they launch their product
nationwide.

• The test marketing is the most reliable method of sales forecasting wherein the
product is launched in a few selected cities/town to check the response of customers
towards the product.

• On the basis of such response, the firm decides whether to commercialize the
product on a large scale or not.
5. Controlled Experiments:
• Controlled experiment refer to such exercise where some of the major determinants of
demand are manipulated to suit to the customers with different tastes and preferences,
income groups, and such others, it is further assumed that all other factors remain the same.

• Under this method, an effort is made to ascertain separately certain determinants of

demand which can be maintained, e.g., price, advertising etc. and conducting the
experiment, assuming etc., and conducting the experiment, assuming that the other factors
remain constant.

• Thus, the effect of demand determinants like price, advertisement packing etc., on sales can
be assessed by either varying them over different markets or by varying them over different
time periods in the same market.
6. Judgmental Forecasting Methods:
• When none of the above methods are directly related to the given
product or service, the management has no alternative other than
using its own judgment.
• Incorporate intuitive judgement, opinions and subjective probability
estimates.
• Judgmental forecasting is used in cases where there is lack of
historical data or during completely new and unique market
conditions.