Lecture 5-6 pm ECO531 11-5 -20

Introduction to Managerial economics

 Lecture Outcomes

Students will be able to :

1. Understand the concept of managerial economics.

2. Comprehend the nature and fundamentals of economics.

 Managerial
Economics
According to Spencer: “Managerial economics is the integration of
economic theory with business practice for purpose of facilitating
decision making and forward planning by management”. It means
management of limited funds available in most economical way. It deals
with basic problems of the economy i.e. what, how & for whom to
produce.

Scope of Managerial Economics

1.Demand Analysis & Forecasting: A major part of managerial decision
making depends on accurate estimates of demand. By forecasting
future sales manager prepares production schedules and employ
resources which helps mgt. to strengthen its market position & profit.
2.Cost & production Analysis: A manager prepare cost estimates of a
range of output, and choose the optimum level of output at which cost
is minimized. Manager is supposed to carry out the production
function analysis to avoid wastage of materials & time.
3.Pricing Decisions: Success of a business firm depends upon
correct pricing policy decisions taken by it. Different pricing
method is used for various market structure, Cz price to a
great extent determines the revenue of the firm.

4.Profit Management: Aim of business firms is to earn profits in

long run. Profits are reward for uncertainty & risk bearing. A
manager should be able to take calculated risk & try to avoid
uncertainty for higher profits.

5.Capital Management: M.eco helps in planning & controlling of

capital expenditure since it involves huge amount of money &
time.
 Nature of Managerial
Economics
1.ALLOCATION OF RESOURCES: SINCE RESOURCES ARE SCARCE AND THEY HAVE
MULTIPLE USES, ME FOCUSES ON OPTIMUM ALLOCATION OF FUNDS AVAILABLE,
WHICH ALSO REDUCES THE WASTAGE LEVEL.

2.MICRO ECONOMIC NATURE: M.ECO IS MICRO ECONOMIC IN CHARACTER. IT

DEALS WITH BUSINESS FIRMS. A FIRM IS THE SMALLEST DECISION MAKING UNIT
OF PRODUCTION. SINCE THE STUDY IS ABOUT FIRM,THE PROBLEMS FACED BY
THE FIRMS ALSO FALLS UNDER THE PURVIEW OF MICRO ECONOMICS.

3.MARKET KNOWLEDGE: A FIRM IS OPEN TO THREATS AS WELL AS

OPPORTUNITIES IN MARKET PLACE. SO KNOWLEDGE OF MARKET MUST BE
PERFECT.

4.MACRO-SETTING: A FIRM HAS TO OPERATE WITHIN A GIVEN ECONOMY. SO ITS

ALSO GOVERNED & AFFECTED BY THE TRENDS IN INCOME, CONSUMPTION,
INVESTMENT, SAVINGS LEVELS IN AN ECONOMY.
5. Positive & Normative Approach: Positive approach concerns
with what is, was or will be, while normative approach concerns
with what ought to be. Positive eco is of 2 types: Economics
description shows state of operation of the firm at a point of time
whereas economic theory explains why it happened.

Relationship with other Disciplines.

1. Statistics & Economics: Statistical techniques are very useful for

collecting, processing & analyzing business data, testing & validity
of economic laws before they can be applied to business. Statistical
techniques like regression analysis, forecasting is used in
economics.
2.Operation Research & Economics: OR is an activity carried out by
specialist within the firm to help the manager to do his job of
solving decision problems.OR is also concerned with model
building but economic models are more general & confined to
broad decision making. OR models like linear programming,
queuing are widely used in managerial economics.

3.Accounting & Economics: Accounting data & statements reflect

financial position, net loss or net profit earned by a company.
For decision-making a manager should be familiar with
generation, interpretation & use of A/c data.

4.Mathematics & Economics: Managers have to deal with

quantitative concepts like demand, cost, prices & wages. So
knowledge of mathematical concepts is imp to take
decisions.
5. Computers & Economics: Today each person is dependent on
computers. Managers depends on comp for decision making. Through
comp data is presented in organized manner which facilitates
decision making.

Role of Managerial Economist in Business

1.Specific Decisions: There are several specific decisions that managers

might have to take like: Production scheduling, demand forecasting,
market research, security management analysis, economic analysis of the
industry, advice on trade, Pricing decisions.

