RBMI

Meaning Of Economics
Economics as a science is concerned with the problem of

allocation of scarce resources among competing ends. Economic behavior is related to choice by individuals and others. Individuals and others have to decide how to allocate scarce resources in the most effective ways. Economics provide optimum utilization of scarce resources to achieve the desired result. It provides the basis for decision making.

Definitions
Managerial economics is an offshoot of two disciplines

economics and management

Definitions
Dr Alfred Marshall Economics is a study of mans

actions in the ordinary business of life: it enquires how he gets his income and how he uses it He says, the main aim of economics is to promote Human Welfare then wealth

Promote Human Welfare than wealth

Management
Management is the art of getting the work done

through and with the people It entails the co-ordination of human efforts and material resources towards the achievement of organizational objectives.

Managerial Economics
Edurin

Mansfield Managerial Economics is concerned with the application of economic concepts and economic analysis to the problem of formulating rational managerial decisions Spencer and Siegel man Business economics is the integration of economics theory with business practice for the purpose of facilitating decision-making and forward planning for management

Introduction
Managerial Economics is economics applied

in decision-making. Decision making is the process to select a particular course of action from among a number of alternatives. It is the study of managing maximum gains out of scarce resources.

Definition
Managerial economics is concerned with the application of economic principles and methodologies to the decision process with in the organization. It seeks to establish rules and principles to facilitate the attainment of the desired economic goals of management. -- By Edwin Mansfield

Economics
Micro Economics

when something is concerned with individual (person, firm or household)

Macro Economics

something related to the environment as a whole

Micro Economics
It has been defined as that branch where the unit of study

is an individual, firm or household. It studies how individual make their choices about,
what to produce? How to produce? For whom to produce?, and

What price to charge?

It is also known as the price theory. It is the main source of concepts and analytical tools for

managerial decision making

Micro economic theories

Theory of production;
Theory of price determination;

Theory of profit;
Theory of demand.

Macro Economics
It studies the economics as a whole. It is aggregative in character and takes the entire economic

as a unit of study. Macro economics helps in the area of forecasting. It includes National Income, aggregate consumption, investments, employment etc. It facilitates government in taking policy decisions such as,
How much to spend on health? How much to spend on services? How much should go in to providing social security benefits?

Macro economic theories

Environment or external issues;
Theories of government policies;

Theory of capital and Investment.

Economic Theory: Microeconomics Macroeconomics

Management Problems

Analytical Tools: Mathematical Economics Econometrics

Managerial Economics

Economic Methodology: Descriptive Models Prescriptive Models

Optimal Decisions

Study of Functional Areas: Accounting Personnel Finance Production Marketing

Role of Managerial Economics in Managerial Decision Making

Business Management Decision Problems Traditional Economics: Theory & Methodology Decision Sciences Tools & Techniques of analysis

Managerial Economics Application of Economic theory & Methodology to solve business Optimal Solution to problems Business Problems

16

Role of Managerial Economics in Managerial Decision Making

CHARACTERISTICS OF MANAGERIAL ECONOMICS

Microeconomics
Normative economics: Pragmatic Prescriptive rather than descriptive Takes the help of macroeconomics Multidiscilinary

DIFFERENCE BETWEEN ECONOMICS AND MANAGERIAL ECONOMICS

ECONOMICS TELLS US ABOUT BODY OF

PRINCIPLE WHILE THE MANAGERIAL ECONOMICS TELLS DEALS WITH THE APPLICATION OF ECONOMIC PRINCIPLES TO THE PROBLEM OF THE FIRM

DIFFERENCE BETWEEN ECONOMICS AND MANAGERIAL ECONOMICS

ECONOMICS HAS BOTH CHARACTERSTICS OF

MICRO AND MACRO MANAGERIAL ECONOMICS HAS MAJOR CHARACTERSTICS OF MICRO

DIFFERNCE BETWEEN ECONOMICS AND MANAGERIAL ECONOMICS

MICRO ECONOMICS AS A PART OF ECONOMICS

DEALS WITH INDIVIDUALS AND FIRMS WHILE MANAGERIAL ECONOMICS DEALS ONLY WITH FIRMS AND NOT WITH INDIVIDUALS

DIFFERENCE BETWEEN ECONOMICS AND MANAGERIAL ECONOMICS

MICRO ECONOMICS BEING PART OF ECONOMICS DEALS WITH DISRIBUTION THEORY OF RENT,INTEREST,PROFIT.WAGES WHILE MANAGERIAL ECONOMICS DEALS ONLY IN PROFITS.

Nature of managerial economics

It is a science.
It is an art.

It is a micro economics.
It is a normative science.

