Micro Economics

1. Introduction to Managerial economics

2. Economics: Study of the behavior of human beings in producing,
distributing and consuming material goods and services in a world of
scare resources.
Management: The discipline of organizing and allocating a firm’s
scare resources to achieve its desired objectives.
ME: It is the use of economic analysis to make business decisions
involving the best use of an organization’s scare resources.
Economics of business or managerial decisions.
Integration of economic principles with business practices.
Pertains to economic analysis that can help in solving business
problems, policy and planning.
Traditional Economics &
Tools & Techniques
of Decision Sciences
ME
Business
Management
in theory& Practice:
Decision, Problems

3.  In Economic Theory:
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Assumption of a single Goal i.e. rational consumer aims at
maximization of utility and a firm tries to maximize its profit.
ET is based on Ceteris Paribus i.e. given conditions with certainty of
actions or events or within the framework of axioms.
 In Business Decision Making:
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Multiple goals in running a business.
Lack of certainty due to dynamic changes.
Uncertainty may create disappointment in the realizations of business
expectations.
 ET cant provide clear cut solutions but helps in arriving at a
better decision.
 ME helps bridge the gap between purely analytical
problems dealt in ET and decision problems faced in real
business.

4. MAIN CHARACTERISTICS OF ME
 Applied Micro economics
 Science as well as art of management disciplines.
 Concerned with the firm's behavior in optimal
allocation of resources.
 Provides tools for best alternatives and competing
activities in any productive sector.
 Incorporates both Micro and Macro Economics for
optimal decisions.
 Helps Manager to understand the intricacies of the
business problems which make the problem solving
easier and quicker.
contd.

5. .
Study of managerial economics essentially involves the analysis of certain
major subjects like:
 The business firm and its objectives
 Demand analysis, estimation and forecasting
 Production and Cost analysis
 Pricing theory and policies
 Profit analysis with special reference to break-even point
 Capital budgeting for investment decisions
 Competition.

7. Managerial Economics:
Uses analytical tools of mathematical and econometrics
with two main approaches
Descriptive Models are data based in describing and
exploring economic relationships of reality in simplified
abstract sense. Describe the economic forces that shape the
internal and external environments of a business firm.
 Prescriptive models are the optimizing models to guide the
decision makers about set goal. Prescribe rules for
managerial decision-making that furthers the objective of the
firm.
 DM provide a building block for developing optimizing
models in solving the managerial and business problems.
 Helps in depth analysis of key elements involved in the
business.

8. IS ME POSITIVE OR NORMATIVE?
 +ve economics explains the economic phenomenon as what
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is, what was and what will be.
Normative economics prescribes what it ought to be.
ME is a blending of pure or +ve science with applied or
normative science.
+ve when confined to statements about causes and effects
and to functional relations of the economic variables.
It is normative when it involves norms and standards,
mixing them with the cause effect analysis.
ME is a mix of both consideration in scientific approach.

9. DUTIES OF A MANAGERIAL ECONOMIST
 Two broad aspects of his duties are –
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 Decision Making
 Forward Planning
Demand Estimation and forecasting
Business and sales forecasting
Analysis for extent and nature of competition.
Analyzing the issues and problems of the concerned industry.
Assisting the bus Planning process of the firm.
Discovering the new and possible fields of business endeavors and its
cost benefit analysis.
Advising on pricing , investment, and capital budget policy.
Evaluation of capital budgets.
Building micro and macro eco models for solving business problems.
Directing Economic research activities.
Briefing the management on current domestic and global economic
issues and emergiing challenges.
Keeps an eye on fast changing technological developments.

10. Managerial Economic analysis in Decision
Making
 ME adopts the scientific approach of economic analysis:
 Define the problem
 Formulation of the hypothesis
 Abstraction for the model building
 Data collection
 Deduction based on data analysis
 Testing the hypothesis
 Evaluating the test results
 Conclusion for decisions

11. A Decision-Making Model
Objectives
Define the
problem
Alternative
Solutions
Social
constraints
Evaluation
Organizational
and input
constraints
Implement and
monitor the
decision
11

