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Managerial EconomicsManagerial Economics
DouglasDouglas - “Managerial - “Managerial economics is .. the application of economics is .. the application of economic principles and economic principles and methodologies to the decision-methodologies to the decision-making process within the firm making process within the firm or organization.”or organization.”
SalvatoreSalvatore - “Managerial - “Managerial economics refers to the economics refers to the application of economic theory application of economic theory and the tools of analysis of and the tools of analysis of decision science to examine how decision science to examine how an organisation can achieve its an organisation can achieve its objectives most effectively.”objectives most effectively.”
Positive Economics:-Positive Economics:- Derives useful theories with Derives useful theories with
testable propositions about testable propositions about WHAT IS.WHAT IS.
Normative Economics:-Normative Economics:- Provides the basis for value Provides the basis for value
judgements on economic judgements on economic outcomes.WHAT SHOULD BEoutcomes.WHAT SHOULD BE
Scope of Managerial Scope of Managerial EconomicsEconomics
Utility analysisUtility analysis Demand and supply analysisDemand and supply analysis Production and cost analysisProduction and cost analysis Market analysisMarket analysis PricingPricing Investment decisionsInvestment decisions Game theory Game theory
Basic problems of an Basic problems of an economyeconomy
What to produce( Choice)What to produce( Choice) How to produce ( Technology)How to produce ( Technology) Whom to produce ( Distribution)Whom to produce ( Distribution)
Fundamental ConceptsFundamental ConceptsManagerial EconomicsManagerial Economics
Marginal PrincipleMarginal Principle Opportunity cost principleOpportunity cost principle Incremental PrincipleIncremental Principle Discount PrincipleDiscount Principle Time PerspectiveTime Perspective
Demand AnalysisDemand Analysis
Demand – Demand –
Desire + ability to pay + Desire + ability to pay + willingness to paywillingness to pay
Demand is relative term –Demand is relative term –
PricePrice
TimeTime
PlacePlace
Determinants of demandDeterminants of demand
PricePrice IncomeIncome Taste, preference and fashionTaste, preference and fashion Prices of related goodsPrices of related goods Government policyGovernment policy Custom and traditionCustom and tradition AdvertisementAdvertisement
Law of demandLaw of demand
If other things remain constant, If other things remain constant, when price increases demand when price increases demand contracts and when price contracts and when price decreases demand expands. Price decreases demand expands. Price and demand are inversely and demand are inversely proportionate.proportionate.
D = a - bPD = a - bP
Why demand curve slopes Why demand curve slopes downwardsdownwards
Law of diminishing marginal Law of diminishing marginal utilityutility
Income effectIncome effect Substitution effectSubstitution effect Multiplicity of usesMultiplicity of uses
Market Demand CurveMarket Demand Curve
Shows the amount of a good that will Shows the amount of a good that will be purchased at alternative prices.be purchased at alternative prices.
Law of DemandLaw of Demand The demand curve is downward sloping.The demand curve is downward sloping.
Quantity
D
Price
Exception to the law of Exception to the law of demanddemand
Giffen GoodsGiffen Goods Prestigious goodsPrestigious goods Buyers illusionsBuyers illusions Necessary goodsNecessary goods Brand loyaltyBrand loyalty
ElasticityElasticity
Elasticity is a measure of Elasticity is a measure of responsiveness of one variable to responsiveness of one variable to another variable.another variable.
Can involve any two variables.Can involve any two variables. An An elastic elastic relationship is relationship is
responsive.responsive. An An inelasticinelastic relationship is relationship is
unresponsive.unresponsive.
Types of Elasticity of Types of Elasticity of demanddemand
Price Elasticity of demandPrice Elasticity of demand Income elasticity of demandIncome elasticity of demand Cross Elasticity of demandCross Elasticity of demand Promotional Elasticity of demandPromotional Elasticity of demand
Price elasticity: Price elasticity: pp==%%Q/%Q/%PP
Causality: denominator numerator!Causality: denominator numerator! An An elasticelastic response is one where response is one where
numerator is greater than denominator.numerator is greater than denominator. i.e., i.e., %%Q>%Q>%P so P so EEpp
Imagine extreme example.Imagine extreme example.
An An inelasticinelastic response is one where response is one where numerator is smaller than denominator.numerator is smaller than denominator. i.e., i.e., %%Q<%Q<%P so P so EEpp
Again, imagine extreme example.Again, imagine extreme example.