Concept of ME
Concepts of Micro-Economics
Elasticity of demand Marginal cost Marginal revenue Market structures and their significance in pricing

policies. Concepts of Macro-Economics The magnitude of investment and the level of national income, The level of national income and the level of employment, The level of consumption and the level of national income In ME emphasis is laid on those prepositions which are likely to be useful to management

Scope of ME
Demand analysis and Forecasting, Production function,

Cost analysis,
Inventory Management, Advertising,

Market structure and Pricing System,

Profit Analysis, Resource allocation etc

ME and Other Disciplines

Mathematics

Statistics
Operations Research Management Theory Accounting Computers

Importance of managerial economics:

Decision making Knowledge of concepts Promotion of sales Understanding significant external forces Ideal from other subject Helpful to new age manager Revenue to the government Social benefits

Role of Managerial Economist

Making decisions and processing information are the two primary tasks of managers. The task of organizing and processing information and then making an intelligent decision based upon this information and the basic theory can take two general form:
Specific decision General task

Specific decision
Production scheduling

Demand forecasting,
Market research, Economic analysis of industry,

Investment appraisal,
Advice on trade Security management analysis,

Pricing and related decision,

Analyzing and forecasting environmental factors.

General task
External factors General economic conditions Demand for the product Input cost of the firm. Market conditions. Firms share in the market. Economic policies. Internal factors Determination of pricing policies. Decision of expansion of business activities . Determination of level of efficiency and operation. Determination of wages policy.

Responsibilities of Managerial Economist

To measure the increase in earning capacity of the firm.
To make successful forecasting. To contact the sources of Economic information and

Experts. To keep the management informed of all the possible economic trends. To achieve economic respectable status in the firm. To perform functions sincerely.

Decision Making
Decision making is the central objective of Managerial

Economics Decision making may be defined as the process of selecting the suitable action from among several alternative courses of action The problem of decision making arises whenever a number of alternatives are available. Such as, What should be the price of the product? What should be the size of the plant to be installed? How many workers should be employed? What kind of training should be imparted to them? What is the optimal level of inventories of finished products, raw material, spare parts, etc.?

Decision Making Areas

Demand forecasti ng

Producti on plannin g and cost revenue decision

Study of econo mic enviro nment

Pricing and related decisio ns

Invest ment decisio ns

DEMAND FORECASTING
QUALITATIVE CONSUMER SURVEY JURY OF EXPERT OPINION SALESFORCE COMPOSITE METHOD DELPHI METHOD
TIMESERIES METHODS

QUANTITATIVE

CAUSAL METHODS

NOMINAL GROUP METHOD

PRODUCTION PLANNING AND COST REVENUE DECISIONS Production Function : The production function is a technological relationship between output and various inputs used

in production viz., land, labour, capital and

technology.

The output depends on the increasing function of

all the factor inputs Q=f(S,L,K,T)

The following types of cost are useful in the

decision areas

Average, Marginal and Total Costs

Fixed and Variable Cost

Direct and Indirect Cost

Replacement and Original Cost

Opportunity and Industrial Cost

Sunk Cost and Outlay Cost

STUDY OF ECONOMIC ENVIORNMENT

Economic environment is the most significant component of the business environment. It affects the survival and success of a business organization.

Economic environment
Stage of supply of resources of production

General conditions

Industrial conditions

PRICING AND RELATED DECISIONS

The Price-output decisions are taken under various market structures. The structure of the market refers to the degree of competition in the market for the firms goods and services.

Perfect competition Monopoly market

Market

Monopolistic market

Oligopoly market

INVESTMENT DECISION Forward planning involves investment problems. These are problems of allocating scarce resources over time. For example, investing in new plants, how much to invest, sources of funds, etc..

STEPS IN DECISION MAKING

Various steps in the decision making by a business firm are as fallows :

Defining business problem Determining objective Exploring available alternatives Assessing consequences of various alternatives Choosing best alternative

Performing sensitive analysis

Why Problems of Decision Making Arises?

Due to the scarcity of resources. We have unlimited wants and the means to satisfy those

wants are limited, With the satisfaction of one want, another arises, and here arises the problem of decision making. While performing his function manager has to take a lot of decisions in conformity with the goal of the firm. Most of the decisions are taken under the condition of uncertainty, and involves risks. The main reasons behind uncertainty and risks are uncertain behavior of the market forces.

Factors Influencing Managerial Decision Making

Besides

economic variables managerial decision making is also influenced by other significant variables, such as
Human and Behavioral Considerations
Technological Forces Environmental Forces

Principles of Managerial Economics /Tools of Decision Making

Opportunity cost Incremental principle (Cost & Revenue) Principle of the time perspective Discounting principle Equi-marginal principle

Opportunity cost
The opportunity cost of anything is the return that can

be had from the next best alternative use. A farmer who is producing wheat can also produce potatoes with the same factors. Therefore, the opportunity cost of a quintal of wheat is the amount of the output of potatoes given up. The opportunity costs are the costs of sacrificed alternatives.

Incremental principle (Cost & Revenue)

Incremental cost - change in total cost as a result of

change in the level of output, investment etc. Incremental revenue- change in total revenue resulting from a change in the level of output, prices etc. A manager always determines the worth of a decision on the basis of the criterion that IR>IC. For Example:

Principle of the time perspective

Decision maker must give due consideration to time

element in his decision maker exercise. General distinction is made between short-run and long-run. Short-run- volume of output cannot be changed by altering the sixe of the firm and the scale of plant. The output can be increase or decrease only by changing the variable input. Long-run- time period in which all factors are variable and that the size of the firm and the scale of plant can be changed to change the volume of output.

