November 22, 2012

[Managerial Economics]

Unit-1
Introduction The major function of ME in a business enterprise is decision making & future planning. Decision making means the process of selecting one of the best courses of action among numbers of alternatives & future planning. The resources are limited in an organization like Men, Machine, Money and Materials so it s difficult to use in alternates for effective & efficient utilization. !ne effective decision is made about the particular goal to be achieved, plans as to production, pricing, capital, labour etc., are prepared. Definition of Managerial Economics Managerial Economics can be defined as amalgamation of economic theory with business practices so as to ease decision-making and future planning by management. !ccording to Mc "air # Meriam Managerial Economics consists of the use of economics models of thought to analyse business situation. !ccording to $pencer # $iegelman Managerial Economics is the integration of economic theory with the business practices for the purpose of facilitating decision making # forward planning by management.

%haracteristics of the Managerial Economics

Managerial Economics consists of some of the useful characteristics are as follo"s# $ %. Managerial Economics is micro$economic in character. &. Managerial Economics considers the concept and principles, "hich are kno"n as 'Theory of the firm( or 'Economics of the firm(. ). Managerial Economics is pragmatic. *. Managerial Economics belongs to normative economics rather than positive economics +also sometimes kno"n as Descriptive Economics,. -n other "ords, it s prescriptive rather than descriptive. .. Decision Making at Managerial /evel.

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November 22, 2012

[Managerial Economics]

"ature # $cope of Managerial Economics "atures of Managerial Economics are as follows( Managerial economics is concerned "ith the application of economic concepts and analysis to the problem of formulating rational managerial decisions. There are four groups of problems in both decision$making and for"ard planning. 1. )esource !llocation 0care resources have to be used "ith utmost efficiency to get optimal results. These include production programming, problem of transportation, etc. *. In+entory and ,ueuing &roblem -nventory problems involve decisions about holding of optimal levels of stocks of ra" materials and finished goods over a period. These decisions are supply conditions, 1ueuing problems involve decisions about installation of additional machines or hiring of e2tra labour in order to balance the business lost by not undertaking these activities. -. &ricing &roblems 3i2ing prices for the products of the firm is an important part of the decision$making process. 4ricing problems involve decisions regarding various methods of pricing to be adopted. .. In+estment &roblems 3or"ard planning involves investment problems. These are problems of allocating scarce resources overtime. 3or e2ample, investing in ne" plants, ho" much to invest, sources of funds etc. 0tudy of Managerial economics essentially involves the analysis of certain major subjects like#

Demand analysis and methods of forecasting. 5ost analysis 4ricing theory and policies 4rofit analysis "ith special reference to 6reak$Even point 5apital budgeting for investment decisions
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November 22, 2012

[Managerial Economics]

The business firm and objectives 5ompetition

Demand analysis and forecasting help a manager in the earliest stage in choosing the product and in planning output levels. 7 study of demand elasticity goes a long "ay in helping the firm to fi2 prices for its products.

$cope of Managerial Economics ME deals "ith the use & allocation of scare resources in an effective & efficient manner that minimize the cost. 7s "e all kno" & discussed that managerial economics is different from macroeconomics, so that "e can say that managerial economics deals "ith the managerial issues using micro economics. 8herever there are scarce resources, managerial economics ensures that managers make effective and efficient decisions concerning customers, suppliers, competitors as "ell as "ithin an organization. The fact of scarcity of resources gives rise to three fundamental 1uestions$ a. 8hat to produce9 b. :o" to produce9 c. 3or "hom to produce9 Managerial Economics is not only applicable to profit$making business organizations, but also to non$ profit organizations such as hospitals, schools, government agencies, etc. Managerial economics to a certain degree is prescriptive in nature as it suggests course of action to a managerial problem. 4roblems can be related to various departments in a firm like production, accounts, sales, etc. %. Demand decision &. 4roduction decision ). Theory of e2change or 4rice Theory *. Theory of 4rofit .. Theory of 5apital and -nvestment ;. Environmental issues $ignificance/ Importance of Managerial Economics in Decision Making

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November 22, 2012

[Managerial Economics]

