MB 0042-Managerial Economics Unit-1 1:Managerial economics:Managerial economics is a science that deals with the application of various economictheories, principles,

concepts and techniques to business management in order to solve business and management problems. It deals with the practical application of economic theory and methodology to decisionmaking problems faced by private, public and non-profit making organizations. The same idea has been expressed by Spencer and Seigelman in the following words. Managerial Economics is the integration of economic theory with business practice for the purpose of facilitating decision making and forward planning by the management. According to Mc Nair and Meriam, Managerial economics is the use of economic modes of thought to analyze business situation. Brighman and Pappas define managerial economics as, the application of economic theory and methodology to business administration practice. Joel dean is of the opinion that use of economic analysis in formulating business and management policies is known as managerial economics. Characteristic of managerial Economics:i) Microeconomics: It studies the problems and principles of an individual business firm oran individual industry. It aids the management in forecasting and evaluating the trends of the market. ii)Normative economics: It is concerned with varied corrective measures that management undertakes under various circumstances. It deals with goal determination, goal development and achievement of these goals. Future planning, policy-making, decisionmaking and optimal utilisation of available resources, come under the banner of managerial economics. Iii)Pragmatic: Managerial economics is pragmatic. In pure micro-economic theory, analysis is performed, based on certain exceptions, which are far from reality. However, in managerial economics, managerial issues are resolved daily and difficult issues of economic theory are kept at bay. iv)Uses theory of firm: Managerial economics employs economic concepts and principles,which are known as the theory of Firm or 'Economics of the Firm'. Thus, its scope is narrower than that of pure economic theory. v)Takes the help of macroeconomics: Managerial economics incorporates certain aspects of macroeconomic theory. These are essential to comprehending the circumstances and environments that envelop the working conditions of an individual firm or an industry.Knowledge of macroeconomic issues such as business cycles, taxation policies, industrial policy of the government, price and distribution policies, wage policies and antimonopoly policies and so on, is integral to the successful functioning of a business enterprise. vi)Aims at helping the management : Managerial economics aims at supporting the management in taking corrective decisions and charting plans and policies for future. vii)A scientific art: Science is a system of rules and principles engendered for attaining given ends. Scientific methods have been credited as the optimal path to achieving one's Roll NO:571119224

goals.Managerial economics has been is also called a scientific art because it helps the management in the best and efficient utilisation of scarce economic resources. It considers production costs, demand, price, profit, risk etc. It assists the management in singling out the most feasible alternative. Managerial economics facilitates good and result oriented decisions under conditions of uncertainty. viii) Prescriptive rather than descriptive: Managerial economics is a normative and applied discipline. It suggests the application of economic principles with regard to policy formulation, decisionmaking and future planning. It not only describes the goals of an organisation but also prescribes the means of achieving these goals. 2:Demand:In economic terminology the term demand conveys a wider and definite meaning than in the ordinary usage.Ordinarily demand means a desire, whereas in economic sense it is something more than a mere desire. It misinterpreted as a want backed up by the - purchasing power. Further demand is per unit of time such as per day, per week etc. moreover it is meaningless to mention demand without reference to price. Considering all these aspects the term demand can be defined in the following words. Any want or desire will not constitute demand Demand = Desire to buy + Ability to pay + Willingness to pay The term demand refers to total or given quantity of a commodity or a service that are purchased by the consumer in the market at a particular price and at a particular time The following are some of the important qualifications of demand It is backed up by adequate purchasing power. It is always at a price. It should always be expressed in terms of specific quantity It is created in the market. It is related to a person, place and time. Consumers create demand. Demand basically depends on utility of a product. There is a direct relation between the two i.e., higher the utility, higher would be demand a nd lower the utility, lower would be the demand. Law Of Demand:This law explains the functional relationship between price of a commodity and the quantity demanded of the same.It is observed that the price and the demand are inversely related which means that the two move in the opposite direction. An increase in the price leads to a fall in the demand and vice versa. This relationship can be stated asOther things being equal, the demand for a commodity varies inversely as the priceor The demand for a commodity at a given price is more than what it would be at a higher price and less than what it would be at a lower price i)Demand Schedule or Demand Table These are the two devices to present the law. The demand schedule is a schedule or a table which contains various possible prices of a commodity and different quantities demanded at them. It can be an individual demand schedule representing the demand of an individual consumer or can be the market demand schedule showing the total demand of all the consumers taken Roll NO:571119224

