Managerial Economics UNIT-1
Managerial Economics UNIT-1
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Managerial economics
"The application of economic theories to the problems of management is referred to as managerial economics."
Which simply means that finding solutions to the problems of management with the help of economic theories, concepts and laws.
The prime focus of managerial economics is to maximize the profit.
Managerial Economics is also known as "Business economics" or "Economics for firms".
Nature of managerial economics
1. It is microeconomic in nature because Managerial Economics is completely based on the concept of microeconomics.
2. Pragmatic because it avoids all the complex abstract issues of theories and involves practical problems from the end of ground reality.
3. Related to normative economics because it is used to determine that "What should be done."
4. Conceptual in nature
5. Problem solving in nature
6. Study of allocation of resources
This means answering to these 3 questions🤷♂️
•What to produce
•How to produce
•For whom to produce
7. Inter disciplinary, which means it is blend of many disciplines/subjects like management, statistics, psychology, mathematics, accounts, etc.
Scope of managerial economics
Demand analysis and forecasting
Cost Analysis
Production analysis
Pricing decision
Policy making
Profit management
Business environment analysis
Capital Management, etc
Limitations of managerial economics
1. Lack of Reliability as Managerial Economics is done on the basis of data collected from the accounting information of a firm and no doubt accounts can be manipulated.
2. Inaccurate conclusions as economic theories are majorly based on past information.
3. Expensive process as it requires higher salary to pay to the experts of this field.
4. Narrow scope as Business Economics is only used for internal management of the firm.
Branches of managerial economics
There are two main branches of Economics:
1. Microeconomics
Microeconomics stands for the analysis of the behaviour of an individual in an economy(as the word micro means small).
The sole objective of microeconomics is to give maximum utility on demand side and attain maximum profit on supply side.
2. Micro economics
Macro stands for huge/large and hence macro-economics deals with the entire system of an economy, for say inflation, deflation, national income, GDP, etc.
Managerial Economist
"Managerial economist is said to be a person who uses economic theories, methodologies and concepts to manage his business efficiently."
Managerial Economist is also known as economic advisor or business economist.
Roles and responsibilities of managerial economist
Analysing internal and external factors
Market research
Sales forecasting
Advising on Trade and Public Relations
Economic analysis of competing firms
Solving economic problems
Evaluating profitability of new projects, etc
Basic tools
For say basic tools are some of the fundamental concepts or principals used in managerial economics.
1. Opportunity cost concept
This is a very widely used concept which means that "The sacrifice of alternative course of action for any decision is referred to as opportunity cost".
It is also called as imputed cost.
Simply, if you choose decision "B" in place of decision "A", then the loss or profit you face is the opportunity cost of taking that decision.
Opportunity cost will be zero, if there are no sacrifices made.
2. Incremental concept
This principle says that significant change in total cost and total revenue due to changes in prices, products, production process, etc should be computed and regularly monitored.
It clearly states that higher the risk more will be the profit.
3. Equi marginal principle
Allocating all the available resources among different activities in such a way that they all produce same level of output is known as equi marginal concept.
4. Principle of time perspective
This principle says that affects of decision made on production cost, revenue, etc should be analysed for short-term as well as for long-term in order to make it more effective.
5. Discounting principle
Discounting means a process of reducing a future value to the present value of it.
In this context, discount is referred to as interest rate.
Simply, this means that the value of money today will not be same a year later and hence, all investing decisions should be made after keeping this principle in mind.
6. Marginal principle
This is the application of marginal concepts in Managerial Economics for taking decisions as the "marginal concepts measures the rate of change in dependent variables."
For example
Price and Demand are dependent to each other and measuring the changes in demand when the price fluctuates is the marginal concept of Economics.
And hence, this marginal principle is the most significant principle in managerial economics.
It involves marginal utility(MU), marginal cost(MC), marginal product(MP), marginal revenue(MR).
Marginal means change in value (demand/production/cost, etc) on increasing an additional value (supply/consumption/revenue, etc)
7. Scarcity principle
"Exccess demand of any commodity or service is referred to as scarcity."
Amount of demand respective of the supply of that commodity determines the scarcity or excess in the production. And hence, it is a relative concept because supply and demand are directly related to each other.
"Scarcity is the essence of all the economic problems".
If there will be no scarcity of resources, labour, capital, etc then, there will be no economic problems as well.
Scarcity jobs = unemployment
Scarcity of goods = inflation
Unsold stock of inventory = scarcity of buyers
8. Principle of risk and uncertainty
Risk and uncertainty both are the most prominent situations faced by an entrepreneur or business owner.
Risk refers to the possibility of amount of uncertainty which simply means that, risk is a way to predict the possibility of outcomes which can be negative also and can be positive also.
BUT
Uncertainty refers to a situation where outcomes cannot be predicted and hence, uncertainty is equal to "immeasurable risk".
Demand Analysis
"The analysis of such factors which affect the demand of any commodity or service is demand analysis."
Demand analysis helps the producer to modify his production techniques in order to meet the demand and attain maximum profit.
