Mefa Notes 1

8/3/2019 Mefa Notes 1

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MANAGERIAL ECONOMICS AND FINANCIAL ANALYSIS

By: - B. Mallesham,

Assistant prof,

Dept of MBA, JITS.

ASSIGNMENT-1

Q1> Define managerial economics in a state how it helps in solving managerial problems?

Ans:-

Economics is study of human activity both at individual and national level. the economists of early age treated economics

merely as the science of wealth. The reason for this is clear, as every one of us is involved in earning and spending

money. Such activities of earning and spending money are called economic activities. it was only during 18th

century that

Adam Smith, the father of Economics, defined economics as the study of nature of wealth.

Definitions:

1. According to Adam Smith, The study of nature of national wealth.

2. Dr. Alfred Marshall, Economics is a study of mans actions in the ordinary

Business of life; it enquires how he get his income and how he uses it.

3. A.C.Pigov, the study of economic welfare that can be brought directly and indirectly, into relationship with the

measuring rod of money.

4. Prof. Lionel Robbins, The science which studies human behavior as a relationship between ends and scarce means

which have alternative uses.

From the above definitions, we can observe that managerial economics

y Refers to the application of principles of economics to solve the managerial problems such as minimizing cost ormaximizing production and productivity.

y Directs the utilization of scarce resources in a goal-oriented manner.y Seeks to understand and to analyze the problems of business decision-making.y Facilitates forward planning.y Examines how an organization can achieve its aims and objectives most efficiently.


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Managerial economics helps in solving many managerial problems and used in many areas. Some of them are discussed

over here these can also be considered as features of economics

1. Close to microeconomics: - managerial economics is concerned with finding the solutions for differentmanagerial problems of a particular firm. Thus, it is more close to microeconomics.

2. Operates against the backdrop of macroeconomics: - The managerial economist has to be aware of the limits setby the macroeconomic conditions such as government industrial policy, inflation, and so on..

3. Normative statements: - A normative statement usually includes or implies the words ought or should. Theyreflect peoples moral attitudes and are expressions of what a team of people ought to do.

One problem with normative statements is that they cannot be verified by

Looking at the facts, because they mostly deal with the future.

4. Prescriptive actions: - it is goal oriented. Given a problem and the objectives of the firm, it suggests the courseaction from the available alternatives for optimal solution. It does not merely mention the concept. It also

explains whether the concept can be applied in a given context or not.

5. Applied in nature: - Models are built to reflect the real life complex business situations and these models are ofimmense help to managers for decision making. We also use case study method to conceptualise the problem.

6. Offers scope to evaluate each alternative: - Managerial economics provides an opportunity to evaluate eachalternative in terms of its costs and revenues. The managerial economist can decide which is the better

alternative to maximize the profits for the firm.

7. Interdisciplinary: - the contents, tools and techniques o managerial economics are drawn from different subjectssuch as economics, management, mathematics, statistics, accountancy, psychology, organizational behaviour,sociology, etc.

8. Assumptions and limitations: - every concept and theory of managerial economics is based on certainassumptions and as such their validity is not universal. Where there is no change in assumptions, the theory may

not hold at all.

Q2> Explain the nature of demand what could be the different variations in the nature of demand?

Ans: - A Demand always implies at a given price how much is the quantity demanded at a given level of price? This is

the volume of demand. The use and characteristics of

Different products affect their demand. In other words a product with more number of uses is naturally more in demand

than one with a single use. The nature of demand is better understood when we see these variations given below:

1. Consumer goods vs. Producer goods:-

Goods can be grouped into consumer goods and producer goods.

Consumer goods are those which are available for ultimate consumption; these give direct and immediate satisfaction.


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Ex: - bread, apple, rice.

Producer goods are those which are used foe further processing or production of goods or services to cash income.

Ex: - machinery, tractor.

These goods yield satisfaction indirectly, these are used to produce consumer goods and sometimes these goods can be

producer goods as well as consumer goods.Ex: - Paddy.

