UNIT-I

INTRODUCTION TO MANAGERIAL ECONOMICS

Introduction to Economics

Economics is a study of human activity both at individual and national level. The
economists of early age treated economics merely as the science of wealth. The
reason for this is clear. Every one of us in involved in efforts aimed at earning
money and spending this money to satisfy our wants such as food, Clothing, shelter,
and others. Such activities of earning and spending money are called
“Economic activities”. It was only during the eighteenth century that Adam Smith,
the Father of Economics, defined economics as the study of nature and uses of
national wealth’.

Dr. Alfred Marshall, one of the greatest economists of the nineteenth century, writes
“Economics is a study of man’s actions in the ordinary business of life: it enquires
how he gets his income and how he uses it”. Thus, it is one side, a study of wealth;
and on the other, and more important side; it is the study of man. As Marshall
observed, the chief aim of economics is to promote ‘human welfare’, but not wealth.
The definition given by AC Pigou endorses the opinion of Marshall. Pigou defines
Economics as “the study of economic welfare that can be brought directly and
indirectly, into relationship with the measuring rod of money”.
Prof. Lionel Robbins defined Economics as “the science, which studies human
behaviour as a relationship between ends and scarce means which have alternative
uses”. With this, the focus of economics shifted from ‘wealth’ to human behaviour’.

Lord Keynes defined economics as ‘the study of the administration of scarce means
and the determinants of employments and income”.

TYPES OF ECONOMICS
Microeconomics

The study of an individual consumer or a firm is called microeconomics (also called

the Theory of Firm). Micro means ‘one millionth’. Microeconomics deals with
behavior and problems of single individual and of micro organization. Managerial
economics has its roots in microeconomics and it deals with the micro or individual
enterprises. It is concerned with the application of the concepts such as price theory,
Law of Demand and theories of market structure and so on.
Macroeconomics

The study of ‘aggregate’ or total level of economics activity in a country is called

macroeconomics. It studies the flow of economics resources or factors of production
(such as land, labour, capital, organisation and technology) from the resource owner
to the business firms and then from the business firms to the households. It deals
with total aggregates, for instance, total national income total employment, output
and total investment. It studies the interrelations among various aggregates and
examines their nature and behaviour, their determination and causes of fluctuations
in the. It deals with the price level in general, instead of studying the prices of
individual commodities. It is concerned with the level of employment in the
economy. It discusses aggregate consumption, aggregate investment, price level,
and payment, theories of employment, and so on.

Though macroeconomics provides the necessary framework in term of government

policies etc., for the firm to act upon dealing with analysis of business conditions, it
has less direct relevance in the study of theory of firm.

Management

Management is the science and art of getting things done through people in formally
organized groups. It is necessary that every organisation be well managed to enable
it to achieve its desired goals. Management includes a number of functions:
Planning, organizing, staffing, directing, and controlling. The manager while directing
the efforts of his staff communicates to them the goals, objectives, policies, and
procedures; coordinates their efforts; motivates them to sustain their enthusiasm;
and leads them to achieve the corporate goals.

Managerial Economics

Introduction

Managerial Economics refers to the firm’s decision making process. It could be also
interpreted as “Economics of Management” or “Economics of Management”.
Managerial Economics is also called as “Industrial Economics” or “Business
Economics”.

DEFINITIONS OF MANAGERIAL ECONIMICS:

1) MC Crutgan and Moyer:-

“Managerial Economics is the application of economics theory and methodology to
decision making problems faced by both public and private institutions”
2) MC Nair and Meriam:-
“Managerial economics consists of the use of modes of thought to analysis business
situations”.
3) Spencer and Siegelman:-
“Marginal economics is the integration of economic theory with business practice for
the purpose of facilitating decision making and forward planning by management”.
4) Haynes mote and paul:-
“Managerial economics refer to those aspects of economic and its tools of analysis
most relevant to the firm decision making process”.

5) Joel dean:-
“Use of economic analysis in formulating policies is known as managerial economics”
6) Edwin mans field:-
“Managerial economics is concerned with application of economics concepts and
economics analysis to the problem of formulating rational managerial decisions”.
Thus managerial economics is the process of application of the principles, technical
and concepts of economics to solve the managerial problems of a business and
industrial enter price.

Nature of Managerial Economics

Managerial economics is, perhaps, the youngest of all the social sciences. Since it
originates from Economics, it has the basis features of economics, such as assuming
that other things remaining the same (or the Latin equivalent ceteris paribus). This
assumption is made to simplify the complexity of the managerial phenomenon under
study in a dynamic business environment so many things are changing
simultaneously. This set a limitation that we cannot really hold other things
remaining the same. In such a case, the observations made out of such a study will
have a limited purpose or value. Managerial economics also has inherited this
problem from economics.

Further, it is assumed that the firm or the buyer acts in a rational manner (which
normally does not happen). The buyer is carried away by the advertisements, brand
loyalties, incentives and so on, and, therefore, the innate behaviour of the consumer
will be rational is not a realistic assumption. Unfortunately, there are no other
alternatives to understand the subject other than by making such assumptions. This
is because the behaviour of a firm or a consumer is a complex phenomenon.

