Economics and

Accounting for Engineers

Dr. Y RK PRASAD
Unit-1: Introduction & Demand Analysis: Definition and Scope: Introduction to
Economics, Nature and Scope of Managerial Economics. Demand Analysis:
Demand Determinants, Law of Demand and its exceptions. Elasticity of Demand:
Definition, Types, Measurement and Significance of Elasticity of Demand.
Demand Forecasting, Factors governing demand forecasting, methods of demand
forecasting.
Why to Study Economics
 To understand the world better: You’ll begin to understand the cause of many of
the things that affect your life
 To gain self-confidence: You’ll lose that feeling that mysterious, inexplicable
forces are shaping your life for you
 To achieve social change: You’ll gain tools to understand origins of social
problems and design more effective solutions
 To help prepare for other careers: You’ll discover that a wide range of careers
deal with economic issues on many levels
 Unit-1: Introduction & Demand Analysis

 What is “Economics”?

 What is ‘ Micro and Macro economics?

 What is Managerial Economics?

 Nature, scope and significance of Managerial Economics

 Demand Analysis

 Law of demand

 Demand Elasticity (Simple problems)

 Demand Forecasting
Economics is a social science, which studies human behaviour in relation to optimizing allocation of
available resources to achieve the given goals.
Eg : Individual household behaviour, firm, industry and nation Economics is also a study of choice-
making behaviour of the people.
Economics is the science that deals with production, exchange and consumption of various
commodities in economic systems. It shows how scarce resources can be used to increase wealth and
human welfare. The central focus of economics is on scarcity of resources and choices among their
alternative uses.
 ECONOMICS is all about making choice out of given resources which are limited and
have different use in order to satisfy human wants

 ECONOMY is an entire network of producers , distributors , and consumers of goods

and services in a local , regional , or national community
DEFINITIONS OF ECONOMICS
Several economists have defined economics taking different aspects into account. The word
‘Economics’ was derived from two Greek words, oikos (a house) and nemein (to manage) which
would mean ‘managing an household’ using the limited funds available, in the most satisfactory
manner possible.
Many economist define economics in different ways . The set of definitions given by different
economists can broadly be classified into the following four categories :-
1. WEALTH - ADAM SMITH
2. MATERIAL WELFARE – ALFREED MARSHALL
3. SCARCITY – LIONEL ROBBINS
4. GROWTH - PAUL. A. SAMUELSON
Adam Smith’s Wealth Definition:

Adam smith is also known as ‘father of modern economics’. Adam smith born in 1723 and write a book
on economics in 1774 and published in 1776. The book written by him ‘AN INQUIRY INTO THE
NATURE AND CAUSE OF WEALTH OF NATION’

He defines ‘Economics is an enquiry into the factor that determine the wealth of a country
and its growth’.
 He emphasised the production and expansion of wealth as the subject matter of economics.
 Economics as a science of wealth which studies the process of production, consumption and
accumulation of wealth
Economics is an enquiry into the nature and causes of wealth of nation / firms / individuals

Criticism : This definition is not a precise. It gives importance to wealth rather than production or
human and social welfare
Marshall’s Welfare Definition:

Alfred Marshall defines ‘Economics’ in his book - ‘Principal of Economics- published in 1890’
and emphasis on human activities or human welfare rather than on wealth.

He define as ‘Economics is a mankind of ordinary business of life ,it enquiry how he gets his
income and how he spend it’
He argued that economics, on one side, is a study of wealth and, on the other, is a study of man.

The definitions is discarded by the Lionel Robbins by giving these point :-

 In economics we also study immaterial things welfare cannot be measured in terms of money
 Welfare definition makes economic a purely social science
 The concept of welfare is different in different countries and at different times
 The basic difference between Adam Smith’s and Alfred Marshall's definition is that Adam gives
stress on earning of money whereas Marshall gives importance to human welfare as motive
behind the economic activities of man.
Robbins’ Scarcity Definition:
The most accepted definition of economics was given by Lord Robbins in 1932 in his book ‘An Essay on the
Nature and Significance of Economic Science. According to Robbins, neither wealth nor human welfare
should be considered as the subject-matter of economics.

His definition runs in terms of scarcity: “Economics is the science which studies human behaviour as a
relationship between ends and scarce means which have alternative uses.”

LIONEL ROBBINS DEFINE WITH THE HELP OF FOUR POINTS :-

1. HUMAN NEEDS ARE UNLIMITED .
2. RESOURCE(INCOME) ARE LIMITED.
3. ALTERNATIVE USE OF RESOURCE .
4. PROBLEM OF CHOICE

GROWTH - PAUL. A. SAMUELSON: Samuelson defines economic is the study of how man
and society choose , with or without use of money, to employ scarce resource which have
alternative uses ,to produce various commodities over time and distribute them for consumption
now and in future among various people and group of society.
 
In ancient period, whole economics theories were studied as a single economics, but modern economists have
divided the economics theories into two parts. Micro and Macro economics. These two words first used by
Ragnar Frisch in 1933.
What is Microeconomics and Macroeconomics :Micro means “ Small” and Macro means “Large”

Microeconomics Microeconomics studies the economics activities and behaviour of small individual units of the
economy. It means microeconomics can be defined as the study and analysis of the behaviour of individual
economic units.
For example: Microeconomic studies about the behaviour of an individual consumer, one producer, a firm, a
household, one industry and so on. It means microeconomics makes the microscopic study of small individual
units. In particular, microeconomics focuses on patterns of supply and demand and the determination of
price and output in individual markets

Macroeconomics on the other hand, deals with economy wide aggregates. Macroeconomics is a branch of
economics dealing with the performance, structure, behaviour and decision-making of an economy as a whole,
rather than individual markets.

This includes national, regional, and global economies. It is concerned with nature, relationship and
behaviour of such aggregate quantities and averages as national income, total consumption, savings,
investment, total employment, general price level aggregate expenditure and aggregate supply of goods
and services.
Positive Economics
Positive economics is a stream of economics that focuses on the description, quantification, and
explanation of economic developments, expectations, and associated phenomena. It relies on objective
data analysis, relevant facts, and associated figures. It attempts to establish any cause-and-effect
relationships or behavioural associations which can help ascertain and test the development of
economics theories.

Positive economics is objective and fact-based where the statements are precise, descriptive, and
clearly measurable. These statements can be measured against tangible evidence or historical
instances. There are no instances of approval-disapproval in positive economics.

Normative Economics
Normative economics focuses on the ideological, opinion-oriented, prescriptive, value judgments, and
"what should be" statements aimed toward economic development, investment projects, and
scenarios. Its goal is to summarize people's desirability (or the lack thereof) to various economic
developments, situations, and programs by asking or quoting what should happen or what ought to be.

Normative economics is subjective and value-based, originating from personal perspectives,

feelings, or opinions involved in the decision-making process. Normative economics statements are
rigid and prescriptive in nature.
 What is Managerial Economics?

