UNIT-1 Introduction To Managerial Economics and Demand Analysis
UNIT-1 Introduction To Managerial Economics and Demand Analysis
UNIT-1 Introduction To Managerial Economics and Demand Analysis
UNIT-1
INTRODUCTION TO MANAGERIAL
ECONOMICS AND DEMAND ANALYSIS
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Objectives:
The main objectives of this lesson are
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2. DEMAND ANALYSIS
2.1 Introduction
2.2Demand Function
2.3 Law of Demand
2.4 Types of Demand
2.5 Extension and Contraction of Demand & Increase of Demand and Decrease
in Demand
2.6 Elasticity of Demand
2.7 Types of Price Elastic of demand
2.8 Measurement of Price Elasticity of Demand
2.9 Factors Determining Price elasticity of Demand
2.10 Demand Forecasting
2.11 Types of Demand Forecasting
2.12 Importance of Demand Forecasting
2.13 Approaches to Forecasting
2.14 Demand Forecasting Methods
2.15 Requisites of a Good Forecasting Method
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The definitions of economics can be broadly classified into three different categories.
Economics influences the technical decisions of any industry by using the techniques such as
demand analysis, elasticity of demand, demand forecasting, break-even analysis, production
function, capital budgeting etc.
Kinds of Economics:
1. Micro Economics
Micro Economics is also called “Theory of Firm”. Micro economics is that branch of economics
which is concerned with the analysis of the behavior of the individual units or variables such as
individual demand or the price of the product.
Micro economics basically deals with individual decision making and the problem of resource
allocation. It is concerned with applications such as Law of Demand, Price Theory etc.
2. Macro Economics:
Macro economics is that branch of economics which deals with the aggregate behavior of the
economy as a whole,which makes a study of the economic systems in general. E.g. National
income, Total saving, Total Consumption, Unemployment, Economic Growth rate.
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2. It is individualistic. It is aggregate.
5. It deals with the data of individual It deals with the data of total industry.
firm.
M
A --- The Manager
N
A
G --- Knowledge
E
M
E --- The People
N
T --- Technology/Techniques/Tactics
In the above, Man refers to the manager who leads the groups and organization and is
responsible for the performance of other activities. Here age does not means chronological age,
it refers to the knowledge to be possessed by a manager to operate the organization successfully.
Knowledge can be secured through experience, study and exposure.
The word men stands for the term people, i.e the team of subordinates working under the
supervision and control of the managers. They achieve the objectives with the assistance of
subordinates. T denotes technology, it means know how. Managers should also possess skills,
techniques and tactics to win the game and to achieve the objects.
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Definitions:
“Managerial Economics is the use of economic modes of thought to analyze business situations”.
Mc Nair and Meriam.
“Managerial Economics is the integration of economic theory with business practice for the
purpose of facilitating decision making and forward planning by management”.
M. H. Spencer and Louis Siegelman
Based on the above definitions the common view regarding managerial economics is as follows
1. Managerial Economics is concerned with decision making of economics nature.
2. Managerial economics is goal oriented.
3. Managerial Economics facilitates forward planning.
4. Managerial economics provides link between traditional economics and decision science.
5. Managerial Economics directs the utilization of scarce resources in a goal oriented
manner.
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Normative Economics
Application Oriented
Take the help of Macro Economics
Evaluation of each alternative
Assumptions
Goal Oriented
Normative Economics:
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. Managerial
Economics tells a business firm to do certain things which will benefit them and not to do certain
things which leads to losses.
Application Oriented:
In managerial economics, we employ case study methods to conceptualize the problem, identify
the alternative and determine the best course of action. Managerial Economics tries to solve
some complicated business problems with the help of economics tools, techniques and
principles. Decision making skills can be improved by applying some principles and concepts of
economics. So managerial economics is application oriented.
Assumptions:
Managerial Economics is based on certain assumptions and the assumptions are not valid
universally. Therefore, if there is a change in assumption, the theory may not hold good.
Goal Oriented:
Managerial Economics is goal oriented and problem solving in nature. It uses the economic
theory and decision science for solving business oriented problems.