Discounting principle
Time value of money
Examples:

Equi-marginal principle
According to this principle, different courses of action

should be pursued up to the point where all the courses provide equal marginal benefit per unit of cost. It states that a rational decision-maker would allocate or hire his resources in such a way that the ratio of marginal returns and marginal costs of various uses of a given resource or of various resources in a given use is the same. For example, a consumer seeking maximum utility (satisfaction) from his consumption basket, will allocate his consumption budget on goods and services such that

MU1/MC = MU2 / MC2 =..= MUn / MCn Where MU1 = marginal utility from good one, MC1 = marginal cost of good one and so on. Example:

Activity
1. Make a list in your own words of some of the economic decision that
you are facing your family has to take your country has to take

2. Take any quality newspaper, go through it and make notes on the following:
Micro economic Macro economic (problems and issues you find)

3. Suppose there is a firm with a temporary idle capacity. An order for 5000 units comes to managements attention. The customer is willing to pay Rs 4/- unit or Rs.20000/- for the whole lot but not more. The short run incremental cost (ignoring the fixed cost) is only Rs.3/-. There fore the contribution to overhead and profit is Rs.1/per unit (Rs.5000/- for the lot) What long run repercussion of the order is to be taken into account?

REFERENCES 1. MANAGERIAL ECONOMICS -D.N.DWIVEDI 2. BUSINESS ECONOMICS -D.D. CHATURVEDI S.L. GUPTA SUMITRA PAUL 3. MICRO ECONOMICS -JHON KENNADY 4. MANGERIAL ECONOMICS MITHANI

THANK YOU

References
Google search engine.
Wikipedia Scribd.com Slideshare.com

Why does a Demand Curve Slope downward?

The demand varies inversely to changes in price. Dx = f(Px). The demand curve is downward sloping indicating an inverse relationship between price and demand. The price is measured on the Y axis and Demand on the X- axis. When the price falls, demand increases. The downward slope of demand curve implies that the consumer tends to buy more when the price falls. Thus the demand curve is shown as downward sloping.

What are the assumptions underlying law of demand?

No change in Consumers income. No change in consumers preferences. No change in the Fashion. No change in the Price of Related Goods. No expectation of Future price changes of shortages. No change in size, age composition, sex ratio of the population. No change in the range of goods available to the consumers. No change in the distribution of income and wealth of the community. No change in government policy. No change in weather conditions.

What are the exceptions to the Law of Demand?

Sometimes it may be observed, that with a fall in price, demand also falls and with a rise in price, demand also rises. This is apparently contrary to the law of demand. The demand curve in such cases will be typically unusual and will be upward sloping.

What are the exceptions to the Law of Demand?

Giffen Goods: In the case of certain Giffen goods, when price falls, quite often less quantity will be purchased because of the negative income effect and peoples increasing preference for a superior commodity with rise in their real income. E.g. staple foods such as cheap potatoes, cheap bread, pucca rice, vegetable ghee, etc. as against good potatoes, cake, basmati rice and pure ghee.

What are the exceptions to the Law of Demand?

Articles of Snob appeal (Veblen effect) : Sometimes, certain commodities are demanded just because they happen to be expensive or prestige goods and have a snob appeal. They satisfy the aristocratic desire to preserve the exclusiveness for unique goods. These goods are purchased by few rich people who use them as status symbol. When prices of articles like diamonds rise, their demand rises. Rolls Royce car is another example.

What are the exceptions to the Law of Demand?

Speculation: When people are convinced that the price of a particular commodity will rise further, they will not contract their demand; on the contrary they may purchase more for profiteering. In the stock exchange, people tend to buy more and more when prices are rising and unload heavily when prices start falling.

What are the exceptions to the Law of Demand?

Consumers phychological bias or illusion: When the consumer is wrongly biased against the quality of a commodity with reduction in the price such as in the case of a stock clearance sale and does not buy at reduced prices, thinking that these goods on sale are of inferior quality.

Reasons for change (increase or decrease) in demand:

Change in income. Changes in taste, habits and preference. Change in fashions and customs Change in distributioin of wealth. Change in substitutes. Change in demand of position of complementary goods. Change in population. Advertisement and publicity persuasion. Change in the value of money. Change in the level of taxation. Expectation of future changes in price.

Examples of change in Demand

Increase in Advertising

Easy loans for housing

Recession in the Economy

Cut in Incometax Rates

Elasticity of Demand
Elasticity of Demand is the degree of responsiveness of quantity demanded to a change in price. Any elasticity is simply a ratio between cause and an effect always in percentage terms. The cause goes to the denominator of the ratio, while the effect goes to the numerator of the ratio.

Demand Analysis

Demand

Desire

Willing ness

Ability

Deman d

What is Demand?
Demand means effective desire or want for a commodity which is backed up by the ability (purchasing power) and willingness to pay for it.
Demand = Desire + Ability to pay + Willingness to spend Demand is a relative concept not absolute

It is related to price , time and place. The demand for a commodity refers to the amount of it which will be bought per unit of time at a particular price ( in a particular market).