• Managerial Economics can be defined as: ‘Amalgamation of economic

theory with business practices so as to ease decision-making and future
planning by management.’

• Managerial Economics assists the managers of a firm in a rational solution

of obstacles faced in the firm’s activities.
 Purpose of Managerial Economics
Managerial Economics may be defined as the study of economic theories, logic and methodology which
are generally applied to seek solution to the practical problems of business. Managerial Economics is
thus constituted of that part of economic knowledge or economic theories which is used as a tool of
analysing business problems for rational business decisions. Managerial Economics is often called as
Business Economics or Economic for Firms.

How to produce? For whom to

What to produce? produce?

The purpose of use of Managerial Economics principles in a firm is to answer these questions. Let us try to
understand how a manager can use Managerial Economics principles to answer the three questions.
 Introduction to Managerial Economics

Definitions of Managerial Economics?

“Integration of economic theory with business practice for the purpose of facilitating decision-making
and forward planning” - Milton H. Spencer

“Managerial Economics is economics applied in decision making. It is a special branch of economics

bridging the gap between abstract theory and managerial practice” – Willian Warren Haynes, V.L.
Mote, Samuel Paul

“Managerial economics is the study of the allocation of scarce resources available to a firm or other
unit of management among the activities of that unit” - Willian Warren Haynes, V.L. Mote, Samuel
Paul

“Managerial economics is concerned with application of economic concepts and economic analysis to
the problems of formulating rational managerial decision.” – Mansfield
 Introduction to Managerial Economics

BUSINESS ADMINISTRATION

DECISION PROBLEMS

TRADITIONAL ECONOMICS : DECISION SCIENCES :

THEORY AND METHODOLOGY TOOLS AND TECHNIQUES

MANAGERIAL ECONOMICS :
INTEGRATION OF ECONOMIC
THEORY AND
METHODOLOGY WITH TOOLS
AND TECHNICS BORROWED
FROM OTHER DECIPLINES

OPTIMAL SOLUTIONS TO
BUSINESS PROBLEMS
 Introduction to Managerial Economics
Nature, Scope and Significance of Managerial Economics:
 Micro Economic Frame work
 Managerial Economics is normative approach
  Integration of economic theory and business practice
  Applied in Nature
  Assumptions and limitations
  Profits
  Optimization
  Interdisciplinary Nature
Scope of managerial economics: The scope of managerial economics is not yet clearly laid out
because it is a developing science. Even then the following fields may be said to generally fall under
Managerial Economics:
1. Demand Analysis and Forecasting
2. Cost and Production Analysis
3. Pricing Decisions, Policies and Practices
4. Profit Management
5. Capital Management
1.Demand Analysis and Forecasting: A business firm is an economic organisation which is engaged in transforming
productive resources into goods that are to be sold in the market. A major part of managerial decision making depends on
accurate estimates of demand. A forecast of future sales serves as a guide to management for preparing production
schedules and employing resources. It will help management to maintain or strengthen its market position and profit base.
Demand analysis also identifies a number of other factors influencing the demand for a product. Demand analysis and
forecasting occupies a strategic place in managerial economics.
 
2.Cost and production analysis: A firm’s profitability depends much on its cost of production. A wise manager would
prepare cost estimates of a range of output, identify the factors causing are cause variations in cost estimates and choose
the cost-minimising output level, taking also into consideration the degree of  uncertainty in production and cost calculations.
Production processes are under the charge of engineers but the business manager is supposed to carry out the production
function analysis in order to avoid wastages of materials and time. Sound pricing practices depend much on cost control.
The main topics discussed under cost and production analysis are: Cost concepts, cost-output relationships,

Economics and Diseconomies of scale and cost control.

3.Pricing decisions, policies and practices: Pricing is a very important area of Managerial Economics.
In fact, price is the genesis of the revenue of a firm ad as such the success of a business firm largely depends on
the correctness of the price decisions taken by it. The important aspects dealt with this area are: Price
determination in various market forms, pricing methods, differential pricing, product-line pricing and
price forecasting.
 

4.Profit management: Business firms are generally organized for earning profit and in the long period,
it is profit which provides the chief measure of success of a firm. Economics tells us that profits are the reward
for uncertainty bearing and risk taking. A successful business manager is one who can form more or less correct
estimates of costs and revenues likely to accrue to the firm at different levels of output. The more successful a
manager is in reducing uncertainty, the higher are the profits earned by him. In fact, profit-planning and profit
measurement constitute the most challenging area of Managerial Economics.
 
  
 5.Capital management: The problems relating to firm’s capital investments are perhaps the most
complex and troublesome. Capital management implies planning and control of capital
expenditure because it involves a large sum and moreover the problems in disposing the capital
assets off are so complex that they require considerable time and labour. The main topics dealt with
under capital management are cost of capital, rate of return and selection of projects.
 
Conclusion: The various aspects outlined above represent the major uncertainties which a business
firm has to reckon with, viz., demand uncertainty, cost uncertainty, price uncertainty, profit
uncertainty, and capital uncertainty. We can, therefore, conclude that the subject-matter of
Managerial Economics consists of applying economic principles and concepts towards adjusting
with various uncertainties faced by a business firm.
 
 Demand Analysis
Demand analysis is a research done to estimate or find out the customer demand for a product
or service in a particular market. Demand analysis is one of the important consideration for a
variety of business decisions like determining sales forecasting, pricing products/services,
marketing and advertisement spending, manufacturing decisions, expansion planning etc.

Demand analysis covers both future and retrospective analysis so that they can analyse the
demand better and understand the product/service's past success and failure too.

A market is a place where we buy and sell goods and services. A buyer demands goods and
services from the market and the sellers supply the goods in the market. In economics, demand
is “the quantity of goods and services that will be bought for a given price, place over a
period of time”.

This is one of the most important managerial factors because it assists the managers in
predicting changes in production and input prices. The manager can take better decisions
regarding the kind of product to be produced, the quantity, the cost of the product and its selling
price.
Demand: Demand means the ability and willingness to buy a specific quantity of a commodity at
the prevailing price in a given period of time. Therefore, demand for a commodity implies the
desire to acquire it, willingness and the ability to pay for it.
Demand in economics is how many goods and services are bought at various prices during a
certain period of time. Demand is the consumer's need or desire to own the product or experience
the service. It's constrained by the willingness and ability of the consumer to pay for the good or
service at the price offered.
Determinants of Demand: There are various factors affecting the demand for a commodity. They are:

1. Price of the good: The price of a commodity is an important determinant of demand. Price and demand are
inversely related. Higher the price less is the demand and vice versa.

