M EMANAGERIAL ECONOMICS

• DEFINITIONS

• Adam Smith: Father of modern economics.

• Wealth of nations.

• ALFRED MARSHALL: Material welfare: creation of wealth.

• LEONEL ROBBINS: Science of scarcity or science of choice.

• SCIENCE OF SCARCITY OR SCIENCE OF CHOICE:

• In 1931, Lionel Robbins challenged the traditional view of the nature of economic science. He defined Economics as follows:

• “Economics is the science which studies human behaviour as a relationship between ends and scarce means which have alternative uses.”

• Ends (wants): Wants are unlimited. So, one is compelled to choose between the more urgent and the less urgent wants. That’s why Economics is also called a SCIENCE OF CHOICE.

• Means (Resources):; Means is limited. • ‘Resource’ means land, labour, capital and entrepreneur

(organisation).• Since these resources are limited, the ability of the

society to produce goods and services is also limited. So, the term ‘SCARCITY’ is used in respect of ‘means’.

• ‘Means’ is scarce in relation to ‘ends’.

• Scarce means are capable of alternative uses.• Economic activity lies in man’s utilisation of

scarce means having alternative uses for the satisfaction of multiple ends.

• “Means” refer to time, money or any oth;er form of property. These are all limited. “Ends” are unlimited. So, choice-making is essential. That’s why Economics has been called a “science of choice.”

• According to Prof. Stigler, “Economics is the study of the principles governing the allocation of scarce means among compe-ting ends when the objective of allocation is to maximise the satisfaction”.

• Robbins raised his point with two foundation stones, viz:

• Multiplicity of wants, and• Scarcity of means.

• MICRO AND MACRO ECONOMICS• These are relative terms. Micro economics refers to

study of sub-groups or an element in a large mass of data, whereas macro economics refers to study of the universe ( the entire field of study). For ex: A study of demand for certain product in a given market condition or place is a micro-economic study in relation to the demand condition prevailing in the entire nation or world. So, if the market condition for steel in Bangalore city is under study, then it is micro-economic study in relation to market condition for steel in India (macro) or the world(macro).

• Is Economics a science or art?• MANAGERIAL ECONOMICS• Definitions:• McNair & Meriam define ME as “ME is the use

of economic modes of thought to analyse business situations.”

• Prof. Evan J. Douglas defines: “ ME is concerned with the application of economic principles and methodologies to the decision-making process within the firm or organisation under the conditions of uncertainty.”

• SUBJECT-MATTER AND SCOPE OF ME• ME is concerned with the application of

economic concepts and analysis to the problem formulating rational managerial decisions.

• There are 4 groups of problem in both decision-making and forward planning. They are:

• 1. Resource allocation.• 2. Inventory queuing problem.• 3. Pricing problem.• 4. Investment problem.

• Study of ME essentially involves the analysis of certain major subjects like:

• Demand analysis and methods of fore-casting demand.

• Cost analysis.• Pricing theory and policies.• Break-even point and analysis.• Capital budgeting for investment decisions.• The biz firm and objectives.• Competition.

• GOALS OF MANAGERIAL ECONOMICS

• 1. Production goal.

• 2. Inventory goal.

• 3. Market-share goal.

• 4. Profit-maximisation goal.

• 5. Growth-maximisation goal.

• CONCEPTS APPLIED IN M E

• 1. Opportunity cost.

• 2. Equi-marginal principle.

• 3. Incremental cost principle.

• 4. Time perspective (time element).

• 5. Discounting principle.

• OPPORTUNITY COST• It is the maximum possible alternative ear-

nings that will be sacrificed if the productive capacity or service is put to some alternative use. For ex: if an own building is used to run own business, then the rent that could be earned by letting it out is sacrificed. This is an opportunity cost of the productive capacity of an asset.

• This sacrificed benefit is related(deducted)to the revenue/return earned from the project.

• 2. EQUI-MARGINAL PRINCIPLE• This principle is used in determining options in

resource allocations. For ex: an input is used in several biz activities. The question is as to how the input is allocated among various activities,e.g., the input is capital.

• The combination of factors of production is such where:

• MC = MR

• The knowledge of Equi-marginal principle helps the businessman in selecting the combination of various factors of production.

• 3. INCREMENTAL CONCEPT• This refers to additional cost incurred due to changes in

the level of production acti-vity. When the production pattern is changed, extra cost is incurred.

• Incremental Cost= New TC– Old TC.• If the incremental revenue is more than incremental cost,

it is welcome.• Note: The concept of incremental cost does not arise if

the biz is set up afresh. It arises only when a change is contemplated in the existing biz.

• 4. TIME PERSPECTIVE• Economists use the functional time periods in

analysing equilibrium pheno-menon. The functional time periods are:

• Short period and Long period.• Short Period– Fixed cost remains constant• Long Period– Fixed cost vary.• Short Period– If the expansion is under-taken,

the firm tolerates normal losses.• Long Period– If the loss persists, it indicates

complete failure of biz.

• 5. DISCOUNTING PRINCIPLE

• In(capital budgeting) decision-making process, the p.v of the project is discounted from the future net cash-inflow from the project.

• The present gain is valued more than a future gain.

• PRINCIPLE OF EQUI-MARGINAL UTILITY• The marginal utility (mu) theory applies to one

commodity at a time.• Consumer buys more than one commodity at a time with

his given money income. Now, the problem is as to how to allocate a given money on various goods he wants. Consumer’s main objective in spending money is to attain the equilibrium (E).

• Equilibrium is a situation in which the consumer gets maximum satisfaction from the consumption of given commodity.

• So, E = mu/p where, p=price.• If p=mu, the consumer is said to have attained E.

