Course Outlines

Week 1-2: the nature and scope of managerial economics, management problems, effective
management, theory of a firm, the objective of the firm, constrains faced by a firm, business vs
economic profit , theories of economic profit

Week 3-4: advanced demand analysis, the market demand function , total and marginal revenue,
sensitivity analysis, computation of price ,income and cross price elasticity of demand by two methods,
uses and application of price ,income and corss price elasticity of demand , some other demand
elasticity

Week 5: advanced demand analysis, price elasticity , marginal and total revenue, optimal pricing policy
under given price elasticity

Week 6: demand estimation by regression analysis, simple linear and multiple linear regression models,
significance of estimated coefficients and models , forecasting power of regression model use of R2

Week 7: rest / exams

Week 8: demand forecasting , quantitative methods for forecasting , best forecasts

Week 9,10 : economic optimization, mathematical tools for derivatives, unconstrained vs constrained
optimization, the substitution vs lagrange methods of optimization

Week 11,12: production analysis, production function, total , marginal and average products in case of
single and two variable inputs, marginal revenue product and optimal employement of inputs, return to
scale vs return to factor

Week 13: cost analysis explicit and implicit costs, incremental and sunk costs, short run vs long run costs,
economies of scale and economies of scope , learning curves , breakeven analysis, degree of operating
leverages

Week 14: pricing practices , markup pricing and profit maximization , mark up on costs and price,
optimal mark up on price and cost, price discrimination

Week 15 : Risk analysis, economic risk vs uncertainity , various types of risks, expected profit of a
project, absolute vs relative risk, beta as measure of risk,managerial application.

Economics:
Economics is the study of how individuals and societies choose to use the scarce resources that
nature and the previous generation have provided. The world’s resources are limited and scarce.
The resources which are not scarce are called free goods. Resources which are scarce are called
economic goods.

Managerial Economics
Managerial economics is a stream of management studies which emphasises solving business problems
and decision-making by applying the theories and principles of microeconomics and macroeconomics. It
is a specialised stream dealing with the organisation’s internal issues by using various economic
theories.

Managerial economics generally refers to the integration of economic theory with business
practice. Economics provides tools managerial economics applies these tools to the management
of business. In simple terms, managerial economics means the application of economic theory to
the problem of management. Managerial economics may be viewed as economics applied to
problem solving at the level of the firm.
It enables the business executive to assume and analyze things. Every firm tries to get
satisfactory profit even though economics emphasizes maximizing of profit. Hence, it becomes
necessary to redesign economic ideas to the practical world. This function is being done by
managerial economics.

OR

Managerial economics is the study of how scarce resources are directed most efficiently to achieve
managerial goals. It is a valuable tool for analyzing business situations to take better decisions.

OR

Managerial economics refers to the application of economic theory and analysis tools of decision
sciences to examine how an organization can achieve its aims or objective most effiecently .

Nature Of Managerial Economics:

1. Managerial economics is concerned with the analysis of finding optimal solutions to decision
making problems of businesses/ firms (micro economic in nature).

2. Managerial economics is a practical subject therefore it is pragmatic.

3. Managerial economics describes, what is the observed economic phenomenon (positive economics)
and prescribes what ought to be (normative economics).

4. Managerial economics is based on strong economic concepts. (Conceptual in nature)

5. Managerial economics analyses the problems of the firms in the perspective of the economy as a
whole (macro in nature)

6. It helps to find optimal solution to the business problems (problem solving)

Scope of Managerial Economics:

M
icro-Economics Applied to Operational Issues

To resolve the organisation’s internal issues arising in business operations, the various theories or
principles of microeconomics applied are as follows:
Theory of Demand: The demand theory emphasises on the consumer’s behaviour towards a product or
ervice. It takes into consideration the needs, wants, preferences and requirement of the consumers to
enhance the production process.

Theory of Production and Production Decisions: This theory is majorly concerned with the volume of
production, process, capital and labour required, cost involved, etc. It aims at maximising the output to
meet the customer’s demand.

Pricing Theory and Analysis of Market Structure: It focuses on the price determination of a product
keeping in mind the competitors, market conditions, cost of production, maximising sales volume, etc.

Profit Analysis and Management: The organisations work for a profit. Therefore they always aim at
profit maximisation. It depends upon the market demand, cost of input, competition level, etc.

Theory of Capital and Investment Decisions: Capital is the most critical factor of business. This theory
prevails the proper allocation of the organisation’s capital and making investments in profitable projects
or venture to improve organisational efficiency.