2. Price of related goods: The price of related goods like substitutes and complementary goods also affect the
demand.

3. Consumer’s Income: This is directly related to demand. A change in the income of the consumer
significantly influences his demand for most commodities
4. Taste, preference, fashions and habits: These are very effective factors affecting demand for a commodity. When there is a
change in taste, habits or preferences of the consumer, his demand will change.
5. Population: If the size of the population is more, demand for goods will be more. The market demand for a commodity
substantially changes when there is change in the total population.
6. Money Circulation: More the money in circulation, higher the demand and vice versa.
7. Value of money: The value of money determines the demand for a commodity in the market. When there is a rise or fall in
the value of money there may be changes in the relative prices of different goods and their demand.
8. Weather Condition: Weather is also an important factor that determines the demand for certain goods.
9. Advertisement and Salesmanship: If the advertisement is very attractive for a commodity, demand will be more. Similarly
if the salesmanship and publicity is effective then the demand for the commodity will be more.
10. Consumer’s future price expectation: If the consumers expect that there will be a rise in prices in future, he may buy more
at the present price and so his demand increases.
11. Government policy (taxation): High taxes will increase the price and reduce demand, while low taxes will reduce the price
and extend the demand.
12. Credit facilities: Depending on the availability of credit facilities the demand for commodities will change. More the
facilities higher the demand.
13. Multiplicity of uses of goods: if the commodity has multiple uses then the demand will be more than if the commodity is
used for a single purpose.
 Law of Demand

The law of demand governs the relationship between the quantity demanded and the price. This economic principle
describes that, if the price goes up, people buy less. The reverse is, of course true, if the price drops, people buy
more. But, price is not the only determining factor. Therefore, the law of demand is only true if all other determinants
don't change.

According to Marshall : The law of demand states that, all other things being equal, the quantity bought of a
good or service is a function of price. As long as nothing else changes, people will buy less of something when
its price rises. They'll buy more when its price falls. 

The Demand Function, Schedule and Demand Curve:

The demand function specifies the relation between the quantity demanded and all variable that determines
demand.

The demand schedule is a mathematical expression of law of demand. It express the relationship between the price
of commodity and quantity demanded.

The demand curve is the part of the demand function that express the relation between the prices charged for a
Demand Equation or Function: This equation expresses the relationship between demand and its five
determinants:

QD = f (price, income, prices of related goods, tastes, expectations, etc….)

It says that the quantity demanded of a product is a function of all the factors: price, income of the buyer, the
price of related goods, the tastes of the consumer and any expectation the consumer has of future supply,
prices, etc.

Demand schedule and demand curve

 A demand schedule is a table that shows the quantity demanded at each price.

 A demand curve is a graph that shows the quantity demanded at each price. Sometimes the demand curve is
also called a demand schedule because it is a graphical representation of the demand schedules.
 Demand schedule and demand curve
PRICE (Rs) Quantity Demanded In the table, we can see that when the price of the
(units)
12 10 commodity is Rs. 12/- per unit, the consumer
10 20 purchases 10 units of the commodity. When the
8 30
price of the commodity falls to Rs. 10/-, he
6 40
4 50 purchases 20 units of the commodity. Similarly,
2 60 when the price further falls, quantity demanded
by him goes on rising until the price Rs. 2/- the
quantity demanded by him rises to 60 units.
 

We can convert this demand schedule into a

demand curve by graphical plotting the various
prices – quantity combinations. The demand curve
slope downward left to right, because of demand
determinants
 Market demand Schedule and Market demand curve:
 For managerial decision-making the primary focus of managerial economist is market demand. The aggregate
and total individual demands constituted as market demand. The relation between demand and all factors that
influence its level i.e. the market demand function for a product is a statement of the relation between the
aggregate quantity demanded and all factors that affect this quantity
PRICE INDIVIDUAL(A) INDIVIDUAL(B) TOTAL MARKET QUANTITY
( A& B) DEMANDED
OP1 ( 20 ) 2 3 5 OQ1 – 5
 
OP2 ( 10 ) 4 6 10 OQ2 - 10
 Exceptions to the Law of Demand
Definition: There are certain situations where the law of demand does not apply or becomes ineffective,
i.e. with a fall in the price the demand falls and with the rise in price the demand rises are called as
the exceptions to the law of demand.
1. Giffen Goods:
Some special varieties of inferior goods are termed as Giffen goods. Cheaper varieties millets like Millet,
cheaper vegetables like potato etc come under this category. Sir Robert Giffen of Ireland first observed
that people used to spend more of their income on inferior goods like potato and less of their income on
meat. After purchasing potato the staple food, they did not have staple food potato surplus to buy meat. So
the rise in price of potato compelled people to buy more potato and thus raised the demand for potato. This
is against the law of demand. This is also known as Giffen paradox.

2. Conspicuous Consumption / Veblen Effect:

This exception to the law of demand is associated with the doctrine propounded by Thorsten Veblen. A few
goods like diamonds etc are purchased by the rich and wealthy sections of society. The prices of these goods
are so high that they are beyond the reach of the common man. The higher the price of the diamond, the
higher its prestige value. So when price of these goods falls, the consumers think that the prestige value of
these goods comes down. So quantity demanded of these goods falls with fall in their price. So the law of
3. Conspicuous Necessities: Certain things become the necessities of modern life. So we have to purchase them despite
their high price. The demand for T.V. sets, automobiles and refrigerators etc. has not gone down in spite of the increase in their
price. These things have become the symbol of status. So they are purchased despite their rising price.

4. Ignorance: Often people are misconceived as high-priced commodities are better than the low-priced commodities and
rest their purchase decision on such a notion. They buy those commodities whose price are relatively higher than the substitutes

5. Emergencies: During emergencies such as war, natural calamity- flood, drought, earthquake, etc., the law of demand
becomes ineffective. In such situations, people often fear the shortage of the essentials and hence demand more goods and
services even at higher prices.

6. Future Changes in Prices: Households also act as speculators. When the prices are rising households tend to
purchase large quantities of the commodity out of the apprehension that prices may still go up. When prices are expected to fall
further, they wait to buy goods in future at still lower prices. So quantity demanded falls when prices are falling.

7. Change in Fashion: A change in fashion and tastes affects the market for a commodity. When a digital camera replaces
a normal manual camera, no amount of reduction in the price of the latter is sufficient to clear the stocks. Digital cameras on the
other hand, will have more customers even though its price may be going up. The law of demand becomes ineffective.
 
8. Demonstration Effect: It refers to a tendency of low income groups to imitate the consumption pattern
of high income groups. They will buy a commodity to imitate the consumption of their neighbors even if they do
not have the purchasing power.

9. Snob Effect: Some buyers have a desire to own unusual or unique products to show that they are different
from others. In this situation even when the price rises the demand for the commodity will be more.

10. Speculative Goods/ Outdated Goods/ Seasonal Goods: Speculative goods such as shares do
not follow the law of demand. Whenever the prices rise, the traders expect the prices to rise further so they buy
more. Goods that go out of use due to advancement in the underlying technology are called outdated goods. The
demand for such goods does not rise even with fall in prices

11. Seasonal Goods: Goods which are not used during the off-season (seasonal goods) will also be subject
to similar demand behaviour.

