MANAGERIAL ECONOMICS

DR. Itty Benjamin

MANAGERIAL ECONOMICS

DR. Itty Benjamin

WHAT IS ECONOMICS• Economics is the study of those

activities of human beings, which are concerned, with the satisfaction of unlimited wants by using the limited resources.

• Economics was made compulsory for engineers in the first decade of 20th century. Institute of Mechanical Engineers (UK) found that 90% of the management decisions required some managerial responsibility and most of them were basic in nature. Hence, managerial economics was introduced in engineering and management subjects.

• Economics is the study of those activities of human beings, which are concerned, with the satisfaction of unlimited wants by using the limited resources.

• Economics was made compulsory for engineers in the first decade of 20th century. Institute of Mechanical Engineers (UK) found that 90% of the management decisions required some managerial responsibility and most of them were basic in nature. Hence, managerial economics was introduced in engineering and management subjects.

What is Managerial Economics?

• Managerial economics is essentially applied economics in the field of business management.

• It is the economics of business or managerial decisions.

• Managerial decision making mainly deals with the question of what to produce, how to produce and how much to produce.

• Managerial economics is essentially applied economics in the field of business management.

• It is the economics of business or managerial decisions.

• Managerial decision making mainly deals with the question of what to produce, how to produce and how much to produce.

Managerial Insight

• Managers have to acquire the insight of both microeconomics and macroeconomics. The former analyses the behaviour of individual economic entities such as consumer and producer, while the later deals issues pertaining to the economy as a whole, such as unemployment, population etc.

Managerial Insight

• Managers have to acquire the insight of both microeconomics and macroeconomics. The former analyses the behaviour of individual economic entities such as consumer and producer, while the later deals issues pertaining to the economy as a whole, such as unemployment, population etc.

The Business Decision

Functions: Role and Responsibilities of a Managerial Economist

A managerial economist in a business firm may carry on a wide range of duties, such as:

• Demand estimation and forecasting.

• Preparation of business/sales forecasts.

• Analysis of the market survey to determine the nature and extent of

competition.

• Analysing the issues and problems of the concerned industry.

• Assisting the business planning process of the firm.

• Discovering new and possible fields of business endeavour and its

cost-benefit analysis as well as feasibility studies.

A managerial economist in a business firm may carry on a wide range of duties, such as:

• Demand estimation and forecasting.

• Preparation of business/sales forecasts.

• Analysis of the market survey to determine the nature and extent of

competition.

• Analysing the issues and problems of the concerned industry.

• Assisting the business planning process of the firm.

• Discovering new and possible fields of business endeavour and its

cost-benefit analysis as well as feasibility studies.

• Advising on pricing, investment and capital budgeting policies.

• Evaluation of capital budgets.

• Building micro and macro economic models.

• Directing economic research activity.

• Briefing the management on current domestic and global economic

issues and emerging challenges.

• Interpretation, analysis and reporting of current economic matters,

upcoming developments in business, government and foreign or

global sectors.

• Advising on pricing, investment and capital budgeting policies.

• Evaluation of capital budgets.

• Building micro and macro economic models.

• Directing economic research activity.

• Briefing the management on current domestic and global economic

issues and emerging challenges.

• Interpretation, analysis and reporting of current economic matters,

upcoming developments in business, government and foreign or

global sectors.

Scope of Managerial Economics

Following are the core topics of managerial economics:

• Demand Function and Estimation

• Demand Elasticity

• Demand Forecasting

• Production Function and Laws

• Cost Analysis

• Pricing and Output Determination in different market structures such as perfect competition,

monopoly, oligopoly and monopolistic competition

• Pricing Policies and Practices in Real Business

• Profit Planning and Management

• Break-even Analysis

• Linear Programming

• Game Theory

• Government and Business.

Following are the core topics of managerial economics:

• Demand Function and Estimation

• Demand Elasticity

• Demand Forecasting

• Production Function and Laws

• Cost Analysis

• Pricing and Output Determination in different market structures such as perfect competition,

monopoly, oligopoly and monopolistic competition

• Pricing Policies and Practices in Real Business

• Profit Planning and Management

• Break-even Analysis

• Linear Programming

• Game Theory

• Government and Business.

Managerial economists tend to rely on the scientific research method

in building and empirically testing business oriented economic

models. This scientific approach consists of the following steps:

• Defining the problem

• Formulation of the hypothesis

• Abstraction for the model building

• Data collection

• Testing the hypothesis

• Deduction based on data analysis

• Evaluating the test results

• Conclusion for decisions

• Effective Demand

A buyer’s desire for a product in the market backed by the ability and willing to pay for its price.

