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Economics: Study of the behavior of human beings in

producing, distributing and consuming material goods and


services in a world of scare resources.
Management: The discipline of organizing and allocating a
firms scare resources to achieve its desired objectives.
ME: It is the use of economic analysis to make business
decisions involving the best use of an organizations scare
resources.
Economics of business or managerial decisions.
Integration of economic principles with business practices.
Pertains to economic analysis that can help in solving
business problems, policy and planning.
Traditional Economics &
Tools & Techniques
of Decision Sciences

ME

Business
Management
in theory& Practice:
Decision, Problems

In Economic Theory:

Assumption of a single Goal i.e. rational consumer aims at


maximization of utility and a firm tries to maximize its profit.
ET is based on Ceteris Paribus i.e. given conditions with
certainty of actions or events or within the framework of
axioms.

In Business Decision Making:

Multiple goals in running a business.


Lack of certainty due to dynamic changes.
Uncertainty may create disappointment in the realizations of
business expectations.

ET cant provide clear cut solutions but helps in

arriving at a better decision.

ME helps bridge the gap between purely analytical

problems dealt in ET and decision problems faced in


real business.

MAIN CHARACTERISTICS OF ME
Applied Micro economics
Science as well as art of management

disciplines.
Concerned with the firm's behavior in optimal
allocation of resources.
Provides tools for best alternatives and
competing activities in any productive sector.
Incorporates both Micro and Macro Economics
for optimal decisions.
Helps Manager to understand the intricacies of
the business problems which make the problem
solving easier and quicker.
contd.

Study of managerial economics essentially involves the


analysis of certain major subjects like:
The business firm and its objectives
Demand analysis, estimation and forecasting
Production and Cost analysis
Pricing theory and policies
Profit analysis with special reference to break-even point
Capital budgeting for investment decisions
Competition.

Managerial Economics:

Uses analytical tools of mathematical and


econometrics with two main approachesDescriptive Models are data based in describing
and exploring economic relationships of reality in
simplified abstract sense. Describe the economic
forces that shape the internal and external
environments of a business firm.
Prescriptive models are the optimizing models to
guide the decision makers about set goal. Prescribe
rules for managerial decision-making that furthers
the objective of the firm.
DM provide a building block for developing
optimizing models in solving the managerial and
business problems.
Helps in depth analysis of key elements involved in
the business.

IS ME POSITIVE OR NORMATIVE?
+ve economics explains the economic phenomenon as

what is, what was and what will be.


Normative economics prescribes what it ought to be.
ME is a blending of pure or +ve science with applied or
normative science.
+ve when confined to statements about causes and
effects and to functional relations of the economic
variables.
It is normative when it involves norms and standards,
mixing them with the cause effect analysis.
ME is a mix of both consideration in scientific approach.

DUTIES OF A MANAGERIAL ECONOMIST


Two broad aspects of his duties are

Decision Making
Forward Planning
Demand Estimation and forecasting
Business and sales forecasting
Analysis for extent and nature of competition.
Analyzing the issues and problems of the concerned industry.
Assisting the bus Planning process of the firm.
Discovering the new and possible fields of business endeavors
and its cost benefit analysis.
Advising on pricing , investment, and capital budget policy.
Evaluation of capital budgets.
Building micro and macro eco models for solving business
problems.
Directing Economic research activities.
Briefing the management on current domestic and global
economic issues and emergiing challenges.
Keeps an eye on fast changing technological developments.

Managerial Economic analysis in


Decision
Making
ME adopts the scientific approach of economic
analysis:
Define the problem
Formulation of the hypothesis
Abstraction for the model building
Data collection
Deduction based on data analysis
Testing the hypothesis
Evaluating the test results
Conclusion for decisions

A Decision-Making Model
Objectives
Define the
problem
Alternative
Solutions
Social
constraints

Evaluation

Organizational
and input
constraints

Implement and
monitor the
decision
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Scope of ME
Objectives of a firm
Demand Analysis and Forecasting
Cost and Production Analysis
Pricing Decisions, Policies and Practice
Profit Management
Capital Budgeting
Linear Programming and the theory of games
Market structure and conditions
Strategic Planning
Others Areas (Macroeconomic Management, Fiscal and

