Managerial Economics Khem Chand (Assistant Professor), APIIT SD INDIA

Q1. Define Managerial Economics. Discuss in brief the nature and scope of Managerial
Economics.
Ans. Introduction: Managerial refers to functions of management. The main functions of
management are decision making and forward planning. Decision making: It is process of
choosing from among available alternative to achieve the firm's established goal. Forward
planning: It refers to making the plan for future. Economics: The optimal use of scarce resources
to satisfy human needs and wants. Microeconomic: Behaviour of individual economic unit like a
consumer, a producer and a market. Macroeconomic: it is concerned with the behaviour of
aggregate, like national income and total employment
Definitions:
Douglas - Managerial economics is the application of economic principles and methodologies
to the decision-making process within the firm or organization.
Pappas & Hirschey - Managerial economics applies economic theory and methods to business
and administrative decision-making.
Salvatore - Managerial economics refers to the application of economic theory and the tools of
analysis of decision science to examine how an organisation can achieve its objectives most
effectively.
Nature of Managerial Economics:
1. Managerial economic is concerned with study of a firm and not entire economy.
2. Based on theory of the firm
3. Managerial economics take the help of macroeconomics to understand and adjust to the
environment in which firm operate
4. It is goal oriented
5. It is conceptual: Understand conceptual framework and quantitative technique to measure
the impact of different factors and policies.
6.

Normative (Prescriptive): It tells us what should be done under the given situation. It is
not concern with what should be done to achieve the organization goal efficiently.

Choudharykc24@gmail.com, 8059910766, Management Department

Application
of Economic
Theory APIIT SD INDIA
Managerial Economics
Khem Chand
(Assistant Professor),

Descriptive and
Prescriptive

Management Decision
Problems

Managerial
Economics

Optimal
solutions to
specific
organizational
objectives

Decision Science
7. Applied Economic theory: Managerial economics is application of economic theory to
managerial decision making.
8. Pragmatic: It suggests how the economic principles are applied to the formulation of
policies and programs, and achieve organization goals.
9. Multi-disciplinary: statistics, management, operation

research,

economic

and

psychology.
10. Descriptive: it attempts to interpret observed phenomena and to formulate theories about
possible cause and effect relationship.

It is used to explain and predict economic

behaviour.
11. Applied science: ME formulate theories in a systematic manner about possible cause and
effect relationships.
Scope of ME
1. Demand Analysis and Forecasting: Demand analysis helps in analyzing the various types
of demand which enables the manager to arrive at reasonable estimates of demand for
product of his company. Managers not only assess the current demand but he has to take
into account the future demand also.
2. Production Function: Conversion of inputs into outputs is known as production function.
3. Cost analysis: Cost analysis is helpful in understanding the cost of a particular product.
4. Inventory Management: It refers to stock of raw materials which a firm keeps. Both the
high inventory and low inventory is not good for the firm.
5. Advertising: Advertising forms the essential part of decision making and forward
planning

Choudharykc24@gmail.com, 8059910766, Management Department

Managerial Economics Khem Chand (Assistant Professor), APIIT SD INDIA

6. Pricing system: It is also important to understand how product has to be priced under
different kinds of competition, for different markets.
7. Resource allocation: Resources are allocated according to the needs only to achieve the
level of optimization.
8. Decision theory under uncertainty: Demand Uncertainty, Cost, Price, Interest Profit, Sales
uncertainty
Significance of Managerial Economics
1. Utilization of natural and man-made resources
2. Solving economic problems
3. Application of traditional economics
4. Variety of business decision
5. Revenue to government
6. Social benefits
7. Advertising media
8. Minimizing the uncertainties and risk
9. Demand forecasting
10. Forward planning
11. Helpful in understanding external environment
Q2. What is Managerial Decision Making? Give the process of Managerial DecisionMaking?
Ans. Introduction: Managerial refers to functions of management. The main functions of
management are decision making and forward planning Decision making is process of choosing
from among available alternative to achieve the firm's established goal. Forward planning: It
refers to making the plan for future.
Spencer- Managerial decision making may be defined as the process of selecting one
alternative from two or more alternative courses of action

PROCESS OF MDM

Choudharykc24@gmail.com, 8059910766, Management Department

Managerial Economics Khem Chand (Assistant Professor), APIIT SD INDIA

Importance of Decision Making

1. Product Decision
2. Product Method Decision
3. Price And Qualities Decision
4. Promotional Strategy Decision
5. Locational Decision
Decision Environment

Certainty: A state of knowledge in which the decision maker know in advance the
specific outcome of each alternative.

