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MANAGERIAL

ECONOMICS
DR. Itty Benjamin

WHAT IS ECONOMICS
Economics is the study of those activities
of human beings, which are concerned,
with the satisfaction of unlimited wants
by using the limited resources.
Economics was made compulsory for
engineers in the first decade of 20 th
century.
Institute
of
Mechanical
Engineers (UK) found that 90% of the
management decisions required some
managerial responsibility and most of
them were basic in nature. Hence,
managerial economics was introduced in
engineering and management subjects.

What is Managerial Economics?


Managerial economics is essentially applied
economics in the field of business management.
It is the economics of business or managerial
decisions.
Managerial decision making mainly deals with the
question of what to produce, how to produce and how
much to produce.

Managerial Insight

Managers have to acquire the insight


of
both
microeconomics
and
macroeconomics. The former analyses
the behaviour of individual economic
entities such as consumer and producer,
while the later deals issues pertaining to
the economy as a whole, such as
unemployment, population etc.

The Business Decision

Functions: Role and Responsibilities of a Managerial


Economist
A managerial economist in a business firm may carry on a wide range of
duties, such as:
Demand estimation and forecasting.
Preparation of business/sales forecasts.
Analysis of the market survey to determine the nature and extent of
competition.
Analysing the issues and problems of the concerned industry.
Assisting the business planning process of the firm.
Discovering new and possible fields of business endeavour and its
cost-benefit analysis as well as feasibility studies.

Advising on pricing, investment and capital budgeting policies.


Evaluation of capital budgets.
Building micro and macro economic models.
Directing economic research activity.
Briefing the management on current domestic and global economic
issues and emerging challenges.
Interpretation, analysis and reporting of current economic matters,
upcoming developments in business, government and foreign or
global sectors.

Scope of Managerial Economics


Following are the core topics of managerial economics:

Demand Function and Estimation

Pricing Policies and Practices in Real Business

Demand Elasticity
Demand Forecasting
Production Function and Laws
Cost Analysis
Pricing and Output Determination in different market structures such as perfect competition,
monopoly, oligopoly and monopolistic competition

Profit Planning and Management


Break-even Analysis
Linear Programming
Game Theory
Government and Business.

Managerial economists tend to rely on the scientific research method


in building and empirically testing business oriented economic
models. This scientific approach consists of the following steps:

Defining the problem


Formulation of the hypothesis
Abstraction for the model building
Data collection
Testing the hypothesis
Deduction based on data analysis
Evaluating the test results
Conclusion for decisions

Effective Demand
A buyers desire for a product in the market backed by
the ability and willing to pay for its price.

Definition of Demand - The demand for a product refers to the


amount of it which will be bought per unit of time at a
particular price.

Determinants of Demand
Factors Influencing Individual Demand
Price
Income
Tastes, habits and preferences
People with different tastes and habits have different preferences for
different goods
Relative prices of other goods substitute and complementary
products
Consumers expectation
Advertisement effect

Factors Influencing Market Demand

Price of the product


Distribution of income and wealth in the community
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 expectations
Level of taxation and tax structure
Inventions and innovations
Fashions
Climate or weather conditions
Customs
Advertisement and sales propaganda

Demand Function
Mathematical of expression of functional relationship between determinants (such
as price, income, etc., determining variables) and the amount of demand of a
given product.
In composing the demand function for a product, therefore, one should identify
and enlist the most important factors (key variables) which affect its demand. To
suggest a few, such as:
The own price of the product itself (P)
The price of the substitute and complementary goods (Ps or Pc)
The level of disposable income (Yd) with the buyers (i.e., income left after
direct taxes)
Change in the buyers taste and preferences (T)
The advertisement effect measured through the level of advertising
expenditure (A)
Changes in population number or the number of the buyers (N).
Using the symbolic notations, we may express the demand function, as follows:
Dx = f (Px, Ps, Pc, Yd, T, A, N, u)

Demand Schedule
A tabular statement of price/quantity relationship is called
the demand schedule.
Individual Demand Schedule

A Market Demand Schedule (Hypothetical Data)

Market Demand Curve


In graphical terms, a market demand curve for a product
is derived through the horizontal summation of all
individual buyers demand curves for the given product.
Demand Curve
Demand curve refers to the graph of a demand schedule,
measuring price on the Y-axis and quantity demand on
the X-axis. Usually, a demand curve has a downward
slope, representing an inverse relationship between price
and demand.

A Linear Demand Curve

The Law of Demand

The conventional law of demand, however, relates to the


much simplified demand function:
D = f (P)

Demand Curve

Assumptions Underlying the 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 or shortages
No change in size, age composition and 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

Exceptions Demand Curve: Upward-sloping Demand


Curve

Exceptional Cases

Giffen goods
Articles of snob appeal
Speculation
Consumers psychological bias or Iillusion

Extension and Contraction of


Demand
The terms extension and contraction are
technically used in stating the law of demand.

Quantity Demanded

Increase and Decrease in Demand


An increase in demand signifies either that more will be
demanded at a given price or same will be demanded at a
higher price. An increase in demand really means that
more is now demanded than before at each and every
price. Likewise, a decrease in demand signifies either
that less will be demanded at a given price or the same
quantity will be demanded at the lower price. Decrease in
demand really means that less is now demanded than
before at each and every rise in price. Shifting the demand
curves shows the increase and decrease in demand.

Increase in Demand (A) and Decrease in Demand (B)

Reasons For Change (Increase or Decrease) in Demand

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

Major Types of Demand


1.
2.
3.
4.
5.
6.
7.

Demand for Consumers Goods and Producers


Goods;
Demand for Perishable Goods and Durable Goods;
Autonomous demand and Company Demand;
Industry Demand and Long-Run Demand;
Short Run Demand and Company Demand;
Joint Demand and Composite Demand; and
Price Demand, Income Demand, and Cross Demand.

Industry Demand and Firm or Company


Demand
Industry and Company Demand

Short-run and
Long-run Demand

Bandwagon Effects
Demonstration effect of consumption by the
others lead to the bandwagon effects of change in
demand for a product in the market. Advertising
and fashion play a significant role in this regard.

Bandwagon
Effect: The
Demand Curve
Shifts to the Right

Veblen Effect
Snob appeal of luxury goods leads to the Veblen effect
of demand through conspicuous consumption.

The Market Demand Curve for


Veblen Effect Product