Managerial Economics

 Douglas - “Managerial
economics is .. the application
of economic principles and
methodologies to the decision-
making process within the firm
or organization.”
 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.”
 Positive Economics:-
 Derives useful theories with
testable propositions about
WHAT IS.
 Normative Economics:-
 Provides the basis for value
judgements on economic
outcomes.WHAT SHOULD BE
 Scope of Managerial
Economics
 Utility analysis
 Demand and supply analysis
 Production and cost analysis
 Market analysis
 Pricing
 Investment decisions
 Game theory
 Basic problems of an
economy
 What to produce( Choice)
 How to produce ( Technology)
 Whom to produce ( Distribution)
 Fundamental Concepts
Managerial Economics
 Marginal Principle
 Opportunity cost principle
 Incremental Principle
 Discount Principle
 Time Perspective
 Demand Analysis
Demand –
Desire + ability to pay +
willingness to pay

Demand is relative term –

Price
Time
Place
Determinants of demand
 Price
 Income
 Taste, preference and fashion
 Prices of related goods
 Government policy
 Custom and tradition
 Advertisement
 Law of demand
 If other things remain constant,
when price increases demand
contracts and when price
decreases demand expands.
Price and demand are inversely
proportionate.

D = a - bP
 Why demand curve slopes
downwards
 Law of diminishing marginal
utility
 Income effect
 Substitution effect
 Multiplicity of uses
 Market Demand Curve
 Shows the amount of a good that will
be purchased at alternative prices.
 Law of Demand
 The demand curve is downward sloping.

Price

Quantity
 Exception to the law of
demand
 Giffen Goods
 Prestigious goods
 Buyers illusions
 Necessary goods
 Brand loyalty
 Elasticity
 Elasticity is a measure of
responsiveness of one variable
to another variable.
 Can involve any two variables.
 An elastic relationship is
responsive.
 An inelastic relationship is
unresponsive.
 Types of Elasticity of
demand
 Price Elasticity of demand
 Income elasticity of demand
 Cross Elasticity of demand
 Promotional Elasticity of demand
 Price elasticity: Εp=%∆Q/%
∆P

 Causality: denominator numerator!

 An elastic response is one where
numerator is greater than denominator.
i.e., %∆ Q>%∆ P so Ep >1
 Imagine extreme example.
 An inelastic response is one where
numerator is smaller than denominator.
i.e., %∆ Q<%∆ P so Ep <1
 Again, imagine extreme example.
 Look at the Extremes
 Perfectly Elastic D  Perfectly Inelastic
Ep =infinite D
P P
D
Ep =0
D

Q
Q
 Relatively Elastic vs.
Inelastic Demand Curves

P
D’ is relatively more elastic
than D

P1

P2
D’
D
Q
Q1 Q2 Q2’
 Point Elasticity Formula
 Price (Rs.)
 Point elasticity
 Point elasticity is
responsiveness at a
point along the
demand function
P1
Ep =∆ Q/Q1
∆ P/P1 D
simplifying: Q
Ep =(∆ Q/∆ P)* P1 /Q1 Q1
 Point Elasticity Formula
 Price (Rs.)
 Point elasticity
 Point elasticity is
responsiveness at
a point along the
demand function
P1
Ep =∆ Q/Q1
∆ P/P1 D
simplifying: Q
Ep =(∆ Q/∆ P)* P1 /Q1 Q1
 Example: Q=56-0.002*P
 Point elasticity  Price (Rs)
Ep =(∆ Q/∆ P)* P1 /Q1

 Suppose P=17000
 Q=56-0.002*17000
 Q=56-34=22 17k
 Plug into equation gives:
Ep =( -0.002)* 17000 /22
D
Ep =-34/22=-1.54
Q
22
 Arc Elasticity
Briefly, arc elasticity is simply
an average elasticity along
a range of the demand
curve.
 Arc Elasticity Formula

 Arc elasticity: Price ($)

Responsiveness along a
range of D. function

Ep =∆ Q/((Q1+ Q2)/2) Avg.