DEMAND
Demand is the effective desire or want for a commodity, which is backed up by the ability (i.e. money or purchasing power) and willingness to pay for it. Demand = Desire + Ability to pay + will to spend The demand for a product refers to the amount of it which will be bought per unit of time at a particular price.

Essentials of Demand
An Effective Need,
A Specific Price, A Specific Time, A Specific Place.

Consumer Demand
Two levels: Individual Demand Market Demand
Market Demand is the sum total of all individual demands. Prices are determined based on Market Demand.

Individual and Market demand

Individual Demand : Individual demand for a product is

the quantity of it a consumer would buy at a given price, during a given period of time. Market demand : Market demand for a product is the total demand of all the buyers in the market taken together at a given price during a given period of time. Demand Schedule: A tabular statement of price quantity (demanded) relationship at a given period of time Individual demand schedule Market demand schedule.

Types of demand
Price Demand
Income Demand Cross Demand

Joint and complementary demand

Composite demand Direct an derived demand Individual demand & Market demand Demand for capital goods and demand for consumer goods Autonomous demand & Derived demand Direct & indirect demand Demand for durable & non-durable goods

Determinants of Demand Price of the product

Price of the related goods Consumers income level Distribution pattern of national income Consumers taste and preferences Advertisement of the product Consumers expectation about future price and supply position Consumer credit facility Demography and growth rate of population General std. of living and spending habits Climatic and weather conditions Savings

Demand Function: It states the (functional/mathematical) relationship between the demand for the product ( dependent variable) and its determinants ( independent variables).

Factors influencing individual demands:

Price of the products. Income of the buyer. Tastes, Habits and Preferences. Relative prices of other goods. Relative prices of substitute and complementary products. Consumers expectations about future price of the commodity. Advertisement effect.

Factors influencing Market Demand

Price of the product. Distribution of Income and Wealth. Communitys common habits and scale of preferences. General standards of living and spending habits of the people. Number of buyers in the market and the growth of population. Age structure and sex ratio of the population. Future expecations. Level of taxation and Tax structure. Inventions and Innovations. Fashions Climate and weather conditions. Customs Advertisement and Sales propaganda.

Important factors (key variables)affecting demand:

own price of the product Price of substitute or Price of complimentary product Level of disposable income (income left with buyers after paying tax) Change in the buyers Taste Advertisement effect (level of ad. Exp) Changes in population (or number of buyers)

(P) (Ps) (Pc) (Yd) (T) (A) (N)

Thus, Demand Function, Dx = f(Px, Ps, Pc, Yd, T, A, N, u) Commodity = x Hence, price = Px, Demand = Dx

Law of demand
Statement of Law : Other things being equal, the higher the price of a commodity, the smaller is the quantity demanded and lower the price, larger the quantity demanded. Assumptions to the Law of Demand:
(1) Income level should remain constant, (2) Tastes of the buyer should not change,

(3) Prices of other goods should remain constant,

(4) No new substitutes for the commodity, (5) Price rise in future should not be expected and (6) Advertising expenditure should remain the same.

Why Demand Curve Slopes Downwards:

Factors behind Law of demand

Substitution effect
Income effect Utility Maximising behaviour
Exceptions to Law of demand

Expectation regarding future prices Giffen goods Articles of snob appeal / Veblen effect Consumers psychological bias ( about quality and price relationship)

Changes in quantity demanded & Changes in demand

Changes in quantity demanded is related to law of demand i.e. due to changes in price.
When with a fall in price more of a commodity is

demanded, there is EXTENSION of demand & when with a rise in price less of a commodity is purchased, there is CONTRACTION of demand.

Changes in demand is caused by changes in various other determinants of demand, the price remaining unchanged.
When more of a commodity is bought than before at

any given price there is INCREASE in demand & when less of a commodity is bought than before at any given price there is DECREASE in demand.

Elasticity of demand
Elasticity of demand is the degree of responsiveness of demand to the changes in its determinants.
(A) PRICE ELASTICITY O DEMAND

The extent of response of demand for a commodity to the changes in its price, other determinants of demand remaining constant is called price elasticity of demand.
ep = Proportional changes in quantity demanded
Proportional changes in price

ep = ep =

Q /Q

P /P

Q/QX P/

ep =

Q/

P X P/Q

Types of Price Elasticity

1.
2. 3.

4.
5.

Perfectly elastic Perfectly Inelastic Unity Elasticity Relatively Elastic Relatively Inelastic.

Measurement of elasticity of demand

Graphical Method Point Method Expenditure Method

Graphical Method
Perfectly Elastic Demand (ep= infinity)
Y p r i c e
Where no reduction in price is needed to cause an increase in demand. The firm can sell the quantity in wants to sell at the prevailing price but none at all at even slightly higher price. The shape of the demand curve is horizontal. The elasticity is = infinite.

