managerial economics

1. Managerial Economics
According to Spencer: “Managerial economics is the integration of
economic theory with business practice for purpose of facilitating
decision making and forward planning by management”. It means
management of limited funds available in most economical way. It deals
with basic problems of the economy i.e. what, how & for whom to
produce.
Scope of Managerial Economics
1.Demand Analysis & Forecasting: A major part of managerial decision
making depends on accurate estimates of demand. By forecasting future
sales manager prepares production schedules and employ resources
which helps mgt. to strengthen its market position & profit.
2. Cost & production Analysis: A manager prepare cost estimates of a
range of output, and choose the optimum level of output at which cost is
minimized. Manager is supposed to carry out the production function
analysis to avoid wastage of materials & time.

2. 3. Pricing Decisions: Success of a business firm depends upon
correct pricing policy decisions taken by it. Different pricing
method is used for various market structure, Cz price to a great
extent determines the revenue of the firm.
4. Profit Management: Aim of business firms is to earn profits in
long run. Profits are reward for uncertainty & risk bearing. A
manager should be able to take calculated risk & try to avoid
uncertainty for higher profits.
5. Capital Management: M.eco helps in planning & controlling of
capital expenditure since it involves huge amount of money & time.

3. 1. ALLOCATION OF RESOURCES: SINCE RESOURCES ARE SCARCE AND THEY HAVE
MULTIPLE USES, ME FOCUSES ON OPTIMUM ALLOCATION OF FUNDS AVAILABLE,
WHICH ALSO REDUCES THE WASTAGE LEVEL.
2. MICRO ECONOMIC NATURE: M.ECO IS MICRO ECONOMIC IN CHARACTER. IT
DEALS WITH BUSINESS FIRMS. A FIRM IS THE SMALLEST DECISION MAKING UNIT
OF PRODUCTION. SINCE THE STUDY IS ABOUT FIRM,THE PROBLEMS FACED BY
THE FIRMS ALSO FALLS UNDER THE PURVIEW OF MICRO ECONOMICS.
3. MARKET KNOWLEDGE: A FIRM IS OPEN TO THREATS AS WELL AS
OPPORTUNITIES IN MARKET PLACE. SO KNOWLEDGE OF MARKET MUST BE
PERFECT.
4. MACRO-SETTING: A FIRM HAS TO OPERATE WITHIN A GIVEN ECONOMY. SO ITS
ALSO GOVERNED & AFFECTED BY THE TRENDS IN INCOME, CONSUMPTION,
INVESTMENT, SAVINGS LEVELS IN AN ECONOMY.
Nature of Managerial Economics

4. 5. Positive & Normative Approach: Positive approach concerns with
what is, was or will be, while normative approach concerns with
what ought to be. Positive eco is of 2 types: Economics description
shows state of operation of the firm at a point of time whereas
economic theory explains why it happened.
Relationship with other Disciplines.
1. Statistics & Economics: Statistical techniques are very useful for
collecting, processing & analyzing business data, testing & validity
of economic laws before they can be applied to business. Statistical
techniques like regression analysis, forecasting is used in economics.

5. 2. Operation Research & Economics: OR is an activity carried out by
specialist within the firm to help the manager to do his job of
solving decision problems.OR is also concerned with model building
but economic models are more general & confined to broad decision
making. OR models like linear programming, queuing are widely
used in managerial economics.
3. Accounting & Economics: Accounting data & statements reflect
financial position, net loss or net profit earned by a company. For
decision-making a manager should be familiar with generation,
interpretation & use of A/c data.
4. Mathematics & Economics: Managers have to deal with
quantitative concepts like demand, cost, prices & wages. So
knowledge of mathematical concepts is imp to take decisions.

6. 5. Computers & Economics: Today each person is dependent on
computers. Managers depends on comp for decision making. Through
comp data is presented in organized manner which facilitates decision
making.
Role of Managerial Economist in Business
1. Specific Decisions: There are several specific decisions that managers
might have to take like: Production scheduling, demand forecasting,
market research, security management analysis, economic analysis of the
industry, advice on trade, Pricing decisions.
2. General Tasks: It includes understanding external factors & suggesting
the firm which policy is to be used. External factors include- economic
condition of the economy, demand for the product, market conditions of
raw materials, input cost of the firm affected by outside forces.

