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DUNDIGAL, HYDERABAD - 500 043
UNIT-I
INTRODUCTION TO MANAGERIAL ECONOMICS & DEMAND ANALYSIS
ECONOMICS
Economics is a study of human activity both at individual and national level. The economists of early age treated economics merely as the science of wealth. The reason for this is clear. Every one of us in involved in efforts aimed at earning money and spending this money to satisfy our wants such as food, Clothing, shelter, and others. Such activities of earning and spending money are called “Economic activities”.
According to Adam Smith
“Economics as the study of nature and uses of national wealth”.
According to Dr. Alfred Marshall
“Economics is a study of man’s actions in the ordinary business of life: it enquires how he gets his income and how he uses it”.
MICRO AND MACRO ECONOMICS
Micro Economics
The study of an individual consumer or a firm is called Micro Economics. It is also called the theory of Firm.
(^) Micro means one millionth. Micro Economics deals with behaviour and problems of single individual and of micro organisation.
Managerial Economics
(^) Managerial Economics has its roots in micro economics and it deals with the micro or
individual enterprises.^
(^) It is concerned with the application of concepts such as Price Theory, Law of Demand and Theories of market structure and so on.
Macro Economics
The study of aggregate or total level of economic activity in a country is called Macro Economics.
**3. C.I.SAVAGE AND T.R.SMALL therefore believes that managerial economics is concerned with business efficiency.
“Managerial Economics is a fundamental academic subject which seeks to understand and to analyse the problems of business decision-making”.
5. In the words of PAPPAS AND HIRSHEY
“Managerial Economics applies economic theory and methods to business and administrative decision-making. Because it uses the tools and techniques of economic analysis to solve managerial problems, managerial economics links traditional economics with decision sciences to develop important tools for managerial decision-making”.
6. MICHAEL R.BAYE defines
Managerial Economics as “the study of how to direct scarce resources in a way that most efficiently achieves a managerial goal”.
7. HAYNES, MOTE AND PAUL define
Managerial Economics as “economics applied in decision-making. They consider this as a bridge between the abstract theory and the managerial practice”.
Managerial Economics, therefore, focuses on those tools and techniques, which are useful in decision-making.
MANAGERIAL ECONOMICS:
Managerial Economics refers to the firm’s decision making process. It could be also interpreted as “Economics of Management”. Managerial Economics is also called as “Industrial Economics” or “Business Economics”.
Managerial Economics bridges the gap between traditional economics theory and real business practices in two days. First it provides a number of tools and techniques to enable the manager to become more competent to take decisions in real and practical situations. Secondly it serves as an integrating course to show the interaction between various areas in which the firm operates.
(a) Close to microeconomics : Managerial economics is concerned with finding the solutions for different managerial problems of a particular firm. Thus, it is more close to microeconomics. (b) Operates against the backdrop of macroeconomics : The macroeconomics conditions of the economy are also seen as limiting factors for the firm to operate. In other words, the managerial economist has to be aware of the limits set by the macroeconomics conditions such as government industrial policy, inflation and so on. (c) Normative statements : A normative statement usually includes or implies the words ‘ought’ or ‘should’. They reflect people’s moral attitudes and are expressions of what a team of people ought to do. For instance, it deals with statements such as ‘Government of India should open up the economy. Such statement are based on value judgments and express views of what is ‘good’ or ‘bad’, ‘right’ or ‘ wrong’. One problem with normative statements is that they cannot to verify by looking at the facts, because they mostly deal with the future. Disagreements about such statements are usually settled by voting on them. (d) Prescriptive actions : Prescriptive action is goal oriented. Given a problem and the objectives of the firm, it suggests the course of action from the available alternatives for optimal solution. If does not merely mention the concept, it also explains whether the concept can be applied in a given context on not. For instance, the fact that variable costs are marginal costs can be used to judge the feasibility of an export order. (e) Applied in nature : ‘Models’ are built to reflect the real life complex business situations and these models are of immense help to managers for decision-making. The different areas where models are extensively used include inventory control, optimization, project management etc. In managerial economics, we also employ case study methods to conceptualize the problem, identify that alternative and determine the best course of action. (f) Offers scope to evaluate each alternative : Managerial economics provides an opportunity to evaluate each alternative in terms of its costs and revenue. The managerial economist can decide which is the better alternative to maximize the profits for the firm. (g) Interdisciplinary : The contents, tools and techniques of managerial economics are drawn from different subjects such as economics, management, mathematics, statistics, accountancy, psychology, organizational behaviour, sociology and etc. (h) Assumptions and limitations : Every concept and theory of managerial economics is based on certain assumption and as such their validity is not universal. Where there is change in assumptions, the theory may not hold good at all.