• RISK AND UNCERTAINTY

• The element of risk and uncertainty is involved in all decisions including invest-ment decisions.

• Uncertainty is a situation where there is more than one possible outcome to a decision but the probability of each speci-fic outcome occurring is not known.

Module-2: DEMAND ANALYSIS

• ESTIMATION AND FORECASTING• Produce products which have continuous demand in the

market.• Types of Demand:• For managerial decisions, classify the large number of

goods and services avail-able in every economy as under:

• 1. Consumer goods and producer goods:• Goods and services used for final consumption are

consumer goods.• Producer goods refer to the goods used for production of

other goods, e.g., P&M, Raw-materials,etc.,.

• 2. Perishable and durable goods.

• 3. Autonomous and Derived demand:

• The goods whose demand is not tied with the demand for some other goods are said to have autonomous demand, while the rest have derived demand, e.g., pen-ink.

• 4. Individual’s demand and market demand.

• 5. Firm and Industry demand:

• E.g., Demand for Maruthi cars– firm’s demand.

• Demand for all types of cars– Industry’s demand.

• 6. Demand by market segments and by total market.

• 7. Joint demand and composite demand.

• DEMAND CURVE

• SHIFTS IN DEMAND CURVE

• a. Increase in Demand.

• b. Decrease in Demand.

ELASTICITY OF DEMAND

• Alfred Marshall introduced and perfected the concept of ED.

• The law of demand indicates only the direction of change in quantity demanded in response to a change in price.

• The law of demand makes only the gene-ral statement and it ignores the specific aspect. The specific aspect is provided by a concept of EoD.

• Meaning of EoD• EoD means a quantitative response to a change

in price, income or the price of a related/substitute product.

• Definition of EoD– by Alfred Marshall:• “The elasticity or responsiveness of demand in a

market is great or small according to the amount demanded increases much or little for a given fall in price and diminishes much or little for a given rise in price.”

• Thus, EoD refers very much to price EoD.

• KINDS OF EoD:

• 1. The price EoD

• 2. The Income EoD

• 3. The Cross EoD.

• 1. THE PRICE EoD:

• Price EoD expresses the responsiveness of quantity demanded to changes in it’s price.

• Price Elasticity= Proportionate change in quantity demanded/ Proportionate change in it’s price.

• eP= ^Q/Q = ^Q/Q X P/^P. ^P/P If 5% change in price leads to 12% change in

quantity demanded, price EoD is 12/5= 2.4.

• Classification of Price EoD• a. Perfectly elastic demand.• b. Perfectly inelastic demand.• C. Unitary elastic demand.• d. Relatively elastic demand.• E. Relatively inelastic demand.• a. Perfectly elastic demand:• If a small change in price leads to big rise in the quantity

demanded, it is perfectly elastic demand.• The shape of the curve is horizontal straight line.

• B. Perfectly inelastic demand:• Even if a big rise in the price of a product does

not affect the quantity demanded, it is inelastic demand. ( That means the demand does not show any response to a change in price).

• Perfectly inelastic demand has zero elasti-city.• Demand curve is that of a vertical straight line.• This situation is not found in the present day

economies.• In this case, the seller can charge any price and

still sells the same quantity.

• 3.Unitary Elastic Demand:

• This is the dividing line between elastic and inelastic demand. Here, eD=1. That means the response to change in quantity demanded is the same as change in price.

• The unitary eD curve is that of a rectangular hyperbola.

• The perfectly elastic and perfectly inelastic demand are not in real world and hence they have only theoretical value. There are only two possibilities namely, either the demand is elastic or inelastic.

• FACTORS DETERMINING Ed:• Some important factors are—• 1. Luxury or Necessity goods• 2. % of income• 3. Substitutes• 4. Time.

• MEASUREMENT OF ELASTICITY• Elasticity is a measurable concept. There

are 3 ways to measure—• 1.Ratio method 2. Total Outlay method• 3. The Point method.• 1. RATIO METHOD:• EoD= % change in qnty demanded % change in price

• 2. TOTAL OUTLAY METHOD• In this method, the changes in the total outlay

(expenditure) on the good is calculated.• In this method, it is possible to know whether the

elasticity is =1, >1 or <1.• The total expenditure remains the same, change

in price and quantity are the subject-matters.• Ex: Price per unit is Rs.50, total expenditure is

Rs.500. Price changes to Rs.60 and total expenditure is same, i.e.,Rs.500. Then. EoD=1.

• Ex:2: Original price is Rs.50 and the increased price is Rs.100. The original expenditure is Rs.500 and new expendi-ture is Rs.1500. Then, Ep=1500/500=3.

• 3. THE POINT METHOD: The Point method assumes a straight line

demand curve. Elasticity is represented by the fraction of distance from D to a point on the curve divided by the distance from other end of that point.

( Diagram is to be drawn and explained).

• ARC EoD• Under the Point method, EoD is measured when

changes in price and quantity demanded are small. If the price changes are large, then we have to measure elasti-city over an arc of the demand curve rather than at any specific point on the curve. For ex: price change is from Rs.30 to Rs.45– then we calculate the elasticity by arc method.

• Under Point method, Old and new prices and quantity are taken to measure EoD. But, under arc method, the average of old and new prices are taken.

• In arc elasticity, the change in price is exp-ressed as a proportion of average of the old price and new price and the previous quantity and the new quantity. So, the Arc elasticity is called the Average elasticity.

• Arc Ela= Q1- Q2 divided by P1- P2 Q1+Q2 P1+ P2Ex: Quantity demanded is 500 units at Rs.25 and

250 units at Rs.37.50. Then—Arc Ela = 500 – 250 divided by 25 – 37.50 = 1.66 500 + 250 25 + 37.50