The other features of managerial economics are explained as below:

(a) Close to microeconomics: Managerial economics is concerned with finding

the solutions for different managerial problems of a particular firm. Thus, it
is more close to microeconomics.
(b) Operates against the backdrop of macroeconomics: The
macroeconomics conditions of the economy are also seen as limiting factors
for the firm to operate. In other words, the managerial economist has to be
 aware of the limits set by the macroeconomics conditions such as
government industrial policy, inflation and so on.
(c) Normative statements: 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. For instance, it deals with
statements such as ‘Government of India should open up the economy. Such
statement are based on value judgments and express views of what is ‘good’
or ‘bad’, ‘right’ or ‘ wrong’. One problem with normative statements is that
they cannot to verify by looking at the facts, because they mostly deal with
the future. Disagreements about such statements are usually settled by
voting on them.
(d) Prescriptive actions: Prescriptive action is goal oriented. Given a problem
and the objectives of the firm, it suggests the course of action from the
available alternatives for optimal solution. If does not merely mention the
concept, it also explains whether the concept can be applied in a given
context on not. For instance, the fact that variable costs are marginal costs
can be used to judge the feasibility of an export order.
(e) Applied in nature: ‘Models’ are built to reflect the real life complex
business situations and these models are of immense help to managers for
decision-making. The different areas where models are extensively used
include inventory control, optimization, project management etc. In
managerial economics, we also employ case study methods to conceptualize
the problem, identify that alternative and determine the best course of
action.
(f) Offers scope to evaluate each alternative: Managerial economics
provides an opportunity to evaluate each alternative in terms of its costs and
revenue. The managerial economist can decide which is the better
alternative to maximize the profits for the firm.
(g) Interdisciplinary: The contents, tools and techniques of managerial
economics are drawn from different subjects such as economics,
management, mathematics, statistics, accountancy, psychology,
organizational behavior, sociology and etc.
(h) Assumptions and limitations: Every concept and theory of managerial
economics is based on certain assumption and as such their validity is not
universal. Where there is change in assumptions, the theory may not hold
good at all.

Scope of Managerial Economics:

The scope of managerial economics refers to its area of study. Managerial economics
refers to its area of study. Managerial economics, Provides management with a
strategic planning tool that can be used to get a clear perspective of the way the
business world works and what can be done to maintain profitability in an ever-
changing environment. Managerial economics is primarily concerned with the
application of economic principles and theories to five types of resource decisions
made by all types of business organizations.

a. The selection of product or service to be produced.

b. The choice of production methods and resource combinations.
c. The determination of the best price and quantity combination
d. Promotional strategy and activities.
e. The selection of the location from which to produce and sell goods or service
to consumer.

The production department, marketing and sales department and the finance
department usually handle these five types of decisions.
The scope of managerial economics covers two areas of decision making

a. Operational or Internal issues

b. Environmental or External issues

a. Operational issues:
Operational issues refer to those, which wise within the business organization and
they are under the control of the management. Those are:
1. Theory of demand and Demand Forecasting
2. Pricing and Competitive strategy
3. Production cost analysis
4. Resource allocation
5. Profit analysis
6. Capital or Investment analysis
7. Strategic planning
1. Demand Analyses and Forecasting:

A firm can survive only if it is able to the demand for its product at the right time,
within the right quantity. Understanding the basic concepts of demand is essential
for demand forecasting. Demand analysis should be a basic activity of the firm
because many of the other activities of the firms depend upon the outcome of the
demand fore cost. Demand analysis provides:

1. The basis for analyzing market influences on the firms; products and thus
helps in the adaptation to those influences.
2. Demand analysis also highlights for factors, which influence the demand for a
product. This helps to manipulate demand. Thus demand analysis studies not
only the price elasticity but also income elasticity, cross elasticity as well as
the influence of advertising expenditure with the advent of computers,
 demand forecasting has become an increasingly important function of
managerial economics.

2. Pricing and competitive strategy:

Pricing decisions have been always within the preview of managerial economics.
Pricing policies are merely a subset of broader class of managerial economic
problems. Price theory helps to explain how prices are determined under different
types of market conditions. Competitions analysis includes the anticipation of the
response of competitions the firm’s pricing, advertising and marketing strategies.
Product line pricing and price forecasting occupy an important place here.

3. Production and cost analysis:

Production analysis is in physical terms. While the cost analysis is in monetary terms
cost concepts and classifications, cost-out-put relationships, economies and
diseconomies of scale and production functions are some of the points constituting
cost and production analysis.

4. Resource Allocation:

Managerial Economics is the traditional economic theory that is concerned with the
problem of optimum allocation of scarce resources. Marginal analysis is applied to
the problem of determining the level of output, which maximizes profit. In this
respect linear programming techniques has been used to solve optimization
problems. In fact lines programming is one of the most practical and powerful
managerial decision making tools currently available.

5. Profit analysis:

Profit making is the major goal of firms. There are several constraints here an
account of competition from other products, changing input prices and changing
business environment hence in spite of careful planning, there is always certain risk
involved. Managerial economics deals with techniques of averting of minimizing
risks. Profit theory guides in the measurement and management of profit, in
calculating the pure return on capital, besides future profit planning.

6. Capital or investment analyses:

Capital is the foundation of business. Lack of capital may result in small size of
operations. Availability of capital from various sources like equity capital,
institutional finance etc. may help to undertake large-scale operations. Hence
efficient allocation and management of capital is one of the most important tasks of
the managers. The major issues related to capital analysis are:

1. The choice of investment project

2. Evaluation of the efficiency of capital
3. Most efficient allocation of capital

Knowledge of capital theory can help very much in taking investment decisions. This
involves, capital budgeting, feasibility studies, analysis of cost of capital etc.

7. Strategic planning:

Strategic planning provides management with a framework on which long-term

decisions can be made which has an impact on the behavior of the firm. The firm
sets certain long-term goals and objectives and selects the strategies to achieve the
same. Strategic planning is now a new addition to the scope of managerial
economics with the emergence of multinational corporations. The perspective of
strategic planning is global.