The main focus in managerial economics is to find an optimal solution to a given managerial problem, the problem may related to production, reduction or control of cost,
If it is necessary for the manager to know the relationship between the cost and output both in the short-run and long-run to position his products amidst the competitive environment.
3. Price-Output Decision:
Here, the production is ready and the task is to determine the price these in different market situations such as perfect market and imperfect markets ranging from monopoly, monopolistic competition, duopoly and oligopoly.
The features of these markets and how price is determined in each of these competitive situations is studied here.
The pricing policies, methods, strategies and practices constitute crucial part of the study of managerial economics.
4. Profit -related Decisions:
Here we employ the techniques such as Break even analysis, cost reduction and cost control and ratio analysis to ascertain the level of profits.
We determine break-even point beyond which firm start getting profits.
(^) In other words, if the firm produces less than break- even point, it loses. (^) We can also plan the production needed to attain a given level of profits in short-run.
Cost reduction and cost control deal with the strategies to reduce the wastage and thereby reduce the costs.
These indirectly enhance the level of profits.
(^) Ratio analysis helps to determine the liquidity, solvency, profitability of the activities of the firm.
There are certain ratios used to analyse and interpret the profitability of the firm given a set of accounting data.
5. Investment Decisions
Investment decisions are also called capital budgeting decisions.
These involve commitment of large funds, which determine the fate of the firm.
These decisions are irreversible.
Hence the manager needs to be more attentive while committing his scarce funds, which have alternative uses.
The allocation and utilisation of investments is paramount importance.
Capital has a cost. It is expensive. Hence, it is to be utilised in such a way as to maximise the return on capital invested.
It is necessary to study the cost of capital structure and investment projects before the funds are committed.
6. Economic Forecasting and Forward Planning
Economic forecasting leads to forward planning.
The firm operates in an environment which is dominated by the external and internal factors.
The external factors include major forces such as government policy, competition, employment, labour, price and income levels and so on.
These influence its decision relating to production, human resources, finance and marketing.
The internal factors include its policies and procedures relating to finance, people, market and products.
It is necessary to forecast the trends in the economy to plan for the future in terms of investments, profits, products and markets. This will minimise the risk and uncertainty about the future.
Demand Analysis
Demand
Demand in common parlance means the desire for an object. But in economics demand is something more than this. According to Stonier and Hague, “Demand in economics means demand backed up by enough money to pay for the goods demanded”. This means that the demand becomes effective only it if is backed by the purchasing power in addition to this there must be willingness to buy a commodity.
In case of complementariness like car and petrol a fall in price of one commodity leads to an increase in the demand for other commodity and vice versa.
If the price of pens goes up, their demand is less as a result of which the demand for ink is also less. The price and demand go in opposite direction. The effect of changes in price a commodity on amounts demanded of related commodities is called cross demand.
3. INCOME OF THE CONSUMER
The third most important factor influencing demand is consumer income.
(^) In fact we can establish a relationship between the consumer income and demand at different levels of income, price and other things remaining same.
(^) The demand for a normal commodity goes up and falls down when income rises and falls down.
