Managerial Economics for Imt

8/6/2019 Managerial Economics for Imt

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MANAGERIAL ECONOMICS FOR IMT

MANAGERIAL ECONOMICS

KEY TERMS

1) NEED OR DESIRE : The items we need in our

daily lives. Needs are unlimited.

2) UTILITY : the satisfaction received when someneed is fulfilled. It is a state of mind. The items

which provide satisfaction are called utilities.

3) COMMODITY : It includes goods and services,

which will satisfy needs.

4) DEMAND: Need becomes demand when the

following conditions are satisfied

a) willingness to purchase

b) ability to purchase.

The most important factor of economics and

determinant of all economic activities. It is inversely

proportional to price of commodities.

5) SUPPLY : Providing commodities for satisfying

demand. It is directly proportional to price of

commodities.


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6) PRODUCTION : The act of creation of

commodities, or conversion of natural resources to

usable commodities capable of satisfying demand . it

is called creation of utility.Factors of production the resources required for

production are

LAND, LABOUR, CAPITAL, ENTREPRENEUR

7) CONSUMPTION : The act of utilization of

commodities to derive satisfaction is consumption. It

is called destruction of utility.

8) INCOME : Any earning out of productive service

is income. Earning is always as factor of production.

Land Rent

Labour Wages/salary

Capital - InterestEntrepreneur - Profit

9) SAVINGS : Part of the income not used for

consumption is savings

10) INVESTMENT :Part of the savings used for

income generating assets for future is investments.

BASIC Problems of an Economic System

An economic system has to search answers to three

basic problems


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What to produce ?

How to produce ?

For whom to produce ?

In a free market economy, these problems can be

solved by operation of a invisible hand.

But in a command economy these problems are

solved by planning undertaken by a central planning

authority.

CIRCULAR FLOW OF GOODS ANDINCOME

TWO SECTORS

Household Firms

Generates demand Generates supply

Buyer of goods Seller of goods and

and services services

Supplier of factors Buyer of factors

SUPPLY OF FACTORS


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PAYMENT FORGOODS

SUPPLY OF GOODSPAYMENT FOR FACTORS

THREE SECTORS

Inclusion of govt. sector

Purchase of goods

Taxes & subsidy

taxes

compensation&social security

&subsidy

HOUSEHOL FIRMS

househol firmFinancialmarkets

governm


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Savings Investments

Cardinal utility analysis

Proposed by Prof. A. Marshall

Main presumption : utility is measurable in terms of

money.

1 unit of utility from a commodity = Re 1 spend on

it

Total utility (TU) : total satisfaction received from

all the units consumed

Marginal utility (MU) :utility received fromconsumption of one additional unit of a good

MU = TU / x = TUn TU n-1

Where x the good being purchased


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Law of diminishing MarginalUtility

The law states that when a person consumessuccessive units of a commodity, the marginal utility

from each successive unit gradually diminishes and

finally becomes negative. The total utility first

increases and then falls.

Assumptions of the law

1) The consumer is rational.

2) The commodity is a normal good and the

consumers need for the good is not satiated.

3) The commodity is finely divisible.

4) The consumer purchases all units successively ,i.e.

there is no time gap between successive

consumption.

5) The price of the commodity and the money

income of the buyer remains constant during

analysis.

6) There is no improvement in the quality of the

product.


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Table showing

diminishing MU

Figure showing relation between TU and MU

No.

of

units

TU MU

1 8 -

2 15 7

3 20 5

4 22 2

5 22 0

6 20 -2

TU

UNITS

CONSUMED

UTILITY


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CONSUMERS EQUILIBRIUMPURCHASE

Up to what level would a consumer consume a

particular commodity ?


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A consumer is willing to purchase a unit as long as

the utility from that unit is greater than or equal to the

[price paid for it.

If price is fixed or falls for every successive unit, hewill purchase up to that unit when MU = P

E

Ordinal utility analysis

Proposed by Prof. J. R. Hicks

units P MU

1 8 12

2 8 11

3 8 9

4 8 8

5 8 6


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Main presumption : utility cannot be measured,

consumers can rank commodities according to

their utilities.

Types of ordering of utility

Strong preference:- A>B or A P B

When good A provides much more utility than

good B and if good A is not available, buyer will

not buy good B.

Weak preference :- A B or A R B

Both good A and good B gives more or less

equal utility but if both are available buyer willchose good A.

Indifference :- A B or A I B

good A and good B gives exactly same utility

and the buyer chooses any one randomly.


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AXIOMS OF ORDINAL UTILITY

ANALYSIS

RATIONALITY : The buyer is rational. He

seeks to maximize utility.

COMPLETENESS : the buyer will express any

one the above preferences.

CONSISTENCY : If between any two goods at

any time A > B , then for any time B will not

be preferred to A.

TRANSITIVITY : If A > B and B > C, then A

> C.

If A = B and B = C, then A = C.

NON-SATIETY : the consumer is not fully

satisfied with the two commodities. He still

needs more units of at least one of the good.