Concept of demand
Willingness + Ability of a consumer to buy any commodity at a given price is demand of that commodity.
Determinants of demand
1. Price of a commodity(P)
There is an inverse relationship between Price and Demand of a commodity which means when price increases, demanded decreases and vice versa.
2. Income of the consumer(Y)
When income of a consumer increases, his purchasing ability increases and vice versa.
3. Taste and preference(T)
The more a consumer prefers a commodity, the more demand he will have of that commodity.
4. Price of related goods(Pr)
Complementary and substitute goods are generally known as related goods.
For example, when price of Coca-Cola falls, the demand for Coca-Cola will increase in comparison to the demand of Pepsi.
Some other factors which determine the demand of a commodity are
•Advertisement and sales techniques
•Consumers expectation
•Growth of population
•Weather condition
•Tax rate
•Pattern of saving, etc
Demand function
Demand fuction is the algebraic representation of demand in respect to the determinants of demand.
It can be categorised into two types:
1. Individual demand function
This represents demand of an individual for a particular commodity at a different prices, income levels, etc.
D = f(P)
2. Market demand function
This is the sum of many individual demand function.
D = f(P,Pr,T,Y,A,U)
P is price of commodity
Pr is price of related goods
T is taste and preference of consumer
A is advertisement and sales tactics
U is unknown factors
Types of demand
●Individual and market demand●
●Demand for firms product and industries product●
Demand for a particular brand is demand for firm's product and demand for a product of particular industry is demand for industry's product.
●Autonomous and derived demand●
Autonomous is also known as direct demand as it is the demand for food, shelter, clothing, etc which arises due to biological & physical needs of a consumer whereas derived demand is related with the demand of one commodity to other such as petrol for car etc.
●Demand for durable and non durable goods●
Durable goods can be used for indefinitely long period of time for example house, furniture, etc whereas non durable goods are those which can be consumed only once like milk, bread, etc.
●Short term and long term demand●
●Joint demand and composite demand●
Joint demand can be said as demand for bike and petrol, pen and ink whereas composite demand is made when one commodity is used for different purposes like steel can be used to make utensils as well as car bodies.
●Total market demand and market segment demand●
Total market demand is referred to as summative demand of a product whereas market segment demand is for a specific segment.
Such as demand of chocolate in Rajasthan, Karnataka, etc will be called as market segment demand and demand of chocolate in India will be called as total market demand.
Law of demand
"Law of demand explains the inverse relationship between the price of a commodity and quantity demanded of that commodity."
Law of demand assumes that all the other determinants like income, taste & preference, price of related goods, etc will remain constant.
Exceptions to the law of demand
1. Conspicuous goods
In our society, there are some consumers who measure the utility of any commodity by its price and these goods are status reflecting goods. Hence, the more expensive they will be the more demand they will create.
2. Giffen goods
Giffen goods can be identified when two goods are compared to each other.
For example, no matter how much the price raises for wheat and how much the price falls for maggie but people will buy wheat because it is more necessary to them when compared to Maggie. In this situation, wheat is a giffen good.
3. Outdated goods
No matter how much the price falls for fax machine but majority of the consumers will not shift from printer to FAX machine again.
Demand schedule
Demand schedule is defined as the tabular representation of the inverse relationship between price and quantity demanded of a commodity.
It is of two types:
1. Individual demand schedule
2. Market demand schedule
Demand curve
Demand curve is the graphical representation of the demand schedule.
It is also of two types;
1. Idividual demand curve
It is the graphical representation of individual demand schedule.
2. Market demand curve
It is the graphical representation of market demand schedule.
Variations in demand
There are two kind of variations in demand curve:
1. Movement along the demand curve
This variation takes place when the price of a commodity changes.
It can produce two results:
a) Extension in demand which means rise in demand when the price falls.
b) Contraction in demand which means fall in the demand when the price rises.
2. Shift in demand curve
This variation happens when the other factors such as price of related goods, income level, etc also changes and affects the demand of a commodity.
It can produce two results:
a) Increase in demand which means the rightwards shifting of demand curve.
b) Decrease in demand which means leftwards shifting of demand curve.
Why does demand curve slopes downwards?
Demand curve is the graphical representation of the inverse relationship between Price and Demand of a commodity and hence, it always slopes downwards.
Other reasons for the downward slope of demand curve are:
1. Income effect which means the higher will be the income, the more will be the purchasing ability and vice versa.
2. Substitution effect which means the higher will be the price of substitute goods, the lesser will be demand of the substitute goods and vice versa.
Indifference curve
"The curve that represents some different combinations of two goods (X,Y) which provides equal level of satisfaction to consumer is known as indifference curve."
Properties of indifference curve
1. Indifference curve slopes downwards / Negative
This is because when a consumer wants to consume one extra unit of commodity(X), then he has to sacrifice some units of other commodity(Y).
2. Indifference curves are always convex to the origin
It is because indifference curve is based on diminishing marginal rate of substitution (MRS) which again means that in order to consume an extra unit of commodity(X), consumer has to sacrifice some units of commodity(Y).