together, this is indicated in the following table.It can be observed that with a fall in price every individual consumer buys a larger quantity than before as a result of which the total market demand also rises. In case of an increase in price the situation will be reserved. Thus the demand schedule reveals the inverse price-demand relationship, i.e. the Law of Demand. ii)Demand Curve DD It is a geometrical device to express the inverse price-demand relationship, i.e. the law of demand. A demand curve can be obtained by plotting a demand schedule on a graph and joining the points so obtained, like the demand schedule we can derive an individual demand curve as well as a market demand curve. The former shows the demand curve of an individual buyer while the latter shows the sum total of all the individual curves i.e. a market or a total demand curve. The following diagram shows the two types of demand curves. In the above diagram, figure (A) shows an individual demand curve of any individual consumer while figure (B)indicates the total market demand. It can be noticed that both the curves are negatively sloping or downwards sloping from left to right. Such a curve shows the inverse relationship between the two variables. In this case the two variable are price on Y axis and the quantity demanded on X axis. It may be noted that at a higher price OP the quantity demanded is OM while at a lower price say OP1, the quantity demanded rises to OM1 thus a demand curve diagrammatically explains the law of demand.

iii)Assumptions of the 'Law of Demand' The law of demand in order to establish the price-demand relationship makes a number of assumptions as follows:1.Income of the consumer is given and constant.2.No change in tastes, preference, habits etc.3.Constancy of the price of other goods.4.No change in the size and composition of population. These Assumptions are expressed in the phrase other things remaining equal. iv)Exceptions of the 'Law of Demand' In case of major bulk of the commodities the validity of the law is experienced. However there are certain situations a n d c om mo d i ti e s w h i ch d o n ot f ol l ow t h e l a w. T h e s e ar e t e r me d as th e e xc e p ti o n s to th e l aw ; th e s e ca n b e expressed as follows:1.Continuous changes in the price lead to the exceptional behaviour. If the price shows a rising trend a buyer is likely to buy more at a high price for protecting himself against a further rise. As against it when the price starts falling continuously, a consumer buys less at a low price and awaits a further in price.2.Giffenss Paradox describes a peculiar experience in case of inferior goods. When the price of an inferior commodity declines, the consumer, instead of purchasing more, buys Roll NO:571119224

less of that commodity and switches on to a superior commodity. Hence the exception.3.Conspicuous Consumption refers to the consumption of those commodities which are bought as a matter of prestige. Naturally with a fall in the price of such goods, there is no distinction in buying the same. As a result the demand declines with a fall in the price of such prestige goods.4.Ignorance Effect implies a situation in which a consumer buys more of a commodity at a higher price only due to ignorance. In the exceptional situations quoted above, the demand curve becomes an upwards rising one as shown in the alongside diagram. In the alongside figure, the demand curve is positively sloping one due to which more is demanded at a high price and less at a low price. 3:A demand forecasting is the prediction of what will happen to your company's existing product sales. It would be best to determine the demand forecast using a multi-functional approach. The inputs from sales and marketing, finance, and production should be considered. The final demand forecast is the consensus of all participating managers. You may also want to put up a Sales and Operations Planning group composed of representatives from the different departments that will be tasked to prepare the demand forecast. Survey Methods:Survey methodshelp us in obtaining information about the future purchase plans of potential buyers through collecting the opinions of experts or by interviewing the consumers. These methods are extensively used in short run and estimating the demand for new products. There are different approaches under survey methods. i) Consumers interview method: Under this method, efforts are made to collect the relevant information directly fr om the consumers with regard to their future purchase plans. In order to gather i nformation from consumers, a number of alternative techniques are developed fr om time to time. Among them, the following are some of the important ones. Survey of buyers intentions or preferences: It is one of the oldest methods of demand forecasting. It is also called as Opinion surveys. Under this method, consumerbuyers are requested to indicate their preferences and willingness about particular products. They are asked to reveal their future purc hase plans with respect to specific items. They are expected to give answers to questions like what items they intend to buy, in what quantity, why, where, when, what quality they expect , how much money they are planning to spend etc. Generally, the field survey is conducted by the marketing research department of the company or hiring the services of outside research organizations consisting of learned and highly qualified professionals. ii) Direct Interview Method Experience has shown that many customers do not respond to questionnaire addressed to them even if it is simple due to varied reasons. Hence, an alternative method i s developed. Under this method, customers are directly contacted and interviewed. Direct and simple questions are asked to them. They are requested to answer specifically about their budget, expenditure plans, particular items to be selected, the quality and quanti Roll NO:571119224