2.General Tasks: It includes understanding external factors & suggesting

the firm which policy is to be used. External factors include- economic
condition of the economy, demand for the product, market conditions of
raw materials, input cost of the firm affected by outside forces.
 FUNDAMENTAL CONCEPTS OF
ECONOMICS
1. Opportunity Cost: The benefit of the next best alternative
which had been sacrificed due to the choice of the best
alternative is known as opportunity cost of the best alternative.
It tells us the gain from the proposed use of input.
Eg- Opportunity cost of funds employed in one’s own
business is the amt of interest which cud have been earned
had these funds been invested in the next best channel of
investment.

2. Incremental Reasoning: It’s the most important concept in

economics. Incremental principle is applied to business decisions
which involves a large increase in total cost & total revenue.
Incremental cost is defined as”change in total cost as a result of
change in the level of output. Incremental revenue is change in
total revenue resulting from change in the level of output. It tells
us gain arising from the change in activity.
3.The Discounting Principle: Discounting factor determines the present
value of future inflow of cash. Its based on the fundamental fact that a
rupee now is worth more than a rupee earned a year after. PV=
FV*PVFn,i

4.Time Perspective: Aim of the firm is to make profit in the long run. There
is a difference between long & short run. In short run all of the
inputs(called fixed inputs) cannot be altered, while in the long run all the
inputs can be changed(i.e. there are no fixed inputs). A decision should
take into account both the short run & long run effects on revenues & costs
to maintain a right balance b/w short & long run perspectives.

5.Risk & Uncertainty: In real world, uncertainty influences the estimation

of costs & revenues & hence the decision of the firm. Since future
conditions are not perfectly predictable, there is always a sense of risk &
uncertainty about outcome of decisions. When a firm is operating in a
market along with other firms there is generally an element of
uncertainty regarding the actions & reactions of the competitors. Other
uncertain factors can be shifts in consumers choices, changes in govt
Concepts of Economics

1.Utility: Utility refers to the amount of satisfaction which a consumer

gets by consuming the various units of commodity.

2.Marginal Utility: Addition made to the total utility by consuming 1

more unit of a commodity. MU= change in total utility/ change in
quantity of good X.

3.Law of Diminishing Marginal Utility: “For any individual consumer

the value that he attaches to successive units of a particular
commodity will diminish slowly as his total consumption of that
commodity increases, the consumption of all other goods being
constant”. Assumptions of the Law:
4. Various units of goods are homogeneous.
5.There is no time gap b/w consumption of different units.
3.Tastes, preferences & fashion remain unchanged.
4.Consumer’s Equilibrium: The quantity of good X where marginal
utility of X equals price of good X.
Mux=Px.

5.Income Effect: Change in consumption of the good due to the

change in income of the consumer.

6.Price Effect: Change in the consumption of the good due to

change in the price of the good.

7.Micro Economics: Studies the behavior of individual decision

making units like consumers, firms( regulates under
Company’s Act). It includes i) Product Pricing which includes
Theory of Demand & Supply, ii) Factor Pricing which includes
wages, rent, interest & profit.
8. Macro Economics: Studies the aggregate of all economic
units. It includes theory of growth & employment, theory of
Inflation & Price Level, theory of Income & theory of
Distribution.
Eg- Automobile industry includes firms like Maruti Suzuki
India Ltd, Hindustan Motors, Hyundia Motors India Ltd, Tata
Motors etc.
 DEMAND
ANAL
Demand for a commodity YSIS
refers to the quantity of the commodity
which an individual consumer is willing to buy at a particular
price & time. Demand for a commodity implies-
a) Desire of a consumer to buy the product.
b) His willingness to buy the product.
c) Purchasing power to buy the product.
Individual Demand: Goods demanded by an individual.
Household Demand: Goods demanded by a household.
Market Demand: Demand for a commodity by all individuals in
the market taken together.

Determinants/ Factors Affecting Demand

1. Price of the commodity: Consumers buy more of a commodity
when its prices fall. A fall in the price of a normal good leads to
rise in consumer’s purchasing power.
2.Income of the Consumer: With an increase in income, a consumer
buys increased amount of the commodities.. Both quantity
demanded of a good & income move in the same direction.

3.Price of Related Goods: When change in price of one commodity

influences the demand of the other commodity, it implies that two
commodities are related. Related commodities are of two types;
Substitutes & Complements. When price of one commodity &
demand of other commodity move in same direction, goods are
called substitutes, e.g. tea & coffee, apple & pears. On the other hand
when price of one commodity & demand of other commodity move
in opp. Direction, goods are called complementary goods, e.g. bread
& butter, pen & ink, petrol & automobiles etc.

