Managerial economics

Scope

What is economics about?

Would these be Economic issues?

The

crisis in Greece is having a global

impact
OPEC likely to raise prices further
the food inflation in India goes up to 10%
Airlines to raise domestic fares.
Indian economy slows down- below
expectations

Would these..?
You

can save either $90 on your $200 trip to

chicago or save $100 on your $2000 trip to
Tokyo. Where would you use your discount
coupon?
Why do female models earn much more than
male models?
A hike in minimum wages

Would this
Climate

change??!

.. mispricing the risks of toxic air.

Is economics

Arcane,

incomprehendible?

It is !

All

those horrible graphs!

It actually is not!

Its basic principles are

SIMPLE and COMMONSENSICAL

Ed Arno cartoon

Economics is about

Allocation

of resources to uses.

Economics.. Contd

Becomes

complicated because?

 Resources

are scarce

Resources

have alternative uses-Trade offs.

Growing

set of wants.
Some examples of trade offs??

Optimization
Resources

need to be OPTIMALLY allocated

and utilized.
This has to be done at all levels: right from
the individual to the nation.
Every individual is an optimizing individual
Satisfying his/her own preferences.

Outcome?
Each

individual optimizing

What

is the impact on the entire group?

In other words.

Impact on the group

Could

be awfully bad

or

amazingly good !

 Tragedy

of the Commons.Hell!
( who coined this and when?)
Or the miraculous effect of the Invisible
HandHeaven!
Examples????

Hell or Heaven?
Can

be a heaven even if the world is full of

selfish jerks .
in certain situations.

Which are those situations and how do we get

there??

Economics..contd

At

the level of the Individual as consumer,

as producer- Microeconomics
At the level of the Nation, the Economy
Macroeconomics

How is it done?

Resort

to Models

How does an economic system work?

The

circular flow model

Model
Can

building in general

opener syndrome

Circular flow model

household

Product mkt

Factor mkt

Firm

From the circular flow model

Focus

on the two markets-Product market

and Factor market MICROECONOMICS

Focus on the entire systemMACROECONOMICS

Managerial Economics
Managerial

economics uses the tools and

techniques of Microeconomics for
Managerial decision making.

Sometimes

called Business economics

Markets

Relies on markets for solutions so

Managerial economics examines how
markets work.

Markets

are made up of individual buyers

and sellers- so this subject examines how
these individuals take decisions

Issues in Man: Eco

Three

categories of solutions that are sought:

Those that seek Equilibrium Solutions ( at the
Market level)
Those that seek to probe further to see how
and when these equilibrium solutions change.
Those that seek Optimal solutions ( at the
individual decision making level)

quirky ways of Economists!

Concept

of cost- Opportunity cost

Recognition of Sunk cost Fallacy
Break economic effects into pieces.(next
slide)
Self-interested behaviour- maximizing
behaviour.
Think marginal.

Breaking into pieces is necessary!

As an absurd and tortured example, government production of

helium for (allegedly) military purposes reduces..
the cost of childrens birthday balloons, causing substitution
away from party hats and hired clowns.
The reduction in demand for clowns reduces clowns wages
and thus reduces the costs of running a circus.
This cost reduction increases the number of circuses, thereby
forcing zoos to lower admission fees to compete with circuses.
Thus, were the government to stop subsidizing the
manufacture of helium,
the admission fees of zoos would likely rise, even though zoos
use no helium.

The tool Box

Three

Tools:

Equilibrium

analysisAppln 1.2, L-B-D: 1.3

Comparative staticsAppln 1.2, L-B-D: 1.3
(Constrained) optimization: Example of Beer
sales and advertising pg 10.

Working tools for Equilibrium

solutions
Supply
P

demand analysis: Chapter 2 sec 2.1

D

P*
S

D
Q*

Algebraic solution

P = 300 Q or Q= 300 - P

P = 60 + 2Q or Q= -30+0.5P

Equating the two and solving for Q or for P, we have,

Q = 80; P = 220

L-B-D 2.3

Changes in equilibrium solutions

Shifts

of SS and DD

Meaning?
L-b-D

2.4

Case
Application
Readings

2.1 and 2.2

essential at this stage:

climate change- cap and trade; Appln 1.2,LB-D 1.3, 2.1, 2.2, L-B-D 2.4

Extension of cap and trade Q 1

Let

the cap on emissions permits be set for a

market at M* units of emissions. In other
words, M* permits will be issued, where each
permit allows the purchaser one unit of
emissions. In a diagram with price on the
vertical axis and quantity of emissions on the
horizontal axis, illustrate the emissions cap.