12. Goods in Short Supply: Goods that are available in limited quantity or whose future availability is
uncertain also violate the law of demand.
 Demand Distinctions: Types of Demand
Demand may be defined as the quantity of goods or services desired by an individual, backed by the ability and willingness
to pay.
Types of Demand:
1. Direct and indirect demand: (or) Producers’ goods and consumers’ goods: demand for goods that are directly used for
consumption by the ultimate consumer is known as direct demand (example: Demand for a T-shirts). On the other hand
demand for goods that are used by producers for producing goods and services. (Example: Demand for cotton by a textile
mill)
 

2. Derived demand and autonomous demand: when a produce derives its usage from the use of some primary product it is
known as derived demand. (Example: demand for tyres derived from demand for car) Autonomous demand is the demand
for a product that can be independently used. (Example: demand for a washing machine)
 

3. Durable and non-durable goods demand: durable goods are those that can be used more than once, over a period of
time (example: Microwave oven) Non-durable goods can be used only once (example: Band-Aid)
4. Firm and industry demand: firm demand is the demand for the product of a particular firm. (Example: Dove soap) The
5. Total market and market segment demand: a particular segment of the markets demand is called as segment demand
(example: demand for laptops by engineering students) the sum total of the demand for laptops by various segments in India is
the total market demand. (Example: demand for laptops in India)
6. Short run and long run demand: short run demand refers to demand with its immediate reaction to price changes and
income fluctuations. Long run demand is that which will ultimately exist as a result of the changes in pricing, promotion or
product improvement after-market adjustment with sufficient time.
7. Joint demand and Composite demand: when two goods are demanded in conjunction with one another at the same time
to satisfy a single want, it is called as joint or complementary demand. (Example: demand for petrol and two wheelers) A
composite demand is one in which a good is wanted for several different uses. (Example: demand for iron rods for various
purposes)
8. Price demand, income demand and cross demand: demand for commodities by the consumers at alternative prices are
called as price demand. Quantity demanded by the consumers at alternative levels of income is income demand. Cross
demand refers to the quantity demanded of commodity ‘X’ at a price of a related commodity ‘Y’ which may be a substitute or
complementary to X.
 9. New Demand and Replacement Demand: New demand refers to the demand for the new product and it is the addition to
the existing stock. In replacement the items is purchased to maintain the asset in good condition. Ex: Car and spare parts.
 Elasticity of Demand
In economics, the term elasticity means a proportionate (percentage) change in one variable relative to a proportionate
(percentage) change in another variable. The quantity demanded of a good is affected by changes in the price of the good,
changes in price of other goods, changes in income and changes in other factors. Elasticity is a measure of just how much of the
quantity demanded will be affected due to a change in price or income.

The concept of elasticity of demand is one of the original contribution of Dr. Marshall. He studied the concept of elasticity
of demand only with reference to price changes. Income & cross elasticity of demand fall outside the scope of his study.

The law of demand studies the inverse relationship between demand and price at low price demand will be more and at
high price demand is low. It tells us only the direction of change in price and quantity of demand.
 Elasticity of demand means the degree of responsiveness of demand due to change in price. If a small change in price a large
change in demand or consequent change in demand is known as elasticity of demand. A small change in price results in a large
change in demand, then the demand is elastic. A large change in price results only a small or slight change (effect) of demand,
the demand is inelastic.
The expression “how much is important” this indicated the concept of elasticity of demand is basically a question of
Definition of elasticity of demand
 Dr. A. F. Marshall defines “The elasticity of demand in a market is great or small according to 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”
From the above definition, it is clear elasticity of demand is primarily related to extension or contraction of
demand for a fall or rise in price. Hence it is referred to as price elasticity of demand.

Different types of elasticity of demand: According to the source of the change, the following types of
elasticity of demand can be mentioned:
 
1. Price Elasticity of Demand
2. Income Elasticity of Demand
3. Cross Elasticity of Demand (the elasticity in relation to the change of the price of other goods and
services)
4. Advertisement Elasticity of Demand (the elasticity in relation to the advertisement expenditure)
Price elasticity of demand (PED)
Price elasticity of demand is one of the important concepts of elasticity which is used to
describe the effects of change in price on quantity demanded. The measure of relative
responsiveness of quantity demand to price along a given demand curve is known as price
elasticity of demand (PED). Marshall had given a clear formulation of price elasticity as the
ratio of a relative change in quantity to a relative change in price.

Price Elasticity = Proportionate change in the Quantity demanded / Proportionate change in

price
Percentage change in quantity demanded
PED = ----------------------------------------------------
Percentage change in price
= [( Q2 – Q1)/ Q1] / [( P2 – P1)/ P1]

= [Δ Q / Q ] / [Δ P / P] ;
Therefore E (Pd) = [ΔQ / ΔP ] X [P/ Q]

PED = Price elasticity, P = Price, Q = Quantity, Δ Delta for change, ΔQ = change in quantity
demanded, ΔP = change in price.
Calculation of Price Elasticity of Demand

1. Suppose that price of a commodity falls down from Rs.10 to Rs.9 per unit and due to this, quantity
demanded of the commodity increased from 100 units to 120 units. What is the price elasticity of
demand?
Give that,
p= initial price= Rs.10
q= initial quantity demanded= 100 units
∆p=change in price=Rs. (10-9) = Rs.1
∆q=change in quantity demanded= (120-100) units = 20 units
Now,

The quantity demanded increases by 2% due to fall in price by Rs.1.

2. Determine the price elasticity of demand given that, the quantity demanded for product M is
1000 units at price of Rs. 100. The price declines to Rs. 50 and the quantity demanded increase
to 1500 units.
3. The demand for “Y” product priced Rs.10/unit and Rs. 8/unit is 200 and 400 units
respectively. Compute the point and arc elasticities.
 Types or degrees of price elasticity of demand
1. Perfectly Elastic Demand (EP = ∞)
The demand is said to be perfectly elastic if the quantity demanded increases infinitely (or by unlimited
quantity) with a small fall in price or quantity demanded falls to zero with a small rise in price. Thus, it is
also known as infinite elasticity. It does not have practical importance as it is rarely found in real life.

In the given figure, price and quantity demanded are measured along the Y-axis and X-axis respectively. The
demand curve DD is a horizontal straight line parallel to the X-axis. It shows that negligible change in price
causes infinite fall or rise in quantity demanded.
2. Perfectly Inelastic Demand (EP = 0)
The demand is said to be perfectly inelastic if the demand remains constant whatever may be the price
(i.e. price may rise or fall). Thus it is also called zero elasticity. It also does not have practical importance as
it is rarely found in real life.