7. FUNDAMENTAL CONCEPTS OF ECONOMICS
1. Opportunity Cost: The benefit of the next best alternative which
had been sacrificed due to the choice of the best alternative is
known as opportunity cost of the best alternative. It tells us the
gain from the proposed use of input.
Eg- Opportunity cost of funds employed in one’s own business
is the amt of interest which cud have been earned had these
funds been invested in the next best channel of investment.
2. Incremental Reasoning: It’s the most important concept in
economics. Incremental principle is applied to business decisions
which involves a large increase in total cost & total revenue.
Incremental cost is defined as”change in total cost as a result of
change in the level of output. Incremental revenue is change in total
revenue resulting from change in the level of output. It tells us gain
arising from the change in activity.

8. 3. The Discounting Principle: Discounting factor determines the present
value of future inflow of cash. Its based on the fundamental fact that a
rupee now is worth more than a rupee earned a year after. PV= FV*PVFn,i
4. Time Perspective: Aim of the firm is to make profit in the long run. There
is a difference between long & short run. In short run all of the
inputs(called fixed inputs) cannot be altered, while in the long run all the
inputs can be changed(i.e. there are no fixed inputs). A decision should
take into account both the short run & long run effects on revenues & costs
to maintain a right balance b/w short & long run perspectives.
5. Risk & Uncertainty: In real world, uncertainty influences the estimation
of costs & revenues & hence the decision of the firm. Since future
conditions are not perfectly predictable, there is always a sense of risk &
uncertainty about outcome of decisions. When a firm is operating in a
market along with other firms there is generally an element of uncertainty
regarding the actions & reactions of the competitors. Other uncertain
factors can be shifts in consumers choices, changes in govt policies,
national international political scenario.

9. Concepts of Economics
1. Utility: Utility refers to the amount of satisfaction which a consumer
gets by consuming the various units of commodity.
2. Marginal Utility: Addition made to the total utility by consuming 1
more unit of a commodity. MU= change in total utility/ change in
quantity of good X.
3. Law of Diminishing Marginal Utility: “For any individual consumer
the value that he attaches to successive units of a particular commodity
will diminish slowly as his total consumption of that commodity
increases, the consumption of all other goods being constant”.
Assumptions of the Law:
1. Various units of goods are homogeneous.
2.There is no time gap b/w consumption of different units.
3.Tastes, preferences & fashion remain unchanged.

10. 4. Consumer’s Equilibrium: The quantity of good X where marginal
utility of X equals price of good X.
Mux=Px.
5. Income Effect: Change in consumption of the good due to the
change in income of the consumer.
6. Price Effect: Change in the consumption of the good due to
change in the price of the good.
7. Micro Economics: Studies the behavior of individual decision
making units like consumers, firms( regulates under Company’s
Act). It includes i) Product Pricing which includes Theory of
Demand & Supply, ii) Factor Pricing which includes wages, rent,
interest & profit.

11. 8. Macro Economics: Studies the aggregate of all economic units.
It includes theory of growth & employment, theory of Inflation &
Price Level, theory of Income & theory of Distribution.
Eg- Automobile industry includes firms like Maruti Suzuki India
Ltd, Hindustan Motors, Hyundia Motors India Ltd, Tata Motors
etc.

12. DEMAND ANALYSIS
Demand for a commodity refers to the quantity of the commodity
which an individual consumer is willing to buy at a particular price
& time. Demand for a commodity implies-
a) Desire of a consumer to buy the product.
b) His willingness to buy the product.
c) Purchasing power to buy the product.
Individual Demand: Goods demanded by an individual.
Household Demand: Goods demanded by a household.
Market Demand: Demand for a commodity by all individuals in the
market taken together.
Determinants/ Factors Affecting Demand
1. Price of the commodity: Consumers buy more of a commodity
when its prices fall. A fall in the price of a normal good leads to rise
in consumer’s purchasing power.

13. 2. Income of the Consumer: With an increase in income, a consumer
buys increased amount of the commodities.. Both quantity demanded
of a good & income move in the same direction.
3. Price of Related Goods: When change in price of one commodity
influences the demand of the other commodity, it implies that two
commodities are related. Related commodities are of two types;
Substitutes & Complements. When price of one commodity &
demand of other commodity move in same direction, goods are called
substitutes, e.g. tea & coffee, apple & pears. On the other hand when
price of one commodity & demand of other commodity move in opp.
Direction, goods are called complementary goods, e.g. bread & butter,
pen & ink, petrol & automobiles etc.
4. Tastes & Preferences: Taste & preference of a consumer in favor of
a commodity results in greater demand of a commodity, while if this
change is against the commodity it results in smaller demand

14. DEMAND FUNCTION
A mathematical expression of the relationship b/w quantity demanded
of the commodity & its determinants is known as the demand function.
When this relationship relates to the market , it is called market demand
function.
THE LAW OF DEMAND
Law of demand states that higher the price lower the quantity
demanded & vice versa, other things remaining constant.
Exceptions to the Law of Demand
1) Giffen Goods: Giffen goods are also known as inferior goods and is
consumed by the poor sections of the society. It’s a case where decrease
in price of a good results in decrease in its quantity demanded & vice
versa. E.g. bajra, barley, gram.
2) Commodities which are used as status symbols: Some expensive
commodities like diamond, gold, acs, cars are used as status symbols to
display one’s wealth. The more expensive these commodities become ,
more will be their value as a status symbol and hence greater will be the
demand.

15. 3) Expectations of change in the price of the commodity: If a
consumer expects the price of a commodity to increase, it may start
purchasing greater amount of the commodity even at current
increased price.
Why do Demand Curve Slope Downwards?
1. The law of diminishing marginal utility is at the root of the law of
demand. In order to get maximum satisfaction, a consumer buys a
commodity in such a way that marginal utility of the commodity is
equal to its price.
2. A commodity tends to be put to more use when it becomes
cheaper. Thus existing buyers purchase more & some new
consumers enter the market. Eg. Use of electricity.
3. A fall in price of a superior good will lead to a rise in the
consumer’s real income. The consumer therefore buy more of it. On
the contrary rise in price of superior good will result in a decline in
consumers' real income. Hence they will buy less of it.

16. Extension & Contraction of Demand: A movement downward on the
demand curve is extension of demand & a movement upward on the
demand curve is contraction of demand.
Shift of the demand curve: Shift in demand is brought about by
change in factors other than the own price.
ELASTICITY OF DEMAND
Definition: Ed is defined as “the percentage change in quantity
demanded caused by one percent change in the demand determinant,
other determinants held constant.”
Ed= % change in quantity demanded of good X/% change in
determinant Z.
KINDS OF ELASTICITY MEASUREMENT
1) Point Elasticity: It relates to the elasticity at a particular point on
the demand curve.
E=diff. in quantity/diff. in price*quantity/price

17. 2) Arc Elasticity: It is the average elasticity over a segment of the demand
curve. Co-ordinates of mid-point be, P1+P2/2, Q1+Q2/2…
Formula: diff.in Q/diff. in P*P1+P2/Q1+Q2.
Types Of Elasticity
A) Price Elasticity: Proportionate change in quantity demanded of good X/
Proportionate change in price of good X.
Types of Price Elasticity
1. Perfectly Elastic Demand: Where no reduction in price is needed to cause
an increase in quantity demanded.
2. Absolutely Inelastic Demand: Where a change in price causes no change
in quantity demanded.
3. Unit Elasticity of Demand: When proportionate change in price causes
an equal change in quantity demanded.
B) Income Elasticity of Demand
C)Cross Elasticity of Demand
D)Advertising Elasticity of Demand

18. Significance Of Elasticity Of Demand
1. Level of output & price
2.Fixation of rewards for factor of production
3.Demand Forecasting
4.Government Policies.
SUPPLY: Supply of a commodity refers to the various quantities of the
commodity which a seller is willing & able to sell at different prices in a
given market, at a point of time, other things remaining the same.
Determinants Of Supply
1. Price of the good: When producers get a higher price for their product,
the supply of the product increases.
2. Prices of other goods: Change in prices of other goods in the market also
has influence on the supply of a commodity.
3. Prices of factors of production: An increase in the price of a factor, say
labor, may lead to a larger increase in the costs of making those
commodities that use more labor.
4. State of technology: A change in technology may result in lower costs &
greater supply of the good.

19. LAW OF SUPPLY
The law of supply states that, other things remaining constant, more of a
commodity is supplied at a higher price & less of it is supplied at a lower
price.
Shifts in Supply: Shift in supply means increase or decrease in quantity
supplied at the same price
Extension & Contraction of Supply: When more units of the goods are
supplied at a higher price, it is called the extension of supply. When less
units of the good are supplied at a lower price, it is called contraction of
supply.
ELASTICITY OF SUPPLY
Elasticity of supply of a commodity is defined as responsiveness of quantity
supplied to a unit change in price of that commodity. When the quantity
supplied changes more than proportionately to the change in price, the
supply tends to be elastic. On the other hand, if the change in price leads to
less than proportionate change in quantity supplied, supply tends to be
inelastic.

20. THEORY OF PRODUCTION
Production is an activity that transforms inputs into output, eg. Sugar
mill uses inputs like labor, raw materials like sugarcane, capital
invested in machinery, factory building to produce sugar.
Factors Affecting Production
1. Technology: A firm’s production behavior is determined by the
state of technology. Modern or high level of technology increases
production of the firm irrespective of the size of the firm or kind
of management.
2. Inputs: There are wide variety of inputs used by the firm like raw
materials, labour services, machine tools, buildings etc. Inputs are
divided into 2 main groups- fixed & variable inputs. A fixed input is
the one whose quantity cannot be varied during the period, like plant
& equipment. An input whose quantity can be changed during the
period is known as variable input like raw materials, labor, power
etc.

21. 3. Time period of Production: The fixity or variability of an input depends on
the time period. Time periods are short & long run. In short run period some
of firm’s inputs are fixed. Whereas in long term all the inputs are variable i.e
all inputs can be changed.
Factors of Production
1. Land: It is the most basic factor that is needed for any production activity.
It includes all natural resources below or above the land surface. It includes
all those resources which are free gift of nature. Like hills, rivers, water etc.
2. Labor: It includes any work done by body or mind for remuneration.
Work done for pleasure like singing, dancing, playing etc is not labor, if it is
not done for remuneration. Labor is divided into 3 categories: unskilled,
semi-skilled & highly skilled.
3. Capital: Capital does not mean money only. It means resources which are
man made. It includes those factors which have been produced by human
efforts for further use in production activity is capital. Like plant, building,
machinery, road, bridges, rail lines etc.

22. 4. Entrepreneurship: All the above factors are passive. They will not work
unless there is somebody who can make them work. Producer takes
decision regarding various activities like what products to produce,
arranging factors of production, fixing payments to labor services, bearing
risk & uncertainty etc.
Laws Of Production
1. Law of Variable Proportions: It is also known as “Law of Diminishing
Returns” or Returns to a Factor. This law becomes applicable when we
increase one factor of production(variable factor), while keeping other
factors constant, the output will increase. But after some time addition to
variable factors will reduce the total output at a diminishing rate.
Assumptions of the Law
1. Only one factor is increased while others are kept constant.
2. Various units of variable factor are homogeneous.
3. Conditions of production like production methods, climatic conditions
are constant. (Graph).

23. Production Function with 2 Variable Inputs.
Isoquant: It is a curve representing the various combinations of two inputs
that produce the same amount of output. An isoquant is also known as iso-
product curve or equal-product curve
Properties Of Isoquants
1. An isoquant is downward-sloping to the right: It means that if more of
one factor is used, less of other factor is needed to produce the same
level of output.
2. Higher Isoquant represents larger output: It means that with the same
amount of one input & greater amount of second input, will result in
greater output.
3. No 2 isoquants touch or intersect each other.
4. Isoquants are convex to the origin.
(Graphic Representation)-Outlay line or price line & Producers
Equilibrium.
Total outlay of Producers- Rs.1000.
Price of 1 unit of Labor-Rs.50 (20 units)
Price of 1 unit of Capital-Rs.100(10 units).

24. This means that producer can take OM units of labor & ON units of capital
to produce 200 units, which is the optimum combination for him.
Production Possibility Curve
Many a times firms do not produce a single product but more than one
product. They utilize their productive resources to produce a given
combination of products. The question is how to choose the best
combination of products that can be produced with the given resources?
Suppose there are 2 products X & Y. If we want to increase the
output of X, it can be produced by producing lower quantity of Y. hence the
curve which shows, different quantities of 2 products that can be produced
with the given level of resources, it will be a negative sloped curve. This
curve is known as ‘Production Possibility Curve’.(Graphic Representation)
If firm produces only X then it can produce OB units & if it
chooses to produce only Y then OA units it can produce. As we move from
A to B, we produce more of X & less of Y. In other words Y transforms into
X. This is known as Production Possibility Curve(PPC) also known as
Transformation Curve.

25. UNIT - 2

26. BUSINESS CYCLES
Business cycle or trade cycle refers to the fluctuations in economic activity.
In a business cycle there are wave like fluctuations in 4 inter-linked
economic variables: aggregate employment, income, output & price level.
When the values of these economic variables over time are plotted on a
graph, we get a wave-like figure, which is given the name of a cycle.
According to Keynes, “ a trade cycle is composed of periods of good trade
characterized by rising prices & low unemployment %, alternating with
periods of bad trade characterized by falling prices & high unemployment
%.”
These fluctuations are cyclical in nature. The secular
trend represents long run changes in business activity which occur slowly
& are spread over a number of years. Such long run changes are the result
of factors like improvement in production techniques, changes in
population etc. Random fluctuations are a result of events like labor strike,
power cut, war, drought, flood etc which suddenly & are unpredictable.
Seasonal variations repeat themselves each year( demand for heavy woollen
cloths, cotton cloths & so on depending on season each year). Cyclical
fluctuations have a longer life span. The sequence of changes in business
cycle( recovery, prosperity, depression & recession) recur frequently & in a
similar pattern.

