Managerial Economics Khem Chand (Assistant Professor), APIIT SD INDIAQ1. Define Managerial Economics. Discuss in brief the nature and scope of Managerial Economics. Ans. Introduction: Managerial refers to functions of management. The main functions of management are decision making and forward planning. Decision making: It is process of choosing from among available alternative to achieve the firm's established goal. Forward planning: It refers to making the plan for future. Economics: The optimal use of scarce resources to satisfy human needs and wants. Microeconomic: Behaviour of individual economic unit like a consumer, a producer and a market. Macroeconomic: it is concerned with the behaviour of aggregate, like national income and total employmentDefinitions: Douglas - Managerial economics is the application of economic principles and methodologies to the decision-making process within the firm or organization.Pappas & Hirschey - Managerial economics applies economic theory and methods to business and administrative decision-making.Salvatore - Managerial economics refers to the application of economic theory and the tools of analysis of decision science to examine how an organisation can achieve its objectives most effectively.Nature of Managerial Economics:1. Managerial economic is concerned with study of a firm and not entire economy.2. Based on theory of the firm3. Managerial economics take the help of macroeconomics to understand and adjust to the environment in which firm operate 4. It is goal oriented 5. It is conceptual: Understand conceptual framework and quantitative technique to measure the impact of different factors and policies.6. Normative (Prescriptive): It tells us what should be done under the given situation. It is not concern with what should be done to achieve the organization goal efficiently.

Optimal solutions to specific organizational objectivesManagerial Economics Descriptive and Prescriptive Management Decision ProblemsApplication of Economic TheoryDecision Science

7. Applied Economic theory: Managerial economics is application of economic theory to managerial decision making. 8. Pragmatic: It suggests how the economic principles are applied to the formulation of policies and programs, and achieve organization goals.9. Multi-disciplinary: statistics, management, operation research, economic and psychology.10. Descriptive: it attempts to interpret observed phenomena and to formulate theories about possible cause and effect relationship. It is used to explain and predict economic behaviour. 11. Applied science: ME formulate theories in a systematic manner about possible cause and effect relationships.

Scope of ME1. Demand Analysis and Forecasting: Demand analysis helps in analyzing the various types of demand which enables the manager to arrive at reasonable estimates of demand for product of his company. Managers not only assess the current demand but he has to take into account the future demand also.2. Production Function: Conversion of inputs into outputs is known as production function.3. Cost analysis: Cost analysis is helpful in understanding the cost of a particular product.4. Inventory Management: It refers to stock of raw materials which a firm keeps. Both the high inventory and low inventory is not good for the firm.5. Advertising: Advertising forms the essential part of decision making and forward planning6. Pricing system: It is also important to understand how product has to be priced under different kinds of competition, for different markets.7. Resource allocation: Resources are allocated according to the needs only to achieve the level of optimization. 8. Decision theory under uncertainty: Demand Uncertainty, Cost, Price, Interest Profit, Sales uncertainty Significance of Managerial Economics1. Utilization of natural and man-made resources2. Solving economic problems3. Application of traditional economics4. Variety of business decision5. Revenue to government 6. Social benefits7. Advertising media 8. Minimizing the uncertainties and risk9. Demand forecasting10. Forward planning11. Helpful in understanding external environment

Q2. What is Managerial Decision Making? Give the process of Managerial Decision-Making? Ans. Introduction: Managerial refers to functions of management. The main functions of management are decision making and forward planning Decision making is process of choosing from among available alternative to achieve the firm's established goal. Forward planning: It refers to making the plan for future.Spencer- Managerial decision making may be defined as the process of selecting one alternative from two or more alternative courses of action

PROCESS OF MDM

Importance of Decision Making 1. Product Decision2. Product Method Decision3. Price And Qualities Decision4. Promotional Strategy Decision5. Locational Decision

Decision Environment Certainty: A state of knowledge in which the decision maker know in advance the specific outcome of each alternative. Risk: A state of knowledge which involve, multiple possible outcomes in which probability of each outcome in known or may be estimated. Uncertainty: A state of knowledge which involves choices involving multiple possible outcomes in which the probability of each outcome is unknown and could not be estimated. Marginal Change in dependent variable associated with one unit change in independent variable. Types of marginal concepts Marginal revenue Marginal cost Marginal profit Marginal product Marginal cost pricing Marginal product of labour Marginal productivity of capital Marginal rate of substitute Relation between Total, Average and Marginal