Risk: A state of knowledge which involve, multiple possible outcomes in which

probability of each outcome in known or may be estimated.

Uncertainty: A state of knowledge which involves choices involving multiple possible

outcomes in which the probability of each outcome is unknown and could not be
estimated.

Marginal

Change in dependent variable associated with one unit change in independent variable.

Types of marginal concepts

Marginal revenue

Marginal cost

Marginal profit

Marginal product

Marginal cost pricing

Choudharykc24@gmail.com, 8059910766, Management Department

Managerial Economics Khem Chand (Assistant Professor), APIIT SD INDIA

Marginal product of labour

Marginal productivity of capital

Marginal rate of substitute

Relation between Total, Average and Marginal

Basic concept

Opportunity cost principle: The opportunity cost is the cost of next best alternative
foregone. It is also called alternative cost.

Example: a farmer can grow both wheat and gram on a farm. If on a farm measuring onehectare he grows only wheat, he foregone the production of gram. If the price of the
quantity of gram, that he foregoes is Rs 1000, then the opportunity cost of growing wheat
will be Rs 1000.

Incremental Principle

Incremental cost is the change in total cost as result of a particular decision. On the other
hand incremental revenue is the total revenue resulting from a particular decision.

Principle of Time Perspective

Choudharykc24@gmail.com, 8059910766, Management Department

Managerial Economics Khem Chand (Assistant Professor), APIIT SD INDIA

Short run: structure of industry, size of the firm and the scale of plant are not alterable.

Long run: all the factors are variables like price, revenue, cost and profit.

Discounting principle

A rupee today is worth more than a rupee at a future date.

Equi-Marginal principle

The Equi-marginal principle says that a rational decision maker would allocate or hire his
resources in such a way that the ratio of marginal returns and marginal cost of various
uses of given resource in a given use is the same.

The law of Equi-Marginal utility states that the consumer will distribute his money
income between the goods in such a way that the utility derived from the last rupee spend
on each good is equal
Rs.
1
2
3
4
5
6

Apple
8
7
6
5
4
3

Mango
6
5
4
3
2
1

Risk and Uncertainty

It influences the estimation of cost and revenues.

Decision of the firm

Future conditions are not perfectly predictable

Unexpected environment change

Q3. Define the Elasticity of demand? Under what conditions elasticity is equal to: (a) Zero, (b)
Unitary, (c) Less than unitary and (d) Greater than unitary

Ans. Elasticity is a measure of the responsiveness of one variable to change in other.

The elasticity of demand measures the responsiveness of the quantity demanded of a

good, to change in its price, price of other goods and changes in consumers income.
Choudharykc24@gmail.com, 8059910766, Management Department

Managerial Economics Khem Chand (Assistant Professor), APIIT SD INDIA

Price Elasticity of Demand

Elasticity of demand may be defined as the percentage change in the quantity demanded
divided by the percentage change in the price (Marshall).

There is an inverse relationship between price and quantity demanded of a good.

Elasticity of demand is expressed by minus (-) sign.
Percentage changequantity demanded
Percentage change price

Ed= (-)

Example:

Price decrease 10 per cent

Demand increase 20 per cent

Ed = (-)

20 per cent
10 per cent

= (-)-2= 2

Degree of Price Elasticity of Demand

Perfect elastic Demand

Perfectly inelastic

Perfect inelastic demand is one in which a change in price produces no change in the
quantity demanded.

Choudharykc24@gmail.com, 8059910766, Management Department

Managerial Economics Khem Chand (Assistant Professor), APIIT SD INDIA

Greater than unitary It is one in which a given percentage change in price produces
relatively more percentage change in demand.

Example: 5 percentage in price

20 percentage change in demand

Less than unitary In which a given percentage change in price produces relatively less
percentage change in demand.

