Managerial Economics

Managerial Economics
Prepared By
Dr. Ravindra Tripathi
Associate Professor & Head
Department of Humanities and Social Science
Motilal Nehru National Institute of Technology
Unit-1 Introduction
 Douglas - “Managerial economics is .. the
application of economic principles and
methodologies to the decision-making process
within the firm or organization.”
 Spencer and Siegelman : “Managerial economics is

the integration of economic theory with business
practice for the purpose of facilitating decision
making and forward planning by management”
 O Mc Nair and Meriam : “Managerial Economics is

the use of economic modes of thought to analyze
business situation”
Feature
 Concerned with decision making economic
nature
 Goal oriented and prescriptive
 Pragmatic
 Link between traditional economics and
decision sciences
 Conceptual and metrical
Approach
Positive Economics:-
Derives useful theories with testable
propositions about WHAT IS.
 Normative Economics:-
Provides the basis for value judgements on
economic outcomes. WHAT SHOULD BE
Scope of Managerial Economics
 Utility analysis
 Demand and supply analysis
 Production and cost analysis
 Market analysis
 Pricing
 Investment decisions
 Game theory
Fundamental Concepts Managerial
Economics
 Marginal Principle
 Opportunity cost principle
 Incremental Principle
 Discount Principle
 Time Perspective
Oppurtunity Cost
 Benham : “The opportunity cost of anything is the
best alternative which could be produced instead
by the same factors or by an equivalent group of
factors, costing the same amount of money”.
 W. W. Haynes : “Opportunity cost of a decision
means the sacrifice of alternatives required by
that decision “.
 Adam Smith has explained opportunity cost like
this –If a hunter finds a bear and a dear while
hunting, if he kills bear, dear is the opportunity
cost & vice versa.
Discounting principle
 Discounting principle is a continuation of time perspective & we can say
it is a corollary of time perspective.
 The old proverb “A bird in hand is better than two in the bush” is a
representative of this discounting principle. The worth of a rupee
receivable tomorrow is less than that of a rupee receivable today. Since
the future is unknown & incalculable, also there is a lot of risk &
uncertainty about the future.
 If the return is same for now & future, then definitely present return
will be given importance. So the future must be discounted both for the
elements of waiting & risk of the future. Even if one is certain that he
will get some income in the future, it is essential to make a discount in
the income because he has to wait for the future, which involves
sacrifice.
 Moreover inflation may reduce the purchasing power. For making a
decision regarding investment which will yield a return over a period of
time, it is important to find its net present worth. To know the returns
over a period of years to decide over an alternative investment, it is
necessary to use discounting principle.
Equi- Marginal principle
 To make optimum allocation of resources, a firm can use equi-marginal principle. Equi-
marginal principle can be applied to the allocation of the resources between their
alternative uses with a view to maximize their profit in case a firm carries out more than
one business activity.
 Equi-marginal Principle States that an input must be allocated between various uses in
such a way that the value added by the last unit of the input is the same in all its uses.
 To understand the principle, let us assume a simple example. Suppose a firm produces
two products A & B and market price of both the product is the same. Suppose the last
unit of the labor used for production of A gives rise to a marginal product of 20 units
and the last unit of the labour used in producing B gives rise to a marginal product of
30 units, then the firm must shift the labor from production of A to B. Firm should
relocate the laborers till the Marginal product of A = Marginal product of B of the last
labourer used in both production. When prices are different, then
 MPA / PA = MPB /PB
 It can be generalised as
 MPA / P A = MPB /P B = MPC / PC =… ………=MPN / PN
Role of Managerial Economist
 Making decision and processing information
are two primary tasks of managers
 In order to make intelligent decisions,
managers must be able to obtain, process

and use information
 The purpose of learning economic theory is
to help managers know what information

should be obtained and how to process and
use the information
Demand Analysis
 According to Prof. Hibson, “Demand means the
various quantities of goods that would be
purchased per time period at different prices in a
given market. “ thus three things are necessary for
the demand to exist;
 (1) Desire for the commodity,

 2) ability to purchase the commodity and
 3) willingness to pay the price of the commodity.
 Benham - “The demand for a commodity refers to

the amount of it which will be brought per unit of
a time at a particular price”.
Demand Function
 The functional relationship between the demand for a commodity and its various
determinants may be expressed mathematically in terms of a Demand Function.
 Dx = f(Px,Py,M,T,A,U)
 Dx = Quantity demanded for commodity X
 Px = Price of commodity X
 Py = Price of substitutes and complementary goods
 M = Money income of the consumer
 T = Taste of the consumer
 A = Advertisement effects
 U = Unknown variables or influence.

Determinants of demand
 Price
 Income
 Taste, preference and fashion
 Prices of related goods
 Government policy
 Custom and tradition
 Advertisement
Law of demand
 If other things remain constant, when price increases
demand contracts and when price decreases demand
expands. Price and demand are inversely
proportionate.
 Marshall states the law of demand as: “The amount

demanded rises with a fall in price and diminishes with
a rise in price.”
 The law can also be stated as “other things being

equal, higher the price of a commodity, the smaller is
the quantity demanded and lower the price, larger is
the quantity demanded.”
Demand Curve
 A demand curve is a graphical representation
of a demand schedule when price quantity
information is plotted on a graph. Thus,
demand curve depicts a picture of a data
contained in the demand schedule.
Individual Demand Schedule
 Demand schedule expresses the relationship
between price and demand of an individual
Exceptions to the law of demand
 Giffen Goods
 Prestigious goods
 Share Market
 Consumer’s Hobbies
 Brand loyalty
Why does the demand curve slope
downwards
 Law of diminishing M.U.
 SUBSTITUTION EFFECT
 INCOME EFFECT
Elasticity
 Elasticity is a measure of responsiveness of

one variable to another variable.
 Can involve any two variables.
 An elastic relationship is responsive.
 An inelastic relationship is unresponsive.

ELASTICITY OF DEMAND
 According to Marshall, “Elasticity or
responsiveness of demand in a market is great
or small according, as the amount demanded
increases much or little for a given fall in the
price and diminishes much or little for a given
rise in price.”
 Stonier and Hague deifned Elasticity of demand

as a technical term used by the eocnomist to
describe the degree of responsiveness of the
demand for a commodity to a change in its price.
Types of Elasticity
 Price Elasticity of demand
 Income elasticity of demand
 Cross Elasticity of demand
 Promotional Elasticity of demand

Price elasticity:
 Causality: denominator numerator!
 An elastic response is one where numerator is
greater than denominator.

 i.e., %Q>%P so Ep 
 Imagine extreme example.
 An inelastic response is one where numerator
is smaller than denominator.

 i.e., %Q<%P so Ep 
 Again, imagine extreme example.
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Managerial Economics

 Spencer and Siegelman : “Managerial economics is

 O Mc Nair and Meriam : “Managerial Economics is

managers must be able to obtain, process

to help managers know what information

 (1) Desire for the commodity,

 Benham - “The demand for a commodity refers to

 Dx = Quantity demanded for commodity X

 Py = Price of substitutes and complementary goods

 M = Money income of the consumer

 T = Taste of the consumer

 U = Unknown variables or influence.

 Marshall states the law of demand as: “The amount

 The law can also be stated as “other things being

 Elasticity is a measure of responsiveness of

 Can involve any two variables.

 An elastic relationship is responsive.

 An inelastic relationship is unresponsive.

 Stonier and Hague deifned Elasticity of demand

 Income elasticity of demand

 Cross Elasticity of demand

 Promotional Elasticity of demand

greater than denominator.

is smaller than denominator.

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