7 managerial economist helps the management by using his analytical skills and highly developed techni1ues in solving comple2 issues of successful decision$making and future advanced planning. Managerial economics, or business economics, is a division of microeconomics that focuses on applying economic theory directly to businesses. The application of economic theory through statistical methods helps businesses make decisions and determine strategy on pricing, operations, risk, investments and production. The overall role of managerial economics is to increase the efficiency of decision making in businesses to increase profit. The role of economics in management can be summarized as follo"s# %. 0tudy of economic pattern at macro$level and analysis its significance to the organization and its functioning &. E2amine ho" the changing environment is profitable to ones organization in the best possible "ay ). :elps is making sound decision by choosing the best available alternative in case of choices. *. Many managerial economic tools and analysis models are used to help make investing decisions both for corporations and savvy individual investors. These tools are used to make stock market investing decisions and decisions on capital investments for a business. .. 7ssists businesses in determining pricing strategies and appropriate pricing levels for their products and services. 0ome common analysis methods are price discrimination, value$based pricing and cost$plus pricing ;. 7ssists the management in the decisions pertaining to internal functioning of a firm such as changes in price, investment plans, type of goods <services to be produced, inputs to be used, etc= >. 7nalyse changes in macroeconomic indicators such as national income, population, business cycles, and their possible effect on the firm s functioning. ?. The most significant function of a managerial economist is to conduct a detailed research on industrial market. @. :e also provides management "ith economic information such as ta2 rates, competitor s price and product, etc. They give their valuable advice to government authorities as "ell. %A. Bncertainty e2its in every business and managerial economics can help reduce risk through uncertainty model analysis and decision$theory analysis. :eavy use of statistical "otes are designed as per U&'U $yllabus
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November 22, 2012

[Managerial Economics]

probability theory helps provide potential scenarios for businesses to use "hen making decisions. 0undamental %oncepts of Managerial Economics Economic theory offers a variety of concepts and analytical tools "hich can be of considerable assistance to the managers in his decision making practice. These tools are helpful for managers in solving their business related problems. %. !pportunity cost &. -ncremental principle ). 4rinciple of the time perspective *. Discounting principle .. E1ui$marginal principle 11 2pportunity cost principle( 6y the opportunity cost of a decision is meant the sacrifice of alternatives re1uired by that decision. 3or e.g. a, The opportunity cost of the funds employed in one s o"n business is the interest that could be earned on those funds if they have been employed in other ventures. b, The opportunity cost of using a machine to produce one product is the earnings forgone "hich "ould have been possible from other products.

-t s clear no" that opportunity cost re1uires ascertainment of sacrifices. -f a decision involves no sacrifices, its opportunity cost is nil. 3or decision making opportunity costs are the only relevant costs. *1 Incremental principle( -t is related to the marginal cost and marginal revenues, for economic theory. -ncremental concept involves estimating the impact of decision alternatives on costs and revenue, emphasizing the changes in total cost and total revenue resulting from changes in prices, products, procedures, investments or "hatever may be at stake in the decisions. The t"o basic components of incremental reasoning are "otes are designed as per U&'U $yllabus
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November 22, 2012

[Managerial Economics]

%. -ncremental cost &. -ncremental Cevenue The incremental principle may be stated as under# '7 decision is obviously a profitable one if D

it increases revenue more than costs it decreases some costs to a greater e2tent than it increases others it increases some revenues more than it decreases others and it reduces cost more than revenues(

-1 &rinciple of 'ime &erspecti+e Managerial economists are also concerned "ith the short run and the long run effects of decisions on revenues as "ell as costs. The very important problem in decision making is to maintain the right balance bet"een the long run and short run considerations. 3or e2ampleE 0uppose there is a firm "ith a temporary idle capacity. 7n order for .AAA units comes to management s attention. The customer is "illing to pay Cs *<$ unit or Cs.&AAAA<$ for the "hole lot but not more. The short run incremental cost+ignoring the fi2ed cost, is only Cs.)<$. Therefore the contribution to overhead and profit is Cs.%<$ per unit +Cs..AAA<$ for the lot,.

.1 Discounting &rinciple( !ne of the fundamental ideas in Economics is that a rupee tomorro" is "orth less than a rupee today. 0uppose a person is offered a choice to make bet"een a gift of Cs.%AA<$ today or Cs.%AA<$ ne2t year. Faturally he "ill choose Cs.%AA<$ today. This is true for t"o reasons$ i, The future is uncertain and there may be uncertainty in getting Cs. %AA<$ if the present opportunity is not availed of ii, Even if he is sure to receive the gift in future, today s Cs.%AA<$ can be invested so as to earn interest say as ?G so that one year after Cs.%AA<$ "ill become %A? 31 E4ui 5 marginal &rinciple(