Macro-Economics Applied to Business Environment

Any organisation is much affected by the environment it operates in. The business environment can be
classified as follows:

Economic Environment: The economic conditions of a country, GDP, economic policies, etc. indirectly
impact the business and its operations.

Social Environment: The society in which the organisation functions also affects it like employment
conditions, trade unions, consumer cooperatives, etc.

Political Environment: The political structure of a country, whether authoritarian or democratic; political
stability; and attitude towards the private sector, influence organizational growth and development.

Managerial economics provides an essential tool for determining the business goals and targets, the
actual position of the organization, and what the management should do fill the gap between the two.
Scope of Managerial Economics ( College Lecture )
Management decision need to be made in any organization. It may be in a business form or a non
profitable organization say a hospital or college

For example:

• A firm may seeks to maximize profits subjects to limitation in availability of essential inputs and
some legal constrains

• A hospital may seek to treat as many as patients as possible subject to limited resources such as
physicians, nursing staff, tools e.t.c.

In both of the above cases the organization faces management decision problem, as it seeks to
achieve its goal or objective.

Relationship of Managerial Economics with Other Fields:

Relationship to Economic theory

Any organization can solve its management decision problem by the application of economic theory and
tools of decision sciences.

Economic theory refers to micro economics and macro economics

Microeconomics is the study of economic behaviour of individual consumers, resource owners and
business firms in a free enterprise system

On the other hand macroeconomics is the study of total or aggregate level of output, income,
employment, consumption, and prices for economy viewed as a whole.

Although theory of a firm (MICRO ECONOMICS) is single most important element, in managerial
economics however, the macroeconomic condition of economy (unemployment, inflation, interest rate )
with which the firm operate are also important.

Relationship to decision sciences

Managerial economics is also closely related to the decision sciences, these use the mathematical
economics and econometrics (figa) to construct and estimate decision models aimed at determining the
optimal behaviour of the firm (how the firm can achieve its goals, most efficiently).

Mathematical economics is used to formalize the economic model postulated by economic theory and
econometrics then apply statistical tools (particularly regression analysis) to real world data to estimate
the model postulated by economic theory.

For example:
Economic theory postulates that quantity demand of a commodity is function of its price, income, price
of related commodities (Pc & Ps) while holding other variables constant. the following mathematical
model are

Q x = f (Px, Ix , Px ,Pc)

Q x = a0 +a1 Px +A2ic+a3px+a4pc+E

By collecting data of all variables for a particular commodity say X. We can estimate the empirical
relationship between the variables. This will permit the form to determine how much Q x would change
in Px,Ic,Ps and Pc. And to forecast future demand for X. These information are essential for management in
order to achieve the objective of the firm most efficiently.

Relationship to the functional areas of business studies

Managerial economics is also closely related to the functional area of business administration studies. It
includes accounting, finance, marketing, HRM and production. These disciplines study the business
environment in which the form operates and as such they provide the background for managerial
decision making. Thus managerial economics can be regarded as an overview course that integrate
economic theory decision sciences and functional areas of business administration studies and it
examines how they interact with one another as the firm attempts to achieve its goals most efficiently.

Basic Process Of Decision Making

• Define the problem

• Determine the objective

• Identify all possible solutions

• Implement the decision

Theory of the firm

FIRM: a firm is an organization that combines and organizes the resources for the purpose of producing
goods or services for sale. A firm mat be proprietorship(firm owner by an individual), Partnership (form
owned by two or more) & corporations (owned by stockholdes). The firm maybe govt and non profit
organization such as college, hospital, museum e.t.c.

Existence of a firm: a firm exists because it would be very inefficient and costly for entrepreneur to
enter into and enforce contracts with workers and other resources for each separate steps of
production and distribution process. The firm exists in order to save many types of costs, save on sales
taxes & other govt regulations.
Functions Of A Firm:
The basic function of a firm is to purchase resources or inputs of labor services, capital and raw material
in order to transform them into goods and services for sale. the resource owners ( workers and owners
of capital, land and raw materials) then uses the income generated from the sale of their services
produced by the firm . thus the circular flow of economic activity is completed .