In the given figure, price and quantity demanded are measured along the Y-axis and X-axis respectively. The
demand curve DD is a vertical straight line parallel to the Y-axis. It shows that the demand remains constant
whatever may be the change in price. For example: even after the increase in price from OP to OP2 and fall
in price from OP to OP1, the quantity demanded remains at OM.
3. Relatively Elastic Demand (EP> 1): The demand is said to be relatively elastic if the percentage
change in demand is greater than the percentage change in price i.e. if there is a greater change in
demand there is a small change in price. It is also called highly elastic demand or simply elastic demand.
For example: If the price falls by 5% and the demand rises by more than 5% (say 10%), then it is a case of
elastic demand. The demand for luxurious goods such as car, television, furniture, etc. is considered to be
elastic.

In the given figure, price and quantity demanded are measured along the Y-axis and X-axis respectively. The
demand curve DD is more flat, which shows that the demand is elastic. The small fall in price from OP to
4. Relatively Inelastic Demand (Ep< 1 )
The demand is said to be relatively inelastic if the percentage change in quantity demanded is less than
the percentage change in price i.e. if there is a small change in demand with a greater change in price. It
is also called less elastic or simply inelastic demand. For example: when the price falls by 10% and the
demand rises by less than 10% (say 5%), then it is the case of inelastic demand. The demand for goods of
daily consumption such as rice, salt, kerosene, etc. is said to be inelastic.

In the given figure, price and quantity demanded are measured

along the Y-axis and X-axis respectively. The demand curve DD is
steeper, which shows that the demand is less elastic.
The greater fall in price from OP to OP1 has led to small increase in demand from OM to OM1.
Likewise, greater increase in price leads to small fall in demand.
5. Unitary Elastic Demand ( Ep = 1)
The demand is said to be unitary elastic if the percentage change in quantity demanded is equal to the
percentage change in price. It is also called unitary elasticity. In such type of demand, 1% change in price
leads to exactly 1% change in quantity demanded. This type of demand is an imaginary one as it is rarely
applicable in our practical life.

In the given figure, price and quantity demanded are measured along Y-axis and X-axis respectively. The
demand curve DD is a rectangular hyperbola, which shows that the demand is unitary elastic. The fall in
price from OP to OP1 has caused equal proportionate increase in demand from OM to OM1. Likewise,
when price increases, the demand decreases in the same proportion.
2. Income elasticity of demand: Income elasticity of demand is the degree of responsiveness of
quantity demanded of a commodity due to change in consumer’s income, other things remaining constant. In
other words, it measures by how much the quantity demanded changes with respect to the change in income.

The income elasticity of demand is defined as the percentage change in quantity demanded due to
certain percent change in consumer’s income.
Expression of Income Elasticity of Demand

Where, EY = Elasticity of demand,

q = Original quantity demanded
∆q = Change in quantity demanded, y = Original consumer’s income, ∆y= Change in consumer’s income
Suppose that the initial income of a person is Rs.2000 and quantity demanded for the
commodity by him is 20 units. When his income increases to Rs.3000, quantity demanded by
him also increases to 40 units. Find out the income elasticity of demand.
Solution:

Here, q = 100 units

∆q = (40-20) units = 20 units
y = Rs.2000
∆y =Rs. (3000-2000) =Rs.1000
Now,

Hence, an increase of Rs.1000 in income i.e. 1% in income leads to a rise of 2% in quantity demanded.
Types of Income Elasticity of demand : Positive Income elasticity and Negative Income elasticity
1. Positive income elasticity of demand (EY>0)
If there is direct relationship between income of the consumer and demand for the commodity, then income
elasticity will be positive. That is, if the quantity demanded for a commodity increases with the rise in
income of the consumer and vice versa, it is said to be positive income elasticity of demand. For example: as
the income of consumer increases, they consume more of superior (luxurious) goods. On the contrary, as the
income of consumer decreases, they consume less of luxurious goods.

 Positive income elasticity can be further classified into three types:

Income elasticity greater then unity (EY > 1)

If the percentage change in quantity demanded for a commodity is greater than percentage change in
income of the consumer, it is said to be income greater than unity. For example: When the consumer’s
income rises by 3% and the demand rises by 7%, it is the case of income elasticity greater than unity.
In the given figure, quantity demanded and
consumer’s income is measured along X-axis and Y-
axis respectively. The small rise in income
from OY to OY1 has caused greater rise in the quantity

demanded from OQ to OQ1 and vice versa. Thus, the

demand curve DDshows income elasticity greater than
unity.
 Income elasticity  equal to unity (EY = 1)
If the percentage change in quantity demanded for a commodity is equal to percentage change in income of
the consumer, it is said to be income elasticity equal to unity. For example: When the consumer’s income
rises by 5% and the demand rises by 5%, it is the case of income elasticity equal to unity.

In the given figure, quantity demanded and consumer’s

income is measured along X-axis and Y-axis respectively.

The small rise in income from OY to OY1 has caused equal

rise in the quantity demanded from OQ to OQ1 and vice versa.

 Income elasticity less then unity (EY < 1)
If the percentage change in quantity demanded for a commodity is less than percentage change in

income of the consumer, it is said to be income greater than unity. For example: When the consumer’s
income rises by 5% and the demand rises by 3%, it is the case of income elasticity less than unity.

In the given figure, quantity demanded and consumer’s

income is measured along X-axis and Y-axis respectively.

The greater rise in income from OY to OY1 has caused

small rise in the quantity demanded from OQ to OQ1

and vice versa. Thus, the demand curve DD shows income elasticity less than unity.
2. Negative income elasticity of demand ( EY<0)
If there is inverse relationship between income of the consumer and demand for the commodity,
then income elasticity will be negative. That is, if the quantity demanded for a commodity decreases
with the rise in income of the consumer and vice versa, it is said to be negative income elasticity of
demand.
For example: As the income of consumer increases, they either stop or consume less of inferior
goods.

In the given figure, quantity demanded and consumer’s income is measured along X-axis and Y-axis
respectively. When the consumer’s income rises from OY to OY1 the quantity demanded of inferior
goods falls from OQ to OQ1 and vice versa. Thus, the demand curve DD shows negative income
elasticity of demand.
3. Zero income elasticity of demand ( EY=0)
If the quantity demanded for a commodity remains constant with any rise or fall in income of the
consumer and, it is said to be zero income elasticity of demand. For example: In case of basic necessary
goods such as salt, kerosene, electricity, etc. there is zero income elasticity of demand.

In the given figure, quantity demanded and consumer’s income is measured along X-axis and Y-axis
respectively. The consumer’s income may fall to OY1 or rise to OY2 from OY, the quantity demanded
remains the same at OQ. Thus, the demand curve DD, which is vertical straight line parallel to Y-axis
shows zero income elasticity of demand.
3. Cross Elasticity of Demand
Cross elasticity of demand is the ratio of percentage change in quantity demanded of a product to
percentage change in price of another product. It is used to measure how responsive the quantity
demanded of one product is to a change in price of another product.