12. Scope of ME
 Objectives of a firm
 Demand Analysis and Forecasting
 Cost and Production Analysis
 Pricing Decisions, Policies and Practice
 Profit Management
 Capital Budgeting
 Linear Programming and the theory of games
 Market structure and conditions
 Strategic Planning
 Others Areas (Macroeconomic Management, Fiscal and Monetary
Policy, Impact of Liberalization, Globalization, privatization,
marketization, international changes, environmental degradation,
socio-political, cultural and external forces on management)

13. Importance of Managerial Eco.
 It gives guidance for identification of key variables in decision making
process.
 It helps the business executives to understand the various intricacies
of business and managerial problems and to take right decision at the
right time.
 It provides the necessary conceptual, technical skills, toolbox of
analysis and techniques of thinking to solve various business
problems.
 It is both a science and an art. In the context of globalization,
privatization, liberalization and a highly competitive dynamic
economy, it helps in identifying various business and managerial
problems, their causes and consequence, and suggests various policies
and programs to overcome them.
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14. responsive, realistic and competent to face the ever changing
challenges in the modern business world.
 It helps in the optimum use of scarce resources of a firm to
maximize its profits.
 It also helps in achieving other objectives a firm like attaining
industry leadership, market share expansion and social
responsibilities etc.
 It helps a firm in forecasting the most important economic
variables like demand, supply, cost, revenue, price, sales and
profit etc and formulate sound business polices
 It also helps in understanding the various external factors and
forces which affect the decision making of a firm.
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 It helps the business executives to become much more

15. Demand and demand analysis

16. Market system- basics
 Market – System where buyers and sellers interact to
determine the price and quantity of goods or service.
 Based on two market forces – demand and supply.
 Purview of the market depends upon the expanse of
its buyers and sellers.
 Buyers and sellers need not come into personal
contact.
 Market refers to a commodity/ service or a
geographical area.
 Markets distinguished basis nature of goods and
services and extent of competition.

17. Definition of Demand
 The demand for a product refers to the amount of it
which will be bought per unit of time at a particular
price.

18. Individual demand and Market
demand
 Individual demand is a single consuming entity’s
demand
 Market demand is the total demand of all individual
buyers at a particular price and over a given period of
time.

19. Determinants of demand
Factors influencing Individual demand
 Price of product
 Income availability
 Tastes , habits and preferences
 Price of substitutes and compliments
 Consumer expectation
 Advertisement effect
 Season prevailing at the time of purchase
 Fashion

20. Determinants…Market demand
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Price
Distribution of income and wealth in the community.
Standards of living and spending habits
Growth of population
Number of buyers in the market
Age group
Gender ratio
Future Expectations
Taxation and tax structure
Fashion and Innovation
Climate
Customs
Advertisements

21. Demand Function
Mathematical expression establishing relationship between
demand and its various variables
Dx= F(Px, Ps,Pc,Yd,T, A, N, u)
Px – Own price
Ps - Price of a substitute
Pc – Price of complements
Yd – Disposable income
T - buyers tastes and preferences
A – effect of advertisement
N- population growth
U – other aspects

22. Demand Function - contd..
A linear demand function is as below :
D= a – bP
D= Units demanded
a = Constant parameter signifying initial demand
irrespective of price.
b = Constant parameter representing functional
relationship between D and P. Also measures the slope
of the demand curve.

23. Law of demand
All other things remaining constant (ceteris paribus),
the quantity demanded of a commodity increases
when its price decreases and decreases when its price
increases.
Demand curve :
demand curve
Price of Shirts
1000
500
demand curve
0
8
15
30
40
No Of Shirts
55
80

24. Assumptions underlying the Law of
Demand
 Habits, tastes and fashions remain constant.
 Money, income of the consumer does not change.
 Prices of other goods remain constant.
 The commodity in question has no substitute or is not
in competition by other goods.
 The commodity is a normal good and has no prestige
or status value.
 People do not expect changes in the price.
 Price is independent and demand is dependent.

25. Demand Schedule
 Demand schedule is a tabular representation of the
quantity demanded of a commodity at various prices.
For instance, there are four buyers of apples in the
market, namely A, B, C and D.
The demand by Buyers A, B, C and D are individual
demands. Total demand by the four buyers is market
demand. Therefore, the total market demand is
derived by summing up the quantity demanded of a
commodity by all buyers at each price.