Basic concept Opportunity cost principle: The opportunity cost is the cost of next best alternative foregone. It is also called alternative cost. Example: a farmer can grow both wheat and gram on a farm. If on a farm measuring one-hectare he grows only wheat, he foregone the production of gram. If the price of the quantity of gram, that he foregoes is Rs 1000, then the opportunity cost of growing wheat will be Rs 1000. Incremental Principle Incremental cost is the change in total cost as result of a particular decision. On the other hand incremental revenue is the total revenue resulting from a particular decision. Principle of Time Perspective Short run: structure of industry, size of the firm and the scale of plant are not alterable. Long run: all the factors are variables like price, revenue, cost and profit. Discounting principle A rupee today is worth more than a rupee at a future date. Equi-Marginal principle The Equi-marginal principle says that a rational decision maker would allocate or hire his resources in such a way that the ratio of marginal returns and marginal cost of various uses of given resource in a given use is the same. The law of Equi-Marginal utility states that the consumer will distribute his money income between the goods in such a way that the utility derived from the last rupee spend on each good is equalRs.AppleMango

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275

364

453

542

631

Risk and Uncertainty It influences the estimation of cost and revenues. Decision of the firm Future conditions are not perfectly predictable Unexpected environment change

Q3. Define the Elasticity of demand? Under what conditions elasticity is equal to: (a) Zero, (b) Unitary, (c) Less than unitary and (d) Greater than unitary Ans. Elasticity is a measure of the responsiveness of one variable to change in other. The elasticity of demand measures the responsiveness of the quantity demanded of a good, to change in its price, price of other goods and changes in consumers income.Price Elasticity of Demand Elasticity of demand may be defined as the percentage change in the quantity demanded divided by the percentage change in the price (Marshall). There is an inverse relationship between price and quantity demanded of a good. Elasticity of demand is expressed by minus (-) sign. Ed= (-) Example: Price decrease 10 per cent Demand increase 20 per cent Ed = (-) = (-)-2= 2Degree of Price Elasticity of DemandPerfect elastic Demand

Perfectly inelastic Perfect inelastic demand is one in which a change in price produces no change in the quantity demanded.

Greater than unitary It is one in which a given percentage change in price produces relatively more percentage change in demand. Example: 5 percentage in price 20 percentage change in demand

Less than unitary In which a given percentage change in price produces relatively less percentage change in demand. Price decrease 4 per cent Demand increase 2 per cent

Unitary elasticity of demand Unitary elasticity of demand is one in which a percentage change in price produces an equal percentage change in demand Example: Price decrease 5 per cent Demand increase 5 per cent

Q4. Explain the different methods of measuring the price elasticity of demand and exception of law of demand. Ans. Measurement of Price Elasticity of Demand Methods of measuring price elasticity of demand: Total expenditure method was evolved by Marshall It is essential to know how much and in what direction the total expenditure has changed as a result of change in the price of a good.Total Expenditure Method

Price of Commodity Quantity Total Expenditure Effect on Total Expenditure Elasticity of Demand

241428888Same Total Expenditure Unity Elastic

24141108410Less total Expenditure More total Expenditure Greater than Unity

241324684More total Expenditure Less total Expenditure Less than Unity

BCDPMETANRPrice Total Expenditure Ed = 1Ed 1

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Proportion or Percentage Method Ed= (-)P/Q x Q/P Example: price of ice cream = 4, demand = 1 Price fall in ice cream = 2, demand extends = 4Point Elasticity of Method Elasticity of demand at the mid point on the demand curve is unity, at a point above the mid-point, it is greater than unity and at a point below the mid-point, it is less than unity.