ty of products, relative price preferences etc. for a particular period of time. Ther e are two different methods of direct personal interviews. They are as follows: i. Complete enumeration method Under this method, all potential customers are interviewed in a particular city or a region. The answers elicited are consolidated and carefully studied to obtain the most probable demand for a product. The management can safely project the future demand fo r its products. This method is free from all types of prejudices. Experience of the experts show that it is impossible to approach all customers; as such careful sampling of representative customers is essential. Hence, another variant of complete enumeration method has been developed, which is popularly known as sample survey method. iii)Collective opinion method or opinion survey method This is a variant of the survey method. This method is also known as Sales force polling or Opinion poll method. Under this method, sales representatives, prof essional experts and the market consultants and others are asked to express their considered opinions about the volume of sales expected in the future. The logic and reasoning behin d the method is that these salesmen and other people connected with the sales department are directly involved in the marketing and selling of the products in different regions. Salesmen, being very close to the customers, will be in a position to know and feel the custo mers reactions towards the product. They can study the pulse of the people and identify the specific views of the customers. These people are quite capable of estimating the likely demand for the products with the help of their intimate and friendly contact with the customers and their personal judgments based on the past experience. Thus, they provide approximate, if not accurate estimates. Then, the views of all salesmen are aggregated to get the overall probable demand for a product. Further, these opinions or estimates collected from the various experts are considered, consolidated and reviewed by the top executives to eliminate the bias or optimism and pessimism of different salesmen. iv)Delphi Method or Experts Opinion Method This method was originally developed at Rand Corporation in the late 1940s by Olaf Helmer, Dalkey and Gordon. This method was used to predict future technological changes. It has proved more useful and popular in forecasting non economic rather than economical var iables. It is a variant of opinion poll and survey method of demand forecasting. Under this method, outside experts are appointed. They are supplied with all kinds of infor mation and statistical data. The management requests the experts to express th eir considered opinions and views about the expected future sales of the company. Their views are generally regarded as most objective ones. Their views generally avoid or reduce the Halo Effects a nd Ego Involvement of the views of the others. Since experts opinions are more valuable, a firm will give lot of importance to them and prepare their future plan on the basis of the forecasts made by the experts. v)End Use or Input Output Method Under this method, the sale of the product under consideration is projected on th e basis of Roll NO:571119224

demand surveys of the industries using the given product as an intermediate product. The demand for the final product is the end use demand of the intermediate product used in the production of the final product. An intermediate product may have many en d users, For e.g., steel can be used for making various types of agricultural and industrial machinery, for construction, for transportation etc. It may have the demand both in the domestic market as well as international market. Thus, end use demand estimation of an intermediate product may involve many final goods industries using this product, at home and abroad. Statistical Method:Statistical Method It is the second most popular method of demand forecasting. I t is the best available technique and most commonly used method in recent years. Under this method, statistical, mathematical models, equations etc are extensively use d in order to estimate future demand of a particular product. They are used for estimating long term demand. They are highly complex and complicated in nature. Some of them require considerable mathematical back ground and competence. They use historical data in estimating future demand. i) Trend Projection Method An old firm operating in the market for a long period will have the accumulated previous data on either production or sales pertaining to different years. If we ar range them in chronological order, we get what is called as time series. It is an ordered sequence of events over a period of time pertaining to certain variables. It shows a series of values of a dependent variable say, sales as it changes from one point of time to another. In short, a time series is a set of observations taken at specified time, g enerally at equal intervals. It depicts the historical pattern under normal conditio ns. This method is not based on any particular theory as to what causes the variables to change but merely assumes that whatever forces c ontributed to change in the recent past will continue to have the same effect. On the basis of time series, it is possible to project the future sales of a company. The heart of this method lies in the use of time series. Changes in time series ari se on account of the following reasons: 1. Secular or long run movements: Secular movements indicate the general conditions and direction in which graph of a time series move in relatively a long period of time. 2. Seasonal movements: Time series also undergo changes during seasonal sales of a company. During festival season, sales clearance season etc., we come across most unexpected changes. 3. Cyclical Movements: It implies change in time series or fluctuations in the demand for a product during different phases of a business cycle like depression, revival, boom etc. 4. Random movement. When changes take place at random, we call them irregul ar or random movements. These movements imply sporadic changes in time series occurring due to Roll NO:571119224

unforeseen events such as floods, strikes, elections, earth quakes, droughts and other such natural calamities. Such changes take place only in the short run. Still they hav e their own impact on the sales of a company.