4.Tastes & Preferences: Taste & preference of a consumer in favor of

a commodity results in greater demand of a commodity, while if
this change is against the commodity it results in smaller demand
DEMAND FUNCTION
A mathematical expression of the relationship b/w quantity demanded
of the commodity & its determinants is known as the demand function.
When this relationship relates to the market , it is called market demand
function.

THE LAW OF DEMAND

Law of demand states that higher the price lower the
quantity demanded & vice versa, other things remaining
constant.
Exceptions to the Law of Demand
1)Giffen Goods: Giffen goods are also known as inferior goods and is
consumed by the poor sections of the society. It’s a case where
decrease in price of a good results in decrease in its quantity
demanded & vice versa. E.g. bajra, barley, gram.
2)Commodities which are used as status symbols: Some expensive
commodities like diamond, gold, acs, cars are used as status symbols to
display one’s wealth. The more expensive these commodities become ,
more will be their value as a status symbol and hence greater will be
3) Expectations of change in the price of the commodity: If a
consumer expects the price of a commodity to increase, it may
start purchasing greater amount of the commodity even at
current increased price.

Why do Demand Curve Slope Downwards?

1.The law of diminishing marginal utility is at the root of the law of
demand. In order to get maximum satisfaction, a consumer buys a
commodity in such a way that marginal utility of the commodity is
equal to its price.
2.A commodity tends to be put to more use when it becomes
cheaper. Thus existing buyers purchase more & some new
consumers enter the market. Eg. Use of electricity.
3.A fall in price of a superior good will lead to a rise in the
consumer’s real income. The consumer therefore buy more of it.
On the contrary rise in price of superior good will result in a
decline in consumers' real income. Hence they will buy less of it.
Extension & Contraction of Demand: A movement downward on the
demand curve is extension of demand & a movement upward on
the demand curve is contraction of demand.
Shift of the demand curve: Shift in demand is brought about
by change in factors other than the own price.

ELASTICITY OF DEMAND
Definition: Ed is defined as “the percentage change in quantity
demanded caused by one percent change in the demand
determinant, other determinants held constant.”
Ed= % change in quantity demanded of good X/% change
in determinant Z.

KINDS OF ELASTICITY MEASUREMENT

1) Point Elasticity: It relates to the elasticity at a particular point
on the demand curve.
E=diff. in quantity/diff. in price*quantity/price
2) Arc Elasticity: It is the average elasticity over a segment of the demand
curve. Co-ordinates of mid-point be, P1+P2/2,
Q1+Q2/2… Formula: diff.in Q/diff. in P*P1+P2/Q1+Q2.

Types Of Elasticity
A) Price Elasticity: Proportionate change in quantity demanded of good
X/ Proportionate change in price of good X.

Types of Price Elasticity

1. Perfectly Elastic Demand: Where no reduction in price is needed to
cause
an increase in quantity demanded.
2.Absolutely Inelastic Demand: Where a change in price causes no change
in quantity demanded.
3. Unit Elasticity of Demand: When proportionate change in price causes
an equal change in quantity demanded.
B)Income Elasticity of Demand
C)Cross Elasticity of Demand
D)Advertising Elasticity of
Demand
Significance Of Elasticity Of Demand
1. Level of output & price
2.Fixation of rewards for factor of production
3.Demand Forecasting
4.Government Policies.

SUPPLY: Supply of a commodity refers to the various quantities of the

commodity which a seller is willing & able to sell at different prices in a
given market, at a point of time, other things remaining the same.

Determinants Of Supply
3.Price of the good: When producers get a higher price for their product,
the supply of the product increases.
4. Prices of other goods: Change in prices of other goods in the market
also
has influence on the supply of a commodity.
3.Prices of factors of production: An increase in the price of a factor, say
labor, may lead to a larger increase in the costs of making those
commodities that use more labor.
4. State of technology: A change in technology may result in lower costs
LAW OF SUPPLY
The law of supply states that, other things remaining constant, more of a
commodity is supplied at a higher price & less of it is supplied at a
lower price.

Shifts in Supply: Shift in supply means increase or decrease in

quantity supplied at the same price
Extension & Contraction of Supply: When more units of the goods are
supplied at a higher price, it is called the extension of supply. When less
units of the good are supplied at a lower price, it is called contraction
of supply.