Question 2
Draw

a downward-sloping demand for

emission permits on the same diagram as
your cap in (a). Assuming that permits can
be traded freely among emitters, illustrate the
new equilibrium price of a permit on your
diagram .

Question 3
The

economic recession reduces the

demand for industrial output, which means
that firms do not wish to produce as much
emissions. Draw the effect of the economic
recession on the demand for emissions
permits that you illustrated in (b). What will
be the effect of the recession on the price of
emissions permits? Why?

Question 4
The

government decides that it wishes to

reduce emissions further in this market, and
so reduces the cap from M* to M units where
M < M*. Illustrate and explain the effect of
this change on the price of emissions
permits.

Answers
1. a vertical supply line of permits of M* quantity.
2. A downward sloping demand curve for permits
which cuts this supply line( curve).
3. An inward or leftward shift of the demand
curve( line) resulting in a lower price for emission
permits. This is because during recession,
industrial production is lower and hence the
demand for permits is lower and so is the price.

 4.

The vertical supply line shifts to the left

and so the price of emission permits goes up
.

Valentines Day Q 1
In

Aug 1991, price per rose stem was $0.20

and about 2 mill stems were sold. In Feb
1991, price was $0.50 and about 9 mill stems
were sold.
Show the above two sets of outcomes with a
diagram.

Valentines Day Q 2
Show, with a diagram , a situation other than
the one you have shown in the first question,
where the outcome would be higher price AND
higher quantity.

Valentines day Q 3
Show

with a diagram, when we could have

an outcome where price is higher than the
initial situation but quantity is lesser than the
initial situation.

Answers
1.

Downward sloping demand and upward

sloping supply curves intersecting at price
0.20 and quantity of 2 mill stems
corresponding to the situation in Aug 1991.
Draw a demand curve to the right of the
initial one intersecting the original supply
curve at 0.50 and 9 million stems
corresponding to the situation in Feb 1991.

Answers contd
2.

Another situation where the outcome

would have been similar would be one where
the supply curve also shifts rightward in Feb
1991 but the Demand shifts by a far greater
proportion so that both price and quantity
rise.

Answers contd
3.

This would be the outcome if: a)the supply

curve(line)shifted inwards (leftwards)
b) if both the Supply and demand shifted but
supply shifted inwards by a far greater
proportion . You could give either of these
two situations.

Computers market Q 1
The

price of computers ( 1988 equal to 100) ,

came down to 10 in 2008. That Demand for
computers expanded hugely is common
knowledge. What then ought to have
happened for price to fall by such a huge
margin? Show this with a diagram.

Computers market q 2:
Show

with a diagram, a situation where we

would have high prices and smaller
quantities sold of computers given that
demand has expanded.

Computers Market Q 3
Show

with a diagram, any one situation when

we would have larger quantity and higher
price than the initial levels.

Answers
1.There would be rightward( outward) shift of the
demand curve but a far greater rightward
(outward) shift of the supply curve so that the
new price is much lower and quantity demanded
and sold much larger.
2. The diagram would show a rightward shift of
the demand curve( given that demand has
expanded), but a leftward ( inward) shift of the
supply which will be far higher in proportion so
that price is much higher and quantity much
lower now.

Answers contd
3.

There could be either of these two

situations:
a) only demand curve has shifted to the
right (outward)
b) Supply also may have shifted to the right
but Demand has shifted by a far greater
proportion.

The big question

How

are these two equations obtained?

Working tools for Constrained

optimization
The

Beer Sales example:

New Beer Sales Resulting

from
Amounts
Spent on TV and
New
Beer Sales
Generated
(in barrels per years)
Radio Advertising
Total Spent

TV

Radio

100,000

4,750

950

200,000

9,000

1,800

300,000

12,750

2,550

400,000

16,000

3,200

500,000

18,750

3,750

600,000

21,000

4,200

700,000

22,750

4,550

800,000

24,000

4,800

900,000

24,750

4,950

$ 1,000,000

25,000

5,000

Tools for arriving at Optimal solutions

TOTAL , AVERAGE AND MARGINAL MAGNITUDES.

An Example:
P
Q
TR
10
0
0

AR
-

MR
-

TR=PQ

AR= TR/Q

16

MR= Ch inTR/Ch in Q

21

24

MR=limit dTR/dQ
Q--0

Assumes that you have a PQ function.

Relation between Marginal and

average magnitudes

MARGINAL pulls the AVERAGE up or down.

When AVERAGE is rising, MARGINAL rises faster

than AVERAGE

When AVERAGE is falling, MARGINAL is falling

faster than AVERAGE

TOTAL is maximum or minimum when MARGINAL

is equal to zero

 How

to get the PQ function???