It is in contrast to project planning which focuses on a specific project or activity. In

fact the integration of managerial economics and strategic planning has given rise to
be new area of study called corporate economics.

B. Environmental or External Issues:

An environmental issue in managerial economics refers to the general business

environment in which the firm operates. They refer to general economic, social and
political atmosphere within which the firm operates. A study of economic
environment should include:

a. The type of economic system in the country.

b. The general trends in production, employment, income, prices, saving and
investment.
c. Trends in the working of financial institutions like banks, financial
corporations, insurance companies
d. Magnitude and trends in foreign trade;
e. Trends in labour and capital markets;
f. Government’s economic policies viz. industrial policy monetary policy, fiscal
policy, price policy etc.

The social environment refers to social structure as well as social organization like
trade unions, consumer’s co-operative etc. The Political environment refers to the
nature of state activity, chiefly states’ attitude towards private business, political
stability etc.

The environmental issues highlight the social objective of a firm i.e.; the firm owes a
responsibility to the society. Private gains of the firm alone cannot be the goal.

The environmental or external issues relate managerial economics to macro

economic theory while operational issues relate the scope to micro economic theory.
The scope of managerial economics is ever widening with the dynamic role of big
firms in a society.

DEMAND ANALYSIS

Introduction & Meaning:

Demand in common parlance means the desire for an object. But in economics
demand is something more than this. According to Stonier and Hague, “Demand in
economics means demand backed up by enough money to pay for the goods
demanded”. This means that the demand becomes effective only it if is backed by
the purchasing power in addition to this there must be willingness to buy a
commodity.

Thus demand in economics means the desire backed by the willingness to buy a
commodity and the purchasing power to pay. In the words of “Benham” “The
demand for anything at a given price is the amount of it which will be bought per
unit of time at that Price”. (Thus demand is always at a price for a definite quantity
at a specified time.) Thus demand has three essentials – price, quantity demanded
and time. Without these, demand has to significance in economics.
DEMAND – Definition:

The willingness to pay money for some quantity of a particular good or

performance of service is called as demand.
Ex:- I want a car and I cannot pay for it there is no demand for it from
my side.
FEATURES OF DEMAND
 Desire on the part of the buyer to buy
 Willingness to pay for it.
 Ability to pay the specified price for it.

Types of Demand:

There are three types of demand:

1. Price elasticity of demand

2. Income elasticity of demand
 3. Cross elasticity of demand

1. PRICE DEMAND:- price demand refer to the quantity of a product

or service demand at a given price.
2. INCOME DEMAND:- Income demand refers to the quantity of a
particular product or service demand at a given level of income of
the consumer or the households.
3. CROSS DEMAND:- Cross demand refers to the quantity demand
for a particular product or service given the price of a related good
the related good that may be complementary or substitute goods.

LAW of Demand:

Law of demand shows the relation between price and quantity demanded of a
commodity in the market. In the words of Marshall, “the amount demand increases
with a fall in price and diminishes with a rise in price”.

A rise in the price of a commodity is followed by a reduction in demand and a fall in

price is followed by an increase in demand, if a condition of demand remains
constant.

The law of demand may be explained with the help of the following demand
schedule.
The law of demand tells us a commodity and relation between the price of a
commodity and its quantity demand in the market
As lower the price greater the quantity will be demanded the law of demand shows
the inverse relationship between the price and quantity demanded.
OPERATIONS OF THE LAW OF DEMAND
The law of demand explains that with every fall in the price of a particular
product its demand goes on increasing vice versa.
CHANGES IN DEMAND:-
1. Increase in demand
2. Decrease in demand
3. Extension and contraction in demand

1. INCREASE IN DEMAND:-
If the consumer is willing and able to buy more of the product or
services at the same price the result will be an increase in demand
the demand curve will shift o the right.

2. DECREASE IN DEMAND:-
A decrease in demand occurs when buyers are ready to buy less of
a product at the same price because of facts like fall income rise in
price of complimentary goods and so on ment along a demand
curve which indicates that a higher quantity is demand for a given
fall in the price of the goods.

3. Extension and contraction in demand:-

A contraction is the upward movement along a demand curve which
indicates that a lower quantity is demanded for a given increase in
the price of the goods.
 In the above figure we can see that at op is the price the quantity
demanded is oq when the price decreases from op to op1 the
quantity demanded extends from oq to oq1 this is called extension
in demand.
Contraction refers to the movement upwards along the same
demand curve when the price increases from op to op2 the demand
contrast from oq to oq2 along the same demand curve this is called
contraction in demand

Demand Schedule.

Price of Appel (In. Rs.) Quantity Demanded

10 1
8 2
6 3
4 4
2 5

When the price falls from Rs. 10 to 8 quantity demand increases from 1 to 2. In the
same way as price falls, quantity
demand increases on the basis
of the demand schedule we
can draw the demand curve.
 Price

The demand curve DD shows the inverse relation between price and quantity
demand of apple. It is downward sloping.

Assumptions:

Law is demand is based on certain assumptions:

1. This is no change in consumers taste and preferences.

2. Income should remain constant.
3. Prices of other goods should not change.
4. There should be no substitute for the commodity
5. The commodity should not confer at any distinction
6. The demand for the commodity should be continuous
7. People should not expect any change in the price of the commodity

Exceptional demand curve (or) Exceptions of Law of demand:

Some times the demand curve slopes upwards from left to right. In this case the
demand curve has a positive slope.