Objective and value of the firm

The theory of the firm is based on the assumption that goal or objective of the firm is to maximize short
and current profits, firms often are however observed to sacrifice the short term profit for increasing
long term profit. For Example expenditures on the research,marketing and quality of the product so
both the short and long term profit are important and according to theory of the firm the primary
objectives of firm is to maximize wealth value of the firm. This is given by the present value of all
expected future profits of the firm

Future profit must be discounted to the present because the dollar of profit in hand is better than dollar
of profit in future. wealth or value firm is given by

PV = π1/(1+r)1+ π2/(1+r)2 + ……….+πn/(1+r)n

Where π is the profit and π = Total Revenue –Total Cost

(CONSTRAINS ON THE OPERATION OF THE FIRM & LIMITATIONS OF THEORY OF THE FIRM)

Business versus economic profit

In business community business profit refers to the revenue of the firm minus explicit or accounting
costs of the firm

i.e. Business profit = total revenue – explicit cost

where explicit costs are the cut of pocket expenditures of the firm to purchase or hire the inputs it
requires in production these expenditures includes:

• Wages to hire labor

• Interest on borrowed capital

 • Rent on land and building and

• Expenditures on raw materials e.t.c

Economic Profit
On the other hand economic profit equals to total revenue minus explicit & implicit costs of the firm i.e

Economic profit = Total revenue – Explicit – Implicit

Where implicit costs refers to the value of inputs owned and used by the firm in its own production
process. Implicit costs includes

• Salary that an entrepreneur could earn from working for someone else in the similar capacity

• NOTE: explicit costs are the expenditures of the firm where as implicit costs include
entrepreneur services, lands etc

•
• Return that a firm could earn from investing its capital and

• Renting its lands and other input to other firms

Thus, economists include both implicit and explicit costs in the calculation of profit

Market Equilibrium:
Market equilibrium is a market state where the supply in the market is equal to the demand in the
market. The equilibrium price is the price of a good or service when the supply of it is equal to the
demand for it in the market. If a market is at equilibrium, the price will not change unless an external
factor changes the supply or demand, which results in a disruption of the equilibrium.

( Algebric Representation with numerical is present in notebook page # 45 )

Supply, Demand & Equilibrium

If a market is not at equilibrium, market forces tend to move it to equilibrium. Let's break this concept
down.

If the market price is above the equilibrium value, there is an excess supply in the market (a surplus),
which means there is more supply than demand. In this situation, sellers will tend to reduce the price of
their good or service to clear their inventories. They probably will also slow down their production or
stop ordering new inventory. The lower price entices more people to buy, which will reduce the supply
further. This process will result in demand increasing and supply decreasing until the market price
equals the equilibrium price.

If the market price is below the equilibrium value, then there is excess in demand (supply shortage). In
this case, buyers will bid up the price of the good or service in order to obtain the good or service in
short supply. As the price goes up, some buyers will quit trying because they don't want to, or can't, pay
the higher price. Additionally, sellers, more than happy to see the demand, will start to supply more of
it. Eventually, the upward pressure on price and supply will stabilize at market equilibrium

Algebrically:

Qd = f (p)

Qd= a-bp

Qs= F (p)

Qs= -c+dp

Qd = Q s

FIND THE PRICE AND QUANTITY

Qd=10,000-1000p
Qs= -2000+1000p

Solution:

As market equilibrium

Qd = Q s

So,

10,000-1000p = -2000+1000p

10,000+2000 = 1000p+1000p

P=6

Now to find quantity we will put price in any of equation

So

10,000-1000(6) = -2000 + 1000(6)

4000=4000

Price is 6 and quantity is 4000 at equilibrium

DEMAND THEORY:

An individual for a commodity :

The demand for a commodity arises from the consumer willingness and ability to purchase a
commodity. According to the consumer demand theory the quantity demand for a commodity depends
on its price consumer income price of related commodities and taste of the consumers it can be
expressed with the following functional form :

Qx = F (px,Ic,pr,T)

Where Qx = quantity demand of commodity

Px= price of commodity

I= income of the consumer

Pr = price of the related commodities

T= taste of consumer

Demand faced by the Firm:

The demand for a commodity faced by a firm depends on the market or industry. Demand for
commodity which in turn is the sum of the demands for commodity of the individual consumers in the
market. The demand for a commodity that a firm faces depends on the price of the commodity , size of
the market, consumer’s income, price of related commodities, tastes , the promotional efforts of the
firm ,competitor prices and promotional policies. In general the quantity response by a firm to a change
in the price of the commodity will be sum fraction of the total market response

The functional and linear form of demand function faced by the firm is given by;

Functional form:

Qx=f (Px, N, Ic, Pr, T....)

