PAN African eNetwork Project

Masters of Business Administration

Managerial Economics
Semester - I

Ms. Geeta Jaglan

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MANAGERIAL ECONOMICS
The application of economics theories
and principles in managerial problems with
the purpose of optimization of decision
making.
Decision making involves the activities
regarding production, distribution and
consumption.

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The use of Economic Analysis in

management is to make business decisions
involving the best use (allocation) of
scarce resources.

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Economic Theory helps managers to

collect the relevant information and
process it in order to arrive at the
optimal decision.Given the goals of a
firm, a decision is OPTIMAL if it brings
the firm closest to its goals

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Management Decision Problems

Product Price and Output
Production Technique
Stock Levels
Advertising Media and intensity
Labor hiring and firing
Investment and Financing

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Decision Making Process

Identifying the problem
Generating the alternative course of
action
Evaluating the alternative
Selecting the best alternative
Implementing the decision; and
Evaluating the decision

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Nature of Decision
What goods shall firm produce?
How should firm raise the necessary capital and
what shall be its legal form.
What technique shall be adopted, and what shall
be the scale of operations?
Where production is located?
How shall its product be distributed?
How shall resources be combined?
What shall be the size of output?
How shall it deal with its employees?

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Types of Decision
Organizational and personal decisions
Basic and routine decisions
Programmed and non-programmed
decisions.

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Conditions Affecting Decision Making

Certainty
Risk
Uncertainty

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Economic Conditions
Market Structure
Supply and Demand conditions
State of Technology
Govt. Regulations
International Dimensions
Future Macroeconomic factors

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Decision Making Model

The Classical Model
The Administrative Model

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The Classical Model

The manager has completed information about the
decision situation and operations under a condition
of certainty.
The problem is clearly defined, and the decisionmaker has knowledge of all possible alternatives and
their outcomes.

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Through the use of quantitative

techniques, rationality, and logic, the
decision-maker evaluates the alternatives
and selects the optimum alternative -the
one that will maximize the decision
situation by offering the best solution to
the problem.

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The Administrative Model

The manager has incomplete information about
the decision situation and operates under a
condition of risk or uncertainty.
The problem is not clearly defined, and the
decision-maker has limited knowledge of possible
alternatives and their outcomes.
The decision-maker satisfies by choosing the
first satisfactory alternative- one that will
resolve the problem situation by offering a good
solution to the problem.

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Tools of Decision Making

Marginal Analysis
Linear Programming
Game Theory
Optimization
Forecasting

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Demand Forecasting
Estimation of demand for a product in a forecast
year/ period is termed as Demand forecast.
Demand forecast is a must for a firm operating
its business as today's market is competitive,
dynamic and volatile.

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Purpose of Demand Forecasting

Better planning and allocation of resources
Appropriate production scheduling
Inventory control
Determining appropriate pricing policies
Setting s les targets and establishing controls and
incentives.
Planning a new unit or expanding existing one
Planning long term financial requirements
Planning Human Resource Development strategies.

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Steps Involved in Forecasting

Identification of objective
Determining the nature of goods under
consideration.
Selecting a proper method of forecasting.
Interpretation of results.

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Period of forecasting

Short run forecasting: In short run

forecasting, we look for factors which bring
fluctuation in demand pattern in the market
for example weather conditions like monsoon
affecting the demand.
Medium run forecasting: In medium run
forecasting is done basically for timing of
an activity like advertising expenditure.
Long run forecasting: It is done to
ascertain the validity of trend. It is done
for decision like diversification.