ELASTICITY OF SUPPLY
Elasticity of supply of a commodity is defined as responsiveness of
quantity supplied to a unit change in price of that commodity. When the
quantity supplied changes more than proportionately to the change in
price, the supply tends to be elastic. On the other hand, if the change in
price leads to less than proportionate change in quantity supplied, supply
tends to be inelastic.
 THEORY OF PRODUCTION
Production is an activity that transforms inputs into output, eg.
Sugar mill uses inputs like labor, raw materials like sugarcane,
capital invested in machinery, factory building to produce sugar.
Factors Affecting Production
1. Technology: A firm’s production behavior is determined by the
state of technology. Modern or high level of technology increases
production of the firm irrespective of the size of the firm or
kind of management.
2.Inputs: There are wide variety of inputs used by the firm like raw
materials, labour services, machine tools, buildings etc. Inputs are
divided into 2 main groups- fixed & variable inputs. A fixed input is
the one whose quantity cannot be varied during the period, like
plant & equipment. An input whose quantity can be changed during
the period is known as variable input like raw materials, labor,
power etc.
3. Time period of Production: The fixity or variability of an input depends
on the time period. Time periods are short & long run. In short run period
some of firm’s inputs are fixed. Whereas in long term all the inputs are
variable i.e all inputs can be changed.

Factors of Production
1.Land: It is the most basic factor that is needed for any production activity.
It includes all natural resources below or above the land surface. It
includes all those resources which are free gift of nature. Like hills, rivers,
water etc.
2.Labor: It includes any work done by body or mind for remuneration.
Work done for pleasure like singing, dancing, playing etc is not labor, if it is
not done for remuneration. Labor is divided into 3 categories: unskilled,
semi-skilled & highly skilled.
3.Capital: Capital does not mean money only. It means resources which are
man made. It includes those factors which have been produced by human
efforts for further use in production activity is capital. Like plant, building,
machinery, road, bridges, rail lines etc.
4. Entrepreneurship: All the above factors are passive. They will not work
unless there is somebody who can make them work. Producer takes
decision regarding various activities like what products to produce,
arranging factors of production, fixing payments to labor services, bearing
risk & uncertainty etc.

Laws Of Production
1. Law of Variable Proportions: It is also known as “Law of Diminishing
Returns” or Returns to a Factor. This law becomes applicable when we
increase one factor of production(variable factor), while keeping other
factors constant, the output will increase. But after some time addition
to variable factors will reduce the total output at a diminishing rate.
Assumptions of the Law
1. Only one factor is increased while others are kept constant.
2. Various units of variable factor are homogeneous.
3.Conditions of production like production methods, climatic conditions
are constant. (Graph).
 Production Function with 2 Variable
Isoquant: It is a Inputs.
curve representing the various combinations of two inputs
that produce the same amount of output. An isoquant is also known as
iso- product curve or equal-product curve

Properties Of Isoquants
1. An isoquant is downward-sloping to the right: It means that if more
of
one factor is used, less of other factor is needed to produce the same
level of output.
2.Higher Isoquant represents larger output: It means that with the same
amount of one input & greater amount of second input, will result in
greater output.
3. No 2 isoquants touch or intersect each other.
4. Isoquants are convex to the origin.

(Graphic Representation)-Outlay line or price line &

Producers Equilibrium.
Total outlay of Producers- Rs.1000.
Price of 1 unit of Labor-Rs.50 (20 units)
This means that producer can take OM units of labor & ON units of
capital to produce 200 units, which is the optimum combination for him.

Production Possibility Curve

Many a times firms do not produce a single product but more than one
product. They utilize their productive resources to produce a given
combination of products. The question is how to choose the best
combination of products that can be produced with the given resources?
Suppose there are 2 products X & Y. If we want to increase the
output of X, it can be produced by producing lower quantity of Y. hence the
curve which shows, different quantities of 2 products that can be
produced with the given level of resources, it will be a negative sloped
curve. This curve is known as ‘Production Possibility Curve’.(Graphic
Representation)
If firm produces only X then it can produce OB units & if it
chooses to produce only Y then OA units it can produce. As we move from
A to B, we produce more of X & less of Y. In other words Y transforms into
X. This is known as Production Possibility Curve(PPC) also
known as Transformation Curve.