Linear form :

Qx= a0 +a1px ,a2N, a3Ic, a4Pr,a5 T

Where Qx is quantity demand

PX is price of commodity

N is size of the market

Ic is consumers income

P is price of substitutes

T is taste of the consumer

And an represents the coefficients to be estimated by the regression analysis which is the most used
technique for estimating demand.

Price Elasticity Of Demand:

The responsiveness in quantity demand of a commodity change in its price is known as price elasticity of
demand. It measures the percentage changes in the quantity demand of a commodity divided by the
percentage change in its price while holding constant all other variables in the demand function. We can
measure point or arc price elasticity of demand. The point price elasticity of demand can be measured
by the following formula;

∑p = %age changes in Qd / % changes in its price

(solved in notebook page 113)

∑p= a1 × p/q

Arc Price Elasticity Of Demand:

It measures the price elasticity between the two points on the demand curve ... for example we can find
the price elasticity between B and C with the following formula:

∑parc=

Cross Price Elasticity:

The responsiveness in the quantity demand for a commodity x to a change in price of commodity Y is
known as cross price elasticity of demand. This is given by the %age changes in the quantity demand of
commodity X divided by the percentage change in the price of commodity Y

∑xy =

∑xy =

(notebook page 122 for solving )

∑xy = an ×

using elasticities in managerial decision making

the analysis of the forces or variables that affect demand and reliable estimates of their quantitative
effect on sales are essential for the firm to make the best operating decisions and to plans for its growth

the first step in managerial decision making to identify all the important variables that effect the
demand for the product it sells

the second step in managerial decision making is that a firm should use technique of regression analysis
to obtain the reliable estimates of the effect of a change in each of the identified variables on the
demand of the product

the third step is that the firm will use this information to estimate the elasticity of demand for the
product. It sells with respect to each of the variables in the demand function which are essential for
optimal managerial decisions in the short term and in planning for growth in the long run
for example ; suppose that a tasty company market coffee brand X depends on the following variables.

Qx= f ( Px, I, Py, Ps, A)

The linear form of the function is

Qx = a0+a1px+a2i+a3py+a4ps+a5A

(example on page 125 )

Demand Estimation
Demand estimation in managerial economics refers to predicting how consumers will behave in a
relation to a firm product / services in future

The estimation is based on number of different variable that can include changes in price changes in
competitor price and economic factor such as recession etc. Which would effect consumer buyer
applying these variable a firm can analyse how their demands might changes for the better or for the
owrse depending on a specific factor

On the basis of these information management can begin to make strategic business decision , ranging
from reviewing price strategy to setting product inventory level to deciding whether to make fixed asset
investments and to introduce new product or enter into a new market

Approches to demand estimation

Market research approach ( qualitative method)

• Consumers survey and observational research

• Consumer clinics

• Market experiments

regression analysis( quantitative approch )

consumer survey involves questioning a sample of consumers about how they would response to a
particular changes in price of commodity , incentives and other determinents of the demand these
surveys can be conducted by simply stopping and questioning people at shopping centre or by
administering questionares to a carefully constrictive represteentative sample of consumer by the
trained interviewers /

on the other hand ( an observational research ) information are collected on the basis of
consumer preferences by watching their buying and using of the product .

Regression Analysis ( Quantitative Approch )

Is a statistical tool for estimating the quantitative relationship between a depending variable and one or
more independent or explainatory variable . the most common form of regression analysis is linear
regression in which the researcher finds the line that most closely fits thee data according to the specific
mathematical criteria.

The objective of the regression line is to obtain estimates of “a” ( vertical intercept ) and “b”
(regression coefficent ) in order to desire the regression line that best fit the data points the regression
analysis is primarily used for two basic purposes

• Regression analysis is widely used for prediction and forecasting where its use has substantial
overlap with the feet of machine learning.

• In some situation the regression analysis can be used to infer casual relationships between the
independent and dependent variables . to use regression for prediction or to infer causal
relationshipp respectively a researcher must carefully justify why existing relationships have
predicitive power for a new context or why a relationship between two variables has a causal
relationship

ordinary least square method

-is used for estimating the unknown parameters in a linear regression model in this technique a
researcher uses the parameters of a linear function of a set of explainatory varables by the principle of
least squares which states that minimizing the sum of squares of the differences between the observed
and estimated values of the dependent variable as the objective of regression analysis is to obtain
estimates of ‘’a’’ and ‘’b’’ of regression line

Regression line y on x

Y = a+bx

( mathmatical in notebook page # 135 )