106 MANAGERIAL ECONOMICS Dated 01/08/2023

Economic Theories

1. Macroeconomics – It deals with individual economic decision (may be a person or a

company)
2. Micro economics – It deals with economic decision of a nation as a whole.

Law, labor, capital and entreprunial capabilities (4 resources for an economy)

When taking decision within an economic firm, our focus would lie on the macroeconomic theories.
However, the Micro economic theories such as GST, Repo rates also plays an important role in
determining the development and expansion.

THEORY OF DEMAND

1. Exchange relation between the buyer and seller.

2. Commodities bought and sold at a particular price at a particular period of time.
3. It always has two sides: A. Demand side B. Supply side.

In economics the concept of demand is always that of effective demand.

Effective demand can be defined as the willing to purchase something when backed along with the
purchasing power.

Price X quantity demanded follows an inverse relationship.

Higer the price, lower the quantity demanded and vice versa, other things (factors) remaining
constant during the stipulated period of time.

‘Other things’ may be defined as the interest of a consumer, Tastes and preferences, Wealth of a
consumer, Prices of related Goods, Prices of complimentary goods, direct taxes.

Price can however be considered the basic influencing factor.

Direct taxes cannot be avoided by the consumer while indirect taxes such as sales tax, GST are
usually avoided by the manipulation of prices of the commodity mainly in cases of essential goods.
The person in some cases may avoid paying taxes or can transfer it down the line.

1. Change in quantity demanded- Due to the change in prices of a commodity.

2. Increase or decrease in demand- Due to the change in other factors.

Price is the basic influencing factor that can be explained by the help of demand function.

Qdx= a- (b* Px), where a and b are constant while X is an independent variable.

Qdx=a+b/Px

Qdx= f(Px,Py,Pz) J,T,W,DI, etc. (J,T,W,DI are fixed and denoted by A _ above their head while Px,Py….
Are the independent variables.)

When solving an equation all the other variables are kept constant except the price of the quantity
itself. Qdx= f(Px) …………………Simplified

Let’s consider an example .

Qdx= 10 . 2Px solving the equation we get When Px is 1 Dx is 8, when Px is 2 Dx is 6 and when Px is 3
dx is 4.

Price can be Zero. But demand cannot be negative as P&Q must always have meaningful values.

0<P<5 (range of possible values)

Quantity can be ‘0’ but not negative and taking ‘0’ for P yields the value of 5.

Goods that follow the law of demand are called normal goods.

Exception to the law of demand include snobbish goods, luxury items,

giffin goods and judging quality based on price.

When future price forecasting exists the law of demand does not
follow.

Giffen goods – This term was coined by Robert Giffen, who noticed that
the poor slum dwellers had two primary items as their foods. Bread
(inferior item) and meat (superior item). According to Giffen, people
would not follow the law of demand when the price of the inferior
good fell instead of buying more of the inferior goods they would buy
extra superior goods. Inversely when bread prices saw a surge the
people would instead buy greater quantities of bread while reducing
the consumption of meat.

Real income- it is the money divided by the unit price of the commodity. The relationship between
price and real commodity is inverse.

106. MANGERIAL ECONOMICS. Date: 02/08/2023

Individual demand graph for a normal commodity.

Market demand graph for normal goods may be obtained from the individual demand curve by the
process of horizontal summation.
Change in quantity demanded indicates fluctuation in demand due to price change while the change
in demand indicates fluctuation in demand due to a change in factors other than the price of the
commodity itself. This change in quantity demanded is shown by the shift in demand curves upward
or downwards.

Degree of responsiveness to a change in the price of

luxury goods is high as compared to the change in
case of essential goods.

Price elasticity of demand is determined by a small

“p”.

Elasticity of demand

Elasticity measures the degree of response given by

Quantity demanded to that of the change in price.