Price

When price increases from OP to Op1 quantity demanded also increases from to
OQ1 and vice versa. The reasons for exceptional demand curve are as follows.
1. Giffen paradox:

The Giffen good or inferior good is an exception to the law of demand. When the
price of an inferior good falls, the poor will buy less and vice versa. For example,
when the price of maize falls, the poor are willing to spend more on superior goods
than on maize if the price of maize increases, he has to increase the quantity of
money spent on it. Otherwise he will have to face starvation. Thus a fall in price is
followed by reduction in quantity demanded and vice versa. “Giffen” first explained
this and therefore it is called as Giffen’s paradox.

2. Veblen or Demonstration effect:

‘Veblan’ has explained the exceptional demand curve through his doctrine of
conspicuous consumption. Rich people buy certain good because it gives social
distinction or prestige for example diamonds are bought by the richer class for the
prestige it possess. It the price of diamonds falls poor also will buy is hence they will
not give prestige. Therefore, rich people may stop buying this commodity.

3. Ignorance:

Sometimes, the quality of the commodity is Judge by its price. Consumers think that
the product is superior if the price is high. As such they buy more at a higher price.

4. Speculative effect:

If the price of the commodity is increasing the consumers will buy more of it
because of the fear that it increase still further, Thus, an increase in price may not
be accomplished by a decrease in demand.

5. Fear of shortage:

During the times of emergency of war People may expect shortage of a commodity.
At that time, they may buy more at a higher price to keep stocks for the future.

5. Necessaries:

In the case of necessaries like rice, vegetables etc. people buy more even at a
higher price.
 NATURE OF DEMAND
A product with more number of uses in naturally more in demand than
one with a single use.

 Consumer goods Vs producer goods

 Autonomous demand Vs derived demand
 Durable Vs perishable goods
 Firm demand Vs industry goods
 Short run demand Vs long run demand
 New demand Vs replacement demand
 Total market Vs segment market demand

Factors Affecting Demand:

There are factors on which the demand for a commodity depends. These factors are
economic, social as well as political factors. The effect of all the factors on the
amount demanded for the commodity is called Demand Function.
These factors are as follows:

1. Price of the Commodity:

The most important factor-affecting amount demanded is the price of the

commodity. The amount of a commodity demanded at a particular price is more
properly called price demand. The relation between price and demand is called the
Law of Demand. It is not only the existing price but also the expected changes in
price, which affect demand.

2. Income of the Consumer:

The second most important factor influencing demand is consumer income. In fact,
we can establish a relation between the consumer income and the demand at
different levels of income, price and other things remaining the same. The demand
for a normal commodity goes up when income rises and falls down when income
falls. But in case of Giffen goods the relationship is the opposite.

3. Prices of related goods:

The demand for a commodity is also affected by the changes in prices of the related
goods also. Related goods can be of two types:

(i). Substitutes which can replace each other in use; for example, tea and coffee are
substitutes. The change in price of a substitute has effect on a commodity’s
demand
in the same direction in which price changes. The rise in price of coffee shall
raise
the demand for tea;

(ii). Complementary foods are those which are jointly demanded, such as pen and
ink. In
such cases complementary goods have opposite relationship between price of
one
commodity and the amount demanded for the other. If the price of pens goes
up,
their demand is less as a result of which the demand for ink is also less. The
price
and demand go in opposite direction. The effect of changes in price of a
commodity on
amounts demanded of related commodities is called Cross Demand.

4. Tastes of the Consumers:

The amount demanded also depends on consumer’s taste. Tastes include fashion,
habit, customs, etc. A consumer’s taste is also affected by advertisement. If the
taste for a commodity goes up, its amount demanded is more even at the same
price. This is called increase in demand. The opposite is called decrease in demand.

5. Wealth:

The amount demanded of commodity is also affected by the amount of wealth as

well as its distribution. The wealthier are the people; higher is the demand for
normal commodities. If wealth is more equally distributed, the demand for
necessaries and comforts is more. On the other hand, if some people are rich, while
the majorities are poor, the demand for luxuries is generally higher.

6. Population:

Increase in population increases demand for necessaries of life. The composition of

population also affects demand. Composition of population means the proportion of
young and old and children as well as the ratio of men to women. A change in
composition of population has an effect on the nature of demand for different
commodities.
7. Government Policy:

Government policy affects the demands for commodities through taxation. Taxing a
commodity increases its price and the demand goes down. Similarly, financial help
from the government increases the demand for a commodity while lowering its
price.

8. Expectations regarding the future:

If consumers expect changes in price of commodity in future, they will change the
demand at present even when the present price remains the same. Similarly, if
consumers expect their incomes to rise in the near future they may increase the
demand for a commodity just now.

9. Climate and weather:

The climate of an area and the weather prevailing there has a decisive effect on
consumer’s demand. In cold areas woolen cloth is demanded. During hot summer
days, ice is very much in demand. On a rainy day, ice cream is not so much
demanded.

10. State of business:

The level of demand for different commodities also depends upon the business
conditions in the country. If the country is passing through boom conditions, there
will be a marked increase in demand. On the other hand, the level of demand goes
down during depression.

ELASTICITY OF DEMAND

Elasticity of demand explains the relationship between a change in price and

consequent change in amount demanded. “Marshall” introduced the concept of
elasticity of demand. Elasticity of demand shows the extent of change in quantity
demanded to a change in price.