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November 22, 2012

[Managerial Economics]

This principle deals "ith the allocation of an available resource among the alternative activities. 7ccording to this principle, an input should be so allocated that the value added by the last unit is the same in all cases. This generalization is called the e1ui$marginal principle. 0uppose, a firm has %AA units of labor at its disposal. The firm is engaged in four activities "hich need labors services, viz, 7, 6, 5 and D. it can enhance any one of these activities by adding more labor but only at the cost of other activities. 2b6ecti+es of a firm 5onventional theory of firm assumes to ma2imization of the profit is the sole objective of the business enterprises< firms. 6ut no" a days it s not only the objective of the firms includes more than one, some important objectives "hich are indulge in it other than profit ma2imization are as follo"s# $ %. Ma2imization of the firm s gro"th rate. &. Ma2imization of the use of Managerial 0kills. ). /ong run survival of the firms. *. Cisk avoidance & optimum utilization of scare & other useful resources. &rofit Ma7imi8ation( - 4rofit ma2imization means optimum utilization of resources & generate ma2imum profit. To an accountant '4rofit( means the e2cess of revenue over all paid out costs including both manufacturing and overhead e2penses. Economist s concept of profit is of '4ure 4rofit( called Heconomic profit or 'Iust profit(. 4ure profit is a return over and above opportunity cost, i. e. the income that a businessman might e2pect from the second best alternatives use of his resources. Ma7imi8ation of sales )e+enue( - The reason behind sales revenue ma2imization objectives is the division bet"een o"nership & management in business firms. This division gives managers an opportunity to set their goals other than profit ma2imization. -t helps to use the managerial functions effectively to ma2imize their sales revenue. The factors, "hich e2plain the pursuance of this goal by the managers are follo"ing#.

First: 0alary and others earnings of managers are more closely related to sales revenue than to profits Second: 6anks and financial corporations look at sales revenue "hile financing the corporation. Third: Trend in sales revenue is a readily available indicator of the performance of the firm.

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November 22, 2012

[Managerial Economics]

Ma7imi8ation of 0irms 9rowth rate( Managers ma2imize firm s balance gro"th rate subject to managerial & financial constrains balance gro"th rate defined as# J K JD D JC 8here JD K Jro"th rate of demand of firm s product & J CK gro"th rate of capital supply of capital to the firm. -n simple "ords, 7 firm gro"th rate is balanced "hen demand for its product & supply of capital to the firm increase at the same time. Ma7imisation of Managerial Utility function # The manager seeks to ma2imize their o"n utility function subject to the minimum level of profit. Manager s utility function is e2press as# BK f+0, M, -D, 8here 0 K additional e2penditure of the staff MK Managerial emoluments -D K Discretionary -nvestments The utility functions "hich manager seek to ma2imize include both 1uantifiable variables like salary and slack earningsE non$ 1uantifiable variables such as prestige, po"er, status, Iob security professional e2cellence etc. :ong run sur+i+al # market share( according to some economist, the primary goal of the firm is long run survival. 0ome other economists have suggested that attainment & retention of constant market share is an additional objective of the firm s. The firm may seek to ma2imize their profit in the long run through it is not certain. Entry$prevention and risk$avoidance, yet other alternative objectives of the firms suggested by some economists is to prevent entry$prevention can be# %. 4rofit ma2imization in the long run &. 0ecuring a constant market share ). 7voidance of risk caused by the unpredictable behavior of the ne" firms Unit-* Demand analysis( $Demand analysis is the method to analyse the desire of the consumer for particular product or service. -t s used to identify "ho "ants to purchase the given product or service, ho" much they are likely to pay for it.

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November 22, 2012

[Managerial Economics]

-n simple other "ords "e can say that it s the method to forecast the demand and "ant the consumers "ants to pay against the product or service. :aw of Demand( $The /a" of demand states that the relationship bet"een the demand & price are inversely proportional i.e. "hen the price of the product is increased then demand "ill be decreased as same "hen the price of the product is decreased then demand "ill be increased. ! microeconomic law that states that; all other factors being e4ual; as the price of a good or ser+ice increases; consumer demand for the good or ser+ice will decrease and +ice +ersa. Mathematically "e can e2press it as# $ LM Kf +4M, 8here# $ LM is the 1uantity demanded of M goods. 3 is the function of independent variable contained "ithin the parenthesis, & 4M is the price of M goods. :ence, in the above model, the function + , is a varying one i.e., the la" of demand postulates as the causal factor +independent variable, and is the dependent variable.

