UNIT 1
The fundamentals of
Managerial
Economics
INTRODUCTION
Economics is the social science that deals with the
production, distribution, and consumption of goods and
services.
Economics focuses on the behavior and interactions of
economic agents and how economies work.
NATURE OF MANAGERIAL ECONOMICS
“Managerial Economics is economics applied in decision making. It
is a special branch of economics bridging the gap between abstract
theory and Business practice.” – Haynes
Managerial Economics may be defined as the study of economic
theories, logic and methodology which are generally applied to seek
solution to the practical problems of business.
Managerial Economics is thus constituted of that part of economic
knowledge or economic theories which is used as a tool of analysing
business problems for rational business decisions.
CENTRAL PROBLEM OF AN ECONOMY
1. What to produce
A country cannot produce all goods because it has limited resources.
It has to make a choice between different goods and services.
Every economy has to decide what goods and services should be produced.
Eg. If farmer has a single piece of agriculture land. Farmer has to make
choice between two goods whether to grow rice or wheat.
Similarly, our Government has to decide where to allocate funds, for the
production of defense goods or consumer goods and if both then in what
proportion.
2. How to produce
This problem refers to the choice of technique of production. This
problem arises when there is the availability of more than one way
to produce goods and services.
There are mainly two techniques of production. These are:
Labour intensive technique(greater use of labour)
Capital intensive technique(greater use of machines)
Labour intensive technique promotes employment whereas capital
intensive technique promotes efficiency and growth.
3. For whom to produce
The third central problem of an economy is to decide for
whom to produce these goods.
Distribution of income determines who will be getting what.
A rich person may have a large share of the luxuries.
The poor person will have basic goods.
It depends on the principle of efficiency and equity.
SCOPE OF ECONOMICS:
Economists use different economic theories to solve various
economic problems in society.
Its applicability is very vast.
From a small organization to a multinational firm, economic laws
come into play.
The scope of economics can be understood under two subheads:
Microeconomics and Macroeconomics.
MICROECONOMICS
Microeconomics examines individual economic activity, industries, and their
interaction. It has the following characteristics:
Elasticity: It determines the ratio of change in the proportion of one variable to
another variable. For example- the income elasticity of demand, the price
elasticity of demand, the price elasticity of supply, etc.
Theory of Production: It involves an efficient conversion of input into output.
For example- packaging, shipping, storing, and manufacturing.
Cost of Production: With the help of this theory, the object price is evaluated
by the price of resources.
Monopoly: Under this theory, the dominance of a single entity is studied in a
particular field.
MACROECONOMICS
It is the study of an economy as a whole. It explains broad aggregates and their
interactions “top down.” Macroeconomics has the following characteristics:
Growth: It studies the factors which explain economic growth such as the
increase in output per capita of a country over a long period of time.
Business Cycle: This theory emerged after the Great Depression of the 1930s. It
advocates the involvement of the central bank and the government to formulate
monetary and fiscal policies to monitor the output over the business cycle.
Unemployment: It is measured by the unemployment rate. It is caused by
various factors like rising in wages, a shortfall in vacancies, and more.
Inflation and Deflation: Inflation corresponds to an increase in the price of a
commodity, while deflation corresponds to a decrease in the price of a
commodity. These indicators are valuable to evaluate the status of the economy
of a country.
BASIC CONCEPTS
These are the basic terms, concepts involved in the scope of economics.
Scarcity – Availability of a resource in a limited amount.
Choice – Different alternatives are used to resolve scarcity is an issue
and is called choices.
Scale of Preference – Here we consider that all humans are rational
thinker. Thus, He will always choose the alternative which yields the
maximum satisfaction.
Opportunity cost – When a man chooses one over others, he gives
up the satisfaction coming from the other also known as opportunity
cost.
THE LAW OF DEMAND
The law of demand states that other factors being
constant (cetris peribus), price and quantity
demand of any good and service are inversely
related to each other.
When the price of a product increases, the demand
for the same product will fall and vice versa
DEMAND FUNCTION
As per the law of demand, demand is function of
price provided other things remain constant.
Dx = f (Px)
Dx is demand for commodity X, which is dependent
variable,
Px is the price of X, which is independent variable.
BASIC ASSUMPTIONS OF LAW OF DEMAND
No change in the income.