Q1

Quantity Demanded

Perfectly inelastic demand (ep = 0)

Y p r P1 i c P e O

Q Quantity Demanded

Less Elastic Demand (ep<1)

Y p r P1 i c P e

D O Q1 Q Quantity Demanded X

Relative/ unitary Elastic Demand

Y p r i P1 c e P D

D O Q Q1 Quantity Demanded X

Highly Elastic Demand (ep>1)

Y p r i c e D P1 P D

Q1

Quantity Demanded


ep=infinity ep>1 ep=1

Point Elasticity of Demand

Formula :
ep=lower segment upper segment
ep<1

ep=0

Expenditure Method
Elastic Demand ( ep>1)

P (Rs.) 6 5

Q (Nos.) 10 13

TE (Rs.) 60 65

Inelastic Demand (ep<1)

P (Rs.) 6 5

Q (Nos.) 10 11

TE (Rs.) 60 55

 Unitary Elastic Demand (ep=1)

P (Rs.) 6
5

Q (Nos.) 10
12

TE (Rs.) 60
60

Factors determining Price Elasticity of Demand

1. Nature of the commodity
Extent of use Range of substitutes

Income level
Proportion of income spent on the commodity Urgency of demand

Durability
Purchase frequency

Perfectly inelastic demand

Where no reduction in price is needed to cause an increase in demand. The firm can sell the quantity in wants to sell at the prevailing price but none at all at even slightly higher price. The shape of the demand curve is horizontal. The elasticity is = infinite.

Perfectly inelastic demand

Even a large change in price, does not change the quantity demanded.
Here the shape of the curve is vertical. Elasticity = 0

Unity elasticity
A proportionate change in price results in exactly the same proportional change in quantity demanded.
Shape of the demand curve is a rectangular hyperbola. Elasticity = 1

Relatively elastic demand

A reduction in price leads to more than proportionate change in demand.
Shape of the demand curve is flat. Elasticity > 1

Relatively inelastic demand

A decline in price leads to less than proportionate increase in demand.
Shape of the demand curve is steep. Elasticity < 1

Change in Demand Vs. Elasticity of Demand

Change in demand occurs when

price does not change but demand changes due to other factors.
Elasticity of demand refer to that change in

demand which occurs due to change in price, other factors remaining the same.

 Determinants of price elasticity of demand - Nature of commodity - Uses of commodity - Availability of substitutes - Durability of commodity - Possibility of postponement - Income level of consumers - Price range of the product - Complementary relationship - Knowledge level of consumers - Frequency of purchase - Proportion of expenditure on the product - Time period Practical application - Pricing decisions - Factor rewarding - Terms of trade - Foreign exchange rates - Tax rates - Public utilities

(B) INCOME ELASTICITY OF DEMAND

The degree of responsiveness of demand for a commodity to the changes in the consumers income is known as income elasticity of demand ey = Q / Y X Y / Q
Types of income elasticity 1. Unitary income elasticity 2.Income elasticity grater than one 3. Income elasticity less than one 4.Zero income elasticity 5. Negative income elasticity Practical application
- Growth rate of firm - Production planning

- Demand forecasting - Marketing plan

Income Elasticity
Income Elasticity may be defined as the degree of responsiveness of

quantities demanded to a given change in income. Income Elasticity of Demand is defined as the ratio of the percentage or proportionate quantity demanded to the percentage or proportionate change in income. OR Q2 Q1 (effect) Q2 + Q1 ey = --------------------Y2 Y1 (cause) Y2 + Y1 Q1 Original Quantity demanded before Income change Q2 - Quantity demanded after Income changed Y1 - Original Income Y2 - Changed new income.

Illustration

Suppose a consumer's income is Rs.1000 and he purchases 10 kgs. of sugar. If income goes up to Rs.1100 he is prepared to buy 12 kgs. Calculate income elasticity of sugar. Q2-Q1 12 - 10 Q2+Q1 12 + 10 ey = ---------- = -------------------Y2-Y1 1100 - 1000 Y2+Y1 1100 + 1000 = 2 -:- 100 = 1 x 21 22 2100 11 1 = 21 = 1.99 11 Demand for sugar is income elastic

(C) CROSS ELASTICITY OF DEMAND

The degree of responsiveness of demand for a commodity to a given change in the price of some other related commodity is known as cross elasticity of demand.

exy = Proportional change in demand for X

Proportional change in the price of Y

exy =

Qx

Py X Py Qx

Cross Elasticity
Cross elasticity of demand
Cross elasticity of Demand refers to the degree of responsiveness of demand for a commodity to a change in the price of some related commodity. Cross elasticity of demand is the ratio of proportionate or percentage change in demand of one commodity to proportionate or percentage change in the price of another related commodity.

Cross elasticity of Demand

Proportionate or %ge change ec = in the quantity demanded of X Proportionate or %ge change in the quantity demanded of Y
=

Qx2 - Qx1 Qx2 + Qx1 Px2 Px1 Py2 + Py1

If commodities are inter-related, a change in price of one may cause a change in the price of the other. This is known as Price elasticity of demand. Py2 Py1 Py2 + Py1 PxEpy = -------------------Px2 Px1 Px2 + Px1

ADVERTISING / PROMOTIONAL ELASTICITY OF DEMAND

The degree of responsiveness of demand for a commodity to given change in the advertising or promotional expenses is known as cross elasticity of demand.
ea= Proportional change in demand for X
ea =
Proportional change in the advertisement expenditure Qx ad.exp X ad.exp Qx

Advertising
Advertising consists of those activities by which visual or oral messages are addressed to selected respondents for the purpose of informing and influencing them to buy products or services or to act or be inclined favourably towards ideas, persons, trade marks, institutions or associations featured. Two important functions of advertising are (a) To shift the demand curve to the right (b) To reduce the elasticity of demand. (c) However, advertising has a cost payable to the media. 1. A certain amount of sales is possible without advertising. 2. Other things being equal, there is a direct relationship between extent of advertisement and volume of sales. 3. Upto a point an increase in advertisement will lead to more than proportionate increase in sales.Beyond this point, an increase will lead to leass than proportionate increase in sales till the saturation point, when no further increase in sales is possible.