E7ceptions of law of demand

The la" of demand does not apply in every case and situation. The circumstances "hen the la" of demand becomes ineffective are kno"n as e2ceptions of the la". 0ome of these important e2ceptions are as under# $

%. &. ). *. .. ;. >.

Jiffen Joods. 5onspicuous 5onsumption. 5onspicuous Fecessities. -gnorance. Emergencies. 3uture 5hange in 4rices. 5hange in 3ashion.

1. 9iffen goods( 0ome special varieties of inferior goods are termed as Jiffen goods. 5heaper varieties of this category like bajra, cheaper vegetable like potato come under this category. 6ut potatoes constitute their staple food. 8hen the price of potato increased, after purchasing potato they did not have so many surpluses to buy meat. 0o the rise in price of potato compelled people to buy more potato and thus raised the demand for potato. This is against the la" of demand. This is also kno"n as Jiffen parado2.

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November 22, 2012

[Managerial Economics]

2. %onspicuous %onsumption(

7 fe" goods like diamonds etc. are purchased by the rich and "ealthy sections of the society. The prices of these goods are so high that they are beyond the reach of the common man. The higher the price of the diamond the higher the prestige value of it. 0o "hen price of these goods falls, the consumers think that the prestige value of these goods comes do"n. 0o 1uantity demanded of these goods falls "ith fall in their price. 0o the la" of demand does not hold good here.

-.

%onspicuous necessities( 5ertain things become the necessities of modern life. 0o "e have to purchase them despite their high price. The demand for T.N. sets, automobiles and refrigerators etc. has not gone do"n in spite of the increase in their price. These things have become the symbol of status.

.. Ignorance( 7 consumer s ignorance is another factor that at times induces him to purchase more of the commodity at a higher price. This is especially so "hen the consumer is haunted by the phobia that a high$priced commodity is better in 1uality than a lo"$priced one. 3. Emergencies( Emergencies like "ar, famine etc. negate the operation of the la" of demand. 7t such times, households behave in an abnormal "ay. :ouseholds accentuate scarcities and induce further price rises by making increased purchases even at higher prices during such periods. During depression, on the other hand, no fall in price is a sufficient inducement for consumers to demand more. <. 0uture changes in prices( :ouseholds also act speculators. 8hen the prices are rising households tend to purchase large 1uantities of the commodity out of the apprehension that prices may still go up. 8hen prices are e2pected to fall further, they "ait to buy goods in future at still lo"er prices. 0o 1uantity demanded falls "hen prices are falling. =. %hange in fashion( 7 change in fashion and tastes affects the market for a commodity. 8hen a broad toe shoe replaces a narro" toe, no amount of reduction in the price of the latter is sufficient "otes are designed as per U&'U $yllabus
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November 22, 2012

[Managerial Economics]

to clear the stocks. 6road toe on the other hand, "ill have more customers even though its price may be going up. The la" of demand becomes ineffective. Determinants of Demand 8hen price changes, 1uantity demanded "ill change. That is a movement along the same demand curve. 8hen factors other than price changes, demand curve "ill shift. These are the determinants of the demand curve. -ncome 5onsumer 4references Fumber of 6uyers 4rice Celated Joods E2ception of future

1. Income( 7 rise in a person s income "ill lead to an increase in demand +shift demand curve to the right,, a fall "ill lead to a decrease in demand for normal goods. Joods "hose demand varies inversely "ith income are called inferior goods +e.g. :amburger :elper,. *. %onsumer &references( 3avorable change leads to an increase in demand, unfavorable change lead to a decrease. -. "umber of >uyers( the more buyers lead to an increase in demandE fe"er buyers lead to decrease. .. &rice of related goods( a. 0ubstitute goods +those that can be used to replace each other,# price of substitute and demand for the other good are directly related. E2ample# -f the price of coffee rises, the demand for tea should increase. b. 5omplement goods +those that can be used together,# price of complement and demand for the other good are inversely related. E2ample# if the price of ice cream rises, the demand for ice$cream toppings "ill decrease. 3. E7pectation of future( a. 3uture price# consumers current demand "ill increase if they e2pect higher future pricesE their demand "ill decrease if they e2pect lo"er future prices.

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November 22, 2012

[Managerial Economics]

b. 3uture income# consumers current demand "ill increase if they e2pect higher future incomeE their demand "ill decrease if they e2pect lo"er future income.

