M E

MANAGERIAL ECONOMICS
• DEFINITIONS
• Adam Smith: Father of modern
economics.
• Wealth of nations.
• ALFRED MARSHALL: Material welfare:
creation of wealth.
• LEONEL ROBBINS: Science of scarcity
or science of choice.
• SCIENCE OF SCARCITY OR SCIENCE
OF CHOICE:
• In 1931, Lionel Robbins challenged the
traditional view of the nature of economic
science. He defined Economics as follows:
• “Economics is the science which studies
human behaviour as a relationship
between ends and scarce means which
have alternative uses.”
• Ends (wants): Wants are unlimited. So, one is
compelled to choose between the more urgent and the
less urgent wants. That’s why Economics is also called a
SCIENCE OF CHOICE.
• Means (Resources):; Means is limited.
• ‘Resource’ means land, labour, capital and entrepreneur
(organisation).
• Since these resources are limited, the ability of the
society to produce goods and services is also limited.
So, the term ‘SCARCITY’ is used in respect of ‘means’.
• ‘Means’ is scarce in relation to ‘ends’.
• Scarce means are capable of alternative uses.
• Economic activity lies in man’s utilisation of
scarce means having alternative uses for the
satisfaction of multiple ends.
• “Means” refer to time, money or any oth;er form
of property. These are all limited. “Ends” are
unlimited. So, choice-making is essential. That’s
why Economics has been called a “science of
choice.”
• According to Prof. Stigler, “Economics is
the study of the principles governing the
allocation of scarce means among compe-
ting ends when the objective of allocation
is to maximise the satisfaction”.
• Robbins raised his point with two
foundation stones, viz:
• Multiplicity of wants, and
• Scarcity of means.
• MICRO AND MACRO ECONOMICS
• These are relative terms. Micro economics refers to
study of sub-groups or an element in a large mass of
data, whereas macro economics refers to study of the
universe ( the entire field of study). For ex: A study of
demand for certain product in a given market condition
or place is a micro-economic study in relation to the
demand condition prevailing in the entire nation or world.
So, if the market condition for steel in Bangalore city is
under study, then it is micro-economic study in relation to
market condition for steel in India (macro) or the
world(macro).
• Is Economics a science or art?
• MANAGERIAL ECONOMICS
• Definitions:
• McNair & Meriam define ME as “ME is the use
of economic modes of thought to analyse
business situations.”
• Prof. Evan J. Douglas defines: “ ME is
concerned with the application of economic
principles and methodologies to the decision-
making process within the firm or organisation
under the conditions of uncertainty.”
• SUBJECT-MATTER AND SCOPE OF ME
• ME is concerned with the application of
economic concepts and analysis to the problem
formulating rational managerial decisions.
• There are 4 groups of problem in both decision-
making and forward planning. They are:
• 1. Resource allocation.
• 2. Inventory queuing problem.
• 3. Pricing problem.
• 4. Investment problem.
• Study of ME essentially involves the analysis of
certain major subjects like:
• Demand analysis and methods of fore-casting
demand.
• Cost analysis.
• Pricing theory and policies.
• Break-even point and analysis.
• Capital budgeting for investment decisions.
• The biz firm and objectives.
• Competition.
• GOALS OF MANAGERIAL ECONOMICS
• 1. Production goal.
• 2. Inventory goal.
• 3. Market-share goal.
• 4. Profit-maximisation goal.
• 5. Growth-maximisation goal.
• CONCEPTS APPLIED IN M E
• 1. Opportunity cost.
• 2. Equi-marginal principle.
• 3. Incremental cost principle.
• 4. Time perspective (time element).
• 5. Discounting principle.
• OPPORTUNITY COST
• It is the maximum possible alternative ear-
nings that will be sacrificed if the
productive capacity or service is put to
some alternative use. For ex: if an own
building is used to run own business, then
the rent that could be earned by letting it
out is sacrificed. This is an opportunity
cost of the productive capacity of an asset.