A farmer having 10 bags of paddy may use 5 bags for his personal consumption and the other 5 bags as seeds for next

crop. So here paddy is both producer good and a consumer good. The demand for producer good in indirect and

demand for consumer goods in direct.

2. Autonomous demand vs. Derived demand:-

Autonomous demand refers to the demand foe products & services directly.

Ex: - The demand for the services of a super specialty hospital can be considered as autonomous, where as the demand

for hotels around that hospital is called a derived demand, if there is no demand for houses, there may not be demand

for steel, cement, bricks, demand for houses is autonomous whereas demand for these inputs is derived demand.

3. Durable vs. Perishable goods: -

Here the demand for goods is classified based on their durability. Durable goods are those goods which give service

relatively for a long period. The life of perishable goods is very less, may be in hours or days.

Ex: - milk, vegetables, fish.

Rice, wheat, sugar, these are examples for durable goods.

Freezing facilities, the life of perishable goods can be extended for sometime.

Products such as:

TV, refrigerator, and washing machines are useful for a longer period, hence they are classified as consumer durables.

4. Firm demand vs. Industry demand: -

The firm is a single business unit where as industry refers to group of firms carrying on similar activities. The quantity of

goods demanded by a single firm is called firm demand and the quantity demanded by the industry as a whole is called

industry demand.

Ex: - one construction company may use 100 tonnes of cement during a given month. This is a firm demand. The

construction industry in a particular state may have used ten million tonnes. This is industry demand.


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5. Short-run demand vs. Long-run demand: -

Joel dean defines short-run demand as, the demand with its immediate reaction to price changes, income fluctuations.

Long-run demand is that demand, which will ultimately exist as a result of the changes in pricing, promotion or product

improvement,

y The demand for a particular product or service in a given region for a particular day can be viewed as short-rundemand.

y The demand for a longer period for the same region can be viewed as long-run demand. The demand that canbe created in the long-run by changes in the design as a result of changes in technology is long-run demand.

y Short-run refers to a period of shorter duration & long-run refers to the relatively period of longer duration.In short-run additional changes cant be made, but in long-run it can be made like living of additional plant, we cant

expand the output overnight. The short-run is a period in which the firms can adjust their production by changing

variable factors such as material & labour. They cant change fixed factors such as technology or capital. The long-run is

a period relatively long so that all factors of production including capital can be adjusted to meet the market

requirements.

6. New demand vs. Replacement demand: -

New demand refers to the demand for the new products and it is addition to the

existing stock. In replacement demand, the item is purchased to maintain the asset in good condition.

Ex: - The demand for cars is new demand and demand for spare parts is Replacement

demand.

7. Total market and Segment market demand: -

Ex: - sugar

The consumption of sugar in a given region, the total demand for sugar in the region is the total market demand.

The demand for sugar from the sweet, making industry from this region is the segment market demand.

Q3> Explain how would you measure elasticity of demand illustrate, how do you interpret the different types of

elasticity?

Ans: - The term elasticity is defined as the rate of responsiveness in the demand of a commodity for a given change in

price or any other determinants of demand. In other words, it explains the extent of change in quantity demanded

because of a given change in the other determining factors, may be price or any other factors.


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There are 4 types of elasticity of demand

1. Price elasticity of demand.2. Income elasticity of demand.3. Cross elasticity of demand.4. Advertising elasticity of demand.

1. Price elasticity of demand:-

Elasticity of demand in general refers to the price elasticity of demand. In other words, it refers to the quantity

demanded of a commodity in response to a given change in price. Price elasticity is always negative which indicates that

the customer tends to buy more with every fall in the price. The relationship between the price & the demand in inverse.

It is measured as follows..

Price elasticity of demand = Proportional change in the quantity demanded for product X

Proportional change in the price of X.

Edp= (Q2-Q1)/Q1/ (P2-P1)/P1.

Q1= quantity demanded before price change.

Q2= quantity demanded after price change.

P1= price before change.

P2= price after change.

The price is said to be elastic, when the proportionate change in quantity demanded is more than the

proportionate change in price.