Elasticity of Demand( - -t refers to ho" sensitive the demand for a product is to changes in other economic variables. -t s helpful to measure the demand affected if another factor changes +economic variable,, it s very important for setting the prices as it s helpful to ma2imize the profit of the organization. The degree to "hich demand for a good or service varies "ith its price. Formally, sales increase "ith drop in prices and decrease "ith rise in prices. 7s a general rule, appliances, cars, confectionary and other non$essentials sho" elasticity of demand "hereas most necessities +food, medicine, basic clothing, sho" inelasticity of demand +do not sell significantly more or less "ith changes in price,, also called price demand elasticity. 0ee also cross price elasticity of demand. &rice Elasticity of Demand( $ 7 measure of the responsiveness of the 1uantity demanded of a good to a change in its price. -t is calculated as# 7n important aspect of a productOs demand curve is ho" much the 1uantity demanded changes "hen the price changes. The economic measure of this response is the price elasticity of demand. 0actors affecting price elasticity of demand

'he number of close substitutes D the more close substitutes there are in the market, the more elastic is demand because consumers find it easy to s"itch. Degree of necessity or lu7ury( lu2ury products tend to have greater elasticity. 0ome products that initially have a lo" degree of necessity are habit forming and can become PnecessitiesP to some consumers. &roportion of the purchaser?s budget consumed by the item( products that consume a large portion of the purchaserOs budget tend to have greater elasticity. 'ime period considered( elasticity tends to be greater over the long run because consumers have more time to adjust their behaviour. &ermanent or temporary price change( a one$day sale "ill elicit a different response than a permanent price decrease.
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November 22, 2012

[Managerial Economics]

Income Elasticity of Demand( $ -t the measures the rate of response of 1uality demand due to a change +raise or lo"ering, in a consumer income. 7 measure of the relationship bet"een changes in the 1uantity demanded for a particular good and a change in real income. -ncome elasticity of demand is an economics term that refers to the sensitivity of the 1uantity demanded for a certain product in response to a change in consumer incomes. The formula for calculating income elasticity of demand is# Income Elasticity of Demand @ A change in 4uantity demanded / A change in income 3or e2ample, if the 1uantity demanded for a good increases for %.G in response to a

%AGincrease in income, the income elasticity of demand "ould be 13A / 1BA @ 1.3. %ross Elasticity of Demand( $7n economic concept that measures the responsiveness in the 1uantity
demand of one good "hen a change in price takes place in another good. The measure is calculated by taking the percentage change in the 1uantity demanded of one good, divided by the percentage change in price of the substitute good#

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November 22, 2012

[Managerial Economics]

5ross elasticity of demand is synonymous to Pcross price elasticity of demandP.

!d+ertising Elasticity of Demand( $7ED measures degree of change in demand brought

about by change in advertising e2penditure. Definition( &roportionate change in demand brought about by a unit change in ad+ertising e7penditure. !ED can be e7pressed as 7ED K + Q D2,<+ Q 7E, 2 7E<D2

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November 22, 2012

[Managerial Economics]

8here, D2 K !riginal +initial, Demand for commodity 2 QD2 K 5hange in demand for 2 7E K !riginal 7dvertising E2penditure Q 7E K change in 7dvertising E2penditure -t can also be e2pressed as 7ED K +G change in D2,<+G change in 7E, )elati+ely Elastic Demand -f 7ED R %, it is relatively elastic demand. -t means that demand is more sensitive to the advertising e2penditure and proportionately giving more than proportionate increase in demand. 4romotional e2penditure is e2erting more than proportionate effect on demand e.g. 8hen this soft drink company H 5ool H has raised its promotional e2penditure by &.G, demand may rise by .AG 7ED K G change in D2G change in 7E K .A G&. G K & 7ED K & +R %, Celatively Elastic Demand, )elati+ely Inelastic Demand -f 7ED S %, it is relatively inelastic demand. -t means that change in advertising e2penditure brings about less than proportionate change in demand. E.g. "hen this soft drink company H5ool spends &.G additional e2penditure on promoting its ne" product, demand rises only by .G 7ED K G change in D2G change in 7E K . G&. G K A.& 7ED K & +S %, Celatively -nelastic Demand, &erfectly Inelastic Demand -f 7ED K A it is 4erfectly -nelastic demand. -t means that increase in advertising e2penditure has no effect at all on demand e.g. 8hen the company H 5ool H spends &.G additional e2penditure on advertising, its ne" product demand remains rigid or constant. -n such a case, advertising strategy is ineffective. 7ED K G change in D2G change in 7E K A G&. G K A 7ED K A +4erfectly -nelastic Demand, 0actors Influencing !ED "otes are designed as per U&'U $yllabus
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November 22, 2012