Levels of Forecasting
Macroeconomic forecasting is concerned with
business conditions of the whole economy. It is
measured with the help of indices like wholesale
price index, consumer price index.
Industry demand forecasting gives indication to
firm regarding direction in which the whole
industry will be moving. It is used to decide the
way the firm should plan for future in relation to
the industry.
contd

Firm demand forecasting is done for planning

companies overall operations like sales
forecasting etc.
Product line forecasting helps the firm to
decide which of the product or products should
have priority in the allocation of firm's limited
resources.
General purpose or specific purpose forecast
helps the firm in taking general factors into
consideration while forecasting for demand.
contd

Forecast of established product or a new

product
Types of commodity for which forecast is to
be done. Goods can be broadly classified into
capital goods, consumer durable and Nondurable consumer goods. For each of these
categories of goods there is a distinctive
pattern of demand.

Methods of Forecasting
Qualitative Methods
Surveys Technique

Survey of business executives, plant and

equipment, expenditure plans. Basically compilation
of expenditure plans of related industries.
Survey of plans for inventory changes and sales
expectations.
Survey of consumer expenditure plans.

Opinion Polls
Consumer survey: In this method the consumers
are contacted personally to disclose their future
purchase plans. This could be of two typesComplete enumeration and sample survey.
Sales force opinion method: In this method
people who are closest to the market( sales
peoples) are asked for their opinion on future
demand. Then opinion of different people is
compiled to get overall demand forecast.

Expert Opinion (Delphi Technique):

Opinions of different experts are taken
and compiled. If there are
discrepancies between the different
viewpoints, successive rounds of
iterations are undertaken taking into
account the opinions of other experts,
until near consensus emerges

Statistical Methods
Time Series Analysis
Forecasts on the basis of an analysis of historical time
series data
Trend Projection Method
Based on the assumption that there is an identifiable
trend in the variable to be forecast which will continue in
the future
Time Series data is used to fit a trend line on the
variable under forecast either graphically or by statistical
techniques
Y = a + bt;
t time
Forecasting is done by extrapolating the trend line
into the future.

Barometric Methods
Leading Indicator Method : correlated with
the variable to be forecast. These
indicators tend normally to anticipate
turning points in a business cycle.
Coincident indicators: These are
indicators which move in step or coincide
with movements in general economic activity
or business cycle.
Lagging indicator: These are indicators
which lag the movements in economic
activity or business cycle.

Regression Method
Identification of variables which influence the
demand for the good whose function is under
estimation.
Collection of historical data on all relevant
variables.
Choosing an appropriate form of the function.
Estimation of the function

Simultaneous Equation Method

(Econometric Models)

Econometric forecasting models range from

single equation models of the demand that the
firm faces for its product to large multiple
equation models describing hundreds of sectors
and industries of the economy. Use estimating
equations based on Economic Theory

Input Output Forecasting

Input output analysis was introduced by Prof.
Leontief. With this technique the firm can also
forecast using Input output tables. It shows the
use of the output of each industry as input by
other industries and for final consumption. Input
and output analysis allow us to trace through all
these inter industry input and outputs flow though
out the economy and to determine the total
increase of all the inputs required to meet the
increased demand.

Risks in Demand Forecasting

Overestimation of demand
Underestimation of demand
First risk arises from entirely unforeseen
events such as war, political upheavals and
natural disasters. The second risk arises
from inadequate analysis of the market.

Prevention Measures
Carefully defining the market for the product to
include all potential users of the market and
considering the possibility of product substitution.
Dividing total industry demand into its
components and analyzing each component
separately.

Meaning of Demand
Conceptually, demand can be defined as the desire
for a good backed by the ability and willingness to
pay for it. The desire without adequate purchasing
power and willingness to pay do not become
effective demand and only an effective demand
matters in economic analysis and business
decisions.

Types of Demand
The demand for various commodities is generally
classified on the basis of the consumers of the
product, suppliers of the product, nature of
goods, duration of the consumption of the
commodity, interdependence of demand, period of
demand and nature of use of the
commodity(intermediate or final).

Individual and Market Demand

Autonomous and derived demand
Demand for durable and nondurable goods
Demand for firms product and industry
product
Demand for consumers and producers goods

Individual and Market Demand

The quantity of a commodity which an individual is
willing to buy at a particular price during a specific
time period given his money income, his taste and
prices of other commodities is called individuals
demand for a commodity.
On the other hand market demand of a commodity is
the summation of individual demand by all the
consumers. Market demand is a multivariate
relationship and determined by many factors
simultaneously.