Percentage change in Quantity/ Percentage change in Price= Elasticity (e)

e>1- non essential goods

e<1- essential goods

e=1- comfort goods

e=infinity – highly non-essential and committed to being a comfort and luxury product

e=0- very essential

The ‘+’ and the ‘-“ sign signifies whether the commodity follows the law of demand or not. The
absolute value of the commodity will give the interpretation whether the commodity is an essential
good, non- essential product or a comfort product. The cases where e either has an infinite value or
a value of ‘0’ is highly theoretical in nature and as such real-life examples cannot be found.

(-) represents the normal goods.

(+) – represents the exceptional goods

In real life the elasticity value cannot be lesser than zero. (0)

 e>1- Elastic demand.

  e<1- inelastic demand.
 E=1- unitary elastic demand.
 E=infinity- Perfectly elastic demand.
 E=0- Perfectly inelastic demand.

When we try to change demand with respect to the income it is called elasticity of demand.

It is represented by= Percentage change in demand/ percentage change in Income.

Percentage change in dependent variable is taken as the numerator. The percent change in
independent variable is taken as the denominator.

Price Demand

$10 200 units

$15 100 units

Therefore, absolute change in price=

ΔP= P2-P1= 15-10 = 5

Absolute change in quantity demanded

∆ Q= Q2-Q1= 100-200= -100

∆P 5
Percentage change in P = = X 100=50 %
P 100

∆Q −100
Percentage change in Q= ∗100= ∗100=−50 %
Q 200

Elasticity of demand= 50%/50%= 1

Thus, the good has a unitary elastic demand.

“CROSS ELASTICITY” it refers to the change in the demand of an item owing to the change in the
price of its substitute goods. It is denoted by edc..

X
Edc= percentage change∈quantity demanded ofcommodity commodity price change .
Y

It is especially relevant in the case of complimentary and supplementary goods. When the cross
elasticity is negative(-) the commodity is complementary and when the cross elasticity of the
commodity is positive(+) the commodity is supplementary.
 The cross-elasticity equation can
be simplified and written as

∆Q
∗100 ¿ P
Q 100
e= ∗¿
P
ΔQ
∗∆ P
= Q
P
∆Q
∗∆ P
= P
Q

106 MANAGERIAL ECONOMICS. date- 08/08/2023

Theory of supply:

The law of supply may be stated as higher the price of a commodity will be the greater will be its
supply and vice versa., other factors remaining constant during the specified period of time. The
relation between the piece and quantity supplied is positive.

“Other factors” include the factors of production, technique of production, weather, and indirect
taxes.

Change in quantity supplied takes place when the price changes.

Change in supply occurs when the other factors affecting supply changes.

Formulae of supply function,

Qs+ F( px, f1,f2,f3,……T , IT, W ) where except PX all other factors remain constant.

The Qs is a dependent variable while the other variables such as Px , F1,F2 etc. are independent
variable.

SUPPLY CURVE.

Corresponding to different values of P, values of Qs may be calculated by the following function

mentioned above . usually, most products follow the normal pattern of the supply curve with the
labor supply curve being an exception. Initially the labor supply curve appears to follow the normal
shape of the supply curve. But after a certain point of time, the supply curve follows an inverse
relationship and decreases the hours of labor . for if the wage rates are insanely high, the lesser
number of hours are clocked by the workers.
 The leftward shift of the supply curve shows an increase in supply
while a rightward shift of the supply curve shows a decrease in
supply.

THEORY OF EQUILIBRIUM.

Initially before proofing the meeting point of the demand and supply
curve is to be called the intersection point. It has to be proved as the
equilibrium price.

A change in equilibrium price would occur when the demand changes or supply changes or both
factors change simultaneously.

change in supply without the change in

demand causes the supply graph to shift to
the right.

The relative strength of the shift of the

demand and supply line depends on the
extent of the shift. In a special case where
the demand and supply both change in an
equal ratio results in an increase of the
equilibrium price as well as the equilibrium
quantity.

