Managerial Economics

(SML780)

Dr. Seema Sharma

Dept. of Management Studies
Indian Institute of Technology Delhi
 Objective
The objective of this course is to examine
the principles of microeconomics largely,
and illustrate how they apply to
managerial decision-making.
 Course Contents
Introduction to managerial economics. Basic concepts,
Consumer behavior, Demand analysis: Determinants,
estimation and managerial uses of elasticity of demand.
Demand forecasting. Supply function and Market equilibrium
analysis. Production and Cost analysis and Equilibrium of the
firm, production Analysis, Production efficiency analysis.
Pricing and output under different market situations: Perfect
Competition, Monopolistic Competition, Monopoly,
Oligopoly and Cartels.
 Evaluation
Apart from the major exam at the end of the semester,
students would be examined throughout the semester via
minor exams, case assignments etc. The distribution of
the marks would be as follows:

Major Exam 40 Marks

Minor Exam I 20 Marks
Assignments 10 Marks
Class Participation and Attendance 10 Marks
Term Project 20 Marks
 Reading List

Salvatore D., Managerial Economics in a

Global Economy, Thomson South-Western,
Singapore 2003.

Economic Survey (various issues).

Economic Times
 Managerial Economics Defined
The application of economic theory and the
tools of decision science to examine how an
organization can achieve its aims or objectives
most efficiently.
Responding to the Changing Environment

Environmental Management Perspective

Taking a proactive approach to managing the micro environment

and the macro environment by taking aggressive (rather than
passive) actions to affect the publics and forces in the economic
environment.
 Historical Perspective: A shift from Political Economy to Economics and ; Classical to
Neo-classical school of thought
Classical Economics was developed in the 18th and 19th Centuries. It was based on Value
Theory and Distribution Theory.

The value of a product was thought to depend on the costs involved in producing that product.
The explanation of costs in Classical economics was simultaneously an explanation of
distribution. A landlord received rent, workers received wages, and a capitalist tenant farmer
received profits on their investment. This classic approach included the work of Adam Smith
and David Ricardo and Say. However, some economists gradually began emphasizing the
perceived value of a good to the consumer. They proposed a theory that the value of a product
was to be explained with differences in utility (usefulness) to the consumer. Another step from
political economy to economics was the introduction of marginalism and the proposition that
economic actors made decisions based on margins. For example, while buying the second unit
of a product, the most important thing for a consumer is how much satisfied he or she is with
the first unit. Also, when a firm hires a new employee, it is based on the expected increase in
profits the employee will bring.

This shift is also known as shift from.

Alfred Marshall is considered to be the father of Modern Economics. His book, Principles of
Economics (1890), was the dominant textbook in England a generation later.
Utility

Marginalism in the form of Marginal Utility

Want satisfying characteristic of the Good.

Utility is the feeling of satisfaction that is

derived from the possession, consumption or
use of the commodity.

"Utility is the basis on which the demand of a

individual for a commodity depends upon".
The concept of utility dates back to 18th century in work done by

Jeremy Benthem and his fellows. However it aquired its precise

meaning in 19th century through the collective work of Jevons,

Walrus, Menger and Alfred Marshall in the form of marginal

Analysis when it turned out as a basic theory of consumer behaviour.

Theories on Consumer Behaviour

* Cardinal Utility Theory

* Ordinal Utility Theory

Cardinalist School Vs. Ordinalist School
Assumptions of cardinal Theory:

(i) Rationality: The consumer is rational. He aims to maximize his

satisfaction from his income.

(ii) Utility is cardinally measurable.

(iii) Marginal utility of money remains constant.

(iv) Diminishing marginal utility. Marginal utility obtained from the

consumption of a good diminishes we consume more.

(v) Independent utilities: utility which is derived from the

consumption of a good is not a function of the consumption of other goods.
Hence utilities are addible.
Pareto, an Italian Economist, criticized the concept of cardinal utility. He stated
that utility is neither quantifiable nor addible. It can, however be compared. He
suggested that the concept of utility should be replaced by the scale of preference.
Hicks and Allen, following the footsteps of Pareto, introduced the technique of
indifference curves.
 Law of Diminishing Marginal
Utility
Total Utility
TU = U1+U2+Un
Marginal Utility
MU =
TU
Q
MU of nth unit = TUn -TUn-1
 Total and Marginal Utility Schedule

Units Consumed TU Mu
1 50 50
2 90 40
3 120 30
4 140 20
5 150 10
6 150 0
7 140 -10
Law of Diminishing Marginal utility

200
TU
150 Mu
Tu & MU

100

50

0
1 2 3 4 5 6 7 8
-50
Quantity
 Theory of Demand and
Supply: Price Mechanism
 All economic activities are largely
demand driven
Demand is the mother of production e.g. rising
demand for fuel, automobiles, telecom, computers
have enhanced the business prospect for their
production whereas in products like cycles, landline
connections, B&W T.V., business has come down.
 DEMAND vs. WANT vs. NEED

Demand relates the quantity of a good that

consumers would purchase at each of various
possible prices, over some period of time,
ceteris paribus
Demand statement contains:
Quantity demanded
Price at which demanded
Time period
Market area

Hence - Total demand for computers in

NCR region in 2010 at an average price
of Rs. 30,000 is 50,40,000- is a valid
demand statement.
 Demand Function

D = F(P, Y, Pr, T&P, Eco En. PE, Pop)

 Why does the Demand Curve
Slope Downward?

Law of Demand Inverse relationship between price

and quantity.

