Managerial economics

What is Economics?
Manager + Economics:
Economics is the study of men as they live, behave, move
and think in ordinary business life.
Economics is a social science, which studies human
behaviour in relation to optimizing allocation of
available resources to achieve the given goals.
It is the study of how society uses its scarce resources.
Wants are Unlimited and Means are Limited.
How to use Limited means for unlimited wants?
1Prof.Shantilal Hajeri

Income – Expenses = Savings.
Income : How much the people earn and How
they earn?
Expenses : How much the people spend and
How they spend?
Savings: How much the people save and
How they save?

Micro and Macro Economics.
Micro Economics
The branch of economics that analyzes the market behavior of
individual consumers and firms in an attempt to understand the
decision-making process of firms and households.
The analysis of the decisions made by individuals and groups, the
factors that affect those decisions, and how those decisions effect
others.
Macro Economics.
Study of the entire economy in terms of the total amount of
goods and services produced, total income earned, level of
employment of productive resources, and general behaviour of
prices.
Macroeconomics examines economy-wide phenomena such as
changes in unemployment, national income, rate of growth,
gross domestic product, inflation and price levels.

Meaning of Managerial Economics
Manager + Economics:
Management is Planning, Organising, Staffing,
Directing, Coordinating, Controlling, budgeting
and Reporting.
Application of Principles of Economics by a
Manager in day to day decision making.
Managerial Economics is the study of allocation
of resources available to a business firm or an
organisation.
ME generally refers to the integration of
economic theory with business practice

Meaning of Managerial Economics
It relates to the managerial decision making in
achieving a business goal by using the given
business resources in the most effective manner.
Managerial economics can be broadly defined as
the study of economic theories, logic and tools
of economic analysis that are used in the
process of decision making. Economic theories
and techniques of economic analysis are applied
to analyze business problems, evaluate business
options and opportunities with a view to arriving
at an appropriate business decision.

Definitions of Managerial Economics
“Managerial economics is the Integration of economic
theory with business practices for the purpose of
facilitating decision making and forward planning by
management”
-Spencer and Siegelman
“Managerial Economics is the use of Economic modes of
thoughts to analyse business situation”
-Mc Nair and Meriam
“The Purpose of Managerial Economics is to how
Economic analysis can be used in formulating policies.”
-Jeal Dean

Definitions of Managerial Economics
“Managerial economics is concerned with the application
of economic principles and methodologies to the decision
making process within the firm or organization. It seeks
to establish rules and principles to facilitate the
attainment of the desired economic goals of the
management.” - Douglas
Managerial economics is a “fundamental academic
subject which seeks to understand and to analyse the
problem of business decision taking”. D.C.Hayue
Managerial Economics is “the application of theory and
methodology to business administration practice”.
Brigham and Pappas.

Characteristics of Managerial Economics
Microeconomic in nature;
Pragmatic
Descriptive as well as prescriptive.
Conceptual in nature
Utilizes some theories of Macroeconomics
Finds solutions to Problems.
Involves Decision making
Reconciling Traditional Theoretical concepts to the
actual business behaviour and conditions.
Incorporates useful Ideas from other branches of study

Scope of Managerial Economics
There are 5 departments in an organisation:
Production/Operations Department.
Finance Department:
Marketing Department:
Human Resources Department:
IT Department:
ME has a wide scope in all these departments

Production/Operations Department.
ME tries to answer the following questions.
What to Produce?
How to Produce?
When to Produce? Where to Produce?
For whom to Produce?
How much to Produce?
What is the Cost of Production?
To Produce or not?

Finance Department.
How much capital to Invest?
How much Equity?
How much Debt? From which source?
When to Invest?
What is Cost of Capital?
How to service the Debt?
What is the return on investment?

Marketing Department.
How much to Spend on Marketing?
How to market?
How to identify the customers?
When to Inform the customers about your product?
How to forecast the Demand?
What is the pricing policy?
What is face the competition?
How to retain the customers?

Human Resources Department.
How much to Spend on Salary and wages?
How to assess the skills required for
employees?
How to recruit the employees?
How to compensate the employees?
What is face the competition?
How to retain the employees?

IT Department.
How much to Spend on IT?
How to assess the hard ware and software
required for the organisation?
How to buy the hard ware and software?
From whom to buy the hard ware and software?

What is Demand?
Effective demand is a desire backed by ability to
pay and willingness to pay for it,
Demand= Want + Ability to pay +Willingness to
pay for it.
Demand is defined as “Demand for any
commodity, at a given price, is the quantity of it
which will be purchased per unit of time at that
price”.