In the words of “Marshall”, “The elasticity of demand in a market is great or small

according as the amount demanded increases much or little for a given fall in the
price and diminishes much or little for a given rise in Price”

Elastic demand: A small change in price may lead to a great change in quantity
demanded. In this case, demand is elastic.
In-elastic demand: If a big change in price is followed by a small change in
demanded then the demand in “inelastic”.

TYPES OF ELASTICITY OF DEMAND

1. Price elasticity of demand

2. Income elasticity of demand
3. Cross elasticity of demand
4. Advertising elasticity of demand
1. Price elasticity of demand:-
It refers to the quantity demanded of a commodity in response to a
given change in price. Price elasticity is always negative which
indicates that the customer tends to buy more with every fall in the
price. The relationship between the price and the demanded is
inverse
Price elasticity of demand = proportional change in the quantity
demanded/proportional change in the price.
It was developed by Alfred marshall the changes in the price of a
particular good will never bring uniform changes in the quantity
demanded.

2. Income elasticity of demanded:-

Income elasticity of demand refers to the quantity demanded of a
commodity in response to a given change in income of consumer
Income elasticity is normally positive which indicates that the
consumer tends to by more and more with every increase in income
Income elasticity of demand = proportionate chage in the quantity
demanded/ proportionate change in the income
Cross elasticity of demand; cross elasticity of demand refers to the
quantity demanded of a commodity in response to a change in the
price of a related good which maybe substitute or complement.

3. Cross elasticity of demand:-

Proportionate change in the quantity demanded/proportionate
change in the price of product
Complementary goods will have negative cross elasticity of demand
where as substitutes will have positive cross elasticity of demand.
4. Advertising elasticity of demand:-
 It refers to increase in the sales revenue because of change in the
advertising expenditure. In other words, there is a direct
relationship between the amount of money spent on advertising and
its impact on sales advertising elasticity is always positive
Advertising elasticity of demand=proportionate change in the
quantity demanded for product/proportionate change in the
advertising costs.

MEASUREMENT OF PRICE ELASTICITY OF DEMAND

A. Perfectly elastic demand:

When small change in price leads to an infinitely large change is quantity demand, it
is called perfectly or infinitely elastic demand. In this case E=∞

The demand curve DD1 is horizontal straight line. It shows the at “OP” price any
amount is demand and if price increases, the consumer will not purchase the
commodity.

B. Perfectly Inelastic Demand

In this case, even a large change in price fails to bring about a change in quantity
demanded.
When price increases from ‘OP’ to ‘OP’, the quantity demanded remains the same. In
other words the response of demand to a change in Price is nil. In this case ‘E’=0.

C. Relatively elastic demand:

Demand changes more than proportionately to a change in price. i.e. a small change
in price loads to a very big change in the quantity demanded. In this case
E > 1. This demand curve will be flatter.

When price falls from ‘OP’ to ‘OP’, amount demanded in crease from “OQ’ to “OQ1’
which is larger than the change in price.

D. Relatively in-elastic demand.

Quantity demanded changes less than proportional to a change in price. A large

change in price leads to small change in amount demanded. Here E < 1. Demanded
carve will be steeper.
When price falls from “OP’ to ‘OP1 amount demanded increases from OQ to OQ1,
which is smaller than the change in price.

E. Unit elasticity of demand:

The change in demand is exactly equal to the change in price. When both are equal
E=1 and elasticity if said to be unitary.

When price falls from ‘OP’ to ‘OP1’ quantity demanded increases from ‘OP’ to ‘OP1’,
quantity demanded increases from ‘OQ’ to ‘OQ1’. Thus a change in price has
resulted in an equal change in quantity demanded so price elasticity of demand is
equal to unity.

MEASUREMENT OF PRICE ELASTICITY OF DEMAND

Different methods have been devised by the economist to measure the
degree of elasticity they are
1. To total outlay method
2. The point method
3. The arc method
1. The total out lay/Revenue method
Under this method we compare the total outlay of the buyer or total
revenue of the seller before and after the change in price we can get
total out lay.
 P*q = price*quantity
P*q = total outlay=total revenue
According to this method, prince elasticity of demand is expressed in
three forms, they are:
 Elastic demand
 Unity elasticity
 In elastic demand
a. Elastic demand:- when the total amount spent on goods increases
with a fall in price and decrease with a rise in price then elasticity is
said to be greater than unity or elastic demand
b. Unity elasticity:- when the total amount spent on goods remains the
same before and after the price change, then it is called unity
elasticity.
c. Inelastic demand:- when the total amount spends on the goods
decreases with a fall in price, then it is called inelastic demand.

price of Total out

product (p) Q.D lay(PxQ) Elasticity
elasticity demand
9 40 360 np>1
8 50 400
elasticity demand
7 60 420 np=1
6 70 420
elasticity demand
5 80 400 np<1
4 90 360
2. Point method:-
This method helps us to measure the elasticity of demand at any point
on the demand curve this method has also given by Alfred marshall
and is known as “Geo-metrical method”.
According to this method, elasticity at any point is the ratio to the
lower position of the demand curve to the upper positon.

3. Arc method:-The main drawback to the point method is that it can

be used only when we have complete data on the changes in the
price of the good and quantity demand but in real life, it is not easy to
get and quantity this means that there will be gaps in the demand
schedules in such cases, it is not possible to apply the point method to
get the desired results.
In the arc method, the mid-points b/w the old and new data in the
case of price and quantity are used.
 This method studies a portion or segment (Arc) of the demand curve
between the two points
Np=change in the quantity demanded/original quantity +new
quantity/change in the price/old price + new price.

Factors influencing the elasticity of demand

Elasticity of demand depends on many factors.