But in case of Giffen goods the relationship is opposite.
(^) Demand always changes with a change in the incomes of the people.
When income increases the demand for several commodities increases and vice versa.
The fourth most important factor influencing demand is consumers’ tastes and fashions.
The demand also depends on consumer's taste. Tastes include fashion, habit, customs etc.
A customer taste is also affected by advertisement.
If the taste for a commodity goes up, its amount demanded is more even at the same price.
This is called increase in demand. The opposite is called decrease in demand.
A change in the tastes and fashions brings about a change in demand for a commodity.
(^) When commodity goes out of fashion, the demand for it will decrease even though the price remains the same. Demand curve shifts to the left.
5. AFFECT OF WEALTH
(^) The amount demanded of the commodity is also affected by the amount of wealth as well as its distribution.
When the wealth of the people is more, demand for the normal commodities is also more.
If wealth is more equally distributed, the demand for necessaries and comforts is more.
On the other hand, if some people are rich, while the majorities are poor, the demand for luxuries is generally higher.
Increase in population increases demand for necessaries of life.
(^) The compositions of population also affect demand.
Composition of population means the proportion of young and old and children as well as the ratio of men and women.^
A change in composition of population has an affect on the nature of demand for different commodities.^
(^) A change in size as well as composition of population will affect the demand for certain
commodities.^
For example: An increase in size of population will increase the demand for food grains. Similarly, an increase in percentage of women increases the demand for bangles and sarees.
(^) Demand always changes with a change in weather or climate even though price remains unchanged.
In summer the demand for cool drinks increases and in winter it decreases.
The climate of an area and the weather prevailing there has a decisive effect on consumer’s ^ demand.^
(^) In cold areas woollen cloth is demanded. During hot summer days, ice is very much in demand. On a rainy day , ice cream is not so much demanded.
Government policy affects the demand for commodities through taxation.
QD = F( P, I, Psc, T, A)
Where
Qd = quantity demand
F = functional relational between input
P = price of the product
I = income of the consumer
Psc= price of substituted or complementary
T = taste and preference
A = advertisement
Law of Demand
DEMAND ANALYSIS
INTRODUCTION OF DEMAND:
Demand in common practice / ordinary language means the desire for an object. Suppose a person desires to have a car. It is called demand in ordinary usage.^
But in economics demand has a separate meaning which is quite distinct from the above meaning.
A mere desire cannot become demand in Economics.
A desire which is backed up by (i) ability to buy and (ii) willingness to pay the price, is called demand. Unless the desire is accompanied by ability to buy and willingness to pay, it cannot be called demand in Economics.
1. According to Stonier and Hague,
“ Demand in economics means demand backed up by enough money to pay for the goods demanded”.^
This means that the demand becomes effective only if it is backed by purchasing power in addition to this there must be willingness to buy a commodity.
Thus demand in economics means the desire backed by the willingness to buy a commodity and the purchasing power to pay.
2. In the words of Benham,
“The demand for anything at a given price is the amount of it which will be bought per unit of time at that price ”. (Thus demand is always at a price for a definite quantity at a specified time.)
Thus demand has three essentials i.e., price, quantity and time. Without these three demand has no significance in economics.
1. ALFRED MARSHALL stated that Law of Demand as
“a rise in the price of commodity or service is followed by a reduction in demand and fall in price is followed by an increase in demand, if the conditions of demand remain constant.”
Marshall stated that the Law of Demand basing on the law of Diminishing Marginal Utility..
2. In the words of SAMUELSON
the Law of Demand may be stated as
“Other things being equal, the quantity demanded increases with a fall in price and decreases with a rise in price.”
.Law of Demand
Law of demand states the relationship between price and quantity demanded. As per the law when price is increased demand will decrease, and similarly, when price is decrease demand will increase, this law assumed that, other things remaining constant, the change in price will inversely affect demand, thus the relationship between price and demand is inverse.