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Resource Allocation:
Managerial economics provides the methods effective resource allocation. It mainly aims at
achieving high output through low and proper allocation of resource. It is useful for getting
higher productivity
Marginal analysis is applied to the problem of determining the level of output, which
maximizes profit.
Production Analysis:
Production analysis refers to the physical terms of output,while cost analysis refers to monetary
terms. Production analysis deals with different production functions and their managerial uses.
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Cost Analysis:
Every business firm wants to reduce cost. A study of economic costs and their estimates are
useful for management decisions. Estimation of cost is essential for decision making. An
element of cost uncertainty exists, as all the factors determining cost are not always known or
controllable. Cost control is essential for pricing policies.
Pricing Policies:
Pricing is an important area of managerial economics. Price is the basic thing for the revenue of a
firm, and the success of the price decisions taken by it. Different pricing methods and price
forecasting occupy an important place here.
Market Strategies:
Managerial Economics provides marketing strategies like Product, Price, Place and Promotion
strategies for better result in the organization. These strategies are called marketing mix or 4P’s.
Profit Management:
The primary aim of any firm is to maximize profits. Their exists an uncertainty in the estimation
of profits, because of differences in the costs and revenues, and the effects of its internal and
external factors. Therefore, profit management is the difficult area in managerial economics.
Profit theory guides in the measurement and management of profit, in calculating the pure return
on capital, besides future profit planning.
Capital management:
Capital Management implies planning of acquisition, disposition and control of capital.
Product Decisions:
These decision are related to the what products the firm will produce and offer for sale and
decision may be related to additions of a product or deleting the existing product. It also includes
the style or design, packing and size of the product.
Pricing Decisions:
These decisions are related to fixing a price for the products manufactured. If the price is very
high the firm may not be able to sell its products. Even if the price is low, the consumers think it
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is an inferior product. Application of pricing techniques helpful for the managers to attract the
customers.
Quantity Decisions:
These decisions are related to how much to be manufactured. The production depends normally
in anticipation of demand. It means it totally dependent on demand forecasting.
Technological Decisions:
It is concerned with the method to be adopted in manufacturing a product. One should see
whether a change in technology will benefit the business firm or not.
Hence, there may be more problems to be faced while planning for the future. It may relate to
production, pricing, capital and raw material. The resources are scarce but they have alternative
uses. Decision making is very important because it is related to uncertain. Managerial economics
understand these decision making problems and guides us in a purposeful direction.
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management. They both deal with the allocation of scarce resource in an maximum way. A
managerial economist must know about traditional economics in order to understand the
principles of managerial economics.
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1.11 Role
The managerial economist plays a very important role in an organization
The objective of a managerial economist plays a very important role in an organization
The managerial economist must try to maximize profits on their invested capital
Managerial economist must make an accurate forecast as possible, because forecast
depends on future which is uncertain.
he should advise the management on domestic and global economic issues
The managerial economist has to maintain contact with data sources. He has to obtain
statistical data on national income, price level and tax policies
He should identify new business opportunities
He should build micro and macroeconomic models to solve specific problems
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DEMAND ANALYSIS
2.1 Introduction:
Demand is the basis for the starting of any business, as the product decision and amount of
product to be produced would be decided only on the basis of the demand prevailing in the
market i.e. depending on the market survey and demand forecast. Demand only decides
indirectly the amount of factors of production to be employed in the organization i.e. money,
men, material, machinery and management required. Without proper demand analysis, if
production activity is undertaken the business firm may suffer huge losses.
.
Demand in ecnomics means effective demand, which can be defined as a desire backed by
willingness and ability to pay for a particular product. Thus for a demand to be effective three
factors are impoartnat
If there is ability and willingness but no desire then it is nor a demand. Similarly, without
willingness if there is desire and ability, then also it is not a demand.
Definitions of Demand:
“Demand means the various quantities of a good that would be purchased per time period at
different prices in a given market”-------------------------------------------------------------Hibdon
“By demand, we mean the quantity of a commodity that will be purchased at a particular
price and not merely the desire for a thing”---------------------------------------------------Hausen
Dx = F (Y , P , P , P ,T , E , N , D,u, a)
X S c p
Where
D = Quantity demanded for the product
x F = Function of
Y = Consumer’s income
Px = Price of good x
Ps = Price of substitute of x
Pc = Price of complements of x
T = Measure of consumer tastes and preferences
Ep = Consumer’s expectations above future prices.