Ex: 5% fall in the price results in an increase of 20% in the quantity demanded, the price is said to be elastic, which

implies that the elasticity is more than one (e>1).

On the other hand, if the price is said to be inelastic then it means that the quantity demanded is less than the

proportional change in the price. A 10% increase in price resulting in a 2% drop in the quantity demanded of the profit

implies a product where the demand is said to be price inelastic, which means the elasticity is less than one(e1).


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Determine the price elasticity

y The quantity demanded for product is 1000 units at a price of 100/-.y The price declines to 90/- & the quantity demanded increases to 1500 units

Sol: - Edp= (Q2-Q1)/Q1/ (P2-P1)/P1

Q1=1000 units

Q2=1500 units

P1= 100/-

P2= 90/-

Edp= (1500-1000)/1000/(90-100)/100 = -5

Since Edp in -5, it means for a 10% change in price, there is a change in demand by 50% where the numerical value of

elasticity is more than one the demand is elastic in other words, the % of increase in quantity demanded is more than the

% change in decrease in price.

Significance of price elasticity of demand -

It is necessary that the trader should be aware of the impact of changes in the quantity demanded for a given change in

price. He can take a decision as to how much he can supply if he is aware of the likely change in quantity demanded as a

result of change in price.

2. Income elasticity of demand:-

Income elasticity of demand refers to the quantity demanded of a commodity in response to a given change in income of

the consumer.

Income elasticity is normally positive, which indicates that the consumer tends to buy more and more with every increase

in income.

Income elasticity of demand= Proportional change in quantity demanded for product X

Proportional change in income.

Edi= (Q2-Q1)/Q1/ (I2-I1)/I1

Q1= quantity demanded before change,

Q2= quantity demanded after change.


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I1= income before change.

I2= income after change.

Positive income elasticity indicates that the demand for the product rises more quickly them the rise in disposable

income. In other words, the demand is more responsive to a change in income.

Example: -

Elastic income demand (e>1)

Determine the income elasticity

y The quantity demanded for product is 1000 units at a price of 100/-.y The income declines to 80/- & the quantity demanded decreases to 700 units.

Sol: - Edp= (Q2-Q1)/Q1/ (I2-I1)/I1

Q1=1000 units

Q2=700 units

I1= 100/-

I2= 80/-

Edp= (700-1000)/1000/(80-100)/100 = 1.5

Since Edi in 1.5, it means for a 10% fall in income, there is a decrease in demand by 15%. Where the numerical value of

elasticity is more than one, the price demand is relatively elastic. In other words, the % of decrease in quantity demanded

is more than the % of fall in income. In times of depression, the incomes fall & consequently the demand for the goods

& services also decrease.

Similarly the inelastic income demand and unity income demand can be determined.

Significance of income elasticity of demand:-

In determining the effects of changes in business activity it is necessary for the trader to be aware of the income elasticity

of demand for given commodities. With the help pf income elasticity of demand, he can estimate the likely changes in

the demand for his product as a result of changes in the national income. Income elasticity will help us in knowing

whether a commodity is a superior good, normal good or an inferior good.

If the income elasticity is positive and greater than one, it is a superior good. The superior goods such as automobiles

and refrigerators can be located where high income group customers find it convenient to shop. If the income elasticity is


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positive and less than or equal to one, it is a normal good. If the income elasticity is negative, it is an inferior good.

Knowledge of the nature of goods help in allocating advertising budget.

3. Cross elasticity of demand:-

Cross elasticity of demand refers to the quantity demanded of a commodity in response to a change in the price of a

related good, which may be substitute or compliment.

Cross elasticity of demand= proportional change in quantity demand for product X

Proportional changes in price of product X.

Edc= (Q2-Q1)/Q1/ (P2y-P1y)/P1y.

Q1= quantity demanded before change.


P1y= price before change

P2y= price after change.

Example: -

Inelastic cross demand (e


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Edp= (1200-1000)/1000/(30-20)/20 = 0.4

Since Edp in 0.4, it means for a 10% increase in price, there is an increase in demand by 4%. Where the numerical

value of elasticity is less than one, the cross demand is relatively inelastic. In other words, the % increase in quantity

demanded is less than the % of increase in price of related good say sugar.