1. Nature of commodity:

Elasticity or in-elasticity of demand depends on the nature of the commodity i.e.

whether a commodity is a necessity, comfort or luxury, normally; the demand for
Necessaries like salt, rice etc is inelastic. On the other band, the demand for
comforts and luxuries is elastic.

2. Availability of substitutes:
Elasticity of demand depends on availability or non-availability of substitutes. In
case of commodities, which have substitutes, demand is elastic, but in case of
commodities, which have no substitutes, demand is in elastic.
3. Variety of uses:
If a commodity can be used for several purposes, than it will have elastic demand.
i.e. electricity. On the other hand, demanded is inelastic for commodities, which can
be put to only one use.
4. Postponement of demand:
If the consumption of a commodity can be postponed, than it will have elastic
demand. On the contrary, if the demand for a commodity cannot be postpones, than
demand is in elastic. The demand for rice or medicine cannot be postponed, while
the demand for Cycle or umbrella can be postponed.

5. Amount of money spent:

Elasticity of demand depends on the amount of money spent on the commodity. If

the consumer spends a smaller for example a consumer spends a little amount on
salt and matchboxes. Even when price of salt or matchbox goes up, demanded will
not fall. Therefore, demand is in case of clothing a consumer spends a large
proportion of his income and an increase in price will reduce his demand for clothing.
So the demand is elastic.

6. Time:

Elasticity of demand varies with time. Generally, demand is inelastic during short
period and elastic during the long period. Demand is inelastic during short period
because the consumers do not have enough time to know about the change is price.
Even if they are aware of the price change, they may not immediately switch over to
a new commodity, as they are accustomed to the old commodity.

7. Range of Prices:

Range of prices exerts an important influence on elasticity of demand. At a very high

price, demand is inelastic because a slight fall in price will not induce the people buy
more. Similarly at a low price also demand is inelastic. This is because at a low price
all those who want to buy the commodity would have bought it and a further fall in
price will not increase the demand. Therefore, elasticity is low at very him and very
low prices.

Importance of Elasticity of Demand:

The concept of elasticity of demand is of much practical importance.

1. Price fixation:
Each seller under monopoly and imperfect competition has to take into account
elasticity of demand while fixing the price for his product. If the demand for the
product is inelastic, he can fix a higher price.

2. Production:

Producers generally decide their production level on the basis of demand for the
product. Hence elasticity of demand helps the producers to take correct decision
regarding the level of cut put to be produced.

3. Distribution:

Elasticity of demand also helps in the determination of rewards for factors of

production. For example, if the demand for labour is inelastic, trade unions will be
successful in raising wages. It is applicable to other factors of production.

4. International Trade:

Elasticity of demand helps in finding out the terms of trade between two countries.
Terms of trade refers to the rate at which domestic commodity is exchanged for
foreign commodities. Terms of trade depends upon the elasticity of demand of the
two countries for each other goods.

5. Public Finance:

Elasticity of demand helps the government in formulating tax policies. For example,
for imposing tax on a commodity, the Finance Minister has to take into account the
elasticity of demand.

6. Nationalization:

The concept of elasticity of demand enables the government to decide about

nationalization of industries.
 Demand Forecasting

Introduction:

The information about the future is essential for both new firms and those planning
to expand the scale of their production. Demand forecasting refers to an estimate of
future demand for the product.

It is an ‘objective assessment of the future course of demand”. In recent times,

forecasting plays an important role in business decision-making. Demand forecasting
has an important influence on production planning. It is essential for a firm to
produce the required quantities at the right time.

It is essential to distinguish between forecasts of demand and forecasts of sales.

Sales forecast is important for estimating revenue cash requirements and expenses.
Demand forecasts relate to production, inventory control, timing, reliability of
forecast etc. However, there is not much difference between these two terms.

Types of demand Forecasting:

Based on the time span and planning requirements of business firms, demand
forecasting can be classified in to 1. Short-term demand forecasting and
2. Long – term demand forecasting.

1. Short-term demand forecasting:

Short-term demand forecasting is limited to short periods, usually for one year. It
relates to policies regarding sales, purchase, price and finances. It refers to existing
production capacity of the firm. Short-term forecasting is essential for formulating is
essential for formulating a suitable price policy. If the business people expect of rise
in the prices of raw materials of shortages, they may buy early. This price
forecasting helps in sale policy formulation. Production may be undertaken based on
expected sales and not on actual sales. Further, demand forecasting assists in
financial forecasting also. Prior information about production and sales is essential to
provide additional funds on reasonable terms.

2. Long – term forecasting:

In long-term forecasting, the businessmen should now about the long-term demand
for the product. Planning of a new plant or expansion of an existing unit depends on
long-term demand. Similarly a multi product firm must take into account the
demand for different items. When forecast are mode covering long periods, the
probability of error is high. It is vary difficult to forecast the production, the trend of
prices and the nature of competition. Hence quality and competent forecasts are
essential.