Price decrease 4 per cent

Demand increase 2 per cent

Choudharykc24@gmail.com, 8059910766, Management Department

Managerial Economics Khem Chand (Assistant Professor), APIIT SD INDIA

Unitary elasticity of demand

Unitary elasticity of demand is one in which a percentage change in price produces an

equal percentage change in demand

Example: Price decrease 5 per cent

Demand increase 5 per cent

Q4. Explain the different methods of measuring the price elasticity of demand and exception of
law of demand.
Ans.
Measurement of Price Elasticity of Demand

Methods of measuring price elasticity of demand:

Total expenditure method was evolved by Marshall

Choudharykc24@gmail.com, 8059910766, Management Department

Managerial Economics Khem Chand (Assistant Professor), APIIT SD INDIA

It is essential to know how much and in what direction the total expenditure has changed
as a result of change in the price of a good.

Total Expenditure Method

Price of

Quantity

Commodity

Total

Effect on Total

Elasticity of

Expenditure

Expenditure

Demand
Unity Elastic

Same Total

Expenditure

Less total

Expenditure

10

10

More total

Greater than Unity

Expenditure
2

More total

Expenditure

Less total

Less than Unity

Expenditure
Y

T
A

R
Ed
> 1 Department
Choudharykc24@gmail.com,
8059910766,
Management
Price

N
PM

B
Total Expenditure
E D Ed
CEd<1
=1

Managerial Economics Khem Chand (Assistant Professor), APIIT SD INDIA

Proportion or Percentage Method

Ed=

Percentage Change Demand of GoodX

Percentage ChangePrice of GoodX

Ed= (-)P/Q x Q/P

Example: price of ice cream = 4, demand = 1

Price fall in ice cream = 2, demand extends = 4

Point Elasticity of Method

Elasticity of demand at the mid point on the demand curve is unity, at a point above
the mid-point, it is greater than unity and at a point below the mid-point, it is less
than unity.

Ed=

Lower Portion of demand curve

Upper Porton of demand curve

Choudharykc24@gmail.com, 8059910766, Management Department

Managerial Economics Khem Chand (Assistant Professor), APIIT SD INDIA

Non-linear

Revenue method

Sale proceeds that a firm obtains by selling its products is called its revenue.

Example

Selling 10 Meters cloth

Get = 50 Rs. 50 Rs is called revenue

When total revenue is divided by the nu. Of units sold we get average revenue or
price per unit. Additional unit called marginal revenue.

Extra unit 11 meters

Total revenue = 54

Total change 54-50= 4

Choudharykc24@gmail.com, 8059910766, Management Department

Managerial Economics Khem Chand (Assistant Professor), APIIT SD INDIA

Price elasticity of demand is also measured with the help of average and marginal
revenue.

Ed = AR/ AR-MR

Lower portion
Upper portion

Ed

PB/PA

PMB and AEP

AET and TPL

PL= AE BY putting PL in place of AE in equation. Ed

PL= PM-LM

Hence, ed=

Here, PM = AR and LM = MR

So, Ed =

PM
PL

PM
PM LM

PM
PM LM

AR
ARMR

ARC Elasticity Method

Watson: arc elasticity is the elasticity at the mid-point of an arc of a demand curve.

Choudharykc24@gmail.com, 8059910766, Management Department

Managerial Economics Khem Chand (Assistant Professor), APIIT SD INDIA

Q 1Q
Q 1+ Q
x=

P 1+ P
P 1P

Example: price of ice cream = 4, demand = 1

Price fall in ice cream = 2, demand extends = 4
Factors Determining the Price Elasticity of Demand

Nature of the commodity

Available of substitutes

Goods with different uses

Postponement of the use

Income of consumer

Influence of habit and custom

Price level

Time

Joint demand

Durable goods

Exception of the Law of Demand

Articles of distinction or Veblen goods

Ignorance

Giffen goods

Expectation of rise or fall in price in future

Choudharykc24@gmail.com, 8059910766, Management Department

Managerial Economics Khem Chand (Assistant Professor), APIIT SD INDIA

Necessaries of life

Commodities with special brand and trade mark

War or emergency

Type of demands

Demand for consumers goods and producers goods

Demand for perishable goods and durable goods

Autonomous demand and derived demand

Industry demand

Short run and long run demand

Joint demand and composite demand

Market demand and market segment demand

Individual demand and market demand

Determination of Demand

Price of the commodity

Prices of Related Goods

Substitute goods

Choudharykc24@gmail.com, 8059910766, Management Department

Managerial Economics Khem Chand (Assistant Professor), APIIT SD INDIA

Complementary Goods

Income of the Consumer

Normal goods: It is good for which an increase in consumers income results in an

increase in demand.