4:Meaning of equilibrium: The word equilibrium is derived from the Latin word aequilibrium which means equal balance. It means a state of even balance in w hich opposing forces or tendencies neutralize each other. It is a position of rest characterized by absence of change. It is a state where there is complete agreement of the economic plans of the various market participants so that no one has a tendency to revise or alter his decision. In the words of professor Mehta: Equilibrium denotes in economics absence of change in movement. Changes In Market Equilibrium: The changes in equilibrium price will occur when there will be shift either in dem and curve or in supply curve or both. Effects of shit in demand Demand changes when there is a change in the of demand like the income, tastes, prices of substitutes and complements, size of the population etc. If demand raises due to a change in any one of these conditions the demand curve shifts upward to the right. If, on the other hand, demand falls, the demand curve shifts downward to the left. Such rise and fall in demand are referred to as increa se and decrease in demand. Quantity demanded and supplied is shown on OX axis, Price is shown on OY axis. SS is the supply curve which remains unchanged. DD is the demand curve. Demand and supply curves intersect each other at point E. Thus OP is the equilibrium price and OQ is the eq uilibrium quantity demanded and supplied. Now, suppose the demand increases. The demand curve shifts forward to D1D1. The new demand curve intersects the supply curve at point E1, where the quantity demanded increases to OQ1 and pri ce to OP1. In the same way, if the demand curve shifts backwards and assumes t he position D2D2, the new equilibrium will be at E2 and the quantity demanded will be OQ2, price will be OP2. Thus the market equilibrium price and quantity demanded will change when there is an increase or decrease in demand.

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Effects Of shift in Supply And Demand: Changes can occur in both demand and supply conditions. The effects of such changes on the market equilibrium depend on the rate of change in the two variables. If t he rate of change in demand is matched with the rate of change in supply there will be no change in the market equilibrium, thenew equilibrium shows expanded market with increased quantity of both supply and demand at the same price. If the increase in demand is greater than the increase in supply, the new market equilibrium is at a higher level showing a rise in both the equilibrium price and th e equilibrium quantity demanded and supplied. On the other hand if the increase in supply is greater than the increase in demand, the new market equilibrium is a t lower level, showing a lower equilibrium price and a higher quantity of good sup plied and demanded. Similar will be the effects when the decrease in demand is greater than the decr ease in supply on the market equilibrium.

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5:Meaning of LAC: Long run is defined as a period of time where adjustments to changed conditions are complete. It is actually a period during which the quantities of all factors, variable as wells fixed factors can be adjusted. Hence, there are no fixed costs in the long run. In the short run, a firm has to carry on its production within the existing plant capacity, but in the long run it is not tied up to a particular plant capacity. If demand for the product increases, it can expand output by enlarging its plant capacity. It can construct new buildings or hire them, install new machines, employ administrative and other permanent staff. It can make use of the existing as well as new staff in the most efficient way and there is lot of scope for making indivisible factors to become divisible factors. On the other hand, if demand for the product declines, a firm can cut down its production permanently. The size of the plant can also be reduced and other expenditure can beminimized.Hence, production cost comes down to a greater extent in the long run.As all costs are variable in the long run, the total of these costs is total cost of production.Hence,thedistinction between fixed and variables costs in the total cost of production will disappear in the long run. In the long run only the average total cost is important and considered in taking long term output decisions. Important features of LAC curves: i)Tangent curve: Different SAC curves represent different operational capacitie s of different plants in the short run. LAC curve is locus of all these points of tang ency. The SAC curve can never cut a LAC curve though they are tangential to ea ch other. This implies that for any given level of output, no SAC curvecan ever be below the LAC curve. Hence, SAC cannot be lower than the LAC in the ling run. T hus, LAC curve is tangential to various SAC curves. ii) Envelope curve: It is known as Envelope curve because it envelopes a group of SAC curves appropriate to different levels of output. iii)Flatter Ushaped or dishshaped curve: The LAC curve is also U shaped or dish shaped cost curve. But It is less pronounced and much flatter in nature. LAC gradually falls and rises due to economies and diseconomies of scale. iv)Planning curve:The LAC cure is described as the Planning Curve of the firm because it represents the least cost of producing each possible level of output. T his helps in producing optimum level of output at the minimum LAC. This is possi ble when the entrepreneur is selecting the optimum scale plant. Optimum scale plant is that size where the minimum point of SAC is tangent to the minimum poi nt of LAC. v)Minimum point of LAC curve should be always lower than the minimu m point of SAC curve. This is because LAC can never be higher than SAC or SAC can never be lower tha n LAC. The LAC curve will touch the optimum plant SAC curve at its minimum point. A rational entrepreneur would select the optimum scale plant. Optimum scale plant is that size at which SAC is tangent to LAC, such that both the curves have the minimum point of tang ency. In the diagram, OM2 is regarded as the optimum scale of output, as it has t he least per unit cost. At OM2 output LAC = SA. LAC curve will be tangent to SAC curves lying to the left of the optimum scale or right side of the Roll NO:571119224