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DIMINISHING MARGINAL RATE OF

SUBSTITUTION : As quantity of A increases,the quantity of B the consumer is ready to

sacrifice gradually diminishes.

MRS = - B / A = - MUx/MUy

Marginal rate of substitution is the units of any

good B which the buyer is ready to sacrifice, to

buy one additional unit of another good A.

Concept of DMRS can be explained from this

table. It is assumed that the buyers income is

fixed and he is buying two goods A & B.

Units of A Units of B MRS8 10 -

9 6 4

10 4 2

11 3 1


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12 2.5 0.5

Indifference curve analysis

The choice or preference pattern in the ordinal

utility analysis is explained with the help of anindifference curve. The demand and buyingpattern of consumers can be shown with thehelp of this curve.

If we assume that a buyer buys two goods,then the locus of the different combination of

the two goods among which the consumer isindifferent , i.e. he gets the same level ofutility, is known as indifference curve.

Assumptions of Indifference curve

1.The consumer buys only two goods X andY.

2.There can be different combinations of thetwo goods that he buys. Each suchcombination is called a commodity bundle.


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3.The consumer is rational, he seeks tomaximize utility.

4.The consumer has a given fixed moneyincome.

5.The prices of the two goods remain fixed.

Properties of Indifference curve

It is downward sloping

It is convex to origin

Two Indifference curves will never intersect

Higher Indifference curves indicate higherlevel of utility.

DEMAND ANALYSIS

Demand : the desire to get a commoditysupported by two qualities :-

o Willingness to purchase it.


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o Ability to purchase i.e. having the

necessary purchasing power.

FACTORS AFFECTING DEMAND

Factors affecting demand of anindividual

The need of the buyer

Price of the commodityIn usual cases, price and demand areinversely related.

In exceptional cases, positive relationmay prevail.

Income of the buyerUsually for normal goods, demand riseswith increase in income.

If demand falls with rise in income, it isan inferior good.

Price of other related commodities Complementary goods Px and Dy are

inversely related.


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Substitute goods Px and Dy aredirectly related.

Taste and preference of the buyer

Demonstration or publicity affect

Factors affecting demand for the entire

market or country

Total population

Age composition of population

Availability of consumer credit

Expectation regarding future changes in

price

LAW OF DEMAND


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States the inverse relationship betweendemand and price. The law states

other factors remaining constant, the

demand will rise with a fall in price and willfall with a rise in price.

Demand schedule

price Qty.demanded

20 1524 1228 1032 9

36 8

Explanation to the law of demand

OrExplanation to the downward slope of the

demand curve

There are two major explanations


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1) Law of diminishing Marginal Utility

Asexplained by Prof. Marshall, due to theprinciple of MU = P to make any purchase, as

price falls, the buyer gets utility frompurchasing some further units of the good

2) Price EffectAs explained by Prof. Hicks, price effect

is a combination of 2 effects:- income effect

and substitution effect.Income effect: the increase in real incomeexperienced by the buyer when the price of agood falls. This induces him to buy a few moreunits of that good.

Substitution effect: after a fall in price, thegood becomes cheaper compared to its

substitutes. So the buyer purchases more units.

P.E. = I.E. + S.E.

3) Increase in no. of consumers:

As price falls, some more buyers are ableto afford the good or the good is put to moreuse. Thus consumption increases.


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Exceptions to the law of demandOrCan the demand curve slope upwards ?

Cases where the law of demand is not obeyed

Giffen goods /Giffen effect

Bandwagon and Snob effect

Veblen effect items of conspicuousconsumption

Share market

Certain expectations of future pricechanges

Elasticity of demand

The relative change in demand due to changein any of the factors affecting demand

Different types of elasticity:


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1) Price elasticity : percentage change in demand due

to 1% change in the own price of the commodity.

ep = ( q/ p)*(p/q)

2) Income elasticity : percentage change in demand

due to 1% change in the income of the buyer.

ei = ( q/ Y)*(Y/q)

3) Cross price elasticity : percentage change in

demand due to 1% change in the price of related

commodities like complements or substitutes.

ec = ( qx/ py)*(py/qx)

4) Advertising / Promotional elasticity :percentage increase in sales of a good due to1% increase in advertising expenses.

EA = ( S/ A)* A/S


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DIFFERENT TYPES OF PRICE

ELASTICITY

Perfectly Inelastic

When there is no change in demand

for some infinite change in price

Ep = 0

Relatively Inelastic

When proportional change in demand isless than proportional change in price.

Ep < 1

Unit Elastic

When proportional change in demand is

equal to proportional change in price.

Ep = 1

Demand


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Relative elastic

When proportional change in demand is

more than proportional change in price.

Ep > 1

Perfectly Elastic

When there is no change in price but

infinite change in demand.

Ep =

Factors affecting price elasticity

Nature of the good

Availability of substitutes


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Use of the good

Possibility of postponing consumption

Time factor

Managerial Economics for Imt

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