26. Demand Schedule for apples
PRICE (Rs. Buyer A
per dozen) (demand
in dozen)
Buyer B
(demand
in dozen)
Buyer C
(demand
in dozen)
Buyer D
(demand
in dozen)
Market
Demand
(dozens)
10
1
0
3
0
4
9
3
1
6
4
14
8
7
2
9
7
25
7
11
4
12
10
37
6
13
6
14
12
45

27. Demand Curve
Demand curve is a diagrammatic representation of
demand schedule. It is a graphical representation of
price- quantity relationship.
Individual demand curve shows the highest price which
an individual is willing to pay for different quantities
of the commodity.
While, each point on the market demand curve depicts
the maximum quantity of the commodity which all
consumers taken together would be willing to buy at
each level of price, under given demand conditions.

28. Demand Curve

29. Features of demand curve
 Demand curve has a negative slope
The reasons for a downward sloping demand curve can be
explained as follows Income effect- With the fall in price of a commodity, the
purchasing power of consumer increases. Thus, he can buy same
quantity of commodity with less money or he can purchase
greater quantities of same commodity with same money.
Similarly, if the price of a commodity rises, it is equivalent to
decrease in income of the consumer as now he has to spend
more for buying the same quantity as before. This change in
purchasing power due to price change is known as income effect.

30. .
 Substitution effect- When price of a commodity
falls, it becomes relatively cheaper compared to other
commodities whose price have not changed. Thus, the
consumer tend to consume more of the commodity
whose price has fallen, i.e, they tend to substitute that
commodity for other commodities which have not
become relatively dear.

31. .
Law of diminishing marginal utility
It is the basic cause of the law of demand.
It states that as an individual consumes more and more
units of a commodity, the utility derived from it goes
on decreasing. So as to get maximum satisfaction, an
individual purchases in such a manner that the
marginal utility of the commodity is equal to the price
of the commodity. When the price of commodity
falls, a rational consumer purchases more so as to
equate the marginal utility and the price level. Thus, if
a consumer wants to purchase larger quantities, then
the price must be lowered. This is what the law of
demand also states.

32. Exceptions to the law of demand
 There are certain goods which are purchased mainly for their
snob appeal/ as status symbol, such as, diamonds, air
conditioners, luxury cars, antique paintings, etc. The more
expensive these goods become, more valuable will be they as
status symbols and more will be there demand. Thus, such goods
are purchased more at higher price and are purchased less at
lower prices. Such goods are called as conspicuous goods.
 The law of demand is also not applicable in case of giffen goods.
Giffen goods are those inferior goods, whose income effect is
stronger than substitution effect. These are consumed by poor
households as a necessity. For instance, potatoes, animal fat
oil, low quality rice, etc. An increase in price of such good
increases its demand and a decrease in price of such good
decreases its demand.

33. Exceptions to the law of demand
 The law of demand does not apply in case of
expectations of change in price of the
commodity, i.e, in case of speculation. Consumers
tend to purchase less or tend to postpone the purchase
if they expect a fall in price of commodity in future.
Similarly, they tend to purchase more at high price
expecting the prices to increase in future.

34. Change in Quanity demanded Vs Change in demand
 Extension and contraction of demand- Movement
along the same demand curve and represents the
change in quantity demanded because of the change
in price of the product.

35. Change in demand
Increase and decrease in demand – More is demanded at a given price when
demand increases and vice versa. This change in demand is due to other factors
than price.

36. Network externalities in demand
Dependence of individual demand on the demand of
other people in case of some products is network
externality.
Two externalities :
i) Bandwagon effect
ii) Veblen effect

37. Bandwagon effect
The demand for products is not by their usefulness but
mostly influenced by trend setters/ pace setters.
It is the result of the buyer’s desire to be in style or
fashion.
This forms the basic objective of advertising and
marketing of many products and manipulates market
demand.
Helps in determining the pricing strategy of the business
firm for such firms.

38. Veblen effect
 The desire of a person to own exclusive/ unique
product as a status symbol.
 A rise in price of such products enhances their snob
appeal and shifts the demand curve upwards.
 Network externality is negative.
 The product loses its prestige when it starts getting
commonly used.

39. Veblen paradox
At high prices, limited but high demand from the rich.
Slight upward variation in demand when the prices are
reduced a little.
After a certain extent of price reduction, demand dips.
Once the product is made available to the common
man, it follows the usual law of demand.