optimum scale. But at these points of tangency, neither LAC is minimum nor will SAC be minimum. SAC curves are either rising or falling indicating a higher cost. Diagram of LAC:

6:A costschedule is a statement of avariation in costs resulting from variations in th e levels of output. It shows the response of cost to changes in output.cost output relationship with reference to changes in output. i)Total fixed cost and output TFC refers to total money expenses incurred on fixed inputs like plant, machinery, tools & equipments in the short run. Total fixed cost corresponds to the fixed inputs in the short run production function. TFC remains the same at all levels of output in the short run. It is the same when output is nil. It indicates that whatever may be th e quantity of output, whether 1 to 6 units, TFC remain constant. The TFC curve is horizontal and parallel to OXaxis, showing that it is constant regardless of out put per unit of time. TFC starts from a point on Yaxis indicating that the total fixed cost will be incurred even if the out put is zero. In our example, Rs 30000 is TFC. It is obtained by summing up the p roduct or quantities of the fixed factors multiplied by their respective unit price. ii) Total variable cost (TVC) TVC refers to total money expenses incurred on the variable factors inputs like raw materials, power, fuel, water, transport and communication etc, in the short run. Total variable cost corresponds to variable inputs in the short run production function. It is obta ined by summing up the production of quantities of variable inputs multiplied by their prices. The formula to calculate TVC is as follows. TVC = TCTFC. TVC = f (Q) i.e. TVC is an increasing function of out put. In other words TVC varies with output. It is nil, if there is no productio n. Thus, it is a direct cost of output. TVC rises sharply in the beginning, gradually in the middle and sharply at the end in accordance with the law of variable propo rtion. The law of variable proportion explains that in the beginning to obtain a giv en quantity of output, relative variation in factors needed are in less proportion, but after a point when the diminishing returns operate, variable factors are to be employed in a larger proportion to increase the same level of output. TVC curve s lope upwards from left to right. TVC curve rises as output is expanded. When out put is Zero, TVC also will be zero. Hence, the TVC curve starts from the origin. iii)Total cost (TC) Roll NO:571119224

The total cost refers to the aggregate money expenditure incurred by a firm to pr oduce a given quantity of output. The total cost is measured in relation to the production function by multiplying the factor prices with their quantities. TC = f (Q) which means that t he T.C. varies with the output. Theoretically speaking TC includes all kinds of mo ney costs, both explicit and implicit cost. Normal profit is included in the total co st as it is an implicit cost. It includes fixed as well as variable costs. Hence, TC = TFC +TVC. TC varies in the same proportion as TVC. In other words, a variation in TC is the result of variation in TVC since TFC is always constant in the short run.T he total cost curve is rising upwards from left to right. In our example the TC cur ve starts form Rs. 30000 because even if there is no output, TFC is a positive am ount. TC and TVC have same shapebecause an increase in output increases the m both by the same amount since TFC is constant. TC curve is derived by adding up vertically the TVC and TFC curves. The vertical distance between TVC curve and TC curve is equal to TFC and is constant throug hout because TFC is constant.

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