• This sacrificed benefit is related(deducted)to the
revenue/return earned from the project.
• 2. EQUI-MARGINAL PRINCIPLE
• This principle is used in determining options in
resource allocations. For ex: an input is used in
several biz activities. The question is as to how
the input is allocated among various
activities,e.g., the input is capital.
• The combination of factors of production is
such where:
• MC = MR
• The knowledge of Equi-marginal principle
helps the businessman in selecting the
combination of various factors of
production.
• 3. INCREMENTAL CONCEPT
• This refers to additional cost incurred due to changes in
the level of production acti-vity. When the production
pattern is changed, extra cost is incurred.
• Incremental Cost= New TC– Old TC.
• If the incremental revenue is more than incremental cost,
it is welcome.
• Note: The concept of incremental cost does not arise if
the biz is set up afresh. It arises only when a change is
contemplated in the existing biz.
• 4. TIME PERSPECTIVE
• Economists use the functional time periods in
analysing equilibrium pheno-menon. The
functional time periods are:
• Short period and Long period.
• Short Period– Fixed cost remains constant
• Long Period– Fixed cost vary.
• Short Period– If the expansion is under-taken,
the firm tolerates normal losses.
• Long Period– If the loss persists, it indicates
complete failure of biz.
• 5. DISCOUNTING PRINCIPLE
• In(capital budgeting) decision-making
process, the p.v of the project is
discounted from the future net cash-inflow
from the project.
• The present gain is valued more than a
future gain.
• PRINCIPLE OF EQUI-MARGINAL UTILITY
• The marginal utility (mu) theory applies to one
commodity at a time.
• Consumer buys more than one commodity at a time with
his given money income. Now, the problem is as to how
to allocate a given money on various goods he wants.
Consumer’s main objective in spending money is to
attain the equilibrium (E).
• Equilibrium is a situation in which the consumer gets
maximum satisfaction from the consumption of given
commodity.
• So, E = mu/p where, p=price.
• If p=mu, the consumer is said to have attained E.
• RISK AND UNCERTAINTY
• The element of risk and uncertainty is
involved in all decisions including invest-
ment decisions.
• Uncertainty is a situation where there is
more than one possible outcome to a
decision but the probability of each speci-
fic outcome occurring is not known.
 Module-2: DEMAND ANALYSIS
• ESTIMATION AND FORECASTING
• Produce products which have continuous demand in the
market.
• Types of Demand:
• For managerial decisions, classify the large number of
goods and services avail-able in every economy as
under:
• 1. Consumer goods and producer goods:
• Goods and services used for final consumption are
consumer goods.
• Producer goods refer to the goods used for production of
other goods, e.g., P&M, Raw-materials,etc.,.
• 2. Perishable and durable goods.
• 3. Autonomous and Derived demand:
• The goods whose demand is not tied with the
demand for some other goods are said to
have autonomous demand, while the rest have
derived demand, e.g., pen-ink.
• 4. Individual’s demand and market demand.
• 5. Firm and Industry demand:
• E.g., Demand for Maruthi cars– firm’s
demand.
• Demand for all types of cars– Industry’s
demand.
• 6. Demand by market segments and by
total market.
• 7. Joint demand and composite demand.
• DEMAND CURVE
• SHIFTS IN DEMAND CURVE
• a. Increase in Demand.
• b. Decrease in Demand.
 ELASTICITY OF DEMAND
• Alfred Marshall introduced and perfected
the concept of ED.
• The law of demand indicates only the
direction of change in quantity demanded
in response to a change in price.
• The law of demand makes only the gene-
ral statement and it ignores the specific
aspect. The specific aspect is provided by
a concept of EoD.
• Meaning of EoD
• EoD means a quantitative response to a change
in price, income or the price of a
related/substitute product.
• Definition of EoD– by Alfred Marshall:
• “The elasticity or responsiveness of demand in a
market is great or small according to the amount
demanded increases much or little for a given
fall in price and diminishes much or little for a
given rise in price.”
• Thus, EoD refers very much to price EoD.