A rise in the price of a commodity is followed by a fall in demand and a fall in price is followed by a rise in demand, if a condition of demand remains constant.
(^) In the above Diagram, demand is shown on OX – axis and price is shown on OY-axis. DD is the demand curve.
(^) The demand curve DD shows the inverse relation between price and quantity demand of Mangoes.
The demand curve slopes downward from left to right.
Law of Demand is based on the following assumptions. The Law will hold good only if the following assumptions are fulfilled.
**1. That the tastes and fashions of the people remain unchanged.
commodity. EXCEPTIONS TO THE LAW OF DEMAND
Some times in case of some commodities demand curve slopes upwards from left to right. It shows that when price rises demand also rises and when price falls demand also falls. In this case the demand curve has a positive slope. We can draw the Exceptional Demand Curve as follows.
Price (Rs.) D
Quantity Demanded
In the above Diagram, demand is shown on OX – axis and price is shown on OY-axis.
DD is the demand curve.
When price increases from OP to OP1 quantity demand also increases from OQ to OQ1 and the price falls down from OP1 to OP quantity demand also falls down from OQ1 to OQ.
^ ^ Hence the exceptional demand curve slopes upwards from left to right in this diagram.
The following are the important exceptions to the Law of Demand.
**1. Giffen Paradox 2. Prestige goods 3. Speculation 4. Trade Cycles 5. Changes in Expectations.
In the early part of the 19th^ Century, Sir Robbert Giffen, a British Economist observed that the Low paid British workers were purchasing more bread, when its price increased.
This is some thing contrary to the law of demand.
(^) He observed that the people spend a major portion of their incomes on bread only a small part on meat.
Meat is more costly but less essential that bread.
(^) When the price of the bread increased, they reduced the expenditure on meat.
With the money thus saved they purchased more bread to compensate for the loss of meat.
(^) Thus where the price of bread is increases, its demand is also increased. This is the against
law of demand.^
This paradox was stated by Sir Robbert Giffen. Therefore, it is called Giffen Paradox.
Marshall could not explain this. It appeared to be a paradox to him.
The Demand Curve for Giffen goods(Inferior goods) goes upward from left to right as shown in the above diagram.^
2. PRESTIGE GOODS:
They may be expecting a further in prices. ELASTICITY OF DEMAND
Elasticity of demand explains the relationship between a change in price and consequent change in amount demanded. “Marshall” introduced the concept of elasticity of demand. Elasticity of demand shows the extent of change in quantity demanded to a change in price.
In the words of “Marshall”, “The elasticity of demand in a market is great or small according as the amount demanded increases much or little for a given fall in the price and diminishes much or little for a given rise in Price”
Elastic demand: A small change in price may lead to a great change in quantity demanded. In this case, demand is eastic.
In-elastic demand: If a big change in price is followed by a small change in demanded then the demand in “inelastic”.
Types of Elasticity of Demand:
There are three types of elasticity of demand:
Elasticity of demand in general refers to price elasticity of demand. In other words, it refers to the quantity demanded of a commodity in response to a given change in price. Price elasticity is always negative which indicates that the customer tends to buy more with every fall in the price, the relationship between the price and the demand is inverse.
Proportionate change in the quantity demand of commodity
Price elasticity = ------------------------------------------------------------------
Proportionate change in the price of commodity
Q2 - Q1/ Q
Edp = ----------------
Where:
Q1 = quantity demand price before change
Q2 = quantity demand price after change
P1 = price before change
P2 = price after change
Income elasticity of demand:
Income elasticity of demand refers to the quantity demand of a commodity in response to a given change in income of the consumer.
Proportionate change in the quantity demand of commodity
Income Elasticity = ------------------------------------------------------------------
Proportionate change in the income of the people
EdI = ----------------
I2 – I1 /I
Where:
Q1 = quantity demand price before change
Q2 = quantity demand price after change
I1 = income before change
I2 = income after change
Cross elasticity of demand:
