Managerial Economics PDF

**Faculty of Commerce and Management, SGT University** **Managerial Economics** **IMBA - Sem I** **Faculty : Dr. Nitesh Rawat** **Module -- 1** **MEANING OF BUSINESS ECONOMICS** **Business Economics also called Managerial Economics is the application of economic theory and methodology to busin...

**Faculty of Commerce and Management, SGT University** **Managerial Economics** **IMBA - Sem I** **Faculty : Dr. Nitesh Rawat** **Module -- 1** **MEANING OF BUSINESS ECONOMICS** **Business Economics also called Managerial Economics is the application of economic theory and methodology to business. Business involves decision-making. Decision making means the process of selecting one out of two or more alternative courses of action.** **DEFINITIONS OF BUSINESS ECONOMICS** **Managerial Economics is economics applied in decision-making. It is a special branch of economics bridging the gap between the economic theory and managerial practice. Its stress is on the use of the tools of economic analysis in clarifying problems in organizing and evaluating information and in comparing alternative courses of action.‖ -W. W. Haynes** **Managerial Economics is the integration of economic theory with business practice for the purpose of facilitating decision-making and forward planning by management.‖ - Spencer & Siegelman** **The purpose of Managerial Economics is to show how economic analysis can be used in formulating business policies.‖ - Joel Dean** **NATURE OF BUSINESS ECONOMICS** **(i) Business Economics is a Science** What is Science? It is simply a systematic body of knowledge which can establish a relationship between cause and effect. Further, Mathematics, Statistics, and Econometrics are decision sciences. **(ii) It is based on Micro Economics** Business Economics is more concerned with the decision-making situations of individual establishments. Therefore, it depends on the techniques of Microeconomics. **(iii) It Incorporates Elements of Macro Analysis** Even though all businesses focus on their profitability and survival, a firm cannot operate in a vacuum. The external environment of the economy like income and employment levels in the economy, tax policies, etc., affects the firm. All these external factors are components of macro economy. Therefore, a business manager has to take all such factors into consideration which may influence his business environment. **(iv) It is an Art** Business Economics is an art as it requires the practical application of rules and principle to achieve set objectives. **(v) Use of Theory of Markets and Private Enterprises** Business Economics primarily uses the theory of markets and private enterprises. It uses the theory of the firm and resource allocation in a private enterprise economy. **(vi) Pragmatic in Approach** Microeconomics is purely theoretical and analyses economic occurrences under unrealistic assumptions. On the other hand, Business Economics is pragmatic in its approach. It tries to solve the problems which the firms face in the real world. **(vii) Interdisciplinary** Business Economics incorporates tools from many other disciplines like mathematics, statistics, accounting, marketing, etc. Therefore, is in interdisciplinary in nature. **(viii) Normative & Positive science** Broadly speaking, Economic Theory has evolved along two lines -- Positive and Normative. A positive or pure science analyses the cause and effect relationship between variables in a scientific manner. However, it does not involve any value judgment. On the other hand, normative science involves value judgments. It suggests a course of action under the given circumstances.Usually, Business Economics is normative in nature. It offers suggestions for the application of economic principles while forming policies, making decisions, and planning for the future. **SCOPE OF BUSINESS ECONOMICS** **(A) Microeconomics Applied to Operational Issues** As the name suggests, internal or operational issues are issues that arise within a firm and are within the control of the management. It is within the scope of business economics to analyse this. Further, a few examples of such issues are choice of business, size of business, product designs, pricing, promotion for sales, technology choice, etc. Most firms can deal with these using the following microeconomics theories: **(i) Analysing Demand and Forecasting** Analysing demand is all about understanding buyer behaviour. It studies the preferences of consumers along with the effects of changes in the determinants of demand. Also, these determinants include the price of the good, consumer's income, tastes/ preferences, etc. **(ii) Production and Cost Analysis** A business economist has the following responsibilities with regards to the production: - Decide on the optimum size of output based on the objectives of the firm. - Also, ensure that the firm does not incur any undue costs. **(iii) Inventory Management** Firms can use certain rules to reduce costs associated with maintaining inventory in the form of raw materials, work in progress, and finished goods. Further, it is important to understand that