[Managerial Economics]

%. Type of product i.e. "hether the product is already e2isting or ne" product &.6rand name. ). Fumber of competitors and substitutes in the market. *. 0trategies of competitors ..3re1uency of advertisements. ;. Mode of advertisements. >. Time of advertisements. ?. !ther factors influencing demand like tastes, professions, income etc. !pplications / Uses of !ED %. :elps in evaluating success of adverting campaign. &. :elps the firms in deciding advertising e2penditure or budget. ). :elps in choosing more effective media for promotion. *. :elps in "ithdra"ing ineffective promotional campaigns. .. :elps in strategic management to respond to competitor s promotional policies. ;. :elps in building brands. :imitations of !ED %. Nalue of 7ED does not help in analyzing effect of advertising a single product. &. Difficult to analyze the effectiveness of promotional strategies at a particular period of time, especially "hen the campaigns are over a long period of time ).The 4urpose of campaigns may be to create brands, rather than only influencing size of demand. *7ED does not take into account effect of other factors influencing demand. Uses/ Importance of Elasticity of Demand for Managerial Decision Making Economists compute several different elasticity measures, including the price elasticity of demand, the price elasticity of supply, and the income elasticity of demand. 3or managers, a key point in the discussions of demand is "hat happens "hen they raise prices for their products and services. -t is important to kno" the e2tent to "hich a percentage increase in unit price "ill affect the demand for a product. 8ith elastic demand, total revenue "ill decrease if the price is raised. 8ith inelastic demand, ho"ever, total revenue "ill increase if the price is raised. 0ince profit is e1ual to total revenue minus total costs, profit "ill increase as price is increased "hen demand for a product is inelastic. -t is important to note that an entire demand curve is neither elastic nor inelasticE it only has the particular condition for a change in total revenue bet"een t"o points on the curve +and not along the "hole curve,.

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November 22, 2012

[Managerial Economics]

Demand elasticity is affected by three things( 11 a+ailability of substitutesC *1 the urgency of need; and -1 the importance of the item in the customer?s budget. Measurement of Elasticity of Demand( -Elasticity of demand is kno"n as price$elasticity of demand because elasticity of demand is the degree of change in amount demanded of a commodity in response to a change in price. 4rice elasticity of demand can be measured through three popular methods. These methods are# %. 4ercentage method or 7rithmetic method &. Total E2penditure method ). Jraphic method or point method. 1. &ercentage method(7ccording to this method price elasticity is estimated by dividing the percentage change in amount demanded by the percentage change in price of the commodity. Thus given the percentage change of both amount demanded and price "e can derive elasticity of demand. -f the percentage change in amount demanded is greater that the percentage change in price. The coefficient thus derived "ill be greater than one. -f percentage change in amount demanded is less than percentage change in price, the elasticity is said to be less than one. 6ut if percentage change of both amount demanded and price is same, elasticity of demand is said to be unit. *. 'otal e7penditure method Total e2penditure method "as formulated by 7lfred Marshall. The elasticity of demand can be measured on the basis of change in total e2penditure in response to a change in price. -t is "orth noting that unlike percentage method a precise mathematical coefficient cannot be determined to kno" the elasticity of demand. 6y the help of total e2penditure method "e can kno" "hether the price elasticity is e1ual to one, greater than one, less than one. -n such a method the initial e2penditure before the change in price and the e2penditure after the fall in price are compared. -. 9raphic method( Jraphic method is other"ise kno"n as point method or Jeometric method. This method "as popularized by method. 7ccording to this method elasticity of demand is measured on different points on a straight line demand curve. The price elasticity of demand at a point on a straight line is e1ual to the lo"er segment of the demand curve divided by upper segment of the demand curve.