N = No of customers
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D = Distribution of consumers
u = Other determinants of the demand for
x a = advertisement
5. Consumer Expectation:
A consumer expectation about the future changes in the price of a given product may also affect
its demand. When the consumer expects the prices to fall in the future he tends to buy less and
vice versa.
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6. Population:
Increase in population increases demand for necessaries of life. Decrease in population will also
affect the demand for different products.
8. Advertisement Effect:
In modern times the consumer preference can be changed by advertisement and sales. Demand
for may products like tooth-paste, soaps, washing powder etc., is partially caused by the
advertisement affect.
The attractive and wise advertisement will influence the demand for a product.
Demand schedule is the table showing the prices per unit of the commodity and the
amount demanded per period of time.
In the above table or schedule when the price of the product is Rs.5, its demand is only
1000 units. But when the price has fallen to Rs.1, demand for the product has gone up to 5000
units. This shows that a fall in the price deals to extension of demand. Similarly when we take
Rs. 1 price, the demand for the product is 5000 units, when the price started rising up to Rs.5 the
demand for the product has fallen to 1000 units. This shows that a rise in price leads to
contraction of demand.
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Demand curve
If we show the demand schedule graphically, we get a demand curve. The demand curve shows
the maximum quantities per unit of time that consumers will take at various prices.
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Income effect:
The income of a consumer affects the demand of the product. If the income is fixed i.e. there is
no change in income, but there is a change in the prices of the products, then it will affect the
demand and the curve slope downwards.
Substitution effect:
A fall in the price of a product, while the prices of its substitutes remain unchanged will make it
attractive to the buyers who will now purchase more and vice versa.
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According to the Law of Demand, when the price of a commodity falls the demand for it rises.
Giffen's Paradox is an exception to this law. It is named after the 19th century British economist,
Sir Robert Giffen, who found that when the price of bread fell, the demand for it also fell. This
was because when the price fell, the real income of the consumer rose and he was in a position
to buy better quality/more bread.
Consumer Expectations:
Whenever the consumer expects a further fall in the price in future he will not purchase the
products or goods immediately, when price decreases, demand tends to decline. Similarly when
the consumer expects a further increase in the price for the future he will buy the products
immediately
Necessaries:
The demand almost remains constant irrespective of the price changes concerned to these goods
as people tend to adjust their consumption on other goods as they feel these are most necessary
products.
Impulse buying:
In Exhibitions and functions, the social habit, place or situations force people to purchase goods
at higher prices
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When goods are demanded independently for the direct satisfaction of the consumer wants, it is
called autonomous demand.
E.g. The demand for sugar is loosely tied up with the demand for drinks
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In the above table Mr. X is demanding 10 units at Rs. 100 and 50 units at Rs 80, this
demand is called individual demand. Individual demand refers to goods demanded by a single
individual. The table showing at different prices different units were demanded by Mr. X that is
called individual demand schedule.
Market demand refers to total demand made by all the individuals in the market. In the
above table total demand is 17 units at Rs. 100 and 90 units at Rs. 80. The table representing
different prices, different units were demanded by all the individuals that is called market
demand schedule
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2.5 Extension and Contraction of Demand & Increase of Demand & and
Decrease in Demand:
There is a difference between extension of demand and increase of demand. Extension of
demand may be happened doe to decline of the price level. For example, the price of one
commodity is Rs.5 and then there is a demand for 3 commodities. Suppose the price of the
commodity falls to Rs.3. As a result of this fall in price, the demand for commodity rises to 5.
This is called ‘extension of demand’. On the other hand, increase in demand may be happened
due to changes in factors other than price. Increase of demand may be happened doe to increase
of population, income or due to tastes and preferences of the consumers or due to substitution
effect etc.
In the diagram, at OP price level, OM commodities are demanded. For a higher price OP 1, the
amount demanded is reduced to OM 1. For lower price OP1, the amount demanded goes up to
OM2. These movements along the demand curve are called extension and contraction of demand.