Promotional or Advertising Elasticity of Demand

Advertising elasticity of demand is the degree of responsiveness of demand to changes in advertising expenditure. Q2-Q1 Q Q2+Q1 Q Q A eA = ------------------------------- = -------------------------- = ------- x ----A2-A1 A2+A1 Q = Quantity of sales A A A Q

A = Advertisement expenditure.

Illustration:
At initial advertisement expenditure of Rs.50,000 the demand For the firms product is 80,000 units. When the advertisement Budget is increased to Rs.60,000 the sales volume increased to 90,000 units. What is the advertising elasticity? A1 = Rs. 50000 A2 = Rs.60000 A = Rs.10000 Q1 = 80000 units Q2 = 90000 units Q = 10000 units Q x A = 10000 x 50000 = 0.625 A Q 10000 80000 Note: When price-quantity changes are very small, point Elasticity is used. When there is substantial change, arc elasticity is used. eA = If Arc elasticity is found for the above example, eAarc = Q x A1 + A2 = 10000 x 50000 + 60000 = 0.647 A Q1 + Q2 10000 80000 + 90000

Point Elasticity of Demand

Point Elasticity of Demand at any point on the Linear Demand Curve is measured as under :

Lower segment of the Demand Curve ep = -------------------------------------------------Upper Segment of the Demand Curve

ep = Infinite elasticity

ep > 1 Elastic range

ep < 1 Inelastic range

(E) SUBSTITUTION ELASTICITY OF DEMAND

The degree of responsiveness of demand ratio between X&Y to a given change in their price ratio is known as substitution elasticity of demand.
es= Proportional change in the ratio of demand for X & demand for Y
Proportional change in the ratio of price of X & price of Y

es =

(Qx / Qy)
(Qx / Qy)

(Px / Py)
(Px / Py)

Factors influencing elasticity of demand

1. Nature of the commodity. 2. Availability of Substitutes 3. Number of Uses 4. Consumers Income. 5. Height of Price and Range of Price Change. 6. Proportion of Expenditure. 7. Durability of the Commodity. 8. Habit. 9. Complementary Goods. 10. Time. 11. Recurrence of Demand. 12. Possibility of Postponement.

 Measuring price elasticity of demand

- Total Expenditure Method - Point Method - Arc Method

Demand forecasting

Demand forecasting is predicting or anticipating the future demand for a product.

USES OF DEMAND FORECASTING DATA

Micro level Industry level Macro level

1) 2) 3) 4) 5)

Short term demand forecasting

Evolving production policy Determining price policy Evolving purchase policy Fixation of sales targets Short term financial policy Business planning Man power planning Long term financial planning

Long term demand forecasting

1) 2) 3)

Basis of Individual demand

Utility
- From the commodity point of view - From Consumers point of view

Approaches to Consumer Demand Analysis o Cardinal Utility approach

- Total utility
- Marginal utility LAW OF DIMINISHING MARGINALUTILITY

Assumptions underlying cardinality approach

- Rationality - Limited money income - maximisation of satisfaction - Utility is cardinally measurable - Diminishing marginal utility - Constant marginal utility of money

 Consumers equilibrium
UTILITY

- One commodity model - Multiple commodity model THE LAW OF EQUIMARGINAL

Ordinal Utility Approach

Assumptions underlying ordinal approach

Rationality Ordinal utility Transitivity & consistency in choice Nonsatiety Diminishing marginal rate of substitution

Marginal rate of substitution - MRS is the rate at which one commodity can be substituted for another, the level of satisfaction remaining the same. Diminishing MRS The quantity of a commodity that the quantity of a commodity that a consumer is willing to sacrifice for an additional unit of another goes on decreasing when he goes on substituting one commodity for another. Indifference Curve - Indifference curve is a locus of points, each representing a different combination of two substitute goods, which yield the same level of utility or satisfaction to the consumer. Indifferent Map

 Properties of Indifference curve

- Indifference curves have a negative slope - Indifference curves are convex to the origin - Indifference curves do not intersect with each other

- Indifference curves are not tangent to one another

- Upper indifference curve always indicate a higher level of satisfaction

Budgetary constraint & The Budget Line

The limitedness of the income acts as a constraint on how high a consumer can ride on his/her indifference map.