3. Two indifference curve can never intersect each other
This is because intersection means same level of satisfaction from both the commodities at same price which is not possible for any combination of commodities.
4. Indifference curve neither touches x-axis nor y-axis
This is because touching any of the axis means that particular commodity(X or Y) has not been purchased by the consumer.
And this is not possible in the case of indifference curve as it based on the assumption that two commodities are purchased.
5. Indifference curve need not to be parallel to each other
Two indifference curves should be parallel to each other is not necessary.
As this is only possible when commodity X & Y are not complementary goods to each other or perfect substitute of each other. But in majority of cases, two indifference curves are not parallel to each other.
Elasticity of demand
Concept of elasticity
The relative responsiveness of a supply or a demand curve in respect to price is referred as elasticity.
"Elasticity of demand is referred to as the percentage change in quantity demanded divided by the percentage change in one variable that affects the demand(price, income, etc)."
E = % change in qty demanded / % change in other factors
Higher elasticity represents higher changes in quantity demanded and other factors, on the same hand, lower elasticity represents lower changes in quantity demanded and other factors.
Types of elasticity of demand
There are broadly 4 types of elasticity of demand.
1. Price elasticity of demand
Price elasticity of demand denotes the percentage change in quantity demanded divided by percentage change in price of that commodity.
E(p) = % change in quantity demanded / % change in price
Degrees of price elasticity
1. Perfectly elastic demand(E = infinity)
This is a state when demand for a commodity changes even there is no change in price.
2. Perfectly inelastic demand(E = 0)
This is a state when demand for a commodity does not change even there is a change in price of it.
3. Unitary elastic demand(E = 1)
This is a state when change in demand for a commodity is equal to change in price of that commodity
4. Elastic demand(E >1)
This is a state when change in demand is greater than change in price of that commodity.
5. Inelastic demand(E < 1)
This is a state when change in demand of a commodity is less than the change in price of that commodity.
Factors determining price elasticity of demand
1. Availability of substitutes
Higher the substitutes available, higher will be the elasticity.
2. Position of commodity in consumer's budget
Higher the priority of commodity in consumer's budget, lower will be the elasticity.
3. Number of uses a commodity has
4. Nature of needs a commodity satisfices(luxury needs, basic needs,etc).
5. Possibility of postponing the consumption
6. Consumer habit
More habitual a consumer is of a commodity, least will be the elasticity of demand.
Some other factors are brand name, income distribution, time, etc.
There are four methods of measuring price elasticity of demand🤷♂️
1. Arc elasticity
This method uses average quantity demanded and average price to calculate the price elasticity of demand.
2. Total outley method
This method just multiplies the price by quantity demanded of a commodity.
3. Proportionate method
It is also known as percentage method, flux method, ratio method and arithmetic method.
4. Point method or geometric method
This method uses the straight line demand curve to derive the price elasticity.
5. Revenue method
This method uses average revenue and marginal revenue to derive the price elasticity of demand
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2. Income elasticity of demand
Income elasticity of demand can be explained as the percentage change in quantity demanded divided by the percentage change in income(Y).
E(y) = %change in quantity demanded/ %change in income
Degrees of income elasticity of demand
1. High income elasticity
This is a state when change in demand is more than change in income.
2. Unitary income elasticity
This is a state when change in demand is equal to change in income.
3. Low income elasticity
This is a state when change in demand is less than change in income.
4. Zero income elasticity
This is a state when there is no change in demand on change in income.
5. Negative income elasticity
This is a state when demand decreases of a commodity on increase in income.
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Cross elasticity of demand
Cross elasticity of demand can be defined as a change in demand of commodity X due to change in the price of commodity Y.
This elasticity derives three types of conclusion as follows 😌
1. In case of substitute goods (pepsi and Coca-Cola OR coffee and tea) demand for commodity X rises when price of commodity Y rises AND demand for commodity X falls when price for commodity Y falls.
2. In case of complementary goods (pen and ink OR car and petrol) demand of commodity X rises when price of commodity Y falls AND demand of commodity X falls when price of commodity Y rises.
3. In case of Independent goods, there is no change in demand of commodity X on change in price of commodity Y.
For example, there will be no change in demand of wheat on change in price of shoes.
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Advertisement and promotional elasticity of demand
This can be defined as the percentage change in demand divided by the percentage change in expenditure on advertisement and other promotional activities.
Degrees of advertisement elasticity of demand
E(A) = 0
This is a state when sales do not get affected by change in advertisement expense.
E(A) < 1
This is a state when increase in sales is less than increase in expenditure on advertisement.
E(A) = 1
This is a state when increase in sales is equal to increase in advertisement expenses.
E(A) > 1
This is a state when increase in sales is more than increase in advertisement expenses.
Uses of elasticity of demand
●Determination of pricing policies
●Price discrimination
(It is a process of selling same product at different prices to different section of consumers, in different markets).
●For making taxation policies
●For making subsidy policies
●Important in international trade
●For taking output decisions
●For determining cost of production, etc.
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