The movement upwards to the left is contraction and the movement downward to the right is
extension of demand
Increase of demand and decrease of demand can be known with the help of following
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Increasing the demand can be shown by a shift of the entire demand to the left side as shown in
the first diagram. In this diagram the demand curve is shifted from DD to D 1 D1. In this even
though there is no change in price i.e. OP, the demand increases form OM to OM1.
A decrease in the demand can be shown by a shift of the entire demand to the left side as shown
in the diagram ‘B’. in this diagram the demand curve is shifted to left i.e. from D 1 D1. in this
diagram, even though there is no change in price i.e. OP, the demand is decreased from OM to
OM1
Meaning:
Price elasticity of demand measures the responsiveness of demand to changes in price. The price
elasticity of demand for a commodity is the rate at which quantity bought changes as the price
changes. It is denoted by (Ep)
Pr oportionatechangein thequantitydemanded
Ep Pr oportionate changein price or
Changeinquantity demanded
Ep Quantity demanded
Changein Pr ice
Pr ice
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(Q2 Q1 )
Q1
Ep
(P P )
2 1
P1
Q
Q1
(P)
P1
Q P1
P Q1
Where
Q1= Quantity demanded before price
change Q2= Quantity demanded after price
change P1= Price charged before price
change
P2= Price changed after price change
Higher the elasticity of demand, greater will be the percentage change in quantity demanded
every percentage change in price.
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In the above figure the quantity demanded increases from OQ to OQ1 from OQ1 to OQ2 even
though there is no change in price. The price is fixed at OP.
Perfect Inelastic Demand (Ep=0):
This is one which shows that whatever the change in price may be the amount demanded remains
same.
In the above figure it is shown that there is no change in the quantity demanded even
though the price is changing (increase or decrease).
Even though there is an increase in price from OP0 to OP1 to OP2 there is no change in
demand.
Unit Elasticity of Demand (Ep=1):
In this type of demand a given percentage change in price leads to exactly the same percentage
change in amount demanded. As there is no change in the demand and price it is called as
unitary demand.
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The figure shows that the quantity demanded increases OQ to OQ 1, as there is a decrease
in price from OP0 to OP1. The amount of increase in the quantity demanded is equal to the
amount of fall in the price.
The demand is said to be relatively elastic when the change in demand is more than the
change in price. The figure shows that the quantity demanded increases from OQ to OQ1 as
there is a decrease in price from OP 0 to OP1. The amount of the increase in the quantity
demanded is greater than the amount of decrease in the price.
In the figure the demand increases from OQ 0 to OQ1 as there is a decrease in the price
from OP0 to OP1. The amount of increase in the quantity demanded is lesser than the amount of
decreases in the price.
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Pr oportionatechangein thequantitydemanded
Ep Pr oportionate changein price or
Changeinquantity demanded
Ep Quantity demanded
Changein Pr ice
Pr ice
(Q2 Q1 )
Ep Q1
(P P )
2 1
P1
Q
Q1
(P)
P1
Q P1
P Q1
Where
Q1= Quantity demanded before price
change Q2= Quantity demanded after price
change P1= Price charged before price
change
P2= Price changed after price change
Higher the elasticity of demand, greater will be the percentage change in quantity demanded
every percentage change in price.
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In the above schedule when price decreases from Rs. 6 to 1 the Demand extends from 10 to 60.
But the total outlay does not change like that. In the first stage, when price decreased for Rs. 6 to
Rs.5 the Total outlay increased from Rs. 60 to Rs. 100. In the second stage when price decreased
from Rs. 4 to Rs. 3, the total outlay did not change. It remained constant. In the third stage, when
the priced decreased from Rs. 2 to Rs. 1, the total outlay decreased from Rs. 100 to Rs. 60.
3. Point Method:
If the demand curve is a straight line sloping downwards from left to right then the elasticity at a
given point on that demand curve, can be given by dividing the lower segment by the upper
segment. This can be explained
If the LM is the demand curve and if we want elasticity of demand at point P on this demand
curve, it can be given by dividing the lower segment (PM) by the upper segment.