Types of Demand
1. Firm Demand Vs Industry Demand
2. Short run demand Vs. Long run Demand
3. Autonomous Demand Vs Derived Demand
4. Demand for Perishable and Durable goods.
5. Complimentary Vs Supplementary Demand

Law of Demand
The law of demand state that “other things
being same”, the quantity of goods purchased
will vary inversely with its price i.e. the lower
price, more will be the quantity demanded
and vice –versa.
If Price goes up the demand comes down and
If Price comes down the demand goes up.

Demand Schedule
Demand schedule shows the various quantities
of a commodity which bought at different
prices during a specific period.
Price of Vegetable
per Kg in Rs
Quantity Demanded
in Kg
10 15
8 25
6 30

Demand Curve
When price increases demand decreases or
when price decreases demand increases.
0
10
20
30
40
50
60
0 2 4 6 8 10 12
Quantity Demanded in Kg
Quantity Demanded in Kg

Shift in Demand

Price Elasticity of Demand
Dr.Marshall has defined price elasticity of demand
as follows:”The elasticity of demand in market is
great or small according to the amount demanded
increases much or little for a given rise in the price”.
We can define price elasticity of demand as the
degree of responsiveness of demand for
commodity to a change in price.
“Price elasticity of demand is the ratio of
proportionate change in the quantity demanded of
commodity to given proportionate change in its
price”.
It is the ratio of the relative change in quantity to a
relative change in price.

Price Elasticity of Demand
Change in Demand due to Change in Price
%change in the elasticity demanded of X
Price elasticity Epd = ------------------------------------
%change price of X .
Example: When the price of a produce was Rs. 10 the demand
was 100 units and when the price changed to Rs.11 the demand
was 95 units
%Change in Demand=D2-D1/D1*100
=95-100/100*100 =-5%
% Change in Price=P2-P1/P1*100
=11-10/10*100 =10%
Epd= -5%/10% =-0.5

Types of Price Elasticity of Demand
There are six types of Price Elasticity of Demand
as under:-
1. Zero elastic Demand.
2. Less than Unitary Elastic Demand
3. Unitary Elastic Demand
4. More than Unitary Elastic Demand
5. Perfectly Elastic Demand
6. Negative Elastic Demand

Zero Price Elasticity of Demand
No change in Demand even though there is
change in Price
Price Changes from Rs.10/- to Rs.11/-. Demand
remains at 100 units
Epd = 0. Angle : 90 degree
Graph”

Zero Price Elasticity of Demand
No change in Demand even though there is
change in Price
remains at 100 units

Less than Unitary Elastic Demand
Change in Demand is less proportionate to
change in Price
Changes from 100 to 95 units
Epd < 1. Angle : <90 degree > 45 degree
Graph”

Unitary Elastic Demand
Change in Demand is proportionate to change
in Price
Graph”

More than Unitary Elastic Demand
Change in Demand is more proportionate to
change in Price
Epd > 1. Angle : <45 degree > 0 degree
Graph”

Infinite Elastic Demand
Change in Demand even though there is no
change in Price
Change in Demand even though there is no
change in Price
Epd = ∞. Angle : 0 degree
Graph”

Supply Analysis
The quantity of stock offered for sale at a particular
price is called as Supply.
There is a difference between the Stock and Supply.
Example: A farmer has 100 Kg of Rice. The price is
Rs.40 per KG. He has offered 60 KG for sale at this
rate. Then the stock is 100 Kg and supply is 60 KG.
Supply is less than or equal to Stock. Supply
cannot be more than Stock

Law of Supply
The law of Supply state that “other things
remaining unchanged”, the quantity of goods
supplied will vary in direct proportion with its
price i.e. the lower price, the less will be the
quantity supplied and vice –versa.
If Price goes up the Supply goes up and If
Price comes down the Supply comes down.

Supply Schedule
Supply schedule shows the various quantities
of a commodity which bought at different
prices during a specific period.
Price of Vegetable
per Kg in Rs
Quantity Supplied in
Kg
6 15
8 25
10 30

Supply Curve
Price
10
8
6
15 25 30 (Supply)

Law of Supply
When the price of a goods rises, other things remaining the same,
its quantity which is offered for sale increases and if price falls, the
amount available for sale decreases.

Determinants of Supply
1. The Cost of Production.
2. Technology.
3. Natural conditions. Rain fall, weather,
Natural calamities.
4. Government policies regarding tax rates,
Interest rates, subsidy and inflation.
5. Speculation and Hoarding
6. Transportation Costs.

Shift in Supply Curve
Price S2
10 S1
8 S2 S3
6 S1
S3
15 25 30 (Supply)

Shift in Supply Curve
Shift in Supply means increase or decrease in
supply due to factors other than the price.
During drought the supply of agricultural goods
goes down. During optimum rainfall supply of
agricultural goods goes up.