• KINDS OF EoD:
• 1. The price EoD
• 2. The Income EoD
• 3. The Cross EoD.
• 1. THE PRICE EoD:
• Price EoD expresses the responsiveness of
quantity demanded to changes in it’s price.
• Price Elasticity= Proportionate change in
quantity demanded/ Proportionate change in it’s
price.
• eP= ^Q/Q = ^Q/Q X P/^P.
^P/P
If 5% change in price leads to 12% change in
quantity demanded, price EoD is 12/5= 2.4.
• Classification of Price EoD
• a. Perfectly elastic demand.
• b. Perfectly inelastic demand.
• C. Unitary elastic demand.
• d. Relatively elastic demand.
• E. Relatively inelastic demand.
• a. Perfectly elastic demand:
• If a small change in price leads to big rise in the quantity
demanded, it is perfectly elastic demand.
• The shape of the curve is horizontal straight line.
• B. Perfectly inelastic demand:
• Even if a big rise in the price of a product does
not affect the quantity demanded, it is inelastic
demand. ( That means the demand does not
show any response to a change in price).
• Perfectly inelastic demand has zero elasti-city.
• Demand curve is that of a vertical straight line.
• This situation is not found in the present day
economies.
• In this case, the seller can charge any price and
still sells the same quantity.
• 3.Unitary Elastic Demand:
• This is the dividing line between elastic
and inelastic demand. Here, eD=1. That
means the response to change in quantity
demanded is the same as change in price.
• The unitary eD curve is that of a
rectangular hyperbola.
• The perfectly elastic and perfectly inelastic demand
are not in real world and hence they have only
theoretical value. There are only two possibilities
namely, either the demand is elastic or inelastic.
• FACTORS DETERMINING Ed:
• Some important factors are—
• 1. Luxury or Necessity goods
• 2. % of income
• 3. Substitutes
• 4. Time.
• MEASUREMENT OF ELASTICITY
• Elasticity is a measurable concept. There
are 3 ways to measure—
• 1.Ratio method 2. Total Outlay method
• 3. The Point method.
• 1. RATIO METHOD:
• EoD= % change in qnty demanded
% change in price
• 2. TOTAL OUTLAY METHOD
• In this method, the changes in the total outlay
(expenditure) on the good is calculated.
• In this method, it is possible to know whether the
elasticity is =1, >1 or <1.
• The total expenditure remains the same, change
in price and quantity are the subject-matters.
• Ex: Price per unit is Rs.50, total expenditure is
Rs.500. Price changes to Rs.60 and total
expenditure is same, i.e.,Rs.500. Then. EoD=1.
• Ex:2: Original price is Rs.50 and the increased
price is Rs.100. The original expenditure is
Rs.500 and new expendi-ture is Rs.1500. Then,
Ep=1500/500=3.
• 3. THE POINT METHOD:
The Point method assumes a straight line
demand curve. Elasticity is represented by the
fraction of distance from D to a point on the
curve divided by the distance from other end of
that point.
( Diagram is to be drawn and explained).
• ARC EoD
• Under the Point method, EoD is measured when
changes in price and quantity demanded are small. If the
price changes are large, then we have to measure elasti-
city over an arc of the demand curve rather than at any
specific point on the curve. For ex: price change is from
Rs.30 to Rs.45– then we calculate the elasticity by arc
method.
• Under Point method, Old and new prices and quantity
are taken to measure EoD. But, under arc method, the
average of old and new prices are taken.
• In arc elasticity, the change in price is exp-
ressed as a proportion of average of the old
price and new price and the previous quantity
and the new quantity. So, the Arc elasticity is
called the Average elasticity.
• Arc Ela= Q1- Q2 divided by P1- P2
Q1+Q2 P1+ P2
Ex: Quantity demanded is 500 units at Rs.25 and
250 units at Rs.37.50. Then—
Arc Ela = 500 – 250 divided by 25 – 37.50 = 1.66
500 + 250 25 + 37.50