Look at the ExtremesLook at the Extremes
Perfectly Elastic DPerfectly Elastic D
EEpp infiniteinfinite
Perfectly Inelastic Perfectly Inelastic DD
P
Q
P
Q
Ep 0
D
D
Relatively Elastic vs. Relatively Elastic vs. Inelastic Demand CurvesInelastic Demand Curves
Q1 Q2 Q2’
P1
P2
D’D
D’ is relatively more elasticthan D
P
Q
Point Elasticity FormulaPoint Elasticity Formula
Point elasticityPoint elasticity Point elasticity is Point elasticity is
responsiveness at a responsiveness at a point along the point along the demand functiondemand function
EEpp Q/QQ/Q1 1
P/PP/P11
simplifying:simplifying:EEpp
Q/Q/P)* PP)* P1 1 /Q/Q1 1
Price (Rs.)Price (Rs.)
QQ1
P1
D
Point Elasticity FormulaPoint Elasticity Formula
Point elasticityPoint elasticity Point elasticity is Point elasticity is
responsiveness at responsiveness at a point along the a point along the demand functiondemand function
EEpp Q/QQ/Q1 1
P/PP/P11
simplifying:simplifying:EEpp
Q/Q/P)* PP)* P1 1 /Q/Q1 1
Price (Rs.)Price (Rs.)
QQ1
P1
D
Example: Q=56-0.002*PExample: Q=56-0.002*P
Point elasticityPoint elasticityEEpp
Q/Q/P)* PP)* P1 1 /Q/Q11
SupposeSuppose P=17000P=17000 Q=56-0.002*17000Q=56-0.002*17000 Q=56-34=22Q=56-34=22 Plug into equation gives:Plug into equation gives:
EEpp -0.002)* 17000-0.002)* 17000
/22 /22 EEpp
=-34/22=-1.54=-34/22=-1.54
Price (Rs)Price (Rs)
Q22
17k
D
Arc ElasticityArc Elasticity
Briefly, arc elasticity is simply Briefly, arc elasticity is simply an average elasticity along an average elasticity along
a range of the demand a range of the demand curve.curve.
Arc Elasticity FormulaArc Elasticity Formula
Arc elasticity:Arc elasticity:
Responsiveness along a Responsiveness along a range of D. functionrange of D. function
EEpp Q/((QQ/((Q11++ QQ22)/2))/2)
P/((PP/((P11++ PP22)/2))/2)
simplifying:simplifying:EEppQ/Q/P)*((PP)*((P11+P+P22)/(Q)/(Q11+Q+Q22))))
Price ($)Price ($)
QQ2
P2
P1
Q1
Avg. responsiveness
D
Example Q=56-0.002*PExample Q=56-0.002*P
Arc elasticityArc elasticityEEpp
Q/Q/P)*((PP)*((P11+P+P22)/(Q)/(Q11+Q+Q22))))
Look atLook at P range 16k - P range 16k - 17k 17k
Q=56-0.002*17000Q=56-0.002*17000 Q=56-34=22Q=56-34=22 Plug into equation Plug into equation
gives:gives:EEpp
-0.002)*(33000/46)-0.002)*(33000/46)
EEpp =-66/46=-1.43=-66/46=-1.43
Price ($)Price ($)
Q22
17k
D
24
16k
Factors influence Price Factors influence Price elasticity of demandelasticity of demand
Nature of commodityNature of commodity Availability of substituteAvailability of substitute Multiplicity of usesMultiplicity of uses HabitHabit Proportion of income spentProportion of income spent Price rangePrice range
Managerial Applications of Managerial Applications of Price elasticity of demandPrice elasticity of demand
Pricing DecisionPricing Decision Fiscal policyFiscal policy Labour marketLabour market International tradeInternational trade
Income Elasticity of DemandIncome Elasticity of Demand
Recall demand function is:Recall demand function is:Q=f(P,Q=f(P,I,PI,Prelatedrelated,Tastes,Buyers,Expectations,Tastes,Buyers,Expectations......))
Change in I causes Change in I causes shiftshift in demand. in demand. Size of shift depends on income elasticity.Size of shift depends on income elasticity. EEI I Q/Q/II Focus again on point formula.Focus again on point formula. Value of EValue of EII determines type of good. determines type of good.