Price Equillibrium
Equilibrium occurs at the intersection of the
demand and supply curves, It indicates efficiency. At
this point, the price of the goods will be P* and the
quantity will be Q*. These figures are referred to as
equilibrium price and quantity.

Cost Concepts
Costs of production are the most important
force governing the supply of a product.
A firm chooses a combination of factors which
minimizes its cost of production for a given level
of output.
Production of a commodity involves expenses to
be incurred on different factors viz. Land,
Labour, Capital and Enterprise.
It is the sum total of expenses incurred by the
producer to pay for the factors of production.
Costs of production have different meanings.

Accounting Cost , Money Cost and Real Cost
Accounting Cost: All those expenses incurred by a
producer that enter the accounts is known as
accounting cost.
Land : Rent , Labour: Wages, Capital: Interest and
Enterprise: Profit.
Money Cost: The sum of money spent for
producing a particular quantity of commodity is
called its money cost.
Real Cost: According to Marshall the real cost of
production of a commodity is expressed not in
money but in efforts and sacrifices undergone in
the making of a commodity.

Opportunity Cost
Opportunity Cost: opportunity cost of a commodity
is forgoing the opportunity to produce alternative
goods and services.
In view of scarcity of resources, every producer has
to make a choice among several alternatives. The
second alternative use of a resource has to be
sacrificed for using it in a particular way.
Examples:
Rent on own land and building used for business.
Salary on the own efforts of owners/proprietor.
Interest on the own capital invested by owners.

Opportunity Cost
Opportunity Cost: It can be also defined as the
benefit forgone on the second best alternative.
If you have a building, you can give it on rent. If
you are using it for the own business, the rent
that you would have received is sacrificed by
you and that is the opportunity cost of Building.
If you were not working in your own business,
you would have done a job and earned salary.
The salary that you would have received is
sacrificed by you and that is the opportunity
cost of your services.

Explicit cost
Explicit cost includes these payments which are
made by the employer to those factors of
production which do not belong to the employer
himself. Direct Contractual Monetary Payments.
These costs are explicitly incurred by the producer
for buying factors from others on contract.
For example, the payments made for raw materials,
power, fuel, wages and salaries, the rent on land
and interest on capital are all contractual payments
made by the employer.
Explicit cost is also called accounting cost.

Implicit cost
Implicit cost includes the opportunity costs of
those factors of production which are already
owned by the businessman.
These costs are not explicitly incurred by the
producer for buying factors. Implicit cost is also
called opportunity cost.

Direct and Indirect Cost
Direct Cost indicates that cost which can be
identified with the individual cost center. It consists
of direct material cost, direct labour cost and direct
expenses. It is also termed as Prime Cost.
Indirect Cost indicates that cost which cannot be
identified with the individual cost center. It consists
of indirect material cost, indirect labour cost and
indirect expenses. It is also termed as overheads. As
it is not possible to identify these costs with
individual cost centers, such identification is done in
the indirect way by following the process of
allocation, apportionment and absorption.

Fixed, Variable and Semi-Variable/Semi-Fixed Cost
Fixed cost indicates that portion of total cost which
remains constant at all the levels of production,
irrespective of any change in the later. As the volume of
production increases, per unit fixed cost may reduce, but
not the total fixed cost.
Variable cost indicates that portion of the total cost which
varies directly with the level of production. The higher
the volume of production, the higher the variable cost
and vice versa, though per unit variable cost remains
constant at all the levels of production.
Semi-variable or semi-fixed cost indicates that portion of
the total cost which is partly fixed and partly variable in
relation to the volume of production.

Graphical Representation
a) Fixed Cost.
b) Variable Cost
c) Semi Variable Cost

Marginal cost
In Economics and Finance marginal cost is the
change in Total Cost that arises when the
quantity produced changes by one unit. It is the
cost of producing one more unit of a
commodity.
The marginal cost of production is the increase
in Total cost as a result of producing one extra
unit. It is the variable costs associated with the
production of one more units.
Marginal Cost = Change in Total Cost = ΔTC
Change in Output Δ Q

Marginal cost: Example
Units of Output Total Cost Marginal Cost
1 5 5
2 9 4
3 12 3
4 16 4
5 21 5
6 29 8

Sunk Cost
The historical cost which has been incurred in
the past is called as “Sunk Cost”.
This type of cost is normally not relevant in the
decision making process. This is also called as
the Historical Cost.
Example: Cost of acquiring a machinery for the
business.
The Relevant cost: It the realisable Market Value
of an asset. This type of cost is relevant in the
decision making process.

Controllable and Uncontrollable costs
The costs which can be Controlled by the
management are called Controllable Costs.
Example: Advertising expenses, Pay packages.
The costs which cannot be Controlled by the
management are called Uncontrollable Costs.
Example: Cost of Interest, Depreciation, Taxes,
Dearness Allowances, raw material prices,
electricity charges, water charges etc.