the inventory policies affect the profitability of a firm. **(iv) Market Structure and Pricing Policies** Any firm needs to know about the nature and extent of competition in the market. A thorough analysis of the market structure provides this information. Further, with the help of this, firms command a certain ability to determine prices in the market.. **(vi) Theory of Capital and Investment Decisions** Among other decisions, a firm must carefully evaluate its investment decisions an allocate its capital sensibly. Various theories pertaining to capital and investments offer scientific criteria for choosing investment projects.. **(vii) Profit Analysis** Profits depend on many factors like changing prices, market conditions, etc. The profit theories help firms in measuring and managing profits under such uncertain conditions. Further, they also help in planning future profits. **(viii) Risk and Uncertainty Analysis** Most businesses operate under a certain amount of risk and uncertainty. Also, analysing these risks and uncertainties can help firms in making efficient decisions and formulating plans. **BASIS FOR COMPARISON** **MICROECONOMICS** **MACROECONOMICS** -------------------------- ----------------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------------------------- **Meaning** The branch of economics that studies the behavior of an individual consumer, firm, family is known as Microeconomics. The branch of economics that studies the behavior of the whole economy, (both national and international) is known as Macroeconomics. **Deals with** Individual economic variables Aggregate economic variables **Business Application** Applied to operational or internal issues Environment and external issues **Tools** Demand and Supply Aggregate Demand and Aggregate Supply **Assumption** It assumes that all macro-economic variables are constant. It assumes that all micro-economic variables are constant. **Concerned with** Theory of Product Pricing, Theory of Factor Pricing, Theory of Economic Welfare. Theory of National Income, Aggregate Consumption, Theory of General Price Level, Economic Growth. **Scope** Covers various issues like demand, supply, product pricing, factor pricing, production, consumption, economic welfare, etc. Covers various issues like, national income, general price level, distribution, employment, money etc. **Law of demand** **Law of demand states that there is an inverse relation between the price of a commodity and its quantity demanded, assuming all other factors affecting demand remain constant. It means that when the price of a good falls, the demand for the good rises and when price rises, the demand falls.** **Law of demand may be explained with the help of the following demand schedule and demand curve :** https://search-static.byjusweb.com/question-images/byjus/infinitestudent-images/ckeditor\_assets/pictures/215961/content\_709218.png **The above table and diagram show that as the price of the good reduces from Rs 5 to Rs 4, the demand for the good increases from 100 to 200 units.** **Assumption of the law of demand: The law of demand is valid only when all other factors determining demand like income of the buyers, price of related goods, tastes and preferences of the buyer etc. remain constant.** **Causes of the law of demand:** i. **Income effect: When the price of a commodity falls, the real income of the consumer, i.e., his purchasing power increases. As a result, he can now buy more of a commodity. This is called income effect. This causes increase in the quantity demanded of the good whose price falls.** ii. **Substitution effect: When the price of a commodity falls, it becomes relatively cheaper than others. This induces the consumer to substitute this cheaper commodity for the other goods which are relatively expensive. This is called as the substitution effect. This causes increase in quantity demanded of the commodity whose price has fallen.** **Law of Demand Exceptions ** 1. **Giffen Goods: Giffen goods are inferior goods for which the quantity demanded increases when the price of the good increases. This is because these goods are considered essential, and when their price increases, consumers may have to cut back on purchasing other goods, including higher-quality substitutes, in order to continue buying the Giffen goods.** 2. **Veblen Goods: Veblen goods are luxury goods for which the quantity demanded increases when the price of the goods increases. This is because these goods are associated with social status and prestige, and as such, consumers may perceive them as more desirable as their price increases.** 3. **Essential Goods: For essential goods, such as life-saving medicines, consumers may be willing to pay a higher price regardless of the quantity demanded, as their demand for the good is not impacted by changes in price.** 4. **Expectations: Consumer expectations about future prices or economic conditions can also impact the Law of Demand, as consumers may be willing to buy more of a product now in anticipation of future price increases, or may reduce their demand for a product now in anticipation of future price decreases.