Lower Segment
E p Upper Segment
PM
E p PL
Here Ep= Elasticity at Point P
Lower Segment = PM
Upper Segment = PL
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QM
E p QL
When P is the Mid-point of LM, the e=1. Point above that on the demand curve represent
whether elasticity (e>1) and points below that represent lower elasticity (e<1). At L, e=∞ and at
M, e=0. So elasticity of demand is different at different points on the same downward sloping
demand curve, if the demand curve is not a straight line, but a curve, then a tangent has to be
drawn at the point where elasticity is required. Then the lower segment of the tangent from that
point is to be divided by the upper segment to get elasticity.
In the above figure we can get elasticity at point P in the Demand curve DD, we have to drawn a
target to DD at P. This tangent touches the x-axis at R and Y axis at T. its lower segment is Pr
and upper segment PT
PR Lower Segment
Ep
PT Upper Segment
If we want to know elasticity at another point on the demand curve, then at that point another
tangent has to be drawn. By dividing the lower segment of that tangent by the upper segment,
we can get elasticity.
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In the above diagram P and P1 are 5 and 4 respectively and Q and Q1 are 100 and 110
respectively then Arc elasticity will be as given below
Q1 Q P1 P
Arce
Q1 Q P1 P
110 100 4 5
Arc e
110 100 4 5
10 1
Arce
210 9
10 9
Arce
210 1
3
Arce
7
3
Arce (NegtiveSymbol is avoided)
7
So Arce = 3/7(or e<1)
1. Nature of goods:
Goods may be classified into three groups. They are necessaries, comforts and luxuries. The
demand for necessaries like salt, clothes etc is inelastic where as demand for comforts and
luxuries like television vehicles etc is elastic
2.Availability of Substitutes:
A commodity having a number of substitutes has relatively elastic demand whereas a
commodity have less or without substitutes is relatively inelastic demand.
3. Income level:
High income group people are less affected by price changes than low income groups’ people.
Demand for high priced and quality goods in inelastic for high income groups whereas the same
is elastic for low income people
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3. Price discrimination
Discrimination pricing implies charging different price for the same product in different
markets. This monopolist can do this decision depending upon the price elasticity of a given
product in different markets
4. Taxation Policy
Tax authorities study the price elasticity of each type of product before fixing its rate of tax, as
charging a higher rate of tax for a relatively elastic product lead to increase in price and
consequently reduce its sales and thus tax revenues
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Demand Estimation:
Demand estimation tries to find our expectation present sales level, given the present state of
demand determinants.
1. Passive Forecasting:
Here prediction about future is based on the assumption that the firm does not change the course
of its action.
2. Active Forecasting:
Forecasting is done assuming that, it will be changes in the actions by the firm.
3. Micro Forecasting:
When individual business firm forecast the demand for their products, it is known as micro level
forecasting.
4. Short term forecasting:
Short-term forecasting normally related to a period not more than a year. Short term forecasting
relate to the day-to-day information. In the short term forecasting a firm is primarily concerned
with the optimum utilization of its existing production capacity
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Control of Business
Inventory Control
Long term Investment Programs
Maintain Stability
Helpful for Planners and Policy Makers
Sales Forecasting:
Sales forecasting is dependent on the demand forecasting. Advertisement pattern of the firm
should be based on sales forecasting.
Control of Business:
The business firm may have to prepare the budget of cost and revenue occurring in future. The
future accurate estimation of cost and revenues is based on the demand forecasting.
Inventory Control:
The business form can have a better control on raw materials, semi- finished goods, finished
goods, spare parts etc., for future requirements of the firm with the help of demand forecasting.
Maintain Stability:
Production and employment growth rates can be stable through demand forecasting.
Identify and clearly state the objectives of forecasting. The objective may be short-term or
long-term
Select Appropriate method of forecasting
Identify the variables affecting the demand for the product and express them in appropriate
forms
Gather all relevant date o represent the variable.
It may be made either in terms of physical units or in terms of rupees of sales volume
It may be in terms of product group or individual products
It may be annual basis or moth wise or week wise on the basis of past records
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Accuracy:
It is necessary to check the accuracy of past forecast against future performance and of present
forecast against past performance.
Economy:
Costs must be weighted against the benefits of the forecast to the operation of the business.
Availability:
The methods employed should be able to produce meaning results quickly.
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