Sugar and coffee are compliments. The increase in price of sugar has shown its impact on the demand for coffee by

marginalizing the % of increase. Similarly, the elastic cross demand (where e>1) and unity cross demand (where e=1) can

be determined.

Significance of cross elasticity of demand:-

Knowledge of cross elasticity of demand helps a firm to estimate the likely effect of pricing decision of its traders dealing

in related products on sales. It also helps in defining industry.

4. Advertising elasticity:-

It refers to increase in the sales revenue because of change in the advertising expenditures. In other words, there is a

direct relationship between the amount of money spent on advertising and its impact on sales. Advertising elasticity is

always positive.

Advertising elasticity= Proportionate change in quantity demanded for product X

Proportionate change in advertisement costs.

Eda= (Q2-Q1)/Q1/ (A2-A1)/A1

Q1= quantity demanded before change.


A1= amount spent on advertisement before change.

A2= amount spent on advertisement after change

Example 6:-

Elastic advertising demand (e>1)

Determination of cross elasticity

y The quantity demanded for a product is 100000 per day at a monthly advertising budget of 10000/-.y The monthly advertising budget is slashed to 5000/- & the quantity demanded will fall down to 30000 units per

day.


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Sol: - Eda= (Q2-Q1)/Q1/ (A2-A1)/A1.

Q1=100000 units

Q2= 30000 units

A1= 10000/-

A2= 5000/-

Eda= (30000-100000)/100000/(5000-10000)/10000 = 1.4

Since Eda in 1.4, it means for a 10% decrease in advertisement budget, there is a decrease in demand by 14%. Where

the numerical value of elasticity is more than one, the advertising elasticity is relatively elastic. In other words, the %

decrease in advertising budget is less than the % of decrease in the quantity demanded.

Similarly, the inelastic advertising demand (where e what do you understand by demand forecasting; explain different methods of demand forecasting?

Ans:-Forecasting a demand is not an easy exercise. It may be easy only in the case of a very few products or services.

Where the demand for the product does not change from time to time or competition is not significant. It may be

relatively easy to forecast demand for a particular product or service. In a majority of the cases, market demand in

general and company demand in particular change from year to year. in such a case, the determining factor for

marketing success is only a good forecasting technique. The more the demand is sensitive, the more important it is to

forecast it accurately. this calls for an elaborate forecasting process.

There are many methods of forecasting demand. The different methods of forecasting demand can be grouped under

(a) survey methods (b) statistical methods.

1. Survey methods.

(a) Survey of buyer intentions

-census method

-sample method

(b) Sales force opinion method


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2. Stastical methods.

(a) Trend projection method.

- Trend line by observation.

- Least square method.

- Time series analysis.

- Moving averages method.

- Exponential smoothing.

(b) Barometric techniques.

(c) Test marketing.

(d) Correlation and regression methods.

3. Other methods.

(a) Expert opinion method.

(b) Test marketing.

(c) Controlled experiments.

(d) Judgment approach.

1. Survey methods

(a) Survey of buyers intentions: - to anticipate what buyers are likely to do under a given set of circumstances, a most

useful source of information would be the buyers themselves. It is better to draw a list of all potential buyers, approach

each buyer to ask how much does he plans to buy of the given product at a given point of time under particular

conditions. This is the most effective method because the buyer is the ultimate decision maker and we are collecting the

information directly from him.

(b) Sales force opinion:- the sales people are those who are in constant touch with the main and large buyers of a

particular market, and hence they constitute another valid source of information about the likely sales of a product. The

sales force is capable of assessing the likely reactions of the customers of their territories quickly, given the companys

marketing strategy. It is less costly as the survey can be conducted instantaneously through telephone, fax or video-

conferencing and so on. The data, thus collected, forms another valid source of reliable information.


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2. Stastical Methods

For forecasting the demand for goods and services in the long-run, statistical and mathematical methods are used

considering the past data.