P2 responsiveness
∆ P/((P1+ P2)/2)
P1
D
simplifying:
Ep=(∆ Q/∆ P)*((P1+P2)/(Q1+Q2)) Q
Q2 Q1
 Example Q=56-0.002*P
 Arc elasticity Price ($)
Ep =(∆ Q/∆ P)*((P1+P2)/(Q1+Q2))
 Look at P range 16k -

17k
 Q=56-0.002*17000
 Q=56-34=22
 Plug into equation 17k
gives: 16k
Ep =( -0.002)*(33000/46) D
Ep =-66/46=-1.43
22 24 Q
 Factors influence Price
elasticity of demand
 Nature of commodity
 Availability of substitute
 Multiplicity of uses
 Habit
 Proportion of income spent
 Price range
Managerial Applications of
Price elasticity of demand
 Pricing Decision
 Fiscal policy
 Labour market
 International trade
 Income Elasticity of Demand

 Recall demand function is:

Q=f(P,I,Prelated,Tastes,Buyers,Expectations...)
 Change in I causes shift in demand.
 Size of shift depends on income elasticity.
 EI =%∆Q/%∆I
 Focus again on point formula.
 Value of EI determines type of good.
 Values for Income
Elasticity (Ε Ι )
 Sign indicates normal or inferior
EI >0 implies normal good.
EI<0 implies inferior good.
 Normal goods may be necessity or
luxury.
 If EI>1 then this is luxury (responsive
to income).
 If 0<EI<1 then this is necessity
(unresponsive to income).
 Cross Price Elasticity
(EXY)

QX=f(PX ,I,PY,Tastes, Buyers,Expectations...)

 Change in PY causes shift in demand for X.
 Size of shift depends on cross-price elasticity.
 EXY=%∆ QX /%∆ PY
 Sign indicates relationship between two goods
EXY>0 implies goods are substitutes.
EXY<0 implies goods are complements.
OBJECTIVES OF SHORT TERM DEMAND
FORECASTING
 Production planning
 Evolving sales policy
 Fixing sales targets
 Determining price policy
 Inventory control
 Determining short-term financial planning
 OBJECTIVES OF LONG-TERM DEMAND
FORECASTING
 BUSINESS PLANNING

 MANPOWER PLANNING

 LONG-TERM FINANCIAL PLANNING

METHODS OF DEMAND FORECASTING

Survey methods:
 Consumer interviews
 Opinion poll
 Experts opinion
 End-use method
Statistical methods:
 Trend Analysis
 Regression Analysis
 Market Supply Curve
 The supply curve shows the amount
of a good that will be produced at
alternative prices.
 Law of Supply
 The supply curve is upward sloping
Price
S0

Quantity
Supply Shifters

 Input prices
 Technology or
government
regulations
 Number of firms
 Substitutes in
production
 Taxes
 Producer
expectations
 The Supply Function
 An equation representing the
supply curve:
QxS = f(Px , PR ,W, H,)

 QxS = quantity supplied of good X.

 Px = price of good X.
 PR = price of a related good
 W = price of inputs (e.g., wages)
 H = other variable affecting supply
 Change in Quantity
Supplied
Price A to B: Increase in quantity supplied

S0
B
20

A
10

5 10 Quantity
 Change in Supply
S0 to S1: Increase in supply
Price

S0

S1

5 7 Quantity
 Producer Surplus
 The amount producers receive in excess of
the amount necessary to induce them to
produce the good.
Price
S0
P*
Producer
Surplus

Q* Quantity
 Market Equilibrium
 Balancing supply and
demand
Q S= Qxd
x
 Steady-state
Equilibrium Price and
quantity
Price S

8 Quantity
 If
Price
price is too low...
S

7
6

Shortage D
12 - 6 = 6
6 12 Quantity
If price is too high…
Surplus
Price 14 - 6 = 8
S
9

8
7

6 8 14 Quantity