No change in size and composition of the
population.
No change in prices and quantity of related goods.
No substitute of the commodity.
No change in consumer's taste, preference, etc.
No expectation of a price change in future.
No change in the climatic conditions.
DEMAND SCHEDULE AND DEMAND CURVE
The demand schedule tells you the exact
quantity that will be purchased at any given price.
The demand curve plots those numbers on a
chart. The quantity is on the horizontal or x-axis,
and the price is on the vertical or y-axis.
SHIFT IN DEMAND AND MOVEMENT ALONG DEMAND CURVE
A shift in demand means at the same price,
consumers wish to buy more.
A movement along the demand curve occurs
following a change in price.
MOVEMENT ALONG DEMAND CURVE
Decrease in prices – Expansion in demand Increase in prices – Contraction in
demand
y
y
B
A 2
2 0
price
price
0 A
B 1
1
0 0
Dx
Dx
0 x
0 100 120
100 120 x
Quantity demanded Quantity demanded
SHIFTS IN DEMAND
Increase in Demand
Increase in Demand refers to a rise in the demand of a commodity caused due to any
factor other than the own price of the commodity.
Decrease in Demand
Decrease in Demand
refers to a fall in the
demand of a
commodity caused due
to any factor other than
the own price of the
commodity.
It leads to a leftward
shift in the demand
curve.
ILLUSTRATION 1:
Which figure stated below is most likely to represent each of
the following?
Income elasticity of demand for low-price cuts of meat.
Income elasticity of demand for the latest smartphone
Price elasticity of demand for petrol.
–1.6 –0.1 +4.3
Give reasons for your choice in each case.
–1.6 –0.1 +4.3
YED for low-price cuts of meat = –1.6.
Low-price cuts of meat are inferior goods and so have a negative YED.
Low-price cuts of meat are not a necessity so it is income elastic (YED > 1).
YED for the latest smartphone = +4.3.
The latest smartphone is a normal good so they have a positive YED.
The latest smartphone is a luxury so they are income elastic (YED >1).
PED for petrol = –0.1.
Petrol is a normal good so it has a negative PED.
Petrol is a necessity so it is price inelastic (PED < 1).
SUPPLY
THE LAW OF SUPPLY
The economy is composed of two forces:
the producers (who produce goods and services) and
the consumers (who buy the products available in the market).
Supply refers to the amount of a good or service that the
producers/providers are willing and able to offer to the market at various
prices during a period of time.
The law of supply - as the price of a product rises, so businesses expand
supply to the market.
A supply curve shows a relationship between price and how much a firm
is willing and able to sell.
The law of supply is a basic principle in economics that asserts that,
assuming all else being constant, an increase in the price of goods
will result in a corresponding direct increase in the supply thereof.
The law of supply depicts the producer’s behavior when the price of
a good rises or falls. With a rise in price, the tendency is to increase
supply because there is now more profit to be earned. On the other
hand, when prices fall, producers tend to decrease production due
to the reduced economic opportunity for profit.
SUPPLY FUNCTION
The functional relationship between the quantity of
commodities supplied and various determinants are
known as supply function.
It is the mathematical expression of the relationship
between supply and factors that affect the ability and
willingness of the producer to offer the product.
The relationship may exist between two or more number
of variables.
In supply function, quantity supplied is expressed as a function
of various variables.
Qs = f(P, C, Prg)
where, Qs = Quantity of commodity supplied
P = Price of the good
C = Cost of production
Prg = Price of related good
DETERMINANTS OF SUPPLY
The Price of the Good/ Service
The Price of Related Goods
The Price of the Factors of Production
The State of Technology
The Government Policy
The Future expectation
THE LAW OF SUPPLY
There are three main reasons why supply
curves are drawn as sloping upwards from
left to right giving a positive relationship
between the market price and quantity
supplied:
1.The profit motive
2.Production and costs
3.New entrants coming into the market
MOVEMENT ALONG SUPPLY CURVE
SHIFTS IN SUPPLY
PRICE ELASTICITY OF SUPPLY
• If the price of a cappuccino increases by 10%, and the supply
increases by 20%. We say the PES is 2.0
• Inelastic supply – a change in price causes a smaller proportional
change in quantity supply
• Elastic supply – a change in price causes a bigger proportional
change in supply