107 MANAGEMENT ECONOMICS date- 09/09/2023

Theory of production:

It is the process in which raw material is converted in useable end products. Man, capital, labor and
entrepreneurship is required. Production is the satisfaction giving capacity. Creation of satisfaction
giving products is called production.

CONCEPT OF PRODUCTION FUNCTION.

Relation between the commodity input and the commodity output. The relationship between inputs
and the outputs. The independent variables in this case are the inputs. The dependent variable in
this case is the output. Depending on the inputs the outputs are determined.

Qx= F(A,B,…..,N)

Qx= F(L,K) ( function of labor and capital)

The production function helps us get an estimated value of output considering the input.
Situation when the time bracket is short, only a few factors can get adjusted so as to cater to the
higher demands. Essentially it means that certain factors only can be varied during the period of
production while keeping the other factors constant.

Total product (TP)- , Average Product(AP), Marginal Product (MP).Let us assume the capital and the
machinery is fixed and only the labor is variable.

a. Total Product (TP)- total output of a commodity produced by all units of variable factors.
b. Average Product(AP)- Total Product\Quantity of variable factors.
c. Marginal Product(MP)- quantity of product made by the last variable factor. Change in total
product for one unit change in respect to the change in variable factor.

Formulae of MP= MPn+1 = TPn+1 – TPn.. When the variable factor gets gradually increased at first with
the total capital fixed, the output, increases exponentially at first, followed by a slower pace finally
reaching the stage of maturity where there is a unitary relationship and finally followed by a decline.

THEORY OF COST

Short run cost curve.

Short run is a situation when the producer cannot change all factors of production. There will be
fixed and variable factors in the short run curve so the total cost (TC) will be the sum of Total
Variable Cost (TVC) and the Total Fixed Cost (TFC) in the short term. TVC varies with the level of
production but TFC remains constant throughout the short run.

TC TFC TVC
TC= TVC+TFC. = + Average Cost =AVC= AFC .
Q Q Q
We may define Average Cost (AC) and Average Variable Cost (AVC) and Average Fixed Cost as
follows:

TC TVC TFC
AC= = + ∨ AC= AVC+ AFC
Quantity Quantity Quantity
MC is the change in TC per unit of output. If to produce 2 units of a commodity costs rupees 20 and
the third unit of the production costs rupees 27 in total then the MP for the third unit is rupees 7.

We may also define Marginal Cost (MC) as the change in the Total Cost for one unit of change in
production. MCn+1 = TCn+1 – TC n where (n) is any positive number. MCn+1 is defined as the marginal
cost of the n+1 units of production.

NUMERICAL consider TOTAL FIXED COST = 50 Rupees.

Number of TVC in Total Cost Average Average Marginal Average

units of rupees in rupees Cost (TC/Q) Variable Cost Fixed cost.
output (Q) Cost (AFC)
(TVC/Q) (TFC/Q)
01 10 60 60 10 - 50
02 19 69 34.5 9.5 9 25
03 26 76 25.3 8.66 7 16.66
04 34 84 21 8.50 8 12.5
05 42.5 92.5 18.5 8.50 8.5 10
06 64 114 19 10.6 21.5 8.33
 the TC and the TVC curve will be parallel if the perpendicular
distance between the curves remains constant.

The rate of change of TC is MC.

As the TC slopes become higher , the MC starts rising.

The area of the Quadrilaterals of the AFC will be constant. The value of AFC will never be zero and it
never touches the axis of output/ quantity.

LONGRUN RUN TOTAL COST CURVES.

The TVC of the short run curve becomes the TC in the long run curve.

Long run is a situation where quantities of all the factors may be changed to adjust the output. There
will be no fixed factors during the long run and all factors will be variable. Rate of change of TC is
MC.

relationship between AC and MC :

1. So long as MC remains below AC, MC<AC , AC continues

to fall.
2. MC if equal to AC, MC=AC, Ac remains constant.
3. When MC becomes greater than AC, AC will rise ,
MC>AC.