Consumers Equilibrium

Price Elasticity of Demand

Formula:
ep = Proportionate change in the Quantity demanded
Proportionate change in price
change in the quantity demanded Quantity demanded = ---------------------------------------------------------------change in price price

Price Elasticity of Demand

Law of demand tells us that as the price of a commodity falls, the quantity demanded increases, and vice versa. It does not tell us by how much the quantity demanded increases, as a result of a certain fall in price or vice versa. Law of demand tells us only the direction of change in demand but not the rate at which the change takes place. To know this, we should know the elasticity of demand or Price elasticity of demand.

Price elasticity of demand

(Q2 Q1) Q1 ep = ------------------------------P2 P1 P1
Q1 = Original Quantity before price change. Q2 = Quantity demanded at the changed price. P1 = Original price. P2 = Changed price.

Illustration: If Q1 = 2000 P1 = 10

and

Q2 = 2500 P2 = 9

(2500 2000) 2000 ep = ----------------------------------------------------- =

-- 2.5

9 10 10 Price elasticity is negative showing inverse relationship.

Price elasticity of demand (modified Formula)

___ Q2 Q1)__

Q1 + Q2 2 ep = -------------------------------------___P2 P1___ P1+ P2 2

Q1 = Original Quantity before price change. Q2 = Quantity demanded at the changed price. P1 = Original price. P2 = Changed price.

Illustration: If Q1 = 2000 P1 = 10

and

Q2 = 2500 P2 = 9

_____(2500 2000)____ 2000 + 2500 2 ep = ----------------------------------------------------- = -- 2.11 9 10 10 + 9 2 Price elasticity is negative showing inverse relationship.

Modified Formula:
While computing elasticity, instead of taking Q1 and P1 in the denominator, we take the average of Q1 + Q2 and P1 + P2. 2 2 The price elasticity ep when worked out using the modified formula = - 2.11 A 1% reduction in price, will result in 2.5% increase in demand as per the first formula and 2.11% increase as per modified formula. Modification in formula is done to ensure reversibility and consistency when eleasticity = unity. This is called Arc Elasticity of Demand And is used when the changes in price and quantity are quite large.

Types of Price Elasticity

1.
2. 3.

4.
5.

Perfectly elastic Perfectly Inelastic Unity Elasticity Relatively Elastic Relatively Inelastic.

Factors determining Price Elasticity of Demand

1. Nature of the commodity
Extent of use Range of substitutes

Income level
Proportion of income spent on the commodity Urgency of demand

Durability
Purchase frequency

Perfectly inelastic demand

Where no reduction in price is needed to cause an increase in demand. The firm can sell the quantity in wants to sell at the prevailing price but none at all at even slightly higher price. The shape of the demand curve is horizontal. The elasticity is = infinite.

Perfectly inelastic demand

Even a large change in price, does not change the quantity demanded.
Here the shape of the curve is vertical. Elasticity = 0

Unity elasticity
A proportionate change in price results in exactly the same proportional change in quantity demanded.
Shape of the demand curve is a rectangular hyperbola. Elasticity = 1

Relatively elastic demand

A reduction in price leads to more than proportionate change in demand.
Shape of the demand curve is flat. Elasticity > 1

Relatively inelastic demand

A decline in price leads to less than proportionate increase in demand.
Shape of the demand curve is steep. Elasticity < 1

Change in Demand Vs. Elasticity of Demand

Change in demand occurs when

price does not change but demand changes due to other factors.
Elasticity of demand refer to that change in

demand which occurs due to change in price, other factors remaining the same.

Income Elasticity
Income Elasticity may be defined as the degree of responsiveness of

quantities demanded to a given change in income. Income Elasticity of Demand is defined as the ratio of the percentage or proportionate quantity demanded to the percentage or proportionate change in income. OR Q2 Q1 (effect) Q2 + Q1 ey = --------------------Y2 Y1 (cause) Y2 + Y1 Q1 Original Quantity demanded before Income change Q2 - Quantity demanded after Income changed Y1 - Original Income Y2 - Changed new income.

Illustration

Suppose a consumer's income is Rs.1000 and he purchases 10 kgs. of sugar. If income goes up to Rs.1100 he is prepared to buy 12 kgs. Calculate income elasticity of sugar. Q2-Q1 12 - 10 Q2+Q1 12 + 10 ey = ---------- = -------------------Y2-Y1 1100 - 1000 Y2+Y1 1100 + 1000 = 2 -:- 100 = 1 x 21 22 2100 11 1 = 21 = 1.99 11 Demand for sugar is income elastic

Cross Elasticity
Cross elasticity of demand
Cross elasticity of Demand refers to the degree of responsiveness of demand for a commodity to a change in the price of some related commodity. Cross elasticity of demand is the ratio of proportionate or percentage change in demand of one commodity to proportionate or percentage change in the price of another related commodity.

