Introduction To

Managerial Economics

1
 Contents

Definition of Economics
Difference between micro and
macro economics
Managerial economics
Decision making

2
 Economics
Economics is a social science
concerned with the allocation of
scarce means in such a manner that
consumers can maximize their
satisfaction
producers can maximize their profits
and
society can maximize their social
welfare.

3
 Difference Between Micro And Macro economics

Microeconomics Macroeconomics
Difference in the Studies problem Studies problem of all
degree of aggregation relating to a single firms in an economy
unit
Difference in the Optimum allocation of Full employment and
focus resources growth of the
resources
Different importance Main determinant of Main determinant of
to price and income the problems is price the problems is
income
Difference in the Partial equilibrium General equilibrium
method of study analysis analysis

Different assumptions Full employment, Assumes optimum

total output and total allocation of the
expenditure are fixed resources to know full
to know optimum employment
allocation of 4
Managerial Economics

Managerial economics is the

application of economic
theory and quantitative
methods to the managerial
decision making process.

5
 Economic concept and techniques to solve
managerial problems
Management Decision sciences
Economic concept
Decisions Problems Tool and techniques
Frame work for
Product price and of analysis
decisions
Theory of consumer output Numerical analysis
Production technique Statistical
behavior
Inventory level estimation
Theory of the firm
Advertising media and Forecasting
Theory of market
intensity optimization
structure
Labour hiring and
training
Investment and
financing

Managerial Economics
Use of economics concept and decision
sciences methodology to solve
managerial decision problems

Optimal solutions to managerial

decision problems 6
Nature Of Managerial Economics

Application of
economic theory
Management
decision problem
Manageri
Descriptive al
Optimum
and economic
solutions to
prescriptive s
specific
organization
al objectives
Decision making
sciences

7
 Scope of managerial
economics
Demand analysis and forecasting
Production function
Cost analysis
Inventory management
Advertising
Price system
Resource allocation
Capital management/ Budgeting
Profit management
8
 Importance

Utilization of natural and man made

resources
Solving economic problems
Application of traditional economics
Use of ideas from other subjects
Variety of business decisions
Revenue to government
Social benefits
Advertising media
9
 Decision Making

Decision making refers to the

choices between courses of action or
strategy
Managerial decision making is the
process of selecting one alternative
from two or more alternative courses
of action

10
 Process of decision
making
Determining the
objective

Defining the problem

Identifying possible
solutions Consider
Consider Predicting the legal and
input consequences other
constraints constraints
Selecting the best
possible solution

Implement the decision

11
 Importance

Importance of product decision

Importance of product method
decision
Importance of prices and
quantitative decisions
Importance of promotional strategy
decisions
Importance of locational decisions
12
Cardinal utility
analysis
The cardinal utility approach

The question to begin with is : Why

does a consumer desire a
commodity?
MARSHALL thought, it is because it
gives the consumer utility or
satisfaction or happiness or
subjective sensation from the act of
consuming the commodity.
UTILITY is thus a measure of
satisfaction that a consumer
receives from the consumption of a
 Concepts of Utility
Initial Utility : derived from the first Unit of
Commodity .
Total Utility : Aggregate of Utilities obtained
from the consumption of different units of a
commodity .
TU x =f {Q x}
Marginal utility: change that takes place in total
utility by the consumption of an additional unit
of commodity.
MU nth= T n Tn-1
Can be positive, negative or zero.
Total utility curve

As the Quantity demanded increases

total utility curve increases to a
certain point, reaches an equilibrium
and then starts decreasing.
Assumptions

The Marshallian theory of demand is based on

the following set of assumptions:
The consumer behaves rationally
Utility is a cardinal concept
Marginal utility of money remains constant
The proportion of income spent on each
product is very small
Utility is independent
 The consumer is never satiated with a
commodity
Consumers tastes remain same
Consumers income is constant and the money
income is spent in the same period
Each consumer forms a tiny part of the market.
The consumer behavior is subject to law of
diminishing marginal utility
 Law of diminishing marginal
utility

According to MARSHALL," The

additional benefit which a person
derives from a given stock of a
thing diminishes with every
increase in the stock that he
already has
Units consumed in Total Utility in Marginal Utility
units) units) in units)
1 10 10
2 18 8
3 23 5
4 25 2
5 25 0
6 23 -2
7 18 -5
rationale BEHIND THE LAW

After sufficient units of a commodity

have been consumed, a consumer
experiences diminishing marginal
utility for the additional units
consumed,i.e additional utility from
each additional unit of a commodity
goes on diminishing. The total utility
will be increasing but at a
diminishing rate.
Causes of its application

Commodities are imperfect

substitutes
Satiability of particular wants
Alternative uses
Derivation of demand curve from the
law of diminishing marginal utility
CRITICISM OF THE LAW

Cardinal measurement of utility is

not possible.
Marginal utility of money is not
constant.
Every commodity is not an
Independent commodity.
Marginal utility cannot be estimated
in all conditions.
Unrealistic assumptions.
INDIFFERENCE CURVE
APPROACH OR
ORDINAL UTILITY APPROACH
ORDINAL UTILITY
APPROACH
Givenby Edgeworth and Pareto and
the concept is further developed by
R.G.D. Allen and J.R. Hicks in 1934

Based upon comparability of utilities

Express according to the preference
of the consumer for different goods.
INDIFFERENCE
SCHEDULE
It is a set of combination of two
commodities which offer a consumer the
same level of satisfaction. So that he is
indifferent between these combinations.
COMBINATION
OF APPLES APPLES ORANGES
AND ORANGES
A 1+ 10

B 2+ 7

C 3+ 5

D 4+ 4
INDIFFERENCE CURVE

DEFINITION:-
An indifference curve is a curve
which represents different
combinations of two goods which
yield equal satisfaction to the
consumer and he is indifferent in the
matter of choice among them.
Contd.
Y

A
COMMODITY Y

C
D
INDIFFERENC
E CURVE

X
O COMMODITY X
INDIFFERENCE MAP

Indifferencemap is that graph which

represents a group of indifference
curves each of which expresses a
given level of satisfaction.
Contd..