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November 22, 2012

[Managerial Economics]

Thus at mid$point on a straight$line demand curve, elasticity "ill be e1ual to unityE at higher points on the same demand curve, but to the left of the mid$point, elasticity "ill be greater than unity, at lo"er points on the demand curve, but to the right of the midpoint, elasticity "ill be less than unity. 0orecasting( $Demand forecasting is the activity of estimating the 1uantity of a product or service that consumers "ill purchase. Demand forecasting involves techni1ues including both informal methods, such as educated guesses, and 1uantitative methods, such as the use of historical sales data or current data from test markets. Demand forecasting may be used in making pricing decisions, in assessing future capacity re1uirements, or in making decisions on "hether to enter a ne" market. 2b6ecti+es of Demand 0orecasting( Drafting of &roduction &olicies( $ Demand forecasts facilitate in drafting appropriate production policy so that there may not be any space bet"een future demand and supply of a product. This can in addition ensure.

%. )outine $upply of Materials( $Demand forecasting assists in figuring out the preferred volume of production. The essential prere1uisite of ra" materials in future can be calculated on the basis of such forecasts. This guarantees regular and continuous supply of the materials in addition to managing the amount of supply at the economic level. &. >est &ossible Use of Machines( $Demand forecasting in addition e2pedites cutting do"n inactive capacity because only the necessary amount of machines and e1uipment s are set up to meet future demands. ). )egular !+ailability of :abour( $7s soon as demand forecasts are made, supplies of the necessary amount of skilled and unskilled "orkers can be organised "ell be forehand to meet the future production plans.

Drafting of &rice &olicy( -Demand forecasts facilitate the management to prepare a fe" suitable pricing systems, so that the level of price does not rise and fall to a great e2tent during depression or inflation. !ppropriate Management of $ales# $ Demand forecasts are made area "ise and after that the sales targets for different regions are set in vie" of that. This abets the calculation of sales performances.

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November 22, 2012

[Managerial Economics]

2rganising 0unds( $!n the basis of demand forecast, an individual can find out the monetary re1uirements of the organisation in order to bring about the desired output. This can make it possible to cut do"n on the e2penditure of ac1uiring funds. $ignificance/ Importance of Demand 0orecasting

Management Decisions( $7n effective demand forecast facilitates the management to take appropriate steps in factors that are pertinent to decision making such as plant capacity, ra"$ material re1uisites, space and building re1uirements and availability of labour and capital. Manufacturing schedules can be drafted in compliance "ith the demand re1uisitesE in this manner cutting do"n on the inventory, production and other related costs. E+aluation( -Demand forecasting furthermore smooth the process of evaluating the efficiency of the sales department. ,uality and ,uantity %ontrols( $Demand forecasting is an essential and valuable instrument in the control of the management of an organisation to provide finished goods of correct 1uality and 1uantity at the correct time "ith the least amount of e2penditure. 0inancial Estimates( $7s per the sales level as "ell as production functions, the financial re1uirements of an organisation can be calculated using various techni1ues of demand forecasting. -n addition, it needs a little time to ac1uire revenue on practical terms. 0ales forecasts "ill, as a result, make it possible for arranging ade1uate resources on practical terms and in advance as "ell.

!+oiding $urplus and Inade4uate &roduction( $Demand forecasting is necessary for the old and ne" organisations. -t is some"hat essential if an organisation is engaged in large scale production of goods and the development period is e2tremely time$consuming in the course of production. -n such situations, an estimate regarding the future demand is essential to avoid inade1uate and surplus production. )ecommendations for the future( $Demand forecast for a specific commodity furthermore provides recommendations for demand forecast of associated industries. E.g. the demand forecast for the vehicle industry aids the tyre industry in calculating the demand for t"o "heelers, three "heelers and four "heelers.

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November 22, 2012

[Managerial Economics]

$ignificance for the go+ernment( $7t the macro$level, demand forecasting is valuable to the government as it aids in determining targets of imports as "ell as e2ports for various products and preparing for the international business !pproaches /Methods of Demand 0orecasting

7pproaches to demand forecasting vary, but generally fall into one of t"o categories# Luantitative 3orecasting Lualitative 3orecasting ,uantitati+e forecasting utilizes statistical models to predict future values. These models may take into account current and historical trends. ,ualitati+e forecasting is less mathematical and more intuition$based. -n many instances, especially those that feature rollouts of 'uni1ue( products +like the original i4hone,, statistical models can provide inade1uate results because they don t have enough past data to make an accurate prediction of future demand. Different Methods of Demand 0orecasting( - 3orecasting demand is a difficult task that can be approached in multiple "ays. The methods can mainly be broken do"n into those that rely on e2trapolating data about previous demand, and those that are purely a prediction of the future. Modern technology greatly e2pands the capacity to analyze data in "ays that uncover more detail and minimize the effects of incorrect predictions and assumptions. &ast Data !ne of the most common methods for forecasting demand is simply to e2trapolate previous demand levels. This method can be made more accurate by using as detailed data as possible and taking steps to make sure it ties in "ith the period of the forecast. 3or e2ample, the sales figures for childrenOs toys in December are likely to be a very poor indicator for sales in Ianuary.