Normal and abnormal costs
The costs which are incurred in the normal
course of the business are called as Normal
Costs.
Example: Rent, Material Cost, Wages, .
The costs which are incurred due to the reasons
beyond the control of the management such as
Floods, earthquake, Tsunami, fire etc are called
as abnormal Costs.
Example: Dacoit/loot of the goods, Loss of
goods due to fire/flood/earthquake.

Average costs
No of
units
Fixed cost Average
Fixed
Cost
Variable
Cost
Average
Variable
Cost
Total Cost Aver Total
Cost
0 100,000 n.a. 0 0 100,000 n.a
200 100,000 500 20,000 100 120,000 600
400 100,000 250 40,000 100 140,000 350
600 100,000 167 60,000 100 160,000 267
800 100,000 125 80,000 100 180,000 225
1,000 100,000 100 100,000 100 200,000 200
1,500 100,000 67 150,000 100 250,000 167

Average Fixed cost.
Calculation of average cost is important to fix the
selling price per unit.
Average Fixed Cost = Total Fixed Cost
Total No. Of Units.
Total Fixed Cost remains constant but Average Fixed
Cost goes on decreasing as the level of production
increases. If the production is very high, the average
fixed cost may become negligible. This is called
Economy of Scale. It means if the scale of business
is high, the average fixed cost becomes negligible
and average cost becomes equal to variable cost.

Average Variable cost.
Average Variable Cost = Total Variable Cost
Total No. Of Units.
Average Variable Cost remains constant but
Total Variable Cost goes on increasing as the
level of production increases.
Average Variable Cost Total Variable Cost

Average Total cost.
Average Total Cost = Total Fixed + Variable Cost
Total No. Of Units.
Average Total Cost goes on decreasing as the level
of production increases. But, Total Cost goes on
increasing as the level of production increases.
Average Total Cost Total Cost
Total Cost = Total Fixed Cost + Total Variable Cost

Formulas.
Average Fixed Cost = Total Fixed Cost
Total No. Of Units.
Average Variable Cost = Total Variable Cost
Total No. Of Units.
Average Total Cost = Total Cost
Total No. Of Units.
Total Cost = Total Fixed Cost + Total Variable Cost.
Total Variable Cost = Total No. Of Units X
Variable Cost Per Unit

Abbreviations.
TFC = Total Fixed Cost
AFC= Average Fixed Cost
TVC = Total Variable Cost
AVC= Average Variable Cost
ATC= Average Total Cost (AC= Average Cost)
TC = Total Cost
TR= Total Revenue
AR= Average Revenue
TP = Total Profit
AP = Average Profit

Average Fixed cost. Fill in the Blanks
No of units Fixed cost Average
Fixed Cost
Variable
Cost
Average
Variable
Cost
Total Cost Aver Total
Cost
0 5,000 n.a. 0 0 5,000 n.a
200 5,000 25.00 600 5,600 28.00
400 5,000 12.50 3 6,200 15.50
600 8.33 1,800 3 6,800 11.33
800 5,000 6.25 2,400 3 9.25
5,000 5.00 3,000 3 8,000 8.00
1,500 5,000 3.33 4,500 3 9,500
2,000 5,000 6,000 3 11,000 5.50
2,500 5,000 2.00 7,500 3 12,500 5.00

Revenue Concepts.
Revenue also means Total Sales or Turnover.
Total Revenue = Total No. Of Units X Selling Price Per Unit
Average Revenue = Total Revenue
Total No. Of Units.
Total Profit = Total Revenue-Total Cost
Average Profit = Total Profit
Total No. Of Units.

Marginal Revenue.
The Marginal Revenue is the increase in Total Revenue
as a result of selling one extra unit.
Marginal Revenue = Change in Total Revenue = ΔTC
Change in Quantity Δ Q
No of
units
Sales Change in
Units
Change in
Revenue
Marginal
Revenue
200 30000
400 60000 200 30000 150
600 87000 200 27000 135
800 112000 200 25000 125
1,000 136000 200 24000 120

Cost, Volume and Profit Relation.
No of
units
Total
Cost
Aver
Total
Cost
Sales
(Revenue)
Average
Revenue
Total
Profit
Average
Profit
No of
units
0 10,000 n.a 0 n.a -10,000 na 0
500 15,000 30 7,500 15 -7,500 -15 500
1,000 20,000 20 15,000 15 -5,000 -5 1,000
1,500 25,000 17 22,500 15 -2,500 -2 1,500
2,000 30,000 15 30,000 15 0 0 2,000
5,000 60,000 12 75,000 15 15,000 3 5,000
10,000 110,000 11 150,000 15 40,000 4 10,000

Managerial economics

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Managerial economics