IC5 > IC4 > IC3 >

IC2> IC1
COMMODITY Y

INCREASING
UTILITY (LEVEL OF
SATISFACTION)

IC5
IC4
IC
IC 3
IC 2
1 X
O COMMODITY X
MARGINAL RATE OF
SUBSITUTION
The rate at which consumer can substitute
one good for another without changing the
level of satisfaction.
e.g in order to get one more unit of apple a consumer
gives up three units of oranges. Marginal rate of
substitution of apple for orange is 1:3

Satisfaction gained of apples = Satisfaction lost of

oranges
 LAW OF DIMINISHING MARGINAL
RATE OF SUBSTITUTION

Y
COMBIN APPLES ORANGE MARGIN
ATIONS S AL RATE
OF 1 A
SUBSTIT 0
UTION

ORANGES
A 1 10 _ B(1:3
7
) C(1:2
B 2 7 1:3
5 ) D(1:1)
C 3 5 1:2 4
D 4 4 1:1
O 1 2 3 4 5 X
6
APPLES
ASSUMPTIONS OF INDIFFERENCE
CURVE ANALYSIS

Rational consumer
Ordinal utility
Diminishing rate of substitution
Non satiety
Consistency in selection
Transitivity
PROPERTIES OF
INDIFFERENCE CURVES
Y

An indifference curve
generally slopes

COMMODITY Y
downward from left to
right

Convex to the point of

origin
O COMMODITY
X
X
 HIGHER INDIFFERENCE CURVE
INDICATES HIGHER SATISFACTION
Y

OT >
OS
COMMODITY Y

A B C

IC
2
IC
1
X
O S T
COMMODITY
 TWO INDIFFERENCE CURVES NEVER
INTERSECT EACH OTHER
Y
COMMODITY Y

B C
IC2

IC1
X
O
COMMODITY
 INDIFFERENCE CURVES NEED NOT BE
PARALLEL TO EACH OTHER
COMMODITY Y Y

IC
3
IC
IC 2
1
O X
COMMODITY
X
PRICE LINE OR BUDGET
LINE
The budget line
shows all the
different Y

combinations of
two goods that a
consumer can
purchase given his
money income GOOD

and price of two

2

commodities

X
O
GOOD 1
CONSUMERS
EQUILIBRIUM
It refers to a situation in which a consumer with
given income and given prices purchases such a
combination of goods which gives him maximum
satisfaction and he is not willing
Y to make any
change in it.

GOOD
A
L

O S
GOOD 1 X
SHIFTING OF THE PRICE
LINE
DUE TO CHANGE IN THE PRICE OF
ONE COMMODITY
DUE TO CHANGE IN INCOME
 DUE TO CHANGE IN THE PRICE OF ONE
COMMODITY
Y

A
COMMODITY Y

X
O B C D
COMMODITY
 DUE TO CHANGE IN INCOME

Y
COMMODITY Y

X
O B D
COMMODITY
X
PRICE CONSUMPTION
CURVE Y

A
COMMODITY Y

E3
E1 E2
IC3
IC2
IC1
X
O B C D
COMMODITY
X
INCOME CONSUMPTION
CURVE Y

C
COMMODITY Y

A
E3

E2
E1 IC3
IC2
IC1
X
O B D F
COMMODITY
X
SLOPES OF INCOME
CONSUMPTION
Y
CURVE
ICC
2
ICC
COMMODITY

ICC
1
Y

X
O
COMMODITY X
Contd
Y

ICC
2
COMMODITY Y

ICC
1

X
O COMMODITY
X
PRICE EFFECT

Effect of change in commodity price on

its quantity demanded is called price
effect. It is split into two components:
1. Income effect:- Change in consumption of
the good due to change in income of the
consumer.
2. Substitution effect:- Change in the
quantity of good. purchased due to change in
their relative prices alone, while real income
of the consumer remains the same.
NORMAL GOODS
Y

PRICE EFFECT : L1 L2
A SUBSTITUTION EFFECT :
L1 L3
INCOME EFFECT : (-)L3
C L2
E2
COMMODITY

E1

E3
IC 2
Y

IC 1

X
O L1 L3 L2 B
C B

COMMODITY X
INFERIOR GOODS
Y

PRICE EFFECT : L1 L2
SUBSTITUTION EFFECT :
A L1 L3
INCOME EFFECT : (-)L3
L2
C
COMMODITY

E2
E1
IC 2
E3
Y

IC 1

X
O L L2 L3 B C B
1COMMODITY X
GIFFENS GOODSY

A
PRICE EFFECT : L1 L2
E2 SUBSTITUTION EFFECT :
C L1 L3
INCOME EFFECT : (-)L3
COMMODITY

L2
E1
IC 2
E3
Y

IC 1

X
O L2L1L3 B
C B

COMMODITY X