Monetary Policy, Impact of Liberalization, Globalization,


privatization, marketization, international changes,
environmental degradation, socio-political, cultural and
external forces on management)

Importance of Managerial
Eco.
It gives guidance for identification of key variables in decision

making process.
It helps the business executives to understand the various
intricacies of business and managerial problems and to take
right decision at the right time.
It provides the necessary conceptual, technical skills, toolbox
of analysis and techniques of thinking to solve various
business problems.
It is both a science and an art. In the context of globalization,
privatization, liberalization and a highly competitive dynamic
economy, it helps in identifying various business and
managerial problems, their causes and consequence, and
suggests various policies and programs to overcome them.

responsive, realistic and competent to face the ever


changing challenges in the modern business world.

It helps in the optimum use of scarce resources of a firm

to maximize its profits.

It also helps in achieving other objectives a firm like

attaining industry leadership, market share expansion and


social responsibilities etc.

It helps a firm in forecasting the most important economic

variables like demand, supply, cost, revenue, price, sales


and profit etc and formulate sound business polices

It also helps in understanding the various external factors

and forces which affect the decision making of a firm.

It helps the business executives to become much more

Market system- basics


Market System where buyers and sellers interact to

determine the price and quantity of goods or service.


Based on two market forces demand and supply.
Purview of the market depends upon the expanse of its
buyers and sellers.
Buyers and sellers need not come into personal
contact.
Market refers to a commodity/ service or a
geographical area.
Markets distinguished basis nature of goods and
services and extent of competition.

Consumer Demand
It is the
Desire to buy
Willingness to pay
Ability to pay
which determines the quantity with reference to
price
Period of time
place

Definition of Demand
The demand for a product refers to the

amount of it which will be bought per unit of


time at a particular price.

Individual demand and


Market
demand

Individual demand is a single consuming


entitys demand
Market demand is the total demand of all
individual buyers at a particular price and
over a given period of time.

Determinants of demand
Factors influencing Individual demand
Price of product
Income availability
Tastes , habits and preferences
Price of substitutes and compliments
Consumer expectation
Advertisement effect
Season prevailing at the time of purchase
Fashion

DeterminantsMarket
demand
Price
Distribution of income and wealth in the community.
Standards of living and spending habits
Growth of population
Number of buyers in the market
Age group
Gender ratio
Future Expectations
Taxation and tax structure
Fashion and Innovation
Climate
Customs
Advertisements

Demand Function
Mathematical expression establishing relationship
between demand and its various variables
Dx= F(Px, Ps,Pc,Yd,T, A, N, u)
Px Own price
Ps - Price of a substitute
Pc Price of complements
Yd Disposable income
T - buyers tastes and preferences
A effect of advertisement
N- population growth
U other aspects

Demand Function contd..


A linear demand function is as below :
D= a bP
D= Units demanded
a = Constant parameter signifying initial
demand irrespective of price.
b = Constant parameter representing functional
relationship between D and P. Also measures
the slope of the demand curve.

Law of demand
All other things remaining constant (ceteris
paribus), the quantity demanded of a
commodity increases when its price decreases
and decreases when its price increases.
Demand curve :
Price of Shirts
No Of Shirts

Assumptions underlying the


Law
of
Demand
Habits, tastes and fashions remain constant.
Money, income of the consumer does not change.
Prices of other goods remain constant.
The commodity in question has no substitute or is

not in competition by other goods.


The commodity is a normal good and has no
prestige or status value.
People do not expect changes in the price.
Price is independent and demand is dependent.

Demand Schedule
Demand schedule is a tabular representation of

the quantity demanded of a commodity at various


prices.

For instance, there are four buyers of apples in the


market, namely A, B, C and D.
The demand by Buyers A, B, C and D are individual
demands. Total demand by the four buyers is market
demand. Therefore, the total market demand is
derived by summing up the quantity demanded of a
commodity by all buyers at each price.