Prof. C. I. Savage and T.R. Small classify demand forecasting into time types. They
are 1. Economic forecasting, 2. Industry forecasting, 3. Firm level forecasting.
Economics forecasting is concerned with the economics, while industrial level
forecasting is used for inter-industry comparisons and is being supplied by trade
association or chamber of commerce. Firm level forecasting relates to individual
firm.
ADVANTAGES OF FORECASTING
 Production scheduling
 Reducing cost of manufacturing
 Inventory control
 Determination of price policy
 Setting sales targets
 For suitable advertising
 Make a long term investment decision
 Manpower planning

FACTORS GOVERNINIG THE DEMAND

FORECASTING

 Purchasing power of customers

 Price
 Substitutes
 Complementary
 Nature of the goods
 Degree of competition
 Socio-economic condition of the country
 Credit conditions
 Demography
 Time factors(long term or short term)

Methods of forecasting:
1. Survey methods.
A. Survey of buyer intention:- To anticipate what buyer are likely to do under a
given set of circumstances. Most useful sources of information would be the buyers
themselves. It is better to draw a list of all potential buyers approach each buyers to
ask how much does he plans to buy of the given product of a given point of time
under particular conditions.
B. Sales force opinion method:- The sales people are those who are in constant
touch with the main large buyers of a particular market and hence they constitute
another valid source of information about the likely sales of a product.
2. Statistical methods:-
For forecasting the demand for goods and services in the long run, statistical
and mathematical methods are used condition ring the past data.
A. Trend projection methods:-
These are generally based on analysis of past sales patterns. These methods
dispense with the need for costly market research because the necessary
information is often already available in company files in terms of different time
periods, that is a time series data.
B. Barometric Techniques:-
Under the barometric technique, one set of data is used to predict another set In
other words, to forecast demand for a particular product or service, use some other
relevant indicator which is known as barometer of future demand.
C. simultaneously equation method:- In this method, all variables are
simultaneously considered, with the conviction that every variable influences the
other variables in an environment. Hence the set of equations equal the number of
dependent variable which is also called endogenous variables.
D. Correlation and regression methods:-
Correlation and regression methods are statistical techniques. Correlation describes
the degree of association between tow variables such as sales and advertisement
experiment. When the two variables tend to change together. Then they are
correlated is measure by correlation co-efficient of these two variables one is a
dependent variables and the other is an independent. If the high value of one
variable are associated with the high values of another, they are said to be positively
correlation.

3. OTHER METHODS:-
A. Expert opinion method: well informed person are called expert. Experts
constitute yet another source an expert is good at forecasting and analyzing
the future trend in a given product or services at a given level of technology.
B. Test marketing:- It is likely that opinions give by buyers, sales man or other
experts may be, at times, misleading. This is the reason why most of the
 manufacturers favour to test their product or services in a limited market as
test- run before they launch their products nationwide.
Based on the result of test marketing valuable lessons can be learnt on how
consumer reacts to the given product and necessary changes can be introduced to
gain wider acceptability.
To forecast the sales of a new product or the likely sales of an established product in
a new channel of distribution or territory, it is customary to find test marketing in
practice.
C. Controlled experiment:- In this method the product is introduced with
different package, different prices in different markets or same markets to
asses which combination appeals to the customer most.
This method cannot provide better result, unless these markets are homogeneous in
terms of, tastes and preference of the customers their income so on.
D. Judgmental approach:- when none of the above the methods are directly
related to the given product or services, the management has no alternative
other than using its own judgment.

E. Delphi Method:

A variant of the survey method is Delphi method. It is a sophisticated method to

arrive at a consensus. Under this method, a panel is selected to give suggestions to
solve the problems in hand. Both internal and external experts can be the members
of the panel. Panel members one kept apart from each other and express their views
in an anonymous manner. There is also a coordinator who acts as an intermediary
among the panelists. He prepares the questionnaire and sends it to the panelist. At
the end of each round, he prepares a summary report. On the basis of the summary
report the panel members have to give suggestions. This method has been used in
the area of technological forecasting. It has proved more popular in forecasting. It
has provided more popular in forecasting non-economic rather than economic
variables.

QUESTIONS

1. What is managerial economics? Explain its focus are as

2. Point out the importance of managerial economics in decision making
3. What are the contributions and limitations of economic analysis in business
decision making
4. Managerial Economics is the discipline which deals with the applications of
economic theory to business management discuss.
 5. Explain the fundamental concepts of managerial economics
6. Discuss the nature & Scope of Managerial economics
7. Managerial Economics is the study of allocation of resources available to a
firm or other unit of management among the activities of that unit explains.
8. Explain the nature of problems studies in managerial economics. What is the
importance of the study of such problems in business management?
9. Explain the role and responsibilities of a managerial economics?
10. “Managerial Economics is an integration of economic theory and with business
practice for the purpose of facilitating decision making and forward planning”
explain.
11.
12. What is meant by elasticity of demand? How do you measure it? What are
determinates of elasticity of demand?
13. What is the utility of demand forecasting? What are the criteria for a good
forecasting method? Forecasting of demand for a new product? ‘ Economic
indicators’
14. What is promotional elasticity of demand? How does if differ from cross
elasticity of demand.
15. Explain in law of demand. What do you mean by shifts in demand curve?
16. What is cross elasticity of demand? Is it positive for substitute or
complements? Show in a diagram relating to the demand for coffee to the
price of tea?
17. Income elasticity of demand and distinguish its, various tapes. How does it
differ from pure elasticity of demand?
18. What is meant by demand? Everyone desires a Maruti 800 Car – Does this
mean that the demand for Maruti Car is large?
19. Calculate price elasticity of demand:
Q1= 4000 P1= 20
Q2= 5000 P2= 19
20. What is demand analysis? Explain the factor influencing the demand for a
product?
What are the various factors that influence the demand for a computer.