(a)Trend Projection Methods: - These methods dispense with the need for costly market research because the necessary

information is often already available in company files in terms of different time periods, that is a time series data. There

are five main techniques of mechanical extrapolation. In extrapolation, it is assumed that existing trend will maintain all

through.

- Trend line by observation.

- Least square method.

- Time series analysis.

- Moving averages method.

- Exponential smoothing.

(b) Barometric techniques: - where forecasting based on time series analysis or extrapolation may not yield significant

results, barometric techniques can be made use of. Under the barometric technique, one set of data is used to predict

another set. In other words, to forecast demand for a particular product or service, use some other relevant indicator of

future demand.

(c)Simultaneous Equation Method: - In this method all variables are simultaneously considered, with the conviction that

every variable influences the other variables in an economic environment. Hence, the set of equations equal the number

of dependent variable which is also called endogenous variables. In other words, it is a system of n equations with n

unknowns. It can be solved the moment the model is specified because it covers all the unknown variables; it is also

called complete systems approach to demand forecasting.

(d)Correlation and regression methods: - these are statistic techniques.

Correlation describes the degree of association between two variables such as sales and advertisement expenditure.

When the two variables tend to change together, then they are said to be, correlated.

In regression analysis, an equation is estimated which best fits in the sets of observations of dependent and independent

variables. The best estimate of the true underlying relationship between variables is thus generated.

Other Methods


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These are some other methods of demand forecasting which are different from survey and statistical methods.

(a) Expert opinion

(b) Test marketing

(c) Controlled Experiments

(d) Judgemental approach

Q5> define production function, how can a producer find it useful, illustrate?

Ans:-

Production function is defined as a technical relationship between a given set of inputs and the possible output from it. It

is a function that defines the maximum amount of output that can be produced with a given set of inputs.

Production function is more concerned with physical aspects of production. It is the concern of the engineer rather than

that of the manager to know how much can be production with given set on inputs. Production function enables us to

understand how best we can make use of technology to its greatest potential.

The inputs for any product are land, labour, capital, organization and technology. In other words the production here is

the function of these five variable inputs. Mathematically, this is expressed as

Q= f (L1, L2, C, O, T)

Where Q is quantity of production, f explains the function, that is, the type of relation between inputs and outputs,

L1,L2,C,O,T refer to land, labour, capital, organization and technology respectively. These inputs have been taken in

conventional terms. In reality, materials also can be included in a set of inputs.

A manufacture has to make a choice of production function by considering his technical knowledge, the process of

various factors of production and his efficiency level to manage. He should not only select the factors of production but

also should work out the different permutations and combinations which will mean lower cost of inputs for a given level

of production.

A production function as outlined above depicts the relationship between the inputs and the output in general. In a

specific situation, some factors of production may be important and the relative importance of the factors depends upon

the final product to be manufactured. For example, in case of the software industry, land is not an input factor as

significant as that in case on agricultural product.


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In the case of an agricultural product, increasing the other factors of production can increase the production; but beyond

a point, increased output can be had only with increased use of agricultural land. Investment in land forms a significant

portion of the total cost of production for output; whereas, in the case of software industry, other factors such as

technology, capital, management and others become significant. With change in industry and the requirements, the

production function also needs to be modified to suit to the situation.

Q8> Differentiate between perfect and imperfect markets?

Ans:-

Perfect Market:

i. it is a market where demand and supply forces operate freely.ii. It is a market where there is no restriction on the entry into the market.iii. In this market large number of buyers and sellers exist.iv. In this market, price elasticity of demand is infinite.i. In a perfect competitive market, all the firms produce homogenous products and accept those prices which have

been determined by market forces of demand supply.

Imperfect Market:

i. It is a market where demand and supply forces do not operate freely.ii. In this market there is a restriction on the entry into the market.iii. Here, only one or few sellers are present and covers entire market.iv. Here, price elasticity of demand is relatively very less.v. Here, there is no such competition exists.vi. Here, also all the firms produce quite similar products and set prices on their own.

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Mefa Notes 1