Demand for durable and nondurable goods

Durable goods are those whose total utility is not
exhausted in a single or short run use. Such goods
can be used repeatedly over a period of time.
Durable goods may be consumer goods as well as
producer goods.
The demand for nondurable goods depends largely on
their prices, consumer income and is subject to
frequent change.

Autonomous and derived demand

The demand for a commodity that arises on its
own out of a natural desire to consume or
possesses a commodity independent of the
demand of other commodities, the demand for
the product is termed as independent.
Commodities like tea and vegetables
absolute terms. On the other hand
demand for a product is tied to the
some parent product, the demand is
derived demand.

do come on
if the
demand for
termed as

Demand for firms product and industry

product
Firms demand denotes the demand for the products
by a particular company or firm whereas industry
demand is the aggregation of demand for the
product of all the firms of an industry as a whole.

Demand for consumers and producers

goods
Consumer goods are those, which are, meant for
the final consumption by the consumers or the
end users. Producer's goods on the other hand
are used for the production of consumer goods or
they are intermediate goods, which are further
processed upon to convert them into a form to be
used by the end user. Another distinction is that
the demand for producers goods is derived
demand and it indirectly depends on the demand
for the consumer goods which the producer goods
is used to produce.

Determinants of Demand
Own Price
Prices of related goods Substitutes
and Complements
Income
Tastes & Preferences
Expectations
Population
Other exogenous factors

Demand Analysis
Law of Demand There is Inverse relationship
between price and quantity demanded ceteris
paribus i.e.,other factors remaining constant.
Demand Schedule A list / table showing
quantity demanded of a good at different
prices, all other things being held constant

Demand Function The determinants of quantity

demanded when summarized in the form of
functional notations are called a demand
function. A typical demand function can be
specified as follows:
QXD = f ( px, p1,..pn, Y, T, Ey, Ep, u)
Demand Curve Represents the relation between
price and quantity demanded of a good, all other
things being held constant.

Demand Curve
P

Linear Demand Curve

Q
Non Linear Demand Curve

Q
Perfectly Inelastic Demand
eDP = 0

Q
Perfectly Elastic Demand
eDP =

Q
Less than Perfectly inelastic demand
0 < eDp < 1

Q
Less than perfectly elastic demand
1 < eD p <

Q
Unitary Elastic Demand Curve
eDp = 1

Change in Quantity Demanded A

movement along the demand curve in
response to a change in price Expansion /
Contraction of Demand
Change in Demand A movement of the
entire demand curve in response to a change
in one of the other determinants of demand
Shift in Demand

Effect of a Price Change

Income Effect A price change causes Real
Income to change and therefore consumption
of both goods changes
Substitution Effect Price change of one
good causes the relative price of the two
goods to change and consumers substitute
the relatively cheaper good for the more
expensive one

Elasticity of Demand
Responsiveness of quantity demanded towards a
change in the concerned variable or factor.

Price Elasticity of Demand - refers to the

responsiveness of quantity demanded to price
changes.
Ed = dQ/Q dP/P
Defined as the percentage change in quantity
demanded divided by the percentage change in
price
EPd is negative due to the inverse relationship
between quantity and price, but we consider the
absolute value for interpretation

Determinants of Price Elasticity

of Demand
Number and availability of Substitutes
Expenditure on the commodity in relation
to the consumers budget
Nature of the product and extent of its
use
Length of time period under
consideration
Consumers Preferences

Price elasticity and Decision Making

Information about price elasticities can be
extremely useful to managers as they contemplate
pricing decisions.
If demand is inelastic at the current price, a price
decrease will result in a decrease in total revenue.
Alternatively, reducing the price of a product with
elastic demand would cause revenue to increase.
* Remember TR = P*Q

We may summarize this relationship as follows:

If the demand is inelastic (e < 1) an increase in
price leads to an increase in total revenue and
vice versa.
If the demand is elastic (e>1) an increase in
price will lead to a decrease in total revenue and
vice versa.
If the demand has unitary elasticity (e =1), total
revenue is not affected by changes in price.