QUIZ

1. Managerial Economics as a subject gained popularity first in______. ( )

(a) India (b) Germany (c) U.S.A (d) England
2. When the subject Managerial Economics gained popularity? ( )
(a) 1950 (b) 1949 (c) 1951 (d) 1952

3. Which subject studies the behavior of the firm in theory and practice? ( )
(a) Micro Economics (b) Macro Economics
(c) Managerial Economics (d) Welfare Economics

4. Which subject bridges gap between Economic Theory and Management

Practice? ( )
(a) Welfare Economics (b) Micro Economics
(c) Managerial Economics (d) Macro Economics

5. Application of Economics for managerial decision-making is called____. ( )

(a) Macro Economics (b) Welfare Economics
(c) Managerial Economics (d) Micro Economics

6. Which areas covered by the subject “Managerial Economics”. ( )

(a) Operational issues (b) Environmental issues
(c) Operational & Environmental issues (d) None

7. The relationship between Managerial Economics and Economic Theory is

like that of Engineering Science to Physics (or) Medicine to ___________. ( )
(a) Mathematics (b) Economics
(c) Biology (d) Accountancy

8. Making decisions and processing information are the two Primary tasks of
the Managers . It was explained by the subject _____________________. ( )
(a) Physics (b) Engineering Science
(c) Managerial Economics (d) Chemistry

9. Managerial Economics is close to_________Economics ( )

(a) National (b) Business (c) Micro (d) Industrial

10. The theory of firm also called as_____________. ( )

(a) Welfare Economics (b) Industrial Economics
(c) Micro Economics (d) None
11. “Any activity aimed at earning or spending money is called ____activity”. ( )
(a) Service activity (b) Accounting activity
(c) Economic activity (d) None

12. Who explained the “Law of Demand”? ( )

(a) Joel Dean (b) Cobb-Douglas
(c) Marshall (d) C.I.Savage & T.R.Small

13. Demand Curve always ________ sloping. ( )

(a) Positive (b) Straight line (c) Negative (d) Vertical

14. Geffen goods, Veblan goods and speculations are exceptions to___. ( )
(a) Cost function (b) Production function
(c) Law of Demand (d) Finance function

15. Who explained the “Law of Demand”? ( )

(a) Cobb-Douglas (b) Adam smith
 (c) Marshall (d) Joel Dean

16. When PE =  (Price Elasticity of Demand is infinite), we call it ___. ( )

(a) Relatively Elastic (b) Perfectly Inelastic
(c) Perfectly Elastic (d) Unit Elastic

17. Income Elasticity of demand when less than ‘O’ (IE =  O), it is
termed as _______. ( )
(a) Income Elasticity less than unity (b) Zero income Elasticity
(c) Negative Income Elasticity (d) Unit Income Elasticity

18. The other name of inferior goods is _______. ( )

(a) Veblan goods (b) Necessaries
(c) Geffen goods (d) Diamonds

19. Estimation of future possible demand is called ______. ( )

(a) Sales Forecasting (b) Production Forecasting
(c) Income Forecasting (d) Demand Forecasting

20. How many methods are employed to forecast the demand ( )

(a) Three (b) Four
(c) Two (d) Five

21. What is the formula for Price Elasticity of Demand? ( )

(a) % of change in the Price (b) % of change in the Demand
% of change in the Demand % of change in the Income
(c) % of change in the Demand (d) % of change in the Demand of ‘X’
% of change in the Price % of change in the Price of ‘Y’

22. When a small change in price leads great change in the quantity demand,
We call it ________. ( )
(a) Inelastic Demand (b) Negative Demand
(c) Elastic Demand (d) None

23. When a great change in price leads small change in the quantity demand,
We call it ________. ( )
(a) Elastic Demand (b) Positive Demand
(c) Inelastic Demand (d) None

24. “Coffee and Tea are the ________ goods”. ( )

(a) Relative (b) Complementary
(c) Substitute (d) None

25. Consumers Survey method is one of the Survey Methods to forecast the__( )
(a) Sales (b) Income
(c) Demand (d) Production

26. What is the formula for Income Elasticity of Demand? ( )

(a) % of change in the Income (b) % of change in the Demand
% of change in the Demand % of change in the Price
(c) % of change in the Demand (d) % of change in the Demand of ‘X’
% of change in the Income % of change in the Price of ‘Y’
27. What is the formula for Cross Elasticity of Demand? ( )
(a) % of change in the Price of ‘X’ (b) % of change in the Demand
% of change in the Demand of ‘Y” % of change in the Price
(c) % of change in the Demand of ‘X’ (d) % of change in the Demand
% of change in the Price of ‘Y’ % of change in the Income

28. When PE = 0 (Price Elasticity of Demand is Zero), we call it ___. ( )

(a) Relatively Elastic demand (b) Perfectly Elastic demand
(c) Perfectly Inelastic demand (d) Unit Elastic demand

29. When PE =>1 (Price Elasticity of Demand is greater than one),

We call it ___. ( )
(a) Perfectly Elastic demand (b) Perfectly inelastic demand
(c) Relatively Elastic demand (d) relatively inelastic demand

30. When PE =<1 (Price Elasticity of Demand is less than one),

We call it ___. ( )
(a) Perfectly inelastic demand (b) Relatively Elastic demand
(c) Relatively inelastic demand (d) perfectly Elastic demand

31. When PE =1 (Price Elasticity of Demand is one), we call it ___. ( )

(a) Perfectly Elastic demand (b) Perfectly inelastic demand
(c) Unit elastic demand (d) Relatively Elastic demand

32. When Income Elasticity of demand is Zero (IE = 0), It is termed as ___. ( )
(a) Negative Income Elasticity (b) Unit Income Elasticity
(c) Zero Income Elasticity (d) Infinite Income Elasticity

Note: Answer is “C” for all the above questions.

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