Demand Schedule for


apples
PRICE
(Rs. per
dozen)

Buyer A
(demand
in
dozen)

Buyer B
(demand
in
dozen)

Buyer C
(demand
in
dozen)

Buyer D
(demand
in
dozen)

Market
Demand
(dozens)

10

14

25

11

12

10

37

13

14

12

45

Demand Curve
Demand curve is a diagrammatic representation
of demand schedule. It is a graphical
representation of price- quantity relationship.
Individual demand curve shows the highest price
which an individual is willing to pay for different
quantities of the commodity.
While, each point on the market demand curve
depicts the maximum quantity of the commodity
which all consumers taken together would be willing
to buy at each level of price, under given demand
conditions.

Demand Curve

Features of demand
curve
Demand curve has a negative slope

The reasons for a downward sloping demand curve can be


explained as follows Income effect- With the fall in price of a commodity, the

purchasing power of consumer increases. Thus, he can buy


same quantity of commodity with less money or he can
purchase greater quantities of same commodity with same
money. Similarly, if the price of a commodity rises, it is
equivalent to decrease in income of the consumer as now
he has to spend more for buying the same quantity as
before. This change in purchasing power due to price
change is known as income effect.

Substitution effect- When price of a

commodity falls, it becomes relatively cheaper


compared to other commodities whose price
have not changed. Thus, the consumer tend
to consume more of the commodity whose
price has fallen, i.e, they tend to substitute
that commodity for other commodities which
have not become relatively dear.

Law of diminishing marginal utility


It is the basic cause of the law of demand.
It states that as an individual consumes more
and more units of a commodity, the utility
derived from it goes on decreasing. So as to get
maximum satisfaction, an individual purchases
in such a manner that the marginal utility of the
commodity is equal to the price of the
commodity. When the price of commodity falls,
a rational consumer purchases more so as to
equate the marginal utility and the price level.
Thus, if a consumer wants to purchase larger
quantities, then the price must be lowered. This
is what the law of demand also states.

Exceptions to the law of


demand
There are certain goods which are purchased mainly for

their snob appeal/ as status symbol, such as, diamonds, air


conditioners, luxury cars, antique paintings, etc. The more
expensive these goods become, more valuable will be they
as status symbols and more will be there demand. Thus,
such goods are purchased more at higher price and are
purchased less at lower prices. Such goods are called as
conspicuous goods.

The law of demand is also not applicable in case of giffen

goods. Giffen goods are those inferior goods, whose


income effect is stronger than substitution effect. These
are consumed by poor households as a necessity. For
instance, potatoes, animal fat oil, low quality rice, etc. An
increase in price of such good increases its demand and a
decrease in price of such good decreases its demand.

Exceptions to the law of


demand

The law of demand does not apply in case of


expectations of change in price of the
commodity, i.e, in case of speculation.
Consumers tend to purchase less or tend to
postpone the purchase if they expect a fall in
price of commodity in future. Similarly, they
tend to purchase more at high price expecting
the prices to increase in future.

Change in Quanity demanded Vs Change in


demand
Extension and contraction of demand-

Movement along the same demand curve and


represents the change in quantity demanded
because of the change in price of the product.

Change in demand
Increase and decrease in demand More is demanded at a given
price when demand increases and vice versa. This change in
demand is due to other factors than price.

Network externalities in
demand

Dependence of individual demand on the


demand of other people in case of some
products is network externality.
Two externalities :
i) Bandwagon effect
ii)Veblen effect

Bandwagon effect
The demand for products is not by their
usefulness but mostly influenced by trend
setters/ pace setters.
It is the result of the buyers desire to be in
style or fashion.
This forms the basic objective of advertising
and marketing of many products and
manipulates market demand.
Helps in determining the pricing strategy of the
business firm for such firms.

Veblen effect
The desire of a person to own exclusive/

unique product as a status symbol.


A rise in price of such products enhances their
snob appeal and shifts the demand curve
upwards.
Network externality is negative.
The product loses its prestige when it starts
getting commonly used.

Veblen paradox
At high prices, limited but high demand from
the rich.
Slight upward variation in demand when the
prices are reduced a little.
After a certain extent of price reduction,
demand dips.
Once the product is made available to the
common man, it follows the usual law of
demand.

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