Non-linear

Revenue method Sale proceeds that a firm obtains by selling its products is called its revenue. Example Selling 10 Meters cloth Get = 50 Rs. 50 Rs is called revenue When total revenue is divided by the nu. Of units sold we get average revenue or price per unit. Additional unit called marginal revenue. Extra unit 11 meters Total revenue = 54 Total change 54-50= 4 Price elasticity of demand is also measured with the help of average and marginal revenue. Ed = AR/ AR-MR

Ed PB/PA PMB and AEP AET and TPL PL= AE BY putting PL in place of AE in equation. Ed PL= PM-LM Hence, ed= Here, PM = AR and LM = MR So, Ed = ARC Elasticity Method Watson: arc elasticity is the elasticity at the mid-point of an arc of a demand curve.

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Example: price of ice cream = 4, demand = 1Price fall in ice cream = 2, demand extends = 4Factors Determining the Price Elasticity of Demand Nature of the commodity Available of substitutes Goods with different uses Postponement of the use Income of consumer Influence of habit and custom Price level Time Joint demand Durable goodsException of the Law of Demand Articles of distinction or Veblen goods Ignorance Giffen goods Expectation of rise or fall in price in future Necessaries of life Commodities with special brand and trade mark War or emergency Type of demands Demand for consumers goods and producers goods Demand for perishable goods and durable goods Autonomous demand and derived demand Industry demand Short run and long run demand Joint demand and composite demand Market demand and market segment demand Individual demand and market demandDetermination of Demand Price of the commodity

Prices of Related Goods Substitute goods

Complementary Goods

Income of the Consumer Normal goods: It is good for which an increase in consumers income results in an increase in demand.

Inferior goods It is a good for which an increase in consumers income results in decrease in its demand.

Necessaries of Life Taste and preference Size and composition of population Distribution of income Customs Climate and weather conditions Invention and innovationIncome Elasticity of Demand Watson: Income elasticity of demand means the ratio of the percentage change in the quantity demanded to the percentage change in incomeMeasurement of income elasticity: Ey Income (Y): 3000 Demand (Q): 10 units of ice cream Increase monthly income (Y1): 6000 Demand (Q1): 30 units ice cream = Q1-Q= 30-10= 20 EyDegree of Income Elasticity of Demand Positive income elasticity of demand

Unitary Income Elasticity of Demand Positive income elasticity of demand is unitary when a given percentage change in income is followed by equal percentage change in demand. Example income increase by 100 per cent and demand also increases by 100 per cent.

Less than Unitary Income Elasticity of Demand Percentage change in demand is less than percentage change in income.

Greater than Unitary Income Elasticity of Demand Percentage change in demand in more than percentage change in income.

Negative and Zero Income Elasticity of Demand Income elasticity of demand is negative when increase in the income of the consumer is accompanied by fall in demand of a good and decrease in income is followed by rise in demand. It refers to inferior goods/Giffen goods

Importance of Income Elasticity in Business Decision regarding investment Forecasting of demand Classification of commodities

Cross Elasticity of Demand Cross elasticity of demand is measure of change in quantity demanded of good-y as a result of change in the price of good-x.

Degree of Cross Elasticity of Demand Positive Negative Zero Q5. What is the objective of firm? Explain the significance of price elasticity of demand in business. Economic profit: the difference between total revenue and total cost (TR-TC). Explicit costs are those cash payments which firms make to outsiders for their services and goods. Implicit costs are costs of self-owned or self-employed resources. Normal profit is just another name for the implicit cost that a firm incurs when it employs self supplied resources such as financial capital and management services. It transforms valued factors into products of a higher value. The firm tries to attain its objective of profit maximization in a rational manner. The market environment Short-run and long-run Analyze changes in the prices and quantities of input and outputConditions of Profit Maximization TR-TC Marginal Revenue (MR) = Marginal Cost (MC) Slope of MR curve should be less than the slope of Marginal Cost curve or, MC curve must cut MR curve from below

Favor of profit maximization goal Strongest motive Essential for the survival of the firm Accurate prediction Efficiency of firmArguments against Profit Maximization Uncertainty The goal of joint companies may be different Impractical Preventing governments intervention Lack of knowledge of demand Not a proper goalImportance/managerial use and business of price elasticity of demand Significance in price determination: Determination of price under monopoly Price discrimination Dumping Price determination of joint supplyImportance in Govt. Policy Formulation Price control policy Protection to industries Distribution of taxation Fixing rate of exchange Demand forecasting Wage determination Effect on employment International trade

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