Inferior goods

It is a good for which an increase in consumers income results in decrease in its

demand.
Choudharykc24@gmail.com, 8059910766, Management Department

Managerial Economics Khem Chand (Assistant Professor), APIIT SD INDIA

Necessaries of Life

Taste and preference

Size and composition of population

Distribution of income

Customs

Climate and weather conditions

Invention and innovation

Income Elasticity of Demand

Watson: Income elasticity of demand means the ratio of the percentage change in the
quantity demanded to the percentage change in income

Measurement of income elasticity: Ey

Ey

Y Q
x
Q Y

Income (Y): 3000

Demand (Q): 10 units of ice cream

Increase monthly income (Y1): 6000

Demand (Q1): 30 units ice cream

Q = Q1-Q= 30-10= 20

Y =60003000=3000

Y Q
x
Q Y

Degree of Income Elasticity of Demand

Choudharykc24@gmail.com, 8059910766, Management Department

Managerial Economics Khem Chand (Assistant Professor), APIIT SD INDIA

Positive income elasticity of demand

Unitary Income Elasticity of Demand

Positive income elasticity of demand is unitary when a given percentage change in

income is followed by equal percentage change in demand.

Example income increase by 100 per cent and demand also increases by 100 per
cent.

Less than Unitary Income Elasticity of Demand

Percentage change in demand is less than percentage change in income.

Choudharykc24@gmail.com, 8059910766, Management Department

Managerial Economics Khem Chand (Assistant Professor), APIIT SD INDIA

Greater than Unitary Income Elasticity of Demand

Percentage change in demand in more than percentage change in income.

Negative and Zero Income Elasticity of Demand

Income elasticity of demand is negative when increase in the income of the consumer
is accompanied by fall in demand of a good and decrease in income is followed by
rise in demand. It refers to inferior goods/Giffen goods

Importance of Income Elasticity in Business

Decision regarding investment

Forecasting of demand

Classification of commodities

Cross Elasticity of Demand

Cross elasticity of demand is measure of change in quantity demanded of good-y as

a result of change in the price of good-x.
Choudharykc24@gmail.com, 8059910766, Management Department

Managerial Economics Khem Chand (Assistant Professor), APIIT SD INDIA

Ec=

Py Qx
Qx Py

Degree of Cross Elasticity of Demand

Positive

Negative

Zero

Q5. What is the objective of firm? Explain the significance of price elasticity of demand in
business.

Economic profit: the difference between total revenue and total cost (TR-TC).
Explicit costs are those cash payments which firms make to outsiders for their
services and goods.

Implicit costs are costs of self-owned or self-employed resources.

Normal profit is just another name for the implicit cost that a firm incurs when it
employs self supplied resources such as financial capital and management services.

It transforms valued factors into products of a higher value.

The firm tries to attain its objective of profit maximization in a rational manner.
The market environment
Short-run and long-run
Analyze changes in the prices and quantities of input and output
Conditions of Profit Maximization

TR-TC
Choudharykc24@gmail.com, 8059910766, Management Department

Managerial Economics Khem Chand (Assistant Professor), APIIT SD INDIA

Marginal Revenue (MR) = Marginal Cost (MC)

Slope of MR curve should be less than the slope of Marginal Cost curve or, MC
curve must cut MR curve from below

Favor of profit maximization goal

Strongest motive

Essential for the survival of the firm

Accurate prediction

Efficiency of firm

Arguments against Profit Maximization

Uncertainty

The goal of joint companies may be different

Impractical

Preventing governments intervention

Lack of knowledge of demand

Not a proper goal

Importance/managerial use and business of price elasticity of demand

Choudharykc24@gmail.com, 8059910766, Management Department

Managerial Economics Khem Chand (Assistant Professor), APIIT SD INDIA

Significance in price determination:

Determination of price under monopoly

Price discrimination

Dumping

Price determination of joint supply

Importance in Govt. Policy Formulation

Price control policy

Protection to industries

Distribution of taxation

Fixing rate of exchange

Demand forecasting

Wage determination

Effect on employment

International trade

Choudharykc24@gmail.com, 8059910766, Management Department