27. Phases Of Business Cycle
A) Recovery(revival of economic activity): 1. Economic activity as a
whole increases slowly, although the general prices start rising. 2.
The upward movement of business activity is slow, production picks
up, construction activity is revived & there is a gradual rise in
employment. 3. Industrialists & the businessmen repay the loans
taken by them from the banks. 4. Investment process is increased, the
result is demand orders increase & the producers get encouragement
to produce more. 5. There is expansion in business activity. 6. Banks
are liberal in matter of advances. 7. The prices recover & tend to
reach the normal.
The revival of goods & services may mainly due to 2
reasons:
i) Change in business psychology in favor of optimism.
Ii) Fresh public investments in development projects which create
additional demand for goods & services.

28. B) Prosperity: 1. During this phase there is rapid movement of prices,
employment, income & production. 2. Total output starts growing at
a rapid pace due to higher investment & employment. 3. Prices of
finished products rise faster than the increase in wage-rate, raw
material prices & interest rate. 4. The sequence of general price rise
generally begins with increase in security prices, which then passes
on to raw material prices, wholesale prices, wages of unskilled labor,
retail prices & finally the interest rates. 5. Sales increase so dealers
increase the stocks to satisfy new customers, keeping existing
customers satisfied. 6. Producers tend to produce more than the
amount they can sell at present & wholesalers buy more than what is
demanded by retailers.
The peak of prosperity may lead to over-
optimism in business psychology resulting in over-full employment
of resources & raw material, leading to inflationary rise in prices. If
it happens it signifies the end of prosperity phase & the advent of
recession in the very near future.

29. C) Recession: When the business cycle takes a downward turn from
the state of prosperity, the state of recession is said to have set in.
There is a collapse of confidence. If not controlled in the beginning
by timely monetary & fiscal measures by government, recession may
give way to even more grave situation, called Depression. 1.
Production increases with every increase in commodity prices. 2. As
more & more of unemployed labor, capital, raw material are
employed interest rate, wages & other costs rise. 3. Sellers upload the
stocks in the market. 4. Due to uploading of stocks by many firms, the
prices start declining. 5. Profit margins decline further because cost
start overtaking prices. Business psychology becomes depressed & the
boom bursts. 6. Some firms close down while others reduce
reduction, leading to reduction in investment, employment, income &
demand. 7. Soon the production falls, banks call back the loans,
unemployment increases, interest rate increases & investment falls.

30. D) Depression: 1. General demand for goods & services falls faster than the
production of goods. 2. Producers suffer losses because by the time the
goods are ready for sale the prices are found to have fallen further, so
producers are not able to recover their full costs. 3. The phenomenon of
over production appears & workers in large numbers are thrown out of
work. 4. There are accumulated reserves with banks, demand for credit is
at its lowest, resulting in idle funds with the banks.
Depression is thus characterized by low prices, idle
funds with banks, mass unemployment & slack trade.
Factors Causing Swings In Business Activity
1. Banking operations plays a vital role. By expanding & contracting credit
creation, changing discount rates & the ratio between deposits & cash
reserves, the bank can change the volume of money supply in the economy.
Thus contribute to cyclical fluctuations.
2. Changes in the proportion between capital goods & consumer goods
production in the economy can also lead to shortages & surpluses in
commodity supply in the short run. This results in business cycle.
3. If purchasing power does not correspond to the expansion or contraction
of production, the market suffers from cyclical fluctuations.

31. 4. The profit mania of the producer is also a contributory cause of the
business cycles. This makes the producer too optimistic. This behavior tends
to intensify the process of rise or fall in prices.
5. The cyclical changes in weather also contribute to the emergence of
trade cycle. Agriculture production & prices of basic goods is affected. This
in turn affects the wage rate, cost of raw material leading to fluctuations in
the economic activity.
Measures To Control Business Cycles
1. Balance between demand & supply is possible if appropriate information
is available at the right time.
2. Taking care that inventories do not increase or decrease excessively,
financial commitments do not exceed financial resources & plant &
equipment increase at a steady rate.
3. The overhead cost per unit of output(indirect cost eg advertising, rent,
repairs, research & development) should not be allowed to go up.
4. Soundness in judgment in placing the order must be ascertained before
accepting the offer.

32. 5. Controlling costs & their reduction can help in overcoming the
problem of recession.
6. Firms can also change their sale methods & strategies so as to
adjust to new situations.
7. In the time of depression firms can utilize a part of its retained
profits.