** **Elasticity of demand** Elasticity of demand or the degree of responsiveness of demand by comparing the percentage price changes with the quantities demanded. In other words elasticity of demand shows degree of responsiveness by a consumer when prices are changed. The variables on which demand can depend on are: - Price of the commodity - Prices of related commodities - Consumer's income,  **[Price Elasticity]** The price elasticity of demand is the response of the quantity demanded to change in the price of a commodity. It is assumed that the consumer's income, tastes, and prices of all other goods are constant. It is measured as a percentage change in the quantity demanded divided by the percentage change in price. Therefore,  Price Elasticity=Ep=Percentage change in quantity demanded / Percentage change in price **[Income Elasticity]** The [income elasticity](https://www.toppr.com/guides/business-economics/theory-of-demand/income-elasticity-of-demand/) of demand is the degree of responsiveness of the quantity demanded to a change in the consumer's income. Symbolically, EI=Percentage change in quantity demanded / Percentage change in income **[Cross Elasticity]** The [cross elasticity of demand](https://www.toppr.com/guides/business-economics/theory-of-demand/cross-elasticity-of-demand/) of a commodity X for another commodity Y, is the change in demand of commodity X due to a change in the price of commodity Y. Symbolically,  **[Measurement of elasticity ]** **1. Percentage Method:** It is the most common method for measuring price elasticity of demand (E~d~). This method was introduced by Prof. Marshall. This method is also known as 'Flux Method' or 'Proportionate Method' or 'Mathematical Method'. According to this method, elasticity is measured as the ratio of percentage change in the quantity demanded to percentage change in the price. **Elasticity of Demand (E~d~) = Percentage change in Quantity demanded / Percentage change in Price** **Proportionate Method:** The percentage method can also be converted into the proportionate method. Putting the values of 1, 2, 3 and 4 in the formula of percentage method, we get: clip\_image002 Q = Initial Quantity demanded Q~1~ = New Quantity demanded ∆Q = Change in the Quantity demanded P = Initial Price P~1~ = New Price ∆P = Change in Price **2. Geometric Method:** Geometric method was suggested by Prof. Marshall and is used to measure the elasticity at a point on the demand curve. When there are infinitely small changes in price and demand, then the 'Geometric Method' is used. This method is also known as 'Graphic Method' or 'Point Method' or 'Arc Method'. Elasticity of demand (E~d~) is different at different points on the same straight line demand curve. Elasticity of Demand (E~d~) = Lower segment of demand curve (LS) / Upper segment of demand curve (US) As seen in Fig. 4.1, elasticity at a particular point 'N' is calculated as NQ/NP. Similarly, elasticity of demand on different points of a straight line demand curve is shown in Fig. 4.2: clip\_image006 **[Types of price elasticity ]** **1. Unitary Elastic Demand ed=1** **2. Highly Elastic Demand ed\>1** **3. Less Elastic Demand ed\ 1: The supply is elastic. 4. Es\ - **Perfectly Elastic Supply:** When the supply elasticity is limitless, it is said to be perfectly elastic. This indicates that even a slight rise in price increases the supply to infinity. For any change in the amount delivered, the % change in the price is zero for an utterly elastic supply. - **Smaller than Unit Elastic Supply:** When a commodity's supply change is less than the change in its price, we say it has a substantially less elastic supply. The price elasticity of supply is \ - **Perfectly Inelastic Supply:** When the % change in the amount delivered is zero regardless of the change in the price, the supply is said to be perfectly inelastic. Exclusive products are subject to this form of supply elasticity of pricing---for instance, a designer gown styled by a celebrity. - **More than Unit Elastic Supply:** A commodity's price elasticity of supply is more significant than one when the % change in supply exceeds the % change in price. **Factors that affect the Elasticity of supply** - **Number of Businesses**: When there are many firms, the supply is more likely to be elastic. This happens because other businesses can cover the supply gap. - **Time:** As the price elasticity of supply rises, producers will increase the amount provided by a more significant proportion than the price rises. - **Marginal Cost:** The rate of output production will be limited if the cost of producing one more unit or Marginal Costs rise rapidly with output, i.e. Price Elasticity of Supply will be inelastic. This means that the quantity supplied % changes are more minor than the price change. On the other hand, supply will be elastic if the Marginal Cost grows slowly. - **Factors of Production Mobility:** When factors of production are mobile, supply price elasticities are more significant. This means that labour and other industrial inputs might be imported from other parts of the world to boost output swiftly.