Cross elasticity of Demand

Proportionate or %ge change ec = in the quantity demanded of X Proportionate or %ge change in the quantity demanded of Y
=

Qx2 - Qx1 Qx2 + Qx1 Px2 Px1 Py2 + Py1

If commodities are inter-related, a change in price of one may cause a change in the price of the other. This is known as Price elasticity of demand. Py2 Py1 Py2 + Py1 PxEpy = -------------------Px2 Px1 Px2 + Px1

Advertising
Advertising consists of those activities by which visual or oral messages are addressed to selected respondents for the purpose of informing and influencing them to buy products or services or to act or be inclined favourably towards ideas, persons, trade marks, institutions or associations featured. Two important functions of advertising are (a) To shift the demand curve to the right (b) To reduce the elasticity of demand. (c) However, advertising has a cost payable to the media. 1. A certain amount of sales is possible without advertising. 2. Other things being equal, there is a direct relationship between extent of advertisement and volume of sales. 3. Upto a point an increase in advertisement will lead to more than proportionate increase in sales.Beyond this point, an increase will lead to leass than proportionate increase in sales till the saturation point, when no further increase in sales is possible.

Promotional or Advertising Elasticity of Demand

Advertising elasticity of demand is the degree of responsiveness of demand to changes in advertising expenditure. Q2-Q1 Q Q2+Q1 Q Q A eA = ------------------------------- = -------------------------- = ------- x ----A2-A1 A2+A1 Q = Quantity of sales A A A Q

A = Advertisement expenditure.

Illustration:
At initial advertisement expenditure of Rs.50,000 the demand For the firms product is 80,000 units. When the advertisement Budget is increased to Rs.60,000 the sales volume increased to 90,000 units. What is the advertising elasticity? A1 = Rs. 50000 A2 = Rs.60000 A = Rs.10000 Q1 = 80000 units Q2 = 90000 units Q = 10000 units Q x A = 10000 x 50000 = 0.625 A Q 10000 80000 Note: When price-quantity changes are very small, point Elasticity is used. When there is substantial change, arc elasticity is used. eA = If Arc elasticity is found for the above example, eAarc = Q x A1 + A2 = 10000 x 50000 + 60000 = 0.647 A Q1 + Q2 10000 80000 + 90000

Point Elasticity of Demand

Point Elasticity of Demand at any point on the Linear Demand Curve is measured as under :

Lower segment of the Demand Curve ep = -------------------------------------------------Upper Segment of the Demand Curve

ep = Infinite elasticity

ep > 1 Elastic range

ep < 1 Inelastic range

Uses of Elasticity of Demand for Managerial Decision Making

For taking decisions on a pricing policy, the businessman has to know the likely effects of price changes on the demand for his product in the market. He can calculate if the demand will increase by lowering of the price and to what extent, and whether it will result in substantial increase in revenue and profits. Some businessmen do not pay any attention to the aspect of elasticity of demand, and suffer heavy losses by wrong decisions. In scientific management decision making, on has to have as precise an idea as possible of the degree of elasticity of demand. By knowing the type of elasticity, it is possible to fix the precise price of the product in a very profitable way. Unitary elastic demand will not bring in more revenue. Demand elasticity being more than unity, a price cut would lead to increase in revenue. If the product has inelastic demand, raising price will fetch better revenue and profits. A monopolist can have a rational price discrimination policy. E.g., BSES, BWSSB. In items which are highly responsive to change in income, such as TV sets, when per capita income rises, larger number of TV sets are sold even at slightly higher prices. Cross elasticity helps businessmen to mould their business policies. Demand for oil increases when ghee price rises. Sugar prices has a relationship to changes in price of gur. Rise in umbrella prices may push demand for raincoats. So businessmen can fix their prices appropriately in such cases.

Factors influencing elasticity of demand

1. Nature of the commodity. 2. Availability of Substitutes 3. Number of Uses 4. Consumers Income. 5. Height of Price and Range of Price Change. 6. Proportion of Expenditure. 7. Durability of the Commodity. 8. Habit. 9. Complementary Goods. 10. Time. 11. Recurrence of Demand. 12. Possibility of Postponement.

Factors influencing elasticity of demand

1. Nature of Commodity: Luxury and comfort goods are price elastic while necessaries are price inelastic.
2. Availability of substitutes: Where there are close substitutes in the same price range, demand will be elastic. E.g., beverages, coffee-tea. Where there are no effective substitutes, demand is inelastic. E.g.salt.

3. Number of uses: Demand for a multi-use commodity in those uses where marginal utility is high, will be inelastic, while in those uses where marginal utility is low, the demand will be elastic.

Factors influencing elasticity of demand

4. Consumers Income: Larger the income, demand is relatively inelastic. Low income tends to make the demand for some goods relatively elastic. 5. Height of price and range of price: If the change in price in highly priced commodities is substantial, the demand will be elastic. 6. Proportion of Expenditure: The demand for Items which are a small percentage of the family budget is relatively inelastic.

Factors influencing elasticity of demand

7. Durability of the commodity: In the case of durable goods the demand is relatively inelastic.

8. Habit: Demand of habituated products is inelastic. e.g., cigarettes.

9. Complementary goods: Goods which are jointly demanded have less elasticity. E.g., ink, petrol.

Factors influencing elasticity of demand

10. Time : Demand in the short period is generally inelastic and become elastic in the long period. 11. Recurrence of Demand: If the demand is recurring, it will be elastic. (FMCG). 12. Possibility of postponement: Consumption goods which cannot be postponed, the demand is inelastic. Demand is elastic if it is postponable.