Cross elasticity of demand indicates whether any two products are substitute goods, complementary
goods or independent goods. A positive cross elasticity of demand means that the products are
substitute goods. A negative cross elasticity of demand means that the products are complementary
goods. A near zero cross elasticity of demand means that the products are independent goods i.e.
quantity demanded of product A is not affected by any movement in price of product B.
Sign and Size to be taken into consideration: if sing is “+ ” it is Substitute and : if sing is “ - ” it
is Complement goods

Substitute Goods: When the cross elasticity of demand for product A relative to a change in price
of product B is positive, it means that in response to an increase (decrease) in price of product B,
the quantity demanded of product A has increased (decreased). Since A, say Coke, and B, say Sprite,
are substitutes, an increase in price of product B means that more people will consume A instead of B,
and this will increase the quantity demanded of product A. Increase in quantity demanded of product
A relative to increase in price of product B gives us a positive cross elasticity of demand.
Complimentary Goods: When the cross elasticity of demand for product A relative to change in price
of product B is negative, it means that the quantity demanded of A has decreased (increased) relative
to an increase (decrease) in price of product B. As A, say car, and B, say gas, are complimentary goods,
and an increase in price of B will reduce the quantity demanded of A. This is because people consume
both A and B as a bundle and an increase in price reduces their purchasing power and decreases quantity
demanded.
Description: With the consumption behaviour being related, the change in the price of a related good leads to
a change in the demand of another good. Related goods are of two kinds, i.e. substitutes and complementary
goods.

 In case the two goods are not related, the Coefficient of Cross Elasticity is zero.
 In case the two goods are substitutes for each other like tea and coffee, the cross price elasticity will
be positive, i.e. if the price of coffee increases, the demand for tea increases.
 On the other hand, in case the goods are complementary in nature like pen and ink, then the cross
elasticity will be negative, i.e. demand for ink will decrease if prices of pen increase or vice-versa.

Promotional Elasticity or Advertisement Elasticity Demand

 In the modern competitive or partial competitive market economy, advertising has a great signifi­cance.
Under advertising, various visible or verbal activities are done by the firm for the purpose of creating or
increasing demand for its goods or services. Informative advertising is very helpful for the consumer in
making rational purchase decisions.
But the extension of demand through advertising can be measured by advertising or promotional
elasticity of demand (EA) which measures the expected changes in demand as a result of change in
other promotional expenses. The demand for some goods is affected more by advertising such as the
demand for cosmetics. Following is the formula for advertising elasticity,

The elasticity of demand for a good should be positive because there is the possibility of extension
of demand and market for the good with advertising expenditure. The higher the value of this
elasticity, the greater will be the inducement of the firm to advertise that product. It is on the basis of
advertising elasticity that a firm decides how much to spend on advertising a product.
What Is Arc Elasticity?
Arc elasticity is the elasticity of one variable with respect to another between two given points. It is used when
there is no general function to define the relationship between the two variables.

Arc elasticity is also defined as the elasticity between two points on a curve. The concept is used in both
mathematics and economics.

In economics, there are two possible ways of calculating elasticity of demand—price (or point) elasticity of
demand and arc elasticity of demand. The arc price elasticity of demand measures the responsiveness of quantity
demanded to a price. It takes the elasticity of demand at a particular point on the demand curve, or between two
points on the curve.

One of the problems with the price elasticity of demand formula is that it gives different values depending on
whether price rises or falls.

To eliminate this problem, the arc elasticity can be used. Arc elasticity measures elasticity at the midpoint between
two selected points on the demand curve by using a midpoint between the two points. The arc elasticity of demand
can be calculated as:
Arc Ed = [(Qd2 – Qd1) / midpoint Qd] ÷ [(P2 – P1) / midpoint P]
Let’s calculate the arc elasticity following the example presented above:
•Midpoint Qd = (Qd1 + Qd2) / 2 = (40 + 60) / 2 = 50

•Midpoint Price = (P1 + P2) / 2 = (10 + 8) / 2 = 9

•% change in qty demanded = (60 – 40) / 50 = 0.4
•% change in price = (8 – 10) / 9 = -0.22
•Arc Ed = 0.4 / -0.22 = 1.82
When you use arc elasticities you do not need to worry about which point is the starting point and which
point is the ending point since the arc elasticity gives the same value for elasticity whether prices rise or
fall. Therefore, the arc elasticity is more useful than the price elasticity when there is a considerable change
in price.
 DEMAND FORECASTING

What is Demand Forecasting?: A forecast is an estimate of a future situation. Forecasting demand denotes an

estimation of the level of demand of the product at a future period under given circumstances. To put it very
simply, it is an “objective assessment of the future course of demand“.
 Definition of Demand Forecasting

According to Cundiff and Still, "Demand Forecasting is an estimate of Demand during a specified period. Which
estimate is tied to a proposed marketing plan and which assumes a particular set of uncontrollable and competitive
forces“
In the words of Prof. Philip Kotler. The company (sales) forecast is the expected level of company sales based on
a chosen marketing plan and assumed marketing environment“

According to Evan J. Douglas, "Demand forecasting may be defined as the process of finding values for demand
in future time periods."

The cost should be controlled by producing correct level of goods in the firm and also according to the demand
for those goods in the market. For the estimation of demand, demand forecasting is to be done by the firm.
The objectives of demand forecasting are divided into short
and long-term objectives, which are shown in Figure-1:
Types of Forecasting
From the point of view of “time span”, forecasting may be classified into two, viz.,

Short-term demand forecasting; and

Long-term demand forecasting.
 
1. Short-term Demand Forecasting: This is limited to short period not exceeding one year. It concerns with policies
relating to sales, purchases, pricing and finances. It is with reference to the existing production capacity of the firm.
Short-term demand forecasting is useful in taking adhoc decisions concerning the day-to-day working of the concern. Many
companies use forecasting for setting sales targets and for establishing controls and incentives. Knowledge of the short-term
forecasting helps in short-term planning.

2. Long-term forecasting: Long-term forecasting involves the assessment of long term demand for the product and involves
expansion of production units. A multi-product firm must ascertain not only the total demand situation, but also the demand for
different items.
Long-term forecasting involves the study of technological developments, economic trends and consumer preferences and
man-power planning, Long-term forecasting enables to take major strategic business decisions.
STEPS INVOLVED IN DEMAND FORECASTING

1.       Identification of business objectives: In the first stage we should know what is the aim of forecasting?
What we get or know from the forecasting? Estimation of factors like quantity and composition of demand for
goods, price to be quoted, sales planning and inventory control etc., are done in the first stage.
 2.       Determining the nature of goods under consideration: Different category of goods has their own
distinctive demand.  Example capital goods, consumer durables and non-durables goods in which category our
goods fall we should estimate.