Income Elasticity of Demand

Measures the responsiveness of quantity demanded
of a good to changes in Income.
Ey = dQ/y dy/Q
Classification of Goods:
Normal Goods Demand Increases as Income
increases (eY >0)
Inferior Goods Demand decreases as consumer
Income increases (eY < 0)
Basic Necessities Commodities like salt, food
grains etc for which demand is relatively inelastic
and does not vary with income after a point

Cross Elasticity of Demand

The proportionate change in the quantity demanded
of x commodity resulting from a proportionate
change in the price of y commodity.
Exy = dQx/Qx dPy/Py
The sign of cross elasticity is negative if x and y
are complementary goods and positive if x and y are
substitutes.
The higher the value of the cross elasticity the
stronger will be the degree of substitutability or
complementarity of x and y.

Exceptions to the Law of Demand Upward

Sloping Demand Curve
Giffen Goods a subclass of Inferior goods for which
the income effect outweighs the substitution effect
Veblen Products / Snob effect Goods that have a
snob value attached to them for which demand
actually increases as price goes up
Speculative Effect In periods of rising prices,
anticipation of future increases may cause consumers
to demand more

Bandwagon Effect Occurs when

people demand a commodity only
because others are demanding it and
in order to be fashionable
Emergencies like war, famine etc.

Theory of Consumer Behaviour

The consumer is assumed to be rational. Given his
income and the market prices of the various
commodities, he plans the spending of his income
so as to attain the highest possible satisfaction or
utility. This is the axiom of utility maximization.
There are two basic approaches to compare the
utilities, the cardinalist approach and the
ordinalist approach.

The Cardinal Utility Theory

The cardinal school stated that utility can be

measured. Under certainty i.e., complete
knowledge of market conditions and income levels
over the planning period utility can be measured
in monetary units, called utils. There are certain
assumptions of cardinal utility theory.
Rationality of consumer
Constant marginal utility of money
Diminishing marginal utility
Total utility is additive

Equilibrium of Consumer
Assuming the simple model of a single commodity x,
the consumer can either buy x or retain his money
income y. Under these conditions the consumer is in
equilibrium when the marginal utility of x is equated
to its market price.
MUx = Px

The Ordinal Utility Theory

The ordinalist school postulated the utility is not

measurable, but is an ordinal magnitude. It
suffices for the consumer to be able to rank the
various baskets of goods according to the
satisfaction derived. The main ordinal theory is
known as the indifference-curve theory is based
on certain assumptions.

Assumptions of ordinal approach

Rationality of consumer
Utility is ordinal
Diminishing Marginal rate of substitution
Consistency and transitivity of choice
Total utility depends on the quantities of the
commodities consumed

Indifference Curve
Indifference curve is the locus of various
combinations Of two commodities, on both the
axis, giving same level of satisfaction.

Properties of Indifference Curve

An indifference curve has a negative slope
The further away from the origin an
indifference curve lies, the higher the utility it
denotes
Indifference curve do not intersect
The indifference curves are convex to the origin

Equilibrium of Consumer
The consumer is in equilibrium when he maximizes his
utility, given his income and the market prices. Two
conditions must be fulfilled for consumer,s
equilibrium.
The first condition is that the marginal rate of
substitution be equal to the ratio of commodity
prices. This is necessary but not sufficient condition.

The second condition is that the indifference

curve be convex to the origin. This condition is
fulfilled by the axiom of diminishing marginal rate
of substitution of x for y and vice versa.

MRSxy = MUx/MUy = Px/Py

Thank You
Please forward your query
To: gdeshwal@amity.edu
CC: manoj.amity@panafnet.com

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