D = F(P); ceteris paribus

 Demand Curve

A The demand curve slopes downward

5 because price and quantity demanded
B are inversely related.
4
C
3
E
2
F Demand
1
G
0
1 2 3 4 5 Quantity
 Factors behind Law of Demand

Law of Diminishing Marginal Utility

Income Effect
Substitution Effect
 Market Demand

Market Demand refers to the sum of

all individual demands for a good or
service.
 Normal Goods
(+ Income effect) (ve Price effect) Demand
curve is negatively sloping)

Inferior Goods
(-ve Income Effect) (ve Price effect) Demand curve
is negatively sloping)

Giffen Goods
(+ve Price Effect) Demand curve is positive sloping)
 Shift in Demand versus Movements
along a Demand Curve

A change in the price of a good causes

a change in the quantity demanded,
but does not shift demand
Movement along the demand curve

A price change
Price ($s)

would change the

quantity demanded
which involves
movement along
the demand curve.

Demand

Quantity
Changes in Demand vs. Changes in
Quantity Demanded
Movement along
the demand
curve.

Decrease
Increase
Demand

Quantity
 Demand Shift Factors

1. Tastes and Preferences

2. Substitutes and Complements
3. Income
4. Population
5. Price Expectations
6. Promotional Campaigns
 Changes in Demand - Decrease
Demand Shifts LEFT

Price
When:
Prices of substitutes decrease
Prices of complements
increase
Normal good-income
decreases D1
Inferior good-income D2
increases
Population decreases Quantity
Tastes & preferences turn
against the product
 Changes in Demand - Increase
Demand Shifts RIGHT
Price

When:
Prices of substitutes increase
Prices of complements
decrease
Normal good-income
D2 increases
Inferior good-income
D1
decreases
Quantity Population increases
Tastes & preferences turn in
favor of the product
 SUPPLY

Supply relates the quantity of a

good that will be offered for sale
at each of various possible prices,
over some period of time, ceteris
paribus.
 Supply Schedule

Price Quantity Supplied

5 4
4 3
3 2
2 1
1 0
0 0
 Supply Curve
Price ($s)

H Supply
5
I
4 The supply curve slopes
J upward because price
3 and quantity supplied
K are directly related.
2

1 L

0
1 2 3 4 5
M Quantity
 Supply Shift Factors

Prices of Inputs
Technological Change
Government or Union Restrictions
Expected Future Prices
Number of Sellers
 Changes in Supply vs. Changes in
Quantity Supplied
Price ($s)

Supply
5
Decrease
4
Movement along
3 Increase Supply
2

0
1 2 3 4 5 Quantity
 Changes in Supply - Decrease

$ S2

Supply Shifts LEFT When:

Sellers expect price to rise in S1
future.
Price of labor or any input
rises.
Government or union
restrictions increase cost.
Number of sellers declines Quantity
 Changes in Supply - Increase

Supply Shifts RIGHT When:

$ S1
Sellers expect price to
S2 decline in future.
Price of labor or any input
falls.
Technological change lowers
cost.
Number of sellers increases

Quantity
 Market Demand Curve
Price C1s Quantity C2s Quantity Market Q
Demanded Demanded Demanded
5 0 1 1
6 4 1 2 3
3 2 3 5
5 2 3 4 7
1 4 5 9
4 0 5 6 11

3
2 Market Demand
C1s C2s
Demand Demand
1
0
1 2 3 4 5 6 7 8 9 10 11
Quantity
 Market Supply Curve
S1s S2s
Supply Supply

5
4
Market Supply
3
2

0
1 2 3 4 5 6 7 8 9
Quantity
 Market Equilibrium

Price ($) Quantity Demanded Quantity Supplied Surplus or Shortage

5 1
4 3
3 5
2 7
1 9
0 11
9 8
7 4
5 0
3 -4
1 -8
0 -11

There is only one price that clears

the market, meaning that the quantity
supplied equals the quantity demanded.
 EQUILIBRIUM
The market clearing price and the resulting
quantity traded comprise what is referred
to as the market equilibrium, meaning that
there is no tendency for either price or
quantity to change, ceteris paribus.
 Market Equilibrium
Market equilibrium occurs where
demand and supply intersect.
5 Supply
Surplus of 4 units
Too High 4
D<S

P* 3
D>S
Too Low 2
Shortage of 4 units
1 Demand

0 1 2 3 4 5 6 7 8 9
Q* Good X
 Estimating the Equilibrium
The Demand schedule can be represented by the
equation QD = 1,600 300P, where QD is the
quantity demanded and P is the price.
The supply schedule can be represented by the
equation QS = 1,400 + 700P, where QS is the
quantity supplied.
Calculate the equilibrium price and quantity
in the market for chocolate bars.
45
 Changes in Market Equilibrium
Snew
Price ($s)

Price ($s)
Snew
S

P*
P*

D
D
Q* Quantity Q* Quantity

An increase or decrease in supply.

 Changes in Market Equilibrium

Price ($s)
Price ($s)

S
S
P*
P*

D
Dnew
D Dnew
Q* Q*
Quantity Quantity
An increase or decrease in demand.
 Changes in
Market Equilibrium

Case Demand Supply Equilibrium P Equilibrium Q

1 No change Right Fall Rise
2 No change Left Rise Fall
3 Right No change Rise Rise
4 Left No change Fall Fall
 Changes in
Market Equilibrium

Case Demand Supply Equilibrium P Equilibrium Q

5 Right Right Unknown Rise
6 Left Left Unknown Fall
7 Right Left Rise Unknown
8 Left Right Fall Unknown