 3.       Selecting a proper method of forecasting: There are different methods for demand forecasting. Which
is best suited method that we should select for doing demand forecasting?

 4.       Interpretation of results: The forecasting which is done by the managerial economist should be
interpreted in detailed manner. That means it should be easy to understand by the top management.
Various factors governing demand forecasting
For making a good forecast, it is essential to consider the various factors governing demand forecasting. These factors are
summarized as follows.
 1. Prevailing business conditions: While preparing demand forecast it becomes necessary to study the general economic
conditions very carefully. These include the price level changes, change in national income, per-capita income, consumption
pattern, savings and investment habits, employment etc.
 2. Conditions within the industry: Every business enterprise is only a unit of a particular industry. Sales of that business
enterprise are only a part of the total sales of that industry. Therefore, while preparing demand forecasts for a particular
business enterprise, it becomes necessary to study the changes in the demand of the whole industry, number of units within
the industry, design and quality of product, price policy, competition within the industry etc.
 3. Conditions within the firm: Internal factors of the firm also affect the demand forecast. These factors include plant
capacity of the firm, quality of the product, price of the product, advertising and distribution policies, production policies,
financial policies etc.
4. Factors affecting export trade: If a firm is engaged in export trade also it should consider the factors affecting the export
trade. These factors include import and export control, terms and conditions of export, exim policy, export conditions, export
finance etc.
5. Market behaviour: While preparing demand forecast, it is required to consider the market behavior which
brings about changes in demand.
 
6. Sociological conditions: Sociological factors have their own impact on demand forecast of the company.
These conditions relate to size of population, density, change in age groups, size of family, family life cycle, level
of education, family income, social awareness etc.
 
7. Psychological conditions: While estimating the demand for the product, it becomes necessary to take into
consideration such factors as changes in consumer tastes, habits, fashions, likes and dislikes, attitudes, perception,
life styles, cultural and religious bents etc.
 
8. Competitive conditions: The competitive conditions within the industry may change.
Competitors may enter into market or go out of market. A demand forecast prepared without considering the
activities of competitors may not be correct.
 Demand Forecasting Techniques

Demand forecasting helps the company to produce the required quantities of products at the right time and to arrange
the various factors of production in advance. Forecasting demand accurately also helps a company to estimate the future
demand for its products and plan its production. There are different methods of demand forecasting in business which
are commonly known as demand forecasting techniques.

There are mainly two methods of demand forecasting in

business, namely – Survey method and statistical method.
However, the Methods of Demand Forecasting in
Economics are presented below:
 Different Methods of Demand Forecasting In Economics

1. Survey of consumers intentions: In this method information will be obtained by asking consumers about their buying
intentions. This is direct method of estimating demand of consumers as to what they intend to buy today or in upcoming future.
Almost every business organization makes survey on the choice or habits of its buyers’ either online or in other modes.
(i) Complete Enumeration Survey: Under the Complete Enumeration Survey, the firm has to go for a door to door survey
for the forecast period by contacting all the households in the area. This method has an advantage of first hand, unbiased
information, yet it has its share of disadvantages also. The major limitation of this method is that it requires lot of resources,
manpower, consumer reluctant to given information and time.
(ii) Sample Survey and Test Marketing: Under this method some representative households are selected on random basis as
samples and their opinion is taken as the generalised opinion. This method is based on the basic assumption that the sample
truly represents the population. If the sample is the true representative, there is likely to be no significant difference in the results
obtained by the survey. Apart from that, this method is less tedious and less costly.
(iii) End Use Method or Input-Output Method: This method is quite useful for industries which are mainly producer’s goods.
In this method, the sale of the product under consideration is projected as the basis of demand survey of the industries
using this product as and intermediate product, that is, the demand for the final product is the end use demand of the
intermediate product used in the production of this final product. The end use demand estimation of an intermediate product may
Opinion polling method / Sales force estimation method

a. Collective opinion or field force composite method: According to this method salesmen estimate sales in their
respective geographical areas. The total estimated sales will be obtained by consolidating the estimations of various
salesmen. These estimates are revised from time to time with respect to the factors affecting demand, like purchasing power,
sales price etc.
b. Expert’s Opinions: Here in methods of demand forecasting, expert opinions are taken from specialists in the related
field, collected opinions from various sources like print or electronic media. Then, these opinions are analyzed to figure out
the demand forecasts.
c. The Delphi method requires a panel of experts, who are interrogated through a sequence of questionnaires in which the
responses to one questionnaire are used to produce the next questionnaire. Thus any information available to some experts and
not to others is passed on, enabling all the experts to have access to all the information for forecasting. The method is used for
long term forecasting to estimate potential sales for new products.
d. Controlled experiments: Demand Forecasting will be undertaken by changing the determinants of demand like price.
advertisement, packaging etc. This may be done either by changing them over different markets or time periods in the same
market. e. Executive Judgment Method: In this method, expert judgments are sought from top executives in the related field.
Collected judgments are combined, averaged out and analysed to figure out the demand forecasts.
Statistical Method: these methods are used in order to forecast long term demand, these are more
reliable than survey (because the subjectivity in more scientific)
 i). Trend projections: these are generally based on the analysis of past sales patterns.  Generally a firm prepares its
own data of sales at different periods. When the firm arranges its data in a chronological order, it gets time series.
Methods of Trend Projection:
 Trend line by observation
 Least Squares Method
 Time series analysis
 Moving Averages Method
 Exponential Smoothing

 (a) The Graphical Method (Trend line by observation):

(b) The Least Square Method. Under the least square method, a trend line can be fitted to the time series data
with the help of statistical techniques such as least square regression. When the trend in sales over time is given by
straight line, the equation of this line is of the form: y = a + bx. Where ‘a’ is the intercept and ‘b’ shows the impact
of the independent variable. We have two variables—the inde­pendent variable x and the dependent variable y. The
line of best fit establishes a kind of mathematical relationship between the two variables .x and y. This is expressed
by the regression у on x.
(c). Time series Analysis represent the past pattern of its effective demand. A trend line could be filled through the
series in visual or statistical way by the method of least squares and then projected into the future for purpose of
extrapolation. So, this can be used for further analysis.
Time series has got four types of components namely, Secular Trend (T), Secular Variation (S), Cyclical Element
(C), and an Irregular or Random Variation (I). These elements are expressed by the equation O = TSCI.
 Secular trend refers to the long run changes that occur as a result of general tendency.
 Seasonal variations refer to changes in the short run weather pattern or social habits.
 Cyclical variations refer to the changes that occur in industry during depression and boom.
 Random variation refers to the factors which are generally able such as wars, strikes, flood, famine and so on.
(ii) Barometric Technique: A barometer is an instrument of measuring change in weaher. This method is
based on the notion that “the future can be predicted from certain happenings in the present.” In other
words, barometric techniques are based on the idea that certain events of the present can be used to predict
the directions of change in the future. This is accomplished by the use of economic and statistical
indicators which serve as barometers of economic change.