Definition of Demand - The demand for a product refers to the amount of it which will be bought per unit of time at a particular price.

Determinants of Demand

Factors Influencing Individual Demand• Price• Income• Tastes, habits and preferences• People with different tastes and habits have different preferences for

different goods• Relative prices of other goods – substitute and complementary

products• Consumer’s expectation• Advertisement effect

Factors Influencing Market Demand

• Price of the product• Distribution of income and wealth in the community• General standards of living and spending habits of the people• Number of buyers in the market and the growth of population• Age structure and sex ratio of the population• Future expectations• Level of taxation and tax structure• Inventions and innovations• Fashions• Climate or weather conditions• Customs• Advertisement and sales propaganda

Demand FunctionMathematical of expression of functional relationship between determinants (such as price, income, etc., determining variables) and the amount of demand of a given product.In composing the demand function for a product, therefore, one should identify and enlist the most important factors (key variables) which affect its demand. To suggest a few, such as:

• The ‘own price’ of the product itself (P)• The price of the substitute and complementary goods (Ps or Pc)• The level of disposable income (Yd) with the buyers (i.e., income left after

direct taxes)• Change in the buyers’ taste and preferences (T)• The advertisement effect measured through the level of advertising

expenditure (A)• Changes in population number or the number of the buyers (N).

Using the symbolic notations, we may express the demand function, as follows:Dx = f (Px, Ps, Pc, Yd, T, A, N, u)

Demand Schedule

• A tabular statement of price/quantity relationship is called the demand schedule.

Individual Demand Schedule

A Market Demand Schedule (Hypothetical Data)

• Market Demand CurveIn graphical terms, a market demand curve for a product is derived through the horizontal summation of all individual buyer’s demand curves for the given product.

• Demand CurveDemand curve refers to the graph of a demand schedule, measuring price on the Y-axis and quantity demand on the X-axis. Usually, a demand curve has a downward slope, representing an inverse relationship between price and demand.

A Linear Demand Curve

The Law of Demand

The conventional law of demand, however, relates to the much simplified demand function:

D = f (P)

Demand Curve

Assumptions Underlying the Law of Demand

• No change in consumer’s income

• No change in consumer’s preferences

• No change in the fashion

• No change in the price of related goods

• No expectation of future price changes or shortages

• No change in size, age composition and sex ratio of the population

• No change in the range of goods available to the consumers

• No change in the distribution of income and wealth of the community

• No change in government policy

• No change in weather conditions

Exceptions Demand Curve: Upward-sloping Demand Curve

Exceptional Cases

• Giffen goods

• Articles of snob appeal

• Speculation

• Consumer’s psychological bias or Iillusion

Extension and Contraction of Demand

• The terms ‘extension’ and ‘contraction’ are technically used in stating the law of demand.

Quantity Demanded

Increase and Decrease in Demand

• An ‘increase’ in demand signifies either that more will be demanded at a given price or same will be demanded at a higher price. An increase in demand really means that more is now demanded than before at each and every price. Likewise, a ‘decrease’ in demand signifies either that less will be demanded at a given price or the same quantity will be demanded at the lower price. Decrease in demand really means that less is now demanded than before at each and every rise in price. Shifting the demand curves shows the increase and decrease in demand.

Increase in Demand (A) and Decrease in Demand (B)

Reasons For Change (Increase or Decrease) in Demand

• Changes in income

• Changes in taste, habits and preference

• Change in fashions and customs

• Change in the distribution of wealth

• Change in substitutes

• Change in demand of position complementary goods

• Change in population

• Advertisement and publicity persuasion

• Change in the level of taxation

• Expectation of future changes in prices

Major Types of Demand

1. Demand for Consumer’s Goods and Producer’s Goods;

2. Demand for Perishable Goods and Durable Goods;

3. Autonomous demand and Company Demand;

4. Industry Demand and Long-Run Demand;

5. Short Run Demand and Company Demand;

6. Joint Demand and Composite Demand; and

7. Price Demand, Income Demand, and Cross Demand.

Industry Demand and Firm or Company Demand

Industry and Company Demand

Demonstration effect of consumption by the others lead to the bandwagon effects of change in demand for a product in the market. Advertising and fashion play a significant role in this regard.

Short-run and Long-run Demand

Bandwagon Effects

Bandwagon Effect: The

Demand Curve Shifts to the Right

Veblen EffectSnob appeal of luxury goods leads to the Veblen effect of demand through conspicuous consumption.

The Market Demand Curve for Veblen Effect Product