Values for Income Values for Income Elasticity (Elasticity ())
Sign indicates normal or inferiorSign indicates normal or inferior
EEII>0 implies normal good.>0 implies normal good.
EEII<0 implies inferior good.<0 implies inferior good. Normal goods may be Normal goods may be necessitynecessity or or
luxuryluxury.. If EIf EII>1 then this is luxury (responsive >1 then this is luxury (responsive
to income).to income). If 0<EIf 0<EII<1 then this is necessity <1 then this is necessity
(unresponsive to income).(unresponsive to income).
Cross Price Elasticity Cross Price Elasticity (E(EXYXY))
QQXX=f(P=f(PXX , ,I,PI,PYY,Tastes, Buyers,Expectations,Tastes, Buyers,Expectations......))
Change in Change in PPYY causes causes shiftshift in demand for X. in demand for X. Size of shift depends on cross-price elasticity.Size of shift depends on cross-price elasticity. EEXYXYQQXX / /PPYY
Sign indicates relationship between two Sign indicates relationship between two goodsgoods
EEXYXY>0 implies goods are substitutes. >0 implies goods are substitutes.
EEXYXY<0 implies goods are complements. <0 implies goods are complements.
OBJECTIVES OF SHORT TERM DEMAND OBJECTIVES OF SHORT TERM DEMAND FORECASTINGFORECASTING
Production planning Production planning Evolving sales policy Evolving sales policy Fixing sales targetsFixing sales targets Determining price policyDetermining price policy Inventory controlInventory control Determining short-term financial planningDetermining short-term financial planning
OBJECTIVES OF LONG-TERM DEMAND OBJECTIVES OF LONG-TERM DEMAND FORECASTINGFORECASTING
BUSINESS PLANNINGBUSINESS PLANNING
MANPOWER PLANNINGMANPOWER PLANNING
LONG-TERM FINANCIAL PLANNINGLONG-TERM FINANCIAL PLANNING
METHODS OF DEMAND FORECASTINGMETHODS OF DEMAND FORECASTING
Survey methodsSurvey methods:: Consumer interviewsConsumer interviews Opinion pollOpinion poll Experts opinionExperts opinion End-use methodEnd-use method
Statistical methods:Statistical methods: Trend AnalysisTrend Analysis Regression AnalysisRegression Analysis
Market Supply CurveMarket Supply Curve
The supply curve shows the amount The supply curve shows the amount of a good that will be produced at of a good that will be produced at alternative prices.alternative prices.
Law of SupplyLaw of Supply The supply curve is upward slopingThe supply curve is upward sloping
Price
Quantity
S0
Supply ShiftersSupply Shifters
Input pricesInput prices Technology or Technology or
government government regulationsregulations
Number of firmsNumber of firms Substitutes in Substitutes in
productionproduction TaxesTaxes Producer Producer
expectationsexpectations
The Supply FunctionThe Supply Function
An equation representing the supply An equation representing the supply curve:curve:
QQxxS S = f(P= f(Px x ,, PPR R ,W, H,),W, H,)
QQxxS S = quantity supplied of good X. = quantity supplied of good X.
PPx x = price of good X.= price of good X.
PPR R = price of a related good = price of a related good W = price of inputs (e.g., wages)W = price of inputs (e.g., wages) H = other variable affecting supplyH = other variable affecting supply
Change in Quantity Change in Quantity SuppliedSupplied
Price
Quantity
S0
20
10
B
A
5 10
A to B: Increase in quantity supplied
Price
Quantity
S0
S1
8
5 7
S0 to S1: Increase in supply
Change in SupplyChange in Supply
6
Producer SurplusProducer Surplus The amount producers receive in excess of the The amount producers receive in excess of the
amount necessary to induce them to produce the amount necessary to induce them to produce the good.good.
Price
Quantity
S0
Producer Surplus
Q*
P*
Market EquilibriumMarket Equilibrium
Balancing supply and Balancing supply and demanddemand QQxx
S S = Q= Qxxdd
Steady-stateSteady-state
Price
Quantity
S
D
8
Equilibrium Price and Equilibrium Price and quantity quantity
7
Price
Quantity
S
D
5
6 12
Shortage12 - 6 = 6
6
If price is too low...If price is too low...
7
Price
Quantity
S
D
9
14
Surplus14 - 6 = 8
6
8
8
If price is too high…If price is too high…
7