iii) Economic indicators: Under this method, demand may be estimated on the basis of some economic
indicators like construction contracts, personal income, agricultural income, and automobile registration.
This method of demand forecasting is well suited where relationship of demand with a particular indicator is
characterized by a Time Lag.
It is not easy to locate one single economic indicator for determining the demand forecast of a product.
Invariably, a multi-factor situation applies Econometric Models, although complex, are being increasingly
used for market analysis and demand forecasts.
iv) Simultaneous Equations: Involve several simultaneous equations.
There are two types of variables that are included in this model, which are as follows:
i. Endogenous Variables: s a variable in a statistical model that's changed or determined by its relationship with other
variables within the model. Therefore, its values may be determined by other variables .These are controlled variables.
ii. Exogenous Variables: Refer to inputs of the model. Examples are time, government spending, and weather conditions.
These variables are determined outside the model.
For developing a complete model, endogenous and exogenous variables are determined first. After that, necessary data on
both exogenous and endogenous variables are collected. Sometimes, data is not available in required form, thus, it needs to
be adjusted into the model. After the development of necessary data, the model is estimated through some appropriate
method. Finally, the model is solved for each endogenous variable in terms of exogenous variable. The prediction is finally
made.
(iii) Regression Analysis: It attempts to assess the relationship between at least two variables (one or more independent
and one dependent), the purpose being to predict the value of the dependent variable from the specific value of the
independent variable. The basis of this prediction generally is historical data. This method starts from the assumption that a
basic relationship exists between two variables. An interactive statistical analysis computer package is used to formulate the
Introduction to Managerial Economics -- Prof. V. Chandra Sekhara Rao

Elasticity : Measure of responsiveness - Qd = f (P, Y, Pr W)

E = percentage change in DV/ percentage change in IV

Concepts of price, income, and cross elasticity

Price Elasticity :

Ep = Percentage change in QD/Percentage change in P

Types of price elasticity :

1. Perfectly elastic demand Ep = ∞
2. Elastic demand Ep > 1
3. Inelastic demand Ep < 1
4. Unit elastic demand Ep = 1
5. Perfectly inelastic demand Ep = 0
Introduction to Managerial Economics -- Prof. V. Chandra Sekhara Rao

 Elasticity and expenditure : If demand is elastic a given fall in price causes a relatively
larger increase in the total expenditure.

 P↓ - TR↑ when demand is elastic.

 P↓ - TR↓ when demand is inelastic.
 P↓ ↑ - TR remains same when demand is Unit elastic.

Elastic Demand Unit Elastic Demand Inelastic Demand

P Q PQ P Q PQ P Q PQ
10 1,000 units 10,000 10 1,000 units 10,000 10 1,000 units 10,000
9 2,000 units 18,000 9 1,111 units 10,000 9 1,050 units 9,450
8 3,000 units 24,000 8 1,250 units 10,000 8 1,100 units 8,800

 Measurement of elasticity :
 Point and Arc elasticity
 Elasticity when demand is linear
 Determinants of elasticity :
 (1) Number and closeness of its substitutes,
 (2) the commodity’s importance in buyers’ budgets,
 (3) the number of its uses.
 Other Elasticity Concepts
 Income elasticity
 Cross elasticity
Introduction to Managerial Economics -- Prof. V. Chandra Sekhara Rao
2. Theory of production :
Input – Output relation

What is a production function :

Q = f (A, B, C, D)

Production function with one variable input

Law of variable proportions
 Equilibrium of producer with one variable input (optimum quantity of
variable input)

Production function with two variable inputs

Iso-costs, iso-quants, equilibrium - least cost combination of inputs
Equilibrium of producer with two variable inputs (optimum combination
of inputs)

Production function with all variable inputs

Returns to Scale
Increasing returns to scale
Constant returns to scale
 Decreasing returns to scale
Introduction to Managerial Economics -- Prof. V. Chandra Sekhara Rao

3. Theory of Cost : Cost - output relations

• Cost Concepts
• Opportunity Cost
• Implicit Cost
• Explicit Cost

• Cost function :
• Short run cost functions
• Fixed Cost
• Variable Cost
• AFC
• AVC
• AC
• MC
• Long run cost functions
• LAC
• LMC
Introduction to Managerial Economics -- Prof. V. Chandra Sekhara Rao

4. Market structures - Price – Output Decisions

 Classification of markets: 1. No of firms 2. nature of the product

 Perfect competition
 Features of perfect competition
 Short-run equilibrium
 Long-run equilibrium
 Monopoly
 Meaning and Barriers to entry
 Short-run equilibrium
 Long-run equilibrium
 Discriminating Monopoly
 Monopolistic competition
 Oligopoly – Duopoly models
 Cournot’s Model
 Edgeworth’s Model
 Chamberlin’s Model
 Paul Sweezy’s Kinked Demand Curve
 Introduction to Managerial Economics -- Prof. V. Chandra Sekhara Rao

5. Profit Management :

 Concept of Profit

 Profit Theories

 Payment to factor services

 Reward for taking risk and baring uncertainty
 Result of Frictions and Imperfections and Monopoly
 Reward for successful innovations

 Cost-volume-profit Analysis

 Break even analysis

 Make or buy decisions
=

Introduction to Managerial Economics -- Prof. V. Chandra Sekhara Rao

6. Investment Decisions:

 Need and importance of Capital Budgeting

 Capital Budgeting Techniques
 Traditional Methods
 Payback Method
 Accounting Rate of Return On Investment (ARORI)
 Discounted Cash Flow Techniques

 Net Present Value (NPV) NPV=

 Internal Rate of Return (IRR)=

 Profitability Index (PI) =

 Capital Budgeting under conditions of risk and uncertainty
 Certainty – Equivalent Approach
 Risk Adjusted Rate of Return
 Introduction to Managerial Economics -- Prof. V. Chandra Sekhara Rao

Functions of a Managerial Economists:

The main function of a manager is decision making and managerial

Economics helps in taking rational decisions.
The need for decision making arises only when there are more
alternatives courses of action.
Steps in decision making :
 Defining the problem
 Identifying alternative courses of action
 Collection of data and analyzing the data
 Evaluation of alternatives
 Selecting the best alternative
 Implementing the decision
 Follow up of the action
Introduction to Managerial Economics -- Prof. V. Chandra Sekhara Rao

 Specific functions to be performed by a managerial Economist :

1. Production scheduling
2. Sales forecasting
3. Market research
4. Economic analysis of competing companies
5. Pricing problems of industry
6. Investment appraisal
7. Security analysis
8. Advice on foreign exchange management
9. Advice on trade
10.Environmental forecasting
- Survey of British Industry by Alexander and Kemp