&rediction Markets

The P"isdom of cro"dsP theory suggests that bringing together the individual assessments of many different people, each "ith their o"n insights and biases can produce an accurate aggregate result. !ne "ay to e2ploit this is for a company to run a competition "here all staff, from every department, attempt to predict demand, "ith a prize going to the most accurate. Bnder the theory, the average of all entries is likely to be close to reality.

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November 22, 2012

[Managerial Economics]

Data Mining

This involves analyzing the relationship bet"een different factors using computer technology to allo" more detailed and sophisticated predictions.

$egmentation

This approach involves breaking do"n the market for a product or service +that is, the consumers, into as detailed and specific groupings as possible. This can be done by age, location, gender, income, education or any other demographic and behavioral groupings. $upply !nalysis

7 detailed revie" of the inputs and outputs of a process that is employed to assess ho" the available 1uantity of a product is affected by changes in demand, input factors and production techni1ues. 0upply analysis is often used to make key policy decisions by manufacturing business managers since it gives them insight into ho" shifts in production are likely to influence market supply. :aw of $upply( $ 7 microeconomic la" stating that, all other factors being e1ual, as the price of a good or service increases, the 1uantity of goods or services offered by suppliers increases and vice versa. -n other "ords, the law of supply states that +all other things unchanged, an increase in price results in an increase in 1uantity supplied.
Elasticity of Supply: - 0upply elasticity is defined as the percentage change in 1uantity

supplied divided by the percentage change in price. -t is calculated as per the follo"ing formula#

-f supply is elastic, producers can increase output "ithout a rise in cost or a time delay -f supply is inelastic, firms find it hard to change production in a given time period. The formula for price elasticity of supply is# Percentage change in quantity supplied divided by the percentage change in price 8hen 4es R %, then supply is price elastic 8hen 4es S %, then supply is price inelastic 8hen 4es K A, supply is perfectly inelastic 8hen 4es K infinity, supply is perfectly elastic follo"ing a change in demand

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November 22, 2012

[Managerial Economics]

The calculation of elasticity of supply is comparable to the calculation of elasticity of demand, e2cept that the 1uantities used refer to 1uantities supplied instead of 1uantities demanded. Time and Supply# $Bnlike the demand relationship, ho"ever, the supply relationship is a factor of time. Time is important to supply because suppliers must, but cannot al"ays, react 1uickly to a change in demand or price. 0o it is important to try and determine "hether a price change that is caused by demand "ill be temporary or permanent. Supply and Demand Relationship# $Fo" that "e kno" the la"s of supply and demand, let s turn to an e2ample to sho" ho" supply and demand affects the 4rice. 7 mobile phone manufacturer manufacture only %AA pieces of handsets "ith the latest features because the company previously analyse that consumers are less in the market as per the price of Cs. *.AAA<$ only, 0o that they manufactures only %AA pieces but the handsets are demanded by numbers of people the price "ill subse1uently rise because according to the demand relationship,
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November 22, 2012

[Managerial Economics]

as demand increases, so does as the price. 0imilarly the demand increases manufacturer need to manufacture more handsets. E4uilibrium( $8hen supply of product are e1ual +"hen supply & demand function intersect, the economy is said to be e4uilibrium. 7t this time the amount of goods being supplied is e2actly the same as the amount of goods being demanded. Thus, everyone +individuals, firms, or countries, is satisfied "ith the current economic condition.

7s you can see on the chart, e1uilibrium occurs at the intersection of the demand and supply curve, "hich indicates no allocate inefficiency. 7t this point, the price of the goods "ill be 4T and the 1uantity "ill be LT. These figures are referred to as e1uilibrium price and 1uantity. Dise4uilibrium( $ -t occurs "hen the demand and supply of the 1uantity of the product< service are not e1ual. %. E7cess $upply( $-f the 0upply of the product is more than the demand of the product in the market and price set is too high than at the same price demand "ill be decreased. :ere, at the price 4% the 1uantity of product "hich is supplied by the producer is L& but the consumers "ant to consume +Demand, is at L%

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